James J. Rizzo, ASA, MAAA, FCA One East Broward Blvd., Suite 505 Fort Lauderdale, Florida 33301 (954) 5276-1616 October, 2011 in Chicago [email protected]Written Outline of Prepared Oral Testimony A. What’s good about it . . . 1. The Principles – a. The ED shows respect for: Concept 4 by putting a pension liability on the balance sheet, b. The ED shows respect for: the characteristic of comparability by selecting one actuarial cost method c. The ED shows respect for: the concept of the cost of services by recognizing the career-long exchange, which led you inexorably to a level % of pay model found in the entry age normal cost method, and d. The ED shows respect for: the cost to taxpayers by recognizing the pension fund’s efficacy in reducing the costs to taxpayers, which led you to adopting the LTeROR as the primary basis for discounting the attributed costs 2. The Discount rate methodology. This captures the heart of these principles. While the methodology can be a bit complex in some situations (quite simple in others), I think there is plenty of time to educate the actuaries and others about it. 3. The Measurement Approach selected was the expected fulfillment cost while the market value of liability was rejected – more about this in a moment. 4. The accountability comparison of the ACEC (actuarially calculated employer contribution) to the actual employer contributions was critical to include in the RSI. You might consider changing the name to actuarially determined employer contribution – ADEC or actuarially based employer contribution – ABEC. B. Speaking to the alternative view . . . The balance of my prepared remarks are for the benefit of those who voted against the LTeROR as the basis for determining the discount rate [without naming names]. I think all three of you would have voted for a govt borrowing rate for the entire TPL. 1. The Pension Fund’s Role. One of you said, “It’s just a liability”, intending it should be measured standing alone, without acknowledgment of the pension fund’s ability to lower the long-term cost to taxpayers. Of course, you advocate offsetting the calculated liability later by an asset figure. a. You decoupled of the liability measurement from the pension fund’s ability to reduce the cost to taxpayers. b. But the ultimate actual cost to taxpayers is inextricably linked to the pension fund’s investment ability. c. Surely, surely, any financial statement liability is intended to measure the cost to taxpayers. d. Consider the cost to taxpayers over past 50 years of two identical employee groups and plan benefits. Employer A’s plan – actuarially funded and invested in a balanced portfolio of, say, 50/50 stocks/bonds. An otherwise-identical Employer B’s plan that has been unfunded. Letter of Comment No. 146 File Reference: 34-E Date Received: 10/12/11 UPDATED INFO RECEIVED: 10/14/11
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James J. Rizzo, ASA, MAAA, FCA One East Broward Blvd., Suite 505
a. The ED shows respect for: Concept 4 by putting a pension liability on the balance sheet, b. The ED shows respect for: the characteristic of comparability by selecting one actuarial cost
method c. The ED shows respect for: the concept of the cost of services by recognizing the career-long
exchange, which led you inexorably to a level % of pay model found in the entry age normal cost method, and
d. The ED shows respect for: the cost to taxpayers by recognizing the pension fund’s efficacy in reducing the costs to taxpayers, which led you to adopting the LTeROR as the primary basis for discounting the attributed costs
2. The Discount rate methodology. This captures the heart of these principles. While the
methodology can be a bit complex in some situations (quite simple in others), I think there is plenty of time to educate the actuaries and others about it.
3. The Measurement Approach selected was the expected fulfillment cost while the market value of liability was rejected – more about this in a moment.
4. The accountability comparison of the ACEC (actuarially calculated employer contribution) to the actual employer contributions was critical to include in the RSI. You might consider changing the name to actuarially determined employer contribution – ADEC or actuarially based employer contribution – ABEC.
B. Speaking to the alternative view . . . The balance of my prepared remarks are for the benefit of those
who voted against the LTeROR as the basis for determining the discount rate [without naming names]. I think all three of you would have voted for a govt borrowing rate for the entire TPL.
1. The Pension Fund’s Role. One of you said, “It’s just a liability”, intending it should be measured
standing alone, without acknowledgment of the pension fund’s ability to lower the long-term cost to taxpayers. Of course, you advocate offsetting the calculated liability later by an asset figure.
a. You decoupled of the liability measurement from the pension fund’s ability to reduce the cost
to taxpayers. b. But the ultimate actual cost to taxpayers is inextricably linked to the pension fund’s investment
ability. c. Surely, surely, any financial statement liability is intended to measure the cost to taxpayers. d. Consider the cost to taxpayers over past 50 years of two identical employee groups and plan
benefits. Employer A’s plan – actuarially funded and invested in a balanced portfolio of, say, 50/50 stocks/bonds. An otherwise-identical Employer B’s plan that has been unfunded.
