Yesterday, we highlighted the fact that more than 50% of Americans were forced to retire prematurely. Just this morning Ted Knutson, Contributor at Forbes, published the following information that adds the exclamation point to our post. Thanks, Ted.

“The COVID-19 recession is likely to cost the jobs of 22 percent of middle-income workers age 50 to 60 making between $48,000 to $137,730 and the jobs of 15 percent of their peers earning above that, according to a report released today.

The recession will force an additional 1.1 million of these middle-income job holders and 360,000 higher-income older workers into a substandard standard of living when they retire, says the study by the New School of Social Research’s Retirement Equity Lab (ReLab).“

ReLab Director Teresa Ghilarducci believes that older workers are likely to get hit harder by this recession than others “because the widely publicized larger vulnerability of the aged to COVID-19 is going to increase age discrimination in hiring.”

Retirement account balances are abysmally low for many American workers and the hit that their portfolios took earlier this year won’t help. Couple the fall in asset levels with the incredibly low interest-rate environment and this combination is a formula for disaster. Help is needed now.

Allianz Life’s 2020 Retirement Risk Readiness Study, published earlier this year highlights the fact that for most Americans choosing when they will retire is likely out of their control. The survey found that more than 50% of Americans were forced to leave the job market earlier than they anticipated as job loss (34%) and health (26%) were cited as the primary reasons.

For those folks who thought that they still had good earning years left to set aside financial resources for retirement, having the proverbial rug pulled out from under them means that their golden years are likely to be tarnished. Importantly, this survey was conducted in January (results were published in April) prior to the Covid-19 crisis that pulverized America’s labor force. One can only imagine the long-term toll this has taken on those who thought that they were on a decent path to financial security.

The study focused on three categories of Americans: pre-retirees (those 10 years or more from retirement); near-retirees (those within 10 years of retirement); and those who are already retired. Given how unprepared many Americans are for retirement, and the situation has only gotten worse, 65% of non-retirees said that they would likely work or have to work in retirement. The reality is that only 7% of retirees actually have at least a part-time job. The fact that 37 million Americans have filed for initial unemployment claims in the last 7 weeks have likely exacerbated the lack of access to employment.

Most Americans know that they aren’t prepared for retirement, but there is little that they can do, as daily living expenses eat up most of their financial resources. Again, Covid-19 is highlighting just how fragile the economic situation is for most Americans. Defined contribution plans were never intended to be used as one’s primary retirement vehicle, but as supplemental income funds. Who has any supplemental income? We need a retirement system that has the defined benefit pension as the foundation of any retirement program. Without this support, too many Americans will fall onto the social safety net long before they die. That is just not acceptable!

We continue to marvel at how many pension plans, primarily in the public and multiemployer space, drive asset allocation decisions through a return on asset (ROA) lens. This is done despite the fact that the ROA is NOT a calculated number, but is often determined because it solves the equation regarding a certain contribution level that is “acceptable”. At best it is a rough guess, and at worst it is nothing more than a Goldilocks solution – not too high, not too low, just about right!

Given this understanding, I read with interest that Axios reported, from data generated by eVestment, that 206 public pension plans with roughly $4.0 trillion in AUM now had an average allocation to fixed income that was at 28.4% at the close of the first quarter, up from 24.5% at year-end 2019. I can’t imagine that this was some kind of strategic or dynamic shift given that equities (R3000) declined by about 21%, while bonds were up 3.2% (Agg.). Furthermore, for comparison purposes, P&I’s asset allocation data indicates that the top 1000 corporate plans had an average allocation to fixed income of nearly 48%, as of September 30, 2019. Despite the significantly greater exposure to fixed income assets corporate plans still saw their funded status decline during the quarter. One can only imagine what the funded status hit would look like for non-FASB plans if a true discount rate were used in the calculation of plan liabilities.

