STUMP » Articles » Actuarial Standards of Practice on Pensions: ASOP 4 - a Call for Comments » 27 July 2018, 21:53

Where Stu & MP spout off about everything.

Actuarial Standards of Practice on Pensions: ASOP 4 - a Call for Comments  

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27 July 2018, 21:53

This is going to be extremely actuarial, and not involving animated gifs. You have been warned.

There are a couple different exposure drafts out now for Actuarial Standards of Practice, which apply to credentialed actuaries in the U.S. I’m going to concentrate on one.

Actuarial Standard of Practice 4 has a draft exposure out — this ASOP is on “MEASURING PENSION OBLIGATIONS AND DETERMINING PENSION PLAN COSTS OR CONTRIBUTIONS” – (and yes, there are other draft exposures right now)

The Actuarial Standards Board are soliciting comments, with the comment period ending July 31, 2018 (sorry for the late notice, if you’re interested in commenting.)

Now, you can see the current responses, and I plan on sending a comment on Monday. Mine will be of a different nature of those from official organizations and pension actuaries, as I am not a pension actuary, but a life-annuity actuary. I know life/annuity regulations very well, but not pensions so much. It’s not my job — it’s a hobby. And this applies to all pension work, not only public pensions.

SPECIFIC QUESTIONS

When the ASB puts out exposure drafts, sometimes they ask for specific comments.

Here are the questions that come along with this:

Request for Comments

The ASB would appreciate comments on all areas of the proposed standard but would like to draw the reader’s attention to the following questions in particular:

1. Section 3.11, Investment Risk Defeasement Measure, requires the calculation and disclosure of an investment risk defeasement measure when the actuary is performing a funding valuation. The guidance allows for discount rates to be based upon either U.S. Treasury yields or yields of fixed income debt securities that receive one of the two highest ratings given by a recognized ratings agency. Are these discount rate choices appropriate? If not, what rate choice would you suggest?

2. Under certain circumstances, section 3.20, Reasonable Actuarially Determined Contribution, requires the actuary to calculate and disclose a reasonable actuarially determined contribution. Do the conditions in this section describe an appropriate contribution allocation procedure for this purpose? If not, what changes would you suggest?

I’m going to tell you right now that the first item is far more contentious than the second.

This IRDM (yeah, we even love four-letter initialisms) is new, and this is an attempt at a risk-free measurement of the pension promises.

Here is how it’s mentioned in the document:

3.11 INVESTMENT RISK DEFEASEMENT MEASURE
If the actuary is performing a funding valuation, the actuary should calculate and disclose an obligation measure to reflect the cost of effectively defeasing the investment risk of the plan. The actuary should calculate the investment risk defeasement measure using the following:

a. benefits accrued as of the measurement date;

b. the unit credit actuarial cost method;

c. discount rates consistent with market yields for a hypothetical bond portfolio whose cash flows reasonably match the pattern of benefits expected to be paid in the future. For this purpose, the actuary should use either of the following:

1. U.S. Treasury yields; or

2. rates at which the pension obligation can be effectively settled. The actuary may use yields of fixed-income debt securities that receive one of the two highest ratings given by a recognized ratings agency; and

d. assumptions other than discount rates used in the funding valuation or other reasonable assumptions based on estimates inherent in market data, in accordance with ASOP Nos. 27 and 35.

ASOP 27 is on economic assumptions in measuring pension obligations, and there’s an exposure draft on that, and ASOP 35 is demographic & other non-economic assumptionsand there’s an exposure draft on that. I may make a graph of dependencies of ASOPs…. mainly because I have trouble knitting right now. I must fill my time, ya know.

Let’s see what some of the response letters have to say about the IRDM.

I’m going to address what organizations have to say, first.

RESPONSE OF THE SOCIETY OF ACTUARIES

(I am a member of the SOA).

In the SOA comment letter:

The SOA Board acknowledges the importance of the newly defined Investment Risk Defeasement Measure disclosure for funding valuation reports (ASOP 4 Exposure Draft, section 3.11). The Pension Task Force report cited the importance of introducing a required market-based measure to provide clarity and context to funding values, provide information about risk not found in other measures, and incorporate into
actuarial science the best practices of other professions. The Investment Risk Defeasement Measure provides important information to assess the degree of risk in a plan’s funding and investment policy that, when accompanied by an actuarial report that provides context for its meaning, improves pension plan sustainability. The SOA Board recommends this measure not be removed or meaningfully changed as ASOP 4 is revised, including any changes that would allow an actuary or plan sponsor to opt out of its calculation.

