I must admit that I’m a pretty sappy guy when it comes to movie selections, and my choices often get me abused by my sons, although my daughters don’t hold back either.  The title of this post reminds me of a movie that I have watched more than a few times, “It Could Happen To You”, which is a Nicolas Cage and Bridget Fonda movie about a winning lottery ticket, and the subsequent troubles that follow. However, in the end all is just grand.

Unfortunately, what I am about to highlight for you does not have a fairy tale outcome, and it might just be the tip of the iceberg for cities around the country.  If you haven’t heard about the pension crisis in Loyalton, CA, you should make sure to get up to speed rather quickly.

Loyalton is a city in Sierra County, CA. As of the 2010 U.S. Census the population was 769, reflecting a decline of 93 from the 862 counted in 2000.  According to Wikipedia, many of the population are ranchers, loggers, former loggers, or suburbanites escaping from the San Francisco Bay Area, Sacramento, and the growing Reno-Tahoe area.

The trouble begins in 2013 when town officials decided to withdraw from CalPERS, upon the retirement of its last guaranteed pensioner. For council members, it just made sense — after all, the town had been fully paying its required annual contributions all along. What they didn’t count on was the $1.6 million termination fee demanded by CalPERS to cover unfunded liabilities that CalPERS had allowed to grow for the last 17 years. The fee amounts to a whopping $320,000 per each of Loyalton’s five retirees, an amount that is impossible for the town to pay. And now CalPERS has put the retirees on notice that their monthly checks will be cut.

I’ve been extremely fortunate to be in the investment industry for more than 35 years.  Because of my tenure in the industry, I’ve been spending much more time in the last several years sharing thoughts on various topics, especially those related to the U.S. pension industry, hoping to provide education and useful perspective.

I recently was asked by FundFire to weigh in on the passive versus active argument, which I was happy to do, as I think that there is a need for both, and factors / exposures that favor one versus the other at various times.

I received the following in my in-box today that also relates to passive indexing. I’m very skeptical of the conclusions in the original study that was the basis for the NY Times opinion piece.

I thought you might like this article from Seeking Alpha
Should Government Regulation End Indexing As We Know It?
by James Picerno

An op-ed in The New York Times today lays out the case for imposing new restrictions on how index funds operate. The rationale, according to the authors, is to prevent the reduction in competition in industries that is a direct consequence of indexing. If the proposal is implemented as outlined, the indexing strategy for equity investing that’s widely practiced could be headed for extinction.

http://seekingalpha.com/article/4028909-government-regulation-end-indexing-know?source=from_friend_readmore

I’m happy to discuss this in greater detail with you.  Please don’t hesitate to reach out, especially if you have an opinion that differs from mine.

Here is something from WSJ.com that might interest you:

Collapse of long-term care insurer reflects deep industry woes
http://www.wsj.com/articles/small-insurers-big-collapse-reflects-deep-industry-woes-1480852801?emailToken=JRrzdv1/Y3SVi9M1a8wn0VQsauwJDfSUXF7NNzXAO0eJv3vRpeu53Khwnda5pW6kWV0/690J9ys+QzHMm3ZwTYqOnLNk1A74KyEN88uUiVQ=

Could this happen to the insurers (Prudential, et al) that have acquired significant pension liabilities? If it does, don’t look for the PBGC to help, as once that liability is transferred from the corporate sponsor to the insurer, the PBGC is no longer on the hook.

According to the article, one of the primary reasons for the impending failure is the fact that “most actuaries badly underestimated costs, and the insurers then met resistance in many state insurance departments when trying to push the pricing miscalculation onto policyholders through steep rate increases.”

“Penn Treaty is the poster child for what happens if everything goes wrong—when key assumptions on…claims, morbidity and interest rates go wrong.”  Sound familiar? We know that pension liabilities for public entities aren’t being accurately measured under GASB, as liabilities are discounted at the return on asset assumption (ROA). We’ve seen public pension liabilities explode during the last 15 years on an actuarial basis despite this hocus pocus accounting.

We are pleased to share with you the latest edition in the KCS Fireside Chat series.  This article discusses the market reaction to Trump’s victory, while also exploring how the U.S. equity market has performed in the initial year of the 13 first terms for U.S. presidents dating to 1926 (there have been 22 elections).

Click to access KCSFCDec16.pdf

Please don’t hesitate to reach out to us if we can be of any assistance to you.  Furthermore, we wish for you and your family a joyous holiday season and a wonderful 2017.

I recently had the great pleasure to stop by the Asset TV studios to provide some perspective on DB versus DC and the DOL Fiduciary Rule, which may or may not survive under President-elect Trump.  Here is a link to that interview.

https://www.assettv.com/player/default-player/102724

As always, please don’t hesitate to reach out to us if we can be of any assistance to you. Happy Thanksgiving to you, your family and friends.

The following is an article that I wrote for eFinancialcareers on the potential impact of a Trump Presidency on the asset management industry.

For the U.S. institutional asset management industry that is already dealing with significant change, including the decline of traditional defined benefit (DB) pension plans to name just one, the election of Donald Trump is likely to create further disarray. First and foremost, there is great uncertainty as to his support – or lack thereof – for the Department of Labor’s fiduciary rule, over which the wealth management industry is divided.

