NIRS Finds No Political Divide When It Comes To Retirement!

Members of both political parties are deeply worried about the unfolding U.S. retirement crisis, according to a new study by the NIRS. Key findings include:

Across Party Lines, Americans Support State Efforts to Enable Savings for Workers Lacking Retirement Plans

Americans’ retirement prospects: Work Longer, Spend Less

77 Percent agree that the disappearance of traditional DB Pensions killing the American Dream

71 Percent Say DB Pensions better than 401(k)s for delivering retirement security

WASHINGTON, D.C., February 28, 2017 – America faces a deep political divide, but not when it comes to economic security in retirement. A new report finds that 76 percent of Americans are concerned about their ability to achieve a secure retirement, with that level of worry at 78 percent for Democrats and 76 percent for Republicans. Some 88 percent of Americans agree that the nation faces a retirement crisis, and the concern is high across party lines.

These findings are contained in a new study, Retirement Security 2017: America’s View of the Retirement Crisis and Solutions.  The research is published by the National Institute on Retirement (NIRS) and is based on a poll of 800 Americans conducted by Greenwald & Associates. The findings will be reviewed today at the NIRS annual retirement policy conference in Washington, D.C. The full report can be found on the NIRS website.

Is There A Cash-out Refi disaster brewing?

We are pleased to share with you another excellent article/analysis by our friend Keith Jurow. This article discusses the potentially negative ramifications from “cash-out refis”. Here you go:

Nearly all analysts who write about the housing bubble have focused on the purchasing madness that occurred. While this is important, it overlooks the refinancing insanity of 2004-2007. This refinancing lunacy will devastate mortgage and housing markets for years to come.

You may wonder why I choose to focus on bubble era refinancing. After all, refinancing happens all the time.

Here is why: California was the nation’s epicenter for the refinancing madness. During the bubble years, roughly five times as many refinanced first liens were originated there as were purchase loans.

Millions of homeowners refinanced once, twice, even three times or more while their homes soared in value. These became known as “cash-out refis,” where the borrower refinanced for a larger amount than the previous loan. A California home that may have been purchased for $200,000 in 1997 could easily have had a $600,000 refinanced loan in 2006. When home prices began to tumble, they found themselves trapped in a badly underwater property.

There were roughly 20 million homeowners who refinanced during the bubble years.

Experience Matters

I don’t think that I’d get too much of an argument for making the claim that experience matters in all industries. One should want to work with an individual or team that has experienced a variety of markets and environments.  To be able to recall how one reacted previously to similar events should provide a level of confidence relative to someone experiencing a situation for the first time.

Because the financial industry produces many cycles, having the ability to draw on one’s knowledge of how those cycles played out is extremely important. I once heard that the investment management industry was a young man’s (or woman’s) game.  I’m sorry, but I totally disagree with that thought.

At KCS we’ve built a team of 8 senior consultants that has a combined 285 years of industry experience, which equates to 35.6 years of average service per consultant. That means that the “average” consultant has been in the investment/pension industry since 1981’s bear market.  How many of you remember the bear market from 1980 through July 1982?  In fact, both Larry Zielinski (48 years) and Ivory Day (45 years) have been working with their clients’ issues since before ERISA. Wow!

The good thing about the years of experience that we’ve accumulated is the fact we’ve already made a lot of mistakes and have learned from those.  For instance, we, too, were focused on the return on asset assumption (ROA) as being the primary objective for managing a pension plan, only to realize many years into the game that achieving the ROA didn’t guarantee funding success.  As a result, we’ve built KCS with the knowledge that a plan’s primary objective is to fund the promise (benefits) at the lowest cost possible.

In order to accomplish this objective, sponsors must have greater knowledge of what that liability looks like on a more frequent basis. We’d appreciate the opportunity to share with you some of what we have collectively learned during our 285 of managing pension issues.  I think that you’ll find we have a lot to offer.

 

 

 

How Are Your DB Plan’s Liabilities Performing Today?