I will point out to you the SOA Blue Ribbon Panel on Public Pension Funding.

In particular, I want to point out this NY Times piece on the Blue Ribbon Panel recommendations (from Mary Williams Walsh):

A blue-ribbon panel of the Society of Actuaries — the entity responsible for
education, testing and licensing in the profession — says that more precise,
meaningful information about the health of all public pension funds would give
citizens the facts they need to make informed decisions.

In a report to be released on Monday, the panel will recommend that pension
actuaries provide plan boards of trustees and, ultimately, t he public with the fair
value of pension obligations and estimates of the annual cash outlays needed to cover
them. That means pension officials would disclose something they have long resisted
discussing: the total cost, in today’s dollars, of the workers’ pensions, assuming no
credit for expected investment gains over the years.

That was from February 2014, btw.

RESPONSES FROM UNIONS

There are three letters from unions so far.

From American Federation of State, County and Municipal Employees, which represents many public employees

They didn’t provide a scannable PDF, so here’s a screenshot:

And then the National Education Association, which represents teachers, had a response.

There are many parts, and I’m just going to excerpt a couple:

Comment #1 – IRDM Used to Mislead, Not Inform

The IRDM will be used by individuals who oppose, or who are paid to oppose, pensions for public-sector employees. These groups will use it to deceive the public about pension costs. The ASB should not force pension plans to pay for this type of political work. Typically, these recommended measures stop short of advocating that pension plans are funded using excessively low return assumptions—instead pushing only for disclosure. Moreover, funding plans in this way would cost tax dollars and is one reason why we strongly believe that this effort is about public relations, not economics.

I will provide an example related to the Society of Actuaries’ Blue Ribbon Panel’s co-chair, Mr. Andrew Biggs, which is relevant given that the panel’s report was a stated reason for this ASB decision.

In 2015, when Mr. Biggs came across erroneous CBO data claiming that Social Security replaces 60% of income, he jumped on the opportunity to use this error to mislead people and further his advocacy in a Forbes article titled “New Social Security Replacement Rate Numbers Cast Reform, Retirement Debates In Different Light,” by stating:

Social Security replaces nearly 60% of pre-retirement earnings. Financial advisers recommend
70% total replacement rate. These numbers don’t support expanding Social Security.

One might assume this was an error, but Mr. Biggs had served as principal deputy commissioner of the Social Security Administration and has even weighed in on technical matters regarding how to accurately measure Social Security’s pay replacement levels as far back as 2005. Given that, he undoubtedly knows that Social Security only replaces about 40% of pre-retirement income.

We feel very confident that, if the IRDM proposal is accepted, it will be used in the same manner that Mr. Biggs used the CBO error: to mislead.

Thus, the proposal would force actuaries to violate Precept 8 of the Code of Professional Conduct.

….
Comment #3 – IRDM Not Relevant to Public Plans

The IRDM is not relevant to the public sector. While insurance companies may find the measure useful in trying to win private-sector business via “de-risking” deals, the public sector doesn’t engage in these deals because they are simply too expensive once you understand the massive inefficiencies inherent in buying annuities through an insurance company.

We would like to know if insurance actuaries, who may be seeking business gains, are promoting this policy. We are asking for transparency.

Comment #4 – IRDM Is More Problematic for Risk-Sharing Plans

In addition to our concerns about misleading claims being made about the IRDM, the mispricing of plans that have variable benefits and cost-sharing arrangements would be more severe. If pension fund returns really fell by more than half in the future, many public plans would see provisions automatically change.

How would one price a plan where the COLAs are based upon funding ratios or investment returns, if an insurance company was taking on those liabilities? In reality, it doesn’t matter. But the IRDM would force decisions to be made about this unrealistic scenario, wasting valuable time and money on speculation. I believe the proposed IRDM would be even more misleading in regard to these types of plans.

Funny they should mention non-guaranteed elements.

Did you know that such sort of non-guaranteed items are part of life insurance and annuities? And they’ve figured out how to deal with that?

Hmmmm. Maybe the pension actuaries should ask the life/annuity actuaries about something for once.

Nebraska State Education Association — and again, not a properly encoded PDF, so I’m giving you a screenshot:

Oh, it’s “illegal” to freeze & defease? Is it illegal for the pension fund to run out of money? Is reality illegal?

Mmmm.

Tell me the fairy tale about governments not running out of money or going out of business. That one is funny.

