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California Attorney: Bankruptcy “Not a Practical or Desirable” Way To Cut Pensions

Teague Paterson, an attorney from Sacramento specializing in labor law, has penned a column in Monday’s Sacramento Bee in which he explains his position that bankruptcy is “not a practical or desirable” way to cut pension benefits.

From the column:

Imagine for a moment that you have run into deep financial trouble and have decided to file for bankruptcy protection. Your credit rating plummets, your home is sold at a fire sale, and you can’t rent an apartment or buy a car. You spend long hours at the negotiating table as creditors pick over the remains of your finances. Ultimately, you place your future in the hands of a total stranger, the bankruptcy judge.

Isn’t that a scenario that you would try to avoid at all costs?

If the consequences for an individual facing bankruptcy are devastating, the consequences for a municipality are 10 times as dangerous. Bankrupt cities face soaring crime rates, shrinking property sales, and the reduction or elimination of basic public services. It’s is not a decision that an elected official or city manager would willingly make unless there were no other options, as the decision by a bankruptcy judge presiding over Stockton’s bankruptcy makes clear.

Judge Christopher Klein’s ruling Thursday to approve Stockton’s bankruptcy plan confirms that the situation in Stockton will have little impact over the larger national debate on public pensions. Municipalities will not be filing for bankruptcy in waves in efforts to jettison pension debt.

For the very few severely distressed cities that may consider bankruptcy, the question will not be whether they can reduce pensions, but whether they should. In Stockton, the answer to that question was clear to all with a stake in Stockton’s future – and after two years of litigation that cost tens of millions of taxpayer dollars, the bankruptcy judge agreed.

Another key excerpt from the column:

Despite the media attention to cities such as Stockton and Detroit, municipal bankruptcy is exceedingly rare. According to one analysis, 13 local governments had bankruptcy filings since 2008. Five of those have been dismissed. To put it in context, there are more than 39,000 local governments in the U.S.

Although the bankruptcy process threatened to rob Stockton of its ability to make the best decisions for its residents, ultimately the judge accepted the city’s decision. In Stockton, the practicalities of running a city with an eye toward a brighter future shaped this outcome. Judge Klein acknowledged the serious and considerable pre-bankruptcy concessions accepted by Stockton’s employees, and the virtual guarantee that employees would leave to work elsewhere if Stockton reduced their compensation any further.

Stockton faced a unique set of circumstances brought on by revenue losses and a crippling national recession. Thankfully, it’s a situation that the overwhelming majority of municipalities will never have to face. As much as pension opponents would like to focus their analyses of Stockton as a blow to pension security, bankruptcy is simply not a practical or desirable option for cities dealing with pension obligations.

Read the whole piece here.

Photo by TaxRebate.org.uk

New York Pensions Paid More Fees To Wall Street In 2013-14, But Fee Growth Is Slowing

New York City released its annual financial report Friday, which gave observers a peek into a part of pension finances under growing scrutiny: investment fees paid by the city’s 5 major pension funds.

The fees paid by the city’s pension funds have grown since last year. But the rate at which they’re growing has slowed significantly.

From Bloomberg:

New York’s five pension funds paid Wall Street investment managers $530.2 million in the most recent fiscal year, an 8.5 percent increase, according to the city’s annual financial report released today.

The rate of growth in the year through June slowed compared with the previous period, when expenses paid to the city’s almost 250 managers rose 28 percent.

New York City Comptroller Scott Stringer, who serves as chief investment adviser to the pensions, has vowed to reduce fees and increase internal management. Fees erode returns crucial to funding benefits for New York’s more than 237,000 retirees and future payments to 344,000 employees.

Pension assets for police officers, firefighters, teachers, school administrators and civilian employees rose about 17 percent to $160.6 billion in the 12 months ended June 30, according to the report.

Eric Sumberg, a spokesman for Stringer, didn’t immediately respond to a request for comment.

The five pension funds included in the report are: the New York City Employees’ Retirement System (NYCERS), Teachers’ Retirement System of The City of New York (TRS), New York City Police Pension Fund, New York City Fire Pension Fund, and the New York City Board of Education Retirement System (BERS).

