What is Unsustainable?

I’m taking a few moments to depart from my nearly singular focus on preserving DB plans for the masses to comment on something that I read this morning.  The following came across my desk, and it echoes a claim that I hear frequently, but one that isn’t based on fact.

“We basically have gone from $8 Trillion to $20 Trillion in Government Debt since 2008, and it is the rate of change of this debt spending that is the real elephant in the room, and we are just coming up on the entitlement’s impact curve on our government debt obligations.

I feel for Trump because he has inherited a boxed in economic situation here. He actually wants to stimulate the economy through growth projects; but the previous wars, financial crisis, bailouts, and unwise and inefficient spending programs have made borrowing any more money at these levels impossible, and Congress knows this fact!

They may try to go down this borrow and spending road, but it will backfire bigtime on the Republicans. By my calculation, the Democrats are going to benefit immensely from the fact that the s*t is going to hit the fan during the Trump presidency and Republican-controlled Congress from past bad governmental practices of what I call “Can-Kicking” and “Short-Termism.””

This constant chatter about unsustainable levels of U.S. debt has been occurring since at least the 1930’s.  My friend and former colleague, Charles DuBois, shared the following quote with me:

“Everyone knows if we continue the present financial program of borrowing billions upon billions of dollars, with an unbalanced budget, piling up debt upon debt, sooner or later, the day of reckoning will come. None of us are prophets. We cannot predict when that time will be. All we know is that if we continue on this road, with no financial policy and an unbalanced Budget we are going down the road to bankruptcy, repudiation and financial chaos.” Rep. Hamilton Fish III (R- NY) on the floor of the House of Representatives – November 1937

Those words were uttered 80 years ago, and we are still waiting for the great bankruptcy to occur.  What we do know is the U.S. will always be able to pay its bills.  Why? Because we possess a fiat currency, and a country with its own free-floating currency and no foreign debt can always meet all of its obligations – including Social Security, so please stop worrying about that political football!

One of the potential consequences of printing money is the possibility that it creates excess demand that exceeds our economies ability to produce the goods and services to meet that increased demand, which will lead to inflation. However, we have tremendous slack in our economy currently, and our ability to meet increased demand should not be an issue in the near-future.

Let’s hope that President Trump’s goal of increasing infrastructure spending to spur economic growth, job creation and enhanced wages is successful.  The last time the US produced an annual GDP growth rate in excess of 3% was 2005.  That is just not acceptable.

How DB Plans Can Be Saved

I just penned the following article, “How Defined-Benefit Pension Plans Can Be Saved” for publication on the Investopedia.com website.  We, at KCS, hope that you find our insights beneficial, and we look forward to having the chance to discuss with you some of our ideas on the subject. We believe that DB plans are too important to see them disappear.

The Slippery Slope Is Primed

Usually, congratulations are in order for finishing first, but in this situation, I will hold back on my celebration. Why? I am not inclined to applaud the Treasury Department’s decision to approve the rescue request for Iron Workers Local 17 Pension Fund, Cleveland. See, this plan becomes the first multiemployer pension plan to win approval to reduce benefits under the Kline-Miller Multiemployer Pension Reform Act (MPRA) of 2014.

According to a December 26, 2016, article in P&I, the benefit reductions can not be lower than 110% of the PBGC’s guarantee, which is presently just under $13,000 per retiree, per year for someone with 30 years of service.  Little consolation as far as I’m concerned for a retiree who may have been receiving $20,000 per year and now has to make due with a 35% reduction.  If only this worker had been in a corporate plan as opposed to a multiemployer pension for that individual’s benefits are protected to nearly $60,000 per year by the PBGC!

Regrettably, Local 17 isn’t the only plan seeking to reduce existing benefits, as there are an additional 60 multiemployer plans that have notified the Department of Labor of “their critical and declining” status, which makes them eligible to consider applying for benefit reductions.

There were several reasons that were cited in the P&I article as to why Local 17 gained approval when four other plans, including the $17.8 billion Teamsters Central States plan were rejected.   Two of the primary reason were the plan’s small size (roughly $90 million in assets) and its reduction in the return assumption from 7.5% to 3.75%.

We do want to recognize that trying to save the plan is better than having it end up being the responsibility of the PBGC as retirees who worked a minimum of 30 years will get at least 10% more from this plan.  However, we continue to worry that this is just a band-aid for an industry that continues to focus on the wrong objective – the return on asset assumption (ROA).

As this situation is proving, the fund only exists to meet a promise that was made to the employee.  The promise is the plan’s liabilities, and meeting that liability should be the main objective, not an arbitrary return target that doesn’t guarantee a plan’s success. Furthermore, with the potential for interest rates to back up in the near future, the present value of that liability declines.  We could witness improved funding without the need to reduce some poor retiree’s benefits.

Instead of granting permission to reduce benefits for all those multiemployer plans currently in the queue, let’s help them change their focus from managing the return side of the equation to finally using the promise that they made to drive asset allocation and investment structure decisions.

KCS Fourth Quarter Update – 2016 was a good year for pension funding

We are pleased to share with you the KCS Fourth Quarter 2016 update. As you will read, 2016 was a good year for DB plan funded ratios, as U.S. long rates backed up marginally from the beginning of the year, and assets performed well despite a troubling beginning to the year and a hiccup following Brexit. Will the “Trump Rally” continue? Will interest rates continue to back up? If they do, plan liability growth will likely be negative, and in that scenario, DB plans do not need to generate outsized returns to begin to see improvement in fund ratios and contribution expense.

