Pension Accounting Catches Up to Reality: New Jersey
Public pension plans are finally starting to use more realistic assumptions to measure their assets and liabilities. New Jersey’s beleaguered retirement system is among the first to use the methodology mandated by the Government Accounting Standards Board (GASB). New Jersey didn’t make any grand announcements. Rather it published the figures in a three-page supplement to the Preliminary Official Statement (POS) for a $525 million bond offering. The 150-page POS issued on November 19, 2014 told prospective buyers that the state pension’s funded ratio was 54.2% based on the valuation of July 1, 2013. A mere five days later, the supplement put that ratio at 32.6%. In less than a week, New Jersey was forced to officially admit that its state pension deficit wasn’t $37 billion, but $83 billion, and the overall deficit, including local pensions, had risen from $51 billion to $103 billion.
What changed? The supplement relies on data through July 1, 2014, which you might have thought would improve the situation a bit, since financial markets have been rising. However, New Jersey’s accounting practices, sanctioned by the old GASB rule 25, overstated assets and grossly understated liabilities. Under the old rules, New Jersey claimed that assets were worth $44 billion in 2013. Under the new rules, the assets, called net positions, are worth $40 billion in 2014. The liabilities (what New Jersey owes beneficiaries) have climbed from $81 billion to $123 billion.
On the asset side, the new rules eliminate smoothing techniques used to decrease year-to-year fluctuations in the value of assets. They also require adjustments for deferred inflows and outflows from the pension, which provides a more accurate picture of the net assets actually available to fund long-term liabilities.
On the liability side, the use of a realistic discount rate is the most important change. Under the old rules, the liabilities were discounted using the expected rate of return on pension assets. In New Jersey’s case, this figure was 7.90%. Under the new rules, the discount rate is 4.29%, which relates to the state’s borrowing costs. Anyone familiar with the basics of finance knows: (i) that discounting liabilities using the expected rate of return is absurd, and (ii) the smaller the discount rate the larger the value of the liability.
The new GASB standards add one more important and ominous element to the picture in New Jersey: the depletion date. Under current conditions and assumptions, the State Employees’ and Teachers’ Pension will no longer have sufficient funds to pay benefits in 2024 and 2027 respectively.
The only good news is that this isn’t new news. New Jersey’s bond rating has been cut six times in the past five years. Only Illinois has a lower rating. The rating agencies have repeatedly pointed out the dire condition of New Jersey’s public pensions. The implementation of GASB 67 makes it official.
Governor Christie inherited a major pension problem and has made it worse. While he’s pushed for some reforms, he’s failed to properly fund the pensions. Like all too many politicians, he’s bet on the magic of the alternative investments to close the gap. I understand why he’s running for President. It’s far better to be on the road in Iowa and New Hampshire than spending your days at home staring at a looming financial crisis. It’s up to Republicans to pick their standard bearer in 2016. However, the three-page supplement to the Preliminary Official Statement (POS) for New Jersey’s bond offering strongly suggests that Republican activists and voters should be telling Governor Christie to spend all his time in Trenton.
GASB 67 is going to force Governors, Treasurers, legislators, and pension trustees to confront an ugly reality. They’ve had plenty of warnings and many opportunities to address the problem. Instead, they’ve pretended that it’s only the outliers like Illinois or Kentucky that face a major problem. I don’t think the pension problem can be put off any longer, and I know that Wall Street’s “solutions” will make matters worse. Pension funding and reform will be on the legislative agenda in 2015.