THE NEW PENSION ACCOUNTING AND ITS IMPACT ON FUNDING CSFMO Oakland, California February 21,

GASB STATEMENT NO. 68 Summary of changes 2

Our focus Employers in single employer and agent multiple- employer defined benefit plans Employers in cost-sharing plans 3

SINGLE-EMPLOYER AND AGENT PLANS Changes for employers 4

Preliminary Only relevant for economic resources measurement focus and accrual basis of accounting No effect on governmental funds Report expenditures rather than expense No effect on fund balance 5

Key changes 1. Employer liability 2. Employer expense 3. Discount rate 4. Actuarial method 5. Amortization 6. Timing 6

1. Employer liability Now: Annual required contribution (ARC) Less: Actual contributions Net pension obligation (NPO) Future: Total pension liability (TPL) Less: Fiduciary net position (FNP) Net pension liability (NPL) 7

Employer liability - Illustration 8

2. Employer expense Now: Calculation tied to funding ARC adjusted for the cumulative effect of prior differences between required contributions and actual contributions Future: Calculation tied to cost Changes in the net pension liability (NPL) 9

Components of expense Annual service cost Interest on the net pension liability Projected earnings on plan investments The full effect of any changes in benefit terms Amortization of deferred outflows/inflows of resources 10

3. Discount rate Now: Estimated long-term investment yield for the plan, with consideration given to the nature and mix of current and expected plan investments Future: Modification necessary if it is expected that FNP will not be sufficient to pay benefits to active employees and retirees Single blended rate 11

Discount rate – single blended rate Single rate equivalent to the combined effect of using the following rates: For projected cash flows up to the point the FNP will be sufficient Long-term expected rate of return on plan investments For projected cash flows beyond that point A yield or index rate on tax-exempt 20-year, Aa-or-higher rated municipal bonds. 12

4. Actuarial method Now: Whatever actuarial method is used for funding Six acceptable methods Must be applied within parameters defined by GASB Future: No tie to actuarial method used for funding All employers will use the entry age method for accounting and financial reporting purposes (with service cost determined as a percentage of pay) 13

5. Amortization Background Circumstances that could affect the net pension liability (NPL) A. Changes in benefit terms B. Changes in economic and demographic assumptions C. Differences between economic and demographic assumptions and actual experience (other than investment returns) D. Differences between expected and actual investment returns Now: Effect amortized over a period not to exceed 30 years Future: Effect to be amortized over a much shorter period Different periods, depending on the circumstances 14

Future amortization periods A. Changes in benefit terms Immediate recognition B. Changes in economic and demographic assumptions Closed period equal to average remaining service period of plan members (average remaining service period of retirees = 0 years) C. Differences between economic and demographic assumptions and actual experience (other than investment returns) Closed period equal to average remaining service period of plan members (average remaining service period of retirees = 0 years) D. Differences between expected and actual investment returns Closed 5-year period (including current period) 15

6. Timing Now: Timing of actuarial valuation Within 24 months of start of valuation period Future: Measurement date for assets and TPL No earlier than 1 year + 1 day prior to reporting date Actuarial valuation date Up to 30 months before employer reporting date Update to “roll forward” to measurement date 16

COST-SHARING PLANS Changes for employers 17

Key changes 1. Employer liability 2. Employer expense 18

1. Employer liability (cost-sharing) Now: Liability only if employer contribution is less than the contractually required amount Future: Liability equal to the employer’s proportionate share of the total NPL of all participating employers 19

2. Employer expense (cost-sharing) Now: Expense = contractually required contribution Future: Expense = employer’s proportionate share of total pension expense of all participating employers 20

EFFECTIVE DATE Employers 21

Effective date of GASB Statement No. 68 Implementation first required Fiscal year ending 6/30/15 Earlier application encouraged Requires cooperation of the pension plan 22

FUNDING CHALLENGE Accounting v. funding 23

Background: Historic contribution of GASB Statement No. 27 Set parameters to ensure reasonable application of actuarial methods Displayed whether employers were meeting the goal of systematic and rational funding each period Highlighted the cumulative financial impact of underfunded contributions Information on funding progress also provided Notes Required supplementary information (RSI). 24

Changes resulting from GASB Statement No. 68 Elimination of GASB parameters Compromises the usefulness of the actuarially determined contribution (ADC) for other purposes by eliminating standardization No automatic requirement to provide information on funding progress Required only if an ADC is calculated or contribution is statutorily mandated 25

DEVELOPMENT OF PENSION FUNDING GUIDELINES Response to GASB Statement No

Objective Provide guidance on funding in the wake of GASB Statement No. 68 Take advantage of the fact that GASB Statement No. 68 requires the presentation of funding data if an ADC is used for funding purposes 27

Task force Convening organization – Center for State and Local Government Excellence Membership “Big seven” Other organizations invited to participate 28

