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Permissionisherebygrantedtodistributethisarticleinitsentiretytoanyparticipantofthe
ChicagoTeachersPensionFund.Permissiontopublishordistributethisarticleinitsentirety
underanyothercircumstanceisprohibited.
ActuarialFailuretoRecognizeAssetDepletionRiskofBabyBoomerRetirementsLedto
DeathSpiralinChicagoTeachersPensionFund
ByTheodoreKonshak
TheodoreKonshakisaformerEnrolledActuary.From1981to1994,Mr.Konshakwasemployedasapension
actuaryintheChicagoofficesofWilliamM.MercerandtheAonCorporation.Hewouldlaterteachmathematicsat
MenomineeIndianHighSchoollocatedontheMenomineeTribalReservationinKeshena,Wisconsin.Mr.Konshak
receivedhisB.A.inmathematicsandsociologyfromNorthwesternUniversity.
WhenGeorgeW.BushwaselectedPresidentoftheUnitedStates,privatizationoftheSocial
Securitysystemwashotlydebated.Atthattimesomeadvocatesofprivatizationwouldclaim
thatthefutureretirementsoftheBabyBoomgenerationwouldbankrupttheSocialSecurity
system.
DeathspiralisatermthatthePensionBenefitGuarantyCorporation,thefederalinsurerof
privatesectorpensionplans,hasusedtodescribethesituationwherethecontribution
requirementsspiralupwardstoapointwheretheemployercannolongeraffordtofundthe
pensionplan.TheskyrocketingcostsoftheChicagoTeachersPensionFundarean
underlyingcauseofapotentialstrikeactionbytheChicagoTeachersUnionagainstthe
ChicagoPublicSchools.
ThedeathspiralintheChicagoTeachersPensionFundresultsfromtheretirementsofthe
BabyBoomgeneration.Thereisasubstantialandcontinuingincreaseinthedisbursements
fromthefundduetotheseretirements.WiththeBabyBoomerretirements,theChicago
TeachersPensionFundceasedtobeinanaccumulationphaseandenteredintoa
disbursementphase.
Individualssavingfortheirretirementareinanaccumulationphase.Individualsmanagingtheir
assetsaftertheirretirementareinadisbursementphase.Individualswhoaccumulatetoosmall
ofaretirementfundmayexperiencefinancialdifficultiesinthelateryearsoftheirretirements.
ThecurrentproblemsoftheChicagoTeachersPensionFundarenodifferentfromthefinancial
difficultiesofthoseindividuals.ThefundaccumulatedbytheChicagoTeachersPensionFund
priortotheseBabyBoomerretirementswastoosmall.
ThecashnecessarytopaythepensionbenefitsoftheChicagoTeachersPensionFund
ultimatelycomesfromeitherthecontributionsintothetrustfundortheinvestmentincomeon
thosecontributions.Theactuarialinterestrateistraditionallydefinedastheexpectedrateof
futureinvestmentreturn.Itdeterminestheportionexpectedtocomefromfutureinvestment
income.Higheractuarialinterestratesassumealargerportionofthiscashwillcomefrom
futureinvestmentincome.
TheChicagoTeachersPensionFundhasbeenunderfundedthroughtheuseofanactuarial
interestrateassumptionthathashistoricallybeensetattoohighofalevel.Toomuchofthe
cashnecessarytopaythesepensionbenefitswasexpectedtocomefromfutureinvestment
income.Notenoughofthecashwasexpectedtocomefromfuturecontributions.
InitiallythisactuarialinterestratecausedtheplantoreceivenocontributionsfromtheChicago
PublicSchoolsforaperiodoftenyears.Nocontributionswerenecessarysincethesuperior
investmentreturnsofthosedayswereexpectedtocontinuefarintothedistantfuture.No
contributionsbeingmadeininsurancetermsisknownasapremiumholiday.
Aftertenyearsofthispremiumholiday,thecontributionscalculatedthereafterbytheactuaries
wouldprovetobeinsufficient.Atthattime,inspiteoflowerinvestmentreturns,theactuaries
stillexpectedthesuperiorinvestmentreturnsoftheolddaystocontinuefarintothedistant
future.AftertheBabyBoomerretirementscommenced,thesesuperiorinvestmentreturnshad
stillnotreturned.Thetrustfundwastoosmallandwoulddepleteduringthisperiodoflower
investmentreturns.
Intheearlystagesofthisdeathspiral,theChicagoPublicSchoolswouldobtainapartial
premiumholidayfrom20112013fromtheStateofIllinois.Thiswouldfurthercompoundedthe
depletion.TheappetiteofthedeathspiralformorecontributionsfromtheChicagoPublic
Schoolswouldnotbeabatedbylegislativeaction.Favorableinvestmentreturnmayprovidea
briefrespitehereandtherebutthedeathspiralwilldemandmoreandmorecontributionsfrom
theChicagoPublicSchools(CPS).TheCPScontributionshavetospiralupwardsto
compensatefortheabsenceoftheexpectedinvestmentdollars.
InselectingtheactuarialinterestrateassumptionfortheChicagoTeachersPensionFund,the
actuariesfailedtoconsidertheriskoftheBabyBoomerretirementsontheassets.Theyonly
consideredtheBabyBoomerretirementsasademographicriskaffectingthecalculationoftheir
actuarialliabilities.
Theactuarialinterestrateisalsotraditionallydefinedasthe
average
rateoffutureinvestment
return.Asanaveragerateofinvestmentreturn,theactuarialinterestrateassumptionmightbe
achievedinthelongtermbuttherewouldstillbeadepletionriskwheretheinvestmentreturnin
actualdollaramountscanbelessthanexpected.Forexample,fortheChicagoTeachers
PensionFund,theannualinvestmentreturnontheActuarialValueofAssetsforthefiveyear
periodfromJuly1,2007toJune30,2012was1.62%.Withanannualinvestmentreturnof
14.38%inthefollowingfiveyears,theinvestmentratewouldaveragetothethenexisting8%
assumedrateofreturn.Sustainingsuchahighrateofinvestmentreturnisimprobablebutthe
actualinvestmentreturnindollarswontaverageanyway.Therewillbeashortfallinthose
actualdollarreturns.
Thisshortfallistheinvestmentincomethatwouldhavebeenearnedontheassetsthatwentout
thedoorfromJune1,2007toJune30,2012intheformofbenefitpayments.Becauseofthe
BabyBoomerretirements,thosebenefitpaymentswereonethirdoftheplansassets($5.132
billion).Anannualinvestmentreturnof14.38%wouldnotbeearnedonthatthirdinthe
subsequentfiveyearperiod.
ThedepletionriskoftheseBabyBoomerretirementsshouldhavebeenconsideredbythe
actuarieslongbeforethoseretirementsactuallyoccurred.Itwasntanunanticipatedevent
beyondthecontroloftheactuary.
OnlymembersoftheAmericanAcademyofActuariesmeetingitsQualificationStandardscan
performandcertifytheactuarialvaluationresultsofpublicsectorpensionplans.Inselecting
theactuarialinterestrate,theactuariesfortheChicagoTeachersPensionFundperformedtheir
taskasspecifiedbytheAmericanAcademyofActuariesanditsActuarialStandardofPractice
No.27(ASOPNo.27).TheriskofassetdepletionassociatedwiththeseBabyBoomer
retirementswasnotconsideredbytheactuariesunderthisASOPNo.27.
StatutoryContribution
ThereisastatutorycontributioncalculatedunderthetermsofIllinoisStateLawanda
calculationoftheActuariallyDeterminedContributionundertherequirementsofthe
GovernmentAccountingStandardsBoard(GASB).Thecashcontributionintothetrustfundis
determinedunderthestatutorycalculationandtheGASBcalculationdisclosesthefinancial
positionoftheplan.Theybothusethesameactuarialinterestrate.
TheDeathSpiral
DuetoarevisionintheGASBrequirements,therewasachangeintheirterminology.The
AnnualRequiredContribution(ARC)wouldbecometheActuariallyDeterminedContribution
(ADC).TheaccelerationintheannualamountsoftheARCandADCdeterminedunderthe
GASBrequirementsshownbelowisthedeathspiral.
