Retirement Readiness Through 2017

The U.S. Federal Reserve’s annual report on the Economic Well-being of U.S. Households has been released for 2017.  There are many areas covered in this report, including retirement readiness. Within the retirement section, the report highlights retirement savings, financial literacy, and retirement timing. The results highlight major differences among retirees and those hoping to retire in the future.

Most notable for me was that 56% of current retirees are drawing income from a defined benefit pension, while only 26% of our current workforce is participating in a DB plan.  It is certainly a lot easier to retire when one has both Social Security (87% of retirees are currently receiving a monthly SS check) and a pension that pays a monthly benefit, too.

The successful movement from DB to DC-type plans depends in large part to how capable the individual participant is from a financial literacy standpoint. According to this report, 60% of non-retirees have little to no comfort managing their investments. Furthermore, more than 25% of working households have nothing saved for retirement.

Finally, a significant percentage of our workforce is still retiring before age 65, but is it because of financial freedom? Hardly. The report highlights the fact that 75% of those that retired in 2017 were younger than 64 years old, but most of these individuals claimed that they retired because of poor health or weak job prospects. Those thinking that working later in life as a way to supplement their retirement income may want to reconsider.

Much more needs to be done to help our future retirees.

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Better, But Still Ugly!

The U.S. Federal Reserve is out with their annual update on the financial well-being of U.S. Households.  There is a ton of very useful information in the more than 50-page report, but one particular item jumped out at me, which we’ve reported on before.
Despite the claims of full employment and stronger economic growth, 40% of American households could not meet a $400 emergency expenditure without having to use either a credit card that spreads payments out over months or through borrowing from family and friends. Now, this is better news than the last survey in which 47% of households reported that they weren’t prepared to meet an unexpected emergency of this magnitude.
What is the likelihood that these households are able to put aside money for retirement now that most employees are being asked to fund their own retirement through a defined contribution type program?

Glorified Savings Accounts

At KCS, we applaud any entity that provides their employees with a retirement vehicle! However, as we’ve written many times, we would prefer a defined benefit plan to a defined contribution plan for several reasons, including the fact that employees can take premature withdrawals and borrow from their accounts through loans. This access is crippling the financial future for many participants, and it will likely lead to significant shortfalls in retirement savings.

Fox Business is reporting on a PwC US study (2018 Employee Financial Wellness Survey), which tracks the financial and retirement wellbeing for 1,600 full-time employees. Not surprising, 42% of those surveyed expressed concern that they would have to tap their “retirement” account for everyday expenses associated with supporting their adult children, parents, and/or both. Furthermore, nearly 2/3rds of those polled anticipate delaying retirement for fear of rising healthcare costs.

There have been many significant improvements to defined contribution plans through the years, including such features as auto-enroll, auto-escalate, target-date funds as an approved QDIA, etc., but until we eliminate premature access to one’s retirement funds, these accounts will remain nothing more than glorified savings accounts.

Despite all the published accounts of how everything is just hunky-dory, we know that a significant percentage of our labor force are struggling to meet daily expenses let alone save for retirement. Student loans, healthcare, housing, etc., are all taking a bigger chunk of one’s income. As a result, we need to create true retirement vehicles for our employees, which are untouchable, that will permit them to retire at the appropriate time without ending up on the welfare ranks, as we expect many will.

 

 

Would That Be True If They Used a Legitimate Discount Rate?

P&I is reporting on a Milliman study of the 100 largest U.S. public pension plans in which they calculate that the aggregate funding dropped to an estimated 71.4% as of March 31, down from 73.1% at the end of 2017.

Milliman is estimating that the challenging markets lead to a collective asset value drop of 1.7% during the quarter to $3.56 trillion, while liabilities increased 0.8% to $4.99 trillion. The first quarter’s investment returns caused six public pension funds to drop below the 90% funded mark, bringing the total number of plans with funding ratios of higher than 90% to 15. Of the remaining plans analyzed, 59 had funding ratios between 60% and 90%, and 26 were below 60%.

However, since these pension systems use a return on asset assumption (ROA) to discount their plan’s liabilities (under GASB), the liability growth described above may in fact have been negative in present value $s if a true mark-to-market evaluation had been conducted. The recent rising interest rate environment would have reduced the present value of a plan’s liabilities during the first quarter as opposed to what Milliman is reporting.

Not having done the analysis, we are not in a position to determine whether the falling level of liabilities would have made up for the collective lower level of assets, but it is doubtful that the funded status would have declined 1.7% during the quarter. Wouldn’t it be better for the plan sponsor community to have a more accurate and transparent evaluation of their liabilities from which appropriate asset allocation decisions could be taken?

 

Just In Case You Didn’t Believe Us

SOA projects 115 multiemployer plans to be insolvent in 20 years

The headline above appeared last week in Pensions & Investmants (P&I). As we’ve been reporting for nearly one year the solvency of many multiemployer plans is very much in jeopardy. We’re glad to see that the Society of Actuaries (SOA) confirms our belief that the problem facing these critical and declining plans are real.  It certainly is for the millions of Americans who may face a sharp reduction in the benefits that they paid into and were promised at the beginning of their employment.

Although the headline suggests a 20-year timeframe, a significant portion of these plans could be insolvent within 10 years. In fact, it is estimated that 21 plans will go kaput by 2023, while another 48 could evaporate by 2028. What we also know is that some of the plans facing more immediate uncertainty are the largest plans, including Central States Teamsters.

