Unmasking Staggering Pension Debt and Hidden Expense

    How New Rules from Moody’s and GASB Affect the Financial Reporting of Pensions in Seven California Counties
    March 15, 2013

    By John G. Dickerson

    About the Author: John Dickerson is a financial professional living in Mendocino County who is involved in public sector pension analysis and reform. Dickerson focuses on the impact of unfunded pension debt on the 21 California counties that operate their own independent Pension Funds. He is a financial and organizational planner and analyst with 30 years of experience. He earned his MBA in Strategic Planning from the University of Texas at Austin. This paper is copyrighted by John G Dickerson, and quotes from this paper should be attributed to: John G Dickerson, YourPublicMoney.com. It may be copied and distributed at will if it is provided to readers and other users for free. However, it must not be changed nor can any type of fee be charged in relation to this material without the author’s express written permission. This material was presented by Dickerson to the Marin County Citizen’s for Sustainable Pension Plans in March 2013 – view video.


    Only accounting fraud allows governments to pretend their budgets are balanced. – Bill Gates

    My County – Mendocino – incurred hundreds of millions of past pension expenses they never reported to the people. Across the nation the hundreds of billions of past government pension expenses that created today’s huge unfunded pension debt have been hidden by a “Fatal Flaw” in how governments report pension finances. That’s about to change. Big Time.

    At the end of June, 2012 the Governmental Accounting Standards Board (“GASB”) imposed major reforms in how state and local governments report pension finances that will kick in over 2 years. Then Moody’s announced their intention to make big adjustments to government reported pension finances in their credit-rating analysis. This report is the content of a presentation about these changes I’ve given to reform groups in counties analyzed in this report.

    My specific goal is to show how GASB’s current rules have a “Fatal Flaw” – how that Fatal Flaw allowed hundreds of billions of unfunded government pension debt to develop – and why the new rules are absolutely necessary. My general goal is to describe to concerned citizens what the impact of GASB’s new rules and Moody’s adjustments will be.

    The Fatal Flaw is that pension expenses that create unfunded pension debt are reported in the future as that debt is paid. That’s absurd – the payments of a debt eliminate the debt, they don’t create it. Unfunded pension debt is created by pension expenses in the past – most of which have never been reported to the people. GASB is changing that.

    GASB’s changes are only about how governments must report pension finances. Moody’s changes are only about how they will analyze government pension financial data in their internal credit rating analysis. Neither will “tell” governments how much they should pay to Pension Funds and Moody’s won’t change government financial statements.

    This report shows the impact these changes would have had on 7 California counties that have their own County Pension Funds (Alameda, Contra Costa, Marin, Mendocino, Orange, San Mateo, and Sonoma). To the extent I modeled GASB’s changes and Moody’s adjustments correctly and obtained the correct data – if you don’t “like” the results your argument is with GASB and Moody’s – not me. I’m the messenger.

    This paper presents a simple model of how pension funding “works” which is what financial statements must report. GASB’s main impacts on statements will be to list Net Pension Liability as real debt for the first time, remove Net Pension Assets related to Pension Obligation Bonds, and make profound changes in how pension expense is reported. Moody’s will also adjust the value of unfunded pension debt, but they won’t recalculate the value of government assets or pension expenses. However, Moody’s will calculate a “benchmark” for payments to Pension Funds – GASB won’t.

    GASB’s new rules would have quadrupled Mendocino County’s pension expenses for 2004 through 2011. Instead of a $63 million surplus they would have reported a $115 million deficit. Most governments will report this type of shift. This table shows the impact GASB’s new rules would have had on the 7 counties’ Balance Sheets.
    Dickenson_GASB_introGASB’s new rules would have forced these counties to report $9 billion of past pension expenses in one year

    Moody’s adjustments would produce a Net Pension Liability of $17.5 billion instead of GASB’s $8.3 billion. If that had been reported as the Net Pension Liability these counties collectively would have had negative Net Assets of ($8.3 Billion). Moody’s adjusted annual payments to Pension Funds would have gone from $1.1 billion to $2.4 billion.

    This is a highly simplified picture of an extremely complex subject. Almost everything has a swarm of “ifs, ands, and buts” that aren’t presented here. If you see errors in data or analysis let me know – I’ll correct them.


      1. GASB
      2. Moody’s
      3. What These Changes Will Do – and What They Won’t Do
      4. What My Analysis is About – and Not About
      1. Normal Costs
      2. Unfunded Pensions
        1. Amortization
        2. Pension Obligation Bonds
      1. GASB’s and Moody’s Domains
      2. The Fatal Flaw – Pension Expenses on the Income Statements
        1. Fundamental Accounting Principles
        2. GASB’s Old Rule: Pension Expense – “Annual Required Contribution” (ARC)
        3. The Fatal Flaw
      3. 10 Year Schedule – Changes in Net Pension Liability – Basis for Pension Expense
      4. Balance Sheet
        1. Net Pension Asset
        2. Net Pension Liability
        3. Impact on Balance Sheet (Statement of Net Assets)
      5. Parting Shots
        1. GASB: Oceans of Red Ink the Year GASB’s New Rules are Implemented
        2. Moody’s: Significantly Higher Government Payments to Pension Funds

     *   *   *


    Bill Gates was asked “Do we have a huge unaccounted for pension overhang problem that’s going to hurt our government budgets?”

    His response –

    “Absolutely! It’s pretty mind blowing. It’s partly because the way state (and local) budgets are presented is so fraudulent. There’s a thing called the Government Accounting Standards Board that allows you not to take (meaning report) full pension costs, not to take retiree healthcare benefits.

    Whenever something’s free it gets overused, and so improving the pensions of people who are already retired – never shows up on the budget. Letting people retire early, have more overtime factored into their retirement –  all these things come from the fact that when the person who says “yes” to those things – the government person – doesn’t feel any pain at all because there’s no number that ever shows up.

    Pension payments to government employees – lots of that look free, and we’ve messed up long enough that we have a huge overhang here.