Frompage32oftheJune30,2012actuarialvaluationoftheChicagoTeachersPensionFund:
Frompage45oftheJune30,2014actuarialvaluationoftheChicagoTeachersPensionFund:
NoticethedecreaseintheActualContributionsintheyears20112013.Thiswasduetoa
partialpremiumholidayprovidedtotheChicagoPublicSchools.
Inapreviousresearchreport,negativeamortizationwasdiscussed.Whentalkingabouta
homemortgage,negativeamortizationmeansthemortgagepaymentisinsufficienttopaythe
interestontheloan.Asaconsequence,theloanbalancewillgrowlarger.Inpensionplan
terminology,negativeamortizationmeanstheamortizationpaymentisinsufficienttopaythe
interestontheunfundedliabilities.Asaconsequence,theunfundedliabilitieswillgrowlarger.
Negativeamortizationhasnoplaceinactuarialcalculationsandisofnoredeemingvalue.Itis
notpermittedunderfederalrulesapplicabletoprivatesectorpensionplans.Itsonlypurposein
publicsectorpensionplansisanunsavoryone.Byinappropriatelyreducingtheamountofthe
ActuariallyDeterminedContribution,negativeamortizationmakesthepensionplanlook
healthierthanitactuallyis.Intheabsenceofthisnegativeamortization,theActuarially
DeterminedContributionfor2014shownabovewouldincreaseby$185millionfrom$720
millionto$905million.
AlthoughthefailureoftheChicagoPublicSchoolstomakecontributionsisanundeniablefactor
inthedemiseoftheChicagoTeachersPensionFund,theinappropriatelyhighactuarialinterest
rateistheprimaryreasonbehindthesecontributionsnotbeingmade.Itisalsothereason
behindtheemergenceofthedeathspiral.Theassetsinthetrustfundweretoolowtosustain
thepensionpaymentsoftheBabyBoomergenerationandthefunddepleted.
SelectionoftheActuarialInterestRateAssumption
IntheChicagoTeachersPensionFund,theactuarialinterestrateassumptionwaschanged
effectivefortheJune30,2013actuarialvaluation.ThiswastheresultofanActuarial
ExperienceReviewfortheperiodofJuly1,2007toJune30,2012conductedbytheplans
actuaries.
Fromthetoneofthisreport,theactuariesdidnotexpecttheActuarialExperienceReviewtobe
reviewedbyanyoneotherthantheBoardofTrusteesoftheChicagoTeachersPensionFund.
Thiscontraststothetoneoftheactuarialvaluationreports.TheActuarialExperienceReview
wasobtainedthroughaStateofIllinoisFreedomofInformationActrequest.Actuarialvaluation
reportsareavailableonthewebsiteoftheChicagoTeachersPensionFund.
ThereportfortheirActuarialExperienceReviewdescribesonpage15howthatactuarial
interestrateassumptionwasdeterminedunderActuarialStandardofPracticeNo.27(ASOP
27):
Thefourbuildingblocksusedinconstructingtheactuarialinterestrateassumptionare(1)
inflation,(2)portfoliorealrateofreturn,(3)investmentexpenseand(4)riskadjustment.
Theadjustmentforinvestmentexpenseistheadministrativecost.Theriskadjustmentis
portfoliorisk.Inotherwords,stocksmightbemoreriskythanbondssoanadjustmentmight
havetobemadetoreflectthepensionplaninvestingmoreorlessofitsportfolioinstocks.
Theriskadjustmentisdescribedonpage17ofthatActuarialExperienceReview:
Theriskadjustmentshowninthetableaboveisonlyapaltry0.31%.Itisaportfoliorisk.The
depletionriskassociatedwithBabyBoomerretirementswasnotconsidered.Itsconsequences
arefarmoreexplosivethanapaltry0.31%.
Thecomponentsoftherecommendedactuarialinterestrateassumptionof7.50%alsototaled
toaniceroundnumberoftwodecimalpoints.Whataretheoddsofthat?
TheCommunicationsGame
IntheaforementionedActuarialExperienceReview,theactuariesfortheChicagoTeachers
PensionFundagreedwithmycontentionthatnegativeamortizationunderminesanyanalysisof
thesufficiencyordeficiencyofemployercontributions.Negativeamortizationoccursunderthe
levelpercentageofpayrollmethodofamortization.
Ratherthaneliminatingthenegativeamortizationofthatlevelpercentageofpayrollmethod,the
actuariesrecommendedfirstdecreasingtheamountofthenegativeamortizationbyclosingthe
amortizationperiod.Underthepreviousopenamortization,theunfundedliabilitieswere
amortizedeachandeveryyearover30years.Underclosedamortization,theamortization
perioddeclineseachyearbyoneyearaswouldoccurunderatraditionalfixedratehome
mortgage.Afteroneyearsworthofpayments,theremainingamortizationperiodundera
30yearfixedratehomemortgagewouldbe29years.
Closingtheamortizationperiodwasthestartingpoint.Afterwards,thenegativeamortization
maybesecretlyeliminatedifandwhenaformalfundingpolicybasedonsoundactuarial
methodsisimplemented.
Frompage9:
AccordingtotheactuariesfortheChicagoTeachersPensionFund,theGASBcalculationis
importantwhenanalyzingthesufficiencyordeficiencyoftheemployercontributionsbecause
thestatutorymethodoftheStateofIllinoisisnotactuariallysound.Thatiswhymyanalysisis
alsobasedontheGASBnumbers.
MyvisualanalysisoftheemployercontributionsundertheGASBrequirements,alongwithan
adjustmentfortheeffectsofthenegativeamortizationofthelevelpercentageofpayrollmethod
ofamortization,indicatesthattheChicagoTeachersPensionFundisinadeathspiral.
Formoreinformationonnegativeamortization,seemyseparateresearchreportonthe
negativeamortizationintheChicagoTeachersPensionFund.
ChangeinDisclosures
ThenegativeamortizationintheChicagoTeachersPensionFundoccursthroughtheuseofthe
percentageofpayrollmethodofamortization.Consistentwiththefuturedesiretosecretly
eliminatethenegativeamortizationofthisamortizationmethod,disclosureofitsusewould
mysteriouslydisappearfromtheactuarialvaluationreports.
Includedonpage11oftheJune30,2013actuarialvaluationreport:
Theannualrequiredcontributionisbasedonaclosed30yearlevelpercentageofpayamortizationofthe
unfundedactuarialaccruedliability.TheBoardofTrusteeselectedtoclosetheamortizationperiod,effective
July1,2013,aspartofthechangesfromthemostrecentexperience
review.
Notincludedonpage11ofthefollowingJune30,2014actuarialvaluationreport:
EffectiveJuly1,2013,theamortizationperiodwassetto30years,butwilldeclinebyoneyearineach
subsequentvaluation.AsofJuly1,2014,thereare29yearsremainingonthisschedule.
Actuariestraditionallyproducethecurrentyearsactuarialvaluationreportbymarkingupa
copyofthepreviousyearsreport.Changesareindicatedandasecretarywillmakethose
changeswhentypingthereport.Thatiswhyactuarialvaluationreportsaresosimilarfromone
yeartothenext.
AnexplanationoftheeffectsofnegativeamortizationappearsinafootnoteintheJune30,2012
actuarialvaluationreportbutthefootnotedisappearsintheJune30,2013actuarialvaluation
report.
Onpage35oftheJune30,2012actuarialvaluationreport:
Onpage35oftheJune30,2013actuarialvaluationreport:
IntheJune30,2014actuarialvaluationreport,conductedundernewGASBrequirements,there
isnosimilarexhibit.Disclosureoftheuseofthepercentageofpayrollmethodofamortization
wasalsoeliminatedonpage11ofthatreport.Theuseofthatamortizationmethodwouldno
longerbedisclosedanywhereinthatJune30,2014actuarialvaluationreport.
Theseattemptstosecretlyeliminatethedisclosureofthenegativeamortizationmethodandits
effectsareindicativeofitssleazyandunsavorynature.Formoreinformationonitssleazyand
unsavorynature,seemyseparateresearchreportonthenegativeamortizationintheChicago
TeachersPensionFund.