A true ROA can be calculated by utilizing the Asset Exhaustion Test (AET) that is required under GASB 67 and 68. We’ve often found that the real ROA needed to fund these plans tends to be less than the current return target, meaning that plans can utilize a more conservative asset allocation. Furthermore, by incorporating a cash flow driven (CDI) approach to matching and funding near-term benefit payments, these plans that are utilizing a greater exposure to alternative products now have more time to meet future liability growth without needing to have them become a source of liquidity.

Let’s try a new course. Can we agree that the pension promise that has been made to participants is important and that it needs to be funded? Can we also agree that by focusing on pension liabilities, we can devise an asset allocation strategy that is more precise in meeting the needs of the plan? We believe that blazing this new course will help a plan stabilize contribution expenses and the funded status. Furthermore, the pension plan will improve liquidity to meet benefit payments, reduce overall risk, extend the investing horizon for the alpha assets, and eliminate interest-rate risk for the portion of the portfolio that is now cash flow matched. Not bad, at all! You don’t believe that all of these benefits are possible? Call us.

We are all in search of positive news and April’s market performance is certainly welcomed, especially on the heels of the first quarter’s devastating results. The Milliman 100 Public Pension Funding Index showed an aggregate 5.92% performance increase for the month – great! Unfortunately, the industry, as it relates to public plans, continues to only focus on the asset side of the equation. In the article highlighting April’s gains, funded ratios were also mentioned and they showed an average “jump” from 66% to 69.8%, but pension liabilities were no where to be found.

We all know that GASB permits public pension plans to value their liabilities at the ROA for discounting purposes, but who is that helping? It isn’t helping the plan trustees who make critical decisions based on one set of books. It isn’t helping the taxpayer who believes what is being reported to be “true”. It certainly isn’t helping the plan participant, who is likely making long-range plans based on the assumption that the promised retirement benefit will be there when they call it a career.

As an example, NJ’s big three pensions – Teachers, P&F, and Employees – have aggregate assets of roughly $80.5 billion (through 4/30). They are reporting liabilities using a 7.3% discount rate of $176.7 billion for a funded ratio of 45.6%. In actuality, the liability is actually $372.2 billion when using an appropriate valuation using a true mark-to-market discount (1.42% in this example). The funded ratio is actually less than 1/2 that which is being reported at 21.6%.

As anyone knows who has read these blog posts for the last 4-5 years, we are huge fans of DB pension plans, but we can’t be doing the same old, same old. It is nearly impossible to tackle an issue if you don’t know the true magnitude of the problem. Many of today’s pension issues have to do with the accounting rules, as they lack consistency. There is no justification that we operate with two sets of guidelines for valuing pension liabilities. The argument that public plans are perpetual doesn’t carry any water with me. Just because something on paper appears to be perpetual doesn’t mean that it is sustainable. Just ask the folks in the Jacksonville, FL Police and Fire plan. As contribution expenses eat up more and more of state budgets they are encroaching more and more on precious resources needed to fund other elements of the social safety net.

We need to adopt one set of books that will lead to the full funding of these plans and not some gimmick that inflates the ROA so that public plans can keep contributions low. This practice has done significant and long-term harm to pension systems throughout the US.

The House of Representatives is preparing to vote as early as tomorrow on a proposed $3 trillion stimulus package (aka HEROES ACT) that consists of 1,815 pages of what Senate Republicans are calling the Democrats ultimate “wish list”. Among the proposals is much needed financial support for struggling multiemployer pension plans. We’ve highlighted for years why addressing this situation is so critically important. However, I am concerned that this all-encompassing legislation will not see the light of day, as Senate Republicans are already proclaiming that this legislation is dead on arrival.

As you may recall, the House passed in July 2019, through bi-partisan support, H.R. 397 (the Butch Lewis Act). I would prefer that this legislation be moved by the Senate before tackling the Heroes Act, which will likely be stalled, watered down, or not acted on at all. The participants in critical and declining multiemployer plans have been fighting for government support for years, and any further delays will ultimately create a situation that sees more than 1 million Americans lose their promised, and EARNED, benefits.

