Regular readers of the KCS blog will know that we have occasionally shared real estate updates provided to us by our friend, Keith Jurow.  Here is a brief note that he recently shared with us.

“Yesterday, Fannie Mae announced the winning bidders in its ninth non-performing residential loan sale. The fourth group was composed of 2,427 loans with an average loan size of $211k. It also had an average unpaid principal balance of $511k.

Wait a minute. How is that possible? Let me explain. It confirms what I said in my latest article:
https://www.advisorperspectives.com/articles/2017/02/20/cash-out-refinancing-during-bubble-years-will-lead-to-disaster

These are bubble-era loans which were modified and then re-defaulted. The interest arrears were tacked on to the unpaid principal (called capitalization) and apparently averaged about $300,000. These loans are so far underwater that I wonder how the new loan owners will ever see a nickel when they are liquidated.”

We suggest that you pay heed to Keith’s concerns.

The WSJ is reporting on an annual study conducted by the Employee Benefit Research Institute (EBRI) that claims that 60% of workers are very confident or somewhat confident in their ability to retire.  This figure is down 4% from last year, and 10% since 2007, but up slightly from 2012.

The report also goes on to say that current retirees are more confident (79%) than workers in their ability to retire.  That leaves 21% of current retirees who must be struggling in their retirement.  It makes sense to us that current retirees are more confident than future retirees, especially when one considers that roughly 50% of the private sector once participated in a DB plan, while private sector participation is only about 14% today.

Furthermore, the study of 1,671 participants indicated that 47% of households reported having less than $25,000 in savings and investment, when not including one’s home.  How is it that 60% feel confident in their ability to retire when 47% have less than $25,000, and nearly 50% of those had less than $1,000 saved?

We’ve frequently expressed our concerns about the impending retirement crisis in the U.S.  The social and economic ramifications will be grave, and there is nothing in this recent study that diminishes our concerns!

The WSJ today published an article, titled “Your Pension Check May Soon Be Coming From An Insurance Company”.  The article highlights the growing trend in the off-loading of pension liabilities to insurance companies.  These pension-risk transfer efforts have been going on for some time, with Prudential Insurance Company being a leader in this space.

As the article highlights, private pension funds are happy to off-load these liabilities, as the volatility associated with funding plans can play havoc with income statements through annual contribution expense.  However, the transfer of the liability is no free lunch, and the cost to transact often results in a sizeable premium being paid by the company.

According to Ron Ryan, risk is best defined as the “uncertainty” of meeting the client’s objective.  For a plan sponsor, the pension plan’s objective should be to fund liabilities in a cost effective manner such that contribution costs remain low and stable. Since the pension objective is a cost objective, then solving for cost while matching the liability payment schedule would be the ideal way to de-risk a pension plan.

KCS, through its affiliation with Ryan ALM, can assist you in de-risking your pension plan without having to transfer assets and cash to an insurance company at a significant premium to the present value of that liability (usually retired lives).  By retaining the assets and establishing a cash-matching strategy, we believe that a 30% savings can be achieved versus standard de-risking approaches.

Please don’t hesitate to reach out to us to learn more about the Ryan ALM / KCS pension de-risking strategy.

In May 2013, KCS produced a Fireside Chat on the state of U.S. fixed income.  We are re-publishing it today, as it is still very much relevant, especially our thoughts regarding the primary sources of inflation.

We were very much correct in 2013 when we argued that U.S. rates would continue to decline, and we still believe today that the U.S. economy’s modest growth profile and global geopolitical risk will temper U.S. interest rate increases.

We look forward to hearing from you, especially U.S. public fund and multi-employer pension sponsors, who have positioned their portfolios for significant rate rises. Asset allocation should be driven by the funded status of a DB plan, and not the return on asset assumption. But, that is not the common practice among asset consultants.  We are here to change that antiquated thinking.

In an article that appeared on Wednesday, March 1st in the NY Daily News, writer Ginger Adams Otis presented a frightening update on the current landscape for the Pension Benefit Guaranty Corporation (PBGC).  According to Otis, the PBGC’s “limited liquidity is part of the spiraling U.S. pension crisis that threatens to wipe out the retirement savings of more than a million Americans”.

