GASB Approves Exposure Draft for Pension Accounting Rules Changes
The week of June 27th, the Governmental Accounting Standards Board (GASB) approved Exposure Drafts as part of its project on pension accounting and financial reporting. The full documents will be available on the GASB website on July 8th. Once they are reviewed, NCTR will hold a webinar on the details and implications of this latest iteration of proposed changes to pension accounting and disclosure rules.
The GASB review of Statement No. 25, “Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined Contribution Plans,” and Statement No. 27, “Accounting for Pensions by State and Local Governmental Employers” began in January of 2006, when the project was added to GASB’s research agenda. Then it was added to the current agenda in April, 2008. The Invitation to Comment was issued in March of 2009, and the Preliminary Views were released in June of 2010.
Once the drafts are formally released, there will be a 90 day period in which to submit written comments. There will also be public hearings: on October 3rd (LaGuardia); October 13th (San Francisco); and October 20th (Chicago O’Hare).
GASB will then begin a final deliberation process to consider the comments and perhaps make further changes in the standards, although at this stage, it is unlikely that there will be many such modifications. Then, probably sometime in the summer of 2012, the final rules will be issued. According to Robert Attmore, GASB’s Chairman, there will likely be a transition period of at least a year before they begin to take effect for larger plans, so they probably will not begin to be implemented until 2013.
New NCTR/NASRA Blog
NCTR and NASRA announced the launch of their new blog, PensionDialog.com, and its corresponding Twitter account @PensionDialog, on June 22nd.
The target audience for both tools is the media, policy makers and staff, and other stakeholders. Both the blog and Twitter will be used to promote research and news, respond to articles and newly released studies, and promote initiatives, including partners' work, from across the U.S.
NASRA and NCTR will continue to serve their members with news and information on each of their individual websites. The PensionDialog blog account will be administered by Ady Dewey, the new NCTR/NASRA manager of external affairs. The new blog has already proved invaluable in getting information out on a “real-time” basis to the media and others concerning the latest Rauh/Novy-Marx study (see story above in this E-News.)
A separate venue for pension system communicators has also been created. This forum is intended to share best practices, strategic messaging, and news. For information on how to connect to this blog, please contact Ady at NASRA.NCTRcomm@gmail.com.
New NIRS Paper Finds Public Pension Asset Exhaustion Only a Remote Possibility
The National Institute on Retirement Security (NIRS) released a new review of two economic studies that evaluate pension sustainability based on the ability of pension trust funds to pay benefits promised over the coming years. The may 5, 2011, paper examines the strengths and weaknesses of these studies and assesses their value as a tool for policymakers.
One of the studies was “Can State and Local Pensions Muddle Through?” produced by the Center for Retirement Research at Boston College in March of 2011. This report investigates two concepts for estimating when plans would run out of money. It found that using a more realistic “ongoing” framework, in which normal costs are used to cover benefit payments, most plans have enough for at least 30 years. Furthermore, these estimates were conservative, as they were based on 2009 data and therefore did not reflect the more recent run-up in the stock market. Nor did they incorporate recent efforts to increase employee contributions and reduce benefits for new employees. And they assumed that states pay only the normal cost when many make the full annual required contribution.
The other study of was “The Day of Reckoning For State Pension Plans,” a posting by Joshua Rauh on the “Everything Finance” blog of the Northwestern University’s Kellogg School Finance Department. According to this study, seven states would run out of money before 2020 and thirty more states are expected to run out of money during the 2020s.
NIRS found that the Rauh study’s theoretical estimates of the number of years in which public pension plans can continue to pay existing benefits based on the investment of current assets “represent a flawed, simplified way to view the sustainability of these pension plans.” The author of the NIRS paper, Diane Oakley, the new NIRS Executive Director, wrote that “With some limited exceptions, states and localities do not face an immediate pension shortfall that would require sponsors to pay benefits from operating revenues even under dire termination assumptions.”
Bipartisan Effort to Control 401(k) Leakage
Noting that the gap between what Americans will need in retirement and what they will actually have saved is estimated to be a staggering 6.6 trillion dollars, Senators Herb Kohl (D-WI), Chairman of the Senate Special Committee on Aging, and Mike Enzi (R-WY), the Ranking Republican member of the Senate Health, Education, Labor and Pensions (HELP) Committee, have introduced legislation intended to help stop 401(k) plan leakage by providing flexibility to loan repayment hardship tax rules and limit 401(k) loan practices.
“As the frequency of retirement fund loans have gone up, the amount of money people are saving for their retirement has gone down,” Senator Kohl noted. “While having access to a loan in an emergency is an important feature for many participants, a 401(k) savings account should not be used as a piggy bank.”
