I hope that you had a wonderful Thanksgiving holiday despite the many impediments that we are facing this year. It is still my favorite holiday, and I might actually be hungry by Friday!

I came across a comment in a ValueWalk.com article that mentioned that pension plan allocations to hedge funds were down in Q3’20. I’m not shocked: just dismayed. What took so long? A quick comparison of hedge fund returns through September 30, 2020, for a variety of time frames reveals consistent underperformance for hedge funds relative to equities (S&P 500), but more shockingly, to bonds as measured by the Bloomberg Barclays Aggregate index. In fact, there is not a single period (1-year, 3-, 5-, 7-, 10- or 20-years) in which the HFRI Hedge Fund Composite tops the BB Aggregate. The 10-year time period reveals that the two indexes actually produced the same result at 3.6% annualized.

Now, I don’t expect HFs to keep pace with equities longer-term, but we’ve gone through a number of difficult markets during the last 20 years, so the fact that HFs (and all of their fees) trailed the S&P 500 by 1.6% per year is troubling. Worse, HFs underperformed the bond market by 0.2% per year for 20-years. A plan sponsor and their consultant(s) may not think that 20 bps per year is much, but bonds haven’t only outperformed HFs, they’ve also been a terrific source of income to meet the promised benefits (and expenses), while being the only asset class that adequately hedges the plan’s liabilities.

As a reminder, defined benefit plans have a relative liability objective (asset growth versus liability growth) that are bond-like in nature and the present value of that liability rises and falls with changes in interest rates (discount rates). An allocation to hedge funds creates a mismatch between the plan’s assets and liabilities. E&Fs and HNW individuals that have an absolute return objective (positive spending each year) should have a greater interest in HFs that also have an absolute return objective. Hedge funds may be much more sexier than bonds, but they certainly aren’t helping the average DB plan given their poor returns and outrageous fees.

Oh, and the extra 20 bps per year that were generated by bonds relative to HFs for 20-years ending 9/30/2020 produces an additional $9.93 million ($100 million starting account) in additional assets that can be used to fund promised benefits. That’s not chump change for most of us.

For years I’ve written about the importance of conducting asset allocation studies based on the plan’s specific liabilities and cash flow needs, as liabilities are like snowflakes in their uniqueness. I recently read an article in P&I that reported the details of an upcoming asset allocation study. The review was to include the “Systems” three plans. It was reported that each of these plans has the same asset allocation targets and the same return on asset (ROA) objective. I wasn’t surprised to read this, but I was disappointed.

As of the end of 2018, this System’s three plans had very different funded ratios: 70.7%, 55.2%, and 82.2%. Given the very different funded status, how is it that they have the same asset allocation? Does that make sense at all? Wouldn’t you think that a plan with an 82.2% funded ratio would have a very different asset allocation from a plan that is only 55.2% funded? Why would you want to subject that plan to a more aggressive asset allocation then is required? Furthermore, if the asset allocation is geared more to the plan that is 82% funded, the one that is 55.2% funded may never see improvement.

As I wrote just the other day, it is neither the asset allocation nor the ROA that dictates how a pension system should be managed. It is the funded status and the cash flows needed to meet the benefit promises that should drive the asset allocation bus. Once those cash flow needs are understood, then the asset allocation and the ROA target can be determined. Regrettably, defined benefit plans are quickly evaporating in the private sector. We must do what we can to preserve public and multiemployer plans. Setting the right ROA and asset allocation targets that are based on the required cash flows will help reduce cost, volatility, and will ultimately stabilize the plan’s funded status. It is pretty elementary my dear Watson.

The pension industry has its own version of the “which came first: the chicken or the egg” riddle. For years, members of our community have debated whether the return on asset (ROA) assumption is set and then asset allocation is determined or the plan’s asset allocation is derived and then the ROA is calculated from that combination of asset class exposures. If you ask actuaries, asset consultants, and plan sponsors this question, you’d likely get 1/3 saying that asset allocation is first determined, another 1/3 saying that the ROA is set first, and another 1/3 that just don’t know. Well, we, at Ryan ALM, believe that none of those are right.

We believe that a DB plan (and E&Fs) must first determine their liability cash flow needs (benefits and expenses or spending requirements) over some prescribed period, which will then inform the plan’s asset allocation from which the ROA will then be determined. How can an asset allocation be determined without a true understanding of the plan’s liability cash flow needs? We’ve witnessed significant market dislocations within the last couple of decades that have challenged plan sponsors from a liquidity standpoint. The Great Financial Crisis (’07-’09) contributed significantly to the use of secondary markets for transactions involving the sale of private equity, private debt, and real estate partnerships when plans needed to raise cash to meet outflows.

