J E S S E H U G H E S

D E B O R A H W H I T E

V G F O A F A L L C O N F E R E N C E

O C T O B E R 2 0 1 2

Practical Implications for the New Pension Standards on Virginia Localities

Why care NOW about new pension standards?

Reactions and questions of your stakeholders to the negative publicity about underfunded public pensions (and OPEB) Governing bodies

Citizens/taxpayers

Bondholders

Employees/retirees

New requirements: Rating agencies

Bond attorneys and underwriters

SEC (threats to regulate if voluntary measures not implemented)

GASB 68: What Will Change

Pension liability will be on government-wide balance sheet by FY 2015 (with prior period adjustments in year of adoption)

Volatile pension expense will be on government-wide Statement of Activities

The “UAAL” equivalent will go up and funded ratios will sharply decline

Teacher’s VRS pool UAAL will be allocated to the Schools (and therefore, on each locality’s CAFR)

Actuary and audit fees will likely rise—more complex calculations and disclosure requirements

GASB 68: What Won’t Change

Commonwealth of Virginia sets the minimum funding policy in the Code of Virginia for those using VRS (currently, VRS Board decides basis)

Annual actuary report from VRS

“…accounting changes do not alter the underlying fundamentals; $1,000 owed to a retired teacher in ten years under current standards will remain $1,000 owed in 10 years under the new standards. So policymakers should not let new numbers throw them off the path to sensible reform.” (Boston College, June 2012)

Lessons Learned from the Private Sector

FASB had similar standards implemented in 2006 because of seriously underfunded Defined Benefit pension plans in the private sector

Congressional laws (ERISA 1974, PPA 2008) forced specific funding levels (now at 100%)

Private companies had to make critical decisions in regards to cash resources—fund pension trusts or fund revenue-producing expenses

By 2009 only 16% had open DB plans

Public sector must be smart to preserve DB plans

Virginia Reforms

Most localities with single employer DB plans have closed them to new hires and joined VRS

The state, via VRS, has initiated major reforms, including an upcoming hybrid DB/DC plan and new hire tiers

The state required employees to start paying up to 5% member contribution (public perception of reform)

Many localities have re-examined OPEB plans and have reduced benefits, at least for new employees

Bond Disclosure Requirements

Most Official Statements now being released have more disclosures in regards to both pension and OPEB (narrative similar to CAFR)

SEC (July 31 report) and National Association of Bond Lawyers “considerations” for more disclosures—nothing yet changed for Best Practices

Underwriters are driving additional disclosures, as needed

S&P Rating Criteria: Pensions

“While the funding schedule for pension and OPEB can be more flexible than that for a fixed-debt repayment, it can also be more volatile and may cause fiscal stress if not managed, in our opinion. The size of the unfunded liabilities and the annual costs associated with funding them, relative to the budget, are important credit factors in our review of state and local governments…We will continue to differentiate credits where these long-term liabilities are large and growing, contributions are less than required, and there has been limited action on reform initiatives.” (Article by S&P in Govt. Finance Review, 8/12)

Fitch Rating Criteria: Pensions

“Fitch generally considers a funded ratio of 70% or above to be adequate and less than 60% to be weak, while noting that the funded ratio is one of many factors considered in Fitch’s analysis of pension obligation.” Feb. 2011 publication

“Fitch will calculate an additional long-term liability metric for use in the credit analysis of states. The new metric measures each state’s net tax-supported debt combined with the unfunded actuarial accrued liabilities (UAAL) in its major pension systems against the state’s wealth base, expressed as personal income...Fitch believes that debt and pensions are fundamentally different types of obligations, and the combined metric is inherently more variable.” (March 2012 special report)

Moody’s Proposed Criteria: Pensions

Moody’s released an extensive draft methodology on July 2 with the comment period just ended (Sept. 30, 2012; original deadline of Aug. 31, 2012)

Moody’s received numerous comments asking them to revise their methodology: GFOA

National Association of State Treasurers

National Conference on Public Employee Retirement Systems

As of today, Moody’s has not finalized their new methodology

Moody’s Proposed Criteria: Pensions

Considers pensions “debt-like obligations”

How local governments manage pension has an impact on how Moody’s measures management

Proposed “adjustments” to pension information: AAL discounted to 5.5% (or high-grade corp. bond index rate)

and 13 year duration

No asset smoothing (similar to GASB 68)

Multiple-employer cost-sharing plans (like VRS teacher’s pool) allocated to localities (similar to GASB 68)

For states, contributions calculated using 5.5% discount rate and 17-year active employee duration (svc life similar to GASB)

Moody’s Proposed Criteria: Pensions

These adjustments will almost triple the UAAL

Moody’s: no effect on state ratings but they are “still evaluating the full impact of the proposed pension adjustments on local government ratings.”

