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Business and Policy Areas
Business and Policy Areas

Proposed Pension Changes Will Impact Public Institutions

August 26, 2011

The Governmental Accounting Standards Board (GASB) has issued an Exposure Draft that will mandate new measurement and reporting requirements for governmental employers that provide defined benefit pension plans to their employees. Many public institutions could face liability recognition. The deadline for submitting comments is September 30.

The Pension Exposure Draft proposes that governments be required to report in their statement of financial position a net pension liability, which is the difference between the total pension liability and net assets (primarily investments reported at fair value) set aside in a qualified trust to pay benefits to current employees, retirees, and their beneficiaries.

Employers are classified in one of the following categories for purposes of this proposed Statement:

  1. Cost-sharing employers are those whose employees are provided with defined benefit pensions through cost-sharing multiple-employer pension plans—plans in which the participating employers pool or share their obligations to provide pensions to their employees and plan assets can be used to pay the pensions of any participating employer’s employees. The proposal would require that each governmental employer report a liability that is equivalent to its share of the collective pension fund liability.
  2. Single employers are those whose employees are provided with defined benefit pensions through single-employer pension plans—plans in which pensions are provided to the employees of only one employer.
  3. Agent employers are those whose employees are provided with defined benefit pensions through agent multiple-employer pension plans—plans in which plan assets are pooled for investment purposes but are legally segregated to pay the pensions of each employer’s employees.

Multiple Employer Cost-sharing Plans

NACUBO research indicates that at least three quarters of public institutions participate in multiple employer cost-sharing pension plans. Each employer participating in a state’s retirement system typically makes an annual (contractually required) contribution that is determined by the plan administrator. Currently, public institutions disclose the amounts funded for their cost-sharing plan; there is no analysis of funding adequacy or projected obligations. Because the assets are pooled, there is no incentive to contribute more to the plan. Under the GASB proposal, if such plans prove to be underfunded, public institutions will have to recognize and report a liability. Liability recognition could have both an administrative and economic impact.

Many governmental entities that are part of multiple employer plans are questioning the type of exchange that exists when employees are promised access to the state retirement system and if the legal structure of such multiple employer plans should dictate the accounting. Is the promise of a future pension benefit made by the employer or the state pension plan? Other complexities that have yet to be explored could also affect how liability allocations are performed across multiple employers.

Other Types of Employer Plans

Underfunded single employer pension plans will also directly impact public institutions’ financial statements. Finally, although some public institutions are considered part of the state employment system and will not have to report unfunded liabilities, many fear that larger state pension expenses and liabilities will reduce appropriations.

Pensions as Compensation Exchange

Pension benefits are part of a compensation exchange between an employer and employee. Employees of governmental entities often receive two types of compensation in return for their labor—current compensation and deferred compensation in the form of post-employment benefits such as pensions. Because the promise of a pension after employment is considered an exchange for current work performed, the government has a current obligation.

September 30 Comment Deadline

NACUBO encourages public institutions to read the Exposure Draft closely and provide comments directly to GASB or NACUBO. Because legal structures and contractual language can vary from plan to plan and state to state, it is important for GASB to hear the concerns of and feedback from public higher education.

Proposal Summary

Measurement of the Pension Liability

The Exposure Draft also proposes significant changes to how a government would calculate its total pension liability and pension expense. Calculating the total pension liability involves three essential steps: (1) projecting future benefit payments for current and former employees or their beneficiaries; (2) discounting the projected future benefit payments to their present value; and (3) allocating the present value to past and future years during which the employees have worked or are expected to work.

  1. Projecting future benefits: The proposal would carry forward the general current practice of incorporating expectations of future employment-related events (such as salary increases and years of continuing employment until retirement) into projections of pension benefit payments. Pension plan provisions for automatic cost-of-living adjustments (COLAs), generally included as part of an employment agreement, statute, or ordinance, would continue to be included in projections as well. Ad hoc COLAs, which are made at the discretion of the government, would only be included if they occur with such regularity that they are substantively automatic.
  2. Discounting future benefit payments: The proposal requires that, as long as plan net assets are projected to be available to make the projected benefit payments, governments discount projected benefit payments using the long-term expected rate of return. However, at the point at which plan net assets are not projected to be sufficient, governments would discount using a tax-exempt, high-quality 30-year municipal bond index rate. Because the recommended municipal bond index rates tend to be lower than long-term expected rates of return, governments that have inadequate net plan assets will recognize a larger net pension liability.
  3. Allocating the present value: Once the projected benefit payments have been discounted to their present value, they are allocated over a period related to the working years when the employees earn benefits. Under the proposal, governments would use the entry-age normal actuarial cost method to allocate present value, and would do so as a level percentage of payroll. Under this method, projected benefits are discounted to their present value when employees first begin to earn benefits and attributed to employees’ expected periods of employment until they leave.

Measurement of the Pension Expense

Pension expense is determined using a combination of immediate recognition of items that affect the pension liability and over-time recognition of either deferred inflows or outflows of resources that do not immediately affect the pension liability.

The following are examples of items that immediately impact the net pension liability:

  • Benefits that are earned each year
  • Interest on the total pension liability at the beginning of the year
  • Changes in the terms of the benefits to be provided to retirees
  • Projected earnings on plan investments
  • Changes in the value of plan assets other than investments

Examples of deferred pension outflows of resources or deferred pension inflows of resources that are introduced into the expense calculation gradually over the remaining years of employment of active employees include:

  • The effect of differences between economic and demographic assumptions and actual experience, as it relates to current employees
  • The effect of using new economic and demographic assumptions, as it relates to current employees.

Finally, the effect of differences between the expected return on plan investments and actual experience would be recognized as deferred outflows of resources or deferred inflows of resources and are recognized as pension expense over five years.


Sue Menditto
Director, Accounting Policy