In this interview, Governmental Accounting Standards Board chairman David Vaudt discusses the entity’s new public pension accounting rules, the results they have produced so far, and what the rules mean for the finances of cash-strapped states.
Video credit: CNBC
Feature photo credit: www.SeniorLiving.Org
A recent piece in The Economist wonders whether Illinois’ pension debt might lead the state down the same path as Greece.
From the Economist, and re-published by Business Insider:
Illinois is like Greece in one obvious way: It overpromised and underdelivered on pensions and has little appetite for dealing with the problem, says Hal Weitzman of the University of Chicago Booth School of Business.
This large Midwestern state, with a population of 13 million (Greece has 11 million, though a far smaller GDP than Illinois), has the most underfunded retirement system of any state and the largest pension burden relative to state revenue. It also has the highest number of public-pension funds close to insolvency, such as the one looking after Chicago’s police and firemen.
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The state devotes one in four of its tax dollars to pensions, which is more than it spends on primary and secondary education.
Mainly as a result of this gargantuan pension debt, Illinois’s bond rating is the lowest of all the states, which means dramatically higher borrowing costs.
When the state government failed to address pension underfunding in its budget for 2014, two credit-rating agencies, Fitch and Moody’s, cut the state’s bond rating, which in Moody’s case put Illinois on a par with Botswana. (An incensed editorial in the Chicago Tribune asked what Botswana had done to be so insulted.)
The main reason for the pension debacle is decades of underfunding. “Everything was always done with a short-term view,” says Laurence Msall, head of the Civic Federation. “Unique to Illinois is the idea that you don’t have to pay for pensions and you don’t have to follow actuarial recommendations.”
Whereas most other states follow the rules set by the Governmental Accounting Standards Board (GASB), which, however imperfect, require some budget discipline, Illinois has mostly ignored them.
Read the entire piece here.
In light of newly adopted GASB accounting rules, the Teacher Retirement System of Texas in 2015 will require school districts, colleges – and any other government entities that pay into the system – to declare their employees’ pension liabilities on their books.
From the Killeen Daily Herald:
School districts across the state will soon have more debt listed on their general fund balances and teachers could see a smaller paycheck…
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“TRS does not want to put this liability on their books so they are taking the allocation to the districts and the cities and colleges and saying, ‘You record this amount; I’ll record this amount,” said Dane Legg, a partner at Lott, Vernon and Company PC, the Killeen Independent School District’s external auditing firm.
Legg reviewed the upcoming financial policy change with board members at their mid-December workshop.
In laymen’s terms, this means Killeen ISD will have to show a $48 million liability in its budget for about 28 years, the amount TRS said it owes toward Killeen ISD employees’ pensions.
The liability stems from the TRS Trust Fund, which is underfunded but will be fully funded in 28 years.
“It’s not set in stone — that number has not been set yet — but this was what they were charged to do to give people a heads up and go ahead and come up with their best guess,” Legg said.
TRS is $28.9 billion underfunded statewide, Legg said. And officials expect many government entities will take issue with the new GASB 68 policy because it will force some of them to look like they are in debt.
“TRS determines how that liability gets allocated by the district, and TRS is only taking a small piece of that $28 billion, and they are giving most of the rest to the district to record,” said Megan Bradley, the chief financial officer for Killeen ISD.
The district will not have to fund the liability, it will simply be a book entry, Legg said. TRS will fund it, however, by changing its member contribution rates and possibly the district’s match rate.
The Teachers Retirement System of Texas managed $124 billion in assets as of the end of 2013.
Photo by www.SeniorLiving.Org
Andrew Biggs, former deputy commissioner of the Social Security Administration and current Resident Scholar at the American Enterprise Institute, penned a column for the Wall Street Journal this week in which he posed the thesis that public pension funds invest in too many risky assets.
To start, he compares the asset allocations of an individual versus that of CalPERS. From the column:
Many individuals follow a rough “100 minus your age” rule to determine how much risk to take with their retirement savings. A 25-year-old might put 75% of his savings in stocks or other risky assets, the remaining 25% in bonds and other safer investments. A 45-year-old would hold 55% in stocks, and a 65-year-old 35%. Individuals take this risk knowing that the end balance of their IRA or 401(k) account will vary with market returns.
Now consider the California Public Employees’ Retirement System (Calpers), the largest U.S. public plan and a trendsetter for others. The typical participant is around age 62, so a “100 minus age” rule would recommend that Calpers hold about 38% risky assets. In reality, Calpers holds about 75% of its portfolio in stocks and other risky assets, such as real estate, private equity and, until recently, hedge funds, despite offering benefits that, unlike IRAs or 401(k)s, it guarantees against market risk. Most other states are little different: Illinois holds 75% in risky assets; the Texas teachers’ plan holds 81%; the New York state and local plan 72%; Pennsylvania 82%; New Mexico 85%.
The column goes on:
Managers of government pension plans counter that they have longer investment horizons and can take greater risks. But most financial economists believe that the risks of stock investments grow, not shrink, with time. Moreover, while governments may exist forever, pensions cannot take forever to pay off their losses: New accounting rules promulgated by the Governmental Accounting Standards Board (GASB) and taking effect this year will push plans to amortize unfunded liabilities over roughly 15 years. Even without these rules, volatile pension investments translate into volatile contribution requirements that can and have destabilized government budgets.
