A Difference of Opinion

I have been fascinated by the dispute between the Ontario Government and the Office of the Auditor General of Ontario that has transpired regarding the treatment of pension plan surpluses.  As a pension actuary who regularly prepares financial statement disclosures for both private and public sector entities, I thought I would be well suited to make a judgement call as to which of the two was ‘right’. However, after some extensive research into this topic, what I have found is that this issue has multiple layers of complexity, with both sides able to make sound arguments for their opinion.  Nevertheless, I believe this dispute misses a bigger point – that public sector accounting standards are in need of an overhaul.

A Difference of Opinions

For those of you who are unfamiliar with the story, I will provide a brief overview…

The Ontario Teachers’ Pension Plan (OTPP) and the Ontario Public Sector Employees’ Union Pension Plan (OPSEUPP) have recently experienced improvements in their financial position, as determined on an accounting basis, with their net pension asset becoming increasingly significant. In early 2016, the Office of the Auditor General advised the Ontario Government that it should not include the accounting surplus from the OTPP and OPSEUPP as a Provincial asset (and the related calculated revenue) in its financial statements because it does not have legal or contractual authority to unilaterally use the surplus.

While the Ontario Government believed they had the right to reflect its share of the accounting surplus from the OTPP and OPSEUPP as a Provincial assets in its financial statements, it ultimately relented to the Office of the Auditor General, and impaired its asset at March 31, 2016 by holding a Valuation Allowance of almost $10.7B on its balance sheet, and also by including an additional $1.5B expense in FY2016 for the change in the Valuation Allowance.

Subsequently, the Ontario Government commissioned a panel of experts to provide it with advice and recommendations on the application of public sector accounting standards to the surplus issue affecting the OTPP and OPSEUPP. This panel was comprised of the following four well recognized leaders in the accounting, legal, and actuarial profession:

  • Tricia O’Malley – an accountant and a former Chair of the Canadian Accounting Standards Board, as well as a former Partner at KPMG;
  • Murray Gold – a lawyer and senior pension and benefits partner at the law firm Koskie Minsky LLP;
  • Uros Karadzic – an actuary and partner at EY’s People Advisory Services Reward practice;
  • Paul Martin – an accountant and Comptroller with the Government of New Brunswick, and a former partner with Grant Thornton LLP.

The panel’s report included a comprehensive review of the legislation, various agreements affecting the OTPP and OPSEUPP, and provided its interpretation of how public sector accounting standards should be applied. Ultimately, the panel’s conclusion was consistent with the Ontario Government’s original position – stating that the guidance in the accounting standards shows that the government will be able to benefit by the entire amount of the asset, and that the Ontario Government should record an asset for its share of the accounting surplus for the OTTP and OPSEUPP.

Following the release of the panel’s report, the Office of the Auditor General responded with a rebuttal of its own. In its rebuttal, the Office of the Auditor General maintains its opinion that, given current conditions and circumstances, and the rules in the accounting standards that limit the recognition of an asset on the balance sheet, that the Government needs to demonstrate that members of the OTPP and OPSEUPP have agreed to a contribution holiday before it can recognize the surplus as an asset.

Following this quarrel, the president of the Ontario Public Services Employees Union made a statement in support of the Office of the Auditor General, stating that it was right to rule that the government cannot balance its books using pension fund surpluses.

Layers of Complexity

At the end of the day, this is a dispute on the interpretation of a technical accounting standard. While it may be uncommon for the professional accountants of a government and an auditor to have such a dispute out in the open, in my view, both sides have made compelling arguments in support of their opinion.

As noted earlier, this issue has multiple layers of complexity. First off, the OTPP and OPSEUPP are jointly sponsored pension plans that have their own unique governance structure in which the government and the members share risks and decision making authority. Furthermore, within public sector accounting standards for retirement benefits, the OTPP and OPSEUPP are treated as joint defined benefit plans, and as such, only the Ontario Government’s portion of the plans are accounted for in its financial statements.

In addition, the accounting standards require several other issues be considered in determining whether a pension surplus should be considered an asset of the Province, such as whether the surplus creates an economic benefit from which the Province could benefit, whether the Province has control of that benefit, and whether there is an expectation that an economic benefit will be obtained from that pension surplus.

Then, if the government has the right to recognize the pension surplus as an asset of the Province, the accounting standards require an asset ceiling test be performed. This asset ceiling test prescribes a series of other calculations be performed to ensure that the value of the asset generated from the pension surplus does not exceed the expected future benefit of the surplus.

