Public pension liabilities have been cut by more than half, Moody’s says


Solid investment returns and higher interest rates have been a boon for state and local pension funds, Moody’s Ratings said in a comment piece this week.

Strong market performance and higher interest rates have resulted in a $3 trillion drop in unfunded pension liabilities as of June 30 compared to the peak in 2020, marking the fourth year in a row of such declines, the rating agency said Tuesday.

That’s a 60% reduction, Moody’s said.

“We estimate that most public pension systems achieved investment returns of 10.6% for the fiscal year that ended June 2024, well above targets ranging from 6.75% to 7.25%,” said Thomas Aaron, a Moody’s vice president and senior credit analyst.

“We estimate that most public pension systems achieved investment returns of 10.6% for the fiscal year that ended June 2024, well above targets ranging from 6.75% to 7.25%,” said Thomas Aaron, a Moody’s vice president and senior credit analyst.

Interest rates on high quality fixed-income securities with duration similar to governments’ pension liabilities surpassed 5% as of June 30, 2024, the first such June 30 occurrence since 2011, Moody’s analysts wrote.

Most U.S. public pension systems take an annual pension funding snapshot on June 30, said Moody’s, adding that most achieved low double-digit investment returns, above their targets.

“While pension risk indicators continue to improve, the credit quality of many governments remains exposed to potential investment volatility, particularly those with a large scale of pension assets and those already making historically high contributions,” Aaron said.

Analysts don’t expect interest rates to return to the “lower for longer” environment of the previous decade, however, Aaron said.

Though the drop in unfunded liabilities has primarily been an outcome of market conditions, efforts by governments to lower assumed investment return rates, decrease pension generosity and increase contributions have helped, Aaron said.

“If not for all of those changes, we would definitely see higher liabilities,” Aaron said. “The number of governments in our rated portfolio that have annual contributions below the tread water level has fallen dramatically.”

The number systemically underfunding pension benefits annually has declined substantially, Aaron said, which is a clear indicator of less risk or improvement when it comes to pensions.

For instance, he said, Illinois has continued to follow its statutory contribution path placing it closer to the tread-water mark in Moody’s analysis. In Moody’s last state sector snapshot in September 2023, the difference between Illinois and the tread water indicator was less than 1%.

Connecticut and New Jersey also improved — and those two states had been associated with reoccurring shortfalls, Aaron said. In recent years, they have ramped up pension contributions, and it has been a direct driver of credit improvement for both states, he said.

Hawaii also has seen improvement from years past, Aaron said. It a statutory contribution rate and enacted a multi-year increase. The state’s improvements come from it contributing more and sooner, he said.

California’s two major funds, the California Public Employee Retirement System and the California State Teachers’ Retirement System, have both enacted changes protecting their pension systems.

“CalSTRS is now a decade into a long-term funding improvement push that focused on higher contributions from the state and participating school districts to bolster cash flow,” Aaron said. “CalPERS has reined in amortization periods and changed its methods to cause governments to contribute more sooner.”

From a budgetary and income perspective, California has seen greater contribution strength as a result of both of those moves, Aaron said.

The two states viewed by Moody’s as top performing in the pension arena are New York and Tennessee. They have very low net pension adjusted liabilities. New York has one of the lowest assumed rates of return at 5.9%, which “has helped to drive stronger contributions over time and increased asset accumulation,” Aaron said.

While fewer governments are exhibiting severe annual funding weakness compared with Moody’s tread water indicator than in the past, Moody’s analysts said historically elevated contribution levels also translate to less capacity to absorb another round of material cost hikes.

“Pockets of the K-12 school district sector, facing declining enrollment and the end of extraordinary federal aid, may also be challenged by lingering costs to amortize past unfunded pension liabilities,” analysts wrote.

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