By: Russ Kamp, Managing Director, Ryan ALM, Inc.

We are pleased to provide you with the weekly update related to the ARPA pension legislation. However, once again there is little to report. We had one pension system submit their revised application. New York State Teamsters Conference Pension and Retirement Fund refiled their application on July 21, 2022. This Priority II (MPRA Suspension) plan originally submitted an application on January 28, 2022, which was subsequently withdrawn on May 26th. In the initial filing, they requested Special Financial Assistance (SFA) of $1.036 billion to help secure the benefits for their 33,643 plan participants. In this most recent filing, the pension system requested an adjusted $918.1 million to be used to cover the same population.

Based on the newly released PBGC Final, Final Rules (FFR), I would have expected the requested SFA to be greater than that of the initial filing. It will be interesting to see what they eventually receive once their application has been approved. Fortunately, there were no other plans that had their applications either rejected or withdrawn. In addition, there were no payments of SFA made to approved applications. Only one plan with an approved application, Local Union No. 466 Painters, Decorators, and Paperhangers Pension Plan, is waiting on its SFA payment. To date, there have been 27 applications approved and an additional 12 are in review. We are expecting much more activity based on the estimated cost of this legislation being roughly $80 billion.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

We have provided perspective within this blog on the importance of having a long time horizon. In fact, we have multiple blogs that discuss the idea of buying time. I’m pleased to add another post to our considerable inventory. The latest version was produced by Ron Ryan, CEO, of Ryan ALM, Inc. As you will read, Ron had the pleasure recently to speak at the FPPTA in Orlando. It was during the conference that he heard further endorsement of this important concept. Ron was thrilled to hear Mike Welker, CEO at AndCo, state the following: “the greatest asset of a pension is time.”

Buying time within a pension plan is critically important. However, a plan must have the correct structure in place from an asset allocation standpoint to accomplish the objective. Public pension systems have shifted significant assets into alternative investments in pursuit of potentially greater returns, but in doing so they have reduced liquidity to meet benefits and expenses (B + E). Ron astutely points out that bonds MUST be used for their cash flows and not as a return instrument to improve a plan’s liquidity. By carefully matching bond cash flows with liability cash flows (benefits and expenses), a plan can successfully extend the investing horizon (buy time!) for the balance of the pension system’s residual (growth) assets to grow unencumbered. I know that you’ll find Ron’s insights beneficial.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

We’ve shared with you on a couple of occasions the output from a report published by Guinness Asset Management. In our February 23, 2022 blog on this subject, we highlighted the fact that Guinness calculated the portion of the S&P 500’s return through time that came from dividends and dividends reinvested. That Guinness report was through December 31, 2011. Given the growth within the S&P 500 of non or low-paying companies (technology stocks), we wondered if the magnitude of the contribution to the S&P 500’s return from dividends had contracted. Good news: it hasn’t!

According to the Guinness study, which has been updated as of April 2020, the contribution to return of the S&P 500 from dividends and dividends reinvested for 10-year periods since 1940 was a robust 47% down insignificantly from 48% a decade ago. Extending the measurement period to 20 years from 1940 forward highlights an incredible 57% contribution to the total return of the S&P 500 from dividends. In the previous review, 20-year periods had revealed a 60% contribution to return. Furthermore, this study is on the entirety of the S&P 500, not just those companies that pay dividends. If the universe only included dividend payers this analysis would reveal strikingly greater contributions given the fact that as of March 31, 2022, there are currently 108 companies within the S&P 500, including GM, Disney, Amazon, Facebook, and Boeing that aren’t paying a dividend.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

CalPERS, the roughly $440 billion public pension plan, has reported the plan’s preliminary fiscal performance results through June 30, 2022, at -6.1% or -$29 billion in AUM. I’m sure that there is tremendous handwringing going on throughout Sacramento, if not the whole of California, as those returns are well below their annual return on asset (ROA) objective of 6.8%. This “poor” result follows a spectacular performance year. We’ll not only see many stories about CalPERS, but we’ll soon get a plethora of performance updates from public pensions both large and small all lamenting a similar fate. But were the last 12 months so bad? After all, I was congratulating CalPERS within the title of this post. Was I just being obnoxious?

