The GASB’s New Pension Accounting and Reporting Standards
On June 25, 2012, the Governmental Accounting Standards Board (GASB) approved new accounting and reporting standards for pensions provided by state and local governments. GASB Statement No. 67, Financial Reporting for Pension Plans, applies to state and local pension plans established as trusts or similar arrangements. GASB Statement No. 68, Accounting and Financial Reporting for Pensions applies to governmental employers that sponsor or contribute to pension plans.
The GASB’s new standards make significant changes to pension accounting and financial reporting by state and local governments. While the current standards under Statement No. 25, Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined Contribution Plans, and Statement No. 27, Accounting for Pensions by State and Local Governmental Employers, link pension accounting and pension funding, the new standards under Statements No. 67 and No. 68 disconnect pension accounting and funding in several ways:
The discount rate used to determine pension liabilities for funding purposes will continue to be the long-term expected rate of return on plan assets. However, for accounting purposes, the discount rate may include a portion based on tax-exempt municipal bond yields.
The asset valuation method used for funding purposes will still allow asset smoothing. However,
for accounting purposes, the fair (market) value of assets will be used.
The amortization period used for funding purposes will still be relatively long. However, for accounting purposes, the period will be considerably shorter.
Overall, these changes will likely make the new pension accounting measures more volatile than the funding measures. It should be noted that the GASB’s changes do not affect the actuarial methods and assumptions used to determine the contributions needed to fund the plan.
Types of Pension Plans and Employers. In applying the accounting and reporting standards for pensions, the GASB makes distinctions between different types of pension plans and employers:
“Single-employer plans” provide benefits to the employees of only one employer. An employer with a single-employer plan is referred to as a “single employer.”
“Agent multiple-employer plans” are essentially collections of single-employer plans. They pool assets for investment purposes, but legally segregate each individual employer’s assets for the purpose of paying benefits. An employer in an agent plan is referred to as an “agent employer.”
“Cost-sharing multiple-employer plans” provide benefits to more than one employer by pooling the assets and obligations across all participating employers. As a result, plan assets may be used to pay the benefits of any participating employer. An employer in a cost-sharing plan is referred to as a “cost-sharing employer.” [The New Hampshire Retirement System is a cost-sharing multiple-employer plan.]
Net Pension Liability. Under the new standards, the employer’s basic financial statement liability will be a measure of the employer’s unfunded pension obligation, referred to as the “net pension liability” (NPL). The NPL equals the “total pension liability” (TPL) minus the “plan’s fiduciary net position” (PFNP), which is essentially the fair (market) value of plan assets available to pay benefits. The NPL will be reported on the balance sheet of the employer’s government-wide basic financial statements.
In many ways, the total pension liability is similar to the actuarial accrued liability that many state and local plans use for funding purposes. It is the liability attributed to past service for benefits related to service, salary, and automatic cost-of-living adjustments (COLAs)1, determined using the traditional entry age normal cost method (the actuarial cost method used by many state and local pension plans).
However, a key difference between the accounting liability and the funding liability is the discount rate. While the discount rate for funding purposes will remain the long-term expected rate of return on plan investments, the discount rate for accounting purposes may include a portion based on a municipal bond rate,2 depending on whether the projected assets of the plan are sufficient to cover projected benefits. This is determined by:
Projecting future benefit payouts for current employees and retirees.
Projecting the plan’s future fiduciary net position, including current assets and projected employer and employee contributions and investment earnings.
Discounting projected benefits using the long-term expected rate of return, to the extent that the plan’s projected fiduciary net position is sufficient to pay benefits.
Discounting all other projected benefits using the municipal bond rate.
Determining the single discount rate that, when applied to all projected benefits, equals the sum of the present values using the long-term expected return and bond rates.
If employer contributions are subject to statutory or contractual requirements, or if a written policy related to employer contributions exists, professional judgment can be used in projecting future contributions. Otherwise, the projected contributions will be limited to an average of contributions over the most recent 5-year period, potentially modified by subsequent events. Having a written funding policy will help provide a solid basis for projecting future contributions.
New Standards for Cost-Sharing Employers. Perhaps the most far-reaching changes in the GASB’s
standards are those related to cost-sharing employers. Under the current GASB standards, a cost-sharing employer’s pension expense is its contractually required contribution to the cost-sharing plan. In addition, the cost-sharing employer’s pension liability is the accumulated difference between its contractually required contributions and its actual contributions over time. Since most cost-sharing employers make their full contractually required contributions to the plan, few have a pension liability under the current standards.
Net Pension Liability for Cost-Sharing Employers. Under the new standards, cost-sharing employers will be required to report their “proportionate share” of the plan’s net pension liability in their government-wide financial statements. To determine these values, the cost-sharing plan will begin by calculating the net pension liability (collectively for all participating employers) using the methods described above.
An individual employer’s proportionate share of the collective net pension liability would then be determined, using a method that is consistent with how the cost-sharing plan determines the contributions for the cost-sharing employers. This could be based on the individual employer’s share of total employer contributions or on payroll or other methods used by the cost-sharing plan to determine employer contribution rates. The GASB encourages the proportionate share to be based on the cost-sharing employers’ long-term contribution effort to the plan.
Pension Expense for Cost-Sharing Employers. Similarly, a cost-sharing employer’s pension expense will include its proportionate share of the plan’s pension expense. In addition, the cost-sharing employer’s pension expense should include: 1) the net effect of annual changes in the employer’s proportionate share, and 2) annual differences between the employer’s actual contributions and its proportionate share. These changes are deferred and recognized in the pension expense over the remaining service lives of all employees and retirees.
Measurement Timing and Frequency. The new GASB standards require that the employer’s pension liability be fully measured at least every two years. The employer should recognize the net pension liability as of the “measurement date,” which should be no earlier than the end of its prior fiscal year, consistently applied from year to year. Moreover, the employer should determine the total pension liability at the measurement date, either by: 1) an actuarial valuation as of the measurement date, or 2) an update procedure to “roll forward” amounts from an actuarial valuation performed as of a date not more than 30 months plus 1 day prior to the employer’s fiscal-year end.
Transition and Effective Dates. The new standards are effective for state and local government pension plans in fiscal years beginning after June 15, 2013. For employers (and non-employer contributing entities), the standards are effective for fiscal years beginning after June 15, 2014. In making a transition to the new standards, their effects should be reported as adjustments to prior periods and a restatement of the beginning balance sheet liability. The GASB encourages restatement of the beginning deferred outflows of resources and beginning deferred inflows of resources, but only if this is practical.
Conclusions. The GASB’s changes have already begun to generate discussion and concern about the financial condition of public pension plans. However, readers should recognize that the pension promise does not change as a result of the accounting changes. Alicia Munnell, director of the Center for Retirement Research at Boston College, said it well in her June 2012 report, How Would GASB Proposals Affect State and Local Pension Reporting?: “…accounting changes do not alter the underlying fundamentals; $1,000 owed to a retired teacher in ten years under current standards will remain $1,000 owed in 10 years under the new standards. So policymakers should not let new numbers throw them off the path to sensible reform.”
1 The GASB’s new standards also require the liability for ad hoc COLAs to be included; to the extent that they are substantively automatic.
2 This rate should reflect the rate for 20-year tax-exempt general obligation bonds with an average rating of AA/Aa or higher.
Paul Zorn is Director of Governmental Research for Gabriel, Roeder, Smith & Company (GRS). James Rizzo is a Senior Consultant and Actuary for GRS. GRS is the consulting actuarial firm for the New Hampshire Retirement System.
Copyright 2012 by the Government Finance Officers Association. Reprinted with permission.