Wednesday, September 11, 2013

Pension Miseducation

Like many benefits and compensation professionals, I receive daily my fair share of e-mail blasts from consolidators -- those services that scour the web for tidbits to provide to their readers. Because they have tens of thousands of free subscribers, they are able to sell advertising. That's their business model, as I understand it.

This morning, I opened one of those e-mails and found this article that looked like it was worth a read. In fact, there was some interesting material in there. And then there was this:
That aphorism also suits one frustration of today's pension plan sponsors. Somehow, they have to attain lofty actuarial return goals of 7% to 8%, but the expected returns they have to draw from, for both equities and fixed income, are stuck at ground level.
Hold on a second. Lofty actuarial return goals, you say? This implies somehow that the actuaries set the target and that based on that, plan sponsors and their associated investment committees then struggle to meet that target.

This is backwards. The selection of actuarial assumptions is different for accounting and for funding. In either case, however, the actuary does not just willy-nilly pick a target return on assets assumption. For ERISA funding purposes, the law mandates the selection. For FASB (ASC) purposes, the plan sponsor selects the return on assets assumption with the advice of experts including the actuary and investment adviser for approval by auditors. To the extent that the actuary finds the assumption to fail to meet Actuarial Standards of Practice (ASOPs), the actuary is to disclose such and to provide calculations representing what the amounts would have been had the assumption met the ASOPs.

Those who do not seem to understand this take a different position. The typical process for those sponsors looks like this:

  • Look at the expected return on assets assumption.
  • Go to the investment adviser and tell them that they need an investment portfolio that will meet or exceed that expected return on assets assumption.
But, the sponsor owns that assumption (if it is for accounting purposes). If it's for government plan funding, usually (state and local laws differ) the sponsoring government has input into the assumption. 

If an actuary has some (or all) purview over the return on assets assumption and (s)he is doing his or her job properly, the actuary will look at the investment lineup together with a capital market model and develop a return on assets assumption commensurate with that lineup. It is not the other way around. If plan sponsors do not think that their investment lineup can return 7% to 8%, then they should lower their assumption for expected return on plan assets. Yes, this will increase their financial accounting costs (and their funding costs for governmental plans). Ultimately, the cost of a plan is what it is. The cost of paying $1 per month for the rest of an individual's life is the same, no matter the actuary.

In my personal experience, for years, many plan sponsors pressured their actuaries to use more aggressive actuarial assumptions in an effort to influence P&L and, back in the days when it mattered for funding costs, to keep required contributions down. Some actuaries agreed to do that, some did not. 

But, when a plan sponsor, including a state or local government, chooses a high expected return on assets assumption, usually to manage short-term costs, that they are unable to find a suite of investments to generate that expected return is not the actuary's fault. Place blame where it belongs.


  1. This is obviously the biggest problem for PUBLIC Sector pensions where common practice has been to discount Plan "liabilities" at the rate assumed for investment returns. That's why almost all Public Sector Plans are in the financial toilet, with many to fail with great distress to both taxpayers and the workers who (right or wrong) assumed they would get the absurdly generous pensions they were "promised".

  2. Anonymous, thanks for reading and commenting. There is and has been a steady debate over the correct methods and assumptions to use when performing funding calculations for public pensions. Many of us in the profession can argue either side, up to a point. But, when governments choose to ignore calculations done by their actuaries because they don't like the answers, we run into insurmountable problems.

    1. They will in short order find out that "reality" and the "math" ALWAYS governs.

  3. Good article John ! I'd also say that the biggest decision is right at the time of 'creating', or increasing by amendment, the pension benefit formula. Many govt plans increased their formulas over the past 20 years and they estimated the affordable cost based on inv return assumption that was too large. Then over the next 20 years they didn't reduce the formula.....thus causing contribution nightmares. Also, 'spiking' wasn't predictable in setting the formulas.....leading to MORE nightmares. Private sector doesn't have that problem.....contributions getting too large? Time to freeze. Problem solved ! Steve B, EA, MSPA

    1. Quoting ..."Then over the next 20 years they didn't reduce the formula...."

      That's because our paid-off elected officials have rigged this system in favor of the Public Sector unions by passing State Constitutional amendments or statutes which make it VERY VERY difficult (if not impossible) to reduce the rate of pension accrual even for FUTURE service of CURRENT workers.

