WASHINGTON — Pension costs will grow for many local governments in 2014 even though adjusted net pension liabilities were lower in 2013, Moody's Investors Service said in a report issued this week.
"U.S. local governments will continue to grapple with pension costs despite some improved liability measures," said Tom Aaron, author of the report.
Moody's expects to see improvements in its ANPLs — or the difference between the actuarial value of a plan's assets and its adjusted liabilities, adjusted for the rating agency's recent revised methodology for pensions — as fiscal year 2013 actuarial valuations are released this year.
The rating agency said that ANPLs will decline because the market interest rates that Moody's uses to discount pension liabilities increased in 2013 following cyclical lows the year before. Also, pension plans' assets had strong investment performances in 2013, the report said.
Nonetheless, Moody's said that four factors will cause pension costs in municipalities' budgets to continue to grow in 2014.
The first factor is that unfunded liabilities will stay elevated after increasing substantially in the past decade. Reported unfunded liabilities of the four largest public pension plans grew to $174 billion in 2012 from $34 billion in 2003, and they grew to 135% of covered payroll from 33% over the same time period.
"Unfunded liabilities are felt in annual budgets because they must be amortized as a component of annual pension plan contributions," the report said.
The second factor is that employer costs lag behind the positive 2013 market performance, Moody's said. Actuarial valuations done at one point in time determine employer contributions for one-to-three fiscal years later. Additionally, "the impact of strong 2013 investment performance on reported funded status and actuarial contribution requirements will also be muted due to the common use of asset smoothing and worse-than-assumed asset performance in 2012," Moody's said.
A third factor is that state and local governments typically use actuarial cost methods that often backload costs. Payments to make up funding shortfalls over time are commonly lower in the short-term and higher in the long-run because the payments are the same percentage of payroll every year and payroll is assumed to increase annually, Moody's said.
Finally, a fourth factor is that shortfalls in government contributions to cost-sharing plans provide short-term budget relief but increase future costs. Based on fiscal 2012 reporting, 21 of the 50 largest cost-sharing plans collected less than 90% of the plans' annual required contribution. "Eventually, these shortfalls, plus accrued interest, must be made up," the report said.
Moody's noted that local governments' abilities to address their pension liabilities is evolving through reform efforts and litigation. The rating agency expects a number of pension-related legal disputes will be resolved in the next 12 to 18 months. The resolutions will help to clarify what options localities have to curb pension liabilities and costs when the costs are hard to manage or when the governments face severe distress.
There are three major legal questions surrounding governments' flexibility to reform public pensions, Moody's said.
The first is whether reforms can change benefits for the future work of current employees. If not, reforms can only lead to savings in the costs for future employees, the rating agency said.
The second is whether cost of living adjustments are considered a protected pension benefit. And the third topic is whether unfunded pension liabilities are considered to be contractual obligations, and if those obligations would be secured or unsecured. This last question is particularly important in the context of Chapter 9 bankruptcies, Moody's said.
