Pension Risk Matters : Pension Risk News & Analysis : Investment Governance, Inc. : Pension Risk & Investment

I have a favorite shirt that gets a few laughs when I wear it. The message is "Change is good. You go first." That is how I feel when I hear pundits talk about the future of pensions and the need for reform. What I continue to believe and have said many times in the last ten years is that the retirement issue is getting closer to the point of no return. Politicians will jump in to allegedly save the day. Part of the problem is that there is a battle of interests with few constituencies aligned to move in the same direction. When this occurs, a central authority typically intervenes.

On May 2, 2013, one speaker who presented as part of the "Bloomberg Forum on Pension Reform" called the situation "desperate." Another speaker said that he is optimistic that the U.S. Congress is proceeding apace with relevant reform. Another speaker hinted at inevitable higher premiums to be paid by plan sponsors to the Pension Benefit Guaranty Corporation ("PBGC"). Comments were made that some underfunded plans will have to materially cut retirement benefits in order to survive.

People are starting to ring the alarm bells. In its 2013 Retirement Confidence Survey, the Employee Benefit Research Institute ("EBRI") found that only 13 percent of workers feel "very confident" about the ability to enjoy a comfortable retirement. That means that 87 percent of workers do not feel confident. Click to see the results of the 2013 Retirement Confidence Survey.

It is unclear how much power voters will have to effect movement as relates to retirement reform such as tax incentives to save, especially when the issue is seldom discussed as part of political campaigns. That could change over time.

When I recently took my 22-year old nephew out to lunch, we talked at length about his views on the budget. He has no debt and has found a job but he knows that many of his peers are not so fortunate. They are graduating with large school loans, have not found a job and are sleeping on mom's couch. These "boomerang" kids are growing in numbers around the world. While they may not be an economic force right now, they vote. At the polar opposite end in terms of desire for how the system should change, if at all, retirees vote as well.

How will politicians respond to younger persons who do not want to shoulder the high costs of social safety net programs and seniors who want them?

Politics and pensions may not make for strange bedfellows after all. As a champion of free markets, I am not particularly happy about the prospect of a "one size fits all" law(s) that seeks to create a national retirement system and/or levies tax penalties for those who wish to save more than $3.4 million or whatever level is deemed "too much." Think higher compliance costs, perverse incentives, the law of unintended consequences, moral hazard and the loss of flexibility. Unfortunately, with disparate owners who each want different things, something will have to take place soon. Many of the retirement piggybanks around the world are close to empty.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Click to register for a January 16, 2013 webinar entitled "Pension De-Risking for Employee Benefit Sponsors: Minimizing Risks and Ensuring ERISA Compliance When Transferring Pension Obligations to Other Parties." Sponsored by Strafford Publications, this Continuing Legal Education ("CLE") webinar will provide benefits counsel with a review of pension de-risking approaches used by companies to reduce some of the risks involved with employee retirement benefits. The panel will offer best practices for leveraging the precautions to prevent ERISA fiduciary law violations when making transfers.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

The Pension Benefit Guaranty Corporation ("PBGC") has a challenging job that shows no sign of abating any time soon. In 100+ pages of its just released 2012 annual report, this federal corporation describes its various funding sources and the need for more flexibility. Announcing its largest ever deficit at $34 billion, PBGC management urges Congress to raise the insurance premiums that companies pay, preferably with those fees taking into account an employer's financial health and characteristics of a particular plan. Click to access the 2012 PBGC Annual Report.

In response to news of the increased funding gap, as quoted by Advisor One journalist Melanie Waddell, the head of the American Benefits Council, James Klein, cautions that [The public,] "should not be led to believe the PBGC is in danger of a bailout and Congress and the Obama Administration should not use this number as a pretext to raise premiums paid by pension plan sponsors." He adds that historically low interest rates have "overstated" pension fund liabilities for everyone, including the PBGC. See "PBGC Deficit Hits $34 Billion; Benefits Council Calls Number Misleading" (November 19, 2012). Last year, the same plaint was voiced by the American Benefits Council, the Business Roundtable, the ERISA Industry Committee and the U.S. Chamber of Commerce. In a joint statement entitled "PBGC Deficit: A Non-Event on the Horizon" (November 11, 2011), the 2011 funding gap was described as "a product of government-created artificially low interest rates[,]" due mainly to a fall in interest rates since late September 2008 that was meant to stimulate the U.S. economy.

