Happy Holidays, Merry Christmas, and a very happy, healthy, and prosperous New Year to you and yours from the Kamp Family. Thank you for your support and friendship in 2017.  I very much look forward to what 2018 might bring.

Consumer debt has hit an all-time high of 26% of disposable income. In the past five years, consumer debt has outpaced income growth by roughly twice. As a reminder, consumer debt excludes mortgages and home equity loans. The growth in consumer debt has been driven by auto and student loans, no surprise there.

However, what does this portend for the consumer and our economy? According to Ray Boshara, Senior Adviser and Director, Center for Household Financial Stability could be both positive and negative (now doesn’t that sound just like an economist). According to Ray, the significant growth in consumer debt could reflect American’s greater confidence in the economy, willingness to invest in assets that build wealth, such as education, and it can also signal that consumers have taken advantage of the lower interest rate environment by paying off previous loans and are now seeking additional borrowing.

However, this growing debt could signal trouble ahead for the U.S. economy, as families use debt to acquire necessities. Rising family debts can diminish future economic activity. In a period of rising rates, the extra interest burden could put this debt at risk of repayment. We are already witnessing troubling trends with regard to the repayment of the massive U.S. student loan debt (roughly $1.5 trillion).

In any case, the growth of consumer debt relative to income growth certainly reduces the amount of disposable income available to fund retirement accounts, in an age where individuals are already contributing far less than what is necessary to build an adequate retirement nest egg.

According to the WSJ, there are two provisions in the tax bill that relate to retirement. First, borrowers of 401(k) loans will now have more time to pay back the loan after leaving their job. Currently, the employee has to repay the loan within 60 days following departure from their employer or face taxes and a possible 10% penalty, if younger than 59 1/2 years old.  In the new bill, the loan must be repaid or the proceeds rolled into an IRA by the date of their next Federal tax filing.

The other provision relates to the recharacterizations of Roth conversions, which will cease to exist in the new tax bill. Currently, a conversion to a Roth from a traditional IRA can be reversed by October 15th of the year following the conversion. This tactic was often used by Roth account owners when account balances fell, eliminating the gains that they would have been taxed on.

Thank goodness that early attempts to significantly reduce tax-free contributions into 401(k) plans were rejected.  Clearly, we do not need any additional obstacles for individuals to fund their future retirements.

Here is a new PolicyNote from The New School’s Schwartz Center for Economic Policy Analysis.  The punchline is truly scary:

“Without a universal supplement to Social Security, many of the 24 million workers ages 55-64 will face declining living standards or poverty in just 10 years. One-third of older workers have neither retirement savings through a 401(k) or IRA, or a defined benefit (DB) pension. Overall, the median account balance of workers approaching retirement is just $15,000. The median account balance for those with retirement savings is just $92,000.”

Think about the loss of demand for goods and services that results from this lack of financial resources? Will a majority of these 24 million be able to stay in their homes? That is highly unlikely to happen in states with high property taxes, even before considering that the deductibility of property taxes may be eliminated or significantly reduced for Federal Tax purposes.

So, what happens to these millions of folks? Do they:

1. Fall onto the welfare ranks?
2. Sell assets (homes, cars)
3. Move in with family members?
4. Borrow from family, friends, credit cards, loans, etc.
5. Engage in criminal activity?
6. All of the above

The potential exists for all of the above to become the standard operating procedure for these individuals. You may scoff at these suggestions, especially the one related to criminal activity, but desperate people don’t always think rationally.  Do we really want our senior citizens to live a life without dignity? Do we want them missing meals, doctor appointments, while skimping on other essential items because we didn’t prepare them appropriately for life after work?

For those in our society who claim that we can’t afford defined benefit plans for the masses, I would argue that we can’t afford to add millions more to the welfare ranks.  It is far better to try to pre-fund a retirement benefit that will provide a monthly supplement to Social Security than it is to have a massively bloated welfare system.