Letter of Comment No. 146 File Reference: 34-E Date Received: 10/12/11 UPDATED INFO RECEIVED: 10/14/11
Employer A’s taxpayers have paid a lot less for their plan (and will continue to pay a lot less in the future) than Employer B’s taxpayers. Therefore, driven by the “cost to taxpayers” as a principled objective, Employer A’s financial statements over the years, should reflect a lower pension liability than Employer B’s. If the pension fund has the ability (under reasonable expectations) to lower the cost to taxpayers, that ability should be baked into the liability measurement approach.
Discounting the entire expected pension stream at a govt borrowing rate, without regard to the pension fund’s ability to reduce the cost to taxpayers, is not a fair representation of the cost to taxpayers.
e. The annual (or daily) rise and fall of muni yields does not change the cost to taxpayers. The present value of a benefit stream discounted at a muni yield would be the cost to taxpayers only if the obligation were settled and transferred to another entity at that yield rate – and that seldom ever happens.
f. Roughly speaking, 50% to 80% of a plan’s benefits are paid for by investment returns. Ignoring the power of the pension fund to lower the cost to taxpayers is like ignoring the 5-ton elephant in the room.
2. Market Value of Liability. You voted “against” using the LTeROR as the basis for the TPL
discounting.
a. Some of you expressed a rejection of a default-free rate, in favor of a govt borrowing rate. But if you think that choosing a govt borrowing rate instead of a default-free rate means you rejected the market value of liability model, you are mistaken. Discounting the whole liability at a govt borrowing rate as observed in the market on the reporting date is still a market value of the liability model – just using a different discount rate from that which is espoused by certain financial economists.
b. It is different only because you believe that a better proxy for the market is the govt borrowing rate rather than default-free. It’s still a market value model. It reflects the trading prices in the muni bond market. It changes for every year’s reporting date.
c. Do you believe that everything that appears as an asset or as a liability should be valued at a fair market value? Everything? What happened to a mixed attribute model? Why is this variation of a fair value measurement approach appropriate for pension plans and not for other assets or liability which are not for sale or exchange?
d. Govts do not settle their pension obligations in a single sum market transaction. Any variation of a market-consistent value (whether using default-free or govt borrowing rates) does not “fairly represent” the balance sheet liability, because it does not reflect the manner in which the obligation is discharged; it does not reflect the deferred nature of the employee/employer exchange that gives rise to the obligation.
3. Expected Fulfillment Cost: The right measurement approach.
a. “Cost”. The thing that goes on the balance sheet should represent the present value of the
“cost to taxpayers”, recognizing the efficacy of the pension fund to reduce the cost to taxpayers. Any variation of the MVL (whether based on default-free or govt borrowing rates observed on the reporting date) is not a measurement of the cost to taxpayers.
b. “Fulfillment”. We should be measuring the cost to taxpayers for fulfilling the obligation under the terms of the er/ee exchange transaction – that is, the accruing obligation is deferred then fulfilled a little at a time over a long period of time.
c. “Expected”. Not a worst-case scenario. While I am conservative for funding purposes, for accounting and financial reporting, we should not be deliberately conservative. We should be using a best estimate or an expected present value of the fulfillment cost to taxpayers.
d. The expected fulfillment cost is the measurement approach that is most consistent with government accounting principles.
Letter of Comment No. 146 File Reference: 34-E Date Received: 10/12/11 UPDATED INFO RECEIVED: 10/14/11
James J. Rizzo, ASA, MAAA, FCA One East Broward Blvd., Suite 505
I am sending you all my belated comments on the EDs. These won’t be as formal as I or you would like, but it’s the best I could pull off given my schedule in recent months.
Once again, I commend the board members and staff for all the hard work and important service you render to the all users of governmental financial statements. Thank you.
At the end of these comments is the written version of my 10-minute oral testimony in Chicago. Thank you again for the opportunity to submit my thoughts and comments concerning the proposed amendments of Statement Nos. 25 and 27.