“Big seven” National Governors Association (NGA) National Conference of State Legislatures (NCSL) Council of State Governments (CSG) National Association of Counties (NACo) National League of Cities (NLC) U.S. Conference of Mayors (USCM) International City/County Management Association (ICMA) 29

Other participating organizations National Association of State Auditors, Comptrollers and Treasurers (NASACT) Government Finance Officers Association (GFOA) National Association of State Retirement Administrators (NASRA) National Council on Teacher Retirement (NCTR) 30

Approach Closely modeled on the work of the California Actuarial Advisory Panel 31

Structure Five policy objectives Starting point = funding based upon an actuarially determined ARC Application of policy objectives to three core elements Actuarial costs Asset smoothing Amortization policy Recognition that employers may need to adopt a transition plan to phase in the new practices over a period of years. 32

General policy objectives Actuarially Determined Contributions Funding Discipline Intergenerational equity Contributions as a stable percentage of payroll Accountability and transparency 33

Actuarially determined contributions A pension funding plan should be based upon an actuarially determined annual required contribution (ARC) that incorporates both the cost of benefits in the current year and the amortization of the plan’s unfunded actuarial accrued liability. 34

Funding discipline A commitment to make timely, actuarially determined contributions to the retirement system is needed to ensure that sufficient assets are available for all current and future retirees. 35

Intergenerational equity Annual contributions should be reasonably related to the expected and actual cost of each year of service. 36

Contributions as a stable percentage of payroll Contributions should be managed so that employer costs remain consistent as a percentage of payroll over time. 37

Accountability and transparency Clear reporting of pension funding should include an assessment of whether, how, and when the plan sponsor will meet the funding requirements of the plan. 38

NEXT STEPS FOR GFOA Best Practices 39

Overall best practice “Guidelines for Funding Defined Benefit Pensions” Every state and local government that offers defined benefit pensions should formally adopt a funding policy that provides reasonable assurance that the cost of those benefits will be funded in an equitable and sustainable manner. Such a funding policy should incorporate each of the four principles and objectives 1. Obtain ADC 2. Balance stable contributions and equitable allocation 3. Commit to funding full amount (with transition period, if needed) 4. Provide information needed to assess funding progress 40

1. Obtain ADC Every government employer that offers defined benefit pensions should continue to obtain no less than biennially an actuarially determined contribution (ADC) to serve as the basis for its contributions 41

2. Balance contributions/allocation The ADC should be calculated in a manner that fully funds the long-term costs of promised benefits, while balancing the goals of 1) keeping contributions relatively stable and 2) equitably allocating the costs over the employees’ period of active service 42

3. Commit to funding full amount Every government employer that offers defined benefit pensions should make a commitment to fund the full amount of the ADC each period. For some government employers, a reasonable transition period will be necessary before this objective can be accomplished 43

4. Transparency Every government employer that offers defined benefit pensions should demonstrate accountability and transparency by communicating all of the information necessary for assessing the government’s progress toward meeting its pension funding objectives 44

Future best practices The GFOA intends to develop additional best practices that will provide specific guidance on the practical application of these principles and objectives to each of the three core elements of a comprehensive pension funding policy 1. Actuarial cost method 2. Asset smoothing 3. Amortization. 45

AUDITING CHALLENGE Participants in multiple-employer plans 46

Cost-sharing plans Issues: Who should calculate the allocation percentages? Who should calculate the allocated pension amounts? 47

Potential solution 1 Opinion from plan auditor on 1. Supplemental schedule of employer allocations in plan financial statements 2. Either: a. Supplemental schedule of plan pension amounts Net pension liability Deferred outflows Deferred inflows Pension expense b. Supplemental schedule of employer pension amounts 48

Example 49

Example 50

Agent multiple-employer plans Issue: Employer assurance regarding the following amounts as of measurement date Total pension liability - fiduciary net position = net pension liability Deferred outflows/inflows Investment experience Changes in assumptions Actuarial gains and losses Pension expense 51

Potential solution – fiduciary net position Opinion from plan auditor on Supplemental condensed schedule of changes in fiduciary position (by employer) SOC 1 (type 2) report from plan auditor on Allocation of plan inflows to individual employer accounts Contributions Investment income Allocation of plan outflows to individual employer accounts Benefit payments Administrative expenses 52

Example 53

Potential solution – other amounts Plan auditor Engaged to issue SOC 1 (type 2) report on census data controlled by plan (retired employees) Plan actuary Issues separate actuarial report for each participating employer which includes net pension liability, deferred outflows/inflows by type and year, pension expense, and discount rate calculation Employer auditor tests census data of active employees and confirms actuarial information used by actuary Employer and employer auditor Responsible for validating deferred outflows/inflows and pension expense related to individual employer 54