The “Savings Enhancement by Alleviating Leakage (SEAL) in 401(k) Savings Act of 2011” (S. 1121) would:
- extend the period for repayment of loans if a 401(k) plan terminates or a plan participant becomes unemployed;
- prohibit 401(k) plans from allowing the use of credit cards or similar arrangements to access loan amounts; and
- allow 401(k) plan participants to make additional contributions to a plan during the six month period following a hardship distribution.
The SEC and Credit Rating Agencies
The Securities and Exchange Commission (SEC) has been very busy the last three months on several matters relating to Credit Rating Agencies, which were a major focus of criticism for their perceived role in the collapse of the mortgage securities market that, when it collapsed, contributed significantly to the financial meltdown that followed.
- On April 27th, the SEC proposed amendments that would remove references to credit ratings in several rules under the Securities Exchange Act. These proposals represent the next step in a series of actions taken under the Dodd-Frank Wall Street Reform and Consumer Protection Act to remove references to credit ratings within agency rules and, where appropriate, replace them with alternative criteria. The purpose is to eliminate over-reliance on credit ratings by both regulators and investors – and to encourage independent assessments of creditworthiness rather than uncorroborated reliance on credit ratings.
According to SEC Chairman Mary Shapiro, “The most significant proposed change in this area would preclude firms from looking solely to ratings when calculating capital charges for commercial paper, nonconvertible debt, and preferred stock under the Commission’s net capital rule. Instead, each firm with proprietary positions in these instruments would need to look at a variety of factors, and they would need to have and document procedures for doing so.” - On May 10th, the SEC requested public input to assist in their study on the credit rating process for structured finance products. Specifically, they are seeking comments on (a) the credit rating process for structured finance products and the conflicts of interest associated with the issuer-pay and the subscriber-pay models; (b) the feasibility of an assignment system in which a public or private utility or a self-regulatory organization would assign a credit rating agency to determine credit ratings for structured finance products; and (c) alternative means for compensating credit rating agencies that would create incentives for accurate credit ratings for structured finance products. Comments will be accepted for four months. The SEC is to submit the findings of its study to Congress by July 21, 2012.
- On May 18th, the SEC proposed a number of new rules and amendments intended to increase transparency and improve the integrity of credit ratings. According to the SEC. the proposed rules would implement certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act and enhance the SEC’s existing rules governing credit ratings and Nationally Recognized Statistical Rating Organizations (NRSROs).
“In passing the Dodd-Frank Act, Congress noted that credit ratings applied to structured financial products proved inaccurate and contributed significantly to the mismanagement of risks by financial institutions and investors,” SEC Chairman Mary Schapiro said. “Our proposed rules are intended to strengthen the integrity and improve the transparency of credit ratings.”
- Report on internal controls.
- Protect against conflicts of interest.
- Establish professional standards for credit analysts.
- Publicly provide – along with the publication of the credit rating – disclosure about the credit rating and the methodology used to determine it.
- Enhance their public disclosures about the performance of their credit ratings.
- Removal of Certain Reference to Credit Ratings
- Study on the Credit Rating Process for Structured Finance Products
- Rules to Increase Transparency and Improve Integrity of Credit Ratings
In April, the Pew Center on the States released a new report entitled “The Widening Gap: The Great Recession’s Impact on State Pension and Retiree Health Care Costs.” The report found that “In the midst of the Great Recession and severe investment declines, the gap between the promises states made for employees’ retirement benefits and the money they set aside to pay for them grew to at least $1.26 trillion in fiscal year 2009, resulting in a 26 percent increase in one year.”
Pew reported that the shortfall was about evenly divided between pensions, which they found had a $660 billion funding gap, and retiree health care and other benefits , which accounted for the remaining $607 billion, with assets totaling $31 billion to pay for $638 billion in liabilities. In other words, with $2.28 trillion in funding for $2.94 trillion in pension liabilities in 2009, state pension plans were 78 percent funded, while retiree health care benefits are only 5 percent funded.
While PEW found that the value of assets in state pension plans dropped a record 19.1 percent in 2009, it also recognized that, “For most states, whose fiscal year 2009 began on July 1, 2008 and ended on June 30, 2009, these data capture the worst effects of the financial crisis.” Pew also acknowledges that “ More recently, many plans have reported double-digit investment gains for fiscal year 2010.”
In an effort to put the Pew report in some perspective, NCTR and NASRA worked together to put out a joint Issue Brief prior to the Pew Center report’s release. This Issue Brief – entitled “Strong Investment Gains and Legislative Changes Speeding Public Pension Recovery” -- underscored that, at the end of calendar year 2010, aggregate state and local government retirement system assets totaled $2.93 trillion, a 35 percent increase from their quarterly low point during the market collapse.
“These asset levels are also nearly 25 percent higher than they were on June 30, 2009 – a date on which many recent studies on the financial condition of state and local pension trusts are based,” the brief noted. “Since then, not only have investment returns rebounded sharply, but many states have adopted changes to benefit levels and financing structures that have positively impacted pension trusts,” it reminded readers.
