State, local pension
accounting takes a GASB step toward transparency For a plain-language
explanation of public pension issues and estimates of liabilities for each
state, check Sunshinereview.org .
Posted on July 8, 2011 By Zachary Janowski Watchdog.org
The way states and local governments account for pensions is
about to change — slowly.
The Governmental
Accounting Standards Board, a nonprofit based in Norwalk, Conn.,
released a draft of changes to pension accounting rules Friday. These changes
will first affect government balance sheets in fiscal year 2014.
The most significant change in the proposal will move
billions of dollars in unfunded pension liabilities out of a footnote and onto
government balance sheets.
GASB officials emphasize the new rules won’t change how much
states and cities owe — or how much they have to contribute to their plans —
but will increase transparency and uniformity.
“The economic reality is that nothing has changed; it’s the
presentation that has changed,” GASB Chairman Robert Attmore
told Stateline recently.
“We would encourage GASB to implement this tomorrow,” said
Sheila Weinberg, founder and chief executive officer of the Institute for
Truth in Accounting. “Right now if you look at the balance sheet,
the balance sheet is a bogus number.”
Weinberg said the changes bring “full transparency” to
pension liabilities. She said it took her organization, experts on the subject,
a year and a half to determine that all 50 states combined have more than $500
billion in unfunded liabilities they admit to. After the changes, Weinberg said
this information will be more accessible to legislators and the general public.
“You can’t make good decisions if you don’t know the right
number,” she said.
Under the current rules, Weinberg said, California had more assets than liabilities
on its balance sheet as recently as 2008. “Obviously, that’s totally bogus,”
she said.
Mark Zehner, an enforcement
officer for the Securities and Exchange Commission’s Public Pension unit, told Watchdog.org that the uniformity also will help
his agency better regulate the market.
“The multitude of options available generates complexity and
the ability to hide a lot of problems,” he said. “In the long term, this
(change) is a positive. We’re bringing to the surface what some of these
numbers really mean.”
The GASB proposal would also:
- Allow only one actuarial method for calculating pension costs
(entry age normal, level percentage of payroll).
- Limit the length of time over which governments can spread pension
costs related to current employees (a weighted average of employees
remaining service period).
- Force pensions to immediately recognize costs or savings caused by
benefit or assumption changes.
- Require governments to report their unfunded liabilities
calculated in three different ways: using their chosen discount rate, the
discount rate minus 1 percent and the discount rate plus 1 percent.
- Implement a new, blended discount rate for pension plans that
expect to run out of assets.
- Include ad hoc cost of living adjustments — or COLAs — in pension
liabilities if the COLAs are essentially automatic.
GASB first mandated the reporting of pension liabilities in
1997. It more recently required governments to report their retiree health care
liabilities, known as other post-employment benefits, or OPEB.
Unions and other supporters of public pensions have blamed GASB’s rules for recent efforts to replace public employee
pensions with defined-contribution plans, similar to private sector 401(k)
plans.
The public will have 90 days to comment on GASB’s proposal, called an exposure draft. The board
expects to finalize the changes by June 15, 2012.
John
Bury, an actuary who serves private-sector clients and blogs about pensions,
said the changes are an attempt to increase the annual required contribution,
or ARC, but he doesn’t see the point when many governments don’t contribute the
full amount anyway.
“If you give them a number of $5 billion and they put in $2
billion, what are you going to do, give them a number of $6 billion so they can
put in $2 billion,” he said.
The Pew Center on the States has reported findings
similar to Weinberg’s institute. State pensions around the country, according
to Pew, have $2.28 trillion in assets set aside to pay $2.94 trillion in
promised benefits, leaving an unfunded liability of $660 billion.
Both Weinberg and Pew collected information reported by
state governments to arrive at their numbers. Many financial economists
question the assumptions used by states, saying they drastically underreport
their liabilities.
Joshua Rauh, an
associate professor of finance at the Kellogg School of Management at
Northwestern University, estimates the total unfunded liability of all 50
states is actually $2.5 trillion.
The difference between Rauh’s
estimate and the numbers reported by state governments is the discount rate.
GASB allows states to use their expected rate of return as the discount rate
for future payments, while financial economists like Rauh
argue those rates are arbitrary and too high.
Jeremy Gold, an actuary with a doctorate in finance, said GASB’s approach may be mathematically accurate, but it
doesn’t reflect the economics behind pension liabilities.
Although GASB’s proposal includes
some changes to the handling of the discount rate, Rauh
is not satisfied.
“I think the entire Governmental Accounting Standards Board
system is so off the mark,” Rauh said, “I’m not
willing to praise them for incremental changes.”
Gold said GASB’s rules rein in the
“most flagrant abuses” but make only minor changes to the “most central
measurement errors.”
When a government calculates how much it owes future
retirees, it has to put a value on future spending. Under current GASB rules,
governments that expect an 8 percent return on their pension investments — the
most common number — discount the value of a future dollar by 8 percent per
year.
GASB and states base their logic on the expectation that
pension funds can earn 8 percent on contributions by investing in the stock
market.
The new GASB rules will allow governments to publish their
unfunded liability based on their chosen discount rate, but they will have to
also calculate their liability based on that discount rate plus 1 percent and
minus 1 percent.
At GASB’s June 27 board meeting,
the members talked about requiring governments to report their liability using
three different discount rates, which they call sensitivity analysis.
“I think the idea of a sensitivity analysis is better than
what we have,” said board member Michael Belsky.
“You’re doing a favor to the user because the user would try to figure it out
anyway.”
“What’s the rationale for 1 percent,” board member Michael Granof asked. “Why not add another column?”
Attmore said users can extrapolate other information
from the three numbers provided in the sensitivity analysis.
“I like it better than what we have now,” Granof said.
