Milliman on Detroit Pension Investment Return Expectations

The expected rate of return on assets is the single most important factor in determining the present value of retirement benefits.  Milliman in their report criticizing Detroit’s official pension numbers under the heading “Optimism of investment return expectations” opines:

Based on our capital market assumptions as of December 31, 2011 we would recommend a long term expected investment return of 6.75% for a 60/40 portfolio.

In the 2010 valuations DGRS employed an assumed rate of 7.9% and PFRS employed an assumed rate of 8.0%.  Both of these rates are above what we would consider to be the top end of our reasonable range, and we expect that there is less than a 1 in 4 likelihood of meeting these assumptions.  We would recommend that the Systems review the investment return assumptions with their investment consultants.

As a VPRG (sic) for Item C in the table above, we have increased the liabilities to reflect our estimate of new liabilities if the DGRS rate was decreased 115 basis points to 6.75% and the PFRS rate was decreased 125 basis points to 6.75%

How does Milliman know that the Detroit plans have a 60/40 portfolio?  They don’t.  In the paragraph immediately preceding their recommendations:

We have not received the current asset allocation or investment policy yet, so we have based this analysis on the assumption that the Systems use a 60% equity and 40% fixed income allocation.  If the actual allocations and/or funding policy differ our results will change.

FRIG* indeed as Milliman’s ‘analysis’ raises more questions:

  • What then is the asset portfolio that WOULD justify a 7.9% or 8% rate of return?
  • What about that portion of the trust ($500 million annually) that gets 0% return since it needs to be distributed each year to pensioners with no money presumably coming in from the bankrupt plan sponsor?
  • What about the return assumption Milliman is using in their June 30, 2012 valuation of the New Jersey Teachers’ Pension and Annuity Fund (page 53), 7.9%?

Applying Milliman’s Detroit rationale to what they do in New Jersey:

OFFICIAL NUMBERS @ 6/30/12 (in billions)
…………………….………TPAF

Actuarial Assets..………31.1
Liabilities………….…….51.4
Deficit……………….….-20.3
Funded Ratio…..………..60%

Now switch to Market Value of Assets:

OFFICIAL NUMBERS WITH ASSETS AT MARKET @ 6/30/12 (in billions)
……………………………TPAF
Market Assets…………26.1
Liabilities……………….51.4
Deficit………………….-25.3
Funded Ratio…………51%

Bump up liabilities by 25% for a less optimistic interest rate and mortality assumption:

DETROIT LIABILITIES WITH MARKET VALUE @ 6/30/12 (in billions)
……………………….……TPAF
Market Assets…..………26.1
Detroit Liabilities….……64.2
Deficit…………………….-38.1
Funded Ratio………..…..41%

Millimans’s FRIG* on Detroit’s valuations resulted in funded ratios (before consideration of the Pension Obligation Bonds which we will get into in the next blog) for the DGRS of 47% and the PFRS of 63%, both far higher than the 41% they would have gotten had they applied their Detroit methodology to the New Jersey plan they provide cover to.
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* Fantastically Rough Initial Guessitmate

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