- In the current economic and budget environment, increased volatility and aggressively escalating contribution schedules could pressure Massachusetts pension plans, weakening issuer creditworthiness.
- While we expect pension costs will rise for almost all local governments, issuers' ability to absorb these costs varies across the state.
- The state government required all plans to achieve full funding by 2040. The currently approved funding schedule for the state's pension plans anticipates full funding in 2036, with many local government pension plans expecting to achieve it even sooner. However, plan funding schedules defer costs through aggressive assumptions and contribution schedules designed to grow at some of the fastest rates in the country, well in excess of estimated annual budget growth.
- Other postemployment benefit (OPEB) costs and liabilities relative to the operating budget vary by issuer, but trusts are generally poorly funded and towns are making little funding progress. There is legal flexibility in the state to change retiree health care benefits, but the extent local governments have adjusted benefits has to date been limited to those of future retirees.
Credit Fundamentals By Sector
- Commonwealth of Massachusetts: Pensions remain a credit risk for the state government. In our opinion, pension funding discipline has been poor and reported aggregate pension funded ratios remain relatively low, measured with what we view as a risky assumed rate of return that could lead to unanticipated increases in costs to the commonwealth. The state contributes on a statutory basis, ramping up to the actuarial recommendation, and expects to meet the full annual actuarially determined contribution (ADC) in 2026, but we anticipate annual funding discipline will remain weak until then. The state expects to make payments in excess of 100% of the ADC after 2026, under the current funding schedule, to become fully funded by 2036.
- Local governments: While we expect pension costs will rise for almost all local governments, issuers' ability to absorb these costs varies across the state. In high-growth areas around Boston, large, growing tax bases and access to a broad and diverse economy will support rising costs, in our opinion. In areas with limited tax base growth or comparatively lower income and wealth metrics, rising costs could put pressure on local government budgets.
- School districts: The majority of school districts in the state are departments of their respective towns, with operations accounted for in the towns' general funds. In limited instances, communities participate in regional school districts. These districts do not have revenue-raising ability, instead relying on assessments to member towns to provide the bulk of annual revenues. However, most employees participate in a state-funded system, resulting in little pension pressure on these districts' annual budgets.
- Other sectors: S&P Global Ratings maintains ratings on various issuers that also participate in cost-sharing multiple-employer plans, including not-for-profit health care providers and public universities. These entities either participate in the state plan, or other public plans that are well funded and of minimal credit concern.
The Current Economy Is Increasingly Volatile Due To The Pandemic-Induced Recession
S&P Global Ratings has been providing periodic updates on the recession-driven volatile markets. Our most recent article, "The U.S. Economy Reboots, With Obstacles Ahead" (published Sept. 24, 2020, on RatingsDirect), focuses on our view that the economy is pivoting into a recovery, but with slowing momentum. This article notes expectations that the near-term outlook remains uncertain. If market returns do not meet assumptions, planned pension contribution growth may take up an even larger portion of an increasingly crowded budget for a given issuer.
Massachusetts has more than 100 defined-benefit public sector pension plans. Of these, 12 are cost-sharing multiple-employer systems (CSMEs) that cover about three-quarters of the state's 351 local governments. As these plans are set up along county lines, they are generally referred to as regional or county plans. The remaining local governments participate in what are technically CSMEs, but the vast majority of the respective plans' total liability reflect the local government, with entities such as the local housing authority accounting for the remainder. State employees participate in the State Employees' Retirement System (SERS). The state is also a non-employer contributing entity for the Massachusetts Teachers Retirement System (MTRS). For MTRS, the state assumes the full liability and makes all contributions on behalf of local governments for participating teachers. This report focuses on the five-largest regional retirement systems by total liability, along with SERS and MTRS.
Charts 2 and 3 reflect contributions for the most recent year compared with our static funding and minimum funding progress metrics, with the net pension liability projected forward assuming continuation of that practice with all else held constant. This chart is not a look into the future, particularly given that participants contribute according to a rate that is based on an actuarial recommendation and reforms to improve funding will be phased in, which should result in improved funding progress. This chart illustrates the most recent contribution sufficiency for the largest plans in the state.