    It looks really free to continue deficit spending – which is nominally a balanced budget but only accounting fraud allows you to pretend it’s balanced.” (Aspen Ideas Festival, July, 2010  –  view video)

    *   *   *


    Ever have that feeling something big is moving just out of sight but you don’t know what it is? Something’s just off stage but you can’t see it? Things are out of place but you don’t know why?

    Mendocino County occupies 3900 square miles of rural beauty on California’s North Coast with 90,000 people and a poor economy. In 1970 over 1/3 of our jobs were in the timber industry. By 2000 it was less than 5%. We had lost our economic base.

    I was a big supporter of economic development programs to replace the jobs, family incomes and local tax base that had been lost. But County funding for these programs was being cut. Explanations offered by County officials “didn’t add up” – something wasn’t being said.

    I’ve been analyzing organizational finances just about all my working life. I’m good at it. I became increasingly alarmed. I started digging.

    I analyzed State Controller’s data for all California counties. On a per capita basis my County had the most debt, debt payments, and interest expense of all counties in our state. Something was very wrong.

    Our County’s 2009 audited financial statements showed $135 million of debt – two-thirds of which was something called “Pension Obligation Bonds”. But a footnote in the back of the audit indicated the County’s Pension Fund was $67 million underfunded. Another showed the County’s retiree health plan was $130 million underfunded.

    “What the heck?!? The County’s Balance Sheet says we owe $135 million. But the footnotes say there’s an additional $200 million of “unfunded retiree benefit obligations”. I’m told the County has to pay that. If we have to pay it, why isn’t it listed as a “bona fide” debt on the County’s Balance Sheet? We owe $1/3 billion of which $287 million has something to do with unfunded County retiree benefits. When and how did this happen? Is it still happening? How much danger are we in anyway?”

    When I earned my MBA from the University of Texas at Austin UT was usually ranked the #1 graduate school for accounting in the country. They made sure we understood “Fundamental Accounting Principles”. I knew that if we owed that much money for “unfunded retiree benefits” then that’s basically an unpaid expense. I should be able to “find” that expense in previous financial statements and track what happened. I entered 20 years of data from County financial statements and the County’s Pension Fund reports into a big complex excel spreadsheet. I dug and dug – read footnotes – reconciled numbers – read about government financial reporting – looking for the expenses that hadn’t been paid that created this unfunded retiree obligation.

    Then one day I was hit by lightning. I suddenly realized something impossible had happened – “My God! My County hasn’t reported a third of a billion dollars of real past pension and retiree healthcare expenses to the people!”

    The rules used by state and local governments today when they report their pension finances are built on a huge “fatal flaw”. When Bill Gates says “Only accounting fraud allows governments to pretend their budgets are balanced” (to paraphrase) he’s essentially correct. It may not be fraud “on purpose” (although I believe in far too many cases it was) – but it’s surely fraud “in effect” – a fraud committed against the people and, frankly, against younger government employees.

    Government financial statements for decades have very seriously understated pension expenses and failed to raise the alarm about the massive unfunded pension debt that was the result.

    This report is the content of a presentation I’ve given to citizen pension reform groups regarding two very powerful changes in how government pension finances will be reported and analyzed.

    At the end of June 2012 the Governmental Accounting Standards Board – known as “GASB” – imposed major changes that will kick in over the next 2 years about how state and local governments must report their pension finances. GASB was finally forced to confront the fatal flaw in its old rules and fix it.

    One week later Moody’s Investors Services announced they aren’t going to wait 2 years. They intend to make big adjustments to government reported pension finances in their credit-rating analysis beginning in the next couple of months. They concluded that government financial statements significantly understate the threat of unfunded pensions to investors who buy government bonds and that even GASB’s new rules “don’t go far enough”.

    My main goal in this paper is to simply describe the fatal flaw, how it allowed hundreds of billions of unfunded pension debt to develop without the people knowing about it, and how GASB’s new rules will eliminate it.

    More generally I’ll describe some of the main changes GASB will impose and the key points in Moody’s proposed adjustments. I’ll show what their impacts would have been on Fiscal Year 2011 financial statements for seven California counties that have their own independent Pension Funds. Six are in the Bay Area – Alameda, Contra Costa, Marin, Mendocino, San Mateo, and Sonoma. One is in Southern California – Orange County.

    This is a highly simplified “Big Picture” of an extremely complex subject. I think it’s a “realistic” picture – but almost everything in this report has a swarm of “ifs, ands, and buts” I don’t even have time to mention.

    *   *   *


    A. GASB

    Dickenson_GASB_logoThe Governmental Accounting Standards Board (“GASB” – pronounced “GAS-Bee”) establishes “Generally Accepted Accounting Principles” (“GAAP” pronounced “Gap”) for state and local governments in the US. They don’t set the rules for the federal government. “Government” in this report refers to state and local governments. GASB is not a government agency. It’s a nonprofit professional association. Almost all governments produce financial statements according to GASB’s rules. They establish these rules by issuing “Statements”. Each Statement is numbered in the order it was adopted. They adopted two new Statements at the end of June, 2012.

    GASB 67 defines how government Pension Funds must report their finances. They must use the new rules for financial years that begin after this coming June 15, 2013.

    GASB 68 defines how state and local government employers must report their pension finances. They must comply no later than for fiscal years beginning after June 15, 2014.

    These are a “done deal” – they’ve been adopted. They are now part of government “GAAP”. As usual with complex new standards GASB is providing a “transition stage” to get ready. Implementing these rules will be a lot of work for Pension Funds and governments. But so far very few governments have any idea about the scale of what’s about to hit them.

    B. Moody’s Investors Services

    Dickenson_Moodys_logoMoody’s Investors Services is one of the two most powerful credit rating agencies in the US. On July 2, 2012 Moody’s published a “Request for Comment” titled Adjustments to US State and Local Government Reported Pension Data (referred to herein as “Moody’s Paper”).  Moody’s believes government reports about state and local government pension finances significantly understate the financial risk of unfunded pension debt to those who lend money to governments. They intend to modify government-reported pension financial data in analyzing credit-worthiness and setting credit ratings for state and local governments in the US.

