What Does Perpetual Really Mean?

Ryan ALM is a leading voice in the trying to rescue and preserve DB pension plans. We were established in June 2004 with the mission to try to preserve these incredibly important social and economic tools by focusing greater attention to the promise that was given to the plan’s employees. We believe that everyone should be entitled to a dignified retirement, but the demise of the DB plan and the greater, almost exclusive use of the DC plan (within the private sector), is undermining this important effort.

Regrettably, we’ve seen DB plans nearly wiped out in the private sector.  However, a significant majority of public employees (estimated at about 85%) still enjoy the benefits of a traditional pension plan.  But for how much longer will they?  As I mentioned at the Opal/LATEC conference in New Orleans just yesterday, there is a perception among public plan participants and sponsors that these plans are perpetual. However, since the Great financial crisis most, if not all, public plans have taken action to reduce the future liability by asking employees to contribute more, extend vesting periods, reduce benefits for new hires, eliminate COLAs, etc.

This doesn’t signal to us that everything is honky dory! In fact, employer contributions have rocketed higher in the last couple of decades.  There are many examples of annual contribution rates being 25% to more than 40% of salary. At what level of contribution do these “perpetual” plans become unsustainable?  For many states and municipalities, the pension contribution is but one element of a social safety net that must be funded.  As the contribution rate escalates for DB plans, it naturally squeezes out other necessary programs unless there is no restriction on the taxing authority’s ability to raise revenue.

Given the pension envy that exists among those taxpayers in the private sector that aren’t participants in a DB plan (most), it is doubtful that they would be supportive of any administration that attempts to substantially raise taxes in this economic environment to fund someone else’s retirement benefit.

DB plans can be saved, but plan sponsors and their consultants need to begin to think outside the box. Focusing on the return on asset assumption (ROA), as if it were the Holy Grail, has lead to greater volatility and little reward to show for it! DB plans need to focus on the promise that they have made, use their funded status to adjust asset allocation, and de-risk plans as they see improved funding.  We missed the boat to de-risk at the end of the 1990s.  Let’s not blow it again!

10 thoughts on “What Does Perpetual Really Mean?

  1. Your statement “Given the pension envy that exists among those taxpayers in the private sector that aren’t participants in a DB plan (most), it is doubtful that they would be supportive of any administration that attempts to substantially raise taxes in this economic environment to fund someone else’s retirement benefit.” struck me, as I am aware of this public perception. People think pensions are some sort of gift a lucky employee gets from a generous employer, but you and I know this is not true. These DB plans, especially the Multi-Employer plans are like Savings Accounts. Workers agree to have a percentage of their wages be deferred into these vehicles to be invested, to grow and to be there when they’re too old to work anymore, so they can keep food on the table and a roof over their heads. Ask those with “pension envy” how they’d feel if they’d put money in the corner savings bank for 50 years, and when they went to withdraw, the banker told them “sorry, we took a beating on Emerging Markets so we’re keeping half of your money.

    • Good afternoon, and thank you for your comment, Steve. I couldn’t agree more. Most people don’t appreciate the fact that employees make substantial contributions to these plans. Furthermore, the promise of a pension upon retirement keeps employees working for the same union/ firm and by not exploring other employment opportunities they may be constraining their own earnings potential. We need to save DB plans and try to figure a way to expand participation for those that don’t currently have access to one. Russ

      • Thanks. I agree that DB plans are critically important. I worry what a DC/401K future will look like. Curious. With Senate Dems at one end of the field holding BLA, and Senate Rs at the other with Grassley/Alexander, what would you suggest as the first step towards compromise legislation? I’m glad they’re talking, but the politics is so complicated.

      • Good morning, Steve – You are asking an excellent question, and the answer is definitely not easy. I personally want to see the BLA because it is the only legislation that actually preserves these plans. That said, if I were starting a DB plan today, I would want to see publics and multis use a more modest discount rate so that plans didn’t habitually under contribute thus relying too much on return. I like the loan feature because these plans have incredible short-term cash flow needs that can’t be made up through investments. I think that a loan program to sure up the retired lives liability and a possible adoption of a hybrid pension system, so workers aren’t forced to manage their own retirement plan through a DC offering is probably the best combination going forward. Have a great day.

  2. Central States de-risked to zero stock equities as of Dec 31, 2019 with about 12B remaining. The fund had about 12% in equities in Sept. missing out on a huge 30% year. With an annual operating deficit of about 2.2B, to fund will become insolvent under current conditions ( and no bailout) by 2025 .I believe no plan should be de-risked unless it is 120% funded and it is using a 5% discount rate or less, otherwise there may not be enough assets to cover liabilities.

    I do generally agree with taxpayers do not want to bail out plans, but I doubt they are envious of plans such as Central States!

