Public-Sector Pension Policy: How Changes to Accounting Standards Affect Us All

For those who do not work in the public sector, you may not pay attention to governmental accounting standards that impact pension funding. However, recent research from Elizabeth Chuk, Associate Professor at the UCI Paul Merage School of Business, may change that.

Along with research partner Divya Anantharaman of Rutgers Business School, Chuk discovered that within a sample of 100 large state-administered pension plans, recent changes to financial reporting requirements have impacted pension funding and pension policy as a whole.

“These changes impact all of us whether we are state employees or not,” Chuk explained. “Any reporting standards that change how governments fund pensions are relevant to everyone because the cost of these pensions is eventually borne by taxpayers.”

For example, most states have laws that require their government to create balanced budgets each year, so for every dollar it spends on pension funding, that’s one less dollar in the budget for something else. Since the mid-2000s, governments in states like New Jersey and Illinois and in cities like Detroit have struggled with pension funding shortages. This has raised concerns that to compensate, governments were shifting money allocated for roads, schools, fire departments, and other public services into pension plans.

“The financial crisis in 2008 revealed how severely underfunded pensions had become,” Chuk said. “In some cases, plans had only 40 cents to the dollar to cover liabilities. When the media caught wind of such large deficits, the problem became impossible to ignore.”

But the financial crisis was only the proverbial straw for an already precarious system. According to a report from The Pew Charitable Trusts and the Laura and John Arnold Foundation, public pension funding has been increasingly tied to risky assets since the early 1980s. When these assets failed during the crisis, large sums of money allocated for pensions quickly disappeared. On the corporate side, some companies had to declare bankruptcy due to these massive pension deficits. On the government side, officials scrambled to compensate for similar deficits within public-sector pensions. Meanwhile, employees were left wondering whether they would receive the benefits promised to them, and citizens were left with the possibility of higher taxes.

“Most people don’t realize the government actually provides pension insurance for private companies like Toyota, American Airlines, and others,” Chuk said. “This means that during the financial crisis, the government had to step in to fund failing plans. But just like car insurance or medical insurance, pension insurance doesn’t cover all the costs. In fact, in some cases, it only covered about 16 cents for every dollar owed. To make matters worse, even that 16 cents is eventually passed onto the taxpayer. So, even the corporate funding shortfall ended up impacting us as citizens, and the magnitude was in the trillions of dollars.”

“Because so many plans were and still are underfunded, they didn’t and still don’t have most of that money set aside,” Chuk said.

“This means that the reporting changes required by GASB 67/68 made the liabilities of the pensions look less favorable than they had before. Our study revealed that as a result, plan administrators often contributed more money to close those funding gaps so they could use the higher discount rate. As researchers, we found this interesting because the changes from GASB 67/68 did not in any way ask administrators to put more money into pensions; they just required stricter measurement and reporting of obligations and discount rates. In other words, the requirements were just about disclosure, but they ended up changing pension funding overall because of what administrators decided to do.”

Chuk explained that GASB 67/68 did meet their intended outcome. Investors, credit-rating entities, government officials, and taxpayers all have more clarity on how much pension liabilities actually are. The unintended outcomes, however, are important for researchers like Chuk to discover and share with both academia and the general public.

Her study’s hypothesis accurately predicted the unintended consequence of funding increases in general, but Chuk and her research partner were surprised by some of the variations from state to state.

For instance, in states with upcoming elections, pension plan administrators were more likely to increase funding than in states without upcoming elections. Chuk speculates this could be a result of pressure from incumbent politicians who want to avoid the mention of deficits. The study also found states with higher union membership had greater pension funding perhaps because those employees had stronger negotiating power via their unions.

But ultimately, are increases in pension funding actually a problem? After all, doesn’t a bump in funding now mean fewer deficits for the government down the road? According to Chuk, the answer is not straightforward. For one thing, some governments didn’t have the assets needed to increase funding, so they had no choice but to cut plan benefits.

“A cut to benefits is particularly hard on employees who have already retired,” Chuk said. “Instead of receiving the equivalent of a dollar for every year worked, retirees may only receive 70 cents worth of benefits. Another common cut was to COLAs [cost-of-living adjustments]. Employees who had expected to get a 5 percent COLA annually were now getting COLAs of only 3 percent.” While benefit cuts most directly affect employees and retirees, Chuk pointed out that in states where funding could and did increase, taxpayers ultimately bear the burden of those costs. Returning full circle to the reason all these matter to the general public in the first place, any increase in money allocated for pensions means that money is not available for other services.

“If the plan administrators couldn’t increase funding, they had to cut pension benefits for current and past employees. If they could increase funding, they had to shift that money from elsewhere in order for the government to present a balanced budget. It had to be one or the other,” Chuk explained.

“It’s really important to us as researchers to make people aware of how these financial decisions their governments are making affect them in very real and lasting ways. Hopefully, this information helps citizens, lawmakers, and elected officials make more informed choices when it comes time to vote, pass laws, and enact policy.”

While most of Chuk’s research on pensions has previously focused on the corporate sector, this current study, her first foray into the field of government-funded pensions, has captured her interest. Going forward, she hopes to continue exploring the space of public pensions and, in particular, how politics and policy are influencing these pensions.

Elizabeth Chuk is an Associate Professor at the UCI Paul Merage School of business. Prior to her time at UCI, she worked as an Assistant Professor at the University of Southern California for six years. Before entering academia, Chuk worked for Deloitte & Touche as a staff auditor and for Levi Strauss & Company as an accountant. In addition to her current faculty role, Chuk serves as an ad hoc reviewer for the Journal of Accounting Research, The Accounting Review, Contemporary Accounting Research, and others. Her primary research interests include financial reporting, consequences of accounting standards, defined benefit pensions, and earnings management.