New Accounting Rules to Identify Unfunded Pension, Benefit Liabilities

New Accounting Rules to Identify Unfunded Pension, Benefit Liabilities
December 1, 2006

While there has been a great deal said in recent years about the impending problems with financing the Social Security, Medicare, and Medicaid systems, much less attention has been paid to similar problems with public employee pensions and other post-employment benefits (OPEB) for public employees, such as health care.

Revised rules from the Government Accounting Standards Board (GASB) are changing that, bringing increased attention to the problem by requiring government bodies to report on these obligations.

The rules, initially codified in 2004 with compliance to begin phasing in this December, require state and major local governments to account for the actuarial liabilities of post-employment benefits and amortize the expense over 30 years.



May Top $1 Trillion

Under the new rules, government bodies now must acknowledge hundreds of billions of dollars of liabilities that have not been accounted for previously. In August, JP Morgan released a preliminary estimate projecting the present value of unfunded government employee health care and other non-pension benefits at between $600 billion and $1.3 trillion.

In mid-October Chris Edwards, director of tax policy at the Cato Institute, released a report putting the number at $1.4 trillion.

The GASB statements include phased-in deadlines for compliance. The effective date for governments with revenues of $100 million or more is December 15, 2006; for those with revenues of $10 million or more but less than $100 million it is December 15, 2007; and for those with revenues of less than $10 million it is December 15, 2008.

States only recently have begun to seriously analyze their potential unfunded liabilities for retiree health care and other non-pension benefits.



Beginning to Tally

"Delaware would need about $3.9 billion if it were to set up the kind of perpetual account required to fully fund the liability in one shot. It already has set aside $28 million and is developing a plan to phase in the fund over time," said an October 9 article in The News Journal of Wilmington, Delaware.

Delaware Deputy Finance Secretary Tom Cook told the Journal it would cost the state an additional $200 million per year over 30 years to fund the benefit fully. Currently the state spends about $100 million per year to pay health care benefits for the more than 20,000 pensioners covered under its program, according to the Journal.

And Delaware is a small state.

In Alabama, officials estimate the state's unfunded liability for state employees and teachers over the next 30 years could be nearly $20 billion.

The Montgomery Advertiser took note of this in an October 11 editorial, calling the estimate "a colossal unfunded liability that should give pause to every Alabama taxpayer."



No Set-Aside Requirement

There is no requirement in the GASB standards that governments begin to set aside money for these obligations, though the standards do require that financial statements amortize them over the anticipated career of the employees, typically 30 years.

However, not funding these liabilities could damage a state or local government's bond rating and increase the cost of borrowing.

The October 11 Montogomery Advertiser editorial noted this, calling for a plan to meet these costs: "Without such a plan or at least the satisfactory beginnings of one, the state's bond rating could suffer, adding greatly to the cost of issuing bonds for state projects."

Don Rueckert, Jr., an actuary and senior vice president at Aon, an international risk management and employee benefits consulting firm, said few lawmakers understand the GASB statements are much more than an accounting change.

"Interpret this as a financial crystal ball," Rueckert said, pointing out that after an actuarial analysis of retiree health care obligations, "most people are amazed at the gargantuan unfunded liabilities. It's not uncommon for government officials to see their cash outlays will double in a four- to five-year period, or triple in six to eight years," Rueckert said.



Retirees More Expensive

Demographic trends--more retirees living longer and using health services that are climbing in cost--are the big reason for the skyrocketing liabilities.

Rueckert said the cash-flow implications are huge. Governments currently pay for non-pension benefits as the bills roll in, with no money set aside for future liabilities.

"Where will these monies to fund these liabilities come from?" Rueckert asked. "What priorities will need to be reconsidered? It's going to be a big issue. Probably 90 percent of these OPEB programs have no assets funding them."

In its "plain language" explanation of the new rules the GASB notes:

"Although the OPEB may not have the same legal standing as pensions in some jurisdictions, the GASB believes that pension benefits (as a legal obligation) and OPEB (as a constructive obligation in some cases) are a part of the compensation that employees earn each year, even though these benefits are not received until after employment has ended. Therefore, the cost of these future benefits is a part of the cost of providing public services today."



Attention Increasing

The GASB statements on financial reporting of pensions and OPEB were initially issued in April 2004 and June 2004, respectively. At the time, the statements received little attention except from those directly involved with the administration of these benefits and those responsible for accounting for them.

In February 2006 the Commonwealth Foundation of Pennsylvania issued "Beneath the Surface," a comprehensive report on state employee pension and OPEB obligations. The report called accounting for OPEB "problematic," explaining most state retiree health care costs were incurred on a "pay-as-you-go" basis. The report predicted the GASB statement on OPEB would "dramatically change" state budgets.

In April 2006 the Rockefeller Institute of Government issued "Retiree Pensions and Health Care Benefits: State and Local Governments Face New Budget Challenges," which said the unfunded liability of health care costs for retirees may be greater than the unfunded liability for pension benefits.

The report used as an example the state of Maryland, which shows an unfunded liability of $4.6 billion for pensions but a staggering $23 billion for retiree health care.



Another Blow to Defined Plans

It remains to be seen whether small, local government units have done a better job in preparing for these obligations--and, if they have not, what they will do about them now.

Rueckert said for years the belief has been that people who work for government would receive lower pay than their private-sector counterparts in exchange for better benefits in retirement. He said as private-sector workers increasingly see the bills come due for government workers who retire younger and with better pension and health care benefits, "That's going to get thrown out on its head."


David Denholm (david@psrf.org) is president of the Public Service Research Foundation in Vienna, Virginia.


For more information ...

Information on the Government Accounting Standards Boards Statements Nos. 43 and 45 is available at http://www.gasb.org.

The Commonwealth Foundation of Pennsylvania report, "Beneath the Surface," is available through PolicyBot™, The Heartland Institute's free online research database. Point your Web browser to http://www.policybot.org and search for document #19898.

The Rockefeller Institute of Government report, "Retiree Pensions and Health Care Benefits: State and Local Governments Face New Budget Challenges," is also available through PolicyBot™. Search for document #19899.