Moody’s Report Shows States’ Failure to Recognize Scope of Broken Promises
Last year, Moody’s Investors Services announced it would begin adjusting officially reported unfunded public pension liabilities before considering their impact on state and local bond ratings. Moody’s made this decision in an effort “to bring greater transparency and consistency to the analysis of pension liabilities.”
The largest change came in Moody’s approach to the discount rate used by public plans. While virtually all plans discount their liabilities according to an assumed investment return in the range of 7-8 percent, Moody’s instead now adjusts liabilities as they are reported by using a discount rate based on Citibank’s Pension Liability Index.
The ratings agency’s figure for Adjusted Net Pension Liability also only allocates liabilities to state governments based on the portion of total employer contributions that come from the states themselves. In the case of multi-employer plans, a large portion of liabilities is therefore allocated separately to municipal governments.
These changes, now accounted for in Moody’s recent assessment of state fiscal year 2012 pension liabilities, demonstrate the very important role that discount rates play in calculating the size of a future liability.
The following table shows the pension liabilities of those state pension plans listed in Moody’s January 30, 2014 report “US State Pension Medians Increase in Fiscal 2012” according to three sets of standards. Side-by-side, these figures show the extent to which pension reporting standards have led public plan sponsors to undervalue, and therefore underfund, the pension promises they make to public employees.
The first column shows those plans’ combined unfunded liabilities according to the standards included in state Comprehensive Annual Financial Reports and individual plan valuations. Figures were taken from the latest available versions of these reports as of August 2013. This is the figure used by state governments’ themselves in determining funded levels and, among other items, annual required contributions.
The second column shows Moody’s Adjusted Net Pension Liability, as reported on January 30, 2014. Importantly, in the case of multi-employer plans, liabilities are only allocated between state and local governments “based on the share of total plan contributions represented by each participating government’s reported contribution.” In Florida, for example, Moody’s only allocates 19.6 percent of the Florida Retirement System’s liability to the state government. Similarly, only 0.4% of Ohio’s largest pension plan’s liabilities are allocated to the state. Liabilities are then discounted according to the Citibank’s Pension Liability Index as of the individual plan valuation date. Moody’s fiscal year 2012 update includes rates ranging from 3.83 percent to 5.75 percent.
Finally, the third column shows unfunded liabilities according to a market-valued discount rate. As State Budget Solutions explained in “Promises Made, Promises Broken – The Betrayal of Pensioners and Taxpayers,” this fair-market approach is used to provide plans the strongest guarantee of future funding for their promised benefits. The discount rate in this case, 3.225 percent, was based on the 15-year Treasury yield.
Moody’s new approach adds to the chorus of voices claiming that unfunded pension liabilities are a much larger problem than state governments currently recognize. These new figures and their potential impact on the bond market, along with coming (if flawed) changes in the way that state and local governments must report their unfunded pension liabilities, mean that legislators will be forced to finally confront the true cost of the promises they have made yet failed to keep. What will most certainly be a drastic wake up call for officials will demand similarly drastic solutions.