The TEXPERS Blog

Proposed change to actuarial standard would impact Texas public pensions

Graphic: iStock/relif

By Elizabeth  Wiley, Consulting Actuary

The Actuarial Standards Board has proposed changes to Actuarial Standard of Practice No. 4, or ASOP 4, entitled “Measuring Pension Obligations and Determining Pension Plan Costs or Contributions.” 

ASOP 4 is an existing standard of practice that guides actuaries in performing work for pension plans. There is a significant proposed change to the standard, which applies to all defined benefit plans, including Texas public pension funds.

Key Change

While the proposed ASOP revision includes changes to a number of technical items relating to funding calculations, the most significant proposed change is the addition of a requirement to calculate and disclose an “Investment Risk Defeasement Measure,” which is the value of liabilities using a risk-free interest rate. Let's refer to this measure as the IRDM. The IRDM is to be calculated as part of the actuarial valuation of a pension plan for funding purposes using:

1.    Benefits accrued as of the valuation date;

2.    The unit credit cost method;

3.    Discount rates that are either

a.    U.S. Treasury yields; or

b.  rates at which pension obligations can be effectively settled. (This can be yields on fixed-income debt securities that receive one of the two highest ratings given by a recognized ratings agency); and

4.    Assumptions, other than discount rates, used in the valuation or other reasonable assumptions based on estimates in market data.

The IRDM is described in the proposal as a measure “to reflect the cost of effectively defeasing the investment risk of the plan.” However, the prescribed method for calculating the measure means that it is essentially a settlement cost for benefits earned to date. Under the prescribed unit credit method, the benefits accrued to date would not include expected salary increases. The actuary is required to use current market interest rates to calculate the value of benefits earned to date. Therefore, we regard this measure as a market-value of liabilities disclosure.

Because it is based on current interest rates for bonds, the IRDM will be a volatile measure that will fluctuate from year to year as market interest rates change. In addition, the actuary will need to ascertain the accrued benefit (benefit earned to date) for each participant even where the plan does not contain such a definition, as is common for public plans.

The purpose of the IRDM is not stated in the proposed ASOP. We do not feel that its disclosure will facilitate assessment and disclosure of risks associated with defined benefit pension plans and may actually be confusing information that me be used, either intentionally or unintentionally, to mislead people about the condition of pension plans.

Public Sector Plans

For public plans, the IRDM will require additional work and is not used for either funding or accounting purposes. It does not measure the level of investment risk to which a plan is exposed, and the cost of settling current benefits is rarely relevant to a public plan. Actuarial valuations for public plans use discount rates consistent with the expected return on plan investments over future years. The goal is orderly funding of the plans over time. Thus, funding calculations are based upon projected benefits. The current value of benefits accrued to date does not play a role in the funding of a plan over time. And, as previously stated, accrued benefits are often not defined for public pension plans.

The long-term aspect of public plan funding has been recognized by the Government Accounting Standards Board in statements 67 and 68. These statements require that the expected rate of return on plan assets be used to the extent the plan assets, including future contributions intended to pay for benefits already earned, are projected to be sufficient to pay benefits. A current market interest rate is only used to the extent plan assets are not projected to be sufficient. In contrast, under the IRDM measure, market interest rates will be used for all periods.

The idea of using a measure such as the IRDM for public plan accounting purposes was thoroughly discussed and rejected by GASB. The Actuarial Standards Board, however, is proposing to require that actuaries calculate and disclose such a measure whenever a funding valuation is performed. We see little value in such a disclosure for a public plan.

We expect that critics of public plans will likely seize on any IRDM as evidence that public plans are underfunded. The critics will point to the IRDM as the “true” measure of plan underfunding and claim the plans are not affordable. They will (as now) overlook the fact that the immediate payment of any underfunding is not required. We fear that even with efforts to communicate the basis and meaning of this liability, it will be presented as that “true” measure and used as a basis for attacks against these plans.

ASOP 51 Requires Risk Disclosure

New ASOP 51 will soon be effective for most plans. I believe that the framework ASOP 51 establishes is the appropriate structure in which to assess and disclose risks. Under ASOP 51, a minimal-risk present value that corresponds to the present value used for funding purposes is one permissible method to disclosing risks, but there are other methods, such as stress testing, that may better disclose risks. I feel it would be appropriate to allow this new standard to come into effect before making further changes to the environment in which actuarial pension valuations are completed.

Comments on this proposed revision were due July 31 and the ASB received a large number of comments. They will review them and likely either issue a revised exposure draft for further comments or make changes to the current exposure draft based on the comments and issue this as the revised version of this standard to be in effect.

If this standard does come into effect including IRDM, it is crucial that the TEXPERS plans understand what this number represents as well as what it does not represent, and begin a proactive campaign of education and communication to limit the potential misuse of this value.

About the Author:

Elizabeth Wiley is an actuary with Cheiron, a full-service actuarial and financial consultancy, advising a national client base of public employers.