Moody’s Final Adopted Adjustments of Government Pension Data

Edward Ring

Director, Water and Energy Policy

Edward Ring
June 2, 2013

Moody’s Final Adopted Adjustments of Government Pension Data

June 2, 2013

By John G. Dickerson

About the Author: John Dickerson is a financial professional living in Mendocino County who is involved in public sector pension analysis and reform. Dickerson focuses on the impact of unfunded pension debt on the 21 California counties that operate their own independent Pension Funds. He is a financial and organizational planner and analyst with 30 years of experience. He earned his MBA in Strategic Planning from the University of Texas at Austin. This paper is copyrighted by John G Dickerson, and quotes from this paper should be attributed to: John G Dickerson, It may be copied and distributed at will if it is provided to readers and other users for free. However, it must not be changed nor can any type of fee be charged in relation to this material without the author’s express written permission.


At the end of June 2012 the Governmental Accounting Standards Board imposed new pension financial reporting requirements on state and local governments that will kick in over the next couple of years. One week later Moody’s Investors Services announced their intention to modify pension financial data reported by state and local governments in Moody’s credit rating analysis. They published their final adopted adjustments on April 17, 2013. They believe current and even the new government financial reports understate the risk of unfunded pensions to buyers of government bonds and do not provide for adequate transparency and comparability. Moody’s will only use these adjustments in their internal credit rating analysis for state and local governments. The adjustments are not a “guide, standard or requirement.” Moody’s projects their adjustments would have increased total state and local government unfunded pension debt from about $782 Billion in 2011 to about $1.9 Trillion – over $1 Trillion more. State and local Pension Funds reported they had 74% of the assets they needed to be “fully funded.” Moody’s adjustments would have reduced that to 53%.

The purpose of this paper is mostly to focus on Moody’s adopted adjustments, compare them to the earlier proposals, and demonstrate how these adjustments and GASB’s new rules will change government pension data.

I applied Moody’s adjustments and GASB’s new pension financial reporting rules on the 2011 statements of 7 California counties’ with County Pension Funds (Alameda, Contra Costa, Marin, Mendocino, Orange, San Mateo, and Sonoma). They reported $1.7 Billion of Pension Obligation Bond (POB) Debt. GASB’s old rules don’t require them to report unfunded pension debt as liabilities – the new rules will. These counties would have reported at least $7.6 Billion of additional liabilities using the new rules. Including the Pension Obligation Bonds, they would have reported nearly $10.0 Billion in unfunded pension debt. Moody’s adjustments increased unfunded pension debt (POB + Net Pension Liability) to about $18.45 Billion. Dickenson_MoodyFinal_intro The impact on Net Assets (Net Worth) is dramatic. The counties reported they had over $10.2 Billion more assets than debts – but they didn’t report the impact of unfunded pension debt as GASB will require next year. Under GASB’s new rules, they would have reported Net Assets were not quite $1.0 Billion – an “overnight” drop of over $9.0 Billion of Net Worth. Moody’s adjustments are even more astonishing – they would have shown the combined Net Worth of these seven counties was a negative $7.4 Billion. Only Marin is left with positive Net Assets.

Moody’s final adopted adjustments are:

1. Multiple-employer cost-sharing plan liabilities will be allocated to specific government employers based on proportionate shares of total plan contributions. (Same as proposed)

2. Accrued actuarial liabilities will be adjusted based on a high-grade long-term taxable bond index discount rate as of the date of valuation. (Slight change)

3. Asset smoothing will be replaced with reported market or fair value as of the actuarial reporting date. (But not for local governments – significant change)

4. The resulting adjusted net pension liability (i.e. adjusted liabilities less assets) will be amortized over 20 years using a level-dollar amortization. (significant change)

Compared to the Proposed Adjustments of last summer the biggest change is that Normal Yearly Pension Contribution by states will not be adjusted. Consistent with their original proposals, Moody’s will adjust State Net Pension Liability amortization payments and will not adjust local government payments. Other significant changes are that Moody’s will use the “Actuarial (Smoothed) Value of Assets” for local governments (while still converting to Market Value for states) and will assume unfunded pensions should be eliminated in 20 years rather than the proposed 17 years.

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Table of Contents



A. PROPOSED – JULY 13, 2012 2

B. ADOPTED – APRIL 17, 2013 2


1. Summary 3

2. What Didn’t Change 3

3. What Changed a Little 4

4. Pension Asset Value – States No Change – Local Governments Change 5

5. Significant Changes – Government Payments to Pension Funds 5







1. Doubles Unfunded Pension Debt 10

2. From $10 Billion of Positive Net Worth to $7.5 Billion “In the Hole” 11








Table of Figures












Table of Tables










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At the end of June 2012 the Governmental Accounting Standards Board (GASB) imposed major changes in pension financial reporting requirements on state and local governments that will kick in over the next couple of years. One week later Moody’s Investors Services (one of the two most powerful credit rating agencies in the US – the other is Standard and Poors) published a report titled “Adjustments to US State and Local Government Reported Pension Data.” They described proposed significant adjustments they would make in their credit rating analysis to pension financial data reported by state and local governments. On April 17, 2013 they released a document with the same title – a description of the adjustments they finally adopted.

I published a paper analyzing Moody’s proposed changes on 1/11/13 that showed what the impact of those changes would have been on six California counties. I produced another paper on 3/13/13 combining that paper with analysis of GASB’s new pension financial reporting rules known as GASB 68. I showed the impact of both on seven California counties.

The purpose of this paper is to:

    • Describe Moody’s adopted adjustments 
    • Compare them to those that were proposed (what changed, what didn’t) • 
    • Demonstrate the impact of both the proposed and final Moody’s adjustments and GASB’s new rules on government financial statements.

Moody’s describes its purposes in making these adjustments:

Moody’s focus is the evaluation of credit risk of rated debt obligations. Because pensions represent material financial commitments that affect a government’s financial risk profile, we have always incorporated pensions into our credit analysis where we have been aware of significant unfunded liabilities. As pension stress began to be a driving factor in a number of government rating downgrades over the past few years, we recognized a need to bring greater transparency and comparability to the pension measures used in our analysis.

Current government financial reporting standards don’t require unfunded pension obligations to be reported as “bona fide” liabilities. Governments and their Pension Funds adopt widely varying actuarial assumptions (expected rate of investment return, number of years and method to eliminate unfunded obligations, etc.) that produce significantly different values even if when there are no fundamental differences in the financial condition of pension funds. Further, current standards don’t require multiple-employer government Pension Funds to allocate unfunded obligations to participating governments.

Moody’s adjustments are designed to approximate unfunded pension obligations for all public pension plans as if they had all used the same target rates of return, policies about eliminating unfunded pension obligations, etc. That makes the adjusted values more “comparable”. By specifically including adjusted unfunded pension values as debts and assigning values to governments in multiple-employer pension plans Moody’s adjustments make these obligations more “transparent.”

Moody’s wants everyone to be very clear about one thing – these adjustments will only be used in their internal credit rating analysis. “Our adjustments are not intended as a guide, standard or requirement for state or local governments to report or fund their obligations.” No government has to change its reporting of its pension finances or increase pension funding. But as a practical matter I think it’s fair to say that Moody’s adjustments regarding payments to eliminate unfunded pensions are in effect “benchmarks.” Governments don’t have to pay that much, but if they don’t they are putting their credit ratings at risk.

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A. Proposed – July 13, 2012

These were Moody’s four proposed adjustments in their July Moody’s Proposed Adjustments (page 1):

1. Multiple-employer cost-sharing plan liabilities will be allocated to specific government employers based on proportionate shares of total plan contributions.

2. Accrued actuarial liabilities will be adjusted based on a high-grade long-term corporate bond index discount rate (5.5% for 2010 and 2011).

3. Asset smoothing will be replaced with reported market or fair value as of the actuarial reporting date.

4. Annual pension contributions will be adjusted to reflect the foregoing changes as well as a common (adjusted net pension liability) amortization period.

