If Only!

The fourth quarter provided a tremendous amount of pain for Pension America. The feared double whammy occurred in which interest rates fell, increasing the present value of a plan’s liabilities, while assets simultaneously fell, too.  The combination impacted plan funded status and future contribution expense.

What could have been done to mitigate this risk? For plans focused on the return on asset assumption (ROA) as the primary objective, I would suggest that not much would have or could have been done.  ROA chasers have a set it and forget it mentality.  This “strategy” has unfortunately been the primary pension game for about 40 years coinciding with the explosion in the use of asset consulting firms.

For those few plans that are focused on the plan’s assets versus that plan’s specific liabilities, the end of the third quarter would have provided an outstanding opportunity to reduce risk within the portfolio in a responsive way.  However, in order to implement this action, one would have had to be monitoring their plan liabilities more frequently than the once per year view that is customary.

What was the opportunity? At the end of September 2018, a “traditional” asset allocation would have generated a return of 5.8% year-to-date. Furthermore, the backup in U.S. interest rates reduced the present value of plan liabilities (using US Treasury STRIPS) by -5.3%. The combination of these two actions would have worked to improve funding status in a dramatic way.  It would have been the perfect time to move assets from your “growth” portfolio to an insurance bucket designed to meet near-term benefit payments. Few did!

As a result, the fourth quarter’s equity swoon created significant headwinds for that sample plan asset allocation, and by the end of the year, the plan would have generated a -3% return.  A collapse of 8.8% in a single quarter.  Worse, U.S. interest rates began to fall.  The U.S. Treasury 10-year saw it’s yield fall from a high of 3.24% to the year-end low of 2.68%. For all of 2018, the U.S. 10-year had rates rise only 22 basis points. So much for significantly higher rates coming. The Treasury STRIP yield curve produced a -1.26% return for the full year, but that was improved by 4% in one quarter.

If plan sponsors and their consultants had implemented more of a liability focus, they could have protected the funded status and future contribution expense by taking risk off the table at the point when assets were outperforming liabilities by 11.1%.  Instead, the set it and forget it mentality resulted in plan assets underperforming a true market-to-market liability growth rate by -1.7%. We cannot afford to sit by any longer with the wrong pension objective.  Plans must be managed against the promise that they’ve made to their participants.

 

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The Deniers Need To Read This Post!

The following was found on the U.S. Department of the Treasury’s website:

“On December 16, 2014, the Kline-Miller Multiemployer Pension Reform Act of 2014 (MPRA) was enacted into law. In MPRA, Congress established a new process for multiemployer pension plans to propose a temporary or permanent reduction of pension benefits if a plan is projected to run out of money before paying all promised benefits.

MPRA requires the Treasury Department, in consultation with the Pension Benefit Guaranty Corporation (PBGC) and the Department of Labor, to review a multiemployer pension plan’s application to reduce benefits and determine whether it meets the requirements set by Congress.”

The idea of proposing a “temporary or permanent reduction” sounds so simple and almost painless; as if the reduction is nothing more than a slight tax increase. But, the pain inflicted on these innocent participants is real and in many cases, devastating to the pensioner’s financial and psychological well-being, as we’ve heard of situations in which the benefits have been slashed by more than 50%!!

You may recall that we’ve written about Carol (blog posts from 8/22 and 12/3), who is a member of Local 805. Carol was given an early retirement (she worked for 26 years for Panasonic) with the promise of $2,600/month for life. Unfortunately, Local 805’s pension system filed for benefit relief under MPRA, and it has resulted in Carol’s monthly pension being slashed from $2,600 to $1,022 per month, an incredible 61% decline! The reduction was to begin in January 2019.

We’ve just heard from Carol, who shared with us the latest in her unimaginable saga. These are her words: “This afternoon, I went to the bank to see if they could check on the reason my pension check didn’t post yet. I called the pension first, and they said that it must be a problem with the bank. Anyway, I have been afraid to see it in print, but I had a good week to keep repeating the amount I will get….$889.14. That is $1022.00-13%. My forever check was $2262.00, which was $2600.-13% So the bank officer said here it is, it just posted..Local 805 Union in the amount of $671.45. To say I had a meltdown is putting it mildly! I started arguing with the guy, and then I broke down in tears…he couldn’t understand me…I was shaking…I felt physically sick. He got me a glass of water and I sat there talking outloud to myself for a while. Then I pulled out my phone and called the union. I got the same girl as I did earlier. She asked for my SS# then got back on the line and said in a jovial voice, “Oh, I see what they did…you were getting $338.00 deducted from each check for taxes”…I said yes I know…13%, so I figured my new amount deducting 13% and it should be $889.14. So she said, “well I guess instead of figuring it out, they just carried over the amount you always had deducted”..I was screaming at her…I said this will barely pay my gas and electric…how could you take over $200.0 more out of a pension that was already cut 61%?   She said it wasn’t them, it was the government…she will send me a form I have to fill out, mail to the tax department and they will change it!’ How screwed up is that? Who the hell knows if I will get that $217.69. I’m done… I’m just done. I should be able to sleep because I’ve been living on cat naps, but I cant. Thanks for being here because I had to let it out…it won’t change things, but I still had to vent.”

