As If We Needed More Evidence

Milliman, Inc. yesterday released the results of their 2020 Corporate Pension Funding Study (PFS), which analyzes the 100 largest U.S. corporate pension plans. The study highlighted the fact that the aggregate performance (17.3%) for this cohort was the second best annual return recorded during the life of this survey. Only 2003's 19.5% performance topped 2019's result.

Despite the significant return achieved last year that was well in excess of the average return on asset assumption (ROA), collective funding for the top 100 plans only modestly improved from 87.1% at 2018 year-end to 87.5% as of December 31, 2019. It once again highlights the fact that a review of asset performance alone only addresses one part of the pension equation. Failure to understand what is happening to plan liabilities often leads to uninformed decisions.

The good news coming from corporate America is their greater use of fixed income within the plans' asset allocation schemes. According to Northern Trust's review of their 300 large institutional universe, ERISA plans benefited from a large allocation to fixed income securities. The average plan had 40.4% exposure to fixed income at the end of the first quarter, compared to only 27% for the median public pension system. This additional exposure to fixed income certainly helped to prop up performance for corporate plans in the first quarter. As we highlighted yesterday, the average corporate plan within Northern's universe outperformed the average public fund by more than 4% during the first 3 months.

It's Not A Coincidence

Northern Trust has published the aggregate performance results through March 31st for its universe of roughly 300 large institutional pension plans and endowments and foundations. Not surprisingly, performance results (-11.6%) are very weak for the entire universe. What also isn't surprising to me is that public pension plan performance once again trails that of private sector corporate plans. Corporate DB pension plans had a median performance for the quarter of -8.1%, while public pension systems produced a decline of -12.6%. This comparative result shouldn't be a surprise to anyone.

Unfortunately, public pension systems operate with the belief that no matter what happens these systems are perpetual. That is absolutely the wrong approach, since perpetual doesn't mean sustainable. Whereas corporate America pays much more attention to the liability side of the asset/liability equation, public pension systems operate as if they have no plan liabilities, and that is reflected in their asset allocations that have gotten more risky since the GFC.

Maybe it is the accounting rules that keep corporate pension systems more focused on plan liabilities. But, whatever the case, they are less prone to wild swings in plan performance, which means that contribution expenses tend to be less volatile, too. Given the impact that Covid-19 will likely have on sources of revenue for state and municipal budgets, wild contribution hikes are going to create significant financial burdens.

It is stupid that we have multiple accounting rules and regulations on how pension systems value plan liabilities. The use of the ROA to value liabilities under GASB accounting leads to public pension plans being habitually underfunded, as contributions are predicated on a deflated estimate of those liabilities, and it also forces them to inject more risk into their asset allocations, which leads to greater disparity in returns versus their more conservative corporate peers. Assuming more risk hasn't lead to greater returns either, as corporate plans have done significantly better than public plans for the 3- and 5-year periods ending March 31st producing returns of 5.6% and 4.8% versus 3.0% and 4.1%, respectively.

What did surprise me in the analysis by Northern Trust is just how badly E&Fs performed during the quarter. As a reminder, these funds should have an absolute orientation given that they operate with a positive spending policy each and every year. The fact that they were down -11.6% for the quarter, while also underperforming both corporate and public plans for the 5-year period (3.9%) ending March 31st, is shocking. I guess the move into hedge funds once again proved to be a failed move. When will they learn?

It is time that we get back to basics within our industry. Public pension funds need to be managed more like corporate plans, and all funds need to pay greater heed to their liabilities, whether relative (DB plans) or absolute (E&Fs and HNW). What are we waiting for?

What Rainy Day Fund?

As we've been reporting, US states are under significant financial stress that will likely get much worse before it gets better. Debate continues as to what the Federal government might be willing to do to help states bridge their cash flow needs as a result of plummeting tax revenues/receipts. As the following chart indicates, not all state budgets are created equally.

For once, New Jersey is not the worst state, but their rainy day fund might help them get through about two weeks of projected cash flow needs, where as Illinois has the financial wherewithal to make it until 10 am this morning.

It is estimated that US states will incur a roughly $500 billion projected loss in tax revenues from shutting down local economies that needs to be made up somehow. Without a federal bailout, drastic cuts in education and other social safety net requirements will be necessary to close this gap. Unfortunately, these cuts will further derail economic activity creating a further burden on state budgets. The $150 billion that has been earmarked for US states is specifically designated for Covid-19 related expenditures and can't be used to offset the economic hit that many states are facing. Something needs to be done today. McConnell's threat of pushing states to use the bankruptcy courts is not helpful or currently legal.

This is Why, Senator!

Anyone who has read my blog throughout the years knows that I often rail about decisions taken in NJ with regard to the state's pension system, but this is one time that I am firmly with NJ and all the other states that have seen their economies wracked by Covid-19-related expenditures.

