GASB Approves New Accounting Standard for Pension Plans
The Governmental Accounting Standards Board (GASB) approved new accounting standards for pension accounting and financial reporting on June 25, 2012. GASB 67 provides for accounting with respect to pension plans and the trusts for such plans and replaces GASB 25. GASB 68 provides for financial reporting by employers with respect to pension plans and replaces GASB 27. The full text of the final statements will not be available until August. The following alert is based on our understanding of decisions the Board made since the Exposure Drafts were issued, but will need to be confirmed when the full text becomes available.
The final statements largely reflect the requirements of the Exposure Drafts issued last year with a few significant changes. The basic changes retained from the Exposure Drafts are:
- Accounting and financial reporting have clearly been divorced from any contribution requirements,
- Balance sheet drives annual pension expense (instead of the reverse),
- Increased uniformity of actuarial methods,
- More timely information for users of financial statements, and
- Significantly more volatile annual pension expense.
- Later effective dates: New GASB 67 is effective for trust years beginning after June 15, 2013. New GASB 68 is effective for fiscal years beginning after June 15, 2014.
- More flexible measurement dates: Both multiple employer and cost-sharing plans will only have one measurement date instead of separate dates for each employer's fiscal year end.
- Consistent deferred recognition periods: Active employee and inactive employee gains and losses and assumption changes are recognized over the same period (average working lifetime including inactive employees in the determination).
- More flexible proportionate share calculation for cost-sharing plans: Employers participating in cost-sharing plans report based on their proportionate share of plan costs. The changes and additional flexibility will make this calculation more accurately represent the future responsibility of each employer.
Dates and Timing
The reporting date for employers is the end of their fiscal year; and for plans, it is the end of the trust year. However, the pension amounts reported on the reporting date are based on a measurement date which can be the same as the reporting date or as early as the end of the prior fiscal year. For example, for the fiscal year ending June 30, 2015, the measurement date could be any date from June 30, 2014 through June 30, 2015.
The fair value of plan assets must be as of the measurement date. But, the total pension liability can be based on an actuarial valuation as of the measurement date or rolled forward to the measurement date from an actuarial valuation as of a date that is no more than 24 months prior to the plan's year end and no more than 30 months plus one day prior to the employer's fiscal year end. The table below shows the earliest measurement and valuation dates permissible for a couple hypothetical plans and employers.
|Illustration of Timing Requirements|
|Plan Year End||Employer Year End||Earliest Measurement Date||Earliest Actuarial Valuation Date|
In many cases, the plan and employer year ends are the same. As shown in the table above, if both year ends are June 30, 2015, the earliest measurement date is June 30, 2014 (one year earlier) and the earliest valuation date is June 30, 2013 (two years earlier). However, if the plan year end is December 31, 2014 and the employer year end is June 30, 2015, the earliest measurement date is still June 30, 2014 (one year earlier than the employer's fiscal year end) and the earliest valuation date is December 31, 2012 (two years earlier than the plan year end and 30 months earlier than the employer's fiscal year end).
If the employers who participate in the plan have different reporting years, the timing requirements should be examined carefully to determine which single measurement date and valuation date will work for both plan and employer reporting. This structure is intended to balance the desire to provide the most current information available with the practical considerations of requiring only one measurement date and one valuation date for each plan each year.
Measurement of Total Pension Liability (TPL)
To improve the uniformity of methods, there are requirements for the determination of the discount rate, the actuarial cost method, and the recognition of cost of living increases (COLAs).
Under current standards, the discount rate is selected as the estimated long-term investment return for the plan's assets. The new standards largely keep the status quo for selection of the discount rate with one important exception. If the current and projected plan assets (with respect to current employees) would not be expected to meet all future plan benefits, then the benefits not covered by projected plan assets would be discounted by a yield or index rate for 20-year, tax-exempt general obligation bonds with an average rating of AA/Aa or higher. The latter situation will usually occur in those instances where the employer is making contributions less than the full actuarially determined contribution or the contribution amount is based on a rolling amortization period.
