The Week in Public Finance: Splitting Pensions, Going Hyperlocal and Charter Schools' Impact on Credit Ratings

A roundup of money (and other) news governments can use.
by | November 13, 2015
A charter school in Wisconsin. Many complain that charter schools siphon crucial money away from traditional public schools. (Wikimedia/Royalbroil)

For previous editions of The Week in Public Finance column, click here.

What Happened to United We Stand?

Connecticut is considering an overhaul of its largest pension system as the retiree fund careens toward insolvency. The state employee fund, SERS, has less than half of the assets it needs to meet liabilities and many believe that its generous accounting standards hide something even worse. The plan has started paying out more to retirees than it is receiving in contributions. Meanwhile, observers expect state payments to SERS to balloon to $6 billion -- a third of the current state budget -- by 2032. Lawmakers are now asking for some creative solutions to the problem.

On Nov. 10, the Center for Retirement Research presented its recommendations to the state. The main suggestions were to lower the plan’s assumed rate of return it uses to calculate its overall pension liabilities. Connecticut’s 8 percent return assumption is higher than the median 7.75 percent across all state pension plans. Many experts also say the past decade of slightly lower investment returns than the historical average should force plans to lower their return assumptions to at least below 7 percent so that governments and employees will put in more money now to keep the fund from running out of money. The other main recommendation is something that Gov. Dannel Malloy supports -- splitting the plan in two. The pension fund would keep workers hired after 1984, who have less expensive benefits than the pre-1984 hires. The older hires’ benefits would be paid for directly out of the state's annual budget. The split would essentially remove the unfunded liabilities from the pension plan’s overall liabilities.

The plan has received unenthusiastic reviews. The state’s treasurer has questioned the legality of the split. Pension blogger Mary Pat Campbell pointed out splitting the plan into one part that is funded and one part that isn't (as opposed to having one big underfunded pool) won't to make the pensions more secure. “I love these plans where the already accrued pension promises aren’t affordable right now will somehow magically become affordable in the future,” she wrote.

Going Hyperlocal

New York state’s pension fund this week announced its plan to encourage small business growth in the state by investing in a fund that provides financing to relatively small New York-based companies. The $184.5 billion pension system is the third largest in the country and is one of the first to offer credit financing through an in-state-focused fund. TD Bank, Bank of NY Mellon, HSBC Bank, Deutsche Bank and First Niagara Bank are also investors in the $200 million New York Credit Small Business Investment Company (SBIC) Fund.

Many banks have been reluctant to lend smaller businesses capital following the financial crisis and the SBIC fund will provide capital to businesses that need money to grow and expand. The state pension fund has committed $50 million to the program.

Still, the fund targets companies with revenues between $5 million and $50 million, leaving out the mom and pop businesses that are struggling the most with financing and can be victims of predatory lending. The smallest businesses also typically are the riskiest investments. “We’ve joined with five major banks to bridge the gap between New York’s companies and the financing they need to excel,” said State Comptroller Thomas P. DiNapoli. “These investments are in line with our priority of generating returns for the pension fund, while helping to boost our state’s economy.”

Charting a New Course

The number of students attending charter schools has increased an average of 10 percent each year since 2000 across the country. The shift is putting financial pressure on public school districts as they struggle to manage dwindling resources. The main problem, said a Moody’s Investors Service report, is that a district's loss of revenues associated with a pupil going to another school is often more than the district is able to cut because of fixed costs and economies of scale. “Even if a district were capable of cutting expenditures dollar-for-dollar with the loss of per-pupil revenues, it's often not obvious to a district how much it needs to cut,” the report explains. “Many district s are unable to project how many students will choose other options, and so find it difficult to build appropriate cost assumptions into their staffing levels, labor contracts and spending plans.”

When schools do cut resources to match their funding, it can result in a downward spiral, the report said. Reduced funding “can weaken the district's educational product, encouraging more students to attend schools outside the home district. The loss of those students then results in additional revenue losses, prompting further expenditure cuts. And so on.” This spiral has hurt the credit rating of the Philadelphia School District, where about one-third of students are enrolled in charters, and in Detroit, which has half of its students in charters. Still other places like Cleveland or Indianapolis that have between 30 and 40 percent charter enrollment, have maintained a good credit rating.

That means charter schools are not inherently negative: For districts in high-growth regions, charter schools can sometimes help by absorbing students for which the district does not have enough capacity, the report said. Rather, the areas where competition from charters has hurt public schools is more due to the district’s inflexible governance and inability to adjust to the changes. “Because charter schools primarily operate in poorer, urban areas, these costs are typically imposed on the very districts with the least capacity to cope with them,” said Moody’s.