Fact Sheet on the GASB’s New Pension Standards: Governments in Cost-Sharing Multiple-Employer Defined Benefit Pension Plans
- What new requirements regarding accounting and financial reporting for pension benefits will governments that participate in cost-sharing multiple-employer pension plans be implementing?
The Governmental Accounting Standards Board (GASB) approved Statement No. 68, Accounting and Financial Reporting for Pensions, in June 2012. Statement 68 significantly changes how governments measure and report the long-term obligations and annual costs associated with the pension benefits they provide. The Statement is available free of charge at www.gasb.org. A separate fact sheet describes the GASB’s new pension standards and why they were issued.
- What is a cost-sharing multiple-employer defined benefit pension plan?
A defined benefit pension specifies the benefits to be provided to the employees after the end of their employment. By contrast, defined contribution pensions stipulate only the contributions to an active employee’s account each year. A cost-sharing multiple-employer plan is one in which the participating government employers pool their assets and their obligations to provide defined benefit pensions—meaning that plan assets can be used to pay the pensions of the retirees of any participating employer. By contrast, the assets of the participating government employers in an agent multiple-employer plan are pooled for investment purposes but separate accounts are maintained for each individual employer. Governments participating in cost-sharing multiple-employer defined benefit pension plans are referred to as cost-sharing employers.
- What is a net pension liability and why is it important?
To the extent that the cumulative long-term obligation to provide pension benefits of the participating governments in a cost-sharing plan (their total pension liability) is larger than the value of the assets available in the pension plan’s trust to pay pension benefits, there is a net pension liability. Each participating cost-sharing government will report its proportionate share of that cumulative net pension liability in their own accrual accounting-based financial statements. This is significant because practically no information about an individual cost-sharing employer’s pension obligation has previously been reported in the financial statements. But under Statement 68, the employer’s proportionate share of the cumulative net pension liability will appear plainly on the face of the financial statements for the first time, along with a cost-sharing employer’s other long-term liabilities.
- How will the amount of the total pension liability be determined?
The new Statement describes the procedures for measuring the total pension liability, which essentially involves three steps:
- Project total future pension benefit payments for current and former employees
- Discount the projected benefit payments to their value at the time of the measurement (present value)
- Attribute the present value of projected benefit payments to the periods when they were or will be earned—past and future.
- How will future benefit payments be projected?
The projection of future benefit payments is based on the terms of the plan and typically is performed by an actuary engaged by the pension plan. The actuary will use assumptions about relevant factors such as how long employees are expected to work for the participating governments, what their salaries are expected to be, and how long they are expected to collect benefits after retirement. The new Statement requires that all assumptions conform to the standards of the actuarial profession, unless otherwise specified by the GASB.
- How will projected benefit payments be discounted?
Discounting projected benefit payments to their present value requires the use of a discount rate. Cost-sharing pension plans will be required to use the long-term expected rate of return on their investments or a single rate based on a combination of the long-term expected rate of return and a municipal bond index rate. At present, cost-sharing plans use only their long-term expected rate of return. To determine which rate to use, both the future benefit payments and the value of assets available in the plan for paying benefits (based primarily on actual contribution experience) will be projected.
At least in the initial years, projected plan assets related to current active and inactive employees can be expected to exceed projected benefit payments related to those employees—as long as this is true, discounting will be based on the long-term expected rate of return. This asset-based rate is appropriate because the earnings on the plan’s investments reduce the amount that the cost-sharing employers will need to contribute to the plan.
However, if a point is reached when the projected benefit payments related to current active and inactive employees exceed the projected plan assets related to those employees—called the crossover point—then benefit payments projected to be made from that point forward will be discounted using an interest rate for 20-year tax exempt municipal bonds rated AA or higher (or an equivalent rating). This liability-based rate is appropriate because the plan no longer is expected to have sufficient assets related to those employees to produce investment income that will reduce how much the cost-sharing employers will have to contribute. The pension liability would then resemble a cost-sharing employer’s outstanding debt and other typical long-term liabilities.
- How will the present value of projected benefit payments be attributed to periods of employee service?
Attribution to past and future periods of employee service is accomplished using an actuarial cost method. Statement 68 requires that all cost-sharing plans use one type of actuarial cost method—called entry age—and apply it only as a level percentage of payroll. Previously, cost-sharing pension plans had been allowed to select from six methods, each of which could be applied in two ways—as a level dollar amount each year or as a level percentage of payroll in each year. The previous variety of actuarial cost methods allowed seriously diminished the comparability of the information that governments reported about their pension obligations and costs.
The portion of the present value of projected benefit payments that is attributed to past periods of employee service is the total pension liability. The total pension liability minus the value of assets in the pension plan trust equals the cumulative net pension liability that will be divided among the participating cost-sharing employers to report in their own financial statements.
- How will the cost of pensions (pension expense) be measured for cost-sharing employers?
A variety of factors contribute to changes in the net pension liability from year to year. For example, the earning of benefits each year increases the net pension liability, while investment earnings and contributions reduce it. Statement 68 requires that most causes of change in the net pension liability be included in pension expense immediately. However, changes resulting from certain causes will be introduced into pension expense over multiple periods. Because the net pension liability is the difference between the total pension liability and plan assets, the causes of change in the net pension liability can be organized into two groups—changes in the total pension liability and changes in plan assets.
