Public pension plan funding does not have a significant effect on bond ratings, although it does have a slight effect on the interest-rate spread of three to seven basis points, according to a new study by the Boston College Center for Retirement Research.
“That result is not surprising given that pension expense accounted for (on average) only 3.8% of state budgets in 2008,” the study said. “The magnitude could increase, however, to the extent that pensions become an increasingly important component of state budgets.”
The “literature from the private sector indicates that pensions should play a role in the cost of (borrowing),” the authors wrote in the study. “To date, however, researchers have not explored whether this conclusion carries over to the public sector.”
“To our knowledge, none of the studies of either state or local bonds” — examining the factors affecting the yield on municipal bond issues — “explicitly include pensions in the analysis,” wrote the three authors — Alicia H. Munnell, director of the center and the Peter F. Drucker Professor of Management Sciences at BC’s Carroll School of Management; and Jean-Pierre Aubry and Laura Quinby, both CRR research associates.
The study’s “results suggest that pensions affect the cost of state debt,” they wrote. An increase of one standard deviation in the annual required pension contribution affects the interest rate by three basis points, they conclude. Even re-estimated weighting by dollar amounts rather than treating each bond issue equally, “the pension effect only increases to seven basis points,” they wrote.
Looking at Moody’s municipal bond ratings, from 2005 through 2009, the study said that “pension funding, as represented by percent of (annual required contribution) paid, does not appear to enter into the rating decision.”
The study examined the issue in regard to the potential impact of new developments in the decline in funded status in general of public retirement systems and Moody’s Investors Service recent change in credit methodology to combine unfunded pension liabilities with outstanding bonds when evaluating a state’s leverage position.
“These developments raise the question of how future pension commitments affect today’s borrowing costs in the public sector,” the authors wrote.
Their research was based in part on data of 758,000 municipal bonds, issued between 2005 and 2010.