Good returns ease public pension fund fears as GASB changes take hold

The first batch of public pension fund financial reports under new accounting standards will be out this fall, and after a bumpy adjustment period, the preliminary results so far are good — or at least not as bad as expected.

Governmental Accounting Standards Board rules for the plans become effective in fiscal 2014 under GASB Statement 67. Those for contributing employers are effective in fiscal 2015 under GASB Statement 68. Both the plans and their sponsors now must report net pension liability, which is based on valuing assets and liabilities on a mark-to-market basis, instead of smoothing.

Until now, public pension plan officials stressed in their reports their actuarially required contribution number, used to set annual pension funding targets. That number — the ARC — is slipping to the footnotes, and unfunded liability is moving to the balance sheet from the footnotes.

As a result, some underfunded plans are expected to look worse because they might have to use a more conservative discount rate to measure their unfunded liabilities, which will now have a more prominent place on their balance sheets. And for even relatively well-funded plans, the change had officials worried that a more prominent liability figure would add to confusion and misconceptions about public-sector pensions.

Now, thanks to strong investment returns since GASB proposed the rules in 2012, public pension officials are breathing more easily.

“The timing was good for the onset of the new GASB statements because of the markets,” said Keith Brainard, Georgetown, Texas-based director of research for the National Association of State Retirement Administrators. “The stars aligned.”

“A lot of plans are going to be very happy,” said Elizabeth Kellar, president and CEO of the Center for State and Local Government Excellence in Washington.

But Ms. Kellar hasn't stopped worrying. She fears even good GASB numbers could take too much attention away from the bigger decisions about setting annual contribution rates. “The focus should be on what GASB is not doing, which is helping elected officials focus on a funding plan. We may be letting down the taxpayers,” said Ms. Kellar.

It “will create a degree of confusion among many important factions,” said Rachel Barkley, vice president of Loop Capital, Chicago, an investment services firm that tracks public pension funding annually. “GASB will definitely generate significant debate about pensions.”

“For all the people arguing for market rate for liabilities, it's still the wrong concept,” said Jean-Pierre Aubry, assistant director of state and local research at the Center for Retirement Research at Boston College. “For funding purposes, it doesn't really matter. We feel that there's not going to be a huge change because the majority of plans are committed to paying the full ARC.”

On a more optimistic note, Ms. Kellar recalled that GASB disclosure requirements implemented in 1986, although controversial at the time, helped to stimulate better funding practices among many public pension funds. “It had been pay-as-you-go, then people started paying (ahead),” she said. ”

Calculations done by the Center for Retirement Research show that for a typical pension plan earning a 7.75% return, a funding level of 76.9% in fiscal 2014 would increase to 80.6% under the new GASB formula based on market assets, and to 82.1% from 79.1% in 2015. “We don't know what the liabilities are today, but we do know the assets. The real story is the pile of assets,” said Mr. Aubry.

One big caveat: Numbers tied to market returns can also go the other way. “People have to understand that this is a more volatile reporting approach,” said Ms. Kellar.

The new net pension liability figure “is now going to become a very volatile number, and next year you could give it all back,” said Robert P. Schultze, director of the $65.2 billion Virginia Retirement System, Richmond. “I would hope that nobody puts too much emphasis on these numbers. These state budgets couldn't take the volatility.”

To help prepare Virginia legislators and local officials for the new numbers, VRS officials did some mock calculations. With an unfunded liability of $21.3 billion, “boy, did we get their attention,” he said, “especially when they could see how some liability from the teacher plan would be allocated to each local government.”

“We've been trying to manage expectations since the GASB rules came out. I am very confident that state legislators and most local officials understand what to expect,” said Mr. Schultze. “We hope these mock calculations will offset some of the sticker shock caused by the new rules.”

When Virginia officially reports its unfunded liability under the new rule this fall, things should look good, thanks to a 9% difference between the market and actuarial value of assets. “That by itself will show that the funded status will probably go up 9%, and unfunded liabilities reduced by about $5 billion,” Mr. Schultze said.

He said he has heard similar predictions from his counterparts at other public pension funds. At a NASRA gathering in August, “the general consensus was that they're feeling comfortable. They are ready,” said Mr. Schultze.

Aside from some significantly underfunded plans, “the dire predictions for all public plans have failed to materialize,” said Bill Hallmark, a public sector expert and consulting actuary with Cheiron Inc. in Portland, Ore. For plans that are not well funded, or do not have a policy in place to get there, the gloom will continue with the GASB rules, which force them to use a more conservative discount rate for measuring their unfunded liabilities.

Until now, projected benefit obligations have been discounted by each plan's long-term assumed rate of return on assets. Under GASB, underfunded plans will use a combined rate that applies the assumed rate of return only to liabilities covered by current assets, while the return for calculating additional liabilities is based on high-grade municipal bond rates, which can be substantially lower.

GASB also gives the pension funds less time to amortize the liability.

“I think it will be a red flag that shows that their funding plan is insufficient,” said Mr. Hallmark. “Those flags could and will pop up.”

The bigger question that won't be answered until statements for fiscal 2015 are prepared is the impact of the new GASB rules on local governments, which for the first time will be reporting their share of pension liabilities on their own financial statements.

Donald Drum, executive director of the $12.9 billion Idaho Public Employee Retirement System, Boise, won't have to deal with the first wave of GASB changes, because the pension fund, which is 94% funded, does not smooth, so assets and liabilities are measured in real time. “It's very useful for us from a planning and political purpose to let legislators really see an impact — if the market dropped, or went up. We can do daily market valuations,” said Mr. Drum.

But the new GASB rules do change the way employers contributing to the pension fund calculate their pension liabilities, so Mr. Drum launched a “GASB state tour,” meeting with employers, calculating their share of unfunded liability and explaining what it will mean when they start reporting in 2015. “I've helped them to understand how to communicate,” said Mr. Drum. “In the end, if everybody understands how it works, it calms down their anxiety.”