New GAO Study Addresses Performance Audit Reports

Courtesy of the U.S. Government Accountability Office, a new study looks at performance audits for different types of pension plans. The report is entitled "Oversight of the National Railroad Retirement Investment Trust" (May 2014) and responds to requests from members of the U.S. Congress for information about this $25 billion retirement plan. Based on countless interviews with regulators, private fiduciary experts (and yes, I did answer some questions about benchmarking) and pension fund executives, the authors put forth the idea that performance audits could be mandated to occur more often. Interestingly, GAO researchers point out that "the frequency with which the Trust has commissioned performance audits is comparable to or exceeds most state efforts," adding that "...nine state plans are audited at least once every 2 or 3 years" with interviewees from 19 states pointing out that retirement plans "were subject to audits at longer set intervals that varied from state to state or were not reviewed according to any established time frame."

Pension fund accounting and performance benchmarking is certainly getting its share of attention. U.S. Securities and Exchange Commissioner Daniel Gallagher recently decried what he believes is an under-reporting of "trillions of dollars in liabilities. In his May 29, 2014 speech before attendees of the Municipal Securities Rulemaking Board's 1st Annual Municipal Securities Regulator Summit, Commissioner Gallagher talks about pension and OPEB liabilities as a serious threat and warned that "...it is imperative that bondholders know with precision the size of the potential pension liabilities of the entities in which they are investing. And yet, they do not." He adds that the "threat has been hidden from investors." As Lisa Lambert and Lisa Shumaker describe, government officials say that these sharp remarks sting and will scare people into thinking that a systemic problem exists. Read "Pension groups strike back at SEC commissioner's criticism" (Reuters, June 16, 2014). In its Q1-2014 update, the National Association of State Retirement Administrators ("NASRA") show that public pension fund assets have grown to $3.66 trillion, up slightly from the year-end 2013 level of $3.65 trillion.

On the rule-making front, the Governmental Accounting Standards Board ("GASB") just published an update to its pension accounting standards and posted a pair of brand new proposals to "improve financial reporting by state and local governments of other post-employment benefits, such as retiree health insurance." See "GASB Publishes Proposed Accounting Standards for Government Post-Employment Benefits" by the editor of AccountingToday.com, Michael Cohn. You can download the three documents by visiting the GASB website. Click to access GASB's microsite about Other Postemployment Benefits ("OPEB").

The good news, as I have said all along, is that initiatives for heightened transparency are underway. For more difficult situations, don't be surprised if litigation about disclosures continues to occur. In case you missed the February 24, 2014 Practising Law Institute ("PLI") CLE webinar, you can purchase the slides and audio recording of "Muni Bonds, Pensions and Financial Disclosures: Compliance, Litigation and Regulatory Trends." I co-presented with Orrick, Herrington & Sutcliffe LLP partner, Elaine Greenberg. My focus was on risk management, valuation, performance and investment decision-making.

J.P. Morgan Predicts Gloomy Year Ahead For Pension Plans

According to its Fall 2012 issue of Pension Pulse, published by the J.P. Morgan Asset Management Strategy Group, 2013 is going to be "grim" for pension funds after a less than jovial 2012. Citing a drop in funded status for many U.S. plans this year, "despite a 14% stock market rally," trouble spots are unlikely to disappear any time soon, putting continued pressure on the size of liabilities.

To tame the beasts in the form of "funded status volatility, unfavorable changes in the index used to value pension liabilities and longevity assumptions that increase liability values," employers continue to explore de-risking transactions such as offering lump sums and buyouts. Contrary to popular belief, the authors point out that even companies with underfunded plans like lump sum arrangements. The appeal is in part motivated by tax rules that allow "certain plans to use backdated discount rates to value lump sum payouts" that are higher than current discount rates.

Although the evidence suggests an increased demand on the part of plan sponsors to de-risk, J.P. Morgan professionals reference a ceiling of about $70 billion more over the next four or five years before industry capacity is reached for pension risk transfers. Of course, any time that demand increases and supply remains static, prices will rise as a result. At the margin, that could encourage some organizations from de-risking.

The report goes on to describe a "surreal discount rate" situation as the result of some bank securities being downgraded below AA in June of 2012. The net effect - a change in the discount rate curve that "reduced the weight of financials" - left only ten issuers to make up 75% of the market value of the index. Arguably, this increases the "inherent concentration risk" which in turn could increase the volatility of the index, thereby sending employers off on a measurement roller coaster ride. Shareholders could then feel the pinch if companies have to add cash to a plan as funding levels sink.

Adding insult to injury, the authors describe a change in actuarial assumptions that could significantly push the costs upward for companies that sponsor pension and Other Post Employment Benefits ("OPEB") programs. Their assertions are that (1) "changing actuarial assumptions are likely to increase pension liabilities by 2% to 5%" and (2) uncapped post-retirement health care benefits could go up by 6% to 9%.

Taken individually or together, the various pressures on retirement plan liabilities suggest a busy year ahead for ERISA fiduciaries and their support staff.

Public Pension Plans Owe $2.73 Trillion

According to a just released study by the Pew Center on the States, state pension plans in aggregate owe nearly $3 trillion in pension benefits, of which about $400 billion is unfunded. Unfortunately, for some state residents, the financial pain is not evenly spread throughout the nation. Consider some of the findings.

  • "Only a third of the states have consistently set aside the amount their own actuaries said was necessary to cover the cost of promised benefits over the long term.
  • Twenty states had funding levels of less than 80 percent at the end of FY 2006—below what most experts consider healthy.
  • Several states have seen particularly troubling drops in their pension funding levels. Some of the biggest drops have occurred in Hawaii, Kentucky, New Jersey, Pennsylvania and Washington."

Hold onto your hats.

The study further reports that post-employment healthcare benefits have a price tag of about $381 billion with only 3 percent of this total liability having been funded to date. "None of the five largest states—California, Texas, New York, Florida and Illinois—had put aside money for non-pension benefits as of FY 2006." and 11 states, including California, New York, New Jersery and Connecticut owe more than $10 billion to plan participants.

Ouch!

As this blog has pointed out repeatedly, there is no free lunch. Putting off the inevitable is going to be painful for employees, retirees and taxpayers.

Now imagine you are a resident of a state with post-employment funding woes. Your taxes go up to pay for someone else to retire at the same time that you are struggling with your own situation. That's exactly what is happening for millions of people, causing great angst for all.

Read "Promises with a Price" in full text. If you missed it, the October 2007 issue of Governing (by the same authors of this new Pew report) addresses anemic pension governance standards at the state level in "The $3 Trillion Challenge." Part of that article includes a sidebar with yours truly on suggested questions to ask as part of a governance check-up for a particular plan. Read the Q&A with Susan Mangiero.

Also check out our earlier blog post entitled "Tea Party Redux: State Pensions in Turmoil." Written a year ago, the message is still the same. Ask your state legislators for their proposed solution to the retirement funding crisis.