According to the NCTR anti-PEPTA hit piece:
For a much more accurate understanding of these so-called “accounting gimmicks,” be sure to read “Understanding the Valuation of Public Pension Liabilities; Expected Cost versus Market Price,” by Paul Angelo, a well-respected senior vice president and actuary for Segal Consulting. In this article, Angelo expertly and very clearly explains how the current process used by public pension plans for measuring liabilities “imparts information about the issues that are most important to decision makers: the expected costs associated with funding promised benefits.” By comparison, the financial economists’ measures “are far less useful for public-sector plans because they are not designed to answer the critical questions facing policymakers, employers, and trustees related to the expected cost of current and future benefit obligations,” he writes.
So what does the Angelo paper tell us?
First you have to understand that AAL stands for the interest rate actuaries are told to use (around 8%) and MVL is the 4% rate that Moody’s GASB, and practically everybody not cashing taxpayer-funded checks wants to use. As most of you understand, higher interest rates mean lower liability values and lower contributions.
Angelo argues for the AAL rates that he has been using with this piece of twisted reasoning:
To the extent that funding costs are the overriding practical concern facing stakeholders of public-sector plans, it is easy to see how the AAL measurement provides viable information that can be used for hands-on decision making. Decision makers must be concerned not only with the here and now, but also with anticipating future developments. Because the AAL qualitatively and quantitatively incorporates more information than MVL measurements—information about future increases in the plan’s benefit obligations (by incorporating future service and salary increases) and about expected long-term earnings on plan assets—it more accurately measures the likely financial burden of the plan on an employer. As a result, the AAL provides useful information to an employer seeking to understand how the plan fits in with the employer’s overall financial position, or to trustees seeking to ensure the long-term viability of the plan.
Think about that. Is it really politicians’ concern for future generations that makes using rates that lowball contributions today the prudent thing to do?
I explain the flaw in a prior blog which basically justifies using a lower interest rate for underfunded plans and lays out this selection method:
- Pick an interest rate that you believe your assets will get
- Use that interest rate if, and only if, the plan is 100% funded
- Otherwise adjust the rate as appropriate
Consideration must be given to both funded status and cash flow. For example, in New Jersey we have about $4 billion coming into the plans with about $10 billion going out annually. That $6 billion difference cannot be expected to earn much from the short-term investments they have to be in so it should be ignored when estimating how much interest will be generated. Rather than doing a detailed analysis of each investment type what actuaries interested in accurate valuations do is artificially lower the interest rate based on their sense of how much earnings are lost through this negative cash flow and not being fully funded.
This methodology however is not generally accepted in the public-plan world since any actuary interested in using this technique to get honest liability valuations (and higher contributions) will also not be generally accepted in the public-plan world.