Are you confused by statements made in TVARA meetings that TVA's pension is 79% funded when you see in TVA's annual report that TVA's pension is only 61% funded, much worse than many comparable electric utilities? There are two different accounting standards at play here.
Accounting standards used by TVA indicate a 61% funded ratio as of 9/30/14. Accounting standards used in the TVARS annual report indicate a 79% funded ratio as of 9/30/13, the latest information available. Liabilities in the TVARS annual report are discounted at the long-term expected return of the system assets, as they are in reports of public government pensions.
William F. Sharpe, one of the recipients of the Nobel Prize in Economics for introducing the capital asset pricing model (CAPM), provided his thinking on pensions and accounting standards in a recently published article in the November/December 2014 Financial Analysts Journal:
The chart below compares electric utility pension funding utilizing the same accounting standard for all. This accounting standard uses a discount rate lower than the long-term expected return on assets:
Accounting standards used by TVA indicate a 61% funded ratio as of 9/30/14. Accounting standards used in the TVARS annual report indicate a 79% funded ratio as of 9/30/13, the latest information available. Liabilities in the TVARS annual report are discounted at the long-term expected return of the system assets, as they are in reports of public government pensions.
William F. Sharpe, one of the recipients of the Nobel Prize in Economics for introducing the capital asset pricing model (CAPM), provided his thinking on pensions and accounting standards in a recently published article in the November/December 2014 Financial Analysts Journal:
Are public pensions a problem? You bet. Is
this a disaster? You bet. The true liabilities of the
public pensions in the United States—by which I
mean governmental pensions—are, according to
the actuaries, much larger than the assets. Using
any sensible economic view of the value of those
liabilities, the difference in value is astronomical.
It’s a crisis of epic proportions. Let me describe this
more clearly.
If the state has promised a worker certain payments
in the future for having worked at least up
to this date—so-called accrued benefits—and it is
certain that those payments are going to be made,
anybody, any economist, and probably most of you
in this room would ask, how do you value that? It’s
simple. You find US Treasury securities that would
provide cash flows to match those payments. That
is how you should value the liability.
As most of you know, that is not what the
Governmental Accounting Standards Board and
the state and local systems do. They value those
liabilities at 7.5% or 8% on the grounds that they
are pretty sure they’ll earn that in the long run. This
is crazy. It gets even worse. Because they want to
minimize the reported value of the liabilities, they
want to use a high discount rate, and in order to
justify it, they have to build really risky portfolios.
Consequently, they believe that one of the great
things to do is put money in private equity, or
maybe a hedge fund, because then they can assume
an extra 300 or 400 bps of expected return for an
illiquidity premium (or just because hedge fund
managers are so smart).
So, the tail wags the dog. Idiotic accountingSource: William F. Sharpe and Robert Litterman, “Past, Present, and Future Financial Thinking,” Financial Analysts Journal, November/December 2014, Volume 70, Number 6, Published by CFA Institute, Pages 16-22.
drives even worse investment decisions. This is the
classic case of an organization that borrowed money
while issuing purportedly guaranteed payments
and then used the money to invest in risky securities.
Where have we recently heard that this is not a
good thing?
The chart below compares electric utility pension funding utilizing the same accounting standard for all. This accounting standard uses a discount rate lower than the long-term expected return on assets:
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