The User's Perspective
July 2011 - GASB
GASB Proposes to Significantly
Improve Pension Reporting
In June
2011, the GASB approved two Exposure Drafts that propose changes to how state
and local governments report and account for the pension benefits provided to
their employees. The proposals would lead to significant improvements in
usefulness of pension information for making decisions and assessing
accountability. One document relates to reporting by governments (gemployersh)
that provide pension benefits, and the other relates to reporting by the pension
plans that administer those benefits through qualified trusts. The GASB also has
published a plain-language supplement to the employer document that explains the
proposals for non-accountant users with a minimum of technical jargon.
The
proposals arise from the GASBfs reexamination of its current pension standards,
which is a part of the GASBfs broader effort to periodically examine the
effectiveness of its existing standards. (For more information about the
reexamination of the GASBfs pension standards, please see the article in the June
2010 issue.)
It should
be noted that the proposals relate only to accounting and financial
reporting and do not extend to how governments approach pension plan
funding. There is a close connection in existing standards between how
governments fund pensions and how they account for and report information about
them in audited financial statements. As proposed, Governments Would
Recognize a Pension Liability on the face of their financial
statements.
Employees
of state and local governments generally receive two types of compensation in
return for their labor—current compensation and deferred compensation. Both
types are earned by the employees as they work. While salaries and other forms
of current compensation are received by employees while they are employed,
deferred compensation is not received until after employment with government has
ended.
Once
earned, a government has a present obligation to pay the benefits in the
future—a total pension liability. Most governments try to meet this
obligation by making annual contributions to a pension plan to accumulate
resources in an irrevocable trust for the purpose of making future payments when
they are due. To the extent that the total pension liability is greater than the
value of the net assets available in the plan for paying benefits, a government
has a net pension liability, and would report that amount as a
liability in its accrual-based financial statements (for example, the
government-wide Statement of Net Position).
Implications for Users
At
present, the difference between a governmentfs total pension obligation and
assets available for benefits—often called the unfunded liability—is
disclosed in notes, but does not appear on the face of the financial statements.
Consequently, some analysts are uncertain whether to incorporate the unfunded
liability into financial ratios that include debt and other long-term
liabilities. Some analysts include it, some do not. Recognition in the financial
statements, alongside other liabilities such as outstanding bonds, claims and
judgments, and long-term leases, will clearly put the pension liability on an
equal footing with other long-term obligations.
How Governments Would Measure the Total Pension
Liability
To
determine the amount that will be recognized as the total pension liability, a
government first has to measure the total pension liability. Calculating the
total pension liability involves three essential steps: projecting future
benefits payments for current and former employees or their beneficiaries,
discounting the projected future benefit payments to their present value, and
attributing (allocating) the present value to past and future years during which
the employees have worked or are expected to work.
Projection of Benefits
The
proposal would carry forward the general current practice of incorporating
expectations of future employment-related events (like salary increases and
years of continuing employment until retirement) into projections of pension
benefit payments. Pension plans provisions for automatic cost-of-living
adjustments (COLAs), generally included as part of an employment agreement,
statute, or ordinance, would continue to be included in projections as well. Ad
hoc COLAs, which are made at the discretion of the government, would only be
included if they occur with such regularity that they are substantively
automatic. For some governments, then, the amount of projected future pension
benefit payments would be higher than under current standards. As a result, the
present value of the future benefit payments and the net pension liability to be
reported by those governments would be larger.
Discounting Projected Benefits
The
process of converting or discounting projected pension benefit payments into
their present value requires assuming an interest or discount rate.
Current standards require governments to apply a discount rate that is equal to
the expected future rate of return on the investments of the pension plan over
the long term. However, the net assets held by a pension plan over time
associated with current employees may not be expected to fully cover projected
benefit payments for those individuals. If plan net assets will not be available
to be invested for the long-term to make benefit payments, then the GASB does
not believe their expected rate of return should be used.
Under the
proposals, governments would project the future benefit payments in each year
and the amount of plan assets available for paying benefits to current
employees, retirees, and their beneficiaries. As long as plan net assets are
projected to be available to make the projected benefit payments, governments
would discount projected benefit payments using the long-term expected rate of
return. Beginning with the point at which plan net assets are not projected to
be sufficient, governments would discount using a tax-exempt, high-quality
(rated AA or higher, including equivalent ratings) 30-year municipal bond index
rate. This proposal reflects that those future benefits payments are not
expected to be made with the pension planfs long-term investments, but with the
general resources of the government.
Implications for Users
At
present, municipal bond index rates are lower than the expected returns on
long-term investments. Therefore, if any projected benefit payments are
discounted using the lower rate, then the present value will be higher. As a
result, the liability would be larger.
