September 16, 2013

Morningstar: State Pensions Complex, Lack Transparency

Pension accounting filled with assumptions, leads to uncertainty, research firm says

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Who’s watching your client’s pension? At the state level, who knows?

A new report from Morningstar notes the “inherent challenge” in understanding and studying the current state of …well, state pensions, mainly due to their complexity, weak disclosure requirements, and their sheer number. In addition, pension accounting is filled with assumptions, which leads to a lot of uncertainty. Morningstar does add that this might be about to change, however.

“During the last few years, there has been a lot of negative attention focused on pensions, but new standards approved by the Governmental Accounting Standards Board could spark some significant changes,” Rachel Barkley, municipal credit analyst for Morningstar, said in a statement. “We’ve seen the funded levels of state pension plans continue to decline during the last year, albeit modestly."

She noted the bankruptcy filings of San Bernardino, Calif., and Detroit may have significant effects on the national level.

Morningstar’s municipal credit analysts found that based on two key funding metrics, Wisconsin had the strongest-funded state pension plan system while Illinois had the weakest among all 50 states, for the second year in a row. However, in a break from past reports, the Chicago-based research firm analyzed Puerto Rico as well, and found it ranked as the weakest among all the pension systems evaluated by Morningstar.

The two key metrics were:

  • Funded Ratio: the ability of a pension plan to meet its obligations, which is calculated by dividing the pension plan’s assets by its liabilities, and
  • Unfunded actuarial accrued liability (UAAL) per capita: the unfunded liability per capita, representing the amount each person in the state would need to pay to fully fund this unfunded liability.

“On the upside, recent data indicate that long-term investment returns are generally in line with assumptions used by most pension plans,” Barkley added. “Additionally, in recent years most states have implemented some level of pension reforms.”

Additional key conclusions from Morningstar’s review include:

  • Wisconsin remains the strongest-funded state pension system; the state’s funded ratio is 99.9%, a 0.1% increase from last year, and the liability per capita is $18, which fell $3 from 2012;
  • Illinois continues to have the weakest-funded state pension system, with a 40.4% funded ratio, falling 3% compared to last year, and a liability of $7,421 per capita, an increase of more than $900 compared to 2012;
  • Puerto Rico’s pension system is weaker than Illinois’, with a funded ratio of 11.2% and a liability of more than $8,900 per capita. According to the commonwealth, all three of its pension plans are projected to deplete their assets over the next few years, but recently passed reforms may mitigate the losses;
  • Twenty-six states and Puerto Rico fall below Morningstar’s fiscally sound threshold of a 70% funded ratio; Puerto Rico has the lowest funded ratio;
  • Twelve states have an aggregate funded ratio of 80% or more, led by Wisconsin for the second year in a row;
  • Seven states have a UAAL of less than $100 per capita. Wisconsin has the lowest UAAL per capita for the second year in a row. Thirteen states have a UAAL under $1,500 per capita, which is Morningstar’s threshold for “Good” unfunded liability levels; and
  • Alaska had the highest UAAL per capita for the second year in a row, currently more than $10,000.

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