New public pension accounting rules scheduled to be issued next month, once expected by some to reveal massive hidden debt, now seem less likely to trigger a shake-up and are even getting applause from pension officials. Under the new rules, experts say, most California pension systems will make little if any use of a lower “risk-free” government bond-based earnings forecast, currently about 4 percent, that causes debt to soar. Pension systems can continue to use earnings forecasts critics say are too optimistic, now 7.5 percent for the three state funds, to offset or “discount” estimates of the cost of pensions promised current workers in the decades ahead.
But if the assets (employer-employee contributions and investment earnings) are projected to run out before all of the pension obligations are covered, the pension system must “crossover” to a lower bond-based forecast to calculate the remaining debt…
So what does this mean and specifically what does it mean for the UC pension system? Defined-benefit pension systems take in employer and employee contributions and guarantee a future retirement benefit based on age, earnings history, and length of service. Their trustees, in the case of UC the Regents, are supposed to aim at 100% funding which means that current assets and the projected inflow of contributions and investment returns will cover future liabilities. To estimate the funding ratio, it is necessary to make a long-term forecast of what assets in the pension trust fund will earn. The higher the earnings assumption, the higher will be the estimated funding ratio.
“Estimated” is the key word. In fact, the earnings on the portfolio will be what they will be and the estimate by itself doesn’t change what the earnings will be. However, if the official estimate is that the ratio is below 100%, then the plan trustees are supposed to raise contributions sufficiently to bring the ratio back to 100% over some time period. Currently, the Regents officially assume a long-term earnings rate of 7.5% and project that those earnings plus a schedule of ramped up contributions will bring the UC pension funding ratio to 100% circa 2040.
Essentially, what the italicized excerpt means is that GASB rules allow the 7.5% assumed earnings rate to be used as the sole rate applied to the estimate of unfunded liability because under the Regents' assumption, the plan will not run out of money and is projected to get to 100% eventually.
Again, it is important to stress that accounting estimates do not change what actual earnings will be. If 7.5% increasingly looks to be too high, at some point actuaries advising the Regents might suggest a lower rate. Were that to happen, contributions would have to be further ramped up to aim for an eventual 100% funding ratio. That is, the less the plan can count on earnings to meet its liabilities, the more it must rely on contributions.
But there are other points to stress, too. First, the plan will not run out of money and the Regents are obligated to pay pensions they have promised. So for old timers, you will get your pension. Second, and maybe most important (and emphasized from time to time on this blog), the pension issue is a young folks' concern. It is not a young folks' concern because younger folks won’t get promised benefits. It is a young folks concern because ultimately future pension contributions come out of the UC budget (state supported part of the budget and the larger part of the budget paid by hospital revenues, research grants, etc.) plus employee contributions.
The state has yet to step up to the plate – despite what you may have heard – and provide the funding for its share, as it once did. But the GASB rules – which at one time were feared as likely to undercut the 7.5% earnings assumption and create more pressure for hiked immediate pension contributions – effectively will spread the funding burden over a longer period into the future.