Author: Ted Ballantine

A hearing this week in Texas’ House Appropriations Committee shed some light onto the state’s pension funding situation – and the funding limitations that are baked into state law.

Keith Brainard of the National Association of State Retirement Administrators (NASRA) testified that the lower and upper bounds of Texas’ annual pension contributed are defined by law.

From the Houston Chronicle:

Texas — unlike Arizona, Louisiana, Maine and Montana – has set constitutional limits on how much the state will contribute to pension plans: no less than 6 percent and no more than 10 percent of the plan’s cost.

“Texas is the only state in which the constitution limits the state’s ability, the employer’s ability to adequately fund its pension plan,” Brainard said.

That point is critical because of the mounting obligations of the four current pension plans for state employees, of which only one is a pay-as-you-go plan. According to the Employee Retirement System, the debt obligation is $8 billion and growing.

Two rounds of benefit adjustments and an infusion of state cash last session under House Bill 9 have only slowed the growing obligation. Outgoing Appropriations Chair Rep. John Otto, R-Dayton, has pressed hard on the issue of a lump sum appropriation, or increased contribution, to defray the cost of current obligations: The Legislative Budget Board has said no while ERS has said yes.

What is not in doubt is the heavy blow long-term financing will be. Porter Wilson, the new executive director of ERS, noted the current trajectory of funding would pay off current obligations in 2048, at a cost of $29.1 billion. Pump in $1 billion and that obligation drops to $20.7 billion; $4 billion will be $11.7 billion; and an $8 billion infusion would cost $9.5 billion and actuarial soundness in 2018.

View the hearing presentations here.

CalPERS on Wednesday postponed a plan to study whether it should re-invest in tobacco-related assets after divesting from such assets 15 years ago.

On Thursday, the pension fund also approved a contribution rate increase for state government and school districts.

The Sacramento Bee reports on the postponement of the tobacco study:

The big California pension fund Wednesday unexpectedly postponed a plan, adopted two days earlier, to launch an extensive study of whether it should reinvest in tobacco company stocks. Instead, the CalPERS investment committee will discuss the issue again May 16, said CalPERS spokeswoman Rosanna Westmoreland.

On Monday, the investment committee voted to begin a 12- to 24-month study of the pluses and minuses of tobacco investments. The vote followed a consultant’s report saying the California Public Employees’ Retirement System had sacrificed $3 billion in profits by deciding in 2001 to dump its tobacco holdings.

The investment committee consists of every CalPERS board member. As a result, approval by the full board usually is a formality. But this time it wasn’t. The representative for State Treasurer John Chiang, who opposed Monday’s decision, asked investment committee chairman Henry Jones to hold off until next month. Jones, who is also vice president of the full board, agreed.

“No public pension fund should associate itself with an industry that is a magnet for costly litigation, reputational disdain and government regulators around the globe,” Chiang said later Wednesday in a prepared statement.

A different report from the Bee also outlines the rate increase:

The state’s contribution will increase by an estimated $602 million, to $5.4 billion a year. School districts will be charged an additional $342 million, to a total of nearly $1.7 billion a year. While teachers are covered by CalSTRS, other school employees get their pensions from CalPERS.

It’s the latest in a series of rate hikes implemented by the California Public Employees’ Retirement System in recent years, primarily to cover longer retiree lifespans, salary increases and the growing pool of state and school district employees. CalPERS is also dealing with lingering financial fallout from the 2008 financial crash, which cost the pension fund tens of billions of dollars.

The rate increase is smaller than initial projections, according to CalPERS.

Late last month, a federal judge ruled that private equity funds are liable for the pension debt of their portfolio companies.

Observers say the ruling could shake up the private equity industry.

The legal nuts and bolts are outlined in this Lexology article; but a New York Times piece provides a more down-to-earth explanation of what this means for private equity:

Late last month, Judge Douglas P. Woodlock of the United States District Court in Massachusetts found that two private equity funds were jointly liable for the pension fund debt of one of the companies they acquired.

“The private equity world is all over this,” said Paul Secunda, a labor law and employee benefits expert at Marquette University Law School. “For everybody else, it’s like, what’s the big deal?”

To answer that, it helps to go back to the beginning of the story.

It started with a Rhode Island company, Scott Brass, which makes brass and copper for all sorts of industries. In 2007, an affiliate of the private equity firm Sun Capital Partners bought Scott Brass, splitting the ownership between two separate Sun Capital funds.

A year later, Scott Brass went bankrupt and stopped contributing to its pension fund, run by the New England Teamsters and Trucking Industry Pension Fund.

Federal law imposes pension liability on any “trade or business” that is under “common control” with Scott Brass. The pension fund argued that Sun Capital’s funds met that definition — and should be liable for the $4.5 million pension fund debt.

