It May Be Time For A Re-think

Since the first use of Pension Obligation Bonds (POB) in 1985 (Oakland, CA), results have been checkered at best. Boston College Center for Retirement Research (CRR) has produced two studies related to POBs and neither shines a great light on the use of POBs to improve funding for public pension systems. Furthermore, the Government Finance Officers Association (GFOA) has come out strongly against the use of POBs “regardless of the economic cycle”, which I guess is a reference to the current environment of historically low-interest rates in the US. But are they thinking about the use of POBs in the right light?

As we know, states and municipalities have issued these securities “hoping” to capture the arbitrage between the ROA (plan’s asset return forecast plus the discount rate) and the interest payment on the bond. For most cases from 1992-2009, the bonds were issued and invested at the wrong time in the cycle leading to underperformance and an increase in the plan’s liabilities. In the 2014 study, CRR found that bonds issued in 2009 and later had shown improved results once again highlighting that timing is an important factor, and we all know how difficult it is to time the market, especially when the POB assets are injected into the plan’s traditional asset allocation, with all the gyrations that markets can create.

All that said, there is a strategy that can be used that can dramatically increase the probability of success. Sure, taking advantage of low interest rates is still an important consideration, but this prudent strategy significantly reduces the “timing” element of when the assets are invested. I think that the GFOA would appreciate a strategy that bifurcates a plan’s assets into two buckets – beta and alpha. The beta assets would use some of the POB’s proceeds to defease the plan’s retired lives liability chronologically for the next 10-years or so. This provides the remainder of the POB proceeds and the current plan assets to be managed more aggressively since they now have a longer investment horizon of 10 or greater years.

As the chart above reflects, a traditional asset allocation with a one-year investment horizon has a tremendous amount of volatility associated with it. By providing the portfolio with a 10-year investment horizon, the standard deviation declines dramatically increasing the probability of achieving one’s return objective. Furthermore, by defeasing the plan’s near-term liabilities, liquidity to meet benefit payments and expenses is enhanced allowing the alpha assets to grow unencumbered. Importantly this change in asset allocation converts fixed income from a performance-seeking investment to a cash-flow-producing investment, which is the true value in bonds, especially in this current environment.

But the proof is in the pudding. A recent analysis that we did for a struggling public pension plan showed that with the injection of a POB and the adoption of this implementation we could dramatically improve the Funded Ratio, freeze contributions at the current level (saving the plan >$10 billion in future contributions), reduce funding costs by >20%, and cover the debt-service while determining that the fund could accomplish all of this with a ROA that was 80 bps lower than their current objective. You may be thinking that this just seems too good to be true, but we would be glad to take you through both our process and this analysis. Call us, especially if you are affiliated with the GFOA.

What Would You do?

It has been reported that the American Federation of Musicians and Employers’ Pension Fund (AFM-EPF) has decided to pull the application for benefit reductions under MPRA and “bet” that the recently passed American Rescue Plan Act will provide a superior outcome. The latest MPRA application by AFM-EPF filed in December (the first application was rejected) called for an across-the-board 30.9% reduction of the multipliers used to calculate benefits for contributions earned before Jan. 1, 2010. Under ARPA, plans designated as Critical and Declining or Critical can file an application with the PBGC for a grant that would ensure that benefits would be paid through 2051 with no requirement that the grant is repaid.

It seems fairly obvious to me what I would do if I were responsible for that plan. But, there are outstanding issues that need to be resolved with regard to the legislation. This determination falls onto the PBGC, which is responsible for providing guidance on the legislation’s provisions, including how the Special Financial Assistance (SFA) is calculated in the first place. I’ve seen multiple interpretations as to how the SFA will be determined, and the size of the assistance varies tremendously under the most extreme differences.

Personally, I can’t imagine that it was the goal of Congress to have legislation passed that doesn’t accomplish the objective of securing the promised benefits for these struggling plans through 2051, especially given that there are roughly 1.4 million Americans in these plans who are expecting to get what was promised. So, what would you do? Would you cut benefits under MPRA, even if the pain is quite severe in order to extend the viability of these entities, or would you “roll the dice” on ARPA and the PBGC’s interpretation of how the SFA should be calculated? I firmly believe that the PBGC will produce guidelines that provide the necessary SFA to ensure that there is enough money in 2051 to meet the plan’s liabilities at that time.

