Good and bad decisions have been made since 2000. Even though it appears that the Trustees may not have understood why the Fund’s liability was expanding so rapidly, they did not ignore the problem. This is to their credit. While some of their actions were responsible, others seem questionable.
As shown in Figure 4, both the Tom Lee and Ray Hair administrations responded to the
falling discount rate with repeated reductions to the beneﬁt multiplier as well as cuts to other
The most radical move was the drop to a beneﬁt multiplier of 1.00 and increased employer
contributions as the plan entered critical status. Lowering beneﬁts reduces the normal cost, so
the accrued liability grows more slowly. Increasing employer contributions as you lower normal
cost has the eﬀect of “catch-up” payments. Both administration’s reactions were similar and
responsible. Unfortunately, these changes were a mere drop in the growing liability bucket caused
by the low interest rate environment and consequent FASB-inﬂuenced lowering of the
discount rate. It’s clear that the Trustees expected more from the beneﬁt multiplier
cuts than the cuts could deliver. Either unaware, or ignoring how the Fund actually
worked, comments from the Trustees during this period were overly-optimistic, even as
the discount rate was plummeting and the liability sky rocketing. They remind us
of the joke about the man who jumped oﬀ a 100-story oﬃce building. Asked by the
window washer on the 50th ﬂoor, “How are you doing?”, the man replied, “Great so
Other changes made by the Trustees in both AFM administrations are more controversial.
Under Tom Lee, the AFM-EPF started using hedge funds, junk bonds (which they purchased too
late in their cycle, for too high a price) and other risky investments. This exposed the Fund to
incredible market risk, and when the 2008 crash occurred, the AFM-EPF did worse than
The current Trustees (as they note in their presentation), prompted by the seemingly unstoppable
liability growth, commissioned a study from Milliman. This study suggested that only by
taking on even greater risk could the Fund avoid future insolvency. Of course, as the study also
points out, there is now also a greater chance of insolvency from the additional investment
Before we leave the subject of the discount rate, we want to make one further point: as bad as it is, we are fortunate that the FASB pushed regulators to lower the discount rates. Public pensions have not been so fortunate. They listen to another standards board: the GASB (Government Accounting Standards Board). Currently most (maybe all) public pension plans are using a 7%-8% discount rate to calculate their accrued liability. This will make pensioners happy until the bill comes due. That is when they will discover there is no money left to pay their pensions. When the City of Detroit went bankrupt in 2013, the city’s actuaries reported pension underfunding of $600 million. A second, independent actuarial ﬁrm showed underfunding of $3.5 billion! The noted actuary and pension authority Dr. Jeremy Gold believes the liability to be north of $7 billion. The low-balling of the pension fund by the city’s actuaries may have made everyone happy, but in the end it hurt not only the retirees, but everyone else aﬀected by the bankruptcy. We are expecting more such municipal implosions down the road.
Why did the city’s actuaries use such a high discount rate to value the pension fund’s liabilities? As Dr. Gold has pointed out in an article on the Detroit pension crisis:
“U.S. Actuarial Standards of Practice (ASOPs) endorse the lowball estimates discussed above. The U.S. Code of Professional Conduct calls upon actuaries to be loyal to their clients. In the case of public plans, the clients are usually the boards of Trustees that administer the plans; the state and local governments that sponsor plans and the unions representing public employees also may hire actuaries. None of these clients wishes to hear a $554 ﬁnancial value when they have diﬃculty paying the back-loaded and understated costs associated with meeting a $258 actuarial value.”
As further grist for our mill, Table 3 from the Center for State & Local Government Excellence’s 2017 Funding Brief, shows how alternative discount rates would aﬀect the unfunded liability and funded ratios of public pension plans. These public plans are just now beginning to feel the heat that private plans have been experiencing for a number of years.
So if you’re tempted to blame the regulators for our current mess, don’t be. If they hadn’t stepped in over a decade ago, we would probably be in a similar situation to the pensioners in Detroit (and elsewhere) who woke up one morning to a $7 billion ﬁnancial hole. At least we have been given a chance to ﬁx our mess.
6The Trustees denied us permission to use anything from their presentation. This is our own graphic, based on one of their slides.
7Nobel Laureate William F. Sharpe has this to say about fund managers who do this sort of thing: “Consequently, they believe that one of the great things to do is put money in private equity, or maybe a hedge fund, because then they can assume an extra 300 or 400 bps of expected return for an illiquidity premium (or just because hedge fund managers are so smart). So, the tail wags the dog. Idiotic accounting drives even worse investment decisions. This is the classic case of an organization that borrowed money while issuing purportedly guaranteed payments and then used the money to invest in risk securities. Where have we recently heard that this is not a good thing?”
8The Trustees have yet to make this point in their presentations. They may (reasonably) feel it is obvious, but we believe it should be clearly stated.