Public retirement systems should use a forward-looking rate to discount pension liabilities rather than actual plan returns, according to a report issued by an independent panel commissioned by the Society of Actuaries.
The new rate would replace the actual long-term rate of return on plan assets generally used now to discount liabilities and set contribution levels, according to the report, which outlined actions recommended by the SOA to strengthen funding of public defined benefit plans.
The panel rejected use of a risk-free rate — or rates on the Treasury yield curve — to discount liabilities despite the basis in economic theory to balance generational risks, the report said.
“Plans should be using rates of return that they believe can be achieved over the next 20- to 30-year period with a 50% probability,” the report said.
“The panel does not believe the rate should be aggressively conservative, as doing so may lead to a surplus.” When making assumptions, “it is important to consider the extent to which future economic and market conditions may differ from those of today or of the past,” the report said, noting that “the long-term secular decline in interest rates … strongly suggests that the robust fixed-income performance of the past is not likely to be repeated in the future.”
The 68-page ”Report of the Blue Ribbon Panel on Public Pension Plan Funding” recommends using the risk-free rate as a risk management tool to discount liabilities to compare against the investment return assumption as a way to gauge the level of investment risk taken by the plan.
Among other recommendations, the panel in its report said:
- Governmental entities responsible for funding and plan trustees “should strive to fund 100%” of pension obligations. “Financial resources, including both current and future contributions, should be adequate to fund benefits over a broad range of expected future economic outcomes” and “respond to changing economic conditions.” That fully funded objective would do more to strengthen funding than the “80% (funded level) commonly referred to as an adequately funded plan,” Bob Stein, panel chairman and retired global managing partner of actuarial services of Ernst & Young, said in a teleconference.
- “Funding adequacy and intergenerational equity should take precedence over the goal of cost stability and predictability.” Even though “predictability of cost in the short term is important for public budgeting purposes,” the report said, “allocating a significant portion of investments to higher-risk, more volatile assets will tend to undermine the goal of cost stability.”
- Actuarial funding reports should have more disclosure, including a presentation over the past 10 years of the ratio of contributions made to the recommended contribution and the relationship between recommended contribution to payroll and to the employer’s budget or revenue source.
The panel plans to take its recommendations to the Actuarial Standard Boards, which adopts standards of practices for the actuarial industry.
“As always, the Actuarial Standards Board welcomes input on pension and other actuarial standards of practice from both within and from outside of the actuarial profession, including the SOA-commissioned blue ribbon panel,” Patricia Matson, ASB chairwoman, said in an e-mail. “The ASB looks forward to considering input from a broad range of stakeholders in public pension systems.”
Mike Musuraca, managing director, Blue Wolf Capital Partners and a former designated trustee to the $46.9 billion New York City Employees’ Retirement System, who is a member of the panel, declined to sign off on the report or provide a reason for his dissent, Mr. Stein said.
Other members of the SOA panel are:
- Larry D. Zimpleman, chairman, president and CEO, Principal Financial Group;
- Bradley Belt, vice chairman, Orchard Global Capital Group; chairman of Palisades Capital Management; and former executive director of the Pension Benefit Guaranty Corp.;
- Bob North, chief actuary, New York City Retirement Systems;
- Dana K. Bilyeu, former executive officer of the $31.8 billion Nevada Public Employees’ Retirement System, Carson City;
- David Crane, lecturer at the Stanford Institute for Economic Policy and Research, Stanford University, and former special adviser to then-California Gov. Arnold Schwarzenegger;
- Richard Ravitch, co-chair, New York State Budget Crisis Task Force and former New York lieutenant governor;
- Andrew G. Biggs, panel co-chair and resident scholar, American Enterprise Institute;
- Douglas J. Elliott, panel co-chair and fellow, Brookings Institution;
- Malcolm Hamilton, retired, partner with Mercer and senior fellow, C.D. Howe Institute; and
- Laurence Msall, president, The Civic Federation, Chicago.
The SOA, whose focus includes public policy advocacy as well as promoting professional standard and research, has 24,000 members, 70% of whom are based in the U.S.