As a lifelong Mets fan, I wish that the title of this article was referring to the heroics of Mets rookie first baseman Pete Alonso, but unfortunately, I am writing today about the continuing demise of defined benefit plans in the private sector.  Clearly, companies have been moving away from offering pension plans for years, but the pace has certainly accelerated and is now rivaling Usain Bolt in his heyday.

According to an article that appeared in the Greater Baton Rouge Business Report, only 81 companies within the Fortune 500 were still sponsoring a plan as of 2017. There were 288 as recently as 1998. Coinciding with this move is the greater use of pension risk transfer strategies, which has seen a 143% increase from 203 plans in 2012 to 493 in 2018.

Placing the burden on employees to fund, manage, and then disburse a retirement benefit is just not good policy. Many Americans are not comfortable with having this responsibility and furthermore don’t have the disposable income to put enough into an account to build the necessary nest egg for a successful retirement.

The Pension Benefit Guaranty Corporation (PBGC) has issued a report detailing its financial health, and unfortunately, the agency may need life support. According to the release, the average expected deficit for the multiemployer backstop is $90 billion by 2028. Worse, however, is the fact that there is a 90% probability that the agency will be bankrupt by 2025.

If Congress fails to put in place a funding solution quickly, there’s a very high likelihood that benefit guarantees will have to be drastically slashed. As a reminder, multiemployer benefits are only protected at a small percentage of those in the private sector. For instance, a 30-year employee would only receive an annual benefit of $12,870, while the same private sector pension recipient would have there benefit protected to $65,000.

Given the projected insolvency for this agency in a relatively short period of time and you can see why tackling the multiemployer pension crisis is of utmost urgency given that we have 1.4 million American workers in plans that are currently designated as Critical and Declining and another 9 million workers who would no longer have the safety net available to them should their plans ultimately falter.

The House recently passed legislation (H.R. 397) to enact a loan program to provide a lifeline to those plans that are deemed Critical and Declining. Let’s hope that the Senate can support this legislation, too. However, I am afraid that they will seek alternatives to the Butch Lewis Act and in the process, mucking up currently healthy plans, while also subjecting participants to steep cuts. Let’s hope that I am wrong!

As anyone knows that follows this blog, the Butch Lewis Act has passed through the House and currently resides in the Senate. The backbone of this legislation is a government loan program that provides low-interest rate loans provided by a government agency within the Treasury. When the legislation was first contemplated the loan interest rate, which is set at 25 basis points above the prevailing 30-year Treasury Bond was going to be roughly 3.25%-3.5%.

This morning the U.S. 30-year Treasury Bond’s yield is an incredible 2.14%. If ever there was a time for these troubled funds to get a lifeline it is now. The roughly 1% savings on the interest rate further improves the likelihood that these loans get repaid in 30 years, while further reducing the needed annual return, which has been only 6.5%, to fund the interest payment, balloon payment, and future benefits.

Perhaps our friends at Cheiron could run a quick and dirty analysis to depict how this incredible move in rates would further aid our struggling multiemployer plans. I implore the U.S. Senate to stop dawdling and get to work passing this important legislation so that we can begin to heal these critically important plans at a likely deep discount to what was originally contemplated.

The WSJ published an article today titled, “America’s Pension Funds Fell Short in 2019”. The subtitle to the article mentioned that public pension plans with assets greater than $1 billion generated a median return of 6.79% during the fiscal year ending June 30, 2019.  Wilshire Trust Universe Comparison Service produced and published this information. The 6.79% was the weakest annual return since 2016 for these large funds and it fell short of the 7.25% average return on asset assumption (ROA) for plans of this size.

Given the fact that the average funded ratio for public pension systems in only 73% (under GASB accounting standards) just meeting the ROA target is going to do nothing to close the funding gap. But, more importantly, the primary objective in managing a pension plan shouldn’t be return focused. The primary objective should be to SECURE the promised benefits at low cost and reasonable risk. Furthermore, public pension systems should adopt a greater liability focus. I am always intrigued by the fact that plans generally know the total plan assets that they have on a daily basis, but can’t tell you what the plan’s liabilities are except on an annual basis (maybe).

