Nice article. Thanks for discussing LDROM, and noting how incorrect it is to describe it as a hypothetical liability if assets were invested differently, rather than, to put this how I might have, the economically meaningful liability that should always be the focus of funded status and funding analyses. It burns me when it's described as they do.
You're right, of course, that essentially zero assets means a 0% funded status no matter what the liabilities are. But $10 billion of missing liabilities is nothing to sneeze at. This is a good example of why dollar deficits are important to focus on as much as funded percentages. I like dollar deficits (real ones, not based on AAL) divided by number of taxpayers or population.
The question is what happens next in this totally hopeless situation -- a Federal bailout? That would be some precedent. Looks like Chicago is going to be the Studebaker of public pensions -- we'll see what happens.
I do need to find something OTHER than a grossly underfunded system to get one of the new ASOP 4 disclosures from.
It's really pointless looking at the LDROM for any of the Chicago/Illinois plans (other than IMRF... and maybe I should go looking for the IMRF one. That would be instructive.)
Mary Pat and Larry, a question I have is, if the Chicago MEABF actuarial report from Segal were written in a way that FE advocate would prefer, what would be different?
For a detailed reply, Larry would be better, due to his pension background.
I'm going to give a high-level reply: if there had been a low-default-risk valuation as a standard view for valuing the pension promises, PERHAPS they wouldn't have deliberately grossly underfunded the pensions for so long.
There would have been a philosophy that "yes, we value these liabilities as if we won't default on them."
Yes, I know that's not how people want to interpret that valuation, but that's my point of view.
The way public pension sponsors behave in some cases, they are planning on defaulting on their promises. It already happened in Detroit, in Rhode Island, in all sorts of places. The original promises were changed.
In some other places, they behave in a manner to demonstrate that they intend to fulfill their promises with low default risk. The participants and retirees, most importantly, can feel secure that their promised benefits will be there.
Thanks. I think this wording around the LDROM is interesting.
As of December 31, 2023, the LDROM for the system is $29,752,140,183. The difference between the plan’s AAL of $19,368,874,758 and the LDROM can be thought of as the increase in the AAL if the entire portfolio were invested in low-default-risk securities. Alternatively, this difference could also be viewed as representing the expected savings from investing in the plan’s diversified portfolio compared to investing only in low-default-risk securities.
ASOP 4 requires commentary to help the intended user understand the significance of the LDROM with respect to the funded status of the plan, plan contributions, and the security of participant benefits. In general, if plan assets were invested exclusively in low default-risk securities, the funded status would be lower and the Actuarially Determined Contribution would be higher. While investing in a portfolio with low-default-risk securities may be more likely to reduce investment volatility and the volatility of employer contributions, it also may be more likely to result in higher employer contributions or lower benefits.
I believe this description, while technically accurate, is a very cynical and disingenuous presentation. The pretense that the ASB thought it important to disclose a hypothetical liability based on a portfolio that happened to consist of liability-matching assets is nonsense. The LDROM came about because of concerns that the current measures of liability shown were not economically meaningful, and a belief that the profession owes at least the disclosure of a more meaningful measure.
The requirement (which is still permitted) from the first exposure draft was a more genuine measure of market liability. That number would have been smaller -- the PV of benefits accrued to date (PVAB) valued with a similar discount rate. What is shown here and probably most other actuarial reports, is an "entry-age-normal-cost" (actuarial method) liability, which is based on a similar discount rate, but, for active employees, the liability is a target value of assets assuming that one were attempting to fund benefits as a level % of pay.
Why would public pension advocates, including many actuaries, lobby for the requirement to show a bigger, less economically meaningful, number? The reason, which was explicit in at least one comment letter that I recall, is that instead of having to say "this is the market liability," it allowed for the presentation shown -- basically, "this is a hypothetical number if you invested in low-default-risk assets, and you don't do that, so who cares, but if you did, look how much more it would cost."
In an NCPERS strategy webcast about how to deal with the possible repercussions of the LDROM disclosure (https://www.youtube.com/watch?v=ASuBoswhi6Y) the actuary, who was involved in putting the toolkit together, said this change to allow this presentation was a "major concession." It was, and largely allowed actuaries to downplay and bury the number. Shameful in my opinion -- instead of helping clients and the public understand their market liabilities, it gives undeserved reassurance that everything is fine -- at least in most cases, though not for this plan.
