Friday, August 15, 2008

pension update and clarifications

News is that the total city pension fund is now at $330 million, down a remarkable $55 million over just 6 months earlier in the year. At that rate the fund is going down $110 million/year which sounds awful and will not last long. Because of the timing of city and state payments, the current annualized burn rate comes to be more like minus $55mil/year. At that rate we are now exactly 6 years from a zero fund balance in the fund. Hopefully the market does not sustain its downward trend and the city will certainly be forced to increase contributions (that is a story unto itself) so that 6 years may be overly pessimistic, but things will be quite insufferable years before the funding ratio reaches absolute 0%. That and parts of the pension fund, especially that for retired police officers will run out of money long before the other parts.

Some may recall my most recent pension manifesto. The punch line was that pension liability in itself for the city of Pittsburgh has for the first time reached over a $Billion. I am told that the city disputes this a bit and that the total pension liability is only $899 million which is what you see reported.

That's fine, but here is the deal. There are different ways to measure pension liability. One measurement is the present value of future payments . A second valuation is the accrued liability. Both values are clearly itemized for a reason on the page 3 of each of the actuarial reports for the (Fire, Police and General Municipal) pension funds. Here is what the two different definitions give you as of January 1, 2007 (still remember 2007) for the city of Pittsburgh.

Present Value:

Accrued Liability:

Which is the better number? The higher PV calculation takes into account the future investment costs that the plan expects to have. There is a weird angle to this. If you are a pessimist like me to think the pension funds are draining away going into the future then its likely the investment costs will be lower than expected as well. So it's contradictory, if you are a pessimist, the lower value is better and if you are an optimist about how the pension funds will be faring over the long run you ought to believe the higher number for the total liability. So the best number may be somewhere between $899 million and $1.04 billion. I hope nobody feels comfortable thinking that the liability is only $899 million. Arguing about which one is better is quibbling while Rome burns. Realize at the very least that the low funding ratios that get reported in the news are the higher of these two possible valuations.

However, I would admit a bad graph in that I do what I often catch others doing either inadvertently or intentionally of mixing and matching data. That is always an easy path to bad analysis. In one chart I mixed past data with the lower version of the pension liability over time with the higher current version. So to be consistent here is the time series of the AAV version of the pension liability for the City over the last decade.

I think there is still a trend in there? It was however, not as big a jump this last two-year cycle as my first graph made it appear. Half of that jump was my mixup of the two definitions of liability calculations. Still, that trend is there. There are reasons to think the trend is still there (and some to think it may not), but barring an historic reversal there has been roughly a 3% increase annually over this period. So even with the lower number and extrapolating from 1/1/07 we are still awfully close to a full billion dollar pension liability.

And even assuming that the total liability number is the lower version, and has not changed at all since Jan 2007, then with $330 in assets the unfunded liability is just under $570 million, not the $462 million that was quoted in the news as recently as July.

It's a sidebar that these reports actually calculate future payments and investment appreciation based on the assumption that the fund will eventually get to be fully funded. That's not an error, but it's optimistic when you realize that that same assumption has been behind every actuary report since they began doing them under current statutes in the 1980's. Somehow the funding ratio has not been marching toward nirvana.

Here is the time series of the asset levels in the 3 major city pension funds. No disputes over definitions there.. money is money. There have been some periods when the stock market has done remarkably well and the pension fund has generally held its own. In flat or declining markets the pension fund has sunk.

So you have to ignore the one big jump in the late 1990's. Some know the history that pension funds for the city were due to run out of money completely in the late 1990's and the solution put forward at the time (by the Competitive Pittsburgh Task Force and by others) was to float a large bond, put the money into a balanced investment portfolio under the assumption that it would appreciate to the point of funding the pension system more fully. So that graph is supposed to have been marching upward. That has not exactly worked out as it was planned, nor is likely to at this point barring truly historic bull markets or other significant changes to how the pension system is funded. .


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