Think that the lack of retirement income isn’t having a profound impact on society already?  Please, think again! According to the Census of Fatal Occupational Injuries, the death rates for those workers aged 65 and older were three times the national average (2016 data).

Why are 65-year-olds still working?  Well, the median savings rate for working-age families is only $5,000 according to the Economic Policy Institute, and the demise of defined benefit plans is certainly exacerbating this incredibly difficult situation.

In addition to the lack of retirement income, older workers remain active for healthcare insurance despite the fact that remaining on the job increases the likelihood that they will get hurt.

The impact of remaining on the job hits men to a much greater extent than women. There were 1,838 job-related fatalities in 2016, and all but 110 were men.

There is no doubt that physical ability deteriorates with age, but leaving the workforce prematurely without any retirement savings is not an option for a significant and growing percentage of the U.S. workforce.

As we’ve said all along, moving responsibility for American workers’ retirements from entities that could handle the challenge and moving it to individuals with little ability to do so has proven to be faulty policy. It is going to get worse – not better!

L.L. Bean has terminated the defined benefit plan and is offering a voluntary buy-out.  Of the roughly 5,000 full-time employees, there are about 900 who are eligible to take a lump-sum distribution. To be eligible the employee must be at least 55-years-old with a minimum of 15 years at the firm.  No layoffs have been announced because the company believes that they are going to get the 10% reduction in force through this buy-out – good luck!

It was not announced what the “average” 15-year veteran, aged-55 would get when taking the lump-sum, but since that individual would have another 11+ years until they are eligible for Social Security, probably not enough to justify taking the lump-sum, as DB plan payouts are predicated on tenure and salary.  An employee terminating employment prematurely is going to negatively impact their future retirement earnings.  Furthermore, how many employees are capable of managing this lump-sum windfall?

Lastly, it was stated in the article that DC contributions would be ramped up, but for how long? These contributions are not contracts, and future contributions will be predicated based on the business’s fundamentals. Oh, and employees will have greater flex-time. How much can you buy with flex-time?

We are pleased to share with you the most recent interview for Russ Kamp on Asset.Tv where he provided an update on the Butch Lewis Act.  As we’ve discussed before, this Bill has the potential to be landmark legislation designed to save the promised retirement benefits for millions of Americans.

Thanks to Ron Ryan, Ryan ALM, KCS has been involved in shaping one of the three potential implementations provided that the legislation passes, and low-cost loans provided to these multiemployer plans with the funding status of “Critical and Declining”. We can’t think of a more important initiative within the U.S. retirement community than identifying solutions to the retirement funding crisis that we find ourselves in at this time.

As always, we thank the folks at Asset.TV for providing us with the opportunity to share our views on this and other critical retirement issues. A special thanks to Sarah Makuta, who conducted the interview and who did such a great job.  We look forward to our next conversation with you.

Here is the latest on the Butch Lewis Act.  We are pleased to report that there are two more co-sponsors of the Bill.  However, this Bill is currently only being supported by Democratic Senators. Where are the pension advocates? Millions of Americans may (likely) see their pension benefits slashed by as much as 50% should their defined benefit plans file for relief from the promises that have been made, and in many cases, participants have been receiving.  The following information is from GovTrack.

As we continue to answer questions from the most recent KCS Fireside Chat, today we address the following:

• How could a 60% and a 90% funded plan have the same return on asset assumption (ROA)? Shouldn’t the asset allocation be based on the funded ratio?

They shouldn’t is the quick response, and yes, asset allocation should be predicated on the defined benefit plan’s funded ratio/status.

If two plans are striving for a 7.5% ROA, they are most likely going to have very similar asset allocations. In 1995, striving for a 7.5% annual return could be achieved through a mostly fixed income-oriented portfolio, and the standard deviation associated with that target return was only +/- 6%.  The plans with very different funded status wouldn’t necessarily be harmed in that environment.

However, according to Callan Associates Capital Market Projections, a 7.5% return objective in 2016 would come with a standard deviation of +/- 17.2%, and as markets continued to ramp up through 2017 that projected variability likely rose from that level. For the plan that is 90% funded (on a market-to-market basis), it has nearly won the battle. Subjecting the plan’s corpus to a traditional asset allocation with a standard deviation of more than 17% borders on being negligent.

