A new government accounting rule will for the first time let taxpayers know how much each local government body has racked up in unfunded public pension liabilities.
According to some analysts, the change will finally shine a light on the impact of unfunded pensions on taxpayers at the local level, and possibly lead to reforms to the system.
The new public employee pension accounting standard that went into effect this summer means that local government entities ranging from towns to fire districts to schools will be required from now on to report millions of dollars in new liabilities on next year’s financial statements.
Whether the new standard will affect local governments’ credit ratings, affect their usual course of business or influence pension payments in the future are topics being debated among financial experts, with no clear answers in sight until the reports are filed for the first time next summer.
But one of the undisputed results of the new requirement will be to bring more clarity to how much local governments owe in current and future pension benefits. Until now, those numbers have only been known as they apply at the statewide level.
Moody’s, the Wall Street credit agency, issued a statement in June saying that while it anticipated a limited impact, “Some liability measures could be affected, however, by new information in the additional disclosure that the standards will require, specifically on the sensitivity of liabilities to changes in the discount rate.”
CHANGES IN THE MATH
The Government Accounting Standards Board, which establishes and improves standards of accounting and financial reporting for state and local government, issued the new rule. It “requires governments providing defined benefit pensions to recognize their long-term obligation for pension benefits as a liability for the first time, and to more comprehensively and comparably measure the annual costs of pension benefits,” according to a GASB statement.
Just how big the new liability will be for local governments depends largely on the state in which they are located. But most states are only funded in the 60- to 80-percent range, some even less. Requiring local government employers for the first time to report their share of the unfunded pension liabilities could result in many governments showing a sizable deficit on their balance sheets.
Two years ago, Moody’s issued a widely cited report noting that by its calculations, unfunded public pension liabilities across the U.S. were roughly triple the amount governments were reporting. Moody’s estimated unfunded state and local pension liabilities at $2 trillion. Last year, the nonprofit State Budget Solutions estimated the level of unfunded public pensions to be $4.1 trillion.
Whatever the number is, local governments are now being required to account for their share. Dave Yost, the state auditor for Ohio, said recently that establishing the amount each local government must report is a matter of simple math.
“You take all of the unfunded liability, whatever amount that is, and divide it up among all the current employees contributing,” Yost said. “And then however many employees you’ve got, you have to show that as liability on your balance sheet.”
Yost said if that figure is large in that particular municipality, it could actually cause the balance sheet to go from being in the black to being in the red.
In Illinois, which has one of the worst-funded pension systems in the nation, the Illinois Policy Institute recently stated, “Under the new GASB rules, governments will be required to use more appropriate investment targets than most public pension plans have been using, bringing them more in line with accounting rules for private-sector plans… Under these new rules, the five (Illinois) pension funds will see their combined unfunded liabilities more than double.”
CONCERNS ON DOWNGRADES
Lisa Morris, executive director of the School Employees Retirement System of Ohio, recently told The Lima News, “Moody’s and the other rating agencies have said they will not downgrade on the basis of this portion of the pension liability. What Moody’s has said is it will take that and add it to other liabilities, and if they are over a certain threshold, they will get downgraded.”
Many local government agencies seem only vaguely aware that the new standards are coming. With that in mind, many public employee pension officials are trying to get the word out. For instance, representatives from SERS in Ohio are touring the state, ensuring that members of the public are not caught off-guard.
At a March meeting of Kentucky’s Public Pension Oversight Board, Bill Thielen, executive director of the Kentucky Retirement Systems, said the new GASB reporting requirement will represent an important change.
Thielen told board members that the new reports represent “a significant amount these employers will have to show for the first time on their financial statements. One result of the new standards is that they could have an effect on some employers’ banking contracts and loan agreements if a certain debt to asset ratio is required to be maintained…” according to meeting minutes.
Thielen added that the change “will not have a significant impact on bond ratings, but some bank covenants may be impacted if this is perceived as a change in debt ratio.”
As in Ohio, Thielen said that in Kentucky “not much information has been sent to the employers, but within the next month or two, KRS will begin sending the information.”
Yost, the Ohio state auditor, said local government bond ratings should not be affected by the new rule.
“We’ve been working to make sure that it doesn’t have an effect on the bond rating,” Yost said. “I met with the rating agencies and explained to them what Ohio law looks like, so they get that even though it’s required for reporting, it’s not something that really changes financial position or the ability to pay for the local government.”
But not everyone is so sure. John Knechtly, a financial adviser and accredited asset management specialist based in Hillsboro, Ohio, said, “No definitive answer can be given since this is a new GASB statement that leaves it unclear as how rating companies or banks will look at this new liability on the governmental entities’ balance sheets it applies to.”
Knechtly said that if the liability is looked at as true debt, it could possibly cause credit ratings to be lowered on bonds and negatively affect borrowing from banks.
“If this would occur, I would be concerned how quickly the governmental pension plans could react to the underfunding of the plans to help remove the liability from the balance sheets,” said Knechtly. “Would it be possible that the pension plans might seek additional funding from the participants or have to reduce proposed benefit amounts in place at this time?”
But, “If the liability on the governmental entities’ balance sheet is not truly considered debt from a lender’s risk position, then probably no major effect would be felt,” said Knechtly.
The GASB says the new rule is designed to replace old standards that have been in place for more than a decade. It should “improve transparency, consistency and comparability of pension information across state and local governments,” according to the group.
While the pension liabilities must be reported for the fiscal year beginning after June 15, 2014, and reported starting in June 2015, GASB officials say that the new rule does not mean the public should be alarmed that local entities offering public employee retirement benefits are suddenly going broke.
GASB officials say the new rule is about more clarity. But the GASB statement adds this warning: “However, it is true — all other factors being equal — that the less well-funded a pension plan is, the more likely it will reach a crossover point and therefore have to discount some projected benefit payments using the municipal bond index rate.”
In many quarters, the new reporting requirement is being hailed as a much-needed warning for taxpayers that eventually they will be asked to foot the bill for unfunded government benefits.
Michael J. Hicks, distinguished professor of economics and the director of the Center for Business and Economic Research at Ball State University in Muncie, Ind., said the new changes to GASB “are important since they offer taxpayers — both households and businesses — a clear picture of the long-term solvency of their state and local government.”
Hicks added, “Now it is far easier to fully understand whether you are facing a large tax hike in the coming years, or if you live and work in a place with stable local government finances.”