In an environment of greater liability transparency and one that has liabilities measured on a mark-to-market basis, a year like 2019, in which the median large public plan generated a 6.79% return, may not be so bad if that return exceeded liability growth. Because the liabilities are bond-like in that their value rises and falls with changes in interest rates, liability growth could be negative. Does a plan really need to generate the 7.25% ROA in such an environment? Hell no. We need public pension systems to produce returns that exceed the growth in their liabilities- nothing more and certainly nothing less.

It may be a fun exercise to see how the median public pension system is performing, but given the fact that every pension’s liabilities are like snow flakes, it really is a worthless comparison. Pension plan trustees would be better served and they could make more informed decisions if we used the appropriate benchmark to measure plan assets versus plan specific liabilities.

Using the return on asset assumption (ROA) as the discount rate for pension plan liabilities has masked the true funded status for those pension systems operating under a GASB accounting framework. As most everyone knows, liabilities are bond-like in how they move with changes in interest rates.  However, because the ROA is the discounting mechanism that fact is hidden from plan trustees.

The U.S. has enjoyed an incredible bull market for bonds since the early 1980s. In fact, my entire 38-year career in this industry has basically witnessed a bond bull market with only the occasional short-term “correction”. Most market practitioners felt that the bond market was about to enter bear market territory some three years ago only to have interest rates rally considerably since last November. In fact the U.S. 10-year Treasury yield has fallen to 1.76% as of this morning for an incredible rally from 3.24% just 9 months ago.

But, we believe that now is the time to adopt a true mark-to-market valuation for pension plan liabilities.  Why? There isn’t much more room for rates to fall given the rapid decline in rates that we’ve witnessed and the absolute level of yields today. Gaining a greater understanding of the true funded status will help plan sponsors and their consultants make more informed funding decisions.

Furthermore, because liabilities are bond-like, a rising interest rate environment will create a scenario in which liability growth could be negative.  In such an environment, asset growth of only 5% could dramatically improve the plan’s funded status.  Link together a few years of negative liability growth with modest asset growth and a plan could enjoy a rapid improvement in the system’s funding.

Most pension systems are reluctant to adopt a mark-to-market accounting of their plan’s liabilities given the potential optics associated with a more negative story. However, continuing on the current course may not show well either, as asset growth after a 10+ year bull market for equities may not deliver returns in line with the ROA. In an environment in which plans fail to deliver against the ROA the funded status will continue to deteriorate.  However, with a greater knowledge of plan liabilities plans my actually see improved funding even in an environment in which returns are more muted.

Let’s remember that the goal of a pension system should be to secure the promised benefits at reasonable cost. We believe that the objective is much more attainable when all of the relevant facts are known, including the true value of plan liabilities.

I’ve spent most of my career focused on general pension-related issues, and recently with a more laser focus on funding policies and asset allocation geared to the pension plan’s liabilities.  Anyone who reads this blog knows that we have many issues in this country when it comes to funding pension systems and protecting those important benefits. But, pension funding issues may just be a drop in the bucket for municipalities and states, as other post-employment benefits (OPEBs) appear to be a greater issue looming on the horizon. OPEBs primarily consist of post-retirement healthcare.

Just how bad is the issue? We’ll need to do much more research to provide a more comprehensive and accurate response, but here is an example that was shared with me. According to the audit as of June 2018, Warwick, RI, has an OPEB liability of $405.8 million. Alarmingly, the ARC for the city’s OPEBs recently jumped from $21 million to $34 million, representing an increase of  61.9%! More unimaginable is the fact that the city hasn’t contributed 1 penny to this >$400 million in liabilities.

