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?

First, it needs to be understood that when doing an actuarial equivalency the interest rate is the primary factor.  If you believe you are going to get 5% on money set aside to pay you an annuity then you would need more money than if you were predicting 8% earnings.  In this very simplistic numerical example I came up with I try to tie into Segal’s 12% difference for their theoretical retiree and fail (I only get a 4% difference but there may be other factors and assumptions) though the point is that there IS a difference and it does INCREASE the monthly benefit when you ignore the COLA.

Now, let’s look at the reverse situation where a state is eliminating COLAs.  New Jersey in their PERS handbook under Optional Forms of Settlement (page 23) does provide for a reduction to anyone who wants to get their payout under a form other than a life annuity.  So if the actuaries for New Jersey were taking into account future COLAs when they translated a life annuity into a Joint & Survivor annuity then the actual elimination of COLAs would mean that the monthly benefits were reduced by too much on the assumption that COLAs would be in place.  In my example it’s as if the New Jersey retiree on a J&100%S annuity would have been received $899 all these years when, with the COLA not in the picture, they should have been getting $935.*

This might be a lawsuit New Jersey public employees win.




* It is likely a bigger differential in New Jersey since the normal form of benefit is a life annuity whereas for the Contra Costa plans it’s J&60%S.  The difference with the COLA elimination could really be 12%.

26 responses to this post.

  1. Posted by muni-man on June 18, 2012 at 3:00 pm

    JB, do you know approx. what the max. and min. haircuts under Options A-D and 1-4 are?


    • It depends on relative ages, survivor percentage chosen, and the assumptions used which aren’t spelled out in the handbook. Maybe some retiree on one of these survivor pensions can contact the NJ Division of Pensions and ask about this. If you get a statement from them I’d be glad to review it.

      If I were to guess I’d say, on average, there would be 5% – 10% more if the adjustments were done without a COLA than with.

      Though any corrections now would get really complicated since you also need to adjust with interest for that portion of the payouts already made (California) or not made (NJ?). It’s a nightmare to correct this and I don’t see how Segal would do it.


      • Posted by muni-man on June 18, 2012 at 3:38 pm

        Thanks, I know there are a lot of moving parts to consider so it’s difficult to estimate with precision. I was just looking for one absolute max/min % for all the options taken collectively but I guess that’s NJ’s trade secret.


        • It’s not a trade secret but they don’t publicize it which is why something like the California error can happen – until it’s caught. Continuing my example for NJ with a 57-year-old retiree and a 27-year-old beneficiary and going from a life annuity to J&100%S a rough comparison would be:

          COLA (8.25% int): $1,000 X 160/210 = $762

          NO COLA (5.5% int.): $1,000 X 125/149 = $839

          Which means those getting $762 per month on the assumption that their benefits would continue to their spouse should have gotten $839 if there weren’t a COLA involved. That’s about a 10% difference.


          • Posted by muni-man on June 18, 2012 at 4:17 pm

            Answers my question. Thanks again, John.

          • Posted by Anonymous on June 18, 2012 at 6:12 pm

            Hey John, do you actually think we deserve the extra 10 percent or do believe like TL that we just dont deserve it anyway even without the COLA and the 10 percent reduction.

          • Posted by Tough Love on June 18, 2012 at 6:31 pm

            Anonymous, Actually, if it turns out (once the COLA lawsuits have ended without reinstatement of NJ’s COLAs) that a recalculated benefit (w/o such future COLA increases) shows an underpayment, you should indeed be reimbursed for the underpayment with interest……. just as those (such as in California) who received overpayments should have to pay it back.

            That’s called fairness … which is what I’m always looking for, and why I advocate for pension reform in general ….. because the grossly excessive pensions afforded Civil Servants are VERY unfair to Taxpayers who are responsible for paying for all but the 10-20% of total Plan costs paid for by the employee contributions (INCLUDING all the investment earnings thereon).

            And I noticed that you are again speaking for me before I even posted a comment …. which of course again shows just what a jackass you are.

        • Posted by Anonymous on June 18, 2012 at 6:46 pm

          I am actually getting bored and tired of pulling TL’s strings like a puppet. I guess she will finally get some peace.


          • Posted by Tough Love on June 18, 2012 at 6:50 pm

            You are a sorry example of a NJ Public Sector worker … I pray you are not a police officer.