No, I wasn’t trying to embarrass anyone, but I may have been a little snarky given that a significant majority of folks in our industry would look at the result and say “WOW”, what a terrible return. However, we at Ryan ALM, Inc. look at -6.1% for the fiscal year in a very different light. You see, plan assets are but one piece of the pension puzzle. Sure, they are the piece that gets all the focus and press, but they remain just one part of a very important equation: Assets need to beat liability growth in order to maintain or improve a plan’s funded status. Toward the end of 2021 and into 2022, US interest rates rose rapidly. Those rising rates impacted both bonds and liabilities as they are highly interest rate sensitive. Rising rates will reduce the present value of future benefit payments and liability growth.

The good news for Pension America is the fact that the duration of pension liabilities is on average longer than the duration of the plan’s assets. For the prior 12 months ending June 30, 2022, liability growth for the average plan fell by -16.2% when using ASC 715 discount rates (FASB). As a result, CalPERS actually enjoyed a wonderful performance year as asset performance (despite being negative) far outpaced liability growth. Instead of fretting about a performance result that looked lousy, they should be celebrating the fact that their system actually saw improved funding when liabilities are valued using ASC 715 rates.

Please don’t hesitate to go to Ryanalm.com for additional information pertaining to discount rates and their impact on liabilities.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Perhaps many sponsors of multiemployer plans potentially eligible to receive SFA grant assets remain confused by the recent PBGC Final Final Rules (FFR)/guidelines? Perhaps we are just in the Summer doldrums and activity related to the ARPA legislation was going to be muted anyway. In any case, activity has been non-existent during the last two weeks, as no new applications were filed, no previously submitted applications approved or denied, and no SFA assets were paid out.

Still, only a fraction of the potentially eligible plans has filed an initial application. Now that the FFR have been published we are left with the task of determining what it means for the plans that have already received their SFA. Will they be eligible to refile for potentially more? Will they have to redo their investment program within the SFA bucket given the expanded list of eligible investments? Should they?

Ryan ALM is on record criticizing the expanded investment options. We believe that it doesn’t support the intent of the legislation to SECURE the promised benefits for as long into the future (hopefully 2051) as they can. Here is our response to the PBGC which was submitted to them last week:

Comments on PBGC Final Rule

Page 20 section titled… 1. Pay all benefits due through 2051 clearly states:

“Section 4262(j)(1) provides that the amount of financial assistance provided to a multiemployer plan eligible for financial assistance under this section shall be such amount required for the plan to pay all benefits due during the period beginning on the date of payment on the special financial assistance payment… and ending on the last day of the plan year ending in 2051, with no reduction in” benefits.

Page 21 section titled… 2. Interest rates for SFA and non-SFA assets clearly state:

“For a plan to project accurately how much SFA is “required” for the plan “to pay all benefits due” through the end of the plan year ending in 2051, it must project the SFA assets, adjusted for earnings, needed to cover each year’s benefit payments and expenses until exhausted, and the non-SFA “other plan assets,” adjusted for contributions and earnings, needed to cover each year’s benefit payments and expenses after the SFA assets are exhausted through the end of the SFA coverage period.”

Page 80 clearly states:

“The changes in the final rule permit plans to invest a specified percentage-up to 33 percent of their SFA funds in return-seeking assets (RSA) as described in 4262.14© of the final rule. That leaves 67 percent or more of the SFA funds to be invested in investment grade fixed income securities (IGFI). PBGC believes this ratio (67 percent IGFI to 33 percent RSA)> appropriately considers the need to protect SFA assets to pay protected benefits of the participants and expenses of the plan, The 33 percent that may be invested in RSA as defined in the final rule will enable plans to grow SFA funds and increase the potential to pay benefits through 2051 while limiting the total risk exposure of taxpayer-funded assistance.

 Ryan ALM observations and recommendations are as follows:

1. The language on page 20 is that of a defeasance[i] that requires assets fully fund benefits + expenses through a certain period of time. A defeasance requires the certainty of asset cash flows to fund chronologically liability cash flows as they come due. Only bonds have the certainty of cash flows and it is why they have been used historically for cash flow matching. Benefits and Expenses (B+E) are a term structure that is paid chronologically from contributions (C) first, withdrawal liability payments (WLP) second, and assets cash flows third. As a result, it is an asset exhaustion test to see if asset cash flows are sufficient to fund net liability cash flows (B+E) – (C+WLP))… net of contributions and withdrawal liability payments. It is not a test to see if assets earn some ROA target or hurdle rate. It is an asset exhaustion test to see if asset cash flows fully fund B+E and when these SFA assets are exhausted.