They also proposed to combine adjusted pension debt with other debts to measure long-term liabilities.

Further, Moody’s example of a government’s net pension liability amortization payments used “beginning of year amortization” rather than “end of year”. That is, the amortization payments were based on the assumption that payments were made at the beginning of each year. That meant there was no interest expense included in the first year’s payment – therefore amortization payments were lower than they would have been had the more common “end of year payment” amortization method been used. (In an email the research manager in charge of developing the adjustments on behalf of Moody’s confirmed that was the method they would use.)

B. Adopted – April 17, 2013

These are the adjustments announced by Moody’s in their April Moody’s Final Adjustments (page 3):

1. Multiple-employer cost-sharing plan liabilities will be allocated to specific government employers based on proportionate shares of total plan contributions. (Same as proposed)

2. Accrued actuarial liabilities will be adjusted based on a high-grade long-term taxable bond index discount rate as of the date of valuation. (Slight change – see below)

3. Asset smoothing will be replaced with reported market or fair value as of the actuarial reporting date. (Changed – see below)

4. The resulting adjusted net pension liability (i.e. adjusted liabilities less assets) will be amortized over 20 years using a level-dollar amortization. (Significant change – see below)

Moody’s won’t combine their adjusted unfunded pension debt value with other debt. Moody’s also changed to the “end of year” amortization payment method. However, they didn’t note that change in their text.

C. Changes

1. Summary

Moody’s provided this exhibit summarizing the changes : Dickenson_MoodyFinal_t1 2. What Didn’t Change

a) Allocation of Multi-Government Pension Funds

The financial data for “Cost Sharing Multiple Government Employer Pension Funds (“CSP”) as a whole will be allocated to participating governments in proportion to each government’s total contribution to the Fund as a percent of contributions from all governments. However, if the Pension Fund’s valuation provides an adequate allocation of total Pension Fund values to individual governments Moody’s would use those values.

b) Common Period to Adjust Total Pension Liability

To determine the value of Total Pension Liability Actuaries first project the amount of pension payments that have already been earned that will be made each year in the future, then they “discount” each future year’s projected payments by the Pension Fund’s assumed rate of investment return to obtain the amount of money that should be in the Pension Fund today. This amount is the “Actuarially Accrued (Pension) Liability” (“AAL”).

Moody’s will use a different – and today a significantly lower discount rate than Pension Funds’ assumed investment rate of return. (For more about the “discount rate” see “Change in “Index” Used” below.) However, Moody’s can’t simply replicate the calculation made by Actuaries using a different discount rate because they don’t have the projected payments in each future year of pensions that have already been earned. Therefore Moody’s devised an “estimating” calculation that approximates the value of Total Pension Liability had the Actuary used the lower discount rate.

The value of the Actuarially Accrued Pension Liability will be projected 13 years into the future using the Pension Fund’s assumed rate of return, and then “discounted” back to the present using the lower return described below. This will produce a higher Total Pension Liability value than the AAL.

There was no change in this 13 year “liability adjustment period”.

3. What Changed a Little

a) Combined Debt and Pension Metrics

We will measure and evaluate debt and pensions separately to reflect a number of factors that differentiate pension liabilities from bonded debt. Most municipal market debt service payments are predictable, set contractually, and subject to default. Pension liabilities are estimates (including an element of future salary growth for current employees) and in many cases can be changed through policy action. Governmental pension contributions are generally not subject to default.

I assume this isn’t a big change – but if the separate values are subject to different mathematical or qualitative analysis this could be more impactful. (I didn’t see anything about this in Moody’s documents.)

b) Discount Rate

(1) Change in “Index” Used

The amount Moody’s will consider to be “pension debt” for a government will be the difference between its shares of the value of a Pension Fund’s assets and it’s Total Pension Liability. The discount rate is used in calculating the Total Pension Liability.

Government Pension Funds use their assumed rate of investment return as a “discount rate” to determine the net present value of future pension payments that have already been earned. That’s the amount of money the Pension Fund is supposed to have today – the “Actuarially Accrued Liability” or “Total Pension Liability”. Assumed rates today are typically in the 7.25% to 7.9% range.

The rules for reporting pension liabilities in the private sector require their Pension Funds to use a much lower discount rate which results in significantly higher Total Pension Liability values. Moody’s will adjust government-reported Actuarially Accrued Liability to approximate what it would have been had the much lower rate used in the private sector been used.

Moody’s initially proposed to use a “high-grade long-term corporate bond index discount rate”. However, the rate defined in their Final Adjustments is “Citibank’s Pension Liability Index”.

The (Citibank Pension Liability Index is composed of high credit quality (Aa rated or higher) taxable bonds and is duration-weighted by Citibank for purposes of creating a discount rate for a typical pension plan in the private sector.

There appears to be very little practical difference between a high quality corporate bond index and Citibank’s Pension Liability Index. However, the Citibank index is commonly used in the private sector to calculate the Total Liability. Therefore the rationale for its use is already established.

Figure 1 shows the value of the Citibank Index over the past several years: Dickenson_MoodyFinal_f1 (2) Change in Date of Index Value

Moody’s originally proposed to set a discount rate that would be used throughout each year, but their final adopted adjustments will apply the Citibank Index discount rate as of the date of a Pension Fund’s Actuarial Valuation. Therefore the discount rate will vary somewhat through each year.

c) End of Year Amortization

In their proposed adjustments Moody’s constructed net pension liability payment schedules based on the assumption that governments would make one payment per year at the beginning of each year rather than at the end of the year. In my paper presenting my analysis of Moody’s proposed adjustments I wrote:

In an email exchange the author of Moody’s paper indicated Moody’s believes the “correct” method of calculating interest expense is “beginning of period” rather than “end of period”. Also they are simplifying the amortization schedules by assuming annual payments. I and several other financial professionals don’t understand the idea that “one payment per year” wouldn’t incur interest expense in the first year. It would have to be made on the first day of the first year in order to have no interest expense – it would all go to reduce debt principal. Payments are generally made to Pension Funds when governments make payrolls or shortly thereafter. Government paydays are sometimes once a month, or twice a month, and sometimes every two weeks or 26 times a year. In any of these “real world” systems there would be at most only one payment for anywhere from a two-week to one-month period that doesn’t accrue interest expense and then only if that payday occurs on the first day of the first fiscal year. However – since this is Moody’s assumption the analysis in this paper uses that assumption – even though we don’t think it’s realistic.

Well … in their paper describing their final adopted adjustments Moody’s changed its amortization payments to the “end of year” payment method thereby incurring a full year’s interest expense in the first year. They didn’t point that change out in their text. This change makes “more sense” – but as indicated above governments typically make payments to their Pension Funds every payday rather than once a year. The one-payment at end-of-year method used in Moody’s Financial Adjustments overstates the expected interest expense. However, the difference between beginning of year and end of year payments is only about 4% or so – not terribly significant.

4. Pension Asset Value – States No Change – Local Governments Change

Moody’s original proposal was to use the Market (or “Fair”) Value of Pension Fund Assets in calculating the Net Pension Liability instead of a “smoothed” Actuarial Value of Assets (“AVA”). Moody’s Final Adjustments maintain that change for States but reverts to using the AVA for local governments. Moody’s says that Market Value is not readily available for many local governments. We’ll see the impact of this change for local governments below.

5. Significant Changes – Government Payments to Pension Funds

Governments make two major types of payments to their Pension Funds:

    • “Normal” Yearly Contributions – calculated by Actuaries to be the amount of money that needs to be contributed in a year so that the part of future pension payments that are being earned that year will be able to be paid assuming all the other assumptions in the Pension Funding plan come true (return on investment, life spans, etc.) This amount typically is split between governments and each year’s employees in varying proportions.
    • Unfunded Pension Obligation Amortization Payments – if in the future the Pension Fund’s Actuary calculates that the Pension Fund in fact has significantly less money than it needs to be able to pay the part of future pensions that were earned in the past (not in the current year – but in past years) then the government must pay additional money to the Pension Fund to eliminate that deficit.

