The problem for many state and local governments is the effect that increasing retirement fund contributions have on already significant budget deficits. This leads to governments with few options other than to pay more for retirement benefits as they start a new fiscal year July 1, according to the US Public Pensions Face Uncertain Times report from Standard & Poor’s (S&P).
S&P points to the potential for municipal credit downgrades due to the increasing pension pressures and how these implications are analyzed. According to the report, w hen S&P’s credit analysts determine the credit implications of public pension obligations, they look at these liabilities in the light of an employer’s total debt structure with an eye for what the consequences may be on the employer’s ability to pay debt service in meeting these benefit obligations.
Adding pensions to the mix puts the additional pressures because of stock market losses and growing retirement benefits. ”The magnitude of the current challenge for some could contribute to rating downgrades,” S&P analyst Parry Young said in the study.
Therefore, aside from the obvious increasing contributions answer that many governments are now staring at, the alternatives for public employers with increasing underfunded liabilities to make any sort of significant dent are limited. Looking at it from the liability side of the ledger, reducing benefit levels – and thus lowering liabilities – is not only difficult to accomplish, but also runs into legal prohibitive legal issues depending upon the plan document, something no employer, public or private, wants to embroiler themselves in.
On the flip side of the ledger, because of the weak investment performance over the last several years, the upside potential for higher investment return assumptions is rather slim. The only recent changes to investment return assumptions have been downward adjustments, which again increases liabilities.
Governments however are beginning to more seriously to consider the Pension Obligation Bond (POB) solution as a viable alternative. In fact, borrowing in the bond market is being used in Illinois, which just sold a record $10 billion of POBs (See Illinois Legislature Okays $10 Billion Pension Bond Issue ), California (See Davis Signs CA Pension Bond Bill) and New Jersey sold $2.8 billion of the securities in 1997 (See New Jersey issues first-ever state POB ). In fact, more than $15 billion of the securities were sold during the 1990s, S&P said in the report.
However, the strategy backfires if returns on invested bond proceeds fall short of rates paid to bondholders or those assumed by plan projections. ”The shortfall results in new unfunded liabilities, and higher contribution rates related to that,” said Young in the study. Therefore, the POBs may actually undermine a government’s finances.
Additionally, more pressures may now come in the form of stricter pension accounting standards. A new standard from the Government Accounting Standards Board (GASB) will require state and local governments to account for retiree health care benefits.
The recently issued GASB Other Post Employment Benefits (OPEB) Exposure is important because OPEB liabilities previously were not required to be reflected as an obligation. However, once the exposure draft is finalized, accounting for OPEBs will substantially conform to the accounting for pensions.
This poses a problem for S&P, which notes pension and OPEB obligations as notoriously difficult to monitor due to the inherent uncertainties associated with the estimation process, the complexity and inconsistency of the applicable accounting models, and the lack of sufficiently robust and timely disclosures. Additionally, the funding requirements also change; the government dictates some and local funding regulators dictate others.
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