As Dr. Susan Mangiero wrote in June 2006, there are many ways to measure pension funding status (and related concepts) and not all of the metrics and methodologies yield the same results. See "Will the Real Pension Deficit Please Stand Up?" (June 22, 2006). It is true that understanding what each number represents is a critical task. It is also true that important decisions should be made on the basis of full information, whether for the PBGC or U.S. corporate employers.

This brings to mind a recent discussion with a financial industry colleague about whether and to what extent the capital markets incorporate the "true" cost of a company's defined benefit plan liability. This is a topic that deserves its own blog post (or two or three) but suffice it to say that the economic obligation associated with a given employee benefit plan(s) is a hugely important issue for any participant, shareholder, creditor or policy-maker to evaluate.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Ever since the PBGC’s 2007 opinion that a private equity fund with a controlling interest can be liable for a portfolio company’s pension problems, there is increased evidence that corporate transactions can go seriously awry if ERISA benefit plans are not properly addressed. Legal issues are not the only risk factor that could cause a merger, acquisition, spin-off or carve-out to fail to materialize. Low interest rates, investment lock-ups, participant longevity and complex vendor contracts are a few of the challenges that must be confronted by the legal and finance team in charge of due diligence. And with virtually every defined benefit plan facing funding issues in light of these circumstances, the PBGC is extremely proactive in seeking concessions to not interfere with corporate transactions yet hold parties who may have responsibility for unfunded liabilities accountable. Headlines are replete with articles about deals that were stalled or failed because ERISA due diligence was given short shrift. In 2010, the acquisition of a major chemical company took less than six months but coordinating the relationships with defined contribution managers took nearly two years to wrap up. Talks between a large manufacturing company and a potential target company are currently focused on how best to tackle the acquiree’s multi-billion dollar pension fund gap. In the aftermath of the settlement of a recent case, private equity firms and limited partners continue to be jittery about joint and several liability for pension plan funding gaps, making it harder to take a portfolio company public or sell. Taken together, the most important thing that a potential corporate buyer and its counsel can do is to acknowledge the importance of proper due diligence. These problems are not going away and arguably could get much worse.

Join Dr. Susan Mangiero, CFA, certified Financial Risk Manager and Accredited Investment Fiduciary Analyst and senior ERISA attorney Lawrence K. Cagney to talk about ways to keep a deal from derailing and to avoid buyer’s remorse due to an incomplete assessment of pension plan economics on enterprise value.

Join us to hear speakers talk about critical steps and lessons learned from their experience, to include the following:

• How to revise investment and/or hedging strategy and policy statement(s) when organizations merge;
• Elements of an ERISA service provider due diligence analysis when plans are combined;
• Red flags for an institutional investor to consider when seeking to allocate to private equity portfolios with “pension-heavy” companies that may be hard to exit without costly restructuring;
• Assuring that participant communication is comprehensive;
• Role of the corporate finance attorney versus ERISA counsel; and
• Installing knowledgeable fiduciaries for the new and/or merged employee benefit arrangements

Click to register for "Pensions and Corporate Finance: How to Avoid Buyer's Remorse," sponsored by the Practising Law Institute on November 15, 2012 from 1:00 pm to 2:00 pm EDT.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In his just proposed federal budget, President Barack Obama opens the door for the Pension Benefit Guaranty Corporation ("PBGC") to determine insurance premiums as a function of the riskiness of the plan sponsor. Having been an advocate for this approach for numerous years, my response is "yippee yahoo." There is empirical evidence aplenty about the costly consequences of forcing good risks to subsidize bad risks. The common sense notion of charging plan sponsors higher insurance premiums if they are deemed "higher risk" is logical and is a long overdue move in the right direction.

