New public pension accounting rules will not change how rates paid by state and local governments are set. But how the public and lawmakers will react to a new way of reporting pension costs is less clear.
After new rules in 2004 told governments to begin reporting the cost of retiree health care promised employees, a major “hidden” debt was revealed – estimated in 2008 to be $118 billion over the next 30 years for state and local government in California.
For the first time some local governments, even in these tough times, began putting money into investments to pay for future retiree health care, moving away from pay-as-you-go and prefunding the cost in the same way as pensions.
Now the Governmental Accounting Standards Board is proposing new rulesto make public pension financial reports “more transparent, comparable and useful to citizens, legislators and bond analysts.”
So, there is a question:
Will the new accounting rules do for pensions what new rules did for retiree health – reveal what some regard as a “hidden” debt showing that pensions are in more trouble than they admit and perhaps trigger a response?
The accounting board issued its preliminary views last fall and a final draft last month. After taking national comment, including hearings Oct.13 and 14 in San Francisco, the board is expected to adopt new rules next year that take effect in 2013.
Last week the eight-member California Actuarial Advisory Panel, created by legislation (SB 1123 in 2008) to provide impartial policy information, voted to comment on the accounting board proposals and assist others in commenting if asked.
“I’m seeing a lot of media basically saying there is going to be sticker shock when these things come out,” the panel chairman, CalPERS chief actuary Alan Milligan, said during a break. “I’m not so sure about that.”
Critics contend that the California Public Employees Retirement System and other public pension systems use overly optimistic investment earning forecasts, concealing debt and the need to raise employer rates to avoid passing debt to future generations.
CalPERS in March left its forecast at 7.75 percent, not dropping to 7.5 percent as recommended by actuaries. The California State Teachers Retirement System dropped its forecast from 8 to 7.75 percent in December, not 7.5 percent as recommended.
Last year Stanford graduate students showed how a much lower earnings forecast caused the long-term debt or “unfunded liability” of the three state systems (CalPERS, CalSTRS and UC Retirement) to soar from $55 billion to $500 billion.
The widely publicized Stanford report followed the view of economists, who say a risk-free bond rate should be used for pension fund earnings forecasts, not a diversified stock-based portfolio, because public pensions are risk free, guaranteed by taxpayers.
The students used a government bond rate, 4.1 percent, not the 7.5 to 8 percent used by the three state funds. The funds expect to get two-thirds of their money from investments. So when the earnings forecast dropped, the unfunded liability soared.
The new accounting rules use a risk-free bond rate – but importantly, only for the part of future obligations not projected to be covered by the pension fund’s investment earnings and employer-employee contributions.
What this means, said the actuaries, is that if a pension system is making its actuarially required employer-employee contribution each year, the system can use its earnings forecast to offset or “discount” virtually all of its future obligations.
The pension system will have to make little or no use of the lower risk-free bond rate that causes the unfunded liability to soar.
At the actuarial panel meeting last week, member Lynn Miller, a retired insurance actuary, asked if the proposed rules require use of a “substantially lower” discount rate for future obligations.
“Yes, only for plans that are not, let’s say, being funded on an actuarial basis,” said Paul Angelo of the Segal Company, the panel vice chairman.
“That would be CalSTRS,” said Rick Reed, chief actuary of the California State Teachers Retirement System.
“That would be a lot of OPEB (retiree health) plans, but this doesn’t yet apply to OPEB,” said Angelo. “In contrast, we think most ’37 act (county) systems, most of the major charter city systems in California probably get to use their long-term earning assumption as a discount rate.”
Unlike most California public pension systems, CalSTRS lacks the power to set employer contribution rates, needing legislation instead. Without a rate increase, CalSTRS is projected to run out of money in about three decades.
Another change in the new accounting rules directs state and local governments to put pension debt in the main pages of their financial reports. The information is currently buried in notes.
The new rules also move away from a link to pension contributions, aiming instead for an accounting-based report that makes retroactive benefit increases and other cost changes more visible instead of spreading them over time.
For example, the rules want a report of what many costs would be if paid off or “amortized” during the time current workers are expected to remain on the job, rather than stretched out into the decades when benefits are expected to be paid.
To make it easier to compare pension systems, the new rules call for a standard five-year period for “smoothing” investment gains and losses and using just one of a half-dozen available actuarial cost methods, “entry age normal.”
The actuaries think the rules could cause a volatile pension expense number on government balance sheets (down when investment earnings are strong and up when earnings are weak) while the actuarially required contribution remains unchanged.
Will people look at the new accounting-based number and draw conclusions about whether pension systems are being properly funded actuarially?
“We just don’t know the answer to that,” said John Bartel, president of Bartel Associates.
In an interview with the Pew Center on the State’s “Stateline,” the chairman of the accounting board, Robert Attmore, was asked if the new pension rules will cause “sticker shock” like the retiree health rules.
“The numbers will be different,” said Attmore. “The appearance looking at a government balance sheet will be that the government is in a weaker financial position because that unfunded liability has not previously been on the balance sheet. It has been disclosed on the notes but not on the balance sheet.
“Adding a large liability to the balance sheet will make the government’s net position lower, and make them appear to be weaker. The economic reality is that nothing has changed; it’s the presentation that has changed.
“We took information that was previously in the notes and put it on the face of the financial statement and therefore it appears to be a negative impact. But the rating agencies have been aware of that and have been factoring in those obligations as they do their credit rating anyway, so it’s not going to change much from their perspective.”
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/ Posted 1 Aug 11