    Moody’s officials say they expect to release their final adjustments “before the end of winter” – which would be in March, 2013. This paper uses the proposed adjustments.

    C. What These Changes Will Do – and What They Won’t Do

    GASB will change the way governments report their pension finances in their audited statements. That’s it.

    Moody’s will change the way they evaluate pension finances in their credit rating process. That’s it.

    Neither will make governments fund pensions differently. No one should say either will require governments to pay more. No one should say they will make governments declare “bankruptcy”.

    No government must change its financial statements because of Moody’s adjustments.

    But what GASB and Moody’s ARE going to do will have very powerful impacts.

    D. What This Analysis is About – and Not About

    I developed models to project the impacts of GASB 68 and Moody’s adjustments. I applied the Moody’s model and parts of my GASB model to the most recent audited financial reports and Pension Fund Valuations for these seven counties that don’t participate in CalPERS but instead chose to have their own independent County Pension Funds – Alameda, Contra Costa, Marin, Mendocino, Orange, San Mateo, and Sonoma. The reports were from 2011 because 2012 reports aren’t yet available for all these counties. I didn’t include Enterprises funded by user fees – water, sewer, airports. I took the values for non-pension related assets and liabilities in County audits at “face value”.

    All these County Pension Funds have participating governments other than these counties. If pension financial values weren’t reported in Actuarial Valuations for these counties separately from other participating governments I allocated total Pension Fund values to the counties according to procedures defined in GASB 68.

    A couple of other financial professionals checked my Moody’s model and say it correctly interprets Moody’s adjustments. But Moody’s adjustments are pretty easy to model. In contrast – several aspects of GASB’s new pension finance reporting rules are very complicated and require considerably more data. To date no other financial professionals have reviewed by GASB model.

    County audit data is pretty easy to interpret. Pension Fund data is much more complex and often hard to decipher. I believe I got the right data although some of it is a little tricky, and I’m pretty confident I interpreted GASB and Moody’s correctly.

    No one should say I’m saying the numbers produced by my GASB and Moody’s models are what I think is “true”. What I’m saying is this – to the extent I correctly modeled these changes and got correct data the numbers in this report are what GASB’s new rules and Moody’s adjustments would have produced.  If you don’t like them your argument is with GASB and Moody’s – not me. I’m the messenger. But if anyone sees any errors in data or analysis let me know. I’ll correct mistakes and if warranted apologize.

    *   *   *


    Meet Jane. Jane went to work for the County 15 years ago. She’s going to work another 15 years and then retire with 30 years of service. She’ll get a raise every year. She’s going to receive a pension for 20 years. Each year she will receive a Cost of Living Adjustment.

    The reality of pension funding is far more complex than this simple model. But this explains what’s going on. Actuaries produce reports – usually every year – called Pension Fund Actuarial Valuations. They are pension funding plans. Valuations provide a number of key values that have to be “interpreted” in government financial statements.

    Jane’s worked half the years she’ll work when she retires. That means she’s already earned half her future pensions – she’ll earn the rest over the next 15 years.

    When Jane retires she will have 100% earned the legal right to receive all her pensions – no matter how long she lives.

    Dickenson_GASB_4tFigure 1.  Jane’s Pension Fund – Normal Cost

    A.  “Normal Cost”

    Jane’s about to start her 16th year – the green step. The little green layer in her future pensions between what she’s already earned and the part labeled “Not Yet Earned” is what she’ll earn in her 16th year. Think of her future pensions as a layer cake. Each layer is what she earned in one year. Over 30 years she’ll lay down 30 layers of her pension cake.
    Here’s the idea – The County and Jane put money into the Pension Fund in her 16th year. The Fund will invest it and it will grow. When she retires the Fund will start paying her Pensions including the layer she’ll earn in her 16th year.

    The goal is to put just enough money into the Pension Fund this year – so that with investment profits – there will be just enough money in the Pension Fund to pay the part of Jane’s last monthly pension payment that she will earn in her 16th year.

    This calculation will be done for each of Jane’s 30 years. It’s only about the part of future pensions being earned each year. This is called the “Normal Cost” – or the “Normal Contribution”. Part is paid by the County – part by Jane.

    B. Unfunded Pensions

    Next the actuary figures out the “Pension Funding Position”. This is the formula:

    Pension Fund Value of Assets
    –    Total Pension Liability
    =    Underfunded or Overfunded Pensions

    As an aside for now – GASB and Moody’s will calculate these values differently from how Actuaries do it.

    Calculating Total Pension Liability is like figuring out the Normal Cost – with one big difference. Instead of calculating how much needs to be paid into the Pension Fund in Jane’s 16th year to fund that thin layer of future pensions Jane will earn that year – the Actuary estimates how much ought to be in the Pension Fund at the beginning of Jane’s 16th year to be able to pay the part of future pension payments Jane has already earned – that part labeled “Already Earned” in the illustrations.

    This amount – how much should be in the Fund today so that – if everything goes according to plan – there will be just enough money to pay all of Jane’s pensions she’s already earned – is the Total Pension Liability.

    It’s what’s supposed to be in the Fund today. Not what’s going to be paid tomorrow – how much is supposed to be in the Fund TODAY.

    The Total Pension Liability is subtracted from the value of Pension Fund Assets. Either the Pension Fund has more Assets than the Total Pension Liability – or less. These days for governments in the US it’s almost universally less.

    What if the Actuary estimates there’s not enough money in the Pension Fund today to pay all of Jane’s future pensions that she’s already earned– that is – the Fund will run out of money when the pensions shown in yellow in Figure 2 need to be paid.

