IT IS NOT UNCOMMON for politicians to promise to “run government like a business.” It may sound great on the campaign trail but sometimes it ignores reality.
A business that is losing money, for example, can cut one product line and put its resources instead into a more profitable approach. Governments, of course, can’t decide to stop locking people up just because the jail is not running in the black.
One’s fish, the other’s fowl.
But that simple wisdom appears lost on the national board that determines how governments prepare their financial statements, according to some county officials who have decided to take them on. The issue centers on how to make clear to the investors who shop for municipal bonds just how high the potential future liability for health care benefits of today’s government employees could reach in future years, and whether particular governments are setting aside enough money in advance to fund those obligations. One outcome from the new reporting requirement could include elimination or drastic reduction in retiree health insurance coverage for current and future employees.
The accounting rule writers are taking the position that what the private sector did in 1990, the public sector should do today.
That year, the body that oversees how most businesses keep their fiscal affairs straight adopted a new rule: from then on, companies would have to put on their books not just their usual summaries of expenses vs. revenues. For the first time, they were required to declare how much they may owe in health care benefits to their employees when they retire. And once that number was posted, they had to set aside enough money to pay for that year’s portion of those future retiree benefits.
Immediately, it became obvious that those future obligations could grow rapidly and exponentially. Even blue-chip companies were forced to report massive liabilities that not only wiped out operating income but also forced them to pare benefits or shift more of the cost to employees. Bound by promises made in union contracts, General Motors discovered their liability equaled about $1,500 per car, forcing the corporate giant to post a $23.5 billion loss in 1992.
Rather than face insolvency, many companies did what they felt they had to – they stopped paying for retiree health insurance at all. Over a brief period of time, the population of uninsured Americans boomed, which quickly became evident at public hospitals and in county indigent health care spending.
The 1990 change only applied to the private sector but now, the Governmental Accounting Standards Board (GASB) is about to apply similar retiree health benefit rules to governments – over the next three years, governments will be required to carry the full balance of retiree health costs on their balance sheets, based on the new rule known as GASB 45.
And to make sure those financial statements actually balance, it could be necessary to either increase taxes significantly, go into longterm debt to finance benefits, or significantly cut back on what is promised to future retirees to pay for what GASB bureaucratically calls “Other Post-Employment Benefits” or OPEB. Some officials, however, believe that following GASB’s instructions would result in breaking Texas law.
In the finance industry, many expect local governments that take the first step of commissioning actuarial studies to determine the burden will experience “sticker shock” when they see how quickly future retiree benefits will add up. “What I’m seeing generally is that every client we’re talking to – almost without exception – they’re stunned by the GASB 45 number,” actuary Rick Davenport told The Dallas Morning News last year. “Virtually none of them have ever valued these liabilities because they haven’t had to. For the first time, they’re actually doing a calculation, and it’s basically shocking them.”
The idea behind GASB 45 is that investors who buy municipal bonds should be made aware of the cost of retirement benefits that this year’s employees are “earning” and that they may expect to be paid when they retire. Because it only applies to future retirees, governments can post “zero” the first year but in each subsequent year – as retirements increase and the cost of health care grows – the burden will increase rapidly.
There is a fundamental question, however, as to whether these potential future expenses should properly be listed as “liabilities” at all. In Texas and many other states, governments have the option to adjust benefit levels each year or even terminate them if the cost goes too high, but that doesn’t matter to GASB’s administrators.
An article published by the Government Finance Officers Association, the professional association that county auditors and their brethren look to for insight on how to do their jobs, makes it clear that even if future benefits may be cancelled or changed, governments must assume they won’t be, for purposes of filling out their financial statements.
State and local governments must report potential retirement costs “even in situations where ‘benefits are limited by the amount of funding approved by the legislature on an annual basis.’ Simply put, OPEB exist whenever there is a mutual understanding between employers and employees … that such benefits will be provided, period,” wrote GFOA’s Stephen J. Gauthier in a widely distributed article, “Dispelling OPEB ‘Urban Legends.’”
Even when officials point out that benefits can be cut or changed from year to year, the GASB response is, that doesn’t matter – an actuarially determined number must be posted because employees expect the benefits and, presumably, governing bodies will not have the will to cut them.
That leaves governments that currently pay for retiree health benefits with some unpleasant choices:
- Eliminate or drastically cut back benefits, which will result in an
unhappy and eventually deteriorating workforce;
- Be prepared to increase taxes (or cut other services) to cover the
future costs – initial estimates in at least one county indicate that
the tax increase would exceed the rollback rate by double;
- Post the anticipated costs but decline to fund them, which
would leave the casual reader of the financial statement to think
the government is insolvent and could affect the public’s perception
of how its leaders are handling their affairs; or
- Based on the awareness that current law does not mandate that future benefits remain the same, decide not to post the potential obligation, resulting in an external audit that would be labeled as “qualified” (which essentially means, “something’s not being accounted for correctly here”) or “adverse” (meaning, “something wrong is going on”). This approach could also damage bond-ratings and in addition, make it difficult to obtain state or federal grants.
None of those options are very pleasant and they’re exacerbated by the fact that many governments, aware that their salaries lag significantly behind the private sector, have offered better retirement benefits as an offset.
“Governments routinely make promises with regard to benefits to attract and maintain employees,” states a July 2006 study for the Pioneer Institute for Public Policy Research, a Massachusetts-based think tank.
“We do not pay competitive wages with the private sector, we just plain don’t,” said Travis County Auditor Susan Spataro. “Some people are willing to take that (lower salaries) if their benefits are somewhat better in the long-term.”