TheBlueCode
Theannualminimumrequiredcontributionforcorporatepensionplansintheprivatesectoris
determinedbyafederallylicensedactuaryunderthetermsoftheEmployeeRetirementIncome
SecurityActof1974(ERISA).Thiscontributionrequirementiscertifiedbytheactuaryona
ScheduleSBattachedtotheinformationreturn(Form5500)thatthecorporatesponsorannually
fileswiththefederalgovernment.Publicemployeepensionplanactuariesarenotsubjectto
thatfederallawandareselfregulatedthroughtheActuarialStandardsBoard.
Theabsenceofoutsideregulationcanraiseissuesregardingtheworkproductofpublicsector
actuaries.Apolicedepartment,forexample,mayconductaninternalinvestigationof
wrongdoingbyoneofitsmembers.Thereisalwaysanissueofthepoliceprotectingoneofits
own.ThesametypeofissueappliestotheActuarialStandardsBoard.Itisagroupof
actuariesestablishingrulesforthemselves.Andlikepoliceofficers,therewillbeanunwritten
ruleorbluecodethatactuariesshouldnot
reportonacolleague'serrorsormisconduct.
AcopyofmyresearchreportonthenegativeamortizationusedintheChicagoTeachers
PensionFundwasprovidedtoitsExecutiveDirectorpriortothepublicationoftheJune30,
2015actuarialvaluation.Thesecreteliminationofthisnegativeamortizationdoesnotbenefit
theChicagoTeachersPensionFund,theBoardofTrusteesoritsExecutiveDirector.Through
itssecreteliminationthecurrentactuaryavoidstheneedtopubliclyexplainwhythissleazyand
unsavoryamortizationmethodshouldbeeliminated.
Thismaybeanexampleofadherencetotheunwrittenruleorbluecodewhereactuariesdo
not
reportonthesleazyandunsavorypracticesoftheprofession.Ifnotsecretlyeliminated,the
actuaryfortheChicagoTeachersPensionFundmightreceivealetterofrebuttalfromthe
AmericanAcademyofActuariesforpubliclydisclosingnegativeamortizationasasleazyand
unsavorypractice.
VerificationofResearchResults
Accordingtomyresearchpublishedyearsago,therewouldbeaminimumcontribution
requirementthatplansponsorsintheprivatesectorwouldaccept,frequentlynolargerthan
zero,andthentheactuarieswouldmanipulatetheactuarialassumptionstoachievethatresult.
Theselectionoftheactuarialinterestrateassumptionwastheprimarymeansofachievingthat
result.
RichardA.Ippolito,aformerchiefeconomistatthePensionBenefitGuarantyCorporation,and
VictorModugno,anactuary,wouldreplicateandfurtherexpanduponmyresearchresults.
InaJanuary2007researchreportwrittenbyactuaryVictorModugnoandpublishedbythe
SocietyofActuariescalledTheImpactofReversionTaxesonPensionPlanFunding(Available
ontheSocietyofActuarieswebsite),loweringcontributionsthroughtheincreasinglyaggressive
selectionofactuarialassumptionsandcostmethodswasthecauseofdecliningfundingratiosin
privatesectorpensionplans.Thefundingratioisthepercentageoftheplansactuarialliabilities
thatarefundedbytheplansassets.
RichardA.IppolitoandVictorModugnowerebothadvocatingtherepealofthe50%excisetax
onassetreversions.Anassetreversionisareturnofthepensionplansassetstothe
employer.Paymentof50%ofthatreversiontothefederalgovernmentintheformofanexcise
taxhadeffectivelydiscouragedthepractice.
Thechangefromconservativeactuarialinterestratesin1980tooverlyoptimisticactuarial
interestratesin2004wasthemostimportantoftheseincreasinglyaggressiveactuarial
assumptions.VictorModugnoreferstotheactuarialinterestratehereastheinterestrateused
forfundingandthefundingrate.
Onpages1,4and5ofresearchreportwrittenbyVictorModugno:
The50%reversiontaxhasledtoadefundingofsingleemployerdefinedbenefitpensionplansthroughlower
contributions.Thisdeclineinfundingratiosthatoccurredafterthereversiontaxeswereenacteddespitefavorable
investmentperformanceresultedfromtheuseofincreasinglyaggressiveactuarialassumptionsandcostmethodsfor
funding.ChartB(attached)showsthedifferencebetweentheinterestrateusedforfundingandmarketinterestrates.
Thefundingratewentfrom5%belowmarketin1980to3%abovemarketin2004.Thisisoneofthemostimportant
causesofthedeclineinfundingratios
Publicemployeepensionplansneverhadthelevelofsurplusassetsofprivatesectorplans.
Butassetreversionsintheprivatesectorareindicativeofthementalitythatexistedwhenthe
ChicagoPublicSchoolsmadenocontributionstotheplanbeginningin1996.
NoContributionsfrom1996Through2005
TheChicagoPublicSchools(CPS)didnotmakecontributionsintotheChicagoTeachers
PensionFund(CTPF)from1996through2005.AsstatedbyCPSinitsFiscalYear(FY)2015
Budget,theschooldistrictdidnotresumemakingcontributionsintotheChicagoTeachers
PensionFunduntil2006:
CPSisrequiredtomakeanannualcontributiontoCTPF,basedonanactuarialcalculation,sufficienttobringto90
percentthefundedratioofactuarialassetstoliabilitiesby2059AsrecentlyasJune30,2001,CTPFhada
fundedratioof100percent,andaccordingtostatelawCPSdidnothavetomakeanemployercontribution.ByJune
30,2004,thefundedratiohaddroppedto86percent,belowthe90percentstatutorythreshold,andthereforeCPS
wasstatutorilyrequiredinFY06,tomakeemployercontributions.Sincethen,theannualpensioncontributionhas
skyrocketed
TheStateofIllinoiscreatedastatutorythresholdwherenocontributionswererequireduntilthe
fundingratiodroppedbelow90%.
NoContributionsDuetoActuarialInterestRateAssumption
TheactuarialinterestrateassumptionfortheChicagoTeachersPensionFundthroughthe
June30,2012actuarialvaluationhadbeen8%.Thisistheassumedrateoffutureinvestment
returnduringthelifetimeofthepensionplan.Itisnottheexpectedinvestmentreturnforone
year.Itistheexpectedinvestmentreturnuntilthelastpersoninthepensionplandies.
LookingonlyattheperiodoftimeaftertheBabyBoomersstarttoretire,whatistheeffectifthat
8%isnotearned?If,forexample,theinvestmentreturnassumptionwas8%tothedatewhen
theBabyBoomerswereexpectedtoretireand5%thereafter,theactuarialliabilitiescalculated
in1996wouldhavebeengreaterthanundertheassumed8%rate.Sincethoseactuarial
liabilitieswouldhavebeenlarger,thecontributionsrequiredtobedepositedintothetrustfund
wouldhavealsobeenlarger.
InthecaseoftheChicagoTeachersPensionFund,nocontributionsweremadebeginningin
1996becausetheplanwasfullyfunded.Theperiodofnocontributionslastedfortenyears.If
theactuarialliabilitiescalculatedbytheactuaryhadbeenlarger,achievingfullfundedstatus
wouldhaveoccurredatahighercalculatedliabilityandatrustfundofahighervaluewouldhave
tobeaccumulatedtoreachit.Contributionswouldhavetobepaidforalongerperiodoftime
untilthathigherlevelofcalculatedliabilitieswasachieved.
FundedRatiosfortheChicagoTeachersPensionFund:
Year UnfundedLiabilities
FundedRatio
2004 1,713,487,462
85.8%
2003 916,773,666
92.0%
2002 384,535,171
96.5%
2001 5,135,714
99.9%
2000 328,168,774
96.7%
1999 (68,180,082)
100.8%
1998 217,199,228
97.3%
1997 (16,582,199)
100.2%
ConsideringthefactthattheChicagoTeachersPensionFundwassoclosetothat100%fully
fundedlevel,inalllikelihood,theChicagoTeachersPensionFundwouldhaveprobablynever
achievedafullyfundedstatusifaloweractuarialinterestratehadbeenused.Contributions
wouldhavebeenrequiredinthose10yearswhennoneweremade.
TheKookyMonster
TheChicagoTeachersPensionFundmadenocontributionsfortenyearsfrom1996through
2005duetoitsfullyfundedstatus.Thefullyfundedstatusofapensionplancancausea
fundamentalshiftinmentalityoftheplansponsorandoftheotherbenefactorsofthatfully
fundedstatus.Thatmentalitymaypersistlongafterthefullyfundedstatusdisappears.The
continuanceofthismentalityamongthevariousstakeholdersoftheChicagoTeachersPension
Fundwouldacceleratethedeathspiralthatwasstartingtoemerge.
