Last week, GASB (Governmental Accounting Standards Board) announced bold new government accounting principles that propose improvements to financial reporting of pensions by state and local governments.
According to their July 8 press release, “The documents would propose amendments to the existing pension standards to improve how the costs and obligations associated with the pensions that governments provide to their employees are calculated and reported.”
Prior to this, cities were either unaware of or at least able to conceal the amount of money promised to employees upon retirement for health care that was unfunded and would come due at the time of retirement.
Under GASB 45, government employers were required to measure and report the liabilities associated with post-employment benefits, which could include medical insurance and other benefits that are not associated with a pension plan.
Suddenly, the City of Davis became “aware” that it had between a $40 to $60 million unfunded liability in its retirement health care benefits. That knowledge forced the city to have to act.
The two current proposals would both impact governments that provide pensions to their employees as well as reporting by pension plans that administer those benefits.
“Users of state and local government financial reports have told the GASB that current standards do not provide enough information to adequately understand the cost and the liability for benefits promised to active and retired employees,” stated GASB Chairman Robert H. Attmore. “The proposals contained in these Exposure Drafts are the result of years of research and extensive deliberations by the Board to address these issues and make financial reporting of pensions more transparent, comparable and useful to citizens, legislators, and bond analysts.”
Added Mr. Attmore, “It is important to note that these proposals relate to accounting and financial reporting, not to how governments approach the funding of their pension plans. Pension funding is a policy decision made by government officials.”
The Pensions Exposure Draft proposes that governments be required to report in their statement of financial position a net pension liability which is the difference between the total pension liability and net assets (primarily investments reported at fair value) set aside in a qualified trust to pay benefits to current employees, retirees, and their beneficiaries.
Most importantly, the proposal would require underfunded public plans to “use a more conservative 30-year municipal bond index rate, and cost-sharing plans will be subject to full accounting for the first time instead of simply included in the combined statements,” according to an article from Pensions and Investments.
What that means for a CalPERS, should it be considered an “underfunded” plan, is they would be forced to reduce their expected rate of return. As we have discussed previously, a quarter of a percent reduction could cost the city of Davis between $600,000 and one million.
Everyone has known this is coming and the result is likely to produce a vastly lowered expected rate of return for CalPERS which, means millions of dollars to the City of Davis.
According to GASB Chair Robert Attmore, these proposed rules will increase transparency and uniformity among plans.
“The point is so people have the best information to make the best decisions,” Mr. Attmore told Pensions and Investments.
To understand the impact of these proposed policy changes, we need to understand the impact of GASB 45.
The GASB 45 changes were close to revolutionary for local governments. To illustrate this point, look no further than the recent budget passed.
During our current budget process, the unfunded liabilities continued to be a huge issue, with the council eventually planning to plug another million into fully funding retiree health.
As Councilmember Stephen Souza put it, in June 2004, GASB (Government Accounting Standards Board) 45 was initiated, that made the city aware of the unfunded retiree health liability. “We started that process, we’re halfway there, so I take exception when the comment [is] that there hasn’t been a plan to attack some of these issues,” he said arguing that we need to look at how we go about getting there in a specific planned process.
He added, “I totally agree that we have to do this, I’ve seen the numbers, I’m aware of the numbers, we’ve attacked part of those numbers.”
However, to illustrate how big this is, as Mayor Joe Krovoza later pointed out, while it is true that we are “halfway there,” halfway there means halfway to putting the funding in place so that in 30 years we have fully-funded retiree health.
The city basically, for the next thirty years, has to put $4 million per year into that fund in order to have the plan fully funded sometime around 2040.
All of that happened because, in 2004, the Governmental Accounting Standards Board (GASB), an independent organization that establishes and improves standards of accounting and financial reporting for U.S. state and local governments, changed accounting practices so that we had to figure out exactly how much money we were promising versus the amount of money were funding to go to those promises.
According to its website, “GASB is not a government entity; instead, it is an operating component of the FAF [Financial Accounting Foundation], which is a private sector not-for-profit entity. Funding for the GASB comes in part from sales of its own publications and in part from state and local governments and the municipal bond community.”
