In Brief

Underfunding, questionable investment decisions, imperfect assumptions on future market returns, declining interest rates, and the structure of defined benefit plans have created a fiscal crisis for many public pension funds. The implementation of several recent GASB pronouncements has made these problems more apparent and distinct to the public. The authors examine the current reporting challenges, describe the approaches taken by some governments, and suggest their own potential solutions.

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Pension disclosure and reporting has been an issue for GASB since its inception in 1984, when the topic appeared on its first technical agenda. Eighteen of the 82 standards issued by GASB to date have addressed pensions and other post-employment benefits. The board’s most recent guidance on timely and important issues involves liability measurement and the “booking” of the pension liability on the balance sheet.

Governmental entities are a fixture of defined benefit plans, many of which offer retirees a guaranteed fixed income with cost of living increases for the life of the retiree and sometimes subsequently their spouse and children until adulthood (Issue Brief: Cost of Living Adjustments, National Association of State Retirement Administrators, October 2016,

Private sector businesses, however, have significantly reduced the use of defined benefit plans, increasingly turning to defined contribution plans. In 1975, 78% of all employees in the private sector participated in defined benefit pension plans; by 2014, that number had dropped to 30% (Private Pension Plan Bulletin Historical Tables and Graphs 1975-2014, Employee Benefits Security Administration, September 2016, In contrast, nearly 90% of public sector participants still have defined benefit plans. A study by the Center for Retirement Research at Boston College (Alicia H. Munell, Kelly Haverstick, and Mauricio Soto, “Why Have Defined Benefit Plans Survived in the Public Sector?” State and Local Pension Plans, December 2007, cites three reasons for the public sector’s continued use of defined benefit plans:

  • The workforce is older, more risk averse, less mobile, and more unionized;
  • The public employer is a perpetual entity facing fewer market pressures; and
  • The regulatory environment is free from the administrative costs and vesting requirements of the Employee Retirement Income Security Act of 1974 (ERISA), with the ability to adjust employee contributions to control the employer’s cost.

Given the prevalence of defined benefit plans, their funding and viability are now at the forefront of nationwide conversations. GASB’s recent pension standards have played an important role in calling attention to this issue.

GASB Guidance

GASB Statement 67, Financial Reporting for Pension Plans, which took effect for fiscal years beginning after June 15, 2013, addresses state and local government pension programs administered through trust arrangements. GASB Statement 68, Accounting and Financial Reporting for Pensions, which took effect for fiscal years beginning after June 14, 2014, covers pension programs of governments whose employees are part of a sponsored plan by the state or local government.

The effects of these statements are listed in Exhibit 1. A principal focus of the standards involves the reporting and calculation of the pension liability. In certain situations, the new standards use a more conservative discount rate rather than the prior, subjective rate, based upon parameters determined by the government. In addition, the net pension liability has been moved from the notes to the balance sheet. A rationale for the previous treatment was that governments have the legal authority and ability to remedy this liability through taxes, plan changes, and employee contributions; however, these remedies may not always be practical, and the reality is that measuring the proper liability can be controversial. The balance sheet recognition is a more prominent recognition of the obligation, bringing attention to its relationship to the entity’s financial position.


Impact of GASB Standards 67 and 68

Area; Standard; Effect Liability disclosure; Net pension liability directly reported in the financial statements; Financial condition of government now looks much worse. Brings more attention to the amount. However, liabilities may be significantly offset by deferrals. Determination of liability amount/new discount rate; Blended tax-exempt rate and expected future earnings rate; For most entities adopting the blended rate, higher projected future payout and higher liability Pension expense; Changes in liability reflected through expense and deferrals; Increased volatility Allocation of liability; Apportions liability to the local government for their employees under state or other multiemployer plans; Huge liabilities hitting books of local governments Notes and supplementary information; Required information on types of benefits, covered employees, determination of plan contributions, and liability calculation; Much more extensive disclosure and transparency

Regarding the discount rate (i.e., the rate of return assumed to estimate the future value of assets), the expected value of future assets increases with the rate itself. Rates used by government entities extending into the 7% and above range may be too optimistic and risk overstating future assets. GASB originally proposed a risk-free rate tied to the government bond rate and to be applied to the whole liability. After much debate, a compromise was reached, using a blended rate; while a subjectively determined expected market rate of return may still be used for the funded portion of the liability (an amount equal to plan assets along with future funding streams), the unfunded portion must use a lower, less risky rate.