    Dickenson_GASB_5tFigure 2.  Jane’s Pension Fund – Unfunded Pensions

    The amount that should be in the Fund TODAY – but isn’t – is the “Unfunded Pension Obligation” – referred to by Actuaries as the “Unfunded Actuarially Accrued Liability” – or – much easier to remember – the “UAAL”. It’s the amount that should be in the Pension Fund today – but isn’t – that’s needed to pay the last part of Jane’s future pensions she’s already earned shown in yellow.

    This is where the Fatal Flaw lives.

    Now – If a significant unfunded pension gap develops usually ONLY the county must pay more money into the Fund to eliminate this deficit. Employees rarely have that obligation and retirees in California never have to do so.

    Governments have two ways to eliminate unfunded pensions.

    1. Amortization

    The first is unfunded amortization payments. Unfunded pensions are almost always decades in the future. The Actuary has to plan that at some point between now and then – that is between the step Jane is taking to begin her 16th year and the yellow part of the illustration above – the deficit will be eliminated. The actuary draws up an “amortization schedule” – kind of like a home mortgage. The County will make payments up to 30 years – but often less – to eliminate this gap. The county will pay an interest expense equal to the Pension Fund’s target rate of return.

    There’s a second way to eliminate UAALs.

    2. Pension Obligation Bonds

    Municipal bond interest rates are a lot lower than Pension Fund target rates of return. Lots of governments borrowed money by selling “Pension Obligation Bonds” (“POB’s”) hoping to get a lower interest rate. They gave the proceeds to their Pension Fund to eliminate the unfunded pensions. Six of the 7 counties in this analysis have sold POBs.

    All that happened is these counties “restructured” their unfunded pension debts. They changed the form of the debt – but the source of the debt is the same – unfunded pensions. The Pension Fund got the money – but the County – which really means – We the People kept the debt.

    You have to include Pension Bonds when you think about the financial impact of unfunded pensions.

    Right after Mendocino County sold its 2nd pension bonds in 2002 the County CEO was interviewed on a local news show. The lady said “Hey – wow – the County’s debt really shot up last year. What’s up with that?”

    The CEO said – “Listen – our County Board of Supervisors deserves huge praise from the people of Mendocino County. They cut our interest expense in half. They saved the people tens of millions of dollars over the next 20 years – money we’ll have for vital public services”.

    Now – of course it’s better to only pay 4% interest than 8%. That’s not the question. The question is “why are we in debt – why are we paying any interest at all? You said you were properly funding pensions all along – what happened? And how are you going to stop putting us deeper in debt?”

    *   *   *


    How does all this get reported in government financial statements today – which statements will GASB’s and Moody’s changes affect – and where’s the fatal flaw?

    A. GASB’s and Moody’s Domains

    Three types of financial statements are affected by pension finances. (I’m really simplifying here.)

    Dickenson_GASB_6tFigure 3.  GASB and Moody’s Domains

    The oval on the left is what GASB will change – the one on the right is what Moody’s will change. The ONLY item both will change is liabilities – that’s the one point where GASB and Moody’s intersect.

    a) Balance Sheet

    The Balance Sheet – called the “Statement of Net Assets” – shows what a government owns – its assets, what it owes –liabilities, and what’s left over – “Net Assets”. GASB will change how assets and liabilities are reported. Moody’s will only adjust the value of liabilities.

    b) Income Statement

    The Income Statement – called the Statement of Activities – reports what revenues were in a year, what expenses were – and if the County is operating with a “surplus” or a “deficit”. The impact here is the value of “Pension Expenses” reported each year. This is where the Fatal Flaw lives. GASB 68 will impose profound changes in how pension expenses are reported – and those changes will “fix” the fatal flaw. Moody’s adjustments won’t touch the Income Statement at all.

    c) Cash Flow

    Then there’s cash flow. How much cash do you start with, how much comes in and goes out, how much is left? How much does – and should the county pay to the Pension Fund? Moody’s adjustments will make a huge impact here – GASB has nothing to say about it.

    B. The Fatal Flaw – Pension Expenses on the Income Statement

    We’ll start with pension expenses – because that’s where the FATAL FLAW is. Many people think it’s about the debt – and there are huge issues about that. But the financial problem STARTS with pension EXPENSES.

    1. Fundamental Accounting Principles

    The complex, huge and always evolving “Generally Accepted Accounting Principles” are supposed to be built on a foundation of 7 or so Fundamental Accounting Principles – simple – obvious – in fact “elegant” in their simplicity.

    One of these Fundamental Principles is called the “Matching Principle”. Think about how simple and obvious this is.

    You have to accurately quantify all your income each year and you have to accurately quantify all your expenses that year. Then you have to “match” them to figure out if you’re making or losing money.

    Pretty basic – huh?

    Here’s how GASB states the Matching Principle in terms of government retiree benefits.

    Dickenson_GASB_7tFigure 4.  GASB’s Statement of the Matching Principle Applied to Retirement Benefits

    GASB asserted this principle over 20 years ago. If they had imposed it THEN – a trillion dollars of unfunded government retiree pension debt in this country would probably have been avoided.

    2. GASB’s Old Rule: Pension Expense = “Annual Required Contribution” (ARC)

    Now – this is only about GASB – Moody’s isn’t dealing with pension expenses reported on government Income Statements.

    The most important concept in the old rules is the “Annual Required Contribution” – or “ARC” – simply what the Actuary says the government must pay the Pension Fund each year – its share of Normal Cost and any unfunded pension Amortization payments. Payments of Pension Bonds aren’t included.

    Each year’s ARC is reported as each year’s pension expense. That’s a simplification – it’s more complicated – but that’s the core concept.

    3. The Fatal Flaw

    Mendocino had a $125 million unfunded pension obligation going into 2012. The County was obligated to eliminate it (Figure 5).

    Dickenson_GASB_7m-lFigure 5.  Fatal Flaw: Unfunded Pensions

    The Actuary set up this unfunded pension Amortization schedule over 30 years. If everything went exactly according to plan – at that point the unfunded pensions would be eliminated – and Jane would get all her pensions.

