Maryland is one of a handful of states that command pristine AAA credit ratings from all three major rating agencies. But the state’s growing debt and pension liabilities could jeopardize Maryland’s top rating in the near future. The risk to the state’s credit is epitomized by the dire financial position of the Maryland Transit Administration Pension Plan, which covers state employees operating bus and rail services in and around Baltimore and Washington D.C.
A key factor contributing to this concern is the relative size of Maryland’s liabilities. Maryland’s long-term liabilities — including bonds and loans, as well as pension and retiree healthcare obligations — were equal to 94% of the state’s total assets as of 2015, according to data compiled by the Mercatus Center. This compared very unfavorably to other AAA-rated states that Mercatus collected data on. For example, Delaware had a long-term liability to asset ratio of just 58%, while Virginia came in at 34% and North Carolina was down at 17%.
Unfortunately, Maryland’s liability to asset ratio got even worse last year. According to the state’s 2016 Comprehensive Annual Financial Report, Maryland’s long term liabilities of $43.3 billion represented 99% of its $43.6 billion in total assets – yielding a five-percentage point increase in this ratio from the prior fiscal year. Over half of the state’s long-term obligations take the form of pension and retiree health liabilities.
Rating agencies have taken note of the state’s growing pension problems. In a February 2017 report, Moody’s said: “The financial condition of Maryland’s retirement system represents the state’s most significant credit challenge.” Fitch’s assessment of the state’s balance sheet is as follows:
The burden of net tax-supported debt and unfunded pensions is elevated for a state, but only a moderate burden in relation to the state’s resource base. Debt is comprehensively managed. Pensions have been a more significant burden, but the state has implemented multiple reforms to benefits and contribution policies to improve pension sustainability and accelerate funded ratio improvement over time.
Like Fitch, S&P and Moody’s applauded the state’s pension reform efforts, which include making increased annual pension contributions, especially when surpluses are available. These initiatives focus on the Maryland State Retirement and Pension System, which was 70.5% funded as of June 30, 2016.
However, a separate pension plan for 4,800 active, former and retired employees of the Maryland Transit Administration (MTA) has received less attention and is in much worse condition.
According to the MTA plan’s latest actuarial valuation, as of July 1, 2016 assets totaled $268.4 million while accrued liabilities were $670.5 million, yielding a funded ratio of 40.03%. The represents a large drop in the plan’s funded ratio from July 1, 2015 when it was 44.59%.
The recent deterioration in the plan’s funded position was largely the result of a changes mandated by a new contract with Amalgamated Transit Union Local 1300. Under the new contract, a cap on monthly benefits was removed, allowing all retirees to receive 1.7% times years of service times final compensation. To balance out the benefit enhancement, the new labor agreement also contained some cost reduction aspects including limits on the number of working hours that can be included in the final salary calculation (thereby limiting the use of overtime to spike pension payouts), and an increase in the vesting period for new employees. The labor agreement also introduced employee contributions for the first time (at a rate of 2% of pensionable earnings). But actuaries determined that balancing out elements came nowhere near offsetting the benefit cap removal, concluding that the benefit changes added $100 million to accrued liabilities.
While MTA’s 40% funded ratio looks bad, it understates the problem for at least two reasons. First, the reported funded ratio is based on an overstatement of plan assets. Actuaries employ a smoothing calculation to reduce year-to-year volatility in asset levels. The smoothed value of $268.4 million (also known as the actuarial value of assets or AVA) is considerably higher than the plan’s net position of $242.1 million shown in its audited financial statements.
Second, and more importantly, the actuarial analysis discounts projected benefit payments at a rate of 7.55%, which fails to reflect the near certainty that these benefits will have to be paid. While high discount rates should be applied to risky cashflows, payments to MTA retirees can be forecast with a high degree of certainty and should thus be discounted at a much lower rate, as Truong Bui and Anthony Randazzo explained in a 2015 Reason Foundation policy brief.
Adjusting MTA’s pension finances for these factors uncovers the reality that the funded status of this plan is far worse than reported. The MTA plan’s GASB 68 valuation reports that the market value of assets (or MVA) is $244.8 million. Meanwhile the value of liabilities using a 3.5% discount rate is reported to be $1,359.4 million. (The liabilities are discounted at the unusually low rate of 3.50% because GASB rules mandate the use of a blended discount rate for low-asset funds like MTA’s. The blended rate is a weighted average of expected asset returns and high quality municipal bond yields.)
The GASB-compliant calculation produces a funded ratio of just 18.01% and a net pension liability of $1.1 billion.
This $1.1 billion unfunded liability appears on Maryland’s Comprehensive Annual Financial Report, weighing on the state’s fiscal ratios. And the problem can be expected to worsen because MTA does not make its full actuarially determined contribution each year. In fiscal year 2016, the state contributed only 92% of the ADC, adding more than $3 million to the system’s red ink. Finding money to raise pension contributions in the years ahead will be challenging given stagnant to declining ridership (as ridesharing services draw passengers away from buses) and downward pressure on federal funding.
While pension funding problems for the neighboring Washington Metropolitan Area Transit Authority (WMATA) have received significant press attention, MTA’s problems have largely flown under the radar. But MTA’s reported Net Pension Liability exceeds the $907.6 million reported by WMATA.
Unlike WMATA, the Maryland Transit Administration is not a standalone agency. Its depleted pension fund is thus buried deep within the accounts of a state that has a stellar fiscal reputation. But that reputation may not continue for long and so now would be a good time for Maryland’s leaders to turn their attention to this problem.