For most plan sponsors and their asset consultants, the return on asset assumption (ROA) drives investment structure and asset allocation decisions.  As U.S. interest rates fell during most of the last 35 years, pension plan exposure to fixed income has fallen to record low allocations.  Yet, a plan’s liabilities (the promise) are highly correlated to interest rates.  The diminished exposure has created a huge mismatch between assets and liabilities.

For years, most industry participants have fully expected growth, inflation, and higher U.S. rates. Well, we’ve seen short-term rates rise during the last 15+ months, but longer rates, such as the U.S. 10-year Treasury, have been in a period of relative calm.  In fact, yields on the 10-year have actually fallen by about 3-4 basis points in 2017, much to the dismay of many market forecasters.

For regular readers of the KCS blog and Fireside Chat series, you may recall that in March 2017 we reissued a Fireside Chat that we had produced back in 2013 on why we didn’t see U.S. long rates rising much in the near future.  Our interest in reproducing this piece was our feeling that 2017 would not be the year that longer rates would spike, and they haven’t.

As equity markets continue to move forward with little concern for valuation, plan sponsors should begin to reallocate their asset class exposures back to long-term policy normal levels.  In doing so, they should consider adopting a cashflow-matching strategy for their fixed income exposure to mirror monthly benefit payments for the plan’s retired lives.  We’d certainly welcome the opportunity to discuss the appropriateness of this strategy.

For the year, UBI had an operating loss of $1.83 million on zero revenues. It had $15,406 in cash, and: “In order to keep the company operational and fully reporting, management anticipates a burn rate of approximately $220,000 per month, pre and post-offering.”

Well, it seems like many investors were willing to pay a lot.  You see, UBI Blockchain Internet, a Hong Kong outfit whose shares trade in the US [UBIA] saw it’s stock price during the six trading days starting on December 11, 2017, soar over 1,100%, from $7.20 to $87 on December 18, as the word “blockchain” is in its name.  By December 21, shares had plunged 67% to $29. They closed on Wednesday at $38.50.

The above information was found in an article by Wolf Richter, who points out that UBI isn’t the only “scam” in town.  There has obviously been tremendous interest in all things crypto and blockchain in 2017, but how different is it from the hundreds, perhaps thousands, of dot-com companies that briefly appeared in the late ’90s with absurd stock market returns only to meet catastrophic destruction like supernovas?

We would suggest that you proceed with caution, but if you feel that you must gamble, please choose a “game” with better odds.

The Washington Post has produced a terrific story on the 998 workers impacted by the 1994 closure of the Tulsa, Oklahoma, McDonnell Douglas plant. Many of the employees interviewed were able to eventually find work again, but in many cases, their new wages were less than half of what they had been making at MD.  Unfortunately, it wasn’t just the loss of wages that has negatively impacted these workers, but the loss of pension benefits that they never were able to replace through their new employers.

Many of these individuals, now in their 70s, are still working today because of their lack of retirement assets and financial security. I’ve heard people joking over the years about likely having to work as a greeter at Wallmart because of their lack of retirement savings, but for several of the former employees in this cohort, that is exactly their reality.  Their financial struggles include losing their homes, incurring significant debt burdens, liens, etc.  Roughly 15% of them have had to file for bankruptcy.

Small companies have always found it challenging to be able to provide a retirement benefit to their employees, but for midsize and large companies, nearly 60% offered a pension plan at one point. Regrettably, the percentage covered by a traditional pension plan has fallen to only 14% of the private sector, when considering all employers, and that percentage is likely to continue to fall rapidly, as today’s employees are living longer exacerbating the liability that these companies are trying desperately to eliminate.

“The U.S. retirement system, and the workers and retirees it was designed to help, face major challenges,” according to an October report by the Government Accountability Office (GAO). “Traditional pensions have become much less common, and individuals are increasingly responsible for planning and managing their own retirement savings accounts and “many households are ill-equipped for this task and have little or no retirement savings.”

Amazingly, most of these employees were in the MD pension plan long enough to secure some retirement benefit, if even a small one. Can you imagine the financial distress that many of our workers will soon face knowing that they only have Social Security to rely on? The Washington Post story claimed that the average SS payout is a little more than $14,000 (we think that it is >$16,000), which certainly isn’t nearly enough for anyone to live on for any length of time.

We have written a ton on the impending retirement crisis. It isn’t a joke. The U.S. will have tens of millions of once productive members of our society falling onto the social safety net. Let’s not let that happen.  We need a recommitment to provide our employees with a benefit upon retirement that will supplement Social Security. Asking untrained employees to fund, manage, and then disperse a retirement benefit is a challenge that most of our workers are not going to handle appropriately.

