THE PENNSYLVANIA STATE UNIVERSITY SCHREYER HONORS COLLEGE DEPARTMENT OF ACCOUNTING

Transcription

1 THE PENNSYLVANIA STATE UNIVERSITY SCHREYER HONORS COLLEGE DEPARTMENT OF ACCOUNTING EVALUATING STATE NET PENSION LIABILITIES UNDER BLENDED DISCOUNT RATES TYLER FAGAN SPRING 2017 A thesis submitted in partial fulfillment of the requirements for a baccalaureate degree in Accounting with honors in Accounting Reviewed and approved* by the following: Karl Muller Associate Professor of Accounting Thesis Supervisor Orie Barron Professor of Accounting Honors Adviser * Signatures are on file in the Schreyer Honors College..

2 i ABSTRACT The Government Accounting Standards Board (GASB) has impacted the discount rates for public pension plans since the implementation of GASB Statement 25 in This original statement allowed for public entities to implement discount rates based of off the effective rate of return on plan assets. The resulting discount rates resided higher than those used in the private industry. GASB implemented Statement 67 in 2012, which introduced a blended rate to derive net pension liabilities. This amendment came after speculation over Statement 25. After the introduction of Statement 67, the blended discount rate has been used only by few states in the calculation of actual state net pension liabilities. Statement 67 also allows for public retirement systems to take credit for future contributions. This allows the retirement systems to continue reporting with a higher discount rate. This thesis will examine state net pension liabilities discounted by the blended discount rates stipulated by Statement 67. The difference between state net pension liabilities discounted by a blended rate and by the effective rate of return will display the significance between the rates. It will show the state net pension liabilities amount if public retirement systems were unable to take credit for future contributions to their pension plans. The study will highlight the net pension liability hidden by future contributions.

3 ii TABLE OF CONTENTS LIST OF FIGURES... iii LIST OF TABLES... iv ACKNOWLEDGEMENTS... v Chapter 1 : Introduction... 1 Chapter 2 : Background on GASB Statements... 3 Introduction to Standards:... 3 GASB Statement 25:... 4 GASB Statement 67:... 5 Chapter 3 : Literature Review... 9 Discount Rate Analysis:... 9 Contributions to Pension Plans: Chapter 4 : Research Methodology Samples: Methodology: Chapter 5 : Results Overview: Range 1 Results: Range 2 Results: Range 3 Results: Range 4 Results: Range 5 Results: Range 6 Results: Overall Results: Chapter 6 : Conclusion Conclusions Reached: Change Needed: Appendix A: Percentage Change in Net Pension Liability Without Highest Percentage Changes... 33

4 iii Appendix B: Range 1 Data Appendix C: Range 2 Data Appendix D: Range 3 Data Appendix E: Range 4 Data Appendix F: Range 5 Data Appendix G: Range 6 Data BIBLIOGRAPHY... 55

5 iv LIST OF FIGURES Figure 1: Discount Rate Difference Example (Iowa Public Employees Retirement System) 16

6 v LIST OF TABLES Table 1 : Current Used Blended Discount Rates Table 2: Current Net Pension Liability Ranges Table 3: Average Percentage Change in Net Pension Liability Table 4: Average of Current Discount Rates Table 5: Net Pension Liability Averages Table 6: Average Funding Percentages Table 7: Overall Average Results... 27

7 vi ACKNOWLEDGEMENTS I want to thank everyone that has assisted me through my academic pursuits. My family and close friends have given endless support. I would also like to thank Karl Muller and Orie Barron for the assistance they provided with this study.

8 1 Chapter 1 : Introduction The current pension funding situation in the United States poses one of the biggest present day threats to the economy. Financial media organizations reporting pension underfunding has become much more common. If not recognized, these underfunded pensions can lead to bankruptcy and greater uncertainty for government retirement systems. This makes the proper financial reporting of public pensions paramount. The financial reporting behind public pensions has had much more attention in current days. Most hotly debated in this area are the current standards in place regarding discount rates for pension liabilities and standards surrounding the crediting of future contributions. These two areas will take up a large segment of this study. Discount rates in public retirement systems within the United States have a large impact on how the systems report net pension liabilities. The rates can change net pension liability amounts dramatically. Net pension liabilities will be mentioned extensively in the study. They represent the underfunding of the retirement system. Because of this, the proper discount rates are determined by standards in place from the Government Accounting Standards Board (GASB). The current discount rates approved by GASB have stood at high levels for years. The higher the discount rate, the lower the liability a public entity reports. Standards require either the usage of a blended discount rate or a discount rate equal to the rate of return on plan assets. Most public retirement systems discount through a rate equal to the rate of return on plan assets.

