Pensions remain a major liability for local governments

The public pension crisis continues, although adjusted net pension liabilities declined in fiscal 2018. Although 2019 brought more declines in adjusted net pension liabilities, 2020 is expected to bring about a significant shift, according to Moody’s Investors Service.

Get The Full Series in PDF

Get the entire 10-part series on Charlie Munger in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues.

Q3 2019 hedge fund letters, conferences and more

Pension liabilities were down, but they will rise

In a recent report, the firm said that in fiscal 2018, adjusted net liabilities declined in 37 of the 50 biggest local governments ranked by amount of outstanding debt. Moody's expects that this trend continued in fiscal 2019 but predicts that adjusted net pension liabilities will increase in fiscal 2020.

The firm adds that now 10 years into the current economic expansion, some of the biggest local governments have limited pension risks. However, weak funding for pension and retiree healthcare and other post-employment benefits results in credit quality that is more vulnerable to market volatility for some local governments.

For most of the biggest local governments, unfunded pensions remain the most significant long-term liability. The 50 biggest local governments have a total of $450 billion in adjusted net liabilities, compared to $238 billion in debt and $167 billion in other post-employment benefits.

On their own, pensions were the largest long-term liability for 29 of the 50 biggest governments in fiscal 2018. Debt led the way for 20 of them, while other post-employment benefits was the biggest liability for one government.

Unfunded pension crisis continues

Moody's expects falling interest rates to drive increases in pension liabilities for many local governments this year after two years of declines. Many governments report their pensions with a lag of up to one year, which is why their liabilities are likely to decline in their fiscal 2019 results and then spoke in 2020.

pensions

For many of these governments, the increase could be quite significant, the firm warned. The firm's analysts added that the FTSE Pension Liability Index declined steeply in 2019. Further, revenue growth has been strong recently, so affordability ratios won't skyrocket.

Not even treading water

Local governments aren't even doing enough to tread water, let alone take care of their unfunded liabilities.

pensions

According to Moody's, contributions relative to revenues ranged from about 1% to 17% among the 50 biggest local governments. Even though most of them had discount rate assumptions at or higher than 7%, 34 of them had tread water gaps in fiscal 2018. The firm also said higher discount rates tend to reduce tread water thresholds.

One concern related specifically to underfunded teacher pensions is the ongoing shift in costs. State governments have been responsible for K-12 education, but K-12 school districts now face risks of these costs being shifted to them. Such a shift could help rebalance the state budget. Some states have considered but not acted on such legislation, while Illinois has taken the opposite approach. Some states have taken on even more responsibility in the underfunded teacher pensions.

A warning about volatility in investments

Moody's also warned that volatility in pension investments is a credit risk. The governments that are at a higher risk of material new unfunded liabilities have pension assets that are large compared to their own budgets. They also have return targets requiring heavy allocations to volatile investment classes.

"The governments with very underfunded pension systems with weak non-investment cash flow (NCIF) have very little flexibility to reduce their annual contributions without risk of severe pension asset deterioration," Moody's warned.



About the Author

Michelle Jones
Michelle Jones was a television news producer for eight years. She produced the morning news programs for the NBC affiliates in Evansville, Indiana and Huntsville, Alabama and spent a short time at the CBS affiliate in Huntsville. She has experience as a writer and public relations expert for a wide variety of businesses. Michelle has been with ValueWalk since 2012 and is now our editor-in-chief. Email her at Mjones@valuewalk.com.