Pensions Warned to Push on With Reform Despite Deficits

“It is a misperception that new benefit structures raise costs in the short run because of a Government Accounting Standards Board (GASB) accounting rule that accelerates amortization schedules,” says Dr. Robert M. Costrell, Professor of Education Reform and Economics at the University of Arkansas.

(May 10, 2012) — Pension reform efforts must be evaluated on their own merits and not be confused with amortization schedules, according to a newly released paper that aims to debunk myths about fixing public pensions.

The paper, released by the Laura and John Arnold Foundation (LJAF): “It is a misperception that new benefit structures raise costs in the short run because of a Government Accounting Standards Board (GASB) accounting rule that accelerates amortization schedules…GASB rules pertain only to financial reporting and not to legislative policy. Several states have made responsible reforms and continue to amortize unfunded liability, just as they did before enacting reforms.”

LJAF Vice President for Public Accountability Initiatives Josh McGee told aiCIO: “As a foundation, we’re interested in promoting and educating policymakers about good public policy,” adding that GASB accounting rules do not bind policymakers when it comes to reforming pension systems. “Nevertheless, policymakers continue to be constrained by the false claim that they can’t transition to a new retirement savings system because of unfunded liabilities,” McGee continued.

To put it more simply, according to the paper, policymakers must ask two separate questions about the retirement savings system they offer employees: 1) What is a responsible retirement savings system? 2) How should they pay off unfunded pension liabilities?

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“The size of the unfunded pension liability shouldn’t tie a policymaker’s hands,” McGee said.

According to McGree, without significant changes to current systems, public pension payments will quickly crowd out other discretionary spending like education and public safety. “Dr. Costrell’s work debunks one of the most pervasive myths used to stymie these much needed reforms. It is imperative we repair broken systems for future generations.”

As outlined by the paper, its main findings are the following:

1) GASB accounting standards unambiguously require a shift in amortization.

2) GASB sets standards for financial reporting; it does not determine funding policy and does not claim to. Pension plans are required to report the ARC for comparison with the actual contribution, but the actual contribution is set by each state’s statutory authority.

3) GASB’s rule assumes that amortization payments must be based on the payroll of DB members alone, a base that shrinks after closing the plan.

Last year, GASB published proposals to improve the way US state and local governments report pension liabilities. As investors have raised concerns that unrealistic expectations of investment returns have concealed the actual size of many unfunded pension obligations, the proposals aim to change the formula that schemes use to determine the value of their pensions. The proposals by GASB would require public pensions to highlight net unfunded liabilities on their balance sheets.

Read “Pension Quandary: Valuing Liabilities” in the Summer issue of aiCIO Magazine: a discussion of public fund discount rates – and what rates are and are not appropriate to use when defining a plan’s liabilities, by Charles E.F. Millard, the former Director of the U.S. Pension Benefit Guaranty Corporation and now a Managing director leading Citigroup’s Pension relations team.

The root of the problem for portfolios today among US investors, from individual retirement accounts to institutional pensions, is home market bias, according to PIMCO.

(May 10, 2012) — Investors in the United States with home market bias risk severely limiting their income potential, says PIMCO’s Raji Manasseh.

The report’s author asks: With so many investors piling in, have dividend-oriented equities become a “crowded trade” and an “unsafe bet?”

With dividend payout ratios on the decline in the US, taxes potentially on the rise, and valuations in sectors that typically offer attractive dividends near historical highs, global equities can provide more attractive dividend income opportunities, Manasseh asserts.

“We believe that in many cases, investors are over-reaching for yield in the wrong places and for the wrong reasons, which could have negative consequences for those sensitive to downside risk,” Manasseh writes, noting that global equities have the potential for additional benefits, including diversification.

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The report by Manasseh, PIMCO’s senior vice president and dividend strategies product manager, urges investors to think of the dangers of home-country bias similarly to putting all your eggs in one basket, increasing concentration risk in the portfolio and the potential for loss if one sector falls in value.

“Despite this risk, over the past year, the majority of inflows have gone to U.S.-focused dividend mutual funds and exchange-traded funds (ETFs), prompting much of today’s concern,” Manasseh continues, outlining the following fundamental problems with a US-only dividend strategy:

1. Dividend payout ratios in the US have been in secular decline.

2. Since 2003, US individual investors have enjoyed a lower tax rate on the qualifying dividends they receive, but this may change as the tax rate on dividends is scheduled to significantly increase at the end of 2012, barring new legislation.

3. The US equity sectors most commonly targeted by investors for income (telecoms, utilities, REITs and MLPs) are trading at historically high valuations.

Related news:Powers Rise and Fall, the US Will Too

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