Help The Patient – Not the Morgue!

President Trump’s proposed budget for fiscal year 2020-2021 has two new premiums to help sure up the Pension Benefit Guaranty Corporation’s (PBGC) multiemployer insurance pool. The White House’s Office of Management and Budget estimates that the current PBGC multiemployer pool is short by $65 billion, with only $2.9 billion in assets at this time. The PBGC estimates that their multiemployer program will become insolvent by 2025, at which time participants in failing plans will likely receive 10% or less of their promised benefit.

The first premium adjustment is a variable premium to be paid by the individual plans per participant, both active and retired, and based on the funding status of the plan. The worst the funded status the more you pay per participant. The second proposed premium is described as an exit premium that will be “equal to 10 times the variable-rate premium cap – to be assessed on employers that withdraw from a multiemployer plan to compensate the multiemployer program for the additional risk imposed on it when employers exit” (ASPPA).

This proposed premium adjustment was part of the Grassley/Alexander proposal that has been floated. Unfortunately, it does nothing to keep these plans viable, but does provide a greater safety net should a plan fail. As we’ve discussed many times, there are roughly 125 multiemployer plans that have been designated as Critical and Declining, which means that they are <65% funded and will likely become insolvent in the next 15 years.

These plans are so cash flow negative that it is highly probable that they will all fail during that period. Raising the cost per head (as much as $80 from $29) isn’t going to help with the cash flow necessary to meet the promised benefits. Also, creating an exit premium (in lieu of withdrawal liability or in addition to?) will likely lead many of these plans to seek an alternative or hybrid retirement program.

The only legislation that keeps these plans alive is the Bill passed by the House of Representatives in July (H.R. 397), which provides critical loans to these failing plans. The plans receiving loans must defease their current Retired Lives Liability thus guaranteeing that the promised benefits will be paid in full, while extending the life of these plans by 30-years. Despite passing the House in July, this legislation continues to sit within the Senate as no action has been taken. It appears that Senate Republicans have no interest in providing a lifeline to these pension plans.

Why let these important retirement vehicles die? Wouldn’t it make more sense to keep these pension funds as on-going concerns so that current and future employees could also benefit from having a DB plan? Funding the PBGC and not these cash-starved plans is like allowing the patient to die, but giving them a nicer funeral! I don’t want to see these plans die!

Mr. Senator – Are You Listening?

For the past couple of years, we’ve been reporting on Carol and the cruel reality that she faces as a result of her multiemployer plan getting benefit relief under MPRA. We told you that there are 1,000s of similar stories to what Carol is experiencing. We’ve also reported that Cheiron estimates that the multiemployer pension crisis gets worse by $750 million per month. As such, Carol’s story and that of Valerie, who I will tell you about shortly will be replicated over and over. It isn’t fair!

Through no fault of their own, plan participants in roughly 125 multiemployer plans that are designated as Critical and Declining are in jeopardy of seeing their monthly pension checked slashed. In some cases, these plans have been able to file for benefit relief before the insolvency has occurred, but that hasn’t rescued the promised benefits. For many others, transfer to the PBGC awaits as these plans are forecast to become insolvent within the next 15 or so years, and in some cases much sooner than that.

I ask why is our government sanctioning this action? Would my Senator or yours be sitting on their hands if their family member was being dealt this raw deal? Doubtful! I am picking on the Senate because the House of Representatives actually did something in July with the bi-partisan passage of H.R. 397. Unfortunately, the Butch Lewis Act, as it is known, has been sitting in the Senate since then without being brought up for a vote. We need for them to hear or read about the painful stories of those who were once promised, and who contributed to, a defined benefit pension that is being pulled from them.