Other notable items in Statements 67 and 68 include the following:

  • Changes in the total pension liability and in the pension plan’s fiduciary net assets are recognized as pension expense and deferred inflows and outflows. Pension expense and deferrals are based on net pension liability (NPL). Changes based upon the difference between actuary assumptions and actual experience are deferred and amortized. Other changes in NPL, along with outlays such as service costs and plan benefit changes for past service, should be expensed in the current period. In addition, changes caused by differences between actual and expected earnings should be deferred and amortized over a five-year period.
  • Cost sharing of pension expense and liability by local governments that are part of state plans is recognized.
  • The already substantive notes to financial statements and required additional supplementary information are strengthened with new details, such as assumptions used to calculate the pension liability.

The AICPA has provided guidance to assist in the implementation of GASB Statements 67 and 68. In 2015, it added a chapter on defined benefit plans to its publication Audit and Accounting Guide: State and Local Governments, and it has also provided other resources, such as articles, white papers, and interpretations.

Implications of GASB Changes

Heightened public awareness.

Beyond the significant attention that GASB Standards 67 and 68 bring to measurement and reporting, the impact of the changes has been an impetus for public debate, plan review, policy conversation, and media coverage, often with close attention to underfunding. This issue is not new; however, concerns may be greater given that the typical funding percentage dropped approximately 10% in 2008–2010 due to investment losses during the recession. As of this writing, there has yet to be a full recovery.

Exhibit 2 depicts the percentage of aggregate state government pension liability. In 2014, the total liability was $3.7 trillion, of which $900 billion was unfunded. Recent conversations and high-profile concerns in certain cities and states can in part be attributed to improved disclosures. Increased public interest is directed particularly at the amount of the liability and the discount rate.


Pension Funding Trends

Blended rate increases unfunded liability.

The blended discount rate reflects the long-term expected rate of return on plan assets achievable following the plan’s investment strategy and forecasted employer, non-employer, and employee contributions sufficient to cover projected benefits for currently covered employees; to the extent these conditions are not met, this is blended with the yield rate for 20-year, tax-exempt general obligation municipal bonds with an average rating of AA/A or higher.

When applied to the entire government pension sector using the Pew Charitable Trust Pension Database (The State Pension Funding Gap 2014: New Accounting Rules Help Provide a Clearer Picture, Pew Charitable Trusts, August 2016,, the unfunded liability increases dramatically under GASB’s blended rate scenario. In addition, changes in municipal bond rates, as well as a range of issues regarding future funding, reflect future risks and influence the blended discount rate. Exhibit 3 evaluates the impact of using alternative discount rates. The average discount rate in 2014 was 7.3%, which translates to a total unfunded liability of $930 billion. That rises to $1.57 trillion when the discount rate is dropped to 4%, decreasing the funded percentage from 75% to 64%. If, as originally proposed, a less risky rate such as 4% were applied to the entire liability, the unfunded liability would increase from $900 billion to $3.41 trillion and the funded percentage would drop from 75% to 45%. How the liability changes based upon use of alternate discount rates highlights the vulnerability of pension funds to economic conditions.


Unfunded Liability Using Different Discount Rates Applied to the Overall Nationwide Pension Liability (Dollars in Trillions)

Application of Alternative Discount Rates to Unfunded Liability Only Measure; 7.30%; 7.00%; 6.00%; 5.00%; 4.00% Total liability; $3.70; $3.83; $3.97; $4.14; $4.33 Total assets; $2.77; $2.76; $2.76; $2.76; $2.76 Unfunded liability; $0.93; $1.07; $1.21; $1.38; $1.57 Percent funded; 75%; 72%; 70%; 67%; 64% Application of Alternative Discount Rates to Entire Liability Measure; 7.30%; 7.00%; 6.00%; 5.00%; 4.00% Total liability; $3.70; $4.20; $4.77; $5.43; $6.17 Total assets; $2.77; $2.76; $2.76; $2.76; $2.76 Unfunded liability; $0.93; $1.44; $2.01; $2.67; $3.41 Percent funded; 75%; 66%; 58%; 51%; 45% Source: Adapted from Munnell and Aubry 2016. Calculations by the authors.

