Managing a defined benefit (DB) plan has never been easy, but it used to be simpler. Why? The true objective of a pension plan should be to meet the promised benefits at the lowest cost and with manageable risk. This used to be the standard! Unfortunately, somewhere along the way, the “objective” became a return game – the return on asset (ROA) assumption.
This change in focus has lead to instability in the plan’s funded status and excessive volatility in contribution expense. DB plans are all but gone in the private sector, but they are still quite prevalent in the public and multiemployer arenas. Will that continue to be the case? Not unless we go back to the future! Perhaps circa 1970 (pre-ERISA) when DB plans, like lottery systems, defeased their plan’s liabilities, ensuring that the assets would be there to meet future benefit payments. Almost simple!
Many corporate plans have undertaken such an action and their plans are much more stable. They have used duration matching, annuity buyouts, and cash matching strategies to accomplish their objective. However, we believe that cash matching is the most cost-effective and precise method to match and fund a plan’s liabilities, and it is this implementation that is highlighted in the Butch Lewis Act that we’ve discussed on this blog.
We would be happy to share with you our insights and approach about how a cash matching defeasement strategy could help stabilize your plan’s funded ratio and contribution cost while setting the plan on a glide path toward full funding. As we’ve said many times, DB plans need to be protected but pursuing the same failed strategies (ie chasing returns) is not the way to accomplish your objective. Remember, managing a pension plan is about cost, not return.
Why are we supporting so vigorously the Butch Lewis Act? Primarily because we are fearful that hardworking participants in failing multiemployer plans will not receive the benefits that they earned through their hard work and years of dedicated service. In fact, they likely won’t earn the minimum “guaranteed” payout should these “critical and declining” plans eventually become the responsibility of the Pension Benefit Guaranty Corporation (PBGC). Outrageous!
PBGC Executive Director Thomas Reeder claimed in testimony before the Congressional Joint Select Committee on the Solvency of Multiemployer Plans that the PBGC “is in such financial dire straits that members of failed multiemployer pension plans would likely receive only one-eighth of the minimum benefits they are supposed to be guaranteed.”
As you may recall from previous blog posts, participants in multiemployer plans supported by the PBGC get a protected “benefit” that is already about one-fifth that of a participant in a single-employer plan. A further reduction of this potential magnitude would obviously be devastating.
During the hearing, Reeder was asked if the PBGC would be able to provide the minimum guaranteed benefit to failed plan members without congressional action (such as passing the Butch Lewis Act), and he responded “no”. He estimated that the PBGC would have to cut participant benefits to about one-eighth the minimum benefit, or less. “If they’re making $8,000 in guaranteed benefits today, they’d get less than $1,000,” said Reeder. That would be an annual payout, not monthly, as full minimum payment for a 30-year employee is only $12,800 under the PBGC’s minimum guarantee.
The U.S. Federal Reserve’s annual report on the Economic Well-being of U.S. Households has been released for 2017. There are many areas covered in this report, including retirement readiness. Within the retirement section, the report highlights retirement savings, financial literacy, and retirement timing. The results highlight major differences among retirees and those hoping to retire in the future.
Most notable for me was that 56% of current retirees are drawing income from a defined benefit pension, while only 26% of our current workforce is participating in a DB plan. It is certainly a lot easier to retire when one has both Social Security (87% of retirees are currently receiving a monthly SS check) and a pension that pays a monthly benefit, too.
The successful movement from DB to DC-type plans depends in large part to how capable the individual participant is from a financial literacy standpoint. According to this report, 60% of non-retirees have little to no comfort managing their investments. Furthermore, more than 25% of working households have nothing saved for retirement.
Finally, a significant percentage of our workforce is still retiring before age 65, but is it because of financial freedom? Hardly. The report highlights the fact that 75% of those that retired in 2017 were younger than 64 years old, but most of these individuals claimed that they retired because of poor health or weak job prospects. Those thinking that working later in life as a way to supplement their retirement income may want to reconsider.
Much more needs to be done to help our future retirees.
The U.S. Federal Reserve is out with their annual update on the financial well-being of U.S. Households. There is a ton of very useful information in the more than 50-page report, but one particular item jumped out at me, which we’ve reported on before.
Despite the claims of full employment and stronger economic growth, 40% of American households could not meet a $400 emergency expenditure without having to use either a credit card that spreads payments out over months or through borrowing from family and friends. Now, this is better news than the last survey in which 47% of households reported that they weren’t prepared to meet an unexpected emergency of this magnitude.
