Open Amortization Paper

Number three on the list of actuarial gimmicks for public pension funding (after allowing negative cash flow and asset smoothing) is a perverse method of amortizing unfunded liabilities that is  accepted within the politician/actuary cabal to understate contributions. Independent observers (or those not being bribed for an opinion) decry open amortization and now we have a scholarly work on the subject.

An analysis of state pension plans from across the country finds that the already troubling state of pension finances may be even worse than it first appears because many pension managers are making their plan’s financial condition look better by perpetually putting off payments.

“Imagine having a 30-year mortgage and each year, instead of making your mortgage payments and having 29 years of payments left, you simply re-amortize the remaining liability over another 30-year period,” says Jeff Diebold, an assistant professor of public policy at North Carolina State University and lead author of a paper on the analysis.

“Using this approach, you can manufacture lower amortization payments for yourself, but you will not eliminate the underlying liability,” Diebold explains. “That’s called open-ended amortization, and despite being an unscrupulous accounting practice, it is widespread among state pension plans.”

State officials can adopt open-ended amortization to reduce the amount the state must contribute to the pension system each year or to improve the appearance, but not the reality, of the state’s current funding effort. Regardless of the reason, open-ended amortization exacerbates funding shortfalls, compounding the risk that the state will have insufficient funds to pay its pension obligations to retired state employees.

“Worse still, we find that officials are most likely to adopt open-ended amortization periods when their plan’s financial condition worsens and would otherwise require higher contributions from the state,” Diebold says.

The paper itself requires a $38 investment for the pdf or $6 to be able to read it for 48 hours. I am not sure about copyright issues with this system but I went with the $6 and here are highlights from my reading:

In 2012, GASB updated these standards with Statements 67 and 68, which specified the entry age method as the only method that plan administrators should use to calculate their plan’s normal costs. The new standards also stated that plans should amortize their unfunded liabilities over a defined, closed period.

The “working assumption” of studies analyzing plan administrators’ choices regarding the accounting methods and actuarial assumptions is that these decisions are influenced by the interests of political actors to keep pension costs to the state low (Stalebrink 2014). Administrators are expected to be sensitive to political preferences of elected officials because, oftentimes, the positions on a state’s pension board are filled by political appointment (Matkin, Chen, and Khalid 2016)….In this context, the opportunistic behavior of plan administrators involves the adoption of accounting and actuarial assumptions favored by state policymakers in exchange for a position on the state’s pension board, which are usually among the highest paying public service positions in state government.

Pension expenses compete directly with the other spending priorities of a state. When the plan’s circumstances generate more fiscal stress, the plan administrators appear to act in the short-term interests of the state to reduce the financial commitment a state’s pension obligations require rather than in the long-term financial interests of the employees to have fully funded pension benefits.

In closing, the results presented here suggest that manipulative pension accounting practices extend beyond the state’s expected rate of return to include other parameters whose effect on the required contribution amount is more subtle, but nevertheless important. The apparent willingness of plan administrators to adjust the specific parameters to paper over the source of their plan’s funding problem suggest the need to  reevaluate the loose regulatory environment in which these actors operate. Their actions obscure the true cost of these benefits to taxpayers and compromise security of the public defined benefit system that provides them to workers.

27 responses to this post.

  1. Posted by Anonymous on June 20, 2017 at 11:45 pm

    In other words, it’s a racketeering enterprise involving all stakeholders; the Public Sector Unions, the Elected/Appointed Officials, and the recipients of Public Sector pensions ………….. with the Taxpayers being treated as the “sucker” to be abused.

    Reply

    • Posted by Anonymous on June 20, 2017 at 11:51 pm

      Abused, because if Public Sector pensions HAD TO BE valued on an appropriately conservative basis (using Closed Amortization, market value of assets, and discount rates in the 3% to 4% range …. as they are in the valuation of PRIVATE Sector Plans), the resulting ARC’s would be so unacceptably great that it would be obvious that the ROOT CAUSE is, guess what ……………… grossly excessive pension promises.

      Reply

  2. Posted by Anonymous on June 21, 2017 at 8:25 am

    It sounds what they call in the private sector as debt restructuring and refinancing, oh that’s different!

    Reply

  3. Posted by skip3house on June 21, 2017 at 11:53 am

    Like was said earlier….K.I.S.S. for 8th grade arithmetic understanding

    Reply

  4. Posted by S Moderation Anonymous on June 21, 2017 at 1:22 pm

    How many and how much?

    How many states still use open amortization, and how much does that affect the nominal funding status and ARC in most cases?

    According to a recent Diebold paper, the practice has decreased, but it doesn’t mention how much these actuarial practices affect the ARCs.

    “According to the figure, nearly 60% of all plans amortized their unfunded liabilities in 2006; since that time, the share has fallen to roughly 35%.”

    http://onlinelibrary.wiley.com/doi/10.1111/coep.12236/full

    Reply

    • Posted by Anonymous on June 21, 2017 at 1:38 pm

      Had a good laugh………….

      I always thought “Diebold” was a manufacturer of night depository safes.

      Now I find that there is a Jeff Diebold who writes about pensions.

