Markets are taking notice of the “unfunded pension liability monster,” says Kemp Lewis, senior managing director and head of Raymond James’ public finance office in New York – due in part to new Governmental Accounting Standards Board regulations (GASB 67/68) that require more transparency when it comes to the funding of government pension plans.
The new GASB standards for pension financial reporting require assets to be shown at market value, which makes it easier to track true funded status. The standards put in place for fiscal year 2015 have revealed some ugly truths. A report this year from Truth in Accounting identified $628 billion of unfunded pension liabilities nationwide.
Pensions pose a huge credit concern. The largest underfunded plans such as Chicago, New Jersey and Illinois may make the headlines, but real credit dangers lie in the thousands of underfunded local plans. The rating agencies are increasingly treating pension liabilities as another form of debt of the sponsoring governments. “Markets are increasingly looking for this pension funding information and pricing it into the cost of borrowing,” says Mr. Lewis.
There are financial as well as political consequences tied to this awakening. As recent history has shown (think Detroit), unfunded pensions can cause fiscal distress for governments that can ultimately lead to bankruptcy. While most governments with severely underfunded plans will not declare bankruptcy or otherwise seek to impair debt obligations, most governments that do declare bankruptcy or another form of workout will have severely underfunded pensions.
“There are no easy solutions and every solution will be different.”
– Kemp Lewis, senior managing director, on dealing with the underfunding of government pensions and related borrowing issues
The stakes for implementing GASB 67/68 effectively – and managing pension funding – are high, but there is help. State and local governments can use the new information provided by GASB 67 to determine the long-term funding direction of a pension plan.
“There are no easy solutions and every solution will be different,” admits Mr. Lewis. Policy options on a basic level include increasing pension funding, earning more in pension investments, and paying out fewer benefits. Pension obligation bonds, in which the proceeds of a taxable bond issue are deposited into a pension fund, are one solution some governments have turned to, though these issuers would be wise to accompany the bonds with further pension reform. For more information, please read our recent Public Finance Market Watch article on POBs.
With hundreds of billions of dollars in unfunded pension liabilities exposed, state and local governments may have a new set of problems on their hands when it comes to borrowing. However, with strategic planning, expert guidance and early action, governments can tame the pension liability monster and navigate the new reporting rules.