A blue ribbon panel of public policy experts has released a set of recommendations to address the problem of underfunded public pensions.
The report, released Monday, are intended to provide a guide for trustees, legislators and plan advisors to improve the financial health of public pension plans. Using the plans’ own financial reporting, the total amount of unfunded public pension plan liabilities in the U.S. amounts to nearly $1 trillion, according to some estimates.
“Public pension plan funding is a complex issue, with many vexing questions and no easy near-term solutions,” said panel chair Bob Stein, former global managing partner of actuarial services at Ernst & Young. “Taken as a whole, the panel’s recommendations will make available to all stakeholders in public pension systems—employees and retirees, plan sponsors and trustees, as well as taxpayers—more reliable and improved information about the financial status of a plan and the risks it faces. This should enable the development of a stronger funding program, more responsive to the rapidly changing environment in which all plans operate.”
The Blue Ribbon Panel on Public Pension Plan Funding was commissioned by the Society of Actuaries to assess the current state of pension plan funding and make recommendations to improve the financial strength of public pension plans going forward. Members of the panel represented a variety of disciplines and interest groups and began their work early last year.
The panel’s report lays out three principles of an effective public pension funding program:
The costs of future retirement benefits should be pre-funded, and funded in a way that targets 100 percent funding of plan obligations. Median economic assumptions should be used to avoid being overly optimistic or overly pessimistic.
Taxpayers receiving the benefit of today’s public employees’ services should pay the taxpayer portion of the costs of those employees’ pension benefits; funding programs should restrain the tendency to shift these costs to future generations of taxpayers.
While the panel believes that stable costs will be difficult to achieve, it does recognize the benefits that predictable costs can bring to the sponsor’s budgeting processes over short periods of time.
The panel said it recognizes that funding entities frequently face significant competing demands on their resources and that the full recommended contribution cannot always be made. In such circumstances, sponsors should develop an effective funding program that moves the plan toward a fully funded status in a reasonable period of time.
The panel’s report includes a number of specific recommendations designed to improve the information available to all stakeholders about the financial condition and level of risk taken by an individual plan. These recommended disclosures include measures of:
Plan maturity, such as the ratio of active employees to retirees and the ratio of the market-value assets to payroll;
Plan cost, such as the ratio of the actuarially required contribution (ARC) to payroll and to the funding entities’ total budget;
Payment experience, the ratio of contributions paid to the recommended contribution;
Investment risk, such as the plan liability at a risk-free rate; and
Stress tests, consisting of projections of contributions and funded status under periods of higher or lower investment return, and in which recommended contributions were not fully paid.
To provide a benchmark that plans can use to measure the aggregate level of funding risk, the panel recommends that a standardized contribution be calculated and disclosed in actuarial reports. Such a standardized contribution would help trustees and other stakeholders assess the reasonableness of the assumptions and methods used in the plan’s recommended contribution.
The Standardized Plan Contribution would use a stipulated rate of investment return and other specified actuarial methods.
The panel also recommended that actuaries be required to disclose such information and that the actuary be required to provide a professional opinion on the reasonableness of the assumptions and methods used in funding the plan. In addition, the panel made several recommendations about how actuarial assumptions and methods are established and encourages the Actuarial Standards Board to consider including these recommendations in Actuarial Standards of Practice.
Finally, the panel called for strong governance practices, including the establishment of governance structures that support payment of recommended contributions, the development of a strong risk oversight function at the board level, and the thorough consideration of the cost and risks of proposed plan changes before they are adopted.