First pensions, now OPEB – New GASB 74 & 75 will transform OPEB reporting

Public sector employers, get ready! The Governmental Accounting Standards Board (GASB) has officially approved new accounting statements for Other Post-Employment Benefit plans (OPEB; retiree medical). Here’s what the recent GASB announcement confirms:

  • Final provisions will closely mirror GASB 67/68 pension accounting. The official statements won’t be released until late June, but last summer’s OPEB exposure draft included similar provisions such as:
    • The unfunded liability will now go on the balance sheet.
    • The liability discount rate will be based on a projection of how long dedicated assets (plus future contributions) will cover current plan members’ future benefit payments.
    • OPEB expense will recognize asset and liability changes over a shorter time period.
    • Goodbye ARC! Funding and accounting are officially separated, so plans and employers should consider developing a new OPEB funding policy.
  • Expanded note disclosures and RSI are required, including sensitivity of results to a +/-1% change in the discount rate and medical trend assumptions.
  • Effective dates:
    • GASB 74 Plan accounting is first effective for reporting periods beginning after June 15, 2016 (e.g., fiscal years beginning July 1, 2016 or January 1, 2017).
    • GASB 75 Employer accounting is first effective for reporting periods beginning after June 15, 2017 (e.g., fiscal years beginning July 1, 2017 or January 1, 2018).

Although the implementation dates are almost 3 years away, employers should take action now to prepare. Some questions to ask include:

  1. How can I develop and implement an OPEB funding policy over the next few years? Prefunding OPEB can help reduce the unfunded balance sheet liability.
  2. What plan benefit adjustments and investment policy changes are available to lower my long-term OPEB liability? Now is the time to review your OPEB management strategies.
  3. What is my strategy to educate stakeholders about OPEB promises and their potential financial impact under the new GASB 74/75 requirements? OPEB is a complex topic that may be unfamiliar to plan members, government decision-makers, and taxpayers.

The new GASB 74/75 statements should help make OPEB promises more understandable and transparent. While there’s still sufficient lead-up time, employers should view this as an opportunity to proactively address an employee benefit which is often unfunded but must be managed prudently.

Higher Discount Rates Will Help 2013 Pension Disclosures and 2014 Expense

The final results are in and pension plan sponsors should be pleased with final year-end discount rates – at least compared to the FY2012 rates. Using the Citigroup Pension Liability Index (CPLI) and Citigroup Pension Discount Curve (CPDC) as proxies, pension accounting discount rates are up by about 90 basis points this year.

This is great news for pension plan sponsors. The higher discount rates will have a very beneficial effect on pension liabilities. This in turn will affect both the year-end funded status of the plan and also the 2014 pension expense calculation.

Analysis
In the chart below we compare the CPDC at four different measurement dates (12/31 2010 to 2013). We also highlight the CPLI at each measurement date. The CPLI can be thought of as the average discount rate produced by the curve for an average pension plan.

Citigroup comparison 12312013

The orange arrows in the chart highlight the trend in yield curve movement and show how rates have increased at almost all points along the spectrum since 2012. This means that pretty much all plans, even closed/frozen plans with shorter durations, should experience the benefit of higher discount rates.

Net Effect on Balance Sheet Liability
Many plans also had strong investment returns during the year. Depending on the starting funded status, the change in pension liabilities and assets can have a leveraging effect on the reported net balance sheet asset/liability.

Below is a simplified illustration for a plan that was 70% funded on 12/31/2012 and we assume a 10% decrease in pension liability during 2013. We then compare the funded status results under two asset scenarios: (1) Assets 5% higher than 12/31/2012 and (2) Assets 15% higher than 12/31/2012.

12312013 bal sheet liability example

In both cases, the funded status of the plan improves measurably. There’s also a magnified decrease in the unfunded balance sheet liability because it’s such a leveraged result. This amount decreases by 45% and 68%, respectively, in the two sample scenarios.

Conclusions
So, what should plan sponsors be considering over the next few months as we approach year-end? Here are a few ideas.

