We are happy to share with you the third quarter Ryan ALM Pension Letter. For public pension systems and multiemployer plans that continue to value plan liabilities under GASB using the ROA, liability growth using the return on asset assumption (ROA at 7.5%) is +5.92% year-to-date.  However, if you use ASC 715 (FAS  158) or a true mark-to-market rate to (US Treasury STRIPS) plan liabilities have actually fallen by -5.1% and -5.3%, respectively.

With negative growth rates for liabilities, funded ratios can improve rather dramatically with even modest asset growth. Think that US interest rates might continue to rise from these levels? If so, having a true (and better) understanding of liability growth will assist you in making more informed investment structure and asset allocation decisions.

Despite the recent outperformance of assets versus liabilities, liability growth has outperformed asset growth by more than 120% since 2000.

The WSJ has produced an article in today’s edition addressing the impact of the retirement wealth gap that exists among Americans. We, at KCS, have been forecasting profoundly negative economic and social ramifications due to the retirement industry’s failure to adequately prepare our retirees.

I attribute much of this unfolding crisis to the demise of the traditional defined benefit plan, while others feel that since only about 40-50% of Americans were ever covered by these plans that can’t possibly be the reason. I strongly disagree. If only we were able to maintain that peak coverage, as today we have about 14% of the private sector in DB plans with many of those participants in frozen programs that are no longer accruing benefits. Furthermore, there are growing pressures on many of the remaining public and multiemployer DB plans that call into question their long-term viability.

The Journal article highlighted the impact that this wealth divide is having on retirement communities (they specifically focused on Oakmont Village in Santa Rosa, CA) where those living on fixed incomes are finding it very difficult to sustain their independence and maintain households in the face of growing monthly dues as well-heeled residents demand upgrades to facilities and more expensive amenities that many residents just can’t afford. It is shameful that residents are being driven from these communities that have become too expensive.

We believe that America needs to address this growing issue, and soon. From an investment standpoint, the absence of affordable senior housing needs to be tackled, which provides our institutional real estate managers a plethora of opportunities. With nearly 10,000 Baby-Boomers reaching age 65 daily and for the foreseeable future, the need appears to be only growing.

We are often criticized as we travel around the country speaking to the need to protect and preserve DB plans, but the migration to defined contribution plans is not working for the majority of American workers. It is poor policy to believe that the average American worker will be able to fund, manage, and disburse a retirement benefit without the financial and educational means to accomplish this objective.

Our support of the Butch Lewis Act, which attempts to preserve DB plans for the most challenged multiemployer pension systems, reflects our understanding of the social and economic implications for the millions of American workers who would see their promised benefits substantially reduced! It is about time that our “leaders” understand that we are going to pay to protect these individuals in one form or another. I suspect that most of those at-risk beneficiaries would much rather have their promised benefits than to fall onto the federal government’s social safety net.

Here is a note that we received from Ron Auer, Executive Director, CORPaTH regarding the Joint Select Committee on Solvency of Multiemployer Pension Plans. As Ron says, we are entering a critical time. At Ryan ALM and KCS, we’d like to see the Butch Lewis Act (BLA) implemented, as is, but understand that everything is a negotiation.  Here is Ron’s letter:

Dear Russ:

Washington is listening, and CORPaTH urges you to ensure the message for pension security is heard loud and clear.
 
The Joint Select Committee on Pension Solvency represents a promising effort by both houses of the United States Congress to resolve the crisis which undermines the health of Defined Benefit plans and the ability of millions of Americans to retire with dignity. Co-chaired by Senators Orrin Hatch and Sherrod Brown, the committee is taking comments and suggestions from the pension community.
 
At CORPaTH, one suggestion stands out as especially promising: tax credits for employers who are funding existing defined-benefit pensions or are establishing new plans.
 
These credits would provide an incentive for employers to secure the future of their workers while benefitting their bottom lines and stabilizing a system which has served millions over the course of many decades. 
 
CORPaTH believes this is a historic opportunity for Americans to come together on a bipartisan basis to secure the economic strength of working families, employers and our country as a whole. 
 
