Stealing From Peter To Pay Paul

It should come as no surprise that Americans who have recently lost jobs, and there are roughly 40 million of those, are now tapping into whatever retirement account that they have to help bridge the loss of their paycheck. According to MagnifyMoney, the average withdrawal is roughly $6,800. Given that 70% of those that now find themselves on unemployment contributed <$1,000 in the last year, the average withdrawal is substantial.

The CARES Act is permitting penalty-free withdrawals (up to $100,000) for those not yet 59 1/2 years old. This may be enticing some to take these early withdrawals, but for many American workers these premature withdrawals are proving to be necessary to pay for basic needs, such as groceries and rent. It is shameful that many working Americans still can’t earn enough to cover their basic living expenses, let alone save for retirement. The American middle class has been substantially reduced, as costs associated with housing, education, food, healthcare, insurance, transportation, etc. have ballooned and the labor force has been transformed into a “on-call” work force.

The Covid-19 crisis may be the final nail in the financial future for many Americans. What we need to do is seek ways to help these fragile households gain access to some emergency funds without having to tap into their retirement accounts. There have been a variety of discussions related to creating side-pocket accounts that would receive payroll, tax-deferred deductions that could fund these emergency savings accounts. I would recommend that 50% of each $ contributed goes into an emergency fund until $1,500 has been saved. Any contributions above that amount would go to fund a retirement account, although SimplyWise is reporting that 70% of those folks that recently lost their jobs contributed <$1,000 in the last year. This once again highlighting how little the average American is able to save after meeting their everyday needs.

We can and should do better. The movement to an on-call work force is destabilizing the American household and fueling the economic crisis that has unfolded during the last eight weeks. A good percentage of American households had seen their wealth fail to regain levels achieved prior to the Great Financial Crisis despite a 10+ year bull market for equities. The additional hardship brought about by Covid-19 may be too much for many to overcome. It is shameful!

Don’t Be A Forced Seller

A terrific article appears In the May 18th issue of P&I, titled, “After extinguishing fires, asset owners turning to liquidity”. The article cites examples from many large overseas plans on how they are handling or preparing for greater cash needs as the Covid-19 pandemic carries on.

Not surprisingly, as this happens in every market crisis, investor’s income has declined as companies have cut or eliminated dividends ($26 billion as of 4/28 according to a Barron’s article), private distributions have trailed off, and interest rates have plummeted. Investor needs for liquidity go beyond pension benefit payments, as investors deal with settle losses from hedging activities, fund margin calls, and meet capital calls from their private market portfolios.

Public funds have dramatically increased their exposure to the alternatives area during the bull market run following the GFC. As a result, exposure to “liquid” assets available to meet these cash needs has fallen. Regrettably, trying to create liquidity often means being a forced seller. Plans can avoid this unfortunate occurrence by restructuring their portfolios into two buckets. First, transform the current fixed income exposure into a cash flow driven investing (CDI) approach to meet both near-term benefits and expenses. We refer to this allocation as the beta bucket. According to the P&I article, many of these mega plans still had significant exposure to traditional fixed income instruments that contain lots of interest-rate risk.

Second, create an alpha bucket with the goal to meet future liability growth. This allocation should contain all non-bond instruments. Because the beta bucket provides all of the necessary liquidity, the alpha bucket can invest with a much longer time horizon and in instruments that no longer have to provide liquidity.

We witnessed back in 2008 and 2009 many E&Fs that were forced to sell assets into weakness, which exacerbated the decline in the value of those instruments. Unfortunately, history has once again repeated itself. By adopting the Ryan ALM CDI strategy, pension systems of all types, can insulate their plans from the damaging impact of being a forced seller. Lock in benefit and expenses for the next 10 years and allow your alpha assets to grow unabated.

A Follow-up to “But, I Wasn’t Ready”

Yesterday, we highlighted the fact that more than 50% of Americans were forced to retire prematurely. Just this morning Ted Knutson, Contributor at Forbes, published the following information that adds the exclamation point to our post. Thanks, Ted.

“The COVID-19 recession is likely to cost the jobs of 22 percent of middle-income workers age 50 to 60 making between $48,000 to $137,730 and the jobs of 15 percent of their peers earning above that, according to a report released today.

The recession will force an additional 1.1 million of these middle-income job holders and 360,000 higher-income older workers into a substandard standard of living when they retire, says the study by the New School of Social Research’s Retirement Equity Lab (ReLab).

