P&I reported in their September 6th edition that the Society of Actuaries and the American Academy of Actuaries Joint Task Force has challenged the practice of valuing liabilities at the ROA discount rate for public pension and Multi-employer plans. They, as do we, believe that liabilities should reflect economic reality, with the risk free rate (Treasuries) being used as the discount rate.

After much internal debate the Joint Task Force initially refused to release the draft report.  Fortunately, they changed their minds and recently released the paper.  It is being reported that NCPERS is trying to squash this movement.  It is truly unfortunate.

Given where the level of interest rates are at present, we believe that it is a great time to bite the bullet and mark plan liabilities at a true risk free rate.  Liabilities are bond-like, and they are likely not going to grow substantially from this level, and may in fact decline if the U.S. economy can generate a little growth and inflation that will lead to interest rates rising.  This may not occur in the immediate future, but it will happen eventually.

For more than 30 years, DB pensions have been under pressure from falling interest rates (liabilities have dramatically outperformed asset growth).  Regrettably, many, if not most, DB plans did not capture this great bull market for fixed income as plans anticipated that the lower bond yields would harm their ability to exceed the return on asset assumption (ROA). As everyone knows, bond values are not just determined by yield, and bonds, especially longer-dated issues, have provided outstanding returns during this period of falling rates.

Furthermore, pricing the liability at an inflated discount rate has artificially reduced annual contributions, while leading plans to take on much more risk in pursuit of the ROA through traditional asset allocation approaches. Given where equity and bond valuations are at present, it is highly unlikely that we are going to earn our way out of this underfunding.  We think that plans should initiate a different course in managing both assets and liabilities, and an honest accounting of the liabilities is a great place to start.

Just think what heroes plan sponsors and trustees will be when liability growth is negative in a rising rate environment and DB plans that were once assumed to be on their death bed are once again flourishing.  It won’t take heroic annual asset returns to close the funding gap in an environment in which liability growth is negative. Funded ratios could improve quite dramatically in this scenario. Your participants are counting on everyone to secure this incredibly important benefit.  The time is now to do something different!

According to Wilshire TUCS performance results for the 12 months ended June 30, are as follows: corporate plans had the highest median return at 1.64%, followed by Taft-Hartley health and welfare funds at 1.37%; public funds, 1.07%; Taft-Hartley DB plans, 1.04%; and foundations and endowments, -0.26%. Well, they aren’t very impressive!

Given the very different objectives of DB plans versus E&Fs, one would think that the results would have been quite different, but alas, these pools of assets use the same asset consultants, who basically have the same approach to investing no matter what type of plan.  E&Fs have an annual spending policy that should dictate much more of an absolute return orientation.  Yet, it is these funds that saw their median result at -0.26%.  Also, corporate and public DB plans have different accounting rules for their liabilities as FASB and GASB treat liabilities quite differently.  Yet, their results are nearly on top of one another.

Isn’t it time for another approach?  At KCS we’ve been highlighting our unique asset allocation for nearly 5 years. In our approach we bifurcate the assets into two buckets, which are insurance (beta) and growth (alpha) assets.  The insurance assets are a cash flow matching  strategy to meet near-term benefit payments.  The growth assets are non-fixed income assets with the objective to beat liability growth.  The plan’s funded ratio and contribution history will dictate how much goes into each bucket.

For plans that have funded ratios in the  70%-80% range, we would have allocated a substantial percentage of the assets to the insurance portfolio.  Unfortunately, most plans have seen their fixed income exposure dramatically reduced as interest rates fell, which has created an asset/liability mismatch.

If plan’s had adopted our approach, they would have done substantially better than the median results highlighted above as the Barclays Aggregate index generated a 6% return for the 12 months ending June 30th.  Plan sponsors need to focus more on their specific liabilities and not the ROA, which is injecting too much risk into the asset allocation decision.  Call us if you want greater insight into how we can help you improve your plan’s funded status.

We are pleased to share with you the latest edition in the KCS Fireside Chat series. We hope that you continue to find value in our insights.

