The Governmental Accounting Standards Board is expected to issue new proposals this week that would require state and local governments to be more open about their pension-funding obligations.
The changes would make it easier for investors to compare pensions across states and ensure that pension costs are accounted for while employees are still on the job.
“Our intent is to improve the decision usefulness of the information that gets reported on the face of the financial statements,” GASB chairman Robert Attmore said in an interview Friday with Accounting Today. “That’s a key point because this proposal would require that the unfunded pension liability of a government be placed on the face of the financial statements, on its balance sheet. That’s not currently required, so that would be a big change.”
The exposure drafts will cover changes in both accounting and financial reporting by governments, along with accounting and financial reporting by the pension plans themselves.
Attmore expects there to be significant changes in pension accounting if the proposed changes are ultimately approved. Putting the unfunded liability on the balance sheet may create the appearance that a government is in worse financial condition than it currently appears to be, Attmore noted, but he cautioned that the economic reality would not be all that different. Financial analysts and rating agencies are already aware of such obligations, and when they do their ratings, they already account for the unfunded pension obligations.
“The economic reality stays the same,” said Attmore. “It’s just more transparent and easier to understand what the obligation is because it’s right there on the balance sheet.”
The board met Monday and approved the release of at least one of the exposure drafts, according to a spokesperson. Constituents will be given 90 days to comment on the drafts, and GASB also plans a series of further roundtable discussions and focus group meetings with constituents around the country before anything is finalized. Attmore already has been hearing plenty of feedback.
“We got almost 200 letters, I believe, in response to the preliminary views document that we put out last year,” he said. “And we also did some public hearings and roundtables, so we got some face-to-face feedback as well. These are potentially and likely to be controversial issues. There are people who take different views of pension accounting and financial reporting, from one extreme where people think our current standards are just fine—if it’s not broke, don’t fix it—to the other extreme where people think we ought to throw out our standards and start over, and everywhere in between on the continuum. We’re not going to either one of those extremes, but we’ve got proposals that will significantly improve the current accounting and financial reporting.”
Among the changes being proposed are that costs and compensation should be accounted for while employees are still on the job.
“When the employee is working and providing a service, the compensation is broken down into two pieces—current and deferred—but they’re actually earning both of those pieces while they’re providing services,” said Attmore. “Those expenses ought to be reflected currently while the employee is working."
The changes should make it easier for investors to compare the unfunded liability and net pension liabilities across states. “Ultimately there will be more consistency in the way governments report and more comparability then across governments,” said Attmore.
Another significant change involves switching from the current funding-based approach to an accounting-based approach. “What we do currently is focus on funding, and say that if a government makes its annual required contribution, meaning that they have a plan that will get the plan funded over a certain number of years, the only thing they need to record as a liability is anytime they don’t make that contribution,” said Attmore. “By eliminating options and standardizing measurement approaches for items like the actuarial cost methods or deferred expense recognition periods, we will reduce complexity.”
He noted that there are now six different allowable actuarial cost methods to calculate pension liability and pension expense. GASB is now proposing to allow only one method, entry age normal, for doing the accounting.
Similarly, when it comes to recognition periods for deferred expenses, right now there is no standard period of years to recognize deferred amounts, Attmore pointed out. GASB is proposing standardized periods to do that recognition to increase consistency and comparability there as well.
GASB is also proposing a principle-based method for determining an appropriate discount rate. “Right now we allow governments to use an expected rate of return on investments as their discount rate,” said Attmore. “Going forward, we’re saying only to the extent that there are assets set aside in an irrevocable trust to be invested long term can you use the expected long-term rate of return. But when we have pension plans that are not adequately funded because they have contributions or whatever it may be, we require that a cash flow projection be done and a comparison be made to see if the assets that are set aside in the trust for benefits will be adequate to make those benefit payments in the future. In those cases where they won’t be adequate, we will require that governments use a discount rate that is based on a tax-exempt high-quality municipal bond index rate, which in today’s environment means using a lower rate. The way the formula works, that means the liability is larger. So, to the extent that money has been set aside, and governments have prepaid part of these benefits by putting money into an irrevocable trust, they get credit for that because the earnings on those investments will be what you use to pay benefits. To the extent that they haven’t done that, then they don’t get to use the expected rate of return because they won’t have assets invested to earn that return."
Another significant change will involve cost-sharing plans made up of a number of employers who share risks and have unfunded liabilities. “We’re going to propose that the participating employers should record in their financial statements their proportionate share of that unfunded liability,” said Attmore. “That’s a big change that will cause some concerns.”
Asked whether state and local governments would be open to the changes, or worried, Attmore replied, “Yes to both. It is a hot topic right now. Everybody understands there is great attention and scrutiny being placed on pension plans right now. There are all sorts of predictions from people who think that pensions could be a major factor in potential fiscal crises in state and local governments. Then there are those who think these are long-term obligations, governments have plenty of time to make the adjustments necessary, and they’ll deal with them as they do everything else. The truth is probably somewhere in between, and it will depend on the facts and circumstances for each specific government. Maybe some governments out there aren’t stressed because their plans are seriously underfunded, but I would say that’s the minority, not the majority. But there will be lots of views and opinions shared with us once we put this proposal out.”
After the 90-day comment period, GASB will begin a re-deliberation process to consider the comments and perhaps make further changes in the standards. Attmore predicts that by early next summer, GASB will have two final documents ready with revised and improved accounting and financial reporting rules for both the pension plans themselves and government employers. He anticipates that there will be a transition period of at least a year before they take effect, so they probably will not be implemented until 2013.
