Thank you, Alanis Morrissette, for coming up with a song title that is just perfect for today’s blog. Many industry practitioners have been complaining loudly, including us at Ryan ALM, that the discount rate used in the ARPA legislation (the 3rd segment under PPA + 200 bps) is wrong! This discount rate understates the “true” level of a plan’s liabilities. Instead of the one that was in the legislation, we should be using all three segments under PPA without any additional basis points penalty. As a result, the Special Financial Assistance (SFA) is much smaller than these struggling pension plans should be getting to fortify their funded status and preserve the promised benefits to pensioners through 2051.
However, many of the same industry voices are arguing that it is absolutely appropriate to use the return on asset assumption (ROA) to value a plan’s liabilities on an ongoing basis. HUH? Public pension systems operate under GASB accounting rules that permit this inappropriate accounting methodology instead of the discount rate required under FASB, which is much more of a true market-based rate. Multiemployer plans operate under a FASB hybrid system, with many (most?) using the ROA to “value” their plan’s liabilities. As a result, most multiemployer pension plans have funded ratios that are overstated, as their plan’s liabilities are understated in this historically low-interest-rate environment.
This action causes many problems, including the belief that the “ONLY” objective for multiemployer plans is to achieve the ROA! That is so wrong! The primary objective in managing a pension plan is to SECURE the promised benefits at a reasonable cost and with prudent risk. The pension objective is absolutely not to achieve a ROA target that in many cases has been determined through a “Goldilocks” approach. Pension plans of all types have been hurt by the significant decline in US interest rates since the bond bull market began in July 1982. As a result of this incredible fall in rates, the present value of plan liabilities has grown disproportionately relative to the benefit that the assets would have gained from a similar fall in rates, given the difference in the duration of a plan’s liabilities and its average fixed income exposure.
However, the absence of a true focus on pension liabilities, especially among public and multiemployer plans, masks this development. It doesn’t mean that the problem isn’t real, it does mean that many decisions with regard to asset allocation and benefits have been based on the wrong set of valuations. Now is the time for a re-thinking as an industry no matter what the accounting rules might suggest. After 39-years of US rates falling to incredibly low levels, we may finally be on the verge of seeing rates rise given the current inflationary environment. If rates rise, the present value of your plan’s liabilities will fall. In this scenario, a plan “wins” if assets outperform plan liabilities whether the targeted ROA is achieved or not. A 3% absolute return on pension assets outperforms a -3% on liabilities growth rate. It won’t take much of a backup in rates for a plan’s liabilities to dramatically underperform.
Most pension systems have an average duration of their liabilities between 10-15 years depending on the maturity of the plan. In an environment in which US rates move 100 bps higher, a plan with a 12-year duration would see the present value of those liabilities decline by 12%, and with a YTM of liabilities (@ 2%) the pension plan experiences a -10% liability growth rate. A plan’s assets achieving only a 3% return would look heroic relative to liabilities despite not achieving the ROA’s hurdle. During the truly remarkable decline in rates, pension liabilities dramatically outperformed assets, even for those plans that regularly achieved or exceeded their return target.
So, is the SFA understated because of the wrong discount rate being used, or is the average multiemployer pension system’s funded ratio/status wrong because we are hiding behind accounting rules that mask the true story? Unfortunately, it is both! As an industry, can we finally commit to a TRUE accounting of our liabilities? Not having the truth means that actions taken are likely based on the wrong set of data which will invariably lead to the wrong conclusions. Ron Ryan wrote an award-winning book several years ago titled, “The U.S. Pension Crisis”. He lays the blame for our current situation on the “inappropriate accounting rules”. I couldn’t agree more. Pension America’s DB plans need to be protected and preserved, but that won’t happen until we truly know the scope of the funding issues.
Is this the reason so many funds withdrew their applications? If it’s a matter of adjusting numbers, 707 revised their application in November, what’s the problem now?
Hi Ray – Happy New Year. I’m not familiar with why 707 had to revise their application, but several other plans have. I’m only seeing one plan that has withdrawn their application. I am surprised that those eligible to file effective 12/27/21 have not done so already given that they had months to prepare their application while waiting for their window to open. I have been hearing some rumblings that some plans that have cut benefits under MPRA might not file for SFA fearing that their attempt to “right the ship” might be undermined by a less than necessary SFA allocation. More to come as I learn more.
At least 2 funds applied December 27th. NYS pension fund posted on their website, and I think western pa pension fund are waiting for year end numbers, whatever that means. Funds that choose not to apply better get ready for a class action lawsuit. Richard Neal and the gang didn’t go through all that trouble for senior citizens only to have guys in suits say no.
Yes, according to the PBGC website, only two funds have applied. If I’m Richard Neal, I’m already furious with how this legislation is playing out. The SFA is being calculated at a much smaller sum necessary to “guarantee” benefits for 30-years, it is causing consternation among sponsors whether to file or not, etc. It is a big mess. The Butch Lewis Act should have been passed in 2019. We wouldn’t have these problems today.
Pbgc updated their status of applications section today. 617 and 3 other funds withdrew their applications. 617 was due to be approved 1-8-21. At this point, I sense this program has unraveled, and the government will now have to step in and save it.
Thanks, Ray. I appreciate you keeping me up to date. I have the PBGC website open on my browser, but it hadn’t been updated as of this morning.
What do you think is going on, it’s a laughable process at this point. At this point, there’s more application withdrawals than approvals.
Hi Ray – Good evening. In reviewing the excel spreadsheet on the PBGC’s website, they have 14 plans listed as having withdrawn applications. The first 13 have all filed revised applications, while # 14 – Management-Labor Pension Fund Local 1730 ILA – only withdrew their application yesterday and have not refiled. Yes, it is truly unfortunate that the process to file and receive SFA is so complicated that it is leading to many of the applications having to be resubmitted after revisions. As you know, two plans have had their SFA approved. Let’s hope that we can get all of the other applications approved now that revisions have been made.