What Can Be Done About This?

The following article appeared in the WSJ yesterday.

Slowdown in state, local investment in roads, other infrastructure dents U.S. economy

We are not surprised by this news, and would be shocked if you are, too, especially given growing claims on budgets to meet contributions for healthcare and pensions. Despite this growing claim on tax revenues, we believe that DB pensions must be preserved, not only for public workers, but for the private sector, too.

Can you imagine a future economy in which the only source of revenue for a significant percentage of its residents is Social Security?  We can, and the social and economic consequences from that happening will be grave. So, what needs to be done? First, DB plans need to begin to derisk.  A sponsor might ask “even if they are poorly funded?” Absolutely! As we’ve discussed on many occasions, managing a pension plan shouldn’t be about achieving the ROA, but about providing the promised benefit at the lowest risk and cost possible. Trying to achieve a 7.5% ROA in this environment is proving very problematic. Plans are getting much more risk, but not the commensurate reward.

These plans must begin to stabilize their funded ratios and contribution expense. It is through this enhanced discipline that municipalities and states will be able to more appropriately meet these liabilities, while providing the necessary resources to invest in their community’s infrastructure needs.  However, a new approach to the management of DB plans will need to be undertaken if they are to reduce funding volatility. The same old, same old is just not cutting it!




Mental Healthcare Funding Under Attack in NJ

For regular readers of the KCS blog this is obviously not a subject that I often write or report about, but it is an area that I am passionate about as I’ve served on the WBMH Board and Foundation Board for the last 15-16 years.  As most of you probably don’t know, New Jersey is moving to a new funding system for mental healthcare organizations that will potentially hurt many of the neediest recipients of mental health services.

A fellow Rotarian of mine, Andrew Garlick, has written a blog post on this subject, which I share with you: please take a moment and read about it here: https://t.co/NoTyGQ9EJh

Ironically, I participated in a finance committee meeting at WBMH last evening, which touched on this very subject. It is frightening to me, and I’m sure to many others, that many mental health services that we take for granted may not be offered in the future, as fee reimbursement rates don’t cover the costs to provide those services.

The transition to the new funding mechanism occurs on July 1, 2017. As Andy is encouraging, we need to get our legislators to rethink this transition before it is too late. Your help is needed – thank you!

Assets and Liabilities Need to Work Together

As we’ve discussed on many occasions, the purpose of a DB plan is to meet a promise (liability) that has been made to a plan participant.  Furthermore, this benefit should be provided at the lowest cost possible.  However, in order to do that plans need to stop focusing on the return on asset assumption (ROA) as the fund’s primary objective.  It isn’t!

We, at KCS, believe that DB plans, whether private or public, need to enhance their current actuary / generalist consultant model with a Liability Aware consultant.  The following link highlights the role that we are referencing.


In this role, KCS interfaces with both the actuary and the generalist consultant. We will help determine the appropriate ROA (it shouldn’t be a Goldilocks number) and advise on an asset allocation that reflects the funded status of the plan.  Plan’s should de-risk, especially as their funded status improves.

The current approach of focusing on the ROA has not improved funding, but it has increased cost, as the significant increase in the use of alternatives has been done in an attempt to jump-start returns.  That hasn’t worked!  Let us share with you how we can reduce cost, improve funding, and begin to de-risk your plan.  It is an approach whose time has come.


KCS Third Quarter Update


Attached for your review is the KCS Third Quarter Update. As you will note, we have been busy during the last few months, and the next three are nearly as packed. We thank you for your continuing support, and many others in our industry who have provided us with a forum to express our unique insights, as we attempt to alter the conversation regarding the day to day management of defined benefit and defined contribution plans.

We continue to believe in our firm’s mission, as we fear the adverse consequences of a failing retirement system. The statistics that are highlighted reveal a consistently ugly story, as fewer and fewer retirement participants are in a position to retire. In fact, only 1 in 7 contributors to a DC plan (only about 50% of the population actually fund a DC plan) are contributing enough to replace an appropriate portion of their current income.

Please don’t hesitate to call on us if you’d like to learn more about our approaches to working with DB, DC, E&F and HNW individuals. With a combined 191 years of relevant experience, we believe that our team can assist you and your team to navigate through these difficult challenges. But despite the choppy seas, they must be navigated.

