It was announced yesterday that consulting firm Mercer has agreed to acquire most of Summit Strategies Group’s asset consulting business and Pavilion Financial Corp. (Canadian consulting firm). The acquisition brings more than $800 billion in AUA/AUM to Mercer and further consolidates an already concentrated industry.  Mercer indicated that acquiring these two entities will strengthen their presence in the non-profit universe.

They also believe that adding additional research resources, especially among alternative investments, will permit them to be more responsive to new innovation among niche strategies. As part of the deal, Summit’s public fund business is being sold to AndCo Consulting.

However, do these deals ultimately help or hurt the plan sponsor community? Consolidation among asset consulting firms has been on-going for a while as the original owners/pioneers have looked to capitalize on the businesses that they have built (Marco, RogersCasey, Ennis, Knupp, Hammond, and Watson, Wyatt to name but a few). These transactions may provide some economies of scale for the acquiring entity, but it also narrows differences in thought/approaches and the generation of new ideas.

In an industry that does much to support emerging managers and new investment products, it seems that only size matters when choosing asset consultants, particularly in the defined benefit universe. But, where are the benefits? We have frequently voiced our concerns about the lack of innovative thinking when it comes to managing a DB plan. We believe that the focus on the return on asset assumption continues to plague our retirement industry while supporting the notion that deep research teams are needed to wade through the 1,000s of managers and products.

However, managing a DB pension plan is all about providing the promise at the lowest cost and not the highest return. Furthermore, with the lack of success among many (most) active managers, how good has this research effort truly been? Despite an effort to support emerging firms there still exist many constraints (arbitrary) to review and use smaller, less tenured asset management organizations that have less than a 5-year track record and fewer than $500 million in AUM.

If consolidation is needed to sure up the economics for these firms, perhaps a greater effort should be undertaken to price the consulting services based on their true value added, and not try to undercut the competition by giving away the business in order to acquire AUA. Asset/liability consultants are a critical component in the management of a successful retirement program. The consolidation that we are witnessing does little to encourage the challenging of the status quo.

The return on asset assumption (ROA) for a public pension system is a critical variable in whether a plan is ultimately successful in meeting its promises (pension liability).  The ROA is used to value the plan’s liabilities, as well as to determine the annual contribution into the plan.  Unfortunately, many public pension systems are using inflated ROAs, which has lead to the systematic underfunding of these systems.

According to various studies, most public pension systems are using an ROA assumption between 7.25% and 7.50%. The focus on achieving the ROA has injected far more volatility into the process then is necessary.  We are aware that long-term returns would suggest that equities are the place to be over multiple decades, but given the poor level of funding and escalating contribution expenses, these plans can’t afford to wait for decades to be proven correct.

Furthermore, employees have consistently contributed to their plans, and benefit reductions are not an appropriate alternative to building a more sound approach to the day-to-day management of these systems. When defined benefit plans were first offered, the plan’s liabilities were defeased in a similar way to how a lottery system ensures that future assets are available to meet future liabilities. Regrettably, the focus on generating a greater return to “lessen” employer costs has forced the retirement industry to adopt a new playbook. It hasn’t worked.

Public pension systems, as well as multiemployer plans, need to get back to basics before they collapse under the weight of the plan’s weak funded status. The Butch Lewis Act (BLA) adopts as one of the core principals a return to pension management in the past. If a low-interest rate loan is taken, the proceeds MUST be used to defease the retired lives portion of the plan’s liabilities. By doing so, the plan’s liquidity to meet benefits is improved, highly interest rate sensitive fixed income is replaced by a cash flow matching portfolio, and the investing time horizon is extended for the remaining assets to capture the liquidity premium in less liquid assets, which will be used to meet future plan liabilities.

There is nothing wrong with getting back to basics and proven pension management techniques, especially when the new-fangled strategies have produced very poor results to date.

There appears a commentary in the latest P&I daily (8/9) by W. Gordon Hamlin Jr., titled, “Getting Retirement Solutions Right is a Matter of National Defense”. I saw the headline and got excited because we’ve written about the likely profound social and economic consequences of our failure to provide an adequate retirement for our workers. As I began to read the article I couldn’t help but agree with him that there are three separate but intertwined retirement issues that need to be addressed, and each one is going to be challenging.

