Recognizing Reality is a Good Thing!

Headline: Kentucky Teachers Retirement System adds $3 billion in unfunded liabilities to their books basically overnight. In actuality, they really didn’t. What they did do was to reduce a high discount of 7.5% to a more reasonable assumption of 7.1%. Do we hear 6.5%? In addition, they adjusted the assumptions for annual salary increases from 3.5% to 2.75% and extended longevity for the average participant. These are all very reasonable. Yes, on paper it looks as if Kentucky’s taxpayers are on the hook for more (roughly $200 million per year), but in actuality, they were already on the hook for much more than that! These moves are just more in line with reality! Good for them. The fact that accounting rules and actuarial practices allow public pension plans to discount their liabilities at the return on asset assumption (ROA) distorts economic reality, especially in an historically low interest rate environment. Economic reality and greater transparency would actually reveal a funded status that is not 54%, but something dramatically lower.

The argument in using the ROA to discount a plan’s liabilities has been that public pension plans are perpetual – baloney! We’ve seen a number of situations over the years that had public fund DB plans being shuttered and hybrid or DC plans being offered in their place to new employees. Furthermore, even without freezing and terminating, the use of multiple tiers reflects the reality that the original promise wasn’t going to be met for the entirety of the plan’s participants. Adopting a truer, more realistic, discount rate for the pricing of liabilities will help keep these plans better funded, as annual contributions will be greater. Please note that corporate pensions use market value discount rates and are much better funded. It also means that asset allocations can be less risky. Given current extreme valuations for both equities and bonds, this might just be a very good time to act. We congratulate KY on taking these steps and hope that other public pension systems follow a similar course.

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