There are many in our country that would love nothing more than to see public pension systems unwound. They often cite the burgeoning unfunded liabilities as their motivation for this action: protecting the taxpayer. In a recent blog post on Burypensions Blog (not much doubt where the author stands on this subject) he listed some data that had been extracted from a recent Fitch Report, and on the “evidence” it looks damning for states such as Illinois, NJ, Massachusetts, and Kentucky with estimated unfunded liabilities totaling $352 billion. The unfunded liabilities were calculated using a mark-to-market discount rate (2.14%) instead of the return on asset assumption that is permitted under GASB (average is roughly 7.5%).

The use of the defined benefit plan has been dramatically reduced in the private sector with roughly 120,000+ plans having been terminated since the mid-‘80s. There are currently about 23,000 DB plans still functioning that cover roughly 15% of the private sector and about 85% of the public sector. At one point in time, nearly 50% of the private sector was covered by a DB plan.

We would suggest that the issue isn’t the DB plan, but how they have been mismanaged. These plans function well when annual required contributions are made, benefits are calculated based on lifetime earnings (salaries), and not spiked with overtime, sick and vacation pay, etc., plans focus on their specific promise (liability) to drive asset allocation and investment structure decisions, and not managed to some artificial return on asset number that is primarily used to calculate contributions, but in doing so has added far more risk to the process with little reward to show.

I get that those in the private sector are naturally concerned about their lack of a retirement benefit and the potential growing cost to fund the retirement plan of someone else. This pension envy is understandable but misdirected. The incredible risk transfer that began to take place in the early ‘80s from corporate America funding and managing a retirement benefit to the individual employee being asked to now take on this responsibility with far fewer skills is crippling America’s retirement dream for most of us. This is a huge policy misstep that needs to be corrected, and fast!

What many fail to realize is that there is a great benefit (no pun intended) to the local economies where DB plan beneficiaries live, as they spend those monthly checks that they receive, which is a proven catalyst to economic activity and tax receipts at the federal level. Does it make sense to close DB plans that ensure a monthly compensation and use DC plans that don’t? Of course not!

So, what can be done? First, we need to support efforts to get the private sector workforce back into DB plans, whether at their companies (highly unlikely) or through a state or federal effort. Second, for those plans that remain open, we need to get sponsors and their consultants to adopt more of a liability focus to the day-to-day management. As previously stated, managing to the ROA has only injected more risk into the process with little certainty of success. Understanding the promise that has been made and managing to that promise should be the standard operating procedure. By doing so, one establishes a glide path to full funding, whether at 50% funded or 90%. The U.S. equity and bond markets have enjoyed long bull markets, but for how much longer? Despite this rosy market environment, funded ratios are stubbornly low, while contributions expense is growing rapidly – not a great combination.

DB plans need to be supported, as they are the only true retirement vehicle. The absence of DB plans will place a greater burden on an aging population that already has a significant percentage of their cohort living on Social Security wages only. Economic growth in the U.S. has been modest, at best, for the last 12 years. Can you imagine what it would look like if we had 10s of millions of “retirees” living exclusively on a Social Security benefit? Where would the economic activity come from?

The following chart highlights the fact that the “recovery” since the GFC has left many Americans behind. According to Credit Suisse and the U.S. Federal Reserve, the median American household hasn’t come close to recovering their level of net worth achieved as of early 2007. The shortfall has been attributed to lower ownership rates of stocks and lower housing prices for the least-wealthy groups.

Will the benefits from a reduction in corporate tax rates being considered in the Republican tax proposal filter through to the average American? Unfortunately, they are not likely if the proceeds are used to increase dividends and share buybacks given the low ownership of stocks among the median American household, as opposed to reinvestment in plants, equipment, inventory, jobs, and wages.

Remember, more than 40% of the private sector doesn’t have access to an employer-sponsored retirement plan, and it is an unfortunate fact that the average American household does not save when not contributing to their employer’s retirement plan. Furthermore, income inequality has a negative impact on economic growth rates, so it isn’t surprising that the U.S. hasn’t generated an annual GDP growth rate >3% since 2005, as incomes between the few haves and the many have-nots have grown to its widest point.

