compensation agreements with employees and plan
structure obligations. Among these are:
■Monthly stipends based on plan formula;
■Disability entitlements; and
■Death benefits.
An important focus of this area will be on the
process of how benefits are revised and whether
there are built-in factors that could cause future
pension benefits to increase substantially. Examples
are pension benefit increases or accelerations that
could increase or accelerate payments of pension
benefits, such as early retirement legislation, or
changes in the method of calculation of eligible
compensation as the basis for pension payments. In
addition, Standard & Poor’s will need to assess the
history of retiree benefit enhancements or other
changes, and how any modifications were compen-
sated for in terms of funding.
Other areas to be reviewed are the vesting rights
of employees, as well as obligations for termination
payments by the plan when an employee withdraws
from the plan or government employment.Furthermore, Standard & Poor’s will closely exam-
ine the pension fund’s actuarial assumptions,
including funding method, asset valuation smooth-
ing assumptions, mortality, and inflation. Analytical
questions include:
■Is participation optional, allowing for competing
plans and possible withdrawal of participants’
and sponsors’ contributions and shares of assets
into other pension plans?
■Under what conditions can employee termination
withdrawals occur and what has been the histori-
cal experience?
■If non-vested, do employees have rights to their
contributions alone, or are they also entitled to
benefits with respect of employer contributions
made on their behalf?
■If termination payments are made to the employ-
ees, do sponsor contributions remain in the plan
or revert to the sponsor?
■Has there been a change in actuaries and/or have
any significant actuarial assumptions been altered?
Operating and financial performance measurements
Standard & Poor’s employs trend analysis to assess
public pension fund operating and financial per-
formance. Depending on the metric, the trend
analysis timeframe can range from three to ten
years, and the analysis will determine the underly-
ing factors behind positive or negative changes.
Standard & Poor’s will conduct its trend analysis in
the context of the pension fund’s various manage-
ment factors, which include funding objectives and
financial risk acceptance.
Standard & Poor’s begins its operating and finan-
cial performance trend assessment by analyzing the
pension fund’s funding ratios. Specifically,
Standard & Poor’s will look at the pension fund’s
unfunded actuarial accrued liability (UAAL) and
the funded ratio.
Overall, the higher the funded ratio, the more
likely that accumulated assets will be able to sup-
port annual benefit obligations. Generally,
Standard & Poor’s will favorably view a pension
fund with a funded ratio trend that is stable or
increasing. Although funded ratios that are 100%
or higher are viewed most favorably, Standard &
Poor’s understands that keeping a pension system at
or near full funding is a very difficult balancing act
and may not be desirable.
For example, very strong funding levels can result
in greater pressure to increase benefit levels.
Further, in actuarially funded pension systems, full
funding results in downward pressure on the contri-
bution rate and, in some cases, outright contribu-
tion holidays. Benefit enhancements and/or contri-
bution holidays have the potential to pressure thehttp://www.standardandpoors.com 333Public Pension FundsA pension fund’s unfunded actuarial accrued liability (UAAL) and funded ratio are
tied to the fund’s actuarial value of assets (AVA) and actuarial accrued liability
(AAL). The UAAL is established by subtracting the fund’s AVA from the fund’s AAL.
When the difference is a positive number, it means that the AVA is not sufficient to
cover the AAL. Conversely, when the difference is a negative number, it means that
the AVA exceeds the AAL. The funded ratio is derived by dividing the fund’s AVA
by the AAL, and is important in quantifying the adequacy of the pension fund’s
accumulated assets.
Pension Fund Unfunded Actuarial Accrued
Liability And Funded RatioIn addition to the UAAL and funded ratio, Standard & Poor’s employs a variety of
quantifiable metrics in order to gauge a pension fund’s operating and financial
performance. These metrics include:
■Actuarial discount rate assumptions.
■Return on investments, return on assets (change in net assets divided by
total assets), and return on net assets (change in net assets divided by
net assets).
■Total margin (change in net assets divided by total revenue).
■Pension benefit expense service delivery efficiency
■Annual pension expense (employer contributions) as a percentage of the
sponsor’s budget.
■UAAL as a percentage of the sponsor’s budget.
■UAAL per capita (for the sponsor’s population).
■UAAL as a percentage of the sponsor’s per capita income.
■Historical pension fund balance sheet and liquidity trends.
■Historical pension fund income statement trends.Assessing Pension Fund Operating And Financial Performance