Some Answers

On August 2nd we wrote a blog post on OPEBs and asked the question, “Just how awful is the funding issue?” Well, we have some additional anecdotal evidence and it isn’t looking too good. The Houston Chronicle has recently published information pertaining to the city’s OPEB liability, which is smaller than their pension debt, but not enough so to get excited. It seems that Houston’s OPEB liability has grown by $160 million per year in recent times, which equates to more than $400,000 per day. The total liability is now $2.4 billion, and with an aging workforce and healthcare inflation outpacing revenue growth, action to remedy the situation must occur now.

In addition, the Government Finance Officers Association estimates that the total OPEB liability for states and municipalities is roughly $2 trillion. Again, a pittance when compared to the total pension liability, but in many cases the OPEB liability has become a pay-as-you-go system.  According to the Chronicle’s article, U.S. states took on another $63 billion in OPEB liability in 2017 to just under $700 billion.

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Going, Going, Gone!

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.

 

Painting a Grim Picture

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!

If Ever There Was a Time – It Is Now!

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.

Not The Correct Objective

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.

The Time Has Come

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.

 

OPEBs – Just How Awful Is This Funding Issue?

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!