Over the past 12 years the asset allocation strategies for public pension plans and corporate pension plans have diverged. Most corporate plans have adopted LDI strategies in one version or another, while most public plans have maintained asset focused, pro-growth approach. There are many reasons behind the divergence. One of them is the liability discount rate. Corporate plans are required to use (versions of) market consistent discount rates, per PPA 2006, while public pension plans have been using expected returns of plan assets as discount rates.
Will the adoption of the Revised Edition of ASOP No. 4 (Doc. No. 205) become the beginning of public pension fund LDI? My view is that,
- Given that they are (mostly) open to new entrants, public pension plans will not fully adopt the LDI approach.
- However, the impact of the adoption of the new discount rate methodology (section 3.11) will be transmitted quickly to all stake holders, as public pension plan actuaries are required to “provide commentary to help the intended user understand the significance of the low-default-risk obligation measure.”
- Hence, the adoption of the revised edition of ASOP No. 4 will cause public pension plans to be more “liability aware” when making asset allocation decisions.
- Therefore, I expect public pension plans will gradually increase allocation to long duration corporate bonds, starting at the beginning of 2024.
What is in the revision? Here is a quick summary.
- ASOP No 4 is the ASB (Actuarial standard board) guidance for “Measuring Pension Obligations and Determining Pension Plan Costs or Contributions.”
- The revised edition, which was adopted by ASB in December 2021 and with the effective date February 15, 2023, requires plans use a discount rate based on the yields of high-quality bonds when reporting their pension liability, much like the approach that corporate pension plans are required to take, per PPA 2006.
- This new requirement supplements, but does not replace, the long-term expected return based discount rate approach that public pension plans have been using.
- It also states that “(t)he actuary should provide commentary to help the intended user understand the significance of the low-default-risk obligation measure with respect to the funded status of the plan, plan contributions, and the security of participant benefits.”
Appendix: The actual language in the actuarial standard board requirement for public pension discount rates (ASOP 4, Revised edition, adopted by ASB, December 2021, Doc No. 205, Section 3.11)
3.11 LOW-DEFAULT-RISK OBLIGATION MEASURE
When performing a funding valuation, the actuary should calculate and disclose a low-default-risk obligation measure of the benefits earned (or costs accrued if appropriate under the actuarial cost method used for this purpose) as of the measurement date. The actuary need not calculate and disclose this obligation measure more than once per year.
When calculating this measure, the actuary should use an immediate gain actuarial cost method.
When calculating this measure, the actuary should select a discount rate or discount rates derived from low-default-risk fixed income securities whose cash flows are reasonably consistent with the pattern of benefits expected to be paid in the future. Examples of discount rates that may meet these requirements include, but are not limited to, the following:
- US Treasury yields;
- rates implicit in settlement of pension obligations including payment of lump sums and purchases of annuities from insurance companies;
- yields on corporate or tax-exempt general obligation municipal bonds that receive one of the two highest ratings given by a recognized ratings agency;
- non-stabilized ERISA funding rates for single employer plans; and
- multiemployer current liability rates.
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For purposes of this obligation measure, the actuary should consider reflecting the impact, if any, of investing plan assets in low-default-risk fixed income securities on the pattern of benefits expected to be paid in the future, such as in a variable annuity plan.
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The actuary should provide commentary to help the intended user understand the significance of the low-default-risk obligation measure with respect to the funded status of the plan, plan contributions, and the security of participant benefits. The actuary should use professional judgment to determine the appropriate commentary for the intended user.