Attributing Present Value of Projected Benefits
Once the
projected benefit payments have been discounted to their present value, they are
allocated over a period related to the working years when the employees earn
benefits. Under the proposal, governments would use the entry age normal
actuarial cost method to allocate present value, and would do so as a level
percentage of payroll. Under this method, projected benefits are discounted to
their present value when employees first begin to earn benefits and attributed
to employeesf expected periods of employment until they leave.
Implications for Users
Because governments can now select from six actuarial cost methods to
attribute the present value of projected benefits to specific years, making
comparisons across governments can be highly complex. The use of a single
approach would considerably improve the consistency and comparability of
reported pension information.
How Governments Would Measure the Annual Cost of Pensions
A governmentfs net pension liability changes from year to year for a
variety of reasons: employees work and earn more benefits; the outstanding
liability accrues interest; contributions to the plan increase or decrease;
actual economic and demographic changes differ from what was assumed in
actuarial calculations; changes are made in assumptions about economic and
demographic factors; changes are made in the terms of the pension plan that
affect benefits already earned in past years; and, the value of plan investments
change. An important issue is when to recognize these period-to-period changes
as a cost of a governmentfs operations—as expenses in the accrual-based
financial statements.
Several
causes of changes in the net pension liability would be factored into the
calculation of pension expense immediately in the period the change
occurs, including:
- Benefits that are earned each year
- Interest on the total pension liability at the beginning of the year
- Changes in the terms of the benefits to be provided to retirees
- Projected earnings on plan investments
- Changes in the value of plan assets other than investments
- The effect of differences between what was assumed regarding economic and
demographic factors and what actually occurred, as it relates to persons no
longer working for the government
- The effect of using new economic and demographic assumptions, as it
relates to persons no longer working for the government.
Other
causes of changes in the net pension liability would be recognized initially as
deferred pension outflows of resources or deferred pension inflows of resources
(see related article on Statement 63), and then introduced into the expense
calculation gradually over the remaining years of employment of active
employees:
- The effect of differences between economic and demographic assumptions and
actual experience, as it relates to current employees
- The effect of using new economic and demographic assumptions, as it
relates to current employees.
The effect
of differences between the expected return on plan investments and actual
experience would be recognized as deferred outflows of resources or deferred
inflows of resources and included in expense in a systematic and rational manner
over five years. All other changes would be included in the calculation of
pension expense in the period in which they occur.
Implications for Users
Most
governments would recognize pension expenses sooner than they currently do under
the proposal. The full impact of changes in pension benefit terms would be
recognized as expense immediately, for example, rather than gradually over up to
30 years.
Cost-Sharing Multiple-Employer Pension Plans
In
cost-sharing multiple-employer plans, governments share the costs of providing
benefits, administering the plan, and investing the assets accumulated to pay
benefits. Governments participating in cost-sharing plans are not currently
required to present actuarial information about the plan. Instead, this
information is required to be presented in the cost-sharing pension planfs own
financial statements for all of the participating governments combined.
However,
the needs of the users of information about cost-sharing plans and their
participating governments are no different from the needs of people interested
in governments participating in single-employer and agent multiple-employer
pension plans.
The GASB
is proposing that a government participating in a cost-sharing plan would report
a net pension liability in its statement of financial position based on its
proportion of the collective net pension liability of all of the
governments participating. The proportion would essentially equal the
governmentfs long-term expected contributions to the plan divided by those of
all governments in the plan.
Implications for Users
Users
would have access to essentially the same pension information about individual
governments regardless of what kind of plan they participate in.
Note Disclosures and Required Supplementary Information Governments
Would Provide
The GASBfs
proposed standards contain requirements for disclosing information in the notes
to the financial statements and presenting required supplementary information
(RSI) following the notes. All governments participating in a defined benefit
pension plan would include the following information in their note
disclosures:
- Descriptions of the plan and benefits provided
- Numbers of retirees and beneficiaries, and active and inactive employees
- Significant assumptions employed in the measurement of the net pension
liability
- Descriptions of benefit changes and changes in assumptions
- Assumptions related to the discount rate and the impact on the total
liability of a one percent change in the discount rate
- Net pension liability, deferred outflows of resources and deferred inflows
of resources, and pension expense
Governments participating in single-employer and agent multiple-employer pension
plans also would disclose:
- For the current period, the beginning and ending balances of: the total
pension liability; assets held for pension benefits; and the net pension
liability
- Components of the current-period pension expense
- Reconciliation of the beginning and ending balances of deferred outflows
of resources and deferred inflows of resources.