Add this unknown to the impact on the financial services industry from changing demographics, new technology, consumer demands and a Trump presidency and we have a situation that is likely to shake traditional buy-side and less-nimble sell-side firms to their core.

You can find the remainder of the article at the following link to eFinancialcareers.com

http://news.efinancialcareers.com/us-en/265638/trumps-winds-of-change-are-blowing-across-the-asset-management-industry/

P&I recently published a chart using data from that National Association of State Retirement Administrators (NASRA), which highlighted the fact that the once the holy grail 8% return on asset (ROA) target had moved from that level in 2001 to somewhere between 7.25% and 7.5%.  Although a full 50% of those using 8% in 2001 were still anchored there today.

We believe the data, but continue to shake our head at the foolishness of the ROA objective.  How is it that all these state plans, with a few exceptions, have a return objective that falls within 50-75 basis points of one another, especially when one considers the differences in current funding, contribution policies, workforces, economic environments, benefit structures, COLAs, etc.

As we’ve mentioned, if two plans have the same 7.5% objective they are likely going to have an asset allocation that is similar. But, does that make sense if one plan is 90% funded and the other one is 50% funded? Hell no! Given this example, one of these plans has an asset allocation that is either way to conservative or aggressive. The funded status and contribution policies should dictate asset allocation and investment structure – NOT the ROA.

A DB Plan should use cash flow (contributions) to meet benefit payments, where possible.  Why subject this important asset to the whims of the market? DB plans should also de-risk where possible.  The liability is known (promise made).  What isn’t known is how the markets will behave.  There are no guarantees, even with the benefit of time.  I suspect that most plan sponsors and their consultants would have assumed that the 8% was achievable over a 20 year horizon, but even the S&P 500 (7.7%) and the Russell 2000 (7.9%) failed to meet that objective for the 20 years ending October 31, 2016, and DB asset allocations aren’t only in equities.

It may be too much to ask of plan sponsors to completely flip the ROA switch off, but a portion of the assets should be se-risked in order to meet near-term obligations should the markets fall significantly from these levels.  Call us, we can help guide you on how to become more liability aware.

Regular readers of the KCS Fireside Chat series will know that 3-4 times per year we dedicate this monthly series to issues related to the defined contribution space, and November just happens to be one of those months.  Here is the link:

Click to access KCSFCNov16.pdf

In this article, Dave Murray, KCS’s DC Practice Leader, addresses such diverse topics as the IRS contribution levels for 2017, the DOL Fiduciary Rule, and a recent spate of lawsuits targeting small (not smaller) defined contribution sponsors.  DC lawsuits had once been relegated to the big corporate sponsors, but successful litigation at these firms has lead enterprising lawyers to pursue similar cases against much smaller sponsors.

Plan sponsors who felt that freezing and / or terminating their DB plan significantly reduced their fiduciary responsibility / liability are finding that they were kidding themselves.  Given that most private sector employees are in defined contribution plans, if they are in a retirement plan at all.  The DOL and IRS are getting much more aggressive in conducting audits of these plans.  We would be happy to provide you with a fiduciary review of your activities in order to make sure that you and your plan are prepared should you be contacted about an audit.

The following article appeared in the WSJ yesterday.

Slowdown in state, local investment in roads, other infrastructure dents U.S. economy
http://on.wsj.com/2eS7sKD

We are not surprised by this news, and would be shocked if you are, too, especially given growing claims on budgets to meet contributions for healthcare and pensions. Despite this growing claim on tax revenues, we believe that DB pensions must be preserved, not only for public workers, but for the private sector, too.

Can you imagine a future economy in which the only source of revenue for a significant percentage of its residents is Social Security?  We can, and the social and economic consequences from that happening will be grave. So, what needs to be done? First, DB plans need to begin to derisk.  A sponsor might ask “even if they are poorly funded?” Absolutely! As we’ve discussed on many occasions, managing a pension plan shouldn’t be about achieving the ROA, but about providing the promised benefit at the lowest risk and cost possible. Trying to achieve a 7.5% ROA in this environment is proving very problematic. Plans are getting much more risk, but not the commensurate reward.

These plans must begin to stabilize their funded ratios and contribution expense. It is through this enhanced discipline that municipalities and states will be able to more appropriately meet these liabilities, while providing the necessary resources to invest in their community’s infrastructure needs.  However, a new approach to the management of DB plans will need to be undertaken if they are to reduce funding volatility. The same old, same old is just not cutting it!

For regular readers of the KCS blog this is obviously not a subject that I often write or report about, but it is an area that I am passionate about as I’ve served on the WBMH Board and Foundation Board for the last 15-16 years.  As most of you probably don’t know, New Jersey is moving to a new funding system for mental healthcare organizations that will potentially hurt many of the neediest recipients of mental health services.

A fellow Rotarian of mine, Andrew Garlick, has written a blog post on this subject, which I share with you: please take a moment and read about it here: https://t.co/NoTyGQ9EJh

Ironically, I participated in a finance committee meeting at WBMH last evening, which touched on this very subject. It is frightening to me, and I’m sure to many others, that many mental health services that we take for granted may not be offered in the future, as fee reimbursement rates don’t cover the costs to provide those services.

The transition to the new funding mechanism occurs on July 1, 2017. As Andy is encouraging, we need to get our legislators to rethink this transition before it is too late. Your help is needed – thank you!