Fitch Ratings will be discounting pension liabilities of public pension systems at a 6% investment return rate, rather than the 7% the rating agency was using previously, based on its views relating to slow economic growth that does not justify the higher rate of investment return.

Douglas Offerman, senior director, Fitch Ratings, noted, “US growth has been slower and more incremental over the current economic expansion than over longer time horizons. There is little evidence to suggest the economy will accelerate to previous levels of growth in the near term. Fitch believes that pensions will be hard-pressed to achieve their long-term growth expectations in the current economic context.”  

Fitch believes “the 6% return assumption, and increased total pension liability, better reflect the magnitude of the burden posed by pensions.” The New York ratings agency will apply the change to its input for assessing the pension liabilities of state and local governments.

It seems that for the 1% drop in Fitch’s investment return assumption, on average, these entities will see about a 11% hike in their total pension liabilities. Most of them will see their pension liabilities increase in the 9% to 15% range. There will also be a small number of state and local governments that are outliers, whose pension liabilities will rise beyond this expected range, based on their individual pension system characteristics.

US growth has been slow in recent years, and feeling the impact of an aging population, reduced participation in the workforce, productivity that hasn’t risen, and restrained growth in wages. The economy last went through this sort of slow growth in the 1970s and 1980s.

Fitch finds that challenged pension systems are investing more in “broader ranges” of equity, fixed-income, and alternative assets so as to preserve their long-term returns in today’s environment of low market interest rates. However, these investments are also more volatile and expose the systems to higher risk.

“Among some outliers, exposure to unusually risky asset classes is well beyond what is typical for pensions with very long-term liabilities, and ultimately raises the risk that pension sponsors and participating governments will have to absorb the heightened risk of return underperformance,” according to Fitch.

The ratings agency also expects that the lower 6% discount rate serves to better gauge other risks associated with a defined benefit pension plan. For instance, actuarial updates could make for upward revisions to mortality expectations, and government policies could impact hiring levels, benefits, and contribution trends. These sorts of changes could expose state and local governments to higher liabilities and contributions.

Tags: Fitch, pension liabilities, ratings