    Dickenson_GASB_7b-rFigure 6.  Fatal Flaw: Amortization Payments

    This is how the unfunded pension obligation developed (Figure 7). Mendocino sold $90 million in Pension Bonds in December 02. They didn’t reduce unfunded pensions to zero – but we’ll assume they did for this explanation. The columns are each year’s change in the UAAL. The pink area is the balance of the UAAL up to the $125 million.

    There were a couple of good years when the UAAL went down – but 6 of these 8 years saw the UAAL increase.

    Dickenson_GASB_8tFigure 7.  Fatal Flaw: How Unfunded Pensions Developed


    When does the pension expense happen that created this $125 million unfunded pension debt?

    Under today’s rules the Annual Required Contribution is what the County will report as its pension expense each year –the sum of the government’s Normal Cost Contribution – AND UAAL AMORTIZATION PAYMENTS. These payments (Figure 8) over the next three decades would be added to the Normal Contributions in those years to produce the reported pension expense in each of those years. The pension expense related to the $125 million UAAL will be reported over 30 years in the future.

    Dickenson_GASB_8mFigure 8.  Fatal Flaw: Today’s Statements Tell Us the
    Payment of Debt “Creates” Debt – Absurd

    That’s saying the payments of a debt create the debt. That’s absurd. The payments of a debt eliminate a debt – they don’t create it. The real economic pension expense that created this debt happened here (circled area below, Figure 9) – it’s what built up the $125 million debt.

    Dickenson_GASB_8bFigure 9.  Fatal Flaw: The Real Expense Creates the
    Unfunded Pension Debt That Must Be Paid

    Here’s a close up of the eight years before Mendocino County started paying amortization payments in 2012 (Figure 10).

    Dickenson_GASB_9tFigure 10.  Fatal Flaw: How Mendocino’s 2012
    Unfunded Pension Debt Developed

    These are the six years unfunded pensions went up – and two in which they went down.

    Dickenson_GASB_9mFigure 11.  Fatal Flaw: Mendocino’s Reported Pension
    Expense – This is the Fatal Flaw

    The line (Figure 11) shows the County’s Annual Required Contributions (ARC) AND what they reported as their pension expense. Remember – if everything works out according to the pension funding plan this is supposed to be the only money the County needs to pay to the Pension Fund to completely fund employees’ future pensions.

    Now – this is absolutely critical – The ARC is an ESTIMATE of what should be paid in and reported as pension expense – and given the complexity, these estimates will never be exactly correct.

    If a significant Pension Fund deficit develops that forces the County to start making amortization payments or borrow Pension Bonds – THAT means two very powerful things:

    •    It turns out the County and its employees should have contributed far more than they did. PERIOD.

    •    And the reported pension expense turned out to be much lower than what the real expense turned out to be.

    GASB is divorcing pension expenses from how actuaries plan to eliminate unfunded pensions,
    Under GASB 68 pension expenses will be a function of the change in government pension obligations.

    Here’s what GASB’s new rules would have said the pension expense was (Figure 12).

    Dickenson_GASB_9bFigure 12. Fatal Flaw: The Real Pension Expenses
    That Would Have Been Reported Under GASB 68

    The county’s GASB 68 pension expenses would have been four times more than what the county reported.

    As I said earlier – my GASB model is much more complicated than the Moody’s model because GASB 68 is much more complicated. One complication is how pension expenses will be calculated. GASB 68 defines 11 different variables for which you need data for as many as 16 years or so. I had data for all these variables back to 1993 which allowed me to project what GASB 68’s reported pension expenses would have been for 2010 and 2011 – the larger diamonds on this graph. I had to estimate some variables for the values from 2004 through 2009. However, I had most of the necessary data and the scale of the missing variables before 1993 was much smaller and therefore the range of possible error for the 2004-09 estimates is pretty small. I’m pretty confident the line in that period is essentially accurate.

    Dickenson_GASB_10tFigure 13. Fatal Flaw – Mendocino Reported Surplus –
    GASB 68 Would Have Shown Big Deficit

    Here’s the impact on the bottom line (Figure 13). Over those 8 years the county reported a total of $60 million in “surpluses”. If GASB 68 had been in effect it would have been a $100 million deficit. My County would have reported 160 million more pension expenses in those 8 years.

    A major reason the $125 million UAAL was less than this $160 million is that large unreported expenses that created the need to sell Pension Bonds in 2002 would have been included in pension expenses during this period by GASB 68.

    I haven’t used my GASB 68 model to estimate what reported pension expenses for the other 6 counties in this analysis would have been. Frankly, I don’t have the time to get all the data and shove it through the model.

    However, although I expect GASB 68 to whack Mendocino County more than most I believe the scale of GASB 68’s changes in pension expenses and resulting changes in surplus and/or deficits for most state and local governments will be in this range all across this country.

    The only reason most governments report balanced budgets is because the rules allow them to hugely understate their real pension expenses and then shove them decades into the future. Government financial statements failed to report the real pension expense that was much larger than what was reported, and thus failed to sound the warning of the huge debt that was emerging. Bill Gates calls this “fraudulent accounting” – I call it the “fatal flaw”.

    I believe many – in fact I suspect most governments are going to suddenly report deficits when GASB 68 kicks in – many very significant deficits.

    C. 10 Year Schedule – Changes in Net Pension Liability – Basis for Pension Expense

    As a transition to Balance Sheets – I’ll touch briefly on what I think in many ways will be the most helpful change in GASB 68. Governments will have to show a schedule of changes in 11 different variables over the past 10 years that cause the Net Pension Liability to change. These are things like the cost of the government’s guaranteed Pension Fund investment profits, actual investment returns, retroactive benefit increases, Pension Fund administrative expenses, etc.

    The table below shows the schedule produced by my GASB 68 model for Mendocino County. This table differs in a couple of ways from what GASB 68 will require but it’s mostly the same. Obviously this is complicated. I won’t dive into this– but it’s rich with information.

