Doris Day, Scarlett O'Hara and Financial Market Tumult

Posted on July 19, 2008 by Susan Mangiero

Remember the 1939 epic classic "Gone with the Wind" wherein Scarlett O'Hara protests serious conversation? Interrupted by news of an imminent Civil War, this party gal (with the famous 17-inch waist) complains. "Fiddle-dee-dee. War, war, war: this war talk's spoiling all the fun at every party this spring. I get so bored I could scream." 

As I read "Why No Outrage" by James Grant (Wall Street Journal, July 19, 2008), I wonder if this southern belle might now be heard to say "Loss, loss, loss: this loss talk is spoiling all the fun..." About structural reforms (a 2007-2008 equivalent of losing Tara, the family homestead), Scarlett might encourage delayed action. "After all...tomorrow is another day." Why fuss now?

Well, as we all know, Main Street and Wall Street are inextricably linked. Unlike Las Vegas, what happens in the financial markets,  does not "stay here." (Read "Slogan's run" by Newt Briggs, Las Vegas Mercury, April 8, 2004.) When huge losses roil capital markets (not just in the U.S. but around the world), real people can get hurt:

  • Employees lose jobs
  • Shareholders see their portfolios plummet in value
  • Pension plans that allocate big money to equities and bonds scramble to improve funding
  • Retirees who depend on the financial health of plan sponsors pinch their pennies further
  • Vendors who do business with financial institutions tighten their belts and/or layoff staff
  • Businesses, seeking to grow, borrow at higher rates, if they can borrow at all...

It is therefore a mystery to the editor of Grant's Interest Rate Observer that relatively few bad players are taken to task "in the wake of the 'greatest failure of ratings and risk management ever,' to quote the considered judgment of the mortgage-research department of UBS." Grant conjectures that high gas prices and an election-focused Congress may be to blame or that "old populists" have hoisted themselves by their own petard, having pushed for paper money, federal insurance subsidization of higher risks and government intervention with respect to credit decision-making. From the tone of this long, yet fascinating, commentary, Grant rants about big government at the same time that, ironically, big government seeks to become even bigger in the form of new financial market regulations.

For my two cents as an advocate of free markets (not faux capitalism as exists around the world), a return to the gold standard merits serious consideration. Improperly priced federal insurance of bank deposits and pension liabilities (and much more) induces adverse selection and moral hazard. Riskier organizations get subsidized by more prudent market participants and have little incentive (arguably no incentive) to get their risk management house in order. Regarding government intervention as to how credit is allocated, plenty of empirical studies quantify the economic "bad" that results from information asymmetry. When buyers and sellers are not fully informed, supply and demand cannot intersect at the"correct" price of money or the optimal level of borrowing/lending.

Then there is the shame factor. In an era of reality shows, can we expect honor and accountability? Grant has few kind words for market behemoths (current and now extinct) who watch(ed) the Titanic sink "under the studiously averted gaze of the Street's risk managers." Will today's villains of excess rise, Phoenix-like, as have infamous names of yore, now reincarnated as media superstars? (Nick Leeson of Baring's fame has his own website and earns a living as a consultant and speaker. Henry Blodget pens "Internet Outsider" and e-newsletter, Silicon Alley Insider - a fun read for this bloggerette.)

Related to Grant's provocative piece, a recent article about voluntary standards caught my eye with its suggestion that industry attempts may be more show than reality. In its "agenda-setting column on business and financial topics," the Financial Times' Lex states that such guidelines receive little scrutiny and are put in place as a way to attract risk-averse institutional investors and/or to avoid the harsh spotlight of global regulators. (See ""Funds of hedge funds," Financial Times, July 17, 2008.) An easy way to check is simply ask each hedge fund manager about his/her reliance on published guidelines. Inquire how traders are compensated. Are they encouraged to take pure risks or are they instead benchmarked on the basis of risk-adjusted returns (with "risk" referring to the holistic assessment of uncertainties)? Don't stop with hedge funds. Ask any service provider or trader about their controls and how they monitor the quality of their processes.

The creation of an effective reward system and "best practices" are favorite topics of this blog. Our team (Pension Governance, LLC) and fiduciary community colleagues decry the status quo that makes it difficult to reward good players, at the same time that questionable practices are frequently left untouched. Poor quality disclosure is just one factor that inhibits the design of a better mousetrap.

Two hours into this post, I'm going to conclude with the notion that "freedom is not free" (anonymous). To enjoy flexibility and regulatory latitude, people of great courage must buck the existing system and both demand and assume accountability. At a minimum, interested parties (retirees, shareholders, taxpayers) want to better understand what went wrong and how internal controls will be strengthened post-haste as a result of introspection. Leaders at troubled institutions do a great service by informing the public about corrective actions underway.

