LGA Lyceum

Pension Bill Signed into Law

Submitted by Colleen Deer,
Mockenhaupt Benefits Group
412.394.9333 (direct and fax)
800.405.3620 (toll-free)
Colleen.Deer@MBGbenefits.com

On Friday, September 18, the governor signed House Bill No. 1828 into law. The primary purpose of the bill, now known as Act 44 of 2009, is to provide financial relief to local government pension plan sponsors in the wake of significant financial losses in 2008.

Some of the provisions of the bill offer widespread financial relief to plan sponsors statewide, while others are targeted at the most distressed, underfunded plans. Municipalities whose Minimum Municipal Obligations for their defined benefit plan(s) for 2010 will be calculated based on the 2007 actuarial valuation report may not see any relief from this bill until 2011.

Highlights of the bill include:

• Assignment of new distress scoring system based on the aggregated funding ratio of all of a municipality’s pension plans (total actuarial value of assets divided by total actuarial accrued liabilities) at the last valuation
* Distress Level 0 – funding ratio of 90% or more
* Distress Level 1 – funding ratio of 70% - 89%
* Distress Level 2 – funding ratio of 50% - 69%
* Distress Level 3 – funding ratio of less than 50%

• An increase in the maximum value that can be used for the actuarial value of assets in the 2009 valuation from 120% of market value to 130%; extension of this provision to the 2011 valuation for Level 1 and to the 2013 valuation for Levels 2 and 3

• Decrease in the amortization periods for discretionary changes that increase or decrease the plan’s unfunded liability (such as assumption changes or locally modified benefits)

• Increase in the assumption periods for non-discretionary changes that increase or decrease the plan’s unfunded liability (such as actuarial losses, actuarial gains, and state mandated benefit enhancements)

• Permit payment of MMO with 75% of amortization payment for distressed municipalities for up to 6 years, depending on Distress Level

• Mandatory aggregation of plan assets for municipalities with more than one defined benefit plan that are Level 2 or 3 Distress, and voluntary aggregation for Level 1

• Mandatory submission of a plan for administrative improvement for Level 2 and 3 municipalities (voluntary for Level 1)

• Special taxing authority for Level 2 and 3 Distress municipalities

• Establishment of a new plan for new hires for Level 3 Distress plans (voluntary for Level 2)

• Authorization of DROP provisions for all pension plans

• Standardized DROP provisions for all new DROPs

• Specific relief measures for Pittsburgh and Philadelphia

• New regulations on professional services contracting to reduce "pay to play"

The legislation will affect municipalities differently, and you should contact your Actuary for further information.

Towards Better Pension Accounting: A Practitioner's View

On July 28, 2009 LGA convened a Roundtable discussion in order to provide comments in response to the Governmental Accounting Standards Board’s (GASB) Invitation to Comment (ITC) on Pension Accounting and Financial Reporting. The comments were provided to the GASB in order to communicate the group’s suggestions on how to proceed with this important topic. We asked one of our participants, Bob Lentz, Assistant Deputy for Accounting, Allegheny County Controller’s Office, to provide some insights and opinions on the ITC process and what is needed in terms of changes to pension accounting.

The ITC is a useful document that gives governmental officials and financial managers, as well as the public, a forum to express their opinions to the GASB before they adopt standards on an accounting issue.

With regard to Pension Accounting and Financial Reporting, the main two calculations associated with the basic premise of the Pension ITC currently exist in Allegheny County’s government-wide statements or within the notes of its financial statements. For example, the first calculation determines the Annual Required Contribution (ARC) that is expected to provide sufficient resources for funding both normal costs and the Unfunded Actuarial Accrued Liability (UAAL) over an amortization period of 30 years or less. The County’s cumulative deficiency of underfunding the required annual contribution on December 31, 2008 was $27.8 million. As required, this deficiency is recorded on governmental-wide statements. However, the second calculation that estimates the UAAL is only disclosed in the notes and is $181.4 million. Based on the distinct possibility that this liability may be recorded in the near future, the County’s unrestricted net deficit at December 31, 2008 would have grown from $30.7 million to $184.3 million.

