Wednesday, October 29, 2014

Actuaries: Telling Pension Trustees What They Want to Hear

Actuaries: Telling Pension Trustees What They Want to Hear

Just over a year ago, I wrote a blog post implicating money managers and actuaries in helping to drive up public pension deficits.  My post was prompted by Mary Williams Walsh’s reporting in The New York Times about the unsound decisions made by the trustees of Detroit’s public pension.[1]  Her article had focused entirely on the actions of the board.  Today, Ms. Walsh reports that a retiree in the City of Detroit, municipal police and firefighters, and workers in Wayne County are suing Gabriel Roeder Smith & Company for actuarial malpractice.[2]  The lawsuit contends that the actuary recommended various accounting practices that resulted in the systematic underfunding of the pension plans and repeatedly attested to the soundness of those plans.

The entirety of actuarial mathematics is hard for many trustees (and money managers) to grasp.   Most of us focus on investment returns and benefits, but don’t spend much time making sure that the two are properly connected.  We assume that the actuaries have proposed assumptions that are financially sound.  As I wrote a year ago, we’ve been making a bad assumption about the assumptions that underpin public pensions.

Until I can dig deeper into these lawsuits, it’s hard to say whether they have any merit.  However in reading Ms. Walsh’s article, it appears that many of the assumptions that helped drive up Detroit’s pension deficit were the same ones employed by public pension plans across the country and utilized by most actuaries.  For years, actuaries have been giving trustees the advice needed to maintain or increase benefits, while minimally funding pensions.   There’s nothing unique here.  Like every other governing body, pension trustees prefer to push financial burdens into the future.  In other words, actuaries have been giving trustees exactly what they want.

Ms. Walsh highlights two of the mundane assumptions that have a large impact on the long-term health of public pensions.  In order to properly estimate a pension’s long-term liability, the trustees have to make an assumption about the future growth of the public payroll.  The faster the payroll grows, the larger the future contributions that will flow into the pension to help fund it.  In Detroit, they used a 5% assumption, which turned out to be wrong.  It was only in the last couple of years as Detroit’s government shriveled that the actuary advised the trustees to rethink that assumption.

Since most pensions run some type of current deficit, the trustees have to agree on a time period over which to make the additional contributions needed to bring the plan into balance.  A longer time period dramatically decreases the present requirement to eliminate the deficit and pushes the problem into the distant future.  In Detroit, they were using a thirty-year horizon (North Carolina’s Teachers’ and State Employees’ Retirement System uses a much more reasonable 12-year period). As Ms. Walsh reports, public pension plans reset this amortization period each year in hopes of pushing the problem indefinitely into the future.

The bottom line is that we don’t like to pay for stuff now, whether it’s personal expenditures or public obligations.  As consumers, we’ve run up $3.1 trillion in consumer debt (not including mortgages).  I’m not suggesting that we should totally get rid of credit cards, student loans or automobile leases.  However, we’d be better off and more stable in the long run if we put down a bit more cash upfront.  The same is true of public pensions, which are running a collective deficit of some $2 trillion.  While there’s no reason to eliminate the deficit overnight, here to we need to put more money in upfront.

While the actuaries may escape legal liability, there’s little doubt that they’ve been important enablers in destabilizing the long-term health of our public pensions in Detroit and across the country.  Telling trustees they need to put more money into pension plans or trim benefits isn’t good for an actuary’s business. However, it is the truth. 

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