How are your defined benefit plan’s liabilities performing?  If you are a public fund plan sponsor this simple question might be very difficult to answer.  Why? Well, for one reason, you are only receiving an update annually, perhaps 4- 6 months dated, when your actuary delivers their annual update.  Second, the totally arbitrary discount rate being used under GASB is understating the plan’s true liability in this low-interest rate environment.

As a reminder, the DB plan only exists to fund a promise (liability) that has been made to the plan’s employees/participants. It is funding this promise at the lowest cost possible that should be the ultimate objective.  Regrettably, that is not the case for most plans, as they’ve been inappropriately convinced (hoodwinked?) that achieving the return on asset (ROA) assumption is all the matters.

I suspect that you know the current market value of assets in your plan down to the penny.  If not today’s valuation then you certainly know the value as of January 31, 2017.  Why is it more important to know the asset side of the equation than the liability side?  If I were running a pension plan, I’d certainly want to know the following:

  1. What is the current value of the promise (liability) that has been made?
  2. What are the current funded ratio and funded status of the plan?
  3. What do the benefit payments look like on a monthly basis?
  4. Do I have the liquidity to meet those payments?
  5. Will the plan run out of money prematurely? If so, when?
  6. Are the estimated contributions enough to narrow the funding gap?
  7. What happens to the plan’s long-term funding if only a fraction of the contribution is made?
  8. Can I “safely” award a COLA or benefit enhancement?
  9. How much alpha do I need relative to liability growth to begin to whittle away at my unfunded liability?

I would suggest that without greater knowledge of the plan’s liabilities, you will not be able to answer the questions above.  In fact, without a custom liability index (CLI) being produced for your plan’s specific liabilities it would be impossible to answer those questions.

Investment structure and asset allocation should be driven by the liability side of the equation. It makes no sense that trying to achieve an arbitrary ROA would be the plan’s primary objective. As we reported earlier today, the average public DB plan has a 7.6% ROA target with only 7 of 132 large public funds having a ROA < 7%. How is it possible that all these plans have roughly the same ROA objective?

One would think that a plan that is 90% funded would have a much more conservative asset allocation than one that is 50% funded. But if both plans are striving for the same 7.6%, they are going to get a very similar asset allocation from their generalist asset consultant. DB plans should be removing risk from the process as funding improves. But, if you don’t know how the liabilities are performing, then you can’t possibly know when to take risk off the table.

If you’d like to be able to answer the questions posed above, please reach out to us to construct a CLI for your plan.  It isn’t prudent to perform surgery without a set of X-rays.  Why engage in the management of a DB plan without the appropriate x-rays being made available for your plan’s liabilities?

 

Many U.S. States Continue to Struggle

According to a recent Barron’s article written by Thomas Donlon, there are 23 U.S. States whose inflation-adjusted revenues remain below pre-recession levels.  This is shocking to me given that we are in year eight of the “recovery”. Unfortunately, there also remain 18 U.S. States that have lower employment levels than they had in 2007, further stressing state budgets, as tax revenue declines.

This unfortunate combination of lower revenue and weaker economic growth will make funding public DB plans even more challenging than it already has been.  Contribution costs continue to escalate for many public pension systems despite the 8-year recovery in equity markets and the use of a discount rate that averages 7.6%.

Given current valuation levels for both bonds and stocks, it is unlikely that we can expect outsized gains from the capital markets.  Furthermore, given the pressure on state budgets, it is unlikely that our public pension system will be cured of its underfunding by just allocating more of the state budget to the problem through contributions. We have seen most, if not all, state plans address their troubled systems with changes to contribution rates for employees, new tiered benefits, longer required retirement ages, elimination of COLAs, etc., and in many cases, funding levels continued to deteriorate.

As we’ve frequently said, these plans are much too important to the individual participants and their local economies to subject them to undue risk. Pursuing the ROA in this market environment is adding considerable risk to the traditional asset allocation process.  At KCS we espouse a much different approach: one designed to stabilize both contribution costs and the funded status.  Once those objectives have been met, a plan can begin to de-risk.

I don’t believe that most public pension systems can survive another 2000-2002 or 2007-2009 equity market decline, especially if is accompanied by declining U.S. interest rates.  Putting in place a lower risk investment structure and asset allocation will reduce the risk of such an occurrence.  DB plans need to get a better handle on their plan’s liabilities.  With this greater knowledge, more informed asset allocation decisions can be taken.  We are ready to assist you.

