By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Perhaps many sponsors of multiemployer plans potentially eligible to receive SFA grant assets remain confused by the recent PBGC Final Final Rules (FFR)/guidelines? Perhaps we are just in the Summer doldrums and activity related to the ARPA legislation was going to be muted anyway. In any case, activity has been non-existent during the last two weeks, as no new applications were filed, no previously submitted applications approved or denied, and no SFA assets were paid out.

Still, only a fraction of the potentially eligible plans has filed an initial application. Now that the FFR have been published we are left with the task of determining what it means for the plans that have already received their SFA. Will they be eligible to refile for potentially more? Will they have to redo their investment program within the SFA bucket given the expanded list of eligible investments? Should they?

Ryan ALM is on record criticizing the expanded investment options. We believe that it doesn’t support the intent of the legislation to SECURE the promised benefits for as long into the future (hopefully 2051) as they can. Here is our response to the PBGC which was submitted to them last week:

Comments on PBGC Final Rule

Page 20 section titled… 1. Pay all benefits due through 2051 clearly states:

“Section 4262(j)(1) provides that the amount of financial assistance provided to a multiemployer plan eligible for financial assistance under this section shall be such amount required for the plan to pay all benefits due during the period beginning on the date of payment on the special financial assistance payment… and ending on the last day of the plan year ending in 2051, with no reduction in” benefits.

Page 21 section titled… 2. Interest rates for SFA and non-SFA assets clearly state:

“For a plan to project accurately how much SFA is “required” for the plan “to pay all benefits due” through the end of the plan year ending in 2051, it must project the SFA assets, adjusted for earnings, needed to cover each year’s benefit payments and expenses until exhausted, and the non-SFA “other plan assets,” adjusted for contributions and earnings, needed to cover each year’s benefit payments and expenses after the SFA assets are exhausted through the end of the SFA coverage period.”

Page 80 clearly states:

“The changes in the final rule permit plans to invest a specified percentage-up to 33 percent of their SFA funds in return-seeking assets (RSA) as described in 4262.14© of the final rule. That leaves 67 percent or more of the SFA funds to be invested in investment grade fixed income securities (IGFI). PBGC believes this ratio (67 percent IGFI to 33 percent RSA)> appropriately considers the need to protect SFA assets to pay protected benefits of the participants and expenses of the plan, The 33 percent that may be invested in RSA as defined in the final rule will enable plans to grow SFA funds and increase the potential to pay benefits through 2051 while limiting the total risk exposure of taxpayer-funded assistance.

 Ryan ALM observations and recommendations are as follows:

1. The language on page 20 is that of a defeasance[i] that requires assets fully fund benefits + expenses through a certain period of time. A defeasance requires the certainty of asset cash flows to fund chronologically liability cash flows as they come due. Only bonds have the certainty of cash flows and it is why they have been used historically for cash flow matching. Benefits and Expenses (B+E) are a term structure that is paid chronologically from contributions (C) first, withdrawal liability payments (WLP) second, and assets cash flows third. As a result, it is an asset exhaustion test to see if asset cash flows are sufficient to fund net liability cash flows (B+E) – (C+WLP))… net of contributions and withdrawal liability payments. It is not a test to see if assets earn some ROA target or hurdle rate. It is an asset exhaustion test to see if asset cash flows fully fund B+E and when these SFA assets are exhausted.

• The SFA assistance is a grant and does not need to be paid back. Page 20 makes it clear that it requires the grant to be used to pay all benefits chronologically through 2051. Page 21 contradicts page 20 suggesting that non-SFA assets can be used to fund net B+E through 2051 in determining how much SFA is required to fully fund B+E through 2051. This language is inconsistent with the intent of the SFA grant.

