Pension Risk Matters

Pension Report Card - Process, Not Point in Time Numbers

PG-Info@pensiongovernance.com (Susan Mangiero) — Wed, 19 Nov 2008 00:52:48 -0500

In "Pension Plans Under Closer Watch" (November 18, 2008), MarketsmediaLive reporter Karla Yeh quotes me as emphasizing process. Rather than dwell on singular numbers that can change over time and according to the selected time period and/or reporting rules, I urge interested parties to focus on what happens next. In the event that a defined benefit plan suffers a loss, how will things have to change as a result?

Here is the article for your reading pleasure. The original version can be found at http://www.marketsmediaonline.com/news_details.htm?wP=1&wPI=1&cN=2306.

<< Pension funds struggling with declining asset values could be hurt more by the consequences from losses than the losses themselves, said Susan Mangiero, president of Pension Governance Inc., on Tuesday.

“The real question is what actions are forced upon plan sponsors as a result of reported losses,” she added. “For some plan sponsors, the pension chain of events is significant.”

The Organization for Economic Co-operations and Development last week reported average pension fund returns plummeted by more than 20 percent between January and October, resulting in a $4 trillion loss in pension assets. In addition, consulting and actuarial firm Milliman on Monday said corporate pension funds could be $93 billion in debt by the end of the year after asset values dropped by $120 billion.

“A loss of $120 billion is hard to ignore, especially since many economists believe that market volatility is here to say, for a while at least,” Mangiero said.

To combat record losses, Mangiero said companies could be forced to contribute billions of dollars in cash or freeze their defined benefit plans if funding ratios drop below 60 percent, pursuant to the Pension Protection Act of 2006. They might also reduce benefits paid to retirees and face ratings downgrades or higher capital costs in an attempt to replenish the funds, she added.

As the New Year approaches, shareholders and plan participants will most likely watch their pension plan sponsors under a close lens to “better understand the nature of the reported losses,” said Mangiero.

In the meantime, plan sponsors will “try to figure out how they are going to recoup equity sector losses” and “may be tempted to allocate more monies to riskier investments,” Mangiero said. She added that asset allocation will be a top priority for pension plans that need to boost money management and risk management focuses. >>

Financial Domino Effect: Pensions and Alternatives

PG-Info@pensiongovernance.com (Susan Mangiero) — Mon, 17 Nov 2008 08:07:41 -0500

As this blogger has said for many months, pension risk management trumps a return-only focus. Few care about the risks associated with the upside. It's the extreme tail of a price distribution that gets people's attention. When low frequency (read DIRE) values occur, watch out. The dominoes crash into other, the structure crumbles and someone is left picking up the pieces. Is that happening now? You betcha! Any problems with investments, heretofore put into neat asset buckets, spill over into other parts of the portfolio, forcing major decisions about asset allocation, liquidity and cash requirements.

A November 16, 2008 New York Times article makes my point. (See "From the Valley Comes a Warning.") Writers Jeff Segal, Lauren Silva Laughlin and Rob Cox explain that the California Public Employees' Retirement System (Calpers) has to now decide whether and how to rethink its strategic asset allocation to alternative investments. Originally meant to be about 10 pecent of its overall portfolio, equity sector losses have apparently pushed the giant public plan's relative exposure to hedge funds, venture capital, private equity beyond its limit, to about 14 percent of its asset holdings. Worse yet (from a strategic asset allocation orientation) is that a market downturn may now accelerate calls for capital from the private equity and venture capital funds in which Calpers is invested, forcing an even higher allocation. (The idea is that some portfolio companies need more money now because their respective revenue projections cannot be met as corporate spending contracts. Private equity and venture capital fund managers - and their investors - can either lose everything they have invested in the portfolio companies or try to help them stay afloat, by giving them a cash lifeline sooner than anticipated. Hence, the need to accelerate capital calls.)

Calpers is not alone. We've heard from plenty of plan sponsors that the "stay the course" or bid adieu to alternatives (some or all) is at the top of their decision list. The problem is that exiting a particular private fund may be costly, so much so that the plan sponsor is made worse off in the short- and intermediate-term. Additionally, plan sponsors seldom have the legal right to turn down a request for additional capital from private equity fund X or venture capital fund Y. According to private investment fund attorney John Brunjes, a partner with Bracewell & Giuliani, "in a private equity or venture capital fund is a contractual relationship. Except for fraud or duress, pensions are on the hook to write a check when the alternative fund manager comes calling."

If true, that some plan sponsors are "stuck" for the foreseeable future (i.e. must meet their capital commitments to alternative fund managers) AND their losses continue in traditional equity land, participants may take it on the chin in the form of reduced benefits. Taxpayers and/or shareholders may be asked to make up the difference. From the mail and calls we get at Pension Governance, Inc., there are a lot of individuals who are beyond unhappy about what they see as their diminished future due to rescinded benefits, disappearing plans, sponsor insolvencies and so on. (While our company focus is on plan sponsors and their service providers, our web presence encourages communication from plan participants.)