We invite you to join the conversation by contacting the members of the Joint Committee and making your voice heard. You can find a list of committee members and their contact information by clicking here.
 
Thank you for stepping forward and speaking out on behalf of hard-working Americans who have earned the promise of a secure retirement.
Sincerely,

Ron Auer
Executive Director, CORPaTH

We agree that providing the right incentives is always important, but without low-interest rate loans from the Treasury Department to the 114 critical and declining pension systems, millions of Americans will suffer significant social and economic consequences. Please reach out to your representatives, even if they aren’t on the JSC, to lend support to getting the BLA passed in its entirety. Thank you.

There are many U.S. states that conduct on-going (and necessary) training for public fund trustees. I’ve been fortunate to speak at a number of these events since KCS was created.  The folks at the Florida Public Pension Trustees Association (FPPTA) do an especially good job as they also provide a test/certification program following the completion of required coursework and attendance.  Ron Ryan and I have just returned from speaking at FPPTA’s most recent event in Naples, FL.

Our presentation was titled, “How to Enhance the Funded Ratio”. We’ve given presentations touching on a similar subject matter at this event before, but never have we gotten the type of immediate and positive feedback that we received this time. For the last 6-7 years, both Ron and I have been trying to raise awareness regarding the need for defined benefit plans in both the private and public sectors to achieve a greater knowledge of their plan’s specific liabilities in order to manage their pension systems more effectively. OUR goal is to enhance the information that is available to these trustees in order to make more informed decisions.

As we’ve often articulated, managing a pension system without knowledge of the plan’s liabilities (the promise made to the participants) is similar to trying to play football without knowing how many points your opponent has scored. Obviously, it is not an easy task, if not impossible.

Our message to the folks attending this educational symposium was very simple and straightforward:

• The primary pension objective is not about beating the return on asset assumption (ROA), but that plan’s specific liability growth, which of course can be negative in a rising interest rate environment.
• EVERY DB pension system should be on a de-risking path toward full-funding no matter what the current funded status, as asset allocation will be driven by the funded ratio.
• Lastly, running a single asset allocation strategy geared to the ROA is yesterday’s approach, which hasn’t worked and likely won’t going forward. Plans need to implement our bifurcated approach to asset allocation that separates de-risking assets (used to meet retired-lives benefit payments) and growth assets that are benchmarked to future liabilities.

This approach is one of three potential implementations in the Butch Lewis Act legislation that we’ve highlighted on many occasions in this blog. Please let us know if you would like a copy of the FPPTA presentation that we delivered, and thank you once again to the folks at FPPTA for giving us the opportunity to share our insights with many of the Florida public pension trustees.

There is little question that passing the Butch Lewis Act is of paramount importance for the roughly 114 Critical and Declining multiemployer pension systems.  These plans are forecast to become insolvent within the next 15 years, and many much sooner, and without the benefit of a lifeline in the form of a low-interest rate loan, little can be done to rescue them at this time. It is incredibly unfortunate that plan participants are facing potentially catastrophic benefit cuts. Shameful, actually!

Hopefully, Republican and Democratic Senators and House of Representatives members will work together to overcome their philosophical differences to find a working solution to this unfolding pension crisis. Yesterday was actually too late in some cases.

However, while we wait, there are roughly 1,300 additional multiemployer plans not facing the prospect of imminent collapse. These plans have the luxury of more time to work through their funding shortfalls, but doing the same old, same old is not the answer. Why? Continued focus on the return on asset assumption (ROA) as the primary objective subjects these plans to the potential volatility associated with market corrections. As everyone realizes, we are currently participating in the longest U.S. equity bull market ever recorded (>9 1/2 years).

There is a way to protect the assets in these plans, but it will take a new approach to accomplish the objective.  Ryan ALM and KCS are presenting to the Florida Public Pension Trustees Association on Monday, October 1st. The topic is “How to Enhance the Funded Status” and we will be showcasing an alternative approach to asset allocation one in which the fund’s assets are bifurcated into de-risking assets and growth assets. The de-risking assets are fixed income securities used to cash flow match projected benefit payments net of contributions, while the growth assets get the benefit of a longer investment horizon to meet future liabilities.

