Fact 1: Managing a pension plan is NOT an easy endeavor. In fact, it is incredibly difficult. Forecasting the size of one’s future workforce, their longevity, salary and benefit increases, inflation, market returns, contributions, etc. can be as difficult an actuarial exercise as exists. The fact that we have so many Americans collecting a pension in retirement is a testament to a job well done – by most! But we can and should be doing better.
It is truly unfortunate that traditional private defined benefit pension (DB) plans have nearly disappeared. They are hanging on for dear life within the multiemployer and public pension arenas. Some of these systems are doing incredibly well, while others continue to struggle for a variety of reasons. As contribution expenses ratchet higher and higher, as we’ve witnessed for more than two decades, it is inevitable that these systems will begin to face a similar struggle as we’ve witnessed in the private sector.
Fact 2: The primary objective in managing a DB pension is to SECURE the promised benefits at both reasonable cost and with prudent risk. The primary objective is NOT achieving a return on asset assumption (ROA) that in many cases is nothing more than a Goldilocks # driven by what “feels good” from a contribution standpoint. Given the lack of consistency in our accounting standards, it is understandable why there is confusion. There should NOT be two ways to measure US pension plan liabilities, especially when one (under GASB) allows for the discount rate to be the ROA that doesn’t adjust with changes in the US interest rate environment. Incredibly, we’ve gone through a nearly 40-year bull market for bonds as interest rates have plummeted. Yet, this fact could easily have been lost on those valuing their plan’s liabilities based on GASB accounting. It was not lost on our private sector.
Fact 3: There exists a schism within our pension community that leads to the great disconnect between the primary pension objective and what we have today. The ability to actually manage pension assets to pension liabilities is made more challenging by the fact that most asset consultants don’t have any way to value a plan’s liabilities on a regular basis. I have been given an opportunity to participate in a program for the IFEBP in February. I will be presenting along with two very senior and more than capable asset consultants. I had raised a point with my co-presenters about needing to reflect on the very first page of a performance report on the relationship of plan assets to a plan’s specific liabilities. I wrote a post several years ago that asked that question. When I raised this concern with my co-presenters one of them asked a simple question: “Where am I supposed to get this information?” And, there lies the problem.
We have incredibly talented folks within the pension community, whether I’m speaking about the plan sponsor or the actuary, asset consultant(s), investment managers, legal counsel, etc. But there is a general lack of communication among all of these important constituents that are holding us back. We must find a way to bring all of the insights together on a more comprehensive and frequent basis. There should be no impediment for an asset consultant to have the proper insight into how that plan’s liabilities are performing. Furthermore, the development of the asset allocation should reflect the plan’s funded status, while also taking into consideration where we are likely to be going with regard to the capital markets than where we have been. Communication will be the key to pension funding success.
Most pension plans, thanks to their custodians, know the value of their public investments on a daily basis. They gain knowledge of their private investments with a bit of a delay, but they still have a general idea of what the total assets are. Unfortunately, most plan sponsors of multiemployer and public plans have little knowledge of the price movements of a plan’s liabilities, despite the fact that the “pension promise” is the only reason why a plan exists in the first place. The accounting rules certainly don’t help, but one can get around this issue by pricing liabilities using a FAS AA Corporate discount rate that would reflect a more accurate value for a liability stream and doing so on a much more frequent basis through the production of a Custom Liability Index (CLI).
Fact 4: Inappropriate decisions can and have been made based on the belief that pension liabilities and a plan’s funded status were X, when in fact they were very different, with liabilities being far larger and the funded status much weaker, as we’ve migrated through this unprecedented declining US interest rate environment. Having greater knowledge of the true economics of a pension system may have led to different conclusions. With greater transparency comes greater insight. We should all be working with the same information. Why is a market-based discount rate appropriate for private pensions, but not public? Please don’t tell me it is because public plans are “perpetual”. We’ve seen many examples of municipalities that have frozen and then terminated their DB pension plan – so much for perpetual!
Anyone who knows Ron Ryan and I understands that we are staunch supporters of defined benefit plans. Our mission is to secure the promises that have been made to plan participants. We want DB plans to remain the primary retirement vehicle for the masses. But the battle is far from won. Success will only happen if we all work together to manage these plans through a greater focus on the benefit promises (liabilities). Can you imagine playing a football game, but only knowing what your team has scored but not the opponent? How can you possibly adjust your offense and defense to reflect the current scoreboard situation? Regrettably, that is how many of us have been managing pension plans to date. A rising US interest rate environment could be very helpful to pension funding, as the present value of future liabilities will fall. Wouldn’t it be nice to know that fact? In an environment in which rates rise modestly the return on plan liabilities will likely be negative. You don’t need a 7.25% return to be successful. There is the fallacy! You need asset growth to match or exceed liability growth. You need asset cash flows to match and fund liability cash flows.