STUMP » Articles » Rock Em Sock Em Actuaries: How Much are Public Pensions Worth? » 16 August 2016, 18:10

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Rock Em Sock Em Actuaries: How Much are Public Pensions Worth?  


16 August 2016, 18:10

Well, that squabble hasn’t gone away.

Now two of the co-authors of the suppressed paper, Jeremy Gold and Ed Bartholomew, have taken to MarketWatch to put out what they have to say:

Opinion: The $6 trillion public pension hole that we’re all going to have to pay for
Why your state’s public pension plan is in a much bigger hole than you already fear

U.S. state and local employee pension plans are in trouble — and much of it is because of flaws in the actuarial science used to manage their finances. Making it worse, standard actuarial practice masks the true extent of the problem by ignoring the best financial science — which shows the plans are even more underfunded than taxpayers and plan beneficiaries have been told.

The bad news is we are facing a gap of $6 trillion in benefits already earned and not yet paid for, several times more than the official tally.

Pension actuaries estimate the cost, accumulating liabilities and required funding for pension plans based on longevity and numerous other factors that will affect benefit payments owed decades into the future. But today’s actuarial model for calculating what a pension plan owes its current and future pensioners is ignoring the long-term market risk of investments (such as stocks, junk bonds, hedge funds and private equity). Rather, it counts “expected” (hoped for) returns on risky assets before they are earned and before their risk has been borne. Since market risk has a price — one that investors must pay to avoid and are paid to accept — failure to include it means official public pension liabilities and costs are understated.

The leadership of the American Academy of Actuaries, which speaks for its 18,500 members on public policy matters, rejected the paper. It also persuaded the Society of Actuaries, the other industry group, not to publish it. On Aug. 1, the presidents of the two organizations issued a joint letter disbanding the task force and declaring that the authors couldn’t publish the paper anywhere.

This is more than just an internal dispute. Today’s public plan actuaries serve their clients, who want lower liabilities and costs, even at the expense of future taxpayers and other stakeholders.

Plans are in trouble. Every year they are in deeper trouble. Many taxpayers are aware that state and local government pension plans are underfunded. They generally aren’t aware just how dire the situation is.

Good numbers don’t assure success, but bad numbers lead to bad decisions and may invite disaster.

So yay from hearing from Ed and Jeremy directly.

By the way, they got a few more places to cover this since my last update.


From The Economist:

No love, actuary

A report on American pension funds is controversially shelved

Aug 13th 2016 | From the print edition

WHEN it comes to funding the pensions of their workers, American states and local governments have not been doing a good job. Back in 2000, the average pension plan was fully funded, according to the Centre for Retirement Research (CRR); at the end of 2015, the official funding ratio was just 72%.

So a report from a pension-finance task force into the way economic principles apply to public pension funds ought to make compulsory reading. But the paper, commissioned by the American Academy of Actuaries (AAA) and the Society of Actuaries (SoA), is not going to see the light of day. That is very disappointing, since the report (a draft of which has been seen by The Economist) highlights how the approach to valuing American public pensions is highly questionable.

The ideas in the paper have been circulating among European actuaries for 20 years. But the conclusions are controversial in America; an AAA spokesman said the study “did not meet the editorial and policy standards of our review process”. Pressed for details, the AAA referred to the paper’s “tone and clarity” and cited the wording of a footnote on pension costs.

It was perfectly within the rights of the actuarial bodies not to publish but they went further. In a memo, Tom Wildsmith and Craig Reynolds, respectively presidents of the AAA and SoA, said that, as the paper was produced by a group set up by them, “we do not think it would be appropriate for members of the task force, as individuals, to take the existing paper and simply publish it somewhere else.”

The decision angered those who have been working on the paper since 2014, who see the move as censorship. “This is a paper that they didn’t write, they didn’t fund and don’t want to publish,” says Ed Bartholomew, a former banker and one of the authors who worked on a voluntary basis. Jeremy Gold, another of the authors, says the affair illustrates the insularity of the actuarial profession.

In its defence, the AAA says it has in the past published similar views to those expressed in the report. And the SoA plans to hold a webinar on September 27th, in which the authors can discuss the issue. Still, the two bodies should just allow the report to be published. American public-sector pension deficits are more than $1 trillion, even on the most generous assumptions. This is an issue in which debate should not be stifled.

From Ed Mendel at CalPensions:

Dissident actuaries want to show big pension debt
Two actuarial associations did not publish a controversial paper by their joint task force, reflecting a split in the profession over whether public pension debt should be measured with risk-free bonds or the earnings forecast for stock-laden investment funds.

