By Joan Gralla
July 2 (Reuters) - U.S. states and localities have run up more than $2 trillion of unfunded pension liabilities, Moody's Investors Service said on Mo nday, citing data on plans offered by 8,500 local governments and over 14,000 individual entities.
The Wall Street credit agency said that according to its estimate, the total liabilities for fiscal 2010 were more than three times the amount reported by local governments.
"Pension liabilities are widely acknowledged to be understated," Moody's Managing Director Timothy Blake said in a statement. Most states end their fiscal years on June 30.
Investors in the $3.7 trillion municipal bond market are focused on whether states, counties, cities and towns can afford the pension benefits granted public workers.
The rising cost of public pensions has strained finances for cities around the country. Stockton, California, which last week became the biggest U.S. city to file for Chapter 9 protection, plans to cut employee compensation and retiree benefits by $11.2 million to help close its deficit.
Public pension benefits have become a flashpoint in elections around the country.
Since 2009, at least 43 states have tried to rein in costs. . But many states spread the savings out over long periods.
Moody's is seeking public comment through the end of August on four major changes it plans to make in how it treats pension liabilities. The negative impact of the modifications - which will start taking effect in the fall - will hit local governments such as counties, cities and towns, as well as school districts, most heavily - unless Moody's significantly alters them after reviewing the public comments.
"Moody's expects the proposed pension adjustments to result in rating actions for local governments where the effect is outsized relative to their rating category, but no state rating changes are expected solely as a result of pursuing the adjustments now under consideration," it said.
Cities and counties are likely to see downgrades, Blake said.
That is partly because some liabilities in state pension plans that also cover localities will be allocated to the specific local governments. Currently, some of those liabilities might not be broken out by the individual city, town or school that is part of a state plan.
The liabilities of all public pension funds, for both states and localities, could leap, as Moody's will also consider a revision of the rate used to calculate them.
Currently, many public pension plans use the same rate - often 7.5 percent to 8.25 percent - for the assumed investment rate of return and the discount rate used to calculate liabilities.
Moody's would cut the discount rate to that of a high-grade long-term corporate bond index - which was 5.5 percent in 2010 and 2011.
The actuarial accrued liability would climb about 13 percent for each percentage point difference between 5.5 percent and whatever discount rate was used.
For example, a plan with a $10 billion liability based on an 8 percent discount rate would see that amount leap to $13.56 billion if a 5.5 percent rate were used.
Asset-smoothing, which enables pension plans to spread losses or gains over a number of years, will be abolished. Instead, pension fund assets will be valued based on the market value or the fair value on the actuarial reporting date, Moody's said.
Finally, yearly pension contributions will be adjusted on a common amortization period and in line with the three other modifications, Moody's said.
Some of the changes implemented by Moody's are in line with the new accounting rules for pension funds approved at the end of June by the Governmental Accounting Standards Board .