GAO Finds that Most Private Sector Retirement Plan Tax Benefits go to Higher Income Workers
In a foreshadowing of what will likely be a centerpiece of any future debate over tax reform and deficit reduction, the Government Accountability Office (GAO) has taken a look at the tax expenditures associated with retirement savings in the private sector and found that they benefit mostly higher income employees.
GAO said that while the existing system of tax preferences for pensions has played at least a supporting role in fostering current levels of pension plan coverage, private plan participation nevertheless remains stalled at roughly 50 percent of the private sector workforce. Furthermore, even for the 50 percent of the private sector workforce that does participate in a plan, GAO found that for defined contribution plans, “a disproportionate share of these tax incentives accrues to higher income earners.”
Specifically, while 72 percent of those who make tax-deferred contributions at the maximum limit earned more than $126,000 annually in 2007, less than 1 percent of those who earned less than $52,000 annually were able to do so. Also, GAO said that “even the additional $5,500 contribution permitted to participants 50 and older may not allow moderate income workers to catch up anytime soon.” In short, private sector retirement savings tax incentives accrue primarily to higher income employees and do relatively little to help lower income workers save for retirement.
The subject of the tax expenditures associated with retirement savings incentives is an increasing topic of conversation among policy makers on and off Capitol Hill. Tax expenditures are losses to the U.S. Treasury that result from granting certain deductions, exemptions, deferrals or credits to specific categories of taxpayers in order to encourage or promote certain policy objectives. They are an indirect form of government spending on specific policy programs. According to the Joint Committee on Taxation, the largest FY 2009 tax expenditures were the exclusion of health benefits from income taxation ($94.4 billion); the home mortgage interest deduction ($86.4 billion), and the net exclusion of pension contributions and earnings associated with defined benefit and defined contribution retirement plans ($73 billion).
Last year’s two major deficit commissions both called for a scrapping of the existing system, including many of the expenditures related to retirement savings. For example, the Domenici -Rivlin Task Force suggested restructuring itemized deductions, eliminating “almost all” tax expenditures and modifying those for 401(k) plans, IRAs and Keogh plans, permitting individuals and employers combined to contribute up to 20 percent of annual earnings to such qualified plans, up to a maximum of $20,000 per year, indexed to inflation. The goal, they said, was to ensure that “qualified plans will no longer be a vehicle for wealthy individuals to convert a substantial share of their assets into tax-free retirement assets.”
In response to these suggestions that the tax expenditures related to defined contribution plans be cut, the American Society of Pension Professionals & Actuaries (ASPPA) recently produced a study examining these estimates of tax expenditures as they applied to defined contribution plans. They argue that tax expenditure estimates for retirement savings provisions should be prepared on what they refer to as a present-value basis. “Measuring retirement savings provisions on a present-value basis would help policymakers understand the lifetime tax benefits occurring with respect to retirement savings contributions and would allow an ‘apples to apples’ comparison with tax expenditures such as current deductions and credits,” they argue..
Using this present-value basis, they find that the one- tax expenditure estimates related to contributions to defined contribution retirement plans are 34 percent lower than the Joint Committee on Taxation’s one-year estimates and 54 percent lower than the Treasury one-year estimates. In addition, the present-value tax expenditure estimates of contributions made in the first five years are 55 percent lower than the JCT five-year estimates and 75 percent lower than the Treasury five-year estimates.
A similar analysis theoretically could extend to defined benefit plans, the study notes, but to simplify the discussion, the ASPPA study presents only defined contribution plans.
For the DC plan community, the fight over tax expenditures related to retirement savings is a very real one. But what about defined benefit plans? Is it conceivable that Congress would cut DC plans’ tax expenditures but leave DB plans untouched?
- GAO Report on Distribution of Tax Benefits for Retirement Savings
- ASPPA Study on Measuring DC Plan Tax Expenditures
Boston College’s Center for Retirement Research has a report suggesting a new way in which to combine the defined benefit (DB) model with the defined contribution (DC) plan in the public sector.
The new approach would be to “stack” the two together, combining a defined benefit plan based on a certain amount of wages – for example, the first $50,000 – with a defined contribution plan on amounts above that.
“The advantage of the ‘stacked’ approach is that it allows employees with modest earnings to receive the full protection of a defined benefit plan,” the report argues. “This group would be the most vulnerable if required to rely on a 401(k) for a portion of their core retirement benefit.”
More highly-paid public employees would still have the protection of a defined benefit plan as a base and would then rely on the 401(k) for earnings replacement that exceeded the earnings of a typical private sector worker. “This overall arrangement offers a reasonable balance by providing adequate and secure benefits targeted to public employees who need them most while limiting the risk to taxpayers of covering large pension shortfalls,” the report concludes.
