Spending Cuts?

According to a Bankrate study, nearly 70% of American adults are trying to reduce their monthly spending, and saving isn’t the only reason.

Bankrate reports that stagnant wages and growing debt burdens are more to blame for the intended spending reduction than the need to save. What are the long-term implications for our economy that is still driven by personal consumption? Furthermore, the need to save for both emergencies and retirement is still very much necessary. According to two recent studies, retirement readiness is lacking for a significant percentage of American workers.

Northwestern Mutual found that roughly one-third of Americans had saved less than $5,000 for retirement, while a GOBankingRates survey concluded that almost 42% of Americans have saved less than $10,000 for their golden years.  Alarmingly, more than 60% of Americans still couldn’t meet a $1,000 emergency expense through savings.

With regard to stagnant wages, GOBankingRates found that American middle-class families are making less money in every state, but two (Indiana and Vermont) since 1999.  The study was inflation adjusted.

 

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Questionable Analysis

Critique of MEPSIM By Ronald J. Ryan, CFA, and Russell D. Kamp

The paper has several misleading, if not erroneous assumptions and facts.

You do NOT want to fund the deficit at a discount rate of 7% for several reasons:

  • 7% discount rate is not a market rate and undervalues liabilities and the deficit significantly.
  • Using a market rate yield curve of AA corporates (i.e. like FAS 158/ASC 715) would calculate @ roughly a 4.00% discount rate. This difference of 3.00% equates to a PV difference of 30% to 45% higher liabilities such that a 40% deficit would now jump to a 58% deficit.
  • You want to fund and defease Retired Lives not the deficit. This produces certainty and transparency that these liabilities are fully funded. The Butch Lewis Act ONLY contemplates the loan being used to defease Retired Lives.
  • Funding a deficit does not provide any evidence of where the deficit is (short, long?) or how to allocate funds to where the deficit is. Can’t cash flow match a single deficit number, as you need to understand where in the liability term structure is within this deficit.

The loan should be at the interest rate the Treasury can finance (even a little higher for a profit margin). You don’t want to create more of a Treasury deficit. If the loan rate was 15 to 25 bps higher than the Treasury financing rate this new government agency (PRA) could operate at a profit. Fifteen basis points on $100 billion in loans produces $150 million a year in revenue, which is more than enough to operate this agency at a profit.

You want time to cure the problem. The Treasury does not issue 20-year bonds. Let the Treasury issue its normal 30-year bond auction. According to historical facts, the average return on the S&P 500 over a rolling 30-year period is over 8%. If you buy time (extend the investing horizon), the odds of success dramatically improve.

Since this is an asset / liability objective running 500 iterations of a Stochastic model without running liabilities is not very helpful.

They calculate that the loan is expensive costing $56b defined as PV of loan plan repayments? We don’t understand this math. Why won’t the loans be repaid?

It is true that these plans currently invest in risky assets. If through our work a lower ROA can be used than the plan’s asset allocation should respond and switch to a less risky profile.

NO, NO, NO… you never want to cut benefits. This is certainly a last resort. Our approach buys time, lowers the hurdle rate (ROA), and fully funds Retired Lives. There should be no benefit cuts for Retired Lives.

The PBGC is not a solution because it has a very low cap (guarantee) for the payment of benefits (max of $17,160 for 40 years of service) and it is not currently solvent given the forecast of future needs.  You want a loan to fully fund your Retired Lives. The PBGC could never fully fund Retired Lives given its current funding.

A 6% average return seems conservative over a long-time horizon (30 years). Only when an Asset Exhaustion Test (AET) is run will we know the true economic ROA needed to meet future plan obligations.

We recommend that the loan proceeds are used 100% to defease Retired Lives with investment grade bonds. This leaves the current assets in tact. The output from the AET will help us determine the economic ROA needed to fully fund residual liabilities. The asset allocation here could be heavily skewed to non-bond assets instead of the 40% allocation in the MEPSIM forecasts. Remember the loan is new money and does not affect current assets and/or contributions.

The Butch Lewis Act – The ONLY Solution

The loan from the government should be 30-years at the Treasury financing rate with a small premium (15 to 25 bps) to pay for this new agency’s (PRA) operating budget.

The loan proceeds should be mandated to fully fund Retired Lives through a defeasance process so there is no risk of default here or lack of funding resources.

The amount of the loan must be based on what it costs to defease Retired Lives with Treasury STRIPS. If a cash flow matching strategy is used on the loan proceeds (mainly investment-grade corporate bonds) it should fully fund Retired Lives at a cost savings of roughly 8%+.

This cost savings could be held in escrow or transferred over to current assets to help fund residual liabilities. If transferred over to current assets these savings will reduce the economic ROA hurdle rate to fully fund residual liabilities.

Moreover, we have replaced the actuarial ROA rate (@ 7.50%) on Retired Lives with a Treasury loan rate (@ approximately 3.25%), which lowers the economic ROA needed to fully fund residual liabilities.