A Tale as Old as Time

Adding to all this complexity is the fact that the liabilities of a pension plan, and its related surplus, are measured in different ways for different purposes (e.g. going-concern funding basis, hypothetical wind-up basis, accounting basis, etc.).

As many pension plan sponsors can attest, having a surplus on an accounting basis, does not mean that the plan is sufficiently well funded and able to take a contribution holiday. In fact, a plan with a surplus on an accounting basis could easily have a deficit on a funding basis.

If we dive in to the results for the OTPP, we can see that the Ontario Government is using a discount rate of 6.25% to measure the plan liabilities in its March 31, 2016 financial statements. But on a funding basis, the OTPP used a discount rate of 4.80% in its January 1, 2016 funding valuation. While I do not have access to the calculation results, suffice to say that the surplus is lower in the OTPP’s funding valuation than it is in the Ontario Government’s financial statements. Furthermore, from a more principals based point of view, I think it is fair to question to ask what is the benefit the Ontario Government expects to realize from the OTPP’s accounting surplus.

This isn’t to suggest that the Ontario Government has done anything wrong. As noted above, the expert panel has presented a compelling argument to support their interpretation of public sector accounting standards.

The Bigger Issue

In my view, the bigger issue here is with the ambiguity inherent in public sector accounting standards. More to the point, I believe these standards need an overhaul – and need to recognize the fact that jointly sponsored pension plans, like the OTPP and OPSEUPP, and other risk sharing plans, are not like traditional defined benefit pension plans, and should not be accounted for as such.

Furthermore, I believe public sector accounting standards for retirement benefits should be updated to have the discount rate established using a fair-value approach (as is consistent with private sector accounting standards), and to eliminate the deferral of actuarial gains/losses (as is generally consistent with recent trends in private sector accounting standards).

And, I may just get my wish…  The Public Sector Accounting Board has approved a project to review Public Sector Accounting Standards PS 3250 (Retirement Benefits) and PS 3255 (Post-employment Benefits, Compensated Absences and Termination Benefits).  However, this project is taking its time to progress, allowing the dispute between the Ontario Government and the Office of the Auditor General to keep me entertained.

 

 

Dean Newell
Dean Newell
Dean Newell is a Vice President of Actuarial Solutions Inc. and manages ASI’s actuarial practice. Dean performs valuations for pension and post-retirement benefit plans for the purpose of funding, accounting, and plan wind-up. In addition, he has experience consulting with plan sponsors on matters affecting pension and post-retirement benefit plans, including plan design, plan conversion, benefit improvement costing, legislative compliance, plan documentation, plan administration, and risk management.

2 Comments

  1. Avatar Bob says:

    While I am not an actuary, the 6.25% assumption tied into a plan with indexing in place may suggest a return above 9% in the long term to meet its obligations.

    Add to it the on-going rate of 4.8 again in an indexed plan suggest over a 7% return long term. 2 issues here, if a private sector plan the rate would be much lower and likely a deficit, the second issue is that this rate is higher than the rate used in the CPP valuations.

    My view would be that in a jointly sponsored program, the government does not have true easy access to the assets and so it should not be included. At the same time maybe one should consider if the assumptions are a little too aggressive. Of course if a problem arises, the government can contribute more.

    I seem to recall in the 90’s, when the on-going surplus grew beyond the 2 times limit imposed by the feds, there was to be a contribution holiday, the joint concept arose and both sides took a contribution holiday. Then when the tech crash occurred, interest rates continued to decline, the members and the sponsor has to increase their contributions above the traditional levels and I do not believe they have ever been reduced back.

    It is also interesting to note that for about the first 13-15 years of the accounting rules, the government did not include this when the surpluses were the greatest but they have included them for the past13- 15 years.

  2. Good note Dean. I agree that there should be careful consideration to impairing the asset when the surplus exceeds the asset limit and the conditions under which an impairment should be made. Swings in the amount of the unrecognized pension asset year over year as gains and losses arise however can cause distortions in the reported expense or income and be confusing to financial statement readers. The answer is to have proper disclosure so readers can make their own judgement. The original standards were designed to get numbers that were off balance sheet onto the balance sheet and that was a big transition for many layers of government. Modernizing the standards is a good initiative in my opinion. Perhaps you can volunteer to be part of the group doing the review of the standards.

Leave a Reply

Your email address will not be published. Required fields are marked *