Saw an interesting note this morning regarding Citigroup’s U.S. economic surprise index.

Obviously, 2017 has been an incredible year for the markets with the S&P 500 up more than 20% so far, reflecting a strong economy that has achieved its highest sustained growth in more than 3 years. However, when this reading has achieved such lofty heights previously (>70, it is now 84.5), the subsequent 6 month period has been modest at best for the U.S. equity markets.  In fact, according to Jim Paulsen, CIO, Leuthold Group, the S&P 500 has only achieved a 2.8% annualized return during the next 6 months.

The momentum witnessed in the economy is likely to lead research analysts to continue to ratchet up their economic forecasts making it very difficult for the economy to continue to surprise going forward. Markets tend to outperform when expectations are more modest providing opportunities for positive surprises.

Happy Holidays, Merry Christmas, and a very happy, healthy, and prosperous New Year to you and yours from the Kamp Family. Thank you for your support and friendship in 2017.  I very much look forward to what 2018 might bring.

Consumer debt has hit an all-time high of 26% of disposable income. In the past five years, consumer debt has outpaced income growth by roughly twice. As a reminder, consumer debt excludes mortgages and home equity loans. The growth in consumer debt has been driven by auto and student loans, no surprise there.

However, what does this portend for the consumer and our economy? According to Ray Boshara, Senior Adviser and Director, Center for Household Financial Stability could be both positive and negative (now doesn’t that sound just like an economist). According to Ray, the significant growth in consumer debt could reflect American’s greater confidence in the economy, willingness to invest in assets that build wealth, such as education, and it can also signal that consumers have taken advantage of the lower interest rate environment by paying off previous loans and are now seeking additional borrowing.

However, this growing debt could signal trouble ahead for the U.S. economy, as families use debt to acquire necessities. Rising family debts can diminish future economic activity. In a period of rising rates, the extra interest burden could put this debt at risk of repayment. We are already witnessing troubling trends with regard to the repayment of the massive U.S. student loan debt (roughly $1.5 trillion).

In any case, the growth of consumer debt relative to income growth certainly reduces the amount of disposable income available to fund retirement accounts, in an age where individuals are already contributing far less than what is necessary to build an adequate retirement nest egg.

According to the WSJ, there are two provisions in the tax bill that relate to retirement. First, borrowers of 401(k) loans will now have more time to pay back the loan after leaving their job. Currently, the employee has to repay the loan within 60 days following departure from their employer or face taxes and a possible 10% penalty, if younger than 59 1/2 years old.  In the new bill, the loan must be repaid or the proceeds rolled into an IRA by the date of their next Federal tax filing.

The other provision relates to the recharacterizations of Roth conversions, which will cease to exist in the new tax bill. Currently, a conversion to a Roth from a traditional IRA can be reversed by October 15th of the year following the conversion. This tactic was often used by Roth account owners when account balances fell, eliminating the gains that they would have been taxed on.

Thank goodness that early attempts to significantly reduce tax-free contributions into 401(k) plans were rejected.  Clearly, we do not need any additional obstacles for individuals to fund their future retirements.

Here is a new PolicyNote from The New School’s Schwartz Center for Economic Policy Analysis.  The punchline is truly scary:

“Without a universal supplement to Social Security, many of the 24 million workers ages 55-64 will face declining living standards or poverty in just 10 years. One-third of older workers have neither retirement savings through a 401(k) or IRA, or a defined benefit (DB) pension. Overall, the median account balance of workers approaching retirement is just $15,000. The median account balance for those with retirement savings is just $92,000.”

Think about the loss of demand for goods and services that results from this lack of financial resources? Will a majority of these 24 million be able to stay in their homes? That is highly unlikely to happen in states with high property taxes, even before considering that the deductibility of property taxes may be eliminated or significantly reduced for Federal Tax purposes.

So, what happens to these millions of folks? Do they:

1. Fall onto the welfare ranks?
2. Sell assets (homes, cars)
3. Move in with family members?
4. Borrow from family, friends, credit cards, loans, etc.
5. Engage in criminal activity?
6. All of the above

The potential exists for all of the above to become the standard operating procedure for these individuals. You may scoff at these suggestions, especially the one related to criminal activity, but desperate people don’t always think rationally.  Do we really want our senior citizens to live a life without dignity? Do we want them missing meals, doctor appointments, while skimping on other essential items because we didn’t prepare them appropriately for life after work?