—David M. Greenwald reporting
[quote]“Users of state and local government financial reports have told the GASB that current standards do not provide enough information to adequately understand the cost and the liability for benefits promised to active and retired employees,” stated GASB Chairman Robert H. Attmore. “The proposals contained in these Exposure Drafts are the result of years of research and extensive deliberations by the Board to address these issues and make financial reporting of pensions more transparent, comparable and useful to citizens, legislators, and bond analysts.”[/quote]
Shame on GASB for taking so long to do what is clearly the right thing by anyone’s standards…
A number I would like the City of Davis to report, in every one of our labor contracts, is how much is the Net Present Value of each retirement benefit for each job.
In other words, what is the real dollar value to the employee of the benefits he is getting upon retirement from the City of Davis? Stated differently, if the City had to buy a 3.5% coupon bond at the time each employee retires from the City to pay for a pension and retiree medical until the employee passes away, how much would that bond cost?
Here is an example of what I am getting at: I calculated the retirement benefits for a theoretical person leaving the City of Davis today at age 55, who lives to age 85 and who had a final salary of $120,000 per year. This person is married and has a 13-year-old child. This person was in a public safety position.
The answer: $3,049,003.
[i]How do I arrive at that figure?[/i]
I start with the NPV of his/her pension. It starts at $108,000 per year (i.e., $120 x 90%) and inflates each year by 2%. The NPV of that pension flow to age 85 is $2,620,828.
I then consider his/her medical benefits. I assume they start at the current rate of $18,000 per year on the Kaiser Family Plan for 3 people (retiree, spouse, child). I assume that amount inflates at 8% per year* until the retiree is 64 years old.
At age 65, I take the child (age 22) off of the plan and assume Medicare picks up half the cost for the retiree and spouse. I lower the inflation rate on the premium for the next 20 years to 5% per year.**
The NPV for the 31 years of receiving retiree medical benefits is worth today $428,175. When that is added to the pension value ($2,620,82), you get a bond cost of $3,049,003 for this one employee.
I think the NPV number would be an eye opener to the members of the City Council who are approving these very lucrative retirement packages.
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*8% per year is a LOWER rate of inflation for medical premiums than the City has experienced going back 15 years or so.
**The reason I lowered the inflation rate to 5% in 10 years is because I cannot believe that medical inflation will be able to inflate that much higher than general inflation forever. Most of the reason medical inflation is so much higher is due to innovations, such as newer and better medical tests and newer and better drugs. Those may keep coming, but we will not as a society be endlessly willing to pay for all of them.
Rich: The math and assumptions look good to me.
Now compare that to a private sector professional making $120,000 that retires at age 65. What would the cost be for his employer? Likely zero. However, the employee would have to work 10 more years and save at least $2MM to purchase an immediate annuity that would allow them the same standard of living… or retire at age 55 having saved $3MM.
More important to me that this is disclosed to the employee, I want every taxpayer to see it.
What shouldn’t surprise me but kind of does is that people get up in arms about the council cutting $2.5 million off the budget and yet this type of article barely registers on people’s radar and yet it is the underlying reason you are going to see cuts not only this year but several years in a row.
“Shame on GASB for taking so long to do what is clearly the right thing by anyone’s standards… “
This is really misplaced. Shame on the local governments that we need this type of accounting standard to be implemented.
[i]”What shouldn’t surprise me but kind of does is that … this type of article barely registers on people’s radar.”[/i]
It does not help when you write a headline which is not supported by your column. The headline is fictional: “New Regulations on Pensions Might Cost Cities Like Davis Millions.” Really? Where do you show any cost from a change in the accounting standard? Answer: you don’t, because there is none.
Your headline, if you wanted it to be accurate, would read something like this: “New Regulations on Pensions Might Show the Balance Sheets of Cities like Davis are Worse Off by Millions.”
On the other hand, if your point is that the assumed ROI of CalPERS is unrealistically high, which you seem to think (and do so with some justification), then you could have explained in the body of your column that while the GASB standard will have no monetary cost to cities like Davis, they might influence funds like CalPERS to reduce their expected ROIs, and if that happens, CalPERS will be forced to raise the rates it charges its member agencies even more than it is already raising rates.
I have explained this to you once before, but I don’t think you really understand it: ultimately, it does not matter what ROI CalPERS expects to achieve. All that matters is what ROI it actually achieves. In other words, if CalPERS sets its target ROI at 7.75% and over time it only achieves 7.25%, its actual rates charged will reflect the 7.25%, not the 7.75%. Given the poor average annual returns CalPERS has achieved over the last 5 years, it has had to raise its rates substantially. Never in that period did PERS change its target ROI.