    This table shows changes in liabilities. The annual changes in 7 of these variables will also be included in the annual pension expense to be reported. Changes in 4 variables will be spread over several years. Therefore the annual change in liability will not exactly equal the yearly pension expense. I won’t go into how pension expenses will be calculated – it’s one of the most complex aspects of GASB 68. For this discussion the point is that the changes in liability shown below directly drive the pension expense that will be reported.

    One of the major purposes of financial statements is “actionability” – to direct action where it needs to be focused. Another is “accountability” – the ability to hold people accountable for financial results. Today’s reporting of pension finances fails to achieve these goals. The new standards are a huge improvement – especially this 10 year schedule.


    This detail over 10 years is a tremendous advance in accuracy, actionability, and accountability. This will point to where the problem is – where action is needed.

    Just a head’s up – this is going to be valuable. Now – on to the Balance Sheet.

    D. Balance Sheet

    Both GASB and Moody’s will adjust liabilities – and in effect Net Assets. GASB’s new rules will put unfunded pension debt directly in the Balance Sheet for the first time. But Moody’s adjustments will produce much higher unfunded pension debt.

    Only GASB will directly impact the value of assets – which is where we’ll start.
    And – I guarantee you – THIS IS WEIRD!

    Dickenson_GASB_11bFigure 14.  GASB & Moody’s & the Balance Sheet

    1. Net Pension Asset

    Mendocino County again – 1993 through 2003 (Figure 15). The red stalactites hanging down are the UAAL. The little green columns are the Annual Required Contribution.

    The red columns are the proceeds of Pension Bonds. The County sold its first Pension Bonds in 97. They sold their second in 03.

    Dickenson_GASB_12tFigure 15.  Mendocino – UAAL, County Pension Fund
    Contributions, Pension Obligation Bonds

    The borrowing is simple. They have a $112 million liability – Pension Bonds. They got $106 million in cash and the “Bond Boys” kept $6 million as their cut – part of the county’s cost of issuing the Bonds.

    Where it gets weird is what they did with the $106 million. They gave the money to the Pension Fund – but what did the County report they got for it?

    Imagine this – you gave your kid a credit card. The kid tells you he’s only spending a few hundred dollars a month on the credit card. What’s really happening is he’s only paying the minimum payment – but charging thousands a month.

    A $10,000 balance builds up. The minimum payment is $1000. Your kid borrows $10,000 from Aunt Betsy – a generous soul. He pays it to the credit card. You ask your kid what the heck is going on – and he says:

    “Hey Dad – Mom. I’m a genius. Sure I owe Aunt Betsy $10,000 – BUT I’VE GOT A PREPAID CREDIT CARD BALANCE OF $9000 – SO – I REALLY only owe $1000.

    He says he’s got a $9000 prepaid balance – an asset – because that’s how much he paid above the minimum payment.

    Does that make sense?

    That’s what governments that sold Pension Bonds did. The amount they paid to the Pension Fund over the minimum payment (which is what the Annual Required Contribution is, by the way) was reported as a Net Pension Asset – prepaid pensions.

    Now – it’s time to start looking at what the impact of GASB 68 would have been had it been in force when the 7 counties I analyzed produced their 2011 audited financial statements.

    And – we’ll see what Moody’s adjustments would have been had they been applied to those financial statements-

    Four of these counties reported Net Pension Assets in 2011:


    These counties total UAAL was $2 billion. Their Pension Bond debt was $1.2 billion for a total debt created by unfunded pensions of $3.3 billion. And they reported a Net Pension Asset of $1 billion.

    Does it make sense to you that when these counties reported a total of $3.3 billion of unfunded pension debt (the UAAL was disclosed in footnotes – not on the face of the Balance Sheet) they also had a $1 billion “Net Pension Asset”? REALLY? GASB used to say “yes” – it’s about to say “no”.

    Under GASB 68 you won’t be able to have a Net Pension Liability AND a Net Pension Asset at the same time. You can only have one – or the other – not both.

    Dickenson_GASB_13tFigure 16.  Net Pension Assets & Total Assets

    The red part of these columns (Figure 16) is the portion Net Pension Assets are of total assets for the 4 counties and for all 4 combined. The moment GASB 68 is implemented these Net Pension Assets are going to go “poof” – they’ll disappear. That will be a billion dollar hit for these counties – in one year.

    The impact ranges from less than 5% of assets being written off for Marin to nearly 30% for Mendocino.

    2. Net Pension Liability

    Now we go to Liabilities – the one place GASB and Moody’s overlap.

    GASB’s old rules didn’t put unfunded pension obligations on Balance Sheets. GASB 68 will. But the value Moody’s will use in its credit analysis will usually be much higher than what will be reported under GASB 68.

    There are 3 steps in calculating the value of unfunded pensions. First – what’s the value of the Pension Fund’s assets. Second – how much is the Total Pension Liability – the money that is SUPPOSED to be in the Pension Fund today so that all future pensions that have already been earned can be paid? Finally – is there more or less money in the Pension Fund than we need?

    Now – the way Actuaries do these calculations is different from how GASB 68 will do them and both are different from how Moody’s will do them. I was going to describe all this to you – but even I kept falling asleep as I ran through this stuff. There’s already too much detail in this presentation – this would be over the top.

    So I’ll just hit a couple of the “high points” as I show you the results.

    Dickenson_GASB_13mFigure 17.  UAAL = 100%

    These “hollow boxes” (Figure 17) are the UAAL – it isn’t reported on Balance Sheets today. I’m showing these as 100% so we can see the percentage change of what would be reported under GASB 68 and what Moody’s adjustments would do. The total UAAL for these 6 counties was about $4 billion.

    As shown on Figure 18 (below), GASB 68 would have put $4.1 billion of net pension liabilities on these Balance Sheets had it been in effect in 2011.

    Two things.

    Actuaries use something called the “Smoothed” value of Pension Fund assets. It’s kind of a “moving average” that “slows down” the chaotic year to year changes that sometimes happen in stock markets. If the market goes down sharply the “smoothed” value won’t go down as much in the first year. The smoothed value will be higher than the market value.

