C&B Notes

Obscuring Pension Reality

When evaluating business managers, we applaud those who make conservative accounting assumptions.  While this story focuses on a public instead of a private entity, it is a useful illustration of how a lack of conservatism in key assumptions can mask underlying economic realities that have a big impact on an enterprise’s financial health.

When private-sector companies account for their pension schemes, therefore, they discount liabilities with a corporate-bond yield.  Lower yields have pushed up liabilities and led to big deficits. Moody’s, a ratings agency, will in future use a long-term bond yield to discount American public-pension schemes, resulting in much larger liabilities than before.

Even if you use the expected-return methodology, the discount rate used by public-sector pension funds should fall.  That is because all pension funds tend to own some bonds, and low bond yields mean low future returns.  But the paper finds no link at all between the discount rates used by public-sector funds and the level of bond yields.  The motto seems to be: if reality is challenging, just ignore it.  The Governmental Accounting Standards Board (GASB) did change the rules for public pension funds last year.  But the revised rules still throw up absurdities. I n a paper for the Financial Analysts Journal, Robert Novy-Marx of the University of Rochester argues that by destroying assets invested in cash a scheme can reduce its deficit by increasing the expected return on remaining assets.  “A plan can sometimes improve its funding status by literally burning money,” he remarks.