This presentation, in my opinion, violates precepts in the code of conduct requiring integrity and recognizing a duty to the public, and it violates the ASOP 1 requirement to apply standards of practice in good faith. But never mind ASOPs and the Code of Conduct. It seems to be an intentionally cynical and technical reading for the purpose of diverting attention from somewhere it's needed and spinning something to one's advantage.
To answer your original question, what would be different in this case if the report were more aligned with a reasonable market-based presentation, my guess would be probably nothing would be all that different. As Mary Pat points out, this plan is a complete basket case no matter how you look at it. To get to this point would have required a level of intentional negligence that would likely have been unaffected by more honest reporting.
I started watching the video. I did see Paul Angelo say that LDROM was a concession (but I don't think he said why). He also said that a comment in Reason said that LDROM was the "right" number, but on his slide it said that the comment said it was a better number (or something like that). Then the second guy, talking about the toolkit, said something like, "plans will continue to fund based on expected return," and my immediate reaction was, "but some don't fund even that number!" So many layers to this.
Thanks, Justin. Sorry for belaboring the point here, but to respond to a couple of your recent comments:
On the video, in discussing the concession, he talked about "why it helps" with the explanation. In going through the toolkit language, slide 7 that he showed said something like "Assuming we use the same level cost method" (EANC) is what allows for the explanation offered.
Also, from the comments on 2nd exposure draft,
comment letter #11, from NASRA, NCPERS, NCTR, (https://www.actuarialstandardsboard.org/wp-content/uploads/2020/07/Comment-11.pdf) said that being allowed to use the same funding method as the regular funding number "allows for the interpretation of this new number as what the ongoing funding liability would be if the plan actually invested entirely in low default risk bonds. Under that interpretation, the difference between that LDROM and the actual funding liability provides a measure of what the plan expects to save the taxpayers through taking on a prudent level of investment risk."
Note that here, and in the toolkit, actuaries are ultimately being instructed by non-actuary political lobbyists on how to comply with actuarial standards of practice. It's also notable that unlike many less-controversial issues, the Academy to this day has not issued a practice note. Rather, they have remained silent as their member actuaries work with overtly political organizations to develop guidance (the toolkit). What's the deal with that?
These discussions had been going on a long time, and prominent economists weighed in, and didn't (and still don't) think that the question is all that layered. I think it just seems like it because of the dust kicked up by public pension actuaries, which confuses the issue greatly.
Donald Kohn, then vice-chair of the Federal Reserve Board, said in a 2008 speech at an NCPERS conference:
"While economists are famous for disagreeing with each other on virtually every other conceivable issue, when it comes to this one there is no professional disagreement: The only appropriate way to calculate the present value of a very-low-risk liability is to use a very-low-risk discount rate.
However, most public pension funds calculate the present value of their liabilities using the projected rate of return on the portfolio of assets as the discount rate. This practice makes little sense from an economic perspective."
Also in 2008, at an AAA forum on this topic, David Wilcox, an economist at the Fed, testified as follows:
"The economics of how cash flows with no credit risk should be discounted back to the present are completely unambiguous and utterly noncontroversial. Those cash flows should be discounted back to the present using interest rates that are derived from securities with no credit risk. Every first year MBA student, even as we speak, is having this simple point drilled into their head right now in an introductory finance class. The only factors that matter for the determination of the scale of these obligations are the size of the promised cash flow and their essential characteristic which is that they are free of risk. That’s all you need to know. These are riskless cash flows. There’s an unambiguous answer as to what their value today is. What I’m trying to suggest, over and over again, is that the analytics of valuing cash flows that have no credit risk in them – those analytics are very straightforward. There’s no professional dispute associated with that question. These happen to be really simple cash flows to value. They’re free of credit risk. There’s only one conceptually right answer to how you discount those cash flows. You use discount rates that are free of credit risk. This is one of those things where it just really is that simple"
By the way, I wrote the Reason piece that was referred to in the video. I did not, and don't know anyone else who claims that solvency liability is the "one true measure," though it is certainly more economically meaningful than anything out there, and FE refers frequently to the "law of one price." The Reason piece was written before the first LDROM disclosure came out and before I knew about the toolkit. I expressed some fears about how actuaries and the lobbyists they're allied with (NCPERS, NASRA, NIRS, GFOA, NCTR) might react. Unfortunately, my worst fears were realized. The Reason piece is here: https://reason.org/commentary/a-chance-to-enter-a-new-era-of-financial-transparency-and-awareness-for-public-pension-plans/
Got me. Maybe others want to hazard a specific guess. It’s fair to say, though, that Chicago seems likely to get there first and pretty soon, and as economist Herbert Stein said, “if something cannot go on forever it will stop.”
