Rightfully So!

I read a blog post from the Squared Away Blog (Center for Retirement Research at Boston College), which highlighted findings from an Allianz study that surveyed more than 1,000 Baby Boomers and Generation-Xers. Not surprisingly, the vast majority of those in the survey that admit to being behind on their retirement savings wish that they could save more. But, as we’ve said many times before, life gets in the way, especially for lower-income households, where wage growth has been muted for quite some time, and household expenditure growth continues to outpace wage growth. As a result, they are correct in being concerned!

Unfortunately, and despite understanding that they need to do more, many are contributing 3% or less, which will never be a rate sufficient to generate even a decent retirement. The Squared Away Blog also pointed out that these participants also tend to be somewhat risk-averse in their asset allocation. But, can you blame them, especially given what has transpired in the markets since 2000? Furthermore, most of these participants have never taken an investment class, so why should we assume that they would understand and appreciate cycles within the markets?

As much as we’d like to see DB plans remain the plan of choice for employers and employees, we understand that the trends are not favorable, particularly for the private sector.  As such, we would like to see several things done to improve 401(k)s for those that are given access to them. Many of these are being adopted, but we’d prefer universal acceptance to protect the plan participant from “retiring” without the financial means to truly do so.

Desired features:

Payroll-deducted savings account sidebar that would allow for pre-tax withdrawals to fund an emergency account that would reduce the need to withdraw from one’s “retirement” account prematurely.

Auto-enrollment – Participant could decline to enroll, but they would have to take the action.

Auto-escalate with regard to contribution rates – Timing of the escalation should be every three years, at a maximum.

No loans!

No premature withdrawals when switching jobs. Account balances must be shifted into new employer’s 401(k) or participant’s IRA.

Target date funds as the QDIA – Not all TDFs are the same, and significant differences with regard to key features can impact the participant’s long-term success. Be careful when choosing the provider.

Make sure that low-cost index fund options are available. Expense ratios have been coming down, but remain high for many “active” products.

Fewer options in a fund line-up – Studies have shown that too many options lead to paralysis.

We are not fond of lump-sum distributions and prefer that 401(k) providers annuitize a significant portion of the participant’s retirement funds to be used to support monthly payouts throughout retirement.

Finally, we’d like to see employers step up to the plate and do more for their employees, too, especially given the dramatic reduction in corporate tax rates. If an employer is too small to offer an affordable retirement plan, they should be required to provide pre-tax payroll deductibility to fund state or federally provided retirement plans.

We could go on, but adopting most of the above suggestions would go a long way to securing a more financially stable retirement for all.

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But, Is It Good For The Plan Sponsor?

It was announced yesterday that consulting firm Mercer has agreed to acquire most of Summit Strategies Group’s asset consulting business and Pavilion Financial Corp. (Canadian consulting firm). The acquisition brings more than $800 billion in AUA/AUM to Mercer and further consolidates an already concentrated industry.  Mercer indicated that acquiring these two entities will strengthen their presence in the non-profit universe.

They also believe that adding additional research resources, especially among alternative investments, will permit them to be more responsive to new innovation among niche strategies. As part of the deal, Summit’s public fund business is being sold to AndCo Consulting.

However, do these deals ultimately help or hurt the plan sponsor community? Consolidation among asset consulting firms has been on-going for a while as the original owners/pioneers have looked to capitalize on the businesses that they have built (Marco, RogersCasey, Ennis, Knupp, Hammond, and Watson, Wyatt to name but a few). These transactions may provide some economies of scale for the acquiring entity, but it also narrows differences in thought/approaches and the generation of new ideas.

In an industry that does much to support emerging managers and new investment products, it seems that only size matters when choosing asset consultants, particularly in the defined benefit universe. But, where are the benefits? We have frequently voiced our concerns about the lack of innovative thinking when it comes to managing a DB plan. We believe that the focus on the return on asset assumption continues to plague our retirement industry while supporting the notion that deep research teams are needed to wade through the 1,000s of managers and products.

However, managing a DB pension plan is all about providing the promise at the lowest cost and not the highest return. Furthermore, with the lack of success among many (most) active managers, how good has this research effort truly been? Despite an effort to support emerging firms there still exist many constraints (arbitrary) to review and use smaller, less tenured asset management organizations that have less than a 5-year track record and fewer than $500 million in AUM.

If consolidation is needed to sure up the economics for these firms, perhaps a greater effort should be undertaken to price the consulting services based on their true value added, and not try to undercut the competition by giving away the business in order to acquire AUA. Asset/liability consultants are a critical component in the management of a successful retirement program. The consolidation that we are witnessing does little to encourage the challenging of the status quo.