Active Management Is Not Dead

Come on, folks. Let’s stop the silliness right now.  I can’t tell you how many times in recent weeks I’ve read about the demise of active managers versus passive offerings, but I can tell you that it has been too many times.  This discussion of passive versus active has been around since the creation of passive indexes, and it will remain a topic of conversation for a long time to come.

The KCS team has addressed this issue in prior blog posts, but given the recent fervor, we felt that it was necessary to discuss this topic again.  There are cycles throughout the capital markets, and it is no different for active equity managers versus their passive equity benchmarks.

There are portfolio biases that favor passive versus active and vice versus. Active managers tend to do better when small capitalization stocks and value-oriented stocks / sectors are in favor.  In addition, active managers tend to do better when markets are falling, as they often have cash reserves that help support portfolio performance.  These are portfolio construction issues given that most active managers build equal weighted portfolios, and have stock selection criteria that screens for value (price to something).

Passive portfolios, particularly larger cap indexes, benefit from momentum, rising markets, and large capitalization leadership.  These are the areas that have most recently been in favor (last 3 years), and so it isn’t surprising that active managers would be struggling in this environment.  Does this mean that something has changed that will always create this opportunity for passive investing?  Hell no!

There are certain segments of our capital markets that are more difficult to add substantial value add, but given the cycles in the markets there will always be opportunities.  We suggest that plan sponsors use both active and passive strategies to achieve their desired equity exposure and tilt to one versus the other when portfolio construction biases make sense to do so.

In addition, be careful what you pay in fees, and consider using performance fees to insure that you are only paying for value-added strategies.  Also, assets under management are an important consideration, too.  There are too many asset gatherers that have built asset bases that far exceed their product’s natural capacity to add value. Small can be a beautiful thing!

Funding Crisis

via Daily Prompt: Urgent

It was reported today that only 1 in 7 contributors to defined contribution plans (401(k) and 403(b)) are contributing enough to sustain a reasonable standard of living in retirement.  This is compounded by the fact that only about half of our labor force is participating in a DC-type retirement vehicle.

This is clearly an untenable situation for the individual, but equally important for our economy and social structure. Where will demand for goods and services come from if a significant percentage of our population don’t possess the financial wherewithal to be consumers?  Furthermore, this places a significant burden on our ability to manage the labor force through a natural evolution.

We urgently need to re-think the elimination of defined benefit plans (DB) in favor of defined contribution structures. In a DB plan the individual participant has little responsible for the ultimate outcome, which is the receipt of a monthly pension check. Regrettably, they possess the entire burden in a DC plan, from contributing, to allocating the assets, to managing the distributions.  Why do we think that untrained individuals will handle this responsibility?

The urgent need for education is clear, but the ability for most individuals to self fund these plans is still the greatest challenge. We live in an environment where real wages have stagnated for many years. In addition we have a significant percentage of our potential labor force on the sidelines (94 million age-eligible 16-65 year olds) who are not funding retirement programs.  Discretionary income is almost an oxymoron for a vast majority of our citizens.

GASB versus FASB – Clumsy

via Daily Prompt: Clumsy

Sorry, but I don’t understand how our powers that be can support two different accounting standards for valuing a defined benefit plan’s liabilities.  The International Accounting Standards Board requires pension liabilities to be valued at a risk free market rate.  However, in the U.S. we have two governing bodies that oversee pension accounting with one supporting public and multi-employer plans (GASB) and the other supporting private sector plans (FASB).

In the case of GASB, a DB pension plan can value their liabilities at a discount rate equivalent to the return on asset assumption (ROA), which for most plans is in the 7.5% to 7.75% range.  Under FASB, a private sector plan must use a blended AA corporate rate, which will be much lower in this environment, but still significantly inflated versus the risk free rate (Treasury security). Why does this situation exist?  Not sure, but it seems to be creating a stir for actuaries, too.

The Society of Actuaries has been stating for a long time that liabilities should be valued at a true economic rate, and not one predicated on a guess as to how much a plan is going to earn (ROA) over time.  Having two different accounting standards is very clumsy, and it creates uncertainty in the marketplace.  At KCS, we remain strong advocates for DB plans, but we believe that these plans will only continue to be viable if there is an honest assessment of their liabilities.  Without this transparency, how can a sponsor truly know whether or not they are winning the pension game.