It is interesting that they recently contributed $13.4 million to fund the city’s four pension plans. The current pension liability is roughly $435 million. Unfortunately, pension inflation and healthcare inflation have very different growth rates. The fact that one promise is being funded while another seems to be totally neglected is perplexing. Both liabilities will need to be paid. I certainly wouldn’t want to be an elected official in that town when the piper comes calling.

Let’s hope that this situation is unique, but I fear that I’m being too optimistic. Much more to come!

The return on asset (ROA) calculation

The ROA calculation is certainly a mysterious activity. Why would a pension plan with a 60% funded ratio and another with a 90% funded ratio have the same ROA, which we witness frequently? Why is the ROA so static when market returns are so volatile? The truth is the ROA is not a calculated number but a target return. Moreover, pension plans are brain washed into thinking that if they don’t earn the ROA they cannot become fully funded – this is incorrect thinking. There are two examples to disprove this ROA mentality:

First, if we use market values for liabilities we can easily see that liabilities are highly interest rate sensitive (bond-like in nature). Using the 30-year Treasury as a proxy for liabilities reveals that a small increase in interest rates (+60 bps per year) would create negative growth in liabilities! How great would it be if you were playing a sport and your opponent could score negative points? Accordingly, any positive growth in assets would enhance the funded ratio. In just five years a 60% funded ratio could be 89% funded with just 5% asset growth and a 70% funded ratio would become 104% and in no case did your fund match or exceed the ROA!

5-year Horizon

Liabilities (30-yr Treasury) = if the discount rate goes from 2.50% to 5.50%

                                                         Liabilities Growth Rate = (3.06%)

                                                         Assuming a Liability duration = 12 years

                                                        —– Annual Growth Rate —–

                     Assets growth           5.00%       6.00%       7.00%          

                     Liabilities                – 3.06%       -3.06%     – 3.06%

                     Alpha (Annual)        8.06%       9.06%       10.06%  

Produces

     Funded Ratio = 60% …        89.37%     93.79%       96.46%

                                = 70% …        104.36%   109.41%    111.47%

Secondly, under GASB 67/68 public pensions need to run an asset exhaustion test (AET). The AET determines at what point in time the assets are exhausted (including contributions) and can no longer fund benefit payments. At that point the discount rate bifurcates into a 20-year AA muni yield if the plan has not consistently paid the ARC (did someone say NJ?). This exercise brings up two key considerations. GASB is now requiring using market rates to price liabilities and contributions are now included as assets. What has been missing from the funded ratio forever has been contributions. Contributions are a very large future asset and initially fund benefit payments plus administrative expenses. In truth, current assets fund the net liabilities after contributions and not the gross projected liabilities!

Because of the singular focus on the ROA, many pension systems have injected significant risk into their asset allocation in an attempt to achieve the out-sized returns dictated by the ROA. In addition, striving for a greater ROA has caused pension systems to habitually underfund their plans. By adopting a greater liability focus, plans will be able to understand that achieving the ROA is not the objective, but having assets outperform liability growth is all that matters. Remember, the pension mission is to secure the benefits in a cost effective manner. It is NOT to generate the highest return, which guarantees greater risk but not more return!

I am thrilled to announce that I’ve joined Ryan ALM. I’ve had the pleasure of working closely with Ron Ryan on a number of initiatives during the last 6+ years. I believe that Ron is one of the few true visionaries in our industry, and I am very much looking forward to continuing to learn from him. There are many challenges facing the retirement industry today and it will take a “back to the future” mentality to overcome them. At Ryan ALM we have the tools to help plan sponsors and their consultants navigate these difficult waters. Don’t hesitate to reach out to us if you desire smoother sailing.

Here is the press release announcing my arrival:

PRESS RELEASE

Ryan ALM hires Russ Kamp as Managing Director

July 29, 2019 – Ryan ALM, Inc., a well-known asset/liability manager, custom liability index, and ASC 715 discount rate provider has hired Russell D. Kamp, formerly head of Kamp Consulting Solutions, as Managing Director. Russ will be involved in all aspects of the Ryan ALM business, but his primary focus will be to head sales/marketing and client service.

