Two Large Issues Municipalities Face

Two of the largest issues facing municipalities today are underfunded pensions and unfunded “other” post-employment obligations (“OPEB “). Historically, public accounting rules have allowed these obligations to be largely hidden or less visible to investors and taxpayers. Change is being phased in through the introduction of new GASB standards that require municipalities to disclose the full impact of pension and OPEB liabilities and expenses.

In addition to accounting disclosure deficiencies, the legacy benefit funding problem has been exacerbated by:

• Aggressive return rate assumptions that are significantly above actual median returns for the last five years;
• Benefits are increased in good times and can’t be reduced in a less favorable economy;
• Macroeconomic pressures and local stagnation;
• Funding portions of the pension plan with borrowed money; and
• Actuarially recommended contributions are often not made

Similar to the change in accounting standards, Moody’s, which specializes in bond credit ratings, announced in July 2012 proposed adjustments on how public sector pension data will be evaluated.  These proposed adjustments, which will severely downgrade credit ratings of municipal bonds, include:

• Using a high-grade long-term corporate bond rate instead of a pension fund’s target rate of return; and
• Adjusting government payments to pension funds to reflect the lower discount rate, the need to fully fund pensions by the time employees retire, and a 17 year level-dollar amortization of unfunded pensions.

Six counties in California (Alameda, Contra Costa, Marin, Mendocino, San Mateo, and Sonoma) were evaluated using the proposed adjustments to determine the impact.  The previously reported total unfunded pension obligations for the counties approximated $1.8 billion, including their existing pension obligation bond debt.  After adjustment, the unfunded pension debt increased by an additional $6 billion, reducing average reported pension funding ratios from 78% to 58%.

Unfortunately, bankruptcy does not provide an expedient resolution.  In court or out of court, the same elements are required.  These elements include: taking leadership for the process, developing a well thought out and balanced plan that provides for shared responsibility, engaging in a sustained, fact-based, sober public communication campaign to gain support from as many stakeholders as possible, and being prepared to pursue the plan relentlessly, but perhaps gradually when resistance is met.