9 The continual usage of the expected rate of return as the discount rate comes from the 2 ability of systems to take credit for future contributions. Current GASB standards allow for the public retirement systems to take credit for expected contributions to future members. This means that, as a portion of pension funding, public retirement systems can claim funding for contributions to individuals that have not been included in a retirement systems plan yet. The total expected plan contributions, for both current and future members, are then weighed against only the current projected plan benefit payments. This allows for artificial inflation of pension funding percentages. Public retirement systems use these expected contributions to future members to cover their pension funding when it comes to financial reporting. These contributions have a large impact on the discount rates used on the pension plan s net pension liability. It allows for public entities to discount using a rate equal to the market rate of return instead of the blended discount rate. When a pension plan is underfunded a blended discount rate is required. Therefore, with these extra contributions the retirement systems evade reporting with a blended discount rate. This study analyzes the effect expected contributions to future members have on current net pension liabilities. In order to show this, the study discounts net pension liabilities under a blended rate. This reflects how net pension liabilities look when retirement systems cannot take credit future contributions. The study displays the magnitude of a change in the discount rate to a lower amount. The results of the study indicate the importance of the statements surrounding contributions to future plan members. The findings of the study offer insight towards whether public retirement systems should be allowed to take credit for future contributions or be allowed to discount using the rate of return on plan assets.

10 3 Chapter 2 : Background on GASB Statements Introduction to Standards: Current standards in place deem what the proper accounting methods for pension plans are. Standards from different regulating boards govern different areas. The Financial Accounting Standards Board (FASB) issues statements that create guidelines for the private sector, while GASB covers the financial reporting methods within the public sector. Both have issued statements on the financial reporting of pension plans. The statements are meant to result in useful information for users of financial reports, and guide and educate the public (GASB website). Statements regarding public pension plans allow for users to understand the weight of pension plans and how the entities respond to current funding levels. Many elements give light to the status of pension plans. The main element under scope is the discount rate. In financial reporting the discount rate is used to discount future amounts to a present value. For pension reporting in particular the discount rate assists in determining the present value of future payments. The future payments for pension plans represent liabilities for entities. In estimating the value of the future payments, organizations figure out how much to contribute in the present in order to meet future obligations. Therefore, the discount rate affects the amount contributed to plans. The importance of the discount rate highlights why a higher organization, GASB, should have oversight over proper discount rate usages. The issue is that the rates allowed by GASB have received speculation since their initial implementation. Statement 25 from GASB indicated the first necessary method behind public pension discount rates.

11 GASB Statement 25: 4 The current issue stems from GASB s first attempt at the discount rate used for public pensions. GASB Statement 25 states that public pension liabilities have to be discounted at a rate equal to that of the expected rate of return (GASB, 1994). This ruling was made in 1994, before large public pension underfunding came about. Although GASB Statement 25 was amended by GASB Statement 67, the expected rate of return still dominates as the discount rate for a majority of public entities. The average of this discount rate sits around 8.0% but extends typically from % (Novy-Marx and Rauh). This high discount rate has allowed for the underreporting of the public pension funds, while also preventing more contributions to the fund. Extra contributions occur when the pension fund is underfunded. These back-pay contributions to the fund are given based on the underfunding of the pensions. With a higher discount rate a lower amount of underfunding is reported and therefore a lower contribution to the fund occurs (Novy- Marx and Rauh). Nowadays these funds already sit well underfunded and these high discount rates fail to assist in contributing to the plans. The high discount rates also fail to adequately display the funding situation of public pension plans, leading the situation to appear better than it is. Recent studies also bring into question the people in charge of the public pension funds. This arises from boards being comprised of a decent proportion of government officials, although it has not been proven substantially yet (Andonov, Bauer, and Cremers). GASB Statement 25 has also been studied for leading public pension plans to invest in a large amount of risky assets compared to the plans of private companies. If public pension plans invest more over time in riskier assets, it leads to an increase in the expected rate of return. This follows from riskier assets promising higher returns. The increase in the expected rate of return leads to an increase in the discount