Moody’s final adopted adjustments regarding these payments are significantly different from what they originally proposed.

a) No Adjustment to “Normal” Yearly Contribution

Moody’s originally proposed to adjust the amount of the Normal Yearly Contribution governments should be paying to Pension Funds in a manner similar to how they will adjust the Total Pension Liability. However in their final adopted adjustments they announced they will not change the value of the Normal Yearly Contribution. Moody’s explains:

As initially proposed, our adjusted annual cost measure required computation of normal cost for each issuer. In many cases, actual normal costs are not reported and must be estimated from percentages set in actuarial valuations from previous years. This process was arduous, introduced errors into our data, and was impractical to apply to the local government sector, which consists of about 8,000 rated entities.

This has a significant impact on adjusted government payments to Pension Funds as we will see below. It is the biggest financial difference between the impact of the proposed and the final adopted adjustments.

b) Unfunded Pension Amortization Payments

Governments are required to pay additional money to their Pension Funds if unfunded pension obligations develop.

(1) What Stayed the Same

(a) Only State Payments Will Be Adjusted

Moody’s originally proposed to adjust the amount of these payments for States but not recalculate the value of these payments for local governments. That remains the same in Moody’s Final Adjustments. Moody’s explains that the data needed for these recalculations for local governments is often not easily available. I encouraged them to make these adjustments for local governments for which the data is readily available – but Moody’s decided not to follow my advice (as difficult as I’m sure that decision was for them).

(b) Interest Rate (Basically the Same)

Moody’s will calculate a new “amortization schedule” for each State. Two aspects of the new payment schedule remain essentially the same as originally proposed. Firs,t Moody’s will use the lower interest rate they will use to adjust the value of Total Pension Liabilities. (As discussed in ”Change in “Index” Used” above they will use a slightly different source for the rate they will use but it most likely won’t make a big mathematical difference.

(c) Level Dollar Amortization – Not Level Percent of Payroll

Second, Moody’s will use the “Level Dollar Amortization” method instead of the “Level Percent of Payroll” method used by most Pension Funds and governments.

The “Level Dollar” method is basically the same as the traditional 30 year fixed interest rate & payment home mortgage except the number of years can be shorter. You borrow money to buy a house and pay it back by making equal payments every month for 30 years. Most of the early payments are interest but the last payments mostly reduce debt.

Under the “Level Percent of Payroll” method the Actuary first estimates how much the government’s total payroll will be in each year of the amortization period assuming it will grow the same percent each year – usually projected at about four percent. Then the Actuary calculates a fixed percentage of each year’s payroll the government needs to pay to eliminate the unfunded pension debt by the end of the amortization period. That fixed – or “level” percent of each future year’s projected payroll is projected to be each future year’s payment.

The Level Percent of Payroll method produces payments that are significantly lower than the Level Dollar method in the early years and significantly higher in later years. If the “amortization period” (the number of years payments are made) extends beyond 18 years or so the payments in the early years will be less than the yearly interest expense on the debt and therefore the debt will grow for a number of years. This is called “negative amortization” because the debt grows rather than shrinks.

(2) What Changed – 20 Year Amortization, Not 17 Year

Moody’s originally proposed to use a 17 year amortization period. Their Final Adjustment is to use a 20 year period. They explain:

will amortize adjusted net pension liabilities on a level dollar basis over a period of 20 years rather than the proposed 17 year period. The change to 20 years makes the amortization similar to a bond payment structure, as opposed to the average employee remaining service life concept on which the 17-year proposal was based. The resulting metric is a pro-forma measure of the potential annual cost of addressing prior service liabilities over a time period similar to that of bonded debt.

Those extra 3 years lower the annual payment amount.

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A. Significant Impact on Pension Financial Values

Moody’s Final Adjustment report presented these changes in Net Pension Liability as a result of their adjustments as applied to fiscal year 2011 financial statements. Dickenson_MoodyFinal_t2 The Market Value of Pension Fund Assets for states was $71 Billion less than the reported Actuarial Value – 7% less. However, Moody’s Adjusted Total Pension Liability was $485 Billion more than the reported Actuarial Liability – 34% more, Moody’s adjustments added $556 Billion to the states’ Net Pension Liability that Moody’s would have used in its credit rating analysis had the adjustments been made for 2011. The resulting $964 Billion of Net Pension Liability was 2.4 times greater than the reported Actuarial Value.

Moody’s has decided not to adjust the value of Local Government Pension Fund Assets. But their adjustments added $537 Billion to Total Pension Liabilities which therefore increased the Net Pension Liabilities by the same amount. This was also 2.4 times larger than the reported Actuarial Value.

The combined Moody’s Adjustment Net Pension Liability grew from $782 Billion to $1,875 Billion.

The “Funding Ratio” (Pension Fund Assets/Total Pension Liabilities) for states declined about 1/3 and that of local government Pension Funds went down about a quarter.

B. Moody’s Projects Modest Impact on Credit Ratings

At first glance Moody’s adjustments produce such striking changes in pension funding values that it seems “intuitive” they would lead to a significant number of government credit rating downgrades. But Moody’s indicates the portion of downgrades would be very minor at most – at least in the immediate future.

The application of the adjusted pension data in our ratings of state governments is discussed in “US States Rating Methodology” released simultaneously with this report. The incorporation of the pension adjustments into our updated methodology will have no immediate impact on state ratings.

Application of the adjusted pension data in our ratings of local governments will be made within the context of our methodology, “General Obligation Bonds Issued by US Local Governments”. We expect that less than 2% of the total population of local general obligation (GO) and equivalent and related ratings will be placed under review for possible downgrade as a result of adopting the adjustments. The affected ratings will be for those local governments whose adjusted pension obligations relative to their resources place them as significant outliers in their ratings categories. 

How can Moody’s adjustments result in Net Pension Liabilities nearly two and a half times larger on average than is reported today by state and local governments and have such a negligible impact on credit ratings? Frankly – I don’t know – doesn’t make sense to me. However, the answer may lie at least in part in the methodology Moody’s uses to determine credit ratings as defined in the two documents cited above.

C. Moody’s Credit Ratings Result from Many Factors

As cited above Moody’s released two other updated documents with its Final Adjustments on April 17:

    • US States Rating Methodology
    • General Obligation Bonds Issued by US Local Governments

These documents generally describe how Moody’s evaluates state and local government credit worthiness. The adjustments to pension financial data will impact Moody’s credit ratings in the context of these methodologies. Moody’s describes its general approach in analyzing Local Governments this way:

Moody’s employs a weighted average approach to analyzing these factors (described below) to arrive at a rating range. The precise rating is based on a comparison with peers, interactions of the individual factors, and additional considerations that may not adequately be captured within the factors. While this framework is comprehensive, it still may not adequately capture the complex web of economic, financial and political issues that affect a local government’s relative creditworthiness. Therefore, some of our general obligation ratings may lie outside the rating range implied by the weighted average approach.

The factors Moody’s uses in evaluating credit rating and the “weight” given to each are:

    • Economic Strength
    • Financial Strength 30%
    • Management and Governance 20%
    • Debt Profile 10%

See Moody’s Credit Rating Factors for Local Government General Obligation Bonds on page 22 for a list of the four major factors and 16 sub-factors used in Moody’s analysis.)

At first glance it might appear that Moody’s adjusted values for unfunded pension debt might only be relevant to the last factor – Debt Profile – that has only a 10% impact on credit ratings. Perhaps that’s why Moody’s projects a very modest portion of rating downgrades – such seemingly large changes in Net Pension Liabilities might only be a part of the Debt Profile that all together drives only 10% of a credit rating.

Economic Strength is a factor largely separate from the internal financial reality of a government, although it plays a major role in determining that internal financial reality. Basically – how strong are the local economies that provide the revenue base for governments, are they growing or shrinking and how risky are projections of those local economies?

