GASB proposal could spark major changes

Some parts of plan call for immediate show of gains, losses

The GASB's newly released public pension accounting proposal tilts strongly in favor of the current use of expected long-term return on investment for valuing pension plan liabilities, rather than moving closer to a market-based discount, according to actuarial accounting consultants.

But other elements in the Governmental Accounting Standards Board's preliminary views document, issued as a precursor to an exposure draft of a new rule, could cause major changes in the way public plan sponsors recognize pension costs and funding.

Among them are requiring plan sponsors to report the full unfunded liability on the balance sheet and immediate recognition on the balance sheet of benefit improvements and asset gains or losses.

Overall, the GASB proposal “would have a significant impact on” employers' financial statements, said James J. Rizzo, senior consultant and actuary, Gabriel, Roeder, Smith & Co., Fort Lauderdale, Fla.

On the discount rate for valuing pension liabilities, Paul Angelo, San Francisco-based senior vice president and actuary, The Segal Co., said in a statement that “sponsors and systems will be pleased that GASB agrees that, to the extent that future benefits can be paid out of fund assets, then the employer's net cost should reflect the expected earnings on those assets, rather than a market discount rate unrelated to the earnings on plan assets.”

Jeremy Gold, president, Jeremy Gold Pensions, an actuarial consulting firm in New York, said, “compared to the private sector, the (GASB current rules and proposal) are weak” in terms of accounting for economic costs of pensions plans. “It will really be business as usual” for many public plans.

“The end result is taxpayers (and other financial statement users) aren't getting good information on the value of benefit promises,” Mr. Gold said.

Discounting liabilities by “the use of (long-term expected) return on plan assets is not a good method for financial reporting,” he said.

“If you have future cash flows (the pension benefits payouts) that are without risk, you should discount them at a rate that has very little risk, very little default risk,” rather than the long-term expected investment return on plan assets, Mr. Gold said.

“There will be considerable controversy surrounding these new reporting requirements, and we expect and encourage substantive public input and debate during the process leading up to the final GASB statement,” according to Mr. Angelo.

The proposal calls for public plan sponsors to use a blended rate for valuing pension liabilities. They would use the traditional valuation method — the expected long-term rate of return on plan investments — to calculate the value of liabilities so long as the assets are projected to be sufficient to cover present and future benefits. But then the plans would use a high-quality municipal bond index rate to value those pension liabilities that are in excess of those benefits covered by current and projected plan assets.

Most plans would continue to use only the traditional valuation method, and not have to use the blended rate, because they have current and projected assets to cover present and future benefits, according to some actuarial consultants.

That condition generally applies to plans that meet their actuarially determined contributions and intend to meet such future actuarial contributions, even if the plans are underfunded, Mr. Gold said.

Not much change

“There isn't much change” in the way most plans will value liabilities, said Frank Todisco, senior pension fellow, American Academy of Actuaries.

Mr. Rizzo said, however, “I'm not sure what proportion of the plan population will have to use the blended rate (to discount liabilities). I don't think we will know that until we start modeling the different aspects of the (preliminary views), how it would have played out over the last 20 years or (would play out) over the next 20 years. I'm hesitant to say how many (plans) ... will use the blended rate.”

“The GASB's approach has been, and remains, significantly different from that of the standard setters for the private sector” — the Financial Accounting Standards Board and the International Accounting Standards Board. They “prescribe a high-quality bond-based discount rate,” Mr. Todisco said in a summary statement about the proposal.

“The appropriate discount rate — and, by extension, whether public and private sector plans should have different accounting — has been a key point of contention in the controversy surrounding public plan valuation,” he said in the statement.

GASB released its proposals June 18 as preliminary views, a formal step toward issuing an exposure draft of a new pension accounting standard. It is seeking public comment through Sept. 17 and plans to hold public hearings in October.

“There has been too much focus on the discount rate” in discussion about the GASB proposal, Mr. Rizzo said. “That is a huge distraction from more important matters such as governance and funding. There are so many other aspects to the PV that make it a significant change to pension accounting.”

For one, “a large liability will go on the (public employer) balance sheet.”

Under the proposal, public employers would have to place the entire unfunded actuarial accrued liability of the plan on their balance sheet.

Currently GASB requires only the cumulative difference or shortfall between the annual required contribution and the actual contribution sponsors make to their plans to be placed on the balance sheet.

The cumulative shortfall “is a pretty small number compared to the net (or unfunded) pension liability,” Mr. Rizzo added. “Most employees have been paying the ARC (annual required contribution) every year ... or close to it.” The annual required contribution is an expense number GASB uses as “a measure of actuarial full funding over time,” he said.

Employers now under GASB rules put the funded status in notes to their financial statements.

“The (unfunded) pension liability on the balance sheet is informative,” Mr. Rizzo said. “But it was in the notes already.” The GASB proposal “raises its profile,” he added.

If the proposal is approved, “the volatility in that liability ... will create balance sheet volatility” for employers, Mr. Rizzo said. It “is a dramatic change in the financial statement.”

Messrs. Rizzo and Angelo said that in putting the full unfunded liability on the balance sheet rather than the cumulative shortfall, the proposal will make it harder for readers of the data to tell whether an employer is funding the benefits on a consistent, actuarially determined basis.

Recognized immediately

Among other elements in the GASB proposal, “shortening the amortization period for benefit improvements, assumption changes, and actuarial gains and losses will increase contributions,” Mr. Gold said. Benefit increases for current retirees would have to be recognized immediately, while other impacts would be amortized over the average expected remaining service life of active participants, typically 10 to 20 years, instead of the up to 30 years now allowed by GASB rules, actuarial consultants said.

Mr. Rizzo noted the potential immediate recognition of some of the gains and losses “is one of the sources of volatility” that will affect sponsors' financial statements.

“The GASB PV does not present a better economic cost picture of pension plans for taxpayers or other users of financial statements,” Mr. Rizzo added.

The GASB proposal has good and bad features, Mr. Rizzo said. On the bad side, the proposal creates balance sheet volatility by using the market value of the plan assets as the offset against the liability number, he said. But, “the method (the GASB PV) uses to discount liabilities is a good thing; having one cost method (entry-age normal method) is a good thing” for comparability of employers' financial statements, he noted.

The GASB preliminary views proposal also would require public plan sponsors to use only the entry-age normal method to discount projected pension benefits of participants, rather than the projected unit credit or any other valuation method. That element of the proposal would likely have no impact on the 65% to 70% of public plan sponsors that already use the entry-age normal method, Mr. Gold said.

“It's not a significant change for a majority of plans,” Mr. Todisco agreed. “The requirement for the use of a single method is a step toward uniformity and comparability” of the finances of public plans and sponsors, he added.