12 rate, as the two are required to be the same. This higher discount rate leads to a lower 5 underfunding amount being reported, which goes hand in hand with lower contributions being made to the fund (Andonov, Bauer, Cremers). This displays the current unease with the public discount rate situation. These results indicate a source of pressure for possible change. Current research also has it that the current status of GASB Statement 25 leads to the incentivizing of public pension plans to invest in riskier assets. This higher investment into riskier assets creates a higher discount rate that, although may lower contribution payments, creates a lower liability and lower back-pay contributions. The continual investment into risky assets also results in the fund underperforming compared to those of private company pension funds along with foreign public/private pension funds (Andonov, Bauer, Cremers). This highlights another area where the standard receives criticism. Recently, slight changes have been made to GASB Statement 25 in order to ease criticism. GASB Statement 67: Even with the implementation of GASB Statement 67, liabilities are currently being recorded at the high rates previously mentioned. The recent rulings have made a slight betterment. They make it so only the severely underfunded portion of funds will use a lower discount rate (GASB, 2012). The initial fund status still comes from the use of a high discount rate. The pension liabilities are now calculated using the discount rate equal to the expected return rate, average of 8%, and then the underfunded portion of plans will be discounted using a lower rate. The underfunded portion will be discounted using a tax-exempt, high-quality

13 6 municipal bond index rate (Smyth). This results in a blended discount rate used to calculate the total net pension liability. In order to determine funding status, projected benefit payments are discounted and weighed against the plan s assets. A plan is underfunded when the present value of payments exceeds the net value of the plan s assets. Funding status of plans assists with determining contribution amounts and budgetary concerns. For the amount of which the pension plan s fiduciary net position covers projected benefit payments, the long-term expected rate of return on the pension plan s investments will be used. To the extent that the pension plan s net position does not cover projected benefit payments, a yield or index rate for 20-year, tax-exempt municipal bonds with an average rating of AA/Aa or higher will be used (GASB, 2012). GASB has also issued clarifications on the implementation of the standards. Another section of GASB Statement 67 allows for public retirement systems to take credit for expected contributions to future members regarding a plan s funding position. The retirement system can indicate that with the expected contributions to future members, that the plan has the ability to cover the it s position. The retirement systems have the power to do this even though those plan members have not actually been added yet. Retirement systems can use the expected contributions to future members to then lower the net pension liability. This comes from the entities continuing to use the long-term expected rate of return as the discount rate. In order to continue using the long-term expected rate of return, retirement systems use the contributions to cover the extent that a pension plan s net position does not cover projected benefit payments. This negates the need for a blended discount rate and the use of a yield or index rate for 20-year, tax-exempt municipal bonds. The effect of allowing the credit of future contributions is the major focus of this study.

14 The lack of clarity from GASB Statement 67 resulted in an issuance of particular 7 questions, accompanied by answers, from the board. The answers mainly pertain to concerns of two major parties, those within public entities and those outside the entities with purely financial perspective. Both have differing takes, but neither should be dismissed. Members of public entities primarily worry about the increase in the present value of their projected future benefit payments. From GASB s perspective, using the expected rate of return on plan investments as the discount rate only affects the liabilities covered by the net plan position. This viewpoint comes from the idea that if the investments have the ability to cover the liabilities, then the expected rate of return is appropriate ( Setting the Record Straight ). Therefore, the discount rate should only be used for the projected payments that will be paid by the plan investments with the corresponding rate. In turn, the high-quality municipal bond discount rate comes into effect from the lack of investments, along with an expected rate of return, to cover the excess projected benefit payments ( Setting the Record Straight ). The allowance of credit for future contributions allows for the possibility of these higher discount rate as well. This highlights GASB s reasoning behind the discount rates, which displays another area of criticism. Heavy scrutiny from experts comes on the discount rate standard from GASB, mainly the use of the expected rate of return. GASB defended their case by posing and answering another question, which asked whether the standards allowed governments to make their liabilities look smaller. The answer claimed that the standards did not allow for understatement of liabilities. GASB also claimed that if the liabilities were discounted using an unrealistic expected rate of return, the entity misapplied the standards ( Setting the Record Straight ). This response attempts to dissuade the opinion that the standard allows for a loophole of sorts. The response

15 8 fails to mention how GASB plans to approach such misapplication or where the misapplication may stem from. GASB standards should not have clear room for misapplication. The standards board also fails to mention anything regarding policies allowing future contributions. Data in this study will highlight the implementation of blended discount rates arising from retirement systems being unable to take credit for future contributions.

16 9 Chapter 3 : Literature Review Discount Rate Analysis: Some research has it that the proper discount rate depends on the default risk of the pension liabilities. One researcher believes that the proper discount rate can be found from looking at state specific GO credit ratings, to which yields on states municipal GO bonds are closely related (Novy Marx and Rauh). Others have it that a discount rate based on treasury yield curves would better represent the liabilities due to the somewhat risk free nature of the promise to pay pensions to employees (Smyth). Lastly, some believe that a discount rate similar to those of reasonable assumed long-term rate of investment return is appropriate due to the perpetual nature of government entities (Smyth). There are many different opinions when it comes to what discount rate would best represent these public pension fund liabilities. The accounting for pension fund liabilities under FASB in relation to discount rates differs heavily from the reporting of public pension funds under GASB. First off, companies must report a projected benefit obligation (PBO) and must also discount the PBO with a blended corporate bond yield (Novy-Marx and Rauh). In this instance, FASB requires these companies to report their pension fund liabilities this way in order to properly represent the time value of the money and the level of uncertainty behind the fund. This discount rate comes from a mix between upper-medium and high-grade long-term corporate bonds (Rauh, 2006). Unlike the United States, in looking at the pension plans within foreign countries, both the public and private pension plans within Canada use a discount rate equal to