ReLab Director Teresa Ghilarducci believes that older workers are likely to get hit harder by this recession than others “because the widely publicized larger vulnerability of the aged to COVID-19 is going to increase age discrimination in hiring.”

Retirement account balances are abysmally low for many American workers and the hit that their portfolios took earlier this year won’t help. Couple the fall in asset levels with the incredibly low interest-rate environment and this combination is a formula for disaster. Help is needed now.

But, I Wasn’t Ready

Allianz Life’s 2020 Retirement Risk Readiness Study, published earlier this year highlights the fact that for most Americans choosing when they will retire is likely out of their control. The survey found that more than 50% of Americans were forced to leave the job market earlier than they anticipated as job loss (34%) and health (26%) were cited as the primary reasons.

For those folks who thought that they still had good earning years left to set aside financial resources for retirement, having the proverbial rug pulled out from under them means that their golden years are likely to be tarnished. Importantly, this survey was conducted in January (results were published in April) prior to the Covid-19 crisis that pulverized America’s labor force. One can only imagine the long-term toll this has taken on those who thought that they were on a decent path to financial security.

The study focused on three categories of Americans: pre-retirees (those 10 years or more from retirement); near-retirees (those within 10 years of retirement); and those who are already retired. Given how unprepared many Americans are for retirement, and the situation has only gotten worse, 65% of non-retirees said that they would likely work or have to work in retirement. The reality is that only 7% of retirees actually have at least a part-time job. The fact that 37 million Americans have filed for initial unemployment claims in the last 7 weeks have likely exacerbated the lack of access to employment.

Most Americans know that they aren’t prepared for retirement, but there is little that they can do, as daily living expenses eat up most of their financial resources. Again, Covid-19 is highlighting just how fragile the economic situation is for most Americans. Defined contribution plans were never intended to be used as one’s primary retirement vehicle, but as supplemental income funds. Who has any supplemental income? We need a retirement system that has the defined benefit pension as the foundation of any retirement program. Without this support, too many Americans will fall onto the social safety net long before they die. That is just not acceptable!

Stick Finger In The Air – Wait For The Breeze

We continue to marvel at how many pension plans, primarily in the public and multiemployer space, drive asset allocation decisions through a return on asset (ROA) lens. This is done despite the fact that the ROA is NOT a calculated number, but is often determined because it solves the equation regarding a certain contribution level that is “acceptable”. At best it is a rough guess, and at worst it is nothing more than a Goldilocks solution – not too high, not too low, just about right!

Given this understanding, I read with interest that Axios reported, from data generated by eVestment, that 206 public pension plans with roughly $4.0 trillion in AUM now had an average allocation to fixed income that was at 28.4% at the close of the first quarter, up from 24.5% at year-end 2019. I can’t imagine that this was some kind of strategic or dynamic shift given that equities (R3000) declined by about 21%, while bonds were up 3.2% (Agg.). Furthermore, for comparison purposes, P&I’s asset allocation data indicates that the top 1000 corporate plans had an average allocation to fixed income of nearly 48%, as of September 30, 2019. Despite the significantly greater exposure to fixed income assets corporate plans still saw their funded status decline during the quarter. One can only imagine what the funded status hit would look like for non-FASB plans if a true discount rate were used in the calculation of plan liabilities.

A true ROA can be calculated by utilizing the Asset Exhaustion Test (AET) that is required under GASB 67 and 68. We’ve often found that the real ROA needed to fund these plans tends to be less than the current return target, meaning that plans can utilize a more conservative asset allocation. Furthermore, by incorporating a cash flow driven (CDI) approach to matching and funding near-term benefit payments, these plans that are utilizing a greater exposure to alternative products now have more time to meet future liability growth without needing to have them become a source of liquidity.

Let’s try a new course. Can we agree that the pension promise that has been made to participants is important and that it needs to be funded? Can we also agree that by focusing on pension liabilities, we can devise an asset allocation strategy that is more precise in meeting the needs of the plan? We believe that blazing this new course will help a plan stabilize contribution expenses and the funded status. Furthermore, the pension plan will improve liquidity to meet benefit payments, reduce overall risk, extend the investing horizon for the alpha assets, and eliminate interest-rate risk for the portion of the portfolio that is now cash flow matched. Not bad, at all! You don’t believe that all of these benefits are possible? Call us.

Is It An Illusion?

