The Pension World’s Example of an Oxymoron

Oxymoron – “A rhetorical figure in which incongruous or contradictory terms are combined, as in a deafening silence and a mournful optimist.” (Yahoo dictionary search)

Well, we need go no further than most public DB plan’s actuarial reports to find a “perfect” example of an oxymoron – the “Schedule of Funding PROGRESS”! This schedule is truly a treasure chest of information, but to describe what has transpired in nearly all public plans during the last 10-15 years as “progress” would be an outrageous exaggeration.  Let’s take a look at the following information that I was able to grab from the web on a public pension plan, whose identity will remain anonymous.

As of year-end 1999, this plan had an actuarial value of assets in excess of $450 million and an actuarial accrued liability of $611 million, giving the plan an unfunded actuarial accrued liability (UAAL) of $161 million and a funded ratio of 73.7%.  The payroll supporting this plan was $178 million, so that the UAAL was 90.4% of payroll.  Let’s fast forward 13 years from 1999’s conclusion to December 31, 2012.  Unfortunately, the data that I am about to share with you doesn’t paint a happy picture.  The actuarial value of assets has grown nicely, net of contributions / benefit payments, and now stand at $667 million, but the actuarial accrued liability has jumped to $1.3 billion, for a UAAL of $653 million, representing an increase in excess of 400%!  Furthermore, the funded ratio has plummeted from 73.7% to 50.5%, and that isn’t on a mark to market basis. Lastly, the UAAL now represents more than 270% of payroll.

How did this happen?  The common practice in public DB plans is to focus on the return on asset assumption (ROA), as the plan’s primary objective, and not the plan’s specific liabilities. When attributing blame for the poor funding of public DB plans, most sponsors and their consultants regularly mention as the culprit the bear markets of 2001-2003 and 2007 – 2009.  In reality, it has been the massive decline in US interest rates that have exacerbated Pension America’s funding woes.

As the data above highlights, DB plans on average were much better funded in the late ’90s, with many plans being significantly over-funded. Had they adopted their plan’s liabilities as the primary objective and not the ROA, it is safe to say that these plan’s would not have significantly reduced their exposure to traditional fixed income, which only served to exaggerate the asset / liability mismatch, and lead them to seek more risky assets, including alternatives.

As 2014 will further highlight, liability growth continued to far outpace asset growth deepening DB Plan funding issues.  The benefits received from traditional retirement programs are too valuable to lose.  The communities in which these beneficiaries live derive great economic stimulus from the monthly annuity that is received.  We need, and can, do a better job.

For one thing, plan sponsors need to get a better handle on their plan’s liabilities.  Receiving an actuarial report every one to two years, delayed six months will not accomplish that objective.  Plan sponsors need to drive asset allocation decisions based on the plan’s liabilities and expected contributions, and not on some ROA, that is more of a Goldilocks number (it just “feels” right) than fact.  We believe that every plan should have a custom liability index (CLI) created using their specific liabilities.  It is only with a CLI that asset allocation can be responsive to changes in the plan’s funded ratio.  Let’s talk before contribution costs get so out of control that your DB plan becomes the next victim of the rush to DC alternatives.

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