In 2013, the United States Court of Appeals for the First Circuit found that one of Sun’s funds did constitute a “trade or business” — the first time a private equity fund was classified as such. The appeals court sent the case back to a lower court to decide whether Sun’s other fund was “a trade or business” as well.

On March 28, Judge Woodlock found not only that the other fund’s activities met the test of being “a trade or business,” he also found that the two funds served as a “partnership in fact” — one that was under common control with Scott Brass. That made the funds liable for the pension debt.

And what does the ruling mean, if it’s upheld? From the New York Times:

Two years ago, the appeals court’s opinion drew a flurry of attention over whether the Sun Capital case would challenge the foundation of the private equity business model by changing how it is taxed. That’s because the appeals court relied on federal income tax principles to conclude that Sun’s private equity fund was a “trade or business” for the purposes of employee benefits law.

In theory, if the I.R.S. were to adopt the same reasoning in a tax context, it could kill the goose that lays the golden eggs of the private equity industry: its huge tax breaks. It could do it in a way that would turn the investing world upside down.

And that’s why it probably will not happen, said Gregg D. Polsky, a tax law professor at the University of North Carolina School of Law who has written critically about the industry’s practices.

“It could create all sorts of potential headaches and uncertainties for investors,” Professor Polsky said, including foreign investors and tax-exempt investors like university endowments. “I don’t think the I.R.S. is interested in doing that.”

Until now, private equity firms have looked at companies with underfunded pension plans as undervalued targets, because the private equity firms were not responsible for funding those plans once they took over the company. Now they know they might be if Judge Woodlock’s ruling is upheld on appeal, and if other courts adopt it.

The aggregate funding status of the country’s multiemployer pension plans dropped 4 percent in the second half of 2015, according to a report by Milliman.

[See the report here.]

The aggregate funding level now sits at 75 percent; the funding drop was due to flat investment returns.

More from Pensions & Investments:

“Multiemployer plans continued to be stuck in a rut in 2015,” said Kevin Campe, principal and consulting actuary at Milliman and co-author of the report, in a news release. “Currently, at least 76 plans with $28 billion of shortfall are projected to be insolvent at some point. These plans may be beyond help at this point, and several more may be headed in this direction.”

As of Dec. 31, 192 plans were more than 100% funded with an aggregate surplus of roughly $4 billion, down from 279 plans with an aggregate surplus of roughly $6 billion as of June 30.

Also as of Dec. 31, 264 plans were less than 65% funded, with an aggregate shortfall of $77 billion, accounting for more than half of the $151 billion aggregate shortfall for all multiemployer pension plans, and up from 214 plans as of June 30.

For the funding ratio to remain at 75% at the end of 2016, the pension funds would have to achieve an aggregate 5.5% return in 2016, Milliman estimated. Returns of 11% or more for the year are needed to return to the 79% level seen as of June 30, 2015. A flat return could lower the funding ratio to approximately 72%; a -5% return could drop the funding ratio below 70%. For the first month and a half of 2016, the assessed plans returned roughly -3% in aggregate, Milliman noted.

Read the full study here.

Sometime in the next few weeks, the U.S. Treasury Department will make a crucial decision: whether to approve benefit cuts to the Central States Pension Fund, one of the largest pension funds in the country, that represents hundreds of thousands of truckers across the country.

The decision is important because it could set a precedent for other troubled multiemployer plans to take similar action.

From the Washington Post:

The potential cuts are possible under legislation passed by Congress in 2014 that for the first time allowed financially distressed multi-employer plans to reduce benefits for retirees if it would improve the solvency of the fund.

[…]

Consumer advocates watching the case say the move could encourage dozens of other pension plans across the country that are facing financial struggles to make similar cuts.

If Treasury approves the fund’s proposal, then retirees could see their paychecks shrink by July 1. The move would give the fund at least a 50 percent chance of lasting for another 30 years as opposed to running out of cash in 10 years if no changes are made, Nyhan said. A decision is expected by May 7.

[…]

Out of the 10 million workers and retirees covered by multi-employer pension plans, roughly 1 million people are in plans that could run out of money over the next two decades, according to estimates from the PBGC. Already, three other pension plans that pay benefits to truck drivers and ironworkers have applied to the Treasury to have their pension benefits reduced.

The proposal introduced in September by Central States would cut benefits for current workers and retirees by 23 percent on average, though exact amounts would vary based on people’s age, health status and where they worked.

If the cuts are approved, they would still be put to a vote among the plan’s 400,000 participants. But even if they vote down the plan, the Treasury has the authority to enact the cuts anyway to keep the PBGC solvent.

In light of a consultant report showing CalPERS may have lost out on $2 billion in investment gains since divesting from tobacco-related assets 15 years ago, the pension fund announced on Monday it would review its divestment policy.

The review includes consideration of whether to re-invest in tobacco.

