By Divya Anantharaman, Elizabeth Chuk

The funding policy for defined benefit pension plans covering government employees represents an important decision for government entities sponsoring those plans. In recent years, a number of state and local governments have experienced extreme funding shortfalls (e.g., New Jersey, Illinois, and Detroit), raising concerns about whether government entities are contributing enough to their pensions. Governmental Accounting Standards Board Statements Number 67/68 (hereafter, “GASB 67/68”) fundamentally alter the financial reporting of pension liabilities, by (i) requiring pension liabilities to be estimated using a potentially lower discount rate (which increases estimated liabilities and any funding deficits), and (ii) mandating recognition of funding deficits (surpluses), which were previously only disclosed in footnotes, as a liability (asset) on governmental balance sheets. Although GASB 67/68 only changes financial reporting requirements and acknowledges specifically that funding decisions are outside its scope, we find, for a sample of 114 large state plans, that governments increase pension contributions upon applying GASB 67/68. The increased funding response is primarily from governments expecting a larger dollar impact upon applying GASB 67/68, and those facing more adverse economic or political consequences from financial statement recognition. Plans that increase funding are also more likely to have passed benefit cuts, suggesting that taxpayers and public employees share the costs. Overall, these responses suggest that governmental entities are willing to take actions with cash flow consequences to avoid recognizing large liabilities on-balance sheet; purely accounting changes, therefore, can have “real” effects on governmental pension policy.

Source: SSRN