New accounting rules swell CalSTRS’ debt

New government accounting rules will more than double the pension debt reported by CalSTRS, boosting an “unfunded liability” that is now about $71 billion to a newly calculated “Net Pension Liability” of $166.9 billion.

The CalSTRS board was told last week that it’s unclear whether the new liability figure will be reported by the state or spread among school districts, where more than doubling current debt might lower credit ratings and drive up borrowing costs.

If the “Net Pension Liability” is distributed among employers, the reported total debt of a typical small-enrollment school district might jump from $21 million to $49 million and the debt of a typical large district from $280 million to $728 million.

Neither the state nor the school districts have been including CalSTRS debt in their financial statements. The new accounting rules call for pension debt to be added to employer balance sheets.

“This Net Pension Liability is a hot potato,” Robert Yetman, a CalSTRS financial adviser told the board. “Nobody wants to be the one holding on to it.”

The new Governmental Accounting Standards Board rules, requiring a lower earnings forecast for some pension debt, take effect for CalSTRS financial reports this fiscal year and for the financial reports of employers next year, fiscal 2014-15.

The new rules are a “blended” solution to the controversy over whether the forecasts of investment earnings, often expected to provide about two-thirds of the money needed to pay future pensions, are too optimistic and conceal massive debt.

The usual earnings forecast (7.5 percent for CalSTRS) can be used to project assets needed to pay future pension obligations. But if the assets fall short, a lower bond-based forecast (the cost of borrowing) must be used for the remainder of the obligation.

The California State Teachers Retirement System, which has been seeking legislation for a rate increase for a half dozen years, is projected to run out of money in about 30 years and must “crossover” to the lower earnings forecast, 4.85 percent in one example.

While the new rules show a big CalSTRS debt change, most public pension systems, unlike CalSTRS, can set annual rates paid by employers, allowing them to project enough assets to reduce or avoid the switch to a lower earnings forecast.

A better match with the new GASB rules was one reason cited as the California Public Employees Retirement System, with the goal of full funding in 30 years, approved an employer rate increase in April of roughly 50 percent over the next seven years.

“We expect around the country, at least when you are looking at the larger state systems, most systems will not use a blended rate,” the CalSTRS actuary, Rick Reed, told the board. “They will in fact use a long-term rate.”

A decade ago new GASB rules directed government employers to begin calculating and reporting the debt for retiree health care promised current workers in the future.

The revelation of big debt for retiree health care (estimated to be $64 billion for current state workers over the next year 30 years) prompted some government employers (not the state) to begin pension-like “prefunding” of promised future retiree health care.

The new GASB pension rules are intended to make debt more visible and to aid comparisons among pension funds. In addition to the “net pension liability,” the rules add a new “pension expense” calculation to promptly show annual changes in finances.

But the new accounting rules do not change how retirement systems are funded or managed. The pension systems will continue to use their own actuarial methods to set contribution rates and project future pension obligations.

Another way that CalSTRS is unusual, apart from lacking rate-setting power, is that a non-employer, the state, contributes to the pension fund. School districts contribute 8.25 percent of pay, teachers 8 percent of pay and the state about 5 percent of pay.

“It is important to note the state of California does not currently recognize a liability on its financial statements for the California State Teachers Retirement System,” a CalSTRS fact sheet said.

“GASB has not provided clear guidance for these types of circumstances, therefore it is not clear whether the state or individual districts would disclose CalSTRS NPL (Net Pension Liability).”

Who will decide: the Legislature, the governor, the state auditor? CalSTRS officials said they do not know. But the issue was raised during the long rulemaking process with GASB, which apparently expects the state to solve the problem.

A staff presentation to the CalSTRS board last week showed the main figures if the NPL is reported by the state: Net Pension Liability $166.9 billion, pension expense $12.9 billion, deferred outflow of resources $8.6 billion, and deferred inflow none.

The NPL in the example is based on the main defined benefit pension plan as of June 30 last year. An actual updated NPL would include the much smaller defined benefit supplement and cash balance plans.

To show what happens if the school districts report the NPL the staff gave the 1,700 employers a piece of the NPL based on their percentage of total contributions to CalSTRS. The NPL share was added to the bond and other debt listed by the districts.

Examples (see graph) illustrating the scale of the increase: The total debt of a typical small-enrollment district increased from $21 million to $49 million, a medium district $31 million to $133 million, and a large district $280 million to $728 million.

“To the extent there is a large liability or deferred responsibility, that can have an impact on rating for debt,” the CalSTRS chief financial officer, Robin Madsen, told the board. “We have seen that, in some cases, in write-ups that are coming out in the last three to six months.”

Given the uncertainty, could there be a standoff: Both the state and the school districts simply ignoring the NPL, saying if asked that it’s the other’s responsibility to put the big new debt number on their balance sheets?

GASB is a non-governmental organization with no regulatory power. A CalSTRS board member asked about the “leeway” if a school district decides not to show any of the NPL in its financial statements.

“I think that’s up to them and their auditor in terms of their view or interpretation of their responsibility related to their liability,” Madsen said.

A CalSTRS rate increase would reduce the NPL. As of June 30 last year, CalSTRS was 67 percent funded, had a $71 billion unfunded liability and needed an annual contribution increase of $4.5 billion to project full funding in 30 years.

A $4.5 billion CalSTRS rate increase that would nearly double the total annual contribution from school districts, teachers and the state (about $5.7 billion last fiscal year) is unlikely. The state is still trying to restore deep cuts in school funding and other programs made during the recession.

After a legislative hearing in March, some hoped a smaller rate increase might be phased in over several years — not to reach full funding in 30 years, like the CalPERS rate increase, but to extend the date at which the CalSTRS fund is projected to run out of money beyond 30 years.

When the Legislature adjourned for the year last week, once again there had been no action on a CalSTRS funding solution.
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Ed’s Note: Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.