The Governmental Accounting Standards Board's proposed changes in public pension accounting and reporting standards, if adopted, will not have immediate credit implications, but probably would make the reporting of year-to-year unfunded pension liabilities more volatile, Standard & Poor's will say in a report Wednesday.

The report also is expected to warn that it could become more difficult to track pension-funding progress if GASB standards no longer require disclosure of a government's actuarially determined annual required contribution, or ARC.

A draft of the six-page report on GASB's "preliminary views" on public pension standards notes that the accounting standards-setter would no longer allow multiyear smoothing of pension-fund asset valuations in certain circumstances. Instead, the standards would require states and localities to immediately report pension investment gains or losses that deviate in excess of 15% from the actuarially assumed rate of return.

Though this could lead to volatility in pension reporting during periods of large market swings, the proposed standards would only affect pension reporting within financial statements, the rating agency noted. GASB's proposals would not necessarily affect the contributions that states and localities must make to their pensions.

"If governments eventually moved from current annual pension-funding requirements, based on actuarial asset smoothing, to the potentially new [generally accepted accounting principles] reporting requirements as outlined in GASB's preliminary views, it could lead to higher annual pension contributions in certain years with big market losses," wrote David Hitchcock, a senior director, and Sherman Myers, a director, who both worked on the report.

For many pensions, there is a big difference between unfunded pension liabilities calculated on an actuarial smoothing method and unfunded liabilities calculated using the current market value of the pension assets, they said.

For instance, New Jersey's Public Employees Retirement System reported a pension-funding ratio of assets to liabilities of 56.5% as of June 30, 2009, based on the actuarial value of assets, while on a market value basis, the ratio decreased to 42.1%, according to the rating agency report.

Under the preliminary proposed standards, GASB is calling for several fundamental changes to pension reporting. In particular, GASB would require the unfunded portion of a retirement plan to be included in the financial statement and to constitute a liability.

Currently, many governments disclose pension information in the financial statement footnotes, but generally only report the amount of contributions they are actuarially required to make during a given year, as well as what they actually paid. The report urges GASB to clarify that ARCs should continue to be reported or else it may be more "difficult to determine a municipality's progress toward adequately funding its pension system on an annual basis."

Though GASB has not said if it will require the unfunded liability to be reported on the balance sheet or in the footnotes of financial statements, Standard & Poor's said it essentially does not matter for credit rating purposes because the rating agency "already evaluates a government's pension funding status as part of its general obligation rating criteria."

Meanwhile, GASB is proposing to alter the formula that states and localities use to convert projected pension benefit payments into present value based on an assumed "discount rate." The board is proposing a blended discount rate, if a government does not have enough assets in its plan to cover expected payments. For benefit payments that are expected to occur after the fund's assets are depleted, the government would have to use a rate based on a "high-quality municipal bond index rate."

Though the lower, "blended rate" would show a higher present value of the pension benefits and therefore a larger overall liability in the financial statement, Standard & Poor's said that this "will not often come into effect from a practical perspective," because it is unlikely governments would report that they would not have sufficient assets to make required pension contributions in the future.

GASB released the preliminary views document in June, collected comments on it and held a series of public hearings this fall. The accounting standards-setter is expected to issue a follow-up "exposure draft" proposal in the second quarter of 2011, with final accounting rules expected one year later.

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