Expanded auditor testing.

Auditors are now testing new data regarding not only the net pension liability, but also deferred inflows, deferred outflows, and pension expense. These assessments are challenging matters regarding audits of local governments under a state or multi-employer plan. The data that local government auditors start with is in most cases derived from state plans, particularly regarding retirees and inactive employees, active employees, and actuarial data. A review and reconciliation of the local government retiree data with that of the state plan should be prepared each year.

Ratings agencies adjust.

An initial concern was that there would be massive bond ratings downgrades and the cost of debt for state and local governments would soar if GASB’s measures were too severe. Such ratings intuitively should dip with greater liabilities and new disclosures that signal greater under-funding; however, a review of state bond ratings over 10 years shows little movement (Pamela Prah and Stephen Carr, “Infographic—S&P State Credit Ratings, 2001–2014,” Stateline, June 2014, Moody’s made four adjustments that better aligned its analysis to GASB Statements 67 and 68:

  • Multiple-employer cost-sharing plan liabilities were allocated to specific government employers based on proportionate shares of total plan contributions;
  • Accrued actuarial liabilities were adjusted based on a high-grade, long-term taxable bond index discount rate as of the date of valuation;
  • Asset smoothing was replaced with reported market or fair value as of the actuarial reporting date; and
  • Net pension liability was amortized over 20 years using a level-dollar method to create a measure of annual burden related to the net pension liability. (Adjustments to U.S. State and Local Government Reported Pension Data, Moody’s Investor Services, April 2013,

Standard & Poor’s (S&P) response was to accept the movement of the liability to local governments and analyze accordingly. S&P continued to focus on commitment to funding, investment performance, trend analysis, and overall sustainability based on state management (John Sugden, “Standard & Poor’s Approach to Pension Liabilities in Light of GASB 67 & 68,” Ratings Direct, July 2013,, stating, “We do not anticipate significant revisions to state rating solely on the changes to GASB reporting.” Similarly, the new GASB rules have had little bearing on Moody’s credit ratings because they already factor the unfunded liability in their calculations. Moody’s Thomas Aaron said, “While GASB 67 and 68 impose many new rules related to pension accounting disclosure, our approach to evaluating credit risk stemming from public pensions remains fundamentally unchanged” (“Modest Credit Impact for GASB Pension Changes, but Con tribution Weaknesses Now High lighted,” Moody’s Investor Services, Mar. 16, 2015, But Moody’s also observed that weaknesses are now better highlighted.

The analysts seem to believe that, although the extent of pension underfunding was news to the public, the rating agencies had already been doing their own calculations and adjusting for underfunding. Nevertheless, S&P noted that “the changes to pension liabilities resulting from the new GASB standards, such as the use of the blended rate, are more likely to affect governments for which we have already factored their weak pension funding status into our ratings” (Sugden 2013).

Liability shifting to local government.

Local government units that are part of a state or other multiemployer plan must now report directly on their financial statements a portion of the liability for retired employees collecting from the state pension fund and current employees who have earned pension benefits directly on their financial statements. Despite the bond market’s adjustment for this change, the public and many government officials seemed unaware; even mid-sized governments are now seeing liabilities in the hundreds of millions. Many if not all state and local government entities have had in-depth meetings between management and various government legislative and advisory bodies on the issue. Exhibit 4 highlights the redistribution of the liability from states to local governments (Munell and Jean-Pierre Aubry, “Will Pension and OPEBS Break State and Local Budgets?” State and Local Pension Plans, October 2016, Note that states have numerous mechanisms in place, described below, that could be exercised before any liability payment would need to be assumed by local agencies.