This is why I did the spreadsheet tool -- I originally created it in ~2017 to project MEABF going bankrupt, specifically, but then allowed projecting any of the plans in the Public Plans database.
MEABF was projected, back then, to run completely out of assets by 2024. That was assuming they didn't increase contributions, and of course they had to increase the contributions by huge amounts since then.
But they can't keep up those contribution levels. Johnson is having a hell of a time with his budget wishes. And that's just MEABF being a problem -- the teachers plan is even bigger, and while it doesn't promise to run out of $$ any time soon, its contribution needs are bankrupting the city rapidly.
I left Illinois a number of years ago. When does this "game of musical chairs" actually come to a head? Will it be like the film, Margin Call ? Chicago can go bankrupt if the State of IL authorizes it. The State of IL can't go bankrupt so it will have to reduce benefits as the pension debts can't be covered by raising tax rates, the Laffer Curve goes into effect.
I see your point … when a plan is about to completely run out of money it’s not worth arguing about what the real funded status is. Though if they had been working with real numbers all along maybe it doesn’t get to this? I don’t know…
If you are familiar w/ the quote from Adam Savage (from Mythbusters): “I reject your reality and substitute my own”
It doesn't matter how many "real numbers" we sent them. Even now, with the abysmal funded ratios, they're trying to figure out tricks to avoid having to put in higher contributions. They will always fall back on the "magic" of "the money will appear".
That's Chicago, at least. Forget about the pensions, they have been involved in so many dodgy finance practices, the only thing that stops them is the credit cards being taken away. The bond buyers who are involved in the scoop & toss figure they won't be left with the hot potato. The teachers unions may have finally made an ask too big... but we'll see.
I saw a piece from Eric Allie thinking that New Jersey is worse off than Chicago, and maybe it is, but I don't think that's the case. Nobody is under the delusion that anybody likes NJ so much they'll get bailed out.
Nice article. Thanks for discussing LDROM, and noting how incorrect it is to describe it as a hypothetical liability if assets were invested differently, rather than, to put this how I might have, the economically meaningful liability that should always be the focus of funded status and funding analyses. It burns me when it's described as they do.
You're right, of course, that essentially zero assets means a 0% funded status no matter what the liabilities are. But $10 billion of missing liabilities is nothing to sneeze at. This is a good example of why dollar deficits are important to focus on as much as funded percentages. I like dollar deficits (real ones, not based on AAL) divided by number of taxpayers or population.
The question is what happens next in this totally hopeless situation -- a Federal bailout? That would be some precedent. Looks like Chicago is going to be the Studebaker of public pensions -- we'll see what happens.
Thanks again -- look forward to the next one.
I do need to find something OTHER than a grossly underfunded system to get one of the new ASOP 4 disclosures from.
It's really pointless looking at the LDROM for any of the Chicago/Illinois plans (other than IMRF... and maybe I should go looking for the IMRF one. That would be instructive.)
Mary Pat and Larry, a question I have is, if the Chicago MEABF actuarial report from Segal were written in a way that FE advocate would prefer, what would be different?
For a detailed reply, Larry would be better, due to his pension background.
I'm going to give a high-level reply: if there had been a low-default-risk valuation as a standard view for valuing the pension promises, PERHAPS they wouldn't have deliberately grossly underfunded the pensions for so long.
There would have been a philosophy that "yes, we value these liabilities as if we won't default on them."
Yes, I know that's not how people want to interpret that valuation, but that's my point of view.
The way public pension sponsors behave in some cases, they are planning on defaulting on their promises. It already happened in Detroit, in Rhode Island, in all sorts of places. The original promises were changed.
In some other places, they behave in a manner to demonstrate that they intend to fulfill their promises with low default risk. The participants and retirees, most importantly, can feel secure that their promised benefits will be there.
Thanks. I think this wording around the LDROM is interesting.
As of December 31, 2023, the LDROM for the system is $29,752,140,183. The difference between the plan’s AAL of $19,368,874,758 and the LDROM can be thought of as the increase in the AAL if the entire portfolio were invested in low-default-risk securities. Alternatively, this difference could also be viewed as representing the expected savings from investing in the plan’s diversified portfolio compared to investing only in low-default-risk securities.