They all go on about the “true cost”… I like to call the difference between the risk-free cost and the market value of assets they actually have on hand as the “taxpayer/bondholder/pension participant put”. When the money runs out, those are the ones who get soaked.

WHY WON’T ANYBODY THINK OF THE PENSION PARTICIPANTS?

Yes, I know they think they can tap the limitless resource of taxpayers… but Nebraska should think real hard about how much they can depend on taxpayers being a limitless resource, and how much bondholders are interested in extending credit to Nebraska, and how happy pensioners will be if they have to soak up the shortfall when the other two don’t come forward.

Yes, the IRDM is very different from most GASB measures.

Let me teach you about STAT vs. GAAP for insurance. They have different purposes, don’t they?

PENSION FUND RESPONSES

But wait, there’s more. Not just the unions, but also some specific pension funds.

I’m not excerpting them all, but I’ll link them all.

Here’s an excerpt from the last:

Challenges of Explaining Two “Right” Numbers

If the ASOP No. 4 Exposure Draft is adopted as written, given the mandated nature of the
IRDM, Colorado PERA is very concerned there will be confusion as to which pension liability
value is accurate. Additionally, the issuance of the new pension liability likely would be
misinterpreted as a recommendation of the actuary despite any disclosure to the contrary. We
believe this approach will unnecessarily cause confusion and misunderstanding among the
memberships, employers, legislators, and tax-payers who embody the stakeholders of all public
pension plans.

Again, let me introduce you to insurance actuaries. On the property/casualty side, the difference between GAAP and STAT is not as stark as on the life/annuity side.

I swear, I about smacked someone once from the P/C side who didn’t understand why I couldn’t just do a “GAAP adjustment” to go from statutory reserves to GAAP reserves.

YOU KNOW NOTHING, ACTUARY SNOW.

(note: that GIF is not animated)

Sorry, I’m deep in the weeds here. (I’m not sorry at all)

Anyway, I think I know the basis for my response letter. Actuaries have to explain more than one measure for the same liability all the time. What’s so special about pensions?

And I want to note — ASOP 4 is about all types of pensions. There are problems with multiemployer pensions (which are being asked to be bailed out by the federal government), church plans (which have been exempted from certain requirements), not only public pensions.

THE LETTERS I AGREE WITH

There are two letters I’ve already read thoroughly, and I know the authors, and I knew I’d agree with them. (There may be others I agree with, but I haven’t read them all yet.)

First, from Robert North, who had been the actuary for New York City

Section 3.11, Investment Risk Defeasement Measure, requires the calculation and
disclosure of an investment risk defeasement measure when the actuary is
performing a funding valuation. The guidance allows for discount rates to be based
upon either U.S. Treasury yields or yields of fixed income debt securities that receive
one of the two highest ratings given by a recognized ratings agency. Are these
discount rate choices appropriate? Yes and no. The use of U.S. Treasuries yields as
a discount rate is appropriate. The use of “yields of fixed income debt securities that
receive one of the two highest ratings given by a recognized ratings agency” is NOT
appropriate.

If not, what rate choice would you suggest? Only the use of U.S. Treasury yields is
appropriate if the intent is to have a measure (called by the ASB an Investment Risk
Defeasement Measure (“IRDM”)) whose calculation would provide to help evaluate
the level of investment risk being taken by a Pension Plan.

Note: First, I strongly favor the disclosure of an IRDM. I do, however, also feel
strongly that referring to this measure as an Investment Risk Defeasement Measure
puts too much emphasis on only one of its uses. It would be better to refer to this
measure, which represents the economic value of a projected stream of promised
benefits earned to date, as a Solvency Liability, a Secured Accrued Benefit Liability
(“SABL”), a Guaranteed Accrued Benefit Liability (“GABL”), a Defined Accrued Benefit
Liability (“DABL”), a Promised Accrued Benefit Measure (“PABM”) or something
similar. The greatest advantage of disclosing such a measure is that it represents the
economic value of the accrued benefits, assuming they are sure to be paid.

As defined, the IRDM can be utilized to evaluate the level of investment risk being
taken. However, to do so best would require comparing that IRDM with an Actuarial
Accrued Liability (“AAL”) determined based on the Traditional Unit Credit (“TUC”)
Actuarial Cost Method (“ACM”), where the accrued benefits are discounted at the
expected rate of return on the Plan investments. This TUC AAL should be easy to
compute since the accrued benefit cash flows would likely already exist from
determining the IRDM. Nevertheless, given that most Public Plan actuaries utilize the
Entry Age ACM, for many actuaries, making the more precise comparison could mean
a second step would be required.