Hamlin cites “the impending meltdown in multiemployer pension plans; the roughly 50% of private-sector workers not in a workplace retirement plan; and the enormous unfunded liabilities associated with public pension plans.” These are the primary issues in a nutshell. However, that is basically where our enthusiastic support came to a halt.

I’ve been engaged with a team of amazing industry professionals in helping to craft and present the legislation for the Butch Lewis Act, designed to preserve and protect the pension benefits for participants in “critical and declining” status multiemployer pension systems. Without major assistance from the U.S. Treasury through a low-interest rate loan program, these plans will become insolvent in the next 5-15 years. The actuaries from Cheiron have modeled each of the 114 plans to make sure that the loan could be repaid and the PBGC protected. Only 3 of the 114 plans will need additional assistance from the PBGC, but for a total sum that is about 1/3 what the insurer of last resort would pay if each of these plans defaulted.

Unfortunately, Mr. Hamlin states, “needless to say, the loans won’t solve many, if any, of the existing problems with each existing plan. Given the existing trouble, how many employers and plans will be able to repay the loans?” Really? How can you make this claim when you haven’t modeled the plans?

One of the biggest challenges facing these multiemployer plans is the significant cash flow payout that is needed in the near-term to meet the promised benefits of an aging population. The Butch Lewis Act calls for all of the loan proceeds to be used to defease the retired lives. By doing so, the cash flow needs are met. The existing assets and annual required contributions will then be used to meet future plan liabilities, annual interest payments, and the loan repayment in year 30. Again, all but three of these plans can meet these obligations and do so at an annual return on asset assumption (ROA) of ONLY 6.5%. That is right! The required annual ROA used to ensure that these plans meet their obligations is dramatically lower than the ROA currently used by each of these plans.

Without the loan program these plans will fail, the PBGC’s insurance program will be overwhelmed and collapse, the promised benefits to the participants will not be paid, and in its place, the PBGC will make benefit payments that are roughly 1/8 what was promised. Guess what? These participants will likely fall on to the social safety net, and instead of securing these plans and extending the solvency for decades, we now initiate a pay as you go system for millions of plan participants. Seems like that cost would far exceed anything that the loan program might ultimately cost taxpayers.

I’d say that the loan program solves all the problems facing these critical and declining funds by improving cash flow to meet near-term benefits, by extending the life of these plans by at least 30 years, by extending the investment horizon for the “risky” assets to capture the liquidity premium, while saving the PBGC in the process. Not bad for one piece of legislation! Congress needs to act and act now. These participants did nothing wrong and they shouldn’t be harmed in this process.

We’ve highlighted in multiple blogs the issues and challenges facing the Millennial generation in terms of beginning their lives. I have four Millenial children among the five that my wife and I have. We see first hand the barriers that they and their friends/peers face regularly. The following graphs should wake everyone up to this reality.

As a result, women are marrying later, if at all, and having fewer children. This trend could impact future economic growth. We recently reported that the median age for a first-time buyer in 2017 was an astounding 42 years-old (it used to be 34). Furthermore, in 1975 only about 25% of 30-year-old men earned less than $30,000/year. In 2016, 41% of 30-year-olds made <$30,000.  How could that be?

At the same time that Millennials are seeing their wages flatline, we are asking them to pick up the slack from corporate America, who are paying less to support medical and retirement expenditures despite record profits. Is there any wonder why anxiety levels have skyrocketed in the last couple of decades.

I can hear some of my friends saying “move” if it costs too much where you live. But, the reality is that there are many reasons why someone is tethered to a particular area. What we should be doing is figuring out how to create higher quality jobs with greater wages so that our children can meet their basic living expenses while hopefull socking a few shillings away for retirement.

If you are a believer that managing a pension system is about generating the highest return then you may appreciate a recent WSJ article that referenced Wilshire Trust Universe Comparison Service (TUCS) data highlighting growing exposure among public pension plans to domestic and international equity.  However, if you believe like I do that managing a pension system is all about meeting the promise (benefits) at the lowest cost, you may be very concerned about the data shared by Wilshire.