17 10 the market yields of high-quality corporate debt instruments (Canadian Institute of Actuaries, 2011). Again, they use these rates in order to properly reflect the uncertainty behind these funds. The U.S. private pension funds and the Canadian public and private pension funds are not regulated via the expected return on their assets and that means any additional investment into riskier assets would not affect the discount rate. All of these other discount rates are also much higher than that of U.S. public pension funds. Discount rates for private pension funds in the United States and those in Canada and European public funds use liability discount rates equal to high credit quality interest rates (Andonov, Bauer, Cremers). When standards boards dictate a set rate, the entities have no control over managing the rate. Allowing entities to have a high level of control over their discount rate creates a higher possibility of understatement of liabilities. Public pension funds also have no constraints on how much of plan assets can be invested in risky assets (Andonov, Bauer, Cremers). This highlights the possibility that public entities can take a more risky investing strategy in order to obtain a higher discount rate for liabilities, which in turn would show a better funding position. Further research shows the public pension sector s increase in investment to risky assets and the comparison of this investment to other areas. Researchers found that from 1993 to 2012 the allocation to risky assets in public pension plans increased from 56.1% to 72.4% (Andonov, Bauer, Cremers). This highlights entities extensively increasing both the discount rate for pension liabilities and the riskiness of their investments. Differences between the different types entities and their respective discount rates have also been calculated. The time period observed is 1993 to Public pension funds maintained a constant discount rate of 7.5% to 8.0% compared to private pension fund rates, which

18 11 decreased from 8.2% to 4.4% over the timeframe (Andonov, Bauer, Cremers). Over the time period the discount rates of Canadian plans decreased and European rates maintain around 4% (Andonov, Bauer, Cremers). These significant differences in discount rates should be concerning. Other countries using much more conservative accounting policies in similar situations should result in speculation towards current discount rates. Also, within the U.S the difference in discount rates reaches up to 3.6%, showing drastic implications of the current standards. Research by others claims that promised pensions, such as those within public entities, should be discounted using a rate which reflects characteristics of the liabilities rather than the assets (Brown and Wilcox). Currently the discount rates takes into consideration the nature of pension plan assets, not liabilities. Consequences arise from the current discount rate policies. Studies show the higher than necessary discount rates allow for the reduction of pension obligations and that in turn likely decreases the contributions due to how sponsors feel about fund status (Brown and Wilcox). This shows how the discount rates affect the contributions. Contributions to Pension Plans: The rest of the literature surrounding retirement systems look into the current implementation of GASB Standard 67 and the impact of future contributions. One researcher focused on the effect of public pension financial reporting on the employment in state and local governments. The research explains how regular private-sector jobs have returned to levels similar to those before the financial crisis, but that state and local staffing remains lower than in

19 Had pension costs maintained lower levels the state and local workforce would amount to totals matching the prerecession peak (Eide). This displays how current pensions do not appear prepared for the coming surging costs of pensions and that these increasing costs have resulted in a lack of job development within the public sector. The point is further displayed when the author, Stephen Eide, states that the costs have risen from the large extent of current benefit promises that currently have no asset backing (Eide). The lack of asset backing and the reliance upon risky assets creates a situation where public entities must pay more into pensions in order to cover these debts. This in part derives from retirement systems being able to take credit for future contributions. Through GASB Statement 67 pension plans need to project benefit payments against projected plan assets. To the extent that plan assets do not cover the projected benefit payments, the pension plan must discount with a lower discount rate. This results in the blended rate. There is an important difference when developing the projections. When determining the projected benefit payments the, benefits that are expected to be paid to future employees should not be included in the benefit payment projections (Winningham). This displays pension plans only accounting for the benefit payments that they have to make for the individuals they currently employ. The difference comes with the projection of plan assets. When calculating this projection, GASB allows for the inclusion of expected contributions for future members (Winningham). Through this, future contributions combined with expectations of contributions for current members are then weighed against only the projected benefit payments for current members. These expected contributions to future members then reduce the unfunded portion of

20 13 the pension to the point of negating the use of a blended discount rate. This issue is the main focus of this study.