EllenE.Schultz,investigativereporterforthe
WallStreetJournal
,wroteabookcalled
RetirementHeist
detailingthevariousschemesusedtotapintothesocalledsurplusassetsof
privatesectorpensionplans.Havingbeenontheinsideoftheactuarialprofession,Iseethe
storiesinherbookasbeinganalogoustotellingyourselfthatyouwilleatonlyonecookiefroma
box.Thenyounoticethatallthecookiesinthatboxaregone.
Ininsuranceterms,whentheChicagoPublicSchoolsmadenoannualcontributionsintoits
pensionplan,itiscalledapremiumholiday.Itishardtohavejustonepremiumholiday.After
eatingacookie,thereisdesiretohaveanotherone.Intheprivatesectorpensionplansofthe
Schultzbook,youmaywanttokeepeatingthosecookieseventhoughtherearentanysurplus
assetsanymore.InthecaseoftheChicagoTeachersPensionFund,thestakeholdersmay
wanttokeepeatingthosecookieseventhoughthepensionplanisntfullyfundedanymore.
Technicallyspeaking,tappingintosocalledsurplusassetsiseatingthecookiesinthecookie
jarwhilepremiumholidaysareeatingthecookieswhileintheprocessoftransferringthem
fromtheboxintothecookiejar.
TheStateofIllinoisgrantedtheChicagoPublicSchoolsapartialpremiumholidayfrom
20112013eventhoughthepensionplanwasntevenclosetobeingfullyfunded.Inthis
instance,thementalityofthepremiumholidaywouldpersist.Asinreallife,peeringintothe
emptycookiejardoesntalleviatethehungerforanothercookie.
Autumnof1996
PriortotheretirementsoftheBabyBoomergeneration,thetrustfundofapensionplanwillbe
inanaccumulationphase.AftertheretirementsoftheBabyBoomergeneration,thetrustfund
willbeinadisbursementphase.
ThefollowingstatementsweremadeintheAutumn1996issueof
Compensation&Benefits
Management
duringaperiodofsuperiorinvestmentreturnsandpriortotheretirementsofthe
BabyBoomergeneration.
Compensation&BenefitsManagement
wasajournalpublishedfora
humanresourceaudience.
Onpage67ofmyarticleTheThreeFacesoftheCorporatePensionPlanActuary:
Pensionplansintheaccumulationphasewillhavealowratioofretireestoactiveemployees,anddepositswill
exceeddisbursementsfromthefund.Pensionplansinthedisbursementphasewillhaveahigherratioofretireesto
activeemployees,anddisbursementswillexceeddepositsintothefund.
Theeffectsofinvestmentreturnsnotmeetingexpectationsaremarkedlydifferentforpensionplansinaccumulation
anddisbursementphases.Whenthepensionplanisinanaccumulationphase,theinvestmenthorizonislongand
thereissufficienttimetowaitforthereturnofsuperiorinvestmentreturns.Whenthepensionplanisina
disbursementphase,assetsarebeingpaidoutandsuperiorinvestmentreturnswillneverbeearnedonthosepension
planassets.Thefinancialconditionofapensionplaninadisbursementphasecandeterioraterapidlyduringaperiod
oflowerinvestmentreturns.
MostdefinedbenefitpensionplanswillnotbeinadisbursementphaseuntiltheretirementsoftheBabyBoom
generation.
TheassetdepletionriskoftheBabyBoomerretirementsontheChicagoTeachersPension
Fundshouldhavebeenconsideredbytheiractuariesbeforethoseretirementsactually
occurred.Itwasntanunanticipatedeventbeyondthecontroloftheactuary.
InDisbursementPhase
TheChicagoTeachersPensionFundiscurrentlyinadisbursementphaseduetothe
retirementsoftheBabyBoomergeneration.TheretirementsoftheBabyBoomergeneration
willcauseanaccelerationinthebenefitpaymentsactuallybeingpaid.Whenthisacceleration
occursduringaperiodoflowinvestmentreturns,itcancausethetrustfundofanunderfunded
pensionplantodeplete.
Below,thetablefrompage22oftheJune30,2012actuarialvaluationreportdemonstratesthe
accelerationinthebenefitpayments.Theymorethandoubledfrom2003to2012.Meanwhile,
becauseoflowerinvestmentreturns,theActuarialValueoftheAssetshasactuallydeclinedby
10%from$10.430billionin2003to$9.364billionin2012.
Intheaboveexhibit,thebenefitpaymentsmadeinthefiveyearsfrom2008through2012total
to$5.132billion.Attheendofthatfiveyearperiod,theactuarialvalueofassetswas$9.364
billion.Thatsumsto$14.496billion.Morethanonethirdoftheplansassets($5.132billion
dividedby$14.496billion)wentoutthedoorduringthatfiveyearperiodintheformofbenefit
payments.
IntheActuarialExperienceReview,theactuariesweretalkingabouttheiractuarialinterestrate
assumptionbeingtheaveragerateofreturnover20years.Insomeyearslessthan7.50%will
beearned.Inotheryearsmorethan7.50%willbeearned.Hypothetically,therateof
investmentreturnwouldaveragetoan7.50%rateofreturnoverthat20yearperiod.
TheannualrateofinvestmentreturnontheActuarialValueofAssetsforthefiveyearperiod
fromJuly1,2007toJune30,2012intheActuarialExperienceReviewwas1.62%.Withan
annualinvestmentreturnof14.38%inthefollowingfiveyears,theinvestmentratewould
averagetothethenexisting8%assumedrateofreturn.Buttheactualinvestmentdollarswill
notaverage.Therewouldbeashortfallinthedollaramounts.Aninvestmentreturnof14.38%
willnotbeearnedonthatthirdoftheassets($5.132billion)thathadwentoutthedoorinthe
formofbenefitpayments.
20YearAveragingPeriod
Theactuarialinterestrateselectedbytheplansactuarieswouldbeanexpectedaverageovera
20yearperiod.Focusingonan
average
rateofinvestmentreturncanprovidedeceptiveresults
duringthedisbursementphaseofapensionplan.Theresultsbecomemoredeceptivewhen
lengtheningtheaveragingperiod.Intheshortterm,thoseassetswillactuallybegoingoutthe
doorintheformofbenefitpayments.
IftheChicagoTeachersPensionFundwasinsolvent,theChicagoPublicSchoolswouldmake
acontributionanditwouldbeimmediatelypaidtotheretirees.Therewouldbenoinvestment
return.Theaveragingperiodwouldbezero.AstheChicagoTeachersPensionFundgradually
movestowardinsolvency,thatsocalledaveragingperiodshouldgraduallydeclinetozero
ratherthanhaveitfalloffacliffattheexacttimeofinsolvency.
DebateinDecemberof1995
AfterIhadpublishedaresearchreport,therewasadebateintheDecember1995issueof
EmployeeBenefitNews
betweenaspokespersonfortheAmericanAcademyofActuaries
namedLarrySherandmyselfregardingtheactuarialinterestrateassumption.
Intheexcerptbelow,thePensionBenefitGuarantyCorporation(PBGC)istheagencyofthe
federalgovernmentthatpartiallyinsuresthepensionbenefitspayablefrominsolventprivate
sectorpensionplans.TheChicagoTeachersPensionFund,asapublicsectorpensionplan,is
noteligibleforthisinsolvencyprotection.
LarrySher,vicechairoftheAmericanAcademyofActuariesPensionPlanCouncilbelievesthefindingsareflawed,
unfairandaninsulttothevastmajorityofactuariesoutthere.Sher,whosalsoKwashaLiptonLLCschief
actuary,believesthestudyisflawedbecauseitIgnoreslowinflation,superiorinvestmentperformancepatterns,
andcompanyand/orindustryspecificfactorsthatcouldexplainwhyanactuaryleanedtowardliberalassumptions
dictatinglowerminimumdepositfees
AccordingtoKonshak,whenactuarialserviceprovidersplayfastandloosewiththerules,itunderminespension
plansolvencynottomentionfiduciaryresponsibilityandraisestheprospectthatemployerswillpayhigher
premiumstothePensionBenefitGuarantyCorporation
AsforSherscontentionthatcertainconditionssuchaslowinflationorhighratesofreturnoninvestmentsmay
explainchangesinactuarialassumptions,Konshakadoptsacautiousoutlook.
