STUMP » Articles » Public Pensions: Actuarial Assumptions and Professional Ethics » 12 February 2017, 15:21

I’m going to start out with a question I’ve been asking for years.

I will see if I can find every instance that I asked it at the Actuarial Outpost, but I doubt I will (because I don’t always phrase it the same way).

The essential question is this: is there any set of actuarial assumptions for valuing public pension liabilities that would be so bad no ethical actuary could take that assignment?

As far as I can tell, the public pension actuaries in the U.S. say “no” to that.

MEEP HAS A QUESTION

Post from me in September 2010:

Problem is, of course, some of these ridiculous assumptions are written into state law.

I’ve asked this on other pension threads before – are there any statutorily prescribed assumptions that would be so outrageous that no (ethical) actuary can do the work? That would be interesting.

August 2013:

On that discussion, I still haven’t gotten anybody to tell me that there does exist an assumption set dictated by the client that’s so bad that no ethical actuary could use it.

At the very least, prudent (as opposed to strictly ethical) actuaries may be coming alive to the possibility that they’re not shielded from third party torts, and that “but the client said!” and ASOPs may not protect them at all.

June 2015, from my comment letter to the Actuarial Standards Board:

3. When elected officials and union representatives both want the lowest cost, can we expect consulting actuaries to develop costs that are higher than the lowest costs that can be asserted to be ASOP compliant?

…..
As for my third question, if ASOPs are such that one can provide a wide variety of results in terms of liability measurement and cost measurement, the pressure will likely be (and has been) for the actuaries to give a result at the lower end of estimates.

This kind of pressure exists not only in public pensions, but also in insurance. There have been cases within the insurance industry where an actuary has not been willing to sign off on reserves due to professional ethics.

Sometimes the strength of the reputation of our profession is such that those wishing the actuary to lower reserves will back down; other times, the actuary resigns. In the cases I’ve known where the actuary resigned, the replacement actuary was no more willing to give a result at the lowest amount.

Would we have such strength to our standards such that public pension actuaries would stand up in a similar way? I have asked before whether there were any assumption set for public pension valuation so inappropriate that no ethical actuary would be willing to value under such assumptions. As far as I can tell, so such assumption set exists.

July 2015, a comment from (non pension) actuary Carol Marler:

There was another article in that Contingencies issue I have been mentioning, called “The Start of a Meaningful Ethics Discussion.” Apparently across all the actuaries surveyed by the Academy, the most common ethical concern is “pressure from principals/managements to select inappropriate assumptions. . .”

And, as I understand it, ASOP 41 gives public pension a special out on this very issue, if they are able to get these assumptions included in a law or regulation, it pulls the teeth of the ASOP on requiring the actuary to comment on the appropriateness of these assumptions.

Am I reading this correctly? Is this something that needs attention? Is it too late already to even talk about it?

As you can see, this can’t possibly be all the times I’ve referenced it (I may have done it at actuarial conferences, and didn’t write it down at the Outpost), but it did come up a lot. I threw in Carol Marler, who is now retired and whose background, like mine, is primarily as a life actuary.

Here’s the deal: it may say “actuarial assumptions” but it doesn’t mean the actuaries pick those assumptions.

Nope, almost always those assumptions are given to the actuaries, when it’s a public pension. Sure, the actuaries can make recommendations, and sometimes the real decision-makers will go along with it (or the actuaries give assumptions that the clients want to hear).

But the actuaries act, essentially, as really expensive calculators when it comes to public pensions. It seems that the profession has no interest in trying to change that role. The politicians tell the actuaries the numbers they are to use, and the actuaries respond “Whatever you say!”

CHANGES IN ASSUMPTIONS

There are two things that have prompted this post (other than this being a long-standing issue I’ve had with public pension actuarial practice… I think I’m at ten years of bitching about this within the profession come this fall.)

First, there have been loads of articles about the reduction in assumed return on assets for public pension plans. Partly this is due to the largest public pension plan, Calpers, setting a new target return on assets (as well as Calstrs, etc.)

I will just link to a few of these articles:

• Down they go: more public pension plans reducing assumed rates of return
• PUBLIC PENSION FUNDS CONTINUE TO RECOVER FROM THE RECESSION
  — to quote: “When looking at the past 10 years, the investment rate of return was 6.2 percent, but that 10 year period includes the recession. While funds continue to achieve these strong rates of return, many are lowering their actuarial assumed rate of return to account for continued weakness in the market.”
• Acknowledging lower returns, CalSTRS drops investment forecast
• Pension boards must get real when it comes to numbers and challenges
• US pension funds are slashing their forecasts…and some don’t even think they’ll meet those
  
• California Teachers’ Pension System Lowers Projection, Potentially Tripling What Taxpayers Will Owe

Now I will quote from that last piece, who points out the upshot of these changes:

It’s important to remember that changing those future projections doesn’t alter the total future cost of the system. Those benefits are still just as costly and still must be paid for, but reducing the amount of money coming from Pot Three (investment returns) means states and cities will have to get a larger share of the money from Pot One and Pot Two (contributions from employees and taxpayers, respectively).