• The SFA assistance is a grant and does not need to be paid back. Page 20 makes it clear that it requires the grant to be used to pay all benefits chronologically through 2051. Page 21 contradicts page 20 suggesting that non-SFA assets can be used to fund net B+E through 2051 in determining how much SFA is required to fully fund B+E through 2051. This language is inconsistent with the intent of the SFA grant.

• Allowing 33% in RSA is another contradiction of the intent of the SFA grant. The SFA grant is to cash flow match (defease) net liability cash flows… it does not have a ROA hurdle rate. It does not need RSA. RSA belongs in the legacy assets (non-SFA). Fixed income assets can now be removed from the legacy assets since the segregated SFA account is now where fixed income assets belong. Removing fixed income from the legacy portfolio asset allocation would enhance their ROA. You do not need or want RSA assets in the SFA asset pool. You need SFA assets to have certainty of cash flows… only bonds can apply. Furthermore, bonds not used to defease pension liabilities are return-seeking assets (RSA). In 2022, a core bond portfolio used as RSA lost >10% YTD. Where is the certainty in funding benefits and expenses?

• The proper discount rate to calculate the SFA grant should be the U.S. Treasury STRIPS yield curve or at worst all three PPA segments chronologically. Each multiemployer plan’s liabilities are unique with the different labor force, salaries, mortality, contributions, withdrawal liability payments, and plan amendments. No generic discount rate could possibly price such a different array of liabilities correctly. This requires a custom liability index (CLI) for each plan to price and calculate the present value of net liabilities (B+E) – (C+WLP). 

Please confirm receipt to:

rryan@ryanalm.com and rkamp@ryanalm.com

Thank you for your time and opportunity to comment.

Ronald J. Ryan                       Russ Kamp

CEO                                         Managing Director

[i]  Defeasance is the setting aside of dedicated funds to repay debts. In this PBGC reference, it is the cash flow matching of asset cash flows to liability cash flows with certainty. This will guarantee full payment of each liability payment when due.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

The CPI-U was published today. Market forecasters had anticipated that inflation would continue to rise, and they estimated that the 12-month annualized inflation # would be 8.8%. They got the direction right, but the magnitude was clearly wrong as the number posted was 9.1% That reading is the highest annual inflation registered since October 1981, which happens to coincide with the month that I entered this industry. Quite surprisingly, equity and bond markets have recovered losses since the announcement this morning and they are now registering gains on the day.

Does this make sense? I guess it might if you believed that the Fed has already accomplished its objective of taming inflation by having increased the Fed Funds Rate by 1.5% and that today’s # is actually a peak. It also might be that today’s number will force the Fed to be more aggressive in its fight against inflation by raising rates perhaps by a full 1% at the end of this month like Canada just did, which will force the US economy into recession. But what is the likelihood that the Fed has achieved its goal by raising rates by only 1.5%? Furthermore, do interest rate increases drive economies into recession overnight? Does inflation evaporate immediately when interest rates are increased? I would suggest that the answers are NO, NO, and NO!!

Perhaps a little context is necessary. Let’s look back at the last inflationary environment of the 1970s into the early ’80s. In December of 1972, the CPI for the previous 12 months was 3.2%. Two months later the annual CPI # had crept up to 3.86%. It would be a full decade later until the annual CPI once again had a 3 before the decimal place. You see, inflation doesn’t rocket skyward only to fall back to earth once the Fed begins to raise rates. For those of you that didn’t live through that period let alone work in this industry, inflation would go through two periods of significant increases before falling to levels to which we all became accustomed.

It took 23 months from the bottom of the inflation cycle in December 1972 (3.16%) to the first peak (11.13% in November 1974). From there inflation began to taper as the Fed raised rates, but the bottom for annual inflation would only fall to 4.5% in November 1976, a full 1.34% above the previous low for the cycle. Regrettably, the Federal Reserve took its foot off the pedal of increasing rates and the result was a rapid increase in inflation to 13.46% in March 1980. It would be another 2 3/4 years before inflation returned to a level below 4%. For the decade ending December 1982, the CPI averaged an annual rate of 8.68%. At no point did inflation begin and end on a dime despite aggressive attempts by the Federal Reserve to combat inflation through interest rate increases.

For investors believing that rate increases will have a dramatic and immediate impact on inflation and the economy, I encourage you to please look to the 1970s as a guide. It won’t likely play out as you are hoping. Inflation may still go higher. In this environment, why would anyone want to own long bonds (30-year US Treasury Bond) with a current yield of 3.08% for a real return of negative 6%? Bond yields have provided investors with a roughly 2% real yield advantage (inflation premium) relative to the CPI throughout time. Remember, it took from February 1973 (CPI 3.86%) to December 1982 (CPI 3.5%) for inflation to get controlled. Even at 3.5% inflation, the real return to bonds is negative. Since when are investors willing to live with such meager returns?

