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Unmasking Hidden Costs: Best Practices for Public Pension Transparency

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Unmasking Hidden Costs: Best Practices for Public Pension Transparency

February 8, 2011
Public SectorOther

In 2010, the pension plans of state and local governments came under increased scrutiny in response to their generally weak financial positions and mounting costs to taxpayers. By some measures, these funds are as much as $3 trillion short of the assets they would need to cover the promises they have made to government workers and retirees. However, several shortcomings in these funds' financial disclosures have made it difficult for even lawmakers and policy experts to accurately evaluate pensions' actual financial condition.

There are several steps, over and above what the Government Accounting Standards Board already requires, that funds could take that would disclose their finances more fully. The recommendations lie in five areas:

  • Discounting
  • a. In calculating their pension liabilities and funded status, pension funds should use a market-value discount rate.
    b. The disclosure of the sum this method produces would accompany the existing disclosure, which rests on a discount rate based on expected returns on assets.
  • Smoothing
  • a. Funds should use a standardized "smoothing" period of five years to calculate asset values.
    b. Funds should also report funded status on the basis of a market value of assets with no smoothing.
  • Accrual method
  • a. Funds should continue to use Entry Age Normal as a standard accrual method for calculating funded status when applying the standards stated above.
  • Projections
  • a. Funds should issue annual five-year projections of contribution rates required of participating governments.
  • Normal cost
  • a. Funds should calculate and report the normal cost of pension benefits using the market-value discount rate they use to calculate pension liabilities and funded status.

    These steps would make it easier to answer such questions as: How well funded is a given state's pension plan? How much does a public employee's pension in a given state cost? And what effects are pension costs likely to have on the next few years' budgets?

    The report also discusses which entities should be responsible for implementing these changes in disclosure policy. It argues that states should voluntarily adopt them, and that they should require municipalities to do so. The federal government should also take steps to encourage states to make the recommended disclosures. A bill currently before Congress, the Public Employee Pension Transparency Act, would give states financial incentives to make some of the disclosures that this report recommends.

    This report does not recommend substantive changes to state and local governments' retirement benefit policies. A government could comply with all of the recommendations in this report and still leave payout amounts, retirement ages, and all other aspects of benefit packages unchanged. However, a clearer understanding of the extent of governments' liabilities, which these recommendations, if implemented, would afford, might lead governments to make substantive and meaningful reforms.