By Peter Hayes, Managing Director, head of BlackRock's Municipal Bonds Group.
Longer life: It's as much a blessing as a retirement planning conundrum - and not one for retirees alone.
As much as individuals need to adjust their financial plans to account for longevity, the same is true of companies and governments that provide retirement benefits.
For states and municipalities, providers of public pension plans, the challenge is balancing near-term budgetary and operating requirements with the long-term liability of funding pension and retiree healthcare benefits. The balancing act was complicated by the financial crisis and "Great Recession." Not only had it become difficult to arrive at workable budgets, but the pension burden loomed larger as market losses caused pension asset pools to shrink, bringing funded ratios to unhealthy lows.
Why Pensions Matter to Municipalities
The challenge for fiscally strapped U.S. states and cities is twofold:
1. They must deliver on the promise to provide public employees (past, present and future) with a measure of security in retirement.
2. They must simultaneously assure they have the resources to provide proper facilities, services and public safety for all of their residents on an ongoing basis. At times, and in some places more than others, the dual mandate becomes tortured.
While the health of municipal pension plans varies widely, Morningstar reported in September 2013 that more than half of all states' plans fell below their "fiscally sound" threshold of 70%. Clearly, plans put in place decades ago under different circumstances (with promises through the years that augmented the obligations) have not stood the test of time. And rating agencies are increasingly acknowledging that pension pain can have an impact on a states' and municipalities' ability to meet short-term obligations - and they are increasingly factoring this into their assessments of states' creditworthiness.
Change (read: reform) Can Be Good
The question we hear from investors in the municipal market is to what extent the pension burden will weigh down state and local finances to the point of distress or, as in the case of Detroit, bankruptcy.
We do not believe pension liabilities will be the financial demise of municipalities. In fact, we're more optimistic on this front than we have been in some time given greater awareness of the problem and a step-up in reform.
Since 2009, 45 states have imposed some type of pension reform, according to Pew Center data. Recent events in some high profile cases (Detroit, Illinois and a few cities in California) evidence the growing recognition of the problem and inclination among legislators to adopt change. And that's good news for states' long-term fiscal health, and for those who invest in munis.
Bottom line: There has been a greater recognition among state and local legislators, rating agencies and municipal market participants that long-term pension liabilities can be a more imminent financial strain if left unaddressed.
Stay tuned for a related post, in which I'll outline three signs of outsized pension pain - a potential warning that a state's or city's pension burden is so heavy as to impair its ability to meet current expenses and debt repayment.