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Proposed changes in public pension accounting rules scheduled to be heard in San Francisco next week are drawing fire from both sides – critics of the current system say massive debt will remain hidden, and supporters say costs could jump.
A previous rule change telling state and local governments to report the cost of retiree health care promised current workers revealed an estimated $118 billion debt in California, sparking a move to begin setting aside money to pay for it.
Now the Governmental Accounting Standards Board, in a lengthy process that began four years ago, is updating rules for public pensions at a time of controversy over whether their soaring retirement costs threaten funding for basic government services.
Conflicting views of the proposed rule changes are expressed in 183 written comments submitted for hearings that begin Oct. 13 in Dallas, move to San Francisco on Oct. 14 and conclude Oct. 27 in New York City.
The proposed changes released in June would push pensions toward more disclosure of what critics say is a massive “hidden” debt owed by state and local government, taken on without voter approval and guaranteed by contract law.
A report by Stanford graduate students in April helped move the issue into the public arena. Instead of the reported $55 billion, said the report, the shortfall of the three big state public employee pension funds is more than $500 billion.
Pension funds expect to get most of their money from investment earnings, not annual contributions by employers and employees. The funds assume annual earnings will average 7.5 to 8 percent during the next 30 years.
The Stanford students used a “risk-free” bond earnings rate of 4.1 percent, which some financial economists say is the proper way to calculate debt backed by the government and taxpayers.
The estimated shortfall or “unfunded liability” dramatically increased for the California Public Employees Retirement System, the California State Teachers Retirement System, and the University of California retirement system.
A leading critic of the earning rates assumed by pension funds to pay off or “discount” their future obligations thinks the proposed accounting rule changes are inadequate.
“So long as employers are liable (primarily, secondarily or otherwise) for benefit payments, whether projected to be paid from plan net assets or otherwise, GASB’s proposal for determining the discount rate with which to derive the total pension liability is flawed,” David Crane, Gov. Arnold Schwarzenegger’s pension advisor, said in a letter to the board.
“Worse, your proposal would allow governments to continue to cover up the true size of full-recourse promises to pay,” Crane said. “I look forward to testifying.”
Pension systems, on the other hand, worry that rules aimed at revealing more of the long-term liability will result in annual reports that hide a key indicator: whether payments to the pension fund are large enough to avoid shifting debt to future generations.
“If there are few or no reporting implications to an employer not making pension contributions, in today’s economic environment, more pension plan sponsors will consider not making the actuarially determined contribution,” said a letter from the new California Actuarial Advisory Panel.
The panel chaired by the CalPERS chief actuary, Alan Milligan, which began meeting last summer, was formed to provide independent information and “best practices” under legislation in 2008 recommended by the governor’s pension commission.
A letter from the National Association of State Retirement Administrators, representing 82 statewide public pension systems, said the new rules could undermine the current clear standard for annual payments to pension funds.
“The ARC (Annual Required Contribution) also provides a ‘safe harbor’ for policymakers, giving them political cover from those who seek to divert pension contributions from their target,” said the administrators’ letter.
The proposed rules deal with the controversial earnings rate assumption by using a “blend” of the two methods.
Pension funds could use their assumed earnings rate to discount the debt covered by their assets. But if the assets do not cover all of the debt, the remaining debt would be discounted by a lower bond earnings rate.
The blend method is not opposed by a number of the pension funds. Their letters seemed more concerned that other proposed changes could increase “volatility” or abruptly drive up costs for employers.
For example, the rules would change some of the “smoothing” used to spread investment gains and losses over several years, requiring assets to be reported at their market value.
Some periods for paying off or “amortizing” pension fund obligations, now as long as 30 years, would be shortened. So annual payments, when spread over fewer years, would be higher.
A story in the Wall Street Journal last week said the Governmental Accounting Standards Board, a nonprofit organization, is said to have a conflict of interest because four of the seven members work for state or local governments.
The critics say the jobs of the GASB board majority are an incentive to allow pension funds to assume a high earnings rate, which helps government employers reduce their pension costs.
“They are likely to listen to their constituents in state and local governments and the labor unions who say there is no problem using the current discount rate,” Keith Ambachtsheer, a University of Toronto pension center director told the Journal.
Critics say the Financial Accounting Standards Board requires corporate pension funds to use a more realistic lower discount rate, roughly 6 percent based on highly rated corporate bonds.
Defenders of a higher earnings rate for public pensions say a lower rate may be appropriate for corporations, because they have the risk of going out of business. The government sponsors of public pension funds presumably are here to stay.
A GASB rule change in 2004 requiring the reporting of retiree health care debt had an impact. Most government employers in California pay annual retiree health care costs without setting aside money to pay for future obligations.
The rule change led to the first statewide estimate of the future cost of retiree health care promised current state and local government workers – $118 billion over 30 years according to a governor’s commission report in January 2008.
A growing number of government employers are beginning to set aside money for future retiree health care costs. Pension-like prefunding provides investment earnings to help cover costs and reduces the shift of debt to future generations.
By last July, a retiree health care fund operated by CalPERS had $1.3 billion invested from 258 government employers. A competitor, Pacific Public Partners, launched a retiree health care trust fund in August.
Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at http://calpensions.com