Here is the question of the day: If your pension plan beats the ROA, but loses to liability growth, did you win?
I suspect that most plan sponsors and many consultants would suggest that they have won the game. But, have they really?
Despite the “fact” that GASB permits public pension systems to discount their plan’s liabilities at the ROA, liabilities are bond-like in nature and are repriced based on interest rate changes. As we’ve witnessed during the last nearly four decades of collapsing rates, pension liabilities have blown out. The impact on funded ratios and contribution expenses has been particularly onerous this century, creating a very challenging environment for sponsors of public and multiemployer systems.
On the other hand, if your plan generates only a 4% annual return failing to achieve the 7.25% ROA, but liability growth is -2% during the same time frame: didn’t you win?
The good news for Pension America going forward is that historically low interest rates are not likely to fall much further, if at all. A rising interest-rate regime will negatively impact liability growth creating an environment that will allow modestly growing assets to add significant value in a relatively short period of time.
Unfortunately, most plan sponsors do not see this relationship because of the accounting rules. Going forward, all pension plans should be given multiple views of their liabilities, including a risk-free rate. Of course, a pension liability in this low-interest-rate environment will look atrocious and the funded status very weak. However, given the likelihood that rates will rise going forward, plans could see a dramatic improvement in all metrics. Decisions by trustees should be predicated on the truth, including an accurate funded ratio/funded status, but without complete transparency with regard to plan liabilities (benefit payment), this is not possible.