What is the likelihood that these households are able to put aside money for retirement now that most employees are being asked to fund their own retirement through a defined contribution type program?
At KCS, we applaud any entity that provides their employees with a retirement vehicle! However, as we’ve written many times, we would prefer a defined benefit plan to a defined contribution plan for several reasons, including the fact that employees can take premature withdrawals and borrow from their accounts through loans. This access is crippling the financial future for many participants, and it will likely lead to significant shortfalls in retirement savings.
Fox Business is reporting on a PwC US study (2018 Employee Financial Wellness Survey), which tracks the financial and retirement wellbeing for 1,600 full-time employees. Not surprising, 42% of those surveyed expressed concern that they would have to tap their “retirement” account for everyday expenses associated with supporting their adult children, parents, and/or both. Furthermore, nearly 2/3rds of those polled anticipate delaying retirement for fear of rising healthcare costs.
There have been many significant improvements to defined contribution plans through the years, including such features as auto-enroll, auto-escalate, target-date funds as an approved QDIA, etc., but until we eliminate premature access to one’s retirement funds, these accounts will remain nothing more than glorified savings accounts.
Despite all the published accounts of how everything is just hunky-dory, we know that a significant percentage of our labor force are struggling to meet daily expenses let alone save for retirement. Student loans, healthcare, housing, etc., are all taking a bigger chunk of one’s income. As a result, we need to create true retirement vehicles for our employees, which are untouchable, that will permit them to retire at the appropriate time without ending up on the welfare ranks, as we expect many will.
P&I is reporting on a Milliman study of the 100 largest U.S. public pension plans in which they calculate that the aggregate funding dropped to an estimated 71.4% as of March 31, down from 73.1% at the end of 2017.
Milliman is estimating that the challenging markets lead to a collective asset value drop of 1.7% during the quarter to $3.56 trillion, while liabilities increased 0.8% to $4.99 trillion. The first quarter’s investment returns caused six public pension funds to drop below the 90% funded mark, bringing the total number of plans with funding ratios of higher than 90% to 15. Of the remaining plans analyzed, 59 had funding ratios between 60% and 90%, and 26 were below 60%.
However, since these pension systems use a return on asset assumption (ROA) to discount their plan’s liabilities (under GASB), the liability growth described above may in fact have been negative in present value $s if a true mark-to-market evaluation had been conducted. The recent rising interest rate environment would have reduced the present value of a plan’s liabilities during the first quarter as opposed to what Milliman is reporting.
Not having done the analysis, we are not in a position to determine whether the falling level of liabilities would have made up for the collective lower level of assets, but it is doubtful that the funded status would have declined 1.7% during the quarter. Wouldn’t it be better for the plan sponsor community to have a more accurate and transparent evaluation of their liabilities from which appropriate asset allocation decisions could be taken?
SOA projects 115 multiemployer plans to be insolvent in 20 years
The headline above appeared last week in Pensions & Investmants (P&I). As we’ve been reporting for nearly one year the solvency of many multiemployer plans is very much in jeopardy. We’re glad to see that the Society of Actuaries (SOA) confirms our belief that the problem facing these critical and declining plans are real. It certainly is for the millions of Americans who may face a sharp reduction in the benefits that they paid into and were promised at the beginning of their employment.
Although the headline suggests a 20-year timeframe, a significant portion of these plans could be insolvent within 10 years. In fact, it is estimated that 21 plans will go kaput by 2023, while another 48 could evaporate by 2028. What we also know is that some of the plans facing more immediate uncertainty are the largest plans, including Central States Teamsters.
Based on various discount rates used to calculate the potential liability of this unfolding funding crisis the projected liability could be $57 billion (using a 6% ROA discount rate) to $107.4 billion when applying a 2.9% Treasury rate. These numbers mirror those that were calculated by members of the Butch Lewis Act team that recently presented to House and Senate staff members.
As a result of this unfolding crisis, Congress has established a Joint Select Committee to tackle this issue before it becomes a moot point. As we’ve reported in previous blog posts the committee has begun meeting with various industry experts. Select committee co-Chairman Sherrod Brown, D-Ohio, said Thursday that the panel will hold hearings until July, and then “we will have to start the process of negotiating a bipartisan solution to the crisis.” They are striving to have a “solution” established by a self-imposed deadline of November 30th. Obviously, we hope that the Butch Lewis Act will be the foundation for the legislation that eventually evolves from the Committee’s effort.