“Defined contribution plans may well have a role in the public sector,” the report’s authors note, “but in combination with, not as an alternative to, defined benefit plans.”
GASB Issues Report on Timeliness of State and Local Financial Reporting
GASB has released a research brief that examines how long it takes state and local governments to issue financial reports prepared in conformity with generally accepted accounting principles (GAAP), and how the passage of time affects the usefulness of the financial information for users.
Based on its review of the financial reports of the 50 states, the 100 largest counties and localities, and the 50 largest independent school districts and special districts for the 2006–2008 reporting periods, GASB found that in general, 73 percent of the largest governments issued their reports within 6 months, while 2 percent took more than 1 year.
The largest local and county governments and independent school districts issued their financial reports approximately six months after the fiscal year-end on average, while State governments averaged closer to seven months. Special districts averaged about four months.
GASB also looked at smaller governments, and found, based on a random sample drawn from the list of 89,527 governments included in the 2007 Census of Governments, and found that smaller county governments took an average of 8 months to issue their financial reports, while smaller local governments took 6 months. Overall, under 46 percent of the smaller governments examined issued their reports within 6 months, and 7 percent took more than 1 year.
GASB also found that financial report information retains some degree of usefulness to municipal bond analysts, legislative fiscal staff, and researchers at taxpayer associations and citizen groups for up to six months after the fiscal year-end. However, afterward its usefulness quickly declines.
While GASB does not require that GAAP-based financial reports be issued within a specific timeframe, the research brief notes that timeliness -- or the lack thereof -- continues to be a central “as it strives to balance the benefits of information to its users with the cost of providing that information.”
New Survey by Prudential Finds Growing Interest in Guaranteed Retirement Income for Life
An Interesting new survey from Prudential supports the need and desire for a national response to retirement insecurity and reinforces NIRS polling data on this point. The report on the survey, “The Next Chapter: Meeting Investment and Retirement Challenges,” also suggests that there is growing interest in the kind of guaranteed income for life that DB plans provide.
Here are some of the results as stated in the Prudential survey:
- Most investors believe that the investments they have today are not earning enough to make up for the losses they’ve experienced over the past few years (73%). In the aftermath of the recession, 72% of Americans acknowledge that they need to think differently about how they save, invest, and plan for retirement—a recognition perhaps that “the rules have changed”.
- Six in 10 (58%) say they want to feel less pressured, less threatened, and less overwhelmed by the prospect of making financial decisions. However, 40% are going it alone with no help from an advisor; in fact, 53% don’t believe an advisor is helpful even in extreme market conditions.
- More than half (54%) do not feel well prepared to take on the task of rebuilding their portfolios, and three-quarters (73%) point to challenges that span from deciphering confusing product information to navigating an overwhelming amount of options to overcoming distrust of advisors and firms. Nearly seven in 10 believe there are few financial services firms that are trustworthy.
GRS Looks at Recent Trends in COLAs
In their search for ways of controlling pension costs and stabilizing required contributions, many public pension plans and their sponsors are reviewing their plan designs. This can often include taking a look at the costs associated with cost-of-living adjustments (COLAs).
Paul Zorn, Mark Randall, and Joe Newton with Gabriel Roeder Smith & Company have written an article that discusses the purpose of COLAs, how they are provided, and the advantages and disadvantages of different types of COLAs. It also discusses recent changes in public-sector COLAs and the relative costs of COLA designs.
Brand New GAO Report Looks at Ensuring Income Throughout Retirement
A newly-released report by the Government Accountability Office (GAO) examines what it refers to as the “difficult choices” in trying to ensure income throughout retirement.
GAO found that most retirees rely primarily on Social Security and pass up opportunities for additional lifetime retirement income. Furthermore, only 6 percent of those with a defined contribution plan chose or purchased an annuity at retirement. Those in the middle income group who had savings typically drew down those savings gradually, but an estimated 3.4 million people (9 percent) aged 65 or older in 2009 had incomes (excluding any noncash assistance) below the poverty level. (Among people of all ages the poverty rate was 14.3 percent.)
“Given the long-term trends of rising life expectancy and the shift from DB to DC plans, aging workers must increasingly focus not just on accumulating assets for retirement but also on how to manage those assets to have an adequate income throughout their retirement,” GAO pointed out. Furthermore, GAO noted that workers are increasingly finding themselves “depending on retirement savings vehicles that they must self-manage, where they not only must save consistently and invest prudently over their working years, but must now continue to make comparable decisions throughout their retirement years.”
GAO also stressed that although retirement savings may be larger in the future as more workers have opportunities to save over longer periods through strategies such as automatic enrollment in DC plans, “many will likely continue to face little margin for error.” “Poor or imprudent investment decisions may mean the difference between a secure retirement and poverty,” GAO warns.