Using safe but low-yield bonds to offset or “discount” future pension obligations would cause pension debt to soar, creating pressure to raise the annual rates paid by state and local governments that are already at an all-time high for many.

Critics have been contending for a decade that overly optimistic pension fund earnings forecasts conceal massive debt and the need to take even more money from government budgets or find a way to cut pension costs.

The leading California critics, now mainly at Stanford University, are not professional actuaries. They have backgrounds in finance, like David Crane, and in academic economics, like Joe Nation and Joshua Rauh.

The paper of the joint Pension Finance Task Force paper of the American Academy of Actuaries and the Society of Actuaries, which did not make it through the usual peer review process, was based on the principles of financial economics.

“One of the assertions of the paper is that public pension plans are purported to be default-free obligations so they would be valued using default-free interest rates,” an anonymous former task force member told Pensions & Investments.

Although not as well publicized as criticism from outside the profession, a group of actuaries has been urging the adoption of a risk-free discount rate for about a decade, said Paul Angelo of Segal Company actuaries in San Francisco.
The California Actuarial Advisory Panel agreed with the blended rate and suggested a few tweaks in a letter to GASB on Sept. 17, 2010, from the chairman at the time, Alan Milligan, CalPERS chief actuary, who is retiring this year.

An independent “Blue Ribbon Panel” commissioned by the Society of Actuaries issued a report in 2014 that, among other things, endorsed the use of some version of a risk-free discount rate.

“The Panel believes that the rate of return assumption should be based primarily on the current risk-free rate plus explicit risk premia or on other similar forward-looking techniques,” said the panel report.

Angelo said the influential Actuarial Standards Board, which was essentially neutral in Actuarial Standards of Practice issued in 2013, may revisit the risk-free discount rate issue, possibly within a year or so.

There are a few interesting comments on that post.

I will come back to this assertion:

Kris Hunt Says:
August 16, 2016 at 10:47 am
The problem is that the real cost of those “services” are not currently being revealed. By understating the real cost of pensions and pushing the costs of today far into the future means bad decisions are being made. Cities could spend differently if they knew the actual cost of a firefighter when accurate pension and retiree healthcare costs are included. Also, the people receiving the services today should be paying for them and not passing them on to the children of tomorrow.

Some others may come up. There’s a shoe I’m waiting to see if it will drop, but maybe it did I hadn’t noticed. It’s August after all.

If it drops, I’m sure somebody will be posting it here: Actuarial Outpost thread titled AAA and SOA censor research and disband voice of pension finance


If you care to know what is in the suppressed paper… well, I’ve not actually seen that specific draft. But I saw a draft and a presentation on it in March 2015.

It was at the 2015 Investment Symposium:

1:45 PM – 3:00 PM
Session 11: Financial Economics Principles Applied to Public Pension Plans icon pdf
Presentation(s): View Presentation

Competency: Strategic Insight and Integration

Moderator(s): Jeremy Gold, FSA, CERA, MAAA

Presenter(s): Ed Bartholomew; Jeremy Gold, FSA, CERA, MAAA; Larry Pollack, FSA, EA, MAAA

The session is to investigate how Financial Economics applies to public pension plans, serving to extend the Pension Actuary’s Guide to Financial Economics (the Guide). Six key principles are carefully studied and results are presented.

Experience Level: All Levels

Session Coordinator(s): Larry Zhao, FSA, CERA

I was in the audience. People can buy recordings, if they wish.

But you can look at the slides for free.

It’s really just taking a paper that was published in 2006, and applying it to public pensions specifically. As Jeremy Gold remarked, one issue for public plans that isn’t there for private plans is intergenerational equity, which I will address below.

But even more — there’s an upcoming webcast:

Financial Principles Applied to the Management of Public Pension Plans Webcast

Competency (Learn more)

External Forces & Industry KnowledgeLeadershipTechnical Skills & Analytical Problem Solving


September 27, 2016

Presented by

Social Insurance & Public Finance Section


Noon-1:30 p.m. ET


This webcast takes place via the Internet.

Registration Fees

Starting at $149 (includes access to subsequent webcast recording). More information on all registration fees .

Who Should Participate

Members of the following sections: Pension and Social Insurance & Public Finance Sections, as well as actuaries in other areas of practice who are interested in better understanding the principles of finance as applied to public pension plans.