Collectively, the funds allocate 6 percent of assets to private equity, 2 percent to hedge funds, 29 percent to fixed income and 58 percent to equities.

$200 Million To Asia Private Equity Among Series of Moves By Illinois Teachers’ Fund

The Illinois Teachers’ Retirement System (TRS) made a series of moves at Thursday’s board meeting that included making $300 million in commitments to two private equity funds and approving the hire of a firm to manage domestic stocks.

The system made several new commitments, including $300 million to two private equity funds, one focusing on Asia and the other on technology. From Pensions & Investments:

Siris Capital Group […] graduated from the emerging managers program with a commitment of $100 million to its technology-focused private equity fund, Siris Partners III. TRS invested $12.5 million in Siris Partners II.

TRS committed up to $200 million to a customized Asia-focused private equity strategy managed in a strategic partnership by Asia Alternatives Management. The allocation will be split evenly between a diversified fund of funds and a co-investment fund. The goal is to eventually move some of the Asian private equity managers from the fund of funds into TRS’ direct investment portfolio, Stefan Backhus, private equity investment officer, told trustees.

Taurus Funds Management, a new manager for the TRS, right, received a $30 million commitment to its Taurus Mining Finance Fund.

Active large-cap value equity managers Affinity Investment Advisors and Lombardia Capital Partners each received $25 million commitments from the emerging managers program for domestic and international portfolios, respectively.

Trustees ratified staff-initiated co-investments of $18.5 million and $20 million to existing managers Carlyle Group and Natural Gas Partners, respectively.

Funding for the Siris, Asia Alternatives, Taurus, Affinity, Lombardia, Carlyle Group and Natural Gas Partners hires will come from cash, index funds and rebalancing.

TRS also hired a new firm to manage domestic equities, promoted one other firm and fired another. From P&I:

Trustees of the $43.5 billion pension fund ratified the hire of LSV Asset Management by investment staff in August to manage $360 million in active domestic large-cap value stocks. LSV, which already managed $1.3 billion for TRS in two other equity strategies, replaced Loomis Sayles & Co., which was terminated in August.

Active bond manager Garcia Hamilton & Associates, was promoted from the pension fund’s $732 million emerging managers program to manage a 4% allocation from the fund’s $7.7 billion fixed-income portfolio. The $61 million Garcia Hamilton previously managed will be returned to the emerging managers program. Funding for the new account will come from reducing Prudential Asset Management’s core-plus bond portfolio and rebalancing among other fixed-income managers.

[…]

In further changes to the fixed-income portfolio, Hartford Investment Management was terminated as manager of a $350 million U.S. Treasury inflation-protected securities portfolio. Investment staff “believes the net-of-fees results from these mandates can be improved through two mandates. Further, staff prefers to utilize global inflation-linked mandates, while Hartford’s portfolio is U.S. only,” said R. Stanley Rupnik, chief investment officer, in an answer to a request for clarification.

The Illinois Teachers’ Retirement System manages $43.5 billion in assets.

Arizona’s Gubernatorial Candidates Both Vow To Address Pension Woes, But Specifics Hard To Come By

Both of Arizona’s gubernatorial candidates (Republican Doug Ducey and Democrat Fred DuVal) have said they will try to find a solution to the funding problems plaguing the Arizona Public Safety Personnel Retirement System (PSPRS). The system is only 49 percent funded.

But neither candidate offered much in the way of specifics during interviews with the Arizona Republic’s editorial board. From the Arizona Republic:

Neither Republican Doug Ducey nor Democrat Fred DuVal, during interviews with The Arizona Republic, offered specific plans to fix the troubled Public Safety Personnel Retirement System.

Both said they would try to develop a consensus among employees, employers and lawmakers to find a solution for the $7.78 billion unfunded liability that has put a crimp on local communities’ ability to hire police officers and firefighters.

DuVal and Ducey say working with all groups involved in the pension systems is the only way to avoid litigation, which thwarted pension reforms the 2011 Legislature enacted.

[…]

DuVal said PSPRS is financially unsustainable, but court rulings have made it clear that state constitutional changes, which would require voter approval, may be needed for reform.