Also proposed: comparison of UAAL relative to full property value for local governments—part of new “score card”

Will take place immediately and will stay in place even after local governments implement GASB 68

Moody’s Proposed Criteria: Pensions

Moody’s wants comparability but many feel this methodology will not do that

GFOA feels the new numbers will cause confusion and undermine GASB 68 numbers in CAFRs

HEADLINE RISK—problem with perhaps arbitrary high numbers

Boston College study shows Virginia needing only a 7.5% blended discount rate, very similar to VRS current discount rate Moody showing Virginia UAALs artificially high?

VRA Credit Analysis

VRA performs in-house credit analysis for every loan

The VRA loan portfolio must meet the rating criteria of AA (GO/MO bonds) or AAA (utility bonds)-- therefore they are reactive to Rating criteria of Moody’s and other rating agencies

Underwriter disclosure requirements

Currently, VRA uses Moody’s 2009 GO Rating Methodology and will mention pension details in the credit report when Funding ratio is below 80% (state average was 76% in 2011)

UAAL is over 50% of payroll (state average was 98% in 2011)

Analysis of Virginia Localities: Source of Data

Latest CAFR (June 30, 2011)

VRS (teacher’s pool)

Pew Center for the States

Center for Retirement Research, Boston College

Association of Municipal Securities

GASB

Analyzed all Virginia local governments with a population more than 40,000

Potential Problems with Database

Pensions and OPEB not always allocated to entities where employees work (including regional organizations/schools)

Fixed assets not consistently allocated between primary government and School Board.

Economic Development Authorities and other non-School component units not included

Retirement Health Insurance Credit not included in OPEB since local government UAAL is small and Teachers Pool allocation not known.

Database Analysis

With no change in pension accounting, how did Virginia localities do as of June 30, 2011?

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Cities and Counties

Fitch Bond Rating Benchmark

Average

Cities Counties

Funded Pension Ratio for VA Localities as of 30 June 2011

Virginia Localities Below Fitch Rating Benchmark of 70% as of 30 June 2011

Cities: Alexandria (supplement & Fire/Police), Charlottesville, Hampton, Lynchburg, Newport News, Portsmouth (supplement & Fire/Police), Richmond

Counties: Arlington (Law Enforcement), Bedford (Fire/Rescue), Chesterfield (School Board Supplement)

This simple ratio does not tell the whole story and needs to be put in context of the size of the UAAL relative to the localities assets, payroll or revenue.

Database Analysis: Net Assets

Without any change in how the UAAL is calculated, what would happen if the UAAL appeared on the government-wide balance sheet?

A simple calculation is to divide the current net asset value for the general government by the UAAL,

a number greater than 1.0 would mean the net assets would remain positive;

a number less than 1.0 would mean net assets are negative (possible fiscal sustainability issues)

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Cities and Counties

% Net Assets Available for Pension UAAL (excludes VRS) for VA Localities as of 30 June 2011

Problem Area Cities Counties

Virginia Localities With Net Asset Availability Below 1% as of 30 June 2011 (without VRS Allocation)

City: Newport News

City School Boards (non-professional employees): Chesapeake, Lynchburg, Norfolk

Counties: Fairfax, Fauquier, Prince William, Rockingham

County School Boards (non-professional employees): Chesterfield, Montgomery

Database Analysis: VRS Teacher Allocations

VRS has informally determined an allocation of the 2011 VRS teacher UAAL (current rules) to each locality based on the contributions paid in 2011.

Can a school system cover its own UAAL?

Can a locality cover the school’s UAAL on top of its own? (Most School teacher UAAL allocations are at least as large as the locality’s.)

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Cities and Counties

% Net Assets Available for Pension UAAL for VA Localities as of 30 June 2011 (includes VRS UAAL)

Problem Area

Cities Counties

Virginia Localities With Net Asset Availability Above 1% as of 30 June 2011 (with VRS Allocation)

No change to previous table for cities and counties (School UAAL has not been combined with the locality)

City School Boards: None!

County School Boards: only Arlington, Bedford, Fauquier, Loudoun, Prince William, Rockingham, Spotsylvania, Stafford, and York

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Cities and Counties

% Net Assets Available for Combined Pension UAAL for VA Localities as of 30 June 2011

Problem Area Cities Counties

Virginia Localities With Net Asset Availability Above 1% for Pensions within Whole of Government as of 30 June 2011

Cities: All (except Alexandria and Newport News)

Counties: All (except Campbell, Fairfax, Pittsylvania, Shenandoah, Tazewell, and Washington)

Database Analysis: New Standards

Moody’s is projecting the UAAL will triple with its new methodology—if so that would add another 50% increase to the locality and school board combined UAAL

Under GASB, the combined UAAL in Virginia may only increase slightly because the blended discount rate may be close to the 7% used by VRS—however, using a market value for plan assets is currently decreasing the value of assets –assume a 50% increase on the combined UAAL as a worse-case scenario

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Cities and Counties

% Net Assets Available for Combined Pension UAAL for VA Localities as of 30 June 2011(includes 1.5X UAAL)

