New York Times: Estimates for Pensions to Tighten

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New York Times, December 29, 2006

By Mary Williams Walsh
The states of New York, New Hampshire, Tennessee and about a dozen other governments may no longer be able to say their pension funds are fully funded no matter how the markets perform.

Accounting rule makers have proposed an amendment that would force these governments to provide a more realistic estimate of how much they owe retirees over time. They would also have to compare this with the assets they have set aside, showing whether they have enough to make good on their promises.

The Governmental Accounting Standards Board, an independent body that sets the rules for state and local governments, is also proposing that an outside auditor be required to vet this new financial snapshot. That is not now required of the pension funds that would be affected by the rule change, believed to make up about 8 percent of the nation’s public pension funds.

That’s just the first step,” said Timothy S. Lucas, a former research director for the accounting board’s sister organization, the Financial Accounting Standards Board. He oversaw that body’s slow and tortured efforts years ago to issue pension accounting rules for corporations.

“Small changes are important,” said Mr. Lucas, who now has his own consulting firm in Connecticut. “A journey of a thousand miles starts with a single step.”

It is not yet clear whether the rule change will give rise to any big new pension shortfalls in New York or elsewhere. The new rule is expected to take effect near the end of 2007, and the market conditions prevailing then will determine whether any shortfalls — or surpluses — appear.

Officials representing the New York State pension funds say they stand behind the existing financial report. But, they added, if there were changes, the effects would not be damaging.

The rule change would also force the incoming governor, Eliot Spitzer, to modify his previous assertion that the state pension fund “is fully funded,” and that the numbers his predecessors issued were accurate.

The method Albany has been using “doesn’t provide adequate information for disclosure purposes,” said David R. Bean, director of research and technical activities for the government accounting board, known as GASB and pronounced “gaz-b.”

New York City, meanwhile, will not be directly affected by the proposed rule change, because it does not use the same method of tracking its pension fund as New York State and the others in the affected group. But New York City’s unique methodology also greatly distorts its pension fund’s appearance, experts agree.

The city’s chief actuary, Robert C. North, suggested that the city might voluntarily provide the same type of numbers the accounting board will be requiring the state to report. He declined to be specific, saying he had not had a chance to study the accounting proposal yet, or discuss it with the city’s pension trustees.

Perhaps more important than the proposed rule change, GASB said it was beginning to research other possible changes in pension accounting, long one of the most controversial areas of financial reporting.

The board is responding to mounting concern about whether the benefits being promised to retired public workers are being accurately measured. Because employee compensation is usually a big part of government budgets, miscalculating benefits can cause significant problems.

Officials could award benefits that are unaffordably rich, for instance, or unions could sign off on benefits plans that are not really secure. Local residents may not understand why taxes are going up. Credit analysts might rate municipal bonds inaccurately.

Similar problems have already come to light with the pension accounting rules for the private sector — the ones Mr. Lucas helped to draft. Last year, the Securities and Exchange Commission told the rule makers to make improvements.

The S.E.C. has not delved into accounting rules for the public sector, but other authorities are venturing in. The Government Accountability Office, a nonpartisan research arm of Congress, has been studying the rules for public pensions and retiree health plans at the request of the Senate Finance Committee. The International Public Sector Accounting Standards Board issued a proposal in October for making public pension disclosures more comparable from one country to another.

Closer to home, the New York State Insurance Department has been reviewing the public pension funds in the state, over which it has regulatory authority.

The governmental accounting board has no legal authority to enforce the rules it issues, and must therefore rely on each pension fund’s outside auditor to provide monitoring and enforcement. But the outside auditor’s ability to be a whistle-blower is severely limited by client confidentiality rules.

The audit industry itself got its own oversight body, the Public Company Accounting Oversight Board, after the scandals at Enron, WorldCom and other companies in 2002. But this new watchdog has no jurisdiction over the auditors working for governments.

Jack R. Buchmiller, a risk management specialist with the New York State Insurance Department, said he had taken a professional and personal interest in the controversy over pension measurements — particularly the question of whether the sector is habitually underestimating its obligations to retirees through the use of faulty actuarial methods and assumptions.

Public pension plans usually make assumptions about their investment income over the long term, then use these assumptions to measure the value, in today’s dollars, of the benefits they must pay in the future. Many economists consider this practice incorrect, and corporate pension plans are not permitted to use it.

“It’s circular logic,” Mr. Buchmiller said.

Pension funds in the private sector are required instead to measure their obligations using a conservative bond rate. The thinking is that an interest rate associated with a safe bond is appropriate because the pensions themselves are supposed to be safe.

Mr. Buchmiller, who worked on Wall Street before going to work for the state, has been completing a study of what the nation’s public pension funds would look like if they were required to calculate their obligations in a way closer to what corporate plans must do — though he noted that economists criticize corporate pension measurements, too. A draft of his paper, which he hopes to publish in a financial journal, showed that when potentially misleading investment assumptions were replaced with conservative bond rates, tens of billions of dollars worth of unfunded obligations appeared.

Mr. Buchmiller stressed that the views expressed in his paper were his own, and his calculations should not be taken as a sign of any coming regulatory changes.

For now, the only imminent change is the one being proposed by GASB for the New York State pension fund and others like it. The board will be receiving public comments on the proposal until the end of February.

The rule change takes aim at a type of pension calculation that makes public pension funds look fully funded at all times. Normally, values float up and down in response to changes in the financial markets.

Actuaries use the calculation at issue as a tool for tracking pension costs over time and helping local governments decide how much money to put into their pension funds each year. Experts say the calculation — called the aggregate cost method — is a good one for that purpose because it tends to force governments to put money behind their pension promises more quickly.

The accounting board is not disputing that. But it said that when the numbers generated by the aggregate cost method were picked up by accountants and included in annual reports, they often ended up being misinterpreted.

If New York City were to voluntarily follow the proposed new method, it could reduce the friction that became apparent last summer, after a report in The New York Times cited accounting experts who said the city’s pension disclosures were not compliant with the rules.

New York City maintains that there is nothing wrong with its pension accounting.

When asked about the accounting proposal, Mr. North, the city’s chief actuary, said he would reserve comment until he had had a chance to study it.

“The New York City Retirement Systems, and the City of New York,” he said, “have always followed and will continue to follow the GASB rules and provide whatever information GASB requires, and more.”

That suggested the way to a truce, in which New York City could start disclosing the type of numbers the accounting board will be making the state provide — while continuing to disclose the type of numbers it already publishes.

Because of his own concerns about the confusion that actuarial methods can cause, Mr. North has already been offering additional pension values as a supplement for the last few years. He is believed to be the only actuary for any public pension fund to report the financial condition of its fund on a market basis — the sort of calculation Mr. Buchmiller has been trying to devise.

New York City’s most recent supplementary numbers showed a $49 billion shortfall. Mr. North’s calculations for the fiscal year that ended last June are scheduled to appear in January.