Cleaning the books

Change afoot for public pension plan accounting

GASB draft would move unfunded liabilities onto balance sheets

After years of deliberation and debate, the Governmental Accounting Standards Board has unveiled a draft of what could be game-changing rules for public pension plan accounting.

The key draft rules are:

• moving net unfunded pension liabilities from the notes to a prominent place on the balance sheet;

• changing the discount rate for plans whose assets do not cover projected benefits, to a 30-year municipal bond rate from one based on an expected rate of return;

• requiring all plans to use the entry-age normal actuarial cost method to allocate present value of projected benefits;

• requiring immediate recognition of a government's net pension liability in the event of changes, instead of doing so over a 30-year basis; and

• requiring municipalities that are part of larger statewide pension systems to report their portion of the collective liability, instead of just annual costs and payments.

The GASB unveiled the two sets of proposals — one for government employers and one for pension plans — on July 8. A 90-day comment period follows, along with three public hearings this fall; final rules are expected a year from now.

Backers and detractors agree the proposals will change both balance sheets and perceptions about public pension plans.

On one side are actuaries and accountants, who commend the GASB for taking on the project as a way to increase transparency and uniformity among public plans. On the other side are public fund groups and state officials who, while understanding the quest for more complete disclosure, warn that by focusing on balance sheets and an immediate accounting of pension expenses, the proposal gives a skewed version of public plans' financial health.

“The concrete isn't set. If people have convincing arguments, we're going to listen,” GASB Chairman Robert Attmore said in an interview. “We think we've heard most of them, and we think we've selected the best answers. The point (of the new rules) is so people have the best information to make the best decisions.”

A hallmark of the latest proposal is what Mr. Attmore calls “more robust disclosure” in notes and other supplemental information that now will be required. The disclosure includes a calculation of how liabilities would differ with a one percentage point change in either direction in the discount rate.

One of the biggest changes concerns unfunded pension liabilities. GASB casts them as “net pension liability” and puts them front and center by moving that information from the footnotes up to the balance sheet itself. The change was designed to increase transparency, yet many plan executives fear it will have the opposite effect, making plans appear to be in worse financial condition than they really are.

“It will distort reality,” Gary Findlay, executive director of the Missouri State Employees' Retirement System, Jefferson City, said in an interview. The system has $7.26 billion in defined benefit assets.

Mr. Attmore counters that while liabilities will appear bigger, “the economic reality doesn't change. People who do financial analysis do that now. anyway.”

Contribution's popularity

Currently, the most important number for a plan's pension obligation is the annual required contribution, which has proved a popular way for people who oversee and track public plans as well as policymakers to identify funding targets and to measure plan sponsors' progress in meeting them. Replacing it on financial statements with a net liability number is equivalent to having a homeowner report his or her entire mortgage, instead of the monthly mortgage payment, the National Association of State Retirement Administrators and the National Council on Teacher Retirement said in a joint statement.

“We don't live in a bubble; we understand the impact it can have,” said Mr. Attmore, but unlike the private sector, “public plans have the opportunity to weather the storm.”

GASB officials also believe that only plans with enough assets to cover benefits should be allowed to use an expected rate of return to discount projected benefit payments; others must use a high-quality, 30-year municipal bond index rate.

Once matching assets are held in an irrevocable trust, “you get to use the long-term rate of return,” said Mr. Attmore. The anticipated volatility from different rates “is not a concern of ours.”

Another big change is the reduced time plans have for recognizing pension expenses. Currently, plans have had up to 30 years to account for actuarial gains and losses. The GASB proposal would start the accounting clock immediately for inactive workers' costs, and sets a new amortization period based on the average remaining service life of active members. To allocate present value of benefits, public plans would have to use the entry-age normal actuarial cost methods, instead of one of six methods now used by many plans.

With budgeting at the heart of public plan funding, perhaps the greatest concern is how the new GASB approach separates funding from accounting by creating two sets of numbers — the unchanged funding calculation and the new pension expense number. “Some people tend to commingle accounting and financial reporting with public policy issues, which should be set by elected officials,” said Mr. Attmore.

At a minimum, critics worry that the delinking would cause confusion about the “true” cost.

“We're concerned about the effects of multiple calculations” needed for compliance and for educating policymakers on funding needs, Georgetown, Texas-based Keith Brainard, research director of NASRA, said in an interview. “We celebrated the marriage of funding and accounting. Now we're concerned about their potential divorce.” At the very least, “it will keep actuaries busy.”

MOSERS' Mr. Findlay was even more blunt. “It's going to be a huge communications problem and it likely will result in unwarranted political decisions,” he said.

GASB officials promise an aggressive outreach campaign in the coming months, along with a “plain language” supplement for non-accountants, notes, illustrations and a 10-year implementation schedule available on its website.

Still good

The new rules will still be a good way to tell if governments are meeting their funding obligations, said Paul Angelo, senior vice president in the San Francisco office of The Segal Co. A self-described “hard-core actuary,” Mr. Angelo served on the GASB task force for the new rules.

“What changes is you will have two different cost numbers — the accounting cost and the funding cost.” For well-funded and underfunded plans, both will use a similar measure of liability, even though the year-to-year costs will still be very different, which gives additional incentives to fund the plans. Still, he cautions, “the new accounting cost is clearly not meant to be used as a funding basis.”

Some states require that GASB standards be followed, but the wider enforcement mechanism is expected to come from auditors and credit-rating agencies. The latter are eager to get a more complete picture of a government's overall obligations and a better way to compare governments. “We think it will make it easier for us,” said Amy R. Laskey, managing director of U.S. public finance for Fitch Ratings Ltd. in New York, “but we do not expect many rating changes.”

Still, GASB's deliberative process has stakeholders cautiously optimistic.

“We are hopeful that on balance, these industry changes may ultimately help alleviate concerns ... and strengthen public confidence,” said the NASRA/NCTR statement.

As Segal's Mr. Angelo puts it, “GASB is very principle-driven in these things. When it comes to measuring the liability of a plan, we think they got it entirely right.”