The big pension liability adjustment

By Cate Long
June 27, 2012

The Government Accounting Standards Board voted Monday to toughen pension reporting standards, a slight accounting change that has significant repercussions for muniland. Reuters’ Lisa Lambert reports how data that was formerly buried in the footnotes of financial statements will have to be made more prominent:

State and local governments will have to post their net pension liability – the difference between the projected benefit payments and the assets set aside to cover those payments – up front on financial statements, under the changes.

“The pension liability will appear on the face of the financial statements for the first time. That’s going to create the appearance of a weaker financial position,” said Robert H. Attmore, GASB chairman, who said the board intended to “peel back the veil so things are more transparent and there’s more information for policy makers.”

In addition to providing taxpayers and municipal investors with easier access to data, the GASB changes also stipulate the method by which future returns are calculated for pension funds that are underfunded. This will likely make many pension funds appear less healthy as they will have to use projected rates of return that are more sober.

For several years state and local governments have been making adjustments to retiree benefits in an effort to square up their pension plans. A consortium of government associations, led by the National Council of State Legislatures, has published a fact sheet so the public has a balanced view of the health of the pension system. It highlights how the majority of governments have already made changes to pension plans:

More state and local governments enacted significant modifications to improve the long-term sustainability of their retirement plans in 2010 than in any other year in recent history. In the past few years, nearly two-thirds of states have made changes to benefit levels, contribution rate structures, or both; many local governments have made similar fixes to their plans.

The biggest factor in determining the health of pension funds is how much return funds are earning on the $3.2 trillion in pension assets. These are the assets that have been earmarked to pay government workers in retirement. It’s vital that returns be as high as possible because pension fund returns make up 60 percent of the annual flow of resources to retirees. Employee and government contributions make up the remainder.

According to the National Council of State Legislatures, investment returns have been healthy: For the 25-year period ending December 31, 2009, the median public pension investment return was 9.25 percent. Moreover, for the year ended June 30, 2010, this return was 12.8 percent. But there’s a lot of variance in returns by state. If you just look at returns between 2001 and 2009, admittedly a period in which many funds suffered major investment losses due to the financial crisis, the variance is more acute:

Along with returns, pension plan funding levels also display a lot of variance. For example, the two New York State plans are funded at over 100 percent of liabilities. In contrast, as Bloomberg notes, “pensions for public workers in Illinois, New Jersey, Indiana and Kentucky have less than 30 percent of assets needed to meet liabilities, according to the Boston College Center for Retirement Research.” Puerto Rico has practically no assets in its pension fund and operates on a pay-as-you-go basis.

Determining the true level of liabilities is an important element of fixing the public pension problem, especially in places like Illinois, New Jersey and many nearly bankrupt municipalities. Negotiating with employees for reduced retirement benefits, especially in distressed municipalities, is critical to preserving what little value is left in the assets in those plans. But it’s important to examine a broader set of data before succumbing to a scare about public pensions generally, and it’s essential to evaluate states and municipalities on a case-by-case basis – you wouldn’t think it, but the city of Detroit has well-funded pension plans. Problems in pension funds need to be addressed, but the big pension fund liability adjustment shouldn’t cause a universal panic.

Further:

Public Plans Database

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