We are all in search of positive news and April’s market performance is certainly welcomed, especially on the heels of the first quarter’s devastating results. The Milliman 100 Public Pension Funding Index showed an aggregate 5.92% performance increase for the month – great! Unfortunately, the industry, as it relates to public plans, continues to only focus on the asset side of the equation. In the article highlighting April’s gains, funded ratios were also mentioned and they showed an average “jump” from 66% to 69.8%, but pension liabilities were no where to be found.

We all know that GASB permits public pension plans to value their liabilities at the ROA for discounting purposes, but who is that helping? It isn’t helping the plan trustees who make critical decisions based on one set of books. It isn’t helping the taxpayer who believes what is being reported to be “true”. It certainly isn’t helping the plan participant, who is likely making long-range plans based on the assumption that the promised retirement benefit will be there when they call it a career.

As an example, NJ’s big three pensions – Teachers, P&F, and Employees – have aggregate assets of roughly $80.5 billion (through 4/30). They are reporting liabilities using a 7.3% discount rate of $176.7 billion for a funded ratio of 45.6%. In actuality, the liability is actually $372.2 billion when using an appropriate valuation using a true mark-to-market discount (1.42% in this example). The funded ratio is actually less than 1/2 that which is being reported at 21.6%.

As anyone knows who has read these blog posts for the last 4-5 years, we are huge fans of DB pension plans, but we can’t be doing the same old, same old. It is nearly impossible to tackle an issue if you don’t know the true magnitude of the problem. Many of today’s pension issues have to do with the accounting rules, as they lack consistency. There is no justification that we operate with two sets of guidelines for valuing pension liabilities. The argument that public plans are perpetual doesn’t carry any water with me. Just because something on paper appears to be perpetual doesn’t mean that it is sustainable. Just ask the folks in the Jacksonville, FL Police and Fire plan. As contribution expenses eat up more and more of state budgets they are encroaching more and more on precious resources needed to fund other elements of the social safety net.

We need to adopt one set of books that will lead to the full funding of these plans and not some gimmick that inflates the ROA so that public plans can keep contributions low. This practice has done significant and long-term harm to pension systems throughout the US.

Will It Pass?

The House of Representatives is preparing to vote as early as tomorrow on a proposed $3 trillion stimulus package (aka HEROES ACT) that consists of 1,815 pages of what Senate Republicans are calling the Democrats ultimate “wish list”. Among the proposals is much needed financial support for struggling multiemployer pension plans. We’ve highlighted for years why addressing this situation is so critically important. However, I am concerned that this all-encompassing legislation will not see the light of day, as Senate Republicans are already proclaiming that this legislation is dead on arrival.

As you may recall, the House passed in July 2019, through bi-partisan support, H.R. 397 (the Butch Lewis Act). I would prefer that this legislation be moved by the Senate before tackling the Heroes Act, which will likely be stalled, watered down, or not acted on at all. The participants in critical and declining multiemployer plans have been fighting for government support for years, and any further delays will ultimately create a situation that sees more than 1 million Americans lose their promised, and EARNED, benefits.

The market correction that we are living through right now has further negatively impacted the funded status of these struggling plans and shortened the likely time frame for insolvency and their ultimate destiny at the PBGC, where promised benefits go to die.

A lot has been written about our ability as a nation to incur further increases in the “deficit”. I’d like to encourage anyone that hasn’t taken the time to study Modern Monetary Theory (MMT) to do so, as you will find that a public debt results in a private surplus. Are we spending too much at this time? Only time will tell, but we need to do what we can to save our economic future, which has been crushed with these lock-downs.

I am blessed to have as a friend and former colleague, Charles DuBois, who invited me to learn about MMT some 7 or 8 years ago. I continue to learn so much from Chuck. He shared with me the other day the following:

“If, and only if, a nation is operating below full usage of its real resources, then public sector deficits can be increased with no negative consequences – currently or in the future.” AND
“This proposition holds only for nations with their own free-floating currency, no debt denominated in a foreign currency and an operating central bank e.g. US, UK, Canada – but not the EU, etc.”

Furthermore, inflation is the constraint. We need to insure that we have the economic capacity to meet the heightened demand that the Federal deficit will produce. There are roughly 37 million unemployed Americans anxious to get back to work to help produce those needed goods.

Bottom line: We shouldn’t be focused on the “cost” of saving these critically important pension systems for fear that the deficit will impact our children’s and grandchildren’s ability to get the goods that they will demand. That myth carries no weight, as there is no crowding out impact.