In yesterday's post, I mentioned that Senate Majority “Leader” Mitch McConnell and the Republican Senate didn’t appear to be willing to provide assistance to states and municipalities. In fact, McConnell was quoted as saying that he would prefer that states file for bankruptcy rather than receive a Federal bail-out despite the fact that everyone else is getting one at this time. Here is why McConnell's thinking is so shortsighted. It was reported that another 140,139 New Jerseyans filed for unemployment last week, bringing the tally to an unbelievable 858,000 workers desperate for checks. The state has already dished out $1 billion or so in unemployment benefits. Some perspective: At this time last year, there were just 84,000 residents collecting from the state's unemployment pool.

As everyone knows, NJ's economic environment is already challenged by one of the country's worst out-migration trends that has been brought about through a combination of high state income taxes, excessive property taxes, and out-sized housing costs that make it challenging for a large percentage of the state's residents. Couple those impediments with a pension system that has a colossal deficit, and not surprisingly, you create a terrible economic environment. Sure, and to be fair, some of this has been brought on by mismanagement, especially when it came to the state's failure to make the full annual required contribution, which they haven't done since Washington slept here! But, the unprecedented impact from this virus is crushing NJ's budget and those of many other states and municipalities.

Does it make any sense to let states collapse? Do we really want to see mass lay-offs in the public sector that would mirror those in the private sector? Isn't it imperative that we have the tools and resources now to meet this crisis head-on, and not wait for some resolution in the courts to begin to defeat this menace? Governor Murphy said, "come on, man" when reacting to McConnell's stance. I couldn't agree more! As a point of reference, I am honored to be an elected official (Councilman) for the town of Midland Park, NJ. In my capacity as a Councilman, I am seeing first hand how state and local budgets are being stretched in ways that we've never considered or imagined. Midland Park certainly doesn't have a rainy day fund of the size necessary to meet these unanticipated burdens. Why should we expect that any state or municipality would?

On the other hand, the US government does benefit from having a fiat currency that can be used at this time to prop up and support our displaced workers and their families, retirees, businesses, AND government entities. It would be foolish to "punish" any one of these important constituencies when we have the economic capacity to provide life saving measures. For once, can we put politics aside and do what is best for our country? If not, then you don't deserve to "lead" us!

Buy Time!

We truly understand and appreciate the funding concerns that all DB plan sponsors are challenged with at this time. However, we are particularly focused on the issues surrounding public pension funds, as they are getting crushed with the doubly whammy of falling asset levels and potentially skyrocketing contribution expenses, in an environment of plummeting sources of revenue, as the closing of the US economy significantly reduces tax and fee revenues.

Senate Majority "Leader" Mitch McConnell and the Republican Senate, don't appear to be willing to provide assistance to states and municipalities at this time. In fact, McConnell is quoted as saying that he would prefer that states file for bankruptcy rather than receive a Federal bail-out despite the fact that everyone else is getting one at this time. Having US states declare bankruptcy was roundly panned by both Republican and Democratic governors during and after the Great Financial Crisis, as this action would cause disruption to bond markets, while simultaneously driving interest rates higher and raising the cost of borrowing at a time when every dollar matters. Why is it acceptable now?

Given that the financial position of many US states is precarious at best, state and municipal pension systems need time to weather this storm. As we shared during the Opal/Ryan ALM webinars (4/15 and 4/22), one of the significant advantages of using a cash flow matching strategy (CDI) to meet promised benefit payments is that it buys time (extends the investing horizon) for the alpha assets to perform. This extension, which keeps the plan from forcing liquidity where it doesn't naturally exist, allows the plan's assets to recover from the significant draw-down experienced year-to-date, but also provides an extended time frame for all of the private assets that have found their way into plans.

The cash flow matching portfolio (beta assets) will be used to meet on-going monthly benefit payments for as long as the current allocation to fixed income can support. With little disruption, a CDI portfolio can be implemented that won't impact the return on asset assumption (ROA) or the plan's asset allocation. In fact, it is highly likely that the Ryan ALM CDI portfolio will out-yield the current core fixed income account, thus improving the plan's ability to achieve the ROA target, at lower cost - management fees and transaction costs. In fact, the conversion from an active, highly interest-rate fixed income portfolio to a CDI approach is quite simple, as the existing portfolio can be transferred-in-kind to us for conversion, saving more money in the process.

It is truly understandable why trustees might be feeling overwhelmed at this time from the negative impact of the Covid-19 virus. They are dealing with falling asset levels, falling interest rates that impact the true liability cost, the likelihood of escalating contribution expenses in an environment of challenged revenue sources, and concern for themselves, family members, and colleagues. It would be enough for anyone to want to go into a bunker. Please don't. By making this simple (really) conversion from active fixed income to a CDI approach the plan sponsor buys critical time needed to help the plan navigate these troubled waters. But, they also create an enhanced asset allocation process that secures benefits, improves liquidity, eliminates interest rate risk, and likely out-yields the current capability, thus enhancing the ability to achieve the ROA. That is a lot of reward for not a lot of effort. Skeptical? Call us or check us out at RyanALM.com.

