IRS Notice 2007-81

[Belgarath]

Re IRS Notice 2007-81. This deals with minimum funding and yield curves. If you have questions, contact an Enrolled Actuary. No one who is sane would ever bother to read this, and if they did, wouldn't understand it.

That's my tongue-in-cheek summary. However, the truth is probably substantially similar...

[david rigby]

Did you just state that all Enrolled Actuaries are insane?

(I'm not saying you're wrong, just asking.)

[Belgarath]

Yes, I did. And after further skimming this release, it was even worse than I thought!! I don't just mean garden variety insane, but seriously demented, probably evil, and definitely a threat to our national security. I mean, really, what kind of a diseased mind could produce the following:

Adjustment Factors for Credit Quality

In the pricing model, the adjustment factors for credit quality are added to the present value of the bond's cash flows as given by the forward rate and the discount function. Specifically, the adjustment factors are made up of two linear regression variables added to the present value with two respective regression coefficients that need to be estimated. These variables adjust the bond prices so that the discount function and the spot rates represent market-weighted average credit quality of the top three quality levels (AAA, AA, and A).

Specifically, some of the deviation between the predicted price for the bond (based on the cash flows and the discount function) and the actual price for the bond can be attributed to differences in credit quality and some of the deviation is an error factor. The model determines the portion of the deviation that is attributable to credit quality by determining the two adjustment factors that reflect the relative proportion of A-rated bonds within the data set and the relative proportion of AA-rated bonds within the subset of AA- and AAA-rated bonds. A high proportion of A-rated bonds results in a larger deviation in price for the higher quality bonds, which means that the discount function used to develop the yield curve is more closely aligned with a discount function for A-rated bonds than for the higher rated bonds. Similarly, a higher proportion of AA-rated bonds within the subset of AA- and AAA-rated bonds means that the discount function is more representative of the AA-rated universe than the AAA-rated bonds.

These adjustment factors allow the yield curve to be based on the proportion of bonds at the three quality levels in the market determined over the entire maturity spectrum (rather than on the proportion at each specific maturity point). This avoids potential distortions which could arise because of different proportions of bonds at the three quality levels at various maturity points.

Estimates for the parameters

These seven parameters, comprising five parameters in the cubic spline and the two adjustment coefficients on the bond-quality adjustment variables, are estimated from the bond price data. The estimation is done by nonlinear least squares, that is, the seven parameter estimates are chosen to minimize the sum of the squared differences between the actual bond prices and the prices given by the bond price model.

Before the estimation is carried out, the bond data are weighted. The weighting consists of two stages. In the first stage, equal weights are assigned to the commercial paper rates at the short end of the curve, and the par amounts outstanding of all the bonds are rescaled so that their sum equals the sum of the weights for commercial paper. Then, the squared price difference for each bond is multiplied by the bond's rescaled par amount outstanding, and the squared difference for each commercial paper rate is multiplied by the commercial paper weight. In the second stage, for bonds with duration greater than 1, the weighted squared price difference for each bond from the first stage is divided by duration.

I used to think all of us Red Sox fans were nuts (well, we are, but that's another story) but you EA's have elevated it to a whole different level. I'm rather glad to be an ordinary simpleton just now.

[david rigby]

..... you EA's have elevated it to a whole different level

Hold on now! This was issued by the IRS, not by "you EA's".

[masteff]

I remember the first time as a junior staff accountant when I was told to footnote something in a work paper with "SWAG". I have never, until this moment, seen a SWAG procedure in written form.

(Should I be concerned about my own mental well-being that I understood nearly 50% of that excerpt???)

[Belgarath]

Details, details. Don't confuse me with facts. In spite of the fact that some of "you EA's" have gone over to the dark side - it is still the actuarial mind that produced this stunning creation.

I prefer the mathematics involved in government accounting - that is to say, complete fiction. That way, I can remain ignorant, yet quote any statistic that I feel like inventing to support my specious arguments.

[AndyH]

I thought I was sane until I started and find that I cannot stop paraphrasing Larry D. to clients when commenting upon PPA.

In a session this summer, he called it the "Grey Goose law", something that results from tossing some IRS people and some economists into a bus and sending them off with many bottles of vodka.

