States May Face Pension Pressure as New GASB Rules Widen Gaps

By Dunstan McNichol

July 9 (Bloomberg) -- States may face increased retirement- fund deficits and pressure to stop skipping pension contributions under proposals being reviewed by the Governmental Accounting Standards Board.

Pension-forecasting proposals from the rule-making organization, released June 16, would revise methods for projecting liabilities and investment returns. The changes mean estimated investment income likely will be reduced from current assumptions and unfunded liabilities will increase, Moody’s Investors Service said July 6 in a report.

The proposed revisions may make states less likely to skip pension payments, Cliff Corso, the chief executive officer of Cutwater Asset Management Corp., said yesterday in a telephone interview. “That should shed a decent amount of light -- a lightning rod -- to spur action.”

Estimates of the gap between the value of U.S. public- pension plans and the amount needed to cover promised benefits range from $500 billion to $3 trillion. The smallest projection, from the Pew Center on the States, is based on annual investment returns of 7.25 percent to 8.5 percent. The higher figure was forecast by George Mason University researchers using the relatively risk-free 3.5 percent return on 15-year Treasuries.

The standards board, based in Norwalk, Connecticut, proposes using the expected return on a basket of high-quality municipal bonds, which would produce a deficit somewhere between the high and low estimates. The Bloomberg Fair Market index of AAA-rated municipal bonds ended yesterday yielding 4.38 percent.

Lower Estimated Returns

“The average discount rate will almost certainly be lower than is being currently used,” Moody’s said, referring to the proportion of projected liabilities forecast to be covered by investment income. “For plans that are expected to be underfunded, this lower discount rate will result in large increases” in the reported deficits, Moody’s said.

Every percentage point drop in the assumed rate of return would increase reported pension underfunding by between 8 percent and 12 percent, according to Moody’s.

“Shedding a light gets things out there and gets things moving,” said Cutwater’s Corso. His Armonk, New York-based company manages $5 billion of municipal bonds in a $44 billion fixed-income portfolio.

The proposed accounting revisions, which are subject to comment through October, come as states are reporting widening pension liabilities following declines in asset values in the year through June 2009. Wilshire Associates, based in Santa Monica, California, has estimated the median investment loss at 17 percent that year.

As fiscal 2010 began, states had only 65 percent of the amount needed to cover promised benefits, down from 85 percent a year earlier, a Wilshire analysis of 125 retirement plans showed.

8 Percent Benchmark

Public-pension plans in the U.S. held assets valued at $2.3 trillion on June 30, 2008, according to a February report from Washington-based Pew. Most commonly, the funds project future returns to average about 8 percent a year, Pew said. The biggest, the California Public Employees’ Retirement System, or Calpers, currently forecasts annual investment gains of 7.75 percent and is considering lowering that benchmark.

In Illinois, the Senate is balking at a plan to borrow $3.7 billion to cover pension fund payments this year, after issuing $3.5 billion in bonds in January to meet last year’s obligations. Illinois shares an A- debt rating from Moody’s with California, the lowest among U.S. states.

Soaring Payments

Pennsylvania’s payments into its retirement plans are projected to almost triple in two years, to $3.7 billion from $1.3 billion in the current budget, Governor Ed Rendell said July 6 in a statement.

In New Jersey, the $29.4 billion budget passed last week was balanced partly by skipping a scheduled $3 billion pension payment this fiscal year. Public defined-benefit plans in the Garden State were underfunded by $45.8 billion as fiscal 2010 began, according to a state bond-offering document in May. In its June 23 report, George Mason’s Mercatus Center in Arlington, Virginia, put the deficit at more than $170 billion.

The accounting standards board will take written comments on its proposed changes through Sept. 17. Hearings on the proposal are set for Oct. 13 in Dallas; Oct. 14 in San Francisco and Oct. 27 in New York.

--Editors: Ted Bunker, Mark Schoifet.

To contact the reporter on this story: Dunstan McNichol in Trenton, New Jersey, at dmcnichol@bloomberg.net

To contact the editor responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net