We will be presenting what we believe is the MODEL on how pension systems should operate. It is a unique approach, but not different just to be different. Our system uses strategies employed when defined benefit systems were first introduced. Please remember that managing a DB plan is about meeting the promised benefit at the lowest cost and modest risk, and not at the highest return.  Unfortunately, asset allocation models are currently overweight equities. Does that truly make sense in this environment?

We need the BLA passed, but we also need the balance of multiemployer pension systems to adopt a more appropriate process before the markets sabotage current funded ratios and contribution expenses forcing many DB systems designated Critical into a worsening situation. We are happy to share our insights with you.

Forbes is reporting on a new study conducted by the National Insitute on Retirement Security forecasting that a modest retirement for the “average” American Middle-class worker is in peril. The study, produced by Diane Oakley, NIRS Executive Director, claims that 4 in 5 American workers are falling short of conservative retirement savings goals, and the same 80% have less than one year’s income with 60% of those having virtually nothing put aside.

There are those in our industry that scoff at the idea that there is, in fact, a retirement crisis, but according to the NIRS, more than 100 million working Americans do not have an employer-sponsored retirement account (DC, DB, and/or individual account) – horrifying!

The typical American needs roughly 85% of their working income to maintain their lifestyle. According to the study, Social Security will only replace on average 35% of one’s income leaving a significant gap that has yet to be filled because of the absence of an employer-sponsored retirement option.

The fight to protect and preserve multiemployer defined benefit plans is happening on many fronts. As regular readers of the KCS Blog know, we have been at the forefront of bringing information to you regarding the crisis that is unfolding for the 114 critical and declining plans. The Joint Select Committee on the Solvency of Multiemployer Pension Plans continues to debate various “solutions” to this issue. Action is needed now and there is no place for politics as usual.

Here is a wonderfully written letter from Mike Smith, President, Teamsters Local Union No. 810.  It highlights the fact that 1.5 million retirees are facing a very uncertain (frightening) future as a result of the failure to protect the benefits for these hardworking Americans. This situation is unacceptable!

There was an article yesterday from Chief Investment Officer Alert highlighting the fact that CalPERS’s fixed income group had received a D grade from their lead consultant Wilshire. As it turns out, the grade was given primarily as a result of key turnover in the leadership of the fixed-income unit and not related to the implementation of their bond program.  However, it got me thinking about bonds. Do you think about bonds?

Where do bonds go in Asset Allocation for defined benefit pension plans? What is the value of owning bonds? Very simply, CASH FLOW!

• Bonds are the only assets with a certain future value (FV)
• They provide the best fit for matching the future value of benefit payments
• Don’t sell bonds in this rising interest rate environment, put it to work more efficiently!

Ryan ALM and KCS have been traveling across the country discussing alternative approaches to asset allocation for much of the last 6 years. In fact, we will be presenting some of our ideas at the Florida Public Pension Trustee Association (FPPTA) next week. I will then be presenting on the same topic in three weeks at the International Foundation of Employee Benefit Plans (IFEBP) in New Orleans.

The idea is very straightforward. Bonds have one role, and that is to provide certain future values that can be used to match the value of future benefit payments. This strategy is the preferred implementation of the three (annuities and LDI being the other two) being proposed within the Butch Lewis Act legislation. Furthermore, cash-flow matching has been a strategy employed by pension executives since DB plans were first introduced.

However, this strategy lost some luster when asset consultants came into being with the promise to build a better pension mouse trap focused on the return on asset assumption (ROA). As a result, asset/liability studies were conducted with a focus on generating a return that would exceed the ROA and NOT on the principle of meeting the promise (benefits) at the lowest cost and at reasonable risk.

Unfortunately, with a focus on return, consultants and plan sponsors have dramatically reduced fixed income exposure in most pension systems during the last two decades as yields fell (asset allocation models use yield as a proxy for return) causing these plans to miss one of the greatest bull markets ever for bonds.

