Pension Accounting
Update
James J. Rizzo, ASA, MAAA Senior Consultant & Actuary Gabriel, Roeder, Smith & Company
Fort Lauderdale Office [email protected]
Annual Florida GFOA Conference Boca Raton
Introduction
The GASB’s New Pension Accounting Standard:
►Exposure Drafts (EDs for plan and employer)
expected to be released this week
►Comments and hearings ►Field testing
►Finals expected to be adopted June 2012
Introduction
Scope
► Applies to employers (and plans) with employees covered under:
• defined benefit pension plans and
• defined contribution account balance plans
► Applies to employers with employees covered under:
• Sole employer plans (e.g., local plans) • Agent multiple employer plans
Introduction
Scope (continued)
► Applies to financial statements that use the economic resources measurement focus
• Government-wide financial statements • Not governmental funds statements
► Applies to all govt employers issuing GAAP financials:
• States and school districts • Cities and counties
Introduction
Implementation
►Effective for periods beginning after June 15,
• 2012 for Big Souls (large sole employers and plans) • 2013 for all others
►Retroactive
• Restate beginning balance sheet liability
• Restate deferred inflow/outflows to the extent it is
The Good, The Bad and The Ugly
The Ugly . . .
►Throw away everything you ever
knew about govt pension accounting
►Lots more work
►Large new costs and liabilities on the
income statement and balance sheet
►Unstable/volatile income statements
and balance sheets
The Good, The Bad and The Ugly
The Bad . . .
►Heavy use of deferred inflow and
deferred outflow accounts
►Immediate recognition of all plan
changes; some say this is good
►Much more disclosure; some say a
The Good, The Bad and The Ugly
The Good . . .
►The GASB chose the Entry Age
Normal cost method
►The GASB chose the long-term
expected ROR (& muni index rate)
►Thank God they rejected the
Market Value of Liability
The Great Debate
Which measurement approach is more
appropriate for financial reporting of
public pension liabilities?
A Market Value of Liabilities (MVL)
- OR -
The Great Debate
The Debate venues:
►In the academic world (where the debate began) ►In the press (national and local, internet)
►At the GASB (staff, members, comments/testimony) ►With taxpayer watchdog groups
►In Congress (PEPTA)
$3 trillion vs. $660 billion
►“The true numbers are . . .”
The Great Debate
What’s the difference?
►The Market Value of Liability seeks to measure the market
price on the reporting date at which the pension obligation for
benefits earned to date should trade, assuming a single sum
settlement transaction in a hypothetical market
►The Expected Fulfillment Cost (conventional approach) seeks
to measure the current value of the expected cost to taxpayers over time, based on costs of service that are a level percent of pay and recognizing that future investment returns lower the
The Great Debate
What’s the difference?
►Essential components of the measurement approaches
Market Value Price of Pension Liabilities
Expected
Fulfillment Cost Discount Rate Model: Market pricing
Default-free yield curve (between 2.5% and 4.0% in recent years; high of 14% in 1981; easily change by 1%+
YOY); not a “fair value” model
Model: Cost of services to taxpayers
Reasonable long-term expected ROR
(currently 7.5% to 8.0% for most plans)
Attribution Method
Borrows from FASB:
Private sector Accumulated Benefit Obligation method; not
Level percent-of-pay model:
The Great Debate
Many MVL advocates say or imply these:
►“Government accounting should be like the private sector.” ►“Current investment return assumptions are unrealistic.” ►“Our numbers are more transparent than yours.”
►“You are in far worse condition than you are being told.” ►“The plans, the actuaries, the auditors and the GASB all
have conflicts of interest.”
►“We economists know best.”
►“Replace your pension plans with defined contribution
Back to the Exposure Drafts . . .
The GASB’s long and deliberative process
►Added to research agenda in January 2006 ►Added to project agenda in April 2008
►Invitation to Comment issued in March 2009 ►Preliminary Views issued in June 2010
The GASB Files for Divorce !
Government-wide employer
accounting
and
funding
have been delinked, decoupled, . . .
