These are the Shortcomings?

Forbes has an article in their latest edition that speaks to the strengths and weaknesses of the US retirement industry. I think that a real strength for plan participants in the retirement industry is a traditional pension plan that provides a monthly benefit no matter what is happening to markets. When discussing the strengths for 401(k) plans the Forbes writer highlights the fact that "these plans have enabled millions of workers to accumulate savings to supplement Social Security and any pension or annuity benefits that they receive". Okay, but that's not a lot to hang one's hat on.

Under weaknesses they highlighted the fact that only about 50% of workers have access to a 401(k) plan and plans often fail to help participants convert retirement savings into a monthly income stream (annuity). That's it? Those are the main deficiencies? How about the fact that plan participants must fund these accounts, then manage, and lastly disburse this benefit. What about the fact that a majority of Americans are now living paycheck to paycheck and can't possibly afford to make contributions into a retirement account. This Covid-19 crisis is certainly highlighting this sorry state of affairs.

Furthermore, Corporate America is already announcing the elimination of their company match into these programs, which reduces by about 50% the annual contribution made into these accounts. This is a similar action that we witnessed following the Great Financial Crisis that ended in April 2009. In addition, Federal Reserve action to dramatically lower rates during the last 10+ years is forcing many plan participants and recent retirees to assume more risk in an attempt to preserve their retirement corpus. As a result, many participants went into this latest severe market downturn invested in less liquid, equity-like products as opposed to being in investment grade fixed income instruments that paid a decent yield and that which would provide some income to help reduce the call on principal.

Furthermore, we now have emergency actions by Congress that will allow plan participants to withdraw from 401(k) plans penalty-free up to $100,000. There are clearly many emergency situations being faced by members of our society, but permitting these withdrawals is only taking from Peter to pay Paul, and will certainly jeopardize their long-term financial security. It further highlights that these plans are nothing more than glorified savings accounts. We need to reinstate pension plans as the true retirement vehicle. Defined contribution plans are great as supplemental income funds, but they shouldn't be anyone's primary retirement vehicle. Asking untrained individuals to handle this responsibility is just poor policy.

Pension Lessons Learned Webinar

Ryan ALM in conjunction with the Opal Group is presenting a two-part webinar series on Pension Lessons Learned beginning tomorrow April 15, at 2pm EST. The first session "Protection From Market Disruptions" will discuss the issues surrounding Pension America's struggles to stabilize both the funded status and contribution expense, while providing a detailed process on what we believe DB pension systems need to do to protect and preserve these critically important benefits.

Here are the links to the webinar:

Website: https://opalgroup.net/conference/pension-lessons-learned-2020/

Registration link: https://zoom.us/webinar/register/6015852510588/WN_PM4XlQuNR9aL7N78aDR4tQ

The second webinar titled "Enhanced Asset Allocation" will be April 22nd at 2pm, and we are excited to announce that Brad Heinrichs, President/CEO, Foster and Foster, who will provide his perspective on asset allocation from an actuarial standpoint, will join us. We hope that you will join us, too. Don't be shy to ask questions either during the sessions or after, as we are excited to discuss these topics with you. Have a great day and stay healthy.

Talk About Being Bass Ackwards - Revisited!

You may recall that in August 2016, I penned the following blog post -

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.

I bring this up again, because focusing on the return on asset assumption (ROA) keeps plans chasing performance. I have no idea what NJ was trying to "hedge" in 2009 after the U.S. equity market was already haircut by 50%, but they built a very large hedge fund portfolio only to unwind about $7 billion of it by 2016, which was well after they already suffered the lost opportunity cost of not having been in cheap beta after the GFC. I suspect that they would have loved that exposure heading into 2020. Unfortunately, NJ is not unlike many (most) pension plans that chase performance in the HOPE that they achieve the ROA.

How many pension systems moved into commodity or other inflation hedges in 2009, as a result of fear that Federal stimulus would prove to be inflationary? I don't know to what extent, but I know that it was massive. Well, it shouldn't be shocking that we didn't get inflation, but worse, the S&P GS Commodities Index is down -10.6% / annum for 10-years! Pension systems would have done so much better had they just managed to their plan liabilities during the last 20-years, as bonds (BB Agg.) have outperformed equities (S&P 500) during this period of time, with so much less volatility. But, we never learn!

Corporate DB plans take hit

Willis Towers Watson conducted a study of pension plan data for 376 Fortune 1000 companies that sponsor U.S. DB plans (RDK's editorial comment: really too bad that only 376 of top Fortune 1,000 offer a DB plan). Results of the study indicate that the aggregate pension funded ratio is estimated to be 79% as of March 31. This is a significant drop from 87% registered at year-end. This level of funding marks the lowest funded status plans have experienced since 2012, when the year-end funded status stood at 77%.