GASB members discussed how they are setting accounting
rules, not changing public policy.
“It might instigate it because it provides information,”
said board member Jan Sylvis.
According to Rauh, a 1 percent
change in the discount rate is roughly equal to a 15 percent change in
liabilities for most pension plans.
The GASB proposal also will require pension funds that
expect to run out of assets to use a lower discount rate — equal to a
high-quality municipal bond index rate — but only on the liabilities that don’t
have underlying assets.
At the June meeting, GASB member James Williams said the
blended discount rate was not a dramatic enough response.
“It switches from a pension plan to a Ponzi
scheme,” Williams said. “This is a disaster if it ever happens. This is not a
business as usual where you switch over to another rate.”
Gold said governments probably will never use the blended
rate because they can design their plans to avoid it. He said GASB will need to
resolve at least one question with potentially serious consequences — will
states that don’t follow the plan set out by their actuaries have to use the
blended rate?
“New Jersey might have that kind of problem,” Gold said,
referring to the state’s decision to fund about one-seventh of its pension
contribution this year and two-sevenths next year.
Rauh said he also disagrees with GASB’s
decision to use a municipal bond index rate because the pension benefits are
more protected than the rest of state debts. Since pensions are less risky, he
argued, they should have a lower discount rate.
Gold said actuarial calculations are useful for constructing
a budget.
“It’s sort of an engineering system,” he said. “That doesn’t
necessarily lead to a good accounting.”
He said the corporate method for pension accounting,
governed by GASB’s sister organization, the Financial Accounting
Standards Board, is not perfect but is “immensely better than
anything GASB has come up with.”
“GASB continues to follow most of the traditional actuarial
assumptions,” Gold said. “They tell you how you’re doing compared to your
budget. They don’t tell you whether the budget is adequate.”
Gold said GASB is setting some limits on the types of
budgets it allows, but the new rules still “don’t create a budget that would be
recognized in the global financial markets as a reliable budget.”
According to Rauh, Gold and others
who share their thinking, if a state has to guarantee a pension payment it
should use a discount rate it can also guarantee, a rate without any risk.
The risk-free rate is usually equated with U.S.
Treasuries, which yield considerably less than the stock market. With a
smaller discount rate, governments would need to set aside more money in the
present to meet their obligations in the future.
Former Federal Reserve Vice Chairman Donald Kohn, in 2008
while still in office, told the National Conference on Public Employee Retirement
Systems that expected rates of return should not be used to discount
pension costs.
“While economists are famous for disagreeing with each other
on virtually every other conceivable issue, when it comes to this one there is
no professional disagreement: The only appropriate way to calculate the present
value of a very-low-risk liability is to use a very-low-risk discount rate,”
Kohn said.
According to Gold, only one government, New York City, publishes its pension
liabilities using the risk-free discount rate he supports. He said there also
is legislation in Congress, sponsored by Rep. Devin Nunes, R-Calif., that would
require all governments that issue tax-free debt to publish their pension
liabilities in this way.
“There are a number of things that are happening which are
challenging GASB,” Gold said.
By pursuing higher returns, pension funds have to take on
risk. In the stock market, Rauh said, “there is a
distribution of possible outcomes.”
“The higher the return you target, the greater the chance
you’re going to fall short,” he said.
Rauh said it can make sense for people to invest their
retirement savings in the stock market, but unlike governments they are able to
reduce their spending if their investments don’t meet expectations.
In the case of state pension plans, Rauh
said, taxpayers are “providing a tremendous amount of downside insurance.”
Rauh said historically stocks have returned 11 percent and yet
no pension fund expects to earn 11 percent. He said if a government proposed
investing entirely in stocks and doubling its expected return using leverage
“most people would look at that and say it’s too risky.”
He said states can “try to shade” their liabilities with
their expected rate of return, but the rate of return doesn’t change the reality
of the amount owed.
Gold said using the wrong discount rate makes some of the
other improvements proposed by GASB insignificant.
“After they mis-measure the
shortfall, they then in a budgetary way plan to pay for the shortfall,” he
said.
Pension liabilities can be analogized to a mortgage,
according to Gold.
“The mortgage that they have in place doesn’t even pay the
interest on the mortgage,” Gold said. “It’s growing to infinity.”
He said in a mortgage this is called negative amortization.
“The teaser rates that were part of the housing disaster
three years ago were based on exactly that,” Gold said.
Bury said there are a number of actuarial problems with
public pensions that should be addressed:
- Health care for life makes public employees live longer, making
standard mortality tables irrelevant.
- Actuaries don’t account for pension spiking, the practice of
taking a high-paying job or extra overtime to maximize pension benefits.
- Plans allow employees to buy credits and only the employees who
benefit buy them, which increases costs.
According to Bury, actuaries are using techniques to keep
contributions down because that is what governments want.
“They’re afraid to be independent,” he said.
Public employees are going to get their benefits, Gold said,
“the question is who is going to pay for it.”
“Essentially, we, this generation, have consumed the
services of police on the beat, but we are asking our children to pay for half
of the pension costs,” Gold said.
In a recent paper, Rauh
estimates governments would need to raise annual taxes by $1,398 on every
American household to fully fund pensions over the next 30 years. Even if all
public employees stopped earning pension benefits now, according to Rauh, each family would have to pay $800 to fully fund
pensions in 30 years.
“As an older taxpayer, I’m getting the benefits,” Gold said.
“Today’s taxpayers are happy because they’re not being charged.
“The unhappy people should be tomorrow’s taxpayers, but
nobody’s standing up for them,” Gold said.
For a plain-language explanation of public pension issues
and estimates of liabilities for each state, check Sunshinereview.org .
http://watchdog.org/10378/state-local-pension-accounting-takes-a-gasb-step-toward-transparency/