Senator Brown Speaks on Need For Pension Protection

Here is a link to a recent presentation/video by Senator Sherrod Brown on the importance of protecting the pensions of workers in “Critical and Declining” multi-employer pension plans. The economic impact of our failure to protect these plans and their beneficiaries will be felt by everyone – not just the workers themselves! It is way past time talking about the retirement crisis. Something needs to be done right now, and adopting the Butch Lewis Act as law would be a great way to begin.

Only 24%?

According to a CareerBuilder survey, approximately one-quarter (24%) do not know how much they will need to save for retirement. Women are much more likely to be unsure of how much to save than men—31% vs. 17%, respectively.  The survey was conducted online within the U.S. by The Harris Poll on behalf of CareerBuilder among 809 employees ages 18 and older (employed full-time, not self-employed, non-government) between November 28 and December 20, 2017.

We are shocked to hear that only 24% are confused by how much they will need. We think that this is a very difficult math problem to solve for most of our workers, and we would fully expect a much higher percentage who lack the financial literacy/acumen to actually determine how much they will need in order to enjoy a dignified retirement.

When asked how much money they think they’ll need to save in order to retire, workers said:

  • Less than $500,000: 20%;
  • $500,000 to less than $1 million: 31%;
  • $1 million to less than $2 million: 14%;
  • $2 million to less than $3 million: 5%; and
  • $3 million or more: 7%.

Presumably, those not providing an “answer” are the workers who were the ones with no clue. However, based on the results above, I’d say that most don’t know what they actually need and are just guessing. How many of them have actually gone through the exercise of determining what percentage of income they need to replace, estimated their life expectancy and that of their spouse/significant other, determined when to begin to take Social Security, estimated medical expenses later in their life, contemplated the impact of inflation on their current savings and future spending needs, etc. Probably few!

Asking untrained individuals to factor in all of the above (and more) is why we don’t like defined contribution plans versus defined benefit pensions, especially when it comes to dispersing one’s retirement savings. We recently produced a post that estimated that Seniors spend on average $46,000 / year in retirement.  Furthermore, in another post, we highlighted the fact that one could expect to pay roughly $275,000 in out-of-pocket healthcare expenses during their Senior years (Federal Reserve).

Those surveyed may not know what they need to live on in retirement, but 4 in 10 workers know enough to believe that won’t be able to retire until age 70 or older. In addition, more than half (53%) of workers ages 60 and older say they are postponing retirement at this time.

When asked if they are currently contributing to retirement accounts, roughly one in four workers ages 55 and older (23%) said they do not participate in a 401(k), IRA, or another type of retirement plan, such as a DB plan. Among younger adults ages 18 to 34, 40% said they do not participate in a 401(k), IRA or another retirement plan. UGH!

This Just Doesn’t Make Sense!

The WSJ does a good job of publishing the occasional personal finance article as they’ve done today with an update on the Employee Benefit Research Institute’s (EBRI) annual survey. Today’s article, titled “Retirees Are Less Confident About Having Enough to Live On” highlights declining optimism as a result of fears that medical expenses will be greater in retirement than they had expected.

However, the “decline” in optimism is only 5% from 85% to the current 80%. Now, I don’t know who the 1,040 retirees or the 1,002 workers aged 25 and older are that participated in this survey, but I do seriously question how 80% of the respondents are confident that they can cover their basic expenses in retirement when at the same time they indicated that only 65% of them or their spouse had saved for retirement.  Furthermore, 50% of those that had “saved” had less than $25,000 in savings not including home equity.

So let me understand. Thirty-five percent have nothing saved, while another 32.5% (1/2 of 65%) have less than $25,000. How is it possible that 67.5% of these surveyed individuals can be confident when they have no retirement assets? Not mentioned, but one must assume, that a good percentage of these folks must be participating in a defined benefit pension plan (aren’t they the lucky few).  However, as future generations look to retire on just defined contribution accounts, these results will surely indicate a further deterioration in one’s confidence.

