Pension Plans of Largest U.S. Cities Offer Food For Thought

Many of the largest pension plans in the U.S. are lowering assumed long-term rates of return in light of global economic headwinds, which further contributes to declining funded ratios and puts a strain on cities' credit ratings.

The title of a new survey report from S&P Global Ratings offers a clear direct warning to readers, and it summarizes nicely the extensive findings: “Pension Pressures Will Weigh On 15 Largest U.S. Cities’ Budgets.”

The analysis suggests right off the bat that making such an assessment is no small task: “U.S. cities have varying legal, governance and benefit structures and operate in different legal and economic environments, so there’s no one-size-fits-all measure for assessing their pension risk.” Still, researchers observe there are some broad similarities that can offer an insight into how cities are doing on a relative basis with the complex and difficult job of managing a legacy pension plan for large groups of municipal workers.

“Regardless of structure, most municipal pension plans experienced the market downturn in 2008-2009 and have not been able to recover to funded levels seen in the early 2000s,” researchers note. “Weak market returns in 2015 and 2016 have not made that recovery any easier.”

The analysis shows many plans across the country are lowering assumed long-term rates of return in light of global economic headwinds, which further contributes to declining funded ratios and puts a strain on cities’ credit ratings.

At a high level the pension systems examined have a median net pension liability per capita which exceeds median debt per capita. They also have “high fixed costs” pegged to the pension and other post-employment benefits, and debt service expenditures are in excess of 20% of expenditures. Other findings show funded ratios for the largest city plans declined between fiscal 2014 and fiscal 2015, bringing the median weighted funded pension ratio aggregated across the plans to 70%. Chicago is a major outlier, at only 23% funded.

“Despite the increasing costs, many of these largest cities benefit from relatively deep and diverse economic bases,” researchers explain. “Furthermore, some cities are experiencing revenue growth or have the capacity to raise revenue, as we have seen with a recent property tax increase in Phoenix to offset rising pension contributions or the dedication of a half-cent sales tax to shore up underfunded pension plans in Jacksonville. This revenue flexibility helps to offset the impact of higher pension liabilities.”

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The report observes that the state “sometimes plays a critical role in determining the level of autonomy local governments can exercise in adjusting benefit management and reforming their own plans.” In states where this is the case it obviously adds yet another layer of complexity to the pension management effort.

“More broadly, as states continue to deal with fixed-cost increases that outpace revenue growth, we believe there is potential for some states to shift more of the cost onto local governments in the future,” the survey report warns. “These cost shifts could occur due to the withdrawal of traditional state support for cost-sharing plan contributions on behalf of local governments … or as state plans change actuarial assumptions that could increase required contributions for local participants.”

One of the broad conclusions drawn by researchers is that “pension, other post-employment benefits, and debt service spending is crowding out discretionary spending.” It is a particularly acute problem for some cities, notably, Chicago, Jacksonville, and San Jose, which all have a carrying charge in excess of 30%.

“As we expect these costs to increase in the near term, we likewise expect there will be additional pressures on city budgets,” researchers warn. “Identification of revenue sources to support pension costs, such as seen in Jacksonville, Philadelphia, and Phoenix, could be an option in supporting these higher costs. On the other hand, in cases where fixed costs approach a very high proportion of budget to materially reduce fiscal flexibility, local governments that lack forward-looking policies and budgetary planning to address these challenges could see their credit ratings adjusted downward.”

Information on obtaining the full analysis, which includes a detailed review of 15 U.S. cities’ pension programs, is available here