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Announcement:

Moody's: US municipal pension risks higher than 10 years ago despite recent strong asset returns

25 Sep 2014

NOTE: On September 25, 2014, following initial publication, the press release was corrected as follows: Changed second sentence of the first paragraph to read “Between 2004 and 2012, unfunded liabilities for these systems as calculated by Moody’s tripled to just under $2 trillion; Changed third paragraph to read “The essential point, however, is that underfunding increased so much from 2004-12 even as these systems were earning close to their currently expected returns. Since these returns serve as the discount rates, they were the basis for calculating liabilities and normal costs, and overall contribution levels. “What went wrong that state and local governments could neither grow their plan funding nor prevent its decline?” asks Al Medioli, a Moody’s Vice President – Senior Credit Officer. “Part of the answer is the simple deferral of contributions for budgetary reasons, but the back-loading of costs through asset smoothing and 30 year amortization allowed by GASB suppresses near-term contribution increases, in many cases causing UAALs to rise for years by design.” Revised release follows.

New York, September 25, 2014 -- Funding gaps for large US public pension plans have widened over the last 10 years despite long-term investment returns meeting plan expectations, says Moody’s Investors Service in a new report. Between 2004 and 2012, unfunded liabilities for these systems as calculated by Moody’s tripled to just under $2 trillion; on an as-reported basis, unfunded liabilities quadrupled to $601 billion. In addition to assets falling further behind liabilities, the plans are also facing riskier asset allocations and the burden of an older US population, leading to more risk for the states and local governments that fund them.

In the report "US State and Local Government Pensions Lose Ground Despite Meeting Return Targets," Moody's reports on the performance of the 25 largest public defined pension systems by assets under unified management for 2004 through 2013. During this period, compound average investment returns averaged 7.45%, broadly meeting current return targets. The simultaneous sharp growth in the funding gap underscores the difficulty of recovering from double-digit asset declines experienced in 2008-09, as well as the broad inadequacy of sponsor contributions.

The essential point, however, is that underfunding increased so much from 2004-12 even as these systems were earning close to their currently expected returns. Since these returns serve as the discount rates, they were the basis for calculating liabilities and normal costs, and overall contribution levels. “What went wrong that state and local governments could neither grow their plan funding nor prevent its decline?” asks Al Medioli, a Moody’s Vice President – Senior Credit Officer. “Part of the answer is the simple deferral of contributions for budgetary reasons, but the back-loading of costs through asset smoothing and 30 year amortization allowed by GASB suppresses near-term contribution increases, in many cases causing UAALs to rise for years by design.”

Looking forward, the downsize risk to funding has heightened because of the increased asset allocation to equities and alternatives, and the large scale of assets necessary to fund the liabilities for demographically aging pensions.

"Employer and employee contributions are the bedrock of any defined benefit pension plan because they establish the base of assets that investments should then help expand," adds Moody's Medioli. "However, the GASB pension accounting and disclosure regime emphasizes investment returns over annual contributions; the resulting funding disincentive is at the core of the public sector pension asset-liability gap."

In addition to using liberal return assumptions, state and local governments will also pay less than the annual required contribution, given the broad flexibility related to assumptions established under GASB.

Moody's notes the strong investment returns combined with benefit reforms and moderating wages have begun to ease the rate of unfunded liability growth in 2014. However, a very large funding gap persists.

The report can be accessed at

http://www.moodys.com/viewresearchdoc.aspx?docid=PBM_PBM174297.

***

NOTE TO JOURNALISTS ONLY: For more information, please call one of our global press information hotlines: New York +1-212-553-0376, London +44-20-7772-5456, Tokyo +813-5408-4110, Hong Kong +852-3758-1350, Sydney +61-2-9270-8141, Mexico City 001-888-779-5833, São Paulo 0800-891-2518, or Buenos Aires 0800-666-3506. You can also email us at mediarelations@moodys.com or visit our web site at www.moodys.com.

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.

Alfred Medioli
VP - Senior Credit Officer
Credit Policy
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Bart Oosterveld
MD - CCO Public Sector Ratings
Credit Policy
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's: US municipal pension risks higher than 10 years ago despite recent strong asset returns
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