“We want to approach this in a way that has long-term solutions,” DuVal said. “We need to make sure everyone is involved. We are looking at broad participation to avoid litigation.”

Ducey said basically the same thing.

“The biggest concern is to look at the unfunded liabilities,” Ducey said. “There are a number of reforms, and lot of different options. I want to talk to leaders of all the organizations.”

He also said he would embrace recommendations by a pension-reform task force he led as state treasurer, including limiting retirement benefits to base-salary compensation. That proposal would prevent using lump-sum payouts of vacation and sick time and prevent the artificial inflation, or “spiking,” of pensions.

The Arizona PSPRS saw its funding ratio drop dramatically over the course of fiscal year 2013-14 – from 58.7 percent to 49.2 percent. It isn’t the only Arizona retirement system in trouble. From the Arizona Republic:

The funding ratio for the Corrections Officer Retirement Plan dropped from 69.7 percent to 57.3 percent, and there are $1.1 billion in unfunded liabilities. The average pension is $26,299.

The funding ratio for the Elected Officials’ Retirement Plan dropped from 56.5 percent to 39.4 percent and there is a $482 million unfunded liability. The average pension is $50,338.

[…]

The plan for elected officials, which includes judges, is in the worst shape. It has less than 40 percent of the money it needs to pay for current and future pension obligations. The fund may run out of money in 20 years if no significant changes are made. That plan is closed to newly elected politicians, and is expected to eventually cease, but additional public funds may be needed.

PSPRS is shouldering $7.78 billion of unfunded liabilities. Since 2010, it has reduced its assumed rate of return from 8.5 percent to 7.8 percent.

Video: Implications of Japan Pension Fund’s Portfolio Shift

The video [above] discusses the decision by Japan’s Government Pension Investment Fund (GPIF) to double its allocation to equities and slash its bond holding, a move that coincides with the Bank of Japan boosting stimulus.

The video description reads:

John Herrmann, rates strategist at Mitsubishi UFJ, and Gary Langer, founder and president at Langer Research Associates, discuss the potential impact of the Bank of Japan boosting stimulus while pension funds move to equities from bonds and how the stock market figures into people’s every day economic lives. They speak on “Bloomberg Surveillance.”

Kolivakis On Canada Pension’s Big Brazil Bet

On Tuesday the Canada Pension Plan Investment Board (CPPIB), the entity that manages investments for the Canada Pension Plan, unveiled plans to invest $396 million in commercial real estate in Brazil.

The CPPIB now has nearly $2 billion committed to real estate investments in Brazil.

Leo Kolivakis, who runs the Pension Pulse blog, weighed in on CPPIB’s Brazil bet in a post this week:

Let me share my thoughts on this Brazilian real estate deal. From a timing perspective, this deal couldn’t come at a worse time. Why? Because the Brazilian economy remains in recession and things can get a lot worse for Latin American countries which experienced a boom/ bust from the Fed’s policies and China’s over-investment cycle. This is why some are calling it Latin America’s ‘made in the USA’ 2014 recession, and if you think it’s over, think again. John Maudin’s latest, A Scary Story for Emerging Markets, discusses how the end of QE and the surge in the mighty greenback can lead to a sea change in the global economy and another emerging markets crisis.
Mac Margolis, a Bloomberg View contributor in Rio de Janeiro, also wrote an excellent comment this week on why the oil bust has Brazil in deep water, going over the problems at Petroleo Brasileiro (PBR).

The re-election of President Dilma Rousseff didn’t exactly send a vote of confidence to markets as she now faces the challenge of delivering on campaign promises to expand social benefits for the poor while balancing a strained federal budget. President Rousseff says the Brazilian economy will recover and the country will avoid a credit downgrade but that remains to be seen.
Having said all this, CPPIB is looking at Brazil as a very long-term play, so they don’t care if things get worse in the short-run. In fact, the Fund will likely look to expand and buy more private assets in Brazil if things do get worse. And they aren’t the only Canadian pension fund with large investments in Brazil. The Caisse also bought the Brazilian boom and so have others, including Ontario Teachers which bet big on Eike Batista and got out before getting burned.

