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Preliminary Views Related to Pension Accounting and Financial Reporting
Posted On: Oct 06, 2010



General President General Secretary-Treasurer

1750 NEW YORK AVENUE, N.W., WASHINGTON, D.C. 20006-5395

? (202) 737-8484 ? FAX (202) 737-8418 ? WWW.IAFF.ORG

September 14, 2010

Director of Research and Technical Activities,

Project No. 34

Governmental Accounting Standards Board

401 Merritt 7

P.O. Box 5116

Norwalk, CT 06856-5116

RE: Preliminary Views on Major Issues Related to Pension Accounting

and Financial Reporting by Employers

Dear Director:

Thank you for the opportunity to provide comments on the Preliminary Views of the

Governmental Accounting Standards Board on major issues related to Pension Accounting and

Financial Reporting by Employers. The International Association of Fire Fighters (IAFF) represents

298,000 members, including over 250,000 who are either current active employees or retirees

participating in public pension plans in the United States that are subject to GASB reporting standards.

In addition, many IAFF members serve as elected or appointed trustees or administrators on governing

boards of many of those pension plans. Those members, in particular, have a unique understanding of

the importance of sound plan funding and liability reporting policies – both as plan participants and

plan managers. As such, the IAFF understands the importance that the GASB reporting standards have

to the long-term defined benefit pension promises made to our members.

Below are our responses to certain questions you have posed in the Preliminary Views. Of

primary concern to us is the potential disconnect that could develop between financial reports prepared

to satisfy GASB reporting requirements and financial reports prepared to satisfy employer funding

requirements. This disconnect, we feel, would lead to unfortunate misunderstandings and confusion as

to both the true cost and true financial health of a pension plan. Any GASB-required reporting of

underfunded pension costs (a "funding gap") implies to many that future contribution increases and/or

benefit reductions would be necessary to close the funding gap. However, increased contributions

and/or benefit reductions may not actually be necessary to satisfy a plan's funding requirements based

on reasonable actuarial assumptions and methods. We understand that the proposed accounting

requirements in the Preliminary Views are substantially similar to accounting requirements under

FASB for private sector defined benefit plans. We believe that the disconnect between FASB

accounting requirements and private sector funding requirements is a contributing factor to the drastic

decline in defined benefit pension plans in the private sector. Therefore, we cannot characterize the

FASB approach as a success, and seek to avoid such negative results in the governmental sector. It is

in this context that we provide you the following responses to your questions posed in the Preliminary


Director of Research and Technical Activities,

Project No. 34

September 14, 2010

Page 2

Our primary objective is to retain a direct connection between annual funding requirements

and annual pension expense.

Issue 1 – An Employer's Obligation to Its Employees for Defined Pension Benefits

We agree with the Preliminary View that the employer is generally primarily responsible (to

the extent provided by collective bargaining and state or local law) for the portion of the obligation for

defined pension benefits in excess of the plan net assets available for benefits. A critical element to

our agreement with this view is the sentence in Chapter 2, Paragraph 5 which reads:

An employer's relationship with the pension plan is characterized by the

adoption of a program of (actual or presumed) systematic annual

employer contributions to the plan in amounts projected to be sufficient,

when added to employee contributions (if any) and expected earnings on

the investment of plan assets, to provide for payment of the defined

pension benefits.

The employer's responsibility to pay employees or their beneficiaries the defined pension

benefits is linked to a systematic program to fund those benefits. Therefore, we feel that there must

always be, at the very least, a funding vehicle to hold plan assets and a funding program to fund those

benefits, by which the employer satisfies its obligation to provide benefits.

Our key point is that an employer's funding costs (less any employee share of the funding

and earnings on the Trust) are equivalent to the value of benefits provided under the Plan.

Issue 2 – Liability Recognition by a Sole or Agent Employer

2a. We agree with the Preliminary View that the unfunded portion of a sole or agent

employer's pension obligation to its employees meets the definition of a liability. This follows directly

from Concepts Statement 4, paragraph 17 which defines "liabilities" as "present obligations to sacrifice

resources that the government has little or no discretion to avoid."

