Pub. 9 2018 Issue 1

Spring 2018 31 West Virginia Banker Source: Plan CAFRs, FTN Financial Source: Plan CAFRs, FTN Financial Source: Bloomberg, FTN Financial Source: Federal Reserve lean departments is not only time-consuming but politically sensitive. Governments in many areas are finding it increasing- ly difficult to get the necessary consensus for these changes. As a result, when governments faced losses during the 2001 and 2007-2009 recessions, their response was not to increase payments into plans as required by actuaries, but to short con- tributions. Shorting contributions meant lower-than-projected asset growth and, as a result, higher required contributions in subsequent years to reduce growing unfunded liabilities. Governments are also facing headwinds from the wave of baby boomers joining the retirement ranks. Municipalities across the country are confronting a decline in the active to retiree ratio that has resulted in less employees paying into plans versus those withdrawing benefits. Plans have also been taking on more risk through increasing allocation to equities and alternative investments to meet still-optimistic return projections. This can cause a windfall in good markets but has exaggerated effects in down markets as governments take time to bump up payments to required levels when they have to make up return shortfalls. Governments like Chicago and Illinois have seen ratings slashed due to rising pension expenses that have started to test residents’ willingness and ability to pay for them. Dallas saw its own ratings dinged after a run on pensions raised alarms about a liquidity crisis in the public safety fund. And states and other large governments across the country with rising pension cliffs and lack of funding plans are catching similar heat from rating agencies and inves- tors. In fact, a simple regression for the largest state names suggest unfunded pension liabilities now account for nearly two-thirds of the spread differential to triple-A benchmark municipals. The pension story isn’t all bad news. The painstaking meas- ures taxpayers in Illinois and other liability-heavy states have taken to right-size pensions have bought more responsible governments the political cover to start discussions with their own bargaining groups. This has led to a growing reform movement across the country through which governments have secured significant savings, sometimes in double-digit percentages. In addition to popular measures such as reduc- ing or eliminating cost of living adjustments and increasing retirement ages, governments are also taking some of the burden on themselves by reducing discount rates to more re- alistic levels and making commitments to fully fund required contributions. Governments have also been toying with more creative solutions to reduce pension liabilities. For example, New Jersey transferred ownership of its lottery enterprise to its pension funds. This move allows the state to count the present value of future lottery revenues as pension assets today and carve $13bn from its $49bn in unfunded liabilities. In Missouri, the State Employees Retirement System offered buyouts for retirees that would distribute lump sums equal to 60% of projected benefits. Another approach being widely adopted by governments is the creation of new 401(k)-style plans that will put the risk of investment performance on new employees entering the system. The growing acceptance of defined contribution plans in the public sector should stem the growth in liabilities and buy governments time to make up for past shortfalls for benefits already accrued in defined benefit systems. Source: Plan CAFRs, FTN Financial Governments are also facing headwinds from the wave of baby boomers joining the retirement ranks. Municipalities across the country are confronting a decline in the active to retiree ratio that has resulted in less employees paying into plans versus those withdrawing benefits. Source: Plan CAFRs, FTN Financial Plans have also been taking on more risk through increasing allocation to equities and alternative investments to meet still-optimistic return projections. This can cause a windfall in good markets but has exaggerated effects in down markets as governments take time to bump up payments to required levels when they have to make up return shortfalls. -15% -10% -5% 0% 5% 10% 15% 20% 94% 95% 96% 97% 98% 99% 100% 101% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 1yr Return Contributions % ARC 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Activ to Retiree Ratio, State and La ge Local Governm nt Plans Contributions vs. Returns, State and Large Local Government Plans Source: Plan CAFRs, FTN Financial Governments are also f cing headwinds from the wav of baby boomers joining the retireme t ranks. Municipalities across the country are confronting a decline in the active to retiree ratio that has resulted in less employees paying into plans versus those withdrawing benefits. Source: Plan CAFRs, FTN Financial Plans have also been taking on more risk through increasing allocation to equities and alternative investments to meet still-optimistic retur projections. This can cause a windfall in good markets but has exaggerated effects in down markets as governments take time to bump up payments to required levels when they have to make up return shortfalls. -15% -10% -5% 0% 5% 10% 15% 20% 94% 95% 96% 97% 98% 99 100 101 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 1yr Return Contributions % ARC 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Active to Retiree Ratio, State and Large Local Government Plans Contributions vs. Returns, State and Large Local Government Plans Source: Federal Reserve Governments like Chicago and Illinois have seen ratings slashed due to rising pension expenses that have started to test residents’ willingness and ability to pay for them. Dallas saw its own ratings dinged after a run on pensions raised alarms about a liquidity crisis in the public safety fund. And states and other large governments across the country with rising pension cliffs and lack of funding plans are catching similar heat from rating agencies and investors. In fact, a simple regression for the largest state names suggest unfunded pension liabilities now account for nearly two-thirds of the spread differential to triple-A benchmark municipals. 0% 10% 20% 30% 40% 50% 60% 70% 80% 1956 1966 1976 1986 1996 2006 2016 Private Public Allocation to Equities and Alternatives  Public Pensions Continued on Page 32 Source: Bloomberg, FTN Financial The pension story isn’t all bad news. The painstaking measures taxpayers in Illinois and other liability- heavy states have taken to right-size pensions have bought more responsible governments the political cover to start discussions with their own bargaining groups. This has led to a growing reform ovement across the country through which governments have secured significant savings, sometimes in double- digit percentages. In addition to popular measures such as reducing or eliminating cost of living adjustments and increasing retirement ages, governments are also taking some of the burden on themselves by reducing discount rates to more realistic levels and making commitments to fully fund required contributions. Governments have also been toying with more creative solutions to reduce pension liabilities. For example, New Jersey transferred ownership of its lottery enterprise to its pension funds. This move allows the state to count the present value of future lottery revenues as pension assets today and carve $13bn from its $49bn in unfunded liabilities. In Missouri, the State E ployees Retirement System offered buyouts for retirees that would distribute lump sums equal to 60% of projected benefits. Another approach being widely adopted by governments is the creation of new 401(k)-style plans that will put the risk of investment performance on new employees entering the system. The growing acceptance of defined contribution plans in the public sector should stem the growth in liabilities and buy governments time to make up for past shortfalls for benefits already accrued in defined benefit systems. 0% 10% 20% 30% 40% 50% 60% 70% Feb-13 Aug-13 Feb-14 Aug-14 Feb-15 Aug-15 Feb-16 Aug-16 Feb-17 Aug-17 Correlation of ANPL % Revenues vs. 10yr Spread to AAA 10 Largest States, Excluding Illinois Moody’s release of ANPL