Let’s Stop The Games With The ROA

The return on asset assumption (ROA) for a public pension system is a critical variable in whether a plan is ultimately successful in meeting its promises (pension liability).  The ROA is used to value the plan’s liabilities, as well as to determine the annual contribution into the plan.  Unfortunately, many public pension systems are using inflated ROAs, which has lead to the systematic underfunding of these systems.

According to various studies, most public pension systems are using an ROA assumption between 7.25% and 7.50%. The focus on achieving the ROA has injected far more volatility into the process then is necessary.  We are aware that long-term returns would suggest that equities are the place to be over multiple decades, but given the poor level of funding and escalating contribution expenses, these plans can’t afford to wait for decades to be proven correct.

Furthermore, employees have consistently contributed to their plans, and benefit reductions are not an appropriate alternative to building a more sound approach to the day-to-day management of these systems. When defined benefit plans were first offered, the plan’s liabilities were defeased in a similar way to how a lottery system ensures that future assets are available to meet future liabilities. Regrettably, the focus on generating a greater return to “lessen” employer costs has forced the retirement industry to adopt a new playbook. It hasn’t worked.

Public pension systems, as well as multiemployer plans, need to get back to basics before they collapse under the weight of the plan’s weak funded status. The Butch Lewis Act (BLA) adopts as one of the core principals a return to pension management in the past. If a low-interest rate loan is taken, the proceeds MUST be used to defease the retired lives portion of the plan’s liabilities. By doing so, the plan’s liquidity to meet benefits is improved, highly interest rate sensitive fixed income is replaced by a cash flow matching portfolio, and the investing time horizon is extended for the remaining assets to capture the liquidity premium in less liquid assets, which will be used to meet future plan liabilities.

There is nothing wrong with getting back to basics and proven pension management techniques, especially when the new-fangled strategies have produced very poor results to date.

Did You Do The Math?

There appears a commentary in the latest P&I daily (8/9) by W. Gordon Hamlin Jr., titled, “Getting Retirement Solutions Right is a Matter of National Defense”. I saw the headline and got excited because we’ve written about the likely profound social and economic consequences of our failure to provide an adequate retirement for our workers. As I began to read the article I couldn’t help but agree with him that there are three separate but intertwined retirement issues that need to be addressed, and each one is going to be challenging.

Hamlin cites “the impending meltdown in multiemployer pension plans; the roughly 50% of private-sector workers not in a workplace retirement plan; and the enormous unfunded liabilities associated with public pension plans.” These are the primary issues in a nutshell. However, that is basically where our enthusiastic support came to a halt.

I’ve been engaged with a team of amazing industry professionals in helping to craft and present the legislation for the Butch Lewis Act, designed to preserve and protect the pension benefits for participants in “critical and declining” status multiemployer pension systems. Without major assistance from the U.S. Treasury through a low-interest rate loan program, these plans will become insolvent in the next 5-15 years. The actuaries from Cheiron have modeled each of the 114 plans to make sure that the loan could be repaid and the PBGC protected. Only 3 of the 114 plans will need additional assistance from the PBGC, but for a total sum that is about 1/3 what the insurer of last resort would pay if each of these plans defaulted.

Unfortunately, Mr. Hamlin states, “needless to say, the loans won’t solve many, if any, of the existing problems with each existing plan. Given the existing trouble, how many employers and plans will be able to repay the loans?” Really? How can you make this claim when you haven’t modeled the plans?

One of the biggest challenges facing these multiemployer plans is the significant cash flow payout that is needed in the near-term to meet the promised benefits of an aging population. The Butch Lewis Act calls for all of the loan proceeds to be used to defease the retired lives. By doing so, the cash flow needs are met. The existing assets and annual required contributions will then be used to meet future plan liabilities, annual interest payments, and the loan repayment in year 30. Again, all but three of these plans can meet these obligations and do so at an annual return on asset assumption (ROA) of ONLY 6.5%. That is right! The required annual ROA used to ensure that these plans meet their obligations is dramatically lower than the ROA currently used by each of these plans.

Without the loan program these plans will fail, the PBGC’s insurance program will be overwhelmed and collapse, the promised benefits to the participants will not be paid, and in its place, the PBGC will make benefit payments that are roughly 1/8 what was promised. Guess what? These participants will likely fall on to the social safety net, and instead of securing these plans and extending the solvency for decades, we now initiate a pay as you go system for millions of plan participants. Seems like that cost would far exceed anything that the loan program might ultimately cost taxpayers.

I’d say that the loan program solves all the problems facing these critical and declining funds by improving cash flow to meet near-term benefits, by extending the life of these plans by at least 30 years, by extending the investment horizon for the “risky” assets to capture the liquidity premium, while saving the PBGC in the process. Not bad for one piece of legislation! Congress needs to act and act now. These participants did nothing wrong and they shouldn’t be harmed in this process.

