UCRP:
The Need for
Actuarial Best Practices &
Joint Governance
By Paul D. Brooks
Spectroscopist University of California, Berkeley
UPTE Pension Bargaining Team
January 2007
Outline
1. Models & Manipulation: The Need for
Actuarial Best Practices at UCRP
2. Regents & Conflicts of Interest: The
Need for Joint Governance at UCRP
Models & Manipulation
1. Actuarial models are subject to considerable manipulation in their
input data to generate a desired outcome.
2. Show an example of how social security data was misquoted
during the President‟s campaign to “save” social security. The
effect of data „propagation of error‟ carries forward and can be
abused.
3. Show how different assumptions made by actuarial firms make a
huge difference in the projections for the retirement fund.
4. The model reporting standards in UC‟s recent actuarial reports
should be upgraded to actuarial best practices. This should
include the „propagation of error‟ and the sensitivity of the
actuarial model to different inputs.
Propagation of Error in Models
• Models are usually computer programs that try to predict
something based on past experience.
• Models input a large number of variables, and then
attempt to predict the outcome.
• Models can be manipulated by not showing data from
different projections.
• All projections must have a “propagation of error” to be
valid.
• This is also true of pension projections.
` Models & Manipulation:
Social Security Privatization
`
`
` • In 2005 President George W. Bush
campaigned to create private accounts in
Social Security, claiming with absolute
certainty that Social Security would be “flat
broke in 2041”.
• The following graph is the actual data as
predicted by Social Security in 2004.
Models & Manipulation:
Social Security Privatization
assets / annual costs
Source: Hiltzik, Michael. 2005. The plot against social security. Harper Collins. ISBN 0-06-083465-X. p. 60.
Models & Manipulation:
Social Security Privatization
• The real figures are that Social Security will go
bankrupt between 2030 and infinite, that is,
never!
• Note that in this 2005 projection, the Social
Security fund will stop accumulating assets and
have to pay out more than it takes in around
2018.
• Has this always been the case? How well have
past projections predicted this point?
Models & Manipulation:
Social Security Privatization
Year
Social
Security Difference
projected from year
Year to begin projected
Projection deficit to
Made spending projection
1991 2010 19 Hardy, Dorcas R., and C. Colburn Hardy. 1991 Social Insecurity. Villard books, New York
2001 2014 13 http://www.csss.gov/meetings/june-11-minuts.htm
2004 2018 14 Hiltzik, Michael. 2005. The plot against social security. Harper Collins.
• Every year the projections are updated and the model checked.
• Note how past projections have been pessimistic and the predicted
date that Social Security will go into deficit spending keeps
advancing into the future.
UCRP: Different Assumptions
Result in Different Projections
Note: Towers and Perrin‟s study projects assets/liabilities of 204% in 2019:
Wilshire‟s study projects assets/liabilities of 118% in 2020.
This data was summarized by Dr. Schwartz, emeritus professor UCB who
asked why was there a discrepancy between the 2 studies.
Source: http://socrates.berkeley.edu/~schwrtz/WHPF6.html
Dr Schwartz eventually received the following reply to the discrepancy:
University of California April 16, 2001
Office of the President
Dear Professor Schwartz:
I am following up on your concern about the differences between Wilshire
Associates and Towers Perrin in comparing respective asset and liability
projections for the University Retirement System. The differences in
funded level projections relate to differences in assumptions and not to
discrepancies in the models. Given the same inputs both the Wilshire and
Towers Perrin models produce nearly identical results. The important
differences are:
1. Lump Sum Distributions: Wilshire assumed no lump sum distributions
while Towers Perrin assumed a 20% lump sum election. The effect of lump
sums is to reduce assets and liabilities in equal dollar amounts and, as a
result, Towers Perrin's liability projections will be lower than Wilshire's and
its ratio of assets-to-liabilities will be higher. This difference in assumption
explains about half of the difference in projected liabilities in year 2015 and
almost all of the difference in projected assets.
continue on next slide
http://socrates.berkeley.edu/~schwrtz part 9
2. New Entrant Age and [Salary]: The remaining difference in liability
projections is explained by assumptions made for the average age and
salary in new entrants. This became a particularly important input given the
assumed 2.5% growth in the active workforce. Wilshire assumed new
entrants would come in at a significantly higher age and salary than did
Towers Perrin, a difference that caused a more rapid growth in Wilshire's
liability projections. This age and salary assumption difference fully explains
the remainder of the difference in 2015 liability projections.