Ithinkitsprettyhardtogeneralizethathighratesofreturnandlowratesofinflationaregoingtocontinuethroughthe
lifeofthepensionplan,hesays.Idontthinkthatsaconsistentlongtermexpectationyouwillhave.Beingso
optimisticwhenmakingsuchassumptionsmaynotalwaysbetherightthingtodo,headds.
Theactuarialinterestratewastoohighofarateextendedovertoolongofatimeperiod.In
understandingtheramifications,theemphasisshouldbeplacedonthedurationofthisactuarial
interestassumptionoronthelengthofthetimeperiodinwhichitwasassumedtobeineffect.
Thosehighratesofinvestmentreturnandlowratesofinflationwerenotgoingtolastuntilthe
lastparticipantinthepensionplandied.
JaneBryantQuinn
ThesesuperiorinvestmentreturnsassumedbyMr.Shernotcontinuingintotheretirementyears
oftheBabyBoomgenerationwouldhaveresultedinanunderstatementoftheplansactuarial
liabilitiesandatrustfundatthattimewhichwouldbetoosmall.Thesponsorsofpensionplans
wouldhavetoincreasetheircontributionsaftertheBabyBoomerretirements.
ThisriskmanagementpointofviewwouldstrikeachordwithfinancialreporterJaneBryant
Quinnwhenshereportedmyresearchinhersyndicated
WashingtonPost
columnofDecember
17,1995:
Pensionplansfacesignificantfuturefundingrisks,especiallyforthebabyboomgeneration
whentheboomers
starttoretireintheyear2012andbeyond,pensionfundswillstartsellingstocksandbondstopaymonthlyretirement
checks.Thatdoesn'tmeanthemarketswillcrash(therewillbeotherbuyersathand).Butmarketpricesmayflatten
out.Corporationsmayhavetoaddextramoneytotheirplanstogeteveryonepaid.Corporationsinfinancialtrouble
mightnothavethecashtospare.
What'smore,somecompaniesmanipulatetheirpensionaccountingtomaketheplanslookhealthierthantheyreally
are.It'sanactuary'sjobtodecidehowmuchmoney,ifany,acompanyhastoputintotheplaneachyear.By
changingcertainassumptions,anactuarycanreducethecompany'scost
Konshakconcludesthatsomecompaniesshopforactuarieswhoarewillingtouseeveryloopholetohold
contributionsdown.Acompany'scurrentactuaryalsomaydecidetousetheloopholestoavoidlosingthebusiness.
Onpaper,aplanmaylookfullyfunded,Konshaksays,butthatmaynotbethecase
Intheprivatesector,nocontributionwasrequiredortaxdeductibleifthepensionplanwas
100%funded.Theactuarycouldlowertheamountoftheactuarialliabilitiesandattaina100%
fundedstatusbyincreasingtheactuarialinterestrate.Thedesiredresultofazerocontribution
wouldtherebybeachieved.
FallingUponDeafEars
Teacherswouldindirectlybenefitfromthat10yearpremiumholidayenjoyedbytheChicago
PublicSchools.Therewouldhavebeenmoremoneytospendinupdatingtheirclassrooms.
Therewouldhavebeenmoremoneytoincreasetheirsalaries.In1995,duringthisperiodof
superiorinvestmentreturns,whenreadingthatcolumnofJaneBryantQuinnaboutpension
plansonlylookingfullyfunded,Chicagoschoolteacherswouldnothavebeenaloneinbeing
apatheticandignoringitsmessage.Whenthepensionplanisearningcloseto20%onits
assets,anactuarialinterestrateassumptionof8%doesntappeartobetoohigh.
Themoneysavedfromthat10yearpremiumholidaywentsomewhere.Teachersmayreceive
salaryincreases.Taxpayersmayreceivetaxrelief.Whenthisfullyfundedstatusdissipated,
theseotherbenefactorswouldhavealsopotentiallyexperiencedthesymptomsofcookie
withdrawal.WhentheStateofIllinoisgrantedtheChicagoPublicSchoolsapartialpremium
holidayfrom20112013,theoppositionoftheteachersunionmayhaveonlybeenperfunctory
sinceitmighthavefreedupmoniesforsalaryincreasesoritmighthavepreventedlayoffs.
ProvidingPromotionalMaterialsforYourCustomers
ActuaryVictorModugnoinhisarticlewrittenforthePensionSectionoftheSocietyofActuaries
saidthattheloweringofemployercontributionshadledtothedefundingofprivatesector
pensionplans.HedidnotmentionthefutureretirementsoftheBabyBoomgenerationbecause
theneedtoincreaseemployercontributionswasnotthethemeofhisarticle.Norwasitthe
desiredresult.Thatwouldhavemadetheclientsofthesepensionactuariesunhappy.
Removaloftheexcisetaxonassetreversionswasthedesiredresult.Thatwouldhavemade
theclientsofthesepensionactuariesveryhappy.
ThearticlewrittenbyVictorModugnoresultedfromaRequestforProposal(RFP).Itwas
solicitedbythePensionSectionoftheSocietyofActuariesandVictorModugnowas
compensatedbythePensionSectionforwritingit.VictorModugnowasformerlyemployedas
anactuarywiththefailedinsurerExecutiveLife.
Pensionactuarieshaveevolvedintoaserviceindustrythathassoughtthecontinuingapproval
ofitscustomers.Theyanticipatewhattheirclientsandotherpeoplewantandthentheygive
thoseresultstothem.Myverifiedresearchstudyin1995indicatedthatpensionactuarieswere
givingthecorporatesponsorsofpensionplansthelowercontributionamountsthatwouldmake
themhappy.Highercontributionamountswouldhavemadethemunhappy.
Duringtheperiodofsuperiorinvestmentreturns,pensionactuariesgavepeopletheresultsthat
wouldmakethemhappy.Duringtheperiodoflowerinvestmentreturnsthatfollowed,pension
actuarieswouldnotgivethemtheresultsthatwouldhavemadethemunhappy.Decreasingthe
actuarialinterestrateassumptionwouldhaveincreasedthecontributionrequirementsand
wouldhavemadethemunhappy.Theirclientsmayhavegottenangryandhiredsomebody
elsetocollectthoseactuarialfees.
Duringthisperiodoflowerinvestmentreturns,therehasbeenmountingcriticismofpublic
sectoractuariesforusingtoohighofanactuarialinterestrate.Whereastheprivatesector
actuaryhastheregulatoryandlegislativeoversightofthefederalgovernment,thepublicsector
actuaryissubjectonlytotheselfregulationoftheactuarialprofessionandtheselfserving
oversightoftheindividualstates.Inmostcases,theindividualstatesareprovidingoversightto
theverypensionplansthattheysponsor.
Theresistanceofpublicsectoractuariestodecreasesintheactuarialinterestrateisfurther
evidenceofthevalidityofmyresearchperformedin1995.
MorethanBabyBoomerRetirements
The101%fundedratiooftheChicagoTeachersPensionFundin1999mightlookimpressive
todaybutmanyprivatesectorpensionplanshadfundedratiosof150%ormorein1999.Ifan
8%rateisappropriateforthepensionplanwitha150%fundedratio,thentheactuarialinterest
rateassumptionfortheChicagoTeachersPensionFundshouldbesomethingless.The150%
fundedpensionplanhasmoretoleranceforriskthanthe101%fundedChicagoTeachers
PensionFund.Eventhoughtwopensionplansmayinvestinthesamemastertrust,the
actuarialinterestratesshouldbedifferentbasedontheirfundedratiosandtoleranceforrisk.
Publicsectorpensionplansin1995and1999didnotnecessarilyenjoythesamelevelof
fundingasprivatesectorpensionplans.However,thehigheractuarialinterestrate
assumptionsusedbyprivatesectorpensionplanswouldinfluencetheirusebypublicsector
pensionplans.Theirlowerfundedratiosandlesstoleranceforriskmaynothavebeen
considered.
