ARPA Update as of August 25, 2023

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

We hope that your "last" week of summer is a good one. Can't believe that Labor Day is almost upon us. The PBGC has been laboring, as they continue to work through a massive universe of potential SFA recipients. They approved four applications during the previous week, including the following funds: Pension Plan for Employees of United Furniture Workers of America and Related Organizations, the Southern California, Arizona, Colorado & Southern Nevada Glaziers, Architectural Metal & Glass Workers Pension Plan (this plan now holds the unofficial record for longest fund name), the New Bedford Fishermen's Pension Fund, and the Local 917 Pension Plan.

The PBGC continues to work through the applications from the initial Priority Groups, as they approved the revised submissions for four plans with one each from Priority Groups 1 and 2, while also accepting two from Priority Group 5. These four plans will receive a total of $613 million, including interest, for their 5,799 plan participants. In total, 62 plans have been awarded Slightly more than $53 billion in SFA grants.

There were no applications denied or withdrawn during the prior week. There were also no new applications permitted to submit from the waiting list, which still has 92 funds waiting for activity to begin.

What A Difference a Year Makes

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

Regular readers of this blog know that we've been on record since the first Fed Funds Rate increase that we were likely in a higher for longer scenario. That the prior nearly 40-year bull market for bonds was about to be eradicated, and with that would come pain for most investors who hadn't worked and, in many cases, lived through a period of sustained inflation and rising rates.

One year ago, I published a post titled, "Tough August For Bonds", which wasn't referring to Barry Bonds once again being rejected by MLB's Hall of Fame, although he was. At this point last year, the FOMC had elevated the FFR 5 times (which is now 11 times), and many investors were sure that US interest rates were nearing a peak. We didn't think so, and expressed that sentiment with the following:

"Based on the current strong employment picture with 315,000 jobs created, 5.2% annual wage growth, and a labor participation rate that grew 0.3% in August (62.4%), it is likely that the Federal Reserve needs to continue to aggressively elevate rates until it accomplishes its primary objective of reducing inflation. This action will continue to weigh on the performance of the US bond market. Fed Chairman Powell has admitted that the Fed’s policy will inflict pain on American families as the strong labor market needs to be tamed. In order to impact the labor market, US rates must rise substantially. Are fixed-income managers and their clients prepared?"

Based on the following graph, I guess that we were correct.

The Fed's action has yet to inflict pain on the American family (fortunately) despite the aggressive increases in US rates, as the US labor market remains strong. These increases really haven't inflicted much pain on the overall economy, as GDP growth has been well above consensus so far through two quarters and the third quarter is looking exceptional, if the Atlanta Fed's GDPNow model is to be believed as they are forecasting a 5.8% annualized growth rate. Oh, my!

It isn't hard to imagine that the Fed will once again say in September that inflation remains well-above the stated objective and that rates will be adjusted based on the data. For us, that means a scenario of higher for longer. If so, I must ask: Are fixed income managers and their clients prepared?

ARPA Update as of August 18, 2023

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

We are pleased to provide you with our weekly update of the PBGC's progress in implementing the life-changing ARPA legislation. Tremendous activity has already taken place, but there is much more to accomplish. With regard to last week's activity, the PBGC announced that the Retirement Plan of the Retirement Fund of Local 305 CIO's Pension Fund's revised application had been approved. This plan will receive $36.3 million to support the promised benefits for the 918 plan participants.

As the chart above highlights, there are still roughly 140 plans that may receive the Special Financial Assistance (SFA). We've highlighted on many occasions how this groundbreaking legislation has been life changing, especially for those participants that saw their promised benefits slashed under MPRA. As a reminder, here is a story about one of those union workers whose life was turned upside down. Still much more to do, but there shouldn't be any question about why this effort is so very critical.

The Extraordinary Impact of Interest Rates on DB Pension Plans

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

I don't think that it is much of a stretch to claim that the last 41 or so years have been an amazing time to be in the capital markets. Personally, I've been blessed to be in the investment/pension industry since October 13, 1981 (thanks, Larry and Ted). On the day that I entered the industry, the US 10-year Treasury Note was trading at a yield of 14.9%. During the next 39 years, that yield would plummet to a Covid-19-induced low of 0.52% on August 4, 2020. Today, that 10-year Treasury note yield is 4.25% (2:10 pm).

