WASHINGTON — The Governmental Accounting Standards Board is set to kick off a series of public hearings next week on its preliminary draft pension-fund accounting and financial reporting standards that are designed to boost the disclosure of public pension liabilities but are proving to be controversial.
State and local issuers are concerned that the proposal would needlessly alarm market participants and lawmakers while some academics are warning it does not go far enough and would continue to allow governments to conceal the true size of their pension obligations.
Though the GASB project began four years ago, the hearings come after states and localities are still reeling from the enormous losses their pension funds suffered in 2008 and many are looking to cut benefits while raising mandatory contributions to pay for expected future liabilities.
GASB has received 183 comments on the “preliminary views” document it released in June. After hearings planned for Wednesday in Dallas, Thursday in San Francisco and Oct. 27 in New York, the board will convene, sift through the comments and eventually release an “exposure draft,” which will be subject to another round of comments during the second half of 2011. The standards are not expected to be finalized until July 2012 at the earliest, according to a technical plan on the board’s website.
If the standards are implemented in their current form, they would likely increase the size of liabilities and expenses for reporting purposes, but would not alter how entities calculate funding requirements. That means governments would not necessarily be required to increase the level of their required annual contributions.
As a result, some market participants are asking GASB to require that states and localities disclose if there is a discrepancy between how they are funding their pension liabilities and how that is accounted for in their financial statements.
In a comment letter filed with GASB, Girard Miller, a senior strategist at the PFM Group who called the overall proposal “masterful,” said: “If a plan sponsor reports pension expenses in one way under GAAP [generally accepted accounting principles], but actually funds the plan in another way, then financial statement users need to know (a) what is the quantitative difference between those accounting and funding policies and (b) what will be the probable and foreseeable outcome of those differences in the future.”
Market participants said this kind of disclosure would help ensure that states and localities do not mislead bond investors, particularly in light of the Securities and Exchange Commission’s August enforcement action against New Jersey for failing to disclose to investors that it was underfunding its two largest pension plans.
Under the preliminary proposed standards, GASB is calling for several fundamental changes to pension reporting.
The first significant change revolves around GASB’s view that the unfunded portion of the retirement plan is an item that belongs on the financial statement of the governmental employer and that it constitutes 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 and what they have actually paid.
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. If GASB decides to require the unfunded liability to be included in the balance sheet, many localities are expected to be “upside down,” or have far more liabilities than assets in their pension plans. Some issuer groups are not happy with the proposal, however.
The National Association of State Auditors, Comptrollers and Treasurers told GASB that it believes a liability should be recognized only when the governmental employer does not pay its annual required contribution.
“We remain concerned with GASB’s belief that it is possible to fully segregate the accounting for pension liabilities from funding those liabilities, and we are not convinced that the net pension liability… would provide more reliable or useful information than existing requirements,” wrote Nancy Kopp, Maryland state treasurer and the president of NASACT.
GASB’s “net pension liability” approach, Kopp added, will “cause fear and misunderstanding among financial statement readers who will interpret this as being an unfunded obligation as of the balance sheet date, when in fact it represents the obligation to be funded by contributions and earnings over time.”
“As long as the contributions are fully made, the obligation will be fully funded at the end of the period,” Kopp wrote. “We can see how this will cause legislators to make significant and detrimental changes to pension plans, even those that are healthy, sound, and being funded properly.”
Meanwhile, GASB also 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, depending on whether the government has enough assets in its plan to cover expected payments. If it does, it may continue to use its expected rate of return. But 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.”
As a result, the lower, blended rate would show a higher present value of the pension benefits and therefore a larger overall liability in the financial statements.
“The GASB believes that this is a more accurate depiction of the level of resources that will be consumed by the promised benefit payments,” the board wrote in a plain-English summary of the proposal.
Finally, GASB is proposing to speed up the amortization for retroactive pension benefit improvements. GASB standards currently allow governments to amortize their liabilities for existing workers for as long as 30 years.
But GASB is now proposing to make the amortization even more stringent by requiring that any increase in overall pension liabilities caused by “retroactive benefit improvements” be recognized as an expense over the employees’ remaining service life.
The move, which would closely mirror corporate accounting standards in this area, would require most governments to recognize these costs as pension expenses sooner than they do at present.
As GASB moves forward with its proposal, some issuers are calling on the accounting standards-setter to implement the new pension standards slowly.
“The board’s proposal would lower the projected rate of return and this would increase contributions,” wrote Charles Holland 2d, finance director of Cocoa Beach, Fla. “Without a gradual phase-in, changes downward in rates of return will have a catastrophic effect on local governments because of large increased payments to the plan. This in turn, will unleash unintended consequences to employee-employer relations.