• Allowing 33% in RSA is another contradiction of the intent of the SFA grant. The SFA grant is to cash flow match (defease) net liability cash flows… it does not have a ROA hurdle rate. It does not need RSA. RSA belongs in the legacy assets (non-SFA). Fixed income assets can now be removed from the legacy assets since the segregated SFA account is now where fixed income assets belong. Removing fixed income from the legacy portfolio asset allocation would enhance their ROA. You do not need or want RSA assets in the SFA asset pool. You need SFA assets to have certainty of cash flows… only bonds can apply. Furthermore, bonds not used to defease pension liabilities are return-seeking assets (RSA). In 2022, a core bond portfolio used as RSA lost >10% YTD. Where is the certainty in funding benefits and expenses?

• The proper discount rate to calculate the SFA grant should be the U.S. Treasury STRIPS yield curve or at worst all three PPA segments chronologically. Each multiemployer plan’s liabilities are unique with the different labor force, salaries, mortality, contributions, withdrawal liability payments, and plan amendments. No generic discount rate could possibly price such a different array of liabilities correctly. This requires a custom liability index (CLI) for each plan to price and calculate the present value of net liabilities (B+E) – (C+WLP). 

Please confirm receipt to:

rryan@ryanalm.com and rkamp@ryanalm.com

Thank you for your time and opportunity to comment.

Ronald J. Ryan                       Russ Kamp

CEO                                         Managing Director

[i]  Defeasance is the setting aside of dedicated funds to repay debts. In this PBGC reference, it is the cash flow matching of asset cash flows to liability cash flows with certainty. This will guarantee full payment of each liability payment when due.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

The CPI-U was published today. Market forecasters had anticipated that inflation would continue to rise, and they estimated that the 12-month annualized inflation # would be 8.8%. They got the direction right, but the magnitude was clearly wrong as the number posted was 9.1% That reading is the highest annual inflation registered since October 1981, which happens to coincide with the month that I entered this industry. Quite surprisingly, equity and bond markets have recovered losses since the announcement this morning and they are now registering gains on the day.

Does this make sense? I guess it might if you believed that the Fed has already accomplished its objective of taming inflation by having increased the Fed Funds Rate by 1.5% and that today’s # is actually a peak. It also might be that today’s number will force the Fed to be more aggressive in its fight against inflation by raising rates perhaps by a full 1% at the end of this month like Canada just did, which will force the US economy into recession. But what is the likelihood that the Fed has achieved its goal by raising rates by only 1.5%? Furthermore, do interest rate increases drive economies into recession overnight? Does inflation evaporate immediately when interest rates are increased? I would suggest that the answers are NO, NO, and NO!!

Perhaps a little context is necessary. Let’s look back at the last inflationary environment of the 1970s into the early ’80s. In December of 1972, the CPI for the previous 12 months was 3.2%. Two months later the annual CPI # had crept up to 3.86%. It would be a full decade later until the annual CPI once again had a 3 before the decimal place. You see, inflation doesn’t rocket skyward only to fall back to earth once the Fed begins to raise rates. For those of you that didn’t live through that period let alone work in this industry, inflation would go through two periods of significant increases before falling to levels to which we all became accustomed.

It took 23 months from the bottom of the inflation cycle in December 1972 (3.16%) to the first peak (11.13% in November 1974). From there inflation began to taper as the Fed raised rates, but the bottom for annual inflation would only fall to 4.5% in November 1976, a full 1.34% above the previous low for the cycle. Regrettably, the Federal Reserve took its foot off the pedal of increasing rates and the result was a rapid increase in inflation to 13.46% in March 1980. It would be another 2 3/4 years before inflation returned to a level below 4%. For the decade ending December 1982, the CPI averaged an annual rate of 8.68%. At no point did inflation begin and end on a dime despite aggressive attempts by the Federal Reserve to combat inflation through interest rate increases.