Are there risks to these private investments in Brazil? You bet. There is illiquidity risk, currency risk, political and regulatory risk but I trust CPPIB’s managers weighed all these risks and still decided to go ahead with big investment because they think over the long-run, they will make significant gains in these investments.

My biggest fear is how will emerging markets act as QE ends (for now) and I openly wonder if big investments in Brazil or other countries bound to oil and commodities are worth the risk now. Also, the correlation risk to Canadian markets is higher than we think. My only question to CPPIB’s top brass is why not just wait a little longer and pick these Brazilian assets up even cheaper?

But I already know what Mark Wiseman will tell me. CPPIB takes the long, long view and they are not looking at such deals for a quick buck. As far as “egos at CPPIB” that Mr. Doak mentions in the BNN interview, I can’t speak for everyone there, but I can tell you Mark Wiseman doesn’t have a huge ego. If you meet him, you’ll come away thinking he’s a very smart, humble and hard working guy who’s very careful about the deals he enters.

Canada Pension Plan Investment Board manages $226 billion in assets.

Read the entire Pension Pulse post here.

Japan Pension Unveils Portfolio Shifts, Takes On More Risk

Japan’s Government Pension Investment Fund has officially announced major changes to its portfolio. The pension fund had been reviewing its investments since the summer, but it wasn’t known when the process would end.

The shifts include doubling its equity allocations, cutting bonds by nearly 50 percent and a new target allocation for alternatives of 5 percent.

From Business Week:

Japan’s public retirement-savings manager will put half its holdings in local and foreign stocks and start investing in alternative assets as the world’s biggest pension fund seeks higher returns.

The 127.3 trillion yen ($1.1 trillion) Government Pension Investment Fund set allocation targets of 25 percent each for Japanese and overseas equities, up from 12 percent each, it said at a briefing today in Tokyo. GPIF will reduce domestic bonds to 35 percent of assets from 60 percent. The new figures don’t include an allocation to short-term assets, while the previous targets did. Analysts surveyed by Bloomberg this month had anticipated levels of 24 percent for local stocks, 15 percent for global shares and 40 percent for Japanese bonds, taking short-term holdings into account.

The new allocations were released hours after the Bank of Japan unexpectedly added to monetary easing, sending the Nikkei 225 Stock Average to a seven-year high. Reports that the fund’s announcement was coming today also buoyed shares. Investors have been awaiting the revised strategy since a government panel said last year GPIF was too reliant on domestic bonds, with the central bank stoking inflation and pension payouts mounting as the nation’s population ages.

GPIF increased its target for foreign bonds to 15 percent, up from 11 percent. The fund will put as much as 5 percent of holdings in alternative investments such as private equity, infrastructure and real estate, with those accounted for within the other asset classes rather than as a separate allocation.

The Government Pension Investment Fund is the largest public pension fund in the world. It manages $1.1 trillion in assets.

Photo by Ville Miettinen

Florida Fund Seeks Audit After Newspaper Reports On Officials Skirting DROP Payout Rules

Over the past few weeks, the Florida Times-Union has run a series of articles detailing how high-ranking public safety workers, and top pension officials, were able to rack up benefits by staying in the Jacksonville Police and Fire Pension Fund’s (JPFPF) DROP program for longer than rules allowed.

The articles have now gotten the attention of the JPFPF – the fund says it will hire an auditor to look into the allegations.

From the Florida Times-Union:

The head of Jacksonville Police and Fire Pension Fund said he will ask his board to hire an independent firm to review the fund’s practices and determine if the fund has been too lenient when it comes to senior members’ participation in the lucrative Deferred Retirement Option Program.

Pension executive director John Keane announced his decision in a four-page statement sent to City Council that takes issue with a Florida Times-Union investigation, “Too Much of a Good Thing.”

The Oct. 19 story exposed how, under strict interpretation of city code, at least three high-ranking police officers and firefighters with strong ties to Keane were able to skirt the rules and participate in the DROP program for too long, or even altogether, piling up excess pension benefits totaling $1.8 million.