Immediately following is rough outline of the primary areas of my comments, in particular order. It does not contain a lot of detail and specificity. I would be pleased to fill in some more blanks at a later date. Also, I rushed through this, so please pardon my typos.
1. Timetable
a. Field test. There was too much work to do in too little time to really do an adequate job of identifying all the devilish details; and there are several that we know of and likely more that we will not discover till later, after the standard is adopted.
b. Cost sharing plans will have a harder time meeting the implementation schedule than single employer plans. You might consider making it effective for cost sharing employers (and maybe the respective plans) for the year beginning after June 15, 2014 instead of 2013.
c. However, I understand the GASB’s push to get this implemented. If you do not change the implementation year, I suspect that most of the cost sharing plans will indeed be able to comply; but it will be very hard and some may not be able to comply in time.
d. If the board adopts some of the recommendations included herein and from other commentators, it would make it easier and ensure more complete compliance.
2. Who pays for all this work?
a. I don’t think it is the role to the GASB to wade into that matter.
Letter of Comment No. 146 File Reference: 34-E Date Received: 10/12/11 UPDATED INFO RECEIVED: 10/14/11
a. Money-weighted returns – Once you decided not to require disclosure of an X-year average
return over a period of time (e.g., 10-year or 30-year period), you effectively rendered the money-weighted average return useless. There is seldom much variation in cash flows within a single year to make an intra-year return meaningful if calculated using a money-weighted method. I was pleased to see that you chose not to require disclosure of an X-year average return, but chose to require disclosure only of the annual returns.
b. Time-weighted returns – Compounding with exponential values for time recognition is overkill and is not the way the time-weighted returns are typically calculated. The GIPS or IMCA standard methods account for time-weighting (either using monthly cash flows or assuming all annual cash flows occur evenly throughout the year or all at mid-year)
c. GIPS or IMCA method adjusted to be net of investment-related expenses (or GIPS as is) should be adopted for financial reporting purposes. These are the two standards; why break new ground with methods that show no particular improvement?
4. WAERSL. I recommend just deleting the part about approximating the results on an individual
basis. No one understands the history of that and it’s not necessary anymore. Just make it the AAL-weighted average expected remaining service life; alternatively, just make it the unweighted average. AAL-weighted would be much easier than TPL-weighted.
5. Special funding situations
a. Conditional and unconditional. I suggest that you improve and/or elaborate on the definition and/or examples for conditional. There is some confusion over the distinction when faced with the numerous ways in which nonemployers are contributing. Also, please include examples of what to do about federal grants and other federal payments for pensions. If the federal side does not go by GASB 27, should the local government side do so for this subsidy?
b. Grants seems to be unconditional – reimbursements of salaries and benefits; so the actual employer contribution for pensions is reimbursed. That seems unconditional, but the informal answer we got back was that it’s conditional. I like the answer because it would be way too much cost for the benefit derived, but there needs to be a better reason or an explicit exemption in the standard or basis for conclusions.
6. Discount rate methodology
a. The methodology is a good reflection of original thoughts on “secondarily responsible”. The model is an accurate reflection of the pension fund’s ability to reduce taxpayers costs and, to
Letter of Comment No. 146 File Reference: 34-E Date Received: 10/12/11 UPDATED INFO RECEIVED: 10/14/11
the extent that the pension fund is scheduled to deplete, it accurately reflects the residual liability falling back upon the employer directly in an unfunded arrangement.
b. The methodology is not too complicated. Over the next couple years’ run-up to implementation, the confusion should be clarified.
c. Need a second illustration that has a funding policy equal to PUC normal cost plus open 30-year amort – this is simpler; maybe use same plan and same benefit projections – just different funding policy
d. You might consider suggesting a maturity/duration that is shorter in cases where the cross-over date is considerably shorter than 20-30 years.
