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A change in pension accounting metrics could upend university balance sheets, threatening everything from accreditation to federal financial aid.
A set of changes proposed by the Governmental Accounting Standards Board, a nonprofit group that sets guidelines for how states, local governments, and entities such as public colleges and universities report finances, is about to unbalance countless balance sheets.
The new guidelines, announced in June and set to take effect in the 2015 fiscal year, are designed to highlight how much state governments -- and governmental agencies -- owe in pension expenses and force policy makers to confront these costs. The change applies only to defined benefit plans, not contribution plans such as 401(k)s.
“The new standards will improve the way state and local governments report their pension liabilities and expenses, resulting in a more faithful representation of the full impact of these obligations,” GASB Chairman Robert H. Attmore said in a statement announcing the approval of the two standards. “Among other improvements, net pension liabilities will be reported on the balance sheet, providing citizens and other users of these financial reports with a clearer picture of the size and nature of the financial obligations to current and former employees.”
Since GASB announced its changes, the new standards have mostly been making headlines about how they will make state pension plans look significantly less healthy than they do currently. And since many pension plans are already looking unhealthy after years of underfunding and poor investment returns, that is a gloomy headline for lawmakers.
But rather than making things clearer, public college and university finance officials worry, these new regulations could greatly complicate universities’ financial pictures. The new guidelines would require institutions that participate in state pension plans – more than 75 percent, according to the National Association of College and University Business Officers – to list their share of the state’s pension liability, potentially billions of dollars, where they previously recorded nothing. That could place a major negative on university balance sheets, one that campus officials say they are not legally responsible for nor capable of repaying on their own, potentially endangering credit ratings, state support, qualification for federal financial aid, and accreditation.
“Using requirements in the current proposal, several large public institutions have determined that their allocated liability will profoundly affect their financially healthy standing in the eyes of these stakeholders,” wrote Susan M. Menditto, director of accounting policy for NACUBO, in a letter to the board that was joined by several major higher education associations.
The exact effects of the policy change are hard to gauge, since GASB is still finalizing the rules and because determining states and institutions’ long-term liabilities require complicated actuarial work that states and institutions cannot do until those rules are finalized.
The picture is also complicated by the fact that the structure of pension plans varies so widely, even within higher education. While most institutions participate in state plans where they share costs, others, such as the University of California system, provide their own pension plans for employees. Others have pension plans that are not defined-benefit plans, and will not be affected by every component of the change.
A Bigger Liability
The biggest change is plainly spelled out in GASB’s press release: “The statement calls for the immediate recognition of more pension expense than is currently required.” What’s confusing is that states and institutions that provide pensions directly to employees won’t actually owe more to pension recipients. Those payments are required by law.
The new GASB guidelines make slight changes to how states and other institutions calculate how much they owe in benefits, and a significant change to how they calculate how prepared they are to meet those obligations. To determine how much an institution needs to set aside today to meet their obligations in the future, colleges and universities use something called a discount rate, the amount they anticipate money in the pension fund will grow over. Right now, most pension plans use a rate of somewhere between 7.5 and 9 percent annual growth, which has been the average rate of return over the past several decades.
The new requirements would allow states to continue to use that rate -- up until the point the money in already set aside in the pension fund would run out. Then the college would have to use a smaller growth rate closer to a municipal bond rate, which is currently around 4 percent.
While a difference of 4 percentage points might seem small, stretched out and compounded over the life of a pension obligation -- which in some cases is more than 100 years -- the difference to institutions could be billions of dollars. Many say this is designed to pressure states and institutions to fund a larger share of their pension obligation, since it will make the liability more manageable on the balance sheet.
A report by the Center for Retirement Research at Boston College released in July estimated that the new regulations will drop the funded ratio – the amount of pension obligations currently funded by the money already set aside – from about 76 percent to 57 percent, meaning that, according to the standards, state and other pension plans, including universities, have only 57 percent of the money they need to meet their long-term needs.
Sharing the Pain
While the changes are likely to make it look as if states and institutions that provide pension benefits have much larger pension liabilities, those that take part in cost-sharing plans don’t have to shoulder the burden themselves. They get to spread that pain around.
The change most likely to have an effect on public colleges and universities is the new requirement that institutions participating in a multi-employer cost-sharing plan, such as a state pension program, record their portion of that overall liability on their balance sheets.
Currently those institutions are not required to record any long-term pension liability. They might record what they are required to pay into the state plan -- a few million dollars for large institutions -- but nothing close to what the change would require.
Institutional officials say this change has them scratching their heads. For one, they say, most public institutions are required by law to pay only their contributions to the plan, not to cover the total cost of their employees’ pensions.
“The promise that the public institution makes to its employees is access to the state’s public employee retirement system,” Menditto wrote, rather than actually paying the full pension.
“This doesn’t, in our mind, fit the definition of a liability,” said Tom Ewing, associate controller at Ohio State University.
Second, they say, is that they don’t have any way to control the repayment of that liability. Since state lawmakers determine how much colleges, universities and other state agencies pay into the system, those institutions don’t have any way to decrease their liability.
Credit rating agencies, accreditation agencies, and the U.S. Department of Education all use ratios that include institutions' liabilities to make important decisions about colleges and universities. The inclusion of pension liabilities on colleges’ books is going to throw those ratios off. Public and private institutions that in all other respects would be comparable financial position are going to look vastly different, wrote a group of Ohio public universities in a letter to GASB.
In Ohio, the state ranks institutions' financial health on a scale from 0 to 5. Ohio State, which has the highest credit rating available and recently issued a 100-year bond, would see its score drop from 4.2 to 0.8 if its share of the state’s pension liabilities were put on its books, according to estimates in the Ohio group’s letter.
Lowered credit ratings could result in higher borrowing costs. Institutions deemed financially unhealthy by the U.S. Department of Education are ineligible from participating in federal student aid programs. Accrediting agencies place institutions under increased scrutiny if their financial ratios fall below a certain threshold.
Administrators said they don't expect the GASB to alter its rules, but they hope that people using the balance sheet, such as accrediting agencies, credit ratings agencies, and others will figure out new ways to interpret the liability. Ewing said that including that liability will make the balance sheet and those ratios less usable, since the liability won’t actually reflect the institution’s financial health. “When people look at the balance sheet, they’re going to have to put their thumb over that number,” he said.
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