…..
Of course, it was always going to come out of your pockets anyway. Those projected future returns are something of a fiction anyway, useful for making budgetary projections but not a guarantee of anything.
…..
If pension plans are pegged to 4 percent annual returns, and they earn 7 percent, taxpayers will be thrilled to learn they don’t have to contribute as much as they thought. Expecting 7 percent and getting only 4 percent leaves governments exposed to higher costs than expected and puts taxpayers on the hook.

“Adopting a higher discount rate than warranted by the pension’s actual risk cannot reduce the true, net cost of a pension plan,” wrote Anthony Randazzo and Truong Bui, pension analysts for the Reason Foundation, which publishes this blog, in a 2015 report. “Similarly, a plan that employs a low discount rate puts a larger burden on today’s taxpayers, leaving smaller obligations for future generations. Either way, the total economic cost of the pension plan remains the same.”

So changing the assumption does not actually change the ultimate cash flows.

However, more conservative assumptions now means that higher contributions are made now… and there is less chance of catastrophic failure later.

I love how we’re supposed to ignore the big loss pension funds had in 2008 & 2009. “That’s just the recession!” as if we’re supposed to say that such very-foreseeable-downtimes were never foreseeable.

Quite the forecasters, there, if the forecast works only if you ignore bad stuff.

PROFESSIONAL ETHICS: WHO IS THE CLIENT?

The second thing that prompted me was this post on lawyerly ethics by Scott H. Greenfield:

To recap, lawyers did something incredibly stupid, got nailed, earned $200, lost $80,000. And then, wait for it, got reprimanded for it, but with a dissent.

“I believe my colleagues’ opinion will have negative and far-reaching ramifications beyond this matter. If a client asks a lawyer to prepare a power of attorney for the client’s mother or father, must the lawyer investigate and determine whether the client’s parent is competent to give power of attorney?”

Before getting to the answer to this question, why raise it?

“I also am concerned that the majority’s ruling will spell the end of affordable powers of attorney, and possibly even lawyer-prepared powers of attorney. Lawyers will be loath to take on potential liability if they are held responsible for their clients’ actions.”

There you go. If we expect lawyers to be ethical and competent (yes, of course the lawyers shouldn’t have been complicit in a fraud by doing the papers), it means they won’t be able to glom up that cool $200 fee. What about the poor people who need shitty, unethical lawyers at a really cheap price?!?

As Carolyn Elefant notes, this could well drive people into the arms of LegalZoom for their $9.99 Power of Attorney form, and starve the poor, unethical, incompetent schmuck for lack of his $200 fee. Is that what we want to see happen?

When I have asked my question, I have gotten no public answers from public pension actuaries. I have gotten private answers, and the upshot is, of course, that if one pension actuary refuses the set of assumptions, then a hungrier pension actuary will just pick up the business.

But it wasn’t simply the initial post that made me sit up. It was this exchange in the comments:

Ehud Gavron
February 11, 2017 at 2:13 pm
Having read all the comments thus far, I think the question really comes down to “who is the client?” In my mind when I walk into a lawyer’s office and ask for a document that says X and pay for the document that is prepared to say X, I am the client.

The lawyer’s job is to represent me, not the nine billion other people on this planet to whom I may give, offer, share, or otherwise entice with this document.

In the discussed case someone PROVIDED AN INSTRUMENT TO DEFRAUD, and someone SIGNED it and someone NOTARIZED that signature. I think penalizing the guy who drafted the document that was thus signed and notarized is moving the responsibility from those who did bad (fraudster), those who aided (notary), those bereft of judgment (the signer) and giving it all to the guy who did his job.

Dissentingly,

Ehud

Reply ↓

SHG [Scott H. Greenfield]
February 11, 2017 at 2:23 pm
This is one of those comments I struggle to decide whether to post or trash, and I frankly can’t figure out why you felt compelled to write it. You have no clue what this is about, and your comment is fundamentally and dangerously simplistic and misguided. But, I’ve decided it might be better to explain this to you (and others) than just trash your comment.

Docs serve purposes, involve different rights and have different impacts. It is not: I came, I paid, I’m the client, do what I tell you to do.

Imagine someone coming to a lawyer for a will. Not his will, but his uncle’s will. He tells the lawyer that the uncle wants to leave everything to him, here’s the money, draft the will. What about the uncle? Not to worry, it’s all good with him and, since he’s in the hospital, don’t worry about execution, he’ll take care of it. Now just do the will, lawyer.

The will is an operative document for the testator, the guy who is bequeathing stuff in the will, not the beneficiary, the guy who told the lawyer what to do and paid him. The same is true of a power of attorney, where the power is given by the person signing and not the beneficiary of the POA. The lawyer isn’t a mouthpiece for the person paying. The lawyer has a responsibility not to harm the person whose rights are being impacted by the document he is creating.

