STUMP » Articles » Revisiting Actuarial Standards: ASOP 4 Has Second Exposure Draft » 27 January 2020, 13:02

Back in July 2018, the Actuarial Standards Board had a draft revision of ASOP 4. I will quote a few of my old comments, in a moment.

A quick reminder: Actuarial Standard of Practice 4 is currently titled “Measuring Pension Obligations and Determining Pension Plan Costs or Contributions”, and had a transmittal date of December 2013. The prior ASOP 4 had a date of May 2011. This is a fairly rapid turnover for an ASOP, for a variety of reasons.

This is a very contentious standard of practice, applying to actuaries practicing in the U.S. This ASOP doesn’t make a distinction between types of pension plans – whether single-employer private plans or public plans. For private pension plans, particularly the ones covered by ERISA legislation, there is a good deal of oversight separate from actuarial standards.

For public pension plans… there is not. That’s one of the big drivers for some aspects of these proposed revisions of this ASOP.

REPUTATIONAL RISK TO THE ACTUARIAL PROFESSION

For some time, I have been saying one of the largest reputational risks to the actuarial profession in the U.S. are public pensions. This is not an insight unique to me, nor am I the first to think it. This came to the fore years ago.

The Society of Actuaries noted it as part of its strategic plan in 2011:

2.Reputational Risk–Public Pension Plans

The SOA Risk Committee is charged with identifying risks to the profession and the organization. Through their work in 2010 they have identified potential risks that could have long term lasting effects on actuaries. This initiative will address the reputational risk to the actuarial profession arising from the current state of public pension plans.

It was noted in a NY Times piece in 2013:

A few years ago, with the debate still raging and cities staggering through the recession, one top professional body, the Society of Actuaries, gathered expert opinion and realized that public pension plans had come to pose the single largest reputational risk to the profession. A Public Plans Reputational Risk Task Force was convened. It held some meetings, but last year, the matter was shifted to a new body, something called the Blue Ribbon Panel, which was composed not of actuaries but public policy figures from a number of disciplines. Panelists include Richard Ravitch, a former lieutenant governor of New York; Bradley Belt, a former executive director of the Pension Benefit Guaranty Corporation; and Robert North, the actuary who shepherds New York City’s five big public pension plans.

This project has drawn fire from a large number of public pension officials. They recently wrote the Society of Actuaries a joint letter, urging it to reconstitute the Blue Ribbon Panel by adding more people “who can provide insight” into the many benefits of the current method, and expressed great concern about switching to a new one that could cause confusion and volatility. Of possible interest to the bondholders and taxpayers of Detroit, they also said that as fiduciaries they were required to “put the interest of all plan participants and beneficiaries above their own interests or those of any third parties.”

Much of the theoretical argument for retaining current methods is based on the belief that states and cities, unlike companies, cannot go out of business. That means public pension systems have an infinite investment horizon and can pull out of down markets if given enough time.

As Detroit has shown, that time can run out.

Oh right, that was the Detroit bankruptcy. And pensions were cut. To current retirees, even.

The actuarial profession in the UK took a hit in the early 2000s due to the failure of Equitable Life Assurance Society, the world’s oldest mutual insurer.

The very short version of the story is that the company sold annuities with certain guarantees, and the actuaries essentially counted those guarantees as worthless. What I mean by that is they said extra money didn’t need to be held to make sure those promises would be kept above what they would hold for the annuities without the guarantees.

This was foolish for multiple reasons, and the biggest reason of all was that reality came and hit…. and the company essentially got wiped out due to the very large value of those guarantees.

There were inquiries in the UK, and one result was the huge loss of reputation for the actuarial profession, and they lost their independence. More here if you care to know.

My comment in 2011 re: the SOA’s look at public pensions as a reputational risk:

In any case, we should be happy there are so many bad actors in the worst cases [where it’s most likely that even current retirees will have to take a hit] that actuaries =might= escape some blame.

Of course, saying that some new benefit was going to cost nothing, that ended up costing tons [and anybody with common sense would know it would cost tons], doesn’t cover the profession with glory.

