Wednesday, July 11, 2012

US Board Stokes Hot Pension Debate?

Nanette Byrnes of Reuters reports, Little-known U.S. board stokes hot pension debate:

The feedback was swift and often scathing when a little-known public board signaled its intent to toughen the accounting rules governing state and local pension funds of millions of U.S. public employees, intensifying worries over a shortfall of billions of dollars.

The plan by the Governmental Accounting Standards Board (GASB) - which was approved on June 25 - drew praise from the American Institute of Certified Public Accountants and from investors looking for transparency in the $3.7 trillion municipal bond markets.

But not so from the likes of Kevin Lillie, treasurer of the Geneva, Ohio area schools district, one of more than 700 letter writers, who asked: "How do you people come up with these things?" He was not alone in his incredulity.

For some states and municipalities the new rules, taking effect in 2013 and 2014, mean acknowledging that pensions for police, firefighters, teachers and other municipal workers are woefully underfunded liabilities.

The public employees worry that could prompt calls for cutbacks at a time of immense financial pressures while advocates for conservative fiscal management say that's precisely what's needed.

The accounting overhaul was a rare foray into the public eye for GASB, a 28-year-old body that shares offices in Norwalk, Connecticut with the far more powerful Financial Accounting Standards Board (FASB), its older brother and the standard setter for private and publicly traded companies and not-for-profit organizations.

In a letter to GASB, Congressmen Gerald Connolly of Virginia and Edolphus Towns of New York called the proposals arbitrary and destructive. Boston College pension expert Alicia H. Munnell wrote that GASB's planned method for valuing pension liabilities "makes no sense at all."

Withdraw the proposal entirely, urged the Lubbock Texas Fire Pension Fund.

GASB listened. Board members read the letters. Staff tallied them in a spreadsheet. The board flew around the country holding public meetings and collecting people's thoughts.

Then the board's seven members - many of whom work day jobs in local and state governments themselves - went ahead and approved the rules, without changing many of the most controversial elements. "This is not a democratic process," said a person close to the board. "The board is not Congress. It looks at the fundamental underpinnings of the issues."

RADICAL CHANGES

In one unanimous vote GASB set in motion changes, termed radical even by supporters, that will force many of the worst-off state and local governments to acknowledge much bigger pension shortfalls as liabilities on their balance sheets, while no longer requiring information about how well they are funding those promises. The rules will add volatility to the funds by eliminating the "smoothing" of their liabilities over time, and will impose new accounting costs on already strapped governments.

The new GASB rules don't alter what's owed, but will make some dramatic changes to the accounting value of liabilities.

Underfunded pension plans will no longer be able to use the projected rate of return on their investments, currently about 8 percent, to value all their liabilities. Instead, any unfunded promises will have to be valued at a far lower rate, close to what it would cost them to borrow the money to cover that debt.

This hybrid plan - which uses one rate for funded liabilities and another for the unfunded ones - will make the most poorly funded plans' liabilities look far larger because the lower the discount rate used to evaluate those liabilities, the higher the present value of the amount owed by local governments.

The new pension math won't exactly mirror how corporations handle these calculations, but will bring the governments' numbers a step closer to the more conservative figures of the private sector.

Pension supporters fret that these on-balance sheet liabilities will be misunderstood as current obligations and add to the tension between funding these promises to police, firefighters, teachers and others, and spending on public services.

Fiscal conservatives say it's high time the real cost of what they see as overly generous public sector pensions is recognized, and warn that these pensions are unsustainable.

CHILDREN OF A LESSER GOD

Begun six years ago as a routine review of existing accounting rules, the pension accounting revamp came to a head at a time when sharp investment losses of the late 2000s, declining contributions from cash-strapped governments, and a rising number of retirees have made questions about their sustainability front-page news.

"That sure raised the level of awareness," GASB Chairman Robert H. Attmore said in an interview, though he maintained that in the end the public debate over pensions did not shape the board's rules.

Founded in 1984, at a time when government bookkeeping came under criticism for not being more like that of business, GASB operated largely under the political radar. While tasked with setting standards, GASB had little in common with FASB, founded 10 years earlier.

FASB has an annual budget of $39 million, a fulltime board of seven, and a chairwoman, Leslie Seidman, who was paid more than $760,000 in 2010, the most recent year for which filings are available.

By contrast, six of GASB's seven board members work part-time, the board has a budget of $8 million this year, and Chairman Attmore, who draws a pension from New York state where he spent 17 years as auditor, made $424,000 last year. The board members are all knowledgeable of government finance and appointed by a nonprofit professional board rather than a political one.

RUBE GOLDBERG MACHINE

Up until this year, when a congressionally mandated fee on brokers took effect, GASB had no permanent funding, relying entirely on voluntary contributions and subscriptions to fund its expenses.

GASB explains the budget gap as stemming from the board's part-time status as well as its lighter workload. GASB, which has a total of 68 accounting standards, approved two new ones last year, while FASB penned 12 to bring its total to 226.

From bankrupt Stockton in California to financially strapped states such as Illinois and Rhode Island, the pressures stemming from pension promises are a constant worry, shared by officials in small and large local governments.

Accounting professionals are split on whether the new rules are a step in the right direction.

Paul Angelo, a senior vice president for the Segal Company, one of the largest actuarial firms in North America, calls the new rule a "perfectly nuanced solution to a difficult question."

Though liabilities will be marked higher for many, economists and actuaries, who yearned for a system closer to the corporate model, say they are not high enough. Given that promises made to public staff are often ironclad in state laws and that future payments must be guaranteed, a cautionary approach would suggest a discount of all those liabilities at a "riskless" rate similar to the borrowing costs of the U.S. Treasury, they argue.

