A recent change by the Governmental Accounting Standards Board, known simply by the acronym GASB, forces government bodies to be more transparent in reporting pension liabilities and long-term commitments for retiree heath care. Among the changes: the liabilities must be reported on the first page of financial reports instead of being buried in a footnote.

“Applying accounting standards can sometimes be complex, but identifying the right standards to apply should be straightforward,” GASB Chairman David A. Vaudt said of a slew of accounting changes.

While changes in accounting rules may not garner time on the evening news, accounting rules have been the primary method for forcing governments to address the rising cost of unfunded pension and health care liabilities. In 2007, the board began implementation of GASB 45, a change in accounting rules that, for the first time, forced government bodies to disclose their pension liabilities. That change was enough to put the issue of pension liabilities on the mainstream public radar.

California’s next major liability: Other Post-Employment Benefits

Although governments have been slow to address the problem of unfunded pension liabilities, the government accounting board nonetheless raised the profile of the issue. With its most recent changes, GASB is likely to drive a conversation about “other post-employment benefits.” Health care benefits are the biggest and most common post-employment perk, which can also include life insurance, disability coverage, legal assistance and other services.

From an accounting perspective, it’s easier to budget for pension liabilities than other post-employment benefits. Due to court rulings, governments have little authority to reduce or change promised pensions. That makes it a liability with a present-day obligation.

In contrast, other post-employment benefits do not have the same legal protections as pensions. As Bloomberg noted earlier this year, “The Supreme Court unanimously decided that retiree health benefits are not necessarily guaranteed.” That case involved private sector workers. In theory, the Court’s ruling could also extend to the public sector.

“Consequently, some governments may be able to change the benefits or employees’ eligibility to receive benefits, or even stop providing benefits altogether, whenever they wish,” GASB explains in a newly published fact sheet. “These facts raise questions about whether OPEB is a liability that should be reported in the financial statements.”

Although the new accounting standards force governments to disclose the liabilities, it does not require governments to set aside funds or budget for the future. “How a government actually pays for OPEB is a policy decision made by government officials,” the board explains.

“These newly published OPEB standards will give financial statement users a much more complete picture of how much state and local governments have promised in retiree benefits—and how much those promises actually cost,” Vaudt, who serves as chairman of the government accounting standards board, said in a press release. “Together with the Board’s recent pension standards, these standards will provide consistent and comprehensive guidance for the full suite of postemployment benefits that governments provide to their employees.”

Rising cost of unfunded health care liabilities

Ed Mendel, who covers the state’s pension issues at CalPensions.com, points out that the rising unfunded liabilities arising from promised retiree health care benefits is skyrocketing. Since 2007, the retiree health care liability for state workers has increased by $24.2 billion. Retiree health care benefits provided to state workers now exceeds $72 billion – more than the state’s unfunded pension liability.

“State worker retiree health care has been one of the fastest-growing state expenses: $1.9 billion next fiscal year, up fourfold from $458 million in 2001,” notes Mendel, one of the state’s top journalists covering pensions. “It’s also one of the most generous benefits, requiring no contribution from most state workers.”

Governor Jerry Brown

This year, Governor Jerry Brown raised the issue of retiree health care benefits with his January budget proposal. As Mendel notes, the governor is looking to move the state away from “pay-as-you-go” funding in favor of pre-funding future health care benefits. By paying in advance, governments are able to reap the benefits of investing the funds and earning more money through appreciation and interest.

“If we don’t rein things in, then down the road there will be drastic cuts, just like there were over the last 10 years,” Brown said earlier this year. “It’s either stop and start or steady as you go.”

The governor’s proposal could be a double-edged sword for the state’s long-term budget picture. By negotiating changes to retiree health care benefits, some analysts believe it increases the chances that courts will protect the benefit as an irrevocable contractual obligation.

Both CalPERS and CalSTRS’ funds have performed better lately, even as members are living longer. CalPERS is doing much better since 2008, when it lost 27.8 percent of the value of its investment portfolio as the Great Recession struck hard. According to its latest Comprehensive Annual Report, it has enjoyed double-digit positive returns for four out of the last five years, with an 18.4 percent boost in 2014.