7. Market-driven govt borrowing rate.
a. Please do not tie it to the rate observed on the reporting date.
b. Unfunded plans will have to change their rate every year. Some funded plans with a
depletion date might be changing their rate every year, especially if the rate swings a lot from year to year.
c. Go back to my testimony about market value of the liability NOT being a fair representation of the pension liability, NOT being a reasonable measurement approach. A govt borrowing rate observed on the reporting date IS a market value of the liability
d. I suggest you peg it to a fixed rate that you can change as a Board when you think the conditions warrant, such as every 5th year or every 10th year or whenever govt borrowing rate become too much different from the rate on implementation. You can use TB vehicle to do that.
e. OPEB and unfunded pensions makes a market-driven rate even more clearly a wrong choice. OPEBs are mostly unfunded and when you start deliberating OPEB, you might likely lean on the methodology you adopt in this standard. The taxpayer cost in unfunded OPEBs and unfunded pensions do not actually change from year to year because the obligation will still be settled a little at a time over a long period of time. Some people think of the market value as a cost of funds and a cost to taxpayers; but that is just a theoretical imagination. Neither settle in a lump sum in the market; so neither should be measuring using an annually (daily) varying
f. Please refer to the section below containing the oral testimony for more on this topic.
8. Proportional share. I like the open phrasing of any reasonable method that “reflects the long-term contribution effort”. It allows for flexibility to handle more complex funding formulas.
Letter of Comment No. 146 File Reference: 34-E Date Received: 10/12/11 UPDATED INFO RECEIVED: 10/14/11
9. Cost sharing plans with different fiscal years. Permit roll-forward of assets also and include the phrase about “significant changes” after the valuation date to the reporting date. This is good enough and accommodates the cost/benefits balance.
10. Adjusted fair value of assets as the offset to TPL to obtain the NPL.
a. Port the ED’s five-year expense recognition mechanism over to the liability recognition; then have immediate recognition of the change in that newly defined NPL (TPL minus adjusted fair value of assets). You might even consider a 20% corridor around the fair value to ensure that the adjusted asset value does not deviate too far from the fair value during extreme periods of gain or of losses.
b. This way, we have no deferred inflows and outflows of resources to deal with for assets deviations.
c. I know the members feel tethered to the fair value of assets. But hearing their discussions, I
felt like they gave an inordinate weighting to the matching of the asset figure for NPP in the plan’s financials with the asset figure for offsetting the TPL to get the NPL. Maybe that just kept them from sleeping at night – “something is out kilter in the universe” if they don’t match. They don’t have to match, especially if they should not (in the interest of fair representation).
d. However, the asset offset to TPL is not an employer asset. As far as measurement approaches go, there is no compelling reason that the asset offset should be measured at fair value. It is not an employer asset. It is not for sale of exchange by the employer. It is more like a value in use. It’s value goes up and down and an adjusted value is more representative of interperiod equity. No reason to write the value up only to take it down again in a year or two (or vice versa), when the employer had no control over whether to take the gain in hand or settle the loss out of hand. Again, it’s not the employer’s asset.
e. Nevertheless, the five-year mechanism applied in the liability recognition (rather than the
pension expense) still acknowledges the trend by fully recognizing the change in fair value over only five year.
f. This approach is subtracting apples from apples: a longer term measure of assets from a long term measure of the liability.
g. I would rather you move this mechanism to the liability recognition because I would rather
you get the balance sheet more right then the expense. h. I advocate Note and RSI disclosures on both fair value and adjusted fair value of plan assets.
So do not think I am suggesting elimination of all reference to an NPL using a fair value of asset offset or the elimination of a fair value of assets divided by the TPL for a second funded ratio calculations. It’s okay to have more than one of those two numbers – we all can handle
Letter of Comment No. 146 File Reference: 34-E Date Received: 10/12/11 UPDATED INFO RECEIVED: 10/14/11
it. Dealing with two versions of that is better than having only one and it be the wrong one. In fact, many actuaries have been disclosing both sets of those two numbers in recent years in our actuarial reports anyway.
11. Assumption changes
a. Just make the entire change an immediate recognition, without regard to whether it is for
actives or inactives.
b. It is like a re-measurement due to new information.
c. The initial NPL is fully recognized as a liability upon implementation through a restatement of the beginning balance; so any re-measurement for new information should be recognized immediately so as to immediately offset the NPL previously recognized immediately.