Back when the Morris/Penrose investigation/report came out in the UK, I said it seemed to me the area of actuarial work that would most likely get the U.S. actuarial profession focused on in a similar way was public pensions. Nice to see that there’s a wee bit of awareness on the SOA’s part.

The SOA made its own letter in response to the first exposure draft. I suppose they’ll respond to the current one as well.

HAVING MORE THAN ONE MEASURE FOR A LIABILITY IS JUST FINE

One of the things people complained about in the prior exposure draft is that there would be a new measure, ISDM, that’s not attached to the other accounting standards out there. And that it would be confusing, supposedly, to do the standard valuation and have this other measure out there, too.

I will point out that many valuation actuaries in insurance have to report two sets of values for the same liability (if not more):

• STAT — statutory reserves, which is intended to protect the policyholder
• GAAP — generally accepted accounting principles – a different, less conservative measurement, intended to give good information about “true” value to shareholders of the insurance company

This new measure, IRDM, is a kind of “risk free” measure of pension promises, which is far from what is done for public pensions, to say the least.

In my post from July 2018:

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?

…..
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.

…..
Actuaries have to explain more than one measure for the same liability all the time. What’s so special about pensions?

And here is the point: there really is nothing special about pensions.

There is nothing magical about pensions that guarantees they will get paid, even if there is a constitutional clause that says that is supposed to happen. If there’s not enough money… there is not enough money.

Because there is nothing magical about pensions, it seems fine to me that there would be more than one measurement of the liability for different purposes.

NEW EXPOSURE DRAFT COMMENTS END APRIL 30, 2020

I haven’t read the second exposure draft yet. I am working through the responses to the comments from the first one.

I liked this bit:

Comment

Several commentators suggested that the required disclosure is an unwelcome contribution to a political campaign against public sector defined benefit pension plans.

Response

The reviewers disagree.

The discussions I have had with others about the IRDM is “It would make DB pensions look too expensive!” … and thus, how this would mean it would be fodder for those wanting to obliterate public DB plans.

Well, these promises are very expensive. Or, rather, some of them are. I have looked at a variety of benefit formulas lately, and some of the very well-funded plans have modest promises. Perhaps some should take a lesson from that.

MY LETTER FROM 2018

It looks like I didn’t post my letter on my blog in 2018, so here it is. Rather than use the “quotes”, I’ll just copy paste it below in its entirety.

Dear Members of the Actuarial Standards Board (ASB) and the Pension Committee of the ASB:

I am a life-annuity actuary who has been following issues surrounding public pensions and multiemployer pensions for some years. In addition to my interest as a taxpayer and having many friends and family who are public pension participants, my main interest is the reputation of the actuarial profession.

I have read through response letters to the draft exposure of ASOP 4 as of this date, and I generally agree with the thrust of the letters from Edward Bartholomew, Gordon Latter, David G. Pitts, and Larry Pollack, dated 23 July 2018; from Robert North, dated 24 July 2018; and from the Society of Actuaries, dated 19 July 2018 with respect to the Investment Risk Defeasement Measure (IRDM).

I want to address three general types of objections to the IRDM.

1. The confusion of having more than one measure for the same liability

Actuaries in non-pension fields often must calculate liability valuations on different bases, that are used for different purposes. The most obvious example here are statutory reserves versus U.S. GAAP reserves for insurance liabilities. One measure is intended to protect policyholders by being somewhat conservative (not to mention risk-based capital requirements above that), and the other is to provide useful financial accounting for shareholders. For life insurance in specific, STAT and GAAP results can be extremely different, and actuaries have had to provide context as to why this is the case.

To quote the SOA letter of 19 July: [emphasis added]

“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.”

Actuaries can explain that the IRDM was intended to provide a “risk-free” valuation of already accrued pension benefits, to separate what is supposed to be un-risky promises from sometimes very risky assets. I am sure there can be some sort of standard language to give an explanation that may be less contentious than, say, “the taxpayer/bondholder/participant put value” as the difference between the IRDM and the pension value reported for accounting purposes.
 
