AGA Today
On Tracking of
Pensions, No Consensus
By MARY
WILLIAMS WALSH and MICHAEL COOPER
The New York Times
Published: August 27, 2006
The disclosure
that New York City uses two different methods to gauge its pension funds
— one showing they are fully funded, and another showing a $49 billion
deficit — has heaped fuel on a long-running debate over how to value
pensions.
The debate,
being waged among actuaries, accountants and economists, is more than
theoretical. Last week The New York Times reported that while officials
usually describe New York City’s pension plans as close to fully funded,
an alternate calculation in the back of the plans’ annual reports shows
a $49 billion shortfall. If the alternate calculation has merit, the
city will probably be forced to raise taxes or cut services at some
point, to provide all the money promised to its retirees.
The question of
which method is more reliable has nationwide implications. New York
City’s chief actuary, Robert C. North, is thought to be the only public
pension official in the country to have done the second pension
calculation — which is more like the way a bank might account for its
money. If actuaries for the many other towns and states with pension
plans were to follow suit, big deficits would probably start popping up
from coast to coast.
“What this
highlights, for us, is a big problem,” said Robert A. Kurtter, the
senior vice president for state ratings at Moody’s Investors Service,
the bond rating agency. People like Mr. Kurtter are supposed to keep
bond buyers informed of the likelihood that the thousands of American
cities, counties, school districts, transit authorities and the like
that issue bonds will pay them off uneventfully and on schedule.
“In any
financial report, there are a wide range of assumptions and acceptable
practices,” Mr. Kurtter said. “But in the area of public pensions, it
seems, the range of acceptable methods is extremely wide. Given that
extremely wide spectrum, which runs from extremely generous to extremely
conservative, it becomes very difficult to value these systems on a
consistent basis across the country.”
Mr. Kurtter
said he would like the accounting and actuarial professions to provide
more guidance on which methods should be used, and what they mean. But
he will probably have to wait. The Governmental Accounting Standards
Board, which sets the rules, is in the initial stages of reviewing the
12-year-old standard governments use when reporting pension values. Any
changes are likely to take years.
Accounting
experts have said that New York’s official method, which makes the plan
look fully funded at all times, does not comply with the current
standard.
Parry Young, a
municipal credit analyst with Standard & Poor’s, said the firm was aware
that there were many ways to measure pensions, and that some methods,
like the ones used by New York City and State, could make pension plans
look fully funded no matter what.
Mr. Young said
it was hard to know what to make of such numbers, and that Standard &
Poor’s, therefore, looked for other signs of a city’s creditworthiness.
He added, however, that the city’s method helped build assets faster
than other methods.
He also said
that in the future, when Standard & Poor’s issued reports ranking public
pension funds by their strengths, he would probably flag cities whose
pension numbers were artificially pegged at full funding.
At its heart,
the debate over pension numbers is about whether it makes sense to
measure pensions the way the stock and bond markets would.
Normally,
pension values are measured by actuaries, who have their own,
decades-old methods for tracking the value of the assets in a pension
fund, and the value of the promised benefits. The methods give the
actuary wide latitude in making assumptions about future economic
conditions, and tools for phasing in corrections when the assumptions
prove wrong. One assumption that is almost always wrong is the one for
how much investment income a pension fund’s assets will earn in the
coming year.
Actuaries say
these errors do not matter, because they are always phasing in the
corrections, slowly but surely, year after year.
“The
traditional actuarial model was developed to help employers develop a
cash set-aside strategy,” said Jeremy Gold, an independent actuarial
consultant in Manhattan. “For budgeting purposes, they didn’t want to
put aside varying amounts. They wanted to create a smooth pattern of
annual contributions.”
Dozens of
actuarial methods for tracking pension funds have been created over the
past century. All of them, Mr. Gold said, “emphasized what employers
wanted: smooth, steady, predictable.”
It is this type
of methodology that makes New York City’s pension plan look fully funded
at all times. The numbers are have been smoothed so much that they never
change much at all.
The actuarial
numbers bear little or no resemblance to what Wall Street would come up
with if it were to measure a pension fund.
A Wall Street
analyst — or an economist schooled in modern financial theory — would
first count up all the assets in a pension fund at their market values
on a given day.
The next step
would be to map out all the pension payments owed to retirees in the
future, and to use current, market rates of interest to discount them
back to today’s dollars — the same basic financial calculation that is
used throughout the financial services industry to assign present-day
values to things like bonds and mortgages that are paid over time. The
interest rates would be chosen to match the characteristics of the
pensions, so that a guaranteed pension payment falling due 30 years from
now would be discounted with the interest rate for a safe 30-year bond.
Finally, the
economist would subtract the value of the pension assets from the value
of the promised benefits. The difference would be the shortfall.
But when Mr.
North applied this method to New York City’s pension fund, he was
breaking a powerful taboo. Actuaries almost never divulge the
market-based numbers.
Business groups
argue such secrecy is needed because the market-based numbers would
needlessly alarm workers and retirees. City officials expressed similar
concerns, saying it would be irresponsible to report Mr. North’s
alternative calculation in a newspaper article, because the calculation
is used only in special circumstances, like corporate mergers or
bankruptcies. But Mayor Michael R. Bloomberg said last week that he
thought both methods seemed “rational” to him.
And Gary
Findlay, of the Missouri State Employees Retirement System, said that
while it was unusual for a plan to seem fully funded at all times, he
believed New York City’s funding method was “perhaps the most fiscally
conservative of all the methods available.”