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:
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.