Spurred by worries about the financial condition of government plans, the Government Accounting Standards Board (GASB) has released an exposure draft of a proposal to require state and local governmental units to report their defined benefit pension liabilities on a uniform basis, much as is now required of public companies by FAS 87/158.  If adopted, the new standards would not compel governments to improve their plans’ funding – a matter not within GASB’s purview – but would give taxpayers a clearer view of the impact of pension obligations in comparison with those of other cities and states.  Written comments are due by the end of September, and GASB has scheduled three “user forums” in October, to be held in New York City (10/4), San Francisco (10/14), and Chicago (10/21).

A key, albeit cosmetic, change is that a plan’s net pension assets, liabilities, and costs would have to be incorporated into the financial statements of the entities responsible for funding it, rather than being relegated to footnotes.  The proposal includes rules for dividing the effects of plans to which several distinct employers contribute.  The fact that information will be part of the financial statements will not, of course, alter the underlying facts, though it could have an effect in such areas as compliance with municipal bond covenants.

At present, public plans report the value of assets and liabilities using a hodgepodge of methods and assumptions.  The GASB proposal aims at greater comparability.  All plans would use the entry age normal actuarial method to spread pension costs over future years, instead of having a choice among six different methods.  The mandate for a single method is important only for comparing plans; no particular method is intrinsically superior to any other.  FAS 87/158, for instance, specifies the unit credit method for public company accounting.

Other GASB prescriptions aim to ensure that the reported values of assets, liabilities, and annual cost are reasonably realistic:

  • The discount rate for reducing projected liabilities to present value would be bifurcated.  The plan’s actuary would project, year-by-year, anticipated pension payments to current participants and income from current assets.  Liabilities attributable to the period during which assets were projected to be positive (that is, while the plan is able to pay benefits out of existing assets) would be discounted at the anticipated rate of return on investments.  GASB does not dictate the rate to be utilized, only that it must be reasonable.  Liabilities for the period after the hypothetical exhaustion of plan assets would have to be discounted at a rate based on the yields of AA-rated or better 30-year municipal bonds (almost certainly a lower rate, resulting in a higher liability).  The rationale is that the gap between total benefits and those that can be paid from plan assets will have to be filled by borrowing, making municipal bond rates the proper measure of the appropriate discount.
  • Assumptions about the future are invariably wrong.  From one year to the next, plans are amended, participants accrue benefits, retire, or die at different rates from actuarial projections, plan assets earn more or less than anticipated, etc.  Under present accounting standards, most deviations between expected and actual experience are amortized over periods of up to 30 years, thus reducing their immediate impact on reported pension cost.  The GASB proposal would require many of these changes to be recognized immediately.  The major exceptions are investment gains and losses, which could be amortized over up to five years, and the differences between actual experience and economic or demographic assumptions relating to active participants, which could be amortized over their average remaining working life.  By contrast, the effects of experience gains and losses relating to retirees, changes in actuarial assumptions, and benefit increases could not be amortized.  Compared to present practices, this part of the proposal would accelerate the recognition of pension costs.  It does not affect the value of liabilities or the extent of underfunding.  

The conventional wisdom is that reports in accordance with the new standards will typically show worse underfunding and higher pension costs than the currently required disclosures.  That is an unpleasant prospect for many state and local governments.  Anxiety about their ability to fulfill their pension promises without starving all other public services already runs high among taxpayers.

Indications that the GASB proposal will be more controversial than the average accounting method change came at a House Ways and Means Committee hearing on the proposed Public Employee Pension Transparency Act (H.R. 567), on May 5, which would make uniform pension reporting legally mandatory.  Committee members clashed vehemently over the need for nationwide disclosure standards.  One called the idea a “political tool to attack the middle-class workers who teach the children of wealthy people, and the cops and firefighters who keep them safe, and the workers who pick their trash.”  GASB can look forward to hearing the same thing at its forums.