      Reply

      • Posted by Anonymous on June 21, 2017 at 2:01 pm

        It’s nice to reference and rely on (or refute as the case may be) source info that’s contrary to one’s opinion and ultimate goal – the destruction of DBP!

        Reply

        • Posted by Anonymous on June 21, 2017 at 2:46 pm

          Not sure why you’re responding to my above comment this way, but YEAH, the END (via freezing for the future service of all CURRENT employees) of DB Plans is indeed a necessary, just, fair (to taxpayers), and desirable goal.

          Reply

  5. Posted by S Moderation Anonymous on June 21, 2017 at 4:00 pm

    In their paper, “Sweat the Small Stuff,…” Diebold (and Vincent Reitano and Bruce McDonald)

    refer to a common theme in public pension practice… deferred compensation. Public workers accepting both lower wages from the state than they could potentially earn in the private sector and lower wage growth in exchange for the promise of higher income in retirement.

    ” In the past decade, almost all states have reformed their pension systems to reduce either, or both, the benefits paid to current retirees and those promised to future retirees. Some of the most common reforms have included a reduction in, or elimination of, cost-of-living adjustments, modifications to the retirement benefit formula, increases in vesting requirements, and increases in the retirement age. As a result, many public workers can expect to receive less pension income in retirement and expect inflation to more rapidly erode what remains.”

    “Such reforms would be particularly unfortunate for the public employees who have willingly accepted both lower wages from the state than they could potentially earn in the private sector and lower wage growth in exchange for the promise of higher income in retirement. By reducing the value of pension benefits, states also reduce the magnitude of the compensating differential for these workers and, thereby, consign them to a lower standard of living both throughout their working lives and in retirement.”

    Got a problem with EQUAL?

    May be…

    They too are asking the wrong questions?

    Reply

    • Posted by Anonymous on June 21, 2017 at 5:43 pm

      Quoting ……………..

      “Public workers accepting both lower wages from the state than they could potentially earn in the private sector ……. ”

      Yeah, “potentially” ………….. for the REALLY smart, the REALLY hard-working, the REALLY honest, and the REALLY productive. Not many Public Sector workers with all of those attributes.
      *************************

      Quoting …………

      “By reducing the value of pension benefits, states also reduce the magnitude of the compensating differential for these workers and, thereby, consign them to a lower standard of living both throughout their working lives and in retirement.””

      WOW, looks like you didn’t read THAT quoted statement very carefully !

      By saying that a REDUCTION in pension benefits, REDUCES the “magnitude of the compensating differential”, it is CLEARLY saying 2 things:

      (a) Before the pension benefit reductions, Public Sector compensation were HIGHER than that of their Private Sector counterparts, and
      (b) Even AFTER the pension benefit reductions, they REMAIN higher.

      Glad you posted that …. just like I have been saying all along.
      *********************

      And why should Private Sector workers CARE if those pension benefit reductions ….”consign to a lower standard of living both throughout their working lives and in retirement.” ….. when Public Sector compensation REMAINS greater than their own ?

      Reply

  6. Posted by S Moderation Anonymous on June 21, 2017 at 6:35 pm

    Reading comprehension.

    A) Public workers accept both lower wages from the state than they could potentially earn in the private sector and lower wage growth.

    B) The “promise of higher income in retirement.”.. IS the “compensating differential”. And what do we call that ?

    Anyone, anyone, Bueller, Bueller?

    C) Correct… deferred compensation.

    D) The higher pensions (and OPEBs) compensate for the lower wages Nowhere does Diebold say the public compensation is “HIGHER”.

    E) And nowhere does he say they will “REMAIN” higher.

    That is your own parallax vision. You can’t hide your lyin’ eyes.

    Reply

    • Posted by Anonymous on June 21, 2017 at 7:25 pm

      SMD,

      Above I said ….
      *************************************
      Quoting ……………..

      “Public workers accepting both lower wages from the state than they could potentially earn in the private sector ……. ”

      Yeah, “potentially” ………….. for the REALLY smart, the REALLY hard-working, the REALLY honest, and the REALLY productive. Not many Public Sector workers with all of those attributes.
      *****************************************

      I was too soft in that last paragraph, and SHOULD have said….

      Yeah, “potentially” ………….. for the REALLY smart, the REALLY hard-working, the REALLY honest, and the REALLY productive. Not many Public Sector workers with all of those attributes when measured against PRIVATE and not PUBLIC Sector standards.

      Reply

    • Posted by Anonymous on June 21, 2017 at 7:52 pm

      SMD, Of course Public Sector workers earn ….POTENTIALLY …..less than they could earn in the Public Sector.

      Absolutely, all of them …………… with their cradle-to-grave need for security, with running for the door the minute the clock strikes 5 PM, and with running to their Union reps for sick-time/compensation/disability if they break a finger nail …………… would undoubtedly have become the Gates, the Paiges, the Jobs, the Bezos, the Zuckerbergs, and the Musks of the world.

      Reply

  7. Posted by S Moderation Anonymous on June 21, 2017 at 9:09 pm

    Oooophs ………

    Careful, when you get into full-rant mode you might accidentally end up insulting yourself.

    As Anonymous said (June 19, 2017 at 7:41 pm)

    “Then by all means we should stop, wouldn’t want to scare TL into hiding again, LOL…..”

    Reply

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