21 14 Chapter 4 : Research Methodology Samples: The sample data for this research comes from the comprehensive annual financial reports (CAFRs) of States and of their respective retirement systems. Where the data came from depended on which entity reported the net pension liability. The data for net pension liability does not always reside in a state s own CAFR. In most cases the retirement systems reported the net pension liability in their own CAFR. The data primarily comes from the 2014-reporting year. The data for the New York State and Local Employees Retirement System is the only data to come from early GASB issued Statement No. 67 in 2012 and therefore the data comes after the issuance. This focuses on which state retirement systems currently do not use blended discount rates. All of the sample retirement systems chosen can be seen through Appendices B to F based on current net pension liability. The net pension liability of state retirement systems that report with a blended discount rate are not included in this study. The blended discount rates of these systems serve a purpose in the research method. The study focuses on how net pension liability changes for state retirement systems that currently use the expected rate of return as a discount rate after the issuance of GASB Statement No. 67. Samples came from retirement systems in almost all fifty states. Three states currently use blended discount rates and their net pension liabilities were not included. Samples came from varying types of retirement systems, with the majority being either state employees or teachers retirement systems. The net pension liability of these systems greatly

22 15 outweighs smaller retirement systems within states. The sample selection resulted in 56 samples from state retirement systems. Methodology: In order to determine the impact a blended discount rate has on net pension liability a blended discount rate is used in place of the expected rate of return in the research method. GASB Statement No. 67 requires that a blended discount rate should be used in order to account for a retirement system s unfunded portion. The statement also allows for retirement systems to account for all future contributions to the plans, which in most plans negates the need for a blended rate. This study uses a method that goes around the allowance of considering future contributions and discounts the net pension liability for all systems under a blended rate. This allows a view at net pension liability if plans did not have the ability to take credit for future contributions. Table 1 : Current Used Blended Discount Rates Retirement System Blended Discount Rate Net Pension Liability Illinois State Employees 7.09% $27,103,519,942 Retirement System New Jersey Public Employees 5.39% $38,849,838,953 Retirement System New Jersey Police and 6.32% 17,486,678,618 Firemen s Retirement System Texas Employees Retirement System 6.07% $14,460,800,000

23 The blended rate used to discount the current net pension liability of the sample 16 retirement systems comes from the few retirement systems that use a blended rate. There are four systems that use a blended discount rate. These systems are displayed in Table 1. The Illinois State Employees Retirement System uses the highest blended rate of 7.09%, and the New Jersey Public Employees Retirement System uses the lowest rate of 5.39%. The blended discount rate used to discount net pension liability in the method is an average of the four discount rates in Table 1. This blended discount rate is 6.218%. Figure 1: Discount Rate Difference Example (Iowa Public Employees Retirement System) In order to measure the effect of the blended discount rate, current net pension liabilities discounted under the expected rate of return are newly discounted by the blended rate of 6.218%. All of the current discount rates used by sample systems resided higher than 6.218%. In order to calculate the new net pension liability more information from retirement system CAFRs is used. Under GASB Statement No. 67 public entities have to disclose the extent to which a 1% increase and a 1% decrease of the discount rate they used would affect the net pension liability. This application is shown in Figure 1, from the Iowa Public Employees Retirement System Comprehensive Annual Financial Report of The effect of a1% decrease in the discount rate is used in this method to recalculate the new total liability for the retirement system. The

24 new total liability is then weighed against the current net plan position to find the net pension 17 liability under the rate of 6.218%. The change in net pension liability from a decrease in 1% helps estimate the change to the current net pension liability to the extent that the current rate drops to the blended rate. This in turn helps to estimate the new net pension liability under the blended discount rate. It also allows for comparison with the current net pension liability and with other systems of similar size. Two formulas derived the main results of the study. They are: NPL Under Blended Discount Rate = (((DR-BDR)*100)*(DCTL-CTL))+CTL)-NPP Percentage Change in NPL = BNPL-NPL/ NPL Where: DR = the expected rate of return on a retirement system BDR = blended discount rate DCTL = total current liabilities -1% in discount rate CTL = total current liabilities NPP = net plan position BNPL = blended rate net pension liability NPL = current net pension liability

25 18 Chapter 5 : Results Overview: The following results display the net pension liability of retirement systems across the United States to increase all across the board. This is expected due to the nature of discount rates, but still shows the impact of public entities not reporting using a blended discount rate. The results are explained in ranges in order to show the different effects of the blended rate based off of the size of the current net pension liability and other categories. These ranges are displayed within Table 2. There are six current net pension liability ranges and each will have a section to explain the results. Table 2: Current Net Pension Liability Ranges Range Number Current Net Pension Liability Range 1 ($3,000,000,000) to $0 2 $0 to $1,000,000,000 3 $1,000,000,000 to $5,000,000,00 4 $5,000,000,000 to $10,000,000,000 5 $10,000,000,000 to $15,000,000,000 6 $15,000,000,000 to $22,000,000,000 Range 1 Results: The main results show the average of current net pension liabilities compared to the average of the net pension liability under a blended discount rate. The net pension liability under

