Recently Moody's Investor Services estimated North Carolina's pension fund is approximately $7.5 billion underfunded. North Carolina's Treasurer complained to Moody's as this might cause confusion since the North Carolina annual report shows an underfunding of only $3.7 billion. The difference is the NC annual report must follow Governmental Accounting Standards Board (GASB) rules which result in horribly underestimated liabilities and overly optimistic future returns on assets. The Moody's analysis, while still flawed is closer to reality.
What is interesting is that both of these estimates are too low - and our Treasurer knows it. GASB plans to change their pension fund accounting standards from horribly ridiculous to merely ridiculous. Recently the Treasurer hired Buck Consultants to estimate how underfunded our pension fund will be when the new GASB standards take effect after June 30, 2014. Buck Consultants found the State Employee and Teacher's portion of the plan will show to be $8.4 billion underfunded under then new GASB standards, and the Local Employee portion of the NC Retirement System will be underfunded by about $2.0 billion. Thus, the entire NCRS would be underfunded by a whooping $10.4 billion under the new GASB pension fund accounting rules.
The full Buck Consultants analysis from 11/14/2012 can be found by clicking here. Below are the two most relevant pages that show
the funding differences between the old GASB rules 25 and 27 and the coming new rules of GASB 67 and 68. On the pages below, you will also see the new funding ratio of 86.3% vs. the old ratio of 94.0%. This may be alarming to pensioners (as well it should be) who have seen the funding status of their pension fall from 108.1% in 2004 to just 86.3% today despite the stock market having reached all-time highs.
What is unfortunate is the new GASB rules are still flawed (albeit less so with the new changes). GASB still allows future liabilities to be discounted at the assumed rate of return on pension assets (in North Carolina's case, we use 7.25%). This discount rate is FAR too high and results in an estimate for future liabilities that is far too low. However, the new rules will require current market value of pension fund assets be compared to these liabilities. But, that is a flaw as well since using current asset values to compare to future liabilities is not consistent. In effect, GASB will continue to require underestimating future liabilities, but then underestimate a fund's ability to meet those liabilities.
In a perverse way, these two wrongs will result in a more realistic funding estimate than the old rules. What I wish the GASB would require would be to use the rate on long-term North Carolina General Obligation Bonds as the discount rate for future estimated pension liabilities (roughly 3-4%) and use a conservative but more realistic assumed rate of return on pension assets of 5-6%. Of course, using this more realistic analysis would show our pension funding gap is MUCH larger than the worst of the three choices above (and far worse than any politician would care to admit in public).
NC State finance professor Richard Warr has weighed in on this as has former NCRS CIO Andy Silton.