Valerie’s story follows:

Valerie tells us ” March 1st, 2020 we lose $1000 (per month) from my husband’s pension. Local 641 NJ. We both know the Republicans are never going to fix the pensions. Did they help all the people who lost their homes and retirement in 2008? They only helped the banks and big businesses. Once again the average guys get screwed. I’m sick and tired of being held hostage by these people. I don’t care anymore…My husband and I have already lost. We now have to move out of state, away from my grandchildren and family. Away from the only place we’ve ever known. My husband’s had two strokes and heart surgery. I will live in a strange place with no friends or family and a sick husband. Talk about a nightmare. We will sit there alone until the end. ”

Horrible, yet Valerie isn’t unique regrettably. The fact that Congress was willing to step in following the GFC at >$800 billion, yet claim that they are protecting the taxpayer now (which by the way each of these plan participants is) rings hallow to me. These DB pension payments are the lifeblood for many American workers. They produce significant economic activity, generate tax revenue at the local and federal level, and keep families off the social safety net, yet we have politicians who are willing to let these plans crash and burn because of ideology – shameful.

Safe and Sound? Hardly!

I’m going to be a bit of a jerk this morning, so please bear with me. I was reading an article about the new crop of DB pension CIOs and how they are likely to be better prepared than the previous lot that barely weathered the market crisis of 2007-2009. In fact, there are 13 new CIOs among the 20 largest DB plans. Despite not having endured the pain of the incredible market volatility and lack of liquidity that prevailed daily for nearly 18 months, we are to believe that because this “new class” of investor is better with data that all things will be great for these DB plans. They better be right, for most of these plans cannot afford another significant increase in contribution expenses. The next crisis may in fact be the last one for many of these plans.

The article described how several of these plans and their consultants had stressed-tested their pension systems through a number of iterations for both return and liquidity. But, I tend to remember that during the last crisis nearly everything correlated toward 1. In addition, during any crisis it becomes very difficult to alter one’s path to try to take advantage of any market dislocations. That needs to be done well ahead of the actual crisis. Others were cited, as having reduced their return on asset assumption, which I tend to believe, is a very prudent decision.

In another example, a plan with an experienced CIO had increased fixed income exposure from 34% to 46% explaining that the fixed income portfolio was less risky. Okay, but equity exposure was only reduced to 64% from 66% because they are now using leverage. Are you kidding me?

Plans need to act before the next crisis. They need to ensure that liquidity is in place to meet monthly benefit payments (Retired Lives liabilities) so that less-liquid assets aren’t sold under less than ideal conditions to meet those payments. Time (investment horizon) is an investor’s friend – the longer the better – especially for all of the alternative assets that have been brought into these systems.

Sponsors should be taking risk off the table now, but they should be bifurcating their asset allocation into beta and alpha assets, where the beta assets (bonds) are cash flow matched to meet benefit payments, while the alpha assets (everything else) have time and no liquidity pressure to meet future liabilities. This is a low-risk, prudent, and time-tested strategy for plan sponsors to adopt, especially in this low-interest rate environment where returns going forward may be challenged.

More On January's Liability Growth

According to Milliman, which produces regularly the Pension Funding Index (PFI), the top 100 US Corporate plans witnessed their pension plan funding deteriorate by $73 billion. The primary driver of this poor performance was the continuing fall in the discount rate. In fact, Milliman used a 2.85% discount rate, the lowest in the 20-year history of producing the PFI, and only the second time that the discount rate was below 3%.

The rate fell by 35 bps in January resulting in an increase in pension liabilities of $87 billion, which was only partially offset by asset growth of $14 billion during the month. The aggregate funded ratio fell to 85.7%. Milliman sees a way forward in which the funded ratio improves to 99% by the end of 2021, but that scenario would result only if pension assets grew by 10.6% in each of the next two years, with a corresponding rise of 60 bps in interest rates in both 2020 and 2021.

However, a further deterioration in the aggregate funded ratio of the top 100 Corporate plans to 73% would occur if U.S. long-rates continue to fall to 2.3% by the end of 2020 and 1.7% by 2021, while plan assets only grow at 2.6% each year through 2021’s conclusion. Since I’m not a betting man, I’d rather de-risk my pension plan to secure the plan’s Retired Lives, extend the investing horizon for the portfolio’s alpha assets to beat future liability growth, and improve liquidity to meet current benefit payments then forecast that rates will eventually rise and assets will not see a correction. What do you think?

