Bond Lawyers Discuss Stronger Pension Disclosures
A National Association of Bond Lawyers discussion draft suggests 10-year projections.
As I've written before, governments borrowing money in the municipal bond market face securities fraud risks if they fail to properly disclose the full extent of their retirement obligations and the claims these plans make on future revenues. One solution would be for the Governmental Accounting Standards Board (GASB) to require enhanced disclosure in the notes to financial statements or the supplemental schedules provided in the back of annual reports. Another approach, although less taxpayer-friendly, would be to require issuers or marketers of bonds to include the needed information in official statements and annual filings with EMMA, the muni bond industry's data repository.
To their great credit, the National Association of Bond Lawyers (NABL) has issued a discussion draft of a disclosure guideline that would provide forward-looking projections of vital actuarial information for defined benefit pension plans. The NABL draft guidelines start with readily available 10-year historical data, but then go the extra step to also include a 10-year table showing projected actuarially required contributions (ARC), unfunded accrued actuarial liabilities (UAAL) and the funding ratio of the plan each future year (the percentage of accrued liabilities funded by plan assets). Conceptually, this schedule has properties similar to standard GAAP disclosures of capital lease obligations: It alerts the bond investor to competing claims.
My view is that the NABL guidelines are a great start, and the bond lawyers have moved the ball well downfield. They should increase the suggested projection period to 15 years for plans that are not funding their full actuarial contributions, and require additional projections of the expected contribution rates and remaining unfunded liabilities at the end of 15 and 20 years if current policies are not changed. The same standards should also apply to OPEB (other post-employment benefits) plans for retiree medical benefits, and compel similar long-term projections of the consequences of pay-as-you-go financing for employers that fail to make actuarially based OPEB contributions. Then bond investors could make rational decisions regarding the safety of their long-term investments in light of the competing claims on future resources that will inevitably arise if these systems are allowed to continue with unsustainable funding practices.
Some actuaries will object to the NABL approach as focusing on point-estimates, when a range of outcomes is the nature of making probabilistic long-term projections. That's a fair argument, and the NABL might consider a multi-factor forecast approach that shows companion projections based on alternative standardized assumptions. With new GASB accounting standards coming soon, an alternative forecast using GASB-based discount rates would provide an alternative projection basis, especially if GASB adheres to its conceptual revision that unfunded liabilities should be amortized over the remaining careers of employees. So would a forecast using the notorious "risk-free" rate of government bond yields which would provide a worst-case perspective — although many folks consider that too extreme. As middle ground, I happen to like the discounting approach used by Barclay's analysts which was cited in my previous article. For a more optimistic forecast, a discount rate based on historical 20 or 30 year returns could be used if that provides a more favorable view. Pension fund administrators may complain of data overload and potential confusion, but the counterpoint to that argument is that the primary audience is investors who need to see the data sliced in different but uniform ways. Besides, it is the actuaries themselves who privately scoff at single point-estimate presentations. Ideally, an independent institute focused on retirement funding practices could provide the needed professional guidance for these projections — an idea I will discuss more fully in a future column.
Of course, this data will come at a cost. The consulting actuaries will complain all the way to the bank about the extra work this demands. The pension funds and employers will bear the cost — even though the immediate financial benefit of this exercise is arguably for the bond investor, not the retirees. In the long run, however, both taxpayers and retirees will benefit from the clear new light that this information sheds on the true long-term costs of retirement benefits and the obligations that employers incur when they increase those benefits. Public employers will be more likely to think twice about future benefit increases if laws and policies require this kind of information before decision-makers vote.