Is It Just The Accounting Rules?

We know that the accounting rules differ quite significantly in the treatment of discount rates for public (GASB) and private pension plans (FASB). Do the differences manifest in asset allocation? According to the following two charts, the answer is yes, and it is quite significant!

Chart 1 (thanks, Deutsche Bank) highlights the change in exposure to fixed income within public pension plans during the last 4 decades. While the second chart reflects the allocation to fixed income by private pensions. After a brief reduction to fixed income during the go go ’90s, private pension plans ramped up their exposure to fixed income and today sit at roughly a 50%/50% mix. But are these differences just the result of the accounting rules? We’d say, no!

Regrettably, private pension plans have been hell-bent on eliminating DB pensions ever since the advent of defined contribution plans (DC) and 1986 Tax Reform. This has driven plans to reduce risk, as they establish glide paths toward full funding and the possible transfer of pension liabilities to insurance companies. But every private plan has certainly not frozen, terminated, and/or transferred their pension liabilities. For those that haven’t, the market valuation pension rules under FASB have created an environment in which the average private pension plan is much better funded than the average public pension system.

With regard to public pension systems, there is the perception that these entities are perpetual. But is that perception reality? We’ve seen examples of DB plans being frozen and new employees being thrust into DC or hybrid offerings. I wrote a blog post several years ago in which I stated that perpetual doesn’t mean sustainable. I fear that we could be entering a time when we could see more examples of public pension systems seeking alternatives to traditional DB plans. A trend that will certainly not be favorable to future public employees. It is likely that burgeoning contributions will make some of these systems unsustainable. We’ve witnessed tremendous growth in contribution expenses throughout pension America since the 2000-2002 recession. This growth is becoming a significant burden for some to handle, as it takes a bigger slice each year from the social safety net. Some pension systems have made the full contribution, while others have not, further pressuring an already tenuous situation.

Given the perception that public pension systems are perpetual, they have embraced the idea that they can become much more aggressive in the allocation of assets to equity and equity-like products. But is that decision sound? The volatility that comes with a much more aggressive allocation has subjected these plans to massive swings as we’ve had to endure three significant market corrections in just the last 20 years. Given the 70+% return in the markets during the last 12-months, is there really that much more to gain before we finally see a pause or correction?

At Ryan ALM, we think that asset allocation should be driven by the plan’s funded status and not the accounting rules. Public pension systems can have a higher exposure to alpha assets (non-bonds), but they need to ensure that near-term liabilities are secured before ramping up the risk. With a greater focus on near-term liabilities through a cash-flow matching strategy, the pension fund has now bought time for the alpha assets to grow unencumbered. Furthermore, they are no longer a source of liquidity removing the possibility of being forced to sell assets at inappropriate times. We are huge supporters of DB plans, but there needs to be a change in how they are managed, or we may see their demise far sooner than expected.

Pay Them Now!

There are 18 multiemployer plans that “successfully” filed for benefit relief under MPRA. Benefit cuts in excess of 50% have occurred for some of the retirees bringing with them true hardship for the participant and their families. With the passage of the American Rescue Plan Act (ARPA) these participants and/or their beneficiaries will FINALLY get what was promised and earned. However, that repayment of lost benefits and the reinstatement of the original benefit payment may not come soon enough.

The Pension Benefit Guaranty Corporation (PBGC) has 120 days (roughly July 9th) since President Biden signed the legislation to provide guidelines on many aspects of the Act, including any prioritization for submission of applications for Special Financial Assistance (SFA). Fortunately, it appears that plans that initiated benefit suspensions are going to be given priority to file along with other entities based on the size of the SFA needed (> $1 billion), whether the plan may soon become insolvent (next 5 years) or based on other considerations (don’t you just love that language). However, there are estimated to be 61 Critical and Declining Plans, 112 plans in Critical status, and the 18 MEPPs that were granted relief. That is a heck of a lot of plans potentially filing between when the application process begins and December 31, 2025 when the filing window closes, except for those plans filing an amended application, which gives them until December 31, 2026.

