Logical Implications of the GASB’s Methodology for Valuing Pension Liabilities

Robert Novy-Marx

Financial Analysts Journal, 2013, vol. 69, issue 1, 26-32

Abstract: The marginal valuation of assets can be negative under the Governmental Accounting Standards Board’s methodology for valuing pension liabilities. In such cases, a plan can improve its GASB funding status by literally burning money. GASB accounting also gives different “valuations” for the same assets and liabilities when they are partitioned differently among plans. Finally, the methodology is exactly equivalent to fairly valuing plan liabilities but accounting for stocks at more than twice their traded prices.State and local governments employ one out of seven U.S. workers, and these workers generally participate in state-sponsored defined benefit (DB) pension plans. Governments value their pension liabilities, which run to trillions of dollars, using a methodology prescribed by the Governmental Accounting Standards Board (GASB). These valuations are used in planning and budgeting. Because they routinely provide the basis for multibillion dollar decisions, their accuracy has direct implications for government efficiency.Disagreement remains, however, regarding the validity of the GASB’s prescribed methodology and, in particular, the rate used to discount liabilities. The GASB discounts projected benefit payments at the expected return on plan assets because it believes this rate “reflects the employer’s projected sacrifice of resources.” Financial economists prefer a lower discount rate because accumulated pension promises are viewed as nearly default free and the basic tenets of financial economics require that cash flows be discounted at rates reflecting their risks. The difference in the aggregate liability posed by state and local DB pension plans calculated using the discount rates preferred by the GASB and financial economists is enormous—in excess of $2 trillion.It is well known that the GASB’s methodology of discounting liabilities at the expected return on plan assets implies that the GASB funding status of state and local government DB pension plans improves when the plans take on more investment risk. In this article, I document several lesser-known pathologies of the GASB methodology. In particular, I show that GASB accounting is susceptible to the “Yogi Berra fallacy,” in which a pizza is less filling when sliced into fewer pieces: The GASB gives different “valuations” for the exact same assets and liabilities when they are partitioned differently among plans. Moreover, the marginal valuation of assets can be negative under GASB rules. In such cases, a plan can improve its GASB funding status by literally burning money. Finally, I show that the GASB’s methodology is exactly equivalent to fairly valuing plan liabilities but accounting for stocks at more than twice their traded prices and further crediting a plan an additional dollar for each dollar of stock that it intends to buy in the future.

Date: 2013
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DOI: 10.2469/faj.v69.n1.2

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