The PBGC addressed its funding issues, as it announced that it is now officially making pension payouts for Teamsters Local 707, which joins a growing list of 70 bankrupt union pension plans and a host of private companies.

With only $2 billion in assets, the PBGC is expected to run out of funds in the next 8-10 years. The company makes its money through premiums charged to unionized multi-employer pension funds.  Premiums have grown substantially during the last several decades.

DB pension payouts provide significant economic stimulus to the local economies of the recipient. Without these monthly checks, participants will have to rely solely on Social Security payouts that barely keep an individual above the poverty line.

Infrastructure “investment” seems to be on everyone’s radar screen, and for good reason, but protecting the benefits from multi-employer plans should be a priority, too.  There is no way that premium increases can support the financial needs of the PBGC in coming years. We should further deficit spend to sure up the finances of this important organization before millions of Americans lose benefits that they worked very hard to earn.

KCS is happy to share with you the latest edition of the Fireside Chat series. This article, written by Dave Murray, speaks to issues related to the defined contribution world. As you will read, plan sponsor liability was a big reason why traditional DB plans have been frozen and/or terminated, but the liability associated with DC plans, although different, may be equally challenging, as it comes in many forms.

Please don’t hesitate to reach out to us with any comments or questions.

Finally, we would like to point out that the KCS team continues to grow. We have recently added more senior talent. We now have 8 senior members of the KCS team with a combined 285 years of investment/pension experience. This amounts to an average of 36 years per consultant. The consultants’ experience ranges from a minimum of 28 years to as many as 48 years (congrats, Mr. Zielinski). Unlike your car, we get better with each year of experience. Why not test-drive us today!

Members of both political parties are deeply worried about the unfolding U.S. retirement crisis, according to a new study by the NIRS. Key findings include:

Across Party Lines, Americans Support State Efforts to Enable Savings for Workers Lacking Retirement Plans

Americans’ retirement prospects: Work Longer, Spend Less

77 Percent agree that the disappearance of traditional DB Pensions killing the American Dream

71 Percent Say DB Pensions better than 401(k)s for delivering retirement security

WASHINGTON, D.C., February 28, 2017 – America faces a deep political divide, but not when it comes to economic security in retirement. A new report finds that 76 percent of Americans are concerned about their ability to achieve a secure retirement, with that level of worry at 78 percent for Democrats and 76 percent for Republicans. Some 88 percent of Americans agree that the nation faces a retirement crisis, and the concern is high across party lines.

These findings are contained in a new study, Retirement Security 2017: America’s View of the Retirement Crisis and Solutions.  The research is published by the National Institute on Retirement (NIRS) and is based on a poll of 800 Americans conducted by Greenwald & Associates. The findings will be reviewed today at the NIRS annual retirement policy conference in Washington, D.C. The full report can be found on the NIRS website.

We are pleased to share with you another excellent article/analysis by our friend Keith Jurow. This article discusses the potentially negative ramifications from “cash-out refis”. Here you go:

Nearly all analysts who write about the housing bubble have focused on the purchasing madness that occurred. While this is important, it overlooks the refinancing insanity of 2004-2007. This refinancing lunacy will devastate mortgage and housing markets for years to come.

You may wonder why I choose to focus on bubble era refinancing. After all, refinancing happens all the time.

Here is why: California was the nation’s epicenter for the refinancing madness. During the bubble years, roughly five times as many refinanced first liens were originated there as were purchase loans.

Millions of homeowners refinanced once, twice, even three times or more while their homes soared in value. These became known as “cash-out refis,” where the borrower refinanced for a larger amount than the previous loan. A California home that may have been purchased for $200,000 in 1997 could easily have had a $600,000 refinanced loan in 2006. When home prices began to tumble, they found themselves trapped in a badly underwater property.

There were roughly 20 million homeowners who refinanced during the bubble years.

