I Am Truly Torn

I read with great interest a P&I article from last Friday that mentioned a group of retirement industry trade groups (roughly 25*) had sent a letter to Congress seeking immediate action to help employers that sponsor retirement programs, participants, and retirees during this unprecedented crisis. According to the article they were calling “for allowing penalty-free qualified distributions and loan modifications for individuals impacted by the coronavirus pandemic; providing a temporary waiver for calendar year 2020 of the rules for required minimum distributions from defined contribution plans and individual retirement accounts; assisting defined benefit plan sponsors by freezing the interest rate at pre-COVID-19 pandemic levels, and extending the final contribution due dates, among other suggestions.”

I am all for protecting the few remaining corporate DB pension plans, so whatever action needs to be taken to protect them I say, “let’s go for it!” But, I am much more concerned about the impact that this crisis is having on both current plan participants and retirees.

My anxiety has to do with these proposed short-term actions to help DC participants and retirees and whether or not they will lead to significantly greater issues in the future. I can’t begin to tell you how many articles/posts I’ve written regarding DC plans being nothing more than glorified savings accounts. Dire circumstances such as the present show that more clearly than ever.

Regrettably, there is no question that a significant percentage of Americans will be harmed by the sudden loss of their livelihoods. The financial impact will be devastating to so many; providing a little lifeline to those individuals that actually have some savings in a defined contribution plan may make all the difference in their ability to keep a roof over their head and food on their table. I get it! But, allowing the raiding of one’s retirement plan will likely sabotage them later in life. We need to make sure that any actions we take now are not setting us up for more pain down the road.

“Financial relief and support is critical as we work through this crisis,” said Tim Rouse, executive director at the SPARK Institute. “The retirement community stands ready to do its part. Really? Where were these groups when DB plans were being wiped away and the dream of a retirement for most Americans crushed?

We have had a slowly unfolding social crisis in our country for decades where a significant percentage of those working full-time barely earn enough to provide the very basics needed to live – our “working poor”. Adequately funding a DC retirement account is out of the question for many even in good times. What we need is real reform that once again provides the American worker with a professionally managed retirement program that can’t be accessed until retirement and is paid out in the form of a monthly annuity. This will then allow workers to use DC-like plans like the glorified savings account that they’ve become. We should allow for payroll withdrawals to fund these emergency accounts so that the financial burden from a crisis of this magnitude can be mitigated to a certain extent.

Let’s not muddy the waters here. We have a retirement crisis that will impact lives for generations which is separate from the immediate crisis that threatens both our economy and our broader way of life. Allowing participants to draw-down their scant retirement savings is not only robbing Peter to pay Paul, it’s robbing Peter and Paul to take out a contract on both of their lives.

We need an enormous Federal stimulus somewhere on the order of 15% to 25% of GDP (i.e. $3-5 trillion) that recognizes the existential threat to American families and immediately provides them with direct cash resources, debt forgiveness, and jobs guarantees in crucial industries to weather this storm. We also need the Senate to pass the Butch Lewis Act now. This loan program is needed now more than ever, as the market action of the past month has likely expedited the insolvency that has been predicted for many of these funds and that which jeopardizes the “golden years” for more than 1.4 million American workers and retirees.. No financial package should be passed without addressing the retirement crisis. Furthermore, we absolutely should not encourage American workers to mortgage their futures by borrowing from what little retirement savings we have.

*note: According to P&I, the groups that signed the letter to Congress were the SPARK Institute; American Benefits Council; American Council of Life Insurers; American Retirement Association; Association for Advanced Life Underwriting; Committee on Investment of Employee Benefit Assets; Defined Contribution Alternatives Association; ERISA Industry Committee; Financial Services Institute; Insured Retirement Institute; Investment Adviser Association; Investment Company Institute; National Association of Insurance and Financial Advisors; National Association of Manufacturers; NTCA-The Rural Broadband Association; Retirement Industry Trust Association; Retirement Industry Trust Association; Securities Industry and Financial Markets Association; Small Business Council of America; Small Business Legislative Council; and Stable Value Investment Association.