But Spataro’s real problem with GASB 45 is the idea that a new accounting rule has the effect of overriding state law when it comes to debt obligation. The rule assumes that just because past governing bodies paid retiree benefits, all future governing bodies will. To Spataro, that means the rules for keeping the books are determining policy, instead of tracking fiscal impact of policy.
“That is not how government works,” she said. “We don’t create obligations by journal entry.”
In fact, only governing bodies in Texas have the authority to create financial obligations, Spataro noted in a strongly worded letter to GASB in November.
“By requiring that a post-employment benefit plan be defined by employee perception, GASB ignores longstanding Texas constitutional law that regulates how government debt is created,” she wrote, adding the Houston-based Vinson & Elkins law firm has looked at Travis County’s particulars and concluded in a comprehensive opinion that no employees have ever been promised future benefits and, just as important, that no one but the commissioners court has the authority to make such a commitment.
So if the Travis County commissioners court adopts a financial statement that complies with GASB, it will be misleading, because Texas law clearly provides that no future obligations exist, she said.
“Now, my governing body and I must choose between financial statements that substantially misrepresent our legal and financial obligations or financial statements that deviate from generally accepted accounting principles as it relates to OPEB,” her letter continued. “This deviation stands to reduce our bond rating, increase our costs and blemish our professional reputations.”
If the financial statements comply, using the misleading estimates could even put the county in legal jeopardy. “Our attorneys have confirmed that the Security and Exchange Commission does not take misrepresentations lightly,” her letter informed GASB. “Neither does the state of Texas, which has criminal penalties for falsifying government records.”
Spataro is so outraged by the presumptions of GASB 45 that she is personally leading a revolt to challenge the rule. For the past several months, she has systematically approached state leaders to explain the problem – most were unaware of what’s about to hit them – and to offer a solution to the dilemma. Thus far, she said, there is a significant amount of agreement among several Texas leaders that something must be done, especially since the quandary also applies to the state.
Her would-be answer is to amend the state laws that currently require governments to report their financial statements according to Generally Accepted Accounting Practices, or GAAP. Instead of reporting according to GAAP, OPEB numbers would instead be reported according to the same “regulatory basis” of accounting used by utility companies or local probation departments, for example. That would mean the potential cost of benefits would be reported, but they wouldn’t have to be funded upfront, as employees are “earning” the potential obligation as required by GASB 45.
Her approach would work, but the idea of “going off GAAP” knocks the breath out of many in the finance business. GAAP is the “gold standard” and a financial statement that deviates could well result in a “qualified” or “adverse” assessment by outside auditors. To an auditor, it would be seen as a violation of professional standards.
Tarrant County Judge Glen Whitley, who is a certified public accountant and co-owner of a 130-employee accounting firm, said he initially thought Travis County’s challenge of GASB was unlikely to be successful because of the magnitude of a fistfight with the Lords of Accounting. But once he met with Spataro to get her full explanation, he agreed to support her approach, despite the odds.
“This is a pretty monumental fight that we’re waging here,” he said. “It’s kind of like trying to move a mountain.”
What pushed Whitley over the edge on GASB 45 was the realization of the potential legal ramification of posting a financial obligation to pay for future benefits –the mere act of estimating the potential obligation could make the obligation real, even though no future benefits have been promised in the past.
“I am concerned that by (approving a financial statement that estimates OPEB), we may in effect be creating a liability that we can’t then lower,” he said. “We could open the door for some attorney on behalf of a retiree saying that you can’t change your benefits in a way that would do harm to employees because you’ve already expressed the fact that you’ve got this liability in your financial statement.”
In addition to the concern that county bond ratings could be adversely affected by implementation of GASB 45, Whitley is concerned about how local taxpayers will view the issue.
“For the individual who doesn’t have an accounting background who picks up the financial statement, they’re going to see this huge liability and say, ‘well, golly, why hasn’t anyone taken care of this? You’re really hurting the financial stability of the county,’” he said. “But just because we’re paying a benefit now doesn’t mean that we’re going to pay it in the future.”
Even if the effort to establish a new basis of accounting succeeds, Whitley said it still comes down to commissioners court having to balance the need to maintain quality employees versus the needs of taxpayers and at some point, benefit plans may well have to be adjusted or cut.
“We basically have to raise enough taxes to pay whatever our current expenses are, and when those current expenses would get to the point to where we can’t raise the taxes to do that, then we have to cut those expenses, and those liabilities or benefits that we’re currently giving to our retired employees would have to go away,” he said.
From Spataro’s perspective, the decision to alter benefits to suit available funding should be a matter between the members of the governing body that sets the tax rate and the voters that elect them, not based on pressure from an accounting rule by GASB. It’s a policy matter, not an accounting matter.
“There may be people who say the way to take care of (the liability for future benefits) is to not give government employees any benefits at all and then we won’t have a problem, but that’s not an accounting issue. That’s a policy issue that should be dealt with by governing bodies,” she said. “That decision cannot be made by fiat by a rulemaking body,” like GASB.
Those who think that governments should conform to the same funding requirement that businesses faced in the early 1990s are forgetting what happened back then and ignoring what could happen in the future, she said, adding that if governments are forced to cut benefits, the number of uninsured will dramatically increase and the cost of insurance will continue to rise, as will the public expense for indigent health care and Medicaid payments.
It particularly gripes Spataro that the rule was adopted by a standards board that is supposed to consider the unique financial circumstances that governments face, as compared to needs of private companies. “The more I’ve thought about it, (the more I’m convinced GASB 45) is such poor accounting policy,” she said. “It really reflects a total lack of understanding and respect for the way governments operate and the laws that govern us.”
Fish Swim, Birds Fly And an accounting rule can’t change the facts, officials say