Big Plans To Fund Regional Pensions May Be Unrealistically Optimistic
In 2010, Massachusetts required all pension plans to adopt a funding schedule leading to full funding no later than 2040. This is the third such deadline, with previous funding deadlines of 2028 (adopted 1988) and 2030 (2009). As the 2040 deadline approaches, the truncated funding schedule is leading to increasing progress toward paying down unfunded liabilities. However, this progress is due to rapidly escalating contributions that may be untenable within local budgets. To meet the 2040 deadline, systems are maintaining contribution growth assumptions we view as aggressive with regard to affordability. In recent years, plans across the state have adopted incrementally more conservative assumptions. Expected cost growth could be exacerbated by the continued adoption of more conservative assumptions, such as lower discount rates. Alternatively, if plan assumptions are not met, costs could also rise. The previous deadlines were set or extended following recessions, and given recent market volatility, combined with state and local government revenue and expenditure uncertainty in the current economic environment, we believe it is possible the state could again extend the deadline. While this would likely lead to stabilized pension cost growth over the near term, due to this cost deferral, it would likely result in further cost escalation in future years.
As demonstrated in chart 4, we expect costs--on average--to outpace budgetary growth in the coming years. The 3.5% assumed budgetary growth is derived from the average change in general fund expenditures in Massachusetts municipalities on which S&P Global Ratings currently maintains a public rating from 2014-2019. Chart 4 is based on the adopted funding schedule for each individual plan, including both normal cost and amortization of unfunded liabilities. The true budgetary effect for a given local government will depend on factors such as the local economic conditions, including underlying metrics such as wealth and income, the size of the government's budget, number of employees participating in the pension plan, and starting costs as a percentage of expenditures. However, the total plan contribution increases on a percentage basis are some of the largest planned pension cost increases in the country and that is before considering unplanned increases due to risky assumptions. While we view each of these systems as poorly funded, with a strong likelihood of escalating and variable costs, we take an individual view of the effect on a rated local government. For example, the Worcester Regional Retirement System adopted funding schedules with 9.95% annual contribution increases, which we believe is highly likely to outpace budgetary growth of the participating municipalities. By 2035, total plan contributions are 425% of 2019 contributions, based on the adopted schedule. To give a sense of scale, assuming 3.5% annual budgetary growth, for a local government in the Worcester system with 2019 expenditures totaling $10 million and with a 5% pension carrying charge, we would expect that by 2035, the charge would grow to more than 13% of expenditures. If local government budget growth stagnates over the next few years, we anticipate pension costs would account for an even larger portion of expenditures in future years.
See tables 1 and 2 for details on the number of years until the plan is designed to be fully funded as well as planned annual contribution increases.
We note that each of the spotlighted systems has a discount rate well above our guideline of 6.0%, meaning assets are assumed to take on added risk to provide plan funding, and there do not appear to be significant risk-sharing, budgetary, or demographic features that might indicate that the additional risk could be tolerable for local budgets. See tables 1 and 2 for the discount rate used by each plan, but as a general theme, the regional systems are maintaining aggressive assumptions that limit expected cost increases. For example, the Plymouth County Retirement System uses a 7.875% discount rate, which is one of the highest in the nation, although the other systems' assumptions are not materially more conservative.
We expect changing contribution-to-budget ratios over time, and we will continue to evaluate pension budgetary stress on a case-by-case basis. We note, however, that the current economic environment could lead to rising costs depending on market returns. This could be exacerbated if municipal budget growth stalls due to the current recession. The same participating government as above, if it maintains level expenditures through 2021, would have a pension carrying charge nearly a full percentage point higher, holding all else constant. In an era of stagnant budget growth and flat or declining employee headcounts, retirement costs are likely to increasingly crowd out discretionary spending items, even above planned increases, as they account for a larger share of the budget. Municipalities with large, diverse, and growing tax bases and affluent residents, particularly those with strong financial management teams, are better positioned to address pension cost growth. Across the state, many governments may struggle to make the required contribution, particularly if the current recession worsens in duration or depth. This could pressure credit quality as governments defer capital and operational investments, through stagnant or declining reserve levels, or through rising debt and fixed costs.
State Systems Are In The Initial Stages Of An Aggressive Funding Plan
SERS is a cost-sharing multiple-employer defined-benefit pension plan covering substantially all employees of the commonwealth and certain employees of the independent authorities and agencies. As of June 30, 2019, the plan had nearly 157,000 participants, with an active-to-retiree ratio of 1.4, indicating less-than-exceptional ability to pass on to employees costs that may be volatile due to a high assumed return. MTRS is a cost-sharing multiple-employer defined-benefit pension plan managed by the commonwealth on behalf of municipal teachers and municipal teacher retirees. The commonwealth is a non-employer contributing entity and is legally responsible for all contributions and future benefit requirements of the MTRS. It has about 161,000 total members, with an active-to-retiree ratio of 1.4, also an indicator of inability to take on higher market risk.
