Actuarial Measures of US Household Income and Wealth from Defined Benefit Pension Plans

1. Agenda item 5 Actuarial Measures of US Household Income and Wealth from Defined Benefit Pension Plans By Marshall Reinsdorf for presentation at the UNECE Group of Experts on National Accounts April 27, 2010

2. Institutions for Retirement Income in the US • Pension plans are sponsored by and funded by employers (employees may also contribute some of their pay). • In defined contribution (DC) pension plans, benefits depend on the actual account balance, so actuarial estimates are not needed. • In defined benefit (DB) pension plans, benefits depend on a formula that typically involves pay and years of service. • Most private DB benefit entitlements are insured by the PBGC. • Social security is a government social insurance program, not a pension plan (but design of most pension plans takes it into account.) • Individuals’ own tax-advantaged retirement saving plans are also important, especially for proprietors of unincorporated businesses.

3. DB pension plans are generally funded • In principle, assets of pension plan’s trust fund should track the participants’ benefit entitlements. • Sources of growth in plan assets include employer and employee contributions, investment income, and holding gains. • In a fully funded plan, a fall in the number of active employees per retiree does not cause a rise in contribution rate required to pay benefits and keep the plan solvent. • Volatility in holding gains can cause volatility in contributions.

4. Cash Approach to Measuring Pensions At present, we measure pensions on a cash basis. Pension trust fund is included in household sector wealth, and employer contributions are included in household sector income and saving. Household saving within pension plan = contributions + investment income on plan assets – benefits – plan administrative expenses.

5. Shortcomings of the Cash Approach • Cash approach has some advantages: • No need to make debatable assumptions and choices of methods. • Availability of data (though data gaps do exist). • Easy to integrate with rest of the accounts. • But it also has disadvantages: • Timing of contributions can cause distortions and spurious volatility. • Can differ from households’ perceptions of pension wealth and income. • Omits key information; imbalances may be hidden from view. • Article in August 2009 Survey of Current Business reports on research on developing accrual approach estimates based on actuarial calculations.

6. Accrual Approach to Measuring DB Pensions The actuarial value of the benefit entitlements in a DB plan may not equal the value of the plan assets. Employer responsible to cover shortfalls of plan assets, so unfunded actuarial liability is part of household wealth. Households’ wealth = the actuarial value of the benefit entitlement under the accrual approach. Compensation income = benefits accrued through service. Property income = interest on the actuarial value of the benefit entitlement, not actual investment income earned on plan assets.

7. Data Sources for Accrual Estimates • We have different kinds of data for private, state and local government and Federal government plans. Private plans: • PBGC provided data sets of Form 5500, including the actuarial schedule, starting with 2000. Federal government plans: • Actuarial estimates from plan actuaries and GAO reports. State and local government plans: • BEA collected data from a sample of large plans/plan families, but Census Bureau will provide in future.

8. Private DB Plans 2000-7, Cash Accounting(billions of dollars;from August 2009 SCB, with revisions)

9. Private Plans 2000-7, Accrual Accounting (ABO approach; in billions of dollars)

10. Income, Saving and Change-in-Wealth: Private Plans using Approach of SNA 2008

11. Income, Saving and Change-in-Wealth: Private Plans using Approach of SNA 2008

12. What’s Different about Government Employee Pension Plans? • In government sector, DB plans continue to predominate. • Employees may not be covered by Social Security. • Inflation protection is common. • Employee contributions are important source of plan funding. • Plan freezes and terminations prohibited by law, which can be viewed as a rationale for measurement by a PBO approach.

13. Federal DB Pensions, 2008 PBO for civilians assumes interest rate of 6.25%, inflation of 3.5%, and salary growth of 4.25%.

14. Income, Saving and Change-in-Wealth of Federal Government Plans using Approach of SNA 2008

15. Income, Saving and Change-in-Wealth of Federal Government Plans using Approach of SNA 2008

16. State & Local Government Plans, SNA 2008 Approach

17. State & Local Government Plans, SNA 2008 Approach

18. All DB Pensions (percents of disposable personal income)

19. All DB Pensions (percents of disposable personal income)

20. What’s Different about the Accrual Estimates? • Less volatile. • Compensation income is slightly lower than in the cash estimates. • Imputed interest is higher than investment income on assets. • Assets < actuarial liabilities. • Investment income on assets excludes capital gains, but interest rates in actuarial calculations reflect expected total returns on assets. • Total household income is higher by enough to add more than 2 percentage points to the personal saving rate. • Accrual estimates are sensitive to assumptions/methods.

21. Government Social Insurance Programs • Pension Benefit Guarantee Corp. (PBGC) is a public financial corporation that pays benefits to retired participants in DB plans whose sponsor has declared bankruptcy. • Railroad Retirement Board is a public financial corporation that provides pension benefits to retirees from the railroad industry. • My Survey of Current Business article has actuarial estimates for pensions from the PBGC and Railroad Retirement Tier II. • Actuarial information on Social Security and Railroad Retirement Tier I will take different approach from the information provided for defined benefit pensions because they are government social insurance schemes.

22. Social Security Social security actuaries calculate “open group unfunded obligation”, “closed group liability” and “maximum transition liability”. Maximum transition liability resembles the ABO of a pension plan. Yet it is not so useful for analytical purposes—it is very large because benefit entitlement grows rapidly in the early part of career. But participation in the remainder of the career can’t be avoided. Closed group liability is useful for inter-generational accounting. Open group unfunded obligation is useful as a measure of solvency. Open group future benefits less taxes for next 75 years, as of 01-2009