ON-Lion Letter

In June, Eileen Norcross of the Mercatus Center at George Mason University in Arlington, Va., submitted comments to the Actuarial Standards Board on how public pension plans' liability should be measured.

"The controversy over what interest rate to select when valuing public sector pension liabilities is due to two different conceptual frameworks:  the actuarial and the economic," according to Norcross, who directs Mercatus' State and Local Policy Project, which is supported by Milwaukee's Lynde and Harry Bradley Foundation

"The actuarial framework begins with methods developed by actuarial science to calculate and fund pension benefits," she continues.  "The economic framework considers the pension liability separately from the assets used to pay benefits. Though the liability and assets bear a relationship to one another in the plan, they are independent in terms of their value.

"Under the actuarial approach, assets and liabilities are improperly linked together," Norcross writes.  "Much like 'crossed wires,' the result is a pension plan that can short-circuit under certain circumstances, such as those culminating in the market crash of 2008.  Crossing wires -- or generating a present value for a riskless, legally guaranteed pension based on uncertain and risky asset returns -- mismatches the value of assets and liabilities and generates a flawed logic that a bull stock market, or the ability to beat the market, is needed for a pension plan to properly function.

"The result is the basis for the structural imbalance of pension plans that are currently under tremendous fiscal stress in the Illinois, New Jersey, and Pennsylvania state governments and many municipal governments," she notes.
Norcross "recommend[s] the actuarial profession adopt economic valuation of public pension liabilities.  This is the same principle used to value US private pension plans, and public and private pensions internationally.

"Economic valuation, which provides a true market value of the plan," she concludes, "is the only basis upon which these pension plans can operate with structural integrity and internal consistency to meet the obligations governments have promised to workers."

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