Primary Competency

External Forces & Industry Knowledge, Leadership, Technical Skills & Analytical Problem Solving


Several actuarial organizations have agreed that solvency, intergenerational equity and predictability/stability of contributions are key factors in funding policy. Public pension plans face challenges in all three areas. Actuarial and accounting practices address these challenges by smoothing methods that favor contribution stability over the other two factors. Financial principles, however, assign greater priority to solvency and intergenerational equity than to predictability/stability of contributions.

Presenters will show how basic financial building blocks applied to public pension plans imply practices that are very different from typical practices today, such as investment in liability matching, default-free securities, liability measurement based on the characteristics of the obligations and not on the assets supporting those obligations, funding that prioritizes solvency and financial reporting that is free of smoothing and deferred recognition.

I do not currently plan to attend this. None of this is new to me, and Jeremy Gold convinced me already 10 years ago. I do not need to be convinced again.


So here’s the deal.

I saw this tweet yesterday:

These essays have been done multiple times.

First off, it’s never been the case that most workers were covered by defined benefit pensions. Even if you throw in public workers.

But the main issue is that the promises made are inherently expensive promises to make.

I am not going to argue that specific point right now. Instead, I provide you with a coming attraction:

That’s me trying to think through the whole cash flow issue of pensions (yes, hand-drawn…call it an artisanal, sustainably-sourced diagram).

We’ve been looking at what I call balance sheet views of pensions — how much are assets and liabilities?

But those aren’t “real” in the way cash flows are.

They’re definitely more abstract than a cash payment made… or not made.

But here’s my point: I believe that there has been deliberate attempts to understate the value of these promises, by people who should know better. I wrote about this two years ago:

Here is the problem: all sorts of entities directly involved in public pensions have thought that the pensions can’t fail. Because of stuff like: constitutional protections of benefits (so paying pensions would take precedent over other spending needs, like paying for current services), “government doesn’t go out of business”, the supposedly infinite taxation power of the government, and so forth.

Because they thought that pensions could not fail in reality, that gave them incentives to do all sorts of things that actually made the pensions more likely to fail. Because, after all, the taxpayer could always be soaked to make up any losses from insane behavior.

One of the insane behaviors is pretending that really expensive promises are not worth quite so much.

One of the most insane undervaluations I’ve seen was when Calpers pretended a benefit enhancement was worth nothing.

In 1999, the fund’s board concocted an astonishing proposal that would take all the post-1991 state employees and retroactively put them in the older, more expensive pension system. The initiative went still further, lowering the retirement age for all state workers and sweetening the pension formula for police and firefighters even more. Public-safety workers could potentially retire at 50 with 90 percent of their salaries, and other government workers at 55 with 60 percent of their salaries.

CalPERS wrote the legislation for these changes and then persuaded lawmakers to pass it. In pushing for the change, though, the pension fund downplayed the risks involved. A 17-page brochure about the proposal that Cal- PERS handed to legislators reads like a pitch letter, not a serious fiscal analysis. The state could offer these fantastic benefits to workers at no cost, proclaimed the brochure: “No increase over current employer contributions is needed for these benefit improvements.” The state’s annual contribution to the pension fund—$776 million in 1998—would remain relatively unchanged in the years ahead, the brochure predicted.

CalPERS board members also minimized the plan’s risks. Board president William Crist contended in the press that the bigger benefits would be covered by the pension fund’s market returns. Labor leader Valdes blasted critics who warned about potential stock-market declines, saying that they were trying to deny workers a piece of the good times. What the board members didn’t mention was that California law protected government pensions, so that taxpayers would be on the hook for any shortfall in pension funding. In essence, the CalPERS position was that government workers should carry zero risk, sharing the bounty when the fund’s investments did well but losing nothing when the investments went south.

But the board members knew that there was a downside. CalPERS staff had provided them with scenarios based on different ways the market might perform. In the worst case, a long 1970s-style downturn, government contributions to the fund would have to rise by billions of dollars (which is basically what wound up happening). CalPERS neglected to include that worst-case scenario in its legislative brochure.

Actuaries pretending that a promised benefit was worth nothing is what destroyed one of the oldest insurers in the world, and which officially removed the independence of the UK actuarial profession.

Thinking you’re being oh-so-clever to slip in benefit enhancements, but not increasing funding was just making it more likely that the benefits wouldn’t get paid.

How clever is that?

In any case, I’m going to be working up some concepts later this week I hope to be useful for future discussion. One is that fancy-pants concept of “intergenerational equity” which is a frou-frou way of talking about fairness in paying for benefits. Or in recognizing it’s hard to get young folks to pay for services provided to long-dead folks, performed by no-longer-working folks. Another is how we measure pension performance.

Look out for them!

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