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Credit Insights

Introducing Morningstar's Municipal Pension Research

We've analyzed current data for pension plans administered by each of the 50 states.

We are pleased to announce the launch of Morningstar's pension research for municipal credit.

The challenges facing government pension plans have gained new public prominence and attention of late. News sources publish articles about the impending crisis confronting municipal pensions on a regular basis while offering little clarity on how this issue should be analyzed. Often, the net effect seems to be more confusion than information. Identifying the critical truths and separating them from misinformation is a difficult task.

There is no denying that the pension liabilities of our nation's states and local governments represent a significant financial challenge. Public pension costs and liabilities have escalated, pressuring the finances of state and local governments still hampered by the recession. Current data indicate these pressures are expected to persist and perhaps even intensify. In terms of analyzing the importance of public pension liabilities, we believe pensions will play an integral role in determining a government's fiscal health and overall credit quality going forward.

Despite their importance, the inner workings of pensions are often not fully understood. To aid investors' knowledge of public pensions and their potential impact on governments, taxpayers, and investors, Morningstar has initiated an ongoing, comprehensive research effort on the topic.

As the cornerstone of our pension research, we've released our "State of State Pension Plans" report. Click here for an excerpt. State pension plans are particularly important as they affect not only the states themselves but also local governments, indirectly. State plans are often umbrella systems covering employees of local governments as well as employees of the state. Additionally, pension liabilities, including the fiscal strain imposed by ballooning pension costs, can lead to reductions in intergovernmental aid to local governments.

To this end, Morningstar has analyzed current data for pension plans administered by each of the 50 states. The goal of this report is to present in a clear and direct manner an explanation of how each state's pension plan is structured, who it covers, and how fiscally sound our analysis finds it to be. As most states have multiple plans, we aggregated data to determine the key ratios for all systems and plans to which each state contributes. Individual data for each plan are also included in the report, as individual plans can often have funded ratios that are above or below the aggregate for the respective state.

Report findings focus on the two key drivers of our pension analysis: the funded ratio and unfunded actuarial accrued liability (UAAL, or unfunded liability) per capita. Industry trends, upcoming regulatory changes, and potential red flags investors should watch for are examined as well. While the traditionally used metric of the funded ratio serves as a good measure of the plan's ability to meet its obligations, Morningstar also highlights the UAAL per capita, which in our opinion is a useful metric not commonly applied in the current pension analysis narrative. Similar to the debt per capita calculation in credit analysis, the UAAL per capita represents the amount each person in the state would need to pay to fully fund this unfunded liability.

While the majority of states are adequately managing their aggregate pension liabilities, several pension systems are coming under duress. On the positive side, seven states have an aggregate funded ratio of at least 90%, while eight states have unfunded actuarial accrued liabilities under $1,000 per capita. Wisconsin is currently the strongest system, with a 99.8% funded ratio and a UAAL of $23 per capita. On the other side of the spectrum, 21 states fall under Morningstar's fiscally sound threshold of a 70% funded ratio. Despite the passage of recent reforms, Illinois continues to have the worst-funded system, with a 43.4% funded ratio and a $6,505 per capita UAAL. While Illinois has the lowest funded ratio, Alaska has by far the highest UAAL per capita, at more than $10,000. This is despite its higher, although still poor, funded ratio of 59.2%. The majority of plans continue to experience declines in their funded levels and increases in their UAAL per capita, although volatility has become more muted since its peak in 2009.

Morningstar will update its pension research annually to keep investors informed about the current fiscal health of each state's pension liabilities as well as any impact it may have on the state's overall credit quality.

Additionally, we previously released our "State and Local Pensions 101" report, which serves as an introduction to public pension plans. It provides an overview of pension accounting, how pension plans can be structured, and how pensions relate to overall government credit quality.