U.S. Treasury To Issue 20-Year Bonds (Again)

It has been 34 years since the U.S. Treasury last consistently issued a 20-year bond, but they have announced plans to once again bring these bonds to the market. According to an article in FinReg which cited an article By Kate Davidson and Julia-Ambra Verlaine February 5, 2020, The Wall Street Journal, the “Treasury said it plans to issue new 20-year bonds each quarter—in February, May, August and November—and will hold auctions in the third week of the month, the same week as Treasury inflation-protected securities, or TIPS.” They have not yet determined when the first auction will be held or the size of the initial offering.

There are natural buyers of longer-dated instruments, such as corporations, pension funds, insurance companies and banks. However, it is a fallacy that the Treasury has to issue debt to finance its spending. It doesn’t. Treasuries are issued to set interest rates and NOT finance the deficit spending (see Mosler, The Seven Deadly Innocent Frauds of Economic Policy).

Yes, It Is Different – So What!

Would you utilize a strategy that enhanced return relative to the strategy that is currently used in your portfolio, especially if it eliminated interest rate risk, secured a plan’s Retired Lives, improved the fund’s liquidity profile, and cost LESS? This question seems silly given all the benefits highlighted above, but alas it is not. You see, despite all of the proven benefits, and we didn’t mention that the funded status and contribution expense for the fund are stabilized for that portion of the portfolio, too, plans and their consultants seem to be reluctant to embrace a cash flow driven investing approach.

Why? I’m not positive that I know the answer, but maybe they feel that the claims are too rosy or perhaps it is just different! But, how different is this strategy? It is what lottery systems use on a daily basis. Furthermore, the insurance industry has built its businesses through matching assets against liabilities. In fact, Pension America used to manage very effectively plan assets versus plan liabilities (the promised benefits) using defeasement strategies. What happened? Why has this concept become so foreign.

As I’ve shared many times before, the true objective of a pension plan is the securing of the promised benefits at low cost and reasonable risk. It is NOT the generation of the highest return, which only serves to create a much more volatile pattern of performance and funding. We have a pension crisis unfolding in the U.S. and for many Americans the idea of a dignified retirement is beyond imagination. There are many contributors to this problem, but one rather large one is plan asset allocations that continue to strive for return and be damn everything else – such as liquidity, cost, volatility, etc.

Are bond portfolios really return generators in this low-interest-rate environment? No! Yet, most plans have a decent if not rather healthy exposure to this asset class. Wouldn’t that segment of your portfolio be better served as a source of cash flow that is matched to your monthly benefit payments chronologically as far out as your current allocation permits? In fact, bonds are the only asset that has a known cash flow and terminal value. They should only be used to defease your plan’s liabilities (Retired Lives) that will then create an environment for the balance of your assets to maximize the liquidity premium that exists.

This cash flow driven investing (CDI) approach maximizes the efficiency of a plan’s asset allocation despite the fact that there is no change in the allocation to fixed income or the return on asset objective (ROA). Now plan liabilities are secured, liquidity to meet those obligations is improved, return on the bond portoflio is improved, and costs reduced. Find out for yourself why this isn’t a fairy tale!

A Chilly Start To The Year For Pension America

The weather in the Northeast has been seasonally mild to start 2020, but that doesn’t mean that DB pension plans haven’t had a cold start to the new year, as funded ratios have declined roughly 3%-5% in January according to October Three, a pension design firm. Both plan assets, which fell in value, and plan liabilities, which advanced as interest rates fell contributed to the steep decline in funded ratios and funded status.

This development impacted all pension plan types, but only corporate plans that use a AA Corporate blended rate (ASC 715) would actually see this in their reporting, as a majority of both public and union plans use the return on asset assumption (ROA) to value their plan’s liabilities, too. Who knows what the remainder of 2020 holds for these plans, but living with this volatility in funded status makes little sense.

As we’ve been discussing at various conferences, plans would be wise to de-risk at this time by cash flow matching near-term liabilities. This strategy serves to reduce interest rate risk, as a cash flow driven investing (CDI) approach defeases benefit payments that are future values, while extending the investing horizon for the true alpha assets (non-bonds) to outperform. Pension plans have struggled to improve funded status and stabilize contribution expenses since the great financial crisis. It would be a shame to see this effort compromised by a correction in the market and further falling interest rates.