The real significance of a target ROI is if it affects investment choices. In other words, if CalPERS set its target ROI very low–say at 4%/year–then the fund could simply invest in high grade bonds and very few equities and no real estate ventures. The rates it would charge its member agencies would still be determined by the actual, not expected ROI. But at such a low expected ROI, the fund would feel no pressure to invest in high-Beta stocks and the like.
[quote]What shouldn’t surprise me but kind of does is that … this type of article barely registers on people’s radar.” [/quote]
Its been on my radar for ten years…this article didn’t add anything, frankly.
Current pension and benefits are unsustainable. the question is how will it all play out. Like Greece, we know the system is insolvent…but how do we get there.
The only reasonable way to deal with the pension liability issue is during this year’s round of labor negotiations.
“Where do you show any cost from a change in the accounting standard? Answer: you don’t, because there is none.”
Yes, because look here:
“the proposal would require underfunded public plans to “use a more conservative 30-year municipal bond index rate, and cost-sharing plans will be subject to full accounting for the first time instead of simply included in the combined statements,” according to an article from Pensions and Investments.”
That would force PERS to use a much lower ARR which will cost us millions.
“The only reasonable way to deal with the pension liability issue is during this year’s round of labor negotiations. “
There is no way you are going to get $7 million in concessions in one round of labor negotiations.
[quote]This is really misplaced. Shame on the local governments that we need this type of accounting standard to be implemented.[/quote]
The GASB was complicit in allowing the cities to hide what was really going on – so how is my criticism misplaced?
DAVID: [i]”Yes, because look here: “the proposal would require underfunded public plans to ‘use a more conservative 30-year municipal bond index rate’ …”[/i]
You are misreading that.
GASB is not telling CalPERS and other funds that they have to have a target ROI equal to the bond index rate. Nor is GASB telling the funds that they have to charge their member agencies as if the funds’ returns on investments were equal to the bond index rate. What GASB is saying, with this recommended regulation, is that when a fund like PERS is underfunded–that is, when they have been achieving ROIs less than their target rates–the funds have to determine how much they are underfunded by discounting the difference using the bond index rate. That will have the effect of making the underfunding appear much greater than PERS is now showing it to be.
Your assertion, that this change in the accounting standard, will result in CalPERS charging higher rates to its member agencies, like the City of Davis, is incorrect. GASB has no authority at all to tell PERS what rates it can or should charge its members.
The rate that PERS charges its members will ultimately be determined by the actual ROIs it achieves. Nothing will change in that regard.
DAVID: [i]”There is no way you are going to get $7 million in concessions in one round of labor negotiations.”[/i]
We will solve the entire pension liability problem in 2012 by going to capped total comp contracts. Doing so is worth $93,686,725 over time.
Our problem is not that our income statement is in the red by $7 million. Our problem is that we have built up serious balance sheet liabilities in pensions, retiree medical, and street and other infrastructure maintenance.
The marginal added expenses of each of these year over year is leading us to a point of complete fiscal breakdown, because our income stream cannot keep up with the added expense stream. But if we cap the growth in total comp at a level equal to income growth, we solve the problem.
Let me give a stylized example with just one theoretical non-safety employee, call him Jim Bob, to show how capping the growth of his total comp works.
Say Jim Bob in year 0 makes a total comp of $150,000. Jim Bob’s compensation has these components:
[u]YEAR 0[/u]
salary: 90,000
pension: 24,120
cafeteria: 17,000
other benefits: 5,000
[u]retiree medical: 13,880[/u]
total: 150,000
Let’s now say that income growth to the City of Davis from Year 0 to Year 1 is 0.0%. In other words, the City can still only afford to pay Jim Bob $150,000 in Year 1.
Unfortunately, the cost of Jim Bob’s cafeteria plan and the cost of funding his retiree medical inflated by 8.48% and the cost of funding his pension increased by 5.7%. If all else were held equal, this would be Jim Bob’s total compensation in Year 1:
[u]YEAR 1[/u]
salary: 90,000
pension: 25,500
cafeteria: 18,500
other benefits: 5,000
[u]retiree medical: 15,000[/u]
total: 154,000
In other words, the City would be in the hole another $4,000.
Yet that would not be the case if Jim Bob’s total comp were capped at the rate revenues into the City grew. In this case, that growth was zero.
