SUSAN STAMBERG, HOST:
When Detroit declared bankruptcy last week, city workers had a very personal reason to be dismayed. They discovered that their retirement plans, their pensions, are not as solid as they thought. Detroit's $18 billion of debt includes pension obligations estimated at $3.5 billion that are underfunded. Seems that there is a lot less money in the pot than everybody thought. There's been an ongoing debate among pension plan advisors, actuaries, about what and how to calculate the value of pensions that will be paid in the future. Jeremy Gold is an actuary and economist. We asked him for an explanation of all of this and why does the think that the math all these years has been wrong. He joined us from our bureau in New York, and I asked him how actuaries go about estimating how much money is needed to fund these plans.
JEREMY GOLD: When they do make these projections, they begin by looking at each retiree one at a time and saying what might this retiree be entitled to over the next 10, 20, 30, 40 years? Those entitlements are then summed across all the retirees so that we have the total future entitlements year by year by year. And at that point, pretty much all actuaries agree. Then next step, however, is where actuaries do not always agree. And that is what discount rate should be applied to those future promises?
STAMBERG: What does a discount rate mean? What does that mean?
GOLD: Suppose I owe you a dollar next year? How much should you and I agree to settle that dollar for this year? Well, if the discount rate is 2 percent, we'll settle for 98 cents. But when we go out multiple years, we get somewhat more complicated calculation but the idea is still the same. If the discount rate is relatively high, then the value today is relatively low. If the discount rate is low, then the value today is high.
STAMBERG: You think that's too optimistic a way to go about it. So, how would you calculate?
GOLD: Well, it's not that I think it's too optimistic so much as where in the spectrum of the low-to-high interest rates we place ourselves. Now, the actuaries, for the most part, in public plans, including Detroit, have, for the last 15 years or so been using an 8 percent discount rate. When they started doing that, interest rates on bonds were more or less in that range. Nowadays, Treasury bonds average about a 3 percent return.
STAMBERG: So, if this is correct, does it mean that even though cities that have contributed over the years the amounts that are required, they're falling behind anyway?
GOLD: That is my opinion, yes. That some of the best states and cities in terms of making the payments that are required, even those have not been funding adequately in light of the low interest rates prevailing in today's markets.
STAMBERG: So, surely you thought in terms of solutions. What might one, say, be?
GOLD: The kind of plans we're talking about called defined benefit plans - these are your classic pensions where the promise relates to the employee's career. So, someone might be getting a benefit of 60 percent of his or her last few years' pay. Some say that the solution in the public sector is to follow the private sector from defined benefit traditional pension plans into 401(k) plans. I want smaller, better funded defined benefit plans. I want traditional pensions that promise less and get more money put into them.
STAMBERG: Thank you very much. Actuary Jeremy Gold joined us from our bureau in New York. Grateful to you, Mr. Gold. Thank you for trudging through that thicket for us.
GOLD: You're very welcome.
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