 

 

 

 

Enough Already

We receive a daily email from Pensiontsunami.com that contains recent pension crisis headlines.  Most of the articles talk about the unsustainability of public pension plans.  Here are a couple of examples from today’s list:

PENSION CRISIS HEADLINES POSTED FEBRUARY 9, 2017

  • California Taxpayers on the Hook for Skyrocketing Teacher Pension Contributions (Kevin Truong / San Francisco Business Times)
  • CalSTRS’ Reduced Goal Will Hit These Districts Most (Romy Varghese / Bloomberg)
  • Public Pension Pilfery (Larry Sand / UnionWatch)
  • Dallas Council Members Sue to Wrest Control of Pension Assets From Board (Matt Goodman / D Magazine)
  • Illinois Budget Deal Hits Snag After Key Pension Bill Fails (Karen Pierog & Dave McKinney / Reuters)
  • The Man Behind the Fiscal Fiasco in Illinois (Dave McKinney / Reuters)

Clearly, some of the more notable state plans are in big trouble from a funding standpoint, but the entire industry surely isn’t.  Furthermore, there are strategies that can be employed to begin to improve the financial health of public pensions. However, it will take a different path than the one that has been traveled for the last 50+ years.

As we’ve said before, managing a DB plan isn’t about generating that greatest return.  It is about meeting the promise at the lowest cost possible. The pursuit of the return on asset assumption (ROA) has forced plans in this low-interest rate environment to inject greater volatility into the asset allocation process.  DB plans should be looking to take risk out of the equation.

Furthermore, we are discouraged by the continuous publication of headlines that predict that all DB public plans will fail (not to mention multi-employer plans, too), without offering meaningful solutions.  Defined contribution plans certainly aren’t the answer, but that seems to be the only remedy being proposed.  Have you seen the results of this failed model?

We, at KCS, have created a five-point de-risking solution that will stabilize a plan’s funded status and contribution expenses while beginning to return these plans to a healthier state.  It starts with understanding what the promise you made looks like.  Once a sponsor has their arms around that promise they can then use the output to drive investment structure and asset allocation decisions.

We know that not all DB plans have been managed appropriately, as contribution holidays have been taken, COLAs awarded and benefits enhanced without a true understanding of the long-term implications of these actions.  But, with a little more discipline and a new approach, DB participants will once again be able to count on having the retirement benefit that was promised to them, and one to which they have been contributing.

Stop – It Isn’t A Return Game

Reuters has published an article, titled “Despite risks, public pensions put faith in long-term returns” As usual, the article stresses return as the savior of defined benefit plans.  But, achieving the return on asset assumption (ROA) has not guaranteed success. We’ve illustrated this point before. But, it has guaranteed much more volatility in the returns achieved.

We understand that the lowering of the ROA target likely increases contribution costs as GASB allows for plan liabilities to be discounted at the ROA.  This practice is leading to the habitual underfunding of DB plans.  Both the IASB and FASB require plan liabilities to be discounted at substantially lower rates (mark-to-market and AA corporate, respectively).

DB plans can earn substantially less return than the ROA target and still come out ahead.  How? Liabilities are bond-like in nature. The present value of a liability rises and falls with changes in interest rates.  Liability growth has been fueled in large part by the collapse in U.S. rates. If rates begin to rise, we could see negative growth rates for plan liabilities.  In this case, a 4% asset return will look very strong versus a -3% liability growth. You need fewer assets in a rising rate environment to meet your future liability.

Even if plans continue in their attempt to beat the ROA, their targets are still too aggressive. The average ROA for a public plan is estimated at 7.5% to 7.6%. Since 1926, the S&P 500 has produced an average 30-year return of 7.81%.  Most plans will not have a nearly 100% allocation to the S&P 500.  How are they going to achieve the ROA?

Stop the singular focus on assets, and begin to focus on your plan’s liabilities. Managing a pension plan should be about meeting the promise (liability) at the lowest cost possible.