Once an understanding of the liability cash flows has been determined, plans can match those needs with a bond portfolio to ensure that the asset cash flows will be on hand when it is required. Bonds are not performance generating instruments, especially in this low interest-rate environment, but they are great for creating cash flow through interest payments, reinvestment of income, and principal at maturity. These “cash flows” can be modeled. The use of a cash flow driven investment approach (CDI) to fund liability cash flows creates a much more efficient asset allocation normally requiring fewer assets allocated to bonds (beta assets), while enabling the remaining alpha assets to grow unencumbered.

The Science community believes that the egg came first when two birds that were almost-but-not-quite chickens mated and laid an egg that hatched into the first chicken likely answering that longstanding argument. We believe that focusing on liability cash flows first puts to bed the pension riddle. We’d be happy to discuss (debate) this subject with you. We are looking forward to hearing from you.

A recent article in PlanSponsor highlighted the fact that Pension Risk Transfers (PRT) have impacted the premium income collected by the Pension Benefit Guaranty Corporation (PBGC). During the 2015-2018 period, 8% of the companies insured by the PBGC transferred some or all of their plan liabilities. The cumulative impact of these actions may produce a fall in premium income received by the PBGC of just under $200 million for 2019’s plan year.

The PBGC is expected to generate roughly $2.23 billion in premium income for 2019, so the $196 million equates to an 8.7% hit. During the 2015-18 time frame, the PBGC saw 44% of large plan sponsors (>1,000) of DB plans engage in some form of a PRT. This activity caused more than 2.4 million American workers (from a pool of 30.9 million in 2014) to no longer be covered by the PBGC, either because they accepted a lump sum distribution or saw their benefit no covered by an annuity product.

Furthermore, in addition to a flat fee per participant ($80 in 2019), the PBGC collects a variable-rate premium (VRP) based on the plan’s underfunding. For the 2019 premium filing year, the VRP rate was $43 per $1,000 of unfunded vested benefits, with a cap of $541 per participant. The PBGC is estimated to have collect nearly $4.8 billion in VRP in 2019. There is no question in my mind that these additional fees are driving plan sponsors to seek alternatives to maintaining their DB pension plans further diminishing the use of these critical important benefits.

According to the PBGC, small plans are three times more likely to participate in a PRT than larger plans. In 2018, 168 plans paying a VRP, covering 117,050 workers, participated in a PRT thus reducing PBGC income by another 1.3%. This isn’t entirely all bad news for the PBGC, as the plans paying the VRP are less well funded and they reduce the participant population and the benefits that PBGC is responsible for insuring.

What may not be bad news for the PBGC, is in fact very bad news for the American worker, who is left with reduced benefits (PBGC cap in 2019 was $67,295 per participant in a single employer plan and $12,870 for a participant in a multi-employer provided plan) or no DB plan for a new worker and reliance on a defined contribution alternative, if they are fortunate to work for a company that offers one. According to a Brookings Institute study (2018) 44% of the American working population (53 million workers) are making on average $10.22/hour or $18,000/year. Do they really have the ability to fund a retirement benefit? This is a travesty!

I was very surprised (shocked) to read an article recently that described the Butch Lewis Act as a band aid. The pension crisis has been unfolding in our country for decades, and for various reasons it has hit multiemployer plans more severely. After many attempts to address this issue, we got MPRA in 2014. That legislation has proven less effective than a band aid would be on a 3″ gash!

The Butch Lewis Act is the tourniquet needed to stop the bleeding that these plans are experiencing, as current assets have little chance of meeting short-term spending needs. As we’ve previously reported, there are roughly 130 Critical and Declining multiemployer plans that are facing major solvency issues. Without dramatic action they are likely to fail! If they do, a transfer of assets and liabilities to the PBGC’s multiemployer insurance pool will result in very little being paid of the promise that was made to plan participants.

The low interest-rate loans that the BLA would provide to these struggling plans would ensure that the necessary funds would be there when called on, as any plan taking a loan MUST defease the Retired Lives liability. The current assets and any future contributions would be used to meet future Active Lives liabilities, interest payments on the loan, and the loan’s principal in 30-years. When the original analysis was initially performed by Cheiron US interest rates were much higher. Yet, even in that environment 111 of 114 plans were able to fully meet their obligations. This environment of low rates further elevates the probability of success.

Unlike other proposed legislation that has been discussed, the BLA doesn’t hurt healthy multiemployer plans to “save” the C&Ds and it doesn’t penalize plan participants and retirees, who did nothing wrong, but stand to lose so much. In fact, this legislation buys 30 more years! How is that a band aid? I would be happy to debate anyone regarding the merits of the BLA. Nearly 1.4 million American workers need action on this issue. For some it is already too late. Let’s not jeopardize the financial futures for the remainder. Let’s work together to push for this critical legislation to pass through the Senate.

