Pension benefit boosts in several states make Fitch wary

A trend of public pension benefit improvements could put credit pressure on states that enact them, Fitch Ratings said this week.

Enacted and proposed state measures providing more generous benefits will “lead to higher required contributions and liabilities in the short term and could affect long-term credit stability if states adopt additional rollbacks to the early 2010s pension benefit revisions over the next few years,” Fitch said in a report Monday.

The Great Recession of 2008 and 2009 led several states to reduce their pension promises, at least for new hires, Fitch said.

Now, a variety of factors connected to the global pandemic, rising inflation, changing job market patterns, and healthy investment returns have led some state governments to reverse course or at least explore the possibility of doing so.

New York and Rhode Island recently adopted improved pension benefits.

In New York’s case, the legislature reduced the pension minimum vesting period to five years from 10 years and changed the average salary calculation period to three years from five years. The changes increase the net present value of state and local pension benefits by over $4.3 billion.

“Fitch expects that New York’s long-term liability burden will remain low due to the state’s history of conservative pension funding practices.” The state’s pension liabilities were fully funded, according to Pew Charitable Trusts data published in September.

Rhode Island, among other things, tweaked the rules so that retirees are more likely to receive cost-of-living adjustments, Fitch said. The changes add $434 million to Rhode Island’s state and local unfunded pension liability, but the rating agency expects the long-term liability burden to resume a general downward trend, absent additional legislative actions.

Illinois is under pressure to increase benefits for employees hired after 2010 to keep the state from falling afoul of IRS minimum “safe harbor” standard.

New Jersey and Alaska governments are either actively considering improving the benefits or have repeatedly considered doing so and may consider it again in the next budget cycle, Fitch said.

Public pensions have been buoyed recently by strong investment returns. The average 2024 estimated rate of return was 9.5%, according to a report the Equable Institute published earlier this month.

Moody’s Ratings in July said pension funding ratios were improving and it expected this to continue in fiscal 2025.

S&P Global Ratings in July said it expected fiscal 2024 to have ended with a robust 16%-17% pension asset performance, following a 12% return in fiscal 2023. These returns should improve pension funded ratios when they are officially reported in annual comprehensive financial reports.

According to a Moody’s report from early October, “States’ ability to service long-term liabilities further improved in fiscal 2023 as the sector saw moderate revenue growth, while adjusted net pension liabilities, the largest long-term liability for most states, declined because of higher interest rates.”

The prognosis for the ANPLs for the future is also positive according to Moody’s. “ANPLs are expected to decrease in fiscal 2024 reporting because of higher rates and will decline further in fiscal 2025 because of higher interest rates and strong investment performance in 2024.”  

Scott Sowers contributed to this story.