With respect to investment fiduciary duty, will members of the investment committee be held liable for not having properly assessed correlation patterns over extreme data ranges? When things go south and investor flee to quality, "contagion" is not uncommon. This means that bad news impacts the performance of multiple asset sectors, even those thought to move inversely or independent of each other. The "one world - one market" phenomenon translates into lower diversification benefits.

Will investment fiduciaries be held accountable for not better measuring liquidity or assessing transferability restrictions or the legal implications of capital calls? What is the role of consultants and fund of funds managers in evaluating risk factors beyond the numbers themselves? Are there some private funds deemed to have done enough to vet the suitability of alternatives for their institutional investor clients.

I'll be writing much more about the changing relationship between institutional investors and private funds. What do you want to know more about in these areas? Drop me a line.

Editor's Notes:

On January 4, 2007, I wrote: "Contagion itself is dangerous but when you consider what some describe as an inevitable convergence towards one global market, with trading that occurs 24/7, the potential for serious harm is real. Continued technological advances, international deregulation and investors' willingness to go offshore promote lightening speed information flow. When bad news hits, it's the shot heard 'round the world. Having worked on three trading desks during volatile times, I know firsthand how quickly things can change." (See "Pension Contagion - Should We Worry?")
The Calpers website reports that, as of September 30, 2008, its current allocation to alternatives is 12.2% versus a target of 10 percent. For more information, click here.
Here is the link to the slide show that has Silicon Alley shivering in their boots. Essentially famed venture capital firm Sequoia Capital told entrepreneurs to watch their cash and acknowledge that the funding party may be over, at least for awhile. See for yourself. Read "The Sequoia: 'RIP: Good Times' presentation: Here it is" by Eric Eldon, Venture Beat, October 10, 2008.

Revisiting Whether a Pension Crisis Exists

PG-Info@pensiongovernance.com (Susan Mangiero) — Mon, 17 Nov 2008 00:30:52 -0500

On March 23, 2006, this blog asked "Is There a Pension Crisis?" wherein readers were requested to take a five question survey. On April 22, 2006, we reported the survey results in a post entitled "Retirement Blame Game Survey". Plan fiduciaries came up high on the list according to 38% of respondents. In the current sub-prime crisis environment, when many clamor for more regulation, it is interesting to note that U.S. Congress (41%), regulators (33%) and governors and state officials (31%) were seen as "culpable" for problems with the retirement system a few years ago. Perhaps not surprising, 54% of respondents in 2006 ranked the U.S. Congress highest when asked about who can fix things. Plan fiduciaries (regulators) were cited by 34% (29%) of survey-takers as empowered to make changes. A whopping 75% of questionnaire participants agreed that a Social Security crisis is upon us.

We'd love to get your feedback now, more than two years after we launched the original "pension crisis" survey. Click here to answer five short questions. Your responses will be kept private.

In the meantime, we asked a few folks what they think.

Mr. Steven Fowler writes: "The public pensions are the hardest hit. The plans base their decisions on outdated and unrealistic life expectancy assumptions. Additionally, all pension plans are going to come under significant pressure as the baby boomer generation enters the retirement phase. This will create a significant draw on pension monies while also reducing cash inflows at a time when it could take several years to recoup losses related to the recent market downturn."
Mr. Larry Steinberg writes: "Pensions, public and private, were in trouble before the stock market dropped 50% in value. Now it will only get worse, especially for people who are counting exclusively on those monies and have not saved elsewhere. Union pensions could actually be the worst off because they are not held to the same rules as private pensions." (Editor's Note: Taft-Hartley Act plans are considered ERISA (Employee Retirement Income Security Act) plans. I have asked Mr. Steinberg for clarification.
Mr. Earl Butler writes: "The short answer is Yes, especially when you consider public pension plans. Most plans for firemen and police officers are overly generous and not fiscally grounded in reality. Given the second wave of the financial crisis (i.e. the tax revenue shortfall at the municipality level), it is foreseeable that either these plans will need to be revised or injected with capital as part of a stimulus package."
Mr. Sanjay Bhasin writes: "The pension industry is currently hit with a double whammy. Increased longevity of pensioners is a fact of life. This has been reinforced by the recent issuance of the VBT2008 by the Society of Actuaries. However, not every pension scheme recognizes this, thereby leaving a 'hole' in its liabilities. Unless duration-matched, the assets of pension schemes are vulnerable to sharp swings in market conditions. If equities are deemed the best long-term inflation hedge and source of long-term economic growth, plan sponsors will have to live with the short-term volatility that comes with a heavy concentration in stocks. Higher liabilities and plunging asset values do not make for a happy future for the pension industry. Available data suggests that the situation is similar for most of the developed world. Consider that in the UK, nearly 8,000 funds being monitored have swung from a 10% surplus to a 10% deficit in the past year. Clearly, plan sponsors - whether private or public - have a problem on their hand, especially as relates to defined benefit schemes. Looking at things a different way begs the question. How realistic is it to require short-term valuations of very, very long-term assets and liabilities? The average duration of pension liabilities (active/retired/deferred) is clearly 20+ years. While the problem certainly cannot be ignored, does it make sense to lose sleep over monthly or quarterly fluctuations due to changing market conditions? There are sophisticated solutions (none of them inexpensive) to tackle the pension problem. However, a simple (rather simplistic) approach is to recognize longevity more accurately, and to the extent possible, duration-match assets. Equity investors are, by definition, exposed to market cycles and they should hope that the current downturn will be followed by an appropriate upturn. I will worry about myself when I am closer to receiving my pension. In the meanwhile, I do worry about my friends who are reaching pensionable age. More than the underlying assets of their pension schemes, the issue is whether the plan sponsor will survive the present crisis."