The market correction that we are living through right now has further negatively impacted the funded status of these struggling plans and shortened the likely time frame for insolvency and their ultimate destiny at the PBGC, where promised benefits go to die.

A lot has been written about our ability as a nation to incur further increases in the “deficit”. I’d like to encourage anyone that hasn’t taken the time to study Modern Monetary Theory (MMT) to do so, as you will find that a public debt results in a private surplus. Are we spending too much at this time? Only time will tell, but we need to do what we can to save our economic future, which has been crushed with these lock-downs.

I am blessed to have as a friend and former colleague, Charles DuBois, who invited me to learn about MMT some 7 or 8 years ago. I continue to learn so much from Chuck. He shared with me the other day the following:

“If, and only if, a nation is operating below full usage of its real resources, then public sector deficits can be increased with no negative consequences – currently or in the future.” AND
“This proposition holds only for nations with their own free-floating currency, no debt denominated in a foreign currency and an operating central bank e.g. US, UK, Canada – but not the EU, etc.”

Furthermore, inflation is the constraint. We need to insure that we have the economic capacity to meet the heightened demand that the Federal deficit will produce. There are roughly 37 million unemployed Americans anxious to get back to work to help produce those needed goods.

Bottom line: We shouldn’t be focused on the “cost” of saving these critically important pension systems for fear that the deficit will impact our children’s and grandchildren’s ability to get the goods that they will demand. That myth carries no weight, as there is no crowding out impact.

We are pleased to share with you the latest research from Ryan ALM – Buy Time. One of the most important benefits of utilizing a cash flow matching strategy is that less liquid assets (the alpha portfolio) have time to perform and capture the liquidity premium that exists. We hope that you enjoy the insights. Please don’t hesitate to reach out to us if you have any questions/comments.

The WSJ is reporting in today’s edition that public pension plans suffered a -13.2% average return for the quarter ending March 31, 2020. This information was obtained from the Wilshire Trust Universe Comparison Service (TUCS) data. The first quarter return eclipsed 2008’s fourth quarter as the worst on record in the 40-years that the TUCS universe has been reported. This shouldn’t be surprising, but it may actually be an understated return, as alternative investments in private equity, real estate, infrastructure, etc. often come with a one-quarter lag. Oh, boy!

We’ve been anticipating that the first quarter was devastating for the funded status of public pension plans, as well as those in the private sector – both corporate and multiemployer plans. The hit to plan asset bases was somewhat soothed by April’s strong market returns, but not nearly enough to maintain contribution levels. Unfortunately, state and municipal governments are also being harmed by significant reductions in revenues as the economy slowly reopens. The ability to meet increased funding requirements may not be possible in this environment.

We are huge fans of DB plans and they must be preserved, but states such as NJ, IL, KY, CT, etc. cannot overcome their significant negative cash flow requirements through “better” investment returns. The only way to make up for this shortfall, without further burdening their tax base, is to have the Federal government provide low-interest rate loans to these struggling plans. The proceeds from the loans must be used to defease the retired lives liability out 10-15 years, so that the residual assets now have time to grow unencumbered. The extending of the investment horizon (buying time) will allow for a more aggressive risk profile since these assets are no longer a source of liquidity.

While the loan is outstanding, states and municipalities would be forced to make the annual required contribution, something that NJ hasn’t done since Washington slept there. They would also have to maintain current benefit levels. If this sounds familiar, this strategy is contemplated in the legislation that passed the House of Representatives last July (H.R. 397 – the Butch Lewis Act).

I’ve enjoyed producing nearly 780 blog posts during the last 4-5 years or so on a variety of pension-related issues. We often get comments and/or questions from the public regarding what’s been produced. I respect people who are willing to share their views, while in many cases challenging our thoughts. It is certainly a great way for me to continue to learn and hopefully the audience does, too.

