Much Ado about Nothing? The Size and Credit Quality Implications of Municipal Other Postemployment Benefit Liabilities

Abstract

This paper presents estimates of the size and scope of other postemployment benefit (OPEB) liabilities among municipal governments. The findings indicate these liabilities vary substantially, ranging from less than a dollar per capita to more than $2,000 per capita. Those liabilities were then incorporated into separate models of credit ratings and borrowing costs. Results suggest OPEB liabilities do not directly affect credit quality, but the interaction between an issuer's fiscal capacity to address its liability does have a notable effect.

Impact of Unfunded Pension Obligations on Credit Quality of State Governments

“…These results suggest that “if states are planning to roll over unfunded pension liabilities into bonds when pension funds eventually run dry, they may find themselves doing so at substantially higher borrowing costs” (Rauh , 587). Of note, both Marlowe () and Novy‐Marx and Rauh () find differential effects of funding levels for lower and higher rated entities. That is, the impact of underfunded pensions on bond spreads is greater for states with lower credit ratings.…”

“…However, their study was limited to a small sample size and a short time period. In his examination of the impact of OPEB liabilities, Marlowe () finds OPEB liabilities do not affect local government borrowing costs, either directly or indirectly but rather OPEB liabilities indirectly affect credit quality via the municipality's fiscal capacity, measured by general fund tax effort per capita and general fund current ratio.…”

“…Even though financial markets and government revenues have returned to prerecessionary levels, the results of chronic underfunding of retirement benefit programs for governments are greater long‐term retirement obligations, structural budget deficits, and intergenerational inequities (Peng ). The government's ability to meet these obligations is further hampered as costs related to benefit programs are also expected to rise with the growing numbers of retirees, increased postretirement life expectancy, as well as rising health‐care related costs (Coggburn and Kearney ; Eaton and Nofsinger ; Marlowe ; Rauh ).…”

The Financial Crisis of 2008

“…Mainstream public administration has viewed this problem in narrowgauged terms, examining how a change in accounting rules will impact balance sheets or bond ratings (Frank, 1997;Marlowe, 2007). A more fruitful research agenda with spillovers for the private and nonprofit sectors would examine financial literacy education that prepares Americans for understanding defined contribution plans that dominate the pension landscape.…”

Recognizing and Responding to Retirement Obligations

“…Governments with higher credit ratings, those seeking to influence a change in their credit ratings, and those that are preparing to issue bonds may be more likely to fund their OPEB liabilities or change their benefit policies. Of course, the relationship between credit ratings and OPEB responses isn't necessarily straightforward, since a higher credit rating also suggests an increased ability to fund OPEB liabilities and previous research suggests that bond investors may have already factored the size of OPEB liabilities into the pricing of municipal bonds (Marlowe, 2007). Based on published reports by the three major credit rating agencies, we know that they are monitoring the disclosure of OPEB liabilities, but there is no evidence that the rating agencies have taken any clear action toward governments with larger unfunded OPEB liabilities.…”