For investors believing that rate increases will have a dramatic and immediate impact on inflation and the economy, I encourage you to please look to the 1970s as a guide. It won’t likely play out as you are hoping. Inflation may still go higher. In this environment, why would anyone want to own long bonds (30-year US Treasury Bond) with a current yield of 3.08% for a real return of negative 6%? Bond yields have provided investors with a roughly 2% real yield advantage (inflation premium) relative to the CPI throughout time. Remember, it took from February 1973 (CPI 3.86%) to December 1982 (CPI 3.5%) for inflation to get controlled. Even at 3.5% inflation, the real return to bonds is negative. Since when are investors willing to live with such meager returns?

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

We are pleased to share with you the Ryan ALM Newsletter for the second quarter of 2022. Despite a very rough start to the year for the capital markets, the present value of pension liabilities (based on an average 12-year duration) underperformed the “average” asset allocation by roughly 2.2%. As a result, Pension America once again witnessed an improving funded status. For pension plans that use GASB for their accounting standard, this outperformance on the part of plan assets versus plan liabilities may be hidden from view.

Please don’t hesitate to reach out to us with any of your questions regarding asset/liability management or go to RyanALM.com for our thoughts on a variety of pension-related issues.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Last week was an incredibly busy week for the PBGC as they published the Final Final Rules (FFR) on how to implement the ARPA Pension legislation. I provided my initial feedback in this blog regarding the updated guidelines on July 6th. Ron Ryan and I are preparing a response to the PBGC regarding some of the elements that remain from the initial Interim Final Rules (IFR) and a few of the changes reflected in the FFR.

I remain concerned about the expansion of permissible investments up to 33% of the SFA assets. First and foremost, BONDS are return-seeking assets if they are not used to defease benefits and expenses. As such, 100% of the SFA assets should be considered RSA, which does not support the mission of this pension grant to SECURE the promised benefits through 2051. Why risk these grant proceeds? Defease the plan’s benefit payments. Assume risk within the legacy portfolio as the SFA assets buy time for the non-SFA assets to grow unencumbered.

As a reminder, most fixed-income assets are managed against the Bloomberg Barclays Aggregate Index. This index declined by -10.4% through June 30, 2022, as a result of rising rates in this inflationary environment. Inflation has not dissipated! Rates are likely to rise further as the Fed aggressively combats inflation. A bond’s principal will fall in a rising rate environment. A bond with a 10-year duration will lose 10% with only a 1% increase in rates. Where is the securing of pension benefits in such an environment? Again, most participants in our capital markets have not witnessed high inflation and rising rates. The last four decades have been an incredible environment for investors as rates fell to historically low levels. Those incredible bond returns from 1982 – 2021 are likely behind us. 

With regard to the mundane activities of ARPA’s implementation, there were no new applications filed last week. Furthermore, there were no applications approved or rejected. Lastly, there were no payouts for the already approved SFA applications. Obviously, all of the focus was on the FFR. It is disappointing that it took one year for the FFR to be produced, especially since they have really muddied the waters with the changes in the SFA investment framework. I’ll address the 67%/33% allocation that must be maintained at least one day per year (12 months) in another post. Talk about over-complicating a process!

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

We are pleased to share with you the Ryan ALM Q2’22 Pension Monitor. Despite the fact that pension assets had another challenging quarter, pension liabilities once again fell to a greater extent, as US interest rates rose rapidly in response to the US Federal Reserve’s action to aggressively address the current inflationary environment, by raising the Federal Funds Rate by 1.5% so far. US corporate plans operating within a FASB construct are aware of this fact since their discount rate is based on market rates for AA corporates. Pension plans – public and multiemployer pension systems – utilizing accounting methods under GASB are probably unaware that pension liabilities had substantial negative economic growth during the quarter and so far in 2022, as they use the return on asset (ROA) assumption as the discount rate for their pension liabilities. Under the ROA as the discount rate, it erroneously appears that pension assets dramatically underperformed liability growth.