Click to access KCSFCSep16.pdf

In this article we provide our readers with an update on multiemployer plans. There has been a lot of press recently related to what is happening within the Central States Teamsters plan that may result in significant benefit reductions. We are obviously concerned about the implications of such a cut on the plan participants. Plans that are struggling to meet minimum funding thresholds are required to develop a rehabilitation plan. In this article we share with you our game plan for putting these plans on a new and improved path.

As always, please do not hesitate to reach out to us for any assistance. We thank you for your continuing support, and we wish for you and your family a wonderful Labor Day weekend. Travel safely!

KCS was pleased to contribute an article to the Association of Benefit Administrators, Inc. (ABA) Insights newsletter for the spring / summer 2016 edition. The article titled, “Rethinking the Use of Traditional Fixed Income in a DB Plan”, highlights KCS’s approach to asset allocation that is driven by a greater understanding and transparency of the plan’s specific liabilities.

We believe that all DB plans should be preserved!  Given different PBGC rules / support we are particularly concerned abut the long-term viability of multi-employer plans and the potential impact on the beneficiaries should any of those plans fail.

We would be pleased to send or email you a copy of the article. Please don’t hesitate to reach out to us at info@kampconsultingsolutions.com or rkamp@kampconsultingsolutions.com.

Regular readers of the KCS blog know that we believe that the pension accounting rules (GASB  and to a lesser extent, FASB) have created many of the issues facing Pension America today, especially for public pension plans given their focus on the ROA as the discount rate for plan liabilities.

Instead of having to listen to us once more on this subject, I am sharing with you today the thoughts expressed by Ron Ryan, Ryan ALM, who is one of the most thought provoking investment professionals and pension experts in our industry.  The following link is to a presentation that he will be delivering to the Florida Public Pension Trustees Association (FPPTA).

http://kampconsultingsolutions.com/images/ROAPENSIONCRISIS.pdf

I encourage you to review this material, as it will give you great insight into why the focus on returns (ROA) has lead to a massive mismatch between a plan’s assets and their liabilities, and why in this low return environment, it is leading to huge increases in contribution rates.

Please don’t hesitate to reach out to either KCS or Ryan ALM with any questions and / or comments.

New Jersey slashes hedge fund portfolio in asset class overhaul
The New Jersey State Investment Council on Wednesday unanimously approved an overhaul of its hedge fund portfolio for the New Jersey Pension Fund including cutting the target allocation in half, reducing the number of hedge funds and cutting fees significantly. (P&I Daily)

I don’t know who first had the “brilliant” idea to allocate so much of NJ’s DB pension portfolio to alternatives following the GFC when cheap beta was so severely discounted, but to now slash the allocation when equity and fixed income valuations are stretching their limits is ridiculous!

First, DB plans have a relative objective (plan liabilities) and not an absolute objective, despite the fact that plans think they need to achieve the ROA.  These aren’t endowments or foundations with positive spending policies. Liabilities are missing in action when it comes to investment structure and asset allocation decisions, and it is leading to the injection of too much risk into their funds.

We are huge proponents of DB plans being the retirement vehicle of choice, but they need to be managed responsibly.  First, identify the primary objective (liabilities) and manage to that objective.  Second, STOP buying high and selling low. Furthermore, I think that the fees associated with hedge funds are outrageous and in most cases, unwarranted, but the NJ plan already has the exposure. Don’t sell it now, as you just might need some uncorrelated assets in the coming months.

Florida Retirement System tops benchmark with 0.61% for fiscal year
Florida Retirement System returned a preliminary net 0.61% in the fiscal year ended June 30, 71 basis points above its benchmark.

The above information was reported in a P&I Daily news release. Interesting information in that it continues to highlight the difficulty Pension America, particularly public pension plans, have had generating returns.  More importantly, it once again reveals the inappropriateness of most asset allocation approaches.

The total fund benchmark (-0.1%) is NOT the appropriate benchmark.  DB plans need to use their plan’s liabilities as the primary benchmark, but if they want to compare assets to something other than liabilities than the return on asset assumption (ROA) should be the proxy. The average public fund ROA is 7.61%.