During this incredible run, the cost of Pension America's promises soared as the present value of those future value benefit promises outpaced asset growth, despite the incredible wind behind the investment community's sails. This dramatic present value cost increase in those future benefit promises certainly contributed to the on-going shuttering of defined benefit plans in the private sector. Why? Liabilities are bond-like and highly interest rate sensitive!

Back in 1981, on the day that I entered this industry, it would have taken only $17.81 to fully fund a $1,000 liability 30-years out. Yes, only $17.81 in contributions to meet that future obligation. On the other hand, at the bottom of the rate cycle, when the US 10-year Treasury note had a yield of 0.52%, it would have cost the plan sponsor $860 to fund that $1,000 liability in 30 years. Oh, my! Any question as to the impact of the collapsing rate environment on those future promises?

Fortunately, for those plans still open and accruing benefits, the cost of those future promises is getting more affordable. At today's 10-year Treasury note yield of 4.25%, it would cost the plan sponsor only $301 to meet that 30-year obligation. Not nearly as great as the $17.81 needed in 1981, but certainly more manageable than the exorbitant costs at the bottom of the rate cycle.

Plan sponsors and their advisors missed opportunities to de-risk Pension America's DB plans in the early '80s and again at the end of 1999 when most plans were well-funded. Let's not let another opportunity pass us by. Corporate America and public pension funds are enjoying improved funding. The higher US rate environment is once again providing us with an opportunity to significantly reduce the cost of those future benefit payments by engaging in a de-risking strategy through Cash Flow Matching (CFM).

Bonds, like liabilities, are highly interest rate sensitive, and the present value of both bonds and liabilities are impacted by interest rate changes. Use the asset cash flows of interest and principal from bonds to cash flow match the plan's liability cash flows. This action will SECURE the promised benefits chronologically as far into the future as the bond allocation goes. Why continue to live with the uncertainty that investing in our capital markets brings? Create an investment program that captures the benefits of our current higher interest rate environment, while securing the promises that have been given to your participants.

Outstanding!

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

Milliman’s midyear 2023 Multiemployer Pension Funding Study has been released. The Headline: "The aggregate market value funded percentage for multiemployer plans is estimated to be 87% as of June 30, 2023, up from 79% at the end of 2022." Most importantly, roughly 6% of that increase is attributable to the Special Financial Assistance (SFA) that has been doled out to more than 50 plans through the ARPA legislation that is being overseen and implemented by the PBGC.

This is outstanding news, as the program is doing exactly what it was intended to do - protect and preserve the promised benefits for the many hard-working American workers that would have seen their benefits put at risk if this legislation hadn't passed. Milliman anticipates that there will ultimately be about $80 billion in SFA allocated to more than 200 eligible multiemployer plans. As you may recall, initial forecasts on the cost of this legislation were in the $90 billion range.

Milliman also estimated in this midyear report that the funded status would improve to about 92% if the remaining SFA were to be included in today's numbers. Obviously, market forces will impact these funds prior to the completion of the SFA application process which should wrap up by 2027. Given the significant importance of this allocation to what were fund's on life support, we encourage recipients of this government grant to treat it with the utmost care.

Equity valuations appear to be stretched at this time, while the rapidly changing US interest rate environment is providing plan sponsors with a wonderful opportunity to SECURE the promised benefits through a cash flow matching strategy at interest rates that we haven't seen in decades.

ARPA Update as of August 11, 2023

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

Good morning. Happy to share with you a very brief update on the PBGC's activity implementing the ARPA pension legislation. Brief because there is only 1 action item to report on. Southwest Ohio Regional Council of Carpenters Pension Plan had its application approved. They will receive $182.6 million for the 5,399 plan participants. Outstanding!

There were no new applications submitted during the prior week. In addition, there were no current applications under review that were either declined or withdrawn in the last 7 days. As reflected in the table below, there are currently 28 applications under review. They consist of 17 applications that had a Priority Group designation and 11 applications that have been submitted from the waiting list.

To date, there have been 57 pension systems that have had their applications approved. In addition, 35 supplemental applications were approved providing additional grant money to these pension systems. In total, $52.4 billion has been granted to these plans, which includes interest. It is anticipated that another roughly 120 plans may receive grant money, too.

If So, How?

