How New Pension Standards Could Make Things Worse

August 14, 2012

The Government Accounting Standards Board (GASB), the agency responsible for public pension accounting, allows state and local governments to report far greater fiscal health than is truly accurate. This has resulted in aggregate underfunding of state and local public pensions in the United States of around $4 trillion -- a figure that portends the greatest fiscal crisis in American history, say Josh Rudolph, a graduate student at Harvard University's Kennedy School of Government, and Jonathan Trichter, a former public finance investment banker and adjunct faculty at Fordham University.

For more than six years, the GASB considered changes to address this issue. Recently, it approved a slate of reforms for this exact purpose, yet their changes could actually make things worse by omitting essential changes.

  • Currently, public pension funds make their own assumptions about their future investment returns without GASB interference.
  • If public pensions increase the riskiness of their investments, they assume a higher rate of return.
  • Simultaneously, pension funds use that high rate to "discount" their long-term liabilities, which artificially reduces today's sticker price for the future costs of retiree benefits.
  • This practice has no basis in finance or economics and encourages public pensions to make risky investments and then underestimate the amount they owe.
  • It is the principal reason economists think they are hiding trillions of dollars in liabilities.

Crucially, the changes to the GASB policies did nothing to correct this problem. Rather, the board implemented new, soft changes. These include requiring pension fund administrators to explain their selected discount rates, instead of requiring GASB approval. This will almost certainly result in more of the same underfunding that has plagued public pension funds for years.

Additionally, the GASB instituted a so-called compromise discount rate that changes the accounting standards for funds that are likely to become insolvent. Yet even this reform was largely empty: the GASB simultaneously changed standards for a fund to claim solvency such that few if any will be subject to the new standard.

Source: Josh Rudolph and Jonathan Trichter, "How the GASB's New Pension Standards Could Make Things Worse," August 7, 2012.

 

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