The commonwealth contributes on a statutory basis for both SERS and MTRS and has not met the actuarially recommended contribution since 2011. It has put in place a plan to increase annual pension contributions a steep 9.63% per year, which has been projected to fully amortize unfunded pension liabilities by 2036. With recent stock market volatility, the achievement of full funding could be pushed back or the state might need to further increase pension contributions. The contribution budgeted in fiscal 2020 is short of the ADC, but is only 2% of estimated fiscal 2020 budgeted operating expenditures, which indicates affordability in the near term for the state. Massachusetts projects state pension contributions will increase by $2.1 billion above the fiscal 2020 level by 2026, the year when the commonwealth projects annual payments will equal the ADC, assuming payments increase at 9.63% per year and all assumptions are met. The commonwealth lowered the discount rate annually in each of the past four years, most recently to 7.25% from 7.35%. The lowering of the discount rate is generating cost growth and limiting funding progress, though we recognize that market risk is being slowly addressed. However, the discount rate remains above our 6.0% guideline. We believe the commonwealth will continue to make adjustments to its funding discipline and actuarial assumptions, which will lead to both contribution growth and smoothing volatility over time. However, in the current economy, with significant pressure on state revenue sources, the state's ability to meet its increasingly onerous funding plan could be pressured.
Other Postemployment Benefits (OPEBs) Are Often Overlooked
OPEBs in Massachusetts are provided on a single-employer basis by the state or local government. Governments have the authority to prefund the liability in an irrevocable trust fund, but funded ratios and discipline vary widely with affluent tax bases or strong management teams more likely to have made material funding progress. A common theme among many local governments in the commonwealth is that management teams expect to start funding OPEBs only after the pension is fully funded. We do not view this in itself as a credible plan to addressing the liability. While pension plans have adopted funding schedules, we believe these remain fluid and subject to change. Should the state permit pension plans to push schedules past the current 2040 deadline, we believe many will likely do so to minimize cost volatility and growth in the short term, allowing OPEB liability to continue to grow. Additionally, as pension plans become funded, we believe it is likely governments will look to address other capital and operational needs at the expense of funding OPEB liabilities. There is legal flexibility in the state to lower OPEB costs by reducing retiree health care benefits, but to date local governments have only done so for future retirees, which indicates a possible lack of practical flexibility for containing rising OPEB costs. We believe it is unlikely that local governments will eliminate these benefits.
Disclosure And Financial Reporting
The state and larger county systems readily publish financial and GASB 67 and 68 statements on their websites. However, the smaller county systems have generally not readily provided financial or GASB statements on their websites and none of the pension plans with a single participating local government publish stand-alone financial reports, and plan GASB statements are not publicly available. While the state retirement website publishes an annual one-page snapshot for each system, the reports are based on systems' actuarial valuations and do not provide sufficient information to assess funding progress metrics. As these metrics are also not published in issuer audits, we rely on available information when ascertaining pension risks at the issuer level. We believe improved disclosure is always positive and could better inform certain pension risks at the issuer level.
