March 4, 2014

For Immediate Release: March 4, 2014
Contact: Alan Barber, (202) 293-5380 x115

Washington DC - Economist Dean Baker, a co-director of the Center for Economic and Policy Research (CEPR), issued the following statement on the Society of Actuaries Blue Ribbon Panel on Pension Funding:

“The report of the Society of Actuaries Blue Ribbon Panel contained many useful insights and recommendations for managing pension funds. In particular, it affirmed the appropriateness of using expected rates of return for assessing pension fund liabilities and planning annual contributions. This has been a major area of contention in recent years. While the panel did recommend that funds also calculate liabilities using a risk-free discount rate, it did not argue that this should be the main measure and should determine the annual contributions.

“The panel also made several recommendations on transparency, which will provide useful guidance for pension fund managers. However there are several aspects of the report that are worth noting.

“First, the panel failed to recognize the dependence of future asset returns on current market valuations. This is disappointing since this failure was one of the main factors leading to the shortfalls many pensions are currently facing. During the stock market bubble of the late 1990s, most pensions assumed that stocks would continue to provide historic rates of return even as price to earnings ratios were reaching levels that were twice their historic average. As a result, they radically reduced their contributions at a time when the economy was experiencing its most prosperous period in three decades.

“When the bubble burst, pensions suddenly faced much higher required contribution rates exactly at a point when state and local government finances were being squeezed by the recession. If pension funds had adjusted their return expectations in accordance with asset values, they would not have reduced contribution levels to the same extent in the bubble years and would not have faced as much difficulty maintaining required contribution rates after the bubble burst.[1] It is disappointing that the panel did not address this issue.

“A second point that may cause some confusion is that the main source of the difference between the 6.4 percent rate of return assumption recommended by the panel and 7.0-7.5 percent assumptions used by many pension plans is a difference in assumed rates of inflation. Many pension plans still assume rates of inflation of 3.0 percent or even higher, based on historical experience. The panel recommended an inflation assumption of 2.3 percent, based on its assessment of inflation prospects in the decade ahead. This implies a 4.1 percent real rate of return on pension assets, which is not very different than the implicit assumption in most funds’ assessments of plan liabilities. For this reason, adoption of the panel’s recommendation would not have a large impact on the funding situations of most plans.

“Finally, it is disappointing that the panel didn’t include recommendations for greater transparency and disclosure from pension funds consultants and managers. There have been many incidents where pension fund have paid excessive management fees, often in cases where managers underperformed index funds. It would be helpful if funds were more transparent on the fees paid to those hired to manage funds and also on the returns received on the assets invested. This would be valuable information not only for reporters and researchers assessing the cost and quality of fund managers, but also for other funds who want to manage their assets in the most cost-effective way.

“A clear statement on this issue by the Society of Actuaries’ panel would have carried considerable weight. It’s unfortunate that it chose not to address this problem. As a result, the report is less valuable than it otherwise could have been.”


[1] This issue is discussed in Weller, Christian and Dean Baker, 2005. “Smoothing the Wave of Pension Funding: Could Changes in Funding Rules Help Avoid Cyclical Underfunding?”  Journal of Policy Reform, V8, #2.