Environmental, social, and governance (ESG) is integral to our public finance credit analysis and we continue to amplify our transparency efforts for market participants. This brief aims to identify when our view of pension analytics and governance as part of ESG intersects with credit rating analysis.
Chart 1
Credit rating analysis for pension and OPEB is built around cash flows, both current and future, and how contribution costs could negatively affect an issuer's willingness and ability to meet its debt obligations and operational expenditures. In our view, ESG factors begin to overlap with our credit rating analysis for pension and OPEB when prioritization of plan contributions, through forward-looking plan governance decisions, is viewed through the lens of risk management, culture, and oversight.
Chart 2
Control Framework
A regulating entity such as the state, for smaller government plans, or the pension board, for cost-sharing multiple-employer (CSME) plans, may limit an issuer's ability to control its own contribution requirements and plan decisions, although the effect could be positive or negative. In some instances, if the plan receives supplemental contributions during periods of economic stress or smaller issuers gain access to higher-level expertise that otherwise would be inaccessible or too costly to employ, we may view that positively from a governance perspective. However, for small governments participating in a CSME plan, there is often an inability to participate in plan decision making, which could lead to less risk mitigation planning to address escalating contributions in long-term financial forecasts. Highly rated entities often plan for volatility and possible cost escalation.
Legal Flexibility
An issuer's ability to modify benefits, funding methods, or plan assumptions to mitigate risks is considered in both an ESG-focused assessment of governance and the overall credit rating analysis. For example, in the state of New York, local governments do not have authority to prefund OPEB benefits in an irrevocable trust, limiting their ability to mitigate risk from rising costs. In Illinois, the state minimum pension contribution typically adhered to by local governments within the state achieves only 90% funding and is in excess of the 20 years we believe is likely to lead to material funding progress, which indicates weak funding discipline and could increase an entity's exposure to financial pressure going forward. Issuers not constrained by such limitations and practices are better positioned to manage pension and OPEB risks. We would view favorably the incorporation of conservative financial forecasts (such as rising or volatile health care claims costs within OPEB projections) and development of strategies to maintain budgetary balance through raised revenue or expenditure reductions to accommodate an increasing fixed cost burden.
Practical Application
When local plan control exists, we assess management's risk focus on whether techniques are considered to address cost escalation. In some instances, changes to funding methods can lead to rapidly increasing costs, such as when plans that defer costs through high annual contribution increases are updated to a level-dollar amortization that addresses costs sooner. If a government is not planning for pending increases, an entity may experience accumulated future fiscal stress absent significant budgetary adjustments to incorporate the higher amounts. Similarly, while some issuers may manage down unfunded liabilities and contribution requirements by relying on higher assumed investment returns and corresponding discount rates, we view these decisions as adding to credit risk as they can lead to volatile and increasing contributions should actual results fall short of assumptions.
Related Research
- ESG Brief: Emerging Themes In U.S. Public Finance, June 3, 2021
- Through The ESG Lens 2.0: A Deeper Dive Into U.S. Public Finance Credit Factors, April 28, 2020
- Guidance | Criteria | Governments | U.S. Public Finance: Assessing U.S. Public Finance Pension And Other Postemployment Obligations For GO Debt, Local Government GO Ratings, And State Ratings, Oct. 7, 2019
- Credit FAQ: Pension And OPEB Guidance In U.S. Public Finance Credit Analysis, July 21, 2020
This report does not constitute a rating action.
| Primary Credit Analyst: | Todd D Kanaster, ASA, FCA, MAAA, Centennial + 1 (303) 721 4490; Todd.Kanaster@spglobal.com |
| Secondary Contacts: | Christian Richards, Washington D.C. + 1 (617) 530 8325; christian.richards@spglobal.com |
| Nora G Wittstruck, New York + (212) 438-8589; nora.wittstruck@spglobal.com | |
| Geoffrey E Buswick, Boston + 1 (617) 530 8311; geoffrey.buswick@spglobal.com |
No content (including ratings, credit-related analyses and data, valuations, model, software, or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced, or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees, or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness, or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment, and experience of the user, its management, employees, advisors, and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process.
S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.spglobal.com/ratings (free of charge), and www.ratingsdirect.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.spglobal.com/usratingsfees.