A local government could be in good financial condition, have good management and governance, and a debt profile that is not disturbing, but it could be mired in a dying local economy and therefore its financial prospects could be not good in spite of how well the government has managed its finances. Conversely a local government that has not been well managed in the past, has squandered financial strength, and has a difficult debt profile could be located in a securely booming economy. In that circumstance, the strong economy can somewhat offset the government’s weakness.

However, adjustments of unfunded pension debt could play a role in measurements of Financial Strength and of Management and Governance as well. As seen in Attachment V.A the major factor of Financial Strength has sub-factors titled “Balance Sheet/Liquidity” and “Budgetary Performance”. Management and Governance has sub-factors titled “Financial Planning and Budgeting” and “Debt Management and Capital Planning”. Why wouldn’t Moody’s greatly increased adjusted Net Pension Liability lead to concerns about these issues?

The main points of all this regarding the impact of Moody’s adjustments are:

    • Many other factors other than Net Pension Liability go into determining Moody’s ultimate credit ratings.
    • Moody’s suggests their adjustments will lead only to a very modest portion of credit downgrades.
    • At least this analyst doesn’t understand how such huge increases in adjusted debt that will have to be paid (even given the uncertainties) could only lead to a very modest portion of downgrades.

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Twenty one California counties (highlighted in map) don’t participate in CalPERS; they have their own independent County Pension Funds. Twenty of these County Pension Funds are organized under the state’s County Employees Retirement Law (CERL). I applied Moody’s proposed adjustments from July 2012 and their final announced adjustments in April 2013 to seven of these (red on this map) – 6 in the Bay Area (Mendocino, Sonoma, Marin, Contra Costa, Alameda, San Mateo) and one in Southern California (Orange). I used fiscal year 2011 financial statements and Pension Fund Actuarial Valuations for these counties. Dickenson_MoodyFinal_f2 A. First Major Impact – Unfunded Pension Debt

1.  Doubles Unfunded Pension Debt

Table 3 and Figure 3 answer these questions:

    • For every $100 of reported “Unfunded Actuarially Accrued (Pension) Liability” (UAAL) for these 7 counties, how much would Moody’s proposed and final adopted adjusted Net Pension Liability be? 
    • What is the percentage difference between reported UAAL and the adjusted Net Pension Liability Moody’s will use in their credit rating analysis? 
    • What’s the difference between the proposed adjustments and the final adopted adjustments?

Dickenson_MoodyFinal_t3 Dickenson_MoodyFinal_f3 On average – for every $100 of UAAL reported for these County Pension Funds on average Moody’s proposed adjusted Net Pension Liability would have been $231 and the final adopted adjusted Net Liability would have been $220. On average Moody’s final adopted adjustments are 5% less than what the proposed adjustments would have produced – not a huge difference. And – bottom line – on average the value of Net Pension Liability Moody’s would have used in its credit rating analysis would have been well more than double.

There’s some variation between counties, but not huge. The final adjustments for Sonoma and Contra Costa produced somewhat lower Net Pension Liability values than those produced by the proposed adjustments whereas Alameda’s final adjusted Net Pension Liability was a bit more. This results from Moody’s decision to use the Actuarial Value of Pension Fund Assets (AVA) instead of the Market (Fair) Value for local governments.

In calculating the value of Pension Fund assets Actuaries apply a technique called “smoothing” that slows down year to year changes in value. This prevents sudden chaotic surges in government payments to Pension Funds that would result from the unavoidable precipitous declines in the stock market that happen from time to time.

Moody’s had proposed to use the Market Value rather than the smoothed Actuarial Value (AVA). But in their final adopted adjustments they decided to use the AVA for local governments because they felt it would be difficult and costly to obtain the market value for all local governments. They will use Market Value for states.

Table 4 shows the dollar amounts of UAAL and adjusted Net Pension Liability and the differences among them. Dickenson_MoodyFinal_t4 These counties reported a total of $7.6 billion of Unfunded Pension Obligations. Moody’s proposed adjustment was about $10 billion higher – $17.5 billion. Their adopted adjustment produces a Net Liability of $16 2/3 billion – $880 million less than the proposed adjustment but over $9 billion more than the reported UAAL.

Under today’s government accounting rules unfunded pension obligations are not listed as a “bona fide” liability. New rules will be imposed within 2 years for force governments to report a Net Pension Liability on their financial statements. If those rules had been in effect in 2011and the UAAL was an “accurate” estimation of that liability, then these 7 counties would be forced to “write off” $7.6 billion of their “net worth”. But if Moody’s adjustment was “accurate”, then they’d have to write off $16⅔ billion – just 7 out of 3000 counties in the US.

Moody’s adjustments very significantly increased the Net Pension Liability that Moody’s would have used in their internal credit rating analysis for all 7 counties – ranging from double to three and a half times greater for the proposed adjustments and from double to triple for the final adopted adjustments.

2. From $10 Billion of Positive Net Worth to $7.5 Billion “In the Hole”

a) County Reported Statement of Net Assets (Balance Sheet)

Table 5 shows the Balance Sheets (Statement of Net Assets) reported by these counties as of June 30, 2011. Dickenson_MoodyFinal_t5

They all reported their assets were worth more than their liabilities – and therefore they had positive “Net Worth” – or “Net Assets”. Both GASB’s new rules and Moody’s adjustments change this picture drastically.

b) GASB 68 Elimination of Most “Net Pension Assets”

Note that in Table 5 four of these counties reported a total of almost $1 Billion of “Net Pension Assets”. Curious – those four counties reported on their Balance Sheets that their Pension Obligation Bond debt was a total of $1.7 Billion. All four counties owed more on their Pension Bonds than the Net Pension Asset – and that doesn’t count their unfunded pension obligations.

The Governmental Accounting Standards Board (GASB) sets the basic rules for government financial reporting in the United States. Last June GASB announced major reforms in how governments must report the finances of their pension benefits and obligations. GASB Statement 67 establishes new rules for government Pension Funds (GASB 67), and Statement 68 establishes rules for governments themselves (GASB 68). Government Pension Funds must conform to GASB 67 no later than for fiscal years beginning after 6/15/13. Governments must use GASB 68 for financial statements beginning no later than for fiscal years starting after 6/15/14.

One aspect of GASB 68 is important to understand when considering the impact of Moody’s adjustment of Net Pension Liabilities on government Balance Sheets. But first – we need to understand the “theory” of how governments are supposed to eliminate unfunded pension obligations.

(1) How Governments Are Supposed to Eliminate Unfunded Pension Obligations

If a significant unfunded pension gap develops usually ONLY the government must pay more money into the Pension Fund to eliminate this deficit. Employees rarely have that obligation and retirees in California never have to do so. Governments have two ways to eliminate unfunded pensions.

(a) Amortization

The first is unfunded amortization payments. Unfunded pensions are almost always decades in the future. The Actuary has to plan that at some point between now and then the deficit will be eliminated. The actuary draws up an “amortization schedule” – kind of like a home mortgage. The County will make payments up to 30 years – but often less – to eliminate this gap. The county will pay an interest expense equal to the Pension Fund’s target rate of return. There’s a second way governments eliminate unfunded pensions.

(b) Pension Obligation Bonds

Municipal bond interest rates are a lot lower than Pension Fund target rates of return. Lots of governments borrowed money by selling “Pension Obligation Bonds” (“POB’s”) hoping to get a lower interest rate. They gave the proceeds to their Pension Fund to eliminate the unfunded pensions. Six of the 7 counties in this analysis have sold POBs.

All that happened is that these counties “restructured” their unfunded pension debts. They changed the form of the debt – but the source of the debt is the same – unfunded pensions. The Pension Fund got the money – but the County – which really means – We the People kept the debt.

You must include Pension Bonds when considering the financial impact of unfunded pensions. More to the point in this paper the Net Pension Assets reported by these four counties was set up when they sold Pension Bonds.