The TUCS data indicates that public pension systems have seen their public equity exposure grow to 59% from 57%. Now it is very likely that this is just the result of good equity market returns relative to other asset classes, but it none-the-less highlights the fact that these systems are willing to roll the dice on equity market returns rather than derisk these plans as the bull market ages (now nearly 9 1/2 years). In addition, alternative investment allocations are growing, especially for pension plans with more than $5 billion in assets.  In fact, the alternative allocations are now greater than fixed income allocations for the $5+ billion systems.

The focus on the return on asset assumption (roughly 7.25% to 7.5% for the average public plan) is forcing asset consultants and their plan sponsor clients to build these aggressive allocations, especially if the funding status is weak. But, will they be rewarded with enhanced returns or are they just injecting more risk than necessary this late in the market cycle?

In addition to the public and private equity allocations, Wilshire is reporting that the allocation to fixed income is declining. Now, most of you will say that a reduction is warranted given the “likely” economic growth, inflation, and rising interest rates that we are about to witness, but bonds play a very important part in pension management – they provide cash flow to meet required benefit payments.

Given the nearly 80% equity and alternative allocation for large public systems, are we about to repeat what transpired in the 2007-2009 Great Financial Crisis when liquidity was at a premium and equity market returns were negatively impacted by forcing liquidity where it wasn’t naturally available? It sure looks to be the case. Can these systems, their employees, and the taxpaying public endure another dramatic hit to a system’s funded status? Not likely! We have an alternative approach to this return-chasing game. Reach out to us and we will be more than happy to share our insights.

We’ve been forecasting that there would be profound social and economic consequences as a result of the shift from defined benefit plans to defined contribution plans, and the proof is starting to become more evident.

According to the Federal Reserve’s survey of consumer finances, bankruptcy’s for older Americans are exploding at the same time that the universe of older Americans is burgeoning! On the surface, it appears that younger Americans are fairing better, but we know that there are more 18-34 year-olds living at home or with a relative than ever before (Pew Research Center). We also know that student loan debt is growing leaps and bounds, which is keeping Millennials from saving for retirement, which will only add to the problem for older Americans in the decades to come.

In addition to the loss of traditional pensions, older Americans are forced to wait longer for Social Security and they are incurring greater out-of-pocket medical expenses. We’ve witnessed a three-decade shift from government and employer support of the American worker to a situation in which the individual is being asked to carry this burden. It is not ending well for many.

“The people who show up in bankruptcy are always the tip of the iceberg,” said Robert M. Lawless, a law professor at the University of Illinois and another author of the study. The next generation nearing retirement age is also filing for bankruptcy in greater numbers, and the average age of filers is rising, the study found. Given the rate of increase, Thorne said, “the only explanation that makes any sense are structural shifts.”

We know that many Americans are carrying greater sums of debt into retirement than ever before. Furthermore, there is a growing wealth gap among Americans. According to the Employee Benefit Research Institute (EBRI), the median household lead by someone 65 or older is roughly $60,600 (2016), but the bottom 25% have at most $3,200, a sum which certainly doesn’t provide for protection should unexpected medical expenses occur.

It is being reported that the participants in a multiemployer pension plan system that received “permission” from the Treasury Department under the Multiemployer Pension Reform Act of 2014 (MPRA) are suing the government challenging them on the legality of authorizing a private pension system to reduce benefits. This is believed to be the first such suit, and the plaintiffs are seeking class-action status to include all of the multiemployer participants in plans that have received such permission to date.

The plan participants, in this case, are part of the New York State Teamsters Conference Pension and Retirement Fund. Unbelievably, the cuts to the participants, which took effect last October, amount to a 29% per participant reduction. According to PlanSponsor’s Rebecca Moore, “the complaint notes that the Employee Retirement Income Security Act (ERISA) expressly prohibits a plan from reducing vested pension benefits: Until and unless a pension fund is broke, a retiree’s monthly payment may not be reduced.”