The excerpted text from "Low Risk Premium Makes PBGC Bargain Insurer" (In the Money, Dow Jones Newswires, July 18, 2005) by Steven D. Jones addresses the concept of risk-based premiums as follows:

 A separate bill that emerged from a House committee in June changes a number of rules governing funding levels and grace periods to meet them. It also ties premiums for PBGC coverage to hikes in the national wage index. But the formula wouldn't impose higher premiums on higher risk plans. "That's a mistake, says consultant Susan Mangiero, author of Risk Management for Pensions, Endowments and Foundations." To be effective, a premium structure needs to reflect the risk of the insured. Without a risk mechanism, "you invite adverse selection" in the insurance plan, she says. For example, a driver with several tickets and an accident record pays more for auto insurance. If there's no cost to the behavior, the carefree driver has no incentive to change, losses mount and premiums go up for every participant. Discouraged by the cost, clients with good risk profiles leave the plan. Companies can't seek pension insurance elsewhere, but they can end defined-benefit plans and shift to defined-contribution plans, such as a 401(k), in which employees share the risk. Such plans are not covered by the PBGC. "The net effect of flat-based insurance, not taking into account different risk levels, is that you have a riskier system, which is counter to the purpose of having an insurance plan," she says.

Think about the issue this way. Would you buy stocks or bonds issued by a public insurance company that charged the same premium for all insured parties, irregardless of their risk behavior? Hopefully your answer is "of course not."

If plan sponsors do the right thing in terms of careful risk-taking and good procedural prudence, they should not be penalized by having to pay for the sins of others who are less careful or, worse yet, sloppy, indifferent and/or take excessive risks unnecessarily and to the detriment of their plan participants.

Note to Readers: Check out "Obama's 2012 Budget: What It Means for Pension Plans and the PBGC" by John Sullivan, Advisor One, February 16, 2011,  "Let PBGC set employer premiums based on risk: Obama" by Jerry Geisel, Business Insurance, February 14, 2011 and "Budget Would Raise Pension-Insurance Costs" by David Wessell (Wall Street Journal, February 14, 2011).

• Email This
• Print
• Comments (1)
• Trackbacks
• Share Link

According to two separate news accounts, cracks may be appearing in the pension back-up systems for the United States and UK, respectively. Already jittery taxpayers may look at these warnings with heightened alarm.

In "Pension Agency Sounds Alarm on Big Three," Wall Street Journal reporter John D. Stoll (November 28, 2008) writes that the Pension Benefit Guaranty Corporation ("PBGC") is worried that large automakers may offer early retirement or buyout deals to some plan participants, at the expense of those who remain. Stoll adds that a year-end accounting by General Motors ("GM") has its pension plans "overfunded by $18.8 billion," but recently reported that "its plan for hourly workers was underfunded by $500 million because of restructuring expenses." The Toronto Star suggests funding woes for GM's Canadian pension plan. (See "GM Canada's pension plan troubled before market collapse" by James Daw, November 15, 2008.)

In "Pension lifeboat may be sunk by wave of firms being liquidated" (November 28, 2008), Phillip Inman and Simon Bowers - reporters for The Guardian - write that "The Pension Protection Fund (PPF), which has already rescued more than 66 retirement schemes, may be forced to increase its levy on profitable companies to boost its finances or risk a government bail-out if more companies go bust." With the collapse of Woolworths and other troubled companies, this UK counterpart of sorts to the PBGC may find itself in a postion of having to pay out more each year than it takes in.

This day after American Thanksgiving, known as "Black Friday" for shopping jaunts, may be the day the bell tolled for two of the world's largest concentrations of private pension schemes.

Editor's Note: On November 17, 2008, a PBGC press release describes a reduction in its deficit as a snapshot number, influenced by events that may not repeat themselves.

<< The PBGC’s insurance program for single-employer pension plans reported a deficit of $10.7 billion, a $2.4 billion improvement over last year’s $13.1 billion shortfall. The deficit of the insurance program for multiemployer pension plans was cut in half to $473 million, a $482 million improvement from the $955 million deficit reported a year earlier. 'The PBGC’s lower deficit is good news, although it is important to remember that the deficit number is only a snapshot of where we stood on September 30,' said Director Charles E.F. Millard. 'Successful negotiations with companies in bankruptcy protected workers’ pensions and sliced hundreds of millions of dollars in liabilities off our books.  Favorable interest rate changes reduced liabilities, and our careful stewardship of the PBGC’s investments limited losses to 6.5 percent of assets. Although the current turbulence in our economy will mean a challenging environment in 2009, the PBGC has the resources to meet its commitments to America's retirees for many years to come.' The decline in the deficit in the single-employer program was primarily due to a $7.6 billion actuarial credit from a favorable change in interest factors, $1.4 billion in premium income, credits of $826 million from completed and probable terminations and $649 million in favorable actuarial adjustments. These amounts were offset by investment losses of $4.2 billion and a $3.4 billion actuarial charge due to passage of time. Total return on invested funds was -6.5 percent. > 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Click here to view "Troubled Pensions," an interview I gave to CNN Money anchor Poppy Harlow on November 24, 2008. (The piece aired on November 26, 2008.) The roughly five minute discussion centered on four questions, including:

• Is Congressional reform of the Pension Protection Act of 2006 needed or should plan sponsors be forced to top off underfunded plans?
• Will the Pension Benefit Guaranty Corporation be able to handle traditional plans of ailing auto manufacturers?
• Will plan sponsors be tempted to assume more investment risk in order to make up for current losses?
• Is pension litigation on the rise?

• Email This
• Print
• Comments
• Trackbacks
• Share Link

According to Wall Street Journal reporters, James R. Hagerty and Aparajita Saha-Burna, musical chairs are moving at the nation's giant mortgage house. Besides a new chief business officer and CFO, the former Senior Vice President for Credit Risk Oversight takes the lead on all things risk. Exiting the  company is the former Chief Risk Officer ("CRO"). (See "Fannie Mae Names New Officers in Shake-Up, August 28, 2008)

According to a May 18, 2006 press release issued by the Federal National Mortgage Association ("Fannie Mae") (ticker symbol FNM), the Chief Risk Officer now being replaced came onboard to lead the "credit market, counterparty and operational risk oversight for all business units within Fannie Mae." Before joining, he headed the market risk management efforts for "the chief investment office and retail financial services" at a large bank. In that same May 18 announcement, the then Chief Business Officer (now departing) commented on the new "One Fannie Mae" approach, "with a rigorous, unified and analytical discipline."

If you are not asking already, let me do it for you. What happened since 2006? 

The Fannie Mae website boasts a "Risk Policy and Capital Committee Charter" (last amended on November 20, 2007) that exists for the purpose of assisting the Board in "overseeing Fannie Mae's capital management and risk management, including overseeing the management of credit risk, market risk, liquidity risk, and operational risk." Members are charged with duties that include risk management oversight and recommendations relating to enterprise risk.

I repeat. What happened? Inquiring minds want to know - shareholders, taxpayers and oh yes, retirement plan participants, including those of plan sponsors that invested in Fannie Mae.

As confirmed by the Pension Benefit Guaranty Corporation ("PBGC"), the Fannie Mae defined benefit plan is an insured plan. If financial woes continue (as suggested by some), could taxpayers be asked to fund a bailout of shareholders as well as a bailout of retirees (in the event that PBGC itself needs help)? (On December 8, 2007, this blog cited TheWashBiz Blog as saying that the Fannie Mae plan would be closed to new employees.)

In a related Wall Street Journal article (entitled "Pension Funds Watch Fannie, Freddie," August 28, 2008), reporter Daisy Maxey lists some public plan notables who hold more than a few shares. Here's another thought. Is a triple taxpayer play a possibility, if things get "too bad?"

• Taxpayers bail out Fannie Mae and Freddie Mac shareholders
• PBGC takes over Fannie Mae and Freddie Mac defined benefit pension plans
• Taxpayers bail out the PBGC (if the insurance premiums prove insufficient to pay retirees of "assumed" plans)
• State taxpayers are asked to help public plans that invested in Fannie Mae and Freddie Mac

As an aside, it would be quite interesting to know what kinds of risk management related questions were asked by pension plan investors of these government-sponsored entities ("GSE"). For those plans that are now exposed as the result of indexing, the situation is somewhat difficult. How can a plan exit a particular position if it has specifically allocated part of its portfolio to an identified index (part of a pure passive strategy) and that index includes a "troubled" security?  

• Email This
• Print
• Comments
• Trackbacks
• Share Link

According to "Now Wall Street Wants Your Pension, Too" by Matthew Goldstein (Business Week, August 5, 2008), troubled banks have no business fiddling around with pension caretaking.  Citing a $2.3 trillion "pension honey pot" that could grow to $7+ trillion in a few years, Goldstein says pension buyouts would be a great prize for investment banks, hedge funds, private equity funds and insurers. (Editor's Note: I've seen estimates of much larger numbers but the message is the same. There is thought to be "gold in them thar hills.)

