Fact Sheet on the GASB’s New Pension Standards: Governments in Single-Employer Defined Benefit Pension Plans
What new requirements regarding accounting and financial reporting for pension benefits will governments that participate in single-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 single-employer defined benefit pension plan?
A defined benefit pension plan specifies the benefits to be provided to the employees after the end of their employment. By contrast, defined contribution plans stipulate only the contributions to an employee’s account each year. Single-employer pension plans provide pension benefits to the employees of one employer, whereas multiple-employer plans provide benefits to the employees of more than one employer. Governments participating in single-employer defined benefit pension plans are referred to as single employers.
What is a net pension liability and why is it important?
To the extent that a single employer’s long-term obligation to provide pension benefits (its total pension liability) is larger than the value of the assets available in the pension plan’s trust to pay pension benefits, a single employer has a net pension liability. The net pension liability will be reported in a single employer’s accrual accounting-based financial statements. This is significant because the net pension liability will appear plainly on the face of the financial statements for the first time, along with a single employer’s other long-term liabilities.
How will a single employer determine the amount to be reported as the liability?
The new Statement describes the procedures for measuring the total pension liability, which essentially involve 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, present, 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 government, 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. Single employers will be required to use the long-term expected rate of return on the investments of their pension plan or a single rate based on a combination of long-term expected rate of return and a municipal bond index rate. At present, single employers 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 a single employer 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 single employer will have to contribute. The pension liability would then resemble a single employer’s outstanding debt and other typical long-term liabilities.
How will the present value of projected future 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 single-employer pension plans use one actuarial cost method—called entry age—and apply it only as a level percentage of payroll. Previously, single-employer pension plans had been allowed to select from six different actuarial cost 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 choices 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 net pension liability that single employers will report in the financial statements.
How will the cost of pensions (pension expense) be measured for single 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 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.
Single employers will report the following changes in the total pension liability 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 sooner that 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 is the reporting of the liability, expense, and deferrals affected if another entity is responsible for a portion of a single employer’s pension obligation?
There are circumstances in which another entity (often governmental) is legally responsible for some or all of a single employer’s obligation to provide pension benefits. For example, a state government may be responsible for making all of the required contributions to a pension plan on behalf of a local government. 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 single employers present?
The notes to the financial statements of single 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. Single 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 net pension liability would be if a discount rate one percentage point higher and lower had been used
The net pension liability at the beginning of the year, the change in the net pension liability during the year presented by cause (service cost, benefit changes, investment earnings, and so on), and the ending net pension liability
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.
Single employers will also present schedules of required supplementary information following the notes.
The schedules will contain the following information for each of the most recent 10 years:
The beginning and ending balances of the total pension liability, the plan assets available for pension benefits (called plan net position), and the net pension liability, as well as the change in those amounts during the year presented by cause (similar to the note disclosure)
Total pension liability, plan net position, net pension liability, a ratio of plan net position divided by the total pension liability, the payroll amount for current employees in the plan (covered-employee payroll), and a ratio of the net pension liability divided by covered-employee payroll
If a single employer’s contributions to the plan are actuarially determined or based on statutory or contractual requirements: the single employer’s actuarially determined contribution to the pension plan (or, if applicable, its statutorily or contractually required contribution), the employer’s actual contributions, the difference between the actual and actuarially determined contributions (or statutorily or contractually required), and a ratio of the actual contributions divided by covered-employee payroll.
When will single employers begin reporting the pensions under the new standards?
Single 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.