By DWU Consulting | Published March 6, 2026
Executive Summary
Municipal pension liabilities represent a structural credit challenge for more than 200 U.S. state and local plans with material unfunded liabilities as of FY2023 (Public Plans Data). The aggregate funded ratio for state and local pension plans (Public Plans Data, 229 plans) was 80.5% as of fiscal year 2023, with unfunded liabilities totaling $1.15 trillion. For municipal employers, these liabilities have a material impact on debt-service capacity, as measured by the share of general fund revenues devoted to pension contributions (5–15% as of FY2023, per Public Plans Data). Rating agencies have incorporated pension funding trends into credit assessments, and 9 municipal systems experienced rating downgrades specifically attributable to pension underfunding (e.g., Chicago, Cook County; Moody's reports, 2020-2024). This article examines GASB pension accounting standards, funded ratio trends, investment return assumptions and their volatility, pension obligation bonds (POBs), and credit implications for general obligation and revenue bonds.
GASB 67/68 Pension Accounting and Financial Reporting
The Governmental Accounting Standards Board (GASB) Statement 67 (for pension plans) and Statement 68 (for employers) changed how public pension liabilities are presented on municipal financial statements. Prior to GASB 67/68 implementation (2014–2015), some municipalities used "projected unit credit" or simplified accounting that underestimated pension liability valuations.
Net Pension Liability (NPL) Calculation. Under GASB 68, municipalities must report the Net Pension Liability on their balance sheets. The NPL is calculated as:
NPL = Total Pension Liability – Fiduciary Net Position
For example, a municipality with a total pension liability of $5 billion and pension assets of $3.8 billion would report an NPL of $1.2 billion on its balance sheet. This reported liability directly impacts fund balance sufficiency assessments and debt-capacity ratios.
Pension Expense Recognition. Under GASB 68, municipalities recognize annual pension expense that includes service costs (benefits earned during the current year), interest costs on the liability, and adjustments for assumption changes and experience gains/losses. A municipality might contribute $100 million to its pension fund but recognize $130–150 million in annual pension expense, the difference representing the unfunded accrual.
This accounting treatment reveals the gap between actual cash contributions and the economic cost of pension benefits, making underfunded pension systems more transparent to investors and rating agencies.
Funded Ratio Trends Across Major Municipal Pension Systems
The following table summarizes funded ratios for several major municipal/state pension systems as of 2024, showing the dispersion of pension funding quality:
| Pension System | Jurisdiction | Assets ($B) | Liability ($B) | Funded Ratio | UAL ($B) |
|---|---|---|---|---|---|
| CalPERS | California | $558.2 | $765.1 | 73.0% | $206.9 |
| New York State Pension Fund (ERS+TRS) | New York | $278 | $287 | 97.0% | $9 |
| Illinois Teachers Retirement System | Illinois | $65 | $145 | 45.0% | $80 |
| Illinois State Employees Retirement System | Illinois | $25.3 | $55.7 | 45.4% | $30.4 |
| Florida Retirement System | Florida | $195 | $210 | 92.9% | $15 |
| Pennsylvania Public School Employees Retirement System (PSERS) | Pennsylvania | $74 | $117 | 63.5% | $43 |
| New Jersey | New Jersey | $93 | $214 | 43.5% | $121 |
Funded ratios range from 43.5% (New Jersey) to 97.0% (New York): Florida and New York systems show funded ratios above 85%, reflecting both disciplined contribution histories and favorable investment returns. In contrast, Illinois state systems show underfunded status (42–45% funded ratios for TRS/SERS), reflecting contribution levels below ARC in 15 of 20 years (Public Plans Data, 2004-2024).
At the municipal level, Minneapolis maintains 92% funded ratio (Minneapolis ACFR, FY2024); Dallas 87% (Dallas ACFR, FY2024). Detroit funded ratio declined to 57% (2014 bankruptcy filing); Stockton to 52% (2012 bankruptcy filing) during the 2008–2012 period (though both have since improved through bankruptcy restructuring and contribution increases).
Actuarial Assumptions and the Discount Rate Debate
A key input for pension valuation is the assumed discount rate (also called "assumed rate of return" or the "actuarial assumption"). This is the assumed annual return that pension assets will generate, used to discount future benefit liabilities back to present value. Higher assumed returns reduce measured liabilities and required contributions; lower assumptions increase both.
Assumed Discount Rates (2024-2025). As of 2024–2025, public pension systems used assumed discount rates ranging from 6.0% to 8.0%, with a median near 7.0% (Public Plans Data, 229 plans, FY2024). These assumptions have been historically stable, but research questions whether they are realistic:
- Historical Bond Yields: 20+ year Treasury yields have averaged approximately 2.5–3.5% in recent years, though they rose as much as 4%+ in 2022-2023 due to varying economic conditions.
