(December 21, 2012) — Recently issued rules by the Governmental Accounting Standards Board (GASB) will alter the way state and local governments account for defined benefit (DB) pension plans, according to Goldman Sachs Asset Management’s Michael Moran.
“A plan’s funded status will now be reflected on the balance sheet, increasing transparency as well as the focus on measures that plan sponsors are taking to address these shortfalls,” says the paper–titled “A ‘Sea Change’ in Public Pension Reporting on the Horizon.” Additionally, funded status and pension expense measures are likely to be more volatile under the revised reporting standards.
So how exactly will public DB pensions be accounted for and reported?
Firstly, funded status will be reported on the balance sheet. “The new GASB requirements will place the actual funded status of the plan on the balance sheet,” the paper explains. “In other words, if a plan had $1 billion of assets and an actuarially determined gross pension obligation of $1.2 billion, a liability of $200 million would now be recognized on the balance sheet.”
Secondly, GSAM’s Moran predicts increased volatility of funded status and pension expense. The old assessments made it so that the the asset value used to calculate funded status was smoothed, often around five years, which often minimized volatility. However, under the new GASB rules, the actual fair market value of plan assets will be used for determining the funded status that will be placed on the balance sheet, GSAM notes. “This is consistent with the way corporate plans account for and report the asset side of their funded status equations. Use of the fair value of plan assets, as opposed to an actuarially determined smoothed value, will increase the volatility of reported funded status.” Potentially lower discount rates may also increase pension obligations and lower funded ratios.
Lastly, the paper by Moran point to increased disclosure requirements as a result of GASB rules, as plan sponsors will be required to disclose the sensitivity of pension calculations to a change in the discount rate and the derivation of the expected return assumption.
“Interest in public DB pension issues has never been greater,” the paper concludes. “These changes by the GASB may serve to further focus attention on many of the most stressed state and local pension programs.”
The gist: Public DB plan sponsors have generally moved to diversify their portfolios in recent years by reducing exposure to US public equities while upping exposure to non-US equities and alternative investments, such as private equity, real estate, commodities and hedge funds. According to GSAM, the need to achieve acceptable returns—while also minimizing the volatility of returns—will become an even higher priority as a result of GASB rules.