From CalPERS:

The California Public Employees’ Retirement System’s (CalPERS) Board of Administration (Board) today laid out a path to review all of the System’s existing divestment initiatives, including tobacco. Based on directions given to CalPERS staff, the Board will consider reinvestment in tobacco after thorough review, study, and stakeholder input. The process is expected to take between 12 and 24 months and will culminate with a decision in early 2018. All non-tobacco divestments will be reviewed according to a new loss threshold policy, to be developed during the same time period.

“Divestment as an investment strategy presents a challenging conflict for CalPERS, as it often pits social responsibility against our fiduciary duty as outlined in the California Constitution,” said Henry Jones, CalPERS Board Vice President and Investment Committee Chair. “As a California public agency, we are sensitive to the policy issues surrounding divestment causes. But we’re also obligated to ensure that we maximize our investment returns on behalf of our members. We now have a clear path forward.”

Today’s direction from the Board follows three months of debate and discussion about how to create a process to periodically review CalPERS’ divestments from an investment and fiduciary perspective. It also comes on the heels of an October 2015 report from the Board’s investment consultant, Wilshire, which shows that CalPERS has lost approximately $8 billion from its various divestments, as of December 31, 2014. Tobacco was responsible for approximately $3 billion in losses.

Read the full statement here.

There were several pension-related items of interest that developed in the final days of Kentucky’s legislative session.

First, lawmakers passed a budget that would infuse an extra $1.2 billion in contributions to the state pension systems over the next two years.

From Pensions & Investments:

Under the bill, the $17 billion Kentucky Teachers’ Retirement System, Frankfort, would receive an additional $498.54 million in fiscal year 2017 and $474.72 million in fiscal year 2018. The $11 billion Kentucky Retirement Systems, Frankfort, would receive an additional $98.19 million and $87.57 million in each of those periods, respectively.

The bill includes a $125 million permanent fund to help shore up the pension funds. Funding would come from a surplus in the state’s public employee health insurance fund. Gov. Matt Bevin previously proposed a $500 million permanent fund, a repository that would help fund future pension costs.

Additionally, House lawmakers failed to pass a controversial, sweeping pension transparency bill that would have disclosed investment contracts and lawmaker pension amounts. The bill was passed by the Senate last month.

Details from WFPL:

The bill would have revealed how much and to whom the pension systems pay to invest pension funds. Kentucky law exempts the investments from open records laws.

Last fall, the Kentucky Retirement Systems Board of Trustees reported that its annual investment expenses are running 75 percent higher than reported in previous years.

Chris Tobe, a former Kentucky Retirement Systems trustee who has been critical of the system, said investment managers should compete to manage Kentucky’s pension assets in public view.

“We need to have open contracts and some kind of documentation and bidding process. Secret backroom deals is not good government,” he said.

[…]

On the last day of the legislative session, Senate leaders attempted to revive the bill by lumping it with language from an Area Development District oversight bill that the House favored, and also taking out some of the controversial provisions. But the bill still languished in the House.

CalPERS divested from tobacco-related assets in 2001.

But the topic re-surfaced last week, when a consultant report estimated the pension fund had missed out on $3 billion in investment gains during the 15 years CalPERS had been tobacco-free.

The report has trustees weighing whether to get back into tobacco. But Phil Angelides – former California State Treasurer and one-time Chairman of the Financial Crisis Inquiry Commission – says the pension fund should stay tobacco-free.

Angelides writes on the Huffington Post:

A 2015 report by Wilshire Associates, a consulting firm hired by CalPERS, claimed that CalPERS had foregone about $2 to $3 billion in investment earnings as a result of its decision to divest from tobacco. Yet, this analysis was deficient because it failed to examine whether and how CalPERS could have made investments with an acceptable risk return profile to replace its tobacco investments, which represented only about one-third of one percent of its investment portfolio at the time of divestment. Given the universe of investment options, there is no question that suitable investments to replace tobacco were and are available.

The same arguments raised against tobacco divestment were raised against divestment from companies doing business in South Africa during the brutal apartheid era and from companies aiding the genocide in Darfur. Make no mistake about it: the world of big finance and big business will continue to fight against divestment by institutional investors to close off any consideration of unethical or damaging corporate conduct in the making of investments, lest those considerations begin to curtail loathsome activities that produce big profits and big bonuses at the expense of the larger society.

As the nation’s largest public pension fund, CalPERS has a particular responsibility to continually strive to invest in ways that not only unequivocally meet its fiduciary obligations, but also strengthen our economy and society. That notion should hardly be considered novel. After all, as a society, we have an expectation that corporations should not only be profitable, but also should produce products of quality and conduct themselves well. Indeed, the ideal business enterprise is one that excels on both fronts. We value the real estate development firm that builds profitable, quality projects that enrich our communities. We respect the successful technology company that creates value for shareholders and innovations for the future. Why should we hold investors of capital — including CalPERS, the nation’s flagship pension fund — to a lesser standard?

Read the full piece here.