Ron Ryan, founder of Ryan ALM, reports, “Ryan ALM is honored and excited to have Russ Kamp join us. In his capacity as managing director, Russ will oversee our marketing efforts and be directly involved with all aspects of our business. I know of few people with the investment knowledge, acumen, and refinement as Russ. He will serve us and our clients well.”

Russ Kamp responded, “This is a great opportunity to work with Ryan ALM and especially Ron Ryan, with whom I’ve worked closely for the past 6 years. I believe in the Ryan ALM mission statement to secure benefits in a cost-effective manner with low risk. The financial models here are unique in the pension world (Liability Beta Portfolio and Custom Liability Index) and provide a true synergistic value to any client and their consultant. As a former consultant who appreciates the challenges that plan sponsors face today, I understand the value added that Ryan ALM brings to every plan sponsor.”

Mr. Kamp was formerly founder of Kamp Consulting Solutions (KCS), a full-service asset/liability consulting firm. Prior to KCS, Russ was Director, Asset Management at Two Sigma Investments, as well as the Global CEO at Invesco’s IQS Group (Quantitative Strategies). He is a frequent speaker at industry seminars, where he is often the chairperson, and a prolific author of pension articles and blogs.

Russ, welcome aboard!

The Committee for a Responsible Federal Budget produced a blog the other day. Here is the first paragraph –

“The House Ways & Means Committee is considering pension reform legislation that CBO estimates will add $64 billion to deficits over the next ten years and could ultimately cost substantially more because of a relatively gimmicky loan approach that allows pensions to pay back only interest for the next 29 years and requires a massive balloon payment in year 30.”

The fact that the bill is proposing ONLY a $64 billion loan package to be spent over 10 years seems a drop in the bucket given the estimated federal fiscal year budget deficit (10/1/18 to 9/30/19) for 2019, which is estimated to be $1.09 trillion, and 2020’s budget shortfall that will grow an estimated 1% on top of that figure.

Would they rather have these pension systems fail and then witness nearly 1.3 million American plan participants fall onto the social safety net?  Furthermore, Cheiron (pension actuary) has calculated that 111 of the 114 pension systems tested in support of the original Butch Lewis Act legislation would be able to make the balloon payment after all was said and done. If so, the “cost” is dramatically lower than the estimated $64 billion. The roughly $6.4 billion to be spent annually to sure up these plans represents 6/10s of 1 basis point per annum.

How about we take care of the people who were promised a benefit and are now facing the growing likelihood that this benefit will be lost or severely reduced through no fault of their own and instead have the Committee for a Responsible Federal Budget tackle the more significant areas of our budget that that seem to have costs spiraling out of control.

Kentucky Governor Matt Bevin has signed legislation to reform pensions in the hope that it eases the financial burden for quasi-government agencies, such as mental health agencies, rape crisis centers, local health departments, etc. The legislation calls for the freezing of contributions from these agencies for another year, allowing them to basically pay half of what they owe until the piper calls in 2020.  That won’t be a pleasant experience when those bills come due!

Another key element of the legislation permits these organizations to withdraw from the state’s pension system and pay off their debt, with interest, over 30 years. The Kentucky pension system is currently the worst funded in the nation at 16%, and the deferment of contributions will likely negatively impact the ongoing funding.  Shockingly, these agencies can move anyone hired after 2013 out of the defined benefit plan and into a defined contribution plan (I can’t imagine that action not being tested in court).

The state’s 118 quasi-governmental agencies can start leaving the Kentucky Retirement System in April. If they do, they have to provide other options for their employees, such as a 401(k), but here’s the rub, they don’t have to continue contributing money toward their retirement! Given that directive do you think that any will?