Here is how Jim Bob’s total comp in Year 1 would look if we capped comp growth:
salary: 86,900
pension: 24,600
cafeteria: 18,500
other benefits: 5,000
[u]retiree medical: 15,000[/u]
total: 150,000
Alternatively, Jim Bob’s union might prefer to give Jim Bob the choice of a less expensive medical plan or changing the age at which Jim Bob becomes eligible for retiree medical. Doing one or both of those would allow Jim Bob’s salary to hold steady or even grow, while reducing the cost of the cafeteria benefit or the retiree medical benefit.
Approved two week ago by the Atlanta City Council with a unanimous 14-0 vote:
[quote]Under the amended proposal, current employees in the traditional pension plan would contribute an extra five percent of their compensation to keep their existing benefits with no other changes.
New sworn police and fire personnel as well as those below a certain payroll grade would be placed into a hybrid composed of a reduced traditional pension and a 401K-type plan. The traditional pension portion would have a one percent defined benefit multiplier and an eight percent employee contribution.
Employees would also participate in a 401K-type plan with a 3.75 percent mandatory contribution that is matched 100 percent by the city. These employees may also contribute an additional 4.25 percent that will be matched by the city. There would be a 15-year vesting period for the defined benefit portion and a five-year vesting period for the 401K-type plan.
In addition, the retirement age for new employees would be increased by two years. The retirement age for new sworn police and fire personnel would be increased from age 55 to 57. The retirement age for all other new employees below a certain payroll grade would be increased from age 60 to 62.
Today’s vote is the result of dozens of committee meetings, presentations, workshops, and employee sessions on pension reform over the past 18 months attended by Atlanta City Council members, employees, union representatives and the public.
Mayor Reed has made shoring up the city’s reserves, balancing the budget and safeguarding taxpayer dollars a top priority, second only to public safety. Shortly after his inauguration in January 2010, he appointed a Pension Review Panel to begin studying the city’s pension fund and make recommendations on how to address the problem
[/quote]
Interesting how the younger generation gets screwed here. Seems like the standard… bleed the opportunities dry with mountains of debt, and then tell the next generation they are going to have to make due with less.
[quote]The city of Atlanta, in sweeping fashion Wednesday, unanimously passed an overhaul of its pension system by shrinking pension liabilities and establishing a 401(k)-type plan for workers.
How the pension works
If you have already retired from the city of Atlanta:
The legislation makes no changes to the benefits of retired city employees.
If you were hired by the city before 1984:
The legislation will not have an impact on your benefits at all.
If you are a current city employee in the Defined Benefit plan (police, fire and general employees):
The legislation allows you to remain in a traditional pension plan.
Your contribution of compensation to keep your existing benefits increases by 5 percentage points — 13 percent if you have beneficiaries and 12 percent if you don’t.
Your multiplier, the rate at which employees accumulate future pension benefits, will be 3 percent for police officers and firefighters; 2.5 percent for general employees; and 2 percent for anyone hired after July 1.
You will have a 10-year vesting period, but if you were hired after July 1, the vesting period will be 15 years.
You can retire at the age of 55 if you fight fires or crime. Otherwise, you retire at 60.
You will have no minimum retirement age, but you will be penalized for retiring early.
That penalty will be 6 percent per year for the first five years before normal retirement age and 3 percent per year thereafter.
Your cost-of-living adjustment will be 3 percent.
Your salary calculation will be based on the highest consecutive three-year average.
If you are a new city employee:
You will be placed into a hybrid plan composed of both a reduced traditional pension and a 401(k)-type plan, similar to those offered to private-sector employees.
In the traditional pension portion of the plan, you will have a 1 percent defined benefit multiplier and an 8 percent mandatory employee contribution.
In the 401(k)-type plan, you will have a 3.75 percent mandatory employee contribution that will be matched 100 percent by the city. You will have the option to contribute up to an additional 4.25 percent, which will also be matched 100 percent by the city.
In the Defined Benefits plan, your vesting period is 15 years. In the 401(k)-type plan, your vesting period is five years.
Unlike current employees, you have to wait until you are 57 to retire if you are a firefighter or police officer. If you are a general employee, you have to wait until you are 62.
If you want to retire early, you have to be 47 if you are a firefighter or police officer and 52 if you are a general employee.
The city will take 6 percent per year if you want to retire early.
Your cost-of-living adjustment will only be 1 percent.
Your salary calculation will be based on the highest consecutive-10-year average.
[/quote]