To remain consistent with private industry and GASB 34 standards, which indicate that government-wide statements should assess government finances in their entirety, the pension UAAL should be recorded. Most users of governmental financial statements are well aware of the unfunded long-term pension liability.

Though I agree with recording the full liability, calculating and liquidating the liability remains a more difficult enigma to solve. At present, the County uses a rate of return of 8% on the investment of present and future assets. While this rate may seem high for the last two years, the County utilizes an aggressive 15 year amortization period. In order to ensure that governments produce consistent and comparable financial data, the GASB must ensure that the number of acceptable actuarial cost methods is reduced; amortization periods be standardized; discount rates be determined objectively and address whether cost-of-living adjustments should be included in projected pension benefits.

But, once accurate and consistent liabilities are recorded, what plan does the government have to fund these liabilities? Although the UAAL is recorded, there is no guarantee that funds will be available to liquidate the liability. The most feasible process would be to pay the ARC, calculated using standards adopted above, to prevent future generations from being saddled with the entire unfunded liability. In addition, steps should be taken to reduce the UAAL by eliminating excessive overtime, lump sum payments and other one-time enhancements from the pension calculation.

Also crucial is that the County and municipalities avoid reacting to short-term economic changes. In 2000 and 2001, the County reduced the employee and employer contribution, through its Pension Plan, to 3.8% of covered payroll from its previous and current rate of 6%. The Pension Plan would have better withstood the poor investment returns of the past two years if it had not reacted to the previous boon years.

Finally, the ITC expressed that many participants in the GASB’s research group would like to see the UAAL recorded in the Plan’s statements and include a statement of changes in the liability from year to year. Because the primary government negotiates labor contracts and has the ability to exert pressure for pension plans to increase or decrease contribution rates, the ARC and/or UAAL liabilities should only be recorded on the County’s government-wide financial statements.

The invitation to comment is only the start of the GASB standard setting process. Watch for future LGA events providing opportunities to engage and express opinions on emerging standards and expectations for local governments.

Municipal Leaders Learn about Accelerating the Policy & Practice of Sustainable Development

Submitted by
Michael A. Spotts
Sustainable Pittsburgh
425 Sixth Avenue, Suite 1335
Pittsburgh, PA 15219
www.sustainablepittsburgh.org

On June 4, 2009, the Sustainable Development Academy (an ongoing training initiative of Sustainable Pittsburgh and the Local Government Academy) presented Sustainable Community Development Essentials: Tools, Strategies, and Case Studies. This hands-on program engaged 32 representatives from 22 local governments and organizations from around the region. Faculty representing diverse community interests led the session, including Susan Hockenberry of the Local Government Academy, Matt Mehalik of Sustainable Pittsburgh, John Trant of Cranberry Township, and Joy Wilhelm of the DCED Governor’s Center for Local Government Services.

The seminar introduced participants to the concept of sustainability with the goal of helping them lead by example through governance, policymaking, municipal operations, and education. The seminar began by identifying sustainability as a process for continuous improvement that takes into consideration social equity, natural capital, and a resilient and restorative economy. The conversation then transitioned to implementation as the audience learned about the steps Cranberry Township has taken to adopt sustainability as the framework for municipal operations, planning, and programming. Finally, attendees learned about the attributes of a municipal government supportive of sustainability. Namely, a sustainable government features principles, policies, and practices that:

• Enhance organizational capacity
• Utilize best management practices
• Exhibit professionalism
• Encourage intergovernmental cooperation
• Foster civic engagement
• Attract investment
• Provide strong stewardship for the community
• Establish sustainable development as a culture of practice and policy

The session emphasized the point that a municipal government’s financial situation is fully linked to its sustainability. Fiscal health is necessary for a municipality to be responsive to the needs of its constituents, from service provision to proper maintenance of infrastructure. This fiduciary responsibility includes budgeting and planning, completing the audit process, and performance monitoring/evaluation.

Furthermore, the municipal budgeting system can serve as a leverage point for implementing sustainability initiatives. Through budget planning and reconciliation, the net costs and benefits from activities (for instance, newly adopted energy saving techniques) can be quantified, and hopefully serve as a catalyst for broader acceptance and implementation.