What motivates advocates of the pension transfer movement? Let me count the ways. More than a few corporations may seize the opportunity to clean up their balance sheets and income statements as new accounting rules kick in, making "problems" more visible to shareholders. Some posit that taxpayers benefit if certain plans are transferred to stronger financial buyers, giving these plan sponsors a fighting chance to steer clear of bankruptcy court. As a result, the Pension Benefit Guaranty Corporation ("PBGC"), could arguably stablilize or even reduce its $14+ billion deficit. (Though the PBGC is technically funded by insurance premiums paid by plan sponsors, experts suggest that mounting IOUs could potentially result in a bailout by Uncle Sam.)

This trend to take over pension liabilities by third parties, popular in the UK, seems to have hit a snag in the U.S. According to an August 6, 2008 press release ("Treasury, IRS Issue Ruling Preventing Certain Pension Transfers"), newly issued Revenue Ruling 2008-45 states that "a transfer of a tax-qualified pension plan from an employer to an unrelated taxpayer when the transfer is not connected with a transfer of significant business assets, operations, or employees, is not permissible under current law. This is clearly a big disappointment to Wall Street as banks have been busy at work, assembling teams to value pension liabilities and trade them, in anticipation of developing a lucrative transfer business.

Accompanying this somewhat rare tax promulgation, readers are told of legislative preferences on the part of the current Administration (IRS, U.S. Department of Labor, U.S. Department of Commerce and the Pension Benefit Guaranty Corporation) that might eventually open the door to pension liability sales. Relevant text is excerpted below:

"Under the legislative framework, a pension plan (or portion of a plan) under which benefits are no longer accruing (i.e. a frozen plan) could be transferred to an entity unrelated to the employer (or former employer) of the participants in the plan, provided that certain conditions are met. The conditions would reflect the following fundamental requirements:

• Plan participants, their representatives, and ERISA regulators would be required to receive advance notice of a plan transfer, and the parties to the transaction would be required to provide regulators information necessary to review and approve the proposed transaction.
• Only financially strong entities in well-regulated sectors would be permitted to acquire a pension plan in a plan transfer transaction.
• The parties to the transaction would be required to demonstrate that participants' benefits and the pension insurance system would be exposed to less risk as a result of the transfer, and that the transfer would be in the best interests of the participants and beneficiaries.
• Limitations on transfers would be imposed to limit undue concentration of risk.
• Transferees and members of their controlled groups would assume full responsibility for the liabilities of transferred plan and would comply with post-transaction reporting and fiduciary requirements.
• Subsequent transfer transactions would be subject to the rules applicable to original transfer transactions."

Don't count the financial institutions out yet. No doubt the next Congress is likely to receive a lot of inquiries from the bank lobby to initiate legislation in favor of pension buyouts. On the positive side, well-capitalized and properly managed banks and other types of money powerhouses could draw on sophisticated risk analytics to strengthen plans. In contrast, poor risk management practices could worsen things. (See "Bank Risk Managers - Missing in Action," November 26, 2007.)

The fiduciary question is of course a big one. Is there a  possibility that a financial institution takes over a pension plan and finds itself in the uncomfortable position of being loyal to plan participants at the expense of shareholders or vice versa? Cynthia Mallett, Vice President, Corporate Benefit Funding, Met Life adds that "Stranger-owned pension plans raise both philosophical and public policy issues, none more telling than the potential for placing plan participants' interests in the hands of unrelated investors who are not regulated in the same fashion as insurers." 

ERISA Attorney Dan Wintz, partner with Fraser Stryker PC, offers the following insight. "While the practice of 'selling' pension plans and transferring their sponsorship to unrelated companies (that is, speculator or investment companies that do not employ the participants covered by the plan) has not yet become widespread, it is heartening to see that the Internal Revenue Service intervened early. However, the Ruling may be overly broad in its application and could prohibit or impede some plan transfers in legitimate re-organizations or other transactions that do not involve the direct transfer of business assets, operations, or employees from the employer to the unrelated taxpayer which will maintain the plan. We will have to see whether this is an absolute prohibition (as appears to be stated in the Ruling) or if it can be applied on a 'facts and circumstances' basis where there is a legitimate business purpose for the arrangement and there are protections for the plan's participants."

A fellow of the Society of Actuaries, David Godofsky, partner with Alston + Bird LLP and leader of the Employee Benefits and Executive Compensation Group, concurs that buyouts may serve a vital function. His comments are provided below.