Well said gentlemen. Thank you for your erudite observations. For anyone else who wants to comment on the state of the pension industry, email PG-Info@pensiongovernance.com. We want to hear from you!

Don't forget to take our short (only five questions) pension crisis survey. Click here to begin.

Pension Plan Metrics - What's Wrong With This Picture?

PG-Info@pensiongovernance.com (Susan Mangiero) — Sat, 15 Nov 2008 00:42:10 -0500

In a November 12, 2008 letter to Congress, the American Institute of Certified Public Accountants ("AICPA") and 300 plan sponsors and pension associations urge new legislation that would help employers avoid "huge, countercyclical contributions," for credit crisis induced losses. The authors' stated rationale is that monies diverted to support defined benefit plans could instead be used for "current job retention, job creation and needed business investments." The letter suggests that, worse yet, employers may be forced to freeze plans altogether unless the Pension Protection Act of 2006 is modified to allow "full smoothing of unexpected losses." Click to read the letter.

One of the letter writers, Watson Wyatt, criticizes the averaging method which, unlike smoothing, does not include projected returns as part of the determination of market values. According to this consultancy's website, "averaged assets cannot exceed (or trail) current market value by more than 10 percent. Prior rules allowed for 20 percent. When asset values drop sharply as they have in recent months, this tight limit around market value creates considerable funding challenges for pension plan sponsors." Finally, the Pension Protection Act of 2006 accelerates replenishment of "underfunded" plans, putting pressure on employers to pony up cash at the same time that they are unlikely to be flush.

While this blogger fully empathizes with the economic pain that can occur when "artificial" reports force real change (i.e. rating downgrade, higher cost of capital, cash squeeze, share price hits, etc), I think Joe and Sally Retiree are still left in the dark as to the financial soundness of their retirement plan. This knowledge gap about which numbers are the right numbers is something we've addressed here before. (See "Will the Real Pension Deficit Please Stand Up?" June 22, 2006.) Global accounting imperatives, national laws and regulatory urgencies add to the confusion about pension metrics - which ones deserve attention and which ones are outright "bad" representations of a plan's ability to send checks every month, made more so when they result in expensive consequences.

This entire debate reminds me of a great line in the 2008 HBO movie entitled "Recount." In this small screen version of uncertainty related to the 2000 U.S. presidential election (remember hanging chads?), the Kevin Spacey character turns to his colleague at one point and says, with great frustration, how he wishes he just knew who won.

In the same vein, one asks - "What is the truth?" Understandably, plan sponsors are upset at having to outlay cash contributions "forced" by the Pension Protection Act of 2006, FAS 158 and/or other "cannot ignore" dictates but should they not counter with a robust solution that gets to economic reality? Should retirees be worried that all or some published numbers lead astray or assume instead that pension decision-makers have it under control?

According to best-selling business author and leadership guru, Warren Bennis, "We have more information now than we can use, and less knowledge and understanding than we need. Indeed, we seem to collect information because we have the ability to do so, but we are so busy collecting it that we haven't devised a means of using it. The true measure of any society is not what it knows but what it does with what it knows."

I raise my hand for reporting rules that (a) reflect the sponsor's true ability to pay, now and later on (b) avoid confusion (i.e. too many regulations can result in conflicting data points or real questions about how to comply with statutory reporting standards) (c) explain the process by which the plan manages its alphabet soup of pension risks and (d) help shareholders, taxpayers, plan participants and other interested parties assess whether a defined benefit plan is "excessively risky."

Is this too much to ask?

Disappearing 401(k) Match - What's Next to Go?