The 376 plans now have an estimated pension deficit of $365 billion as of March 31, which is dramatically greater (up $136 billion) than the $229 billion deficit at the end of last year. Unlike pension asset values that plummeted, pension liability growth was more muted despite falling interest rates, as corporate bond spreads widened considerably. The total estimated liability stands at $1.76 trillion up from $1.75 trillion at December 31, 2019.

What I find most disconcerting about this result is the fact that Corporate America has done a much better job of taking risk off the table. I can only imagine the hit that DB plans in the public and multiemployer space took as a result of having much more aggressive asset allocations that favor equities and equity-like products relative to fixed income. Furthermore, both public and multiemployer plans entered this market disruption in poorer shape than Corporate plans.

Ryan ALM Q1'20 Newsletter

We are pleased to share with you the Ryan ALM Q1'20 Newsletter. As we've been reporting, 2020's first quarter is one of the more challenging quarters ever faced by Pension America. The combination of rising liabilities and falling asset values reeked havoc on funded statuses and will likely lead to ever growing contribution expenses in an environment where additional revenue may not be available to meet such needs.

We hope that you find our insights helpful. We remain focused on our primary objective, which is to secure the promised benefits, while providing as a secondary objective the time necessary to potentially enhance benefits down the road. Please don't hesitate to reach out to us, as we are here for you. Stay healthy and strong.

Ryan ALM's Believe It Or Not!

A generic asset allocation that we have been tracking for more than two decades produced a -12.3% return for the first quarter of 2020. That same pension system with a 15-year duration on it's liabilities allocated equally across maturities and using a US Treasury STRIPS discount rate produced a +18.7% gain in the quarter. Shockingly, pension assets underperformed pension liabilities by 31% during the first 3 months of this year. As a result, assets have now underperformed liabilities by an incredible -288.5% since 12/31/99. A pension system that started with a funded ratio of 100% in December 1999 would now see their funded ratio at 48%.

For those plans that use ASC 715 discount rates (corporations) your underperformance was -14.8%, while those operating with the ROA as it's objective (publics and many multiemployer plans) would have realized underperformance of -14.1%. In any case the impact on the funded status is extraordinary and clearly unacceptable. It further highlights that managing a pension without paying heed to a plan's liabilities is not an effective long-term strategy.

Those Aren't Lessons Learned - They Are Penalties Inflicted on the Participants

We are very much looking forward to presenting "Pension Lessons Learned" with the Opal Group beginning on April 15th. This is the first in a series of Ryan ALM and Opal Group webinars addressing this important topic. But, in order to discuss potential lessons learned from this crisis, we need to reflect on what lessons were learned following the Great Financial Crisis of 2007-2009, when pension America saw its funded status plummet and contribution expense dramatically escalate.

Unfortunately, with regard to the private sector, we continued to witness an incredible exodus from defined benefit plans and the continued greater reliance on defined contribution plans, which is proving to be a failed model. That activity appears to have benefited corporate America, but how did that work for plan participants, who are now forced to fund, manage, and then disburse this benefit through their own actions, which is asking a lot from untrained individuals, who in many cases don't have the discretionary income to fund these programs in the first place.

With regard to public pension systems, we saw a lot of action. There were steps to reduce the return on asset assumption for many systems - fine. But, that forced contributions to rise rapidly, creating a greater burden on state and municipal budgets that began to siphon precious financial resources needed for other social issues. In addition, there was great activity in creating additional benefit tiers, in which newer plan participants, and some existing members, were asked to fund more of their benefit through new or greater employee contributions, longer tenures before retirement, and more modest benefits to be paid out at retirement. Again, not a pension lesson learned, but a penalty for participants.

Multiemployer plans were certainly not immune to these developments. We have seen greater contribution expense and lower ROA targets for these plans, too, but have we seen improved funding? We have more than 300 multiemployer plans that went into 2020 in either Critical status or worse, Critical and Declining status. Given what has transpired in the markets to begin this year, it is highly likely that a number of other plans will have seen their funded status deteriorate to the point that they are also in Critical status.

It seems to me that most of the "lessons learned" have nothing to do with how DB pension plans are managed, but rather asks that plan participants bear the consequences of a failed pension model. A model to has focused on the ROA as if it were the Holy Grail. Pension plans should have been focused on the promise that was made to their participants, and not on how much return they could generate, which has done very little in terms of return, but certainly created a lot more uncertainty and volatility. As we've been reporting, equity and equity-like exposure within multiemployer and public pension systems was greater coming into 2020 then where they were in 2007. What lesson was learned?

