Don’t Frighten the Children (about Illinois Pensions)

Illinois public pension plans are in critical financial condition and were benefits valued using reasonable assumptions the picture would be even worse.  So what is Illinois doing about this?  Last summer the state hired an outside actuarial firm to “review assumptions and valuations prepared by actuaries retained by the boards of trustees of the State-funded retirement systems….and…recommend changes.”

Recently released was their work product, all 190 pages, though only these three pages are likely to be read and only this line likely to be publicized:

“Cheiron reviewed the actuarial assumptions used in each of the five systems’ actuarial valuations and concluded that they were reasonable.”

Which is what they were paid to conclude. However though Cheiron avers that “the interest rate assumptions for each of the five systems were reasonable at this time…..for three of the systems (TRS, SURS, and SERS), Cheiron recommended that the Boards consider lowering the interest rate assumption in the future.”

Those interest rates are: TRS – 8%; SURS – 7.75%; SERS: 7.75%;
The others: JRS: 7%; GARS: 7%

Though most people aren’t qualified (or inclined) to read through the report and argue actuarial concepts, there are some obvious questions that would give even a child* pause:

Actuarial Error Has Wider Implications

An actuarial firm miscalculated optional forms of benefit in a bunch of California public pension plans by disregarding cost-of-living-adjustments (COLAs) in their calculations.  According to the article where it was reported:

For example, consider someone retiring at age 57 who designates a 27-year-old beneficiary. According to Angelo, the pension payments to both are 12 percent higher than if the cost-of-living adjustments had been factored in. The younger the surviving beneficiary, the greater the overpayment.

What does this mean to those retirees and, more importantly, to states like New Jersey who are eliminating COLAs?

Pension Funding Flaws

Public pensions are collapsing in part because of flawed actuarial methods.

Ivory tower concepts like believing the sponsor will be put in what they’re told to put in don’t work in states like New Jersey.   But, beyond that, presuming that you will earn 8% on phantom assets could require you to earn 16.67% on what you actually have.  Taking the most basic example:

Real Number on New Jersey Pensions – 6/30/11 update*

The June 30, 2011 valuation reports are out.

You might be seeing numbers tossed at you regarding deficits in the state pension of $40 billion and a funded ratio of 67%.  They’re way off.  Based on actuarial reports for the three largest plans I put the real deficit now at $162 billion and the real current funded ratio at 30%. Let’s take this in stages as we replace official figures with real-world ones for the three largest plans.

OFFICIAL NUMBERS @ 6/30/11 (in billions)
……………………………TPAF………..PERS……..PFRS……………TOTAL
Actuarial Assets………32.2…………29.1………23.2……………..84.5
Liabilities……………….49.9…………43.3……….30.9…………..124.1
Deficit………………….-17.7…………-14.2……….-7.7……………-39.6
Funded Ratio………..64.5%………67.2%…….75.1%………….68.1%

The funds did not really have $84.5 billion in assets at June 30, 2011. The ‘actuarial value’ in this case means an average of the the asset values over the last five years which in the private sector is used to ‘smooth’ valuations but in the public sector is used to distort. Just because the plan held Lehman stock that was worth something in three of the last five years they get to pretend they really have more money now. Here are the figures when we use market value of assets:

OFFICIAL NUMBERS WITH ASSETS AT MARKET @ 6/30/11 (in billions)
……………………………TPAF………..PERS……..PFRS……………TOTAL
Market Assets…………27.4…………25.7………21.3……………..74.4
Liabilities……………….49.9…………43.3……….30.9…………..124.1
Deficit………………….-22.5…………-17.6…….. -9.6……………-49.7
Funded Ratio………..54.9%………59.4%…….68.9%………….60.0%

Next, we turn to the liability side of the ledger. As I detailed previously on TPAF the underlying assumptions upon which the value of these promised benefits are based (primarily the 8.25% interest assumption in a plan that now demands liquidity) understate the true benefit costs. Here are the figures using realistic liability valuations:

BURY NUMBERS WITH MARKET VALUE @ 6/30/11 (in billions)
……………………………TPAF………..PERS……..PFRS……………TOTAL
Market Assets…………27.4…………25.7………21.3……………..74.4
Bury Liabilities…………75.0…………65.0……….46.0…………..186.0
Deficit………………….-47.6…………-39.3……. -24.7…………..-111.6
Funded Ratio………..36.5%………39.5%…….46.3%………….40.0%

Next we turn to the COLA theft.  2010 liability numbers were adjusted for the plans to take into account the elimination of all future Cost-of-living adjustments that public employees were promised - in writing.  Were that reinstated the respective adjustments that artificially lowered liabilities will need to be reinstated to the tune of 17% (TPAF), 12% (PERS), and 16% (PFRS) giving us:

BURY NUMBERS WITH MARKET VALUE AND COLA (in billions)
……………………………TPAF………..PERS……..PFRS……………TOTAL
Market Assets…………27.4…………25.7………21.3……………..74.4
Bury/COLA Liab………87.7…………72.8……….53.4…………..213.9
Deficit………………….-60.3…………-47.1……. -32.1…………..-139.5
Funded Ratio………..31.2%………35.3%…….39.9%………….34.8%

Now remember these numbers were as of June 30, 2011. The latest report from the Division of Investments shows assets at $69.6 billion and we can add another year of accruals to the liability side:

BURY/COLA WITH MARKET VALUE @ NOW (in billions)
……………………………TPAF………..PERS……..PFRS……………TOTAL
Market Assets…………25.6…………24.0………20.0……………..69.6
Bury/COLA Liab………95.0…………79.0……….58.0…………..232.0
Deficit………………….-69.4…………-55.0……. -38.0…………..-162.4
Funded Ratio………..26.9%………30.4%…….34.5%………….30.0%

For the year ended June 30, 2011 there was about $7.6 billion paid out in benefits from these three funds. With early retirement incentives, the return of cost-of-living adjustments, longer life expectancies, and baby-boomer retirements this payout number should exceed $10 billion in three years by which time the fund will be depleted (after returning the interest-adjusted contributions made by employees) unless, of course, New Jersey politicians step up and do the honorable thing. There’s a debate as to whether you can put a number on that happening.

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* This is an update of pieces I did on April, 2009 and February, 2010 , and February, 2011 with minor changes in the text.

Detroit: A pension fantasyland

Headlines blare: “Detroit Avoids Fiscal Collapse With Landmark Pension Overhaul“

The reality is quite the opposite.  As in New Jersey, Detroit has assured fiscal collapse by passing weak reforms that artificially reduce contribution ‘requirements’ while leaving the unsustainable benefit structure in place and even crowing about their accomplishments.

How Governor Christie unknowingly lied about lower property taxes from pension reform

One of the failings of mass media is that they generally do not have either the time, space,  wherewithal, or inclination to explain what official sources provide for dissemination.

So it is with New Jersey Governor Christie’s prediction about the pension reforms enacted this week that the “first time folks on the property tax side will really see a benefit is in the August 2012 bills”.

Why August, 2012 and will your tax bill really be lower then?

The Pension Crisis and the Systemic Failure of the Actuarial Profession

The global pension crisis has revealed the need to rethink fundamentally how pension systems are regulated.  It has also made clear a systemic failure of the actuarial profession.

Since the 1970s, most actuaries have developed and come to rely on models that disregard key factors – including political whims, longer life expectancies, and lower investment returns when liquidity is paramount – that drive outcomes in asset and other markets.  It is obvious, even to the casual observer, that these models fail to account for the actual evolution of the real-world economy.  Moreover, the current fee-generating agenda has largely crowded out research on the inherent causes of the pension crises.  There has also been little exploration of early indicators of systemic crisis and potential ways to prevent this malady from developing.  In fact, if one browses through the academic actuarial literature, “systemic crisis” seems to be an otherworldly event, absent from actuarial models.  Most models, by design, offer no immediate handle on how to think about or deal with this recurring phenomenon.  In our hour of greatest need, societies around the world are left to grope in the dark without a theory.  That, to us, is a systemic failure of the actuarial profession.