Worst Ever?

According to Milliman's survey of the largest US 100 public DB pension plans, funded ratios collapsed to 66% from year-end's 74.9%, as plan's recorded an average decline of nearly 11% for the quarter. The devastating decline was the largest ever recorded by Milliman in the history of producing their firm’s public pension funding index (PPFI). Furthermore, the losses ($419 billion in market value) wiped out all of the improvement generated by these funds in 2019.

The weak quarter impacted these plans in many ways, as the current deficit (liabilities - assets) ballooned to $1.82 trillion from $1.33 trillion just three months prior. The total liability for this universe of public plans now stands at $5.36 trillion. Only 4 plans currently remain at >90% funded ratios, while 35% of the plans are now below 60%. Can you imagine what these stats would look like if pension liabilities were discounted at a more legitimate rate than GASB's ROA?

Seems right, but...

I want to once again thank the folks from Preqin for providing the following chart:

I'm not surprised by these results, but the responses may be quite premature. How many plan sponsors and consultants have seen performance results for the first quarter? Do they truly know how private investments in both equity and fixed income have been impacted by the closing of the US economy? I've seen reports guesstimating that the average private equity fund could be down substantially. It is one thing to claim that your ship is steady as it goes, but the tsunami may truly alter your course!

As we will be discussing on the Opal/Ryan ALM webinar today, there is a way to enhance the cash flow necessary to meet current benefit payments, while extending the investing horizon for all of this private investment. We are happy to share those details.

Nothing But Beta?

We once asked where the beef was, and if she were alive, Clara Peller would be able to tell us. As an industry we think we understand where the beta is, but do we really? As the chart below indicates (thank you, Preqin), hedge funds once again proved that most of their exposure is still nothing but beta. Where was the alpha or hedge? Yet, we as an industry continue to pay ridiculous levels of fees to gain exposure to them. Why?

Comparisons don't look any better as we extend the time frame to 10-years or even 20-years, despite the inclusion of 3 sharp market sell-offs. It might make sense for endowments and foundations or HNW individuals to use hedge funds given that they have an absolute orientation because of their annual spending policy, but it really makes no sense for pension systems given that their mandate is a relative one - plan liabilities. Cheap beta (S&P 500) is much cheaper today than at year-end, and the cost to access it is a basis point - not some formula that includes high base fees and a percentage of gains.

The Economic Toll Of Inaction

Multiemployer pension reform has been decades in the works with still no outcome that protects and preserves the earned benefits for millions of American Workers. As Congress debates the merits of HR397 or some bi-partisan piece of legislation the cost grows and the economic impact looms ever larger. The full impact of the current economic crisis brought about by Covid-19 is not yet understood, but we know that it is having a major impact on Pension America from the loss of asset values, to growth in liabilities (using a legitimate discount rate), to the loss of jobs and contributions. Something needs to be done almost immediately or a significant percentage of the Critical and Declining plans will be lost forever. The PBGC is not currently funded to handle anywhere close to the number of participants that might become their responsibility.

The debate continues to rage over whether or not this legislation is a government bailout despite the fact that low-interest loans to sure up these plans will have 30-years to make interest and principal payments. That is 30-years of benefit payments that wouldn't be received if these critically important funds are allowed to fail, and they will fail without help now! There is no way for these cash-starved funds can earn their way to solvency. We actually have a wonderful environment to provide these loans as 30-year Treasuries are currently trading at 1.21% and the loan would be issued at that the prevailing rate plus 25 basis points.

According to several sources, including the NIRS and Michael Scott, Executive Director, NCCMP, the Federal government stands to lose far more in lost tax revenue than they would gain by doing nothing at this time. It is estimated that in 2015 alone, the multiemployer system provided $158 billion in taxes to the U.S. Government. They also provided $41 billion in pension income to retirees and paid more than $203 billion in wages to the 3.8 million active workers. Combined, the pension and wage income supported 13.6 million American jobs and generated $1 trillion in GDP. Furthermore, original estimates for the then 114 Critical and Declining plans (now roughly 130) calculated that $32 billion in tax revenue over 10-years would be lost to the Federal government should the C&D plans be allowed to fail. That $32 billion was more than 50% of the expected "cost" of the loan program. Lastly, this estimated cost would decrease with every loan that is repaid, and with these low interest rates, that probability is improved.

Obviously, we are in unprecedented times, and much needs to be done to sure up our economic system, the businesses, and workers before this crisis escalates beyond our capacity to rescue it. However, that doesn't mean that retirees should be ignored at this time. They deserve every protection that any other American is receiving at this time. Failure to secure funding is not an option.

Ryan ALM Enters 21st Century With New Website!

We are very pleased to announce the launch of Ryan ALM's new website. Please check us out at RyanALM.com. Hopefully, you will appreciate the look and feel of the site, but more importantly, you'll be able to find the information that you seek with ease. We welcome your feedback, especially if you find our site wanting for any reason. Thank you, and stay healthy!