(June 26, 2012) — The Governmental Accounting Standards Board (GASB) has voted to implement stricter accounting and financial reporting standards for US public pension plans that could cause a spike in pension underfunding.
In a June 25 afternoon meeting in Norwalk, Connecticut, the GASB approved a host of reforms that would simplify public pension accounting into a single system and could, for some funds, result in larger liabilities than under current rules. The changes will be enacted in a staggered manner, with half implemented on June 15, 2013 and the rest 12 months later.
“The new standards will improve the way state and local governments report their pension liabilities and expenses, resulting in a more faithful representation of the full impact of these obligations,” said GASB Chairman Robert H. Attmore. “Among other improvements, net pension liabilities will be reported on the balance sheet, providing citizens and other users of these financial reports with a clearer picture of the size and nature of the financial obligations to current and former employees for past services rendered.”
The most important modification relates to the discount rate that pensions use to determine the size of their future liability relative to their estimated assets. Under the current rules, public pensions are allowed to base their liability assumptions on an estimated future rate of return that the funds themselves determine. Funds typically predict a rate of return of around 8%, a figure that, while in line with historical averages, has been hard to reach for funds in the past decade.
With the new standards, “sufficiently” funded pensions can continue to employ a rate of return of their choosing, but plans considered under that level must factor in a lower discount rate pegged to the yield on tax-exempt 20-year, AA-or-higher rated municipal bonds. The yield on such bonds generally fluctuates between 3% and 4%, a marked drop from the 8% most funds predict they will achieve. As a result, plans considered insufficiently funded by the new rules could see a sizeable spike in their liabilities.
Recent events have thrown the problem of public pension underfunding into sharp relief. Last week, the Pew Center on the States released a report showing that state-run public pensions faced $1.38 trillion in unfunded liabilities in fiscal 2010. Although pension experts criticized the report for its reliance on out-of-date data, others stressed that public pension funds are not required to disclose their funded status in a timely manner and as a result the fault was not with the Pew survey but with the information that was available.