Is It A Tactical Move?

Bond funds have seen unprecedented outflows. According to Refintiv Lipper data released yesterday, U.S. investment-grade bond funds saw $35.6 billion pulled in the week ending March 18th. To put that in context, the previous “record” was $7.3 billion that had been established just the week before. If that isn’t enough, municipal bond funds experienced withdrawals that were nearly 3 times greater than the previous record, as $12.2 billion was taken out. Actually, nothing was spared within the universe of bonds, as mortgage, high yield, and leveraged loan funds also experienced nearly unprecedented activity.

What is inspiring this dramatic pace of withdrawals? Are the actions specific to fears related to the bonds themselves, such as lower quality corporate bonds that might be in industries most susceptible to the impact from the Coronavirus or are their other reasons? One explanation may be a tactical move back into equities, as DB pension plans, E&Fs, and individuals rebalance their asset allocation back to equities following their precipitous fall. There is some support for the latter explanation, as Vanguard S&P 500 ETF had experienced 19 straight days of inflows until Tuesday.

At Ryan ALM, we have been encouraging our clients and prospects to sell long-dated treasuries (10-years and longer) to take advantage of the strong performance that they’ve experienced and to use those proceeds to establish a cash flow matching portfolio to defease the plan’s, in the case of DB plans, Retired Lives liability. With the nearly unprecedented widening that we’ve witnessed in the yield spreads of corporates, both investment grade and high yield, relative to Treasuries, we believe that the timing is very good.

Thank You, Kelsey!

I am going to depart from my normal focus on pension-related issues to thank my daughter, Kelsey, and all the other medical professionals that are on the front lines of the battle to help those currently stricken with the Coronavirus. I’ve grown up admiring the incredible work and passion displayed daily by nurses, as my mom, sister, sister-in-law, and now daughter are proud members of that amazing fraternity.

Life has been disrupted for most Americans at this time, but where as my wife and I, and our other family members are home safe and secure, we watch as Kelsey commutes to NYC for her shift at NY Presbyterian’s MICU, where they are caring for the hospital’s Coronavirus patients. I so admire her courage as she risks her own health to make sure that those afflicted receive the best care that they can and do deserve. She will tell you that this is what she signed up for, but is it really?

Kelsey’s story is being repeated daily by millions of American health professionals, as there are roughly 1.1 million doctors, 2.9 million RNs, and countless others who are right there with them doing their very best to attack this crisis head on. Please pray that those that are willing to sacrifice so much for us, get through this crisis as well as can be. I am so proud of you, Kelsey. Love you, Dad!

Pension LDI: Cash flow Matching Versus Duration Matching

We are pleased to share with you the latest research piece from Ron Ryan and Ryan ALM. We believe that all DB plans should actively de-risk at least enough of their portfolio in order to defease the next 10-years of the plan’s Retried Lives liability. But, how? As this report will highlight, we think that it makes far greater sense to use a cash flow matching approach than traditional duration matching. We hope that you enjoy Ron’s thoughts on this subject and we encourage you to reach out to us with any questions. We stand ready to assist.

Oh, and based on recent market action regarding the widening of spreads for corporate bonds, now is a particularly good time to act.

They Should Be Fine!

As we all know, Corporate defined benefit pension plans have been off-loading their Retired Lives liabilities for years. One concern that I’ve had has to do with an insurance company default and the impact on pension liabilities that would no longer have the backing of the PBGC. Given the incredible volatility in the markets for both equities and bonds, I was once again wondering about the potential for an insurance company default. I probably shouldn’t, but it is in my nature to do so!

