On July 8, 2011, the Governmental Accounting Standards Board (GASB) released proposed changes to its standards for pension accounting and financial reporting by state and local governments, which face growing scrutiny by financial regulators and legislators.
The two Exposure Drafts distributed by GASB for public comment, “Accounting and Financial Reporting for Pensions” and “Financial Reporting for Pension Plans,” propose revisions that would result in more uniformity and transparency in reporting pension plan liability.
“Accounting and Financial Reporting for Pensions” would amend the requirements of GASB Statements Nos. 27 and 50, and relates to accounting and financial reporting standards for state and local government employers that provide pensions through a qualified trust or equivalent arrangement. “Financial Reporting for Pension Plans” would amend the requirements of GASB Statement No. 25 and relates to financial reporting standards for such pension plans.
Comments on the proposed changes must be provided to GASB by September 30, 2011.
The aim of the revisions is to require governments to recognize the costs and obligations associated with pensions when they are earned by employees, instead of when contributions are made or benefits are paid. The proposed changes include the following:
- Net pension liability must be recognized in financial statements. This represents a major change, as currently this information is included only in the notes to financial statements.
The manner in which total pension liability, or the actuarial valuation of a pension plan, is calculated is subject to the following requirements:
- When projecting future benefits payments, a government must recognize ad hoc cost-of-living adjustments (COLAs) and other post-employment benefit changes made at its discretion if the past practice of granting them indicates that they have become automatic. Currently, only automatic COLAs and post-employment benefit changes are included in future benefit payment projections.
- When discounting projected benefits payments to their present value, a government must use (i) the long-term expected rate of return for its pension plan if plan assets are projected to be sufficient to make the projected benefits payments, or (ii) a tax-exempt, high-quality 30-year municipal bond index rate if plan assets are not projected to be sufficient. Currently, governments use a long-term expected rate of return based on the historical performance of the pension plan, which is typically in the 7 percent to 8 percent range. Depending on what the historical rate of return is, the requirement to use the municipal bond index rate could result in the use of a much lower discount rate, a much larger present value calculation, and a much larger net pension liability. In addition, the revised standards require further sensitivity analysis to be included in the notes to financial statements showing the present value calculation using (i) the chosen discount rate, (ii) the discount rate plus 1 percent, and (iii) the discount rate minus 1 percent.
- When attributing the present value of projected benefit payments to past and future years during which employees have worked or are expected to work, all governments must use a single method known as entry age normal and do so as a level percentage of payroll. Right now, governments have a choice of six attribution methods.
- A government in cost-sharing multiple-employer plans must report its net pension liability based on its proportion of the collective net pension liability of all the governments that participate. Currently, this information is not required to be presented for individual employers participating in these plans, only for the plan itself.
If adopted, the standards in the Exposure Drafts would become effective for a government employer with a single-employer defined benefit pension plan that has a plan net position of $1 billion or more, and for the plan itself, in the first fiscal year ending after June 15, 2010, absent certain special funding or reporting issues. For all other government employers and plans, the standards would become effective for periods beginning after June 15, 2013.
State and local government pension reporting has come under increased scrutiny by financial regulators, including the U.S. Securities and Exchange Commission. In August 2010, for example, the SEC charged a state with violating federal securities law for the first time. The SEC entered a cease and desist order against the State of New Jersey, alleging that it was negligent in preparing disclosure documents with respect to its municipal bonds, resulting in material misrepresentations and omissions regarding the funding and financial condition of its two largest defined benefit pension plans. New Jersey settled with the SEC without admitting or denying the allegations.
In another example, in October 2010, issuer public officials for the first time paid fines in an SEC enforcement action. The fines were part of the settlement of an SEC securities fraud suit against certain City of San Diego officials over their roles in the preparation of pension fund disclosure used in connection with the City’s municipal bond offerings. The suit alleged that the officials knew the City had significant unfunded liabilities with respect to its pension plan and retiree health care benefits, and that the City was deliberately underfunding its annual pension plan payment so that it could increase employee benefits while deferring costs. The individuals did not admit or deny the SEC allegations but agreed to pay fines.
Lawmakers are also concerned about public sector pensions. Legislation introduced in the U.S. House of Representatives in December 2010 would require state and local governments with public sector pension plans to file annual reports, including funded status information, with the Secretary of the U.S. Treasury Department. Under the Public Employee Pension Transparency Act, the reports would be posted on a public, searchable Web site. Failure to file would bar a government from issuing new tax-exempt, tax credit, or direct-pay bonds until it filed its report.
Responding to the heightened scrutiny, the National Association of Bond Lawyers (NABL) on May 2, 2011, released draft guidance titled “Considerations in Preparing Defined Benefit Pension Plan Disclosure in Official Statements,” which provides a framework for comprehensive and detailed disclosure on defined benefit plans by municipal entities in their official statements. NABL has since sought input from municipal market participants and industry groups, including GASB representatives, and plans to revise its report based on comments received.