Public pension funds will continue to shape public policy, budgets and potentially credit quality for states, said a report from Standard & Poor's.
New pension accounting standards and actuarial assumptions; weak funding ratios; slowing reform efforts and legal challenges; and a renewed interest in pension obligation bonds are driving policy and budget debates and could impact credit quality this year and beyond, the report said.
While their impact on credit ratings is expected to be minimal, new Governmental Accounting Standards Board requirements add a “spotlight” to pension liabilities and could increase funding pressures, said Robin Prunty, managing director in the U.S. public finance department at S&P and co-author of the report.
GASB 67 requires that pension funds report a depletion date or when projected benefit payments exceed their projected assets. Benefits payable after the depletion date must be discounted to a present value using a much lower rate, which could raise liabilities for some pension funds.
Changes in actuarial assumptions such as new mortality tables or lower assumed rates of return are also driving liability changes and accelerating funding pressures. The assumed rate of return for the majority of state pension funds ranges from 7.5% to 8%. However, there has been “a general movement to lower return assumptions,” which has “generally increased liabilities, lowered funded ratios and resulted in increased pension contributions,” the report said.
The report further noted that while many states have enacted some amount of pension reform, those efforts come with “implementation risk,” which “translates to budget risk if savings are included before legal challenges are resolved.”
Ms. Prunty said pension reform efforts appear to be in a bit of a “holding pattern” as some states wait on the outcome of legal challenges. Some states might also be slow to take up additional reforms if previous efforts did not appear to “move the needle significantly.”
However, the impact of new GASB standards on unfunded liabilities could give some pension reform efforts “a second wind,” S&P predicted in the report.
Finally, a growing interest in pension obligation bonds could put pressure on states' budget requirements. While bond proposals are still pending in Pennsylvania, Kentucky and Kansas, pension bond issuances have historically “carried risks and opportunities from a credit perspective,” depending on the overall financing plan and timing of the bond issuance, the report said.
