New report measures health of public pensions

New report measures health of public pensions

The National Pension Insurance Institute recently released a report, “Measuring the Health of Public Pensions: New Metrics, New Approaches” that introduces new mechanisms for calculating and judging the sustainability of pension plans.

To create these, the report’s author, Tom Sgurus, fellow and co-chair of The Policy Lab at Brown University, formed and hosted the Pension Accounting Working Group, a group made up of actuaries and public pension experts. The group came together to measure the health of plans, and create new metrics to generate greater insights into pension sustainability, so trustees and policy makers can make better and more informed decisions.

The working group came up with three new metrics. The first is “extended commitment,” which is the measurement of pension liabilities against the size of the underlying supporting economy. The second is the “unfunded actuarial liability stabilization payment”, which is an objectively defined cash flow policy standard that can be compared to the financing ratio. The latter is “risk-weighted asset values”, a method for assessing the value of a plan’s assets that takes into account the plan’s ability to withstand the downside risks it has taken on through its asset allocation.

The extended obligation measurement uses economic power as a proxy for tax power. This measurement helps decision makers get a read on the sustainability of the plan by providing a comparison between the pension plan and the economic strength of its sponsor. The Federal Reserve includes a comparison of net pension liabilities with measures of gross domestic product and state revenue in the Enhanced Financial Accounts component of its US Financial Accounts report.

However, rather than using state revenue or GDP, the measured liability measure uses total taxable resources, published by the Treasury, at the state level, and cash income, published by the Census Bureau, at the county and city levels.

The trajectory of the initial growth of liabilities in plans looks astounding, but when compared to a percentage of personal income in an established economy, the growth of liabilities appears less dramatic, as income has grown as rapidly as liabilities.

The working group concluded that standardized accounting of taxable capacity was a reasonable step for the future of plan reporting, but that the use of total taxable resources at the state level may not be appropriate for states that do not tax property or income, and use cash income. As a measure of cities and counties it may similarly be flawed as a standardized measure due to the lack of income taxes in some jurisdictions.

The UAL stabilization payment is the amount that the payment would have to be to place a pension plan in the same funding position, or condition, at the end of the year as it was at the beginning. This measurement focuses on the plan’s cash flow considerations rather than the percentage derived from the plan’s balance sheet.

The sponsor’s payments necessary to maintain a plan in its current financial condition can be a leading indicator of changes in the plan’s policy and underlying conditions, as well as a useful measure of risk exposure for a plan sponsor.

This measurement is similar to the “water tread” payment level scale used by Moody’s Investors Service and a concept recently introduced by Standard & Poor to assess the health of pensions is called “minimum funding advance.”

Research using the UAL installation payments found that in plans where contributions were lower than the installation payments, the plan experienced a decrease in the percentage of funding. In plans where contributions exceeded stabilization payments, funding ratios increased. However, when there was a rise in both stabilization payments and contribution levels, the financing rate fell.

In a webinar discussing the report, author Sgouros said, “No number means anything by itself—it has to be compared to something else to create meaning.” UAL Stability Payments is an objectively identifiable cash flow ratio that can be easily compared to the financing ratio. It is “a useful yardstick for measuring policy, but not for judging whether a policy is good or bad,” Sgurus said.

The latest proposed new accounting procedure, risk-weighted asset values, is used to measure pension plan sustainability with more complete data. However, most retirement funds measure their return on a risk-free basis. The risk weighting method is not used for any financing purposes, but rather as a mechanism for comparing a plan with other plans over the past few years.

Risk-weighting assets may be more suitable for plans than stress testing, which mostly measures the impact of short-term stressors even though pension fund obligations are often long-term. Weighting plan assets “can be a more direct and intuitive way to evaluate a plan than a regular stress test, even though stress tests are a very important part of modeling the plan’s sustainability,” Sgurus said.

Risk weighting assets are not the norm in pension plan accounting, although they are common in banks and mandated by the Basel Committee on Banking Supervision, where some assets on banks’ balance sheets can be discounted up to 100%.

The NIRS report says that for pension plans, the ability and tolerance of risk depends on the plan’s cash flow. “If you have a plan and positive cash flow, you can take the risk in your investment. Therefore, one can use cash flow forecasts to gauge how much risk the plan can take.

The method uses variables to discount the value of the asset by a weight interpolated between the short-term standard deviation and the long-term deviation, according to the plan’s cash flow. A positive cash flow plan would use the long-term discount, and a negative cash flow plan would use the short-term plan.

The methodology behind the scale is that a plan with positive cash flow can bear to wait for a temporary downturn or loss of value in an asset, while a plan with significant negative cash flow may be forced to liquidate an asset in a downturn.

Accounting for pension systems is a complex endeavor; Money flows through payments and investments and flows through interests and expenses. “What makes a pension fund is not the underlying assets or liabilities, but the strength of the plan from the sponsor of the plan,” Sgurus said.

Innovation of the reporting process, methods, and metrics for evaluating the plan is critical to making better decisions for guardians and policy makers. “Annuities themselves were an innovation — a sum of money actuarially financed for retirement that was an innovation that changed life for the better,” Sgurus said. “How the democracy of finance in the twentieth century has improved the world is incredible. It has improved the world just as much as aviation, refrigeration or railways.”

Tags: National Institute for Retirement Security, Pension Obligations, Public Pension Funds, Tom Sgoros

#report #measures #health #public #pensions

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