GASB pension rules: sticker shock less likely

New public pension accounting rules scheduled to be issued next month, once expected by some to reveal massive hidden debt, now seem less likely to trigger a shake-up and are even getting applause from pension officials.

Under the new rules, experts say, most California pension systems will make little if any use of a lower “risk-free” government bond-based earnings forecast, currently about 4 percent, that causes debt to soar.

Pension systems can continue to use earnings forecasts critics say are too optimistic, now 7.5 percent for the three state funds, to offset or “discount” estimates of the cost of pensions promised current workers in the decades ahead.

But if the assets (employer-employee contributions and investment earnings) are projected to run out before all of the pension obligations are covered, the pension system must “crossover” to a lower bond-based forecast to calculate the remaining debt.

A Governmental Accounting Standards Board member told a seminar in Sacramento early this month that pension systems have a low probability of reaching the “crossover” point if employers make annual contributions determined by actuaries.

“In California that is almost always, because most of the time that’s set in statute,” said David Sundstrom, a GASB board member and Sonoma County treasurer-tax collector.

The chief actuary of the California Public Employees Retirement System, Alan Milligan, told the seminar he thinks the “vast majority” of California public pension systems will not reach the crossover point.

“I’m not that way currently,” he said of the 2,200 separate CalPERS plans for more than 1,500 employers. “But I expect our system will be that way by the time the new rules come into force.”

A well-known exception, the California State Teachers Retirement System, lacks the power to set employer contributions. Pleas for legislation to increase CalSTRS rates have been unheeded for five years as the state, deep in deficits, slashed school funding.

Sundstrom told a California Debt and Investment Advisory Commission seminar that under the new rules the state would begin listing its share of the CalSTRS debt or “unfunded liability.”

“Don’t know what that is yet, but obviously it would be a very significant number, definitely in the billions,” he said.

The importance of the earnings forecast was dramatized two years ago when Stanford graduates students showed how the unfunded liability of the three state pension systems soared if earnings expected from diversified investment portfolios fall short.

The systems, with forecasts of 7.5 to 8 percent, reported an unfunded liability of $55 billion. The debt soared to $500 billion with a forecast based on risk-free bonds, 4.1 percent, the method used by economists for risk-free debt guaranteed by taxpayers.

An early critic of optimistic forecasts, David Crane, an adviser to former Gov. Arnold Schwarzenegger, was removed from the CalSTRS board in 2006 when the state Senate rejected his appointment, reportedly for repeatedly raising the forecast issue.

Since then CalSTRS has lowered its earnings forecast from 8 to 7.5 percent. A report last month showed CalSTRS, as of June 30 last year, with a widening funding gap, only 69 percent of the assets needed to pay pensions during the next three decades.

The total employer-employee contribution, 19.4 percent of pay, would have to be increased by 12.9 percent of pay (about $3.25 billion a year) to fully fund promised pensions. Without a rate increase, CalSTRS is expected to run out of money in 2046.

Public pension systems “from Alaska to Maine” are struggling to lower their earnings forecasts, facing “a painful reckoning” during a period of very low interest rates and unpredictable stock prices, a New York Times story said this week.

The chief actuary for New York City’s five pension funds, Robert North, has proposed lowering the earnings forecast to 7 percent from the current 8 percent. Unions fear the resulting higher city costs will fuel the drive to cut public pensions.

“The actuary is supposedly going to lower the assumed reinvestment rate from an absolutely hysterical, laughable 8 percent to a totally indefensible 7 or 7.5 percent,” Mayor Michael Bloomberg, who made billions in the financial world, told the Times.

“If I can give you one piece of financial advice: If somebody offers you a guaranteed 7 percent on your money for the rest of your life, you take it and just make sure the guy’s name is not Madoff.”

When CalPERS lowered its earnings forecast to 7.5 percent, not 7.25 percent as recommended by actuaries, the board also decided to phase in the resulting rate increase for employers, a move urged by unions to ease the strain on government budgets.

This month the board raised the annual payment to CalPERS for state worker pensions $213 million to $3.7 billion. Part of the increase was spread over the next two decades, saving the state $149 million next fiscal year.

Gov. Brown urged CalPERS to adopt the full increase now. He said phasing in the rate adds $146 million in interest payments to the total cost and is the “equivalent of the state taking a 20-year loan at 7.5 percent interest — not a prudent decision.”

The CalPERS chief actuary, Milligan, told the seminar the rate phase-in is an example of how the new accounting rules, which on paper “divorce” pension accounting from pension funding, may still influence funding practices.

He said under the old rules pension expenses that briefly exceed contributions would have been a concern. But expenses reported under the new rules will be quite different from required contributions, maybe even going negative in high-earnings years.

“It allowed us a little more flexibility in constructing this phase-in,” Milligan said. “So I’ve already made the mental switch to no longer trying to keep pension expenses and funding in synch, and I suspect we all will.”

Another speaker at the seminar said other actuaries are talking about conforming some of their funding methods to the new accounting rules, thereby avoiding the need to explain differences in things like amortization periods for paying off debt.

“In talking to actuaries, there have been a lot of them who have said we will probably change some things just to make them match,” said Brian Whitworth of the First Southwest Company.

Milligan said a CalPERS test using some of the new accounting rules for funding, such as shorter amortizations and asset smoothing, showed a 10 percent increase in the actuarial liability and a crossover to the lower bond-based discount rate after 40 years.