ASOP 4 requires commentary to help the intended user understand the significance of the LDROM with respect to the funded status of the plan, plan contributions, and the security of participant benefits. In general, if plan assets were invested exclusively in low default-risk securities, the funded status would be lower and the Actuarially Determined Contribution would be higher. While investing in a portfolio with low-default-risk securities may be more likely to reduce investment volatility and the volatility of employer contributions, it also may be more likely to result in higher employer contributions or lower benefits.
This is very much in line with the ASOP 4 "toolkit" at https://www.ncpers.org/asop-4-toolkit-pensions-ldrom.
I believe this description, while technically accurate, is a very cynical and disingenuous presentation. The pretense that the ASB thought it important to disclose a hypothetical liability based on a portfolio that happened to consist of liability-matching assets is nonsense. The LDROM came about because of concerns that the current measures of liability shown were not economically meaningful, and a belief that the profession owes at least the disclosure of a more meaningful measure.
The requirement (which is still permitted) from the first exposure draft was a more genuine measure of market liability. That number would have been smaller -- the PV of benefits accrued to date (PVAB) valued with a similar discount rate. What is shown here and probably most other actuarial reports, is an "entry-age-normal-cost" (actuarial method) liability, which is based on a similar discount rate, but, for active employees, the liability is a target value of assets assuming that one were attempting to fund benefits as a level % of pay.
Why would public pension advocates, including many actuaries, lobby for the requirement to show a bigger, less economically meaningful, number? The reason, which was explicit in at least one comment letter that I recall, is that instead of having to say "this is the market liability," it allowed for the presentation shown -- basically, "this is a hypothetical number if you invested in low-default-risk assets, and you don't do that, so who cares, but if you did, look how much more it would cost."
In an NCPERS strategy webcast about how to deal with the possible repercussions of the LDROM disclosure (https://www.youtube.com/watch?v=ASuBoswhi6Y) the actuary, who was involved in putting the toolkit together, said this change to allow this presentation was a "major concession." It was, and largely allowed actuaries to downplay and bury the number. Shameful in my opinion -- instead of helping clients and the public understand their market liabilities, it gives undeserved reassurance that everything is fine -- at least in most cases, though not for this plan.
This presentation, in my opinion, violates precepts in the code of conduct requiring integrity and recognizing a duty to the public, and it violates the ASOP 1 requirement to apply standards of practice in good faith. But never mind ASOPs and the Code of Conduct. It seems to be an intentionally cynical and technical reading for the purpose of diverting attention from somewhere it's needed and spinning something to one's advantage.
To answer your original question, what would be different in this case if the report were more aligned with a reasonable market-based presentation, my guess would be probably nothing would be all that different. As Mary Pat points out, this plan is a complete basket case no matter how you look at it. To get to this point would have required a level of intentional negligence that would likely have been unaffected by more honest reporting.
Just my opinions.
I started watching the video. I did see Paul Angelo say that LDROM was a concession (but I don't think he said why). He also said that a comment in Reason said that LDROM was the "right" number, but on his slide it said that the comment said it was a better number (or something like that). Then the second guy, talking about the toolkit, said something like, "plans will continue to fund based on expected return," and my immediate reaction was, "but some don't fund even that number!" So many layers to this.
Thanks, Justin. Sorry for belaboring the point here, but to respond to a couple of your recent comments:
On the video, in discussing the concession, he talked about "why it helps" with the explanation. In going through the toolkit language, slide 7 that he showed said something like "Assuming we use the same level cost method" (EANC) is what allows for the explanation offered.
Also, from the comments on 2nd exposure draft,
comment letter #11, from NASRA, NCPERS, NCTR, (https://www.actuarialstandardsboard.org/wp-content/uploads/2020/07/Comment-11.pdf) said that being allowed to use the same funding method as the regular funding number "allows for the interpretation of this new number as what the ongoing funding liability would be if the plan actually invested entirely in low default risk bonds. Under that interpretation, the difference between that LDROM and the actual funding liability provides a measure of what the plan expects to save the taxpayers through taking on a prudent level of investment risk."
Note that here, and in the toolkit, actuaries are ultimately being instructed by non-actuary political lobbyists on how to comply with actuarial standards of practice. It's also notable that unlike many less-controversial issues, the Academy to this day has not issued a practice note. Rather, they have remained silent as their member actuaries work with overtly political organizations to develop guidance (the toolkit). What's the deal with that?