Here is my concern. For those that have seen benefits slashed, they have to wait until the 120 days are up and the PBGC issues guidance, then they must wait for their plan to file an application. The PBGC has 120 days to approve the application from the time of receipt. If the application hasn’t been approved after 120 it is assumed to be accepted. Amazingly, the PBGC then has 1-year to provide the pension system with a lump sum distribution equal to the Special Financial Assistance. Once the plan receives the special financial assistance, they must restore the benefit cuts within the first month. Finally, they can reimburse lost benefit payments either within 3-months in a lump sum distribution or monthly for 5-years (no interest tacked on). Wow!

So, a plan participant who has lost a portion of their benefits for some time now (Iron Workers Local 17 Pension Fund had their application approved in March 2017), may have to wait 3+ years to finally get made whole? How is that fair? I say pay them now. We aren’t talking about a tremendous amount of money (although it is to the participant). When Super Storm Sandy hit Ortley, my insurance company paid me 40% of what they believed my claim would be on the day that they came to my home. As a result, I was able to begin the process of remediation right away. Why can’t we apply a similar process for the reinstatement of benefits? Legislation has been approved and the U.S. Treasury is on the hook to provide funding to the PBGC. Why not make a good faith deposit into the PBGC to begin the reimbursement process immediately? It wasn’t right that plan participants had their promised benefits slashed in the first place. Making them wait a considerable period now that legislation has passed is just pouring salt on their wounds. The hardship created by the cutting of benefits will not ease until restitution has been made.

So Many Unknowns

We’ve been dedicating some time in our blog to the American Rescue Plan Act (ARPA), as it is an incredible piece of legislation designed to protect and preserve struggling multiemployer DB plans for the next 30-years through segregated financial assistance (SFA) from the U.S. Treasury and the Pension Benefit Guaranty Corporation (PBGC). But is that protection actually there? I raise this concern because of several gaping holes in the legislation that deserve our attention. They certainly will have the attention of the PBGC, the organization responsible for providing guidelines within 120 days of the Act’s signing (roughly July 9th).

Yesterday, I addressed my concerns regarding withdrawal liability. We, at Ryan ALM, are also very concerned about the discount rate used to determine the segregated financial assistance (PPA 3rd segment rate +200 bps), which we will highlight in another post. In addition, there are still many questions as to how the segregated assets can be invested. The Act states that the assets received through SFA should be invested in investment grade bonds or other assets as allowed by the corporation (read PBGC). But of greatest concern (to me) at this time is how the financial assistance is to be calculated, exclusive of the discount rate issue. Are existing assets and future contributions going to be included, as some suggest, in order to determine the funding shortfall or will a present value calculation of the actuaries forecast of future benefit payments for the next 30-years be the appropriate measure?

I had the pleasure to listen to an IFEBP sponsored webcast on the ARPA yesterday. The speakers did an excellent job going through the many points addressed in the Bill, but they also had questions about the appropriate methodology to be used to determine the level of financial assistance. They presented two methodologies, which create significant differences in the potential aid received by these plans. In one case, the plan is expected to include current assets and future contributions, minus expenses, before determining the potential support. In that example, they “needed” <$200 million in financial aid, but the plan was forecast to become insolvent in 2052. Not ideal!

In the other interpretation, the actuaries 30-year forecast of benefit payments (inclusive of current retirees and those actives that would retire during this time frame) was discounted at a 5.59% rate (PPA 3rd segment rate +200 bps) suggesting that the financial assistance needed to secure those promised benefits was just under $1 billion. Wow! Quite the difference. Wait, it gets more complicated. We reached out to the CEO of a leading multiemployer actuarial firm to get their take. They’ve determined that possibly as many as five different scenarios exist as it relates to determining the appropriate aid. Again, it will be critically important to get the PBGC’s input into which scenario was intended by the legislators. Did they want these plans to continue as viable entities or was their goal simply to get through the next 30-years?