A quick aside about Pension Bonds – Right after Mendocino County sold its 2nd pension bonds in 2002 the County CEO was interviewed on a local news show. The lady said “Hey – wow – the County’s debt really shot up last year. What’s up with that?” The CEO said – “Listen – our County Board of Supervisors deserves huge praise from the people of Mendocino County. They cut our interest expense in half. They saved the people tens of millions of dollars over the next 20 years – money we’ll have for vital public services”. Now – of course it’s better to only pay 4% interest than 8%. That’s not the question. The question is “why are we in debt – why are we paying any interest at all? You said you were properly funding pensions all along – what happened? How are you going to stop putting us deeper in debt?” Unfortunately these county officials weren’t confronted by those questions when these Bonds were sold. (I’ve also written extensively on Pension Obligation Bonds – available at 

(2) The Fatal Flaw in Current Government Financial Reporting of Pension Finances

To explain this aspect of GASB 68 and how it influences the impact of Moody’s Adjusted Net Pension Liability we have to look at the “fatal flaw” in GASB’s old rules about pension financial reporting. Among other huge problems it created, it led to the creation of these Net Pension Assets – that aren’t real assets at all.

The most important concept in the old rules is the “Annual Required Contribution” – or “ARC” – simply what the Actuary says the government must pay the Pension Fund each year. Each year’s ARC is reported as each year’s pension expense. That’s a simplification – it’s more complicated – but that’s the core concept.

I’ll illustrate the “fatal flaw” using Mendocino County.

Mendocino had a $125 million unfunded pension obligation going into 2012 (Figure 4). The County was obligated to eliminate it. Dickenson_MoodyFinal_f4 The Actuary set up this unfunded pension payment schedule over 30 years (Figure 5). If everything went exactly according to plan – at that point the unfunded pensions would be eliminated. Dickenson_MoodyFinal_f5 Figure 6 shows how the unfunded pension obligation developed. Mendocino sold $90 million in Pension Bonds in December 02. They didn’t reduce unfunded pensions to zero – but we’ll assume they did for this explanation. The columns are each year’s change in the UAAL. The pink area is the balance of the UAAL up to the $125 million.

There were a couple of good years when the UAAL went down – but 6 of these 8 years saw the UAAL increase. Dickenson_MoodyFinal_f6 The Trillion Dollar question is –

When does the pension expense that created this $125 million debt happen?

Today’s massive unfunded pension debt in our country happened because for more than 2 decades GASB gave us the wrong answer.

Under today’s rules the Annual Required Contribution is what the County will report as its pension expense each year –the sum of the government’s Normal Cost Contribution – AND UAAL AMORTIZATION PAYMENTS. These payments (Figure 7) over the next three decades would be added to the Normal Contributions in those years to produce the reported pension expense in each of those years. The pension expense related to the $125 million UAAL will be reported over 30 years in the future.

That’s saying the payments of a debt create the debt. That’s absurd. The payments of a debt eliminate a debt –they don’t create it. Dickenson_MoodyFinal_f7 The real economic pension expense that created this debt happened here (Figure 8) – it’s what built up the $125 million debt.

GASB 68’s most profound change is that instead of deferring reporting the true economic pension expense that created today’s unfunded pension debt decades into the future while the debt is paid governments will be forced to report them pretty much when they happen. (As usual when dealing with pension finance it’s more complicated than that – but if you boil it down that’s what GASB 68’s most important change is.) Dickenson_MoodyFinal_f8

(3) GASB’s “Fatal Flaw” and Reported Net Pension Assets

Mendocino County again – 93 through 03 (Figure 9). The red stalactites hanging down are the Unfunded Pension Liability reported by the County’s Pension Fund (but not reported as a debt on the County’s Balance Sheet as it will be when GASB 68 kicks in). The little green columns are the Annual Required Contribution.

The red columns are the proceeds of Pension Bonds. The County sold its first Pension Bonds in 97. They sold their second in 03.

What’s the impact of these Bonds on financial statements?

The borrowing is simple. They have a $112 million liability – Pension Bonds. They got $106 million in cash and the “Bond Boys” kept $6 million as their cut – part of the county’s cost of issuing the Bonds. Where it gets weird is what they did with the $106 million. They gave the money to the Pension Fund – but what did the County report they got for it? Dickenson_MoodyFinal_f9 Imagine this – you gave your kid a credit card. The kid tells you he’s only spending a few hundred dollars a month on the credit card. What’s really happening is he’s only paying the minimum payment – but charging thousands a month. 

A $10,000 balance builds up. The minimum payment is $1000. Your kid borrows $10,000 from Aunt Betsy – a generous soul. He pays it to the credit card. You ask your kid what the heck is going on – and he says: “Hey Dad – Mom – you don’t understand. Sure I owe Aunt Betsy $10,000 – BUT I’VE GOT A PREPAID CREDIT CARD BALANCE OF $9000 – SO – I REALLY only owe $1000.” He says he’s got a $9000 prepaid balance – an asset – because that’s how much he paid above the minimum payment, even though he owed $10,000 when he made that payment. Does that make sense? 

That’s what governments that sold Pension Bonds did. The amount they paid to the Pension Fund over the minimum payment (which is what the Annual Required Contribution is, by the way) was reported as a Net Pension Asset – prepaid pensions. But it isn’t a “real” asset – it provides absolutely no value to the County’s operations in the future. Its only value is that the officials who sold the Bonds don’t have to take the political heat that would occur if they had to report the financial truth – that pension expenses were much more than were reported in the past, that the government was almost certainly really operating with a significant deficit, and they wouldn’t have been able to say they had a Net Pension Asset that was almost as much as the Pension Bond debt. They wouldn’t have been able to say – like your kid – “you don’t understand – sure we owe the Bonds but we have an asset that offsets most of that debt because we ‘prepaid’ millions of our future payments to the Pension Fund and saved a ton of money”.

When GASB 68 goes into effect the Net Pension Assets reported by these four counties will go “poof” – they will be wiped off their Balance Sheets. If GASB 68 had been in effect in 2011 when the summary Statements of Net Assets (the Balance Sheet) shown in Table 5 on page 11 those $1 Billion of Net Assets wouldn’t have been reported. One Billion dollars of these counties’ “Net Worth” (Net Assets) would have disappeared.

I’m including this impact of GASB 68 in analyzing the impact of Moody’s adjustment of Net Pension Liability on the Balance Sheet. When GASB 68 goes into effect next year those false assets will no longer be reported.

c) Impact of Moody’s Adjusted Net Pension Debt and GASB 68

This paper doesn’t delve into the other extensive changes about to be imposed by GASB’s new rules for reporting government employee pension finance. However, I’m showing what the impact of both GASB 68 and Moody’s adjustments would have been on the Statements of Net Assets (Balance Sheet) for these 7 counties in their 2011 financial statements (Table 6 below). You can compare these two sets of changes. Also – Moody’s adjustments will not be reflected in government financial statements – GASB’s new rules will.

The first section of Table 6 repeats Table 5 –Balance Sheets reported by the counties. These are for the “general government” parts of these counties. They don’t include enterprises (water, waste water, etc.).

The second section – “GASB 58 IMPACT” – shows the change GASB 68 would have imposed on the reported Balance Sheets. The third – “MOODY’S IMPACT” – shows the change Moody’s adjustments would have made to the reported statements. The changes relate to the reported Balance Sheets – not to GASB’s changes. Dickenson_MoodyFinal_t6 Figure 10 shows the proportion Liabilities and Net Assets are of Total Assets as reported by the counties in 2011, what they would have been had GASB 68 been in effect, and what they would have been using Moody’s final adopted adjustments. Net Pension Liabilities and Pension Bonds (in a box) are both red because they are two forms of the same debt – unfunded pension-created debt. Dickenson_MoodyFinal_f10 These 7 counties reported they together had Net Assets of over $10 Billion. GASB 68 will have two big impacts on Balance Sheets. The biggest is Net Pension Liability will be reported for the first time. Less impactful will be the disappearance of most “Net Pension Assets”. These changes would have cut these counties’ combined Net Assets by 90% down to less than $1 Billion. A reduction of $9.3 Billion in just these 7 counties – what will be the total “write off” for the more than 3000 counties in the US, tens of thousands of cities, school districts, special districts, and all the 50 states! Two of these counties – Contra Costa and Mendocino – would have reported more Net Pension Liability than the value of their Total Assets. Orange County’s Net Assets would have essentially been wiped out.