    • Hi Tom – Thanks for reaching out to me and for your comment. It is extremely unfortunate that CS’s severe negative cashflow situation forced them to de-risk the entire plan. What I espouse is certainly not this! We recommend that plans convert their current fixed income into a cash flow matching strategy that defease the Retired Lives liabilities from next months benefit payments as far out as that current allocation permits. Because our strategy uses all corporate bonds, our portfolio will out-yield the existing exposure thus not impairing the fund’s ability to achieve the targeted ROA. Furthermore, by cash flow matching the Retire Lives we are actually eliiminating interest rate risk from our portoflio because we are defeasing future benefits that don’t have interest rate risk. We also extend the investing horizon for the remainder of the plan’s assets to now have the necessary time to capture the liquidity premium that exists in those assets. This impementation maximizes the efficiency of the plan’s asset allocation. Please don’t hesitate to reach out to me (not that you do) with any additional questions that you might have regarding Cash Flow Driven Investing (CDI). Russ

  3. BLA is risky, as is almost every time money is leveraged! As I stated there is absolutely NO guarantee to make a certain return around 6.5% ( this number has I’m sure inflated unless more is borrowed. But, some will and have argued, who cares if Central States can pay back the “loan”. Let them default as long as my pension is not cut. Let the next generation worry about it 30 years from now. Active participants are extremely tired of this ponzi scheme such as Central States! Mathematically,( through no fault of their own, other than perhaps wanting “no cuts”) any retiree collecting more than approximately 13 years ( using 7% discount rate) is being compensated entirely from active participants contributions ( or other retirees that passed away sooner). Who, if anybody, should pay for the overpromises? Where should bailout lines ( if any) be drawn?

    • Good morning, Tom. FIrst, CS was one of the three plans that was in such dire straights that PBGC support in addition to the BLA loan was going to be necessary to meet the promised obligations. You are correct in stating that there are no guarantees when it comes to market returns, but I would much rather have to try and get a 6.5% return than what most plans are trying to achieve today, especially if I know that future liabilities now have a 30-year life line to achieve the objective. I’m not sure that I understand your leverage claim. The BLA provides loans and the loan proceeds must be used to defease the Retired Lives liability. I would agree with you to a certain extent if plan sponsors and their consultants were able to inject the proceeds into a traditional asset allocation.

  4. Russ, I will propose a leveraging plan superior to the Butch Lewis Act as far as rate of return assumptions. It is a simplistic cash flow leveraging model. I will use the Central States Plan for specific analysis. I will also assume current data as constant throughout a 30 year time period. Here are some current numbers: current assets -12 billion, current pension payments to approximately 200k retirees- $2.8 billion/year, current contributions from the approximate 50k actives- $600 million (.6B) . Currently the operating deficit is about 2.2B /year. The 12 B in assets would need about 19% returns to cover this deficit.

    In my model, no up front money is needed to qualify for the loan, just more is borrowed. $50 billion in bonds could be sold to the public for Central States use. The current 30 year US Treasury rate is about 1.92%. I will use 2% . *IF* the borrowed 50 billion can make 6% returns (3 billion), one billion could be used to pay the bond interest( 50B x 2% = 1 billion) The other two billion could be added to the current asset investments, 12B x 6%+ 720 million ($.72B) for a total of $2.72 billion. since payouts are currently roughly $ 2.8 billion $100 million could be used from the incoming contributions leaving $500 million ($.5B) in contributions to grow. Over 30 years the 1/2 billion in employee contributions even with no increases( at 0%) would grow 15 billion making the total assets 27 billion at the end of 30 years after the 50 billion lump sum is paid back.

    Now, one could use a model where $100 billion is borrowed and ONLY a 4% return would be needed! **The problem is that is if 6% returns on the 50B model, and 4% returns in the 100B model are not met, the plan would still go insolvent and the payback would be defaulted.**

    Of course, as time goes by after 20 years there may be only 120k retirees. And other factors such as the number of actives could change too. Form 5500 data and attrition rates have not been used for simplistic calculations.

    In conclusion, BLA or a leveraging model will only work if first they can be implemented (pass congress) and second, assumed rates of return are met.

  5. Hi Tom – Thanks, again, for sharing your thoughts with me. What you are proposing is very similar to a pension obligation bond that has been used for years. POBs have not produced the success that many public pension systems have expected. You are correct to point out the arbitrage between the borrowing rate and the ROA is critical. Often, the new assets fail to achieve even the interest rate on the bond. In the BLA legislation, we wanted to get away from playing this arbitrage game and that is why loan proceeds must be used to meet the Retired Lives Liability. Future contributions and current assets meet future liabilities. The extended investing horizon, due to Retired Lives being taken care of, gives the fund a greater certainty of success. It is truly unfortunate that with every passing month of inactivity, the cost to “fix” the pension crisis grows by $750 million. Be well, Russ

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