More than 1 million American Union workers now believe that their benefits have been ensured by the passage of ARPA, but have they been? Anyone of the issues that I’ve raised could impact the amount of money available to meet those promises. If several of these issues are not resolved in a satisfactory way, the celebrations will have proven premature and the fate of the critical and declining (C&D) and critical plans will once again be uncertain. More to come!

Still to be tackled

As we’ve consistently said, the American Rescue Plan Act (ARP) is wonderful for the plan participants, but it does little to address some longer-term issues in multiemployer pension plans that could secure them further into the future. One such issue is withdrawal liability. The House bill specifically stated that employer withdrawal liability would not take into account any special financial assistance for 15-years after a plan received assistance, but this provision was removed from the Senate’s bill. As a result, there is uncertainty how withdrawal liability will be calculated once significant sums of money are received by these struggling plans.

The securing of pension benefits for the next 30-years (for current and future retirees) through the Act’s grant program may, in fact, reduce Withdrawal Liability for current employers given the dramatic improvement in funding. What I fear is that these employers will take advantage of the improved funding, should the PBGC not maintain the current rules, to exit these important pension systems rendering them fragile once again and likely forcing current and future workers into alternative pension structures.

We certainly don’t want this significant victory for union participants to be overshadowed by a potential unintended consequence as a result of changes to the calculation of withdrawal liability. We know that the PBGC has broad authority to impose restrictions on plans receiving financial assistance, including the authority to impose special rules pertaining to withdrawal liability. Let’s hope that any reduction in withdrawal liability penalties is scaled in over a long period of time (at least the 15-years originally considered in the House bill) and that the PBGC understands that DB pension plans must be protected and preserved for the masses.

It is time to address this liability!

We, at Ryan ALM, don’t just focus on DB pension systems, as any entity with a liability is fair game, such as OPEB, E&Fs, Nuclear Decommissioning Trusts, etc. What is important to note, is that we focus all of our energy on modeling that liability and managing to it so as to reduce the cost to the greatest extent possible. Because we believe securing theses benefits in a cost efficient manner and not generating the highest return is the primary goal in managing these programs.

We’ve reported often on the solvency of DB plans, whether they be public, private, or multiemployer. We’ve even reported on OPEBs occasionally, but not nearly to the extent that we should have, as many states are facing growing OPEB liabilities that may just dwarf the pension obligation.

For instance, New York is reported to have a $313.9 billion OPEB liability that equates to more than $16,000 for every man, woman, and child living within its borders. Those of us living in NJ shouldn’t snicker too much, as our OPEB obligation on a per capita basis is the second worst at $11,425 / individual. Delaware, Hawaii, Connecticut, Massachusetts, Maryland, Illinois, and Louisiana all have per capita exposure greater than $5,000 per resident. Kudos to North and South Dakota that have OPEB obligations that are <$100/resident.

What is frightening about OPEB obligations is the fact that they are mostly related to healthcare programs, which carry greater inflationary concerns than pension plans. Many of these states are meeting this obligation on a pay-as-you-go-basis, which is truly disconcerting. Prefunding this obligation could save these entities >30% depending on how far out in maturity a cash flow matching program can be funded.

Although many of these OPEB programs aren’t guaranteed, there is an expectation on the part of public fund workers that the promise made many years ago will be met. Failure to do so could lead to many issues, including retention and recruiting issues. Give us a chance to explain to you how our approach could secure those “other” benefits before it is too late.

1989 – A Bad Year For Pension America

According to a chart shared on by Lori Lucas, President and CEO, Employee Benefit Research Institute, 1989 was the year when Pension America truly began to be impacted by the looming pension crisis. Why 1989? This was considered the cross-over year in which more private sector U.S. workers were only in defined contribution (DC) plans versus those workers in only defined benefit (DB) plans. Unfortunately, 1% of private sector workers are in employment situations where they only have access to a DB plan, while a full 41% only have access to a DC plan. More than 40% of American private sector workers don’t have access to any retirement vehicle – that is the true crisis!

