How GASB Changes Will Affect Public Pensions Part I

• By: Ady
• On: 11/01/2012 17:27:55
• In: In the News

New Hampshire Treasurer Catherine Provencher announced she will be visiting local finance directors and elected officials to educate them about the pending new disclosure and methodology changes to pension liabilities.

Among the primers recently made available are a helpful summary from Gabriel, Roeder, Smith & Company highlighting the key changes; an article in Benefits Magazine by staff at The Segal Company which provides an informative overview; and GASB's own responses to frequently asked questions and a backgrounder. There's also a strong piece on GASB's history written by the executive director of the Missouri State Employees' Retirement System (MOSERS).

However, the changes are inevitably going to cause confusion. An article in the Richmond Times-Dispatch highlights this based on a recent board of trustees' meeting for the Virginia Retirement System (VRS):

Local governments say it would be unfair to force them to show the pension liabilities entirely on their books, since the state shares the responsibility and controls benefits and contributions. … The standards will require the VRS to keep at least two sets for books — one for setting rates based on current methodology and another for accounting for liabilities under GASB.The liabilities will be much larger for accounting than for [required contribution] rates because they must be based on current market value, while the VRS "smoothes" investment losses and gains over five years. The system also will have less time to amortize the unfunded liabilities than it does for rate setting.

It's complex and difficult to explain without including significant amount of details and vocabulary that is not familiar to most. So in what is the first of a series to be spent on explaining GASB's changes, PensionDialog spoke with Thomas J. Cavanaugh, CEO of Cavanaugh Macdonald Consulting, who is the actuary for VRS and other governmental plans, and asked some basic questions.

PD: There are inferences in the media that the new GASB rules will show that public pension funds are financially worse off than we realize. Is this an accurate statement?

TC: No, it's not. The new GASB rules will require that a liability, called the net pension liability, be placed on the balance sheet of the plan sponsor(s). But for the majority of pension funds this liability is already calculated and available through the normal actuarial valuation process.  So I don't see how the new rules will be a revelation for those funds. For some funds, the new GASB rules will require the use of a discount rate that is lower than the current long-term rate used in the actuarial valuation.  As a result the liability measure will produce a higher liability measurement. However, the vast majority of those funds are already aware of the financing challenges they face, so again, I don't see how the new rules will end up surprising folks.

PD: Can you explain if the new "net pension liability" figure will give greater transparency to the fund's condition?

TC: As noted in the answer to the previous question the net pension liability is likely to be already disclosed by the majority of pension funds, so I don't see how it will lead to greater transparency. To me that's an over-used phrase. It seems that most who use it are really saying that the numbers currently being disclosed are wrong, not opaque. Only by using their method and assumptions will the correct, or transparent, numbers be revealed.

PD: In GASB's FAQ, one of the questions state, “Do the GASB's standards allow governments to make their liabilities look smaller by using a discount rate based on unrealistically high expected rates of investment return?” What is your professional opinion: do public pensions use “unrealistically high” rates of return?

TC: This question gets to the heart of the debate over what investment return assumptions to use for measuring the financial status of the pension fund. Different needs generate different results. For funding the plan, a long-term return figure based on the expected return of the underlying asset portfolio should be used. That's what actuaries use. Accountants are looking for a measure of liabilities so that a pension expense can be assigned to accounting periods. Financial economists want a “price” that can be assigned to pension benefits for comparison to other assets and liabilities measured at a specific point in time. Each may require the use of a different discount rate.