From the Chairman
By David A. Vaudt, GASB Chairman
Postemployment Benefits: Determining the Long-term Expected Rate of Return
Calculating an appropriate discount rate to measure the net liability
for postemployment benefits is a critical financial accounting and
reporting issue for state and local governments. The long-term expected rate of return
is a fundamental component used in developing the discount rate. As
can be seen by the sensitivity disclosures required by the
postemployment benefits standards, a change of just 1 percentage point
in the discount rate can have for many plans a significant impact on the
net liability.
Calculating an
appropriate discount rate to measure the net liability for
postemployment benefits is a critical financial accounting and reporting
issue for state and local governments.
In justifying the long-term expected rate of return, one often hears "historical investment performance supports that rate." The standards, however, address the long-term expected rate of return.
Historical data can be inconsistent with the forward-looking nature of
this expectation and is not a complete source for the development of
long-term anticipations about future economic phenomena.
The long-term expected rate of return should be based upon the
nature and mix of current and expected postemployment benefit
investments. That means the postemployment benefit investments must be
expected to be invested using a strategy to achieve that return.
During the development of the postemployment benefits standards the
Board concluded that it was not within the scope of the Board's
activities to set standards that establish a specific funding method
for postemployment benefits—that is a policy decision for government
officials or other responsible authorities to make. Accordingly, the
postemployment benefits standards set requirements in the context of accounting, not funding.
This is a very important distinction, as one also often hears "we will
reduce the discount rate gradually over time, that's all we can afford
now." Affordability is a funding issue, not an accounting issue.
The accounting standards require the use of the long-term expected rate of return to develop the discount rate—funding affordability is not a component to be considered in determining the long-term expected rate of return
when developing the discount rate for financial accounting and
reporting purposes. To appropriately comply with the postemployment
benefits standards for financial reporting purposes, it is critical that
governments measure the net liability for postemployment benefits using
a discount rate based on an accounting perspective—one that appropriately incorporates the long-term expected rate of return—not a rate based on a funding affordability perspective.