The balance sheets of Arizona cities, towns and counties will look very different next year simply because of changes in some key accounting rules. While accounting rules generally do not raise the interest of taxpayers, the new accounting standards on public pensions will require local governments to publish their long-term pension obligations. Addressing the long-term costs of public pensions has been a major focus of many conservative groups and this new disclosure may add new fuel to their interest.
The Governmental Accounting Standards Board, commonly known as GASB, is an independent organization that establishes accounting and reporting standards for state and local governments. Founded in 1984, GASB is recognized by governments, the accounting industry, and most importantly, the capital markets, as the source for generally accepted accounting principles (GAAP) for state and local governments. Effective in 2014, GASB is requiring governments to report their long-term pension obligations. This change may materially affect a government’s credit rating, depending upon the extent of the government’s unfunded pension liabilities. Governments whose unfunded pension obligations are severe may suffer material decreases in their credit ratings, and to avoid such a result, may need to resort to pension obligation bonds to pay off their unfunded liabilities.
GASB standards have been accepted as part of the audit process, where auditors are required to render opinions on the fairness of financial statement presentations in conformity with GAAP. Thus, they are a significant source of data for the private rating agencies, such as Standard and Poor’s, Fitch, and Moody’s. The rating agencies can make or break state and local government budgets by ascribing credit ratings to state and municipal bonds. The increased cost of such funds can significantly impact government budgets and could reduce taxpayers’ willingness to support bond elections.
The literature predicting how much local government bond ratings will be impacted by changes in governmental plan reporting is all over the map; some authors forecast doom and gloom, while others claim the changes in GASB will be barely discernible. What is not debatable is that the long-term pension obligations will get more exposure from the public.
While the prior GASB standards focused on plan expenses, the new standards shift the focus to balance sheet items and view pensions as part of an employee’s compensation. The prior standards reported “Annual Required Contributions” (ARC). This consisted largely of annual required contributions and calculated pension liability as the difference between the ARC and actual pension contributions. The new standards now compute the plan’s unfunded liabilities by ascertaining the “Net Pension Liability” (NPL), which is the difference between a plan’s total pension liability and its net assets at a specific time. The upshot of this change in focus will mean the reporting of NPL as a balance sheet item on the employer’s government-wide financial statement.
For many local governments, such changes in reporting couldn’t have come at a worse time. Still reeling from the effects of the Great Recession that has caused many plans to lower assumptions for investment returns, and already experiencing substantial declines in current plan funding ratios, the changes in reporting methods and inclusion of unfunded pension liabilities on governmental balance sheets has been met with concern and in some instances, outright panic. Since a significant number of state and local plans are underfunded there is little doubt that the new GASB reporting will in many cases have a material impact on governmental balance sheets.
While the changes in GASB standards in reporting pension liabilities will dramatically affect governmental balance sheets, those changes alone do not appear to faze the rating services. Standard & Poor’s, Fitch and Moody’s have apparently analyzed strengths and weaknesses concerning the new reporting scheme and while generally applauding it as a means to provide transparency, appear to have focused on underlying fundamentals, rather than merely a myopic review of reports, in their endeavor to provide ratings. It will be even more interesting to see how taxpayer and conservative watchdog groups see these changes. For the rating services, unfunded pension liabilities, funded ratios, discount rates and pension reform, appear to be more important in taking on such a review. This conclusion will no doubt be tested by the first round of reporting under the new GASB standards for the reporting period ending in June 2014. We will then see whether the rating agencies follow their own rhetoric described in their respective reports. What will be even more interesting is to see how the GASB standards impact elected officials’ behavior and campaign politics.
— Marc Lieberman, chairman, Kutak Rock’s Public Pension Group; Mark Lasee, Kutak Rock.