PG-Info@pensiongovernance.com (Susan Mangiero) — Wed, 12 Nov 2008 00:38:26 -0500

According to "Some Firms Suspend Their 401(k) Match" by Wall Street Journal reporter Jilian Mincer (November 12, 2008), cash-strapped employers are moving quickly to decrease 401(k) plan benefits, shut down 401(k) plans or not create pension incentives in the first place. Ironically, several studies suggest that small companies are in a better position to attract and retain employees if they offer benefits, notably healthcare expenses.

As we tally the cost of the credit crisis, count 401(k) plans as part of the fallout. Healthcare benefits are on the chopping block too. On November 9, 2008, New York Times reporter Nick Bunkley wrote that General Motors is getting rid of lifetime health care coverage for those who had long ago assumed they were all set. In its place, the large auto manufacturer is said to be beefing up pension payments to help offset disappearing medical care goodies. (See "Some G.M. Retirees Are in a Health Care Squeeze.")

If the defined benefit plan is going the way of the dodo bird and now 401(k) plans and health care benefits are leaving town, what's left for the beleaguered employee? Is it possible that benefits will soon become passe? Will individuals be able to cope by quickly saving more, reducing their own costs or both? If not, how is public policy likely to be impacted by a growing class of persons who no longer think of retirement as the "golden years?"

Walking the Public Pension Plan Tightrope

PG-Info@pensiongovernance.com (Susan Mangiero) — Sun, 09 Nov 2008 00:26:18 -0500

According to "States try to stem losses in public pension funds" (November 6, 2008), USA Today reporter Kathy Chu describes the precarious situation now faced by more than a few public pension systems. In order to stem the tide of mounting losses, due in part to market turbulence of late, states are "raising the amount that employers and employees contribute to traditional pensions" while others are freezing benefits or shrinking cost-of-living adjustments.

In addition, there is a certain "catch 22" reality that may render it difficult to solve structural financial problems any time soon. Plan participants suffer when a state or municipality's financial health takes a turn for the worse. On the other hand, funding problems with state/city/county pension plans can cause trouble for the public sponsor, resulting in a ratings downgrade and/or higher cost of capital and/or difficulty in raising external money. This is turn could compound problems with a public entity's ability to write checks to retirees. Chu lists economic changes being made by Wisconsin, Arizona, California, Baltimore and Iowa, respectively.

Having just gone through a U.S. presidential election with numerous discussions about red and blue states, maybe we should instead describe states, cities and counties as "in the red" or "more in the red." It is a sobering thought, isn't it?

Pension Litigation Soars

PG-Info@pensiongovernance.com (Susan Mangiero) — Tue, 04 Nov 2008 10:45:50 -0500

I am speaking at the first annual "National ERISA Fiduciary Execusummit" with a particular focus on litigation. As I've been doing a lot lately, I am addressing the wide array of litigation and regulatory enforcement pain points (too many to list here). My goal is to encourage anyone who will listen that good process can go a long way to defending otherwise expensive and time-consuming actions.

Click to access the National ERISA Fiduciary Execusummit program.

Pension Tension Blues - In Case You Missed It

PG-Info@pensiongovernance.com (Susan Mangiero) — Tue, 28 Oct 2008 01:59:34 -0500

Launched earlier this year, our music video message about pension issues has been viewed by many. Given the rout in the market and recent comments made by House Education and Labor Committee Chairman George Miller ("Miller Declares 401(k) System Paralyzed," Defined Contribution & Savings Plan Alert, October 27, 2008), I'm republishing "Pension Tension Blues." My co-creator Steve Zelin (The Singing CPA) and I hope you enjoy it.

Pension Magic

PG-Info@pensiongovernance.com (Susan Mangiero) — Mon, 27 Oct 2008 22:54:58 -0500

I had the pleasure of speaking on October 23, 2008 in Stamford, CT about "New Directions for the Financial Services Industry." Part of the "Securities Forum 2008: Weathering the Economic Storm," sponsored by the State of Connecticut Department of Banking, panelists addressed the litany of current financial problems, proposed reforms and the likely future for investors and service providers alike.

I was asked to address FAS 157 and international equivalents. In doing so, I urged audience members to make a clear distinction between accounting representation and economic reality or accept the consequences. Unless one truly understands what reported numbers say (or just as importantly don't convey), poor decisions made on the basis of incomplete or even illusory information can lead to costly outcomes (GIGO = Garbage In, Garbage Out).

I've long maintained that disclosure about process is arguably more important than single numbers, derived at a particular point in time. For example, if I'm a pension fund decision-maker who has allocated monies to a manager that in turn invests in "hard-to-value" assets, which information is more helpful to me in understanding my risk exposure to that asset manager - (1) a FAS 157 disclosure that describes possible changes that could affect results or (2) identified likely risk drivers and the controls that have been established to mitigate risk accordingly?

Said another way, am I properly discharging my fiduciary duties by evaluating risk ex poste or instead assessing uncertainty ex ante? I think the answer is obvious, isn't it? After all, no one can respond to "what was" but can certainly act in anticipation of "what might be." By the way, I do believe there is merit in regularly conducting a post-audit of what went wrong and trying to learn lessons as a result.