"As for the meaning, the ruling was rather narrowly tailored to a specific fact pattern, which has been widely discussed and known as "selling" pension plans. Here is a very simplified version of the basic idea:

• Company X has a frozen pension plan with assets of $100 million and liabilities of $100 million. The liabilities are measured by reference to mortality tables and interest rates that are intended to approximate the cost of buying annuities, or the cost of funding those pension benefits when very safe investments are used. In other words, the assumed rate of return on the $100 million of assets is very low, reflecting investments that are nearly risk free.
• However, Company Y believes it can invest the assets of the plan to achieve a higher rate of return. If it does so successfully, there will be money left over when all benefits are satisfied... possibly a LOT of money.
• So Company Y offers to buy the pension plan from Company X. A shell corporation ("ShellCo") is formed as a sub of Company X, and then ShellCo assumes the pension plan from Company X. Company X sells ShellCo to Company Y for $2 million.
• Company Y has no employees and no other assets. Company Y invests the $100 million in investments designed to beat the low assumed rate of return. The assets grow to $120.
• Company Y then buys annuities to cover the liability for $100 million, and is left with a pension plan with no liabilities and $20 million. It then finds a company with an underfunded plan - Company Z.
• Company Z is willing to buy ShellCo for $20 million, and merges the pension plan into its own. So, everyone comes out ahead. X is ahead by $2 million and Y is ahead by $18 million.
• BUT, suppose that Company Y doesn't do so well. It invests the money aggressively, and the assets drop to $80 million instead of increasing to $120 million. Now, the owner of Company Y is insulated, and the PBGC steps in to cover the $20 million underfunding. X is now ahead by $2 million, Y has lost its $2 million investment. As you can see, if Y invests aggressively enough, it has a great upside and a limited downside. This is what is known as "heads I win, tails you lose."

The IRS ruling focused on whether Company Y has an relationship with the employees - that was the way they chose to get to this transaction. However, what is really going on is whether you can take over pension liabilities from another company and try to make a profit by investing the assets to "beat" the actuarially assumed rate of return. Obviously Company X can do that, but so can Company Y. The difference is that X is a real company with real employees and presumably assets at risk. With Company Y, you don't quite know what you have. There is a way of selling pension liabilities - it is to buy annuities. Insurance companies sell annuities and they have to maintain reserves and invest their assets in a way that avoids losses. Basically, the Company Y's of the world wanted to do the same thing without having to comply with all those pesky insurance regulations.

Bottom line - the transaction that the IRS prohibited has the potential for an increased risk to the PBGC and a corresponding gain to the buyer (reward without risk). Now, the challenge for the investment firms that wanted to do this is to come up with a regulatory approach that has financial protections that are as strong as the insurance regulations."

Editor's Notes: There are numerous articles about the UK buyout experience. A few of them are listed below, along with the link to the July 21, 2008 report about plan freezes, published by the U.S. Government Accountability Office ("GAO").

• "Pension buyout capital floods in" (Life & Pensions, May 2006)
• "UK pension buyouts could hit 10 bln stg in 08-LCP" (Reuters, May 7, 2008)
• "Lehman Brothers joins pension buyout fray" (Financial News, July 1, 2008)
• "Booming pension buyouts spur Legal & General" (Times Online, August 5, 2008)
• "Defined Benefit Pensions: Plan Freezes Affect Millions of Participants and May Pose Retirement Income Challenges" (GAO-08-817, July 21, 2008)

Expect more news on the topic of pension buyouts and transfers.

This blog welcomes a chance to publish the pension buyer perspective. Send us an email if you want to comment.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

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:

• To read about the pros and cons of a post 1971 return to the gold standard, check out "What Was the Gold Standard? The Gold Standard vs. Fiat Money" by Mike Moffatt, About.com or "Why Not the Gold Standard?" by Professor Brad DeLong or "The Gold Bug Variations" by Professor Paul Krugman.
• To read about federal insurance problems, click to access the testimony given by Federal Reserve Governor Randall S. Kroszner before the Committee on Financial Services, U.S. House of Representatives, April 9, 2008 or the testimony provided by Sheila C. Bair, Chairman of the Federal Deposit Insurance Corporation before the Committee on Financial Services, U.S. House of Representatives, April 9, 2008 or "On asset-liability matching and federal deposit and pension insurance" by Professor Zvi Bodie, July 2006.
• The Nobel Prize in Economic Science was awarded in 2001 to Professors George A. Akerlof (famous for his "lemons" paper), A. Michael Spence and Joseph E. Stiglitz, respectively, for their research about information asymmetry and related market impact. (This blogger's doctoral dissertation addresses information asymmetry and bid-ask spread decomposition as a function of equity analyst coverage and institutional ownership. While not available in file form, I'm happy to provide hard copies of the published short version to interested parties. Click to email your request.)