Moody’s adjustments are worse. Instead of total Net Assets of $10.2 Billion for the 7 counties combined, Moody’s adjustments would produce negative Net Assets of ($7.4 Billion) – a “write down” of over $17½ Billion! These 7 counties would be deemed by Moody’s to owe $7½ Billion more than the value of their Assets. Only one county would be left “above water” – Marin, which happens to have the highest per capita income of all counties in the United States!

(1) Reported

The first section of Table 6 shows the values that were actually reported by those counties in 2011. The first graph in Figure 10 shows the percentage that Pension Obligation Bonds, all other reported liabilities and “Net Assets” (or Net Worth) were of Total Assets. All 7 counties reported they have more assets than debt. Marin’s debt was reported to be only about 22% of the value of its Total Assets, whereas Mendocino and Contra Costa reported total debt equal to ⅔ of the value of their Total Assets. The average for all 7 counties was Total Liabilities equaling about 45% of Total Assets.

Mendocino’s Pension Obligation Bond debt represented the largest claim against these 7 counties’ Total Assets – nearly 40%. Contra Costa’s POB’s were 24% of Total Assets and Sonoma’s were 22%. Only San Mateo had never sold POBs, and Orange County had only a 1% claim by POB’s against their Total Assets.

(2) GASB 68

GASB 68 will have two big impacts on government Balance Sheets:

    • Net Pension Asset: As discussed in “GASB 68 Elimination of Most “Net Pension Assets” beginning on page 12 GASB 68 will eliminate most reported Net Pension Assets – and would have eliminated all of the $1 Billion of Net Pension Assets reported by these counties in 2011.
    • Net Pension Liability: The big change is that unfunded pension obligations will be listed on government Balance Sheets as a bona fide liability for the first time. The process of calculating the Total Pension Liability is complicated as I’ll explain below.

The second section in Table 6 shows the changes GASB 68 would have made to the reported Balance Sheets. Almost $1 Billion of what was reported as Net Pension Assets in total for these counties would have been removed from the Assets, and about $8.3 Billion of Net Pension Liabilities would have been added to Liabilities. The second graph in Figure 10 shows what the relative impact of GASB 68 would have been. Two counties would have been significantly “upside down” – Contra Costa and Mendocino would have reported they had more than $160 of debt for every $100 of assets. These counties’ would have been forced to report their Unfunded Pension Debt (Net Pension Liability + Pension Bonds) was more than the value of their Total Assets. Orange County’s Total Liabilities would have been reported as just slightly more than Total Assets.

The Net Pension Liability is the result of subtracting the Total Pension Liability from the value of Pension Fund assets. It’s possible the value of Pension Fund Assets would be more in which case a Net Pension Asset would exist – which would be a “real” asset unlike the “false” Net Pension Assets of today. But we aren’t going to see many of those in the US when GASB 68 is implemented.

GASB 68 will require the actual market value of Pension Fund assets be used instead of the “smoothed” Actuarial Value of Assets. That’s fairly simple to determine.

However, the value of the Total Pension Liability will result from a very complex cash flow projection for the Pension Fund that will extend many decades into the future. It’s not within the scope of this paper to describe that cash flow projection. Very briefly – if a government has a history of paying the total “Annual Required Contribution” (ARC) then the Total Pension Liability will calculated based on the Pension Fund’s target rate of return. However, if it has a history of not paying its ARC, then a lower assumed rate of return will be used that will vary depending on the results of the cash flow projection. The result of using a lower rate will increase the reported Total Pension Liability which in turn will increase the Net Pension Liability reported on Balance Sheets.

Only Actuaries have the data necessary to make these projections, and so I use the Total Pension Liability as calculated by Pension Fund Actuaries based on the target rate of return. This produces the lowest possible Net Pension Liability. I’ve seen studies that suggest the Net Liability of half the nation’s local and state governments would be higher because the cash flow projection would “trigger” the use of a lower assumed rate of return. That means the values for Net Pension Liability in the GASB portion of Table 6 are the “best case” from the counties’ point of view. It’s quite likely some of these counties will wind up reporting higher Net Pension Liabilities because they will be forced by GASB 68 to use lower assumed rates of return. In that case the reduction in Net Assets would be even greater.

(3) Moody’s Adjustments

Remember – the only “real world” use of Moody’s adjustments will be in their internal credit rating analysis of state and local governments. Governments will not use Moody’s adjustments for financial reporting – indeed they can’t. Moody’s doesn’t set Generally Accepted Accounting Principles (GAAP) – GASB does. And Moody’s really – really wants everyone to know their adjustments aren’t recommendations or a “public standard”.

BUT – Moody’s settled on these adjustments because they believe they help them more accurately analyze the risk that unfunded pension obligations pose to purchasers of government bonds. I think it’s completely fair for us to use the result of these adjustments in evaluating the financial risks posed by unfunded pension obligations to our governments’ ability to do one of their core duties – provide high quality governmental services and infrastructure at a fair cost to the public consistently through the decades to come.

Moody’s adjustments result in an apparent “loss” of $17.5 Billion of these counties’ Net Assets – their Net Worth. Together, instead of being “worth” $10 Billion as they reported in 2011, Moody’s adjustments would have indicated they collectively were $7.5 Billion “in the hole”. Only one county – Marin – retained positive Net Worth. The other six were “underwater”.

As discussed in “Moody’s Projections of The Impact of Their Adjustments” on page 7 even though Moody’s own projections of the impact of their adjustments on the financial statements of state and local governments across the US are very significant, they also state they expect only minor portions of credit downgrades. And – as I said in that section – I don’t really know how such astonishing “liquidations” of Net Assets for most of these 7 counties wouldn’t drive significant credit downgrades for the counties Moody’s analyzes. We’ll have to wait a year to see what really happens.

B. Second Major Impact – State Payments to Pension Funds

As was stated in their proposed adjustments and confirmed in their adopted adjustments, Moody’s will only adjust the value of state payments to Pension Funds; they won’t adjust payments by local governments. However, I applied their payment adjustment to these 7 counties to show the relative impact the adjustments would have and the scale of adjustments to state payments that will likely result. Further – although Moody’s very emphatically states these adjustments should not be interpreted as recommendations I do think it’s fair to infer they consider the results in effect a “benchmark” of “prudent funding”. It’s useful for concerned citizens and government officials to consider whether or not this “benchmark” is indeed a measure of prudent payment.

Table 7 below answers these questions:

    • For every $100 of county payments to their Pension Funds projected in the Funds’ Actuarial Valuations what would Moody’s proposed and final adopted adjusted payments be? 
    • What is the percentage difference between payments projected in Actuarial Valuations UAAL and the payments produced by Moody’s adjustments?
    • What’s the difference between the proposed adjusted and the final adopted adjusted payments?

Dickenson_MoodyFinal_t7 Dickenson_MoodyFinal_f11 For every $100 of payments projected in these County Pension Funds’ Valuations on average Moody’s proposed adjusted payments would have been $219 and the final adopted adjusted payments would have been $176. On average the value of County payments to their Pension Funds Moody’s would have used in its credit rating analysis would have been ¾ more than the payments projected in the Valuations. (Remember – Moody’s won’t adjust payments for local governments. They will only do so for states. This is only to illustrate the math.)

The final adjusted payments for all counties were significantly less than Moody’s proposed adjustment payments and were 20% less than the proposed payments on average. In contrast the final adjusted Net Pension Liability was only 5% less than the proposed adjusted Net Liability and those for 3 counties were actually higher.

Moody’s made a much more impactful change in its final adjustments of payments than for Net Liability. Governments make two kinds of major payments to Pension Funds – “Normal Yearly Contributions” and “Unfunded Pension Amortization Payments.” Moody’s initially proposed to adjust both kinds of payments. But they decided not to adjust Normal Contributions in their final adopted adjustments. This accounts for most of the difference between the proposed and final adjustments. Moody’s also a) extended the amortization period for Unfunded Pension Payments from 17 to 20 years which reduced adjusted payments, and b) used “end of year” amortization instead of the “beginning of year” method used in its Proposed Adjustments which had the effect of increasing payments because of the inclusion of an additional year of interest expense.