          • Posted by Anonymous on June 18, 2012 at 10:40 pm

            Honestly, I think most people thank God that you are not a police officer and hopefully have no aspirations to be a police officer. I am utterly amazed that you simply cannot ignore me. I am sure if I instructed you not to ignore me, you would no doubt ignore me.

          • Posted by Elise on June 18, 2012 at 10:57 pm

            I follow TL’s comments and she really can’t help herself. She’s posted all over the place. If it’s about public pensions with space for comments sure enough there’s TL. I thought she had a job in the private sector? Can’t be too hard to have this much time on her hands……

          • Posted by Tough Love on June 18, 2012 at 11:31 pm

            Elise, I find it interesting that you “follow” my comments (on multiple sites !). So either you support pension reform and think I’m onto something, or you’re a Civil Servant “bothered” that a taxpayer (not riding this gravy train) has the audacity to upset the Public Sector pension apple cart.

            I’m guessing that you are the latter.

          • Posted by Elise on June 19, 2012 at 11:38 pm

            Am both latter and former TL. I left public sector work and am now in private. I’m using a reduced retirement to start a second career as I quit expecting my pension to be there for me over the long haul. A couple of years of following these discussions was pretty convincing that this was the smart option if I expected retirement security.

            btw…I peruse a lot of people’s comments but yours turn up almost nonstop. Seriously where do you get the time if you’re not retired?

          • Posted by Tough Love on June 19, 2012 at 11:48 pm

            Elise, Being in the financial service industry, and well versed in pensions, I’ve known for many years that this was coming. The market downturn (and the impact of reduced revenue on city budgets) just brought it to a head. I consider pension reform an obligation to my kids (and their kids), so I find the time. Besides, I work so many hours, this is a helpful diversion.

  2. Posted by dentss on June 18, 2012 at 6:40 pm

    Charles Gasparino has a secret JP Morgan report on Gov unfunded pension liabilities
    and he singles out NJ ..New Jersey faces an very big hole. Even after Christie’s reforms, it would still have to cut spending 30.8 percent or raise taxes another 17.2 percent, keeping them in place for two decades, to solve the problem… think this shortens the shelf life of our public pension system ?..


  3. Posted by Mr Surprise!!!!! on June 18, 2012 at 10:22 pm

    From the article: “Why allow retiring workers to designate someone other than a spouse or dependent minor as a recipient of lifetime pension benefits? There’s no rational answer.” Being a Cali, Contra-Costa no less, story I will guess gay marriage. Is there an unusually large difference in ages in Gay and perhaps other sub groups marriage choices? I don’t know. Might be worth trying to find out before any changes to marriage laws.

    IMO inflation adjusted annuities for young people should not be allowed. It is just impossible to predict investment return, inflation, and life expectancy that far into the future. Young people should receive lump sum life insurance payments. A compassionate exception could be given for the disabled.


  4. Posted by Javagold on June 19, 2012 at 1:40 am



  5. Posted by MJ on June 20, 2012 at 9:42 pm

    TL, I think Elise is one of those publics who retired at 55 or 58 and is now working privatelty as a consultant for some public entity sucking up another job and taking away from the college graduates. “Retired from the publci sector” is code for those who are sucking the most out of the system leaving little for anyone else. She probably has the health benefits too that she believes she is entitled to for the rest of her life. Thank God you make the time to get the word out on an many websites and blogs as you can.


    • Posted by Tough Love on June 20, 2012 at 10:15 pm

      Elise says “now Private” so that does not appear to be the situation.

      But the real problem is that granting VERY rich pensions (up to 90% of final pay … COLA adjusted), and collecting them typically at age 55 is VERY VERY VERY costly.

      Such pensions have a TAXPAYER-funded value (after subtraction the employee contributions WITH all of the investment earnings thereon) that is ROUTINELY 2, 4, (even 6 times for safety workers) greater the value of pensions typically afforded Private Sector workers by there employees.

      Since the CASH PAY of Public Sector is NOT lower than Private sector workers (per the US Gov’t BLS, even AFTER adjusting for education), there is ZERO justification for ANY greater pensions let alone ones that are ROUTINELY 2-6 times greater in value.

      Reasonable Public Sector pensions should NEVER exceed 50% of base pay (averaged of no less than the last 3 years), with unreduced payout not before age 65, and with no COLAs. THAT would be consistent with a very generous Corporate Sector pension.