But, how do you know what your return target should be since we know that the ROA is not a calculated number? Simply, every plan should undertake to have an asset exhaustion test run, which will determine the “true” return objective needed to ensure that the plan’s assets are never exhausted.

We recently did a review of two multi-employer plans that had the same ROA. After completing the asset exhaustion test, it was determined that one plan only needed a 6.85% return to ensure solvency, while the other fund needed a return greater than 11% / annum to accomplish that objective. Yet, they had been told that 7.5% was the objective for both, and each plan’s asset allocation reflected that pursuit.

Every defined benefit plan should be pursuing a de-risking strategy no matter what there funded status. Obviously, a plan that is poorly funded will have lessened ability to defease retired lives, but they should at least use the current highly interest rate sensitive fixed income to begin that process. Waiting for the next equity market crash before engaging in a de-risking strategy is very painful, and could prove terminal.

Starting KCS in August 2011 provided me with an opportunity to return to my consulting roots, but it also gave me so much more.  By not having to commute into NYC each day, which I’d done since I was 18, provided me with several hours a day to dedicate to other endeavors. One of those was joining Rotary. I had little knowledge of what it meant to be a Rotarian, but it proved to be so much more than I could have ever expected.

For those of you that don’t know anything about Rotary, it is the world’s largest service organization with more than 1.2 million members in roughly 200 countries. The organization’s motto is “Service Above Self”, and it quickly became apparent that my fellow Rotarians are guided by that call each and every day.

In addition to meeting wonderfully caring individuals all focused on doing “good”, I’ve been extremely fortunate to be engaged in amazing projects, both locally and abroad, that have had a profound impact on the beneficiaries (and me, too). I bring this to your attention because one such project has recently brought fresh clean water to the village of Awhum, Nigeria.

There are roughly 30,000 residents in Awhum, and none of them had access to clean water.  The villagers were forced to walk miles to get drinking water, and I’m not sure if it was actually clean water.  I, for one, take for granted the availability of clean water.

How does a group of mostly middle-class suburbanites from Wyckoff and Midland Park, NJ get involved in a project in Nigeria? Well, we were extremely fortunate to have Father Felix Uguozor as a visiting priest from Nigeria join one of the local parishes for the past couple of summers.  It was Father Felix that brought to our attention this critical need.

Through the cooperation of a Rotary Club in Nigeria, Rotary International, Father Felix, Brian Murray (local entrepreneur) and members of our club, we were able to raise sufficient funds to provide a 700 foot deep well that finally provided clean water to those in desperate need of some. Unfortunately, the digging of the well proved to be phase one, as the electrical grid proved unreliable, and the frequent outages meant that water could not be pumped to the surface.

Fortunately, were able to raise additional capital for a generator, which has recently been installed at the site of the well in Awhum. Here is a video of the villagers benefiting from access to clean water. There are just a few things that I feel trump my work in trying to preserve defined benefit plans for the masses.  Being a part of our local Rotary Club, and helping to provide clean water to a village halfway around the world is certainly one of them. I would encourage each of you to get to know Rotary.  It is an amazing organization doing incredible work throughout the globe. My involvement has profoundly impacted me, and I suspect it would have a similar impact on you.

Are liabilities interest rate sensitive?

YES, the present value of pension liabilities is extremely interest rate sensitive if you use market interest rates as discount rates. This is certainly true for private pensions under FASB (ASC 715) accounting regulations. Unfortunately, GASB allows for the return on asset assumption (ROA) to be used as the discount rate for Public pensions, which is not interest rate sensitive.

However, GASB 67/68 opened the door to market rates by bifurcating the discount rate such that the ROA is used until assets are exhausted, and then you must use a 20-year AA muni index yield. The Society of Actuaries (SOA), in their 2004 white paper “Understanding the Principles of Asset Liability Management”, made it clear that GASB accounting rules can distort economic reality and, as a result, assets cannot function effectively vs. liabilities.