2b. We agree with the Preliminary View that the net liability must be measurable with

sufficient reliability to be recognized in the employer's basic financial statements. However, given our

response to Issue 1 above, we feel that financial statement results based on the employer's stated

funding program is the only information that will be reliable, free from bias, a faithful representation of

what it purports to represent, comprehensive and not misleading. While we recognize that the GASB

Board does not have jurisdiction to set standards for the employer's funding program, we feel that the

results based on an employer's funding program are the only results appropriate for recognition in the

employer's basic financial statements. The liability recognized in the financial statements should track

the actual funding program with transparency as to past, present and future funding, and ultimately

should reflect the actuarially required contributions and active contributions.

Director of Research and Technical Activities,

Project No. 34

September 14, 2010

Page 3

Our key point is that the only costs that are appropriate for recognition in an employer's

financial statement are the employer's funding requirements.

Issue 3 – Measurement of the Total Pension Liability Component of the Net Pension Liability by

a Sole or Agent Employer

3a. In general, we believe that a reasonable actuarial funding (or cost) method should

include a projection of salary and other factors in determining a plan's annual funding costs consistent

with current GASB requirements. We understand that currently GASB accepts six different actuarial

funding methods for financial statement reporting (entry age, frozen entry age, attained age, frozen

attained age, projected unit credit and aggregate). We also understand that each of these six methods

project automatic COLAs, future salary increases and future service credits to calculate plan liabilities.

Therefore, to the extent that these items are projected as part of a plan's actuarial funding method, we

agree with the that automatic COLAs, future salary increases and future service credits should be

included in the calculation of the total pension liability and the service cost.

3b. With respect to ad hoc COLAs, to the extent that a plan has established a consistent

method of providing ad hoc COLAs, we agree with the Preliminary View that such ad hoc COLAs

should be included in the plan's actuarial funding method. For this purpose, we would view an ad hoc

COLA as substantively the same as an automatic COLA if it has been consistently provided in both

timing and amount over a period of at least nine years, which reflects the average length of three

consecutive bargaining contract periods.

3c. We disagree in part with the Preliminary View that a single "blended" rate as defined in

Chapter 4, Paragraph 14 should be used to determine plan liabilities. The states that the long-term

expected rate of return on plan investments should be used to the extent that current and future plan

assets are projected to be sufficient to make benefit payments. Chapter 4, Paragraph 17 describes

future plan assets as follows:

The projection of future employer contributions for this purpose should

reflect a reasonable expectation of future employer contribution levels

for current employees and should consider factors such as the employer's

stated contribution policy and recent contribution pattern.

As we suggested in our response to Issue 1, an employer's stated contribution policy should be

built with a view as to how future contributions will be sufficient to provide the defined benefits.

Therefore, in our view the blended rate would never apply given an employer's stated funding policy

that is designed to in fact ultimately provide the benefit.

This leaves the ambiguous phrase "recent contribution pattern" as relevant to whether the

blended rate should be used. However, we do not believe that past practice is indicative of future

contribution patterns. Consider, for instance, a plan that is 40% funded (using the expected rate of

return on assets) and 25% funded (using the blended rate). The funded status has been driven by a

combination of low investment returns and a recent employer practice of contributing less than the

ARC. However, the employer and members agree in good faith to a combination of increased

employer contributions and certain benefit concessions. As a result, future contributions are expected

Director of Research and Technical Activities,

Project No. 34

September 14, 2010

Page 4

to provide for all future benefits. We believe the expected rate of return on plan assets should be used

in this instance to determine plan assets despite the fact that there has been a recent pattern of

insufficient employer contributions. Shortfalls in meeting the funding plan should be disclosed. The

actuary should set the "expected rate of return" assumption by considering actual plan assets (as well

as other factors). If, for example, the system is in "pay-as-you-go" status, the rate should be based on

the return on general employer assets. In any event there would not be a "blended rate," but instead a

rate reflecting the actuary's judgment of the situation at hand.

As we have indicated, we believe that the assumptions used for financial statement reporting

purposes should be consistent with the assumptions used under a stated funding policy. As a result, we

believe that the discount rate should be the long-term expected rate of return of plan assets, and that

there should be no disconnect between the employer's funding costs and accounting expense. We

believe the actuary should take into account certain factors such as any expectation that the plan assets

may deplete or the employer may pay plan benefits on a pay-as-you-go basis when setting the plan's

expected rate of return on plan assets. We think connecting blocks of plan liabilities to the municipal

bond yield has no better theoretical underpinnings than connecting the same to a diversified portfolio

yield. The municipal bond yield will simply produce more volatility and confuse the stakeholders as to

what an appropriate funding level is.