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

As I mentioned in my last post, I am currently at the TexPERS summer program at the Woodlands just outside of Houston, TX. It is a well attended conference despite the excessive heat of 100+ temps all day long. In addition to the conference being well-attended, they are using a terrific website that allows for great interaction among the attendees, including producing polls. In one case, I asked the question: What is the primary objective in managing a defined benefit plan? The possible answers were:

Achieve a return on asset assumption (ROA)

Enhance benefits

Secure the promised benefits

The outcome from this poll has so far been surprising, as every respondent identified the securing of benefits as the primary objective - yes, 100%. We at Ryan ALM, Inc. absolutely agree (thrilled) with this choice, but we don't see how this is being implemented in the day-to-day management of the public pension systems represented at this conference. Asset allocation decisions are being based on achieving the ROA. All of the assets are focused on beating their respective benchmarks, not the true objective of securing the promises (the plan's liabilities). Why the disconnect?

One primary reason for this apparent dichotomy is the fact that a plan's liabilities aren't known on a daily, weekly, monthly, or even quarterly basis. It is absolutely necessary to measure, monitor, and manage a plan's liabilities, but getting a once per year update through an annual actuarial report just doesn't cut it. Can you imagine playing a football game and only knowing how many points you've scored (assets), but having no knowledge of how many your opponent has scored (liabilities)? How would you adjust your strategy? Unfortunately, that is how a significant percentage of Pension America has been operating. The Ryan ALM solution is a Custom Liability Index (CLI) invented by Ron Ryan over 30 years ago.

So, if SECURING the promised benefits is the primary objective, plan sponsors need to have a Custom Liability Index (CLI) created so that the liabilities can be monitored on a much more regular basis. Having this knowledge is the only way that a plan can even begin to secure the promises. Once the liabilities have been analyzed they can begin to be managed through a Cash Flow Matching (CFM) strategy that can accurately match asset cash flows of interest and principal with the plan's liability cash flows of benefit payments and expenses.

Using a portion of the plan's assets (bonds) to secure the fund's near-term liabilities chronologically creates numerous benefits, including enhanced liquidity, an extended investing horizon for the plan's growth assets, and more stable contributions and funded status. It is time to get off the asset allocation rollercoaster that only serves to create uncertainty. It does absolutely nothing to secure those promises which the folks at the TexPERS conference believe is the primary objective.

Focused on Not Losing!

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

Happy Saturday. I am penning this post from roughly 28,000 feet as I travel to Houston, TX for the upcoming TexPERS conference, where I have the privilege of teaching an investment class tomorrow and speaking at the conference on Tuesday. Like America's pension industry, the plane's altitude (funded status) was greater, but the skies (like our markets/economy) are quite unsettled, and the pilots have settled at a lower altitude to deal with the turbulence.

I've recently produced a couple of posts addressing the psychological impact of uncertainty on human beings, as each of us naturally strive to reduce uncertainty to the greatest extent possible. As I previously stated, we all want solutions — answers to our questions and problems. When the answers aren’t apparent, we find it difficult to stop ourselves from obsessing over the uncertainty. That may be true generally, but as a pension industry we seem to embrace uncertainty by investing huge sums into markets that are uncertain every day, week, month, and year.

This practice has definitely contributed to the private sector's rapid abandonment of the defined benefit plan, as uncertain outcomes had the potential to impact a company's income statements. Something no CFO/CEO wants to have to explain to the investing community, let alone the folks within the company that have day-to-day responsibility for the pension plan.

We at Ryan ALM, Inc. continue to work tirelessly on implementing strategies that will rid Pension America of as much of the uncertainty as possible. We try to accomplish this lofty goal through a focus on NOT LOSING! I've often used the rollercoaster to represent the investing environment for pension sponsors, as we have a tendency to ride markets up and then down as these natural market cycles take form. When are we going to get into the habit of de-risking when the rollercoaster car is nearing it's peak?

As I've stated before, insurance companies and lottery systems can't afford to build their businesses embracing great uncertainty, and pension funds shouldn't either. Collectively, we should be focused on not losing. We believe that a pension funds primary objective should be to SECURE the promised benefits at a reasonable cost and with prudent risk. It is not a return objective. Living on the investment rollercoaster is no way to secure benefits and expenses.

If the securing of benefits is truly the primary goal, then the management of pension assets must been done relative to a pension's liabilities. Those liabilities much be measured, monitored, managed, and secured. The only way to accomplish this objective is to use cash flow matching (CFM) with bonds, as bonds are the only asset class with known cash flows of principal and income to accomplish the objective. You can find chapter and verse on cash flow matching (CFM) at ryanam.com or on this blog, which is accessible through the company's website.