      In some States/Cities they go so far as to lock in the formula (from any reductions ... with increases, of course being OK) with even ONE day of employment.

      Simply another example of the Public Sector Union/worker's "mugging" of the Taxpayers .... of course with the help of our elected official bought-off with Public Sector Union campaign contributions and election support.

      It's WAY past time for Taxpayers to renege on ALL of these grossly excessive pension & benefit "promises". Hopefully the stage to do so will be set from the outcome of Detroit's bankruptcy.

  4. CA CHING, CA CHING, CA CHING! YEAH, IT MUST BE THAT TIME OF YEAR AGAIN! My Union Boss down at the Town Hall emailed me yesterday and.
    Told me that this article was hitting the Papers today, and He told Me.
    to make it Look like I was Working till this Blows Over in a week. I
    know the routine! In a week, I'll be back to my usual activity of.
    Collecting A Paycheck for Doing Nothing! Hey, Private Sector.
    Workers; You really gotta Pony Up more Taxes! I need at least a 10 %.
    raise! My Cabin Cruiser at the Dock behind my Vacation House in.
    Florida needs a New Engine. My wife has been after me for a new car.
    She wants a BMW X6 G-Power Typhoon S! I told her I can't afford that.
    car. So then she says she will accept a Mercedes-Benz CL-Class and.
    Nothing else! I also got Private School Tuition of $ 40,000.00 due.
    in September. I got Credit Card Expenses coming out my AXX! That
    new 3000 sq ft extension on my house raised my property taxes $ 15,000.
    The maid and the housekeeper want raises. The gardener also wants a.
    raise. You see Bunky; It ain't easy in the Public Sector! So come
    on Private Sector Worker; Pony Up and Pay More Taxes so I can afford to.
    live here! You See; Life Is Not Fair, and the DemoRats will take.
    care of Everything! HAPPY DAYS ARE HERE AGAIN!

  5. Thanks to all for reading and commenting. I've obviously struck a chord with this post. As difficult as it is oftentimes, I try to stay apolitical in my posts keeping them to just the facts with my opinion (clearly shown as my opinion) mixed in.

  6. John, what about the dated mortality assumptions used by some police and fire plans? SOme tables date back to the 1970s. Cops & FFs say they live shorter lives but this belief was debunked by a 2010 CalPERs experience study.

    It seems that labor and the government sponsors are good with the bogus assumptions--the state or city gets to make a smaller contribution using bogus mortality estimates and because smaller plan contributions are made, there is more money left for cops and FFs salary increases. Your thoughts?

  7. Yet another "Anonymous", thanks for reading and commenting. I was not aware of the CalPers study that you cite, but I am sure that what you state is true. I didn't comment on the other actuarial assumptions in my post because the article that I was commenting on didn't mention them.

    However, as you seem to know (perhaps you are an actuary as well), especially in the public plan world, the plan sponsor and actuary have lots of leeway with their choices of actuarial assumptions. And, yes, changing from an unrealistic to a realistic mortality table can significantly influence reported costs.

    I don't know that I have ever written about it here, but for years, I have espoused that most pay-related pension plans should be valued for funding purposes using actuarial assumptions that are best estimates (be conservative in choosing them) and the Entry Age Normal actuarial cost method thereby essentially locking in (without regard to plan changes) the cost of the plan as a percentage of pay. Neither Congress nor the accounting profession agrees with me, but neither of them has much actuarial training either.

    And, finally, to the extent that a government is going to increase benefit levels because their plan appears to be well-funded, in my opinion, they should be held to a similar standard with regard to decreasing benefits when the plan appears to be not well-funded.

  8. Take a look at page 34 from this link to the CalPERS shows that public safety life expectancy is slightly longer than the other public employees