Future Contributions Into A DB Plan Should Be Considered An Asset Of The Fund

Recently, Mary Williams Walsh, NY Times, penned an article titled,

“Standards Board Struggles With Pension Quagmire”.

The gist of the article had to do with what role did the actuaries and actuarial accounting play in the current state of public pension funding. Many of the actuaries felt that they were pressed by politicians into reverse-engineering their calculations to achieve a predetermined result (contribution cost). “That can’t be good public policy,” said Bradley D. Belt, a former pension regulator, who is now the vice chairman of Orchard Global Capital Group.

According to Ms. Walsh, “he called for additional disclosures by states and cities, including the current value of all pensions promised, calculated with a so-called risk-free discount rate, which means translating the future benefits into today’s dollars with the rate paid on very safe investments, like Treasury bonds.”

Actuaries currently use higher discount rates, which complies with their professional standards but flies in the face of modern asset-pricing theory. Changing their practice to resolve this is one of the most hotly contested proposals in the world of public finance, because it would show the current market value of public pensions and probably make it clear that some places have promised more than they can deliver.

But, if we are going to require DB plans to mark-to-market their fund’s liabilities, inflating future promised benefits, we should also include future contributions as an asset of the plan. Since many, if not most plans, have a legal obligation to fund the plan at an actuarial determined level or through negotiations, these contributions are likely to be made (NJ is one of the exceptions).

When valuing liabilities at “market” without taking into consideration future contributions, plans are artificially lowering their funded ratio, while negatively exacerbating their funded status. Most individuals (tax payers) would not understand the “accounting”, but they would certainly comprehend the negative publicity of a < 50% funded plan.

Most public pension plans derive a healthy percent of their assets through contributions.  Not reflecting these future assets in the funded ratio creates the impression that these funds are not sustainable, which for most public plans is not close to reality.

We need DB plans to be the backbone of the US retirement industry. Only marking to market liabilities without giving a nod to future contributions doesn’t fairly depict the whole story. We can do better.

KCS Second Quarter 2015 Update

We are pleased to share with you the KCS Second Quarter Update.  As we previously reported through this blog, 2015 has been a better year for pension funding than 2014 was despite the lower market returns, as interest rates have backed up creating a negative growth rate for plan liabilities.  We hope that you find our update insightful. Have a wonderful day.


XYZ’s AUM Up 4%, Add $5 billion – So What!

We are at that point in the quarterly cycle were the largest asset managers, and our industry watchdogs, are once again reporting AUM changes for the previous quarter and last 12 months.  So what! The question that we should be asking and that which should be reported is: “How does this growth or decline in AUM impact the strategy(ies) being managed by the aforementioned firms?”

In my humble opinion, assets are being concentrated among too few firms, and as a result of this asset growth, the products managed by these firms are far exceeding the natural capacity of these strategies.  Subsequently, clients end up paying active fees for, at best, index-like performance.  If that is going to be the result, buy cheap and not expensive beta – index!

Initially, significant asset growth has the potential of driving performance forward, as managers have to buy the same stocks that are in their portfolios.  However, watch out when asset growth levels off or worse, begins to decline, and managers are forced to sell a percentage of their holdings in stocks that remain in their portfolio(s).

Hiring an active manager is never easy, especially given the plethora of options.  However, just evaluating a firm based on its performance, people, philosophy and process is not enough. One needs to understand how the additional assets being received will impact that managers ability to maneuver / trade, especially if that manager is in a less liquid area of the capital markets, such as small cap value.  Every product has a natural capacity, and investment managers should manage to these levels and be transparent with their clients, especially as they near their target AUM.

As markets grow, so does the natural capacity.  But managing through capacity places the client’s interests behind those of the manager, and sets the managers business up for future failure when it becomes nothing more than another underperforming shop.

Relax Plan Sponsors – 2015 is Much Better than 2014!

Many plan sponsors were under the impression that 2014 was a very good year for DB pension funding because the asset growth either met or exceed their plan’s return on asset assumption (ROA). We refuted those claims in blog posts in both March and May highlighting the fact that liability growth should be the primary plan objective, and not the ROA, and that liability growth far exceeded asset growth in 2014.

Well, we still believe that, and we are today sharing with you that the first six months of 2015 have been quite good for DB pensions.  Why? According to our strategic partner, Ron Ryan from Ryan ALM, liability growth has been negative in the US in 2015, as US interest rates have trended upward.  In fact, using Treasury STRIPS as a proxy for the risk-free rate, liabilities have fallen by nearly 3.7% through June 30th. If one uses AA Corporates as the discount rate, liability growth has fallen by 1.6%.

On the other hand, a 60% / 40% asset mix of the Russell 3000 Index (1.94%) and Barclays Aggregate Index (-0.10%) has returned 1.12% through the first six months. This result certainly appears anemic relative to the average public fund ROA of roughly 7.5%, but it is outpacing liability growth by as much as 4.8%. Funded ratios should be improving as a result of liability growth being exceeded.

Again, managing a pension plan is an incredibly challenging endeavor, made especially difficult when focusing on the wrong objective.  Asset allocation decisions made solely on the basis of performance versus the ROA can lead a plan down the wrong path. 2014 was a poor year, yet perceived to be quite good, while 2015 has been a hand-wringing year for many sponsors despite good outperformance for assets versus liabilities.

DB plan sponsors should be focused on their plan’s liabilities as the primary objective and not the ROA.  Allow KCS and Ryan ALM to create a custom liability index for your plan. It will provide you with a much greater understanding of how the liabilities are reacting to changes in the interest rate environment. It will also help you realize that 2015 is looking a lot better than your 2014 relative results!

KCS Fireside Chat July 2015 – We’re Your Advocate

Happy Fourth of July!  May you have a safe and enjoyable holiday.

We are pleased to share with you the latest edition of the KCS Fireside Chat series. In this article we highlight, once again, the importance of the defined benefit plan as the primary retirement vehicle for our workers.

In recent weeks there have been several studies released / updated that highlight the sorry state of the US retirement industry.   Shockingly, 92% of working households for 25 to 64 year olds (according to the NIRS) are not on pace to save enough for retirement. The number is only slightly less scary (65%) when net worth is considered. Yet, DB plans continue to be targets for termination. We can and must do better as an industry.  Let us help you.