When Common Sense Fails!!

When KCS was established in August 2011, the mission of the firm was pretty simple. We set out to “help plan sponsors and their participants address today’s retirement plan challenges.” I can’t think of a greater challenge than the one facing the Critical and Declining multiemployer pension systems (roughly 114 plans) that badly need our help. Without a path forward these plans will face insolvency within a relatively short timeframe (<15 years) and the participants who are depending on the retirement benefits will likely see very little of the promise that they were given and helped to fund! UNACCEPTABLE!

The following article was shared with me through our KCS Facebook page. It is another attempt on the part of industry participants to claim that taxpayer-funded support of these critically important funds is inappropriate.

The short article version of Saving the PBGC, at the expense of the Pensioner. “Lawmakers should resist calls for taxpayers to bail out troubled pension plans with direct subsidies or “loans” from the federal Treasury, whether provided directly to pension plans or funneled through the PBGC. Doing so would unfairly transfer responsibility for pension underfunding from plan trustees to taxpayers and would likely exacerbate existing underfunding.”….

The Butch Lewis Act legislation that is being considered among other proposals by the Joint Select Committee on Solvency of Multiemployer Pension Plans does call for low-interest rate LOANS to be made available to these C&D plans in order to stave off plan failures. Without this help, there is little that can be done to ward off insolvency thus casting aside millions of plan beneficiaries who were counting on these promised benefits and have had nothing to do with the current funding crisis. Do these so-called industry experts really believe that the taxpayers (including these participants) will not be asked to support to a greater extent the social safety net that would be expanded to now include all of these participants?

Providing low-interest rate loans will extend the life of these plans by 30-years! The proceeds from the loans must defease all of the currently retired lives and terminated vesteds ensuring that benefits accrued to date will, in fact, be paid! Furthermore, the investment horizon for the future liabilities has now been extended by decades raising the probability of success.

The Butch Lewis Act Team included wonderful actuaries from Cheiron who analyzed each of the 114 plans, and they determined that 111 of the 114 plans would be able to meet current and future obligations and pay back the loan without any assistance from the PBGC. Yes, there are 3 plans that still would need help, but the estimated support is roughly 33% of what it would be if all of the plans were to become insolvent. Furthermore, the CBO has recently indicated that their analysis has the total loan program at only $34 billion, which is substantially lower than previous estimates.

If one were to add up the anticipated loan expense and the PBGC assistance, the $57 billion is roughly $11 billion less than the amount the PBGC would be on the hook for should each of the 114 plans fail.  Furthermore, it is estimated that the plan participants receiving benefits generate nearly $1.1 trillion in annual economic activity. Can our economy survive an economic hit such as that? Where is common sense?

There have definitely been mistakes made along the way that have negatively impacted these pension systems. Allowing these pension plans to fail because of these issues is foolish. The Butch Lewis Act mandates that these pension systems operate in a more effective way, which will improve the likelihood of success. What could be wrong with extending the life of these plans by thirty years? Think about how many participants will be helped during that timeframe. The taxpayer should embrace this lifeline. It keeps them from having to support the participants within the next few years!

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Going in Opposite Directions

The Center For Retirement Research at Boston College is out with a new brief highlighting the growing divide among well-funded and poorly-funded state and local defined benefit plans (the universe is 180 plans). The funded status of this cohort in the fiscal year 2017 was 72%, which is roughly in line with previous years.  However, the “average plan” masks what is happening within this public fund universe.

According to the study, the top 1/3 of public systems have a 90% funded status, while the bottom third sits at 55% funding and the middle third was at 70%.  Was this divergence always present? Heck no. The researchers looked at how this universe has changed since 2001.  Incredibly, the bottom third had a funded status above 90% in 2001. The deterioration has been most notable since the great financial crisis, and is likely the result of poor performance and underfunding. It is estimated that the weakest third of the universe only received about 60%-70% of the annual required contributions.

With regard to performance, each of the three groupings fell short of their 7.4% target return, with the weakest third generating only a 5.5% return versus the top third’s 6.1%. As a reminder, contributions are based on plans achieving their target ROA, so in this case, each of the three tiers would have received smaller contributions than necessary to keep pace with liability growth.

As we’ve discussed many times, managing a pension plan, public or private, needs to be about providing the promised benefit at the lowest cost and not necessarily the highest return. The 72% funded status is based on GASB permitting the discounting of liabilities at the ROA and not a true mark-to-market evaluation of the liability. Furthermore, this comes after a 10-year bull market recovery for equities. How bad will things get following the next market correction?

 

 

Are We There, Yet?

The above chart is from the Federal Reserve Bank of New York publication that was last updated for the second-quarter 2018.

As the picture clearly reveals, non-housing debt is becoming a bigger chunk of overall household debt, as auto loans, credit cards, and student loan balances rise faster than mortgage debt (>$9 trillion). Job growth and shrinking savings rates have offset flat wage growth allowing for personal consumption to continue to rise, as was reflected in the latest GDP release.

However, how sustainable is this trend? What is the impact on saving for retirement? As we ask more from our workforce to fund, manage, and disburse a retirement plan (DC), is this rapid rise in consumer debt restricting one’s ability to put a few dollars away for later in life?

Slight Improvement, But Much To Do!

According to a PlanSponsor article the Melbourne Mercer Global Pension Index (MMGPI), which is now in its 10th year, shows that the U.S. retirement system enjoyed a slight improvement this year scoring a 58.8, up from 57.8 in 2017. The Index evaluates countries on the adequacy, sustainability, and integrity of the retirement income system. The study evaluated 34 pension systems and rated the Netherlands (80.3) and Denmark (80.2) as the two strongest pension/retirement systems.