The ability to significantly reduce a beneficiary’s pension is an incredibly callous action with absolutely no regard for the individual’s future. The fact that Congress has permitted this action is unacceptable. I guess that we shouldn’t hold out much hope that they will see the error of their ways and finally pass legislation that will help preserve and protect the potentially millions of “Carols” that are facing a similar fate. The longer that they delay (where are we with the Joint Select Committee on Solvency of Multiemployer pension plans?) the more likely that we will see the list of critical and declining plans expand.

Furthermore, we are more than 10 years into a stock market recovery that is showing signs of exhaustion. Funded status hasn’t improved much during this recovery despite outsized equity returns. Just how devastating will another market correction be on these plans and pensioners? We need action now, as Carol, and millions more, are counting on us to remedy this nightmarish situation. There is a retirement crisis that needs our attention. Will you be part of the solution?

Big Change Coming

I hope that everyone had a wonderful holiday season.  Furthermore, I wish each of you a healthy and prosperous New Year!

After 7+ years, I will be leaving KCS to join Alan Biller and Associates as a Managing Senior Consultant.  I will continue to work from New Jersey, primarily covering the firm’s east coast clients and prospects. This is a wonderful opportunity for me to join an outstanding asset and liability consulting firm, whose mission mirrors that of KCS.

Lastly, I want to thank everyone who supported our efforts at KCS.  The past 7 years have been a tremendous learning experience, and I very much look forward to this next chapter in my career.

Another Example

On December 4, 2018, we wrote a post regarding degree inflation within Corporate America. We’ve witnessed greater educational demands placed on candidates requiring higher degrees than previously requested or for those currently in the position. The WSJ is once again reporting on this issue, but this time it isn’t corporate America, but America’s public schools.

At a time when teachers and other school employees are quitting at a historic pace (83/10,000), many public school systems are requiring that the teachers have a Masters degree to be in the classroom. As you can imagine, given the cost of an advanced degree, this is forcing many of these teachers to take out additional student loans (including undergrad), which is only making their situation more untenable. Why? Since 2009, the average teacher’s salary, adjusted for inflation, has fallen -5%. Even as wage growth has accelerated, the average teacher’s compensation only grew 2.2% for the last year through October compared to the 3.1% witnessed in the private sector.

Incredibly, the Labor Department is reporting that 1 million teachers have quit public education positions in just the last 12-months. There are only about 10 million in public education. As of December 2018, it is estimated that there are about 7.1 million job openings in our country (all industries), and the reason often cited is a skills gap.  Well, it doesn’t seem implausible to find a connection between our unwillingness to pay competitive salaries for quality teachers that would help educate our next generation of STEM students who might just get the education needed to be ready to fill many of those open positions in the next decade or so. If education isn’t valued, then what is?

Just Shifting Deck Chairs On The Titanic

You may not have been following KCS’s blog in January of this past year when we produced the following blog post. We questioned the logic of focusing on the ROA as the plan’s primary objective.  We especially challenged the notion that shifting a couple of percent from one asset class to another would produce meaningful results for the pension system. Clearly, given the results produced by asset classes in 2018, it didn’t matter where you placed your assets. There really weren’t any places to hide. Here is that post.

An article appears in today’s WSJ highlighting a dilemma for U.S. public pension plans, but it could be addressing a similar concern for all DB plans, including multiemployer and private plans, that continue to focus on the return on asset assumption (ROA) as the primary objective for both plan sponsors and their asset consultants. You see, most of the retirement community has been sold a bag of rotten goods claiming that a plan needs to generate the ROA or it will not meet its funding goals.  Hogwash!

So, when valuations for most asset classes seem to be stretched, where does a pension plan go to allocate their plan’s assets? Well, this “issue” has plan sponsors once again scratching their collective heads and doing the Curly shuffle.  You see, they have once again through the presumed support of their consultants, begun to approach asset allocation as nothing more than rearranging the deck chairs on the Titanic.

Despite tremendous gains from both equity and fixed income bull markets, these plans are willing to “let it ride” instead of altering their approach to possibly reduce risk, stabilize the funded status, and moderate contribution expense. Can you believe that the California State Teachers Retirement System, the country’s second-largest public plan, has recently decided to roll back fixed income exposure by 2% and equity exposure by 1% from 55% to 54%?  Are you kidding me? Is that truly meaningful or heroic?

Please note that generating a return commensurate with the ROA is not going to guarantee success.  Furthermore, since most public pension plans are currently woefully funded on an actuarial basis, meeting this objective will only further exacerbate the UAAL.

These plans don’t need the status quo approach that has been tried for decades. Real pension reform must be implemented before these plans are no longer sustainable, despite the claim that they are perpetual.  As an industry, we have an obligation to ensure the promised benefits are there when needed. Doing the same old, same old places our ability to meet this responsibility in jeopardy. If valuations are truly stretched, why allow your allocations to remain basically stagnant?

What Does The Future Have In Store? A revisit.

