Hartford Bankruptcy?

As reported in the WSJ, “two credit-ratings firms on Tuesday downgraded the city of Hartford further into junk status, citing an increased likelihood of default as early as November. S&P Global Ratings knocked down Hartford’s rating by four notches to CC. Moody’s Investors Service lowered its rating for Connecticut’s capital city by two notches to Caa3.”

The myth that public pension plans are perpetual has lead to misguided management and decisions. As we discussed earlier this year, just because something is perceived to be perpetual doesn’t mean it is sustainable. We are beginning to get frequent reminders of this fact, and Hartford, CT is just the latest example. Can cities and states truly continue to support contribution rates that are escalating unabated?

We (KCS) are huge proponents of defined benefit plans, but they need another path before most are shuttered. Stop focusing on the ROA as the primary objective despite the fact that GASB allows plan liabilities to be discounted at that rate. The use of the ROA as the discount rate has lead to the habitual underfunding of these plans. Had the true annual required contribution been made, these plans would be in much better shape.

In addition, so much energy is wasted in the day-to-day management of these plans by debating insignificant factors, such as active versus passive, ESG/SRI, minor asset allocation shifts, etc. These plans are failing because they haven’t focused on the true objective, and they will continue to fail until plans begin to focus on their specific liabilities first and foremost to drive asset allocation and investment structure decisions.

The Choice Isn’t Always Yours To Make

Older workers may think that a lack of retirement funding can be overcome by working longer, but that option isn’t always available to the employee.  Paula Aven Gladych recently reported in Employee Benefit Adviser on a recent study conducted by Transamerica’s Center for Retirement Studies that highlighted the fact that nearly three-quarters of employers think that they are “aging-friendly”, but unfortunately, most haven’t put in place procedures or policies to actually implement this objective.

According to the study, “only 39% of employers offer flexible schedules to pre-retirees, and even fewer allow pre-retirees to change from full-time to part-time positions or take on less stressful or demanding jobs with the company.”  Amazingly, only 27% of employers encourage pre-retirees to participate in succession planning, training and mentoring before they leave the company. What a waste of experience.

Why should an employee find this study disconcerting? With the demise of the traditional DB pension plan for the private sector, most employees will have to contribute earlier in the process, while also contributing more in order to actually generate a commensurate retirement benefit through a defined contribution offering.

Not surprisingly, this isn’t happening, and it isn’t likely to happen anytime soon, as higher paying jobs are hard to find in this economic environment, and our younger generation is often burdened with greater demands on their salaries from items such as student loan debt, higher medical insurance premiums, and greater housing expenses to name just a few.

So, if you find yourself a participant in a DC plan, please “pay” yourself first so that you can create a retirement account that might actually allow you to retire at a more normal age without having to count on the support of your employer to “permit” you to work longer.

How Can That Be?

In an article on CNBC’s website, it was reported that Americans are increasingly optimistic about their financial future.  This information is based on a separate report by Allianz Life, with nearly three-quarters of boomers saying that they feel financially prepared for retirement.
However, Boomers have a median retirement savings of just $175,000 while only a third have more than $250,000, Allianz said.

To make matters worse, 63 percent of Americans fear running out of money in retirement more than death! So how is it possible that nearly 75% feel financially prepared?  Furthermore, the Boomer generation, particularly older Boomers, had greater participation in traditional DB plans.  Millennials have very little exposure to DB Plans, and they must now rely on their ability to fund, manage, and disperse proceeds from a DC plan. No easy task for a majority of Americans.


OPEB Liabilities – Hard To Believe!

A study from Pew Charitable Trusts points out that the average OPEB (other post-employment benefits) plan in the U.S. today is only 6.7% funded, and the total liability is approaching $700 billion.  Shockingly, assets set-aside to meet this promise total <$50 billion.  As you can guess, most of the liability is related to post-employment healthcare benefits.

Only 8 states have funded ratios >30% (Arizona is #1 at 92%), while 19 states have funded ratios <1%. These pay-as-you-go systems are subjecting these liabilities to higher inflation rates, escalating future costs, as opposed to pre-funding these benefits.

Several states have accrued net OPEB liabilities totaling in excess of 10% of the personal income generated within their borders. According to the Pew analysis, “The primary driver for the variation in OPEB liabilities is the difference in how states structure health care benefits for retirees. As a percentage of personal income, the liabilities range from less than 1 percent in 16 states to 16 percent in New Jersey.  Alaska has the highest ratio of liabilities to personal income at 42 percent.”