Distribution of Pension Liability before and after GASB Statement 68 (Dollars In Trillions)

Governmental Woes

Nationally, pension issues are garnering headlines. Recent historically low bond rates are netting lower returns and incentivizing governments to invest in riskier equities. As the 10-year U.S. Treasury rate has hovered in the 2–3% range for the last five years, it is unlikely that modest Federal Reserve rate increases will sufficiently redress the issue. According to a Nov. 13, 2016 article in the Wall Street Journal, “low rates exacerbate cash problems already bedeviling the world’s pension funds, and decades of underfunding, benefit overpromises, government austerity measures and two recessions have left many retirement systems with deep funding holes” (Timothy W. Martin, Georgi Kantchev, and Kosaku Narioka, “Era of Low Interest Rates Hammers Millions of Pensions around World,”

Pension liabilities for 50 of the largest local governments have increased 192% since 2005, with Chicago, Dallas, Phoenix, Houston, and Los Angeles the most prominent (Meaghan Kilroy, “Pension Liabilities for 50 Largest Governments Jump 192% since 2005,” Pensions & Investments, Nov. 4, 2016, Furthermore, lagging returns have led to some states not meeting forecasts, with Kentucky, Illinois, New Jersey, and Texas falling short in making sufficient annual contributions (Katherine Greifeld, “U.S. State Pension Deficits to Widen as Investment Gains Shrink,” Bloomberg Markets, Oct. 7, 2016,

In Chicago, the impact of the liability recalculation increased the total from $8 billion to $33 billion. A proposed plan to remedy the situation that called for higher contributions from city workers, a raise in the retirement age, and cutbacks on cost-of-living adjustments was not upheld in court. As a result, in September 2016, the city council, backed by the mayor, passed a 29.5% tax hike for water and sewer usage to fund the pension deficit. In Detroit, the city filed Chapter 9 bankruptcy with a $3.5 billion unfunded pension liability. In the ensuing legal battle with unions, the court ruled against a 4.5% cut on monthly pensions with no cost-of-living allowance (COLA). Dallas may see a similar fate, as bankruptcy looms due to billions in unfunded liabilities in the police and fire pension funds due to investment in risky real estate deals (Mary Williams Walsh, “Dallas Stares Down a Texas-Size Threat of Bankruptcy,” New York Times, Nov. 20, 2016,

Pension concerns are also prominent in South Carolina, where the estimated pension liability doubled from $20 billion to $40 billion when the discount rate was lowered from 7.5% to 4%. Employee contributions have already increased from 6.55% to 8.33%, with wage freezes in 4 of the last 10 years (Cassie Cope, “S.C.’s Pension Debt Is $40 Billion, Lawmakers Told,” The State, Oct. 25, 2016, Ohio’s pension reforms took the form of increased employee contributions and changes to age and service eligibility, benefit formulas, final average salary, medical coverage, and COLA. Lawmakers in Alabama are discussing solutions to the growing pension liability. A related report reflects the experience of many governments:

Unfunded public pensions remain a considerable threat to the finances of states attempting to recover from the Great Recession and slow economic recovery. Yet, despite this threat, unfunded pension liabilities are largely misunderstood and the need for reform is overlooked across all levels of government. While the State of Alabama and many other states have attempted various reforms—some bold, most bland—the measures passed in Alabama thus far have simply been a gauze bandage applied to a gaping wound. (James Barth and John Jahera, “Alabama’s Public Pensions–Building a Stable Financial Foundation for the Years Ahead,” Alabama Policy Institute, 2015,

Some pension plans do seem relatively well funded, such as New York’s Common Pension Fund, which consistently rates among those funds with a higher funded ratio.

These circumstances have crossed over to the private sector. The largest public retirement system in the country—California Public Employees’ Retirement System (CalPERS)—has seen its unfunded ratio increase by 10% in the last decade to a total of $150 billion. Its rate of return for the fiscal year 2016 ended at 0.6%, well below the target of 7.5% (Martin, “CalPERS Reports Lowest Investment Gain since Financial Crisis,” Wall Street Journal, Jul. 18, 2016, Decreasing the discount rate would make this liability even higher. The California legislature responded by passing a law, supported by the governor, requiring private-sector workers who lack access to a workplace retirement plan to contribute a 3% payroll deduction to CalPERS. This action increases the inflow, but also expands the base of future beneficiaries. Although this has been criticized as a short-term fix, six other troubled states have considered similar measures: Illinois, Connecticut, Massachusetts, Oregon, Maryland, and Minnesota (Chuck DeVore, “State Pension Systems Want Your Retirement Savings to Bail Them Out,” The Federalist, Oct. 31, 2016, On December 19, 2016, the CPA Letter Daily noted that the U.S. Department of Labor (DOL) has completed its guidance for cities and counties that wish to establish retirement plans for such private sector employees (Greg Iacurci, “DOL Issues Final Rule on City Retirement Programs,” The DOL rule exempts plans sponsored by cities and counties from liability under ERISA as long as the plans comply with certain guidelines.

