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GASB's New Pension Standards - Bonus Content

BWD Magazine, Spring 2013

Sweeping changes may have a dramatic effect

In a move aimed at increasing financial transparency for state and local governments, the Government Accounting Standards board (GASB) recently made sweeping changes to the way public sector pension plans are accounted for by issuing Statements No. 67 and 68.

The GASB uses such statements to set generally accepted accounting principles for state and local governments.

GASB's approach

Pension benefits are essentially a form of compensation earned by employees during their working lifetimes, and paid out after retirement. Accordingly, the GASB believes that the cost of those benefits should be accounted for in the years when that work was actually performed. In the case of defined contribution pension plans, that is fairly simple. However, the process of projecting how much future pension benefits will cost in a defined benefit plan is more complicated.

Using the work of an actuary, governments are required to project the future benefits that will be paid out of their pension plans. This process involves extensive estimation and actuarial assumptions. Once that is done, future payments have to be discounted to reflect assumed investment growth over time and allocated over the assumed working lifetime of each employee. The final result of these actuarial calculations is a number known as the government’s total pension liability.

Under the new pension standards, governments will then compare their total pension liability to the amount currently held in trust to pay pension benefits. Any shortfall will be recorded on the government’s statement of net position (balance sheet) as a net pension liability.

Impact to local governments

While much information about pension plans currently exists within governmental financial statements, historically there has been no single place that an interested reader could look to get the complete picture. That’s because governments have previously taken a “funding” approach to their pension benefits, which focused on a long-term strategy of setting aside funds in trust to pay future pension benefits. As long as a government was “on track” to set aside resources over time, there was no requirement to record a liability for any current shortfall. At a time when many of even the healthiest governmental pension plans are only 75-80 percent funded, this significant new liability could have a dramatic effect on their financial statements.

However, because of the dual focus found in governmental financial statements (showing both long-term economic condition and short-term fiscal liquidity), this information will still only be presented in certain parts of the financial statements. For example, the general fund of most municipal governments will not be affected by Statements No. 67 and 68 at all (unless their elected officials decided to make larger contributions to the pension plan to help cover any accumulated net pension liability). As with any new accounting standard, it will take users of the financial statements some time to adjust to the new way this information is reported.

Looking ahead

GASB Statement No. 67 becomes effective for public pension plans in 2014. GASB Statement No. 68 becomes effective for the governments participating in those plans a year later. While these new standards currently focus exclusively on pension benefits, the GASB is working on developing similar standards for other post-employment benefits (such as retiree healthcare) that are expected to follow within the next two years.

For more information on GASB 67 & 68, including an archived webinar on the topic, visit our website at www.rehmann.com/government_resources.


Defined Benefit vs. Defined Contribution

While many variations exist, governments operate essentially two different types of pension plans. In a defined contribution plan, the government agrees to set aside resources for its employees at some predetermined level (usually a percent of payroll). Those resources are placed in separate accounts for each employee (much like a 401k plan), and the government’s obligation ends there. Whether the resources accumulated for each employee will be sufficient to cover their needs at retirement is a risk borne by the employee. In a defined benefit plan, the government agrees to provide a retirement benefit at some predetermined level (usually a multiplier of the employee’s final average compensation). While the government may set aside resources each year to help prepare it to pay those retirement benefits, whether they are sufficient or not doesn’t change the government’s obligation to pay the promised level of benefits. Basically, a defined contribution plan places the risk on the employee, while a defined benefit plan places the risk on the employer.

Understanding Discount Rates

For pension plans, the discount rate is a mix of the expected long-term rate of return on plan assets (given the government’s own investment strategies) and a “risk free” rate of return (equal to a 20-year high quality tax-exempt municipal bond index). The discount rate is intended to help answer the question, “if I need $x in 20 years, how much should I invest today?” The higher the discount rate (i.e., the assumed return on a plan’s investments), the less that needs to be set aside today. However, unrealistically high assumptions today can lead to problems in the future when actual results don’t keep up with overly optimistic projections. Historically, governmental pension plans have gravitated towards a discount rate of approximately 8%, despite the fact that very few plans have seen results that come anywhere close to that over the past decade. The GASB’s new standards will require governments to justify their discount rate assumptions with a table that shows the specific mix of investments by type, and their expected performance.

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