Why AOC Is (Mostly) Wrong About Post Office Pensions: An Explainer

Layton, Florida, United States – August 14, 2018: View of the United States Post Office sign by the Overseas Highway in Layton, Florida Keys – United States

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Here’s the background:

In the context of the Bernie Sanders/Alexandria Ocasio-Cortez proposal for a cap on interest rates of 15% that garnered attention over the weekend, that duo has also called for the cap to be paired with the (re)introduction of a “post office bank” which will, in addition to other hoped-for benefits, also lend at lower rates than traditional credit cards and fill in gaps in the market if they cease lending with these limits.  (On my personal website, I dug into the particulars of the actual proposals made by the post office, which are far more limited than the Sanders/AOC dream of a nonprofit full-service bank.)  And in response to what she labelled the GOP “talking smack” about the Post Office, she claimed via twitter:

The funny thing about that: it‘s the GOP’s own “business model” that hurt them! They forced USPS to prefund pensions decades out (which makes NO sense & no solvent biz does)instead of year to year.

Readers, no, I did not literally bang my head against the wall, but, as you might guess, I figuratively did so.

Yes, “solvent businesses” do indeed prefund pensions “decades out.”

To begin with, it is at the core of pension law, since 1974, that private-sector employers must prefund their pensions. (Church plans are an exception but, then again, they’re not “businesses” so not relevant to AOC’s claim.)  In fact, they are required to target a 100% funding level, and make contributions equal to the level needed to fully-fund each year’s new pension accrual, at the 100% level, and rectify any underfunding from past years, though the specifics of how rapidly this is required, and based on what assumptions, have varied as Congress has revised its requirements from time to time.

It is also the case that this prefunding is “decades out” by the very nature of actuarial valuations.  Modern life expectancy tables extend to 120 years; this means that the pension accrual earned by a 20-year-old employee could still be in-payment not just decades but 100 years from now — and an actuarial valuation takes this into account.

What’s more, cash contribution requirements impact cashflow, but have nothing to do with a company’s balance sheet or profit and loss over the year; those calculations are based on FASB accounting rules that companies have to follow whether or not they prefund their plans (by which I mean that multinational companies follow the same rules for non-US plans in cases where local governments don’t require prefunding), and involve annual liability accrual, interest on the plan’s total accrued liability and a credit for investment returns on the pension fund.

And retiree medical plans (to the extent that they still exist) are not bound by these funding requirements; back in 1974 they were considered a small bonus benefit, also not subject to vesting requirements, and as they grew in value — and cost — as medical expenses grew, the government was not keen to mandate their funding but did require that employers follow the same accounting rules as for pensions, recognizing the expense when the benefit is earned by the employee, during his or her working lifetime, rather than when it is paid out.

Now, to be sure, the rules are different for government agencies.  For state and local public plans, they are permitted to use a more generous interest rate to calculate liabilities, and face no particular funding requirements except for what their state legislatures legislate and what their bond rating agencies will tolerate.  For the federal government, well, it’s beside the point because of the overarching issue of the federal deficit.

And for the Postal Service?  The lament one reads repeatedly is that they were “unfairly” forced to fund retirement benefits — though what we’re really talking about is retiree medical benefits which the Post Office neither prefunded nor accounted for at the time of benefit accrual, until the 2006 Postal Accountability and Enhancement Act.  As reported in The Week in 2018, in an article the title of which (“How George Bush broke the Post Office“) makes clear the author’s point of view:

Passed by a Republican-led Congress and signed into law by President George W. Bush, the PAEA gave the Postal Service new accounting and funding rules for its retiree pension and health benefits. Up until 2006, the USPS funded those obligations on a pay-as-you-go-basis, pulling out of its pension fund and adding to it as retirees’ costs came in. But the PAEA required the Postal Service to calculate all of its likely pension costs over the next 75 years, and then sock away enough money between 2007 and 2016 to cover most of them.

However, a 2010 CNBC article clarifies the claim, that’s repeated elsewhere, that the Post Office has to set aside funds in advance for 75 years, including people not yet employed or not even born, in “The Truth About The Post Office’s Financial Mess,” citing a Congressional Research Service memorandum on the issue as well as further correspondence:

“The confusion over 75 years may be due to an “accounting” and not an “actuarial or funding” issue. They only have to fund the future liability of their current or former workforce. This would include some actuarial estimate about the mortality rates of their current workers (I.e. how long they live). So a 25 year old worker would have an average life expectancy (from birth) of 78.7 years. Thus, they would have to project future retiree health benefits for this individual up to about 54 years in the future.

But for accounting purposes they must estimate the future liability over a 75 year period (according to OPM financial accounting guidelines). In this case, they would make some assumptions about new entrants into the workforce and addresses your second question.

Theoretically, these new entrants could include someone who is not born yet. While they have to account for these future liabilities on their financial statements they do not have to fund them if they are not related to their current or former workforce.”

Now, one might point to the private-sector practice of leaving retiree medical liabilities unfunded as justification for doing the same here, so that they sit as an expense item and a balance-sheet liability but don’t require any cashflow, but, at the same time, a private-sector company can justify its lack of funding because they can eliminate these benefits at any time; can the Post Office realistically do the same?

But all this being said, why do I say that Ocasio-Cortez is only “mostly” rather than “wholly” wrong in her statement?  Based on private-sector precedents, the 10 year requirement for the plan to fund its retiree liabilities was unusually harsh.   In the original 1974 ERISA legislation, plans were given 40 years to fully fund plans that had previously been pay-as-you-go, and 30 years to fund plan enhancements.  (You can play Armchair Actuary with this handy summary.)  For plan accounting, plans are able to amortize these amounts over the “average remaining service,” that is, the expected future working lifetime of employees (which might vary from 10 – 20 years for typical plans).  So there’s certainly some discretion to be exercised here.  In addition, the retiree medical fund is required to invest exclusively in U.S. Treasuries (see the Postal Service 10-K, page 35-36), and, as a result, the discount rate used in the valuation is considerably lower than a private-sector plan would be obliged to use, in the latter case based on high-quality corporate bonds.  And both of these factors mean that there is some truth to the overall tenor of her statement, that this put the Postal Service at a disadvantage, though I have no interest in assessing whether or not the Bush administration or Congress maliciously wanted to handicap the Postal Service.

And, of course, none of this has anything to do with whether the Postal Service should offer financial services, which is a whole ‘nother question and should be evaluated on its own merits.

What do you think?  Share your thoughts at JaneTheActuary.com!

 

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