The pension fund’s desire for an audit of its own comes as some city leaders are suggesting the fund be subjected to a forensic audit, which typically investigates whether there are grounds for criminal charges.

Details of the DROP program and the city code that employees may have breached:

The DROP allows police officers and firefighters to continue drawing a regular salary while at the same time having a pension placed into a special account for up to five years.

DROP calculations are based on math.

The number of years one works for either the police department of fire department determines the value of one’s first year of pension payments into DROP. Years of service also determine how long one may participate in DROP.

The code says once a member of the pension fund has worked 30 years, he or she is able to participate in the DROP for three years. Those falling into that category are entitled to 80 percent of the average salary they earned over the previous two years. Those with less than 30 years of service may participate for the full five years, but the percentage of their first year’s pension would be less. For instance, someone with 20 years would get a first-year pension that is 60 percent. That percent grows by two percentage points per work year. So someone with 29 years of service would get 78 percent.

The system is set up so one doesn’t get the best of both perks.

But some people did.

Bobby Deal, a retired police officer and long-time chairman of the pension fund’s board of trustees, and Richard Lundy, a retired firefighter and business partner of Keane and Deal, started their DROP participation after they hit the 30-year mark. And instead of participating for three years, they were allowed to remain in the DROP for the full five years.

Because the city does not currently require that a retiree cash out his or her DROP earnings upon retiring, the norm in states that offer DROP, including the Florida Retirement System, these DROP accounts are being re-invested in the pension fund and are guaranteed to grow 8.4 percent regardless of the true market value of the stock market.

Deal and Lundy now stand to make $1.3 million in questionable benefits on top of their regular pensions.

Read the previous Florida-Times Union investigations here.

Pension Funds Push Back Against Bank of America Governance Changes

Three of the country’s largest public pension funds are pushing back against Bank of America’s recent decision to appoint Brian Moynihan as CEO and chairman.

A shareholder resolution had previously mandated that the positions be separate.

Now, pension funds are telling Bank of America it has poked its “finger in the eye of investors.”

From the Wall Street Journal:

Three of the largest pension systems in the U.S. are pushing back on the bank’s move, announced earlier this month. The resistance from the California Public Employees’ Retirement System, the California State Teachers’ Retirement System and the adviser to New York City’s five pension funds may result in a variety of steps to try to improve governance, including a shareholder campaign to challenge the move in the spring, according to people familiar with the matter.

Bank of America set off these investors’ ire when its board changed the bank’s bylaws Oct. 1 to allow it to combine the chairman and CEO roles, then announced later that day that it had given the chairman’s job to Mr. Moynihan. The move essentially unraveled a binding 2009 shareholder resolution to separate the positions. A majority of shareholders, including the three pension systems, had voted for that change at the bank.

“They have flaunted the will of the shareholders,” said Anne Sheehan, corporate-governance director at the California State Teachers’ Retirement System, or Calstrs, the second-largest pension fund in the U.S. by assets. “It’s like the board poking their finger in the eye of investors,” said Michael Garland, director of corporate governance to New York City Comptroller Scott Stringer, who advises the five New York City pension funds.

Collectively, the three pension systems control 93 million Bank of America shares, or about 0.9% of shares outstanding, according to the most recent data available.

Bank of America’s board is within its rights to combine the positions, because the board of virtually any company incorporated in Delaware is allowed to alter corporate bylaws, even if it means undoing a previous shareholder change.

Warren Buffett, another large shareholder, said he supported the move. From the WSJ:

Some big shareholders supported the move, including Warren Buffett , whose Berkshire Hathaway Inc. made a $5 billion investment in the bank in 2011.

“I support the Board’s decision 100%,” Mr. Buffett said in an email Wednesday in response to questions from The Wall Street Journal. “ Brian Moynihan has done a superb job as CEO of Bank of America and he will make an excellent Chairman as well.”

A CalSTRS spokesman told the Wall Street Journal that it is talking with other shareholders about next steps. The pension funds could use their sway to vote out certain board members; they could also file another shareholder resolution, similar to the one in 2009, which would prohibit the CEO and chairman positions from being occupied by one person.

