The New Pension Accounting and Its Impact on Funding

1. The New Pension Accounting and Its Impact on Funding CSFMO Oakland, California February 21, 2013

2. gasb statement no. 68 Summary of changes

3. Our focus • Employers in single employer and agent multiple-employer defined benefit plans • Employers in cost-sharing plans

4. Single-employer and agent plans Changes for employers

5. Preliminary • Only relevant for economic resources measurement focus and accrual basis of accounting • No effect on governmental funds • Report expenditures rather than expense • No effect on fund balance

6. Key changes • Employer liability • Employer expense • Discount rate • Actuarial method • Amortization • Timing

7. 1. Employer liability • Now: Annual required contribution (ARC) Less: Actual contributions Net pension obligation (NPO) • Future: Total pension liability (TPL) Less: Fiduciary net position (FNP) Net pension liability (NPL)

8. Employer liability - Illustration

9. 2. Employer expense • Now: • Calculation tied to funding • ARC adjusted for the cumulative effect of prior differences between required contributions and actual contributions • Future: • Calculation tied to cost • Changes in the net pension liability (NPL)

10. Components of expense • Annual service cost • Interest on the net pension liability • Projected earnings on plan investments • The full effect of any changes in benefit terms • Amortization of deferred outflows/inflows of resources

11. 3. Discount rate • Now: • Estimated long-term investment yield for the plan, with consideration given to the nature and mix of current and expected plan investments • Future: • Modification necessary if it is expected that FNP will not be sufficient to pay benefits to active employees and retirees • Single blended rate

12. Discount rate – single blended rate • Single rate equivalent to the combined effect of using the following rates: • For projected cash flows up to the point the FNP will be sufficient • Long-term expected rate of return on plan investments • For projected cash flows beyond that point • A yield or index rate on tax-exempt 20-year, Aa-or-higher rated municipal bonds.

13. 4. Actuarial method • Now: • Whatever actuarial method is used for funding • Six acceptable methods • Must be applied within parameters defined by GASB • Future: • No tie to actuarial method used for funding • All employers will use the entry age method for accounting and financial reporting purposes (with service cost determined as a percentage of pay)

14. 5. Amortization • Background • Circumstances that could affect the net pension liability (NPL) • Changes in benefit terms • Changes in economic and demographic assumptions • Differences between economic and demographic assumptions and actual experience (other than investment returns) • Differences between expected and actual investment returns • Now: • Effect amortized over a period not to exceed 30 years • Future: • Effect to be amortized over a much shorter period • Different periods, depending on the circumstances

15. Future amortization periods • Changes in benefit terms • Immediate recognition • Changes in economic and demographic assumptions • Closed period equal to average remaining service period of plan members (average remaining service period of retirees = 0 years) • Differences between economic and demographic assumptions and actual experience (other than investment returns) • Closed period equal to average remaining service period of plan members (average remaining service period of retirees = 0 years) • Differences between expected and actual investment returns • Closed 5-year period (including current period)

16. 6. Timing • Now: • Timing of actuarial valuation • Within 24 months of start of valuation period • Future: • Measurement date for assets and TPL • No earlier than 1 year + 1 day prior to reporting date • Actuarial valuation date • Up to 30 months before employer reporting date • Update to “roll forward” to measurement date

17. Cost-sharing plans Changes for employers

18. Key changes • Employer liability • Employer expense

19. 1. Employer liability (cost-sharing) • Now: • Liability only if employer contribution is less than the contractually required amount • Future: • Liability equal to the employer’s proportionate share of the total NPL of all participating employers

20. 2. Employer expense (cost-sharing) • Now: • Expense = contractually required contribution • Future: • Expense = employer’s proportionate share of total pension expense of all participating employers

21. Effective Date Employers

22. Effective date of GASB Statement No. 68 • Implementation first required • Fiscal year ending 6/30/15 • Earlier application encouraged • Requires cooperation of the pension plan

23. Funding challenge Accounting v. funding

24. Background: Historic contribution of GASB Statement No. 27 • Set parameters to ensure reasonable application of actuarial methods • Displayed whether employers were meeting the goal of systematic and rational funding each period • Highlighted the cumulative financial impact of underfunded contributions • Information on funding progress also provided • Notes • Required supplementary information (RSI).