Seeking Answers

Shifting the cost.

Cost shifting from pension funds to individuals and employers is a technique revealed by data compiled by the National Association of State Retirement Administrators (NASRA); their research data, analysis, and briefs on a variety of government pension issues can be found at Specifically, NASRA data shows that employees are contributing more to funds at higher rates, COLAs are decreasing, and employers are paying more.

Exhibit 5 provides two maps of states that 1) established COLA decreases and 2) changed employee contributions. Thirty-eight states have increased required employee contributions since 2009. Several states, such as Pennsylvania, Arizona, Iowa, Kansas, and Nevada, have implemented variable rates that automatically increase based on actuarial estimates.


COLA and Employee Contribution Changes

COLA adjustments have long been offered to retirees to help their income keep up with inflation. Over the course of a retiree’s life, even a small gap between inflation and COLA will reduce benefits. The standard used to be a guaranteed fixed amount that would be adjusted up for higher inflation; today, high-end COLA plans adjust for inflation with a fixed cap. Since 2009, fifteen states have made adjustments impacting current retirees, eight have reduced benefits for all future retirees who are current employees, and seven have adjusted for all new employees. COLA reductions come in many forms, including direct percentage cuts, eliminating the guaranteed increase amount, delaying adjustments for a period of years or until a retiree reaches a certain age, and limiting COLA to a smaller portion of a pension.

Increasing general public funding.

Chicago chose a tax hike (and Dallas is considering one), while California and other states are raising additional revenue by requiring non-government employees to join the system and contribute. This method may help appease current members and some of the unions but risks provoking the general public. Wolf Richter worries that “regular families who’re just sitting ducks are going to get squeezed dry, in order to slow the momentum of the public-employee pension crisis” (“U.S. Pension Crisis: This Is How Families Get Squeezed to Bail Out Pension Funds in Chicago,” Wolf Street, Nov. 17, 2016, Another criticism concerning California’s approach is found in the rhetoric of the Federalist: “These same irresponsible politicians have figured out a way to bail out their government works pension systems: forcibly enlist the general public into underwater systems, taking their money” (DeVore 2016). Finally, the California Supreme Court has agreed to hear the issue of whether pension benefits can be cut.

Increasing state funding.

Some states have opted to pick up the cost of reducing the unfunded liability themselves, with changes in funding policies in Tennessee and West Virginia; Alabama, however, chose not to follow this approach (“The State Pensions Funding Gap: Challenges Persist, Pew Charitable Trusts,” Jul. 14, 2015, In South Carolina, the legislature has considered a package of solutions, including spending more taxpayer money, but also taking more from government workers and suggesting defined contribution plans.

Seeking higher returns.

Achieving higher investment returns, net of inflation, would of course be helpful; however, optimistically anticipating higher earnings and failing to achieve them risks repeating the problem. In Morningstar‘s user return expectation survey, most respondents did not foresee the high returns that would be necessary (Christine Benz, “What Market Experts Are Saying about Future Returns,” Jan. 14, 2016,

Reducing benefits.

Lower pension benefits are another option. They could come in the form of COLA reductions, formula changes as in Ohio, or as direct benefit reductions as in Detroit. Detroit’s court ruling may provide precedent as to the limits of such an approach, but it does not provide a clear solution. Furthermore, reductions, while substantial to individual retirees, may have only a modest impact on fund deficits.

Expanding the federal government role.

In the past, federal legislators sought to aid private sector employers such as airline or steel industries. The Pension Benefit Guarantee Corporation (PBGC), however, lacks the mandate to go beyond the private sector. Among the reasons the federal government remains a bystander, in addition to complex state’s rights issues, is the perception and concern over “long-standing poor governance and planning, profligacy, continual log rolling, and as reported in the media, sometimes significant conflicts of interest with investment firms, legislators, and unions” (Mark Warshawsky and Ross A. Marchand, “The Extent and Nature of State and Local Government Pension Problems and a Solution,” George Mason University, January 2016, Ed Bachrach of the Wall Street Journal has suggested that Congress should pass laws allowing states and local governments to reduce benefits to clear up the uncertainty once and for all (“How to Save Public Pensions, No Federal Bailout Needed,” Jul. 17, 2016, Given the current political landscape, however, the involvement of the federal government seems unlikely.