A current trend among public pension systems is to reduce the ROA, which increases the present value of liabilities. Just imagine that a 15-year duration public pension liability reduced its ROA by 50 basis points,  from 8.0% to 7.50%, while market rates for AA corporates went up 50 basis points from 3.50% to 4.0%. The ROA method would show a liability growth of  15.5% leading to lower actuarial funded ratio and higher contributions. The AA corporate method would show a liability growth of – 4.0% enhancing the true economic funded status. Which one is right? The proper discount rate is the one that can settle the liabilities, one that you can buy to defease the liabilities. The ROA is not purchasable and should be removed as a discount rate by definition.

Two troubling items crossed my desk this morning that conflict with the tremendous gains that we’ve been witnessing from the U.S. equity markets. Bankrate has once again conducted their survey on the financial health of the American family, and the picture hasn’t improved from when we first reported on this topic several years ago.

Unfortunately, 61% of Americans would not be able to pay a $1,000 emergency expense with savings. Most would have to rely on credit, family/friends, or a personal loan to meet this unexpected outlay.  This analysis mirrors another conducted by the U.S. Federal Reserve that indicated that 44% of Americans would not be able to meet a $400 emergency payment.

The other piece of information that is troubling is the fact that the U.S. savings rate has declined (2.4%) to the third lowest level in recorded history, and it is now back to 2005 levels. The U.S. economy is consumer-driven with roughly 70% of GDP coming from individual consumption. We do know that revolving credit has exceeded the all-time record (8/17), and it now stands at more than $1.1 trillion. The previous record was established in April 2008. Notice that both “records” cited above either correspond with or just precede the great financial crisis.

The wonderful stock market returns are not enjoyed by a good chunk of the American public, and these stellar results mask what is happening in the broader economy.  According to Gallop, only 52% of U.S. adults owned stock in 2016. This is the second-lowest reading since Gallup started measuring this in 1998. These figures include ownership of an individual stock, a stock mutual fund or a self-directed 401(k) or IRA.

There is much discussion related to the impact of technology on the future of jobs in America, and rightly so, but the magnitude is still to be realized. What hasn’t been discussed to the extent that it should have been is what is transpiring right now.  The migration to a contingent workforce (aka independent contractors, freelancers, on-call, contract, temporary help, etc.) has escalated dramatically.

Since 2005, it is estimated that the contingent labor force has grown by more than 9 million, while the number of workers in traditional full-time arrangements has fallen by 400,000.  This information comes from the Study “The Rise and Nature of Alternative Work Arrangements in the United States, 1995-2015” was conducted by Lawrence F. Katz Harvard University and NBER and Alan B. Krueger Princeton University and NBER in March 2016.  This contingent labor force now represents about 16% of all jobs in the U.S.

What’s the issue? Sure, individuals get more flexibility, but with that “benefit” comes inconsistent hours, more modest wages and little ability to influence wage growth, more difficulty getting mortgates, healthcare insurance falls solely on the employee’s shoulders, and saving for retirement becomes nearly impossible, since we know that most workers only save through an employer-sponsored plan.

As we digest news today of the U.S. Q4’17 estimated GDP, remember that roughly 70% of this growth comes from personal consumption. If our workforce has less disposable income available to consume, GDP has to take a hit.  We already have millions of Americans in “retirement” that are participating to a far lesser extent in our economy, which is certainly not helping growth.

Since the firm’s inception, we, at KCS, have been encouraging for a variety of reasons plan sponsors and their asset consultants to embrace greater transparency of the defined benefit plan’s liabilities.  We still believe that with a greater transparency plan sponsors will be able to engage in a more dynamic and responsive asset allocation to changes in the plan’s funded status.

If plan sponsors don’t see the need for this improved insight, U.S. State Treasurers certainly should embrace this movement. Why? Moody’s Investment Service has recently modified their accounting methodology for measuring plan liabilities.  According to Moody’s in a December 2017 update, the most recent modifications replace the “Adjustments to US State and Local Government Reported Pensions Data methodology published in April 2013

Moody’s has updated the description of their standard balance sheet adjustment and included a description of the standard income statement adjustment. According to Moody’s, “both of these reflect the implementation of Governmental Accounting Standards Board Statement 68 accounting standards, which requires adjustments that were not previously necessary.”

What is the problem that they are trying to solve?