For the fiscal year ending June 30, 2014, its fund grew 7 percentage points in a year, to an “estimated funding level of 77 percent,” which is close to the 80 percent investment advisers consider the minimum for a fiscally sound retirement fund.

For CalSTRS, the funding level was 67 percent as of June 30, 2013. Its next annual report will be out in April.

CalSTRS also is worse off because it concedes a “$74 billion unfunded liability,” a number cited in the governor’s budget proposal (p. 4). By contrast, CalPERS has only $530 million in “deferred payments.”

The governor’s budget also brings up the current costs of both of these funds (p. 132). Money going to them means less for schools, roads and the poor:

• “The Budget includes $1.9 billion General Fund in 2015‑16 for CalSTRS. The funding strategy positions CalSTRS on a sustainable path forward, eliminating the unfunded liability in about 30 years.” 

• “The Budget includes $5 billion ($2.9 billion General Fund) in 2015‑16 for state contributions to CalPERS for state pension costs. These costs include the impact of the demographic assumptions adopted by the CalPERS Board in February 2014, which reflect a mortality increase of 2.1 years for males and 1.6 years for females.” 

Returns

Both CalPERS and CalSTRS predicate the sustainability of their pension plans on an average 7.5 percent investment rate of return.

CalPERS’ 10-year average return has been 6.8 percent.

This is from CalPERS’ latest report, p. 5:

GASB 67 

In 2012, Gov. Jerry Brown approved the Public Employee Pension Reform Act of 2013, Assembly Bill 340, to bring its public pensions systems into conformity with the new federal public-pension accounting standards, Government Accounting Standards Board Statement No. 67.

CalPERS’ Comprehensive Annual Financial Report for 2014 indicates it has adjusted its investment assumptions to take into consideration that, as cited above, retirees are living longer.

However, the new GASB 67 standards do not require California pension systems to change their target rates of 7.5 percent returns. Rather, they require disclosure of what the pension fund’s liabilities would be if the rate were at the lower number.

These new standards require calculating pension liabilities on the long-term rate of return, as reflected by the safe rate of return on tax-exempt, 20 year, AA-or-higher municipal bonds. The Bond Buyer’s online calculator for 20-year, double A municipal bonds as of Jan. 26, 2015 is: 3.29 to 3.42 percent.

CalPERS’ response when those lower numbers are brought up is on its Web page, dated May 9, 2014:

“Myth: CalPERS 7.5 percent assumed annual rate of investment return is too high and cannot be achieved.

“May 9, 2014 

“Fact:

• “CalPERS investments have earned an average 7.6 percent annual return over the past 20 years and 9.4 percent over the past 30 years.
• “CalPERS investments earned 13.2 percent in Fiscal Year 2012-13.
• “CalPERS assumed rate of investment return is a long-term (20 years or more) average. Any given year is likely to be higher or lower than the assumed rate.”

Those numbers include the long boom of the Reagan-Clinton-Gingrich years of tax cuts, stable money and eventually balanced budgets, 1981-2000. But if the more sluggish economy of the past 15 years continues, or another big recession hits, then CalPERS’ assumptions might not hold up. But until then, its Midas touch of the past several years will sway many arguments.

CalPERS and CalSTRS facts

CalPERS is the largest public pension system in the world, with $296.1 billion in assets as of October 2014.  CalPERS has 586,959 retirees, reflecting assets of $504,464 per current retiree.

It has 1,715,973 total members, reflecting $172,555 in assets per member.

CalPERS employees contributed 30 percent into the fund in 2014 ($3.8 billion), while taxpayers contributed 60 percent ($8.8 billion).

CalPERS was 77 percent funded as of June 2014, with an unfunded liability of $49.9 billion (p. 7).

The CalSTRS pension fund had $188.8 billion in assets as of the end of 2014, with 868,492 former schoolteacher members, reflecting $217,388 in assets per member.  As of 2013, CalSTRS had 416,643 retirees, reflecting $453,146 in assets per retiree (p. 229).

CalSTRS was 67 percent funded, with an unfunded liability of $71 billion.  CalSTRS is a hybrid defined (guaranteed) benefit program and a 401-K plan funded by each member and by taxpayers.