The effect of using the tax-exempt bond rate as the discount rate will depend upon the time period that current assets and future contributions would run out and the relative difference in the expected return on plan assets and the tax-exempt rate. Based upon today's rates, a plan with an assumed interest rate of 7.5%, a tax-exempt bond rate of 3.5%, and a 35-year period before the tax-exempt rate is used, may see an increase in the TPL of roughly 20-25%.
Actuarial Cost Method
All plans are required to use the Entry Age Normal (EAN) Method for purposes of liability disclosure on the balance sheet and in the determination of the pension expense. Also, the definition of EAN for purposes of this calculation is based on an individual calculation for each active plan member. Variations of this method that use a new entrant average normal cost rate are not be permitted.
Measurement of COLAs
Future COLAs are required to be valued in the liabilities if they are considered to be substantively automatic. Under the current rules, there is no requirement that ad hoc COLAs be recognized. This change will increase the liabilities that are reported for some systems.
Net Pension Liability (NPL)
The net pension liability (the difference between the total pension liability and the market value of assets on the measurement date) is reported on the employer's statement of net position (balance sheet). Under the current standard, the balance sheet only includes a pension liability (the net pension obligation) if the employer has not always contributed an amount equal to the Annual Required Contribution (ARC). This change will substantially increase the liability reported on the balance sheet for most employers and may greatly increase the volatility of the balance sheet.
Recognition of Changes in Net Pension Liability
Unexpected changes in the net pension liability generally come from four sources:
- Investment gains and losses,
- Other actuarial gains and losses (i.e., the difference between actual and assumed experience),
- Changes in actuarial assumptions and methods, and
- Changes in plan benefits.
Actuarially determined contribution amounts are usually based on an amortization of these changes over periods of 15 to 30 years, and for investment gains and losses, it is common to recognize the gain or loss over a five-year period before it even enters the amortization. In contrast, the new standards prescribe much shorter periods for recognizing unexpected changes in the net pension liability. The table below summarizes the period over which each of these changes is recognized in pension expense.
|Recognition Periods for Pension Expense|
|Investment gain or loss||5 years|
|Actuarial gain or loss||Expected remaining service period including inactives|
|Actuarial assumption or method|
For most groups, the expected remaining service period for active employees is usually between 10 and 15 years. However, if there is an equal number of active and inactive members, and inactive members are treated as having no remaining service period, the recognition period would be cut in half to 5 to 7.5 years.
This provision will not only require faster recognition of losses related to liabilities, but also faster recognition of changes that reduce costs. Note that gains and losses related to investment experience will now be recognized over a five-year period (instead of smoothed over five years and then amortized over 15-30).
New Way of Calculating Pension Expense
The annual pension expense under GASB 68 is now equal to the change in the net pension liability from the beginning of the year to the end of the year, adjusted for the deferred recognition of the items described above and actual contributions.
If the discount rate equals the expected return on assets, pension expense is equal to:
- Service cost, plus
- Interest on the difference between the TPL and the market value of assets, plus
- Recognition of gains and losses, benefit changes, and assumption changes.
Given the short recognition periods, the third item will often overwhelm the other two.
Cost Sharing Plans
In a cost sharing plan, the experience of the total plan is shared among all participating employers. Currently, employers sharing costs have simplified disclosures compared to other employers. Cost sharing employers do not need to disclose an unfunded actuarial liability, only their obligation to contribute to the plan. Under the new standards, the plan will allocate a portion of its net pension liability and changes in that liability (the annual pension expense) to each participating employer, which will then include the allocated net pension liability and the allocated annual pension expense in its financial statements. The basis for determining an employer's proportion is more flexible than in the Exposure Drafts in order to be more consistent with the way costs are actually shared.
The new accounting rules are effective for fiscal years beginning after June 15, 2014 for all employers. Employers are required to restate prior financial statements under the new rules if practical, or to reflect the cumulative effect of the new rules in the financial statements as a restatement of beginning net position.
Cheiron is continuing to analyze the potential effect of the standards and plans to issue a more detailed Client Advisory in August. If you have any questions, or desire an estimate of the impact of these changes on reported liabilities and expenses for your plan, please contact your Cheiron consultant.
Cheiron is an actuarial consulting firm that provides actuarial and consulting advice. However, we are neither attorneys nor accountants. Therefore, we do not provide legal services or tax advice.