One purpose for the Towers Perrin liability study was to bring greater
accuracy to the liability projections and to use their findings to further
examine asset allocation for the retirement plan. Wilshire reports that
although the Towers Perrin study shows a stronger projected funded
position for the retirement plan compared to their study, their asset
allocation recommendation at the time would not have changed.
Thank you for your interest in this topic. I hope this addresses your
concerns.
Sincerely,
Joseph P. Mullinix
Senior Vice President -- Business and Finance
http://socrates.berkeley.edu/~schwrtz part 9
UCRP: Different Assumptions
Result in Different Projections
• This shows the sensitivity of the actuarial model.
Adjusting the lump sum distribution from 0 to 20%, and
changing the age and salary of new hires, changes the
projected funding status of the pension fund from 118%
to 208%!
• Sensitivity analysis is required to meet actuarial best
practices.
• This also shows how easy it is for an actuarial firm to
change the results of their projections. This can easily
be subject to pressure on the actuarial firm to come up
with the results that the group funding the actuarial firm
wants to believe.
UCRP: Different Assumptions
Result in Different Projections
• What are the
assumptions used in UCRP Funded Ratio Projection
Segal Co., Nov 2005 Regents Presentation
the following graph?
• What is the model’s
sensitivity to inputs?
• Where are the error
bars? Source: http://www.universityofcalifornia.edu/news/
ucrpfuture/welcome.html
UCRP: Different Assumptions
Result in Different Projections
Why is there no updated Stochastic Study on
UCRP?
“While we appreciate your advice on „best
practices,‟ our actuary, the Segal Company, feels
that a stochastic study in this case would
introduce many variables into the analysis that
would unnecessarily complicate the picture.”
–UC response to Venuti Report, May 26, 2006
In: http://berkeleyaft.org/files/Venuti%20%20Associates%20Report.pdf p. 6.
Actuarial Best Practices & UCRP:
The Need for Joint Governance of UCRP
• This data and statement by Segal is totally unacceptable for the standards at the
University of California.
• The data must be represented with a detailed report on the sensitivity of the model to
various inputs and a report of how realistic these inputs are, meeting actuarial best
practices standards, with peer review.
• Any actuarial work not done to these standards should be dismissed and the actuarial
firm‟s contract discontinued.
• Arguments that the cost of running the model with different inputs would be too costly
are not credible for a fund the size of UCRP.
• The Unions bargaining over the pensions have hired their own actuarial firm, Venuti
and Associates, who have recommended doing a more thorough analysis.
• In a response to a critique of their work by Venuti and Associates, Segal and Co.
have recommended that the unions should do their own actuarial study, but UC will
not release the data for Venuti and Associates to do this.
Actuarial Best Practices & UCRP:
The Need for Joint Governance of UCRP
• Segal and company claim that the data is proprietary. Venuti &
Associates have offered to take this issue before the actuarial board
of counseling and discipline, where they are confident that they will
rule that although the programs that Segal use are proprietary, the
data is not.
• When this data is released, Venuti & Associates can do a thorough
analysis.
• The Regents do not appear to realize that sensitivity to input data
and propagation of error need to be recognized in actuarial models.
This means that :
Joint labor management governance of the UCRP is
needed to protect the interests of Plan participants.
Regents & Conflict of Interest: The Need
for Joint Governance of UCRP
• Gerald Parsky is a UC Regent &
UCRP trustee.
• Parsky was a member of the
Presidents Commission to
strengthen Social Security in 2001.
• Members of the commission were
chosen on the basis that they
favored the creation of private
accounts, and the commission was
charged with recommending
private accounts. http://www.csss.gov/meetings/june-11-minutes.htm
• This raises serious questions as to
the Regents‟ objectivity on pension
matters.
Regents & Conflict of Interest: The Need
for Joint Governance of UCRP
• In the late 1990‟s the Regents' Committee on
Investments met in closed (secret) session and then
recommended that the retirement fund management be
privately managed. These meetings were later shown to
be illegal after CUE sued to get the meeting minutes.
The University appealed this to the California Supreme
Court where UC lost and had to pay CUE‟s legal fees.
