Credit Rating Agencies: Color Them Less Than Impressed

2018 Pension Fixes Aren't a Big a Hit as Hoped.

Pick your favorite idiom – raining on the parade, being a wet blanket, bursting the bubble – the collective “meh” from the credit rating agencies regarding this session’s pension repairs has put a damper on a rare moment of legislative accomplishment.  As a recent Star Tribune article highlighted, the victory lap reversed course with some rhetorical backtracking now taking place.  A month ago rating agencies were going to be told we had solved our unfunded liability problem; now it’s "we weren't trying to fix it once and for all.”  Employees were told the efforts guaranteed pension security for decades to come, now plan officials themselves admit “there’s more work to be done.”  Words like “heroic” and “historic” were used to describe the achievement; now pension lobbyists express hope the repairs have a shelf life of more than a few years.

Credit rating agencies are probably the only external voices with the influence to both prompt these sorts of admissions by stakeholders and call into question the clothing of emperors without being on the receiving end of a fusillade of “anti-public sector” accusations.  So it’s worthwhile to take a look at what they think got lost in the frenzy of self-congratulation.  It really begins and ends with this statement from Moody’s:

“Our approach values accrued pension liabilities independently from pension plan asset amount, composition and return expectation….We recalculate state and local net pension liabilities based on a market-determined discount rate and the market value of assets.”

Translation: “We don’t use accounting conveniences that understate obligations and let public pension plans keep their contribution levels unsustainably low.  We choose to employ the standard methodology of an appropriate-duration credit rate that is used in every other area of finance – public or private.”

Taking this approach makes the state's pension problem much bigger and, by definition, the beneficial impact of the changes enacted this session much smaller.  Public policy organizations including ours, defined benefit plan experts, even our own state economist have drawn attention to this issue, but it now takes on much greater significance given its formal incorporation into Moody's methodology.

Meanwhile, Standard and Poor's flagged a compounding problem: that contribution levels are set by the political process at levels which are lower than what actuaries determine are necessary to fund the benefits.  S&P questions whether the legislature has the political will to increase the contribution rates if they continue to lag behind the actuarily required contribution (ARC) rates.  History says the answer is no – in the aggregate the state has failed to make its ARC 14 years in a row and counting.  The protracted phase-in of this year’s scheduled contribution increases the likelihood that streak will continue.

But despite the less than enamored response of the rating agencies, the Strib article suggests policymakers remain very satisfied with this year's pension bill.  They also appear undisturbed by the acknowledgement that legislators will have to repeat the exercise they just went through in the likely not too distant future under even greater fiscal stress and pressure. "Extend and pretend" has become routine.   

In the Strib article a pension lobbyist acknowledged the rating agencies' criticisms are fair, but suggested that, like doctors, the agencies are always going to find something the state could improve on.  That may sound rather dismissive but it’s actually a spot-on analogy.  State pension policy often does resemble plastic surgery -- semi-regular alterations and adjustments that are far more about looking good than being healthy.  Real pension sustainability won’t be achieved by a tummy tuck in the form of a 50 basis point reduction in return assumptions or a botox injection of a new 30-year amortization period.  It demands a thorough physical to understand the true nature and magnitude of the risks and a careful examination of the lifestyle changes that are necessary.  Because there’s a lot more at stake here than appearances.