P&I reported in their September 6th edition that the Society of Actuaries and the American Academy of Actuaries Joint Task Force has challenged the practice of valuing liabilities at the ROA discount rate for public pension and Multi-employer plans. They, as do we, believe that liabilities should reflect economic reality, with the risk free rate (Treasuries) being used as the discount rate.
After much internal debate the Joint Task Force initially refused to release the draft report. Fortunately, they changed their minds and recently released the paper. It is being reported that NCPERS is trying to squash this movement. It is truly unfortunate.
Given where the level of interest rates are at present, we believe that it is a great time to bite the bullet and mark plan liabilities at a true risk free rate. Liabilities are bond-like, and they are likely not going to grow substantially from this level, and may in fact decline if the U.S. economy can generate a little growth and inflation that will lead to interest rates rising. This may not occur in the immediate future, but it will happen eventually.
For more than 30 years, DB pensions have been under pressure from falling interest rates (liabilities have dramatically outperformed asset growth). Regrettably, many, if not most, DB plans did not capture this great bull market for fixed income as plans anticipated that the lower bond yields would harm their ability to exceed the return on asset assumption (ROA). As everyone knows, bond values are not just determined by yield, and bonds, especially longer-dated issues, have provided outstanding returns during this period of falling rates.
Furthermore, pricing the liability at an inflated discount rate has artificially reduced annual contributions, while leading plans to take on much more risk in pursuit of the ROA through traditional asset allocation approaches. Given where equity and bond valuations are at present, it is highly unlikely that we are going to earn our way out of this underfunding. We think that plans should initiate a different course in managing both assets and liabilities, and an honest accounting of the liabilities is a great place to start.
Just think what heroes plan sponsors and trustees will be when liability growth is negative in a rising rate environment and DB plans that were once assumed to be on their death bed are once again flourishing. It won’t take heroic annual asset returns to close the funding gap in an environment in which liability growth is negative. Funded ratios could improve quite dramatically in this scenario. Your participants are counting on everyone to secure this incredibly important benefit. The time is now to do something different!