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Ocean City

New accounting rules will show more volatility in city pension funds

 

(Oct. 11, 2013) As was relayed to the Ocean City Council last week, the frequent joke among industry insiders is that the common acronym for the Government Accounting Standards Board – GASB – may as well mean “guaranteeing actuaries stay busy.”

But, as has become apparent, it could also just as well stand for “giving accounting some backbone.”

Upcoming revisions by the GASB to its requirements for pension accounting – specifically rules 67 and 68 – have many municipalities fearing a drastic swing in the way their liabilities are presented.

No longer will the schedule used by municipalities to fund their obligations be the same schedule used to illustrate those long-term liabilities on GASB-approved financial reports. Instead, these numbers will now be independent of how a given government agency may have elected to fund, or not fund, their future obligations, in what was described as “a divorce of the funding of a plan and the accounting.”

“The unfunded liability had always been shown on those statements, but it was kind of hidden,” said Ed Koebel of Cavanaugh Macdonald, the city’s actuary. “The GASB wants to bring it front and center.”

The fundamental problem with assessing this liability is that pension debt is a perpetually moving target. The projections of how much the city will have to pay its retirees over their lifetimes – and how much money it must put away now to do so – are based on Cavanaugh Macdonald’s estimates of when employees will retire, how much they will be making at that point, how long they will live, and how well the city’s investment of its pension monies will perform.

The city has two separate trust funds for pension benefits – one for general employees, and another for public safety employees, who pay into the fund at a higher rate but may retire earlier as is typical with police and fire personnel.

Per-employee payment in the general employees’ plan currently average just under $13,500 per year. For police and fire personnel, that increases to just over $40,000.

“They could start receiving that benefit 30 years from now, and they could receive that benefit for 30 years. People are in the system for a long time,” Koebel said.

Estimated future pension payouts are paid for in two ways. Firstly, both the employee and the employer pay a certain amount into the fund on a per-paycheck basis, which is designed to cover the amount of post-retirement benefits earned by the employee in the given period of employment. This is known as “normal cost.”

In its upcoming reform, the GASB will be changing the calculation of normal costs from the “projected unit credit” method used by the city to the “entry age normal” method. In the former, normal costs are accrued each year on a sliding scale, depending on an employee’s tenure, and increase more as time goes on given experience and vesting.

In the latter, the total benefit accrued over the employee’s career, dependent on when he or she joined the city’s employment, is averaged over his or her entire tenure.

EAN accounting will thus accrue more liability earlier, relative to the PUC method. However, toward the end of an employees’ employment, normal cost will be relatively lower.

However, due to changes in the plan or variations in real experience versus the actuarial estimate, the city’s plans gradually accrue additional liability. A portion of this may not be covered by the current assets of the plan, even if the schedule of normal cost payments is maintained. This net is known as “unfunded accrued liability” (UAL).

The general employees’ trust currently has roughly $7.5 million in UAL: $50.7 million of outstanding liability and $43.2 million in assets, creating a funding ratio of 85.2 percent. The public safety plan, likewise, has $11.8 million in UAL.

Any increases in UAL are paid over a 10-year period, per the city’s own funding schedule. But under the new rules, the city will have to show its pension debts as if this cost was being paid over a five-year period.

One of the major contributors to UAL is the underperformance of investments. The city’s normal cost payments are discounted at a rate of 7.5 percent, to assume a return rate of 7.5 percent on the investment of the pension funds. The 2008 market crash saw the city posting negative numbers, although the increased UAL resulting from this was realized over a graduated period of five years in order to reduce sticker shock.

“That was about $2.2 million in new UAL that we were recognizing each year over five years,” Koebel said.

Although the city can continue to smooth its losses for funding purposes, it will now have to show everything real-time on its GASB-regulated statements.

“If you have a big dip, like we did in 2008-2009, your funding will still be based on that smoothing, but the actual market value [of the pension fund] will show some real volatility,” Koebel said.

Under the new GASB rules, the city will also have to provide projections for its pension liabilities assuming one percentage point over and under the 7.5 percent return assumption.

“If you discount it back at 7.5 percent, you get around $66 million in liabilities [for the general employees’ plan],” Koebel said. “If you discounted it back at a lower rate, it would be more. At a higher rate, it would be less.”

This total – $65.9 million, to be exact – takes into account the general employees’ current liability as well as the future normal costs over the life of the employee base. This number is finite, given that the general employees’ plan was closed to new entrants in 2011.

“There will be future accruals for active members, but we don’t see that number increasing much in the next few years,” Koebel said. “Once we get down to less active members and the retiree population starts to die off, we’ll see that number decrease.”

This is not the case with the public safety plan, which was re-opened this year to accept new police officers, albeit at a lesser benefit. Future liability on that plan is at $71.5 million, but will continue to accrue over an indefinite period.

“At some point [with the general employees’ plan], we’ll have a stopping point, even if it’s 60 years from now when the last retiree passes on. The public safety plan will not,” said Councilman Brent Ashley, who voted against re-opening the latter.

This year, the town will contribute $5.7 million in normal costs and the 10-year amortization of current UAL for both plans. This on top of the $1.6 million in normal costs contributed by employees.

Ashley also asked Koebel if the same GASB reforms would be forced onto the city’s trust for retiree medical benefits, which currently holds another $46 million in accrued liability and only $15.5 million in assets.

“We anticipate that they’re going to make similar changes, but they don’t intend to send out an exposure draft until 2015, so it could be 2017 or 2018 before those changes come through,” Koebel said. “If this is what they’re going to do for pensions, they sort of have to do the same for medical benefits as well. It’s definitely coming.”

 

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