According to FORTUNE Magazine senior editor Allan Sloan, critics of FAS 157 allege real harm is being done when illiquid securities are marked-to-model at "artificially low market prices." Call me clueless but finger-pointing seems to answer the wrong question. Instead of focusing on FAS 157 as the culprit because it supposedly forces reporting entities to document "bad" economic numbers, why not create a standard that instills confidence in financial statement users? Sloan writes "It's easier to blame accountants for your problems than to admit you made your institution vulnerable by overleveraging its balance sheet and buying securities you didn't understand." Click to read "Playing the blame game: Will 'mark to market' accounting take the fall for the Wall Street mess?" (October 27, 2008).

Just like the magic impossibility of growing a silver dollar into four years of college tuition, accounting representation should be more than smoke and mirrors.

Pensions and Politics: Argentina Seeks to Nationalize Private Pensions

PG-Info@pensiongovernance.com (Susan Mangiero) — Wed, 22 Oct 2008 02:00:52 -0500

According to Wall Street Journal reporter Matt Moffett, Argentina's leader would like to nationalize the private pension system, allowing this South American country to "raid new pension contributions to cover short-term debts due in coming years." The picture appears bleak indeed. Trounced by lower commodity prices and rising IOUs, the $30 billion plan looks like a juicy target. (See "Argentina MakesGrab for Pensions Amid Crisis," October 22, 2008).

In "Argentina stocks, bonds plunge on pension reform plans" (October 21, 2008), Reuters reports that investors look unfavorably upon a takeover of the private retirement system. In "Argentina Pension Funds Attack Government Plan, Defend Result" by reporter Michael Casey (Dow Jones Newswires, October 21, 2008), a coalition of Argentinian private pension plans decry the need for a takeover. Asserting the need to review long-term performance, private pension leaders say "the reform project was founded on results incurred during the current financial market crisis."

This reminds one of the optical illusion that asks the viewer to recognize both a beautiful woman and an "old hag." Some see Argentina's pension reform as good news and others question the real motivation behind such a proposal.

Is this likely to become a trend around the world? We never thought global megabanks would be nationalized and now they are.

Successful Hedge Fund Manager Bids Adieu, Insults and All

PG-Info@pensiongovernance.com (Susan Mangiero) — Wed, 22 Oct 2008 01:34:45 -0500

In a somewhat scathing goodbye letter to his investors, hedge fund manager Andrew Lahde lambastes his investors. Calling them "low hanging fruit" and worse, click here to read for yourself.

My rationale for posting the letter is not to sensationalize but rather point out that people seem to be getting more vocal about the economic and political state of affairs. I think this angst is going to have a dramatic impact on the legislative landscape. Recently asked whether I think more regulation is on its way, I answered "without doubt."

Plan sponsors are likely to see a lot more politicians passing the retirement benefit plan "hot potato. The calculus is simple.

More pension plan woes + Social Security gaps (or international equivalents)
Blame game begins
Hold plan sponsors responsible for helping retirees make up for losses.

In response, plan sponsors that take pension governance seriously (and are demonstrated fiduciary leaders) are likely to have more influence on the outcome.

Reader's Comment: How Can We Possibly Save?

PG-Info@pensiongovernance.com (Susan Mangiero) — Wed, 22 Oct 2008 01:26:07 -0500

In response to the October 20, 2008 post entitled "Happy National Save for Retirement Week," one reader captures the sentiment of many. Do you agree? Email your thoughts.

"Let me get this straight. Congress, after voting to give bailouts to all the movers and shakers, now has the audacity to pass a meaningless Resolution admonishing We the Sheeple to SAVE for retirement?

With joblessness and debt encumbrances at an all time high, just how do these brain trusts up there on the Hill think there is going to be a lot of "saving" going on? Incredible!!!!"

Editor's Note: The House and Senate resolutions to formalize this holiday are dated late June 2008.

LIBOR Manipulation - Comments from the Author

PG-Info@pensiongovernance.com (Susan Mangiero) — Mon, 20 Oct 2008 22:26:58 -0500

Given its global prevalence as a performance benchmark, the ongoing scrutiny about the economic accuracy of the London Interbank Offered Rate ("LIBOR"), is not surprising. In the text that follows, one of the authors of a recent paper about LIBOR rate-setting adds a few comments.

"Thank you, Susan, for your October 15, 2008 coverage of our "Libor Manipulation?" research manuscript. As always, you succeeded in 'cutting to the heart' of a rather complex topic in your customarily succinct, yet engaging style. When your readers download and peruse our work, I would encourage them to focus on the manner in which we extend and elaborate on the analysis done by the Wall Street Journal. For instance, we were able to detect two specific dates in time that reflect structural 'breaks' in data patterns. One occurred shortly after (and doubtlessly occurred in response to) the publication of the Journal's announcement of its investigation. However, the other event occurred over eight months before the appearance of this announcement, and appeared to coincide with the publication of three relevant external news events that affected the industry. Your readers will find more information in our manuscript. We welcome readers' comments."