That said, insurance companies have reserves, while pension plans don’t. Ron Ryan, CEO, Ryan ALM, has for years said that pension plans should have the same rules that insurance companies do under the NAIC. The list of rules and restrictions seems to be 1,000s of pages, but the key elements are: 1) assets must be matched to liabilities, 2) they must prove that they are fully funded given a +/-3% interest rate sensitivity test, 3) risky assets are limited to only their reserves, 4) there is no mark-to-market, and 5) the insurance company must maintain a minimum level of reserves.

We still believe that a cash flow matching strategy (CDI) focused on defeasing the plan’s Retired Lives liability is a more cost-effective approach than off-loading the liability to an insurance company. This is especially true at this time given how interest rate spreads on corporate bonds have widened relative to Treasuries. It is clear that DB plan funding has been hurt by the simultaneous and dramatic fall in equity valuations and interest rates, but that combination shouldn’t put major insurance companies in a dire situation given the rules that keep them protected during periods of uncertainty. There are a lot of items that should and do keep me awake at night. The potential collapse of the insurance companies and their pension liabilities shouldn’t be one of them.

 

Unfortunately Predictable!

The demise of the defined benefit pension plan that began in earnest in the early to mid 1980s, has forced most workers into defined contribution type “retirement” programs. Anyone who has read a small sampling of our posts would know that we felt that trend was devastating and destabilizing for the financial future of America’s retirees. We’ve had a number of data points in the last 20+ years that speak to a variety of issues related to the negative consequences of this development, but this time may just prove to be the worst, as recent activity in the markets has been particularly devastating.

In most other market corrections during the last 40+ years, retirees and those workers that would soon be retiring, benefited from higher interest rates that were available within bond products, and as such, they likely had more fixed income exposure within a diversified portfolio. Regrettably, the Fed’s easy money policies since the Great Financial Crisis have forced many retirees to seek returns and greater yields from riskier products, including bank loans, high yield, lower investment grade corporate bonds, as well as equities. This asset allocation shift was done to try to keep the corpus from being eroded too quickly as plan participants withdrew money to support their living expenses. What is actually did, unfortunately, was to set retirees up for what appears to be a devastating loss. A loss that many retirees will never recover from.

The recent passage of the SECURE Act, which we wrote about in an October 28, 2019 post, titled “SECURE What?” was intended to provide retirees with more cost-effective access to a retirement income stream through annuities. Unfortunately, the combination of falling interest rates and asset values will highlight just how little the “average” American worker has set aside for their retirement when they attempt to transition their meager balances into a monthly income stream. The “American dream” of one day retiring has become a pipe dream for most. We can do better and we must!

Take Advantage of the Widening

As we’ve consistently reported, the damage to DB pension systems of falling equities and declining US interest rates is an awful combination that is harming the funded ratios of these plans, which will ultimately impact contribution expenses. But, there is always opportunity during periods of uncertainty. One of the great opportunities at this time is provided within the US bond market.

Long Treasury bonds have produced strong returns during this period of time. Most pension systems still have exposure to fixed income despite the fact many plans and their consultants believe that any fixed income exposure would be a drag on a plan’s ability to achieve the “Holy Grail”. Sorry, I meant ROA. Given the significant positive impact of falling rates on long bonds, it is the opinion of Ryan ALM that plans sell long Treasuries (>10 years) and install a Liability Beta Portfolio (LBP) to meet near-term (1-10 year) Retired Lives Liabilities.

Corporate bonds, both investment grade and high yield, have seen their yields widen considerable versus Treasuries during this period of equity market weakness. As a result, they are providing investors with a significant opportunity to add meaningful yield. The Ryan ALM LBP uses corporate bonds, both IG and HY, where permitted by the plan’s investment policy statement. It is a wonderful time to establish this de-risking strategy, as the benefits are numerous, including: improved liquidity, no interest rate risk, higher yields, and a longer investing horizon for the balance of the portfolio, that could definitely use the time to recoup previous equity valuations. We are happy to work with you on developing such a strategy. Don’t let this “crisis” paralyze you. Take advantage of the significant move in rates to help fortify your plan.