Sunday, July 7, 2013

NC Pension Fund managers challenge Moody's assumptions...

Moody's has conducted an evaluation of all state pension funds and the good news is that North Carolina's is in better shape than most.

However, the state pension fund is still facing a funding gap - the difference between what the plan owes and what is in the plan.  

The question is how big is this funding gap?

The answer is that it depends on who you ask...Moody's claims that the the gap is $7.48bn, while the State of NC reckons that it is around $3.7bn.

This difference in estimates is in part due to how the State and Moody's calculate the present value of the liabilities of the fund.  While the State uses the target return of the fund of 7.25%,  Moody's uses the rate on risk free securities.   By using a lower rate, Moody's computes a larger liability and hence a larger funding gap.   I've discussed this issue before.

So who is correct?   The State is taking issue with Moody's and correctly argues that they are following the accounting rules.  The problem is that it is the rules themselves that are at fault.   The liability that the state faces to its retirees is very low risk - it is virtually a certainty.  Therefore, this liability should be discounted using a discount rate that reflects this level of risk.   7.25% is far too high, and a more reasonable rate would be the yield on the long term bonds issued by the state which is in the 3.4-4.5% range - this is basically what Moody's used.

By arguing that Moody's estimate is wrong, the State is blurring the real issue.

The article quotes Andy Silton, whose excellent blog is a great resource for anyone interested in state finances.