For pension fiduciaries, a critical lesson learned is this. If you are not already doing so, waste no time in getting an operational review. This extends to tough and detailed interviews with your external money managers and service providers about all things risk management. Communicating your process to plan participants (for all types of plans) and shareholders/taxpayers gets you brownie points and helps to raise the "best practices" bar. 

Doris Day's sentiment may be great for meditation class but has no place in a discussion about financial system reform and governance of individual organizations, plan sponsors included. "What will be, will be" is the wrong answer (though "Que Sera, Sera" is a favorite tune).

The power of one keeps us in awe. Who will step up to the podium and say - "The buck stops here?"

Please email us with examples of pension and financial service leaders whom you believe inspire and lead the way in terms of governance. Let us know if we may attribute your comments or should post them anonymously.

 Editor's Notes:

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Pension Plan Plaintiffs Cost Corporate Defendants With Opt-Outs

Posted on April 30, 2007 by Susan Mangiero
A recent trend in class action litigation circles is the pension plan opt-out. Choosing not to settle with the rest of the "class," several large institutional investors are getting recompense that reflects multiples of what they could otherwise receive.

Pension Governance contributing editor, attorney Kevin Lacroix talks about this significant shift in class action outcomes, citing a sea change in the cost of litigation. Click here for more information about Kevin's interesting article and here to read more about our first class team of contributing editors.

PG Editor's Note: We have just posted an interesting and complementary item to www.pensiongovernance.com. In "Predicting Corporate Governance Risk: Evidence from the Directors' & Officers' Liability Insurance Market," authors Tom Baker and Sean J. Griffith examine how liability insurance underwriters assess corporate governance behavior - and related expectations of risk - when pricing coverage. The authors also examine whether corporations are deterred by the cost of liability insurance, especially since "virtually all corporations purchase D&O insurance to cover the risk of shareholder litigation, and because virtually all shareholder litigation settles within the D&O insurance limits, the D&O insurance premium represents the insurer’s best guess of the insured’s expected liability costs." The authors conclude that governance factors such as culture and character are taken into account by insurance underwriters. Click here for more information.

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Tontines - Way Out of a Pension Jam?

Posted on February 6, 2007 by Susan Mangiero


In a pension jam? Think tontines, not saltines, according to a newly published article about what to do as the benefits landscape quickly changes. Defined as a type of investment pool, tontines pay dividends only to survivors. Similar to an annuity "in that it provides a life income to a participant," a tontine could help millions of individuals who want retirement security without too much involvement (selecting and managing investments, forecasting post-employment spending and so on).

According to Ralph Goldsticker, author of "A Mutual Fund to Yield Annuity-Like Benefits" (Financial Analysts Journal, January/February 2007), making modern versions of the tontine a reality comes in the knick of time. Hundreds of companies are jettisoning traditional defined benefit plans as fast as you can say "senior citizen."

One version - a mutual fund/tontine hybrid - has the advantage of arguably lower default risk in contrast to a purchased annuity. Upon creation of an age- and gender-specific mutual fund/tontine structure, contributed monies are invested in a "diversified portfolio of high-grade fixed-income securities." A downside is the fact that heirs do not participate, forcing breadwinners to think about financial planning on a family-wide basis (not a bad thing to do anyhow).

Allegedly the brainchild of banker Lorenzo de Tonti, this 350-year old invention may deserve a fresh look.

Editor's Note:
Thanks to Hank Stern, Life Underwriter Training Council Fellow (LUTCF) and contributor to InsureBlog, for alerting me to the news about tontines. Winner of the 2005 Weblog Award, InsureBlog focuses on life and health insurance issues, with an emphasis on Consumer Driven Health Care.
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Employee Benefits and Captive Insurer

Posted on October 5, 2006 by Susan Mangiero
As things change in pension land with respect to rules, regulations and funding issues, industry participants are getting creative about risk management. In September 2006, the Insurance Information Institute (III) wrote, "An increasing number of corporations are using captives to fund their employee benefits programs." One type of Alternative Risk Transfer (ART) mechanism, captives are a response to keeping a lid on commercial insurance costs. (For a primer on captives, visit Captive.com, a self-described "Business-to-Business Risk and Insurance Exchange.")

One wonders if this trend portends an increased emphasis on enterprise risk management (ERM) and, by extension, a strategic focus on benefits as an integral part of a corporation's assets and liabilities. According to a recent overview of ERM by Towers Perrin, "More than half of respondents - 57% in the U.S. and 72% in the U.K. - believe their company's pension related risk is significant relative to other financial and operational risks."

