PEPTA Redux (2) Public Plan Actuary Explains Valuing Liabilities

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:

  1. Pick an interest rate that you believe your assets will get
  2. Use that interest rate if, and only if, the plan is 100% funded
  3. 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.

6 responses to this post.

  1. Posted by dentss dunnigan on March 10, 2016 at 2:59 pm

    With the current interest rate as low as it is and a 6 billion yearly net outflow and growing from new retirees ….I just scratch my head and say no way could this fund ever be fully funded ,at best the hope now is to slow down the leakage .On the horizon I see low rates to negiative rates with the stock market moving sideways ….the ship has sailed for this state because the only way to play catch up is for economic growth ,but all the Democrats ever want to do is raise taxes an increase the min wage and expand sick leave ,that hardly makes business want to flock here. The state must attract jobs we’re at the bottom of the list for business friednly .The only alternative is to cut public payroll we have 550,000K employees cut 10% and at best save 1.5 to 2 million dollars to throw into the pensions .

    Reply

    • Posted by Now retired Pat on March 10, 2016 at 4:16 pm

      I agree. My staff audit team of 7 could easily be reduced to 4 with the same result. But keep in mind this; all new employees must have a college degree and the starting salary has to be at least $50K to get new recruits. So I suggest to raise the starting salary to $75K and ELIMINATE/REDUCE the pensions and benefits formula. That takes care of the service end. For the retired and soon-to-retire, there we have a problem. I suggest a graduated DECREASE in current benefits for retirees making more than $100K per year. Specifically, 20% immediate decrease for those above $100K; 15% decrease for those between $75K and 100K; 10% for those between $50K and $75K.

      Lastly, Medical should never be free. Every retiree should pay a much larger deductible, again graduated by years of service and annual pension. Haircut? absolutely. Completely bald? NO!!

      Reply

      • Posted by Tough Love on March 10, 2016 at 6:41 pm

        Quoting …. “My staff audit team of 7 could easily be reduced to 4 with the same result.”

        So why didn’t you recommend that while you were working ?

        Is it ………….who-cares/why-rock-the-boat/not-my-problem ….. because it’s only the Taxpayers’ money ?
        ————————————

        Earth to now retired pat, you had an obligation to your employer …. NJ’s TAXPAYERS ……….. and you failed that obligation miserably ………. and as such, you hardly “earned” that pension you so ferociously protect.
        ———————————–

        That said, I agree, we should pay “market rate” wages” as determined by what such jobs pay in the Private Sector (assuming equal levels of productive OUTPUT …. meaning the 40 hr/wk Public Sector CPA should be paid 2/3 the wages of the 60 hr/wk Private Sector CPA) and grant pensions and benefits NO GREATER (as a % of pay) that those typically granted Private Sector workers.

        This structure, because what is “accrued” TODAY must be paid for TODAY would halt the grossly unjust pushing-off of current operating costs to FUTURE generations of taxpayers. And because such pensions/benefit accruals have to be aid for in cash TODAY, our States, Cities, and towns would no longer be able to promise more than they can actually afford.

        Reply

      • Posted by PSDrone on March 10, 2016 at 7:21 pm

        Pat – You need to go back to work buddy. One of the main reasons the pension funds are going broke is because drones are retiring at the age of 53. Payments need to be delayed to age 66 so you would have to pick up your pencil again. After you go back you can fire the dead wood and get your team streamlined down to the 4 you actually needed.

        Reply

        • Posted by Now retired Pat on March 12, 2016 at 11:38 pm

          I have gone back to work. After only 1 month of anarchy, I became bored and needed something to do. But instead of wearing a suit/tie in an empty building just to keep up with appearances, I now run a small rental unit for kicks and giggles. Instead of working 35 hours a week with the State, I now work 30 hours and make 20% of what I used to. I do worry a great deal about the inevitable demise to Pay go. What’s a person to do? I have “arranged” all my lifestyle and finances around the fact my nice state pension would be there. Take it away, and I might get very MAD!!

          Reply

          • Posted by Tough Love on March 13, 2016 at 12:04 am

            As A CPA, you SHOULD HAVE know such absurdly generous pension & benefit “promises” would require taxes that the citizenry would NOT put up with.

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