CIO Magazine has published an article that cites the Congressional Budget Office (CBO) indicating that the proposed pension legislation “The Rehabilitation for Multiemployer Pensions Act of 2019” (H.R. 397) won’t be enough to protect and preserve all of the plans. In fact, a CBO “study projected that approximately one-quarter of the pension plans that would be eligible for loans through the bill would become insolvent over the next 30 years and would not fully repay their loans. For those plans that do repay their loans, the CBO projects that they will become insolvent within ten years of repayment.” What’s the issue?

At present, there are roughly 125 multiemployer pension plans that are defined as critical and declining.  With no action, all of these plans are expected to become insolvent within the next 15 years. By providing loans to these struggling plans, we are extending the payment of benefits by 30+ years. If 25% fail to repay the loan in 30-years, so be it. We’ve renegotiated terms on a number of government-funded programs, why should this be any different.

The CBO estimated that the Pension Rehabilitation Administration (PRA), which would be established to issue the loans, would only have to provide $39.7 billion in funding. Seems like a drop in the bucket when compared to TARP. Furthermore, they estimated that only $7.9 billion would be returned. I’d love to understand the inputs that they used in creating this analysis. When Cheiron, a leading pension actuary, conducted their analysis on the original 114 plans, only 3 – the Central States, Coal Miners, and the Bakery, Confectionery, Tobacco Workers – would need extra support from the PBGC. In fact, the remaining 111 plans could meet current benefit payments, interest on the loan, future pension liabilities, and the balloon payment in 30-years while earning only 6.5% on their investments.

Given the modest cost of this loan program and the economic benefit of continuing to provide pension payments to nearly 1.3 million American workers, it seems like a no-brainer to me.  What is the economic benefit? According to Congressional testimony, the “cost of doing nothing in terms of lost tax revenue and increased social safety net spending is estimated to be between $170.3 billion and $241.3 billion over the 10-year budget window, and between $332 billion and $479 billion over the next 30 years.”

So, please explain to me why we, as taxpayers, wouldn’t want to “invest” $39.7 billion in a loan program that has, in my humble opinion, a high degree of success, when not doing so would potentially result in a “loss” of nearly $500 billion in economic activity in the next 30-years?  I would hope that ideology isn’t getting in the way of making a rational decision to finally tackle the pension problem that has existed for decades and one that will only get worse with the passage of more time.

The move away from defined benefit pension plans to defined contribution plans has coincided with stagnant wage growth and no growth in wealth for roughly half the U.S. population. The impact is devastating. How can anyone expect these individuals to meet their basic needs of housing, food, insurance, clothing, education, etc. while also diverting a sum of money to a future liability? It isn’t happening and it won’t! We need to preserve and protect the traditional DB plans that remain, while also figuring out how we can get the bottom 50% participating in our economy to a greater extent.

The following information was provided by the National Institute on Retirement Security. It clearly demonstrates that retirement security is not and should not be a political issue. Most Americans have suffered from weak real wage growth for decades. As a result, they are having great difficulty building the necessary retirement nest egg. Congress has the opportunity to secure the pensions for millions of Americans at this time. Will they continue to let ideology dictate the path forward or will they finally do what is best for the people that they represent?

One of the true positives for me in getting involved in the Butch Lewis Act legislation (H.R. 397) has been meeting (through social media) passionate advocates for pension reform such as John C. Anderson, a retired member of the teamsters, who constantly provides important updates on their legislative initiatives. John has recently posted this update:

Actually there are THREE Newly Applied Funds seeking Reductions that are “In Review”…

#1..ROOFERS Local #42…https://www.treasury.gov/…/Composition-Roofers-Local-42-Pen…

#2..IBEW Local # 237…https://www.treasury.gov/…/IBEW-Local-237-Pension-Fund-Seco… (Has Applied Twice Now)

#3..SHEET METAL LOCAL FUND Troy MI…https://www.treasury.gov/…/Sheet-Metal-Workers-Local-Pension… (Had applied previously a year ago March, then ‘Withdrew’)

It is truly unfortunate that these struggling plans are filing for benefit relief at this time.  I realize that the legislative process has moved at a snail’s pace, but I remain hopeful that Congress finally understands the severity of their inaction. Let’s hope that the above referenced plans can hold off a little longer. Although the proposed legislation calls for reinstituting the benefits previously cut through MPRA, there is significant cost associated with going through the process, and these plans, the employees, and employers cannot afford any more cost that further impacts their funded status.

Despite my comment regarding the Senate’s acknowledgment that something needs to be done, I still believe that ideological differences among the parties will lead to proposed legislation that has the potential to do more harm than good, while costing more than the implementation of H.R. 397.

In a follow-up to our August 2nd post titled, “OPEBS – Just How Awful is the funding Issue?” I’ve come across some excellent work by the folks at Milliman, who have produced the following graph.

The funded ratios for the OPEBs of their corporate 100 index are atrocious. They even make the funded ratios for public pension systems look healthy! This information masks the fact that several entities have funded ratios that are much poorer than the average.  I can only imagine the current status for many of our larger cities.