      Private Sector workers must save OUTSIDE of their pensions to have a reasonable retirement. Why should Public Sector workers not have to do so as well ?

      WHY are Public Sector workers entitled to greater pensions and better benefits on our dime?


      • Posted by Elise on June 21, 2012 at 3:54 pm

        I know private workers who have retired recently with COLAs and I know ones without. Both have made way more money than public workers with equal degrees so their savings is higher. Even if they had a drop in earnings over the recession they are still ahead of public workers from high salaries prior to 08 (that is if they didn’t blow it on stupid stuff….I’ve seen that too).

        We’ll see how all this plays out but I don’t think it’s going to be pretty.


        • Posted by Tough Love on June 21, 2012 at 7:06 pm

          While I’m sure there are SOME examples of what you’ve said, I have the gut feeling that the Private Sector jobs Public Sector workers look to for comparison are not realistic. For example, one Public Sector IT workers mentions the pay at Google.

          Excuse me, but the entrepreneurial mindset Google looks for in potential hires, is about 180 degrees from the take-care-of-me-from-craddle-to-grave mindset of the typical Public Sector worker (no offense intended).

          And I agree with you …. the math leaves little option but for very material pension reductions for future service of CURRENT, not just new employees …. and it WILL get ugly.


    • Posted by Elise on June 21, 2012 at 3:29 pm

      MJ… I retired at 58 from public. I intended to continue working into my 60s but with concerns over pension stability that would have been utterly foolish. My job wasn’t in social security so even if ss lasts I don’t have it as a fall back.

      I’m not a consultant and a college graduate took over the job I left so no worries there. My retirement is 60% of my base pay and I have a high deductible health benefit that I pay part of. I don’t expect the health benefits (nor any COLAs) to last. Currently my retirement is enough combined with savings to see me through pulling a new career together that has nothing to do with my previous job. I know how to live cheap as I didn’t make a lot of money in my public career.

      As for private sector friends… mine are doing quite well and will retire far better off than I within the next few years (or they’ve already retired). Between watching them and educating myself to understand the pension mess, I made the decision to get out now while I can still start over. I will probably make more money a year in my current job than I ever did in my previous and the work isn’t as hard.

      I’m trying not to waste time with too much anger over the mess that will evolve although I certainly feel Dante’s inferno has a special level waiting for people from all sides of this. Right now my time is best spent taking care of myself and unfortunately (or fortunately depending on one’s view) it’s not in a public job. I suspect that I’m not the only post-public employee doing this as well as reading this blog. The vitriol probably keeps most from posting.


      • Posted by Tough Love on June 21, 2012 at 7:15 pm

        I liked your Dante’s inferno comment.

        May I suggest that those who should gain first entrance are our elected officials who betrayed taxpayers by accepting campaign contribution and election support from the Public Sector Unions, and in turn favorably voted on Public Sector pay, pensions, and benefits FAR in excess of what taxpayers can afford, and far greater than what was necessary to attract and retain a qualified workforce.

        Following as a close second should be the Public Sector Union officials … whom you can bet, always make sure THEIR Union pensions are 100% funded. They’ll get “theirs” even if their own Union members’ Plans fail miserably.


        • Posted by Elise on June 21, 2012 at 9:29 pm

          TL ….I don’t always agree with you but on this one you’re spot on. They both ought to be competing for the special hot spot.


  6. Posted by Dave S on June 25, 2012 at 11:52 pm

    I believe the maximum differential for a pension beneficiary is 10 years in NJ. Regarding health benefits, once a worker or retiree is eligible for Medicare, NJ requires that Medicare be primary. That means the cost to the state is only the cost of a Medicare supplement. Retirees without 25 years (life benefits) can often get cheaper coverage by passing on the State plan. New hires are no longer eligible for life benefits.

    As I’ve been saying repeatedly, the COLA lawsuit is by no means over. It may take years till it works it way through the Federal courts, but in the end don’t be surprised if the unions prevail. Better to work out a fair compromise and focus on changing the pension system itself going forward.


    • Posted by Tough Love on June 26, 2012 at 2:34 am

      You want a “fair” compromise ?

      Ok, No COLAs, a 50% reduction to formula benefits for FUTURE service benefits for current workers, and a 25% reduction in accrued benefits for PAST service for both “actives” and those already retired.

      That will still leave NJ’s Public Sector workers and retirees with much better pensions than the Private Sector workers who pay their way.

      What say you ?


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