  • Now maybe a good time to consider strategies that lock-in some of this year’s investment gains. These could include exploring an LDI strategy to more closely align plan assets and liabilities. Or, offering a lump sum payout window for terminated vested participants early in 2014.
  • Additional plan funding (above the IRS minimum requirements) may be appealing in 2014. Not only will it increase the plan’s funded status, but it will also help lower your pension plan’s PBGC variable rate premiums. These are scheduled to increase significantly starting in 2015 as a result of the Bipartisan Budget Act of 2013.
  • Your plan’s specific cash flows could have an enormous impact on how much the drop in discount rates affects your pension liability. If you’ve just used the CPLI in the past, it’s worth looking at modeling your own projected cash flows with the CPDC or an alternative index or yield curve to see how it stacks up.
  • Even though increased discount rates tend to lower the present value of pension liabilities, your plan may still have an overall liability increase. This could result from active participants continuing to accrue new benefits in the plan, or from the fact that benefits will have one fewer year of interest discount at 12/31/2013 compared to 12/31/2012.

Pension Discount Rates – September 2013 Preview

After several years of painfully-low pension discount rates, we’ve seen a modest rebound in 2013. Using the Citigroup Pension Liability Index (CPLI) and Citigroup Pension Discount Curve (CPDC) as proxies, pension accounting discount rates are up by about 80 basis points so far this year.

This is great news for pension plan sponsors, especially if rates continue their upward trend. Add in strong year-to-date equity returns, and we may finally see a reduction in unfunded pension balance sheet liability for fiscal year-end 2013.

Analysis
In the chart below we compare the CPDC at four different measurement dates (12/31 2010 to 2012, and 8/31/2013). We also highlight the CPLI at each measurement date. The CPLI can be thought of as the average discount rate produced by the curve for an average pension plan.

Citigroup comparison 08312013

Rates have increased at all points along the spectrum since 12/31/2012. The orange arrows highlight the trend in yield curve movement. The increase in rates all along the yield curve means that all types of plans (e.g., frozen and open) should benefit if interest rates continue to increase through year-end.

Net Effect on Balance Sheet Liability
Many plans had strong investment returns during the first half of the year, with some fluctuations over the past couple of months. If those early investment gains can be preserved (or increased) until year-end, then this will further improve the pension funded status (assets minus liabilities). Depending on the starting funded status, the change in pension liabilities and assets can have a leveraging effect on the reported balance sheet liability.

Conclusions
So, what should plan sponsors be considering over the next few months as we approach year-end? Here are a few ideas.

  • Don’t count your chickens before they hatch. We’re still several months away from year-end for most plans and a lot can change between now and then. However, there’s reason to be cautiously optimistic.
  • Now maybe a good time to consider strategies that lock-in some of this year’s investment gains. These could include exploring an LDI strategy to more closely align plan assets and liabilities. Or, offering a lump sum payout window for terminated vested participants early in 2014.
  • Even though increased discount rates tend to lower the present value of pension liabilities, your plan may still have an overall liability increase. This could result from active participants continuing to accrue new benefits in the plan, or from the fact that benefits will have one fewer year of interest discount at 12/31/2013 compared to 12/31/2012.

Your plan’s specific cash flows could have an enormous impact on how much the drop in discount rates affects your pension liability. If you’ve just used the CPLI in the past, it’s worth looking at modeling your own projected cash flows with the CPDC or an alternative index or yield curve to see how it stacks up.

Expect Lower Discount Rates (and Higher Liabilities) for 2012 Pension Disclosures

Pension discount rates continued to drop during 2012 and plan sponsors should prepare for yet another potential upward spike in balance sheet liabilities for the fiscal year ended December 31, 2012.

Using the Citigroup Pension Liability Index (CPLI) and Citigroup Pension Discount Curve (CPDC) as proxies, pension accounting discount rates may decrease by roughly 35 basis points. This could present yet another increase in the pension liability compared to FY2011 (when many thought rates couldn’t get any lower). Fortunately, many plans also experienced strong investment returns during 2012 so the combined effect on the net balance sheet liability may be muted.

Analysis

In the chart below we compare the CPDC over the past four years at different dates (12/31/2009, 12/31/2010, 12/31/2011, and 12/31/2012). We also highlight the CPLI at each measurement date. The CPLI can be thought of as the discount rate produced by the curve for an average pension plan.