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

We are pleased to share with you the Ryan ALM Newsletter for the second quarter of 2022. Despite a very rough start to the year for the capital markets, the present value of pension liabilities (based on an average 12-year duration) underperformed the “average” asset allocation by roughly 2.2%. As a result, Pension America once again witnessed an improving funded status. For pension plans that use GASB for their accounting standard, this outperformance on the part of plan assets versus plan liabilities may be hidden from view.

Please don’t hesitate to reach out to us with any of your questions regarding asset/liability management or go to RyanALM.com for our thoughts on a variety of pension-related issues.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Last week was an incredibly busy week for the PBGC as they published the Final Final Rules (FFR) on how to implement the ARPA Pension legislation. I provided my initial feedback in this blog regarding the updated guidelines on July 6th. Ron Ryan and I are preparing a response to the PBGC regarding some of the elements that remain from the initial Interim Final Rules (IFR) and a few of the changes reflected in the FFR.

I remain concerned about the expansion of permissible investments up to 33% of the SFA assets. First and foremost, BONDS are return-seeking assets if they are not used to defease benefits and expenses. As such, 100% of the SFA assets should be considered RSA, which does not support the mission of this pension grant to SECURE the promised benefits through 2051. Why risk these grant proceeds? Defease the plan’s benefit payments. Assume risk within the legacy portfolio as the SFA assets buy time for the non-SFA assets to grow unencumbered.

As a reminder, most fixed-income assets are managed against the Bloomberg Barclays Aggregate Index. This index declined by -10.4% through June 30, 2022, as a result of rising rates in this inflationary environment. Inflation has not dissipated! Rates are likely to rise further as the Fed aggressively combats inflation. A bond’s principal will fall in a rising rate environment. A bond with a 10-year duration will lose 10% with only a 1% increase in rates. Where is the securing of pension benefits in such an environment? Again, most participants in our capital markets have not witnessed high inflation and rising rates. The last four decades have been an incredible environment for investors as rates fell to historically low levels. Those incredible bond returns from 1982 – 2021 are likely behind us. 

With regard to the mundane activities of ARPA’s implementation, there were no new applications filed last week. Furthermore, there were no applications approved or rejected. Lastly, there were no payouts for the already approved SFA applications. Obviously, all of the focus was on the FFR. It is disappointing that it took one year for the FFR to be produced, especially since they have really muddied the waters with the changes in the SFA investment framework. I’ll address the 67%/33% allocation that must be maintained at least one day per year (12 months) in another post. Talk about over-complicating a process!

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

We are pleased to share with you the Ryan ALM Q2’22 Pension Monitor. Despite the fact that pension assets had another challenging quarter, pension liabilities once again fell to a greater extent, as US interest rates rose rapidly in response to the US Federal Reserve’s action to aggressively address the current inflationary environment, by raising the Federal Funds Rate by 1.5% so far. US corporate plans operating within a FASB construct are aware of this fact since their discount rate is based on market rates for AA corporates. Pension plans – public and multiemployer pension systems – utilizing accounting methods under GASB are probably unaware that pension liabilities had substantial negative economic growth during the quarter and so far in 2022, as they use the return on asset (ROA) assumption as the discount rate for their pension liabilities. Under the ROA as the discount rate, it erroneously appears that pension assets dramatically underperformed liability growth.

Given the significant differences produced by these two accounting methodologies, it is no wonder that inappropriate decisions with regard to contributions and benefits are made from time to time. The US Federal Reserve is primarily focused on combating excessive inflation. Aggressive Fed action may lead to significantly higher US interest rates. Will rising rates have a greater impact on pension assets or liabilities? Continue to check in with us at ryanalm.com to see how this story unfolds.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

I penned this post on May 3rd. Markets have continued to sell off, but pension funding has continued to improve as rising rates and the impact on longer-duration pension liabilities created an environment that had liabilities falling to a greater extent than pension assets. Many of the points that I raised in my post appear in a thoughtful piece produced by Zorast Wadia, Consulting Actuary, Milliman. I don’t believe that there exists a retirement plan as critically important as a defined benefit plan and I’m very pleased that Zorast agrees. Let’s hope that rising rates do lead to the thawing of frozen DB plans.