I don’t think that I’d get too much of an argument for making the claim that experience matters in all industries. One should want to work with an individual or team that has experienced a variety of markets and environments.  To be able to recall how one reacted previously to similar events should provide a level of confidence relative to someone experiencing a situation for the first time.

Because the financial industry produces many cycles, having the ability to draw on one’s knowledge of how those cycles played out is extremely important. I once heard that the investment management industry was a young man’s (or woman’s) game.  I’m sorry, but I totally disagree with that thought.

At KCS we’ve built a team of 8 senior consultants that has a combined 285 years of industry experience, which equates to 35.6 years of average service per consultant. That means that the “average” consultant has been in the investment/pension industry since 1981’s bear market.  How many of you remember the bear market from 1980 through July 1982?  In fact, both Larry Zielinski (48 years) and Ivory Day (45 years) have been working with their clients’ issues since before ERISA. Wow!

The good thing about the years of experience that we’ve accumulated is the fact we’ve already made a lot of mistakes and have learned from those.  For instance, we, too, were focused on the return on asset assumption (ROA) as being the primary objective for managing a pension plan, only to realize many years into the game that achieving the ROA didn’t guarantee funding success.  As a result, we’ve built KCS with the knowledge that a plan’s primary objective is to fund the promise (benefits) at the lowest cost possible.

In order to accomplish this objective, sponsors must have greater knowledge of what that liability looks like on a more frequent basis. We’d appreciate the opportunity to share with you some of what we have collectively learned during our 285 of managing pension issues.  I think that you’ll find we have a lot to offer.

How are your defined benefit plan’s liabilities performing?  If you are a public fund plan sponsor this simple question might be very difficult to answer.  Why? Well, for one reason, you are only receiving an update annually, perhaps 4- 6 months dated, when your actuary delivers their annual update.  Second, the totally arbitrary discount rate being used under GASB is understating the plan’s true liability in this low-interest rate environment.

As a reminder, the DB plan only exists to fund a promise (liability) that has been made to the plan’s employees/participants. It is funding this promise at the lowest cost possible that should be the ultimate objective.  Regrettably, that is not the case for most plans, as they’ve been inappropriately convinced (hoodwinked?) that achieving the return on asset (ROA) assumption is all the matters.

I suspect that you know the current market value of assets in your plan down to the penny.  If not today’s valuation then you certainly know the value as of January 31, 2017.  Why is it more important to know the asset side of the equation than the liability side?  If I were running a pension plan, I’d certainly want to know the following:

1. What is the current value of the promise (liability) that has been made?
2. What are the current funded ratio and funded status of the plan?
3. What do the benefit payments look like on a monthly basis?
4. Do I have the liquidity to meet those payments?
5. Will the plan run out of money prematurely? If so, when?
6. Are the estimated contributions enough to narrow the funding gap?
7. What happens to the plan’s long-term funding if only a fraction of the contribution is made?
8. Can I “safely” award a COLA or benefit enhancement?
9. How much alpha do I need relative to liability growth to begin to whittle away at my unfunded liability?

I would suggest that without greater knowledge of the plan’s liabilities, you will not be able to answer the questions above.  In fact, without a custom liability index (CLI) being produced for your plan’s specific liabilities it would be impossible to answer those questions.

Investment structure and asset allocation should be driven by the liability side of the equation. It makes no sense that trying to achieve an arbitrary ROA would be the plan’s primary objective. As we reported earlier today, the average public DB plan has a 7.6% ROA target with only 7 of 132 large public funds having a ROA < 7%. How is it possible that all these plans have roughly the same ROA objective?

One would think that a plan that is 90% funded would have a much more conservative asset allocation than one that is 50% funded. But if both plans are striving for the same 7.6%, they are going to get a very similar asset allocation from their generalist asset consultant. DB plans should be removing risk from the process as funding improves. But, if you don’t know how the liabilities are performing, then you can’t possibly know when to take risk off the table.

If you’d like to be able to answer the questions posed above, please reach out to us to construct a CLI for your plan.  It isn’t prudent to perform surgery without a set of X-rays.  Why engage in the management of a DB plan without the appropriate x-rays being made available for your plan’s liabilities?