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tandard & Poor’s Ratings Services has enhanced
its public pension fund rating criteria to incorpo-
rate an evaluation of a public pension fund’s issuer
credit rating, including reviewing the underlying
characteristics that comprise the fund’s sponsor
credit quality, independence, management controls,
and operating and financial performance. An addi-
tional, though separate, credit consideration
includes the pension fund’s credit enhancement or
related guarantee program. (See Public Finance
Criteria: Pension Fund Credit Enhancement And
Related Guarantee Programs)Background
Public pension funds are vehicles for accumulating
financial assets to advance-fund employee retire-
ment defined benefits that have been earned by, and
promised to public employees as part of their com-
pensation. Employee retirement defined benefit
obligations represent the long-term liabilities prom-
ised by the pension fund’s sponsor. Generally, both
the sponsor and the employee, through regular con-
tributions, share pension benefit funding. Typical
employee defined pension benefits include monthly
stipends based on a formula, including years of
service and final salary.
Public pension fund asset management mainly
focuses on increasing accumulated assets through
investment income and appreciation. However, pen-
sion funds may also engage in alternative means of
revenue generation, such as credit enhancement
programs, which generate fee income through the
extension of the fund’s guarantee of debt instru-
ments of other entities. Standard & Poor’s views
public pension funds as entities that are intrinsically
linked to their respective government sponsor in
terms of contribution support and benefit obliga-
tion modifications. Standard & Poor’s criteria does
not de-link pension fund rating factors from those
of its sponsor.Rating Methodology
Specifically, under Standard & Poor’s enhanced
public pension fund criteria, the creditworthiness of
a public pension fund is a function of performance
in the following basic analytical areas:
■Sponsor credit quality;
■Pension fund independence;■Pension fund management; and
■Pension fund operating and financial
performance.Sponsor Credit Quality
Although public pension funds are generally legally
separate financial entities, their strength and solven-
cy are a function of the willingness and ability of
sponsor governments to ensure that the defined
benefits are provided through the timely payment
of required contributions, and the maintenance of
an adequate funding level. Moreover, public pen-
sion fund employee benefit liabilities are tied to,
and are negotiated and determined by the govern-
ment sponsor. One of the items evaluated in the
context of a pension fund rating is whether a gov-
ernment views pension benefits as a means to
achieve labor settlement, since those costs may have
no substantial immediate effect on the sponsor’s
annual budgets or taxes.
Standard & Poor’s views well-funded public
pension funds as having the ability to withstand a
short-to mid-term disruption in sponsor contribu-
tions, or enhancements of employee benefits due
to the long-term nature of employee retirement
benefit obligation accruals and disbursements, as
well as the large share of income derived by
returns on existing investments. Yet, even though
a well-funded pension fund can likely continue to
make benefit payments in the short-to mid-term, a
prolonged reduction or absence of sponsor contri-
bution payments and/or enhanced benefit liabili-
ties will affect the fund’s long-term operating and
financial performance.
Due to these fundamental relationships between
sponsor and fund, including the ability of govern-
ment sponsors to recover from periods of financial
weakness, Standard & Poor’s analytical approach to
public pension fund ratings limits the upward rating
spread between the sponsor and pension fund to
one full rating category (three notches). In other
words, if a government sponsor’s general credit rat-
ing were ‘A’, then the highest potential rating that
the corresponding pension fund could earn would
be ‘AA’. Conversely, it is possible that a pension
fund may be viewed as less creditworthy than its
sponsor if Standard & Poor’s considers the fund’s
remaining basic analytical areas to be deficient.