Submitted by Professor Michael Kraten, PhD, CPA, Sawyer Business School, Suffolk University

Happy National Save for Retirement Week

PG-Info@pensiongovernance.com (Susan Mangiero) — Mon, 20 Oct 2008 00:46:22 -0500

Given the market rout of late, with 401(k) plans taking more than a tumble, this week's celebration of thrift is especially relevant. Supported with a U.S. House and Senate resolution to encourage financial independence, October 19 through 25 mark the "National Save for Retirement Week."

Expect to read and hear more about the dwindling retirement money pot for millions of individuals. The socioeconomic, political and regulatory ramifications are significant.

PensionRiskMatters Cited as "Favorite Blog" by AllAboutAlpha.com

PG-Info@pensiongovernance.com (Susan Mangiero) — Wed, 15 Oct 2008 02:05:26 -0500

Imagine my surprise and delight when told that PensionRiskMatters.com is part of the "Our Favorite Blogs" collection for a major hedge fund site, AllAboutAlpha.com. Veteran financial guru, founder and editor Chris Holt has done a great job with his site.

Thanks Chris. We are honored.

Laboring Over LIBOR

PG-Info@pensiongovernance.com (Susan Mangiero) — Wed, 15 Oct 2008 01:08:08 -0500

Long accepted as a key rate benchmark, the London Interbank Offer Rate ("LIBOR") may be replaced by something else if a current deal is a trendsetter. According to Bloomberg reporter Cecile Gutscher, Electricite de France SA will repay interest on an 11 billion pound sterling loan - used to finance the acquisition of British Energy Group Plc - by first computing "an average of funding rates supplied by BNP Paribas SA, Deutsche Bank AG, Royal Bank of Scotland Group Pld, Banco Santander SA and Societe Generale SA." (See "EDF to Use Alternative to Libor on 11 Billion-Pound Buyout Loan," October 14, 2008)

This rate at which banks lend to each other in the global capital markets has had its ups and downs lately. Volatility, due in large part to the credit crisis and the resulting financial services industry fallout, has taken its toll. Borrowers, hedge fund investors and fixed-LIBOR interest rate swap counterparties represent just a few of the many organizations that are impacted by gyrating LIBOR rates.

According to a new research study, directional moves may not be the only concern about LIBOR. Authors Rosa Abrantes-Metz, Michael Kraten, Albert Metz and Gim Seow examine LIBOR rates relative to other short-term borrowing costs, along with an assessment of the "individual bank quotes that were submitted to the British Bankers Association." Seeking to dispel or validate the notion that LIBOR levels are artificially low (alleging that quoting banks do not want to be seen as needing money and therefore cite low rates), the authors conclude that manipulation is unlikely, noting some irregularities in the data. For more information, click to read "Abrantes-Metz, Rosa M., Kraten, Michael, Metz, Albert D. and Seow, "Gim, "LIBOR Manipulation?" (August 4, 2008).

This pension blog includes several posts about LIBOR and its varied applications: (a) derivative instrument trades such as swaps-linked LDI strategies (b) asset management performance analyses and (c) borrowing arrangements. See "Are Pension Investments Too Complicated?" (September 5, 2008) or "Lowballing LIBOR May Cost Pensions Plenty" (April 18, 2008).

New Study Addresses Pension Risk Management Gaps

PG-Info@pensiongovernance.com (Susan Mangiero) — Mon, 13 Oct 2008 00:20:48 -0500

At a time of great market turmoil, plan participants, shareholders and taxpayers want to know whether their retirement plans are in good hands. Risk is truly a four-letter word unless plan sponsors can demonstrate that a comprehensive pension risk management program is in place. Unfortunately, there is little information that details if, and to what extent, plan sponsors are doing a credible and pro-active job of identifying, measuring and mitigating a variety of risks. The risk alphabet includes, but is not limited to, asset, operational, fiduciary, legal, accounting, longevity and service provider uncertainties.

While no one could have predicted the extreme volatility that characterizes the current state of global capital markets, it has always been known that poor risk management can make the difference between economic survival and failure. Applied to pension schemes, ineffective risk management could prevent individuals from retiring at a certain age and/or leaving the work force with much less than anticipated. Others pay the price too. Taxpayers worry about rate hikes that may be inevitable for grossly underfunded public plans. Shareholders could find themselves on the hook for corporate promises or experience depressed stock prices due to post-employment benefit obligations.