Given that Social Security’s average payout is only about $16,000/year, it is unrealistic to believe that most of these individuals with little in retirement savings would have the financial means to cover basic living expenses if those living expenses include housing, food, insurance, clothing, transportation, etc. Are these individuals continuing to work to support their daily needs? According to EBRI, 34% of those polled are working after “retiring”.  For those currently in the labor force, 79% believe that they will have to work after “retirement”.  Good luck finding an employer willing to keep you on their payroll later in life.


The Economic Impact Is Huge!

Former Senator Tom Coburn (R-Okla) recently penned an article for The Hill regarding the looming insolvency crisis facing the multiemployer pension system. He stated that the “stakes for this committee could not be higher”. We couldn’t agree more. Furthermore, “failure to safeguard the multiemployer system poses an unacceptable economic risk and cost not only to the millions of workers and their families who paid into these pension plans…but also to the American taxpayer.”

We, at KCS, have been worried about the profoundly negative social and economic implications of our failure to secure the U.S. retirement system since our founding in August 2011. According to Coburn’s article, the economic contribution from multiemployer plans in 2015 alone “provided $2.2 trillion in economic activity, supported 13.6 million American jobs, contributed more that $1 trillion to U.S. GDP, and paid $158 billion in federal taxes and $82 billion in state and local taxes.” A systematic failure would be devastating to our economy and the workers and their families.

For those that claim that a private, market-based system shouldn’t be “bailed out”, we say hogwash! We ask, is it better to rebuild the solvency in these funding-challenged pension systems, allowing them many additional years of viability, or have these millions of plan participants fall onto the U.S. social safety net? The cost of a pay-as-you-go social safety net is far greater than that of a well-funded (through loans) pension system providing the promised monthly benefits that these workers have contributed to throughout their careers.

U.S. Companies See Declining Funded Status in March 2018

According to a study by Mercer, the estimated aggregate deficit of pension plans sponsored by S&P 1500 companies was $286 billion at the end of March, a $24 billion increase from $262 billion at the end of February.  As a result, the estimated aggregate funding status fell 1% in March to 87%.

The decline in the funded ratio of these plans resulted from falling asset prices and a slight decline in the “average” discount rate by 5 basis points to 3.92%. This was the first decline for this cohort since August 2017, as both asset prices and discount rates have steadily risen.  Also, according to the study, the estimated aggregate value of the pension plan assets as of the end of February was $1.97 trillion, compared with estimated aggregate liabilities of $2.23 trillion.

Until recently, markets have been relatively calm. For sponsors of DB plans, this is a very good time to take risk off the table before volatility returns. Funded ratios have been crippled by two major market events in the last 18 years. It makes no sense to continue to subject the entire asset base to the whims of the market when strategies exist to safeguard the funded status and contribution expense.

Moral Hazard versus Moral Obligation

I’ve been extremely fortunate to be a part of the team working on the Butch Lewis Act (BLA) proposed legislation to create the Pension Rehabilitation Administration (PRA).  As regular readers of this blog know, KCS was formed in August 2011 with the Mission to protect and preserve defined benefit plans.  The opportunity to help the team bringing the BLA forward allows us to pursue that critically important objective.

As a reminder, there are millions of Americans who will be negatively impacted when their pension plans collapse under the weight of funding deficits and burgeoning contribution expenses.  There will be grave social and economic implications from this failure. As such, now is not the time to hand out blame for the impending demise of these plans.  However, it is the time to take aggressive and necessary action to insure that the roughly 3.5 million plan participants in pension funds designated as “Critical and Declining” (currently 114 pension plans) get the promised benefits. Doing the same old, same old is not an option at this time.

During our presentations in Washington DC, one attendee referenced the moral hazard associated with this legislation, questioning why the American taxpayer should “bailout” these pension plans given that they were mismanaged? I wasn’t surprised by this question given that we’ve heard and read this before, especially as it relates to public pension systems. It is important to point out that the BLA proposed legislation is not a bailout, but a PRA loan to these plans that must be repaid in 30 years.  

