Actuarial board release likely to have greatest impact on public funds
Pension plan sponsors of all types are keeping an eye on Nov. 1, when new actuarial standards on pension obligation risk assessment kick in.
Officially known as Actuarial Standard of Practice No. 51, the new steps for assessing and disclosing risks associated with measuring pension obligations and determining pension contributions for all types of plans — public, corporate and multiemployer — will apply when actuaries perform a funding valuation of a pension plan, or a pricing valuation for proposed plan changes that would significantly change the levels of risks.
The Actuarial Standards Board's pension committee "believes that the additional disclosures required by this standard will help the intended users of the actuarial findings gain a better understanding of risks inherent in the measurements of pension obligations and actuarially determined pension plan contributions," the new standard said.
Risks could include the possibility of actual future contributions deviating from expected future contributions; actual contributions deviating from a funding policy; and material changes in the anticipated number of covered employees.
"It's definitely a closer look at risks," said Bill Hallmark, a consulting actuary with Cheiron Inc. in Portland, Ore., and former vice president of pensions for the American Academy of Actuaries, which supports the new practice standards. "It would encourage people to understand how things might change if there are changes to the discount rate, or mortality, or if a plan sponsor doesn't make the contributions. It's got a wide range of calculations," said Mr. Hallmark, who expects its most significant impact will be with public pension plans, since multiemployer plans are already required to do some of the same projections and corporate plan sponsors are more likely to be conducting their own risk assessments.
For public plans, the new actuarial standards are "an opportunity to propose to clients some form of quantitative or numerical risk assessment," said Paul Angelo, senior vice president and actuary with Segal Consulting in San Francisco, who is a public plan expert active in actuarial policy issues. "That would show the sponsor how sensitive their costs are to a gain or loss relative to their assumptions."
Not a change for all
It won't change much in states like California, where the law generally dictates funding on an actuarial basis, he said, noting that the biggest impact would be felt in states where plans are not well funded.
"If you have a plan that should be beefing up their funding anyway, this risk assessment may be an additional lever to get them to do that. We hope that seeing those possible consequences will help drive them to better funding decisions," Mr. Angelo said.
Jason Russell, senior vice president and consulting actuary with Segal Consulting and chairman of the multiemployer plans committee for the American Academy of Actuaries, notes that the Pension Protection Act of 2006 already requires multiemployer plan actuaries to perform best estimate, "middle-of-the-road" projections. The new actuarial standard of practice, however, "identifies risk factors that actuaries should be discussing with their clients. We need to help our clients understand, what if future experience is worse than those best estimate assumptions? Many actuaries have already been consulting with their clients about risk. The new standard puts the practice into writing, while still deferring to professional judgment," Mr. Russell said.
Some risk factors for multiemployer plans include investment volatility and contribution risk — both from changing work levels and contribution rate increases not yet bargained for. Plan maturity and the mismatch between assets and liabilities are other important risk factors for multiemployer pension plans.
"These are concepts multiemployer plan sponsors will be thinking about more and more," Mr. Russell said. "Since 2008, many sponsors have been focused on trying to meet benchmark investment returns while improving funding levels. In that time, however, many plans have been getting more mature, which can increase their sensitivity to risk factors like investment volatility.
"The whole point of the new standard is for actuaries to help their clients understand the risks facing their pension plans, so they can better manage them going forward," Mr. Russell said.
With more focus on stress testing and risk that plans will have to address in valuation reports after November, "the intent is to make people more aware of the longer-term risk to the plan. The idea is to get a more robust understanding of the risk today, so the boards can make decisions on how much to contribute and how to invest the assets," Cheiron's Mr. Hallmark said.
More stress testing
More stress testing of public pension funds is welcomed by Pew Charitable Trusts, where officials believe that policymakers at the state and local level should prepare for the next economic downturn by adopting comprehensive annual stress testing to show how plans might perform under various economic scenarios.
Despite the greater risk from moving assets to higher-risk alternative and equity investments from lower-risk fixed-income investments over the last decade, "public-sector plans continue to see real returns underperform against actuarial assumptions," a Pew brief said. While some plans have proactively addressed underperformance by lowering their assumed rates of return — and that trend is expected to grow — stress testing and more transparency about complex investments and fees is also needed, Pew argues.
An important element to any stress testing, cautions Keith Brainard, research director at the National Association of State Retirement Administrators in Georgetown, Texas, "is that there not be a one-size-fits-all approach because every plan is unique and plan sponsors are unique."
Greg Mennis, director of public sector retirement systems for Pew in Washington, is seeing the idea of formal stress testing gain traction with public plans. California and Washington state have recently been joined by Connecticut, Colorado, Hawaii, New Jersey and Virginia, where legislation dictates it. "(Colorado and Minnesota) made substantial changes because they had the information to do that," he said.
By giving plan officials and budget decision makers information that isn't just based on today's assumptions, "the states will be better prepared for the next recession. It will be a foundation for better decision-making. That would be the greatest benefit of this," Mr. Mennis said.
Thomas Aaron, Moody's Investor Service vice president and senior analyst, Chicago, welcomed the new actuarial standards on pension obligation risks, since Moody's focuses on risk to bondholders. State and local pension contributions are competing for public dollars against payments on bonds that Moody's rates. "Additional disclosure on risk is a welcome development from our standpoint. We tend to drill down and look at all kinds of impacts."
Unlike the Federal Reserve and Moody's, which use high-quality corporate bond yields or indexes to discount pension liabilities, public pension funds report smaller unfunded liabilities for actuarial funding purposes because they follow Governmental Accounting Standards Board rules that apply discount rates based on assumed rates of return on investment portfolios that feature more equities.
Mr. Aaron does not anticipate any impact on public plan funding from the Federal Reserve's dramatic but brief shock in September, when its new method of calculating unfunded public pension liabilities more than doubled the amount to $4.1 trillion, up from $1.7 trillion. The accounting change – which now includes expectations of future salary growth — in the Federal Reserve's latest quarterly Financial Accounts report on state and local governments' unfunded pension liabilities, was the result of shifting to a "projected benefit obligation" method from an "accumulated benefit obligation" approach.
Still, said Mr. Aaron of Moody's, which calculates $3.9 trillion in aggregate adjusted net pension liabilities across the state and local government sector because of its more conservative discount rate for pension liabilities, it does serve to underscore the magnitude of public pension obligations.