Pension costs expected to see greater public scrutiny

From The Beacon, November 2011

With the Legislature and governor steadily working to enact a significant pension reform law this year, many fiscal observers are feeling positive about the $5 billion in savings that could be achieved between now and 2040, including $3 billion for the Commonwealth and $2 billion for cities and towns. Indeed, the independent bond rating agencies cited the state’s commitment to pension reform as one of the reasons why the state’s bond rating was increased a couple of months ago. (Plans to bring the state’s rainy day fund up to $1 billion certainly didn’t hurt, either.)

With the state and localities facing a combined $30 billion in unfunded pension liabilities, reforming the system is essential. According to an analysis by the Massachusetts Taxpayers Foundation, pension costs have risen from 5.8 percent of local budgets in fiscal 2001 to nearly 7 percent in fiscal 2011. This trend will continue and worsen without important changes. State and local officials and taxpayers have no choice: pension costs must be moderated, or basic programs and services will be cut and an increasing share of property taxes will be diverted to retirement benefits.

There’s much to like about the pension reform framework that state leaders are pursuing. Major changes include increasing retirement ages (as Social Security has done) to recognize that people are living longer, and providing a longer earnings period upon which the pension benefit is calculated to avoid spiking benefit levels during the very end of a career.

Unfortunately, two amendments were adopted during Senate debate that would undermine the projected savings for cities and towns. One amendment would impose an unfunded mandate on every community by raising the base upon which cost-of-living increases are calculated from $12,000 to $13,000. This may not seem too expensive at first blush, but upon closer examination, the Massachusetts Taxpayers Foundation estimates that this one change would wipe out $680 million of the projected $2 billion in municipal savings – that’s 34 percent. Further, this amendment would mandate the change on all retirement systems, ignoring the local-option provision that currently exists to allow localities to increase the base without state intrusion, based on local projections of affordability.

The second amendment would actually decrease pension contributions by 2.5 percent for any employee with 30 years in the system, and by another 2.5 percent for employees with 35 years in the system. These employees would reduce their contributions during the years when their salaries would be the highest, underfunding the system by hundreds of millions of dollars, according to estimates.

Together, these two amendments could wipe out nearly half of the projected savings that communities would otherwise expect from the legislation.

These amendments should be rejected by lawmakers and the governor, and a strong pension reform bill that delivers all the savings that have been promised should be the end result. Anything less would not only be a major disappointment, it would weaken the pension system for years to come and foster greater taxpayer unhappiness.

Even after the passage of significant reform, taxpayers will be examining pension costs for years to come, and cities and towns will be required to issue new disclosures and data on the cost of retirement benefits. That’s because the Governmental Accounting Standards Board is on the verge of adopting new pension accounting rules that will require all public entities to display pension liabilities on balance sheets and to report the “true cost” of pension benefits in operating statements.

Municipal finance enthusiasts can take a look at what GASB is proposing by visiting www.gasb.org and looking at the “Exposure Draft” for Pension Accounting and Financial Reporting. I recommend downloading the “plain-language supplement” first, as it is less dense and more readable. Of course, the specific implications for each community and retirement system will be different and hard to discern at this time.

For example, these complex new rules, which have been released in draft form by GASB and are expected to be finalized next year, could actually require accounting calculations that would show higher pension liabilities than currently reported by retirement systems.

The new rules could be imposed on all governmental entities as soon as fiscal 2014, and many larger states and localities could face earlier reporting.

Cities and towns would be wise to consult their actuaries and auditors to discuss the implications. The new requirements will trigger much discussion and interest locally, as every city and town balance sheet will show significant new liabilities. Municipal leaders will want to anticipate the new GASB reporting requirements and be prepared to discuss efforts to fund or manage these costs with taxpayers, employees, and, importantly, rating agencies.

And just to show that this public scrutiny of employee benefits is here to stay, GASB is currently studying how to follow the new pension accounting rules with a new set of changes to require quantification of unfunded retiree health insurance obligations.

This shows that pension reform legislation is only the beginning. Taxpayers will soon be seeking explanations and answers, and now is a good time to plan and prepare.