Also, It should be noted that the PRA loan has a 25 bps profit margin so the PRA should be a profitable agency and not a burden on taxpayers. The proposed BLA legislation secures Retired Lives and lowers the ROA (return on assets) hurdle rate for current assets to fund Active Lives + the 30-year loan. The plan participants have made payroll contributions to these plans, and they have a right to expect a benefit upon their retirement… indeed, a moral obligation of the pension plan.  It certainly isn’t through any action on their part that these plans are struggling.

The United States economy is a consumer-driven economy with roughly 70% of GDP coming from consumption. What would likely happen if millions upon millions of Americans no longer had the financial wherewithal to remain active participants in the economy? Would GDP growth come close to 3%? Heck, no! So, is it a moral hazard or a moral obligation to pay the promise to these workers so that our economy doesn’t act like the proverbial house of cards and come crashing down in the next several years when Pension America fails to deliver on their promise of a secure retirement benefit?

We understand that a majority of workers in the private sector are no longer participating in a defined benefit plan.  We do appreciate the fact that this development is truly unfortunate.  Please remember that we are all negatively impacted if the economy suffers under the weight of benefits that aren’t paid as promised.  The Butch Lewis Act mandates that benefits remain at current levels, while forcing plans to de-risk through a defeasement strategy, improving the likelihood that they survive well into the future. Furthermore, I do believe that we have a moral obligation to the plan participants in the pension funds designated as “Critical and Declining”.  These plans can and must be saved. In-action at this time will likely force millions of Americans to “live” below the poverty level.

Round Two

I am pleased to report that the Butch Lewis Act presentation to the Senate staff went well yesterday. This follows the presentation to the House staff last Friday. Both meetings were well attended, and the audience was engaged while asking many good questions. Importantly, these presentations were delivered prior to the first meeting being held by the Joint Select Committee on the Insolvency of Multiemployer plans, which is to meet today in Washington DC.

The Butch Lewis Act should be the foundation of any legislation that emanates from this Committee. There are many benefits to this legislation.  But first and foremost it is intended to preserve and protect the pension benefits for roughly 3.5 million plan participants currently in plans designated as “Critical and Declining”. Furthermore, it is the only proposed legislation that does not call for a benefits reduction.


Benefits from the Butch Lewis Act and the Pension Rehabilitation Administration

Enhances Solvency while reducing risk

  •        Maintains current benefit levels
  • Secures Retired Lives thru Defeasance strategy (100% funded)
  • Defeasement funded thru PRA loan (and in a few cases the PBGC)
  • A Significant shift within the Plan’s asset allocation to greater use of fixed income

Reduces Cost to fund Retired Lives

  •        Three possible strategies to defease the Retired Lives
  •        Cash Flow Matching, Duration Matching, and Annuities
  •        Cash Flow Matching approximately 9% less costly than Annuities
  •        Asset Management fees reduced from 30-40 bps on average to 10 bps

Buys Time for the pension plan and plan participants

  •        Current assets + contributions fund Active Lives + PRA Loan
  •        Much longer liabilities than Retired Lives
  •        Given time, risky assets tend to perform (capture liquidity premium)

Reduces ROA Hurdle Rate

  •        Replaces Retired Lives ROA (@7.50%) with PRA Loan (@3%)
  •        Defeasement cost savings transferred to current assets
  •        Asset management fee savings supports current assets
  •        The savings help fund future liabilities and the repayment of the loan

PRA Loan Should be Profitable

  •        PRA receives 30-year Treasury financing (@3%) into Trust Fund
  •        Trust Fund provides PRA loans at 25 bps yield spread profit
  •        25 bps spread = $2.5 million profit margin per $1 billion loan
  •        $60 billion PRA loans = $150 million profit margin annually

On the other hand, the Butch Lewis Act is neither a “bail-out” nor a windfall for Wall Street. These loans must be paid back, and current contribution levels must be sustained or there are severe withdrawal penalties levied on the plans/employers.  In addition, the significant shift within the plan’s asset allocation toward greater use of fixed income will significantly reduce asset management fees. For most of these plans, Retired Lives make up more than 50% of the liabilities, which means that more than 50% of the assets will now be allocated to fixed income, which carries much lower average asset management fees than do equities, real estate, alternatives, etc.