SuperiorinvestmentreturnswereearnedbytheChicagoTeachersPensionFundfrom1995
through1999.Frompage8oftheJune30,2014actuarialvaluationreport:
LetterofRebuttal
Aftershehadpublishedtheresultsofmyresearchstudy,theAmericanAcademyofActuaries
wouldsendaletterofrebuttaltoJaneBryantQuinnfortwocolumnsshehadwritten.Shehad
expressedopinionscontrarytoitsofficialpoliciesandpositions.JaneBryantQuinnwasthe
voiceofadissident.
Onpage2oftheFebruary1996issueofthe
ActuarialUpdate
,apublicationoftheAmerican
AcademyofActuaries:
AcademyExplainsStandardstoQuinn
TwocolumnsbyfinancialwriterJaneBryantQuinnthatquestionedtheprofessionalismofactuarieshavedrawnan
AcademyrebuttalinaletterfromExecutiveDirectorWilsonWyatt,Jr.
InaJanuary7columnonlifeinsuranceillustrations,Quinncalledactuarialcertificationacleargainforconsumers,
butstatedthatactuariesareusuallyinfluencedbywhatthecompanywants.Wyattsresponsepointedoutthat
actuariesinsurancecompanyemployeesandconsultantsalikearegovernedbythestandardsofpracticeofthe
ActuarialStandardsBoardandtheCodeofProfessionalConduct.Failuretocomplycouldbringanactuarybeforethe
ActuarialBoardforCounselingandDiscipline,henoted.
WyattalsocommentedonaDecember17Quinncolumnthatreferstoanemployersurveyconductedbyenrolled
actuaryTheodoreKonshak.Seventeenofthetwentysurveyedcompaniesmadelowerpensioncontributionsafter
replacingtheiractuary.Wyattstatedthatthesurveysresultsdonotimplythatcircumventingorignoringstandards
ofpracticeiswidespreadamongactuaries.LarrySher,vicechairpersonoftheAcademysPensionPracticeCouncil,
alsowroteQuinntodetailtheflawsinthesurveysmethodology.
JaneBryantQuinninhercolumnonlifeinsuranceillustrationscautionedthatactuariesare
usuallyinfluencedbywhatthecompanywants.Actuarieswerecertifyinglifeinsurance
illustrationsforthecompanythattheywereworkingfor.Thiswasnothingmorethanrecognizing
thepotentialforbias.
ThereportingofmyresearchbyJaneBryantQuinnwastherunneruporthelastplacefinisher
inthisletterofrebuttaldependingonhowyoulookatit.Presumably,thepresentationtoJane
BryantQuinnincludedtheflawsmentionedintheDecember1995issueof
EmployeeBenefit
News
:thestudyisflawedbecauseit:Focusedonahandfulofextremecases,failingto
mentiontheresagoodchancethatthereareafairlylargenumberofcompaniesinwhichthe
changes[inrecommendedminimumdepositfees]isntsignificant
Myresearchwasbasedonthesamplingprocedureofabinomialprobabilitydistribution.The
oddsofrandomlyobtainingthatresultwas776to1.AlthoughasanactuaryLarrySherwould
haveunderstoodtheprobabilitiesofmyresearchstudy,hechosetoignorethevalidityofthe
mathematicsusedinthesamplingprocedureandinsteadpointedtoitasasampleofonly20
extremecases.Theoddsofmyresearchstudyweresoheavilyinmyfavorthatitshouldbe
nosurprisethatRichardA.Ippolitoobtainedthesameresultinhislongitudinalstudycovering
theperiodfrom1980to1995with1,900pensionplans.
IntheircommunicationswithJaneBryantQuinn,theAmericanAcademyofActuarieswas
demandingthatshewriteanothercolumnonmyresearchreportwhichwouldonlypresenttheir
pointofview.IattributemyexclusionfromthatpotentialcolumntotheDecember1995
EmployeeBenefitNews
article.TheAmericanAcademyofActuariesdidntwantthearticle
writteninthedebateformatusedinthatarticle.IwaspleasedatthetimeandIamstillpleased
withthejournalistprovidingbothsidesinthatarticle.Followingatelephonecalltomeabouta
lettershehadreceivedfromafriendofmine,JaneBryantQuinnwoulddecidenottowritethat
column.
SubmitIdeastoPartyOrganizationsforApprovalBeforeRelease
InthatDecember1995issueof
EmployeeBenefitNews
writtenbyBruceShutan,the
spokespersonfortheAmericanAcademyofActuariessubmittedtheirpositionregarding
publicizingthesetypesofissuesbeforethegeneralpublic.
BaffledthatKonshaksoughttopublicizehisresearchbeforeabroadaudience,KwashasShersaystherearemore
constructivewaysofaddressingtheissuesthatwereraised.Konshak,forexample,shouldhaveapproachedvarious
actuarialgoverningbodiestoensurethatstandardsandcodesofprofessionalconductarebeingfollowed,heexplains.
TwosuchorganizationsincludetheActuarialStandardsBoardandtheActuarialBoardforCounselingandDiscipline.
TheAmericanAcademyofActuarieshasalwaysengagedinanaggressivecampaignto
intimidateanymemberoftheactuarialprofessionthatpubliclyexpressesideascontrarytoits
officialpositions.Accordingtotheir
authoritarian
beliefs,anydifferenceinopinionshould
remainwithintheprofessionitselfandnotbediscussedinthepress.Thisintimidationof
dissidentsandtheirideaswithintheactuarialprofessioncanbeachievedthroughcomplaintsto
theActuarialBoardforCounseling&Discipline(ABCD).Thiscouldleadtojoblossdueto
beingexpelledfromtheprofession.
SinceJaneBryantQuinnhadnotsuccumbedtotheirdemands,hermerepresenceprovidedme
withtheleveragenecessarytosuccessfullyachieveadismissaloftheanonymousABCD
complaintfiledagainstme.AccordingtotherulesofprocedureoftheABCDandtheruleoflaw,
Iwouldhavetherightinatrialtoconfrontmyaccuser.Thenthatanonymouscomplaint
wouldntbeanonymousanymore.Oncedisclosed,Iwouldnothavehadanyintentofkeeping
thenameofthataccuserortrialanonymous.ThecolumnofJaneBryantQuinnappearedin
over100newspapers.Lookingforwardtoseeingyournameinthenewspaper?Itwouldhave
beenparticularlydamagingtotheactuarialprofessioniftheaccuserfilingthatanonymous
ABCDcomplainthaddonesoastheofficialspokespersonfortheAmericanAcademyof
Actuaries.
OthermembersoftheactuarialprofessiondonothaveaJaneBryantQuinntoserveastheir
protector.
FollowingthePartyLine
In2008,thesuperiorinvestmentreturnsofthepriordecadehadlongsincedisappeared.The
BabyBoomerretirementswerestartingtooccurandcausingproblemsintheChicago
TeachersPensionFund.AccordingtotheriskmanagementpointofviewpresentedtoJane
BryantQuinn,theactuarialinterestrateshouldhavebeenfarlessthan8%buttheactuaryfor
theChicagoTeachersPensionFundwasstillreluctanttochangetheactuarialinterestrateand
deviatefromthepartyline.
Frompage330oftheminutesoftheMay13,2008BoardofTrusteesmeetingoftheChicago
TeachersPensionFund:
Usingaloweractuarialinterestratewouldhaveraisedconcernsamongtheplanparticipantsas
itwouldhaveloweredthe79.4%fundedratiothatexistedasofJune30,2008.Theschool
boardwouldalsobeupsetasitwouldincreasetheircontributionrequirements.Thisincidentin
theseregardsfollowsmytheoryconcerningtheconductofpensionactuaries.Butthisincident
alsorunscountertomytheoryofactuariesprotectingthecontinuingpaymentoftheiractuarial
feesbydoingwhatthecustomerwants.
Therehadbeenamotiontoreducetheactuarialinterestratebyaminisculeamountto7.75%in
theApril15,2008meeting.Otheractuariesmayhavecompliedwiththatsimplerequest.Both
theloweringofthefundedratioandtheincreaseintheemployercontributionswouldnothave
beenthatsignificant.Frompage275oftheminutesofthatmeeting:
ChangetoLargerActuarialFirm
FouryearsfollowingthatMay13,2008exchangewiththeiractuary,theChicagoTeachers
PensionFundwasconductingaRequestforProposal(RFP)tohireanactuary.Theiractuary
fromthatMay13,2008meetingwasnotincludedamongthefinalists.Evenifthereisan
intentiontoreplaceanactuary,theexistingactuaryisusuallyprovidedtheopportunitytobidas
acourtesy.