26 a blended discount rate was calculated using the formula previously detailed. The data 19 surrounding Range 1 can be found in Appendix B. For retirement systems within the current net pension liability (asset) range of $(3) billion to $0 the average current net pension liability (asset) was $(1.4) billion compared to the blended rate net pension liability average of $5 billion. These averages for all ranges are highlighted in Table 3. The difference between the two averages reaches near $6.4 billion. The average current discount rate of the range was 7.49%. The average current discount rate for each rate can be found in Table 5. Only four entities reside in this range, with two having current net pension liabilities (assets) over $(2) billion. This shows that even with a low net pension liability, the change of a blended rate would increase the amount substantially. One retirement system in this range also had the highest change in net pension liability in the entire sample. The Tennessee Consolidated Retirement System witnessed a change in net pension liability (asset) from $(63) million to $3.4 billion. This also allowed for higher averages in the results for the range. Without the inclusion of the Tennessee Consolidated Retirement System, the range had a current net pension liability average of $(1.8) billion and a blended rate net pension liability of about $5.5 billion. From a percentage change standpoint, the $(3) billion to $0 range experienced the highest percentage change from current net pension liability to blended rate net pension liability out of all the ranges in the study. The average change in net pension liability came out to 1665%. This change stands over 1400% higher than the next highest average percentage change of another range. None of the samples experienced a change in net pension liability beneath 250%. The average percentage change in net pension liability per range can be found in Table 4. As mentioned previously, the Tennessee Consolidated Retirement System had the largest change in net pension liability in the entire sample, a change of 5554%. The Oregon Public Employees

27 20 Retirement System had the next highest percentage change in this range of 477%. The average percentage change of this range, not including the 5554% change, is 369%. The average percentage changes in net pension liability without the highest percentage change are categorized by range in Appendix A. The average percentage change is larger than the rest of the ranges in the study. The average current funding percentage of this range was 103% compared to the blended rate funding percentage of 90.5%. Range 2 Results: The next results come from the current net pension liability range of $0 to $1 million. The data regarding this range is located in Appendix C. Within this range the average current net pension liability of retirement systems was $435 million and the average net pension liability under the blended discount rate was $1.4 billion. The average current discount rate of the range was 7.72%. These results highlight the significant change a blended rate would have on net pension liability reporting. Unlike the previous range, this one contained nine different entities. The highest and lowest current net pension liabilities were $973 million and $145 million respectively. Two out of the nine entities results contained blended discount rate net pension liabilities under $226 million, while the lowest of the other seven was $823 million. In addition, one of the retirement systems in this range experienced some of the highest growth in net pension liability from the change in discount rates. The Oklahoma Public Employees Retirement System experienced a net pension liability change of $184 million to $1.4 billion. These results display the possible net

28 pension liabilities of retirement systems if they were not allowed to take credit for future 21 contributions. Table 3: Average Percentage Change in Net Pension Liability Range of Current Net Pension Liability Average Percentage Change in Net Pension Liability Range % Range % Range % Range % Range % Range % The average percentage change in this range was the third highest out of all the sample ranges. Net pension liability changed by an average of 219%. A large percentage change of 669% comes from the results of the Oklahoma Public Employees Retirement System. The next highest percentage change in net pension liability was 269%, coming from the Delaware State Employees Retirement System. Five of the systems in this range experienced a net pension liability percentage change over 130%. The average percentage change of the sample range without the large change off 669% is 163%. Under this new average, the percentage change of the range is still the third highest of all the ranges. The average current funding percentage of this range was 84% compared to the blended rate funding percentage of 72%. Range 3 Results: Results in this section will come from the net pension liability range of $1 billion to $5 billion. Appendix D details data regarding Range 3. Within this range the average of the current

