Little-known U.S. board stokes hot pension debate

Tue Jul 10, 2012 5:54pm EDT

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(Reuters) - The feedback was swift and often scathing when a little-known public board signaled its intent to toughen the accounting rules governing state and local pension funds of millions of U.S. public employees, intensifying worries over a shortfall of billions of dollars.

The plan by the Governmental Accounting Standards Board (GASB) - which was approved on June 25 - drew praise from the American Institute of Certified Public Accountants and from investors looking for transparency in the $3.7 trillion municipal bond markets.

But not so from the likes of Kevin Lillie, treasurer of the Geneva, Ohio area schools district, one of more than 700 letter writers, who asked: "How do you people come up with these things?" He was not alone in his incredulity.

For some states and municipalities the new rules, taking effect in 2013 and 2014, mean acknowledging that pensions for police, firefighters, teachers and other municipal workers are woefully underfunded liabilities.

The public employees worry that could prompt calls for cutbacks at a time of immense financial pressures while advocates for conservative fiscal management say that's precisely what's needed.

The accounting overhaul was a rare foray into the public eye for GASB, a 28-year-old body that shares offices in Norwalk, Connecticut with the far more powerful Financial Accounting Standards Board (FASB), its older brother and the standard setter for private and publicly traded companies and not-for-profit organizations.

In a letter to GASB, Congressmen Gerald Connolly of Virginia and Edolphus Towns of New York called the proposals arbitrary and destructive. Boston College pension expert Alicia H. Munnell wrote that GASB's planned method for valuing pension liabilities "makes no sense at all."

Withdraw the proposal entirely, urged the Lubbock Texas Fire Pension Fund.

GASB listened. Board members read the letters. Staff tallied them in a spreadsheet. The board flew around the country holding public meetings and collecting people's thoughts.

Then the board's seven members - many of whom work day jobs in local and state governments themselves - went ahead and approved the rules, without changing many of the most controversial elements. "This is not a democratic process," said a person close to the board. "The board is not Congress. It looks at the fundamental underpinnings of the issues."

RADICAL CHANGES

In one unanimous vote GASB set in motion changes, termed radical even by supporters, that will force many of the worst-off state and local governments to acknowledge much bigger pension shortfalls as liabilities on their balance sheets, while no longer requiring information about how well they are funding those promises. The rules will add volatility to the funds by eliminating the "smoothing" of their liabilities over time, and will impose new accounting costs on already strapped governments.

The new GASB rules don't alter what's owed, but will make some dramatic changes to the accounting value of liabilities.

Underfunded pension plans will no longer be able to use the projected rate of return on their investments, currently about 8 percent, to value all their liabilities. Instead, any unfunded promises will have to be valued at a far lower rate, close to what it would cost them to borrow the money to cover that debt.

This hybrid plan - which uses one rate for funded liabilities and another for the unfunded ones - will make the most poorly funded plans' liabilities look far larger because the lower the discount rate used to evaluate those liabilities, the higher the present value of the amount owed by local governments.

The new pension math won't exactly mirror how corporations handle these calculations, but will bring the governments' numbers a step closer to the more conservative figures of the private sector.

Pension supporters fret that these on-balance sheet liabilities will be misunderstood as current obligations and add to the tension between funding these promises to police, firefighters, teachers and others, and spending on public services.

Fiscal conservatives say it's high time the real cost of what they see as overly generous public sector pensions is recognized, and warn that these pensions are unsustainable.

CHILDREN OF A LESSER GOD

Begun six years ago as a routine review of existing accounting rules, the pension accounting revamp came to a head at a time when sharp investment losses of the late 2000s, declining contributions from cash-strapped governments, and a rising number of retirees have made questions about their sustainability front-page news.

"That sure raised the level of awareness," GASB Chairman Robert H. Attmore said in an interview, though he maintained that in the end the public debate over pensions did not shape the board's rules.

Founded in 1984, at a time when government bookkeeping came under criticism for not being more like that of business, GASB operated largely under the political radar. While tasked with setting standards, GASB had little in common with FASB, founded 10 years earlier.

FASB has an annual budget of $39 million, a fulltime board of seven, and a chairwoman, Leslie Seidman, who was paid more than $760,000 in 2010, the most recent year for which filings are available.

By contrast, six of GASB's seven board members work part-time, the board has a budget of $8 million this year, and Chairman Attmore, who draws a pension from New York state where he spent 17 years as auditor, made $424,000 last year. The board members are all knowledgeable of government finance and appointed by a nonprofit professional board rather than a political one.

RUBE GOLDBERG MACHINE

Up until this year, when a congressionally mandated fee on brokers took effect, GASB had no permanent funding, relying entirely on voluntary contributions and subscriptions to fund its expenses.

GASB explains the budget gap as stemming from the board's part-time status as well as its lighter workload. GASB, which has a total of 68 accounting standards, approved two new ones last year, while FASB penned 12 to bring its total to 226.

From bankrupt Stockton in California to financially strapped states such as Illinois and Rhode Island, the pressures stemming from pension promises are a constant worry, shared by officials in small and large local governments.

Accounting professionals are split on whether the new rules are a step in the right direction.

Paul Angelo, a senior vice president for the Segal Company, one of the largest actuarial firms in North America, calls the new rule a "perfectly nuanced solution to a difficult question."

Though liabilities will be marked higher for many, economists and actuaries, who yearned for a system closer to the corporate model, say they are not high enough. Given that promises made to public staff are often ironclad in state laws and that future payments must be guaranteed, a cautionary approach would suggest a discount of all those liabilities at a "riskless" rate similar to the borrowing costs of the U.S. Treasury, they argue.

By instead endorsing a two-pronged approach, the board has built a machine that performs a simple task in a complex fashion, counters New York actuary Jeremy Gold, who would favor the use of one low rate: "GASB has built a Rube Goldberg machine filled with complexity." Governments may like GASB's hybrid model better he said, but future taxpayers will bear the burden.

Devin Nunes, a California Republican member of the U.S. House of Representatives, agrees. "Did GASB do enough? No, I do not think the reforms are adequate to protect taxpayers or retirees," he wrote in an email to Reuters.

Nunes has sponsored legislation in the House, which he hopes to reinvigorate after November's election that would sidestep GASB's rules, requiring governments to use a more conservative calculation of liabilities if they wish to issue tax-free bonds.

UNCERTAIN IMPACT

Until the new math kicks in, it's hard to know how much difference it will make. Even under the old rules, the Pew Center on the States estimated that states were short $757 billion on their pension promises.

A July 2 report by ratings agency Moody's Investors Service calculated that if it used a 5.5 percent discount rate, a rate more conservative than the method GASB proposed in its final rules, but closer to the way corporations value their pensions, it "would nearly triple fiscal 2010 reported actuarial accrued liability" for the 50 states and rated local governments to $2.2 trillion from $766 billion.

Next GASB will tackle accounting for other post-employment benefits such as retiree healthcare plans - this despite complaints from governments that they're struggling to keep up with the board's quickly changing standards.

Attmore said that he was sympathetic to the pressures on government finance departments, but that GASB had no plans to slow down.

"If we do our job well, it should make things better and give policymakers and others making tough choices about cutting resources better information to make those decisions," he said.

(Reporting by Nanette Byrnes; Editing by Howard Goller, Tiziana Barghini and Leslie Gevirtz)

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