Weaknesses in pension plans amplified by GASB, Moody’s rule changes

Thursday, Jul 26, 2012, 07:30AM CST
By Curt Olson
calculator and money

Imagine Houston or Fort Worth cutting police and firefighters. Or Harris and Tarrant counties having less money for construction or to repair roads or to maintain parks.

Or any number of Texas municipalities asking for a tax increase.

A pair of moves this summer, by the Governmental Accounting Standards Board and Moody’s, will almost certainly bleaken the financial outlook for municipalities here and across the country.

Just how seriously these changes will affect state and municipal pensions in Texas will be reflected in a report by the state Pension Review Board expected sometime in October, Chris Hanson, the board’s executive director, said.

Moody’s, the corporate and municipal bond-rating firm, recently warned public officials it was changing how it accounts for pension debt for cities, counties and states. The changes would triple, on paper, total taxpayer liabilities for underfunded pensions to $2.2 trillion from its $766 billion in 2010.

This deeper public red ink might result in lower bond grades for some cities, counties and states, making it more expensive to borrow and leaving less money to spend on public services.

At the same time, the Accounting Standards Board made changes to its accounting standards long used by state and local governments to better reflect the actual return on investments made, particularly by public-sector defined-benefit plans.

When those changes are in place, the weaknesses in funding the state’s public pension plans will be magnified, most acutely in Houston and Fort Worth, said Josh McGee, a public pensions analyst for the Houston-based Laura and John Arnold Foundation.

Houston’s pension payments of $165 million this year, as the Houston Chronicle reported, could rise significantly. New pension accounting rules will weaken Houston’s pensions, but officials don’t know how much, Houston city spokeswoman Jessica Michan said in an e-mail to Texas Watchdog.

Fort Worth officials, trying to close a nearly $1 billion funding gap, are discussing changes to pension benefits, the Fort Worth Star-Telegram reports here. Fort Worth officials did not respond to a request for comment.

Josh McGeeJosh McGee

Action, McGee said, must be taken immediately. “The problem is more acute at the municipal level,” he said. “It actually influences how money is going out the door today.”

The drive to become more realistic about accounting for pension debt has become more intense after four years of recession and growing dissatisfaction with government debt at all levels.

Pension reformers point to municipal bankruptcy and the slashing of pension benefits in Rhode Island as a portent of pension debt that threatens to swallow many more cities and, maybe, states.

Moody’s is reacting by making its debt estimates more realistic and adjusting its bond ratings accordingly, McGee said. When Moody’s downgrades a bond rating the cost for a municipality to borrow increases, money that must be found either in increased taxes or cutting government services, he said.

"Pension liabilities are widely acknowledged to be understated," Timothy Blake, Moody’s managing director, said in a news release. "Moodys’ view on pension-related exposure has been reflected in a number of recent downgrades and negative outlooks, including for the states of Illinois, New Jersey and Rhode Island, and the cities of Chicago and Providence.”

To get a more realistic picture, Moody’s decided to make its rating based on the true value of plan assets at the reporting date and implementing a high-grade long-term corporate bond index discount rate.

Moody’s is actually getting out in front of the Accounting Standards Board, whose rules changes are unpopular with many cities and pension funds, including Paris, Denison, Killeen and the Lubbock Texas Fire Pension Fund.

The new rules, however, will not go into effect until 2014.

Among the controversial changes is lowering the discount rate to 5.5 percent from 8 percent, as National Public Radio reported. For years the Standards Board made provision for public pensions to assume an 8 percent investment return for accounting purposes.

Also, “smoothing,” as the actuaries call it, did not account for the stock market losses in 2008 and 2009 that rocked pensions like the Teacher Retirement System of Texas and the Employees Retirement System of Texas.

Economists wanted GASB to adopt rules for public pensions to align with private-sector, defined-contribution plans, such as a 401(k). This was sought by Andrew Biggs, a pensions scholar at the Washington, D.C.-based American Enterprise Institute. Biggs contends eliminating smoothing and lowering the discount rate could drop a public pension funding ratio by up to 20 percent.

Instead, GASB officials decided:

  • The sponsoring public entity must report net pension losses at the time of the loss, without any smoothing.
  • To use a hybrid discount rate. The plan’s assumed investment rate will be applied to the underfunded part of the pension projected to be paid with current assets. The remainder will be discounted to the Moody’s standard of AA municipal bond rate.

The teacher and employee retirement systems are two of the strongest pension plans in Texas, but even their officials aren’t sure what the changes will mean for them.

“The net impact of the new standards will almost certainly be a higher amount for the reported unfunded liability,” ERS spokeswoman Catherine Terrell said in an e-mail to Texas Watchdog.

“We haven’t done all of the calculations on it, but we know the (underfunding) will go up,” TRS Deputy Director Ken Welch told TRS trustees last Friday.

***
Contact Curt Olson at curt@texaswatchdog.org or 512-557-3800. Follow him on Twitter @olson_curt.

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Comments
Tough Love
Thursday, 07/26/2012 - 09:44PM

It's WAY PAST time for a 50+% cut in the pension accrual rate for FUTURE service for CURRENT employees .... to bring them in line with what Private Sector taxpayers (whose contributions and the investment earnings thereon happens to pay for 80-90% of public Sector pensions) typically get in retirement contributions from their employers.

Yes a 50% cut for misc. workers and a 75% cut (yes 75%) for safety workers.