By focusing on not losing, we believe that you dramatically enhance the probability of success! We can't afford the one-step forward and 3/4s of a step back that our industry has endured for decades. The fact that the current economic environment, which has produced decades high interest rates, is quite favorable for CFM makes the opportunity to get off the rollercoaster that much easier.

We need to protect and preserve defined benefit plans for the masses. We at Ryan ALM, Inc. have as our mission to do whatever we can to protect and preserve DB plans. We honestly believe that CFM is the best way to SECURE the promises that have been made to the plan participants. This is how insurance companies and lottery systems manage their liabilities and it is how Pension America should mange theirs. Let us help you to secure your defined benefit plan so that your participants can enjoy their golden years.

What You Might Expect From Social Security in 2024

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

With the demise of the defined benefit plan for many works in the US private sector, Social Security benefit payments become ever more important for a greater percentage of the American retirees and those with disabilities. There have been several stories recently about Social Security and what the "average" recipient might receive in 2024 and worse, what their benefit reduction might be should the forecast of a "lock-box" shortfall in 2033 come to pass. We'll get the official word on the 2024 COLA sometime in October, but early estimates are forecasting a 3% increase during 2024. This is a far cry from the nearly 9% increase received in 2023 and at 3%, barely matches the headline CPI which came in at 3.2% today.

Social Security's average monthly benefit among all retired workers is $1,789 in 2023, according to the Senior Citizens League. If the 3% increase turns out to be correct, checks will increase to about $1,843 per month. If my math is correct, that equates to an additional $54/month. Please don’t plan to spend all of it too soon.  The maximum Social Security benefit for a worker retiring at full retirement age is $3,627 in 2023. A 3% COLA will bring that figure to $3,736 in 2024. For those retiring at 62-years-old the maximum benefit in 2023 is $2,572, while the maximum benefit for a worker retiring at age 70 is $4,555 in 2023. Those numbers will be adjusted accordingly.

Despite the on-going rhetoric about SS running out of money, it is a fallacy to believe that there exists an "operational constraint on the government’s ability to meet all Social Security payments in a timely manner. It doesn’t matter what the numbers are in the Social Security Trust Fund account, because the trust fund is nothing more than record-keeping, as are all accounts at the Fed." (Warren Mosler, "Seven Deadly Innocent Frauds of Economic Policy") He continues, "When it comes time to make Social Security payments, all the government has to do is change numbers up in the beneficiary’s accounts, and then change numbers down in the trust fund accounts to keep track of what it did. If the trust fund number goes negative, so be it. That just reflects the numbers that are changed up as payments to beneficiaries are made."

What we should fear is our august Congress not understanding this concept and acting rashly to address the impending “crisis”. A recent article in Bloomberg placed the possible reduction in "benefits" at 23% in 2033. Try telling the nearly 70 million Americans that they will see a dramatic reduction in a promised benefit that they themselves helped to fund. With 40% of retirees using SS for more than 50% of their retirement income and another 14% in which SS makes up 90% or more of their retirement income, the economic impact from these potential benefit cuts would be cruel.

Milliman's PFI at 102.5%

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

Milliman released the results of its latest Milliman 100 Pension Funding Index (PFI), which analyzes the 100 largest U.S. corporate pension plans. They reported that July was a very strong month for pension funding as the PV of liabilities fell as interest rates rose (discount rate) and assets appreciated by 0.84%. The combination of falling liabilities and rising asset levels improved pension funding for the third straight month, with the average funded ratio now at 102.5%.

In addition, they provided both optimistic and pessimistic forecasts for 2023's conclusion and 2024. "Looking forward, under an optimistic forecast with rising interest rates (reaching 5.50% by the end of 2023 and 6.10% by the end of 2024) and asset gains (9.8% annual returns), the funded ratio would climb to 109% by the end of 2023 and 122% by the end of 2024. Under a pessimistic forecast (5.00% discount rate at the end of 2023 and 4.40% by the end of 2024 and 1.8% annual returns), the funded ratio would decline to 100% by the end of 2023 and 91% by the end of 2024."

The pessimistic forecast doesn't seem to be that unrealistic. Given that possibility, why would corporate America risk the improved funding status? Secure the promised benefits at this time through a cash flow matching (CFM) strategy. You'll be surprised by how little of the corpus would be needed to accomplish that objective. The balance of the assets can now be managed with the goal of maximizing the surplus. The pension industry has had a few opportunities during the years to de-risk en masse. Those opportunities were often not acted on. Let's not allow that to happen again.