Problem Area

Cities Counties

Virginia Localities With Net Asset Availability Above 1% for Pensions with 50% add-on within Whole of Government as of 30 June 2011

Cities: All (except Alexandria , Newport News, Norfolk, Portsmouth, and Richmond)

Counties: All (except Albemarle, Augusta, Bedford, Campbell, Fairfax, Fauquier, Franklin, Frederick, Henry, Montgomery, Pittsylvania, Prince William, Rockingham, Shenandoah, Tazewell, and Washington)

Database Analysis: Smaller Cities

Looked at all cities with populations under 40,000 Their behavior does not differ from the larger cities in Virginia

Only Falls Church has non-VRS plans

The VRS Teacher UAAL allocation is often much higher than the City’s UAAL

No cities would have negative Net Assets using their FY2011 Govt Wide Statement of Net Assets with the VRS Teacher Allocation UAAL added to the City’s UAAL

Only the following cities will have negative Net Assets with both the VRS Teacher Allocation UAAL and an additional 50% liability: Hopewell, Martinsville, and Colonial Heights.

Database Analysis: Smaller Counties near Cville

Only Goochland, Fluvanna, Louisa, and Orange had CAFRs available on website

All had significantly higher VRS Teacher Pool UAAL than their own (4 to 10 times more)

Of these, only Fluvanna would have a negative Net Asset if the County UAAL is combined with Teacher Allocation UAAL plus 50% more

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Cities and Counties

Fitch Bond Rating Benchmark

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Cities Counties

Funded Pension Ratio for Smaller VA Localities as of 30 June 2011

Database Analysis: Select Authorities

Looked for Authorities that are not component units of related local governments Richmond Metropolitan, Western Virginia Water, Prince

William Co. Service, Central Virginia Service, Loudon Water, Fauquier Co. Water and Sanitation, Charlottesville-Albemarle Airport, Albemarle Co. Service, Rivanna Water and Sanitation, and Augusta Co. Service Authorities

All had more than enough Net Assets to cover double their own UAAL with the Central Virginia Service Authority having the lowest available net assets.

Average of funded ratios for this group slightly higher than other local governments

Database Analysis: UAAL % of Property Value

Database: last group of smaller cities and select counties with Albemarle and Charlottesville (AAA rated) for reference

Ratio as defined in potential new Moody rating criteria (we used total assessed property value found in CAFR statistical tables)

Moody’s will look for outliers to determine strong and weak local governments

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Cities and Counties

Total Pension UAAL as % of Assessed Property Values for Smaller VA Localities as of 30 June 2011

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Cities Counties

Database Analysis: UAAL % of Property Value

AAA rated reference local governments: Albemarle County 1.5%

Charlottesville 2.5%

Strong? Goochland County 0.9%

Louisa County 0.9%

Weak? Martinsville 9.1%

Does this look like a usable ratio?

Database Analysis: OPEB

GASB: The new GASB standards do not address any changes to the

accounting of OPEB

GASB is reviewing OPEB accounting with a possible Exposure Draft as early as the 2nd Quarter 2014

OPEB funding and UAAL are included in the discussions on new bond issues and in credit rating reviews

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Cities and Counties

Funded OPEB Ratio for VA Localities as of 30 June 2011

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Cities Counties

Funded OPEB Ratio for VA Localities above 5% Average as of 30 June 2011

Cities: Alexandria, Charlottesville, Chesapeake, Newport News, Roanoke, Suffolk, Virginia Beach

City School Boards: Alexandria, Newport News, Portsmouth, Suffolk , Virginia Beach

Counties: Arlington, Chesterfield, Fairfax, Fauquier, Hanover, Henrico, Henry, Roanoke, Stafford

County School Boards: Arlington, Prince William

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Cities and Counties

% Net Assets Available for Pension and OPEB UAAL for VA Localities as of 30 June 2011

Problem Area

Cities Counties

Virginia Localities With Net Asset Availability Above 1% for Pensions with 50% add-on + OPEB within Whole of Government as of 30 June 2011

Cities: All (except Alexandria , Chesapeake, Newport News, Norfolk, Portsmouth, and Richmond)

Counties: All (except Albemarle, Augusta, Bedford, Campbell, Fairfax, Fauquier, Franklin, Frederick, Henry, Montgomery, Pittsylvania, Prince William, Roanoke, Rockingham, Shenandoah, Spotsylvania, Tazewell, and Washington)

Resources

PFM’s July 2011 “What will GASB Changes Mean for Public Employers and Debt Issuers”

www.wikipension.com (devoted to local/state govt)

Center for Retirement Research, Boston College (crr.bc.edu) and Center for Local and State Government Excellence (slge.org)—easy to read white papers

Recent Journal of Govt Financial Mgmt (AGA, Summer 2012) and Govt Finance Review (GFOA) articles

GASB’s Implementation Guide for GASB 68, to be released January 2014