Based on various discount rates used to calculate the potential liability of this unfolding funding crisis the projected liability could be $57 billion (using a 6% ROA discount rate) to $107.4 billion when applying a 2.9% Treasury rate. These numbers mirror those that were calculated by members of the Butch Lewis Act team that recently presented to House and Senate staff members.

As a result of this unfolding crisis, Congress has established a Joint Select Committee to tackle this issue before it becomes a moot point. As we’ve reported in previous blog posts the committee has begun meeting with various industry experts. Select committee co-Chairman Sherrod Brown, D-Ohio, said Thursday that the panel will hold hearings until July, and then “we will have to start the process of negotiating a bipartisan solution to the crisis.” They are striving to have a “solution” established by a self-imposed deadline of November 30th. Obviously, we hope that the Butch Lewis Act will be the foundation for the legislation that eventually evolves from the Committee’s effort.

Why Pixie Dust Isn’t necessary

Yesterday we wrote about CalPERS, and the request by Dane Hutchings, legislative representative to the League of California Cities, imploring the CalPERS team to “think outside the Box” in order to generate a fund return that exceeded their 7% annual return on assets objective (ROA). We were wondering what magic potion they might discover that would altar the long-term return expectations for a variety of asset classes.

However, managing a pension plan isn’t about generating the highest return, but it is very much about providing the promised benefit at the lowest cost. As we’ve stated many times before, the true objective for a pension system is that plan’s specific liabilities, and not some made up ROA. We would like to further explain.

  1. Liabilities are highly interest rate sensitive. If rates go up (as most believe that they will) there is a good chance liability growth in present value dollars will be negative, just as the return on long bonds would be negative in that scenario, too.
  2. A pension plan’s true growth objective is to have asset growth exceed liability growth so the economic funded ratio/status is enhanced. Earning the ROA is not the goal here.
  3. The true economic funded ratio for a public pension plan is not currently known, as plans are not using a mark-to-market discount rate to value their liabilities. Yes, a discount rate of 4% (AA Corporate under FASB) or Treasury rate (3%) would increase the value of plan liabilities and reduce the plan’s funded ratio, but it would create the base case from which appropriate action can and then should be taken.

Let’s look at the scenario below. Clearly, assets do not need to achieve the 7.5% ROA objective to witness meaningful improvement in the plan’s funded status provided that asset growth exceeds liability growth. In our scenario, with liability growth of -2.56% annually, a 5% asset growth rate produces 7.6% annual alpha for assets relative to liabilities, and it improves the funded ratio from 60% to 87.8% in just 5 years. If markets cooperate, and the annual return achieved is 7%, then the funded ratio dramatically rises to 96.5%. Knowing the true economic reality of a plan’s liabilities can lead to better decision making, while eliminating the need for pixie dust to be thrown at the “problem”.

   5-year Scenario

                 What would happen to a plan’s liabilities if long U.S. Interest Rates were to rise 60 basis points per year for the next 5 years?

                 30-year Treasury at 3.00% going to 6.00%

                 Liability growth rate would be -2.56% annually or –12.81% cumulative

                 Note: duration of liabilities = 12 years

                                                 —– Annual Growth Rate —–

                  Assets                         5.0%      6.0%       7.0%      8.0%

                  Liabilities                – 2.6%     -2.6%   – 2.6%     – 2.6%

                  Alpha (annual)       7.6%      8.6%      9.6%      10.6%     

Funded Ratio starts at 60%:  87.8%   92.1%    96.5%   101.1%

Every DB plan, public or private, should use an economic set of books to value plan liabilities. Furthermore, every pension system should have a derisking plan in place. Just because a plan’s funded status is currently poor doesn’t mean that it can’t see dramatic improvement in a relatively short time frame. Improving transparency on a plan’s liabilities is an enhancement to the process. Without this honest evaluation how does a sponsor know if they are winning the game?

 

Oh, Okay – No Problem!

You Gotta love this one! CIO magazine is reporting that a “legislative representative to the League of California Cities urged the CalPERS Investment Committee Monday to think “out of the box” in finding a way to exceed its 7% investment return projections, saying that cities won’t be able to pay their monthly contributions to the pension plan if returns are that low.” No problem! I’m sure that they will be able to find a magic potion that will all of a sudden create new and exciting investment opportunities for this fund and all market participants!

Dane Hutchings cited a CalPERS September 2017 report, which showed that 180 of the 449 cities and towns that participate in CalPERS had an individual funding ratio of between 60% and 70% (on an actuarial basis).  Hutchings also warned that a significant number of those communities could fall between the 50% and 60% funded when new CalPERS data come out in August.

CalPERS is in the midst of a three-year plan to lower yearly expected investments to 7% from 7.5% because of diminished (more realistic?) return expectations. As returns expectations drop, CalPERS’s unfunded liability increases (under GASB accounting), therefore it must increase contributions from employers whose employees are in the pension plan, meaning the state, cities, towns, special districts, and school systems that makeup CalPERS must pay more.

How about valuing public pension liabilities using a more realistic discount rate and separating that rate (for contribution purposes) from the return on asset (ROA) assumption? DB plans used to be managed against their liabilities and not the ROA.  Trying to enhance a return will guarantee more volatility, but not necessarily an equivalent pick-up in return.

If plan sponsors began using a mark-to-market evaluation of their liabilities they would understand that the present value of those liabilities changes along with movement in interest rates.  A DB plan does not need to achieve its ROA objective in a rising rate environment given that the present value of the plan’s liabilities is falling. A 4-5% return would look heroic in a market environment, such as that! Have they conducted an asset exhaustion test to calculate the actual ROA needed to keep the plan solvent? Let’s apply some real solutions to this problem and not HOPE for unrealistic returns.