Private Pensions Evade Honest Accounting

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The new infrastructure and student loan bill, to be signed by President Obama on Friday at the White House, will reduce the 10-year deficit by $16 billion, at least according to the nonpartisan Congressional Budget Office. Of this, $11 billion in deficit reduction is attributable to reducing the contributions corporations make to their pension plans.

Ironically, the Governmental Accounting Standards Board, a federally-sponsored, private-sector advisory body, has just brought out new rules to revise the way state and local governments estimate their pension liabilities, increasing required contributions for most funds.

Within the space of a fortnight, a short time in politics, pension accounting rules are eased for corporations and tightened for state and local governments.

Corporations are better off because the new infrastructure bill-which also postpones increases in rates for government student loans-allows them to assume higher average interest rates on their pension funds for the purpose of determining whether these funds have sufficient assets to pay pensions for current and future retirees.

With current interest rates at record lows, corporations' retirement funds are growing more slowly. Allowing corporations to assume that interest rates are closer to historical averages makes the funds look in better shape, and reduces the amount corporations have to contribute.

The nonpartisan Congressional Budget Office calculates that if corporations make fewer tax-deductible contributions to their pension plans, they will have more taxable income-to the tune of $11 billion in revenues over the next decade. No matter that corporations have armies of tax accountants whose job it is to find more offsets to taxable income, once contributions to pension plans are reduced.

The real victims of this sleight of hand are future retirees, who are relying on income from these pension funds for their retirement. Congress has bailed out the corporations, but current and future retirees better have other sources of savings.

Contrast this with the Government Accounting Standards Board, which has done precisely the reverse. Its new rules will increase estimates of liabilities, forcing state and local governments, which have pension liabilities of $4.4 trillion, to make painful choices.

Beginning in 2013, states that are not fully funded must assume a return on assets equal to a rate on tax-exempt 20-year, AA or higher rated municipal bonds, now yielding between three and four percent. That means that state governments would have to contribute more so that the pensions are adequately funded.

The Center for Retirement Research at Boston College has estimated that under the new rules, California State Teachers' Retirement System funding ratio-the adequacy of current assets to pay pensions of current and future retirees-would decrease from 71 percent to 41 percent; the Illinois teachers' plan would decrease from 48 percent to 18 percent, and the Hawaii Employees' Retirement System would decrease from 61 percent to 42 percent.

Some plans would look better under the new guidelines. The Massachusetts State Employee Retirement System and the Teachers' plan would increase from 81 percent to 160 percent, and from 66 percent to 120 percent, respectively. The funding of the Public Employees Retirement System of Ohio would increase from 77 percent to 80 percent, although other Ohio plans would decrease slightly.

New Jersey would have to contribute an additional $2 billion in pension contributions over the next four fiscal years, according to Frank J. Abella Jr., chief executive officer of Investment Partners Asset Management Inc.

The new rules make other changes in pension arithmetic. States have been allowed to smooth gains and losses over 30 years, in contrast to 7 to 10 years for private plans-now 25 under the new infrastructure law. This has meant that public funds could incur greater near-term deficits than private plans, because projected gains 30 years hence could be used to offset near-term losses, at least on paper.

No longer. With the new rules, accounting and financial reporting of public employee pensions by state and local governments has to become more realistic. Even though the Board does not have enforcement power, states often require that that public plans follow the Board's guidelines. Furthermore, bond raters take into consideration whether Board guidelines are being followed.

As of June 15, 2014, governments offering defined benefit plans will have to include in their financial statements a figure on net pension liability (the difference between the projected benefit payments and the assets the government has set aside and restricted to the payment of benefits). The Advisory Board also calls for immediate recognition if a government's pension expense increases-whether from changes in benefit terms or from annual service costs and interest.

The financial statements must also acknowledge changes in the economic and demographic assumptions used in benefit payment projections, as well as differences between assumptions and actual experiences.

Funds considered adequately funded (pension systems having sufficient assets to pay the pensions of current employees and retirees) can keep forecasting rates of return according to historical averages (usually about 8 percent). Those that aren't adequately funded must lower their projected rate of return to match that of a tax-exempt 20-year, AA-or-higher rated municipal bond, between three and four percent.

The Board has also increased states' reporting requirements, such as disclosures of the types of benefits provided, how contributions are determined, and the assumptions and methods behind the net liability calculations.

Although private plans can reduce employee benefits and increase contributions to bring underfunded plans into financial health, many public sector plans have been prohibited from doing this by the courts from doing this. New employees can be charged a higher contribution rate for lower benefits, but not current employees who were hired under more favorable terms. Underfunded public pension plans have to be paid either with taxpayers' dollars, or with increased contributions from new state employees, or both.

What can states do? For new workers, they could gradually raise the retirement age, and convert pension plans to defined-contribution plans, such as 401(k) plans in the private sector, which have been gradually displacing corporate defined-benefit pensions.

The accounting standards board has performed a service to taxpayers and public sector employees by requiring more honest accounting for state pensions. Too bad Congress, in search of funding for the infrastructure bill, is fudging the numbers for private pensions.

Diana Furchtgott-Roth, former chief economist at the U.S. Department of Labor, is senior fellow and director of Economics21 at the Manhattan Institute. Follow her on Twitter: @FurchtgottRoth.   

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