Post-COVID-19 financial and accounting considerations for public retirement plans
COVID-19 will continue to affect public retirement plans in a variety of ways. Your board and management should review these five financial and accounting considerations.
It’s critical that public retirement plans assess the impacts of — not only in the current situation, but the potential future effects as well.
To help your plan make more informed decisions regarding financial and accounting matters, we’ve compiled a list of items that should be on the radar of your management team and board members.
Financial considerations for public retirement plans
The changes in the world economy have the potential to significantly affect public plan investments as well as the ability for participating employers to make actuarially determined contributions. As management and board members proactively consider how the pandemic impacts their plan, with the goal of getting ahead of the conversation, here are three key items plans will have to consider.
1. Investment market volatility
Plan assets available to pay future benefits are highly dependent on the performance of a plan’s investment portfolio. Earnings on these investments play a crucial role in pension plan funding. Nationally, public plan investment portfolios have incurred significant declines in fair value, consistent with the general decline in financial markets due to the economic impact of the COVID-19 pandemic. Much of the global economy virtually shut down in recent months. The domestic economy started to see some of the worst economic data in decades, with record-high jobless claims, an unemployment rate near 15%, and the GDP contracting by nearly 5% in the first quarter. While there’s been a rebound in the financial markets since mid- to late March, much uncertainty lies ahead.
Many plans are long-term investors with an investment strategy tailored for the long term, but the number of unknowns today remains unsettling. The rapid flow of news may stoke emotions that create a sense of urgency to react — to do something. During these times though, it’s important that plans maintain a long-term perspective, look past the volatility and the unknowns, and reaffirm a healthy investment position. A disciplined investment approach can serve as a roadmap for decision-making. A well-conceived plan accounts for periods of volatility to ensure a high probability of success.
During these times though, it’s important that plans maintain a long-term perspective, look past the volatility and the unknowns, and reaffirm a healthy investment position.
2. Actuarially determined contributions (ADCs)
Over the past 20 years, public plan contributions have been steadily increasing. Some of this can be attributed to increases in required contributions as many plans continue to lower their investment rate of return assumptions, implement shorter amortization periods, and/or adopt new mortality tables reflecting longer mortality assumptions. Additionally, some plans have chosen to make additional contributions above those required by participating employers, aiming to improve the funding level of the plan.
Given the decline in values in the financial markets, future calculated ADCs may be higher than current projections. Factors that will impact future contribution requirements include the length of the financial market downturn, how the actuarial valuation of assets is calculated (i.e., market value or adjusted market value using a method such as asset smoothing), and any upcoming actuarial assumption changes.
One assumption change plans may have is to switch to a Pub-2010 Mortality Table issued by the Society of Actuaries (SOA) in January 2019. These are mortality tables based exclusively on public-sector pension plan experience, with separate tables developed for teachers, public safety employees, and general employees. Based on a review performed by the Society of Actuaries, plans will generally see increases in actuarially calculated liabilities under Pub-2010 when measured against current assumptions, which will lead to higher required contributions. Plans will want to discuss potential impacts with their actuary and consider early communication with contributing employers on potential increases to allow for budget planning.
Plans will want to discuss potential impacts with their actuary and consider early communication with contributing employers on potential increases to allow for budget planning.
3. Participating employers’ financial condition
Communicating any potential increase in required contributions with the participating employers early on is critical during this time, given that participating employers have also been negatively impacted by the COVID-19 pandemic. Governments are facing significant budgetary pressures due to the declines in revenue resulting from reduced income tax, sales tax, and other key revenue sources. Prior to the pandemic, some governments already were pressured to meet their funding obligations; this new economic crisis caused by the pandemic has only intensified this burden. These financial difficulties may lead to issues with employers either not being able to make their required contributions or not being able to make them on a timely basis. (Note: While the CARES Act provides a delay in certain required contributions, this only is applicable for minimum required contributions as determined under Section 430(a) of the Internal Revenue Code of 1986 and Section 303(a) of the Employee Retirement Income Security Act of 1974). In addition to investment earnings, contributions are a significant component of a plan’s funding, and any reduction or delays in receiving contributions could lead to potential lost opportunities for investment gains, much less additional challenges for plans that are trying to ensure the systems are adequately funded.
Accounting considerations for public retirement plans
In addition to cash flow and market performance effects from the pandemic, management and board members need to proactively think about potential accounting impacts. Here are two items plans will have to consider.
1. Discount rate
Under GASB accounting standards, the discount rate used to calculate the total pension or OPEB liability is the assumed long-term expected rate of return, to the extent the plan fiduciary net position is projected to be sufficient to make projected benefit payments. At the point when the net position isn’t projected to meet projected benefits, the use of a rate for 20-year, tax-exempt municipal bond is required to discount the projected benefit payments.
Any potential reductions or delays in contributions, as posed above, could influence the calculation of the blended discount rate. When projecting whether the fiduciary net position is projected to be sufficient to cover projected benefit payments, cash flows from future contributions are to be incorporated reflecting known events and conditions. If there’s substantial doubt about the ability of an employer to make future contributions, these depletion date projections may be adversely impacted. This could lead to an increase in the calculation of the total pension or OPEB liability.
Additionally, bond rates have been recently decreasing. For example, the Fidelity 20-year Municipal General Obligation AA rate has decreased from 3.13% at June 30, 2019, to 2.59% as of May 15, 2020. For those plans with a crossover period, this decrease in the tax-exempt rate may again lead to an increase in the calculated liability.
2. Valuation timing
Many public plans use a prior year actuarial valuation to determine their current year liability. Under GASB accounting standards, a plan is allowed to determine the total pension and OPEB liability through the use of update procedures to roll forward to the plan’s most recent fiscal year-end amounts from an actuarial valuation as of a date no more than 24 months earlier than the plan’s most recent fiscal year-end. When the GASB standards on pension and OPEB were implemented, this was a popular choice for plans due to timing considerations, with many plans choosing to have a valuation 12 months earlier than the plan’s most recent fiscal year-end. If update procedures are used, the GASB accounting standards require professional judgment be used to consider whether any significant changes have occurred from the valuation date to the plan’s fiscal year-end, which would require a new valuation to be performed. Plans measuring the liability using update procedures should consider if the recent events might result in significant changes to demographic data or potentially benefit provisions that would necessitate a new valuation.
While there are many unknowns, public plans should be proactive in responding to current and potential effects of the COVID-19 pandemic. As you continue to navigate through the COVID-19 aftermath and plan how to resume office operations safely and securely, we’re here to help. Contact us to get in touch with one of our experts or visit our COVID-19 resource center and COVID-19 resource center for government.
While there are many unknowns, public plans should be proactive in responding to current and potential effects of the COVID-19 pandemic.