These discussions had been going on a long time, and prominent economists weighed in, and didn't (and still don't) think that the question is all that layered. I think it just seems like it because of the dust kicked up by public pension actuaries, which confuses the issue greatly.
Donald Kohn, then vice-chair of the Federal Reserve Board, said in a 2008 speech at an NCPERS conference:
"While economists are famous for disagreeing with each other on virtually every other conceivable issue, when it comes to this one there is no professional disagreement: The only appropriate way to calculate the present value of a very-low-risk liability is to use a very-low-risk discount rate.
However, most public pension funds calculate the present value of their liabilities using the projected rate of return on the portfolio of assets as the discount rate. This practice makes little sense from an economic perspective."
Also in 2008, at an AAA forum on this topic, David Wilcox, an economist at the Fed, testified as follows:
"The economics of how cash flows with no credit risk should be discounted back to the present are completely unambiguous and utterly noncontroversial. Those cash flows should be discounted back to the present using interest rates that are derived from securities with no credit risk. Every first year MBA student, even as we speak, is having this simple point drilled into their head right now in an introductory finance class. The only factors that matter for the determination of the scale of these obligations are the size of the promised cash flow and their essential characteristic which is that they are free of risk. That’s all you need to know. These are riskless cash flows. There’s an unambiguous answer as to what their value today is. What I’m trying to suggest, over and over again, is that the analytics of valuing cash flows that have no credit risk in them – those analytics are very straightforward. There’s no professional dispute associated with that question. These happen to be really simple cash flows to value. They’re free of credit risk. There’s only one conceptually right answer to how you discount those cash flows. You use discount rates that are free of credit risk. This is one of those things where it just really is that simple"
By the way, I wrote the Reason piece that was referred to in the video. I did not, and don't know anyone else who claims that solvency liability is the "one true measure," though it is certainly more economically meaningful than anything out there, and FE refers frequently to the "law of one price." The Reason piece was written before the first LDROM disclosure came out and before I knew about the toolkit. I expressed some fears about how actuaries and the lobbyists they're allied with (NCPERS, NASRA, NIRS, GFOA, NCTR) might react. Unfortunately, my worst fears were realized. The Reason piece is here: https://reason.org/commentary/a-chance-to-enter-a-new-era-of-financial-transparency-and-awareness-for-public-pension-plans/
Apologies for the length of this.
Thanks. I look forward to talking.
Got me. Maybe others want to hazard a specific guess. It’s fair to say, though, that Chicago seems likely to get there first and pretty soon, and as economist Herbert Stein said, “if something cannot go on forever it will stop.”
This is why I did the spreadsheet tool -- I originally created it in ~2017 to project MEABF going bankrupt, specifically, but then allowed projecting any of the plans in the Public Plans database.
MEABF was projected, back then, to run completely out of assets by 2024. That was assuming they didn't increase contributions, and of course they had to increase the contributions by huge amounts since then.
But they can't keep up those contribution levels. Johnson is having a hell of a time with his budget wishes. And that's just MEABF being a problem -- the teachers plan is even bigger, and while it doesn't promise to run out of $$ any time soon, its contribution needs are bankrupting the city rapidly.
I left Illinois a number of years ago. When does this "game of musical chairs" actually come to a head? Will it be like the film, Margin Call ? Chicago can go bankrupt if the State of IL authorizes it. The State of IL can't go bankrupt so it will have to reduce benefits as the pension debts can't be covered by raising tax rates, the Laffer Curve goes into effect.
I see your point … when a plan is about to completely run out of money it’s not worth arguing about what the real funded status is. Though if they had been working with real numbers all along maybe it doesn’t get to this? I don’t know…
If you are familiar w/ the quote from Adam Savage (from Mythbusters): “I reject your reality and substitute my own”
It doesn't matter how many "real numbers" we sent them. Even now, with the abysmal funded ratios, they're trying to figure out tricks to avoid having to put in higher contributions. They will always fall back on the "magic" of "the money will appear".
That's Chicago, at least. Forget about the pensions, they have been involved in so many dodgy finance practices, the only thing that stops them is the credit cards being taken away. The bond buyers who are involved in the scoop & toss figure they won't be left with the hot potato. The teachers unions may have finally made an ask too big... but we'll see.
I saw a piece from Eric Allie thinking that New Jersey is worse off than Chicago, and maybe it is, but I don't think that's the case. Nobody is under the delusion that anybody likes NJ so much they'll get bailed out.