12. Actuarial gains and losses
a. If you want to keep the current split between the actives and retirees, spell out in the standard
that the active vs inactive status may be determined based on their status at the second previous valuation (at the valuation date prior to the valuation date used to develop the NPL). The first previous valuation date used to develop the TPL (whether via roll-forward or not) becomes the actual TPL, whereas the second previous valuation rolled forward becomes the expected TPL. Then we find this difference between the actual and expected TPLs.
b. Another way to phrase it is to say that the status as active or inactive should be determined on the same basis as the status in the previous TPL. That should work as well. All gain or losses associated with inactives included in the previous TPL.
c. This whole split between actives and inactives was formulated based on a desire to have each individual person’s TPL fully recognized by the time he/she retires (on an approximate basis).
d. A better rationale – recognize the entire gain/loss (without regard to split between actives and inactives) over five or 10 years; five or 10 years can be thought of as a reasonable length of time over which demographic gains and losses can be expected to offset each other – assuming the assumptions are a best estimate of the mean. No real science on that, though. This thinking formed the basis of the board’s decision to recognize the asset deviations over five years – a period of time thought to be long enough to capture natural cycles and short enough to capture emerging trends.
e. You could simplify this process a lot by adopting this suggestion.
Letter of Comment No. 146 File Reference: 34-E Date Received: 10/12/11 UPDATED INFO RECEIVED: 10/14/11
13. Plan amendments
a. Retain immediate recognition of active life changes? I would like to ask you to re-think that
one. That one was a shock when the board voted that in. There had been some momentum to recognize the active employee increases in TPL due plan amendments over their working lives for sound theoretical reasons. The reason related to the reasons such increases were granted. There are two ways that the TPL can increase due to plan amendments - One is that benefits were granted retroactively. The best reason we all heard for why that
happens is to keep a happy and rewarded workforce in place for the rest of their tenure – i.e., over their remaining service life.
- The second reasn that happens is for plan changes that only affect future servie. This is happening a lot now with roll-backs of benefits levels for future years of service, i.e., over their remaining service life. Nevertheless, since the entry age normal cost method spreads things evenly as a level percent of pay over the entire career, from hires date to exit dates, the TPL is actually changed on account of a benefit change that, legally, only applies to future years. This is another reason why any changes in the TPL occasioned by a change in plan benefits should be recognitzzed over the average (weighted if you like) expected remaining service life.
b. I suggest you move the active life TPL increase caused by plan changes to be recognized over
a WAERSL. This would be consistent with the notion of accruing benefits over working life of the career-long exchange. The WAERSL is quite short, as I am sure you are learning.
c. Recognizing changes in the TPL for plan changes affecting inactives should continue to be recognized immediately.
14. Legal-oriented definition of cost sharing plan. It would be better to permit separate cost
sharing plans to be identified even if the silos are only on paper. Tie the definitional language to the internal methodology employed for the sharing of costs, rather than the legal framework regarding whether assets of entire legal pool are available to pay benefits of all.
a. Consequences are crazy – local govts without any public safety are charged pension expenses
for richer benefits – not right and not intended; even though they are not being charged for contributions or those richer benefits. Does not make sense.
b. The legal language is there only for the very rare case of insolvency. So for the reason of the unimaginable rare event, all such plans should be forced to share the pension expenses and liabilities throughout the operational life of the plan? Does not make sense.
c. I acknowledge that there may be some occasions in systems without the legal silos, to be tempted to help out one plan with a paper transferor. If so, then that year should reflect the effect of the transaction in the shared pension expense and shared liability; not before.
Letter of Comment No. 146 File Reference: 34-E Date Received: 10/12/11 UPDATED INFO RECEIVED: 10/14/11
d. Let the grouping be based on the internal method of cost sharing employed.
15. Significant changes
a. The timing and linking of valuation dates with reporting dates will make for a long period of time between the most recently available valuation date (rolled forward to the reporting date). A lot will happen between those two dates. And for those that do biennial valuations and those that are especially vulnerable to significant changes occurring between the most recent valuation date and the reporting date.
16. Frequency and timing
a. Liabilities for all pension plans should be re-valued annually; biennially leaves too much time
lag
b. Most are already doing annual valuations. So it will not be much more trouble.
c. It makes for more comparability and consistency
d. It makes for less trouble discerning whether a change is a “significant change” or not
e. Valuation date for a reporting period should be no earlier than 12 months prior to the end of the reporting date.