Table 4 shows the dollar amounts of payments to these Pension Funds – those that were projected in the County Pension Fund’s Actuarial Valuations, Moody’s proposed adjusted payments, and their final approved adjusted payments. Dickenson_MoodyFinal_t8 The Actuarial Valuations for these seven county Pension Funds projected a total of nearly $1.1 billion of County payments to their Pension Funds. If Moody’s proposed adjustments to payments had been applied to these counties total payments would have been about $1.3 billion higher – $2.4 billion. Their final adopted adjustments would have produced total County payments of $1.93 billion- about $835 million more than what they were paying but almost $470 million less than the proposed adjustment.

Both the proposed and final adopted adjustments significantly increased the payments Moody’s would have used in their internal credit rating analysis for all 7 counties if they applied their payment adjustments to local governments.

C. Summary of Impacts

Table 9 shows the total impact of Moody’s proposed and final adopted adjustments on these 7 counties relative to their financial statements in 2011. Since Moody’s won’t adjust payments to Pension Funds by local governments the “Payments” are only to illustrate what the impact of the adjustments are likely to be on states, and to show what I believe Moody’s inherent “benchmark” for prudent pension funding would be for these counties. Dickenson_MoodyFinal_t9 On average Moody’s final adopted adjustment of Net Pension Liability would have been about 220% greater than the Unfunded Actuarially Accrued Liability that was reported by the Pension Funds and provided in footnotes to the counties’ financial statements. Payments to Pension Funds would have been about 76% higher than the payments specified in the Pension Fund Actuarial Valuations.

Moody’s final adopted adjustments produce values for Net Pension Liabilities and government payments to Pension Funds that are less than those produced by their earlier proposed adjustments. The difference in Net Pension Liability is rather small (-5%). In contrast the decrease in payments is somewhat large (-20%).

*   *   *


A. Analysis of Proposed Moody’s Adjustments – 1/21/13 – One Page Summary

On July 2, 2012 Moody’s Investors Services published a “Request for Comment” titled Adjustments to US State and Local Government Reported Pension Data. Moody’s is one of the nation’s major “credit-rating agencies” for state and local governments. They have concluded that published government employee pension financial data greatly understates the credit risks created by unfunded pensions. They propose to make adjustments to that data to use in their credit analysis. Moody’s doesn’t have authority to make governments change their financial statements or fund pensions differently. These proposed adjustments should not be seen as “suggestions” or “requirements” from Moody’s. Governments don’t have to conform to the “benchmarks” implied by these adjustments – but if they don’t their credit rating is at risk.

I developed a financial model to project how Moody’s adjustments would restate published government pension data. I applied the model to 6 Bay Area – North Coast California counties that do not participate in CalPERS; they have independent County Pension Funds. The “logic” of these restatements is Moody’s – my part was only whether I correctly applied the math of Moody’s proposed adjustments.

Moody’s would make four adjustments – two are very significant. First, pension debt would be adjusted using a high-grade long term corporate bond rate (5.5% for 2010-2011) instead of a Pension Fund’s target rate of return (7.75% more or less). Second, government payments to Pension Funds would be adjusted to reflect the lower discount rate, the need to fully fund pensions by the time employees retire, and a 17 year level-dollar amortization of unfunded pensions.

Moody’s adjustments would have two major impacts on government pension financial data. Moody’s states these adjustments would triple the amount of unfunded government pension debt across the US they would use to set credit rates. Moody’s analysis will indicate most governments are paying far less to their Pension Funds than they should.

The main importance of Moody’s proposals to concerned citizens is they strongly support the view that unfunded pensions put state and local government finances at great risk, much more than is reported to the people. They help explain how unfunded pensions produce much greater risk and by implication what to do about it.

These County Pension Funds reported County unfunded pension obligations were a little over $4 billion. Moody’s adjustments would add about $6 billion which would reduce average reported pension funding ratios from 77% to 58%.

Under today’s accounting rules governments don’t report unfunded pensions as debt directly in their financial statements. (New government accounting rules will make them to do so in two years.) Moody’s would include the restated $9.9 billion unfunded pension debt in its credit rating process. In addition these six counties reported Pension Obligation Bond (POB) debt as of June, 2011 of $1.7 billion. They borrowed that money to pay down earlier large unfunded pension deficits. Therefore total unfunded pension-created debt using Moody’s adjustments would be close to $12 billion. All other reported debt (not including unfunded retiree healthcare and other post-employment benefits) was $4.1 billion. Thus Moody’s adjustments would increase the total debt for these counties used in their credit rating analysis from the reported $5.8 billion to $15.8 billion – about triple.

These counties pay about $640 million to their Pension Funds. These adjustments would increase this to $1.4 billion – from 29% of payroll to 63%. Payments to Pension Funds and Pension Bonds today consume about half these counties’ property tax income. The adjusted payments would consume all county property tax income on average.

Moody’s stated they would recalculate total debt for both state and local governments but would calculate what “prudent” government payments to pension funds should be only for states. I strongly urged Moody’s to apply their “prudent payment” adjustments to local governments as well. Moody’s has not yet announced their final decision.

B. Unmasking Staggering Pension Debt & Hidden Expense – 3/13/13 – One Page Summary

Only pension accounting fraud allows governments to pretend their budgets are balanced. – Bill Gates

My County – Mendocino – incurred hundreds of millions of past pension expenses they never reported to the people. Across the nation the hundreds of billions of past government pension expenses that created today’s huge unfunded pension debt have been hidden by a “Fatal Flaw” in how governments report pension finances.

That’s about to change. Big Time.

At the end of June, 2012 the Governmental Accounting Standards Board (“GASB”) imposed major reforms in how state and local governments report pension finances that will kick in over 2 years. Then Moody’s announced their intention to make big adjustments to government reported pension finances in their credit-rating analysis. This report is the content of a presentation about these changes I’ve given to reform groups in counties analyzed in this report.

My specific goal is to show how GASB’s current rules have a “Fatal Flaw” – how that Fatal Flaw allowed hundreds of billions of unfunded government pension debt to develop – and why the new rules are absolutely necessary. My general goal is to describe to concerned citizens what the impact of GASB’s new rules and Moody’s adjustments will be.

The Fatal Flaw is that pension expenses that create unfunded pension debt are reported in the future as that debt is paid. That’s absurd – the payments of a debt eliminate the debt, they don’t create it. Unfunded pension debt is created by pension expenses in the past – most of which have never been reported to the people. GASB is changing that.

GASB’s changes are only about how governments must report pension finances. Moody’s changes are only about how they will analyze government pension financial data in their internal credit rating analysis. Neither will “tell” governments how much they should pay to Pension Funds and Moody’s won’t change government financial statements.

This report shows the impact these changes would have had on 7 California counties that have their own County Pension Funds (Alameda, Contra Costa, Marin, Mendocino, Orange, San Mateo, and Sonoma).To the extent I modeled GASB’s changes and Moody’s adjustments correctly and obtained the correct data – if you don’t “like” the results your argument is with GASB and Moody’s – not me. I’m the messenger.

This paper presents a simple model of how pension funding “works” which is what financial statements must report. GASB’s main impacts on statements will be to list Net Pension Liability as real debt for the first time, remove Net Pension Assets related to Pension Obligation Bonds, and make profound changes in how pension expense is reported. Moody’s will also adjust the value of unfunded pension debt, but they won’t recalculate the value of government assets or pension expenses. However, Moody’s will calculate a “benchmark” for payments to Pension Funds – GASB won’t. Dickenson_MoodyFinal_summary GASB’s new rules would have quadrupled Mendocino County’s pension expenses for 2004 through 2011. Instead of a $63 million surplus they would have reported a $115 million deficit. Most governments will report this type of shift. 