    Then as the market starts to grow again the smoothed value will slip below the market value. The changes in the smoothed value are less extreme and “lag” changes in market value. The purpose of smoothing – and it makes sense – is to prevent huge chaotic sudden increases in government UAAL Amortization Payments that would play havoc with budgets. That makes sense from a funding and cash planning point of view. But you shouldn’t do stuff like that in accounting and financial reporting. You should use “real” – or market values. On the table below, the hollow boxes are the UAAL using actuarial values for assets, the solid boxes are the UAAL using market values.

    Dickenson_GASB_13bFigure 18.  UAAL with Market Value of Pension Assets (solid bar)

    However – by using market instead of smoothed value both GASB 68 and Moody’s will produce Net Pension Liability values that will be more volatile than the UAAL we’re used to looking at. There’ll be a little “noise” put into our analysis of the financial position of governments – not much, but a little.

    The second point about this is GASB 68 requires a very complicated cash flow projection going out to the last expected payment of a pension that’s already been earned – 70 years or more – year by year. The result of this projection CAN result in using a lower projected rate of return than what Pension Funds assume – I’ve seen some analysis that indicates about half of the governments will be forced to use a somewhat lower rate.

    I don’t have the data needed to make this projection so I simply used the Total Pension Liability reported in Valuations and subtracted the market value of assets – not the smoothed value. This is the BEST CASE for governments. It may well be the Net Pension Liability will wind up higher for some of these counties – we’ll have to wait and see.

    Dickenson_GASB_14tFigure 19.  Moody’s Adjusted Total Pension Liability

    Finally – the last column in this third graph (Figure 19) is the increase in the value Moody’s would use in its credit analysis. The total UAAL was a little less than $4 billion – Moody’s would have used a net liability of about $10 billion – on average 2½ times more than the UAAL.

    The main reason Moody’s assumed unfunded pension debt is so much higher is they will NOT accept the calculations of Actuaries based on the target rate of return. Instead they will adjust the net pension liability to estimate what it would have been if the actuary had used a much lower rate – a corporate bond rate. Instead of the average of about 7.75% used by these 6 County Pension Funds in 2011 Moody’s would have applied a 5.5% assumed rate of return. That’s why the value Moody’s would have used in its credit analysis would have been 2½ times higher than GASB’s.

    There are many reasons Moody’s gives for why they will use this lower rate. They believe it’s a more realistic assumption of future profitability over the next decade or more. And by using the same discount rate the resulting values for different governments are more comparable. Today those values can differ only because of different assumptions about future investment profitability. There are other reasons – but again – too many ifs, ands, and buts.

    3. Impact on Balance Sheet (Statement of Net Assets)

    The basic accounting formula is Liabilities plus Net Assets ALWAYS equals Assets. A too-simple but OK for this presentation way to think about it is Net Assets is how much would be left over if you had to pay all your Liabilities right now.

    Here’s what the Balance Sheets for all 7 counties looked like as of June 2011 (Figure 20, below). Assets here are 100%. This shows what percent Pension Bonds are of assets in red, all other liabilities in pink, and what’s left over as “Net Assets”.

    Dickenson_GASB_14bFigure 20.  Reported Balance Sheets (Green = % Net Assets)

    All 7 counties reported significantly more Assets than Liabilities. Total Net Assets was $10.2 billion.

    Here’s what GASB 68 would have done (Figure 21, below):

    Dickenson_GASB_15tFigure 21.  Restated Balance Sheets Applying GASB 68

    A billion of Net Pension Assets would have gone “poof” thereby reducing the Total Assets of these 7 counties down from $17 billion to $16 billion.

    Then $8.3 billion of Net Pension Liability based on the Market Value of Pension Fund Assets (but using the Pension Fund’s reported Total Pension Liability) would be added to the Balance Sheet as a Liability. This plus the $1.7 billion of Pension Bond debt makes $10 billion of debt created by unfunded pensions.

    Then the $5.9 billion of all other Liabilities would increase Total Liabilities for these 7 counties to about $15.9 billion.

    Mendocino and CoCo (that’s what they call Contra Costa over there) would have reported more unfunded pension debt than the value of their assets! Then when the other debts are added in they would have reported they had $160 of debt for every $100 of assets they had!

    Orange County’s Net Assets of nearly $4 billion would have been wiped out by adding $4.1 billion of Net Pension Liabilities. Sonoma and San Mateo’s Net Assets equal to about 50% and 70% respectively would have been cut down to about 5%.

    Marin – being Marin – would still have Net Assets equal to 60% of their Total Assets. Together these 7 counties on average would have reported unfunded pension-created debt was over 60% of the value of their assets. Their combined Net Assets dropped from $10.2 billion down to less than $1 billion – a drop of $9.3 billion – for just these 7 counties! There are over 3000 counties in the US and tens of thousands of cities, school districts and special districts.

    These rules will be imposed in less than 2 years. This is the scale of the shift in Net Assets that’s going to hit all across this country – and certainly California.

    Finally – what if the Discount rate had been Moody’s 5.5% – and all other GASB 68 rules had been imposed in 2011? Figure 22, below, shows the impact of both of these changes:

    Dickenson_GASB_15bFigure 22.  Restated Balance Sheets Applying GASB 68 + Moody’s 5.5% Rate

    Again – red is unfunded pension created debt (Pension Bonds + Net Pension Liabilities). Pink is all other debt. And green is “Net Worth” or “Net Assets”.

    Only Marin would be left standing – all the rest would be underwater. My County of Mendocino and Contra Costa would be at the bottom of the ocean – with $250 to $270 of debt for every $100 of assets!

    Four of these 7 counties would have reported more unfunded pension created debt than assets.

    These counties all together would drop from $10.2 billion of Net Assets down to a negative $8.3 billion hole –$19 billion less– just these 7 counties! On average they’d have more unfunded pension debt than assets.