29 22 net pension liability of retirement systems was $2.6 billion and the average net pension liability under the blended rate was $9.5 billion. This displays a difference of almost $7 billion between the two types of net pension liability. The average current discount rate of this category was 7.57%. There were nineteen samples that fell within this range, making it the largest range category. Three of the net pension liabilities under a blended rate ranged above resulted in some of the largest changes in the entire sample. The Missouri State Employees Plan experienced a net pension liability change of $2.3 billion to $63.2 billion. The New York state and Local Employees Retirement Association experienced a change in net pension liability of around $3.4 billion to about $27.9 billion. Lastly, the North Carolina Teachers and State Employees Retirement System witnessed a change in net pension liability of about $1.2 billion to $8.6 billion. These stand out to display the drastic effect a change in discount rates has on net pension liabilities. Table 4: Average of Current Discount Rates Range of Current Net Pension Liability Average Percentage Change in Net Pension Liability Range % Range % Range % Range % Range % Range % This range experienced the second highest average percentage change in net pension liability. The average percentage change was 292%. The larger amount of samples in this range allowed for a collection of different net pension liability changes. Four of the nineteen samples in

30 the range experienced a net pension liability change over 400%, with the Missouri State 23 Employees Plan changing 2583%. The next highest net pension liability percentage change in this range was 725% from the New York State and Local Employees Retirement Association. The average percentage change of the range not including the Missouri State Employees Plan is 164%. The average percentage changes in net pension liability without the highest percentage change are categorized by range in Appendix A. The average current funding percentage of this range was 80% compared to the blended rate funding percentage of 66%. Range 4 Results: The following are the results for the current net pension liability range of $5 billion to $10 billion. Within this range the average of the current net pension liability of retirement systems was about $7.2 billion compared to the average net pension liability under a blended rate of $13.2 billion. The average current discount rate of the range was 7.76%. Data for Range 3 is located in Appendix E. Eleven of the samples chosen fell into this range category. Only one of the samples in this range experienced a large change compared to the others within the sample. The Florida Retirement System witnessed a change in current net pension liability of $6.1 billion to $34.7 billion. Compared to this change, the next highest experienced was from the California PERF C System. The system s net pension liability changed from $5.8 billion to $11.1 billion. This section contained a difference between average current net pension liability and average blended rate net pension liability of $5.8 billion. This amount stands lower than differences seen in two of the previous three ranges.

31 24 This range experienced the third lowest average net pension liability change. The range net pension liability changed by an average of 90%. The highest change within the range comes from the California PERF C System, which saw a change of 468%. Other than this one result, the rest of the systems in the sample experienced an average percentage change of 52%. The rest of the systems within this sample range experienced net pension liability change under 90%. Five out of the Eleven in the sample witnessed percentage changes less than 50%. The average current funding percentage of this range was 66% compared to the blended rate funding percentage of 57%. Range 5 Results: Results in this section come from the current net pension liability range of $10 billion to $15 billion. The results show an average current net pension liability of $12.4 billion along with an average blended rate net pension liability of $21.3 billion. The difference between the two averages comes out to $8.9 billion. This difference beats out the differences in all of the other current net pension liability ranges. More data surrounding Range 5 can be found in Appendix F. The average current discount rate of the range was 7.88%. This was the highest average discount rate for a sample range. Eight of the samples within the study fell within this current net pension liability range. Three of the samples within this range experienced a larger change than the other samples in the range. The changes in net pension liability in this range stand lower compared to other ranges in the study. The Ohio Public Employees Retirement System witnessed the largest change in net pension liability in this range of $12 billion to $30 billion. The next highest blended rate net

32 25 pension liability in the range was about $22.3 billion. The Public Employees Retirement System of Nevada also experienced a distinct change of $10.4 billion to $20.7 billion. Again, these changes do not quite reach the extent of net pension liability changes in lower ranges. Table 5: Net Pension Liability Averages Range of Current Net Pension Liability Average Current Net Pension Liability Average of Blended Rate Net Pension Liability Range 1 ($1,376,655,361.00) $4,961,266, Range 2 $434,620, $1,358,970, Range 3 $2,611,849, $9,551,403, Range 4 $7,234,878, $13,246,315, Range 5 $12,408,064, $21,320,166, Range 6 $18,081,865, ,066,467, This sample range had the second lowest average net pension liability change out of the six ranges. The average percentage change came out to be 74.5%. The highest net pension liability percentage change of 149% comes from the previously mentioned Ohio Public Employees Retirement System. The next highest percentage change in the range is 99%. The average net pension liability change not including the Ohio Public Employees Retirement System comes out to 64%. The average percentage changes in net pension liability without the highest percentage change are categorized by range in Appendix A. The average current funding percentage of this range was 71.5% compared to the blended rate funding percentage of 60%.

