This report updates "Pension Spotlight: Risk Sharing Dilutes Burden For Five States," published April 21, 2021, on RatingsDirect. S&P Global Ratings provides a glimpse into how retirement systems use various mechanisms to balance funding levels and contribution requirements, as well as distribute pension costs among stakeholders (state, employers, retirees, and employees).

Risk-sharing pension plan designs, including hybrid defined-benefit (DB) and defined-contribution (DC) plans, adjustable employee and employer contribution rates, and variable benefits based on funded status or investment earnings, are generally designed to stabilize and/or contain employer pension costs. Such designs can spread the effects of rapid cost swings among multiple parties, limiting an entity's exposure to budgetary stress. Risk-sharing designs might not fully mitigate contribution volatility and escalation risks and can take time if the measures were recently implemented, as legal limitations typically protect legacy accrued liabilities, so we review pension cost risks on an individual issuer basis.

Table 1

Oregon Public Employees Retirement System (OPERS)

Adequate funded levels indicate a moderate unfunded liability burden, a discount rate above our guideline suggests high volatility risk within the target portfolio, and increasing amortization defers costs to the future. However, risk of budgetary stress from OPERS contributions is partially offset by the risk-sharing mechanisms (table 1). Other risk-mitigating mechanisms that could affect our credit view include a cost-of-living adjustment (COLA) cap of 2% and the implementation of a pensionable salary cap, effective Jan. 1, 2020.

OPERS administers a hybrid cost-sharing, multiple-employer DB pension plan with a supplemental DC component. Employee contributions are statutorily fixed while employer contributions are actuarially determined and adjusted biennially. Employer rates in fiscal years 2024-2025 were adopted by the OPERS board in fall 2022 and based on a Dec. 31, 2021, actuarial valuation, so there might be a delay in contribution adjustments. Contribution rates decreased in fiscal years 2024-2025 due to asset valuation growth from stronger-than-assumed investment returns in fiscal years 2020-2021; however, OPERS uses a rate collar to limit contribution volatility, a form of direct-rate smoothing that can stabilize costs but also lead to some cost deferrals.

South Dakota Retirement System (SDRS)

SDRS pension costs are predictable for state and local governments because the plan is annually one of the most well-funded pension plans in the country, measured with a discount rate of 6.5%, which is slightly above our 6% guideline, although less than the national median.

SDRS is a cost-sharing, multiple-employer pension plan with statutorily fixed contributions, meaning contribution rates do not fluctuate with investment performance or actuarial valuations. Instead, benefit changes are used to maintain the system's financial health, specifically COLAs, which can be modified in response to economic and financial conditions. SDRS uses variable-rate COLAs based on the Consumer Price Index, allowing for COLA reductions if the funded ratio falls below 100%. Therefore, investment and demographic risks are primarily borne by retirees.

SDRS also manages risk through its variable retirement account (VRA), a supplemental benefit for employees hired on or after July 1, 2017, funded by employee and state contributions. However, state contributions only occur when investment performance in the trust fund exceeds the assumed rate of return. Essentially, VRA is a DC plan that, if elected, can be converted to an annuity at retirement.

Tennessee Consolidated Retirement System (TCRS)

TCRS demonstrates historically solid pension funding discipline, with contributions generally well above our minimum funding progress (MFP) metric, especially for the Teacher Legacy Pension Plan, translating into pension liability and costs with a minimal negative credit impact on the state and local governments.

TCRS includes the Public Employee Retirement Plan, consisting of agent multiple-employer pension plans for state and local government employees, as well as multiple-employer, cost-sharing plans for teachers. Recent TCRS hires participate in a hybrid (tier 2) plan with a DC supplement.

Employer contributions are actuarially determined but with statutory minimum rates. An SRT is available for use by employers in years when the actuarially determined contribution (ADC) exceeds the hybrid plan's statutory minimum contribution rate, thus helping manage contribution volatility. The SRT balance was $144.1 million as of June 30, 2023, a 36% increase over the previous five years with just over half of the balance dedicated to the teachers' hybrid plan. The healthy SRT balance and extraordinary one-time contributions from the state to the Public Employee Retirement Plan of $300 million, $350 million, and $250 million in fiscal years 2024, 2023, and 2022, respectively, exemplify a commitment to managing liability-and-cost growth for all participants.

Utah Retirement System (URS)

Through its DC supplement, URS passes most contribution volatility risk on to employees, limited to extreme circumstances, so the credit impact URS has on issuers is typically negligible.

URS consists of traditional DB (tier 1) plans and hybrid (tier 2) plans for recent hires. In addition, there is an optional, stand-alone DC plan for tier 2 employees who opt to not participate in the hybrid plan, with a balance that can be converted to a variable annuity with a benefit based on investment performance.

For tier 1 plans, employers are responsible for meeting the ADC, with the tier 1 noncontributory plan often representing the largest pension liability and cost for employers. In tier 2 plans, employer contributions to the DB component are fixed and capped at 10% of payroll (12% for public safety and firefighter plans), with costs above that borne by employees. When an employer's fixed contribution exceeds the ADC, the excess is redirected to an employee's DC account.

Wisconsin Retirement System (WRS)

WRS typically has limited negative impact on state and local government credit quality, as it is annually one of the most well-funded pension plans in the country and, although reported funded levels are determined using a discount rate above our 6% guideline, contributions are conservatively calculated using a lower rate for retirees. The WRS funded ratio decreased below 100% in fiscal 2022 due largely to negative investment returns.

The state administers WRS--a cost-sharing, multiple-employer pension plan--for almost all public employees (except for City of Milwaukee and Milwaukee County employees), with contribution rates based on an actuarial recommendation and usually exceeding our static and MFP metrics, although this did not occur in fiscal 2022.

Table 2

Table 3