Pensions Resist Accounting Rules That Would Magnify Liability

U.S. public pension systems, facing as much as $3 trillion in unfunded promises to current and future retirees, are resisting proposed new standards that might double their funding deficits.

Investment losses in 2008 and 2009 left state and local pensions with $3.6 trillion in unfunded obligations, according to an October 2010 study by Joshua Rauh of Northwestern University and Robert Novy-Marx of the University of Rochester. By last month, states had 74.6 percent of assets needed to fulfill obligations, down from 82.8 percent in 2007, according to data compiled by Bloomberg.

The Governmental Accounting Standards Board, a private organization that sets bookkeeping rules used by cities and states, is considering changes that would magnify the unfunded liabilities of many pension funds. The new standard would widen the gap for the California State Teachers Retirement System to as much as $150 billion from $56 billion under a “very, very rough estimate,” according to Ricardo Duran, a spokesman for the second-largest public pension.

The rules may imperil school district bond ratings by adding pension liabilities to their balance sheets for the first time, according to the California School Boards Association.

The proposals “represent a radical departure from the way pension benefits have been accounted for by state and local governments for decades,” 130 retirement plan officials said in a letter to David Bean, the board’s research director.

School Bonds

Switching to a more uniform method of calculating pension liabilities would “improve transparency and comparability” of data reported by states and local governments, Moody’s Investors Service said in an Oct. 11 briefing paper. Bond investors would benefit, said Craig Brothers, managing director of Bel Air Investment Advisors LLC in Los Angeles.

“We find it very difficult to get to the bottom of the liabilities on municipal credits,” said Brothers, whose firm oversees a $3.1 billion bond portfolio, about 75 percent of it in municipals. “We as investors would welcome anything that makes it more transparent.”

The board is scheduled to adopt the changes next year, said Robert Stewart, a spokesman for the Financial Accounting Foundation, which oversees the board.

Accounting Principles

While GASB does not have enforcement authority, some states require governments and agencies to comply with its rules, and auditors consider the standards in determining compliance with generally accepted accounting principles, according to a fact sheet on its website.

The proposed changes would require states, cities, school districts and other public employers to disclose their expected pension liabilities on their balance sheets for the first time. That number may be misleading since states, not local governments, usually bear the burden of funding pensions, said Julie Graham-Price, spokeswoman for the Ohio Public Employees Retirement System.

Since retirement plans are pooled, it’s impractical to track which government body is responsible for a particular employee, she said. “Once you scramble an egg you can’t unscramble it.”

In addition, the board would alter how pension funds project the future value of their assets. Instead of relying solely on an expected rate of return on investments, the rules would require use of a AA rated 30-year municipal-bond index for obligations not covered by current assets.

Pension plans could keep using their assumed rates of return for the portion of liabilities covered by assets. The muni rate would be used to calculate only obligations not covered by assets.

Bond Index

Such bonds were yielding 4.52 percent yesterday, according to Bloomberg Fair Value Indexes. Many pension funds set their assumed rates of investment returns between 7 percent and 8 percent a year. The California teachers’ fund, for instance, assumes a 7.75 percent return.

“The GASB standard is an accounting issue, not a funding issue,” Ed Derman, deputy chief executive officer at the fund, said at a board meeting Nov. 4. “It has clear political implications.”

The change may have more practical implications for school districts that issue bonds.

“Balance sheets will now show an enormous negative number and we are fearful of the reaction from Wall Street,” Dennis Meyers, assistant executive director of advocacy and policy for the California Association of School Business Officials, said by e-mail. “We also wonder how the public will react. Will they think that XYZ school district can simply negotiate away that negative balance?”

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