Thefundedratioof79.4%asofJune30,2008haddeclinedto59.7%asofJune30,2011.As
isthecasewithcorporationsandotherbusinessentities,strangethingscanstarttohappen
oncethatentityisontheroadtobankruptcyorinsolvency.Theweirdnessgrowsstrongeras
theinsolvencygetscloser.
Smalleractuarialfirmsfacegreaterriskfromprofessionalliabilitylawsuitsthanlargeractuarial
consultingfirms.Yearsago,allofthelargeractuarialconsultingfirmsparticipatedinthesame
offshoreprofessionalliabilityinsurancepool.Ifalargeactuarialconsultingfirmperformedan
actuarialauditandtestifiedagainstanotherlargeactuarialconsultingfirm,theirshareofany
judgementfromthisprofessionalliabilityinsurancepoolwouldbefargreaterthananyfeesthey
wouldhavecollectedfromperforminganactuarialauditandtestifyingagainstthatotherfirm.It
wouldbecomeimpossibleinaprofessionalliabilitylawsuittofindanactuaryfromalarge
consultingfirmwillingtotestifyagainstanotherlargeractuarialconsultingfirm.
Thisstoryabouttheoffshoreprofessionalliabilityinsurancepoolwasheardfromanother
actuarywhohadbeeninstructedthroughhiscorporateheadquarterstoceaseanddesistfrom
anyfutureactuarialauditingactivities.Theywerethefirmthathaddiscovereda$2billionplus
programmingerrorthatinvolvedtheLosAngelesCountyEmployeesRetirementAssociation.
Iwasservingasanoutsideadvisorinreviewingthecandidatesforapositionasactuary.This
candidatefromalargeractuarialconsultingfirmwouldultimatelybehired.Theprioractuary
hadworkedforasmalleractuarialfirmthatdidnothaveanyprofessionalliabilityinsurance.But
thisactuarialfirmhadalsostructureditselfsotherewerenoassetstoseize.Theprioractuary
himselfmighthavehadassetstoseizeinaprofessionalliabilitylawsuitbuthehadretiredback
tohisnativecountryofIndia.
AtthistimeinJuneof2012,whentheChicagoTeachersPensionFundwasconductingan
RFPtohireanactuary,theplanwasalreadyinthebeginningstagesofthedeathspiral.The
ChicagoPublicSchoolswouldobtainapartialpremiumholidayfrom20112013fromtheState
ofIllinois.Thingswerealreadyintheprocessofgettingweird.
TheactuarytobereplacedfromthatMay13,2008meetinghadhisownsmallactuarialfirm.To
protectagainstlegalcostsandapotentialjudgementinaprofessionalliabilitylawsuit,itwould
begenerallyexpectedthatthisprioractuarywouldeventuallyfindsomereasontoexit.
Actuariesfromlargeconsultingfirmswouldnotbereluctanttotestifyagainsthim.
Frompage812oftheminutesoftheJune21,2012BoardofTrusteemeeting:
IntheMay17,2012minutes,theBoardofTrusteeswerehiringanemergingmarketequity
managerandwereusinganoutsideadvisortovetthecandidates.TheBoardofTrusteesdid
nothireanoutsideadvisortovetthecandidatesforthispositionasactuary.
Consideringtheirfailuretouseanoutsideadvisor,thereasonfortheprioractuarynotbeing
amongthefinalistsisnotpreciselyknown.Thehiringoftheactuarymayhavebeenaforegone
conclusionandthepresentationsoftheotheractuariesmayhavebeenwindowdressing.The
prioractuarymayhaveawareofthesituationandconsideredanypresentationtobeawasteof
timeandeffort.
Thebusinessstrategyofactuarialconsultingfirmshasalwaysbeentoexpandyourexisting
serviceswithaclientintootherservices.Sothefirmbeinghiredmayhaveexpandedthe
servicestheyalreadyprovidedtotheChicagoTeachersPensionFundintothepositionas
actuary.
IntheminutesofthatJune21,2012meeting,thesalespresentationsofthevariousactuarial
consultingfirmswereimmediatelyfollowedbythehiringofSegalAssociates.Thedecisionhad
probablyalreadybeenmadebythethreememberCTPFcommitteeandtheBoardofTrustees
mayhavemerelybeenprovidingitsapprovaltothatdecision.Thefiduciarydecisionand
liabilityassociatedwiththehiringoftheactuarymaythereforeextendtothatthreemember
committeeaswell.
Inthebusinessstrategyofactuarialconsultingfirms,itisalsoimportanttodevelopapersonal
relationshipwiththedecisionmakers.Ifthedecisionmakerisafemale,afemaleactuaryis
morelikelytoprovidethesalespresentationandserveastheleadactuary.Ifitwasmoreofa
maledominatedoccupation,suchaspoliceofficersorfirefighters,amaleactuaryismorelikely
toprovidethesalespresentationandserveastheleadactuary.Speculationontheidentityof
theactualdecisionmakeronthatthreemembercommitteecouldthereforebebasedongender
oftheleadactuarythatwashired.
TheUnitedStatesDepartmentofLaborissuedaninformationallettertomeonDecember1,
1997ontheengagementofactuaries.
SinglePartyRule
TheChicagoTeachersPensionFundandotherpublicemployeepensionplansarenotsubject
tofederalregulation.
Actuariescertifyingactuarialresultsforpublicemployeepensionplansmustbeacardcarrying
MemberoftheAmericanAcademyofActuaries,designatedbytheinitialsofM.A.A.A.appearing
aftertheirnames,andmeettheirQualificationStandards.Asstatedinthetransmittalletterfor
theJune30,2014actuarialvaluationoftheChicagoTeachersPensionFund:
Similarstatementswillbeseenintheactuarialvaluationreportsofeverypublicsectorpension
plan.ThecertificationexclusivityoftheAmericanAcademyofActuariesisaformofoneparty
rulewheretheuglinessofnegativeamortizationispermittedtoexistinpublicsectorpension
plansbutpubliclyexpressinganopinionagainstnegativeamortizationmayresultinaletterof
rebuttalfromtheAmericanAcademyofActuaries.Thefederalgovernmentdoesnotpermit
negativeamortizationinprivatesectorpensionplans.ThecurrentactuaryoftheChicago
TeachersPensionFundwouldsecretlyandsurreptitiouslyattempttoeliminatethenegative
amortizationfromview.
TheintimidationofdissenterswithintheactuarialprofessionbytheAmericanAcademyof
ActuariesthroughpotentialcomplaintstotheirActuarialBoardforCounseling&Disciplinecan
beintenseconsideringtheconsequences.BeingexpelledfromtheAmericanAcademyof
Actuariescanmeananendtoyourcareerasapublicsectoractuary.Itcanalsomeanbeing
ostracizedbypartymembers.Avoidanceofboththispotentialintimidationfromtheparty
organizationandthepotentialostracismfromitspartymembersmayhavebeentherootcause
behindthissecretiveandsurreptitiousbehavior.
ThePoliticalRival
RatherthanmeetingtheQualificationStandardsoftheAmericanAcademyofActuaries,the
sameidenticalQualificationStandardscouldbecreatedwithinthelargerandmorepolitically
powerfulaccountingprofession.Thesameindividualpersoncertifyingtheresultsofthe
ChicagoTeachersPensionFundcouldbeamemberofanaccountingorganizationratherthan
oftheAmericanAcademyofActuaries.
Independencefromtheaccountingprofessionhasalwaysbeenoneofthehallmarksofthe
actuarialprofession.Accordingtothisdoctrine,ifactuariesoperatedwithintheaccounting
profession,thehighersalariesofsenioraccountmanagerswouldbepaidtoaccountantsrather
thantoactuaries.
StatutoryMethodasanUnreasonableActuarialCostMethod
TheactuaryfortheChicagoTeachersPensionFundapparentlywasgoingtosecretlyeliminate
thenegativeamortizationwhenaformalfundingpolicyandsoundactuarialmethodswere
implemented.Inotherwords,thestatutorymethodenactedbytheStateofIllinoisisnota
soundactuarialmethod.