Moving pensioner populations.

Transferring existing and future employees into defined contribution plans, while fiscally appealing, is not politically inviting. Some versions of this approach could also involve a payout of a present value of benefit payments, which may go the furthest to solve the funding problem but lacks a viable transition mechanism. Which present value rate to use, how to effect the transfer, and whether it applies to all employees are just some of the issues. In addition, the psychological sense of income security loss by retirees must be addressed. A voluntary buyout that offers attractive terms is one proposal; in Dallas, pension plan members have withdrawn over $200 million from their fund, concluding it is better to invest on their own than risk bankruptcy. The likelihood of this approach bringing a resolution on a general scale seems limited, however, when examining the finite mathematics involving large-scale withdrawals.

Phasing out defined benefit plans.

Requiring new employees to enroll in defined contribution plans may become a prominent option. In August 2016, the Tennessee Valley Authority Retirement System (TVARS) approved a plan for all employees with 10 years of service or less to move from a defined benefit to a defined contribution plan (Board minutes, Aug. 8, 2016, Michigan has adopted this plan for all new hires for general state and local workers, but not for its school employees. The Alabama Policy Institute recommended immediate transition of new hires to defined contribution plans and also encouraged existing employees to voluntarily do the same (Kilroy 2016). This approach may ease current fiscal stress but, it is an incomplete solution.

Exploring hybrid models.

Hybrid models may be fertile ground for compromise. They offer a smaller guaranteed portion with a matching defined contribution program element. For example, under a defined benefit program, a retiree making $100,000 a year who works 30 years of service with a multiplier of 2.5% for each year of service would have an annual pension of $75,000. A hybrid model might cut the multiplier to 1%, for example, reducing the annual pension to $30,000. A 401(k)-type matching program would help make up the differential. Georgia, Utah, Tennessee, and Virginia already have these types of plans in place, but only for new employees. In Rhode Island, after several years of court battles, the government settled with labor forces, adopting a hybrid model for both new employees and current employees. This approach may, in due time, be capable of resolving under-funding without raising taxes.

None of these proposals will fit every situation, and none are easy or simple. Some have stronger portability features than others, which may be important in a dynamic employment market. Solutions will vary depending on the culture of the state and the ability for all parties to share the sacrifice. It is more difficult in some states to alter plans due to labor, policy making, and legal constraints. In addition, political elements—which party holds power, Supreme Court appointments, and strength of labor representation—will weigh heavily on decisions. Because of this, it seems unlikely that lawmakers will buy out defined benefit plans as some foresee. Rather, solutions may include offering new employees defined contribution plans or adopting hybrid plans. combined with moderate versions of the solutions outlined above, including larger employee contributions.

An Uncertain Future

GASB Statements 67 and 68 have increased the transparency of government accounting for pension liabilities, and, as such, led to increased public scrutiny. The need to identify and manage funding options, which often seems to be left to “the next legislative session,” is now more apparent to those holding public office. In a January 2017 report, the Center for Retirement Research at Boston College summarized much that has been noted above, namely that many states have made changes to their plans in order to improve long-term stability (Jean-Pierre Aubry and Caroline V. Crawford, “State and Local Pension Reform since the Financial Crisis,” Given the size of the relevant age demographic, proposals that attempt to reduce benefits, broaden the base of contributors, or increase taxes will not be popular. Nonetheless, the authors hope that novel and hybrid solutions that represent a sense of shared sacrifice may ultimately prevail.

Craig Foltin, DBA, CPA is an assistant professor of accounting in the Monte Ahuja College of Business at Cleveland State University, Cleveland, Ohio.
Dale L. Flesher, PhD, CPA is a professor of account ancy, associate dean, and holder of the Roland & Sheryl Burns Chair at the University of Miss issippi, University, Miss.
Gary J. Previts, PhD, CPA is E. Mandell De Windt Professor in the Weatherhead School of Manage ment and Distinguished Uni versity Professor of accounting at Case Western Reserve University, Cleveland, Ohio.
Mary S. Stone, PhD, CPA is the Hugh Culver house Endowed Chair and prof essor of accounting at the University of Alabama, Tuscaloosa, Ala.