He said the new rules made little difference in the increase in employer contributions during the early years, but the rates stayed a little higher for a longer period before declining.

Milligan said he may recommend conforming some funding methods to the new accounting rules during a review of actuarial assumptions scheduled to be given to the CalPERS board in December.

The change would mean that few if any of the 2,200 CalPERS funds would reach the crossover point, he said, avoiding the actuarial task of blending the 7.5 percent discount rate with a lower bond-based rate.

“It’s also going to mean that I am going to be able to report the same liability on both a funding basis and an accounting basis, and you will have the same actuarial liability number on both a funding and accounting basis,” Milligan said.

After a process that began in 2006, GASB is expected to approve the new public pension rules on June 18, probably with a few tweaks sought by CalPERS and CalSTRS. One would delay reports using the new rules until October 2014.

“I am very appreciative of the changes that have been made to the accounting standard,” Milligan told the seminar. “It’s very nice to know that they have been listening, and I would like a round of applause for the Governmental Accounting Standards Board.”

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Posted 29 May 12

7 Responses to “GASB pension rules: sticker shock less likely”

  1. Tough Love Says:

    Maybe not a big problem for CA., big this will be a big problem for Ill, NJ, RI, and quite a few others.

  2. Robert Mitchell Says:

    Even the new GASB rules will still allow bad actors to hide their behavior. If you spike a pension for a new retiree, these rules still allow you to force future generations to pay for services long after the work was done.
    But this is still an improvement over the old rules.

  3. gery katona Says:

    At the minimum, the Governor’s 12-point reform plan still needs to be fully implemented. Fat pensions and early retirements are still a problem and this taxpayer is not going to be on the hook to guarantee a 7.5% return.

  4. John Dickerson Says:

    I’ve been following the GASB process re new gov. pension financial reporting standards closely for the past 3 years – analyzing them from my perspective as a financial analyst. I have a significantly different “take” on what they will do than most of my fellow pension reformers and public commentators.

    Two preliminary comments.

    First, there are a lot of “rumors” out there right now that GASB will one way or another delay the implementation of the new rules – either by delaying their publication or allowing more years before they must be adopted after publication. I haven’t heard any official discussion of allowing more years before implementation. We’ll soon find out.

    Second, it’s clear GASB is “simplifying” the accounting compared to what was defined in their last public comment documents published last June. Although I’m a strong advocate of the core reforms in GASB’s proposals and regret some of the simplifications – I and several other financial pros who are pension reformers were very impressed with how complicated some aspects of the proposed new standards would be to implement – esp. for the big statewide systems such as CalPERS/STRS. Simple fact is they would have imposed some significant new accounting costs. GASB’s “field tests” found the same thing.

    Now for the main points.

    First – There are two central changes in the proposed new standards: A) putting a “Net Pension Liability” directly on government Balance Sheets (as discussed in this article), and B) forcing must faster and detailed reporting of the Pension Expenses that create unfunded pensions.

    Most people – as in this article – focus on the first part – reporting the debt. But I’m convinced it’s the second part that will be much more powerful – reporting the pension expenses that create the debt.

    Today the actuarial value of unfunded pensions is shown in Supplementary Information attached to government financial statements. It’s based on “smoothed” Pension Asset values and uses the target rate of return as the discount rate. Many pension reformers object – they think it should be based on the market value of assets and use a lower “risk-free” discount rate.

    Without venturing into the swamp of that debate – it’s clear to me the second change is FAR MORE POWERFUL – forcing much faster reporting of pension expenses that create unfunded pension debt.

    This also can get complicated – but in simple terms today’s standards allow governments to report the pension expense that create unfunded pension debt in the future as they pay the debt. THAT’S ABSURD. The payments of a debt don’t create the debt. Unreported past pension expenses create unfunded pension debt.

    The new standards will force governments to report the pension expenses that create unfunded pension debt anywhere from the year in which the expense happens to within 7 years – depending on the specific cause. Today governments can take up to 30 years to report past expenses that create unfunded pension debt.

    AND – assuming the new standards aren’t changed in this respect –hundreds of billions of unreported past pension expenses that created today’s unfunded pension debt will be forced out of their hiding places and pushed onto Income Statements they year the new standards are implemented. The people are going to get hit with the fact that their governments didn’t report hundreds of billions of past real expenses – all in one year!!!

    The political impact could – and should – be profound.

    Now – what will the impact of these new pension expense reporting rules be on the state constitutional requirements for “balanced budgets”? More than likely legislatures will try to exempt themselves and local governments from including the impact of these unpaid pension expenses so they can report balanced budgets – only balanced because they ignore real expenses they don’t pay for.

    If you want to organize around these new standards – that’s where you need to concentrate. Governments should be forced to produce balanced budgets INCLUDING the full charge of pension expenses each year and not be allowed to continue to ignore the part they don’t pay.

  5. gery katona Says:

    Mr. Dickerson,
    Nice “take” from someone who gets it. When you mention unreported past pension expenses, I immediately think of Greece. I don’t know if their case involved pensions, but they did hide their expenses from view which is what got them into the mess they have today. This sounds kind of similar.

  6. Ted Steele, Junior Petite Says:

    Great article and good news! Great for Cali baby!!!

  7. Cale Says:

    Hey this is good news!

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