In addition, the growing fear that U.S. interest rates would rise rapidly caused many plans to further reduce their bond allocations. As a result, public pensions systems have equity exposures that are greater than those we witnessed in 2007, and this after 9 1/2 years of a historic equity bull market.

We believe plan sponsors would be best served by bifurcating their portfolios into two components – de-risking assets and growth assets. The de-risking assets would be a cash-flow matching strategy aimed at the current retired lives benefits, while the growth portfolio is focused on beating liability growth for active participants.

Timing any aspect of the markets has proven incredibly challenging for most market participants. Our strategy takes the guesswork out of the equation. We are happy to share our presentations with you on how a cash-flow matching strategy can be used to enhanced the funded status and stabilize contribution expense.

Location, location, location may be the real estate agents’ mantra, but it is also becoming critically important in determining the economic fate for the American worker. Regrettably, the recovery from the Great Financial Crisis has been incredibly uneven for a wide swath of our country.

The Economic Innovation Group has produced their annual county-by-county report and the analysis concludes that economic success is most often tied to location. Here are some of the highlights (lowlights):

• New jobs are clustered in the economy’s best-off places, leaving one of every four new jobs for the bottom 60% of zip codes. (Yes, 60% are competing for only 25% of the jobs)
• Most of today’s distressed communities saw ZERO net gains in employment and business establishments since 2000. In fact, more than half have seen net losses on both fronts.
• Half of the adults living in distressed zip codes are attempting to find gainful employment in the modern economy armed with only a high school education, at best.

The analysis covers more than 26,000 counties representing 99.9% of the U.S. population. As the chart highlights, communities are grouped into five categories from Prosperous to Distressed. A further review of the data reveals that 52.3 million Americans live in distressed communities representing 17% of the population, but more than 50% of distressed communities are in the South, which only has roughly 37% of the total population.

The most Prosperous category is also the largest with regard to the percentage of the population. The 84.4 million Americans that live in prosperous communities account for 27% of the U.S. population. “From 2011 to 2015, the U.S. added 10.7 million jobs and 310,000 businesses and establishments, yet growth was limited to the top echelon of U.S. zip codes. According to the DCI, ’85 percent of prosperous zip codes saw rising numbers of business establishments and 88 percent registered job growth.'”

Given the significant gap between Prosperous and Distressed communities is it any wonder that many Americans are suffering? As was reported earlier this year, the U.S. has suffered consecutive drops in life expectancy for the first time since the early 1960s (1962-63). On average, Americans can expect to live for 78.6 years, which is a full 1.5 years less than the average for developed countries.

It is great that many Americans are prospering during the recovery from the GFC, but to claim that the U.S. is humming on all cylinders is a great injustice to many of our fellow citizens who have yet to benefit, and may never.

It is being reported that Laborers Local No. 265, Cincinnati, has applied to the US Treasury Department for benefit relief under the Multiemployer Pension Relief Act (MPRA) of 2014. If approved, plan participants will see a 40% across the board reduction in their benefits. For many, this is likely to be a crushing blow. According to CIO magazine, there are seven plans that have applied and been granted relief since MPRA while another 10 are under review at this time.

We are never in favor of benefit reductions on the plan participants given the economic hardship that will be created. We are especially concerned at this particular juncture when legislation is being debated/crafted in Washington DC through the Joint Select Committee on the Solvency of Multiemployer Pension Plans.  As regular readers of the KCS blog know, the Butch Lewis Act is one of the pieces of legislation being reviewed that would provide low-interest rate loans to Critical and Declining plans, of which Laborers 265 is one, that would likely extend the plan’s solvency long into the future (30-year loan).

“The Board of Trustees does not think it is reasonable to rely on the PBGC,” said the board in its recovery plan. We agree, which is why passage of the loan program under the BLA is incredibly necessary so as to eliminate the PBGC from this equation. As we’ve reported in previous blog posts, it is estimated that only about 1/8 of the promised benefit would be protected should the PBGC become involved.  We cannot let that happen.