Category Archives: Uncategorized

06.17.14
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Unintended Consequences

Unintended Consequences

Recently I had the opportunity to speak at the Financial Research Associates’ conference in NYC on non-traditional fixed income. I had the pleasure of participating on a panel with an industry icon – Ron Ryan, Ryan ALM  He and I presented on the topic “Taking a Close Look at the Liability Beta Portfolio”.  However, before presenting our views on the proper use of fixed income in a defined benefit plan, especially in a low interest rate environment, Ron and I addressed the unintended consequences from accounting rules, both GASB and FASB, that have lead to an under-reporting of plan liabilities and an overstatement of plans assets.  Given both, it is obvious that funded ratios are overstated, too.

The IASB (International Accounting Standards Board) has moved to a mark to market accounting of both pension liabilities and assets.  It isn’t too far fetched to believe that the US will adopt these same standards in the near future.  Unfortunately, since GASB uses the ROA to value plan liabilities, it becomes clear as to why the pension community continues to focus on the asset side of the equation instead of the liability side, which should be driving asset allocation and investment structure.

Attached for your review is our presentation.  We encourage you to reach out to us if you have any questions or challenges.

 

 

06.10.14
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Where are the Economies of Scale?

Since its founding in August 2011, KCS has tried to highlight some of the issues facing the US retirement industry in the hopes that perhaps best practices could be identified and DB plans, as a result, SAVED.  I recently came across the “Status Report on Local Government Pension Plans” for Pennsylvania.  The report was released in December 2012, and it used information through calendar year 2011.

The following paragraph jumped out at me:

“Pennsylvania’s local government pension plans comprise more than 25 percent of the public employee
pension plans in the United States. There are now more than 3,200 local government pension plans in
Pennsylvania, and the number is continuing to grow. Seventy percent of the local government pension plans
are self-insured, defined benefit plans, and 30 percent are money purchase or other type plans. The pension
plans range in size from one to more than 18,000 active members, but more than 98 percent of the pension
plans can be characterized as small (less than 100 members). While 68 percent of the local government
pension plans have ten or fewer members, 32 percent have three or fewer active members.”

I find it hard to believe that anyone thinks that having more than 3,200 local government plans in PA is a good idea, especially when one considers that 98% of the plans have fewer than 100 employees. The local governments and their participants would be much better off pooling their resources into larger, more professionally managed DB plans that afford everyone the benefit or economies of scale. 

I suspect that there exist other states in the Union with a similar governance structure, but if we are to preserve the defined benefit plan as the retirement vehicle of choice, we need to reduce the cost of managing these plans.  Allowing thousands of defined benefit plans with fewer than 100 participants to exist is not sound governance.

06.02.14
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Could This Hybrid Plan Revolutionize the Pension Industry?

As we’ve seen recently in NJ with Governor Christie’s decision to withhold the State’s annual required contribution, public and private pension funds are under extreme funding pressure.  As a result, traditional DB plans continue to be terminated / frozen in rapid fashion, with new employees being migrated to defined contribution structures. Unfortunately, the complete shift in risk from the sponsor to the employee is proving to be a disaster, with most employees incapable of funding and managing their own retirement (median account balance for a DC participant is slightly more than $13,000).

Importantly, KCS is pleased to announce that we’ve entered into an alliance with Ed Friend, a long-tenured and highly successful actuary, Ryan ALM and Longevity Financial Consultants to bring to the marketplace a patent pending hybrid DB structure that provides the plan sponsor with a fixed cost feature. The product is called Double DB, and as a hybrid, combines elements of both DB and DC. We think that this new design could revolutionize the pension industry by making the use of defined benefit plans more economical for the sponsoring organization.

Please don’t hesitate to reach out to us if you’d like to receive more information on Double DB. We think that both employers and employees are better served utilizing the Double DB design.

05.30.14
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KCS’s June Fireside Chat

KCS’s June Fireside Chat

The latest KCS Fireside Chat is attached for your review. This one addresses the importance of proactive communication in a consulting / plan sponsor relationship. To further enhance our communication with you, we have created the KCS Blog. Just in case the Fireside Chat doesn’t provide you with enough exposure to KCS, the blog is used to highlight our thoughts on current events related to the retirement industry and the markets / economy. This article highlights a few of our blog posts, but we’d encourage you to check out our blog at your convenience to see our other postings.

Finally, we are thrilled to announce that Penn Hudson has joined KCS, where he is responsible for developing client relationships. Penn brings tremendous experience and professionalism to our firm.

05.27.14
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Multi-employer Plans Under Duress – Billions in Benefits Potentially at Risk

There are roughly 1,400 multi-employer plans in the US.  Unfortunately, for many of these plans there have been a variety of factors that have lead to a deterioration in their funded status.  Some of these factors include the loss of business due to the poor economic environment and competition, benefit promises that were too rich to maintain, shrinking union populations and the loss of jobs due to deregulation, and legislation.  Recently, the PBGC estimated that 175 of these multi-employer plans were so poorly funded that they would likely run out of assets, forcing the PBGC to take responsibility for the pension liability. However, it is estimated that the benefit liability is $10 billion, while the PBGC has about $1.2 billion in available funding. Clearly, this is an untenable situation.