Governments would present RSI schedules with the following information for each
of the past 10 years:
- The beginning and ending balances of and change in the total pension
liability, the plan trustfs net position, and the net pension liability
- (a) Total pension liability, (b) the plan trustfs net position, (c) the
net pension liability, (d) b divided by a, (e) covered-employee payroll, and
(f) c divided by e
A
government participating in a cost-sharing multiple-employer plan would present
both of these schedules for the plan as a whole. It also would present
the latter schedule with information for its proportionate share of the
plan.
If a government
has an actuarially calculated annual pension contribution, it also would present
an RSI schedule with the following information for each of the past 10 years:
(a) the actuarially calculated employer contribution; (b) amount of employer
contribution made; (c) the difference between a and b; (d) covered payroll; and
(e) b divided by d. A government participating in a cost-sharing
multiple-employer plan would present this schedule for its individual plan
and for the plan as a whole.
Governments
also would present notes to the RSI schedules regarding significant assumptions
underlying the actuarially calculated contributions (if not disclosed in the
notes), and factors that significantly affect the trends in the schedules.
Implications for Users
If the proposals regarding note disclosures and RSI ultimately become
requirements, users would have access to highly significant information that may
not have been available previously, including information regarding the
measurement and funding approaches a government utilizes. Because employers
would be required to disclose a schedule of changes in the net pension
liability, users will be able to determine what has driven changes in the net
position liability in the period—was it factors beyond a governmentfs control,
such as the performance of the economy, or factors a government controls, such
as retroactive changes in benefit terms. Similarly, users will be better able to
understand what portion of each yearfs pension expense resulted from newly
earned benefits, benefit changes, or investment returns that varied from
projections.
Special Funding Situations
In some
pension plans, an entity other than the employer government is legally
responsible for contributing to the plan. For instance, some state governments
are legally bound to make contributions to the teacher pension plans of school
districts. The legal responsibility to contribute is either conditional
on a particular event or circumstance that is unrelated to the pension plan or
unconditional. An example of a conditional responsibility is a
requirement to contribute a certain percentage of a tax revenue stream. An
unconditional responsibility might be a requirement to contribute a certain
percentage of the employer governmentfs covered payroll.
Conditional Special Funding
A
conditional special funding situation is much like a government receiving a
grant. The recipient government recognizes the contribution from the other
government as revenue. The other government reports the contribution as an
expense, but not as a pension expense.
Unconditional Special Funding
Under an
unconditional special funding situation, the non-employer government legally
responsible for contributing has basically taken a portion of the pension
obligation of the employer government as its own. Consequently, the non-employer
government would recognize its proportionate share of the net pension liability,
deferred inflows of resources, deferred outflows of resources, and pension
expense.
The
employer government would calculate its net pension liability and related
financial statement elements, prior to the other governmentfs support,
but would recognize amounts net of the other governmentfs proportionate share.
The employer government would recognize gon behalfh revenue equal to the portion
of the other governmentfs pension expense related to the governmentfs
employees.
Implications for Users
Currently,
it may be difficult for users to understand the extent to which states and other
governments are obligated to make contributions to another governmentfs pension
plans. This proposal would allow users to better understand what portion of a
governmentfs pension liability and expense relates to its own employees versus
the employees of other governments.
How Governments in Defined Contribution Plans Would Report
Defined
benefit plans specify the amount of benefits to be provided to the
employees after the end of their employment. Participating governments make
contributions to the plan in order to accumulate assets which will be available
in the future to make the promised benefit payments. Conversely, defined
contribution plans stipulate only the amounts to be contributed to an
employeefs account each year, and not the amount of benefits employees will
receive after the end of their employment.
The GASBfs
proposed standards would essentially carry forward the existing requirements
regarding defined contribution plans. Participating governments would report an
expense equal to the amount they are required to contribute for employee service
each year and a liability equal to the difference between that required
contribution and what the government actually contributes. These governments
also would make descriptive disclosures about the plan and its terms, and the
method by which contributions to the plan are determined.
How You Can Provide Feedback to the GASB
The GASB
has prepared a supplement to its proposals that discusses them in plain English
and focuses on the information that would result from them. You can help the
GASB to finalize the new standards for pensions by reading the plain-language
supplement, along with the Exposure Draft, Accounting and Financial
Reporting for Pensions, and answering the questions posed in the
supplement. (Links to both documents can be found below.) Your answers can be
shared with the GASB via letter or email. (Instructions for doing so can be
found at the back of the supplement and the front of the Exposure Draft.)
You also
can voice your opinions directly to the GASB members and staff by participating
in one of three user forums the GASB is conducting in New York City (October 4),
San Francisco (October 14), and Chicago (October 21). Further information about
the forums and instructions for letting the GASB know you would like to
participate can be found in both the supplement and the Exposure Draft.