The following blog post was written on January 22, 2018.  We were trying, once again, to encourage plan sponsors to take some of the risks out of their portfolios by adopting a great focus on plan liabilities. We were concerned that plans would not be able to generate returns from traditional asset classes that would support the exclusive pursuit of the return on asset (ROA) objective. Unfortunately, this is proving correct. Here is the post.

The WSJ published an article on Sunday that questions return assumptions by America’s pension plan sponsors and their consultants. The author, Jason Zweig, is particularly concerned given that U.S. stocks are currently at all-time highs.

Zweig references a study by professors Aleksandar Andonov of Erasmus University Rotterdam and Joshua Rauh of Stanford University who looked at expected returns among more than 230 public pension plans with more than $2.8 trillion in combined assets. The professors estimate that the average return on asset assumption (ROA) for these plans is 7.6%, which is roughly 4.8% above an inflation assumption. Almost 25% of these large plans still expect to generate a return in excess of 8%.

The study looks at the average pension plan’s investment profile by asset class.  The average plan has exposure to cash, bonds, both U.S. and international, U.S. and international stocks, real estate, hedge funds, private equity, and real assets (commodities). In order to achieve the 4.8% real return, plan sponsors were asked to forecast the returns that they would get over the long-term (10-30 years). The study reveals that plan sponsors expect to achieve a 3.2% return from cash, 4.9% from bonds, 8.7% from stocks, 6.9% from hedge funds, 7.7% from real assets, including real estate, and 10.3% from private equity.

Given that interest rates are substantially below the cash and bond expectations for future returns, a plan would have to make a dramatic switch into lower quality instruments in order to come close to those return targets.  Furthermore, corporate America has produced a roughly 6.3% annual growth in dividends and earnings for about the last 100 years, while the stock market has generated a 6.5% real return. How likely is it that stocks will achieve the forecasted 8.7% with valuations at these levels? Not likely.

As we’ve discussed in previous blogs, the U.S. pension game has morphed into a return seeking endeavor as opposed to the original mandate, which was one predicated on providing the promised benefits at the lowest cost. Pension plans can protect their funded status in this environment by adopting a bifurcated approach to asset allocation. By adopting this approach the pension plan can reduce cost and volatility by cash flow matching near-term retired lives, while extending the investing horizon for the balance of the corpus, that now benefits from more time to capture the liquidity premium that exists in equities, real assets, private equity, etc.

Most U.S. defined benefit plans will not survive another major market crash.  The plans may be perpetual on paper, but that doesn’t mean that they are sustainable. Regrettably, we’ve already seen a move to alternative retirement structures among public pension sponsors, and that movement will only accelerate as contribution costs become a bigger share of a state’s or municipality’s annual budget.

DB plans need to be protected, but doing the same thing that has been done for the last 50 years is not the approach needed in this environment. Take the path less traveled, as you are less likely to get trampled when the rest of the plan sponsor community heads for the exits.

2018 – A Year To Forget For Pension America

For many of us in the retirement industry, 2018 will be a year to forget. What started off with such promise, as the S&P 500 was up about 6% by January 26th, has deteriorated into being one of the worst years for pension funding in quite some time. In addition to the positive equity start to the year, interest rates were going to ratchet higher, and fast. For pension liabilities marked-to-market, higher rates would mean that the present value of those liabilities would fall, further improving funding. Wow, what happened?

Well, the 6% start to the year for the S&P 500 has evaporated, as the fourth quarter has been a disaster (-14.4% in the last 3 months).  The S&P 500, despite the post-Christmas rally, is now down -6.7% (as of 12/28).  Worse, smaller capitalization stocks and international securities, especially emerging markets, have performed quite poorly generating losses that are significantly greater than those of large-cap U.S. stocks.

The rising U.S. interest rate environment, which was predicted to be swift and painful, had the 10-year U.S. Treasury yield hitting 3.24% in early November.  However, as equities took a hit, the flight to safety and fears about economic growth have combined to drive the 10-year rate to 2.75%, which is only 29 bps above where it began at the start of the year. So, liability growth this year is modest, but that doesn’t help much given that the asset-side of the equation has been so weak.

Another missed opportunity for our retirement industry and the participants that rely so heavily on our ability to help deliver on the promises made be plan sponsors was the failure of Congress’s Joint Select Committee on Solvency of Multiemployer Pension Plans to create legislation that would have protected the pensions for roughly 114 Critical and Declining multiemployer plans covering more than 1 million participants.  The continuing delay in addressing this crisis will only create a more tenuous situation.  The committee was supposed to have produced legislation by November 30th. That deadline came and went with the “promise” that negotiations/conversations would continue. There has been radio silence since then.

Lastly, we continue to live with pension funding volatility because most public and multiemployer plans continue to focus exclusively on the return on asset assumption as the only objective for a pension plan. As we’ve stated so many times, the primary objective should be that plan’s liabilities (promise) and it is the current funded status that should drive asset allocation decisions. If plans had been more liability focused, there is a very good chance that assets would have been shifted from the growth portfolio to the cash-flow matching portfolio earlier in the year, which would have protected assets and the funded status as the markets turned negative. When will we learn?