Key Takeaways
- Minnesota's 2023 legislature enacted various statutes that changed pension plan actuarial assumptions and made one-time plan contributions. S&P Global Ratings believes some of the positive legislative changes enacted are offset by other changes.
- Recent contributions have been low relative to budgets, and we expect they will remain low.
- Statutory contributions have exceeded actuarial recommendations in recent years, yet remain less than our minimum funding progress threshold, which indicates costs are being deferred and there are weaknesses in actuarial assumptions utilized by the plans.
- Retiree medical (other postemployment benefits [OPEB]) costs are generally a minimal credit pressure for Minnesota local governments, as they typically represent a small portion of local government budgets; however, contribution escalation risks remain as a result of pay-as-you-go contribution methods that exacerbate the effects of health care cost volatility.
Chart 1
Pension contributions in Minnesota have been low relative to budgets. While costs are low, contributions have not generated meaningful funding progress on most plans throughout the state. The plans' actuarial recommendations are relatively weak because of lengthy level percentage of payroll amortizations. Despite exceeding the actuarial recommendations, contributions have not exceeded the amount needed to maintain funded ratios should assumptions be met. This is supported by our static funding ratio calculations. The 2023 Pension Omnibus Budget Bill (POBB) has reduced the state's exposure to market-driven volatility by lowering discount rates. However, discount rates for most plans remain at levels that still indicate an acceptance of market-driven volatility. The funded ratios, discount rates, static funding ratio calculations, and minimum funding progress (MFP) ratio calculations can be found in the appendix of this report.
Credit Fundamentals By Sector
- State of Minnesota: State employees participate in the Minnesota State Retirement System (MSRS), for which employer contributions are a low share of the state's budget. We do not view pensions to be a near or medium term credit risk for the state, as net pension liabilities are very low on a per capita basis and relative to personal income.
- Local governments: Nearly all local governments participate in one of the Public Employees Retirement Association of Minnesota (PERA) multiple-employer plans. Pension contributions are a small portion of most issuers' expenditures, and we don't expect major budgetary pressure, even if there is cost acceleration over time. Single-employer plans for volunteer firefighters are not generally sources of credit pressure, as the state makes contributions to the plans and local governments make minor voluntary contributions.
- School districts and charter schools: Districts and charter schools participate in the Teachers Retirement Association (TRA) multiple-employer, defined-benefit pension plan, which covers teachers, and the PERA plan for general employees. Although contributions have exceeded actuarial recommendations in recent years, contributions have been below our MFP metric due to a level percent amortization over 27 years. TRA contributions are a modest portion of district and charter school budgets, and do not present a credit pressure. However, recent legislation lengthened the amortization period to 30 years, which, combined with a level percent of payroll amortization, increases the probability of cost deferrals or negative amortization.
- Public higher-education institutions: Public universities and colleges participate in MSRS plans, with manageable contributions that do not present credit pressure in the near to medium term.
Plan Summaries
Most issuers in Minnesota participate in at least one of the following defined-benefit pension plans:
- MSRS State Employees Retirement Fund (SERF): A cost-sharing, multiple-employer plan for state employees and higher-education institutions;
- PERA General Employees Retirement Fund (GERF): A cost-sharing, multiple-employer plan for municipal governments and local school districts;
- PERA Public Employee Police and Fire Fund (PEPFF): A cost-sharing, multiple-employer plan for municipal governments;
- Teachers Retirement Association (TRA): A cost-sharing, multiple-employer plan for teachers; and
- Single-Employer Plans: Provided by local governments for volunteer firefighters, with modest annual lump sum pension benefit payments. We typically observe these plans to be funded at or above 100%. Because the state makes contribution payments, local government costs are minor.
Any pension system benefit or funding changes are subject to legislative approval. The Minnesota Legislative Commission on Pensions and Retirement (LCPR)'s Standards for Actuarial Work can update plan assumptions for payroll growth, salary increases, and mortality tables. However, plan contributions are set to a fixed percentage of payroll based on state statute; therefore, a legislative change is required to address any underfunding should it materialize for plans. Employer contribution levels for all plans throughout Minnesota have been low relative to budgets in recent years, and we expect them to remain low in the near term with the most recent legislative updates. Over the long term, we believe issuers in the state have a risk of accumulating larger liabilities and higher future costs if contributions continue to defer funding progress.
Latest Changes: Actuarial Adjustments And One-Time Contributions To Minnesota's Pension Plans Improve Funding Discipline
The POBB and various other statutes signed into law in 2023 enacted key changes to actuarial assumptions and amortization methods, and allocated $485.9 million to be distributed to the plans. This one-time allocation is relatively minor when compared with the $16.2 billion of net pension liability across all plans as of June 30, 2022. Key changes include:
- All plans must use a 7% discount rate, revised from 7.5%, which will reduce exposure to market-driven volatility. However, this is still above our 6% guidance, and we therefore believe there is still an acceptance of market-driven volatility that could lead to erosion in funding progress;
- The amortization of TRA will be extended to the year 2053, which we consider long and as a deferral of funding progress that, combined with the level percent of payroll basis, could lead to negative amortization;
- One-time increase in cost of living adjustments for all the retirement systems, offset by a one-time contribution;
- Temporary reduction in employee contribution rates for MSRS and the St. Paul Teachers Retirement Fund Association plans, offset by a one-time contribution; and
- One-time allocation spread across MSRS, PERA, TRA, and the St. Paul Teachers Retirement Fund Association to pay down a portion of unfunded liabilities.
