THE BURNED OVER DISTRICT

And in the red for big bucks tomorrow, you might want to look at how the actuaries did their calculations (this assumes you might have a pension). There is a struggle going on within the actuarial profession as to the validity of their calculations which may violate GAAP even when they are GAAP.

For several years, little noticed in the rest of the world, their staid profession has been fighting over how to calculate the value, in today’s dollars, of pensions that will be paid in the future.

It may sound arcane, but the stakes for the country run into the trillions of dollars. Depending on which side ultimately wins the argument, every state, city, county and school district may find out that, like Detroit, it has promised more to its retirees than it ever intended or disclosed. That does not mean all those places will declare bankruptcy, but many have more than likely promised their workers more than they can reasonably expect to deliver.

The problem has nothing to do with the usual padding and pay-to-play scandals that can plague pension funds. Rather, it is the possibility that a fundamental error has for decades been ingrained into actuarial standards of practice so that certain calculations are always done incorrectly. Over time, this mistake, if that is what it is, has worked its way into generally accepted accounting principles, been overlooked by outside auditors and even affected state and municipal credit ratings, although the ratings firms have lately been trying to correct for it.

Since the 1990s, the error has been making pensions look cheaper than they truly are, so if a city really has gone beyond its means, no one can see it.

“When the taxpayers find out, they’re going to be absolutely furious,” said Jeremy Gold, an actuary and economist who for years has called on his profession to correct what he calls “the biases embedded in present actuarial principles.” In 2000, well before the current flurry of pension-related municipal bankruptcies, he wrote his doctoral dissertation on how and why conventional pension calculations run afoul of modern economic principles.

Mr. Gold made his prediction about taxpayer fury in an interview a number of years ago in which he also explained why he had chosen his topic. He said he hoped to help put a stop to the errors he saw his colleagues making before pension problems that were already starting to brew then boiled over and a furious public heaped blame, scorn and legal liability on the profession.

When a lender calculates the value of a mortgage, or a trader sets the price of a bond, each looks at the payments scheduled in the future and translates them into today’s dollars, using a commonplace calculation called discounting. By extension, it might seem that an actuary calculating a city’s pension obligations would look at the scheduled future payments to retirees and discount them to today’s dollars.

But that is not what happens. To calculate a city’s pension liabilities, an actuary instead projects all the contributions the city will probably have to make to the pension fund over time. Many assumptions go into this projection, including an assumption that returns on the investments made by the pension fund will cover most of the plan’s costs. The greater the average annual investment returns, the less the city will presumably have to contribute. Pension plan trustees set the rate of return, usually between 7 percent and 8 percent.

In addition, actuaries “smooth” the numbers, to keep big swings in the financial markets from making the pension contributions gyrate year to year. These methods, actuarial watchdogs say, build a strong bias into the numbers. Not only can they make unsustainable pension plans look fine, they say, but they distort the all-important instructions actuaries give their clients every year on how much money to set aside to pay all benefits in the future.

If the critics are right about that, it means even the cities that diligently follow their actuaries’ instructions, contributing the required amounts each year, are falling behind, and they don’t even know it.

All this makes those funding the pensions more likely to break the promises that so many people worked a lifetime for in lieu of Social Security. Soup for all who can stand in line.