Reprinted with permission from the Association for Financial Professionals (AFP), the article below highlights one company's experience.

"The Latest to Place Employee Benefits Risk with Captive" by Kraig Conrad, CTP, September 27, 2006

<< The H.J. Heinz Co. earlier this month became the latest company to receive US Department of Labor (DOL) approval to cover employee benefits risks through their captive insurance company.

In the slowly growing trend to take advantage of program costs-savings with captives, the Pittsburgh-based company became the tenth company to receive DOL approval. DOL established EXPRO, or the standardized and expedited procedure, six years ago in order to grant advance approval of certain types of standard transactions-such as the use of captives to fund certain employee benefits- effectively removing roadblocks that prevented such transactions.

Heinz will use Heinz-Noble Inc., its Vermont captive, to reinsure employee and retiree group term life insurance policies, according to Business Insurance. Their Vermont-based captive is also used to cover a variety of property and casualty risks for the company.

In addition to group life insurance, the other nine companies with DOL approval have covered long-term disability and accidental death and dismemberment policies through their company's captive.

As a licensed insurance carrier a captive is under the control of its parent corporation with the primary purpose of insuring or reinsuring portions of the entire risk exposures of the parent and related companies. Though risks covered by captives typically have been related to property and casualty and workers' compensation, companies are looking to place other risks with their captives to help reduce risk management costs. >>

Copyright @ 2006 Association for Financial Professionals. All Rights Reserved.
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Fiduciary Liability Insurance in Pension Land

Posted on September 24, 2006 by Susan Mangiero

Travelers Canada announced a hard hat of sorts for money managers. According to the September 21, 2006 press release, the goal is to provide additional protection to "investment advisers, mutual funds and hedge funds for risks associated with providing asset management products and services to investors." Specific policy terms include coverage for incidents such as the ones listed below:

1. "Failure to adhere to investment guidelines and restrictions

2. Misrepresentations and failure to adequately disclose risks

3. Mismanagement of investments by an adviser on behalf of a pension fund

4. Breach of fiduciary duties to clients or pension plan participants

5. Unintentional errors committed in the course of performing regular investment adviser duties."

New pension laws, heightened scrutiny of fiduciary advisors and a surge in litigation would seem to make this type of enhanced coverage appealing to investment professionals in Canada, the U.S. and elsewhere.

Some interesting questions come to mind.

1. Should pension fiduciaries ask money managers for proof of insurance if they don't do so already?

2. Should pension fiduciaries eliminate a fund from consideration if they do not have this type of insurance?

3. Should the fund selection decision be tied to type and amount of insurance coverage? For example, would a fund with lots of liability protection be perceived as less of a risk-taker and perhaps more likely to deliver lower returns? Alternatively, would a money manager with ample coverage be seen as more of a risk-taker since insurance provides a safety net in the event that something goes awry?

4. Does the carrier matter? Specifically, do pension fiduciaries ask about the insurance underwriter and its financial capabilities to pay a claim?

5. Should a money manager ask pension fiduciaries if they are covered by liability insurance if they don't already inquire?

6. How would proof of plan fiduciary insurance be evaluated by the money manager? Is it an indication that a pension fund is inclined to have an established governance process that includes regular detailed assessments of money managers' risk controls? Would that discourage a more freewheeling money manager from doing business with that retirement plan?

It is our view that scant research has been done about the behavioral aspect of fiduciary insurance in pension land. Analysis of the insurance purchasing decision would be enlightening in several ways. First, it could shed light on process-related risks associated with pension plan investing. Second, it could (and probably already does) encourage a self-selection process that is directly tied to probability of loss on both sides of the fence. Few would argue that rational pension fiduciaries and investment professionals alike seek to avoid monetary losses and reputation-related harm.

Editor's Note: If you know of a study that examines these issues, please email pension@bvallc.com. Let us know if you would like to be credited for providing information.
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Fiduciary Insurance for Hedge Funds

Posted on June 2, 2006 by Susan Mangiero
According to a recent story in HedgeWeek, hedge fund liability insurance may merit some serious consideration. Regulatory enforcement actions and investor lawsuits are on the rise, in the U.S. and elsewhere. Hedge fund directors are arguably more vulnerable than ever before, especially in areas such as valuation and trading controls.

Bigger and more frequent claims make for unhappy insurance underwriters. The logical result? Higher premiums, reduced coverage and larger deductibles.

For pension fiduciaries with hedge funds on the shopping list, now might be the time to ask managers even more questions about their policies and procedures - content, frequency of review and revision, oversight and metrics for determining "errors".

After all, pension fiduciaries themselves are under more scrutiny and are unlikely to want to invest in a hedge fund or fund of fund with few or no documented policies and procedures.
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