Yet public-plan managers may see little option other than to double down on risk. In 2013 nearly half of state and local plan sponsors failed to make their full pension contribution. Moving from the 7.5% return currently assumed by Calpers to the roughly 5% yield on a 38%-62% stock-bond portfolio would increase annual contributions by around 50%—an additional $4 billion—making funding even more challenging.
But the fundamental misunderstanding afflicting practically the entire public-pension community is that taking more investment risk does not make a plan less expensive. It merely makes it less expensive today, by reducing contributions on the assumption that high investment returns will make up the difference. Risky investments shift the costs onto future generations who must make up for shortfalls if investments don’t pay off as assumed.
Read the entire column here.
Photo by dktrpepr via Flickr CC License
The federal law ERISA – the Employee Retirement Income Security Act of 1974 – regulates many aspects of private pension plans.
Should public pension funds be beholden to similar federal regulation? Alicia H. Munnell of the Center for Retirement Research explored this issue in a recent column published on MarketWatch.
Munnell writes:
In a recent meeting, an expert very supportive of public-sector employees raised the question of PERISA. These initials are shorthand for federal regulation of state and local pension plans—essentially extending some or all of the Employee Retirement Income Security Act of 1974 (ERISA), which covers private-sector retirement plans, to the public sector.
I had not thought about such legislation since the early 1980s, and am not sure how I feel about it. On the one hand, proposals these days with regard to federal regulation tend to have a punitive tone—focusing mainly on getting public plans to stop using excessively high discount rates. On the other hand, serious underfunding in some plans is usually the result of delinquent behavior on the part of the sponsor.
So some regulation might be helpful, particularly now that the Governmental Accounting Standards Board (GASB) has clarified that its financial reporting standards do not constitute funding policy guidance, leaving a vacuum when it comes to public pension funding policies. But it is not clear that federal legislation could actually include funding requirements.
Munnell explores the origins of ERISA, and the reasons the federal law wound up covering private plans:
Here’s what I remember from the old days. Originally, governmental plans were included along with private plans in the legislative proposals leading up to the passage of ERISA. In the end, Congress exempted public plans from the Act and instead mandated a study of retirement plans at all levels of government to determine: 1) the adequacy of existing levels of participation, vesting, and financing; 2) the effectiveness of existing fiduciary standards; and 3) the necessity for federal legislation. The study concluded that serious problems existed and that federal regulation was necessary.
The experts believed that the federal government had the constitutional authority under the Commerce Clause of the Constitution to regulate reporting, disclosure, and fiduciary standards of state and local plans. On the other hand, the imposition of funding standards might affect the fiscal operations of state and local governments in a way that could threaten the sovereignty of the states. Hence, early legislative efforts omitted any funding regulation.
Some form of public plan legislation was introduced in each of the next four Congresses. While reporting, disclosure, and fiduciary standards may sound dull and routine, the proposed federal regulation met with passionate opposition during its long legislative history in the early 1980s. Opponents claimed that most public plans were under large systems that were generally well managed, and the public sector had not seen the flood of participant complaints witnessed in the private sector. Supporters contended that major reporting and disclosure deficiencies still existed and that the problems would persist since a major conflict of interest often exists between the goals of elected officials and sound financial management. In the absence of adequate reporting and disclosure, public officials could grant generous benefit increases and shift the costs to future taxpayers.
The two sides battled it out for several years but, in the end, no legislation was enacted for the federal regulation of state and local plans. My sense at this point, three decades later, is that federal regulation would be useful given the importance of state and local plans to the economy and the well-being of millions of workers. But the effort to pass such a bill would be worthwhile only if the legislation included funding requirements. And only the lawyers know whether funding requirements could pass constitutional muster.
Read Munnell’s entire piece here.
The Governmental Accounting Standards Board (GASB) has rolled out new financial reporting rules for pension funds, and the expectation is that the new rules will expose some “red ink”, so to speak, at pension funds who previously kept some liabilities off the books.
But implementation and enforcement of the rules is hardly straightforward. Pennsylvania serves as a great microcosm of the rules’ complexity. Mark Guydish writes about the impact of the rules on small municipalities:
GASB standards do not have the weight of law and GASB has no enforcement powers. The standards are widely adopted because independent auditors look for compliance with GASB, and state and federal money may depend on that compliance.
Theoretically, a small township that has an elected auditor rather than a contracted auditor could disregard GASB standards…though the risk to state and federal funds would still exist.
There’s another quirk in Pennsylvania, and Luzerne County, that complicates how these standards play out: The high number of municipalities managing their own pension funds, creating a wide disparity in the size of those funds.
On the one hand, the sheer number of municipalities and authorities may prevent big swings in the numbers once the new standards are used, simply because so many pension plans cover only a handful of people in many townships and boroughs.
On the other hand, Dave Davare, retired director of research at the Pennsylvania School Boards Association, noted that the dollar figures are so small it wouldn’t take much of a change to move a fund from surplus to deficit.
Dreyfuss pointed out that the standards do not require a municipality to meet pension obligations, simply to report them differently. From the municipality’s point of view, the most important number in Pennsylvania is the state-mandated “Minimum Municipal Obligation,” or MMO. Fail to pay the MMO, and state money can be at risk.
Hanover Township Manager Sam Gusto said that’s the focus at his office, and that there is no way of knowing the impact of the new GASB standard until the actual book work changes are implemented.
You can read the rest of Guydish’s massive piece here. It goes on to explain how the rules might impact school districts and state-level pension funds.
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