(Editor's Note: This commentary applies to state and local government pensions within U.S. public finance and is not intended to describe or represent S&P Global Ratings' methodology for analyzing pensions in other sectors.)
S&P Global Ratings' approach to pensions and other postemployment benefits (OPEBs) focuses on affordability--both current and on a cost trajectory. We analyze funding discipline through assumptions and contribution methods to determine if pension/OPEB costs will lead to budgetary stress. We consider pension/OPEB expenses fixed costs, akin to debt and tailor our analysis to the specific risk factors of individual credits, so our pension/OPEB analysis is holistic and not keyed to any one number or assumption. Ultimately, regardless of the plan type, we believe that state and local governments can take proactive measurements to address potential rising costs.
Frequently Asked Questions
What is S&P Global Ratings' approach to incorporating pensions/OPEBs into its ratings?
Our approach to U.S. public finance pension and OPEB analysis places a strong focus on affordability over both the near and long term. To that end, as a starting point, we incorporate into our analysis liabilities as currently reported, as well as contributions to pension/OPEB plans relative to the budget or tax base. We then take a closer look at underlying assumptions and contribution methods to inform our view of the future cost and liability trajectory. Our forward-looking approach extends beyond a snapshot of an obligor's liabilities and educates our view of management discipline and expected future financial performance.
How much weight do pensions/OPEBs receive in ratings?
S&P Global Ratings factors pension into its scoring of liabilities, budgetary performance, institutional framework, and management. While the specific weighting of these factors varies across criteria, the cumulative analysis of them can result in significant weight on our view of the overall rating. High pension or OPEB costs can also trigger rating caps or notch adjustments within our state and local government rating criteria. Frequently, pension and OPEB liabilities also play into our holistic analysis of the rating beyond the indicative score.
Does S&P Global Ratings provide rating uplift for well-funded pension systems?
S&P Global Ratings does not provide explicit "extra credit" for well-funded pension/OPEB plans because, in our view, well-funded pensions and prudent funding practices represent what we believe governments should be doing routinely rather than the exception. However, these governments will likely score better within our criteria on liabilities, budgetary performance, debt, and management metrics and therefore often carry higher ratings.
Does S&P Global Ratings adjust the discount rate or other assumptions?
We do not adjust liabilities because we think such adjustments fall short of accurately representing liabilities or establishing comparability, and in some cases, even obscure actual risks. We believe a focus on future costs and affordability, rather than adjusted liabilities metrics, is most relevant to credit risk. The discount rate is an important metric, but amortization methods, such as level dollar versus level percent or open versus closed, can have equal or more weight on the liabilities and cost trajectory. We take a qualitative approach to looking at key methods and assumptions to determine our view of the extent to which we believe costs could escalate and lead to budgetary stress.
How does S&P Global Ratings incorporate legal flexibility around benefits into its ratings?
Legal flexibility around adjustments to pension/OPEB benefits varies across states, although frequently, OPEB benefits are more flexible than pension benefits. However, we do not assume that simply because a state does not actively restrict benefit reductions that the state or local government will cut benefits. We have seen significant political resistance to reducing benefits, and such measures can run counter to other state policy objectives, such as retirement security. In addition, protracted legal challenges often follow legislative action or reforms. Therefore, we consider pension/OPEB liabilities as fixed costs until the plan demonstrates credible steps to actually reduce benefits.
Does S&P Global Ratings consider debt, pension, and OPEB liabilities as equivalent?
We consider debt, pension, and OPEB expenses to be fixed costs. Unless there is credible action to reduce pension or OPEB benefits, we treat the liabilities as hard debt that must be paid. Even if a government can legally reduce contributions to pension or OPEB plans in a given year, it is still responsible for funding benefits as they come due.
Does S&P Global Ratings approach single-employer, agent multiple-employer, and cost-sharing multiple-employer pension/OPEB plans differently?
Although multiple-employer plans may benefit from administrative cost savings, overall risk factors (namely, escalating costs that could lead to budgetary stress) are consistent across plans. To the extent that local governments participate in multiple-employer plans, we might additionally factor risks into our view of the institutional framework. In environments where unanticipated cost increases have occurred or have a strong potential to occur, and governments are unable to sufficiently plan for such increases, we would view this as a negative in terms of predictability. In addition, if a government participates in a substantially underfunded state-administered plan over which it has no control, we might consider this an unfunded expenditure mandate.
What does S&P Global Ratings consider to be a "credible plan" to address pension/OPEB liabilities?
Where possible, both adopting realistic assumptions to value liabilities and employing strong funding discipline lay the foundation for developing a credible plan. Without these first steps, alternative actions to account for and curb rising retirement costs will likely prove inefficient. Regardless of whether or not the government has the ability to make plan-level adjustments, it can proactively plan and prepare for increasing costs, such as developing a long-term financial plan and dedicating specific funding sources. Other examples of credible plans include enacting pension and OPEB reforms at the plan level, such as lowering benefits offered, salary measures, or cost-of-living adjustments; applying a service cap to benefit accrual; or increasing the retirement age.
What are characteristics of well-managed pension and OPEB plans?
In our view, plans that demonstrate strong funding discipline by targeting 100% funding on a prudent and consistent actuarial basis with conservative assumptions and methods are much more likely to manage pension and OPEB liabilities and related budgetary costs than plans that do not. These governments will use conservative discount rates and current mortality projections, while also adopting amortization schedules that effectively pay down unfunded liabilities and make progress toward full funding instead of deferring and compounding costs for the future.
How does S&P Global Ratings view pension or OPEB obligation bonds?
As with all credit factors, we will consider pension obligation bonds (POBs) and OPEB obligation bonds (OOBs) holistically within the overall risk factors. As with any added debt, we consider ability to pay, but also as with new debt, we might not always consider POB/OOB issuance to have negative credit implications. However, we will generally view it negatively when one or more of the following conditions exists:
- The bonds are used as a mechanism for short-term budget relief or poor funding structure;
- Issuance is not combined with plan-specific measures to address the long-term liability; or
- The bonds substantially reduce a government's debt capacity.
- Local Government Pension And Other Postemployment Benefits Analysis: A Closer Look, Nov. 8, 2017
- Looking Forward: The Application Of The Discount Rate In Funding U.S. Government Pensions, Sept. 13, 2018
- For The Five Highest-Funded U.S. State Pension Plans, Being Proactive Keeps Liabilities Manageable, Oct. 24, 2017
- Pension Obligation Bonds’ Credit Impact On U.S. State And Local Government Issuers, Dec. 6, 2017
- Pension Brief: Are Asset Transfers A Gimmick Or Sound Fiscal Strategy?, Feb. 19, 2019
This report does not constitute a rating action.
|Primary Credit Analyst:||Carol H Spain, Chicago (1) 312-233-7095;|
|Secondary Contacts:||Geoffrey E Buswick, Boston (1) 617-530-8311;|
|Todd N Tauzer, FSA, CERA, FCA, MAAA, San Francisco (1) 415-371-5033;|
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