In an attempt to shed some light on this critical topic area, Pension Governance, LLC is pleased to make available a new research report that explores current pension risk management practices. In what is believed to be a unique large-scale assessment of pension risk practices since the publication of a 1998 study by Levich et al, this survey of 162 U.S. and Canadian plan sponsors seeks to: (1) understand why and how pension plans employ derivative instruments, if they are used at all (2) identify what plan sponsors are doing to address investment risk in the context of fiduciary responsibilities and (3) assess if and how plan sponsors vet the way in which their external money managers handle investment risk, including the valuation of instruments which do not trade in a ready market. The report was written by Dr. Susan Mangiero, AIFA, AVA, CFA, FRM, with funding from the Society of Actuaries.

Each survey-taker was asked to self-identify as a USER if he/she works for a plan that trades derivatives in its own name. A NON-USER works for a plan that does not trade derivatives directly but may nevertheless be exposed indirectly if any of the plan's asset managers trade derivatives.

In answering broad questions, a large number of surveyed plan sponsors describe themselves as doing all the right things to manage investment, fiduciary and liability risks. However, answers to subsequent questions - those that query further about risk procedures and policies at a detailed level - do not support the notion that pension risk management is being addressed on a comprehensive basis by all plans represented in the survey sample.

Key findings include the following points:

Plan size seems to be one factor that distinguishes USERS from NON-USERS, with 39% of USERS managing plans in excess of $5 billion versus 14% of NON-USERS associated with plans larger than $5 billion.
Pension decision-making appears to vary considerably by job function, with 48% (37%) of USERS (NON-USERS) choosing "Other" rather than selecting from given titles such as Actuary, Benefits Committee Member, CFO or Human Resources Officer.
Time allocation varies considerably with 64% (40%) of USERS (NON-USERS) saying they devote 75 to 100 percent of their work week on pension issues. In contrast, 37% of NON-USERS say they spend 0 to 24% of their work week on pension issues.
A majority of USERS (64%) and NON-USERS (48%) have had discussions about the concept of a fiduciary duty to hedge asset-related risks. A smaller number say they have discussed the concept of a fiduciary duty to hedge liability-related risks.
Few plans currently embrace an enterprise risk management approach with 59% (57%) of USERS (NON-USERS) responding that their organization does not use a risk budget. When asked if their organization has or is planning to hire a Chief Risk Officer, 57% (64%) of USERS (NON-USERS) answered "No."
NON-USERS cite numerous reasons for not using derivatives directly, including, but not limited to, "Lack of Fiduciary Understanding" (25%), "Perception of Excess Risk" (31%), "Considered Too Complex" (23%), "Prohibition Against Possible Leverage" (19%) and/or "Defined Benefit Plan Risk Not Considered Significant" (28%).
A query about whether survey-takers review external money managers' risk management policies results in 70% (58%) of USERS (NON-USERS) responding "Yes." Fifty-two percent (57%) of USERS (NON-USERS) say they review external money managers' valuation policies. This survey did not drill down with respect to the rigor of questions being asked.
Survey respondents seem to rely mainly on elementary tools to measure risk. Eighty-three percent (64%) of USERS (NON-USERS) rank Standard Deviation first in importance. Seventy-nine percent (63%) of USERS (NON-USERS) rank Correlation second. Only one-third (38%) of NON-USERS cite Stress Testing (Simulation). Four out of 10 USERS cite Value at Risk in contrast to 23% of NON-USERS who do the same.
Survey respondents worry about the future with 58% (60%) of USERS (NON-USERS) ranking "Accounting Impact" as a concern. Other concerns were also noted to include "Regulation," "Longevity of Plan Participants" and "Fiduciary Pressure."

Click to download the 69-page study, entitled "Pension Risk Management: Derivatives, Fiduciary Duty and Process" by Susan Mangiero. Given the large file size, readers are encouraged to (a) first save the file (right mouse click) and then (b) open the file from wherever you have saved the file. Otherwise, you may receive an error message, depending on your computer configuration.

The study is also available by visiting www.pensiongovernance.com. Send an email to PG-Info@pensiongovernance.com if you experience any difficulty in downloading the pdf file and/or want to comment about the study.

Pensions to Hedge Funds: Lock Me Up

PG-Info@pensiongovernance.com (Susan Mangiero) — Sun, 12 Oct 2008 02:56:30 -0500

As markets tumble, hedge fund investors are asking for longer lock-up provisions in order to preserve their investment.

Say what?

The reasoning goes like this. If an investor can redeem, and does in fact ask to redeem, a hedge fund manager may be forced to sell assets to raise cash. More liquid assets are sold first, leaving behind less liquid assets that are arguably harder to value. Pre-mature sales, due to accelerated redemption requests, may even force a hedge fund to close and "give long-term investors their money back at a time when asset prices are low." By asking for longer lock-up periods, investors are seeking to forestall forced sales and thereby protect their original investment. See "Hedge investors ask for lock-ups to avoid closures" by Laurence Fletcher, Reuters UK, October 8, 2008.