The following changes in the total pension liability will be reported as pension expense in the year they occur (in other words, immediately): service cost (the value of new benefits earned each year), interest on the total pension liability, and changes in the benefit terms (improvements or reductions in benefits). Two causes of change in the total pension liability will be introduced into pension expense in increments over a period equal to the average remaining years of service of all members of the plan (both current employees and retirees): (1) the effects of a change in the economic and demographic factors used to project, discount, and attribute benefit payments; and (2) the difference between what those factors were assumed to be and what they actually turned out to be (called experience gains and losses).
In addition to contributions, changes in plan assets primarily result from two sources—the assumptions about investment earnings that are made when measuring the liability, and the difference between those assumptions and actual earnings. The assumed earnings reduce the amount of pension expense reported each year (in other words, immediately). The difference between assumed and actual returns will be introduced into expense in increments over five years (which is intended to roughly represent a market cycle).
The overall effect of the new requirements will be that pension expense will be reported significantly sooner than it has been for most governments. Under the prior standards, the effects of changes in benefit terms, changes in assumptions, experience gains and losses, and the difference between assumed and actual earnings were introduced into expense in increments over selected periods of up to 30 years. The average remaining years of service of plan members is likely to be considerably shorter than 30 years and result in earlier expense recognition.
- How will individual cost-sharing employers determine the portion of the cumulative net pension liability, pension expense, and pension-related deferrals that they should recognize in their own financial statements?
The individual cost-sharing employers portion of the cumulative plan-wide pension amounts will be determined by measuring the cost-sharing employer against all of the governments participating in the plan in total. The Statement encourages the proportion to be determined as follows:
Employer’s projected long-term contributions to the planHowever, the calculation may be based on other factors that are relevant to how contributions to the plan are determined. For instance, if a plan assesses a flat amount per active employee covered by the plan, a cost-sharing employer’s percentage might be determined by dividing the employer’s number of covered employees by the number of covered employees for all participating employers.
Projected long-term contributions to the plan by all employers
and other entities on behalf of those employers
However the percentage is determined, the cumulative net pension liability, pension expense, and pension-related deferrals would be multiplied by the percentage to arrive at the “proportionate shares”—the amounts that the cost-sharing employer will report in its own financial statements.
It is possible that a cost-sharing employer’s percentage may change from one year to the next. A cost-sharing employer will include in its pension expense the effect the changing percentage has on its proportionate shares of the cumulative net pension liability and pension-related deferrals. As with experience gains and losses, for example, the effect will be introduced into expense in increments over a period equal to the average remaining years of service of all members of the plan (both current employees and retirees).
- How is the reporting of the liability, expense, and deferrals affected if another entity is responsible for a portion of a cost-sharing employer’s pension obligation?
There are circumstances in which another entity (often governmental) is legally responsible for some or all of a cost-sharing employer’s obligation to provide pension benefits. For example, a state government may be responsible for making all of the required contributions to a teacher retirement plan on behalf of local school districts. These circumstances, if they meet certain criteria spelled out in Statement 68, are called “special funding situations.” The criteria, as well as the effect on accounting and financial reporting, are described in a separate fact sheet on Special Funding Situations.
- Apart from the liability, expense, and deferrals reported in the financial statements, what other information will cost-sharing employers present?
The notes to the financial statements of cost-sharing employers will be significantly enhanced by Statement 68 and will provide a more comprehensive and easier to understand picture of their pension obligations and costs. Cost-sharing employer notes will include, among other things:
- Descriptions of the pension plan and benefits provided
- Disclosure of significant assumptions employed in the measurement of the net pension liability
- Descriptions of benefit changes and changes in assumptions
- Disclosure of assumptions related to the discount rate
- Disclosure of what the employer’s proportionate share of the net pension liability would be if a discount rate one percentage point higher and a rate one percentage point lower had been used
- The balances of deferred outflows of resources and deferred inflows of resources, presented by source (for example, experience gains and losses, or differences between assumed and actual investment earnings)
- The net amount of deferred inflows and outflows that will be recognized as pension expense and the amount of deferred outflows that will reduce the net pension liability—for each of the next five years and in the aggregate thereafter
- The employer’s percentage of the collective net pension liability, how it was determined, and any change in the percentage since the previous measurement.
- Cost-sharing employers will also present schedules of required supplementary information following the notes.
The first schedule will contain information for each of the most recent 10 years, including the employers proportionate share of the collective net pension liability, the employer’s payroll amount for current employees in the plan (employer’s covered-employee payroll), a ratio of the employers proportionate share of the collective net pension liability divided by the employer’s covered-employee payroll, and the pension plan’s net position as a percentage of the total pension liability.
In addition, if a cost-sharing employer’s contributions to the plan are based on statutory or contractual requirements, it will present a schedule of required supplementary information covering the 10 most recent years following the notes. The schedules will present the cost-sharing employer’s statutorily or contractually required contribution, the employer’s actual contributions, the difference between the actual and statutorily or contractually required contributions, and a ratio of the actual contributions divided by employer’s covered-employee payroll.
- When will cost-sharing employers begin reporting the pensions under the new standards?
Cost-sharing employers are required to put the new standards into effect beginning in fiscal years ending June 30, 2015, and later. The GASB does, however, encourage employers to implement the new standards sooner.