Obviously, this burgeoning liability will put further pressure on the funding of state DB plans. As the Baby Boomer generation ages, greater funding will be necessary to meet retiree demands for both healthcare and retirement.  Can these systems survive? We are likely only one more great financial crisis away from seeing many of these plans shuttered. Now is not the time to continue to inject risk into the pension system in pursuit of the ROA

We are likely only one more great financial crisis away from seeing many of these plans shuttered. Now is not the time to continue to inject risk into the pension system in pursuit of the ROA. These plans should be de-risked before it is too late.

Missouri Treasurer Expresses Concerns

Missouri State Treasurer, Eric Schmitt, shared his concerns regarding the Missouri State Employees Retirement System (MOSERS) with the News Tribune. He fears that the system is in much deeper trouble than what is being reported.  He lays the system’s troubles primarily on overly optimistic return assumptions and high investment management fees.

Incredibly, MOSERS has missed its return assumption in 16 of the past 17 years despite equity and bond markets being in a prolonged bull market. The targeted return is currently 7.65%, down from 8%.  Furthermore, MOSERS is paying roughly 4 times the fees of the average public fund.  The Post-Dispatch reported that MOSERS, with $7.9 billion in assets, paid $77.8 million in investment fees during the last fiscal year.  That equates to roughly 0.98%, which seems hard to accomplish given the system’s weak results.

Based on accepted actuarial accounting (GASB) the system is only about 60% funded, but if one were to use a more realistic discount rate, the plan’s funded ratio would be more like 50%.

According to Mr. Schmitt, the pension system owes more in pensions than the entire state owes in bonds. “The crisis is no longer on the horizon,” says Schmitt. “It is at our doorstep,” the Post-Dispatch reports.

Now The Proof!

On March 24, 2017, I penned a blog post titled, “And Then There Are The Student Loans”. Here are the last two paragraphs from that post –

“The significant increase in the cost of education and the greater use of student loans to meet this expense is placing an unfair burden on our younger generation. This burden makes it nearly impossible for one to begin to fund a defined contribution retirement plan, but that is basically what we are left with at this stage. The more it delays funding the less likely it is that one will generate a retirement account meaningful enough to accomplish one’s goal of retiring.

At KCS, we focus on issues related to one’s ability to retire, but the burden of greater educational costs impacts so much more from establishing family units, housing, and the general demand for goods and services. It isn’t shocking to us that the US economy hasn’t generated a >3% GDP growth since 2005 when one looks at the significant growth in student loan debt since 2006.”

The Student Loan Debt and Housing Report 2017 by the National Association of Realtors and the nonprofit group American Student Assistance finally bring some relevant statistics to this discussion (thanks, Mike “Mish” Shedlock for your blog post), and they are UGLY!

51% of student loan borrowers have more than $40,000 in debt

83% of non-homeowners reports that student loan debt is keeping them from buying a house, and the delay in buying a home is seven years!

32% of student loan borrowers have defaulted or forbore on their loans

Only 13% have not had a life event delayed, while more than 50% have said that student loan debt has delayed further education or starting a family.

35% of younger Millenials (1990-1998) live with family compared with older Millenials (1980-1989)

Given the demise of the DB plan and the greater use of DC plans, in which the individual is primarily responsible for funding their retirement program, is it realistic to believe that these accounts are getting the funding that they need? Of course, it isn’t! Funding a DC plan with as much as you can as early as you can goes a long way to preparing one for retirement, but that is becoming a pipe dream in this environment.

We have a retirement crisis, and it will only get worse if we can’t solve how our citizens can afford education and healthcare costs that have gone through the roof, while still being able to contribute to their DC plan!




What Is The True Objective?

Regrettably, defined benefit (DB) plans are being frozen and/or terminated at an alarming rate.  Why? Could it be that the plan sponsor and asset consulting community has been focused on the wrong objective? For both public and multi-employer plans, sponsors are laser focused on trying to meet the return on assets (ROA) assumption. But, is that the real goal?

At KCS and Ryan ALM, we believe that the true objective of any DB plan, private or public, is meeting the promise (benefit) at the lowest cost possible.  It is not trying to generate the greatest return.  Injecting more risk into the asset allocation process achieves one goal – getting more risk! It does not guarantee a greater return.

In this market environment in which both equities and bonds have enjoyed lengthy bull markets, how likely are we to see meaningful longer-term returns that will help plan sponsors achieve the ROA?  Not, likely! Injecting more risk in this environment could potentially sabotage the funded status should the equity and bond markets experience a significant decline.

Sponsors of DB plans cannot afford a further increase in contribution expense. Focusing on delivering the promise at the lowest cost might potentially reduce the plan’s returns in the near-term, but this de-risking approach is likely to stabilize both the funded status and contribtion expense, while preserving this important benefit for the long-term.

You know where we stand on this subject. What do you feel is the true objective?