The U.S. would show further improvement with these suggested changes:

  • raising the minimum pension for low-income pensioners;
  • adjusting the level of mandatory contributions to increase the net replacement for median-income earners;
  • improving the vesting of benefits for all plan members and maintaining the real value of retained benefits through to retirement;
  • reducing pre-retirement leakage (401(k) loans and premature withdrawals) by further limiting the access to funds before retirement;
  • introducing a requirement that part of the retirement benefit must be taken as an income stream;
  • increasing the funding level of the Social Security program;
  • raising the state pension age and the minimum access age to receive benefits from private pension plans;
  • providing incentives to delay retirement and increase labor force participation at older ages; and
  • providing access to retirement plans on an institutional group basis for workers who don’t have access to an employer-sponsored plan.

We’ve written posts/articles on a number of these issues, especially as it pertains to the inadequacies of a defined contribution plan as a true retirement program.  In addition, we are fully supportive of “retirees” working in some capacity, but the fact is that roughly 1/3 of Americans older than 65-years old would like to work, but only about 14% do. Furthermore, as the remaining Boomers turn 65, demand for job opportunities will only increase, but it is likely that the supply of age-appropriate jobs won’t.

Not Sustainable!

I happened to see this comment in an email earlier today (thanks, Rob):

About 83% of U.S.-listed IPOs in 2018’s first three quarters involve companies that lost money in the 12 months leading up to their debut, according to data compiled by University of Florida finance professor Jay Ritter. That is the highest proportion on record, according to Mr. Ritter, an IPO expert whose data goes back to 1980. Source: Wall Street Journal

I asked how those stocks were performing this year and here’s the response:

The stocks of money-losing companies listing in the U.S. (in 2018) have gone up 36% on average from their IPO price through last Thursday, according to the article (IPO Market Has Never Been This Forgiving to Money-Losing Firms – Wall Street Journal)

That does happen to be better than the 32% return for IPO stocks with earnings and the 9% gain for the S&P 500 index year-to-date. Amazing? Incredible? Outrageous? Unsustainable?

Managing a DB is not an easy job. Focusing on the ROA as the primary objective has made it more challenging, especially given the greater market volatility needed to cobble together a combination of assets that might just meet that return target. Throw in the fact that low-quality names are leading the market higher makes it even more challenging.  Given this environment, we believe it is critical that DB plans begin to de-risk.

 

Did you know?

About National Retirement Security Week

National Retirement Security Week is a national effort to raise public awareness about the importance of saving for retirement. National Retirement Security Week is held every year during the third week of October (it is October 21-27 this year). The week provides an opportunity for employees to reflect on their personal retirement goals and determine if they are on target to reach those goals.

National Retirement Security Week commenced in 2006, when Senators Gordon Smith (R-OR) and Kent Conrad (D-ND) introduced the first resolution establishing National Save for Retirement Week. Their goals were to elevate public knowledge about retirement savings and to encourage employees to save and participate in their employer-sponsored retirement plans.

The Senate recently passed Resolution 575 continuing their support of National Retirement Security Week in 2016.  A copy of the resolution can be read here — NRSW Resolution.

Over the years, ICMA-RC has partnered with the National Association of Government Defined Contribution Administrators (NAGDCA) to ensure that the week is a great success. ICMA-RC and NAGDCA remain committed to educating employers and employees about the growing importance of saving for retirement.

Today, plan sponsors and plan participants around the U.S. take part in this exciting week. We invite you to participate and take advantage of the educational resources that we offer on our site to both plan sponsors and participants.

Shame on me for not knowing that there was such a thing as the National Retirement Security Week. We, at KCS, treat every week the same. It is terrific that such a week exists, but how is this information getting into the hands of sponsors and participants? What is being presented that isn’t the same old, same old? What efforts are being put forth to try to preserve and protect defined benefit plans from being terminated and the participants shifted into defined contribution offerings without the skills to fund, manage, and disburse this critical benefit?

Having recently spoken at both the FPPTA and IFEBP, I can assure you that most of the presenters addressing pension plan strategies were once again discussing traditional asset allocation approaches that amount to nothing more than shifting deck chairs on the Titanic. Placing a little more in this asset class versus that one or adding a new asset class with the “promise” of a greater return is not the answer. We need real change in our approach before all of these pension systems no longer exist.

IFEBP Presentation Follow-up

I had the distinct pleasure to once again participate in the IFEBP annual conference. This event had me traveling to New Orleans where it was incredibly warm and humid. There were times during the trip that had me feeling as if I were in a frying pan. Ironically, public pension systems should be feeling the heat at this time, too, as allocations to equity-like products now represent about 70% of the average portfolio which is up more than 30% from just a couple of decades ago.

My presentation was on the “Key Factors in the Long-term Sustainability of Defined Benefit Plans”, and one of the points that I was making is the fact that public pension sponsors and their consultants are injecting a ton more risk into their asset allocation in an attempt to achieve the “Holy Grail”, I mean the return on asset assumption (ROA).

Twenty years ago, states needed only to exceed the yield on a 30-year Treasury bond by 1% in order to meet their investment targets. Currently, the typical state would need to outperform a 30-year Treasury bond by nearly 4.5% to meet its now-lower investment assumption. That reality has forced plans to take on higher levels of investment risk and at a time when U.S. equity markets have enjoyed a historic bull market run.

KCS and Ryan ALM have been encouraging plans to take a different path at this time. We want plans to get their arms around the plan’s specific liabilities and to use that output to drive investment structure and asset allocation decisions. We believe that DB plans need to be sustained, but doing the same old, same old in this environment will prove devastating to funding levels once the next correction occurs.

Sponsors needed to be thinking about this strategy in 2006 and not in 2009 after the market collapsed. Well, are you thinking about de-risking your plan now? If not, why not? It might just be too late in another three to four years.