The Economics Don’t work!

We’ve highlighted in multiple blogs the issues and challenges facing the Millennial generation in terms of beginning their lives. I have four Millenial children among the five that my wife and I have. We see first hand the barriers that they and their friends/peers face regularly. The following graphs should wake everyone up to this reality.

Millennials

As a result, women are marrying later, if at all, and having fewer children. This trend could impact future economic growth. We recently reported that the median age for a first-time buyer in 2017 was an astounding 42 years-old (it used to be 34). Furthermore, in 1975 only about 25% of 30-year-old men earned less than $30,000/year. In 2016, 41% of 30-year-olds made <$30,000.  How could that be?

At the same time that Millennials are seeing their wages flatline, we are asking them to pick up the slack from corporate America, who are paying less to support medical and retirement expenditures despite record profits. Is there any wonder why anxiety levels have skyrocketed in the last couple of decades.

I can hear some of my friends saying “move” if it costs too much where you live. But, the reality is that there are many reasons why someone is tethered to a particular area. What we should be doing is figuring out how to create higher quality jobs with greater wages so that our children can meet their basic living expenses while hopefull socking a few shillings away for retirement.

History Does Repeat Itself – Especially In Markets!

If you are a believer that managing a pension system is about generating the highest return then you may appreciate a recent WSJ article that referenced Wilshire Trust Universe Comparison Service (TUCS) data highlighting growing exposure among public pension plans to domestic and international equity.  However, if you believe like I do that managing a pension system is all about meeting the promise (benefits) at the lowest cost, you may be very concerned about the data shared by Wilshire.

The TUCS data indicates that public pension systems have seen their public equity exposure grow to 59% from 57%. Now it is very likely that this is just the result of good equity market returns relative to other asset classes, but it none-the-less highlights the fact that these systems are willing to roll the dice on equity market returns rather than derisk these plans as the bull market ages (now nearly 9 1/2 years). In addition, alternative investment allocations are growing, especially for pension plans with more than $5 billion in assets.  In fact, the alternative allocations are now greater than fixed income allocations for the $5+ billion systems.

The focus on the return on asset assumption (roughly 7.25% to 7.5% for the average public plan) is forcing asset consultants and their plan sponsor clients to build these aggressive allocations, especially if the funding status is weak. But, will they be rewarded with enhanced returns or are they just injecting more risk than necessary this late in the market cycle?

In addition to the public and private equity allocations, Wilshire is reporting that the allocation to fixed income is declining. Now, most of you will say that a reduction is warranted given the “likely” economic growth, inflation, and rising interest rates that we are about to witness, but bonds play a very important part in pension management – they provide cash flow to meet required benefit payments.

Given the nearly 80% equity and alternative allocation for large public systems, are we about to repeat what transpired in the 2007-2009 Great Financial Crisis when liquidity was at a premium and equity market returns were negatively impacted by forcing liquidity where it wasn’t naturally available? It sure looks to be the case. Can these systems, their employees, and the taxpaying public endure another dramatic hit to a system’s funded status? Not likely! We have an alternative approach to this return-chasing game. Reach out to us and we will be more than happy to share our insights.

 

It Didn’t Take A Rocket Scientist!

We’ve been forecasting that there would be profound social and economic consequences as a result of the shift from defined benefit plans to defined contribution plans, and the proof is starting to become more evident.

According to the Federal Reserve’s survey of consumer finances, bankruptcy’s for older Americans are exploding at the same time that the universe of older Americans is burgeoning! On the surface, it appears that younger Americans are fairing better, but we know that there are more 18-34 year-olds living at home or with a relative than ever before (Pew Research Center). We also know that student loan debt is growing leaps and bounds, which is keeping Millennials from saving for retirement, which will only add to the problem for older Americans in the decades to come.

In addition to the loss of traditional pensions, older Americans are forced to wait longer for Social Security and they are incurring greater out-of-pocket medical expenses. We’ve witnessed a three-decade shift from government and employer support of the American worker to a situation in which the individual is being asked to carry this burden. It is not ending well for many.

“The people who show up in bankruptcy are always the tip of the iceberg,” said Robert M. Lawless, a law professor at the University of Illinois and another author of the study. The next generation nearing retirement age is also filing for bankruptcy in greater numbers, and the average age of filers is rising, the study found. Given the rate of increase, Thorne said, “the only explanation that makes any sense are structural shifts.”

We know that many Americans are carrying greater sums of debt into retirement than ever before. Furthermore, there is a growing wealth gap among Americans. According to the Employee Benefit Research Institute (EBRI), the median household lead by someone 65 or older is roughly $60,600 (2016), but the bottom 25% have at most $3,200, a sum which certainly doesn’t provide for protection should unexpected medical expenses occur.