Don’t be hurt by my characterization of your comment. Too many lawyers don’t grasp what professional responsibility means, so it’s no surprise that non-lawyers can’t grasp it either.

So here’s the deal. As things stand, the client for pension actuaries working on a valuation are the trustees of the pension fund.

Not the pensioners or active employees in the system.

Not the taxpayers who are paying for all the benefits (the “employee contributions” all come from the taxpayers, duh.)

The pension trustees are the sole fiduciaries, as far as I can tell. [I’m one of those lucky people who lives in a state where one person is the state pension fiduciary.]

These trustees are often politicians and union leaders. “We’re too stupid to understand” and “We did what the actuaries said” people.

Not quite sure where actuaries got the professional reputation for integrity, considering. I guess we got lucky.

Or, rather, actuaries in some fields got the advantage of the actual behavior of actuaries in other fields. I know directly at least one actuary who quit their position rather than sign off on a questionable level of reserves — this is not frequent, but not unknown, in insurance companies. It’s not advertized. Everybody pays attention to a CEO resigning; nobody much pays attention to the appointed actuary quitting except the people inside.

I have seen various pension consulting actuaries being replaced for public pension actuaries, but it’s unclear who fired whom — did the plan fire the actuaries, or did the actuaries think the clients were a risk they could no longer take? Sometimes it can be told, when the politicians make an announcement that they’re firing the old actuaries. But then, they could be lying. That’s politicians for you. The actuaries may not squawk in those cases, because… well, they should’ve known these are the type of people they’re dealing with.

Which makes one wonder why actuaries are so complacent in taking the assumption sets these politicians hand them.

Or are they complicit?

ANOTHER OPINION

I’ve fallen behind on reading Theodore Konshak’s scribd posts on South Carolina pensions. But I know he has been calling into question various actuarial practices in public pensions.

I will point out some excerpts from his recent post South Carolina Pension Actuaries: Texas Steers:

In 1980, I was working in the Actuarial Department of a small life insurance company in Seattle, Washington. I was traveling to work on the bus. We were crossing the floating bridge over Lake Washington listening to the radio. The controversy of the day was the funding of the pension plans of Washington State. The state legislature had not contributed the amount determined by the actuary.

“Pay me now”, said the actuary for the pension plans of Washington State, “or pay me more later.”

The State of South Carolina dictates the future investment return assumption to be used by the actuaries for its state. The former actuary for the pension plans of Washington State would have probably said the following in his actuarial valuation reports: “The State of South Carolina can not legislate investment return. The stock and bond markets do as they please.”

Times have certainly changed. The actuaries for the pension plans of the State of South Carolina are Texas steers. Their balls are being held in a jar by the state legislature.

The number of private sector pension plans peaked in 1983. So, in 1980 or 1981, if the state actuary for Washington State got fired for being outspoken, he could have easily found another job. It wasn’t the same after an oversupply of pension actuaries occurred. You could say that pension actuaries lost their nerve or lost their chutzpah.

I get Konshak’s point, but there are two separate issues here: the sponsors making full payments given a specific set of assumptions, and what that set of assumptions is.

From this story, it sounds like the actuary was making a complaint re: the full payment given the assumptions.

Konshak attached a copy from a news story from Washington in October 1981:

There is something different from not making full ARC and whether the assumptions in calculating that ARC were “good”. The actuaries will never decide what actually gets contributed to public pensions. That’s obviously a political thing, and while it’s good for the actuary to complain about underfunding, actuaries can’t do much of anything about that.

It should be in the realm of the actuary to determine reasonability of the assumption set being used to value the already accrued liabilty and to determine what contribution should be made.

But that doesn’t seem to happen at all, does it?

There are certain valuation and funding practices, not to mention certain combinations of assumptions, that make for very bad results when reality deviates from these assumptions.

And yet, some are still being used.

But here are the public pension actuaries:

¯\_(ツ)_/¯

In many cases, though, having talked to a variety of public pension actuaries, many are true believers. It’s silly for me to complain about “absurd assumption sets” when they don’t see them as absurd at all.

But what would it take? Would it take plans that always pay 100% ARC and yet have decreasing funded ratios? Would that do it?

Seemingly no.

But maybe these people are lying to themselves (and then to me). I can’t tell.

A shifty lawyer drawing up a will for a third party while the named beneficiary is sitting in front of them and paying for the drafted will is pretty clear in terms of professional ethics.

An actuary using a bunch of (supposedly) educated forecasts of all sorts of variables trying to tell politicians what to put into a pension plan (while other parties are involved in the asset-side management, and have their own issues), that situation is a lot less clear.

I understand why specific individual pension actuaries do not want to push back on methods and assumptions when there are fewer and fewer pension plans to work for.

I do not understand why the U.S. actuarial profession as a whole does not. The pension field used to be the largest in the U.S. It’s not now. The rest of us have an interest as actuaries, as a profession, in keeping up our professional reputation.

It’s expected that we don’t sign off on inadequate reserves or insufficient premiums, when we work in insurance.

Seems that something similar should apply to public pensions as well.