If the plaintiffs are successful, multiemployer pension systems that are designated “critical and declining” because of weak funded status, will need to seek an alternative to just slashing benefits. This is where potential legislation, such as the Butch Lewis Act, becomes even more critical. These plans can be rescued and secured through a low-interest loan program, preserving the promised benefits and extending the life of these systems for decades to come.

Plan participants in these failing pension systems have done nothing wrong. They contributed to a fund based on a promise that was made. It is disgraceful that the government has passed legislation to significantly reduce the benefit to which these workers are entitled. It is time to support the Butch Lewis Act legislation in order to restore and preserve these benefits. I can’t imagine being in my mid-70s only to have my pension dramatically slashed with little prospect of being able to make up the loss through part-time employment.

Anyone who knows me knows that I spend most of my time focused on issues related to the retirement industry.  However, every once in a while something will pop up that I need to focus on and bring to your attention.  Here is one of those important items!

In my capacity as a member of the Midland Park Borough Council, I was invited to attend an event at the town’s 911 Memorial where U.S. Representatives Michael G. Fitzpatrick (R, PA) and Josh Gottheimer (D, NJ) were speaking about H.R.911, the Saracini Aviation Safety Act of 2015. This Act is named for Victor Saracini, United Airlines pilot of doomed flight 175. His wife, Ellen (pictured below), has been championing for improved safety and security on flight decks since the horrors of 9/11/01.

The Act “directs the Administrator of the Federal Aviation Administration to issue an order to require: (1) the installation of secondary barriers, other than the cockpit door, to prevent access to the flight deck of each covered aircraft; (2) such barriers on the aircraft with a cockpit door to remain locked while the aircraft is in flight and the cockpit door separating the flight deck and the passenger area is open; and (3) such barriers on the aircraft without a cockpit door to remain locked as determined by the pilot in command.”

Furthermore, a “covered aircraft” is a commercial aircraft: (1) equipped with more than 75 passenger seats, and (2) with a maximum gross takeoff weight of more than 75,000 pounds.

As I heard this morning, this is not a partisan piece of legislation, as nearly 90 Congressmen and more than 10 Senators, both Democrat and Republican, have co-sponsored this legislation. It is legislation designed to protect the flying public, as well as airline personnel. Most of us in the retirement industry travel a lot each year. I happened to be flying on the morning of 9/11, but was fortunate to be flying south from Newark to Atlanta. Obviously, many others weren’t as fortunate.

There has been recent movement to require these secondary safety doors to be installed on new planes. But, shouldn’t something be done to improve the security for the 1,000s of planes currently in operation? As the flying public, we should demand that Congress acts to pass this critical legislation and force the airline industry to invest a modest sum (<$5,000 / plane) to significantly reduce the likelihood that events of 9/11 are ever repeated. The substantial reduction in corporate tax rates should provide the airlines with the capital needed to make this enhancement.

Of course, these projected contributions are predicated on achieving the return on asset assumption (ROA) during this period. A significant correction during the next 6 years (likely after a nearly 9 1/2 year bull market) would create a situation in which additional contributions would be necessary. Unfortunately for Chicago residents, they have other budget items that need to be funded, too.

The Fort Worth City Manager, David Cooke, is proposing additional contributions and the elimination of the annual 2% COLA as a means to sure up the $1.6 billion unfunded Fort Worth pension system, which is forecast to become insolvent within roughly 25 years. Both employees and taxpayers are being asked to contribute more to the system.

Cooke’s suggestions flow from a task force created nearly three years ago to tackle Fort Worth’s troubled system.  This is the best that they can do after three years? What is being done with the management of the plan? I suspect that the goal remains to achieve the return on asset assumption (ROA) instead of getting a greater handle on the plan’s liabilities using multiple discount rates, and then using that output to drive investment structure and asset allocation changes. Furthermore, have they done an asset exhaustion test to actually calculate what the plan’s true ROA is?

Pension systems continue to inject too much volatility into their plans by striving to achieve a difficult ROA objective, especially this deep into a bull market. By keeping inflated ROA’s as their primary objective the plan is systematically underfunding the system through lower contributions than necessary that which are needed.

Three years seems like a very long time to determine that additional contributions are needed. It would be fascinating to learn about the other possible action items that were discussed as potential remedies for this plan’s underfunding.