|County Plan Details As Of Most Recently Available CAFR Or GASB Report At Publication|
|Metric (Thou. $)||Barnstable||Middlesex||Norfolk||Plymouth||Worcester||S&P Global Ratings' view|
|Funded ratio (%)||57.6||46.4||58.3||56.1||43.1||Each of the plan's GASB funded ratios is low.|
|Discount rate (%)||7.38||7.50||7.75||7.88||7.75||A discount rate higher than our 6.0% guideline indicates higher market-driven contribution volatility than what we view as within typical tolerance levels around the country. We view each of the plan's discount rates as elevated.|
|Total required contribution (000s)||$65,893||$127,152||$71,227||$72,127||$55,675||Total contributions to the plan recommended by the actuary for the county plans. SERS and MRTS are based on an actuarial recommendation, updated every three years.|
|Total actual contribution (000s)||$65,893||$129,686||$69,958||$72,811||$55,675||Total contributions to the plan that were made last year.|
|Actual contribution as % plan requirement (%)||100||102||100||101||100||Statutory SERS and MTRS payments have historically not met the actuarial recommendation. S&P Global Ratings views contributions below ADC to be weak funding discipline.|
|Actual contribution as % minimum funding progress (%)||78||78||102||101||64||We view under 100% as not making significant funding progress.|
|Actual contribution as % static funding (%)||99||101||125||123||80||Under 100% indicates increasing unfunded liability if all assumptions are met.|
|Period||Closed||Closed||Closed||Closed||Closed||A closed funding period ensures the obligor plans to fully fund the obligation during the amortization period.|
|Length||17||17||13||11||17||Length greater than 20 generally correlates with slow funding progress and increased risk of escalation due to adversity. Currently, all plans must be under 20 due to the state requirement of meeting full funding by 2040. Length is as reported in most recent financial statements.|
|Basis||Increasing||Increasing||Increasing||Increasing||Increasing||Increasing amortizations explicitly defer costs, resulting in slow or even negative near-term funding progress. Escalating future contributions may stress affordability. This method covers most unfunded liabilities. Other amortization basess, such as early retirement incentives, may amortize differently.|
|Basis: Annual increases||5.28||6.50||5.21||6.27||9.95||The higher this is, the more contribution deferrals are incorporated. There is risk of market or other adversity causing unforeseen escalations to contributions beyond the plan. Plans create contribution schedules for total pension costs, with the average of 2020-2024 shown here.|
|Longevity||Generational||Generational||Generational||Generational||Generational||A generational assumption reduces risks of contribution “jumps” due to periodic updates from experience studies.|
|State Plan Details As Of Most Recently Available CAFR Or GASB Report At Publication|
|Metric (Thou. $)||SERS||MTRS||S&P Global Ratings' view|
|Funded ratio (%)||66.3||54.0||Each of the plan's GASB funded ratios is low.|
|Discount rate (%)||7.25||7.25||A discount rate higher than our 6.0% guideline indicates higher market-driven contribution volatility than what we view as within typical tolerance levels around the country. We view each of the plan's discount rates as elevated.|
|Total required contribution (000s)||$995,819||$1,443,710||Total contributions to the plan recommended by the actuary for the county plans. SERS and MRTS are based on an actuarial recommendation, updated every three years.|
|Total actual contribution (000s)||$995,819||$1,443,710||Total contributions to the plan that were made last year.|
|Actual contribution as % plan requirement (%)||100||100||Statutory SERS and MTRS payments have historically not met the actuarial recommendation. S&P Global Ratings views contributions below ADC to be weak funding discipline.|
|Actual contribution as % minimum funding progress (%)||70||64||We view under 100% as not making significant funding progress.|
|Actual contribution as % static funding (%)||86||83||Under 100% indicates increasing unfunded liability if all assumptions are met.|
|Period||Closed||Closed||A closed funding period ensures the obligor plans to fully fund the obligation during the amortization period.|
|Length||17||17||Length greater than 20 generally correlates with slow funding progress and increased risk of escalation due to adversity. Currently, all plans must be under 20 due to the state requirement of meeting full funding by 2040. Length is as reported in most recent financial statements.|
|Basis||Increasing||Increasing||Increasing amortizations explicitly defer costs, resulting in slow or even negative near-term funding progress. Escalating future contributions may stress affordability. This method covers most unfunded liabilities. Other amortization basess, such as early retirement incentives, may amortize differently.|
|Basis: Annual increases||9.63||9.63||The higher this is, the more contribution deferrals are incorporated. There is risk of market or other adversity causing unforeseen escalations to contributions beyond the plan. Plans create contribution schedules for total pension costs, with the average of 2020-2024 shown here.|
|Longevity||Generational||Generational||A generational assumption reduces risks of contribution “jumps” due to periodic updates from experience studies.|
|SERS--State Employees' Retirement System. MTRS---Massachusetts Teachers' Retirement System. ADC--Actuarially determined contribution.|
This report does not constitute a rating action.
|Primary Credit Analysts:||Christian Richards, Boston (1) 617-530-8325;|
|Todd D Kanaster, ASA, FCA, MAAA, Centennial + 1 (303) 721 4490;|
|Secondary Contacts:||Timothy W Little, New York + 1 (212) 438 7999;|
|David G Hitchcock, New York (1) 212-438-2022;|
|Research Assistant:||Tyler Fitman, Boston|
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