2017 should be the year that plan sponsors become more liability aware. What does this mean? Asset allocation and investment structure should reflect a plan’s funded status and not some arbitrary return on asset assumption (ROA). As plans see improvement in their funding they should begin to de-risk. Why continue to live with the volatility associated with pursuing the ROA when achieving said ROA doesn’t guarantee anything. Most DB plans were fully funded in the late 1990’s only to see that funded status get crushed under two significant market declines.

History has a way of repeating itself. Let’s see if we can alter the future for DB plans, by trying a new approach.

All the best in 2017,

The KCS Team

Dave, Ivory, Larry, Lillian, Russ, and Russ

Wake Up To the Reality!

The migration from DB plans to DC plans isn’t working for the individual participant, and it will only get worse! As a result, a retirement crisis is unfolding in the US, and the social and economic ramifications are likely to be profoundly negative.

As a result of the greater use of defined contribution plans, we’ve asked our employees to become investment experts when nearly all of them aren’t trained to handle this responsibility. We certainly require training / licensing when hiring plumbers, electricians, nurses, etc. Under these circumstances, why would anyone think that this migration from one retirement plan to another is a positive development for our society? Worse, our Millennial children are earning wages that are dramatically lower than those from the Boomer generation.

Millennials are falling behind their boomer parents.  According to a new analysis of Federal Reserve data by the advocacy group Young Invincibles, Millennials are worse off than their Boomer parents by roughly 20%.  Couple the lower wages with much greater education costs and you have a formula for disaster.

In addition to excessive educational costs, our employers are footing a much smaller percentage of health care costs, while rental expenses are rising rapidly in many urban environments. Have you checked out Hoboken for instance? I am very concerned about the long-term implications that this toxic combination is producing.  We WILL suffer profoundly negative economic and social ramifications as a result of our failure to address the impending retirement crisis.

DC plan participants can have a successful outcome if they fund their retirement accounts with a good chunk of their compensation (10% to 15% annually), and do so as early in their careers as possible.  However, life gets in the way for many of us today, and the ability to make these on-going contributions can be a challenge. There is a basic level of compensation that must be earned just to survive, let alone thrive!  Clearly, for most of the younger population survival is today’s name of the game.

As a society, we must deal with the ridiculous cost of higher education, the lack of quality jobs accompanied by living wages, the assumption that everyone is capable of managing their own retirement, a public education system that is not producing outcomes that prepare our students for a 21st century economy, while retraining all those workers that have been displaced or soon will be (see driverless cars) as a result of major technology advances.

When will we get serious and begin to tackle these important issues?

As We Were Saying…

We recently penned a post on the sustainability of public DB plans given the escalating cost to fund them.  Here is another example, presented to us through a P&I article, highlighting the contribution to CalPERS that will rise by $524 million next year

According to P&I, California will contribute $5.3 billion to CalPERS for the fiscal year starting July 1, up 11% from the current fiscal year, shows a proposed budget by Gov. Edmund G. Brown Jr.  Furthermore, it appears that the annual contribution will continue to grow substantially at least until 2019, nearing almost $10 billion a year at that point.

We are huge proponents of DB plans, but the continuing focus on the ROA and the subsequent volatility that comes with a traditional asset allocation and investment structure have the potential to drive contribution costs even higher.  We need to get DB plans on a derisking course in order to help stabilize the funded status and annual contributions.

Ryan ALM and KCS have developed a six-step process to become more liability aware.  Let us help you!


Perpetual Doesn’t Mean Sustainable

KCS is a leading voice in the trying to rescue DB pension plans. We established KCS in August 2011 with the mission to try to preserve these incredibly important social and economic tools. We need to be able to manage out labor force through a natural life cycle, but the demise of the DB plan and the greater, almost exclusive use of the DC plan (private sector), is undermining this important process.

We’ve seen DB plans nearly wiped out in the private sector.  However, a significant majority of public employees (estimated at about 85%) still enjoy the benefits of a traditional plan.  But for how much longer will they?  There is a perception among public plan participants and sponsors that these plans are perpetual. However, since the Great financial crisis most, if not all, public plans have taken action to reduce the future liability by asking employees to contribute more, extend vesting periods, reduce benefits for new hires, eliminate COLAs, etc.

This doesn’t signal to us that everything is honky dory! In fact, employer contributions have rocketed higher in the last couple of decades.  There are many examples of annual contribution rates being 25% to more than 40% of salary. At what level of contribution to these “perpetual” plans become unsustainable?  For many states and municipalities, the pension contribution is but one element of a social safety net that must be funded.  As the contribution rate escalates for DB plans, it naturally squeezes out other needy programs unless there is no restriction on the taxing authority.

Given the pension envy that exists among those taxpayers in the private sector, it is doubtful that they would be supportive of any administration that attempts to substantially raise taxes in this economic environment.

DB plans can be saved, but plan sponsors and their consultants need to begin to think outside the box. Focusing on the ROA, as if it were the Holy Grail, has lead to greater volatility and little reward to show for it! DB plans need to focus on the promise that they have made, use their funded status to adjust asset allocation, and derisk plans as they see improved funding.  We missed the boat to derisk at the end of the 1990s.  Let’s not blow it again!