Most local governments have limited control over their pension liabilities because they have cost-sharing plans where pension funding, benefit decisions and investment strategies are centrally managed, Moody’s Investors Service said in a report examining the U.S. public pension landscape.
This finding is key at a time when there is so much focus on unfunded pension liabilities and reforms because it shows many local governments may have little-to-no knowledge of their pension liabilities and no power to make changes in their plans.
Seventy-five percent of local government exposure to pension liabilities are through the largest 125 cost-sharing plans, in which assets and liabilities are pooled and managed as one fund. Among the roughly 8,000 local governments Moody’s examined — including cities, counties, school districts and special districts — 83% participate in multi-employer cost-sharing plans in part or in whole, the rating agency said.
There can be wide variations in the degree of control that local governments have over pension costs, funding and exposure. Moody’s put states into three groups that categorize their local government pensions.
Fifteen states, including Nevada and Wisconsin, have all local government pensions provided through a single multi-employer cost-sharing plan, with limited exceptions. Generally in these states, there is little-to-no local government control over administration, asset management, discount rates and the amount of municipalities’ contributions, Moody’s said.
Ten large states have a handful of cost-sharing plans that dominate municipal pensions. Frequently, these states have one main plan for teachers and another for general employees and have their plans are managed within a single state agency, Moody’s said. The ten states with a few dominant plans include New York, Arizona and Ohio. An 11th state, California, has a greater diversity of plans but also some prominent centrally-administered plans.
The remaining 24 states — including Pennsylvania, Massachusetts and Texas — have local government pensions that stem from multiple plans. In these states, local governments have more control over pensions and there tends to be the greatest variation in funding levels, Moody’s said. But even in these states, all school district pensions tend to be linked to a statewide cost-sharing plan.
Centrally-controlled, cost-sharing pension plans have benefits for small public entities like school districts and villages because the entities do not bear any burden for administering and managing the plans. But the plans also have a downside for local governments because participants have little control over their liabilities and invested assets.
“Many participants have only little understanding of — or may not even acknowledge — their exposure to the unfunded pension liabilities of cost-sharing plans,” the report said. “Changes in plan benefits or funding levels and sources can only occur at the plan or state level.”
Because of the dominance of the centrally-controlled pension plans and because pensions are exposed to the financial markets, one municipal pension fund’s depleting assets and one set of policy actions, investment decisions and changes in key assumptions can have an effect on many local governments, Moody’s said.
Cost-sharing plans allocate local governments’ annual funding responsibilities based on the current participant payroll rather than the accrued liabilities or share of retirees. As a result, demographic changes can impact pension costs of the participants, the report said.
For example, Detroit’s school district used to be much larger than it is now. Because the school district participates in a plan used by teachers across Michigan, the retiree funding burden for Detroit schools is spread across the state and taken on by all school district based on their current payroll. This is beneficial for Detroit but adds costs for other school districts.
Twenty-three states pay part or all of the pension contribution for local governments, primarily school districts. These subsidies could be reduced or eliminated as states face their own pension and fiscal problems, Moody’s said.