Are Local Governments Adopting Optimistic Actuarial Methods and Assumptions for Defined Benefit Pension Plans?

By Vermeer, Thomas E.; Styles, Alan K. et al. | Journal of Public Budgeting, Accounting & Financial Management, Winter 2010 | Go to article overview
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Are Local Governments Adopting Optimistic Actuarial Methods and Assumptions for Defined Benefit Pension Plans?


Vermeer, Thomas E., Styles, Alan K., Patton, Terry K., Journal of Public Budgeting, Accounting & Financial Management


ABSTRACT. Recent news articles about pension funding issues highlight the importance of transparent financial reporting and disclosures for defined benefit pension plans. Using pension-related data for local governments in Michigan and Pennsylvania, we provide descriptive evidence regarding the actuarial methods and assumptions adopted and the factors that explain a government's propensity to adopt optimistic actuarial methods and assumptions that reduce the annual required contribution. Our descriptive data suggests that actuaries are making aggressive assumptions for some governments' pension benefits. Our regression results also suggest there is an association between monitoring mechanisms, fiscal constraints, and socioeconomic factors and the choice of optimistic actuarial methods and assumptions that reduce the annual required contribution. The GASB should consider our findings as they determine whether existing standards should be clarified or whether allowable actuarial methods and assumptions should be restricted.

(ProQuest: ... denotes formula omitted.)

INTRODUCTION

A recent bankruptcy filing by the City of Vallejo, California, a report by the Napa County Grand Jury, and the City of San Diego's fiscal crises that was primarily caused by a two billion dollar deficit in its defined benefit pension (DB) plan highlight the issue of aggressive actuarial methods and assumptions and how these assumptions can risk the financial health of the entire government (Streisand, 2005; Levitt et al., 2006; Jones, 2008; Revell, 2008). In a recent article in the New York Times, Walsh (2008) described the pension funding situation for Fort Worth, Texas, and how aggressive investment rate of return assumptions and five increases in benefits over a few years resulted in a $410 million deficit in the city's pension plan. John Moorlach, an Orange County supervisor, noted "pension benefits are like a lobster trap. You can get in, but you can't get out" (Cauchon, 2007). This study provides descriptive evidence regarding the actuarial methods and assumptions adopted for DB plans by local governments in Michigan and Pennsylvania and the factors that explain a government's propensity to adopt optimistic actuarial methods and assumptions that reduce the annual required contribution (ARC), and which ultimately make governments' results of operations and financial position look better.1

In the government sector, Eaton and Nofsinger's (2004) paper is the primary work that has examined the actuarial methods and assumptions of DB plans for state and local governments.2 Using survey data primarily collected prior to Governmental Accounting Standards Board Statement (GASBS, 2004) No. 27, Eaton and Nofsinger (2004) examined the effects of financial distress and political influence on the actuarial assumptions for DB plans and found that entities facing fiscal constraints and political pressure are more likely to adopt aggressive actuarial methods. In this study, we make several contributions to the accounting literature. First, our data is for the reporting of DB plans under GASBS No. 27, rather than data under the limited footnote disclosure requirements of GASBS No. 5 in Eaton and Nofsinger (2004). The reporting of pension information by employers changed significantly under GASBS No. 27. Prior to Statement No. 27, the ARC was not required to be calculated, disclosure of information about significant actuarial assumptions was minimal, and pension information was not required on the face of the financial statements except when amounts were paid. Second, prior research has examined a limited number of actuarial methods and assumptions. In addition to including factors examined in prior research (i.e., amortization period, expected rate of return, and salary growth assumption), we provide empirical evidence regarding all of the actuarial methods and assumptions in GASBS No. 27, including actuarial cost methods, methods used to determine the actuarial value of plan assets, inflation rates, amortization methods, and open or closed amortization periods.

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Are Local Governments Adopting Optimistic Actuarial Methods and Assumptions for Defined Benefit Pension Plans?
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