In summary, I believe that publishing an IRDM is a great idea, but I feel that IRDM is
a poor choice of name and emphasizes only one possible use for this valuable
measure. It would be better to refer to the IRDM using a name that suggests the
economic value that it represents. This measure is a useful one that can stand on its
own. Hereafter in this letter I shall refer to the economic value of accrued benefits
(i.e. the IRDM) as a Solvency Liability.

Heh, I like that choice of name. And if the pension folks object to it, I will once again mention STAT vs. GAAP.

“But insurance companies can fail!”

So can governments. And unions sponsoring MEPs.

Nothing special about governments re: failure. I’ve got a good book keyed up for this weekend for Mornings with Meep that’s all about that.

And here’s a letter from four people – Edward Bartholomew; Gordon Latter, FSA, FCIA;
David G. Pitts, FSA; Larry Pollack, FSA, MAAA, EA

Listed below are a few modest recommendations for making ASOP No. 4 even better – an extra
half step in the right direction:
• Drop the safe harbor of using AA bond yields as discount rates for IRDM calculations (3.11)
• Require calculation and disclosure of Normal Cost corresponding to the IRDM (3.11)
• Require disclosure of undiscounted cash flows and discount rates used to calculate both the
IRDM obligation and the corresponding Normal Cost (3.11)
• Require that each year’s annual amortization payments must actually amortize (reduce) the
unfunded liability (3.14)
• Specify that an unsmoothed actuarially determined contribution (ADC) also be disclosed so
that application of the reasonableness standard may be judged (3.16)
• Specify that the actuary should opine on the reasonableness of critical assumptions and
methods even when those assumptions are prescribed by the plan sponsor (“by law” or
otherwise) (3.20)

Their letter gets into the details. I have followed stuff by these people, and I agree with them.

ACTUAL PROFILE IN ACTUARIAL INTEGRITY IN GOVERNMENT

Re: actuaries commenting on reasonableness of critical assumptions.

There was an infamous situation with the actuary who was a federal government employee who would not toe the line re: Medicare Part D. In his own words, in 2013:

Medicare’s outgoing chief actuary, Richard Foster, said he almost resigned in protest to White House political pressure during the debate over Medicare’s Part D drug benefits. Foster, now retiring, recalled the controversy in a recent tell-all interview with Kaiser Health News.

“I was fully planning to quit in protest,” Foster said in his KHN interview. “I’d even started writing op-ed articles. I was going to resign pretty noisily, I’m afraid.”

The Obama White House isn’t the first resistance Foster faced. President Bush leaned into him over his cost estimates for the original bill that added prescription drug benefits to Medicare in 2003. At that time Foster said he was told not to respond Capitol Hill inquiries, and that he should send and information to the Medicare administrator, who would selectively pass it along to the Hill.

“The experience itself was pretty awful, as you can imagine,” Foster said.

The American Academy of Actuaries backed Foster at the time. I’m too tired to find their statement in 2003, but here’s their statement when Foster retired:

“The Academy and the profession owe Rick a debt of gratitude for his service,” said
Academy President Cecil Bykerk. “Rick’s objectivity and independence in the midst of
an ever-changing political landscape often made his position as the top Medicare actuary
challenging. But it is his integrity, commitment to public service, and willingness to fight
to preserve the availability of objective, nonpartisan information for the nation’s
policymakers and regulators that should serve as an example for the rest of the profession
to follow.”

….
Foster gained notoriety in 2003 after resisting high-level pressure to withhold information
from Congress about the costs of adding a prescription drug benefit to Medicare during a
highly charged political debate. Foster later acknowledged that he had risked his career in
fighting to maintain his actuary office’s role of providing Congress with independent,
nonpartisan and technical assistance.

Mmm, a government actuary trying to provide professional information and opining on the appropriateness of cost assumptions.

Huzzah to Foster!

Perhaps pension actuaries should realize they’re not unique. At least I know of many life/annuity actuaries and P/C actuaries who quit (okay, “resigned” if we want to be nice about it) when the principals were asking them to use unreasonable valuation assumptions. I actually saw it happen at a prior employer. I have heard from other actuaries who resigned in such situations, and other people who were witness to such situations.

So… I would like to hear of an equivalent story in the pension sphere. If someone knows of such a story (private or public, single employer or multiemployer, I don’t care), please send me info.

In the meantime, I leave you with this link to a piece on special pleading.


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