By: Russ Kamp, CEO, Ryan ALM, Inc.
I recently stumbled onto an article that was highlighting the impending pension crisis (disaster) that is unfolding in Florida. The author’s primary reason for concern is the fact that there are now more beneficiaries collecting (659,333) than workers paying in (459,428). Briefly mentioned was the fact that the pension system currently has a funded ratio of 83.7% up from 82.4% last year. The fact that there are more recipients than those paying into the system is irrelevant. DB pension systems are not Ponzi Schemes, which in nothing more than a fraudulent vehicle that relies on a continuous influx of new “investors” (substitute plan participants) to pay the existing members of the pool.
A DB pension’s promises (benefit payments) are calculated by actuaries who have an incredibly challenging job of forecasting each individual’s career path (tenure), salary growth, longevity, etc. They do a great job, but they’ll be the first to tell you that they don’t get the individual participant calculations correct, but they do an amazing job of getting the total universe of payments nearly spot on. An acquaintance of mine, who happens to be an excellent actuary shared the following, “pension plans are funded over an active member’s career so that there will be sufficient funds to pay retirement benefits for life. The funding rules in Florida require contributions to get the plan 100% funded over time.”
Granted, there are states that have not made the annual required contribution, in some cases for decades, and those plans are suffering (poorly funded) as a result. That isn’t the actuary’s issue, but they are left to try to make up the difference by forecasting the need for greater contributions and more significant returns. The payment of contributions comes with little uncertainty, while the reliance on greater investment performance comes with a huge amount of uncertainty over short time frames. I wouldn’t want my pension fund or livelihood (Executive Director, CIO, etc.) dependent on the capital markets.
I frequently hear the concern expressed about negative cash flow plans (i.e. contributions do not fully fund benefits). Why? If pension systems are truly designed based on each participant’s forecasted benefit, mature plans are bound to eventually fall into negative cash flow situations. These plans are designed to pay the last plan participant the last $1 of assets. These pension systems aren’t designed to be an inheritance for some small collection of beneficiaries who make it to the finish line. Importantly, there should be different investment strategies used for plans that are collecting more than they are paying out versus those in negative cash flow situation.
DB pensions are critically important retirement vehicles that need to be protected and preserved. Fabricating a crisis based on an incorrect observation is not helpful. If plan sponsors contribute the necessary amount each year and manage the assets prudently, these pension systems should be perpetual. Neglect the basics and all bets are off!
Ryan ALM Blog 
Hi Russ — I totally agree that the ratio of retirees/actives is irrelevant. Funding in accordance with actuarial principles means each participant’s retirement benefits are funded over her lifetime. The reductio ad absurdum demonstration of irrelevance is a plan consisting of all retirees that is 100% funded and 100% hedged. That plan has a zero ratio of retirees to actives, but is more secure than any existing plan.
Where actuaries do deserve some blame, however, is defending funding requirements based on understated liabilities calculated with expected-return discount rates. Despite what GASB has (for now) concluded and the fact that actuaries have always done it this way, there is no economic justification. It overstates true funded status and creates incentives for malinvestment in risky assets, because doing so lowers measured liabilities (incorrectly). Even though actuaries are sometimes restricted by law to various discount rates and/or methodologies, actuaries should be stressing economically valid funded status in their discussions with public sector entities. ASOP 4 was a step in the right direction. but too many actuaries downplay the implications, in violation of their professional standards, in my opinion, resulting in an understatement of obligations totaling in the trillions of dollars.
Hi Larry – great to hear from you. I couldn’t agree more. Would love to have one standard for valuing pension liabilities that everyone must live with. Deflating liabilities likely leads to incorrect decisions about benefit increases, contribution decreases, etc. Hope that you’ve been well.
ps: ASOP 4 proved to be a joke because actuaries refused to admit what it truly was and tried to have everyone believe that this was related to an asset allocation invested in risk free securities. Bogus at best – fraud at its worst.
Amen, Russ. Actuaries who believe ASOP 4 is about hypothetically investing in risk-free securities need more finance education. “Fraud” is fair, in my opinion, for actuaries who understand what ASOP 4 is about and, despite that, present it as a hypothetical of investing in risk-free securities. Either way, the profession needs to right itself.
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