A government’s Net Pension Liability is calculated by subtracting the market value of its pension plan assets from the estimated amount of promised benefits. When using the market value of pension plan assets, the Net Pension Liability will fluctuate based upon market conditions. Some argue that because Net Pension Liability is a component of a government’s Net Position (assets minus liabilities), fluctuations in market values would result in great volatility in the Net Position. To avoid such fluctuations, the Governmental Accounting Standards Board allows governments to amortize the fluctuation in market values over time.
Truth in Accounting believes that the Net Position should not be shielded from market fluctuations. Users of the financial report, especially taxpayers, need to understand the reality of pension plan investments. We highlight that reporting, including the market value in the pension liability, does not cause great volatility in a government’s Net Position. Reality does. Taxpayers need to understand this volatility and the risk taken on by governments, which in turn is a risk to taxpayers.
Therefore, our money needed to pay bills is calculated using the market value of pension assets without any amortization of the unrealized gains in market value. We found that for most cities in fiscal year 2021 pension assets* increased dramatically, because of strong markets. The resulting pension liability and money needed to pay bills decreased equally dramatically.
In reviewing cities whose pension plans’ financial reports for fiscal year 2022 were available, we usually found that these unrealized gains either dropped greatly or switched to unrealized losses. Therefore, we suspect that cities' pension liabilities and money needed to pay bills will increase when we issue our next Financial State of the Cities..
In fact, in some cities we found that the dramatic gains of 2021 resulted in their pension plans appearing to be over funded, but investment losses in 2022 brought their pension plans back to an underfunded status. For example, on June 30, 2020 Los Angeles Fire and Police Pension System reported a Net Pension Liability of $2.57 billion. In fiscal year 2021 its pension assets experienced unrealized gains of 32.56% which caused the pension system to appear to be over funded by $2.7 billion. In fiscal year 2022 the funds’ pension assets values experienced unrealized losses of 7.23% which played a large part in bringing the system back to an underfunded status with a Net Pension Liability of $648.8 million.
This highlights the volatility and risk surrounding pension plan assets and corresponding pension liabilities. Taxpayers can only hope that when pension plan investments need to be sold to pay for benefits, the market value of those investments will be high. If not, taxpayers will be on the hook to pay higher taxes to cover the promised benefits.
As in the case of a few cities, pension plans should be overfunded during market upturns, so they can weather downturns in the market. Elected officials may see this temporary, unrealized over funded status as an opportunity to reduce pension contributions and/or increase benefits. Such actions are not advisable, because of future downturns in the markets, as happened in 2022. The 2022 downturn is switching many overfunded pension plans back into an underfunded position.