17. The actuarially calculated employer contribution
a. I suggest you remove the conditional nature of this schedule. I don’t know if certain
employers will just make certain that their actuary does not calculate such a number. That sounds far-fetched. However, stranger things have happened. Please do not relegate this matter to a future amendment to voluntary service efforts and accomplishments reporting, where it may get bogged down forever or may never be embraced. Just require an ACEC to be disclosed.
b. The GASB is not the appropriate body to prescribe the parameters for how that calculation is to be done. That should be between the plan/employer and the actuary – or for a coalition of organizations to develop with input from actuaries to be a best practices or even more formally adopted by all. If you just leave it as the ACEC and define it as you already have, that should be fine for GASB purposes.
c. By the way, can you change it to actuarially determined employer contribution? ADEC flows off our tongues easier than ACEC. Or maybe even the actuarially based employer contribution (ABEC). In reality, determined or based are actually better terms for the purpose at hand than calculated. The calculations are just math; the methods of determining the formulas are actuarially determined or actuarially based.
Letter of Comment No. 146 File Reference: 34-E Date Received: 10/12/11 UPDATED INFO RECEIVED: 10/14/11
18. LTeROR disclosure
a. I suggest that you eliminate from the standard the disclosure requirement for a table
presenting the real rates of return expected for each asset class together with the asset allocation to those same asset classes.
b. Too much temptation to multiply the columns and press the board to adopt that answer; this is more than a mere nudge
c. Strengthen the requirement to explain how the LTeROR was developed; require a specific and detailed explanation. Not sure exactly how to say that or exactly how to strengthen the language already in the ED.
d. Okay to put the that table in an illustration of the other disclosure requirement to explain how the LTeROR was developed. And maybe give another example as well that is based on another approach.
Letter of Comment No. 146 File Reference: 34-E Date Received: 10/12/11 UPDATED INFO RECEIVED: 10/14/11
October, 2011 in Chicago
Written Outline of Prepared Oral Testimony
Mr. Chairman, Board Members and Staff, thank you …..
My name is Jim Rizzo. While I serve on a committees of the Conference of Consulting Actuaries and the American Academy of Actuaries and while I am employed full-time for Gabriel, Roeder, Smith & Company, all of whom have submitted comments and are testifying before you, I am testifying today solely on behalf of myself -- and the opinions expressed are not necessarily those of the organizations mentioned -- and may not even express my own opinions over time, because they have tended to change over time.
A. What’s good about it . . .
1. The Principles –
a. The ED shows respect for: Concept 4 by putting a pension liability on the balance sheet (although it might be a stretch for certain cost-sharing employers),
b. The ED shows respect for: the characteristic of comparability by selecting one actuarial cost method c. The ED shows respect for: the concept of the cost of services by recognizing the career-long exchange, which
led you inexorably to a level % of pay model found in the entry age normal cost method, and d. The ED shows respect for: the cost to taxpayers by recognizing the pension fund’s efficacy in reducing the
costs to taxpayers, which led you to adopting the LTeROR as the primary basis for discounting the attributed costs
2. The Discount rate methodology. This captures the heart of these principles. While the methodology can be a bit
complex in some situations (quite simple in others), I think there is plenty of time to educate the actuaries and others about it.
3. The Measurement Approach selected was the expected fulfillment cost while the market value of liability was rejected – more about this in a moment.
4. The Accountability comparison of the ACEC (actuarially calculated employer contribution) to the actual employer contributions was critical to include in the RSI. You might consider changing the name to actuarially determined employer contribution – ADEC or actuarially based employer contribution – ABEC.
B. Speaking to the alternative view . . . The balance of my prepared remarks are for the benefit of those who voted
against the LTeROR as the basis for determining the discount rate [without naming names]. I think all three of you would have voted for a govt borrowing rate for the entire TPL.
1. The Pension Fund’s Role. One of you said, “It’s just a liability”, intending it should be measured standing alone,
without acknowledgment of the pension fund’s ability to lower the long-term cost to taxpayers. Of course, you advocate offsetting the calculated liability later by an asset figure.
a. You decoupled of the liability measurement from the pension fund’s ability to reduce the cost to taxpayers. b. But the ultimate actual cost to taxpayers is inextricably linked to the pension fund’s investment ability. c. Surely, surely, any financial statement liability is intended to measure the cost to taxpayers. d. Consider the cost to taxpayers over past 50 years of two identical employee groups and plan benefits.