To suggest that the Florida Retirement System had a decent year (ending June 30, 2016) because they beat some artificial hybrid index when they fell incredibly short of their ROA target or liability growth is misleading and wrong!

Asset allocation and investment structure decisions should be driven by a plan’s funded status and not some hybrid index. DB plans need to begin to remove risk from this effort and not inject more risk that could lead to greater contribution volatility.

We are pleased to share with you the latest edition in the KCS Fireside Chat series. In this article we share with you WHY KCS exists, while mentioning that today (8/1/11) marks our fifth anniversary. We at KCS still very much believe in our primary mission to defend and preserve DB plans as THE retirement vehicle in the U.S. Preserving these plans will not be easy, and it will certainly not be done implementing the same game plan that has been in place for the last 50 years!

Click to access KCSFCAug16.pdf

On a personal note, it is hard to believe that KCS has been in operation for five years! It hasn’t been easy, and we still have a long way to go in our development. However, I believe that through our efforts, both through the written word and our speaking engagements, we have begun to impact the conversation related to pensions. However, if not for the support of my wife, Laurie, our five children and their significant others, and my four partners, Dave Murray, Ivory Day, Larry Zielinski, and Lillian Jones, KCS would certainly not have gotten to this point. THANK YOU! We also want to thank our clients for their support and encouragement. I hope that we have proven to be worthy of your confidence.

“However beautiful the strategy, you should occasionally look at the results.”

– Winston Churchill

Pension America has been approaching the management of DB plans the same way for more than 50 years.  My colleague, Larry Zielinski, likes to call it pension orthodoxy. Well, given that Funded Ratios continue to fall, while contribution costs rise, I’d say that it is about time that we look at the results! If not now? When?

The focusing on the ROA to drive asset allocation and investment structure decisions has to stop! It isn’t working, and trying to hit the ROA in the next 5-10 years will likely prove more daunting than it has been in the last 15 years.  We need to preserve and protect DB plans, but doing the same thing over and over again despite the poor results is just silly!

Call us, write to us, visit us, and / or ask us to visit you. We can help, but don’t expect us to follow the same path. Our path is definitely the one less followed!

Why Pensions’ Last Defense Is Eroding

Long-term returns for U.S. public pensions are expected to drop to the lowest levels ever recorded

The above is the title of an article appearing in today’s WSJ. The “lowest levels ever recorded” is a bit of a reach!  Wilshire’s Trust Universe Comparison Service (TUCS) has been measuring the 20-year return for public pension plans for the last 16 years.  They are estimating that the June 30, 2016 20-year return will be 7.47%, which is below the average return on asset assumption for public DB plans, and if the estimate is correct, it will be the lowest 20-year return ever recorded by TUCS. That said, we’ve certainly had some shorter-term periods that were far more onerous for Pension America.

Unfortunately, pension plans continue to focus almost exclusively on the asset side of the equation, and if that is all one does, of course one would be concerned about that 20-year result, especially given that traditional bond and stock markets appear frothy at this time.  However, DB pension plans can certainly survive and even thrive in a low return environment if their plan’s liabilities are performing more poorly than the asset side.  Liabilities are assumed to grow at the ROA (GASB), but that is not how they grow, as they are bond like and go up and down with changes in interest rates (and other benefit and workforce related factors).

Should we get into an environment of improved economic growth, with a little inflation, U.S. interest rates could back up.  If that were to happen, liability growth would be modest, if not negative.  A DB plan’s funded status could see significant improvement in such an environment.  However, given that most plans don’t know the term-structure, growth, rate, and yield of their liabilities, they likely wouldn’t know that assets are outperforming liabilities.

The U.S. retirement industry needs to change its approach to managing DB plans.  It isn’t a return arms race! The ROA is not the Holy Grail. These plans must be sustained, and in order to accomplish that objective, they must be derisked! Measure and monitor your plan’s liabilities, and use that information to create an investment structure and asset allocation that reflects your current funded status.  Your plan’s beneficiaries are counting on you, and so are the taxpayers of your fine state, city and / or municipality.