Responding to the Sept. 6 editorial “Reality and rates of return”:
Unrealistic rates of return are only part of the problem; much worse is the use of return assumptions as liabilities' discount rate. Asset returns have neither fundamental nor statistical relationships to liability cash flows (though they share a common factor, inflation).
If the Governmental Accounting Standards Board and the Actuarial Standards Board have refuted Modigliani and Miller, as their “standards” imply, then they, too, should be awarded Nobel prizes. (But if M&M are refuted so, too, is most of modern portfolio theory!)
I took the liberty of copying into Excel data from Pensions & Investments' recent plan sponsor rankings to correct actuarial liabilities to the time-value of money using Treasury bond yields as of each fund's valuation date. (GASB should require plans to disclose estimated annual benefit payments. Until then, actuarial liabilities are the data we have.) Adjusted to the proper discount rates, these 91 plans have liabilities of $4.74 trillion, not the $3.21 trillion reported.
Ten of the 91 plans listed by P&I didn't have “total DB assets,” so I used their actuarial assets; on that basis, the 91 have total defined benefit assets of $2.35 trillion. This means they are underfunded by $2.39 trillion, not the reported $0.86 trillion. Scaling up for a larger sample, these results are very similar to the $3.12 trillion underfunding tallied by professors Robert Novy-Marx and Joshua Rauh in their recent papers.
To put it in perspective, this problem is several times larger than “subprime” — and we all know how much fun that has been! My (unpublished) research proves that, historically, defined benefit plans should have worked. Instead of directing their anger at each other, taxpayers and beneficiaries should be directing it at those responsible for this failure, while less passionately seeking a fair solution. This failure is something the Securities and Exchange Commission must continue to explore — with San Diego and New Jersey, it has only just scratched the surface.
Jack R. Buchmiller