What to do? There is no magic potion or silver bullet that will quickly eradicate this issue.  However, prudent steps can be taken to begin to right the pension ship. Despite the fact that contributions are determined based on the ROA objective, plans should begin to focus on their specific liabilities to drive asset allocation and funding decisions.  Regrettably, many union plans continue to reduce their plan’s exposure to fixed income further exacerbating the mismatch between the assets and liabilities. We at KCS have a unique approach to meeting this challenge, and we’d be happy to discuss our thoughts with you at your convenience.

 

 

 

 

05.13.14
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I Think I can, I Think I can…Really?

I think I can, I think I can is a signature phrase that appeared in the book, “The Little Engine that Could” , that was first published in the United States in 1930.  The story is used to teach children the value of optimism and hard work.  Based on a recent Gallup Poll, it seems to be influencing American workers, too.  The poll asked working Americans what they expected in retirement. “Half of Americans think they will have enough money to live comfortably after they retire.” This is the first time since before the financial crisis that a majority of Americans have felt this way.

Really? Half the American working population expects to have enough financial resources to not only retire, but to live comfortably in retirement.  How is this possible? According to SSIP, there are 21.5 million US households that are considered “near retirement”.  Of these 21.5 million, 55% have no current participation in a retirement plan, and the median assets accumulated by this cohort is a whopping $4,450.  Yes, 55% of the 21 million near-retirement households have less than $5,000 in savings, and at the same time that the average American man and woman is living longer.

Furthermore, 75% of the remaining near-term households only have a DC plan as their retirement vehicle. Regrettably, only 11.7% of the near-retirement households are currently participating in a defined benefit plan.  In the 1980s, nearly 46% of American workers participated in a DB structure.  The retirement security afforded by DB plans allowed the masses to actually “live comfortably after they retire”.  Unfortunately, with the retirement risk having been shifted from the employer to the employee, the likelihood of a comfortable retirement has been severely and negatively impacted.

The potential negative economic impact on these retirees is fairly obvious, but the impact on the communities in which they live has not been discussed or analyzed enough. How will your community or state fair in the next decades?

05.03.14
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What are you paying for?

A reflection:

I was very fortunate to be hired into the investment industry in 1981. Two gentlemen, Larry Zielinski and Ted Swedock, took a huge leap hiring a not very qualified candidate out of undergraduate business school to fill a role as an analyst in a small consulting group.  I was the first-non consultant or assistant to be hired.  The role’s responsibilities were vast, and the experience that I gained was immeasurable.

But, the most important knowledge that was shared with me was a comment that Larry made on the first day that I began working at Janney Montgomery Scott’s Investment Management Controls division.  Larry told me that anyone or any company can produce vast quantities of paper and/or fancy reports.  A consultant is only worth their salt if they have the ability to interpret the information that they are passing on and at the same time are willing to make recommendations based on their interpretation.

As I sit back today and reflect on my nearly 33 years in this business, I can’t help but remember how important those words were that Larry uttered to me in October 1981.  I’ve tried to follow his lead since day one.  Initially, I didn’t have a clue about how most things truly worked in the investment industry. Today, as we build KCS, we continue to live by Larry’s example.  We can produce all the fancy reports in the world, but they aren’t worth the paper they are printed on if we also don’t share with our clients and prospects our recommendations as to a course that they should follow.  We are Fiduciaries, and we take that responsibility seriously.

As you may know, every month we produce at least one article on an investment subject. We don’t pull any punches.  If you want to know how we feel on a subject, just go to our website and look under the heading “Publications.”  Everything that we’ve produced is there.  I don’t know how many other consultants/consulting firms are regularly producing articles, but they should at least be willing to take a stand on those subjects most important to their clients.

At KCS, we are concerned about retirement security for most Americans.  We do believe that the demise of the defined benefit plan will produce negative economic and social consequences for a large segment of our population.   We don’t think that the status quo approach to managing DB plans is working.  We believe that our clients and their beneficiaries need new thinking and approaches on a variety of retirement subjects.  We’ve articulated those.  Has your consultant? So, I ask again, are you getting what you are paying for?

04.30.14
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Rethinking The Retirement Gameplan

Rethinking The Retirement Gameplan

We at KCS have been contemplating new approaches to the management of retirement assets since our founding in August 2011. We’ve shared many of these thoughts with you through a variety of means, including our monthly Fireside Chat series, which we hope you’ve found educational.

In this month’s addition, we begin to introduce annuities into the conversation. With the demise of DB plans comes the need to create a monthly cash flow for retirees. Annuities are certainly an effective way to accomplish this objective. However, they come in a confusing array of choices and in some cases, steep costs. We believe that sponsors, both DB and DC, as well as anyone hoping to retire at some point will benefit from this article.

As usual, please don’t hesitate to reach out to us if we can clarify any point raised in this piece or if we can be of any service to you.