• The minutes of the meetings showed that there was
significant critique of the management of the pension
fund, which should have been public.
http://socrates.berkeley.edu/~schwrtz
Regents & Conflict of Interest: The Need
for Joint Governance of UCRP
• In 2000, the first $16 billion of
UCRP assets was handed to
outside management on the
advice of Wilshire Associates,
who had been hired to advise
the university.
• Wilshire Associates had
donated money to the “Elect
George W. Bush” campaign in
California, which was managed
by Gerald Parsky.
• Gerald Parsky denied any
connection with this donation.
http://sfgate.com/cgi-bin/article.cgi?f=/e/a/2000/07/16/NEWS9974.dtl&hw=UC&sn=001&sc=1000
Regents & Conflict of Interest: The Need
for Joint Governance of UCRP
The publication of the Examiner article, and subsequent criticism at the
next Regents meeting led Berkeley emeritus professor Dr.
Schwartz to begin a detailed study of the UCRP management
changes. These now total 24 pages and Dr. Schwartz is still
updating them. They can be found at:
http://socrates.berkeley.edu/~schwrtz
Among Dr. Schwartz‟s findings are that:
• The UC Retirement Plan was one of the top performers in the
country in the 1990‟s.
• Since 2000, when compared to CalPERS, the university pension
fund is not performing as well.
UC and CalPERS Retirement Return
UC privatization management begun Bond fund privatized
30
20
UCRP
% return
10 CalPERS
0 UC-CalP
-10 zero line
-20
1989 1994 1999 2004
year
Reference: compiled from the table on page 7 of
http://socrates.berkeley.edu/~schwrtz/UCRP_Data&Questions.pdf
UCRP Management & Performance:
the need for Joint Governance
• It is possible that the lower return for UCRP since privatization is a
result of increased management fees.
• Before the fund was privatized the cost of management was around
$20 million per year, or 0.05% of the fund.
• A 0.5% management fee is regarded as very low for private firms. It
is not clear if all management fees are adequately accounted for.
For example, “most investors are paying much more than they think
they are” (Consumer reports money adviser, Feb 2007 p.6).
• Therefore, if hidden management fees were 0.5%, this would cost
the fund $200 million per year, or $180 million more than under UC
management.
• Joint governance would provide more over site to determine the
extent of these possible fees and cost to UCRP.
UC Retirement Contributions
Regents &
20 UCOP have
discussed
employee and
15 employer
contributions
increasing to
10
8% each.
% contributions
Employer
5
Employee
0
1980.0 1990.0 2000.0 2010.0 2020.0
-5
CAP 1 CAP 2
-10
year
References: Historical section based on UC’s response to an information request, 2006
CAP 1 -Back calculated from CAP 1 held by Paul Brooks
CAP 2 -http://atyourservice.ucop.edu/employees/retirement/cap/index.html
UCRP Management & Performance:
the need for Joint Governance
• UCOP & The Regents have discussed
increasing contributions to 8% each for
employee and employer.
• Equal contributions are not consistent with
UCRP contributions history. Before the
“holiday” employees generally paid 2-3%, and
UC paid the rest, up to 16%, depending on
liabilities and the performance of the Fund.
UCRP Management & Performance:
the need for Joint Governance
• Note that CAP 1 and CAP 2 were awarded instead of a
cost of living increase. This actually took money out of
the Fund, even after the stock market bubble burst in
2001.
• Had this money not been removed from the fund, it
would have at least $1.268 billion more than it does now.
• This means that if employees have to pay into the Fund
before this money is paid back, then the employees are
paying for their own CAP 1 and 2 pay raise, with interest!
Conclusions
1) Joint labor management governance is needed to protect Plan
participants from the privatization agenda and conflicts of interest.
2) Actuarial models are subject to considerable manipulation in their
input data to generate a desired outcome. The model reporting
standards in UC‟s recent actuarial reports should be upgraded to
actuarial best practices. This should include the „Propagation of
Error‟ and the sensitivity of the actuarial model to different inputs.
This is consistent with actuarial industry best practices.
3) Proposals to contribute equally to the UCRP are not consistent with
historical contribution rates.
4) It is unreasonable for the UCRP to require employee contributions
until CAP funds are paid back into the fund. Otherwise, employees
will simply be paying for their own CAP funds, with interest!