DB Plans Are Great, But Some Tweaks Are Necessary

Mary Williams Walsh, NY Times reporter, produced an article this past weekend, titled “A $76,000 Monthly Pension: Why States and Cities Are Short on Cash”.  She described a number of situations in which municipalities were unable to pay for basic services as a result of ballooning pension contributions. The effect of these growing pension expenditures was to crowd out other local services impacting school systems, police forces, infrastructure, etc.

At KCS, our mission is to protect and preserve defined benefit plans, but it isn’t at any cost. We recognize the need to get these systems operating on a more prudent footing, that will allow all employees to be treated in an equal way, and not the current system that favors retirees or current employees in more favorable light relative to future employees.

We believe that the benefit should be based on an employees final “average” salary. It allows the actuary to more appropriately calculate the future benefit while making sure that annual contributions reflect that estimate. The spiking of benefits through the inclusion of overtime, sick or vacation pay, and any other means is nearly impossible to fund on an on-going basis. Benefits need to be based on wages – period!

Retirement ages need to reflect that American workers are living longer. Many public fund systems have retirement ages that are well below those found in the private sector.  These workers in the public sector may enjoy retirements that are longer than their working careers placing further burdens on the pension system.

But, the changes shouldn’t only impact the participant. There are many practices among plan sponsors that need to change, too. First, the annual required contribution (ARC) must be paid.  I don’t think that New Jersey has made the full ARC since George Washington slept there. Furthermore,  we must once again manage these critically important benefits with a cost objective and not one focused on return.

Defined benefit plans were once managed against their specific liabilities (the promise). In the early 1980s, the plan’s primary objective became the return on asset assumption (ROA). It isn’t shocking that funding volatility has ramped up tremendously since then, but funding success hasn’t followed. All DB plans should be on a glide path to full funding. They should be managed with a risk-reducing mandate, seeking opportunities to defease plan liabilities whenever possible.  The ROA is NOT the Holy Grail.

The investment management community isn’t without fault, too. Fees are incredibly high, and the payment of an asset-based fee with no promise of delivery is just not right. Plan sponsors and their consultants should use performance-based fees more often, especially in more traditional long-only mandates. Why are performance-based fees acceptable in an alternative product, but not more traditional long-only mandates?

Regular readers of the KCS blog know that we are fighting tooth and nail for DB benefit plans and their participants (see the Butch Lewis Act). By tweaking a few practices, these plans can be saved/secured without burdening the communities and states that provide funding support.


Butch Lewis Act Math Shared with Members of the House

Last Friday, members of the team behind the Butch Lewis Act had their first opportunity to present the “numbers” to House staff members.  We were very pleased with the extremely positive reaction to the presentation.  Tomorrow, Tuesday, April 17th, the same team will present the analysis to Senate staff members, and we are hoping for an equally successful result.

It was very important for this information to have been presented when it was, as the Joint Select Committee on Solvency of Multiemployer Pension Plans will meet on Wednesday, April 18, 2018, at 2:00 p.m., in 215 Dirksen Senate Office Building, to hear testimony on “The History and Structure of the Multiemployer Pension System.”

As you may recall from previous blog posts, this Joint Select Committee is tasked with developing a plan to address the unfolding retirement crisis within multi-employer plans before year-end. How broad is this issue? There are 114 multi-employer plans that have been designated “Critical and Declining”, meaning that they are <65% funded and will likely face insolvency within 20 years.  These 114 plans have promised benefits to roughly 3.5 million participants, and those benefits are unfortunately very much at risk.