For those in our society who claim that we can’t afford defined benefit plans for the masses, I would argue that we can’t afford to add millions more to the welfare ranks.  It is far better to try to pre-fund a retirement benefit that will provide a monthly supplement to Social Security than it is to have a massively bloated welfare system.

There are many in our country that would love nothing more than to see public pension systems unwound. They often cite the burgeoning unfunded liabilities as their motivation for this action: protecting the taxpayer. In a recent blog post on Burypensions Blog (not much doubt where the author stands on this subject) he listed some data that had been extracted from a recent Fitch Report, and on the “evidence” it looks damning for states such as Illinois, NJ, Massachusetts, and Kentucky with estimated unfunded liabilities totaling $352 billion. The unfunded liabilities were calculated using a mark-to-market discount rate (2.14%) instead of the return on asset assumption that is permitted under GASB (average is roughly 7.5%).

The use of the defined benefit plan has been dramatically reduced in the private sector with roughly 120,000+ plans having been terminated since the mid-‘80s. There are currently about 23,000 DB plans still functioning that cover roughly 15% of the private sector and about 85% of the public sector. At one point in time, nearly 50% of the private sector was covered by a DB plan.

We would suggest that the issue isn’t the DB plan, but how they have been mismanaged. These plans function well when annual required contributions are made, benefits are calculated based on lifetime earnings (salaries), and not spiked with overtime, sick and vacation pay, etc., plans focus on their specific promise (liability) to drive asset allocation and investment structure decisions, and not managed to some artificial return on asset number that is primarily used to calculate contributions, but in doing so has added far more risk to the process with little reward to show.

I get that those in the private sector are naturally concerned about their lack of a retirement benefit and the potential growing cost to fund the retirement plan of someone else. This pension envy is understandable but misdirected. The incredible risk transfer that began to take place in the early ‘80s from corporate America funding and managing a retirement benefit to the individual employee being asked to now take on this responsibility with far fewer skills is crippling America’s retirement dream for most of us. This is a huge policy misstep that needs to be corrected, and fast!

What many fail to realize is that there is a great benefit (no pun intended) to the local economies where DB plan beneficiaries live, as they spend those monthly checks that they receive, which is a proven catalyst to economic activity and tax receipts at the federal level. Does it make sense to close DB plans that ensure a monthly compensation and use DC plans that don’t? Of course not!

So, what can be done? First, we need to support efforts to get the private sector workforce back into DB plans, whether at their companies (highly unlikely) or through a state or federal effort. Second, for those plans that remain open, we need to get sponsors and their consultants to adopt more of a liability focus to the day-to-day management. As previously stated, managing to the ROA has only injected more risk into the process with little certainty of success. Understanding the promise that has been made and managing to that promise should be the standard operating procedure. By doing so, one establishes a glide path to full funding, whether at 50% funded or 90%. The U.S. equity and bond markets have enjoyed long bull markets, but for how much longer? Despite this rosy market environment, funded ratios are stubbornly low, while contributions expense is growing rapidly – not a great combination.

DB plans need to be supported, as they are the only true retirement vehicle. The absence of DB plans will place a greater burden on an aging population that already has a significant percentage of their cohort living on Social Security wages only. Economic growth in the U.S. has been modest, at best, for the last 12 years. Can you imagine what it would look like if we had 10s of millions of “retirees” living exclusively on a Social Security benefit? Where would the economic activity come from?

The following chart highlights the fact that the “recovery” since the GFC has left many Americans behind. According to Credit Suisse and the U.S. Federal Reserve, the median American household hasn’t come close to recovering their level of net worth achieved as of early 2007. The shortfall has been attributed to lower ownership rates of stocks and lower housing prices for the least-wealthy groups.

Will the benefits from a reduction in corporate tax rates being considered in the Republican tax proposal filter through to the average American? Unfortunately, they are not likely if the proceeds are used to increase dividends and share buybacks given the low ownership of stocks among the median American household, as opposed to reinvestment in plants, equipment, inventory, jobs, and wages.

Remember, more than 40% of the private sector doesn’t have access to an employer-sponsored retirement plan, and it is an unfortunate fact that the average American household does not save when not contributing to their employer’s retirement plan. Furthermore, income inequality has a negative impact on economic growth rates, so it isn’t surprising that the U.S. hasn’t generated an annual GDP growth rate >3% since 2005, as incomes between the few haves and the many have-nots have grown to its widest point.