The Marriage
Government-wide employer accounting and
actuarial funding have been ONE
GASB Statement No. 27
► The employer’s obligation is to fund the plan ► The accounting expense --
an actuarial funding contribution ► The balance sheet liability --
contribution shortfall
Member
The Marriage
Government-wide pension accounting expense
was called the Annual Required Contribution
(the “ARC”) for sole and agent employers
The ARC was:
► usually a reasonable number for funding purposes, ► determined under fairly stable methods,
► a benchmark – users knew if a government was funding its pension obligation adequately, and
The Marriage
Accounting and funding were married:
► They made such a nice couple
► You always saw them together; never saw one without the other
► They were made for each other
► They both had the same purpose in life
► We got so used to them being together, we never thought of them separately
The Divorce
Accounting and actuarial funding will be separate
The GASB has found a new, completely new, way
to define the government-wide expense and
liability
“We do accounting; actuaries do funding.” –
The Marriage
Remember how the GASB looked at it this way:
GASB Statement No. 27
► The employer’s obligation is to fund the plan ► The accounting expense --
an actuarial funding contribution ► The balance sheet liability --
contribution shortfall
Member
The Divorce
Now the GASB is looking at it this way:
New GASB Statement No. XX
► The employer’s obligation is “ultimately to the members” ► The accounting expense -- not determined wrt to any
actuarial funding contribution
Plan Member
Employer
► The balance sheet liability --an unfunded actuarial
The Divorce
Accounting expense will not be viable for funding
► Too volatile for contributing ► Too late for budgeting
No more ARC, APC or NPO
Two sets of numbers –
The Divorce
Get used to this divorce
Get your arms around this concept
Catch yourself when you fall back into the
Let’s Wade into some Details . . .
Under GASB 27, expense drives the balance sheet
liability
Under the new standard, balance sheet liability
drives the expense
Net Pension Liability (NPL)
The Net Pension Liability is the new, different
and much larger balance sheet liability - the
entire Unfunded Actuarial Accrued Liability
NPL =
Total Pension Liability (TPL)
minus
Fair Value of Plan Net Position (assets)
TPL is calculated using only one actuarial cost
Total Pension Liability (TPL)
TPL =
Actuarial Accrued Liability (AAL)
determined under the traditional
Entry Age Normal (EAN)
actuarial cost method
Not the so-called Ultimate EAN
Total Pension Liability (TPL)
In the EAN calculations, projected benefit
payments include:
►Cost of living and other automatic benefit increases ►Cost of living and other ad hoc benefit increases that
are substantively automatic
►Projected salary increases
Total Pension Liability (TPL)
The interest discount rate used to calculate the
TPL is determined by a specific and complex
process
Most Florida plans will likely use the long-term
expected rate of return (LTeROR) for the interest
discount rate
►Florida has fairly strong funding requirements
►With a few exceptions, if the employer is contributing
Net Pension Liability (NPL)
To summarize so far, the balance sheet liability
is the Net Pension Liability (NPL)
NPL =
Total Pension Liability (TPL)
minus
Statement of Activities
Expense is “based on” the change in the NPL
from one year to the next
There are many reasons for the NPL changing
from one year to the next
There are many different components of the total
Statement of Activities
NPL = TPL minus FVA
The total change in NPL is separated into:
Statement of Activities
The components of change in the TPL from one
year to the next include:
►Service cost (normal cost) attributed to the year ►Interest (at the discount rate) on last year’s TPL ►Actual benefits paid for the year
►Difference between actual TPL and expected TPL
(i.e., actuarial gains/losses on the liability side)
►Change due to new actuarial assumptions ►Change due to plan benefit changes adopted
Statement of Activities
The components of change in the FVA from one
year to the next include:
►Projected investment earnings on last year’s FVA
►Difference between projected investment earnings and
actual investment earnings for the year
►Actual benefits paid for the year
►Administrative expenses paid for the year
►Actual contributions made for the year by employer(s),
by employees, by retirees and by other sources without a “legal obligation” to contribute
Statement of Activities
Expense: These components of each year’s
change in the TPL and FVA are either:
►Immediately recognized in the expense in full, OR
►Gradually recognized in the expense and deferred
• Some components are amortized/recognized over the
weighted average expected service life of affected employees
• One component is recognized over five years.
Gradually recognized components of change may
Statement of Activities
Immediate recognition of TPL changes:
►Service cost (normal cost) attributed to the year ►Interest (at the discount rate) on last year’s TPL ►Actual benefits paid for the year
►All plan benefit changes
►Assumption changes and actuarial gains/losses
associated with inactive plan members
►Other changes in the TPL from one year to the next
Gradual recognition TPL change:
►Assumption changes and actuarial gains/losses
Statement of Activities
Immediate recognition of FVA changes:
►Projected investment earnings ►Actual benefits paid for the year
►Administrative expenses paid for the year
►Actual contributions made for the year by employer(s),
by employees, by retirees and by other sources without a “legal obligation” to contribute
►Other changes in the FVA from one year to the next
Gradual recognition FVA change:
►Difference between projected investment earnings and
Statement of Activities
Grouping these components differently, think of
them as expense charges and expense credits . . .
