SEGAL Bulletins - Public Sector
July 2010
GASBfs Preliminary Views on
Proposed Changes to Pension Accounting Standards for Public Sector
Employers
The Governmental Accounting Standards Board (GASB) recently issued
Preliminary Views on major issues related to Pension Accounting and
Financial Reporting by Employers.1 This Preliminary Views is a step toward an
Exposure Draft targeted for release in 2011 and, eventually, a new Statement of
Government Accounting Standards that would replace the standards in the current
Statement 27. This Bulletin summarizes the key proposals in the
Preliminary Views, which would make fundamental changes to pension accounting
standards for state and local governments.
PRELIMINARY VIEWS
GASB seeks comments on the following preliminary views:
- Reporting Pension Liability The unfunded
portion of the pension obligation would be reported as a net pension
liability2 (total liability minus the value of plan net
assets) on the balance sheet portion of the employer's financial statements.
This would be a significant change from the current practice of reporting
pension liabilities in the notes that supplement pension plans' financial
statements.
- Projections GASB is proposing that the net
pension liability should be based on projections that include future service
and salary increases. Some pension plans have cost of living adjustments
(COLAs) that adjust benefits for inflation. COLAs can be either automatic or
ad hoc. If an employer's past practice of granting ad hoc COLAs indicates that
they effectively have become automatic, they would have to included in benefit
projections.
- Discounting The basis for discounting
projected benefit payments to their present value would continue to be a
reasonable long-term expected rate of return on the plan's investments,
but only to the extent that the current and expected future plan assets
will be sufficient to cover the future benefit payments. Benefit payments
that are expected to occur beyond the point that expected plan assets are
projected to be exhausted would be discounted to their present value using a
high-quality municipal bond index rate. In practice, these two discount rates
would be combined into a single, weighted average rate. Note that the new
discount rate would be based on a comparison of projected assets to projected
benefit payments, and not simply on the plan's current funded status. This
change should only affect plans that are receiving contributions that are less
than their actuarially determined contribution requirement.
- Cost-allocation Method GASB is proposing
that all plans use the same cost method to determine the total liability as of
the reporting period. Projected benefits are discounted to their present value
as of employees' hire ages and then attributed to employees' expected periods
of employment as a level percentage of projected payroll. This "entry age"
method is already used by most plans. Plans that use the other most common
cost method — "projected unit credit" — most likely would see an increase in
their accrued liability.
- Annual Changes in Total Pension Liability
Changes in liability due to new pension benefits earned by employees and the
interest cost on the beginning balance of the total pension liability would be
reported as expenses each year as they occur. This is generally consistent
with current practice except perhaps for plans using longer amortization
periods.
- Amortization Period for Other Changes in Total Pension
Liability Three types of changes in the total pension
liability would be reported as expense over a period representative of the
remaining service periods of employees: differences between expected and
actual experience ("gains and losses"), changes in assumptions about future
experience, and changes in pension plan terms that affect benefits for past
service. For such changes in liability for active participants, this expensing
approach is much shorter than the current practice which allows recognition
over a period up to 30 years. Corresponding changes in liability for retirees
would be expensed immediately, which is a dramatic departure
from current practice.
- Effect of Investment Return Differences
between assumed and actual returns on pension plan assets would be deferred as
long as the accumulated amount deferred does not exceed 15 percent of the fair
value of plan assets. Any accumulated deferrals that exceed 15 percent of the
plan assets would be reported immediately as an expense (or a reduction in
expense) in the current year. This differs substantially from current practice
where such deferred amounts are recognized in the unfunded liability over a
short period, but then are amortized for expense purposes.
- Cost-sharing Employers' Liability An
employer participating in a cost-sharing multiple employer pension plan would
report an unfunded liability in its own financial statements based on its
proportionate share of the collective unfunded liability for the entire plan.
Currently, these employers do not report an unfunded liability, not even in
their footnotes or schedules.
- Calculation Date The net pension liability
would be measured at the end of an employer's fiscal year. An actuarial
valuation would need to be performed at least once every two years. Although
the valuation date would not need to be the employer's fiscal year-end, it
would need to be a date no more than 24 months earlier. This would require
each plan to project their pension obligation to the fiscal year-end,
including any interim changes since the valuation date that affect the net
pension liability.
IMPLICATIONS
If GASB incorporates the proposals outlined in its Preliminary
Views into a final accounting standard, the consequences for state and local
governments would be significant, including the following:
- Reporting the entire unfunded liability on the basic financial statements
(rather than just any unfunded annual required contributions or "ARC") changes
the focus of the statements from the entity's commitment to fund its
obligation to a snapshot in time. This would make the statements less
transparent regarding whether a government is actually following a responsible
funding plan.
- A significant proposed revision is how three types of changes in unfunded
liability — actuarial gains and losses, plan amendments and changes in
actuarial assumptions — are deferred or amortized. This would change the
meaning of pension expense and would create difficulties in understanding the
new relationship between pension expense and pension funding. That is because
the current expense requirement — the ARC noted above — serves as a standard
for responsible funding.
- The prior point leads to the third major change, which is not given much
discussion in the Preliminary Views, but may be the most important: de-linking
pension expense (the ARC) and pension funding. Under current GASB rules, the
ARC serves as a de facto contribution standard. The creation of two
different sets of "cost" numbers (a funding calculation determined by the plan
that would remain fundamentally unchanged and a separate pension expense
number) could have an unintended, detrimental effect on public attitudes about
state and local government pension plans. At a minimum, it would cause
confusion about which is the "true" cost.
The proposed changes would have other implications. For example,
the proposed change in how investment earnings are recognized will create less
expense volatility in some situations and greater expense volatility in
others.
GASB is accepting comments on the Preliminary Views until
September 17, 2010. The Segal Company will submit comments that will be shared
with clients.3 Segal encourages state and local governments to
prepare their own comments to GASB.
• • •
The Segal Company can be retained to work with employers, plan sponsors
and their auditors in their efforts to determine the potential impact of the
requirements in GASB's Preliminary Views on their plans and practices.
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