The state will continue to utilize a statutory contribution rate that may not match actuarial recommendations. Since the 2018 Omnibus Pension Bill was signed into law, statutory employer contributions exceeded the actuarially determined contribution (ADC) for PERA plans and have closed the gap for TRA (see chart 2), but funding progress remains less than 100% of MFP (see chart 3). In the plans' fiscal 2022 annual comprehensive financial reports, contributions were less than what was needed to maintain the current funded ratio should assumptions be met, or what we refer to as static funding (SF) in the appendix. With the 2023 legislative changes, we expect contributions net of the one-time state aid payment will remain less than 100% of MFP, given the lengthy level percentage of payroll amortization used by the plans.
Chart 2
Chart 3
Other Postemployment Benefits
OPEB costs are generally not a credit stress for local governments because they are a relatively small portion of issuer budgets. Most local issuers fund OPEB costs on a pay-as-you-go basis, which can lead to rapidly rising and volatile payments over time as health care cost trends could continue to outpace general inflation.
Appendix
| Plan details as of most recent plan comprehensive annual financial report | |||||
|---|---|---|---|---|---|
| Metric ($ millions) | GERF | PEPFF | SERF | TRA | S&P View |
| As of date | June 30, 2022 | June 30, 2022 | June 30, 2022 | June 30, 2022 | |
| Funded ratio | 76.67% | 70.53% | 90.60% | 76.17% | Poorly funded plans increase the risk of rising contributions for employers. |
| Discount rate | 6.50% | 7.50% | 6.75% | 7.00% | A discount rate higher than our 6.0% guideline indicates higher market-driven contribution volatility than what we view as within typical tolerance levels around the country. |
| Total plan ADC | $368 | $154 | $107 | $481 | Total employer contributions to the plan recommended by the actuary. |
| Actual total contributions | $562 | $224 | $213 | $518 | Total employer contributions made to the plan. |
| Actual contribution as % ADC | 153% | 146% | 199% | 108% | Contributions exceeded the ADC following the 2018 Omnibus Retirement Bill. |
| Actual contribution as % MFP | 80% | 66% | 93% | 74% | Under 100% indicates funding slower than what we view as minimal progress. |
| Actual contribution as % SF | 90% | 70% | 94% | 84% | Under 100% indicates negative funding progress. Due to amortization notes below, this will likely continue to be under 100% for the next few years. As the amortization length reduces, we expect this will increase. |
| Amortization method | |||||
| Funding goal | 100% | 100% | 100% | 100% | Actuarial funding method that targets < 100% funding results in payments not covering normal costs, interest on the unfunded liability, and principal. |
| Period | Closed | Closed | Closed | Closed | A closed funding period ensures the obligor plans to reach funding goal during the amortization period. |
| Length (years) | 27 years | 27 years | 27 years | 27 years | Length greater than 20 generally correllates to slow funding progress and increased risk of escalation due to adversity. |
| Basis | Level % of payroll | Level % of payroll | Level % of payroll | Level % of payroll | Level % explicitly defers costs, resulting in slow or even negative near-term funding progress. Escalating future contributions may stress affordability. |
| Payroll growth assumption | 3.00% | 3.00% | 3.00% | 3% before July 1, 2028, and 3.25% after | These represent the Tier 1 employees that currently make up the majority of total plan members. The higher this is, the more contribution deferrals are incorporated in the level percent funding methodology. There is risk not only of market or other adversity causing unforeseen escalations to contributions, but of hiring practices not keeping up with assumed payroll growth, leading to contribution shortfalls. |
| Longevity | Generational | Generational | Generational | Generational | A generational assumption reduces risks of contribution “jumps” due to periodic updates from experience studies. |
This report does not constitute a rating action.
| Primary Credit Analysts: | Virginia A Murillo, San Francisco 1-415-371-5098; virginia.murillo@spglobal.com |
| Jessica Olejak, Chicago + 1 (312) 233 7068; jessica.olejak@spglobal.com | |
| Joseph Vodziak, Chicago + 1 312 233 7094; joseph.vodziak@spglobal.com | |
| Secondary Contacts: | Cora Bruemmer, Chicago + 1 (312) 233 7099; cora.bruemmer@spglobal.com |
| Todd D Kanaster, ASA, FCA, MAAA, Englewood + 1 (303) 721 4490; Todd.Kanaster@spglobal.com |
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