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Credit FAQ: How Do U.S. Pension/OPEB Credit Analysis Guidelines Stand Up Amid High Inflation And Lower 2022 Market Returns?

Pension and other postemployment benefit (OPEB) obligations remain a focus of S&P Global Ratings' U.S. public finance (USPF) credit analysis, and with the recent equity market returns widely missing target rates of return, volatility within pension assumptions is on investors' minds in 2022.

Since S&P Global Ratings published "Guidance: Assessing U.S. Public Finance Pension And Other Postemployment Benefit Obligations For GO Debt, Local Government GO Ratings, And State Ratings," on Oct. 7, 2019, its guidance is materially unchanged. However, amid the current high inflation and low market returns, we answers the most frequently asked questions from investors and other market participants about this guidance.

Frequently Asked Questions

How does the current interest-rate environment affect S&P Global Ratings' U.S. pension and OPEB analysis?

Our pension guidance is not meant to be static because it reflects both current and future market expectations. Therefore, there are guidelines within the guidance that we update periodically (details on the 2022 update are below). It's important to note that these guidelines are long-term assumptions and are built on a long-term inflation assumption. The high inflation we have seen recently will only have a direct effect on these assumptions if it lasts long enough to change our expectations, and volatility historically tends to be minimized in the long term. The CPI-W is based on the spending patterns of urban wage earners and clerical workers. The chart shows the Social Security CPI-W assumption, as well as the average quarterly CPI-W rate that has been rapidly increasing this year as published by the Bureau of Labor Statistics. Note the lack of volatility of the Social Security long-term rate over the 20-year time period shown.


Short-term inflation might affect pension and OPEB in other ways, including but not limited to near-term medical cost increases that could lead to spikes in annual OPEB costs for plans that are funded on a pay-as-you-go basis, cost-of-living adjustments (COLAs) if they are based on an index, and the bond rate used to calculate reported liabilities for a plan with poor funding discipline. We might see poorly maintained pension plans and pay-as-you-go OPEB plans showing improved funded ratios in the current high-inflation environment, but this doesn't indicate structural improvement. Our analysis looks beyond just the funded ratio and incorporates funding discipline and other appropriate factors to provide a forward-looking approach to pension and OPEB risk analysis.

Which guidelines are typically reviewed for periodic market movements?

Guidelines inform our analytical opinion and create a starting point to help assess whether contributions, including impacts stemming from reasonably expected low points of market swings, can be absorbed within individual employer budgets. We analyze differences among issuers with regard to various contribution volatility and escalation risks on a unique issuer-by-issuer basis. The following guidelines are periodically reviewed and updated, if applicable:

  • Discount rate: This is used in the calculation of liabilities and funded level and it is generally equal to the assumed asset return in the U.S. public sector; in turn, it is used to calculate actuarially determined contributions. The discount rate is composed of inflation plus the real return on accepted market risk for an individual pension plan; this rate is central to pension costs and associated risks could change with market movements over time.
  • Long-term medical cost trend: This cost trend is central to the estimated future impact of health care costs in the calculation of retiree medical or OPEB liabilities and is built on inflation as well as macroeconomic factors; and
  • Payroll growth: The level percent-of-pay amortization basis uses this assumption with the general intent to match pension costs with the growth in payroll; growth depends in part on inflation and affects how much costs are deferred into the future.
What is the result of the guideline review in 2022?

Our guidelines are materially unchanged in 2022. As noted above, inflation underscores each of the reviewed guidelines on a long-term basis. Should inflation persist at or near recent high levels and begin to be reflected in long-term contracts and medical costs, we could change these guidelines to reflect that experience.

In addition, and not to be overlooked in the unchanging guideline, is that market conditions affecting the discount rate reflect generally lower returns for a given volatility level, a pattern we've seen with each review since the guidelines were first published in 2019. This pattern indicates that a pension plan maintaining a constant discount rate year over year might have been tolerating increasing market risk in its target portfolio over the past four years. If this pattern continues, and the long-term inflation assumption remains the same, we could amend the guideline to reflect this. However, if the long-term inflation assumption increases, a pension plan that maintains its discount rate would likely be taking on notably less market risk in its portfolio.

Date of review Discount rate (%) Long-term medical cost trend (%) Payroll growth (%)
October 2019 6.5 5.0 3.6
July 2020 6.0 4.5 3.4
September 2021 6.0 4.5 3.4
August 2022 6.0 4.5 3.4
Is S&P Global Ratings adjusting reported pension and OPEB liabilities or ratios based on the discount rate guideline described in the guidance?

No, for USPF we incorporate liabilities for credit ratings as reported in the audit. The discount rate guideline serves to inform our view of the potential for escalating contributions and susceptibility to market volatility. Public pension plans have varying attributes and risk tolerances, and therefore uniquely suited pension asset portfolios, so there is no one-size-fits-all "realistic" discount rate. There are many instances where the guideline might not be appropriate for a given plan because of atypical plan characteristics.

Examples of atypical plans might include but are not limited to:

  • Plans that have automatic risk-sharing controls in place to limit contribution escalation;
  • Plans with demographics that do not align with the national average;
  • Plans that are closed to new entrants; or
  • Plans that face other factors, such as a sponsor with high budgetary flexibility and control, that could lead to different contribution volatility tolerances.

Related Criteria And Research

Related Criteria
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This report does not constitute a rating action.

Primary Credit Analyst:Todd D Kanaster, ASA, FCA, MAAA, Centennial + 1 (303) 721 4490;
Secondary Contacts:Geoffrey E Buswick, Boston + 1 (617) 530 8311;
Robert D Dobbins, CPA, San Francisco + 1 (415) 371 5054;
Christian Richards, Washington D.C. + 1 (617) 530 8325;

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