Public pension plans prepare for switch to mark-to-market accounting

Executives at public defined benefit plans are facing a similar fate as their corporate brethren with new accounting rules that apply mark-to-market accounting.

As corporate pension plan executives have found, there aren't a lot of options to escape the new rules.

The corporate world has had a few years to adjust to pension accounting rules issued by the Financial Accounting Standards Board in 2006 that put fair market value of pension assets and liabilities on year-end balance sheets, and with disappointing results, according to many actuaries.

“It's been a major contributor to the death of defined benefit plans,” Thomas D. Levy, senior vice president and chief actuary for The Segal Co., said in a telephone interview. “In a strong market with high interest rates, spotlighting pension assets worked well. Now, it's a kiss of death.”

Some corporate pension plan executives have grudgingly accepted the change, while others continue to resist by simply not following the new FASB standards, which are voluntary.

“Plans generally don't like it because it increases volatility. A very small change in interest rates can have a very large impact,” said Deborah Forbes, executive director of the Committee on Investment of Employee Benefit Assets in Bethesda, Md., whose members represent more than 100 of the largest U.S. corporate pension plans with a combined $1.5 trillion in defined benefit and defined contribution plan assets. In one dramatic example, Ms. Forbes said a member company saw pension liability jump $1 billion simply from a market drop of 20 basis points. She wouldn't identify the company.

For corporations that want to borrow money or attract investors or suitors, ignoring FASB accounting standards is not an option, particularly for those with international operations or investors that need to comply with similar accounting standards issued by the International Accounting Standards Board. They can try to reduce the shock of higher liabilities by smoothing out assets and some losses over two years.

In the public sector — where similar rules from the Governmental Accounting Standards Board, proposed last July and expected in final form this summer, will force pension liabilities based on fair market value into more prominent positions on balance sheets — a major concern is how those bigger liability numbers, at least under current market conditions, will affect defined benefit plan funding decisions.

Robert W. Stewart, vice president of communications for the Financial Accounting Foundation, Norwalk, Conn., which includes both FASB and GASB, appreciates the upheaval involved but defends the group's actions.

“Every standard-setting procedure is a balancing act,” he said in a telephone interview. “A common theme of both (FASB and GASB rules) is trying to give investors and taxpayers a clearer picture of what the liability is. It doesn't affect the reality out there. It affects the way the reality is reported.”

As corporate pension sponsors already know, mark-to-market accounting means more volatility and uncertainty about defined benefit plans. Valuing plan assets at the end of a fiscal year “is like picking one frame out of the movie and trying to understand the whole movie,” said Leigh Snell, federal relations director for the National Council on Teacher Retirement, Sacramento.

Public pension plan executives are particularly worried about disconnecting liabilities from funding numbers. “It will produce unfunded liability numbers that are significantly different from those used to fund the plan. It does have the potential for creating confusion about the sustainability of plans,” said Paul Zorn, director of governmental research for Gabriel Roeder Smith & Co., a Southfield, Mich., actuarial and pension consulting firm. “It will take a substantial amount of education to help people understand the reasons for the differences.”

Mr. Zorn said public pension plan actuaries are considering ways to help public defined benefit plans keep some of the features they like from the current accounting methods, particularly reporting of annual required contributions, smoothing of assets and liabilities, and longer amortization periods, although it's too soon to tell what those ways might be. “There could be a shortage of actuaries” as public plans struggle to keep the focus on the true long-term costs and assets of their plans, he joked.

Shifting the emphasis to the balance sheet from the income sheet “is going to make for a much bigger balance sheet, and that's going to take a lot of explaining,” said Bob Scott, assistant city manager and chief financial officer of Carrollton, Texas, and board member of the Government Finance Officers Association, Chicago. Mr. Scott notes that in Texas, state law requires an annual required pension contribution figure for funding decisions, which means “there will be two sets of books. That isn't going to create a lot of confidence” with politicians, voters and potential investors.

Public pension plan executives worry that losing the current national benchmark that the ARC provides will make it much harder to persuade public officials to make pension contributions. “We are going to be more on our own in terms of funding. That's one of the things that we're going to have to fight with the new standards,” Mr. Scott said.

For states in rocky financial condition, Mr. Scott likens the prospect of much larger public pension liability numbers presented to elected officials to someone wanting to slim down before a class reunion. Losing 10 pounds or so is one thing, “but if you're talking about 150 pounds, you're going to get another bowl of ice cream” and let your successors worry about how to pay it.

Public pension plan executives are prepared to go through the additional trouble and expense of having two sets of books that show the unfunded liability dictated by GASB but also continue to produce an ARC for funding purposes, because it shows the long-term funding base that public defined benefit plans need to consider, as opposed to a market snapshot in time, as well as to help investors make informed decisions, sources said. Once GASB rules go into effect in 2013, executives also expect to rely more heavily on actuaries to help them set values for assets that can be smoothed over longer periods of time.

But public pension plans have more leeway in choosing their asset smoothing periods than the corporate pension plans do.

Mr. Scott notes that public-sector plan sponsors have one advantage over their corporate counterparts — participants who are also often union members. “You have some very strong employee groups, and they are going to be watching closely” as funding decisions are made. Still, while the more open process of public pension funding might help stave off wholesale closing of government-sponsored defined benefit plans, he does expect changes, including a continued trend toward tiered plans that have different contribution and benefit levels for new entrants.

Ms. Forbes of CIEBA agrees that under current conditions at least, mark-to-market accounting “is one of the nails in the coffin” of defined benefit plans. “It's frustrating because my members believe in them, and to the extent that rule changes are making it harder and harder to keep them is unfortunate.”