Given the significant differences produced by these two accounting methodologies, it is no wonder that inappropriate decisions with regard to contributions and benefits are made from time to time. The US Federal Reserve is primarily focused on combating excessive inflation. Aggressive Fed action may lead to significantly higher US interest rates. Will rising rates have a greater impact on pension assets or liabilities? Continue to check in with us at ryanalm.com to see how this story unfolds.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

I penned this post on May 3rd. Markets have continued to sell off, but pension funding has continued to improve as rising rates and the impact on longer-duration pension liabilities created an environment that had liabilities falling to a greater extent than pension assets. Many of the points that I raised in my post appear in a thoughtful piece produced by Zorast Wadia, Consulting Actuary, Milliman. I don’t believe that there exists a retirement plan as critically important as a defined benefit plan and I’m very pleased that Zorast agrees. Let’s hope that rising rates do lead to the thawing of frozen DB plans.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

The PBGC’s Final Final Rules have not been released, but I’ve been sent a “fact sheet” highlighting three areas of “improvement”. First, and most importantly, all 18 MPRA plans that “reconfigured” benefits will be made whole enabling pension funds to restore previous levels of benefits without driving these plans back into insolvency. That is great news for all of the participants in those plans and the highlight of this announcement.

The other two areas addressed in this release are the ROA/discount rate and the permissible investments. With regard to the discount rate, the release states that there will now be two ROAs, with one for the SFA and one for the non-SFA assets. Huh? We don’t need two ROAs… we need discount rates! We need a different discount rate (currently = PPA’s 3rd segment + 200 bps) which determines the size of the SFA grant. It doesn’t matter what the SFA assets earn as they should be used to defease and secure the promised benefits.

With regard to permissible assets in the SFA bucket, I’m really disappointed to see that they are expanding the potential investments beyond bonds. If 2022 has shown us anything, it is that markets can go down and go down severely. How does one secure the promised benefits to 2051 by allowing equities (uncertain cash flows) that can’t defease liabilities? The sequencing of cash flows and returns is critically important to this process. Yes, equities will outperform bonds roughly 80% of the time over 10-year periods, but what happens if the US falls into either stagflation or recession in the near term that dramatically reduces equity valuations? There won’t be enough left in the SFA bucket to meet the 2051 promises! Permitting only 33% is better than 100%, but they should have kept the original mandate.

Why must they overcomplicate these matters? All they had to do was lower the discount rate for determining the SFA grant from the current 3rd segment plus 200 bps to using all three segments under PPA with no additional hurdle and ensure that the promised benefits are met by mandating that asset cash flows in the SFA be used to defease liability cash flows, which would allow for a more risky asset allocation in the legacy asset bucket to meet future liabilities beyond 2051. These are three easy steps to securing the benefits, while keeping these plans viable for current employees and those that will join in the years to come. UGH!!!

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

I am pleased to share with you another thought-provoking research piece from Ryan ALM’s CEO, Ron Ryan, CFA. This article, “The Pension ROA is Plural… ROAs” explores how the return on asset assumption (ROA) is derived, but more importantly how the pension return target is misunderstood. Most pension plans within the public and multiemployer arenas have a ROA equal to or greater than 7%. Does this mean that every investment in the pension system’s portfolio needs to achieve this hurdle? Of course not! Each asset class has its own distinct ROA. Yet, it is amazing how often we hear from various pension professionals that investing in a cash flow matching strategy (CDI) in lieu of a traditional total return-seeking fixed income strategy will HARM the plan’s ability to achieve the plan’s ROA.

That retort is incredibly silly given that a significant majority (all?) of plans have fixed income exposure and have maintained investments in fixed income despite the collapsing US yield environment that we’ve just lived through since 1982. There was no way that a core fixed income strategy benchmarked to the Bloomberg Barclays Aggregate Index yielding <3% was going to generate returns anywhere close to a 7% ROA objective. If every asset category needed to achieve the ROA, then why were bonds still in the fund? If it was to provide liquidity to meet benefits and expenses, then a CDI program would provide a superior link between the promises made and the necessary funds to meet those obligations! Furthermore, a CDI implementation that utilizes 100% corporate bonds would have provided a 75 bps to 100 bps yield advantage depending on the maturity of the program. As a result, using a CDI program in lieu of traditional core bonds would enhance the probability of achieving the plan’s ROA, not diminish it!

