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The Impact of Pensions on State Borrowing Costs

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Publication Date: February 2011

Publisher(s): Center for Retirement Research at Boston College

Author(s): Alicia H. Munnell; Jean-Pierre Aubry; Laura Quinby


Special Collection:

Topic: Economics (Economic conditions)
Economics (Economic policy, planning, and development)
Economics (Infrastructure)

Keywords: State and Local Pensions

Type: Report

Coverage: United States


Municipal bond prices are tumbling and rates rising just as public borrowers face pressure to refinance deals cut during the financial crisis. At the same time, the funded status of public pension plans has declined, and states and localities will have to come up with more money to meet future benefit payments. In the private sector, numerous studies have
shown that pension underfunding affects corporate bond ratings. And Moody’s just announced that it would combine unfunded pension liabilities with outstanding bonds when evaluating a state’s leverage position. These developments raise the question of how future pension commitments affect today’s borrowing costs in the public sector.

The brief proceeds as follows. The first section describes the municipal bond market. The second section describes the factors that traditionally have been considered in the bond rating process. The third section summarizes what other researchers have found regarding the relationship between pension commitments and borrowing costs in the private and public sectors. The fourth section presents a model
for the period 2005-2009 that relates borrowing costs to factors generally considered by the rating agencies, such as the state’s management, finances, economy, and debt structure. Pensions are a component of the
debt structure, and the extent to which states make their Annual Required Contribution (ARC) has a statistically significant – albeit modest – impact on the cost of debt. A side finding is that the bond’s rating explains relatively little about the variation in interest cost, and the effect of pensions remains significant even including the bond’s rating in the equation. The final section concludes that while pension underfunding
had only a small effect on borrowing costs in the 2005-2009 period when pension expenses were only 3 to 4 percent of state budgets, its impact could become more significant as the cost of pensions increases.