Almost Right

I believe the GAO got a few important things almost right.  But they did not address some key issues that they should have.

Personal note:  I'd like to think that some of the good things the GAO did were due, in some small part, to communications I had with them last April when they were first getting into the project.  At that time, I sensed a “drive-by media” level of knowledge of pension liabilities, so contacted them.  After our discussions, it was as if a light went on, and I thought the GAO was moving in the right direction.  As months passed, though, our contact slowed down, and I was starting to grow discouraged.  As the GAO got further involved in the study, they did not choose to take advantage of my offer to serve as their sounding board .

The things they got right (almost) are as follows.

Fool's Gold

The report correctly observes that a snapshot of a plan’s funded ratio at any point in time is not an appropriate measure of funded status.  Instead, you have to track the funded ratio over time.  If it is increasing, that's a good sign, and vice versa.  So far, so good.

But then the GAO goes on to hang their hat on 80% as the desired funded ratio.  This idea that 80% is a "gold" standard drives me mad.  The only basis the agency gives for the assertion is that “Many experts consider a funded ratio of about 80% or better to be sound for government pensions.”  I know of no scientific, or actuarial, study that says 80% is a magic number.  But the figure is referenced so often nowadays that I figured Moses must have brought it down from the mountain.  Still, I can find no reference to it in the Bible.

In reality, 80% is an arbitrary figure that is commonly, but erroneously, used to simplify something that cannot be simplified in this way.  In pensions, things that are “one-size-fits-all” never work.  The notion of an 80% "haven" is a philosophy that has absolutely destroyed pensions in the private sector — the result of a "punish everyone for the sins of a few" mentality.

Death by Ignorance

The GAO also gets it right when it states there is great confusion about how to understand the funded status of public pension plans.  (I would extend this argument to all pension plans).  The GAO report says the media often presents various measures of the funded status out of context or without explaining the meaning of the terms involved.  Well, we all know that, and it’s good to see it acknowledged in the report of such a prominent government agency. 

I'd take it a step farther, though.  I bet that there aren’t five media people in the country who know the difference between the actuarial accrued liability and the actuarial present value of accrued benefits.  Even so, they continue to exploit a few bad situations and scare the pants off the general public, and legislators, by reinforcing the perception that the majority of U.S. pension plans are in trouble.

The GAO got this one right.  But they should have explored the ramifications more.  Why not address the consequences of so much misunderstanding about pension funding?

Now, this is not the only instance where the GAO didn't go far enough.  There were a few things the agency straight-out missed.

What the GAO Left Out — and Why

First, why didn't the GAO address the fundamental question of how to protect governmental plans from the same fate that befell pensions in the private sector?  Except for a few cases that the media loves to milk, governmental pension plans are in pretty good shape.  So, with all their bluster about governments not not fully funding annual required contributions, why didn't the GAO discuss how to protect these plans?.  I believe I know why.

The sinister purpose of the GAO report is to be the first step in application of private-sector pension rules to public sector plans.  Note that the report clearly states that the federal government has a stake in these plans because pension contributions are tax deferred.  The apparent implication is that the money ultimately belongs to the federal government anyway.  So, the GAO seems to be implying, we should "protect" governmental plans by applying private-sector standards — the rules that drove company pensions into extinction.  That is the GAO's logic, though it defies reason.

Actually Getting it Right

Time and space don't permit a full list of measures that should be taken to protect governmental pension plans. But here are my top three.

1. Make it unlawful for Senator Grassley to come within 1,000 yards of any governmental plan.  His Pension Protection Act is an abomination of unnecessary and complex rules.  If we redirected the brainpower that will go into PPA compliance over the next few years, we could find a cure for every disease affecting mankind.  I'll tell you lainly:  A PBGC in the public sector is unthinkable and must be prohibited.  And private sector funding rules should never be applied to the public sector.
   
   
2. The GAO report does not address the need for fiduciary education for those who govern public plans.  But I think such education is essential, and should include a lot on fundamental actuarial principles.  I'm not saying to cover all the mathematics full-time actuaries have to learn.  Just enough to know exactly what an actuarial accrued liability really is and how an actuarial present value is calculated.
   
   The training should also have a lot on pension accounting.  I've read a great deal on the City of San Diego's pension debacle, and believe it would not have occurred had the governing board been educated in basic fiduciary, actuarial, and pension accounting principles.
   
   A typical response when I bring this subject up is that the material is too complicated and mind-numbing.  I believe, though, that any fiduciary who finds this stuff too daunting has a duty to resign.
   
   
3. Our actuarial models are antiquated — a structural reason why no one can define a plan’s true funded status.  Pension calculations have their origin in life insurance company reserve calculations. The “actuarial accrued liability” is analogous to the “level premium reserve” in life insurance.  These concepts facilitated the hand calculations that were needed before the age of electronic calculators and computers, and date back to the 1800’s era of arm bands and eye shades.
   
   Today, computer software allows us to incorporate a myriad of actuarial assumptions into cash flow projections that can also involve sensitivity analyses.  These projections enable us to demote the concept of actuarial “liabilities” to second fiddle.  In this event, “liabilities” whould not be the basic components for determining funding levels.  The actuarial “black box” would go away, and everyone could see what is really happening in the dynamics of a pension plan over time.

In the end, it’s not that the GAO got anything wrong.  They just did not address some of the real issues.

Also, I fear, the GAO is being used as a pawn in a much bigger game.