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VA: New pension accounting rules could incentivize risk

By   /   December 12, 2012  /   No Comments

By Carten Cordell │ Watchdog.org, Virginia Bureau

ALEXANDRIA — New reporting rules from the Governmental Accounting Standards Board for how pension debt is reported will begin next year.

The move is part of an effort to bring consistency and clarity to state employee benefit programs, but with that so-called clarity also comes the possibility of riskier investments wagered to compensate for languishing state funding gaps.

The Virginia Retirement System is projected to adopt new pension accounting rules set by the Governmental Accounting Standards Board in FY 2014.

GASB is an independent organization charged with establishing accounting reporting standards for U.S., state and local governments. To provide greater transparency it made two rule changes to how state pension plans are reported.

At the heart of these changes is how states and localities calculate the discount rate — the projected growth rate of the assets invested by the respective pension program.

When legislatures decide how much money to allocate to their retirement systems, the discount rate is deducted from the final number, thus assuming asset growth over a designated period of time will make up the difference.

For the Virginia Retirement System, the discount rate is 7 percent, assuming that rate of growth over a 29-year period  known as the amortization period.

Critics have said that many states have set their discount rates too high, projecting rosy investment returns that have not come to fruition and failing to to keep pension plans fully funded.

The new GASB rules seek to provide a clearer picture by using a blended-rate system to calculate the health of the pension plan, called such because it splits the liability of the pension plan into two discount rates.

“The way it works out, pragmatically speaking, is to use the rate-of-return on assets up until the plan runs out of assets,” said Eileen Norcross, senior research fellow at the Mercatus Center of George Mason University in Fairfax. “The year it runs out of assets, and then you use a lower discount rate.”

Beginning in June 2013, state pension plans will still use a discount rate on asset growth. If the plan is not projected to be fully funded after that date, the remaining liability will be discounted by the yield of a high-grade municipal bond, the rate-of-return on government-backed debt.

If it sounds confusing, it’s because it is.

A November 2011 paper by the Center for Retirement Research at Boston College said this regarding the new GASB rule: “It makes no theoretical sense for two identical streams of benefits to have different values based on the funded status of the plan. Having the present discounted value of liabilities depend on both the long-run expected rate of return and on the funded status makes the numbers even more difficult to interpret and difficult to adjust for alternative returns than the current liability numbers.”

Norcross said even under the new GASB rules, the investment bets could get riskier to keep the pension plan healthy while state contributions dwindle. If the investment managers lose on their picks, the pressure ratchets up to make back the losses.

“The more poorly funded a plan is, the more dramatic the effect of this rule,” she said. “They double-down on the strategy when the market tanks because they have got to make up the losses. It’s a perverse incentive to take on more risk when they have seen the consequences of too much risk.”

This week in its biennial report to the Joint Legislative Audit and Review Commission, VRS reported the pension plan had not achieved the 7 percent rate-of-return in the past decade and, with $55 billion in assets, the state employee and teacher pension plans were only 65.6 and 62.4 percent funded, respectively.

Jeanne Chenault, spokeswoman for the VRS, said the retirement system would likely apply the GASB changes in fiscal 2014, but could not project what they would mean for the pension’s liability.

Contact Carten Cordell at carten@watchdogvirginia.org

— Edited by John Trump at jtrump@watchdog.org

 

 

 

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