It has been reported that two more multiemployer pension systems – Arizona Bricklayers and the Michigan Carpenters – have filed for benefit relief under the Multiemployer Pension Reform Act of 2014 (MPRA). This is the second application for the Carpenters after they withdrew their first proposal earlier this year. Although the actual cuts to benefits may be different, the factors creating the deterioration in funding are similar in that the number of active employees fell dramatically in relationship to the number of retired participants, the number of employers contributing to the plan also fell, while the number of hours worked (determines contributions) were impacted by multiple economic shocks and have yet to recover.

In the case of the Arizona Bricklayers’ plan, ALL the accrued benefits will be recalculated to a maximum of 110% of the PBGC’s guaranteed amount. As a reminder, the PBGC’s guaranteed amount for a 30-year employee at age 65 is ONLY $12,870. It can be quite smaller for those that didn’t achieve a 30-year career. For comparison purposes, the PBGC’s private insurance program protects benefits to >$72,000 for equally tenured employees. For the Carpenters, their benefits will be slashed by 32% under MPRA! How many of you could withstand a cut in compensation of this magnitude without having it jeopardize your financial future?

It really pains me to think that our government is sanctioning this action. MPRA has little to do with pension reform and everything to do with slashing benefits, while financially burdening workers who had very little to do with the problems related to their plans. Regrettably, Congress continues to dawdle as it relates to true pension reform and as they wait the crisis magnifies. Unfortunately, we have roughly 1.4 million American workers tethered to pension plans that have been designated as in Critical and Declining shape. The only potential resolution to this situation is through legislation. There is no “earning” one’s way out of this jam.

The Butch Lewis Act (BLA), which currently resides in the Senate after having been passed by the House, is wonderful legislation that actually reforms pensions, unlike MPRA, while simultaneously protecting the promised benefits. For those plans that have filed for and been granted relief under MPRA, the benefits that have been slashed would be reinstated under the BLA should they file for a loan. Let’s hope that there is finally a sense of urgency within Congress that will lead all parties to conclude that the BLA is the right path forward and the time is now!

Corporate America has been exiting from defined benefit plans for decades. There are many reasons why this trend exists, but one of the primary reasons cited often focuses on the excessive cost to insure these plans/participants with the PBGC. As a reminder, there are two annual PBGC costs associated with single-employer plans, including both fixed and variable costs. In 2019, the PBGC charged $80 per participant as a fixed cost, and an additional variable premium charge of $43/$1,000 of UVB (unfunded vested benefit) with a maximum cost of $541/participant. As you can imagine, those costs add up quickly.

Multiemployer plans are also insured by the PBGC, but they participate in a separate pool from single-employer plans. As of 2019, Multiemployer plans were charged $29/participant with no additional variable payment. As a result, the level of participant protection is vastly different with the benefits of participants in single-employer plans protected to more than $72,000/year, while a 30-year veteran aged 65 under a multiemployer pension plan would receive a maximum benefit of only $12,870 or about 1/5 of an employee who worked the same length of time, but was fortunate to work for a private company.

With that information as a backdrop, how does it make sense that a proposal being floated in DC to “help” multiemployer plans calls for drastically raising the premium per participant to the same level currently charged single-employer plans? If high premiums are one reason cited for the demise of DB plans within corporate America, how are struggling multiemployer plans going to afford this ridiculous increase? Furthermore, this “rescue plan” contemplates a tax on both active participants as well as current retirees? Wasn’t this a benefit that was promised to, and in many cases, paid partially by the employee?

Levying these additional costs on top of struggling plans that in many cases have few years of solvency left is nothing more than an attempt to drive these plans into bankruptcy and ultimately the PBGC, as opposed to actually providing a lifeline to protecting and preserving theses critically important programs. The other proposal being considered is the Butch Lewis Act, which was passed by the House of Representatives in July 2019. This legislation calls for low-interest rate loans from the U.S. Treasury Department based on the 30-year Treasury rate to be offered to the plans that are designated as in critical and declining status. Given the historically low Treasury 30-year rates today, the timing could hardly be better. It is estimated that the net cost of this proposal is $31.8 billion. However, when Cheiron (pension actuaries) did the original work, 111 of the 114 plans reviewed at that time were able to pay back the loans at the end of 30-years. Given that fact, where is the cost to the taxpayer? It certainly isn’t $31.8 billion.

But, even if it were to be a cost of $31.8 billion, why shouldn’t the stimulus package include multiemployer pensions whose assets were hard hit by the Covid-19 pandemic? With the Federal government handing out trillions to support every conceivable program, why not pensions? The 1.4 million American workers in these failing plans need our support. Furthermore, the economic activity produced by these benefit payments far outpaces the estimated cost to support them. Let’s not be penny wise, but pound foolish. Let’s put forth legislation that actually protects and preserves these plans as opposed to driving them into the PBGC where participants are likely to receive only pennies on their promised dollar of benefits.