Principles For Better Pension Design

A long, insightful discussion and analysis of pension design was published in the Fall issue of the Rotman International Journal of Pension Management. During the course of the paper the three authors, Thomas van Galen, Theo Kocken, and Stefan Lundbergh, propose a set of principles to help navigate the dilemmas and trade-offs posed by both public and private pension systems.

The paper begins:

Designing a pension system is a complex business in which difficult tradeoffs must be made. On the one hand, we may want everyone to receive a retirement income that is linked to their own contribution; on the other, we want to protect people from poverty. How do we weight these two goals? The choice will depend on societal preferences and cultural values. We must also ask for whom we should design the pension system: what is ideal for a self-employed high-income earner may be far from adequate for someone living on a minimum wage, paying rent, and raising a family of five.

Addressing these dilemmas is a daunting task, especially with the recognition that pension systems all have their own historical background, and that each has evolved in its own particular context.

The authors propose a set of pension design principles, organized into three groups: behavioral principles, stability principles and risk-sharing principles.

The behavioral principles:

1. Keep it simple. Don’t make the pension solution any more complex than necessary. Complexity and lack of transparency make decision making more difficult, increasing the risk that people will make decision they will later regret. Simplicity, by contrast, helps manage people’s expectations and increases their trust, both vital qualities for a successful pension system.

2. Provide sensible choices. Employees should be given a standard package, on top of which a limited set of well- considered alternatives are offered, to protect them from making mistakes while allowing them individual freedom (Boon and Nijboer 2012). Creating a set of choices for a pension system is like drawing up a good restaurant menu: it offers people tools (the menu) for tailoring the solution (the meal) to their needs, but without expecting them to be financial experts (the chef) (Thaler and Benartzi 2004).

3. Under-promise, over-deliver. Research has shown that people experience twice as much pain from a loss as pleasure from a gain of equal size. Therefore, it is wise to avoid delivering outcomes below people’s expectations, which implies that a pension system should offer people a minimum level of pension income that, in practice, will likely be exceeded (Tversky and Kahneman 1992). Research shows that people value some kind of certainty very highly and are willing to pay substantial sums of money for it (Van Els et al. 2004), but too much certainty will make the pension design unaffordable.

The stability principles:

1. Ensure adaptability. Constantly changing external conditions require an adaptable pension system. Explicit individual ownership rights ensure flexibility, so that the system can adjust itself over time, and also make pensions more mobile to move to other systems.

2. Keep it objective. The health of a pension system should be measured based on objective market valuations. An objective diagnosis ensures that beneficiaries feel comfortable with how the pension fund deals with their property rights. If the valuations are calculated differently from market practice, participants may feel they are better off outside the system.

3. Prepare for extreme weather. The world is uncertain and unpredictable things happen; a pension system should be robust under extreme circumstances, built not on predictions but on consequences of possible outcomes. To assess the system’s robustness, draw up a set of “extreme weather” scenarios for risks outside and inside the pension system. The design of the pension system should target the ability to endure these extreme scenarios.

And the risk-sharing principles:

1. Avoid winner/loser outcomes. To avoid losing support, pension system design should prevent any one group of participants benefitting at the cost of another group. For example, if internal pricing in DB plans deviates from market pricing, it is likely to create winner/loser outcomes, eventually leading to pension system distrust.

2. Only diversifiable risks should be shared. A system founded on solidarity in bearing diversifiable risk creates value for all by reducing individual risk. For example, we have no idea how long we will live after we retire, but we can estimate the current average life expectancy of a homogenous group reasonably well, so it makes sense for individuals to pool their individual longevity risk with a large group.

3. Individuals must bear some risks. Risks that cannot be diversified or hedged in the market should be borne by the individual. Pooling non-diversifiable risks leads inevitably to transfers between groups in the collective pool and will eventually erode trust in the system. In reaching for higher long-term returns, younger people can absorb more market risk than older people; this calls not for risk sharing but for age differentiation in exposure to financial markets.

The authors go on to provide examples of these principles in action, using pension systems from the UK, Sweden and the Netherlands. The full seven page paper can be read here.

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