S&P State Pension Review

S&P in a recent review of state pension plans provides some key insights into the state of pension reform and pension funding in the US. The rating agency affirms the important role pension funding status plays in a state’s creditworthiness. While pension liabilities are not an immediate threat to most state’s finances, S&P believes that these obligations when mismanaged do adversely affect a state’s credit profile.

State pension funded levels improved slightly in 2013, but the gap between well-funded and poorly funded plans remains substantial. Despite strong market returns, funding ratios of 24 states declined compared to the previous year.

S&P stresses the significance of fully funding the annual required contribution (ARC). It also notes the incentive of many state governments to defer full ARC payments for short-term budgetary needs, eventually creating distressed situations in the long term. Underfunding ARCs, therefore, has a potential of negatively affecting credit ratings.

The report identifies a number of factors that have slowed down pension reform efforts. One possible factor is “reform fatigue”: as it takes so much political capital to effect measures that produce small short-term benefits, legislators with limited terms have few incentives to continuously push for reform. Another factor is recent court rulings that challenge past reforms on constitutional grounds. Combined with recent strong market returns and competing priorities, these factors seem to have discouraged the need for reform.

To read the full report, go here.