Fitch lowers U.S. pension discount rate, putting Illinois in deeper hole
A change in outlook from a major ratings agency is likely to have a big effect on Illinois' public debt. Fitch Ratings announced on June 1 that it is lowering the discount rate for U.S. public pension plan liabilities to 6 percent from 7 percent.
Doug Offerman, senior director at Fitch, cited “slower and more incremental” U.S. economic growth when measured over longer periods.
“There is little evidence to suggest the economy will accelerate to previous levels of growth in the near term,” Offerman said in a statement. “Fitch believes that pensions will be hard-pressed to achieve their long-term growth expectations in the current economic context."
This is particularly bad news for Illinois, where analysts peg total pension liabilities at approximately $130 billion as of the end of 2016.
Reuters reports at the time described “budgetary feuding” between Gov. Bruce Rauner and the Legislature.
As for the new ratings assessment, lowering the discount rate, or “assumed investment return,” will increase pension liabilities, stressing the state budget even further.
Bill Bergman at Truth in Accounting told the Sangamon Sun that increasing projected pension liabilities according to a lower discount rate is a classic example of the inverse relationship between present and future capital values.
“In order to compute a present value, they projected … payments out into the future,” Bergman said. “The lower the discount rate, the higher the present value of the liability.”
Bergman likened the situation to a bond market, in which buyers get lower prices during an interest rate hike.
“Rates go up; bond prices go down,” Bergman said.
A simple analogy, he said, is the age-old slogan, “a bird in the hand is worth two in the bush,” which he said captures the philosophies of these financial equations “in all their glory.”
Bergman also said there is an ongoing debate regarding how analysts should set expected rates of return. Under some models, he said, Fitch would have gone much lower, to around 2.5 percent.
Staff from Fitch declined to provide comments when reached by phone, referring the Sangamon Sun to analysts who did not return calls by press time.