25. Changes resulting from GASB Statement No. 68 • Elimination of GASB parameters • Compromises the usefulness of the actuarially determined contribution (ADC) for other purposes by eliminating standardization • No automatic requirement to provide information on funding progress • Required only if an ADC is calculated or contribution is statutorily mandated

26. Development of pension funding guidelines Response to GASB Statement No. 68

27. Objective • Provide guidance on funding in the wake of GASB Statement No. 68 • Take advantage of the fact that GASB Statement No. 68 requires the presentation of funding data if an ADC is used for funding purposes

28. Task force • Convening organization – Center for State and Local Government Excellence • Membership • “Big seven” • Other organizations invited to participate

29. “Big seven” • National Governors Association (NGA) • National Conference of State Legislatures (NCSL) • Council of State Governments (CSG) • National Association of Counties (NACo) • National League of Cities (NLC) • U.S. Conference of Mayors (USCM) • International City/County Management Association (ICMA)

30. Other participating organizations • National Association of State Auditors, Comptrollers and Treasurers (NASACT) • Government Finance Officers Association (GFOA) • National Association of State Retirement Administrators (NASRA) • National Council on Teacher Retirement (NCTR)

31. Approach • Closely modeled on the work of the California Actuarial Advisory Panel

32. Structure • Five policy objectives • Starting point = funding based upon an actuarially determined ARC • Application of policy objectives to three core elements • Actuarial costs • Asset smoothing • Amortization policy • Recognition that employers may need to adopt a transition plan to phase in the new practices over a period of years.

33. General policy objectives • Actuarially Determined Contributions • Funding Discipline • Intergenerational equity • Contributions as a stable percentage of payroll • Accountability and transparency

34. Actuarially determined contributions • A pension funding plan should be based upon an actuarially determined annual required contribution (ARC) that incorporates both the cost of benefits in the current year and the amortization of the plan’s unfunded actuarial accrued liability.

35. Funding discipline • A commitment to make timely, actuarially determined contributions to the retirement system is needed to ensure that sufficient assets are available for all current and future retirees.

36. Intergenerational equity • Annual contributions should be reasonably related to the expected and actual cost of each year of service.

37. Contributions as a stable percentage of payroll • Contributions should be managed so that employer costs remain consistent as a percentage of payroll over time.

38. Accountability and transparency • Clear reporting of pension funding should include an assessment of whether, how, and when the plan sponsor will meet the funding requirements of the plan.

39. Next steps for GFOA Best Practices

40. Overall best practice • “Guidelines for Funding Defined Benefit Pensions” • Every state and local government that offers defined benefit pensions should formally adopt a funding policy that provides reasonable assurance that the cost of those benefits will be funded in an equitable and sustainable manner. • Such a funding policy should incorporate each of the four principles and objectives • Obtain ADC • Balance stable contributions and equitable allocation • Commit to funding full amount (with transition period, if needed) • Provide information needed to assess funding progress

41. 1. Obtain ADC • Every government employer that offers defined benefit pensions should continue to obtain no less than biennially an actuarially determined contribution (ADC) to serve as the basis for its contributions

42. 2. Balance contributions/allocation • The ADC should be calculated in a manner that fully funds the long-term costs of promised benefits, while balancing the goals of 1) keeping contributions relatively stable and 2) equitably allocating the costs over the employees’ period of active service

43. 3. Commit to funding full amount • Every government employer that offers defined benefit pensions should make a commitment to fund the full amount of the ADC each period. For some  government employers, a reasonable transition period will be necessary before this objective can be accomplished

44. 4. Transparency • Every government employer that offers defined benefit pensions should demonstrate accountability and transparency by communicating all of the information necessary for assessing the government’s progress toward meeting its pension funding objectives

45. Future best practices • The GFOA intends to develop additional best practices that will provide specific guidance on the practical application of these principles and objectives to each of the three core elements of a comprehensive pension funding policy • Actuarial cost method • Asset smoothing • Amortization.

46. Auditing challenge Participants in multiple-employer plans

47. Cost-sharing plans • Issues: • Who should calculate the allocation percentages? • Who should calculate the allocated pension amounts?

48. Potential solution 1 • Opinion from plan auditor on • Supplemental schedule of employer allocations in plan financial statements • Either: • Supplemental schedule of plan pension amounts • Net pension liability • Deferred outflows • Deferred inflows • Pension expense • Supplemental schedule of employer pension amounts

49. Example

50. Example