33 Range 6 Results: 26 Lastly, the final range details results in the from current net pension liability of $15 billion to $22 billion. Appendix G contains data detailing Range 6. Within this area the average current net pension liability was $18 billion and the average blended rate net pension liability was $26 billion. This results in a difference of $8 billion. The difference only sits at the third highest compared to differences of other ranges, even though the largest current net pension liability amounts reside in this range. The average current discount rate of this category was 7.5%. This range has the lowest amount of samples within it compared to the other five ranges. Only four samples resided in the range. The Maryland Total Retirement System experienced the most significant change in the range of $17.7 billion to $28.9 billion. This change stands small compared to distinct changes in other ranges. The range appeared the least changed compared to all of the others. Table 6: Average Funding Percentages Range of Current Net Pension Liability Current Average Funding Percentage Blended Rate Average Funding Percentage Range % % Range % % Range % % Range % % Range % % Range % % The range had the lowest average percentage change in net pension liability compared to the other five ranges in the study. The average percentage change came out to 44%. This is 30%

34 lower than the next highest average percentage change of a range. The highest change in the 27 range came from the previously mentioned total Maryland Total Retirement System, which experienced a change of only 63%. The average current funding percentage for this range was 62% compared to the blended rate average of 53.5%. Table 7: Overall Average Results Overall Average Overall Average Overall Average Overall Average Current Net Pension Current Discount Rate Blended Rate Net Percentage Change in Liability Pension Liability Net Pension Liability $5,440,104, % $11,528,893, % Overall Results: Overall, most of the samples within the study experienced a substantial change from using a blended rate. From the total sample the average current net pension liability was $5.4 billion. The average current discount rate for the entire sample was 7.67%. Average net pension liability under a blended rate came out to $11.5 billion. Lastly, the average change in net pension liability from the entire sample was 289.7%. These results give evidence towards the significance of using a blended discount rate and not allowing the credit of future contributions. All of these significant results can be viewed in Table 7. The total amount of net pension liability under a blended rate from all samples came out to $634 billion. This comes from the original current net pension liability total of $299 billion. This is a resulting total increase of $335 billion in net pension liability. If the rate increase actually occurred, this amount would result. The most important result is the overall effect on funding percentages. The overall average funded percentage of the retirement systems in the study was 77%. After the blended discount rate adjustment the average funded percentage of plans was 69%. Therefore under the

35 blended discount rate and when future contributions cannot be used, plans are on average 8% 28 less funded. This displays the lower funding percentage when using a blended rate.

36 29 Chapter 6 : Conclusion Conclusions Reached: The results help to display the large effect that a blended rate would have on net pension liabilities. The aim of the study was to analyze the effect of disallowing the credit taking of future contributions. Every single retirement system witnessed an increase in net pension liability, although this comes from the nature of discount rates. What matters is the extent to which a blended discount rate changed only a sample of public retirement systems within the United States. All the new net pension liability displayed within this study currently hides behind the public retirement system usage of future contributions within pension financial reporting. The extent of changes display the effect current and blended discount rates have on the results, the effect current net pension liability has, and the seriousness of net pension liabilities in the United States with the allowance of future contributions. Every single one of the current net pension liability ranges had different average discount rates. The size of the discount rate had no relation to the significance in the percentage change of net pension liability. Instead, the changes in net pension liability were more determined off of the net pension liability resulting from a 1% decrease in the discount rate. The public retirement systems computed these numbers themselves and therefore the numbers represent how their systems would react to a lower discount rate. The larger the effect a 1% decrease had, the larger the blended rate net pension liability came out to be. This shows that these retirement systems have it in mind of how sensitive their net pension liability is to a change in the discount rate. It

37 30 also displays the reliability of the numbers used to calculate the new net pension liabilities. The reporting of the effect of both a 1% increase and decrease was a new application coming from GASB Statement 67. More importance should be placed on this aspect from both the retirement system and the users of these financial statements. The size of the retirement system current net pension liability within sample ranges had a relationship to the increase in size of the net pension liability under a blended rate. The three ranges with the lowest current net pension liability contained the three highest average percentage changes in net pension liability. This comes from the small size of the current net pension liability to begin with due to changes having a larger percentage effect. This relationship indicates the possibility that the plans with the lowest net pension liability will be affected most by a decrease in the discount rate to a blended rate. These changes appear concerning, due to the large average percentage change of the lower current net pension liability ranges in comparison to the percentage change highest three current net pension liability ranges. The changes display the possible underreporting of net pension liabilities due to the drastic percentage change that resulted between the two different net pension liabilities. Aside from percentage changes, the size of the current net pension liability also reflected the possible size of the net pension liability under a blended rate. No pattern existed, but the true size of the net pension liabilities resulted in the large increases. The four highest ranges all experienced a difference between average current net pension liability and average blended rate net pension liability over $6 billion. This highlights the effect the sheer size current net pension liabilities will have when combined with a lower discount rate. This should show also how the current rates allow for much lower reporting of net pension liabilities.