The session identified critical factors in the development of sustainable communities through fourteen Sustainable Community Essentials resource sheets. Attendees applied the lessons from the seminar and these Essentials in a case study of Shaker Heights, a suburb of Cleveland, OH. Looking at statistical and municipal information about the community, they conducted a Rapid Assessment of Shaker Heights’ strengths, weaknesses, and areas for improvement.

The Sustainable Community Essentials resource sheets and Rapid Assessment used in this seminar are available to the public at: www.sustainablecommunityessentials.org. For more information about the Sustainable Development Academy and other Local Government Academy events, please visit: http://www.localgovernmentacademy.org/ or subscribe to Sustainable Pittsburgh's weekly e-news, 3E Links by emailing info@sustainablepittsburgh.org.

Michael A. Spotts, Intern
Sustainable Pittsburgh
425 Sixth Avenue, Suite 1335
Pittsburgh, PA 15219
Office Phone: (412) 258-6649
Fax: (412) 258-6645
E-mail: mspotts@sustainablepittsburgh.org
www.sustainablepittsburgh.org

Market Outlook for Government Investors, October 2008

 
Submitted by Tamara Dzeskewicz (dzeskewiczt@pfm.com) and John Molloy, CFA, (molloyj@pfm.com), Senior Marketing Representatives, Pennsylvania Local Government Investment Trust, 800-388-4736

 

The recent upheaval that has swept the financial system leaves in its wake a radically altered investment landscape. The latest wave of financial market realignment began on September 7th when Fannie Mae and Freddie Mac were placed into a conservatorship under the Federal Housing Finance Agency. This action secured bondholders, however shareholders’ stock values fell below $1. Further upheaval followed with a flurry of bank closings, hurried mergers, and stopgap government bailouts.

A predictable flight-to-quality ensued as investors fled to the safety of U.S. Treasuries, driving their prices up and yields to new lows. While this rally will subside when normalcy returns to the markets—be it in a month or a year—other effects of the cataclysm will remain.

The Government Sponsored Enterprise (GSE) bailout, for example, challenges two conditions—ample supply and near risk-free appearance—that have made Federal Agency debt a mainstay in many short-term, fixed-income portfolios.

                If the GSEs are privatized, investing in Fannie Mae and Freddie Mac debt may remain an option only for those permitted to invest in corporate securities. In the public sector, will this lead to increased pressure on legislative bodies to expand the scope of permitted investments? If so, then additional investors may be thrust into the world of corporate credit. This could be complicated further if the privatized GSEs fail to keep their AAA rating. It is generally accepted that without some sort of government backing, the GSEs would not have maintained this top rating in recent years.

For those who invest in anything but Treasuries and Federal guaranteed debt, in-depth credit analysis will become more critical. Credit ratings alone have proven unreliable guides to credit quality as rating agencies appear to have mischaracterized the risks of a great number of investments. Over the past year, 16 AAA-rated issuers in the Merrill Lynch 1-10 Year Corporate Master Index were downgraded to AA or A. An additional 136 issuers previously rated A or BBB fell below investment grade. Downgrades are usually accompanied by an erosion of market value as investors demand higher yields for holding lower credit bonds and in some cases are followed by defaults, which produce real losses.

GSE debt could also go from plentiful to scarce. The Fannie Mae and Freddie Mac conservatorship stipulates that beginning in 2010, each must reduce its portfolio from $750-$800 billion to $250 billion at a rate of 10% per year. A reduction in Federal Agency debt supply could result in a diminished yield advantage over U.S. Treasuries.

If the GSEs become truly private corporations and/or if their debt issuance shrinks substantially, risk-averse investors may be pushed into the U.S. Treasury market. U.S. Treasury securities, however, typically produce the lowest returns of any fixed-income investment. The recent flight-to-quality pushed short-term U.S. Treasury yields to near 0.00% in September. While this is an anomaly, 3-month Treasury Bills yielded 0.26% less than 3-month Federal Agency discount notes over the past 10 years. This translates to $650,000 less earnings on a $25 million portfolio. Investors limited to the U.S. Treasury market will face additional challenges in seeking a reasonable rate of return.

