U.S. State Liabilities Steady But Could Push Higher

News Release from Fitch Ratings, 15 Nov, 2022

Related Content: 2022 State Liability Update (Personal Income Surge Offsets Liability Increase)

Fitch Ratings-New York-15 November 2022: A surge in personal income brought U.S. state long-term liabilities lower for a fifth straight year, though a new report from Fitch Ratings says that inflation, equity market volatility and an early-2023 recession could reverse that trend.

The burden of state long-term liabilities fell slightly in fiscal 2021, continuing a longer-term trend since fiscal 2016. The median ratio of state direct debt plus Fitch-adjusted net pension liabilities (NPLs) declined to 4.6% of personal income in fiscal 2021 from 4.7% in fiscal 2020. According to Senior Director Doug Offerman, a surge in personal income was the dominant factor, offsetting rising direct debt and NPLs. “Personal income gains the last two years were aided by multiple rounds of direct federal pandemic assistance, as well as indirect Federal Reserve Bank monetary policy actions,” said Offerman.

However, rising inflation and interest rates along with the market tumble this year will affect state audits in fiscal years 2022 and 2023. “To the extent it persists, higher inflation will pressure pension liabilities via rising employee wages, which raise projected benefits, and automatic cost of living adjustment mechanisms, which preserve retirees' purchasing power,” said Offerman. Equity market weakness will also weigh on pension assets, pressuring ratios of assets to liabilities. Fitch also anticipates that personal income gains will revert to slower long-term averages following the recent surge.

Carrying costs for long term liabilities--which include debt service, actuarial pension contributions and actual payments for other post-employment benefits--remain manageable, consuming only 4.5% of state governmental expenditures in fiscal 2021. State pension contribution practices remained steady through the pandemic, with 32 of the 50 states making 100% or more of their actuarial contributions. States had gradually improved their contribution practices in the decade before the pandemic to improve pension system funding.

As of fiscal 2021, Connecticut carried the highest long-term liability burden at 25.9% of personal income, with Illinois, Hawaii, New Jersey and Alaska rounding out the top five states with the highest burdens. Conversely, Nebraska's long-term liability burden stood at just 1% of personal income, followed by South Dakota, Tennessee, Wyoming and Florida.

Fitch’s “2022 State Liability Update” is available at www.fitchratings.com.