Pensions face new accounting rules

The Sisyphean task of funding U.S. state and local-government retirement plans, a hidden risk for municipal-bond investors, will get even more daunting under proposed new accounting rules.

Pensions in Illinois, New Jersey, Indiana and Kentucky may have less than 30 percent of the assets needed to cover promised benefits under the measure, according to data from the Boston College Center for Retirement Research. The changes will alter how liabilities are calculated and how assets are reported on financial statements. Pensions would begin using the rules for fiscal years starting after June 15, 2013, and employers such as school districts would follow a year later.

The Governmental Accounting Standards Board, which decides how states and municipalities must keep their books, is set to issue the new rules next month. Any decisions made so far are "tentative and subject to change," John Pappas, a spokesman for the Norwalk, Conn.-based organization, said.

"People are going to be really surprised," said Matt Fabian, managing director with Concord, Mass.-based Municipal Market Advisors. "It's one of the few things out there that could precipitate a major change in investor demand."

The rules may raise government costs in the $3.7 trillion municipal market as investors demand more yield to compensate for higher pension risk and possibly lower ratings. Illinois became Moody's Investors Service's lowest-rated state in January because it hadn't dealt with its underfunded pensions.

The need for higher contributions can add to the returns investors require, according to the Boston College center.

"The market is starting to look much closer at what governments are doing to address the pension problems," said Jean-Pierre Aubry, assistant director of state and local research at the center. "Contributions to pensions matter to bondholders."

A center report in February 2011 showed pension costs as a proportion of budgets rose to 3.8 percent in 2008 from 3 percent in 2005. The effect may increase as unfunded liabilities grow.

The changes may force government officials to cut benefits or spend more to cover what they've promised, Mr. Fabian said. That may lower funding for other programs or prompt tax increases.

"The numbers are going to look worse," Joe Pangallozzi, a managing director and analyst with BlackRock's fixed-income group in Plainsboro, N.J., said. "Now that you have these numbers, what are you going to do to put the system on a solid footing?"

As currently set up, the changes would force pensions and municipalities to report the portion of current and future retiree obligations that exceed projected assets as a liability on balance sheets for the first time.

The new method also may widen the gap between assets and promised benefits by applying a lower discount to the uncovered portion. The rules would tie the measure to a 30-year, AA-rated municipal bond, rather than a typically higher expected investment return.

Pensions in Washington, Minnesota, Pennsylvania and Texas may see funding levels worsen the most under the new accounting rules, according to data from the Boston College center. Two plans for teachers run by the state of Washington would fall to about 40 percent from almost 93 percent.

The new public disclosure requirement may "exacerbate" the unfunded liability of some plans, Washington Treasurer James McIntire said by telephone. He said he doesn't expect the rules to change how the gaps are dealt with in his state, which has taken steps to improve asset levels.

"It doesn't change the amount of money you put into your pension plans, and it doesn't change what you owe," he said. "It just changes how you value it for reporting purposes."