That about explains Belgarath's excerpts of the regs that come from PPA as well as PPA itself.

[Mike Preston]

I hate to say it, but reading that section was downright fun! My guess is that if they put that stuff on the EA exams (the how's and why's of that methodology) there would be far fewer EA's. Maybe that is their intent.

[Effen]

PPA in general will result in far fewer EA's, we won't need harder exams to accomplish that. If we did make the exams more difficult, it would be for the greater good of society. We would be just helping the next generation of workers to find another profession. Did the buggy whip manufactures keep training people once Ford started creating cheap autos?

No reason to churn out more EA's, when there won't be anything for them to do.

[Belgarath]

I do agree that it was fun. We had a small group of non-EA's reading it and laughing out loud. But if you actually understand it,well, then, I'd say you need to get out more...

All kidding aside, is this something where the actual numbers or range will be calculated and released by the IRS so that the EA doesn't actually have to calculate all this stuff, or do all these knots, splines, cubes, derivatives, data sets, deviations, parameters, etc., actually have to be calculated and built into something solid (like a Leggo structure) by the EA? Or something in between?

[AndyH]

The gunshot you just heard came from my software vendor's office.

[Mike Preston]

Definitely determined by the IRS. The methodology was shown for those who wish to do some sort of projection (think Ibbotson) for the future. Us mere mortals will await the IRS prestidigitation.

[Andy the Actuary]

All the kidding aside (I'm included in the set of jokesters), we are witnessing the demise of an important discipline of the actuarial profession. Instead of focusing their attention on greybook minutia, many of which pertain to pension plans with $50 billion in unfunded liabilities, the actuarial profession should have focused on educating legislators and the public and lobbying for practical laws. When the full-funding limit began taking away new investment money in the early 1980s, the actuarial profession should have educated the public and not allowed investment people to make 401(k) a household word. And let's forget that the actuarial profession has done little to combat the FASB. I've attended EA meetings fairly religiously since 1979 and am always flabberghasted to witness big-guy actuaries sit at podium and almost xxxxxxxxxx over the rush they get from their mastery over of this meaningless crud. It's easy to be cavalier when you're nearing retirement as so many of them are.

Lost in all of this are the employees who will now bear the investment risk for an inherently smaller pensions. "For all sad words of tongue and pen, The saddest are these, 'It might have been'".

[Don Levit]

Andy:

You seem to have a lot of gripes with the FASB.

I wonder if you are familiar with the FASAB?

If so, are you familiar with the report on accounting for social insurance that came out last year?

I spoke to Stephen Goss, the chief actuary of Medicare, recently.

The fact that there is no trust fund reserved for Social Security and Medicare liabilities seemed to be of little concern to him.

And, the fact that FASAB considers these obligations as liabilities extending over only the next 2 years, seems to be quite comforting to Mr. Goss.

Should I take him at his word?

Don Levit

[david rigby]

Definitely determined by the IRS. The methodology was shown for those who wish to do some sort of projection (think Ibbotson) for the future. Us mere mortals will await the IRS prestidigitation.

Earlier white paper from the economists at the Treasury Department.

http://www.treasury.gov/offices/economic-p...urve_020705.pdf

[Andy the Actuary]

My gripes with the FASB pertain primarily to FASB158 which may force a number of plans to convert from final pay to career average and to the FASB's adherence that end of fiscal year measurement date makes reporting and comparability more meaningful. Otherwise, I have no issue with FASB87/88.

I have not read the report to which you referred. I apologize if you are an accountant and I hit a nerve, which was not my intention. Rather, we are entangled in seaweed for a reason: "The fault, dear Brutus, is not in our stars, but in ourselves."

[AndyH]

Definitely determined by the IRS. The methodology was shown for those who wish to do some sort of projection (think Ibbotson) for the future. Us mere mortals will await the IRS prestidigitation.

Earlier white paper from the economists at the Treasury Department.

http://www.treasury.gov/offices/economic-p...urve_020705.pdf

Were these people on the Grey Goose bus?

[Mike Preston]

Or maybe downwind of the DEA on burn days.