Cases of unfunded pension liabilities among state and local government issuers have emphasized the importance of considering pension obligations in the analysis of municipal credits. But not all pension plans are alike, and a clear understanding of the various types of retirement plans can help determine the amount of risk a plan may carry for the underlying credit.
Pension plans generally fall into two categories: defined benefit and defined contribution. Governments have traditionally provided the defined benefit plan, which largely calls for the sponsoring government to bear the liability burden. Over the past decade, calls to reduce the risks aligned with defined benefit pension plans have begun to prompt more governments to initiate or switch to defined contribution plans.
A defined contribution pension plan, used by a minority of municipal entities at this point, is similar to a traditional 401(k) plan in that it follows a formula for determining the amount the plan member will contribute. The amount that the member ultimately receives in benefits depends solely on the contributions and corresponding investment earnings. Because defined contribution plans do not offer guaranteed pension benefits, employers participating in this type of plan incur no long-term liability.
On the other hand, a defined benefit pension plan includes terms that specify the amount of pension benefits to be provided at a future date, or after a certain period of time. Under this type of plan, benefits received by the plan member are generally determined by a combination of factors, including age, years of service, and compensation level. Defined benefit pension plans can carry a greater level of risk because benefits are guaranteed, and payment relies on assets that must be set aside for use at a later date.
Defined benefit pension plans can be further subdivided into three types: single employer, agent multiemployer, and cost-sharing multiplier. This distinction is important to note, because each type is subject to different reporting requirements.
- A single employer plan is fairly simple to identify. This type of plan covers the current and former employees, including beneficiaries, of only one employer. Single employer plans must report individualized information pertaining to an employer’s Annual Required Contribution (ARC), actual contributions, Annual Pension Cost (APC), Net Pension Obligation (NPO) and total Unfunded Actuarial Accrued Liability (UAAL).
- An agent multiemployer plan can be thought of as a hybrid of a cost-sharing plan and a single employer plan. Under this type of plan arrangement, more than one employer aggregates the individual defined benefit pension plans and pools administrative and investment functions. The plan for each employer maintains its own identity within the aggregated plan. Separate accounts are maintained for each employer so that its contributions provide benefits only for its respective employees. In addition, a separate actuarial valuation is performed for each individual employer’s plan to determine its periodic contribution rate and other related information based on its respective benefit formula and proportionate share of the pooled assets. The reporting requirements for this type of plan are the same as for single employer plans.
- A cost-sharing multiemployer plan includes members from more than one employer where there is a pooling, or cost-sharing, for all of the participating employers. All risks, rewards, and costs, including benefit costs, are shared and are not attributed individually to the employers. A single valuation covers all plan members regardless of their respective employer. It is important to note that employers participating in this type of plan will not present an unfunded actuarial accrued liability representative of their total obligation to the pension system. The only reporting requirement for employers participating in cost-sharing multiemployer plans is the recognition of annual pension expenditures.
The structure and reporting requirements for the various types of public employee pension plans can influence the ultimate obligation to an issuer’s employees – and investors. Identifying which type of pension plan is associated with an issuer can be an important distinction it its credit analysis.
Merritt Research Services provides summary pension plan information for each governmental body that has responsibility for one or more plans. In the pension data section of Creditscope, users will find an aggregate compilation of all of the plans for which a government is accountable. Following the summary data, individual plans provided by the government are shown separately. Additionally, the pension plan type is noted for State credits so that researchers can assess the full scope of liability that is likely to circle back to the parent governmental party.