Citigroup comparison 12312012

Rates on the long end of the spectrum dropped slightly since 12/31/2011, while short and medium-term rates had a more pronounced decrease. This means plans whose liabilities are “front-loaded” (i.e., significant portion of benefits expected to be paid in the next 15 years) will see larger liability increases. Examples are plans with high concentrations of retirees or those that have been frozen or closed to new entrants for many years.

Net Effect on Balance Sheet Liability

If asset performance was strong during 2012, then this will moderate the situation since the net shortfall (assets minus liabilities) is reported as the balance sheet liability.

Below is a simplified illustration for a plan that was 80% funded on 12/31/2011 and we assume a 5% increase in pension liability during 2012. We then compare the funded status results under two asset scenarios: (1) Level assets since 12/31/2011 and (2) Assets 5% higher than 12/31/2011.

Depending on the starting funded status, the change in pension liabilities and assets can have a leveraging effect on the reported balance sheet liability.

12312012 bal sheet liability example

Conclusions

So, what’s a plan sponsor to do when faced with a big increase in pension accounting liability? Here are a few ideas.

  • Your plan’s specific cash flows could have an enormous impact on how much the drop in fixed income rates affects the pension liability. If you’ve just used the CPLI in the past, it’s worth looking at modeling your own projected cash flows with the CPDC to see how it stacks up.
  • Additional plan funding (above the IRS minimum requirements) may be appealing in 2013. Not only will it increase the plan’s funded status, but it will also help lower your pension plan’s PBGC variable rate premiums.
  • If you’ve implemented an LDI strategy for a portion of the pension trust portfolio, then the drop in discount rates should be accompanied by a corresponding increase in your asset value. If you haven’t adopted an LDI investment strategy yet, now may be a good time to revisit this policy.
  • There are some alternatives to the CPDC and CPLI as a basis for setting accounting discount rates, such as “above-median” versions of these rates. Check with you actuary or auditor to see what your options are.

Low Pension Discount Rates = Big Accounting Liabilities for FY2011

Pension discount rates have plummeted over the past few months and plan sponsors should prepare for a potential upward spike in balance sheet liabilities for the fiscal year ended December 31, 2011.

Using the Citigroup Pension Discount Curve (CPDC) as a proxy, pension accounting discount rates could decrease by 100 basis points (or more). This will mean a big increase in the pension liability and net balance sheet liability for many plans.

Analysis

In the chart below we compare the CPDC over the past two years at different dates (12/31/2009, 12/31/2010, 6/30/2011, and 12/31/2011). We also highlight the Citigroup Pension Liability Index rate (CPLI) at each measurement date. The CPLI can be thought of as the average discount rate produced by the curve for an average pension plan.On the short end of the spectrum, rates continued to drop between FYE2009 and FYE2011. The bigger issue may be the dramatic drop in rates on the long end of the spectrum (e.g., years 15 and beyond) since 6/30/2011.

A large portion of many pension plans’ obligations are discounted at these long-term rates, so they could have a significant impact on the accounting liabilities. This is particularly true for retiree medical plans where assumed health inflation means that considerably higher costs are projected in the later years.

Net Effect on Balance Sheet Liability

If asset performance was weak during 2011, then this will exacerbate the situation since the net shortfall (assets minus liabilities) is reported as the balance sheet liability.

Below is a simplified illustration for a plan that was 90% funded on 12/31/2010 and we assume a 10% increase in pension liability during 2011. We then compare the funded status results under two asset scenarios: (1) Level assets since 12/31/2010 and (2) Assets 5% lower than 12/31/2010.

Depending on the starting funded status, the change in pension liabilities and assets can have a dramatic leveraging effect on the reported balance sheet liability.

Conclusions

So, what’s a plan sponsor to do when faced with a big increase in pension accounting liability? Here are a few ideas.

  • Your plan’s specific cash flows could have an enormous impact on how much the drop in fixed income rates affects the pension liability. If you’ve just used the CPLI in the past, it’s worth looking at modeling your own projected cash flows with the CPDC to see how it stacks up.
  • If you’ve implemented an LDI strategy for a portion of the pension trust portfolio, then the drop in discount rates should be accompanied by a corresponding increase in your asset value. If you haven’t adopted an LDI investment strategy yet, now may be a good time to revisit this policy.
  • There are lots of alternatives to the CPDC and CPLI as a basis for setting accounting discount rates. Check with you actuary or auditor to see what your options are.