A panel of experts is calling for long-overdue actuarial changes that would lead to better funding of the nation's public employee pension plans and more transparency about the financial risks to government agencies and taxpayers who foot the bill.
The recommendations, issued Monday, are particularly noteworthy because the report from the 12 actuaries, academics and financial leaders was commissioned by the Society of Actuaries, a research organization that also conducts the profession's licensing exams.
It calls on the separate Actuarial Standards Board to set more aggressive reporting requirements to ensure today's retirement plan contributions and investment returns sufficiently cover future pensions.
For far too long, pension boards, with the blessings of actuaries, have used overly ambitious assumptions about future investment returns, postponed recognition of market losses and stretched out repayment of system shortfalls.
As a result, the panel found, public pension assets have fallen farther behind where they should be, leaving future generations to pay for benefits that should have already been funded. To make matters worse, the nation's retirement systems are taking greater investment risks to try to make up the shortfalls, without disclosing the gambles to the public.
The panel's recommendations provide a much-needed reality check: Pension promises to employees should be backed up by adequate funding while they are working. And, in taking to task members of the group that commissioned its work, the panel calls on actuaries to more assertively call out insufficient funding plans.
Indeed, too many actuaries, fearful of losing clients who want to keep pension expenses low, have shied away from insisting on adequate contributions. Their accounting gimmicks have contributed to today's shortfalls.
The panel calls for changing three key variables in actuaries' calculations that currently keep pension contributions artificially low.
Investment return: Pensions are funded by contributions from employers and employees, and from investment returns on those contributions. The greater the forecast return on investments, the less the up-front contribution.
Pension systems across the country continue to behave as if the days of soaring stock and real estate prices will return and continue unabated. Most public sector pension plans still assume investment returns of about 7.5 percent to 8 percent annually.
The panel recommends reform of how those investment rate forecasts are made, a change that today would reduce the rate to below 7 percent, a more realistic number. That would increase employer and employee contributions.
Recognition of market gains and losses: The actual investment returns each year almost always diverge from the forecast. To temper the effect of volatile markets, actuaries spread accounting of each year's gains and losses over several successive years, a process known as "smoothing."
Some pension systems have greatly abused the smoothing process. For example, the California Public Employees' Retirement System, the nation's largest pension plan, until last year, had a policy of smoothing most gains and losses over 15 years.
As a result, CalPERS has yet to recognize much of its investment loss from the Great Recession. So its actuarial statements show overly rosy finances.
The panel calls for a smoothing period of no more than five years, a change CalPERS adopted last year.
Paying off the shortfall: When investment returns fail to meet projections, the resulting shortfall, called an unfunded liability, is treated like a long-term credit card debt, with annual payments toward principal and interest.
Those payments are added to the employers' (taxpayers') annual pension contributions. The longer the payoff period, the lower the individual payments, but the higher the total interest costs. Just like a credit card.
To make matters worse, it's a debt for pension benefits that were earned by employees when they worked. Amortizing the debt far into the future burdens the next generation with the costs of labor from which we've already benefitted.
The panel calls for reducing the amortization from the 30-year period commonly used today to no more than 15 to 20 years.
For too long, actuaries who are supposed to provide neutral advice have been part of the problem. These changes would make them more-honest brokers and ensure pension contributions come closer to reflecting the true cost of benefits.