How Would GASB Proposals Affect State and Local Pension Reporting?

States and localities account for pensions in their financial statements according to standards laid out by the Governmental Accounting Standards Board (GASB). Under these standards, state and local plans generally follow an actuarial model and discount their liabilities by the long-term yield on the assets held in the pension fund, roughly 8 percent. Most economists contend that the discount rate should reflect the risk associated with the liabilities and, given that benefits are guaranteed under most state laws, the appropriate discount factor is closer to the riskless rate.

The point is not that liabilities should be larger or smaller, but rather that the discount rate should reflect the nature of the liabilities; the characteristics of the assets backing the liabilities are irrelevant.

In 2006, GASB embarked on a project to review its accounting standards for pensions and propose changes as needed. The resulting proposals, outlined in two exposure drafts released for public comment in 2011, encompass a host of reforms pertaining to virtually every aspect of pension accounting.

As it seems likely that the GASB proposals will soon become final standards, this paper takes a look at how the accounting changes will alter the funded ratios of state and local plans. The first section reviews how plans currently value plan assets and employer liabilities and explains GASB’s proposals. The second section presents aggregate funded ratios for the 126 plans in the Public Plans Database (PPD). The third section discusses some of the implications of the GASB proposals. The conclusion is that employers and plan administrators should be prepared for funded ratios reported in their financial statements to decline sharply under the new rules. But accounting changes do not alter the underlying fundamentals; ,000 owed to a retired teacher in ten years under current Three of the main proposals, however, pertain to the valuation of assets and liabilities used to measure reported funded ratios. First, changes in the fair value of plan assets would no longer be smoothed over a three to five year period, but rather would be immediately incorporated into the measure of plan assets. Second, projected benefit payments would be discounted by a combined rate that reflects the expected return for the portion of liabilities that are projected to be covered by plan assets and the return on high-grade municipal bonds for the portion that are to be covered by other resources. Third, the entry age normal/level percentage of payroll would be the sole allocation method used for reporting purposes.