Underthefederalrules,inclusionofhypotheticalemployeeswhohavenotyetbeenhiredasof
thedateoftheactuarialvaluationisdeemedunreasonable.Technically,thefederal
governmentcallsthisanunreasonableactuarialcostmethod.
ThestatutorymethodoftheStateofIllinoisincludeshypotheticalemployeesthatwillbehired
afterthedateoftheactuarialvaluation.Thatisjustthebeginningofitsunreasonableness.
.
Theunreasonablenessofincludingfuturehiresintheactuarialvaluationisperfectlyclearunder
federalregulations.UnderTitle26ofCodeofFederalRegulations1.412(c)(3)1(d)withthetitle
of
Prohibitedconsiderationsunderareasonablefundingmethod:
(2)
Anticipatedfutureparticipants.
Areasonablefundingmethodmustnotanticipatetheaffiliationwiththeplanof
futureparticipantsnotemployedintheserviceoftheemployerontheplanvaluationdate.
BecauseofthespecialonepartyrelationshipbetweentheAmericanAcademyofActuariesand
theStateofIllinois,theactuarieswiththatM.A.A.A.designationmaynothaveinitially
mentionedtheunsoundnessofthestatutorymethodintheiractuarialvaluationreports.Instead,
theseactuariesmayhavegivencredibilitytotheseunsoundmethodsbysayingnothing.When
theshipstartstosink,however,theactuarialprofessionmaystarttodistancethemselvesfrom
thisunreasonableactuarialcostmethodandotherunsavoryactuarialpractices.
Seemyresearchreportontheuseofthisunreasonableactuarialcostmethodforfurther
information.
RodentsJumpShip
TheActuarialStandardsBoardisconsideringchangesinitsstandardsinvolvingbothnegative
amortizationandthisunreasonableactuarialcostmethod.AsthePublicSectorRetirement
PracticeLeaderofSegalConsultants,theleadactuaryfortheChicagoTeachersPensionFund
addressedbothissuesinaJune12,2015lettertotheActuarialStandardsBoard.Herletteris
availableonthewebsiteoftheActuarialStandardsBoard.WhywasnttheActuarialStandards
Boardagainsttheseasininemethodswhentheyfirstappeared?
ItisnotagoodsignwhentheActuarialStandardsBoardcanbeseenrowingawayinalifeboat.
Arewesinking?
TheBabyTwoStepApproach
TheactuarialinterestratefortheChicagoPolicePensionFundhasbeenat8%since1990but
wasdecreasedto7.75%effectivefortheDecember31,2012actuarialvaluationandto7.50%
effectivefortheDecember31,2014actuarialvaluation.Asmallbabystepwastakeninthe
December31,2012actuarialvaluationfollowedbyanothersmallbabysteptwoyearslater.
Adecreaseintheactuarialinterestratewillincreasetheunfundedliabilitiesanddecreasethe
fundedratio.Thesewillbelessnoticeablewhentheactuarialinterestrateisdecreasedbyonly
of1%.Thisstrategywheretheactuariesavoiddrawingattentiontothemselvesthrough
minisculeactuarialinterestratereductionstwoyearsapartcanbecalledthebabytwostep
approach.
Basedonmy1995researchreportandmyexperiencewithintheactuarialprofession,intheir
ActuarialExperienceReview,theactuariesfortheChicagoTeachersPensionFundcouldhave
beguntheprocessofselectingtheactuarialinterestratewitha7.50%ratealreadyinmind.Itis
aniceroundnumberoftwodecimalpoints.Thenthroughthebuildingblockapproachof
ActuarialStandardofPracticeNo.27(ASOPNo.27),theycouldhavedevelopedthisnumber
thattheywanted.
OtherthanitnotbeingpossibletotaketwosmallbabystepstwoyearsapartifthatASOPNo.
27determinationhadresultedinarateof4.37%,thereisnoactualmeansofdeterminingifthe
actuariesoftheChicagoTeachersPensionFundhadusedASOPNo.27togetthe7.50%rate
thattheywanted.Ofcourse,therearealsotheratherlongoddsofapplyingASOPNo.27and
obtaininganiceroundnumberof7.50%exactlytotwodecimalpoints.
TheactuariesfortheChicagoTeachersPensionFundrecommendedanactuarialinterest
changeto7.50%intheActuarialExperienceReview.Theactuarialinterestratewaschanged
to7.75%effectivewiththeJune30,2013actuarialvaluation.
In1995,myresearchindicatedthatpensionactuariesweremanipulatingtheactuarialinterest
rateassumptiontogettheminimumcontributionrequirementthattheywanted.Arepension
actuariesnowmanipulatingActuarialStandardofPracticeNo.27togettheactuarialinterest
rateassumptiontheywant?
Conclusion
InapplyingActuarialStandardofPracticeNo.27(ASOPNo.27)totheselectionoftheactuarial
interestrate,theactuariesfortheChicagoTeachersPensionFundfailedtoconsidertheeffect
oftheBabyBoomerretirementsontheassets.ThebenefitpaymentsfromtheBabyBoomer
retirementsposeadepletionrisktothoseaccumulatedassets.UnderActuarialStandardof
PracticeNo.27(ASOPracticeNo.27),theactuariesonlyconsideredportfoliorisk.
ThedepletionriskassociatedwiththeBabyBoomerretirementsisdirectlyrelatedtothesizeof
thetrustfund.Iftheactuarialinterestrateassumptionhashistoricallybeensetattoohighofa
level,thetrustfundwillbetoosmallanditwillbedepletedinaperiodoflowerinvestment
returns.
TheoriginsofthedeathspiraloftheChicagoTeachersPensionFundoccurredtwentyyears
agowhennocontributionswerebeingmadeduringatenyearperiod.Thiswasduetotheplan
beingfullyfunded.Theplanwasfullyfundedonlybecausetheactuarieshadusedan
inappropriatelyhighactuarialinterestrate.
ConsideringthefactthattheChicagoTeachersPensionFundwassoclosetothat100%fully
fundedlevel,inalllikelihood,itwouldhaveprobablyneverachievedafullyfundedstatusifa
loweractuarialinterestrateassumptionhadbeenused.Beingsoclosetothat100%fully
fundedlevelalsomadetheChicagoTeachersPensionFundmorevulnerabletoasset
depletionthanapensionplanthatmighthavebeen125%or150%funded.
TheAmericanAcademyofActuarieshasalwaysengagedinanaggressivecampaignto
intimidateanymemberoftheactuarialprofessionthatwouldpubliclyexpressideascontraryto
itsofficialpositions.Accordingtotheir
authoritarian
beliefs,anydifferenceinopinionshould
remainwithintheprofessionitselfandshouldnotbediscussedinthepress.Theviewsofthe
actuarialprofessionshouldbeexpressedonlybyitsdesignatedspokespersons.Ineptand
unsavoryactuarialpracticesasdiscussedinthisarticlewillpersistwhenlimitsareplacedonthe
publicexpressionofviewsinthepress.
TheAmericanAcademyofActuariesandthestategovernmentsthatinstalledtheAcademys
singlepartyruleovertheirpensionplansshouldbeheldpartiallyresponsibleforthedemiseof
theChicagoTeachersPensionFundandothersimilarlysituatedpensionplans.The
relationshipbetweenthisSovietstyleAmericanAcademyofActuariesandstategovernments
hasbeenamutuallyadvantageousone.Stategovernmentsweretheonesthatgaveexclusive
certificationrightstotheAmericanAcademyofActuaries.
TheunreasonablecostmethodenactedbytheStateofIllinoiswasgivencredibilitybyAcademy
memberswhofailedtoprominentlymentionitsunreasonablenessintheiractuarialvaluation
reports.VigorouslycriticizeitsunreasonablenessandtheAcademymaylosethatexclusive
certificationright.ThesameidenticalQualificationStandardscouldbecreatedwithinthelarger
andmorepoliticallypowerfulaccountingprofession.
Independencefromthisrivalhasalwaysbeenoneofthehallmarksoftheactuarialprofession.
Accordingtothisactuarialdoctrine,ifactuariesoperatedwithintheaccountingprofession,the
highersalariesofsenioraccountmanagerswouldbepaidtoaccountantsratherthanto
actuaries.