WASHINGTON — Public pension plans should not be funded with instruments that bear risk or delay cash funding such as pension obligation bonds, a panel commissioned by the Society of Actuaries warned in a report released Monday.
"Plans are not funded in a broad budgetary sense when debt is issued by the plan sponsor to fund the plan, whether inside or outside the plan," said the multidisciplinary panel, which is independent from the Society.
The panel also said that risk management practices of public pension plans should be improved by making more information available to stakeholders and it called for a stronger role by actuaries and better governance of such plans.
Laurence Msall, a panel member and the president of The Civic Federation, said during a webinar Monday that if many of the recommendations in the report had been adopted by Illinois and its municipalities, this "would have saved literally billions of dollars in fiscal distress."
But the distressed pension funds in Illinois are unlikely to see any improvement unless policy makers rely on actuarial-based funding principles, which have been abandoned "in favor of inadequate statutory formulas and budgetary gimmicks," Msall said.
The panel believes that effective pension funding programs should follow three principles. One of the principles is adequacy, or the goal to fund 100% of the value of promises made, another is intergenerational equity, or the goal that current employee costs will not be borne by future taxpayers, and the third is cost stability and predictability.
The report recommended that the Actuarial Standards Board require several types of financial and risk measures to be disclosed in actuarial reports.
Trends in financial and demographic measures should be disclosed so that a plan's stakeholders can understand its changing profile and risk position. Plans should present information for a 10-year period about various plan maturity and cost measures. Additionally, the report said, plans should present information that allows users to compare economic and demographic assumptions with actual experiences.
Actuaries also should disclose three benchmarks in order for current risk levels to be understood, the report said. Those benchmarks are: the expected standard deviation of investment returns of the asset portfolio on the report date; the plan liability and normal cost calculated at the risk-free rate; and a standardized plan contribution that can be compared to the recommended contribution to help users asses the recommended contribution's adequacy.
Additionally, plans should be stress tested to see both the effect of paying only 80% of the recommended contributions each year for 20 years, and the effect of investment returns over a 20-year period that are three percentage points greater and less than those used in calculating the standardized plan contribution.
Also actuaries should provide two sets of benefit payment projections for current employees, one on an earned-to-date basis and the other on a projected-benefit basis, the panel said.
In addition to urging the ASB to require the disclosures, the panel calls for the board to require actuaries to include in their reports "an opinion on the reasonableness of fund methods and assumptions."
The report also makes specific recommendations about methods and assumptions that plans use for funding calculations. The panel believes that the rate of return assumption should be forward looking and based primarily on the current risk-free rate. Also, gains and losses should be amortized over a period of no more than 15 to 20 years. It says asset smoothing periods should be no more than five years.
Actuaries should consider direct-rate smoothing and other asset and liability cash flow modeling techniques, because these approaches "can provide greater transparency into the current financial position of the trust, the level of risk in funding assumptions, and enhanced flexibility to sponsors in the development of sustainable funding programs," the report said.
The panel recommends several good governance characteristics that pension systems should adopt. One of these is that plans should maximize the likelihood that funding objectives be achieved. Plans should ensure that recommended contributions are paid, that complete financial information is disclosed to all stakeholders and that financial instruments that delay cash contributions are not used, the report said.
Pension systems should also ensure that trustees are properly trained and have sufficient information to be able to analyze risk. They also should carefully consider plan changes. For example, they could require that consideration and adoption of plan changes be done over two legislative sessions, adopt a formal process for evaluating the implications of changes, and avoid certain high-risk plan features, the panel said.