                Meanwhile, the market upheaval has also resulted in a reworking of the broker/dealer and banking landscape. The top 5 U.S. broker/dealers of a year ago are now gone, continuing the trend of consolidation and globalization of the U.S. securities markets. The number of primary dealers (broker/dealers and banks that trade U.S. Government securities directly with the Federal Reserve Bank of New York) has shrunk from 31 to 16 over the past 10 years. Today, only 6 are domestic, versus 17 in 1999. In fact, in 2007, 9 of the top 20 underwriters of U.S. corporate and GSE debt were non-U.S. broker/dealers.

With fewer primary dealers, there is bound to be less competition among trading desks. This may lead not only to less attractive quotes and increase the importance of competitive security shopping, but small money managers and in-house finance teams may see the service level they receive from remaining banks and brokerage firms significantly reduced.

Similarly, consolidation of commercial banks into a small number of super-banks is likely to bring about changes in the relationship between investors and their local bank. In this new era, the largest three or four banks will control 30% to 40% of all deposits, giving them enormous power to set prices for services and diminishing their need to raise deposits in the local market. The small local/regional banks will find it increasingly difficult to remain independent as benefits from economies of scale encourage further consolidation.

 

OUTLOOK

With unprecedented worldwide government intervention in the financial markets, the outlook is partially clouded. Each action was initiated to restore stability, but that goal has been elusive to date. In the interim, risk-averse investors have preferred U.S. Treasury securities. We continue to view GSE debt, with its explicit Federal commitment of support, to be appropriate as well.

Corporate and bank obligations should be treated with the utmost caution because the full extent of the economic downturn and the interrelationships among banks and corporate borrowers is not yet fully known.

An investment approach involving discipline, rigorous credit and counterparty analysis, and prudent risk management, will be all the more critical in navigating these difficult and uncharted investment waters.

 

To obtain a PDF of this article, click here.

Some Easy Ways of Measuring Municipal Financial Health

Submitted by:

Susan Hockenberry

Local Government Academy, Executive Director

Phone: 412-237-3171

E-mail: shockenberry@localgovernmentacademy.org

In this entry of LGA Lyceum, we provide some ways to consider the fiscal health of municipal governments in Pennsylvania. While there are some excellent tools to do such analysis comprehensively, such as the International City Management Association’s Evaluating Financial Condition Handbook, the purpose of this list is to offer something less in-depth and to initiate further discussion of financial performance and good government.

1. Start with good data – Local governments in Pennsylvania are not required to utilize generally accepted accounting principles (GAAP), and this limits our ability to make sound judgments about the financial condition of municipalities--both over time and in comparing communities. Required annual financial reporting for local governments in Pennsylvania takes the form of the annual Municipal Audit and Financial Report. Two major short comings exist when relying on this information: (1) the report doesn’t require reporting on the basis of fund types (see discussion below) and (2) the level of professionalism applied to its preparation is lacking (it is not required that an independent CPA prepare the form).

Further limitations of the Municipal Audit and Financial Report also exist. The most significant of these is that it doesn’t require municipalities to state their beginning and end of year fund balance (see fund balance discussion below). Additionally, it doesn’t require the reporting of any post employment benefits, or depreciation of capital assets. This renders it less than useful for making judgments on fiscal health.

The important lesson: information available from statewide sources is limited and is best used for comparisons of income and expenses—not judgments of financial condition. Furthermore, adhering to a more rigorous financial reporting standard by municipalities would benefit all because it would accurately reveal the problems that exist.

 

2. Distinguish fund types:  As stated above, the annual municipal audit and financial report does not require reporting on the basis of fund type. This is important because knowing the activities in major fund categories is crucial to understanding the operations of a government.

Governments segregate funds for a variety of purposes. Most operations are recorded in the general fund—which, as the name implies, tracks all of the general activity of a municipality. But some monies a government receives must be tracked separately, and some governments, for management purposes, may record some income and expenses independent of the rest of the operation. Analysis on each individual fund can be tedious, as such good financial reporting compiles this information into “fund types.”

For the usual and customary operations of the government—like the police, streets, general administration--the Governmental Fund Types are the most revealing. For activities that may be funded by fees or in some way operate like a for-profit enterprise—the Proprietary Fund Types are most useful. Pensions and other trustee relationships should be presented in a third fund type--a Fiduciary Fund Type. All of this information when presented in total depicts an important picture. But understanding that picture sometimes requires digging deeper—and that means looking at operations on a fund type level.