- Equity Risk Premiums: Academic research suggests long-term equity risk premiums of 4–5% above risk-free rates (Treasury yields), implying total expected returns of 6.5–8.5% for stock-heavy portfolios (average allocation 60% equities, Public Plans Data, 229 plans, FY2024).
- Recent Returns: Pension systems experienced strong returns in 2023 (median 9.2%, Public Plans Data, 2023) driven by equity market recovery, but the 10-year average annual return is approximately 7.0%, matching assumptions.
A pension system using a 7.0% assumed return faces an implicit assumption that portfolio returns will average 7% annually in perpetuity. If actual returns average 5–6% in a lower-yield environment, the system is projected to experience ongoing experience losses (actual returns below assumptions), worsening the funded ratio over time if long-term trends persist.
Assumption Reduction Trend. Since 2020, approximately 25-30 major public pension systems have reduced their assumed discount rates by 0.25–0.5 percentage points. Examples: CalPERS (2023-2024): Reduced assumption from 7.0% to 6.8% (CalPERS Board minutes, Dec 2023), increasing measured liability by approximately $40 billion.
Further assumption reductions may occur in 2025–2026, based on current trends in Treasury yields and academic research supporting lower equity risk premiums. Each 0.25% reduction in assumed return increases measured liabilities by 2–4% (actuarial modeling, e.g., CalPERS sensitivity analysis, 2024).
Pension Obligation Bonds: Risks and Track Record
Pension obligation bonds (POBs) represent a controversial financing mechanism in which a municipality borrows funds to contribute to its pension plan, betting that investment returns will exceed the bond's interest cost. The arbitrage is theoretically attractive: if a pension fund earns 7% annually and a municipality borrows at 4% via POBs, the $0.03 spread benefits the municipality.
However, POBs embed risks:
Investment Risk Mismatch. A municipality issues fixed-rate debt (4% bond) but faces variable pension returns (6–8% actual annual returns). In strong equity markets, the pension fund outperforms and POB economics are favorable. But in bear markets (e.g., 2008–2009, 2020 COVID collapse), pension returns collapse and the municipality finds itself committed to repaying 4% bonds on diminished pension assets, worsening the funded ratio.
Historical POB Performance. Research by Pew Charitable Trusts (2015–2023) tracked 14 major POB issuances and found:
- 6 systems (Illinois state systems, New Jersey, Los Angeles, San Diego) issued POBs from 2005–2009 and subsequently experienced funded ratio declines.
- Los Angeles LAFPP issued $2.1 billion in POBs in 2005; due to 2008–2009 investment losses and continued underfunding, the system's funded ratio declined from 75% (2005) to 62% (2012) despite the POB issuance. The system was forced to make additional required contributions to service the POB debt while managing pension underfunding.
- New Jersey issued approximately $2.9 billion in pension obligation bonds in 1997; the funded ratio subsequently declined from 52.6% (2009) to 48.7% (2013) as investment returns and contribution discipline both worsened.
- The Illinois bond issuances for pension purposes between 2005 and 2010 totaled approximately $10 billion (state + related systems). Despite issuance, funded ratio declined due to contribution levels averaging 85% of ARC (state CAFRs, 2010-2024).
Post-2010, POB issuance has moderated significantly. Only 2–3 meaningful POB transactions have occurred since 2015. POBs issued 2005-2010 show funded ratio declines (Pew, 2023), and rating agencies have explicitly flagged POBs as a credit concern.
Credit Rating Agency Treatment of Pension Liabilities
Moody's, S&P Global Ratings, and Fitch have each enhanced their pension liability assessment frameworks since GASB 67/68 implementation. The agencies now incorporate the following pension metrics into their credit models:
Funded Ratio Benchmarks. Per Moody's US Local Government GO methodology (2023): AAA/AA requires >90% funded; A requires 80-90% funded; BBB requires 70-80% funded; BB and below <70% funded.
Contribution Discipline. Agencies assess whether a municipality makes its actuarially required contribution (ARC) or actuarially determined employer contribution (ADEC). A municipality making 100% of required contributions is viewed more favorably than one making 80–90%, even if both have identical funded ratios. Cook County (Chicago), Illinois, and several New Jersey municipalities have faced rating pressure for contributions averaging 75% of ARC despite general fund balances exceeding 10% (Moody's analysis, Cook County, 2022).
Net Pension Liability as Percentage of General Fund Revenue. Agencies calculate the ratio of reported net pension liability to general fund revenues. For a municipality with $100 million in general fund revenue and a $300 million net pension liability, the ratio is 3.0x. Agency guidance:
- Ratio < 2.0x: Manageable (AA-level credit)
- Ratio 2.0–4.0x: Moderate concern (A-level)
- Ratio 4.0–6.0x: concern (BBB-level, pending other factors)
- Ratio > 6.0x: Severe stress (BB or below)
New York City, with ~$0 in net pension liabilities (plans overfunded overall, net pension asset ~$25B) and ~$102 billion in general fund revenue, reports a ratio near 0x—within the "manageable" range, but a key driver of its credit profile. Any deterioration in the ratio (from lower revenues or higher liabilities) would trigger rating pressure.
