Study Shows “Fair Market Valuation” of Pension Liabilities Neither “Fair” Nor “Market”
Method ignores risk and capital structure, does not provide valid and reliable estimates of retirement-plan liabilities
BOSTON – Using government-bond yields as a discount rate to evaluate the liabilities of public retirement systems, often mislabeled “fair market valuation,” contradicts financial-economic principles and ignores risk and capital structure, according to a new white paper published by Pioneer Institute.
The study, “The Logic of Pension Valuation II: A Response to Andrew Biggs,” debunks assertions by some financial economists who have been critical of new public-pension accounting standards adopted by the Governmental Accounting Standards Board (GASB). The Board rejected opinions that debt yields can provide an appropriate “risk-adjusted” measure of retirement obligations.
“These claims are self-contradictory, theoretically unsound and empirically unsupported,” said the study’s author, Iliya Atanasov, who is Pioneer’s senior fellow on finance. “We need to put them to rest so we can have the real debate about pension mismanagement and pension reform in America.”
GASB rules being implemented this year will require unfunded pension liabilities to be discounted at the borrowing-cost rate (debt yield) of the plan provider. The funded portion is to be valued by using an assumed rate of return on the pension fund’s assets. The changes will likely increase the value of liabilities and require much higher annual contributions to public pension systems.
“Fair market valuation” calls for ignoring the capital structure of retirement plans and for discounting both funded (collateralized) and unfunded (uncollateralized) liabilities at the same rate. In the real world, banks demand different interest rates for unsecured loans and secured ones such as mortgages.
“We should be strengthening actuarial standards and contribution mandates,” Atanasov said, adding that the new GASB rules are less than perfect, but still a step in the right direction.
It is naïve to suggest that US government bond yields reflect the creditworthiness of their issuers, let alone the risks associated with public pension plans. The supply of these bonds is fundamentally premised on government issuance while the Federal Reserve has accounted for much of the demand in the past five years, purchasing hundreds of billions of dollars’ worth. In such conditions, it is hard to argue that yields are reflective of the risks involved.
About the Author: Iliya Atanasov is Pioneer’s Senior Fellow on Finance, leading the research tracks on pension management, data analysis and municipal performance. He is a PhD candidate in Political Science and Government and a former Presidential Fellow at Rice University. He also holds BAs in Business Administration, Economics and Political Science/International Relations from the American University in Bulgaria.
About Pioneer: Pioneer Institute is an independent, non-partisan, privately funded research organization that seeks to improve the quality of life in Massachusetts through civic discourse and intellectually rigorous, data-driven public policy solutions based on free market principles, individual liberty and responsibility, and the ideal of effective, limited and accountable government.