The loan program’s (BLA) success must be predicated on work done on an economic basis (economic truth) and not actuarial forecasts and assumptions.

And The Answer Is?

The Joint Select Committee on Solvency of Multiemployer Pension Plans has been meeting since April.  They were tasked with producing bi-partisan legislation to help protect and preserve the defined benefit plans for the 114 (now 121) “critical and declining” multiemployer pension systems.  As we’ve mentioned in multiple blog posts, the committee consisted of 8 senators and 8 congressmen with equal representation among Democrats and Republicans.

There were several proposals that were reviewed including the Butch Lewis Act (BLA) legislation that had been filed with Congress in November 2017. The BLA had strong support among the Democratic members of the committee but lacked similar support from the Republican side. Unfortunately, this process is getting down to the wire with the November 30th deadline fast approaching.  Without support from a minimum of 5 Republicans and 5 Democrats, there will not be legislation put forward for consideration during this Congressional session.

It will be truly unfortunate if nothing comes from this Joint Select Committee because as they debate the merits of any proposed legislation, the number of critical and declining plans is expanding and the need for government support is growing, too, in both urgency and magnitude! The markets and normal contributions will not save these pension systems. Only through the support of the federal government will these plans survive. More than one million Americans are counting on Congress to do something!

As we’ve mentioned before. The BLA is proposing a loan program, which includes a relatively small sum of federal assistance through the PBGC for a few plans. These loans will be paid back in 30 years. This is not a government bailout. By extending the life of many of these troubled plans, we are eliminating the need for the US government to expand the social safety net that would have to be used to support those participants who would be losing a substantial percentage of their monthly benefit. Furthermore, it keeps them as active participants in our economy supporting both business and the government through additional tax revenue. It is a win-win!

If nothing comes from the JSC that can be supported by the two parties, a battle will have been lost, but the war will rage on. A war that has lasted much longer than it should have given the consequences that will result from the failure to legislate positive reform. It is increasingly imperative that members of both parties and both chambers of Congress hear from you regarding the need to support legislation to repair and protect these critical retirement plans.

 

It’s Time to Put the Fiddle Down!

Nero may not have actually fiddled while Rome burned, but I certainly get the feeling that Congress’s “august” Joint Select Committee on Solvency of Multiemployer Pension Plans (JSC) is jamming with every stringed instrument that they can get their hands on while struggling multiemployer plans see their funded status continue to deteriorate.

There is no more time to wait! The proverbial can has been kicked as far down the road as possible. In fact, there is little left to kick. While the JSC fiddles, more multiemployer pension systems are falling into the weakest category (status) of funding known as Critical and Declining. When Ron Ryan and I first had the opportunity to assist the Butch Lewis Act team the terrific actuaries at Cheiron had done a thorough evaluation of the 114 C&D plans at that time. Regrettably, according to Cheiron, there are now 121 plans that wear that mantle.

Cheiron’s analysis is based on the latest annual financial reports filed by multiemployer plans with regulators. Alarmingly, these 121 plans have roughly 1.3 million participants that would suffer grave social and economic consequences should these plans be allowed to fail. Cheiron’s initial study that produced 114 C&D plans was released last year. Several of those 114 have been terminated. The 121 plans include 15 new additions to the list in just one year (>6% increase). Amazingly, this has happened during the longest bull market in US equity history.

The ONLY way that these plans can escape their current death spiral is through assistance from the federal government.  The JSC is evaluating several prospective programs that would provide a lifeline to these struggling pension systems, but the only one worthy of consideration is the Butch Lewis Act. We’ve reported on the BLA in numerous KCS blog posts, but it is worth repeating.

The low-interest rate loan program contemplated within the BLA legislation is NOT A BAILOUT, but a 30-year lifeline to these critically important funds. In the analysis that Cheiron completed last year, only 3 of the 114 C&D plans at that time would need assistance from the Pension Benefit Guaranty Corporation (PBGC). The fact that legislation could extend these plans by a minimum of 30-years should be reason enough to support and pass the BLA legislation.

The economic activity that would be lost should these benefits not be paid to the 1.3 million participants is massive (estimated at >$1 trillion per year). Is Congress truly prepared to damage the U.S. economy to this extent? Furthermore, without benefit payments, the social safety net will have to be expanded tremendously.  It is a dangerous game of possum that our politicians seem to be playing with the fate of so many voters ready to cast their ballots.

Please put your fiddle down and do the job that you were elected to do. We are getting to a point of no return.

 

IRS Indexed Limits for 2019

We are happy to share with you the recently announced Indexed Limits for 2019.

