Report delves into risk meter for cities’ pension funding solvency
3 min read
Twenty-nine individual public pension plans that represent city workers and retirees reported so-called “crossover” years when their assets and contributions will fall short of covering retirement benefits, Merritt Research Services found in a report that delved into 2021 audits.
Pension funding ratios grab the most attention as the metric to gauge a plan’s health but the “crossover” event offers another view and provides warning flags that investors and other market participants should take note of, said Richard Ciccarone, president of Merritt Research Services, an Investortools company.
“What the funding ratio does not tell you is when a pension funding gap might occur if there are no additional funding actions,” Ciccarone said. “It’s a pretty serious situation if a government can’t make its pension payment because it will add to their fixed costs. We don’t want to get to that point.”
The pressure is most acute if the dollar value of the total liability is large relative to the size of a city’s population and tax base.
Following the “crossover” indicator offers both a short-term gauge and long-term risk meter for investors because it can be tracked annually along with funded ratios to gauge whether the fund is deteriorating.
While the number and percentage of pension plans that reported crossover years in fiscal 2021 was small in relation to the number of cities in the study, 2021 investment returns, enhanced funding and reforms help move “the meter in the right direction” even for weakly funded plans, Ciccarone said.
“Looking ahead, if 2022 negative investment returns are prolonged, there is a strong likelihood that the number of plans reporting crossover years in the next two fiscal years will increase, especially among plans that recorded FY 2021 funding ratios below 70% of their liabilities,” the report warned.
For most of the 29, the depletion date is decades off, but for three the year falls within the next decade, while another five forecast insolvency within two decades. The furthest out on the spectrum is 78 years.
Potential insolvency absent any other actions inside of five years is a “red flag” while 20 years is a “yellow flag,” and while some don’t warn of the threat for many decades, it still bears watching, Ciccarone said.
While some governments can trim benefits to help curtail the threat of exhausting assets, local governments in some states, like Illinois, lack the legal ability to take such action. Illinois’ constitution provides stringent protections against any form of benefit cut.
Depleted assets poses additional challenges. With a labor shortage now a pressing demand across the municipal spectrum, pension troubles could damage efforts to attract high-quality personnel, especially in the area of public safety, Ciccarone said.
An additional burden is posed as Governmental Accounting Standards Board rules require the discount rate to be adjusted for the period that follows the crossover point so contributions can be increased, which in turn raises the pension funding demands on a government’s fixed costs.
Crossover events are moving targets as they are subject to annual shifts depending on whether investment performance meets assumptions, pension borrowing, and changes.
The Merritt report looked at a comprehensive list of cities involving 1,668 single-employer and agent pension plans from 1,400 city audited comprehensive financial reports received by Sept. 22.
Among city plans that report crossover years, the two that would occur soonest belonged to the small Manchester, New Hampshire, Public Employees Retirement Plan — Old System, with an expected issue in 2028, and the more significantly sized Berkeley, California, Police Retirement Income Benefit Plan, which would crossover in 2030.
Five cities showed at least one of their pension plans reporting crossover years and net plan pension liabilities of more than $250 million, including two of Chicago’s plans in 2075 and 2078, Dallas in 2059, Cincinnati in 2042, Charlotte in 2047, and St. Louis in 2068.
The most distant crossover year belonged to the Chicago Policemen’s Retirement System in 2078 and the Chicago Laborers Retirement System in 2075. “Since the crossover years for the Chicago plans are more than 50 years from now, it is not currently viewed as an imminent risk, particularly because of recent funding changes taken by the city,” the report said. Both are just 25% funded but are on an amortization schedule aimed at reaching 90% funded status in the 2050s.
For the 29 plans reporting crossover years, the median 2021 plan funded ratio was 40%, with the lowest pension plan funded ratio at 7%, compared to a median funded ratio of all city plans studied of 78%.
