New rules may make public pensions appear weaker

WASHINGTON Mon Jun 25, 2012 6:29pm EDT

WASHINGTON (Reuters) - New accounting rules approved on Monday are likely to show public pension funds are in a weaker financial position than previously thought and intensify disputes over how public retirement systems are funded.

The Governmental Accounting Standards Board, which sets the accounting standards for the public sector, finalized a single system of accounting to replace the menu of financial reporting options public pension funds currently use.

State and local governments will have to post their net pension liability - the difference between the projected benefit payments and the assets set aside to cover those payments - up front on financial statements, under the changes.

"The pension liability will appear on the face of the financial statements for the first time. That's going to create the appearance of a weaker financial position," said Robert H. Attmore, GASB chairman, who said the board intended to "peel back the veil so things are more transparent and there's more information for policy makers."

Governments participating in multi-employer plans - essentially smaller cities that are part of the state systems - will have to represent their share of liabilities, which could also make them appear financially weaker. Currently, they only have to state how much they have contributed.

Richard Ciccarone, managing director and chief research officer at McDonnell Investment Management, said GASB was headed in the right direction in terms of comparability and transparency, adding that some of the changes will sharply increase deficits for some governments.

"It shouldn't immediately cause anyone to file for bankruptcy," he said, adding that "it may immediately raise the level of attention to seriously do something here."

The biggest GASB change affects how the pension funds project rates of return on their investments, which provide 60 percent of their revenue. Underfunded pensions would have to lower their estimates for returns.

GASB also eliminated a process known as "smoothing," where the pension systems spread the liabilities over time, making the funds more reactive to volatility in financial markets. Funds can still spread out expenses, but over a shorter time frame.

Some of the GASB changes go into effect on June 2013, with the others implemented in June 2014.

More changes are coming. Starting next month, GASB will begin work on accounting for other retiree benefits, mainly healthcare, which tend to be in worse shape than pensions.

Some critics say the reforms could distort perceptions of governments' and retirement systems' health. They worry politicians will seize on the new, larger liabilities, to push through policy changes or starve employee retirement systems.

"We're concerned about confusion of the numbers," said Keith Brainard, research director of the National Association of State Retirement Administrators. "If a plan has a liability of $4 billion, does that mean they need $4 billion today? No. It's an accounting number."

Governments typically provide about 20 percent of pension fund revenue, but under the new standards, they will not have to disclose their annually required contributions (ARC). Ciccarone, however, raised concerns that governments would no longer post this information.

The Government Accountability Office, the nonpartisan federal auditor, reported in March that "most state and local government plans currently have assets sufficient to cover their benefit commitment for a decade or more."

Still, skepticism has risen about both the long and short-term prospects of public pensions. A week ago the Pew Center on the States estimated states are short $757 billion to pay retiree pension benefits, and the total could grow.

LOWER RATES OF RETURN MEAN BIGGER TAXPAYER BILL

Although it sounds like a technical accounting move, the new standard on rates of return is key to the pension wars.

Pension funds that are considered adequately funded could continue forecasting investment returns in-line with their historic averages, usually around 8 percent, under the new GASB rules. The board would only define those pension systems as having sufficient assets on hand to pay the pension of current employees and retirees, but did not set a funding ratio.

Funds lacking sufficient cash to cover benefits must lower their projected investment rate to about 3 percent to 4 percent. Specifically, the investment rate would have to match "a yield or index rate on tax-exempt 20-year, AA-or-higher rated municipal bonds," an information sheet on the changes said. On Monday, the yield for AA-rated municipal bonds due in 20 years was 3.12 percent, according to Municipal Market Data.

When investments fail to meet the forecasts, governments - essentially taxpayers - and employees must pitch in money to fill the void. At the depth of the recession in 2008, the return on pension investments fell by 25 percent, Pew found.

The new rules offer a compromise. U.S. Congress would like systems to use a rate they call "riskless," about 4 percent. Pensions counter they should use historical averages.

Pew found that Wisconsin is the best-funded retirement system in the country, and Illinois the worst.

"States like New York, which are making their contributions to their pension plans and are well-funded, their liability should not be affected by the new discount rates," said David Draine, senior researcher at Pew, about the GASB changes. "States like Illinois that are having trouble making their contributions, you would expect to be more affected."

According to a study by the Center for Retirement Research at Boston College, the funding ratio which is at 76 percent in 2010 could decline to 57 percent with the new accounting rules.

In some cases the reductions expected in the funding ratios are massive. Illinois teachers, a notoriously underfunded pension fund, currently has a funding ratio of 48.4 percent. Under the GASB's proposed changes it may fall to as low as 18.8 percent.

Pew also found states are short $627 billion for other retiree benefits, and 17 states have set aside no funds for them. According to Pew, states currently have only 5 percent of what they need for these "Other Post-Employment Benefits."

Until 2006, GASB did not have any accounting standards for those benefits.

(Reporting by Lisa Lambert in Washington and Nanette Byrnes in Chapel Hill; Editing by Anthony Boadle and M.D. Golan)

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Comments (2)
InMotion wrote:
Public pensions are underfunded because states and cities did not fund the pensions as they were required to and instead spent the money on other things. This has been going on for decades in Illinois and every few years, the current employees are required to step up and pay more to make up for that lack of funding. Why are there no rules for politicians. Since there seems to be no honor, they need to be regulated the way they want to regulate everyone else.

Jun 25, 2012 9:33am EDT  --  Report as abuse
Algernon wrote:
First, I find it ludicrous that public pension unfunded liabilities in the U.S. are described as a “gap” or as a “shortfall.” I suspect that this language has been chosen with an agenda in mind. It intentionally misleads.

A public sector defined benefit pension plan is similar to a mortgage. If I have paid off half of my $200,000 home mortgage, and yet I still feel compelled to run through the streets screaming that I am “in crisis.” . . . that I have a $100,000 “shortfall” of unfunded mortgage liabilities . . . my neighbors would rightly consider me “barking mad.” As with home mortgages, pension obligations are met over decades . . . up to 30 years.

So why are we hearing this drumbeat about the “public pension crisis” in the US? If a pension “crisis” exists in the states, it has been self-inflicted by these states through mismanagement of public pensions by elected officials (as noted in the Pew Update.)

The actuarial funded levels of public pensions may be improved through legal, prospective pension reforms.

Another reaction . . . I have read that this Pew Update is being criticized for its use of data that is several years old. I believe that the term “update” used in the title of the report is a misnomer.
The Pew Update notes that “The main data sources used for this report were the Comprehensive Annual Financial Reports produced by each state and pension plan for fiscal year 2010.” The information presented in this Pew report is old news from 2009, so why bother? The funded status information does not further the debate surrounding public pension policy. Was the main purpose of the Pew Update simply to condemn the ineptitude of some states in managing their pension obligations, and to reward those states that have acted as responsible stewards of state resources and liabilities?

Further, the Pew Update notes that a handful of states have enacted the pension “reform” of limiting retiree COLAs. The report provides this information while failing to note which of the COLA limitation “reforms” were reductions of “ad hoc” COLAs, and which “reforms” were reductions of “automatic” COLAs. This information makes all the difference in the world, and it is absurd that the report fails to make this distinction. This practice is akin to reporting that someone has taken money from a checking account, without mentioning whether that checking account belongs to the person taking the money or to a stranger.

Read about Colorado’s attempted pension theft at saveperacola.com. Friend Save Pera Cola on Facebook.

Jun 26, 2012 2:32pm EDT  --  Report as abuse
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