Pension America is once again suffering under the weight of declining asset values and falling interest rates. When will we truly learn that continuing to manage DB plans with a focus on return is NOT correct? The primary objective needs to be securing the promised benefit at low cost and prudent risk. Shifting wads of money into private equity and thinking that you've diversified away equity exposure is just silly. Too much money has flowed into private equity that would have likely diminished returns prior to our economy being shut down. The consequences from an economy that has been placed on life support are likely to result in private equity valuations being sliced by 33% to 50%. That won't help a plan's funded status!

News For the ROA Chasers

A pension system's primary objective should be to secure the promised benefits at low cost and prudent risk. Seems obvious, but regrettably that objective has NOT been the primary focus for most public and multiemployer plans for decades now. We can debate the reasons why when the dust settles, but that isn't going to help us right now.

Unfortunately, the focus for most asset consultants, actuaries, and plan sponsors has been return. As a result, we've insured that the funded status and contribution expenses have become incredibly volatile. Instead of securing the promise and winning the game, we've decided to play Russian roulette. How has that worked out? Again, it shouldn't be surprising, but that pursuit of the ROA has failed to stabilize anything pension-related. Many state budgets are being strained, as contributions become a bigger share of annual state budgets and more than 125 multiemployer plans (likely more after this market crash) face insolvency within the next 15 years.

We've written a few posts in the last 6 months or so highlighting our concern that equity and equity-like allocations within pension systems for public and multiemployer plans were at levels that were greater than that which we'd witnessed prior to 2007. The excuse was that bond yields were so low that they couldn't justify having them in their portfolio because they wouldn't achieve the ROA objective. How's that worked out? For the record, the S&P 500 through March 31, 2020 has achieved a 4.8% return for 20 years! Meanwhile, the Bloomberg Barclays Aggregate (it will always remain the Lehman Agg. to me) index is up 5.1% during that same 20-year period. Wow, bonds have actually outperformed equities by 0.3% per year for 20-years!

Furthermore, we've recently reported that the private equity markets are likely to see massive write-downs of their portfolio companies (33%-50%), as our economy has been shuttered. I have recently seen the results of a business survey conduced in Northern NJ that indicated that 45% of small businesses would not survive three more weeks and that 83% of businesses would be forced to close down if this situation were to extend to the end of June. Think about those jobs and wages lost and the impact on demand for goods and services.

The move to less liquid investments -private equity and debt, real estate, infrastructure, etc. - is also exacerbating the poor performance of pension funds that are forced to sell assets into this weakness in order to make benefit payments. As you know, it didn't have to be this way. Are we finally going to get off this asset allocation roller coaster that I wrote about earlier this week? Defined contribution plans are NOT retirement vehicles, but if we don't do a better job of managing DB plans, they will be the only game in town. Our plan participants, retirees, and the US economy will suffer the consequences.

Looking for Something Positive to Write About

I am tired of writing about the problems within our retirement industry, of which there are many. I need something positive to write about, but I'm having difficulty during this chaotic time finding such a topic. Perhaps we can get excited at the prospect that Congress is actually thinking about cobbling together a fourth stimulus proposal following the recent passage of the $2.2 trillion CARES legislation.

There are rumblings that members of the House are preparing to include the Butch Lewis Act (BLA) in the next round of support. The Critical and Declining plans (roughly 125) were already teetering on the brink of insolvency. The stock market's recent terrible performance will only speed up the time frame to insolvency, while likely pushing many of the multiemployer plans that were deemed to be in "Critical" status into the Critical and Declining bucket. Support for these pension funds is absolutely critical, as nearly 1.4 million American retirees and active plan participants could lose a significant percentage of their earned benefit. Their contribution to our economy, through the monthly benefit payments, is huge. We can't afford any more revenue and demand shocks to our economy at this time.

While my fingers are crossed that we might see some action to help these struggling plans, I am not holding my breath, as pension reform for multiemployer plans has been on going for years and years. Stay well and stay safe!

Here we Go Again?

The following quote was from my November 5, 2019 blog of the same name. I had just returned from speaking at the IFEBP in San Diego on Enhanced Asset Allocation.

"I certainly don’t know when the next recession might occur, but it will. Do we really want to have these plans sitting with their highest equity exposure when it hits the fan? Shouldn’t we be looking for ways to reduce risk after a long cycle of outperformance?"