Fred Munzenmaier’s “Actuary’s Take” on retiree benefits stirred up some deep waters.  Here, in part two, Fred responds to some of your comments.

An Actuary's Take, Part II
by Fred Munzenmaier, FCA, FSA, MAAA, EA

This column is my response to points made, and questions raised, by Don and Jay in “An Actuary’s Take.”

Blaming Unions

First, to Jay’s points. He says we would not be in this boat (i.e., saddled with GASB and FASB requirements) if employers hadn’t just caved into union demands and made promises that were impossible to keep. I agree that this is a significant, but not the sole, source of the problem. My perception is that these “cave-ins” happen because of the lack of education that I mentioned in the original article. Both sides (unions and employers) need to understand the long-term destructiveness of making unrealistic promises. Security of the benefit promise has to come before everything else.

I think, however, that traditional approaches to actuarial reporting make it very difficult for fiduciaries to actually understand the consequences of over-promising. Conversely, the traditional actuarial methods can also overstate the situation. I will get more into this conundrum in response to Don Levit’s questions, below.

(As an aside, in my experience, one of the most glaring examples of giving into unrealistic union demands are negotiations with airline pilots. I have a few war stories, but it would be inappropriate to share them. Of course, in the pension arena, the airlines and big steel have been the bane of the PBGC’s existence.)

Blaming Government

Jay says it’s easy to shift the blame for OPEB problems to government, but that doing so is a cop-out. I think he’s right about one thing: it is easy to blame government. That’s because government clearly owns its share of the blame. In my view, it’s an even bigger sin to ignore this government stupidity and simply hope for the best.

In 2004, when I started my futile crusade to save pensions, I wrote an article for The Journal of Pension Benefits called “Defined Benefit Plans – What Went Wrong? How to Bring them Back.” I pointed out that DB plans had fallen from a high of 114,000 in 1985 to 32,500 in 2004. There are probably a lot fewer than 32,500 now. Whom else but government would you blame for this? Would you say that the 81,500 plans that went out of business should not have been set up in the first place? I don’t believe that. The fact is the government sent them down the tubes to solve a financial problem fabricated by the PBGC.

In the words of Winston Churchill, “A lie gets half way around the world before the truth can get its pants on.”

Blame GASB

Don Levit asks how I would differ from GASB’s approach. Is “pay as you go” okay?

Don, I’ll be glad to answer you.  But I must preface my remarks by saying that, to those who actually make the rules, I am the “thing from the far corner of the bog” – a world too far away for its views to ever be accepted.

So let’s start with Travis County, Texas, an area that includes Austin. They have asked the State Legislature for exemption from GASB requirements based on a number of good points.

For example, they point out, how can you say there is a “liability” associated with retiree health care given the plan sponsor’s legal right to reduce, or even cancel, the future benefits? That’s a great question. And it may be the foundation of a strategy that is workable.

Start Making Sense

One key first step in determining the best way to go is to have your legal department define exactly what you are locked into. For example, are you legally committed to benefits for those who have already retired? Those eligible to retire within a specific time period? All current employees and future hires? And, to what extent are you free to reduce or reprice existing benefits?

The answers to these questions should be the basis for establishing a liability in the accounting sense.

The next step is to get away from the traditional actuarial areas of focus (e.g., the actuarial accrued liability, the normal costs) and from accounting. Ordinary people don’t know what these things mean. No wonder union representatives’ eyes glaze over when you discuss the numbers while they transition back to their laundry list of demands.

Keep in mind that the traditional areas of actuarial focus are merely a snap shot. The numbers represent just the people who are here today. When you do a real projection (i.e., 20 or 30 years, as the traditional numbers erroneously claim to represent), you usually find that the current people make up just a sliver of the group eventually eligible for benefits over time.

What you need to make financial sense of all this in the real world is a year-by-year projection of the cash needed to pay benefits. The projections include the “full monty” of traditional actuarial assumptions, but also allow for new employees to come into the group as old ones terminate, die, or retire. New employees should be assumed to enter at a rate that reflects whether the governmental entity is growing, shrinking, or staying the same size.

At the same time, you need to project what your payroll, benefit, and other costs are going to be. You should also include revenues. In effect, you should project your total budget to get a sense of how your benefit obligations fit in. Are the cash requirements going to grow to where they eat you alive, or are they really just a manageable part of your budget? After all, a government is there forever. Depending on your demographics, you may find you have so many retirees dying that they largely cancel out the new ones retiring and getting new benefits.

The Importance of a Financial Context

Getting a sense of the total financial picture is critical. It leads you to answers to the “big questions,” such as:

1.      Is pay-as-you-go right for us?

2.      Should we pre-fund?

3.      Do we need to adopt a more modest retiree benefit program?

When you can document clear, meaningful numbers within a broad financial context, governmental plan managers and union reps should be able to understand them. At the very least, they’ll be able to listen to you and have an intelligent discussion about the real issues. (Anything less, and these folks should not remain in their fiduciary positions.) All parties must keep in mind one overriding principle: being able to keep the benefit promise takes priority over everything else.

Dealing with Assumptions

Of course, all financial projections require assumptions. I read an article on Travis County stating that they’d received multiple actuarial firm estimates of their GASB liability, ranging from $89 million to $613 million. Wow!

I have found that consideration of the following assumption scenarios is the best ways to get a feel for the financial situation:

1.      No inflation.

2.      Best estimate of general inflation for the full projection period (20 or 30 years).

3.      Best estimate of health care inflation for the full projection period (20 or 30 years).

4.      Calculate either of the “best estimates,” cutting inflation assumptions after, say, ten years, with age-graded per capita claim costs remaining level after that.

This approach allows you to see how much of the GASB liability is linked to inflation that may or may not happen way out in the future. The main reason it may not happen is the likelihood that the entire health care delivery system will change at some point. There’s no way it can continue, given today’s cost trends. 

(By the way, you also need to repeat this exercise at least every couple of years to see if the situation is progressing as expected, has gotten worse, or is improving.)

One thing has always bugged me about GASB/FASB projections. No one expenses today for the effect of inflation 15 years from now for an employee who is, say, age 45 and will remain active at age 60. Yet, if that same 45-year old is retired 15 years from now, you are expected to expense, today, the effect of 15 years’ worth of medical inflation. If you look at real-world projections via scenarios 1-4 above, you can see how much of what GASB wants you to book as a so-called “liability” is nothing more than just an “assumption.”

Given this information, you can develop a plan for meeting your obligations. Remember: it’s not one-size-fits-all. It is what the numbers show for you, and what makes sense for your individual situation.