    This is the picture Moody’s would use in its credit analysis.

    If Moody’s picture turns out to be accurate – how can Mendocino and Contra Costa escape this black hole? How much fun would Alameda, Orange, San Mateo and Sonoma have?
    In the meantime – Marin County gets to play John Jacob Astor – the richest guy on the Titanic.

    E. Parting Shots

    After all this jolly news – GASB and Moody’s each have one more big trick up their sleeves.

    1. GASB: Oceans of Red Ink the Year GASB’s New Rules Are Implemented

    Here’s what GASB 68’s impact would have been on Balance Sheets had it been in effect for the 2011 audited statements (in $millions)


    GASB 68 would have taken about a billion dollars of Net Pension Assets out of Balance Sheets and put $8.3 billion of Net Pension Liability onto Balance Sheets. That’s around a $9.3 billion hit against Net Assets.

    How much it will be in their 2015 financial statements depends on what happens between now and then – but there’s no doubt the hit will be many billions of dollars.

    The way double-entry bookkeeping works is that if these counties had been forced to write off a $1 billion of assets and add $8.3 billion of debt to their Balance Sheets, the “other entry” would have to explain why this was happening. In essence these counties would have had to report that they incurred roughly $9.3 billion of real past pension expenses that they never reported to the people.

    Almost all the pension expenses that would have caused this hit had not yet been reported – they were going to be reported over as much as 30 years in the future.

    When GASB 68 is imposed it will force hundreds of billions – perhaps trillions – of unreported pension expenses all across this country out of their hiding places to hit the 2015 financial statements.

    These 7 counties will be forced to report somewhere around $9 BILLION of past pension expenses that were never reported to the people. Nine Billion in just 7 counties – never reported to the people! Because the calculation GASB 68  requires for pension expenses is so complicated and only Actuaries have the data necessary to do the calculation – the range of error of this estimate is larger compared to projections of the impact on Balance Sheets. However, I think $9 Billion is within 1 or 2 billion or so.

    Very few governments have figured out what’s about to hit them. Tens of thousands of government officials are going to have a whole lot of explaining to do.

    2. Moody’s: Significantly Higher Government Payments to Pension Funds

    Moody’s will recalculate how much governments should be paying their pension funds. This will be a “benchmark” in their credit analysis to judge if governments are adequately funding pension obligations.

    Moody’s says they are only going to recalculate state amortization payments – not local government payments. I’ve urged them to do so for local governments if the information is available. But – they’ll do what they’re going to do. However, I applied Moody’s adjustments to these 7 counties to show what would happen.

    Moody’s wants everyone to know they are NOT saying this is what governments must do. They are saying that if governments don’t meet this benchmark their credit rating is at risk.

    Dickenson_GASB_17tFigure 23.  Moody’s Adjusted County Payments to
    Pension Funds More Than Twice As Much

    The first column (Figure 23) is 100% of what actuaries calculated these counties should pay – the Annual Required Contribution (in 2011 Actuarial Valuations). Green is Normal Costs – pink is UAAL Amortization payments. (100% = $1.00)

    The second is Moody’s adjustment – on average about 2 1/3 times higher – from $1.1 billion a year to $2.4 billion.

    These increases are based on three concepts.

    The most powerful assumption is Moody’s lower discount rate. A significant part of Moody’s increase in payments is because they will calculate that unfunded pension debt is much bigger than Actuaries report. Higher debt means higher debt payments.

    Second – Moody’s adjustment is based on the assumption that unfunded pensions should be eliminated before current employees retire, which Moody’s calculates is an average of 17 years across the country. For those counties using more years to eliminate UAAL’s this would be a significant cause of the increase.

    Third–unfunded pension amortization payments should be “Level Dollar” amortization, not “Level Percent of Payroll”. All 6 of these counties use level percent of payroll – Moody’s would instead use level dollar.

    Level Dollar amortization means governments would pay the same dollar amount each year.

    Level Percent of Payroll starts with the assumption that payroll will grow at a constant percent each year. The government then pays the same percent of each year’s larger payroll – at the end of which the debt would be eliminated. Level Percent causes payments in later years to be much bigger than earlier years. AND – if payments extend beyond 16 years or so you get “negative amortization” – which means payments in the early years aren’t even enough to pay the interest and so the debt actually gets bigger until the payments grow enough to catch up with the interest expense.

    The switch from “Level Percent of Payroll” to “Level Dollar” amortization significantly increases all these counties payments.

    As I say – Moody’s wouldn’t say these counties should or must make this level of payment to their County Pension Funds. But if Moody’s adopts their proposed adjustments (we’ll know within a month most likely) and if they applied these adjustments to these counties, and these counties kept paying what the Actuary tells them to pay, they would be putting their Moody’s credit ratings at risk.

    *   *   *


    1. GASB 68 – Changes Financial Statements ONLY
      1. Income Statements (Statement of Changes in Net Assets)
        1. Pension Expense Tied to Changes in Net Pension Liability – Not Government Payments to Pension Funds
        2. Pension Expenses that Create Unfunded Pension Debt Reported When They Happen – Not When Paid
        3. Many – Probably Most Governments Will Report –
          • Very Significant Increases in Pension Expenses
          • A Significant Shift from Reported Surpluses to Deficits
        4. Actionable and Accountable Reporting of Pension Expenses
        5. Oceans of Red Ink – Flood of Unreported Past Pension Expenses the Year GASB 68 is implemented
      2. Balance Sheet (Statement of Net Assets)
        1. Unfunded Pensions Listed as Liability – Generally Equal to or More than Today’s Reported UAAL
        2. Today’s Net Pension Assets Written Off
    2. Moody’s Adjustments – Used in Their Credit Rating Analysis ONLY
      1. Double to Triple Unfunded Pension Debt
      2. Most Governments Significantly Underpaying Pension Funds (May Only Calculate for States)
      3. How Could This Not Negatively Impact Many if not Most Government Credit Ratings?