Item IRC Reference 2018 Limit 2019 Limit
401(k) and 403(b) Employee Deferral Limit1 402(g)(1)

$18,500

$19,000

457 Employee Deferral Limit 457(e)(15)

$18,500

$19,000

Catch-up Contribution2 414(v)(2)(B)(i)

$6,000

$6,000

Defined Contribution Dollar Limit 415(c)(1)(A)

$55,000

$56,000

Defined Benefit Dollar Limit 415(b)(1)(A)

$220,000

$225,000

Compensation Limit3 401(a)(17); 404(l)

$275,000

$280,000

Highly Compensated Employee Income Limit4 414(q)(1)(B)

$120,000

$125,000

Key Employee/Officer 416(i)(1)(A)(i)

$175,000

$180,000

Social Security Taxable Wage Base

$128,400

$132,900

  1. Employee deferrals to all 401(k) and 403(b) plans must be aggregated for purposes of this limit. A lower limit applies to SIMPLE plans.
  2. Available to employees age 50 or older during the calendar year. A lower limit applies to SIMPLE plans.
  3. All compensation from a single employer (including all members of a controlled group) must be aggregated for purposes of this limit.
  4. For the 2019 plan year, an employee who earns more than $120,000 in 2018 is an HCE. For the 2020 plan year, an employee who earned more than $125,000 in 2019 is an HCE.

No Place To Go, But up?

statepensionfunding

If a picture paints a 1,000 words then how many words does the above chart produce? There are quite a few public systems that are in decent to good shape on an actuarial basis, and they should be de-risking as they approach “full-funding”, especially this far into bull markets for both bonds and equities. Why risk the good work and financial resources that brought the plan to a sound financial position?

For those systems that are more challenged at this time a combination of factors will need to be addressed from contributions, benefit formulas, costs, asset allocation, etc. These poorly funded systems aren’t necessarily crippled, but a new path must be followed if they are to survive.

We’ve highlighted many of the challenges that these states are facing at this time from growing debt burdens to higher taxes and out-migration.  There is no magic bullet, and closing these deficits will take much more than just increasing taxes on their residents.  Ryan ALM and KCS have produced a six-step process to full-funding that is designed to work for all plans no matter what their current funded status. We’d be happy to share our thoughts with you.

When Common Sense Fails!!

When KCS was established in August 2011, the mission of the firm was pretty simple. We set out to “help plan sponsors and their participants address today’s retirement plan challenges.” I can’t think of a greater challenge than the one facing the Critical and Declining multiemployer pension systems (roughly 114 plans) that badly need our help. Without a path forward these plans will face insolvency within a relatively short timeframe (<15 years) and the participants who are depending on the retirement benefits will likely see very little of the promise that they were given and helped to fund! UNACCEPTABLE!

The following article was shared with me through our KCS Facebook page. It is another attempt on the part of industry participants to claim that taxpayer-funded support of these critically important funds is inappropriate.

The short article version of Saving the PBGC, at the expense of the Pensioner. “Lawmakers should resist calls for taxpayers to bail out troubled pension plans with direct subsidies or “loans” from the federal Treasury, whether provided directly to pension plans or funneled through the PBGC. Doing so would unfairly transfer responsibility for pension underfunding from plan trustees to taxpayers and would likely exacerbate existing underfunding.”….

The Butch Lewis Act legislation that is being considered among other proposals by the Joint Select Committee on Solvency of Multiemployer Pension Plans does call for low-interest rate LOANS to be made available to these C&D plans in order to stave off plan failures. Without this help, there is little that can be done to ward off insolvency thus casting aside millions of plan beneficiaries who were counting on these promised benefits and have had nothing to do with the current funding crisis. Do these so-called industry experts really believe that the taxpayers (including these participants) will not be asked to support to a greater extent the social safety net that would be expanded to now include all of these participants?

Providing low-interest rate loans will extend the life of these plans by 30-years! The proceeds from the loans must defease all of the currently retired lives and terminated vesteds ensuring that benefits accrued to date will, in fact, be paid! Furthermore, the investment horizon for the future liabilities has now been extended by decades raising the probability of success.

The Butch Lewis Act Team included wonderful actuaries from Cheiron who analyzed each of the 114 plans, and they determined that 111 of the 114 plans would be able to meet current and future obligations and pay back the loan without any assistance from the PBGC. Yes, there are 3 plans that still would need help, but the estimated support is roughly 33% of what it would be if all of the plans were to become insolvent. Furthermore, the CBO has recently indicated that their analysis has the total loan program at only $34 billion, which is substantially lower than previous estimates.

If one were to add up the anticipated loan expense and the PBGC assistance, the $57 billion is roughly $11 billion less than the amount the PBGC would be on the hook for should each of the 114 plans fail.  Furthermore, it is estimated that the plan participants receiving benefits generate nearly $1.1 trillion in annual economic activity. Can our economy survive an economic hit such as that? Where is common sense?

There have definitely been mistakes made along the way that have negatively impacted these pension systems. Allowing these pension plans to fail because of these issues is foolish. The Butch Lewis Act mandates that these pension systems operate in a more effective way, which will improve the likelihood of success. What could be wrong with extending the life of these plans by thirty years? Think about how many participants will be helped during that timeframe. The taxpayer should embrace this lifeline. It keeps them from having to support the participants within the next few years!