This shows the impact GASB’s new rules would have had on the 7 counties’ 2011 Balance Sheets. Over $9 billion of “net assets” would have been written off the Balance Sheets of just these 7 counties. There are over 3000 counties in the US, tens of thousands of cities, school districts, & special districts.

In addition, the year GASB’s new rules are implemented these counties will be forced to report somewhere around $9 billion of past pension expenses in one year.

Moody’s adjustments would produce a Net Pension Liability of $17.5 billion instead of GASB’s $8.3 billion. If that had been reported as the Net Pension Liability these counties collectively would have had negative Net Assets of ($8.3 Billion). Moody’s adjusted annual payments to Pension Funds would have gone from $1.1 billion to $2.4 billion.

C. Moody’s Credit Rating Factors for Local Government General Obligation Bonds

This is quoted from pages 3 & 4 of Moody’s Final Adjustment paper.

The G.O. (General Obligation Bond) rating generally conveys the highest and best security that a state or local government can offer, typically based upon a pledge of its full faith and credit. While local government GO bonds are secured by a pledge to levy property taxes sufficient to pay debt service, the analysis of GO credit quality is not limited to the narrow coverage of debt service by dedicated property taxes. The unconditional nature of this pledge ensures that in most cases all revenue producing powers of the municipality are legally committed to debt repayment. Accordingly, the GO analysis assesses overall financial flexibility and distance to distress, based on a broad evaluation of four rating factors.

Methodological Approach – Rating Factors

Moody’s rating approach for local government GO bonds includes an analysis of four key rating factors and 16 sub-factors: 1.  ECONOMIC STRENGTH

    • Size and growth trend
    • Type of economy
    • Socioeconomic and demographic profile
    • Workforce profile


    • Balance sheet/liquidity
    • Operating flexibility
    • Budgetary performance


    • Financial planning and budgeting
    • Debt management and capital planning
    • Management of economy / tax base
    • Governing structure
    • Disclosure


    • Debt burden
    • Debt structure and composition
    • Debt management and financial impact/flexibility
    • Other long-term commitments and liabilities

D. Data Sources

Audited financial statements as of 6/30/2011 for these six counties were downloaded and analyzed.

In addition the most recent available Actuarial Valuations were downloaded in early fall, 2012. They are for these counties “County Employees Retirement Associations” – as in “Alameda County Employees Retirement Association”. Dickenson_MoodyFinal_sources There are three kinds of Pension Funds that offer “guaranteed pension benefits” to state and local government employees”

Single Employer Funds – The Pension Fund is for only one government employer. Therefore all the financial balances and activity in the Pension Fund impact that one government.

Then there are two types of “Multi-Employer” Pension Funds in which the Pension Fund provides pension benefits to retirees of more than one governments.

Agent Funds – the Pension Fund maintains its books so that the obligations and balances of each employer government can be specifically identified. Therefore one government may have a lower relative level of unfunded pension obligation than another.

Cost-Sharing Funds – Balances are not maintained for individual governments. As a result unfunded pension obligations are shared among all participating governments even though some governments may have paid a higher portion of its obligations than others. Balances are allocated to individual governments based on the portion of that government’s payments to the Pension Fund relative to all other governments’ payments.

*   *   *


1 – The four Moody’s documents discussed in this paper are available at in the Data/Reports/Video section of the site. The July 2012 document is referred to in this paper and its footnotes as “Moody’s Proposed Adjustments” and the April 2013 document is referred to as “Moody’s Final Adjustments”.

2 – Moody’s Investor Services Proposed Changes in Analyzing Government Pension Finances and Unmasking Staggering Pension Debt & Hidden Expense, both available at At this point I don’t intend to update those two reports to reflect Moody’s final adopted adjustments. These reports delve into pension funding math and larger issues regarding government unfunded pension debt far more than this current report. One-page summaries are provided in Attachment V.A on page 14 and Attachment V.B on page 15.

3 – Moody’s Final Adjustments, Page 2

4 – Moody’s Final Adjustments, page 2

5 – Moody’s Final Adjustments, page 3

6 – Moody’s Final Adjustments, page 5

7 – Moody’s Final Adjustments, page 8

8 – Data for 2007 through Nov. 2009 from Citibank Pension Liability Index, Harper Danesh Data from Dec. 2009 through Mar. 2013 from Citigroup Pension Discount Curve and Liability Index (a downloadable excel file), Society of Actuaries

9 – The Impact of Moody’s Proposed Changes in Analyzing Government Pension Finances, John G Dickerson, 1/21/13, page 9

10 – Moody’s Final Adjustments, page 5

11 – Page 5, Moody’s Final Adjustments

12 – Moody’s Final Adjustments, pages 10 & 11

13 – Moody’s Final Adjustments, page 2

14 – Both documents are in the “Data/Reports/Video” section of

15 – General Obligation Bonds Issued by US Local Governments, Moody’s Investors Services, 10/29 updated 4/13, page 1

16 – Moody’s produces credit ratings for most but not all these counties.

17 – Interestingly these new rules were published (after a very extensive 5 year development process) a week before Moody’s published their proposed adjustments last July. I’ve produced papers analyzing GASB’s new requirements and comparing GASB’s requirements with Moody’s proposed adjustments. They are available at my website

18 – See for reports on GASB 68.

19 – As explained in Pension Asset Value – States No Change – Local Governments Change on page 5 Moody’s initial proposal was also to use Market Value of Pension Fund assets for both state and local governments. However, they elected to not use Market Value for local governments; they will use the “smoothed” Value. They stated the data to calculate Market Value wasn’t available for too many local governments. However, when GASB 68 is implemented that value will be calculated for all local governments as well. I assume Moody’s will also shift to Market Value for local governments at that time.

AUTHOR’S NOTES Moody’s Investors Services was not involved in the creation of this paper beyond the publication of its “Request for Comment” described below. Moody’s has not reviewed the results of my model – this paper is solely my responsibility.

This is complex modeling of even more complex data. The Actuarial Valuations of the Pension Funds used for this report are complex – especially that for Contra Costa County (very – very complex!). I’ve tried to be careful – but if you see an error of fact or of analytical technique please let me know. I’ll correct it and apologize if warranted.

I published two earlier papers on Moody’s proposed adjustments.

    • The Impact of Moody’s Proposed Changes in Analyzing Government Pension Finances: Example – Six Independent County Pension Funds and Counties in California (1/21/13)
    • Unmasking Staggering Pension Debt & Hidden Expense: Seven Counties in California (3/13/13)

Both papers included analysis of Moody’s proposed changes and demonstrations of their impact on the financial statements of those counties. The “Unmasking” paper was also based on analysis of new government pension financial reporting requirements approved by the Governmental Accounting Standards Board last summer (“GASB 68”). This current report focuses specifically on the mathematics of Moody’s final adopted adjustments and on comparing them to their earlier proposed adjustments. These two previous reports were much broader in scope, especially the “Unmasking” paper. In addition to analyzing the math I discussed the much broader nature of Pension Fund finances and the very dangerous unfunded pension debt that has developed across the county. I also dove much deeper into the impacts of Moody’s adjustments – both the math and financial implications for these counties. The “Unmasking” paper was more focused on GASB 68’s new pension reporting requirements and the “fatal flaw” in current reporting requirements that allowed today’s huge unfunded pension to develop almost “sight unseen”.

I have not updated those two previous papers to reflect the final adopted Moody’s adjustments – and it’s likely I won’t. Time marches on and other issues demand attention. The “Unmasking” paper is the “more important” of the two, and its analysis of the new GASB reporting requirements remains valid.

Particular thanks go to Mike Sabin of Sunnyvale Pension Reform

( and Bob Bunnell of Marin County’s Citizens for Sustainable Pension Plans ( for their detailed review of my Moody’s Predictor Model.

This paper is copyrighted by John G Dickerson. It may be copied and distributed at will. However, it must not be changed without the express written permission of Dickerson. Quotes from this paper should be attributed to: John G. Dickerson,

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