We’ve suggested for years that the pursuit of the return on asset (ROA) assumption as the primary goal of pension America was misguided and the latest market events certainly support our point. As plan sponsors and their asset consultants chased the ROA the asset allocation strategies pursued more products that were private in nature – equity, debt, real estate, infrastructure, etc. The hope of more return has likely not been realized and we may soon find out that true valuations have been masked. We certainly understand that pension plan liquidity has been diminished significantly.

With regard to private equity valuations, according to a new report from Investec, “private equity is about to go through a period of violent repricing matched only by the collapse in the global financial crisis: some 50% over the next 3 months!”

In the report from Investec’s Fund Finance team, authors Michael Zornitta and Ian Wiese write “that valuations will fall this month, with major adjustments downward foreseen in June reporting, and that hedging transactions are on the rise as risk management becomes the priority for fund managers. Just one problem: one hedges before the crisis, not after.”

According to the folks at Investec, “almost all managers have shifted their focus from deploying capital to defending assets,” Zornitta and Wiese wrote. Managers are looking into “alternative forms of liquidity to prop up companies, prevent breaches and reduce the possibility of having to call any remaining capital” from investors, they wrote.

DB plans have seen substantial re-pricing for traditional domestic and international equities, and high yield. A repricing of anything near the 50% prediction by Investec will be devastating. We encourage all plans to once again focus on the promise that has been made to your participants (liabilities) to drive asset allocation and invest structure decisions, and to get away from chasing the ROA as if it were the Holy Grail. It is nothing more than a tarnished artifact!

For those of you who are perhaps wondering why I’ve become so passionate about pension reform, there is a social and economic crisis impacting American retirees within the multiemployer universe of Critical and Declining plans (roughly 125) that is about to get even worse, as many of the plans once deemed Critical are likely to have fallen in status with the recent market action.

In 2014, Congress passed legislation (MPRA) that allowed for struggling multiemployer pension plans to file for benefit reductions. To date, there are roughly 15 funds that have been granted permission to “renegotiate” the benefits. These funds have about 75,000 retirees who have seen their benefits reduced. When my friend, John (a retired Teamster) first did his analysis on the impact from these CUTS, there were 43,000 retirees that were in funds that had seen benefit reductions. Their benefit reductions amounted to nearly $34,000,000 / month. What he discovered through his polling and outreach was shocking! Here are just some of the highlights:

How could you not be shocked by these numbers? It is wonderful that we have seen action to help American families and businesses negatively impacted by the Coronavirus, but these American workers have been left behind and their fate won’t improve once the virus has subsided. Furthermore, there are 1.3 million American workers/retirees in failing plans that are right behind them in line! Are we truly okay with dooming them to a similar fate as those original 43,000 who have suffered so much? I am not! It bothers me to no end that our industry has failed to protect these pensioners. How is it that so many of us have prospered so greatly from our participation in this industry, yet the people who counted on us have not?

House Democrats had crafted their own proposed legislation to compete with the Senate’s stimulus proposal. The House version included the Butch Lewis Act to help those Critical and Declining multiemployer pension plans that are on the verge of collapse. Regrettably, the Senate version that passed last night does nothing to help the 1.4 million American workers and retirees in the roughly 125 C&D pension plans. Furthermore, given the devastating impact on pensions from collapsing equity markets and lower interest rates, there are likely to be many more multiemployer plans that now fall into the C&D bucket. Prior to the last month or so there were roughly 200 multiemployer plans that were in the Critical zone.

According to my contact on the front lines of this battle, there may in fact be another bill that specifically addresses the pension crisis. Let’s hope that is the case, as these plans have less time to be saved than they did just two months ago. While Congress tinkers, the fate for millions of retirees and near-retirees becomes more tenuous.

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.

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.

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.

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.

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!

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.

Ron Ryan and I have been trying to get plan sponsors and their consultants to de-risk pension systems for years. In Ron’s case: decades! Our thoughts are often met with skepticism for a variety of reasons, but one of the biggest reasons from multiemployer and public plans has to do with the return on asset (ROA) assumption. We’ve written about the ROA for years and the problems with focusing on this number as if it were the Holy Grail. The pension plan’s objective should be securing the promised benefits, but they continue to dismiss that notion.

One of our largest clients adopted our Liability Beta Portfolio (LBP) strategy that cash flow matches corporate bonds with plan liabilities chronologically in August 2018. This was done despite the fact that US interest rates were low at that time and bond exposure would not help achieve the desired return for the account versus the ROA. The client and their consultant converted a portion of their fixed income allocation to this strategy with the purpose of securing the benefits, improving liquidity, removing interest-rate sensitivity while extending the investing horizon for the remainder of the growth assets (alpha) to capture the liquidity premium.

We recommend building our LBP to secure the Retired Lives Liability for 1-10 years. However, in this case, they decided to go out 8-years through 2026. How has the client fared? From August 31, 2018, until March 11, 2020, our LPB has produced a 9.54% return, while outperforming the client’s liability objective rather handily. This was done in an environment in which the S&P 500 return was -2.62%! Which asset exposure was going to negatively impair the client’s ability to achieve the ROA? By focusing on the ROA, plan sponsors have been forced to inject more risk into their asset allocation process. This action guarantees more volatility but does nothing to secure the benefits. Isn’t about time that we all focus on the right objective?