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Pensions get shock treatment

By   /   July 5, 2012  /   No Comments

By Ryan Ekvall Wisconsin Reporter

MADISON – State officials might want to take a second look at the highly touted Wisconsin Retirement System.

The costs and transparency of state and local pensions may soon be on the rise in Wisconsin and across the nation, driven up by proposed changes from Moody’s Investors Service, the global credit rating agency.

The changes could mean that Wisconsin Retirement System is underfunded by nearly $30 billion – and that could ultimately drag on government bond ratings.

Among other adjustments, Moody’s proposes to standardize the public pension discount rate (or rate of return) at that of a high-grade, long-term corporate bond – currently yielding 5.5 percent. The changes will bring public pension reporting in line with the private sector, which uses the same corporate bond rate for valuing its liabilities.

States currently value their pension obligations based on how much they assume assets will return over the long haul. Wisconsin now uses a 7.2 percent discount rate.

The difference between 7.2 percent and Moody’s proposed standardized rate could mean a gap of billions of dollars in investment expectations.

Based on figures from a 2011 Pew Center on the States study, Wisconsin Retirement System is underfunded by $29.95 billion or 28 percent, using a 5.22 percent discount rate – the corporate bond rate in March 2011. WRS reports itself at 100 percent fully funded.

State public pension overseers, state lawmakers and Gov. Scott Walker have praised the public pension system in recent days, following a state-commissioned report advising lawmakers not to mess with the ostensible success of the system.

The state Department of Employee Trust Funds, the administrators of WRS, did not respond to Wisconsin Reporter’s multiple phone and email requests for comment on Thursday.

The change would put unfunded pension liabilities nationally at nearly $2 trillion – three times the amount reported in the most recent Pew Center on the States study.

“Pension liabilities are widely acknowledged to be understated,” said Moody’s managing director Timothy Blake in a statement. “Our proposed adjustments will improve the comparability and transparency of pension information across governments, enhancing our approach to rating state and local government debt.”

Moody’s uses pension debt as one factor in determining bond ratings for state and municipal governments. It said it doesn’t expect any state credit ratings to change immediately under the new rules, but some municipalities could see their credit rating slashed.

“Moody’s view on pension-related exposure has been reflected in a number of recent downgrades and negative outlooks, including for the states of Illinois, New Jersey and Rhode Island, and the cities of Chicago and Providence,” Blake wrote.

Under Moody’s proposed changes, pension funds would likely require an increase in annual contributions – from taxpayers or public employees – to remain fiscally sound in the eyes of the credit rating agency.

ETF deputy secretary Rob Marchant previously told Wisconsin Reporter, “If you look at WRS over time, the performance of WRS has exceeded the discount rate. Had we been funded at a risk-free rate, given past performance of WRS, there would be significantly more money set aside than the liabilities. It would increase the cost of the system significantly. You’d require taxpayers to fund higher contributions to account for the lower assumed rate of investment return.”

However, Moody’s shift is a step in the right direction, according to one public pension watcher.

“Public pensions will claim these discount rates are too low and thereby increase the measured value of their liabilities,” said Andrew Biggs, economist at the Washington D.C.-based free market think tank American Enterprise Institute. “In fact, they’re likely too high.”

Biggs and other economists argue public pensions should use an even lower discount rate – that of a long term U.S. Treasury Bond – to match the guaranteed nature of pension benefits. Under that standard, Wisconsin Retirement System is approximately underfunded by $60 billion, or 46 percent.

“Where Moody’s changes would really help is in eliminating incentives to take excessive investment risk,” said Biggs. “Under current rules, if you invest in riskier assets you get to discount your liabilities using higher interest rates, and as a result U.S. public pensions take more investment risk than private pensions or public pensions in other countries.”

The Wisconsin Retirement System currently invests over half its assets in foreign and domestic equities. Recently, that strategy has proved to be a double-edged sword. The stock market crash in 2008 cost the system $26 billion. Since then, the system has recovered much of that loss with the rebound in the market.

Another Moody’s change will affect pension accounting, highlighted after the 2008 crash.

Asset smoothing – a practice where investment gains or losses are averaged over a certain time period – will be eliminated from pension reporting. Currently, Wisconsin smooths over a five-year period, meaning the 2008 loss won’t be fully recognized until 2013.

Moody’s proposed changes were released the same day a WRS study recommended no changes be made to its system, in part because of its strong financial footing, at least by common public pension accounting standards.