Let’s say you are going to put your home on the market. You want to know what to list it for, so your realtor suggests getting an appraisal. Good deal. The appraiser comes over, measures for square footage, notes the type of floor coverings and windows, asks about updates. Then he or she takes a look at sales around you, real market value trades. That is how they determine the market value of your home.
In the world of pension fund valuations, seeking the value of your home might go like this: let’s add in a few variables (your neighbors might tear down and build new next door) and market fluctuations over a five year period, the notion that you might add a pool, spa and a new roof, lot values may go up, and take the average of all that. That’s kind of the actuarial value. It’s the “I want to sell my house for $1.5 million because I think that’s what it’s worth” value.
On that note, I found the NYT article about screwy pension accounting and two sets of books. A tiny pension plan for six people in California, decided to convert to a 401(k) plan in 2015. According to California’s renowned public pension system, Calpers, they had more than enough money until they went to pull the funds: surprise, the pension was underfunded. By a half million dollars. Whoa. That’s why William F. Sharpe, professor emeritus of finance at Stanford University’s Graduate School of Business, who won the Nobel in economic science in 1990 for his work on how the markets price financial instruments, says every city in the U.S. needs to demand to see the actual market values of all the pension funds they are responsible for.
Imagine if our Dallas City Council had done that five years ago. And then told us about it.
The two competing ways of valuing a pension fund are often called the actuarial approach (which is geared toward helping employers plan stable annual budgets, as opposed to measuring assets and liabilities), and the market approach, which reflects more hard-nosed math.
The market value of a pension reflects the full cost today of providing a steady, guaranteed income for life — and it’s large. Alarmingly large, in fact. This is one reason most states and cities don’t let the market numbers see the light of day.
But in recent years, even the more modest actuarial numbers have been growing, as populations age and many public workers retire. In California, some struggling local governments now doubt they can really afford their pension plans, and have told Calpers they want out.
Even scarier, this is a problem that reaches into the $3.7 trillion municipal bond market.