New accounting and financial reporting standards for U.S. state and local government pension and benefit funds start to take effect this month. Confusion is likely to ensue as taxpayers, plan participants, and even plan sponsors take a hard look at new numbers that more clearly identify funded or unfunded municipal pension liabilities.
The new rules separate pension accounting from pension funding by changing the focus from a sponsor’s cost of funding the benefits to the employer’s pension liability.
The General Accounting Standards Board (GASB) is the independent standards-setting organization behind the changes, which include two sets of new rules issued on June 25, 2012. Highlights of the rule changes, as described in part by the GASB, are described below.
GASB Statement 67: Financial Reporting for Pension Plans
This Statement requires defined benefit pension plans to present two financial statements: 1) a statement of fiduciary net position; and 2) a statement of changes in fiduciary net position.
The total pension liability, as determined by actuarial valuations, must be performed at least every two years. Notes to financial statements of defined benefit pension plans must also include more descriptive information.
Statement 67 is effective for plan fiscal years beginning after June 15, 2013. For plans with a December 31 fiscal year end, Statement 67 will apply to the December 31, 2014 financial statements.
It replaces the requirements of Statements No. 25, Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined Contribution Plans, and No. 50, Pension Disclosures, as they relate to pension plans that are administered through trusts or equivalent arrangements. Pension plans not administered through a trust remain subject to the earlier rules of Statements 25 and 50.
GASB Statement 68: Accounting and Financial Reporting for Pensions
This Statement establishes standards for measuring and recognizing liabilities, deferred outflows of resources, and deferred inflows of resources, and expense/expenditures. GASB 68 defines how benefit expense calculations and payments should be calculated, including guidance on discount rates and the determination of net present value.
Statement 68 will apply to employers and “nonemployer contributing entities” (“NCEs”) for fiscal years beginning after June 15, 2014. For plans with a December 31 fiscal year end, Statement 67 will apply to the December 31, 2015 financial statements.
Key Changes in New GASB Pension Rules
Primary changes contained in GASB Statements 67 and 68 include:
• The plan sponsor’s “total pension liability” (“TPL”) is similar to the “actuarial accrued liability” (“AAL”), but must:
o Use the Entry Age Normal Cost method
o Use a blended discount rate based on the long-term rate of return and municipal bond rates
o Recognize ad hoc “Cost of Living Adjustments” (“COLAs”) if essentially automatic
• A number representing the plan sponsor’s “net pension liability” (“NPL”) will appear on the plan sponsor’s balance sheet. Municipalities that previously appeared to be in sound financial condition may find that the inclusion of significant unfunded pension liabilities on the balance sheet will rattle taxpayers, investors, and plan participants.
• A “pension expense” (“PE”), which differs from a plan sponsor’s “actuarially determined contributions” (“ARC”), will appear on the sponsor’s income statement.
• Historic requirements in regard to financial reporting disclosures will be replaced with information based on the new measures.
• The discount rate used to calculate future obligations may change, depending on the plan’s funding levels.
• Allowable amortization periods of investment gains or losses will be shortened. A process known as “smoothing” liabilities over time is being eliminated, which is likely to create greater volatility.
As readers can tell, the rule changes are highly technical. Plan sponsors and employers will help participants and taxpayers understand the full impact of individual plans.
Three Types of Municipal Pension Plans Addressed
Accounting and financial reporting pension rules will vary based on the type of municipal plan sponsor. The three types of plans subject to Statements 67 and 68 include:
1. Single-employer pension plans.
2. Agent multiple-employer pension plans. In these plans, assets from multiple pensions are pooled for investment purposes. Each employer plan retains individual responsibility for funding and benefit payments.
3. Cost-sharing multiple-employer pension plans. In these plans, both assets and payment mechanisms are pooled across multiple employers.
The GASB rule changes were issued after an extensive public comment period, including a 2009 Invitation to Comment, the circulation of preliminary documents in 2010, multiple hearings, and a June 2011 exposure draft. While actuaries, investment professionals, and sophisticated plan sponsors have debated the pros and cons of pension reform in financial reporting, the taxpayer remains largely ignorant of unfunded pension liabilities.
According to the Pew Charitable Trusts, “the gap between the promises states have made for public employees’ retirement benefits and the money they have set aside to pay these bills was at least $1.38 trillion in fiscal year 2010.” As these changes show up on municipal financial statements over the next two to three years, watch for even greater taxpayer concern over pension and municipal deficits. Pension litigation is likely to ensue.