S&P is out with a recent analysis suggesting that many American cities with weak pension funded status will likely face challenges in meeting both pension obligations and other social safety net funding. According to an article by Cole Lauterbach, Illinois News Network, S&P Global Ratings is predicting that growing public retirement debt will eat up a greater share of the funds available to meet other taxpayer needs.

S&P’s annual report specifically highlights the funding for America’s largest 15 cities and their public debt. It is not surprising that S&P warns that taxes will rise and services will be cut if additional sources of revenue cannot be identified. This problem has been anticipated for a long time. What is disappointing is the fact that S&P does not focus on the management of the pension systems, but only speaks to the growing burden created by these plans. The failure of pension America to secure full-funding in the late 90’s when the war was won is a critical component not often discussed when highlighting the burgeoning deficits.

Furthermore, we are now 9 1/2 years into a historic equity market bull market and yet, funding hasn’t improved for many of these plans. Focusing on the return on asset (ROA) assumption has never been the right strategy, but it is particularly fraught with peril at this time. Pension systems should be managed against their promised benefits, and investment structure and asset allocation determined by the plan’s funded ratio. By adopting more of a liability focus, plans can remove much of the short-term funding volatility, while extending the investing horizon for the balance of the assets in order to capture the liquidity premium of equities, real estate, private equity, etc.

Pension obligation bonds are another means to close some of the funding gaps, but only if the proceeds are used to defease retired lives (and terminated vesteds) and not placed in a traditional asset allocation subject to all of the equity market’s volatility. It is one thing to repay the bond and interest, but an entirely different scenario to have to make up for a 20% decline in the value of the bond proceeds.  Let’s hope that America’s largest cities develop a willingness to try alternative approaches to the management of these critically important pension programs.