We caught up with Mr. Edward Stavetski, Director of Investment Oversight, Wilmington Family Office, and asked him for his two cents. Here is what he has to say.

"This crush of cash outflows may be only one cause of fund closures at year end. Consider high water marks as we near the end of the calendar year. As news that some hedge funds are down 30 to 40 percent, it will become quite difficult for those fund managers to realize any earnings from their respective 20 percent performance clause. Most funds use management fees to keep the lights turned on but depend on the performance fee income to hire star traders or retain top talent. Without the near-term promise of a high performance payout, we could see a dramatic shift of key players in the hedge fund world. While people may rejoice that the 'nasty' hedge fund cult is finally getting its just desserts, the damage will reach far beyond the hedge fund community. The rush to buoy cash holdings will depress prices of stocks, bonds, mortgage-backed securities and other capital-raising mechanisms in the near-term. None of this is good news for investors, asset managers and/or consumers."

This blogger wonders if smart money will head towards or away from hedge funds. After all, if pensions and 401(k) plans are dumping stocks in record numbers, and U.S. treasuries (and international equivalents) return little, how else will plan sponsors and individuals "make up for losses?"

We'll watch and see.

New Study Suggests That Few Are Ready to Retire

PG-Info@pensiongovernance.com (Susan Mangiero) — Sun, 12 Oct 2008 02:44:02 -0500

According to a new study, retiring at age 67 may not be in the cards for many individuals, partly by choice. Tracking desires and expectations of American workers, a newly created Sun Life Financial Unretirement^SM Index suggests that 8 out of 10 persons want to continue working as a way to "stay mentally engaged." Other results are not surprising. Fewer than half of the respondents feel they can afford to stop working. One-third of survey-takers worry about the financial viability of Social Security. One coping mechanism, cited by 82 percent of the sample group, is to reduce their spending with about two-thirds of respondents saying they will lower their debt as a way to "improve retirement prospects" For more information about this attitudinal metric, click here.

Nice as it is to have choices about when to retire, the recent market rout makes it difficult at best for some to consider anything else but continued employment (assuming no layoffs by their employer). Yahoo! News references Congressional research that "Americans' retirement plans have lost as much as $2 trillion in the past 15 months." Making matters worse, economic conditions that result in lower wages make it difficult for some to keep saving for retirement, if they did so in the first place. Click to read "Retirement accounts have lost $2 trillion" by Julie Hirschfeld Davis, October 7, 2008.

In an interview with PBS, Peter Orszag, Director of the Congressional Budget Office, explains that "two-thirds of the assets that are in 401(k) plans are in stocks," exposing plan participants to fallout, just like institutional investors. He adds that economic problems are already impacting defined benefit plans. As the value of their asset portfolio drops, companies will need to "put in more money, and that will come out of either their shareholders, their workers, or they'll try to pass it along to their consumers." Click to read "Market Turmoil Puts Squeeze on Retirement Savings," October 9, 2008.

This blog has covered changing demographics and retirement angst for months. One can only hope that the current market malaise is short-lived and that individual savings goes up (or at least excess leverage goes down), to the extent that individuals can afford to put monies aside for post-employment consumption.

Debt Clock Runs Out of Numbers

PG-Info@pensiongovernance.com (Susan Mangiero) — Fri, 10 Oct 2008 00:18:28 -0500

According to the Telegraph.co.uk website, the U.S. National Debt Clock has too few digits to measure the current state of affairs. The clock's owner, the Durst Organization, is expected to add a pair of additional placeholders next year, making "it capable of recording a quadrillion dollars of debt." (See "Financial crisis: US debt clock runs out of numbers," October 9, 2008.)

I had to look it up but it turns out that a quadrillion is a thousand trillion or a million million million million (with "quad" referring to four). To put things in context, consider the following statistics:

The world population is currently estimated at 6.729 billion individuals.
The U.S. population is roughly 305 million persons.
As of fall 2007, Apple had sold more than 150 million iPods in countries around the world.
The CIA Factbook approximates a Gross World Product as equal to $65.61 trillion (as of 2007).
Up to Q4-2007, the over-the-counter derivatives market, measured in notional principal terms and reported by the Bank for International Settlements, totaled nearly $600 trillion.
As of June 2008 and reported by the Bank for International Settlements, outstanding futures contracts, in notional principal terms, exceeded $28.6 trillion. The size of the listed options market toppled $55.6 trillion.
The largest corporate bankruptcy to date, as reported by InfoPlease.com, is Lehman Brothers Holdings, Inc. with a bankruptcy date of 9/15/08 and total assets, pre-bankruptcy, equal to $691.063 billion.

As U.S. Senator Everett Dirksen is credited as saying, "A billion here, a billion there, pretty soon it adds up to real money." Imagine his posture today. (According to The Dirksen Center website, it is unclear as to whether the former lawmaker did in fact utter these exact words.)