Expense charges:
1. Service cost (normal cost) attributed to the year 2. Interest (at the discount rate) on last year’s TPL 3. Plan benefit changes that increase the TPL
4. Assumption changes that increase the TPL for inactives 5. Actuarial losses (liability side) associated with inactives 6. Amortized portion of assumption changes that
Statement of Activities
Expense charges (continued):
7. Amortized portion of actuarial losses (liability side)
associated with actives in the current and prior years, till fully recognized
8. Amortized portion of the excess of projected investment
earnings over actual investment earnings for the current and prior years, till fully recognized
9. Administrative expenses paid for the year
10. Other increases in the TPL and other decreases in the
Statement of Activities
Expense credits:
11. Projected investment earnings
12. Amortized portion of the excess of actual investment
earnings over projected investment earnings for the year
13. Assumption changes that decrease the TPL for inactives 14. Actuarial gains (liability side) associated with inactives 15. Amortized portion assumption changes that decrease
Statement of Activities
Expense credits (continued):
16. Amortized portion of actuarial gains (liability side)
associated with actives in the current and prior years, till fully recognized
17. Actual contributions made for the year: • by employer(s),
• by employees and retirees, and
• by other sources without a “legal obligation” to
contribute
18. Other decreases in the TPL and other increases in the
Back to Statement of Net Assets
Liabilities:
►Net Pension Liability (NPL)
►Short-term payables for legally or contractually
required contributions and long-term liabilities for pension-related debt
Deferred outflows (appears below total assets):
►Unrecognized portions of expense charges
Deferred inflows (appears below total liabilities):
Eight High-Level Implications
1. A new and very large balance sheet liability
2. Large pension expense (or pension income)
3. Unstable financial statements
4. Communication challenges
5. Re-visit funding policies
6. Additional disclosures
7. A lot of work
Eight High-Level Implications
1. Net Pension Liability (NPL):
Eight High-Level Implications
3. Unstable employer financial statements . . .
► due to the use of the fair value of plan assets, instead of a smoothed actuarial value, as the offset to the TPL in the balance sheet liability (NPL)
► due to immediate recognition of certain sources of change in the NPL
Eight High-Level Implications
4. Communication challenges . . .
► With the press, legislators, local elected officials, plan trustees, participating employers, your city manager - executive director - superintendent, etc. ► “So which is the true unfunded liability?”
► “So which is the true expense?”
► Delete ARC, APC and NPO from our vocabulary ► Forget everything you knew about government
Eight High-Level Implications
5. Re-visit funding policies
► Cannot just lean on an ARC to set funding level ► Re-visit fundamental funding policy issues
• Actuarial cost method
• Robust, disciplined and well-documented process for setting
the long-term expected rate of return
• Amortization periods and methods • Target dates for funded ratios
Eight High-Level Implications
6. Additional disclosures
► In the Notes to Financials
Eight High-Level Implications
7. A lot more work
► For the implementation year and ► For subsequent years
► More actuarial work ► More preparer work ► More auditor work
Eight High-Level Implications
7. A lot more work (continued)
►One actuarial report for funding purposes
• Timing is driven by the budget calendar • Methods are driven by Funding Policy
►One actuarial report for accounting purposes
• Timing is driven by the CAFR calendar • Methods are driven by the GASB standard
Eight High-Level Implications
8. Get it right
► Auditors are watching
► The GFOA is watching (Certificate of Achievement) ► Taxpayer watchdog groups are watching
Acknowledgement
Circular 230 Notice: Pursuant to regulations issued by the IRS, to the
extent this presentation concerns tax matters, it is not intended or written to be used, and cannot be used, for the purpose of (i)
avoiding tax-related penalties under the Internal Revenue Code or (ii) marketing or recommending to another party any tax-related matter addressed within. Each taxpayer should seek advice based on the individual’s circumstances from an independent tax advisor.
This presentation shall not be construed to provide tax advice, legal
advice or investment advice.
Readers are cautioned to examine original source materials and to
consult with subject matter experts before making decisions related to the subject matter of this presentation.
