We have been doing an analysis on a fairly good sized municipality’s pension system using our Custom Liability Index (CLI). The fund appears to have a roughly 35% funded ratio when using standard accounting rules and actuarial practices. However, when you include projected future contributions (provided by the actuary), the plan is well over-funded. It begs the question, why aren’t contributions part of the funded ratio calculation? Does it make sense to have future liabilities in the equation but not future contributions? As a result of this inconsistency, plan sponsors are forced to make important decisions related to benefits, COLAs, ROA targets, asset allocation, etc. without having the full economic picture.
In this case, future contributions are massive and dramatically overstated. In our analysis we were able to suggest a reduction in annual contributions of $5 million/year for a savings of nearly $100 million during the evaluation period and the plan would still be fully funded. This is a tremendous savings that can now be used to support the other important programs within this city’s social safety net. Furthermore, the fund only needs a very modest return (i.e. 3%), far smaller than the current return on asset assumption (7.25%), to maintain a healthy funded status. Without this insight, the plan sponsor and their advisors would continue to manage a much more aggressive asset allocation injecting unnecessary risk into the process and jeopardizing the current funded status.
There are a lot of things that don’t make sense in our industry. Why do we have two accounting standards – GASB (public funds) and FASB (private plans)? Why don’t we account for future contributions (as assets) while including future liabilities? Why do pension systems focus on the ROA and not the promise (projected benefits) that has been made to the plan participants which is the only reason that these plans exist in the first place? Finally, how can a plan be managed when only focusing on the asset side of the equation? This would be like playing a football game and only knowing how many points you’ve scored. Every pension plan should have an x-ray (asset/liability review) taken quarterly that demonstrates the health of the pension system. Without this review, you could end up throwing a “Hail Mary” when 3 yards and a cloud of dust is all that is necessary.