A LIMRA Secure Retirement Institute (SRI) study “finds 8 in 10 private-sector DB plan sponsors (who also offer a defined contribution plan) are at least somewhat interested in a pension risk transfer transaction (PRT). Four in 10 plan sponsors say they are very interested in PRT, marking a 12 percentage-point increase from plan sponsors surveyed in 2014.”

What is driving this interest? Cost! Benefit plan sponsors are increasingly concerned about the cost of providing a retirement benefit. We know the trend has been for private plans to be shuttered, and according to the study, 46% of the companies that offer both a DB and DC vehicle have frozen their DB plan.

The pace of PRTs has accelerated in the last 18 months.  What had been a strategy dominated by the big boys – Verizon, GM, AT&T, etc – has now migrated to small and midsized plans. SRI indicates that more than $1 billion in the last 18 months and the number of contracts has increased 76% from 2014.

But, we at Ryan ALM feel that the PRT transactions can be expensive. In fact, when comparing PRTs to a cash flow matching strategy for the 1-5 year liabilities a plan sponsor can save an estimated 3%-4% relative to the PRT cost. If longer-dated liabilities are also being immunized, the savings can be closer to 10% to 12%. That is quite a savings in $ terms on that >$1 billion in transactions. Please reach out to us if you’d like to get a better feel for how the savings are achieved.

For many of us living on the East Coast, August was a beautiful month to spend time on the beach.  Unfortunately, it wasn’t as pleasant for those managing a U.S. defined benefit plan, as the “perfect storm” hit with both a market decline and rapidly falling interest rates. According to a study by Mercer, the funded ratio for the S&P 1500 declined an incredible 4% to 82%, and the pension deficit grew by a whopping $129 billion to nearly $450 billion. There is nothing sunny about those numbers.

The only way to have protected plan funding was to have engaged in a de-risking program through either a cash-flow matching strategy or through duration matching using long-duration Treasury bonds or operate under GASB accounting and pretend that liabilities and assets both grow at the same rate. Since we know that isn’t the case, funding once again deteriorated for both multiemployer and public pension systems.

A Unique Perspective on CTAs

I normally dedicate this blog to matters pertaining to pensions, pension funding, and the social and economic impact from our failure to do that effectively, but I also like to discuss other aspects of pension management that could potentially enhance a fund’s ability to meet the promised benefits. In this case, I want to highlight a product that has struggled to meet the expectations on both return and risk. CTAs are valuable diversifiers, particularly when it is needed most. However, since the Global Financial Crisis (GFC) performance has been disappointing, to say the least! The researchers at Spring Valley Asset Management have produced a research study in which they’ve developed a unique framework for understanding CTA performance and exploring the causes of underperformance over the past ten years.

Since CTAs represent an important source of diversification, especially at this point given the equity market’s continuing bull market advance, it is critical to understand the underlying mechanics of CTA strategies and how their performance varies across different environments. While the researchers drill down on the different factors that impact the performance of CTAs, they also provide a promising outlook. With the clarity this research provides, it is difficult to imagine that the reasons CTAs have underperformed will become permanent features of the markets. I highly recommend you read this paper!

Having just reported on the current condition of the U.S. high yield market, we find it somewhat disconcerting that the U.S. investment grade bond market continues to see record-breaking issuance. According to an article that appeared on Bloomberg and written by Brian W. Smith and Michael Gambale, U.S. companies have issued a staggering $74 billion this week alone (the previous record of $66 billion was established in 2013). That is a sum that has never been reached in the 47 years of recorded data (1972).

Clearly, these entities are taking full advantage of the plummeting U.S. interest rate environment, and in many cases are retiring more expensive debt, but that isn’t the case for every company.  I don’t have any perspective on whether these “high-quality” firms are rated BBB or higher.  However, the issuance of new bonds during the last decade has been unprecedented, and it will be interesting to see what transpires during the next recession, whenever that occurs.

According to analysts at Goldman Sachs, 2019 is shaping up to be a very challenging year for the high yield market, as the three-month trailing annualized default rate is running at nearly a 5% clip up from a low of 1.3% achieved in 2018. There have been $36 billion of defaulted “junk bonds” in the first 8 months. The post-financial crisis high was $43 billion in 2016. The Energy sector is where many of the problems are occurring, but given the slowing global growth, there remains concern that the Energy contagion (which is secular in nature), could spread to other challenged sectors through a cyclical shift in economic prosperity.

According to Michiel Tukker, Oxford Economics’ global strategist in a note Friday, 18% of high yield companies have recently reported negative quarterly earnings, which is the highest post-crisis level outside of the Energy sector collapse in 2014-15.

Although the high yield market is showing signs of deterioration, few if any, expect U.S. defaults to reach the level of 14% achieved during the GFC, unless there is a full-blown recession.  Given the U.S. government’s incredible stimulus (deficits >$1 trillion) a deep recession is highly unlikely.

However, as yields on HY bonds continue to compress, profit-taking from that segment of your portfolio may be the correct strategy in this environment.