MuniLand's Pressing Pension Problems

Douglas Offerman, Senior Director at Fitch Ratings, talks about the landscape for public pensions. He looks at how state pensions are faring and discusses what impact the new GASB requirements have on disclosure. He discusses whether contributions will remain a source of fiscal pressure on governments and delves into what the New Jersey Supreme Court ruling says about governments' ability to cut benefits.

OFFERMAN: It's a mixed bag for pensions in the current market. As you know, investment markets have been very choppy in recent years. It's hard to sustain the high investment returns that pensions expect. The pensions really need is the benchmark by which they measure success or failure in covering the unfunded liability over time with internal resources. The fact that investment returns have lagged for many plans means that contributions are rising and that adds fiscal pressure to the governments that are part of those plans.

On the other hand, plans have been lowering investment return assumptions. Reforms have been made to many and those gradually helped the plan become more sustainable over time. It's a good news, bad news situation for pensions right now. The recession really hurt the funded ratios of plans, brought them down significantly. Those funded ratios have really not climbed significantly. They've only stabilized at much lower levels.

Going forward, we expect pension plans to be roughly at this level, assuming continuation of current market performance, which means contributions will stay higher. Plan funded ratios may not improve all that much going forward. It's going to really be a matter of watching whether plans can implement reforms, whether higher contributions can be sustained over time and whether the plans themselves make changes to actuarial assumptions and other policies to essentially improve sustainability.

The new GASB requirements, GASB 67 and 68 add a layer of data. They give us a lot more information to work with when we want to assess whether a pension is risky or not. It essentially creates a single way of calculating a liability across plans and that's an improvement. It also breaks up the liability for multi-employer plans. Every government participating in a plan now shows a portion of the liability. We have a little bit more clarity in cases where, for instance, a state supports the plans of local governments.

All of that is an improvement, but I think, as many observers have cautioned, the fact that funded decisions for the plan, the actuarial decisions that really are how plans manage themselves are now fully separate from the accounting reporting of the plan and that's a significant distinction. We still have to go back and look at the actuarial valuations to understand better what is the goal of the plan in paying down the liability over time.

GASB isn't after that information. GASB is after how the plan looks on the kafir' date. To assess the risk of a plan, you really have to understand how it's going to be paid down over time. That's where the actuarial valuation becomes important. Contributions have gone up a lot since the downturn. They consume more of the discretionary resources that governments have. They are not, for most governments, the largest spending item by far.

For states, for instance, that's Medicaid in schools far and away, but it is a source of rising spending pressure for governments across the board, particularly on the local side where services are delivered. Those are personnel and the benefits that they receive. Those are all costs that are rising. The contribution pressure is going to arise from these lingering unfunded liabilities that plan still face. To reduce them over time, it's requiring more and more of the resources of government. It will remain a pressure.

We believe, for most governments, it's a pressure that's sustainable. There are cases certainly in the news, that your readers are familiar with, where the contributions have risen significantly over time or the required contributions have risen significantly and governments haven't kept up with those requirements. In those cases, we see a steep slope to catch up. That's where it's going to be most problematic. The resources required for pensions in those cases could become significant over time. For the vast majority of governments, the increases demanded will be sustainable.

The legal situation around pensions differs from state to state. The New Jersey ruling has a significant impact on the New Jersey conversation as your readers are very familiar with. The pension situation in Jersey is very complicated. It's about contributions that haven't been made over time. It's about climbing labilities. The ability of the state to make cuts in the middle of its budget year touches on a variety of subjects that are critical to understanding the credit of New Jersey. The issue at stake in this particular decision was whether COLA benefits could be reduced. The fact that the state prevailed in the court decision is significant in that while pensions are still a significant pressure on New Jersey, they are not going to become worse because of a negative court ruling. We've seen decisions go the other way in many other states such as Oregon last year, which is we're going to require significant resources to fix, but in New Jersey's case, there are a variety of other problems that still have to be addressed.

Having this legal clarity is a big deal. It helps to start the conversation about where the pension situation can go from here. The state has significant decisions to make on contributions over time and how they pay those contributions. It's a good starting point.