As an example, I received this comment yesterday. Russ, “promises” i.e. pensions would have been much less under CDI. This individual clearly understands that we at Ryan ALM espouse using a cash flow driven investing (CDI) approach to meeting near-term benefit payments. I have to believe that this individual feels that our bond exposure would somehow reduce the pension plan’s ability to achieve the return on asset assumption (ROA). That isn’t necessarily true, as most pension plans have exposure to fixed income and cash. According to P&I’s annual asset allocation survey, corporate, public, and multiemployer plans had fixed income exposure as of September 30, 2019 of 47.5%, 21.1%, and 35.5%, respectively.

What we suggest is converting the current bond exposure that is highly interest-rate sensitive to a CDI portfolio that matches and funds (secures) benefit payments chronologically from next month’s to ideally ten years out. This CDI portfolio, which we call a Liability Beta Portfolio (LBP), is invested in investment grade corporate bonds, as opposed to a diversified bond portfolio geared to the Barclays Agg. Our portfolio currently has a yield of roughly 3.5% versus the Agg’s yield at 1.5%. This significant yield advantage actually improves the plan’s ability to meet the ROA objective, although we believe that securing the benefits should be the primary objective in managing a plan. If a plan’s investment policy statement (IPS) provides for exposure to high yield, these bonds can be used in support of the LBP, too, which further enhances the portfolio’s yield advantage and ability to achieve the ROA.

Thanks for the comment, and please keep them coming!

Everyone knows that first quarter performance results were ugly. It will not come as any surprise then that funded status and contribution expenses were significantly negatively impacted. But, even before Covid-19 struck, assets were struggling to keep up with the growth in pension liabilities, as the chart above reflects (data through December 31, 2019).

Different accounting rules (IASB, FASB, GASB) permit different discount rates to be used to measure pension liabilities, but the only TRUE measure of pension liabilities is a risk-free rate. The liability index above (red line) uses the Ryan ALM STRIPS index (maturities 1-30 years). The performance of the STRIPS index for the 20-years ending 12/31/19 dwarfs the risk-adjusted returns for many of the major indexes that would represent exposure to the assets in most pension systems.

I mention this because most non-corporate plans continue to focus nearly exclusively on the return on asset (ROA) assumption, and as a result, fail to include liabilities in the analysis when it comes to determining an appropriate asset allocation and investment structure. Clearly, paying heed to plan liabilities would NOT have negatively impacted America’s pensions during the 20-years ending December 19. Furthermore, understanding and managing to pension liabilities would absolutely not have hurt during the first quarter of 2020.

When will out industry wake up to the fact that you can’t manage a pension plan without understanding the promise that you made to the plan’s participants? Can you imagine playing a football game and not knowing what the score was as you entered the fourth quarter? In that case, you wouldn’t know what offense or defense to run. It is the same thing in managing a pension system. The only way to know the “score” is to measure, monitor, and manage to the plan’s liabilities.

We’ve all seen the headlines this morning about the unprecedented 20.5 million American jobs that were lost in April leading to an unemployment rate of 14.7%. The economic consequences related to the virus are beginning to pile up. According to a Bankrate survey, most consumers that have a mortgage or auto loan fear that they will miss a payment in the next 3 months. 54% of American consumers with a mortgage and/or auto loan are at least somewhat concerned about their ability to pay.

Not surprisingly, the ability to pay differs by age group, as only 43% of Baby Boomers are concerned, while 56% of Gen Xers, 65% of older Millennials, and 79% of those 30 and younger are in a precarious position at this time. I fear that this situation will cause many American savers to forgo contributions into their retirement accounts, or worse, force those with retirement accounts to take loans or premature withdrawals.

These actions could profoundly impact their ability later in life to retire. It once again highlights for me why it is important for American workers to participate in a traditional DB plan as opposed to a mostly self-funded (many companies have already suspended contributions), self-managed “retirement” vehicle such as a 401(k).