Dysfunctionality in Pension Land
In a recent speech to the National Association for Business Economists, Bradley D. Belt laid out some cold, hard facts. Executive Director of the Pension Benefit Guaranty Corporation (PBGC) for a few more weeks, Belt described employee compensation as potentially "a rich source of profits" when companies book expected returns that exceed realized returns on invested assets. He points out that pension funds are assuming more risk at the same time that the practice of smoothing allows companies to stretch out pension losses over time.
Who will pay for existing, and accepted, practices that widen the gap between economic and accounting reality?
1. Taxpayers in the event of a bailout of PBGC?
2. Investors who see the value of their portfolio fall due to pension problems?
3. Employees who may lose benefits or even their jobs?
So if things are so bad, why isn't there more screaming in the streets?
Part of the seemingly benign response to one headline after another about the loss of pensions and other retirement benefits is that ownership of the issue is so diffuse.
Who is responsible for setting things right?
1. CEO's and CFO's who want as little as possible involvement regarding benefit-related decisions?
2. Attorneys who rally for damages in a court of law?
3. Congressional legislators who are often accused of doing too much too late?
4. Regulators who face limited resources and competing jurisdictions?
5. Employees who seldom feel they can make a difference?
6. Plan fiduciaries who may not even acknowledge themselves as such, let alone show that they carry out their duties willingly and effectively?
7. Auditors, actuaries, consultants?
Until true "owners" of the pension issue are identified and someone steps up to the plate (or they are forced to do so), the hot coals are likely to be passed from one party to the next.
Not a happy thought!
Who will pay for existing, and accepted, practices that widen the gap between economic and accounting reality?
1. Taxpayers in the event of a bailout of PBGC?
2. Investors who see the value of their portfolio fall due to pension problems?
3. Employees who may lose benefits or even their jobs?
So if things are so bad, why isn't there more screaming in the streets?
Part of the seemingly benign response to one headline after another about the loss of pensions and other retirement benefits is that ownership of the issue is so diffuse.
Who is responsible for setting things right?
1. CEO's and CFO's who want as little as possible involvement regarding benefit-related decisions?
2. Attorneys who rally for damages in a court of law?
3. Congressional legislators who are often accused of doing too much too late?
4. Regulators who face limited resources and competing jurisdictions?
5. Employees who seldom feel they can make a difference?
6. Plan fiduciaries who may not even acknowledge themselves as such, let alone show that they carry out their duties willingly and effectively?
7. Auditors, actuaries, consultants?
Until true "owners" of the pension issue are identified and someone steps up to the plate (or they are forced to do so), the hot coals are likely to be passed from one party to the next.
Not a happy thought!
I totally agree; until someone is designated as responsible why would anyone risk his shirt to solve a problem that ain't his?!?!I am an actuary and I can barely understand what is going on in my DC plan. I receive only one letter a year that tells me how much I have- no wonder so few actively prepare for their pension.Regarding the use of high expected return (thus inflating the expected profits), this should adjust in the short-term (over 5 years I would think as most smoothing is done over such period - at least I think - actually you are right because in the US most companies would amortise losses over 10 to 15 years...). However the UK has tackled this issue pretty well with the accounting standard FRS 17 where annual gains and losses go through the balance sheet annually - creating a lot of volatility (unfortunately?!?) in company value, if the investment returns on the pension assets do not follow the expected returns.I would like to finish with a question-conclusion. Could the value/level of the stock markets be more a factor of fashion (supply and demand) than fundamental value?? Could it be possible that economists and financial analysts "put up together" various theories to explain the flavor of the day (bear or bull market - high versus low P/E ratios)??For myself, I am very much temtped to think market level are a function of supply and demand more than anything else - if all investors (for example if a lot of pension funds decide to play safe with bonds) decide to pull their money out of the stock market what will be left, what would happen?I am very much interested in hearing the views of others on this subject.Ciao!
Hello antoniI am not an actuary but an investment specialist - so from my side the UK decision with FRS17 which forces companies to annually adjust their balance sheet to the current return, is a really bad one. It just shows that the actuarial/accountant (frightfull, Enron-shocked)lobby in the UK was so much more successfull than the company/investment (common sense, long-term) lobby. Stock markets do go up and down and on every day you can have a long discussion about valuations, P/E-Ratios etc. - but in the long run the more volatile investments bring a higher return. So pension money, which is a long term committment should be invested with a long term perspective thereby allowing higher returns - as long as the corridor rule was applicable and companies could amortize over a typical cycle of 10 to 15 years, this is workable. But on shorter period adjustments the pension fund is simply forced to invest short term as well - so it is either CASH or longterm BONDS (low returns!) or Hedge Funds (high risk!) or Structured Products (only Banks really earn on most of these super-complex black box products).Interested to hear other comments.Anche Ciao!Zami
Zami, I see your point and it is totally fair. At the same time pension plans should not be used by company to make money (or reduce future contribution "unduely"). The problem is that if too much risk is taken then the members are at risk; and it's a "double whami" because if the company goes belly up, then current employees lose both their job and part of their pension, this is a very very bad life event!Regarding FRS17, I beleive (someone correct me if I'm wrong) it was created/decided sometime before Enron story and the likes...I also think that ultimately Trustees should take some risk in investing the pension assets; this risk should be commensurate with the rate of discount used to discount the pension debts. Because ultimately the discount rate should be the rate of return expected on the asset - so that the asssets grow big enough to cover the pension debts in the end of teh game! The problem is that companies have used high discount rates to "hide" their liabilities and lower their cost of funding their pension plan; now the time has come to check the books and a lot of company realise they are short of money (this is due to lower bond yields, increasing life expectancy, poor equity market returns and regulatory pressure), so now they have these big deficits to manage, as opposed to surpluses or small deficits. At the same time the regulator and other actor of teh pension world are worried that company will have to pay back these deficits and thus lowering the return available to the investors/stockholders... After a bit of diverging, this leads me to the use of FRS 17 and the likes - someone correct me if I'm wrong - but this is just a methodology to show the value of the pension plan in the book so one can put an "accounting" value on the company once a year. So as an investor I want to know what the company is worth today, not on average in 15 years.. Anyway if you were to use FAS 87 and hide soem unrecognised losses in your pension notes, the curious analysts would go (as it is clearly recommended in the CFA level 2 curriculum) and dig to find out what is the true funded status (i.e. Assets - liabilities); that is net of any "spurious" adjustments!So I think the real question is what discount rate to use (the fact that you amortise or not the losses is more to do with showing an average value OR a true value of the debt - and I am a big fan of honesty and transparency so I suggest FRS 17 - but that means less job for actuaries and accountants!!!). With regard to the discount rate, it is a really though one! I don't think the market has decided yet, but the consensus is moving towards using a bond yield (usualy corporate bonds - but at the same time seem to be moving towards government rates and insurer rates, taht is the famous buyout rate which is pretty low these days - but this is due to the new pension regulator in the UK - one could say it is more political than financial..). Using a bond yield makes sense because it is quite cheaky to use the expected premium for taking risk in investing in equities and applying it straight away. It's like being paid before to do the work!!! A little like John Prescott I suppose ;-)At the end of the day, you must think of the pension fund as a separate entity from the company, and if the company wants a favor it must be ready to pay the price for it - I know I know the pension plan would not exist if it was not for the company; but then I could reply that the company would not exist if it was not for the employees!!!Finally (wow another conculsion?!?)I say if the companies want to take the risk with equity, it must pay the price of volatility, and this, in a sense, is represented by volatility in their balance sheet!Ciao for now!Antoni