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.

 

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