How Do They Know?

It was recently reported in the Hartford Courant Community that Hartford, CT, was beginning to solicit law firms for a possible bankruptcy.  It has been reported that Hartford is facing a $14 million deficit this year while projecting a $65 million deficit in 2018.  Contributing significantly to this underfunding is the $40+ million contribution for the defined benefit plan this year and a slightly larger forecasted amount for next.

We would suggest that they really don’t know what that DB contribution should be.  Why? First, because of GASB, plans can use the return on asset assumption (ROA) to discount their liabilities.  As everyone knows, liabilities and assets don’t grow at the same rate.  Furthermore, because public pension plans and multi-employer plans have been allowed to engage in this activity, they have annually underfunded their plans.

In addition, the ROA is not a calculated number.  It is an exercise in guessing what a combination of assets will do in some defined future period that if achieved will “ensure” that the plan is well funded.  Is that so?  As we’ve highlighted before, there are myriad examples of public plans generating annual returns far in excess of the ROA, yet their funded status is incredibly weak.

Ultimately, we need to get rid of GASB accounting standards and have every plan in the U.S. at least adopt FASB (if not IASB accounting standards).  The discount rate used will still not be a market rate, but it will be substantially more accurate than the fairy tale rate currently being used.  However, I’m not holding my breath while we wait for this to happen.

In the meantime, plan sponsors need to stop being afraid of the truth.  We need all plans to get a more accurate and complete picture of their liabilities by having a custom liability index (CLI) created.  This index can use multiple discount rates, including the ROA, and incorporate future contributions, too.  Next, plans need to have an asset exhaustion test run.  This examination will absolutely determine the true ROA necessary to keep the fund solvent while providing every last promised benefit.

We’ve recently completed a review of one of the poorest funded plans in the country, and our analysis calculated the true ROA at only 6.4%.  We did not alter the anticipated contributions nor the future benefits (no haircuts), and still, this plan had enough in future assets to meet all its obligations. Skeptical? Shocked? Don’t be.  Unlike the ridiculous exercise of guessing what a ROA should be, allow us to build for you a CLI and prepare an asset exhaustion test. Not knowing the truth is far scarier than having to deal with the reality.

Wouldn’t it be great if it was determined that Hartford didn’t need to contribute $40+ million to their plan this year or next? It could be what keeps them from filing for bankruptcy!

 

 

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