• Email This
• Print
• Comments
• Trackbacks (1)
• Share Link

In its newly released "Pension Insurance Data Book", the Pension Benefit Guaranty Corporation (PBGC) continues to show about a $23 billion deficit, adding that "typically, the plans trusteed by the PBGC are only about 50 percent funded on a termination basis. Very few of the claims against the agency (only 1.5 percent) come from plans that are at least 75 percent funded."

By way of background, the "PBGC is a federal corporation created by the Employee Retirement Income Security Act of 1974 to guarantee payment of basic pension benefits earned by workers. Its two insurance programs cover 44 million American workers and retirees participating in over 30,000 private-sector defined benefit pension plans, including some 1,600 multiemployer plans. The agency receives no funds from general tax revenues. Operations are financed largely by insurance premiums paid by companies that sponsor pension plans and by investment returns."

Could it get any worse?

• Email This
• Print
• Comments
• Trackbacks
• Share Link

A flurry of activity is upon us in defined benefit land. The goal? Identify "high risk" plans early on. This, according to certain members of Congress, would be followed with additional funding by plan sponsors and thereby (hopefully) reduce the possibility of a government takeover. Critics counter that such a reform could make things worse, especially for already cash-strapped companies, struggling to stay in business. Moreover, they add that a risk classification based on unrealistic assumptions regarding early retirements at maximum benefit levels makes little sense.

The "Performance and Accountability Report: Fiscal Year 2005" shows a deficit of nearly $23 billion for the Pension Benefit Guaranty Corporation while estimating "future exposure to new probable terminations" at $108 billion, nearly four times the "damage".

In its primer on pension accounting and funding, the American Academy of Actuaries describes at least four types of numbers - service cost, accumulated benefit obligation, projected benefit obligation and present value of future benefits. They add that "Amounts calculated under pension funding rules are completely different than those calculated for pension accounting, and one must be careful not to mix the two topics."

Keep in mind that smoothing and credit balances are other considerations as we try to navigate our way through the maze of pension metrics. New rules that address (a) the treatment of a company's pre-funding of a plan and (b) whether a sponsor can continue to average a plan's value over several years could materially impact reported pension costs. (To the extent that capital market participants react to accounting numbers as inaccurate barometers of economic health, C-level executives could be busy with related financial tasks.)

Okay, we get it. There are lots of ways to measure pension deficits but which one tells us what we really want to know?

What is the truth?

Will the real pension deficit please stand up?

• Email This
• Print
• Comments
• Trackbacks (1)
• Share Link

People are living longer, requiring even more in the bank to pay bills once they quit working. Studies consistently show that most people are saving very little and are not financially prepared to retire any time soon. Social Security trustees project costs to exceed tax revenues as early as 2017 and are urging reform. This is particularly compelling now that only three workers pay taxes into the system to support each existing beneficiary, compared to the original sixteen persons at inception.

Last summer, the U.S. Government Accountability Office released a study citing the largest ever deficit of $23.3 billion for the Pension Benefit Guaranty Corporation, a single-employer insurer that protects the retirement incomes of more than 40 million American workers in excess of 30,000 defined benefit pension plans. Executive director, Bradley Belt, stated that "financially troubled companies have shortchanged their pension promises by nearly $100 billion, putting workers, responsible companies and taxpayers at risk." In July, Standard & Poor's reported that defined benefit plans for 364 of the S&P 500 Index member companies remain under-funded by $165 billion. Public pension plans are struggling too. National Association of State Retirement Administrators statistics indicate a $300 billion aggregate pension shortfall for the largest state and city plans.

What do you think about the current retirement situation? Choppy waters or calm seas?

Take our five question survey and see what others think too.

• Email This
• Print
• Comments
• Trackbacks
• Share Link