I know that you are going to be impressed with Ron’s logic that there is no one ROA, but a series of ROAs that must complement each other in order to achieve the overall objective of funding the promised benefits. As always, don’t hesitate to reach out to us with any questions that you might have regarding this piece or any other that we’ve produced.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

I hope that you and your families enjoyed a Happy Fourth of July weekend. My family and I enjoyed some traditional American activities this past weekend as we took in a Mets game (all 18 of us) at Citi Field on Saturday and the Ridgewood, NJ parade on Monday, which has been an annual tradition in our family since my oldest guy was just 9 days old in 1986. Of course, our weekend culminated in a BBQ in our backyard. Fortunately, the weather in Northern NJ was spectacular as reflected in the picture below.

As for ARPA, it was a slow week in terms of activity although two pension systems filed their initial applications for Special Financial Assistance (SFA) with the PBGC. Bricklayers and Allied Craftsmen Local 7 Pension Plan, a Priority 2 category member, as they are a MPRA Suspension & Partition plan, filed on June 27, 2022, seeking SFA of $31.6 to protect the benefits for their 397 members. Bricklayers Union Local No. 1 Pension Fund of Virginia filed their initial application on June 30, 2022, seeking only $8.7 million for their 395 members. Bricklayer Local No. 1 is a Priority Group 1 member, as they are currently a plan that is insolvent.

There were no applications approved, denied, or SFA proceeds paid out during the previous week. However, there have been some rumblings that the Office of Management and Budget (OMB) has completed its review of the PBGC’s proposed Final, Final Rules. We continue to monitor the PBGC’s website hoping to see an announcement on what, if anything, is being changed by the PBGC as they continue to implement the ARPA legislation first begun nearly one year ago.

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Last Friday we produced an update on market performance through 1H’22. What jumps out is the fact that both bonds and stocks are down to start the year, and down big. It got us thinking about the last time that both bonds (Bloomberg Barclays Aggregate) and stocks (S&P 500) were down in the same year. On a total return basis (including income of dividends and interest), the S&P 500 and the BB Aggregate have NEVER been down in the same calendar year! We’ve come mighty close (1994) when the S&P 500 squeaked out a marginal gain of 1.94% while the Aggregate Index fell by -2.92%. The -2.9% decline in ’94 has been the greatest negative annual return in the history of the Agg index dating back to 1976 when Ron Ryan and the team at Lehman Brothers created it.

For the first half of 2022, the S&P 500 Index plunged by -19.96%, while the Aggregate index declined by -10.35% setting the stage for the first occurrence ever of these two major indexes declining simultaneously in a calendar year. As we’ve stressed, the last 40 years of capital market activity should not be viewed as “normal” given the precipice from which US interest rates fell, while inflation remained muted. Capital market performance during the remaining six months of 2022 will be driven primarily by the US Federal Reserve’s interest rate action. The Fed’s individual Governors have stated on numerous occasions that they will remain singularly focused on tamping down inflation despite the fact that this action might result in the US economy falling into recession. As a reminder, recessionary environments are not a cure for weak stock markets.

We’ll of course need to wait to see what transpires in the markets during the remaining six months of 2022 to see if for the first time both important asset classes declining in the same calendar year, but it doesn’t mean that the plan sponsor and asset consulting communities need to wait. As we’ve been espousing, an environment of rising US interest rates will weigh on markets for the foreseeable future. Convert total return fixed income into a defeasance strategy matching asset cash flows (bonds) with the plan’s liability cash flows, which will buy time for the non-bond assets to grow unencumbered as they are no longer a source of liquidity to meet benefits and expenses. Although rising rates are generally bad for bonds and stocks, they may not be necessarily bad for pension plan liabilities whose present value might fall faster and further than asset levels.

For more info on why higher rates are good for pensions, go to our website… ryanalm.com/insights/whitepapers.