2. How to deal with non-guaranteed benefits

This is in context of trying to calculate the IRDM, when there are risk-sharing elements of the pension benefits or other non-guaranteed elements. There are similar challenges in valuation of life-annuity products, which often have non-guaranteed elements with risk-sharing characteristics.

I agree some sort of guidance would need to be given as to how these elements are handled in an IRDM calculation, similar to ASOPs covering nonguaranteed elements of life/annuity contracts (ASOP 52, Principle-Based Reserves for Life Products under the NAIC Valuation Manual, seems the most relevant for a starting point on guidance.)

3. The issue of providing information/communication to non-principal stakeholders

Again, this situation is not unique to pension actuaries. Actuaries working for insurers as their principals often find other audiences for their work: policyholders, regulators, and credit rating agencies, for instance. Government actuaries may have their governmental employers as principals, but the public obviously has an interest in their work as well.

There are obviously very interested parties outside the plan sponsor or the pension fund trustees: plan participants, bondholders of the sponsor, and taxpayers who are asked to provide the backstop for these plans (whether public or private pensions).

This is where my interest of the reputation of the actuarial profession comes in.

We are expected to be the disinterested quantifiers of contingent liabilities. Our profession has had a reputation of high integrity such that our reports and calculations could be relied on. While this does not occur frequently, actuaries have refused to sign off on what they considered insufficient reserves, sometimes resigning their positions. The former chief actuary of Medicare, Richard Foster, considered resigning when his “principal” (a.k.a. the Executive branch of the U.S. government) tried to block him from communicating his analysis of proposed changes to Medicare to the Legislative branch. As Barbara Lautzenheiser, then-President of the American Academy of Actuaries wrote about Foster in April 2004:

“We support the principle that sound, unbiased actuarial analysis should be available to decision-makers, in both the public and private sectors. The open exchange of information is crucial to our democracy. The news reports have brought to the public’s attention the value of actuarial analysis and the role of the actuary in determining national policy.”

While actuarial organizations such as the Academy provide independent information for public policy-makers, given the multiplicity of pension plans in the U.S., the actuaries working directly on them are in the best position to show the specific risks being taken in those specific plans. The “principal” may not be interested in that risk being exposed, no more than did some insurers wishing too low reserves or a presidential administration that wanted to low-ball prospective policy costs.

In this, I agree with Robert North’s letter of 24 July:

“As noted, actuaries are often not the decision makers on the actuarial assumptions and methods employed to determine financial commitments to many Public and Multiemployer Pension Plans. In these cases, actuaries may, nevertheless, be perceived by the public as responsible (i.e. the actuaries are the experts) and subject to ridicule if they try to hide behind the “it was not my decision” defense when things go wrong. This suggests that having strong actuarial standards is important to protect, not just the actuaries, but Plan participants, the public and everyone else involved with Pension Plan financing.”

I also agree with the SOA when it writes in its comment letter of 19 July:

“The SOA Board recommends this measure [IRDM] 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.”

If the ASB does not include a measure substantially similar to the IRDM, the likelihood is that other, non-actuarial, parties will continue to encroach upon actuarial analysis in the sphere of pensions, and that the actuarial profession will lose credibility in being able to contribute to policy development in this area.

Thank you for this opportunity to comment,

Mary Pat Campbell, FSA, MAAA

MORE TO COME

As I said, I have not yet read this draft, and I may not even have comments to send, given how the committee responded to the last set of comments.

Here is part of their introduction to the draft:

One of the suggestions made by the Pension Task Force was the calculation and disclosure of a solvency value for all valuations of pension plans done for funding purposes. This disclosure was referred to as an investment risk defeasement measure in the first exposure draft and a low-default-risk obligation measure in this exposure draft. The ASB believes that the calculation and disclosure of this measure provides appropriate, useful information for the intended user regarding the funded status of a pension plan. The calculation and disclosure of this additional measure is not intended to suggest that this is the “right” liability measure for a pension plan. However, the ASB does believe that this additional disclosure provides a more complete assessment of a plan’s funded status and provides additional information regarding the security of benefits that members have earned as of the measurement date.

I mean, I may send them a note to say toast them.

via GIPHY

But let me not get too exhilarated yet.