Given this situation, it shouldn’t be surprising that the National Institute for Retirement Security’s Retirement Insecurity 2021 survey found Americans more anxious about their retirement prospects. More than half of those polled doubt their ability to have an adequate retirement when they stop working. Given the uncertainty that has been exacerbated by the impact of Covis-19 on the average American, it shouldn’t be surprising that roughly 1/3 of American workers have adjusted their retirement date, with more than 2/3rds of those extending it. In addition to personal fears related to one’s retirement, 68% of Americans believe that the U.S. is facing a retirement crisis. They cite the lack of pensions (51%) as the primary reason.

DB pensions enjoy quite favorable views across political parties (a rare feat today) with 77% of Republicans and 81% of Democrats believing that DB plans are superior to DC plans. I believe that they are right! Not surprising, the guaranteed monthly payment is the most attractive feature of the DB plan. As I’ve often stated, asking an untrained worker to fund (in many cases with little disposable income), manage, and then disburse a retirement benefit is a cruel exercise! Why do we think that 99% of those individuals will be up to the task? In addition to a lack of a monthly benefit, survey respondents also cited several other reasons for why they believe that a retirement crisis is looming, including, higher healthcare costs, long-term care costs, decades of low-wage growth, and higher debt levels (thanks student loans) for those approaching “retirement”.

According to NIRS, “The U.S. is facing a retirement savings crisis that likely is worsening thanks to yet another economic crisis. Except for the wealthier Americans, the typical working American is not on track to maintain their standard of living in retirement”. A very sobering thought, indeed. Lastly, please don’t confuse average account balances as a measure of success for DC plans, as the lack of participation for a big swath of the American work force and MEDIAN account balances suggest a very different situation/outcome.

Oh, What A Relief!

One more vote! That is all that remains before multiemployer plans (and their participants) finally get the pension relief that they’ve sought and needed for years. Some of you may have missed the fact that the $1.9 trillion stimulus package passed by both the House (February 27th) and the Senate (March 6th) contains multiemployer pension support in the form of H.R.423 – Emergency Pension Plan Relief Act of 2021. The Bill has been sent back to the House for a final vote, perhaps as early as this week.

This Bill is also known as the Butch Lewis Act (BLA), but it isn’t the original BLA, which provided for low-interest loans to Critical and Declining plans provided by a new department within the Treasury (Pension Rehabilitation Administration). This version will provide direct payments to plans to provide the promised benefits for the next 30-years, with no obligation to repay. There are some who say that the legislation doesn’t go far enough to ensure that history won’t repeat itself, but for many American workers who lost a portion (significant, in some cases) of their benefits through MPRA, those benefits will be restored, and forfeitures made whole, and rightly so.

This legislation comes at a time when many American workers and retirees have been crushed by the impact of Covid-19. The fact that benefit payments will be protected means that the communities in which they live will also see the benefits from the economic activity that these payments will create, and those same municipalities will see further support through income and sales tax revenue growth. There are estimated to be more than 180 multiemployer pension systems covering nearly 1.4 million American workers that would be eligible to receive these grants, but those numbers could become significantly greater in the near-future depending on how markets and our economy performs.

Although critics are claiming that little pension reform is included in this Bill, there are a few interesting wrinkles related to discount rates and implementation of the grant proceeds that we will explore in future blog posts. In the meantime, I am thrilled that we are finally going to see support for these struggling plans and their participants. I can’t imagine being promised a benefit only to have the rug pulled out from under me when it was finally time to collect. Too many Americans have struggled with the stress of such action. It just wasn’t right!

CAIA Panel Discussion

I was really pleased to participate in a CAIA panel discussion on February 23rd. The panel was asked to address “Solutions for Optimizing US Pension Structures with CAIA SoCal, Session 1 of a Series”. You can find the video here. The primary focus was on public pension systems that are under considerable pressure due to Covid-19 issues related to both lost revenue and greater expenses. In some cases, public pension systems were already struggling for myriad reasons. I hope that you find my thoughts beneficial and I certainly welcome any questions/comments that you might have to share with me. I know that you’ll find the comments by my co-panelists, Ray Joseph and Von Hughes, and the Moderator, Guy Pinkman to be spot on. Enjoy!