04.24.14
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When everyone expects one thing, you may want to prepare for a different outcome

On January 9th, and again on April 4th, we at KCS addressed the issue that US interest rates wouldn’t necessarily rise, and in fact, with everyone in the world seemingly believing that interest rates had only one way to move – UP – we thought that there was a good chance that rates might fall.  In fact, the interest rate on the 10 year US Treasury has fallen by more than 30 bps so far this year.  That is a fairly meaningful move.  With many plan sponsors and asset consultants trimming, eliminating, and restructuring their US fixed income exposure, a plan’s asset allocation is now more disconnected from the liabilities than before.  This disconnect exacerbates the volatility in funded ratios and contribution costs. 

Don’t believe us, then how about the following.  Here is a brief research piece that I found on Cullen Roche’s website today.

“Jim Bianco, of Bianco Research, points out in a market comment Tuesday that a survey of 67 economists this month shows every single one of them expects the 10-year Treasury  yield to rise in the next six months.

The survey, which is done each month by Bloomberg, has been notably bearish for some time now, with nearly everyone expecting rising rates. In March, 97% expected rising rates. In February, 95% expected yields to climb. And in January, 97% held that expectation. Since the beginning of 2009, there have only been a handful of instances where less than 50% expected rates to rise.”

Read more at http://pragcap.com/the-metamorphosis-of-the-bond-bears#6KE3VCCCBLDYV554.99

The US Retirement industry cannot afford to get the direction of rates wrong.  A continuation in the decline of rates will only further inflate the underfunding of US pension liabilities, and continue to put pressure on both private and public DB plan sponsors to do something else, such as close or freeze the DB plan and move more participants into DC.  At KCS, we’ve spoken and written about alternative strategies that go along way to improving funded ratios and stabilize contribution costs.  We are waiting to hear form you.

The beneficiaries of our collective effort cannot afford to have us screw up any more. DC plans are not the answer, but are quickly becoming the only game in town.

 

“Jim Bianco, of Bianco Research, points out in a market comment Tuesday that a survey of 67 economists this month shows every single one of them expects the 10-year Treasury  yield to rise in the next six months.

The survey, which is done each month by Bloomberg, has been notably bearish for some time now, with nearly everyone expecting rising rates. In March, 97% expected rising rates. In February, 95% expected yields to climb. And in January, 97% held that expectation. Since the beginning of 2009, there have only been a handful of instances where less than 50% expected rates to rise.”

Read more at http://pragcap.com/the-metamorphosis-of-the-bond-bears#6KE3VCCCBLDYV554.99

“Jim Bianco, of Bianco Research, points out in a market comment Tuesday that a survey of 67 economists this month shows every single one of them expects the 10-year Treasury  yield to rise in the next six months.

The survey, which is done each month by Bloomberg, has been notably bearish for some time now, with nearly everyone expecting rising rates. In March, 97% expected rising rates. In February, 95% expected yields to climb. And in January, 97% held that expectation. Since the beginning of 2009, there have only been a handful of instances where less than 50% expected rates to rise.”

Read more at http://pragcap.com/the-metamorphosis-of-the-bond-bears#6KE3VCCCBLDYV554.99

04.16.14
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U.S. Treasury STRIPS – The Naked Truth

At KCS, we have been sharing ideas with plan sponsors to reconfigure their existing fixed income exposure into an enhanced asset allocation framework that might just stabilize a plan’s funded status and contribution costs.  The motivation has been driven by the fear of rising interest rates.  Unfortunately, this fear has provided the impetus for many of our friends in the industry to shed exposure to domestic fixed income programs.  Stop!

Despite the near unanimous expectation that rates have to rise from these “historically low levels”, the fact is that interest rates have actually fallen rather significantly year to date.  In fact, the U.S. 10-year Treasury Bond has seen its yield fall by 37 bps (as of 4/15).  The KCS crystal ball is no clearer than that of any other market participant, so why “guess” where rates are going.

We think it would be advantageous for plan sponsors to reconfigure their existing fixed income exposure to include a separate, lower risk portfolio that matches near term benefit payments for the next 5-7 years depending on the current funded ratio of the plan and projected future contributions. This strategy will improve the plan’s liquidity, while extending the investing horizon for less liquid assets that we would use to support their active portfolio.

We have recommended that the lower risk portfolio be invested in U.S. Treasury STRIPS to match benefit payments.  However, that instrument’s name raises more questions than answers, and has often turned potential users off before the conversation really heats up.  We are here today to say that STRIPS, although misunderstood, are actually low risk, useful fixed income securities.

STRIPS is an acronym for “separate trading of registered interest and principal securities”. Treasury STRIPS are fixed-income securities, sold at a significant discount to face value and offer no interest payments because they mature at par, which is why they are so good at matching projected cash flows. Backed by the U.S. government, STRIPS, which were first introduced in 1985, offer minimal risk and some tax benefits in certain states, replacing TIGRs and CATS (…retired to the zoo?!) as the dominant zero-coupon U.S. security.

If you are concerned about your plan’s funded status, the direction of interest rates and / or the current composition of your fixed income assets, call us to discuss a new path forward. We are here and ready to help you!