Public Pension Underfunding

Long a staple benefit for state and local government employees, defined benefit pension plans guarantee a fixed retirement benefit to the employee for life (and often extending to a spouse after the employee’s death). These types of plans have frequently been part of the attraction of government jobs in the United States, helping them compete with corporate and business positions that usually offered defined contribution plans, such as 401(k) plans. But changes to the accounting standards by the Governmental Accounting Standards Board (GASB) have led to greater scrutiny of defined benefit plans and could affect how they’re used or managed. In 2012, the GASB issued GASB Statement No. 68, Accounting and Financial Reporting for Pensions, requiring state and local government employers to change how they account for the defined benefit pension plans they sponsored. The updated standard became effective in 2015. Its two biggest areas of impact deal with the discount rate and the recognition of the net pension liability on the balance sheet. The discount rate is the expected rate of return on pension fund investments. The new standard requires significantly underfunded plans to use a lower assumed rate of return, thereby making the estimate of their net pension liability larger. Putting the net liability on the books rather than only disclosing it has drawn greater attention to public pension plans. The result is greater transparency, shedding light on the fiscal health and funding status of public pension funds in the U.S. This increased awareness of large pension liabilities has prompted policymakers to consider changes to defined benefit plans that could greatly impact both current and future retirees. Accounting and finance professionals, as well as retirees, need to be prepared for this transformation of the retirement system.