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6.1.C. - Page 21
<br />Benefit in the future to the value of plan assets today, the value of the promise to make a future
<br />payment must first be discounted to its present value. As explained by Messrs. Biggs and
<br />Smetters:
<br />"Discounting is a process similar to compound interest. While compound
<br />interest begins with a current dollar amount and adds interest to determine the
<br />future value, discounting begins with the future value and subtracts interest
<br />each year until a present value is arrived at. ,14
<br />Even small changes in the annual interest to be subtracted from the future value (that is, the
<br />Discount Rate), significantly impact present value and, consequently, a plan's Unfunded
<br />Liability.15 See, the section of this report entitled "Increase in Unfunded Liabilities and Decrease
<br />in Funded Percentages if a Lower Discount Rate is Used" at p. [16] for an example of the impact
<br />on the Cities of a drop of just one percentage point in the Discount Rate. As a result, the
<br />Discount Rate selected for this calculation matters a great deal.
<br />Debate Over CalPERS' Discount Rates and Projected Rates of Return.
<br />Discount rates are set based on CaIPERS' projections for long-term Returns on Investment. 16
<br />The higher the projected Return on Investment, the higher the Discount Rate and the lower the
<br />Unfunded Liability. That is often referred to as the "assumed return approach".17 Although
<br />GASB mandates this method of setting public pension plan Discount Rates,1, it is
<br />controversial. 19 Many economists, academics and commentators claim it understates the size of
<br />Unfunded Liabilities. 20 They argue that the present value of future Benefit obligations should be
<br />14 Ibid., p. 4.
<br />1s Nation, Pension Math 2011, pp. 9 and 11.
<br />16 GASB Statement No. 68, Paragraph 64,
<br /><htto://www.2asb.or2/iSD/GASB/Document C/DocumentPaee?cid=1176160220621&acceDtedDisclaimer---true>.
<br />Mixon, Peter, Estimating Future Costs at Public Pension Plans: Setting the Discount Rate. Pensions & Investments,
<br />April 29, 2015, p. 1, <htto://www.Dionline.com/article/20150429/ONLINE/150429853/estimating-future-costs-at-
<br />Dublic-Dension-Dlans-settine-the-discount-rate>. Brewington, Autumn, Making Sense of the Mathematics of
<br />California's Pension Liability, Hoover Institution, August 21, 2012, <httDs://www.hoover.ora/research/making-
<br />sense-mathematics-califomias-_Dension-liability>. Biggs and Smetters, Understanding the Argument for Market
<br />Valuation, p. 4.
<br />11 U.S. Government Accountability Office, Pension Plan Valuation: Views on Using Multiple Measures to Offer a
<br />More Complete Financial Picture, September 30, 2014, p. 2, <httDs://www.2ao.i!ov/Droducts/GAO-14-264> and
<br /><httDs://www.eao.2ov/assets/670/666287.i)df>. Mixon, Estimating Future Costs at Public Pension Plans, p. 1.
<br />Turner, John, Godinez-Olivares, Humberto, McCarthy, David, del Carmen Boado-Penas, Maria, Determining
<br />Discount Rates Required to Fund Defined Benefit Plans, Society of Actuaries, January 2017, p. 6,
<br /><www. actuaries. orv/oslo20l 5/Daoers/PB S S-Turner&GO&McC&B-P._Ddf>.
<br />18 GASB Statement No. 68, Paragraph 64.
<br />ie Angelo, Paul, Understanding the Valuation of Public Pension Liabilities — Expected Cost versus Market Price, In
<br />the Public Interest, January 2016, p. 9, <httDs://www.soa.or2/library/newsletters/in-_public-interest/.../i_D-2016-issl2-
<br />an2elo.aspx>.
<br />20 Mixon, Estimating Future Costs at Public Pension Plans, p. 1. U.S. Government Accountability Office, p. 2. Bui,
<br />Truong and Randazzo, Anthony, Why Discount Rates Should Reflect Liabilities: Best Practices for Setting Public
<br />Sector Pension Fund Discount Rates, Reason Foundation, September 2015, p. 4, <httvs://reason.or2/wD-
<br />2017-2018 San Mateo County Civil Grand Jury 7
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