3d. The Preliminary View is to use the entry age actuarial cost method applied on a levelpercentage

of payroll basis to determine the total pension liability and the service-cost component of

pension expense. We realize that a consistent method by which plan costs are funded and expensed

reduces complexity, enables the user of financial statement information to appropriately interpret

results, and eliminates any potential bias in reporting financial information. We understand that a

majority of plans currently use the entry age method. If the Board adopts entry age method as the

standard for financial statement purposes, we would anticipate that many additional employers would

switch to entry age method for ongoing funding purposes. These plans could, however, experience

significant disconnects between the method they are using and the entry age method. We feel the

Board should carefully consider this issue when drafting any transition rules from the current standards

to the new standards, allowing for a longer transition period to accommodate those employers who

may change funding methods.

Our key point is that an employer's accounting expense should be equivalent to an

employer's funding requirement based on reasonable actuarial assumptions and methods.

Issue 4 – Attribution of Changes in the Net Pension Liability to Financial Reporting Periods by a

Sole or Agent Employer

4a. In keeping with our view that funding costs and pension expense should be linked, we

believe that the pension expense should be equivalent to the service cost plus an amortization of the

unfunded accrued liability. Given the long-term, stable nature of public safety workforces (as well as

most other governmental workforces), we believe that an amortization period for the unfunded accrued

liability that reflects the entire expected career of an average employee would be a more appropriate

amortization measure than expected future working lifetime. Consequently, any unfunded accrued

liability should, in theory, be funded (i.e. expensed) over the weighted-average periods representative

Director of Research and Technical Activities,

Project No. 34

September 14, 2010

Page 5

of the expected working lives of individual employees (not-to-exceed 30 years). Additionally, we do

not agree that immediate recognition of changes in total pension liability associated with inactives is

appropriate, since immediate funding of the change would ordinarily not be required under a

reasonable funding method. Immediate recognition of any changes in liability would not be consistent

with the level annual expense method concept as outlined in GASB's choice of the entry age method.

Furthermore, immediate recognition of changes in inactive liabilities would create a disincentive to

adopting assumption changes that increase inactive liabilities (for instance, assumptions that increase

life expectancy). For simplicity, we suggest recognizing inactive changes over the same period as

active changes, or, if the plan is primarily comprised of inactives, recognizing inactive changes over

the expected future lifetime of inactives (not-to-exceed 30 years).

4b. Revenue for public pension funds comes from individual taxpayers. Individual

taxpayers demand predictability and stability in taxes. Therefore, it is unreasonable to expect a public

entity to fully fund volatile changes in plan assets. Furthermore, a reasonable funding method would

not require immediate funding of large asset losses. Thus, we do not agree with the cumulative asset

gains and losses exceeding 15% of the fair value of plan investments should be immediately

recognized in pension expense. We believe that large asset gains and losses outside a reasonable

corridor are more likely to be offset in future periods than assets gains and losses within a reasonable

corridor. We would suggest amortizing the excess gains and losses outside of the corridor in a manner

that is consistent with the amortization period described in our answer 4a.

Our key point is that the attribution of changes in pension liability to future accounting

periods should be consistent with a reasonable funding method.

Issue 5 – Recognition by a Cost-Sharing Employer

5a. A characteristic feature of cost-sharing plans is that participating employers make

contractually required contributions. We believe that financial statement recognition of pension costs

for cost-sharing employers should be based solely on the employer's progress towards making the

contractually required contributions. Recognition of a net pension liability, expense and deferred costs

for employers participating in cost-sharing plans would need to be consistent with the characteristics of

understandability, reliability, relevance and comparability as outlined in Concepts Statement No. 3,

paragraph 28. This would be particularly the case if pension obligations are based on contributions, as

suggested by GASB. High workforce mobility and changes in employer participation in a cost-sharing

plan can distort the true cost of the plan to an employer if an allocation method based on contributions

is used.

5b. Not applicable.

Director of Research and Technical Activities,

Project No. 34

September 14, 2010

Page 6

Issue 6 – Frequency and Timing of Measurements

6. We agree with the Preliminary View that a comprehensive measurement should be

made at least biennially and should be adjusted as necessary to reflect the effects of significant changes

between comprehensive measurement dates.

Once again, thank you for the opportunity to respond to the Preliminary Views. We welcome

any questions you may have.



Harold A. Schaitberger

International Association of Fire Fighters


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