I have just returned from Las Vegas, NV where I was very pleased to participate in the most recent CORPaTH conference. This organization should be applauded for their continued work to preserve and protect defined benefit pension plans as the backbone of the U.S. retirement industry.  Importantly, their mission mirrors ours at KCS, which is why I was honored to be asked to speak on one of the panels.

The panel that I participated on involved three senior consultants from leading asset consulting firms and KCS, which was by far the smallest and least well-known entity.  We were each given an opportunity to provide an overview of the current state of the retirement industry. What became obvious to me was the continued focus by these leading firms/consultants on the asset side of the equation, as each stated how difficult it will be in the near-term to generate returns commensurate with a plan’s return on asset objective (ROA). I don’t disagree.

However, we believe that trying to cobble together a collection of asset classes and investment products has always been a challenging problem. There is great uncertainty over short to intermediate timeframes, and worse, there is no assurance that meeting or exceeding one’s ROA will guarantee funding success (please see KCS’s May 2016 Fireside Chat). To this point, we believe that managing a pension plan should be about delivering the promise at the lowest cost.

But, this entails getting one’s arms around the plan’s specific liabilities, and an update from the plan’s actuary once per year is not nearly often enough. Why is it the plan sponsors can tell you on a monthly, if not daily, basis what the market value of their plan’s assets is, but they truly don’t have a feel for the liabilities? We believe that by changing the focus from assets to liabilities, one can set the plan on a derisking path to full-funding in which both the funded status and contribution expense become less volatile. Wouldn’t that appeal to you?

The plan’s funded status should drive investment structure and asset allocation decisions. It should not be some “estimated” ROA. DB plans need to be protected and preserved but doing the same thing over and over, which hasn’t brought funding success to most plans, is certainly not the way to proceed. Embrace your plan’s liabilities, and this new found insight might just lead to your plan achieving greater success.

We, at KCS, have been railing about the impending U.S. retirement crisis since our founding in August 2011, primarily because of the demise of the defined benefit plan and greater use of defined contribution offerings.  However, we’ve been cautiously optimistic that the Millennial generation was going to turn the tide on this looming social crisis.  That is until we stumbled on a recent survey by Earnest, Amino, and Ipsos found that only 31% of this cohort (those born in the early ’80s to mid-’90s) were actually saving for retirement.

In addition, roughly 46% of Millennials reported that they’d have a difficult time covering bills if just their next paycheck was withheld. As scary as this number is, it pales in comparison to a US News and World report from 2016 that had a full 63% of the U.S. adult population not being able to meet within a 30-day period a $400 emergency auto repair or medical expense.

We know that the growing burden of student loan debt is negatively impacting a number of areas of our economy from the delay of family unit creation to the purchase of one’s first home, but the long-term implications of the failure to adequately prepare for retirement may be the most devastating of all. Saving as early and often as one can improve one’s financial situation later in life. The compounding of those early contributions will help to a far greater extent than the possibility of makeup contributions later in life.

Thank you to Rob Coursey, Value Line Funds, who shared the following fact with me. Americans age 55 and older make up more than a fifth of the total labor force today (22.8%, seasonally adjusted), compared with 17.6% at the start of the Great Financial Crisis. Over the last 10 years, in fact, labor force participation has risen only among the 55-and-older contingent.  Source: Pew Research

Think that this is an anomaly? I don’t! At KCS, we believe that the 55-and-older crowd will continue to see their participation in the labor force grow. The elimination of defined benefit pensions in the private sector and the greater use of defined contribution plans will force employees to remain in the workforce for much longer periods of time, if they are lucky to have that option.

Happy to share with you the video from a recent interview that I did with Asset.tv.  I sincerely appreciate the on-going support from the staff at Asset.tv, who remain as concerned about the future of the U.S. retirement industry, as we, at KCS, do.

Our conversation touched on the onerous impact on individuals from the demise of the traditional DB pension plan, the burden that this trend is now placing on employees, and what KCS is doing to try and preserve DB plans for both the private and public workforce.

We encourage you to reach out to us with any comments and/or questions.  We want to be a resource to those in the retirement industry who are trying to preserve and protect this critically important benefit. Without DB retirement plans, I believe that we will face profoundly negative social and economic consequences.