This is especially true as it relates to the reserve funds. Many municipalities use reserve funds to accumulate resources and then spend it in another. When this happens, the transfer from the reserve fund to the general fund is not considered revenue to the general fund (the revenue being recognized in the past when the proceeds were originally received). However, the spending of these reserved monies IS considered an expense. The result: when spending down a reserve, a municipality has a deficit and that may be just according to plan. The issue to be concerned about in regard to reserve funds is the appropriateness of their use. Should municipalities accumulate resources in a fund segregated from their general fund? Does that serve to protect public assets or obfuscate excessive taxation? These are important questions about the use of reserve funds for which we should be concerned. Such questions are the subject of a review by the Governmental Accounting Standards Board, and a LGA round table was convened with the local chapter of the Government Finance Officers Association last year.

3. Know the fund balance - A deficit occurs in an accounting period if expenditures exceed revenues. But a deficit in and of itself doesn’t speak to the solvency of a municipality. For that, one must consider the equity of the organization.

Just like private sector organizations, fund equity is, simply put, the difference between assets and liabilities. Not all equity is spendable. Fund balance represents that equity which is subject to appropriation. Even within fund balance, a portion may be designated or earmarked for certain priorities or commitments.

Clearly a negative fund balance is a problem, but when a fund balance exists, how much should it be? Municipal finance officers have long deliberated over this. The Government Finance Officers Association has offered some assistance in its publication “An Elected Officials Guide to Fund Balance ” stating the following potential means to measure the appropriateness of a fund balance level:

 

· Municipal bond rating agency “rules of thumb” indicate 5% of annual operating expenditures OR

· No less thank one month’s operating expenditures (8.3% of expenditures)

But even at that, this doesn’t tell the whole story. Prudent municipal officials should not necessarily rely on assumptions or rules of thumb, but assess the needs of their communities. How reliable is the tax base? What are the capital needs of the community? Does the municipality have any known threats it should be preparing for like a lawsuit or other large payment? Answering these types of questions help municipalities determine how much fund balance it should have.

 

4. Know the municipality’s debt position – even when all of the long term liabilities are not known because no GAAP financial statements are being prepared, the debts of a municipality can be known.

The schedule of payments for all debt issues can be overlapped to get a total amount of debt service payments each year, as well as the outstanding amount. Readers of that information should consider whether that amount is an appropriate percentage for the economic conditions of the community. Rules of thumb indicate 10% of expenditures is likely wise, but the same advice about using of rules thumb for fund balance exist for determining the appropriate level of debt service—don’t over rely on them. Evaluate the fiscal conditions of the community.

Debt capacity should be considered. Legally, before a community can borrow funds it must determine its borrowing base—an average of its total revenue less intergovernmental revenue, interest and other one-time revenues—and multiply that by 250% to determine its debt capacity. How much of that capacity has been consumed? Is that acceptable given the conditions, needs and expectation of the community?

Knowing a community’s debt position is a good way to understand its financial condition.

 

5. Know the municipality’s tax capacity - Simply put, this relates to the combination of tax rates and tax base. A community close to maxing out in either its rates or base is facing fiscal difficulty.

Most municipalities, depending on the Code under which they operate, are limited in terms of their real estate tax rate. Likewise the property values must be stable or growing to avoid service cuts. When evaluating the financial health of the community, consider to what extent the municipality has tapped its tax rate and to what extent real property values are steady or rising (bearing in mind any limitations of the real estate assessment system). Likewise, most municipalities are limited to charging a .5% earned income tax (the exception being home rule municipalities). To evaluate whether or not a community can generate revenues sufficient to fund operations, consider the trends in taxpayer incomes—are they rising, holding steady, falling? This type of data should inform judgments about the financial health of a community.

Nothing about this list is exhaustive. In fact, many professionals spend many hours of study developing their understanding and expanding the base of knowledge on evaluating municipal financial condition and we stress that these indicators are not exclusive. But hopefully, this list provides the some ideas about what to consider when making judgments of fiscal health.

Update:

LGA provides comments to GASB on proposed standards contained in the Exposure Draft, Fund Balance Reporting and Governmental Fund Type Definition.