Public Pension Plan Accounting Changes Highlight Shortfalls

By Mark Johnson, Ph.D., J.D.


The $1 trillion gap between pension benefits promised to public employees and the actual funding needed to finance these benefits will gain more attention with pending public pension accounting rule changes.


The Governmental Accounting Standards Board (“GASB”), the industry organization responsible for establishing accounting standards for U.S. state and local governments, recently approved two new standards regulating the accounting and financial reporting of public entity employee pensions.


GASB Statement No. 67, Financial Reporting for Pension Plans, revises existing guidance for the financial reports of most pension plans.  This Statement replaces the requirements of Statement No. 25, Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined Contribution Plans and Statement 50 as they relate to certain pension plans.


GASB Statement No. 68, Accounting and Financial Reporting for Pensions, revises and establishes new financial reporting requirements for most governments that provide pension benefits for employees. This statement replaces the requirements of Statement No. 27, Accounting for Pensions by State and Local Governmental Employers, and Statement No. 50, Pension Disclosures, as they relate to governments that provide pension benefits through pension plans administered as trusts or other qualifying structures.


“The new standards will improve the way state and local governments report their pension liabilities and expenses, resulting in a more faithful representation of the full impact of these obligations,” said GASB Chairman Robert H. Attmore. “Among other improvements, net pension liabilities will be reported on the balance sheet, providing citizens and other users of these financial reports with a clearer picture of the size and nature of the financial obligations to current and former employees for past services rendered.”


Effective Dates for GASB Public Pension Plan Rules


GASB Statement 67 takes effect first, with application to financial reporting periods beginning after June 5, 2013. Statement 68 follows, taking effect for fiscal years beginning after June 15, 2014. Plan administrators are encouraged to consider early adoption where feasible.


Copies of Statements 67 and 68 will be available at www.gasb.org later this summer.


Key Pension Accounting Changes


Certain pension expenses will need to be recognized immediately under the new rules. Interest costs associated with pension liabilities, as well as service costs, must now be clearly identified in public entity financial statements. Costs (or savings) associated with benefit level adjustments must also be reflected.


The “discount rate” that plan administrators use to calculate funding levels for future pension obligations will now be based on a single rate determined by the long-term expected rate of return on plan investments or a yield or index rate on tax-exempt 20-year, AA-or-higher rated municipal bonds.


More than half of state pension plans currently use a rate of return assumption of 8 percent, according to a 2011 PBS report. While the assumed rate of return may sound like an academic exercise, it influences billions of dollars in taxpayer expenses when applied to the future funding requirements of pensions and benefits for retired school teachers, fire fighters, police officers and other public employees.


Implications for Public Pension Participants


The potential impact of the GASB financial reporting changes is immediate and significant: 

  • Public entities will be forced to provide a greater level of financial disclosure faster, and in a more standardized format. As citizens become more aware of future pension obligations, the associated public debate may be rancorous. At an extreme, residents in severely under-funded counties or states may choose to move to more fiscally responsible locations. 

  • Previously reported funding levels are expected to decline for most public pension plans; considerably for many states. Aggregate funded ratios for 126 state and local plans will drop from 76 percent as currently reported to 57 percent under the new GASB ruling, according to research published by the Center for Retirement Research at Boston College. 

  • Taxpayers will feel the pinch, as municipal efforts to shore up weak pensions will focus on some combination of higher taxes and reduced service levels. 

  • Active and future public pension holders will continue to be pressured for higher contributions and/or reduced benefits. This is particularly true for retiree health care and other non-pension benefits, which are under-funded by $627 billion according to the Pew Center on the States.


Litigation over pension plan disputes is a likely outcome as the promise of high pension benefits conflicts with the reality of inadequate financial resources. 


ABOUT THE AUTHOR: Mark Johnson, Ph.D., J.D., is a highly experienced ERISA expert. As a former ERISA Plan Managing Director and plan fiduciary for a Fortune 500 company, Dr. Johnson has practical knowledge of plan documents as well as an in-depth understanding of ERISA obligations. He works as an expert consultant and witness on 401(k), ESOP and pension fiduciary liability; retiree medical benefit coverage; third party administrator disputes; individual benefit claims; pension benefits in bankruptcy; long term disability benefits; and cash conversion balances.

July, 2012


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