So You Think You Want To Be A Credit Analyst: Unfunded Pension Liabilities

Recently, S&P released a report entitled "Improved U.S. State Pension Funding Levels Could Be On The Horizon." This report is based on 2005 year-end data, which is the most recent data available for all states. S&P made the case that most state pension funds use 5 Yr smoothed returns, and the returns from 2001-2002 have been acting as a drag on the actuarial value of fund assets. If the equity market behaves itself, the 5 Yr smoothed value of these assets will increase as the returns from 2001-2002 fall off the 5 Yr averages. This increase in asset values will increase the funding of these state pension systems, which will help alleviate the current levels of underfunding. We are in agreement with this conclusion; however, there are some states that are grossly underfunded. Let's take a look at these state retirement plans and see how municipal credits are analyzed.

The chart below shows the 10 states with the largest Unfunded Actuarial Accrued Liabilities (UAAL). California, at $47 billion, has the largest unfunded liability, Illinois is next with $31 billion, and Ohio is right behind with $30 billion. The rest of the top 10 are all under $15 billion.

While it is interesting to know the magnitude of the funding gap, it is beneficial to look at the percentage that is funded to determine the progress the state has made in providing money for these obligations. The chart below is based on data from the same S&P report as above. This chart ranks states by the percentage of the funding. West Virginia has the lowest value at only 47% funded, next is Oklahoma at 57%, and Connecticut at 58%.

We now have charts that show the magnitude of the shortfall and the progress each state has made in achieving their goal of funding these pension obligations. It is also important to see how well these states can afford to meet these pension obligations. The amount of debt each state has outstanding can be calculated. If we divide this number by the population of the state, we arrive at a number for Debt Per Capita. Let's take the amount of the unfunded liability and divide it by the population to arrive at the Per Capita Unfunded Liability. When these 2 numbers are combined, we have a measure that is a better representation of the total obligation of the state. There are also Per Capita income numbers available for each state. These numbers show the earning power of the average person in the state. The combined Debt Per Capita numbers divided by the Per Capita income number gives us the percent of debt to income for each person. This number helps to show how significant the debt burden is for taxpayers in any given state. The chart below shows these numbers for the 10 states with the highest combined debt burden compared to their earning power. All 10 states have 10% or more ratios, with Alaska over 20%. This may be easier to understand if we use some actual numbers. Let's use Alaska as an example. The Debt Per Capita (PC) is $2,000 and the Unfunded Pension Liability is $6,212 PC. This is a total of $8,212 PC divided by the PC Income of $35,612 to give us a debt ratio of 23%. This is a big number and should cause concern in some investors. This measure gives us a better idea of Alaska's financial health than the $2,000 Debt Per Capita number.

These numbers do not include OPEB liabilities. OPEB is Other Post Employment Benefits and is primarily the actuarial accrued liability for health care costs. States will be coming out with these numbers over the next 3 years as required by GASB 45. This is another huge liability that municipalities have incurred. It should be important to each investor to look at not only traditional numbers such as Debt Per Capita, but also to include unfunded pension liabilites and OPEB obligations in their analysis to determine the creditworthiness of each security. So, do you still think you want to be a credit analyst?