Employer A’s plan – actuarially funded and invested in a balanced portfolio of, say, 50/50 stocks/bonds. An otherwise-identical Employer B’s plan that has been unfunded.
Employer A’s taxpayers have paid a lot less for their plan (and will continue to pay a lot less in the future) than Employer B’s taxpayers. Therefore, driven by the “cost to taxpayers” as a principled objective, Employer A’s financial statements over the years, should reflect a lower pension liability than Employer B’s. If the pension
Letter of Comment No. 146 File Reference: 34-E Date Received: 10/12/11 UPDATED INFO RECEIVED: 10/14/11
fund has the ability (under reasonable expectations) to lower the cost to taxpayers, that ability should be baked into the liability measurement approach.
Discounting the entire expected pension stream at a govt borrowing rate, without regard to the pension fund’s ability to reduce the cost to taxpayers, is not a fair representation of the cost to taxpayers.
e. The annual (or daily) rise and fall of muni yields does not change the cost to taxpayers. The present value of a benefit stream discounted at a muni yield would be the cost to taxpayers only if the obligation were settled and transferred to another entity at that yield rate – and that seldom ever happens.
f. Roughly speaking, 50% to 80% of a plan’s benefits are paid for by investment returns. Ignoring the power of the pension fund to lower the cost to taxpayers is like ignoring the 5-ton elephant in the room.
2. Market Value of Liability. You voted “against” using the LTeROR as the basis for the TPL discounting.
a. Some of you expressed a rejection of a default-free rate, in favor of a govt borrowing rate. But if you think that
choosing a govt borrowing rate instead of a default-free rate means you rejected the market value of liability model, you are mistaken. Discounting the whole liability at a govt borrowing rate as observed in the market on the reporting date is still a market value of the liability model – just using a different discount rate from that which is espoused by certain financial economists.
b. It is different only because you believe that a better proxy for the market is the govt borrowing rate rather than default-free. It’s still a market value model. It reflects the trading prices in the muni bond market. It changes for every year’s reporting date.
c. Do you believe that everything that appears as an asset or as a liability should be valued at a fair market value? Everything? What happened to a mixed attribute model? Why is this variation of a fair value measurement approach appropriate for pension plans and not for other assets or liability which are not for sale or exchange?
d. Govts do not settle their pension obligations in a single sum market transaction. Any variation of a market-consistent value (whether using default-free or govt borrowing rates) does not “fairly represent” the balance sheet liability, because it does not reflect the manner in which the obligation is discharged; it does not reflect the deferred nature of the employee/employer exchange that gives rise to the obligation.
e. A market-observed rate that varies from one year to the next makes it “look” like the cost to taxpayers has changed (up or down) – when no such change to taxpayers has occurred. Over the last 30 years, the annual change in MMD’s AAA index yield averaged 70bps - about the same average regardless of whether it was June 30 over June 30, or September over September or December over December.
f. Again, an annually changing market-observed muni yield does not reflect the long-term fulfillment cost to taxpayers in any realistic manner.
g. Lastly, a market-observed rate on the reporting date does not ensure comparability, if that’s what you were thinking (after all that’s what the financial economists have been declaring). Govts with June 30 year ends have very different yields than those with September 30s. Again, from MMD’s AAA index yield, the average difference in yields over the past 30 years was 40 bps.
3. Expected Fulfillment Cost: The right measurement approach.
a. “Cost”. The thing that goes on the balance sheet should represent the present value of the “cost to taxpayers”,
recognizing the efficacy of the pension fund to reduce the cost to taxpayers. Any variation of the MVL (whether based on default-free or govt borrowing rates observed on the reporting date) is not a measurement of the cost to taxpayers.
b. “Fulfillment”. We should be measuring the cost to taxpayers for fulfilling the obligation under the terms of the er/ee exchange transaction – that is, the accruing obligation is deferred then fulfilled a little at a time over a long period of time.
c. “Expected”. Not a worst-case scenario. While I am conservative for funding purposes, for accounting and financial reporting, we should not be deliberately conservative. We should be using a best estimate or an expected present value of the fulfillment cost to taxpayers.
d. The expected fulfillment cost is the measurement approach that is most consistent with government accounting principles.
Letter of Comment No. 146 File Reference: 34-E Date Received: 10/12/11 UPDATED INFO RECEIVED: 10/14/11
