Subcutaneous grey liabilities, from Tasmania to Kentucky via Schleswig-Holstein | FT Alphaville

Subcutaneous grey liabilities, from Tasmania to Kentucky via Schleswig-Holstein

Creakier than sovereigns’ long-term pensions liabilities? Sub-sovereign ones, possibly.

A new piece by Moody’s lands, looking at the problem among the regions and cities of four countries otherwise rated Triple-A: Australia, Canada, Germany and the United States.

This is creeping up the agenda again in the US, thanks to the unfortunate case of can’t pay/must pay Detroit. But Moody’s also wants to draw your attention to Germany’s Länder which, it turns out, do not fund long-term accruals or report liabilities.

Let’s just repeat that for everyone who worries about unfunded healthcare costs of US retirees, or thundered about Greek pensions. While good old Australia has already shifted most of its public sector workers onto defined contribution schemes, and imposed conservative reporting requirements, they do things differently on the Rhine. From Moody’s:

German Länder are at the opposite end of the spectrum in that they do not report the value of their defined-benefit pension liabilities, so there are no reported data to adjust. The Länder operate only on a pay-as-you-go basis without pre-funding during their employees’ working careers.

Additionally, it turns out, civil servants (or beamte in German) do not make any contributions to pension plans. Their pensions are the direct responsibility of the Länder, and the liabilities are bigger in the West, where civil servants account for around 50 per cent to 60 per cent of government workers, against 40 per cent to 50 per cent in the former communist East.

Pension payments rose at 4.6 per cent annually between 2008 to 2012, against a 1.6 per cent rise for Länder revenues overall (click chart to enlarge):

Now, Moody’s is flagging what it calls a “clouding of risks” here, not imminent disaster. Furthermore, there is another big difference between the German system and elsewhere: a lack of contractual obligation to actually pay those pensions.

The Länder can adjust the pension system over the long term by reducing pension benefits for current civil servants and retirees and, hence, annual payments. Unilateral changes of this type are politically challenging to impose, but there are examples in recent history. In 2003, Nordrhein-Westfalen (Aa1 negative) was one of the first of the Länder to reduce the annual bonus it gives to current civil servants and retirees, reducing cash outlays with immediate effect. Another measure is the increase in the retirement age in most of the lander; for example, Baden-Wuerttemberg (Aaa negative) increased the retirement age to 67 from 65 in 2010, a change that will be phased in over several years.

So that’s OK then. Outside Germany, Moody’s is also reasonably relaxed about Tasmania, where legacy liabilities weren’t really funded and so stand at 165 per cent of the state’s annual revenues. But because of a shift to defined contribution in the 1990s, that will decline over time and pension contributions are forecast to eat up no more than 7 per cent of revenues.

Over in the US, however, it ain’t so great. There are around 8,000 separate local government entities, so some have been doing well on the pension front (kudos Nebraska), others less so. Puerto Rico has frozen its largest plan for government employees and is essentially in pay-as-you go mode.

Nine US states are in a Tasmania-like situation where the liability is greater than annual revenues, but unlike Tasmania, the liabilities are still growing. We’re looking at you, Illinois, Connecticut and Kentucky. Moody’s estimates the true liabilities for those states as 241 per cent, 190 per cent and 141 per cent, respectively.

Don’t forget the cities, though. Chicago’s pension funding hole is $28.5bn, almost seven times annual revenues, making it by far the worst of the 50 most indebted cities in America on the Adjusted Net Pension Liability to Revenue measure Moody’s calculates. But it is far from alone:

Related Links:
Space, time and public pension black holes - FT Alphaville
“They haven’t got a handle on what is happening in the Länder.” – FT Alphaville
California governor proposes public sector pension reform – FT Alphaville