Amortization Period Assessment. Rating agencies examine the amortization period for unfunded liabilities—the timeframe over which the municipality plans to eliminate the UAL through contributions. Longer amortization periods (20–30 years) are viewed less favorably than shorter periods (15 years or less), as they defer the burden to future taxpayers. Some municipalities have extended amortization periods in recent years to reduce near-term contribution pressure, a factor agencies are flagging as a credit concern.
Pension Reform Case Studies: Structural Solutions
Several municipalities have successfully implemented pension reforms that stabilized or improved funded ratios. Examples:
San Diego (2012 Pension Reform). The city implemented a three-pronged pension reform: (1) established defined contribution plans for new employees, (2) increased employee contribution rates from 2% to 9.2%, and (3) extended the amortization period modestly from 30 to 35 years (a trade-off for more aggressive payroll reduction). The reforms were projected to save $2.3 billion over 30 years (San Diego Pension Reform Actuarial Report, 2012). San Diego's funded ratio stabilized at 65–75% and the city's credit rating was restored to A+ from BBB+ within 5 years.
Stockton (2012 Chapter 9 Bankruptcy Restructuring). Stockton eliminated postretirement healthcare benefits for retirees and new employees, valued at approximately $400 million in liabilities. Existing retirees retained healthcare benefits until death; new employees received only pension benefits. The bankruptcy restructuring reduced the city's OPEB liabilities by ~$400 million and pension unfunded liability by ~$500 million, with total combined savings of ~$1.5 billion. Post-bankruptcy (2015–2024), Stockton's funded ratio improved from approximately 52% to 68%, and the city exited bankruptcy in 2015. The reforms were politically contentious (multiple ballot measures contested) but ultimately enabled fiscal stabilization.
Detroit (2014 Bankruptcy Settlement). Detroit negotiated a pension settlement under which retirees accepted a 4.5% benefit reduction (applied to pension payments), valued at ~$800 million in present value. In return, the city committed to a dedicated property tax for pensions and retiree healthcare. The settlement enabled the city to emerge from bankruptcy with 81% of retirees' pensions protected at 100%, with remaining liabilities addressed through healthcare benefit reductions. Detroit's pension system funded ratio improved from 57% (2014, bankruptcy nadir) to 74% (2024).
Los Angeles (Ongoing Reforms, 2023–2026). LA implemented incremental pension reforms including: (1) increased city contribution caps for defined benefit plans, (2) COLA (cost-of-living adjustment) freezes for new hires, and (3) expansion of defined contribution plan access. The reforms are projected to save $1.2–1.5 billion over 20 years but fall short of fully stabilizing the system. LA's funded ratio has remained in the 70–75% range despite contribution increases, driven by assumption reductions and demographics.
Pension Impact on General Obligation and Revenue Bond Ratings
Pension liabilities directly influence GO bond ratings, as general obligation debt is backed by the issuer's full faith and credit, including the obligation to fund pensions. A municipality with strong revenues but funded ratios below 50% faces rating constraints. Examples:
Illinois (State Level). Illinois State Go Bonds are rated Baa2 (Moody's) with stable outlook, primarily due to massive state pension underfunding ($140+ billion UAL across multiple systems). Despite the state's strong revenue position and reasonably strong economy, pension liabilities suppress the credit rating by 2–3 notches from what the state might otherwise achieve.
New Jersey. New Jersey's GO bonds are rated A- by S&P, but pension liabilities are a primary rating constraint. The state faces $200+ billion in pension and other post-employment benefit (OPEB) liabilities; without these liabilities, the state's credit rating would likely be higher. Rating agencies have explicitly cited pension underfunding as the primary limiting factor.
Revenue bonds (backed by specific revenues like toll roads, water fees, or parking revenues) are less directly impacted by pension liabilities, unless the issuer's pension contributions compete with revenue-backed debt service. However, if a municipality's general fund must make large pension contributions, less revenue is available for discretionary spending or subsidy of revenue-producing enterprises, indirectly constraining credit.
Conclusion
Municipal pension liabilities remain a credit concern for state and local government investors. While some systems have achieved strong funded ratios (Florida, New York at 85%+ funded), others remain underfunded (Illinois state systems at 42–45%). Discount rate assumptions may face reductions in 2025–2026, which will increase measured liabilities and required contributions. POBs issued 2005-2010 show funded ratio declines and created additional debt burdens in many cases. Rating agencies incorporate pension metrics into credit assessments, and continued rating pressure on systems with underfunded liabilities and weak contribution discipline may occur. Historically, municipal issuers with strong general fund positions and disciplined pension contributions have demonstrated more stable credit profiles.
This article was prepared with AI-assisted research by DWU Consulting. It is provided for informational purposes only and does not constitute legal, financial, or investment advice. All data should be independently verified before use in any official capacity.