By instead endorsing a two-pronged approach, the board has built a machine that performs a simple task in a complex fashion, counters New York actuary Jeremy Gold, who would favor the use of one low rate: "GASB has built a Rube Goldberg machine filled with complexity." Governments may like GASB's hybrid model better he said, but future taxpayers will bear the burden.

Devin Nunes, a California Republican member of the U.S. House of Representatives, agrees. "Did GASB do enough? No, I do not think the reforms are adequate to protect taxpayers or retirees," he wrote in an email to Reuters.

Nunes has sponsored legislation in the House, which he hopes to reinvigorate after November's election that would sidestep GASB's rules, requiring governments to use a more conservative calculation of liabilities if they wish to issue tax-free bonds.

UNCERTAIN IMPACT

Until the new math kicks in, it's hard to know how much difference it will make. Even under the old rules, the Pew Center on the States estimated that states were short $757 billion on their pension promises.

A July 2 report by ratings agency Moody's Investors Service calculated that if it used a 5.5 percent discount rate, a rate more conservative than the method GASB proposed in its final rules, but closer to the way corporations value their pensions, it "would nearly triple fiscal 2010 reported actuarial accrued liability" for the 50 states and rated local governments to $2.2 trillion from $766 billion.

Next GASB will tackle accounting for other post-employment benefits such as retiree healthcare plans - this despite complaints from governments that they're struggling to keep up with the board's quickly changing standards.

Attmore said that he was sympathetic to the pressures on government finance departments, but that GASB had no plans to slow down.

"If we do our job well, it should make things better and give policymakers and others making tough choices about cutting resources better information to make those decisions," he said.

I have covered this topic and think concerns about GASB's new rules are legitimate but the new rules are needed and they won't roil public pensions. You can read this recent paper from the Boston College Retirement Center to get a deeper insights on this topic.

Will the new rules overstate liabilities? Yes, they most definitely will, but they will also introduce more transparency and accountability into US public pension systems, alleviating fears of a muni debt crisis.

But changing accounting rules is not enough. Importantly, US public pensions need a major overhaul of the governance model, one that emulates Canadian, Dutch and Danish pensions. This is the only thing that will fundamentally bolster pensions for the long-term, helping to fix the pathetic state of state pension funds.

As for the true state of these public pensions, Chris Tobe shared this comment with me:

Boston College Retirement Center recently released a paper on the solvency in US public Pension plans. They feel the most relevant solvency ratio is Assets to yearly benefit payout. This ratio at its best in 2001 was at 23 times. In 2010 their most recent the average had fallen to 13. The worst in the country was not Illinois SERS at 6 times but Kentucky ERS at 5.
Finally, things are not much better with private sector pensions where Reuters reports, Pension deficits deepen in corporate Britain and U.S.:

Chronically weak stock markets and record low bond yields have pushed company pension deficits in the United States and Britain sharply higher, adding to the burden of retirees living longer than ever before, reports said on Tuesday.

In the United States the aggregate deficit of S&P 1500 companies grew $59 billion in the first half of the year to $543 billion, consultancy Mercer said.

Corporate America is sitting on total liabilities of $2.09 trillion against total assets of $1.55 trillion, Mercer added.

The picture is no less bleak in Britain, where the combined deficit of FTSE 100 companies more than doubled over the past year to 41 billion pounds ($64 billion), actuarial firm Lane, Clark & Peacock (LCP) said in a separate report.

This is despite companies having poured 11 billion pounds into schemes over the last year in an attempt to plug the deficit, LCP said.

Total liabilities of blue chip British companies stand at 447 billion pounds against total assets of 406 billion pounds, LCP's analysis of 83 of the FTSE 100 companies showed.

The demands on company pension pots have been increasing because people are living longer, meaning schemes are obliged to pay out to workers for longer after they retire.

At the same time, the returns the pension funds make on investments are shrinking because of volatile financial markets and historically low bond yields, used to assess liabilities, which are calculated using benchmark yields such as those on top-rated corporate bonds.

Low yields lead to bigger liabilities, hence more deficits, because pension funds will need more assets to pay sufficient income to pensioners in the future and companies may need to pay more into the pot.

"Deficits have fluctuated by as much as 10 billion pounds in a single day as uncertainty continues to characterise both equity and debt markets," said Bob Scott, partner at LCP and author of the firm's report.

Uncertainty over returns has also prompted a shift out of riskier assets such as equities to those seen as safe havens, such as government bonds, which has resulted in more downward pressure on yields.

Only 35 percent of pension scheme assets in Britain were being held in equities at the end of 2011, compared with 43 percent in 2011 and nearly 70 percent 10 years ago, the report said.

These pressures not only impact the ability of a company to invest in the economy and attract capital, but can also push shareholders to the back of the queue in terms of how a firm's cash is shared out.

Now you understand why President Obama pulled a Mitt Romney on pensions, quietly signing a new law that will let companies contribute billions of dollars less to their workers' pension funds.

As for those British pension funds moving into less risky government bonds, this is proving to be a wise strategy. Nonetheless, I am worried that pension funds' flight to safety is skewing markets, and if Leo de Bever is right, and the top of the bond market is near, this will come back to haunt them.

Of course, if the world enters a protracted period of debt deflation, pension funds de-risking into government bonds will look like geniuses. The only thing that might save us then is Steve Keen's private debt jubilee.

Below, City of San Jose Police and Fire Retirement Plan Trustee Sean Bill discusses the challenges of pension reform. He speaks with Deirdre Bolton on Bloomberg Television's "Money Moves."

Like other public pensions, they are betting on hedge funds (SIGH!) to help them reach their actuarial target. One thing I will give them credit for, however, is overhauling their governance, allowing them to make decisions that align interests with their pension beneficiaries.

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