Category: Pension Newsroom

The vast majority of plan sponsors have renegotiated record-keeping fees since 2013, according to a survey conducted by consulting firm NEPC.

Retirement plan costs are lower than at any point in the survey’s history.

Details from PlanSponsor:

Since 2013, 81 percent of the 117 plan sponsor respondents report having renegotiated their recordkeeping fees; 51 percent of the plans in the survey, which had an average size of $1.1 billion in assets, now apply a per-participant fee for recordkeeping.

Total investment management fees averaged 42 basis points, down from 57 basis points in 2006 and 46 basis points in 2014.

Average recordkeeping costs were $57 per participant last year, down from $92 in 2011.

An NEPC partner mused whether, at some point, the lower fees would affect service levels. From PlanSponsor:

Ross Bremen, a partner at Boston-based NEPC, expected fees to show some leveling in this year’s report.

“While lower fees reflect the good work sponsors have done to reduce fees on participant’s behalf, at some point service levels could suffer,” said Bremen in a statement accompanying the report. “A race to the bottom, at the risk of sacrificing service and innovation, is not in the participants’ best interests.”

[…]

The trend to a strict per-participant fee structure for recordkeeping services is removing flexibility from plan design as a growing consensus of retirement experts, policymakers and participant advocates say savers need more personalized savings and decumulation strategies.

“The idea that recordkeeping is a commodity is just not the case,” said Bremen, who noted that 21 percent of surveyed plans do not use any revenue-sharing agreements to help shoulder the cost of plan services.

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Robin Harding of the Financial Times reports, BoJ launches new form of policy easing:

The Bank of Japan has launched a new kind of monetary easing as it set a cap on 10-year bond yields and vowed to overshoot its 2 per cent inflation target on purpose.

Its decision demonstrates that even eight years after the global financial crisis, central bankers are still willing to experiment with monetary policy tools as they struggle to escape from low inflation around the world.

The move marks another effort by Haruhiko Kuroda, BoJ governor, to surprise market expectations by expanding his monetary policy toolkit to signal his determination that Japan escape its decades of on-and-off deflation.

But the question for Mr Kuroda is whether three-and-a-half years of slow progress on prices have damaged the BoJ’s credibility too much for promises of higher inflation to be taken seriously by the public.

“The price stability target of 2 per cent has not been achieved … [and] this is largely due to developments in inflation expectations,” said the BoJ on Wednesday. “Inflation expectations need to be raised further in order to achieve the price stability target.”

Markets initially reacted positively, with the yen losing 1 per cent to ¥102.7 against the dollar, spurring a 1.9 per cent rally in the exporter-sensitive Nikkei 225 equity average, with banks and insurers leading the gains. But scepticism about the BoJ’s overhaul set in and the yen reversed its early losses, appreciating by 1 per cent by mid-afternoon in London.

The BoJ kept interest rates on hold at minus 0.1 per cent — describing further rate cuts as a “possible option for additional easing” — but announced a framework with two main elements.

The first is a pledge to cap 10-year government bond yields at zero per cent. In essence, that means the BoJ is promising to buy any bonds offered for sale at that price.

It will maintain its government bond buying “more or less in line with the current pace” of ¥80tn a year. However, the BoJ will buy fewer very long-term bonds, which should make it easier for banks to earn profits by allowing the yield curve to steepen.

Second, the BoJ has pledged to continue buying assets until inflation “exceeds the price stability target of 2 per cent and stays above the target in a stable manner”.

Although that commitment is vague, it marks a departure for global monetary policy, following the logic of economists such as Paul Krugman by making a deliberate “commitment to be irresponsible”.

If the pledge is credible then it should raise public expectations of the price level in the future. That, in turn, should lower real interest rates and stimulate the economy because loans will be paid back in a devalued currency.

But the BoJ’s credibility is a big question given its struggle to raise inflation over the past three years, with headline inflation running at minus 0.4 per cent in July. Public expectations of future inflation have steadily declined over the past 18 months.

Some analysts were downbeat about the BoJ’s decision not to cut interest rates or expand asset purchases, seeing it as a signal that the central bank has little scope for further easing.

“We are quite sceptical that this change in the framework will loosen financial conditions in any meaningful manner,” said Kiichi Murashima at Citi in Tokyo. “Monetary policy has effectively reached its limit, in our view, and today’s decision appears to show that policymakers share this assessment.”

Masaaki Kanno, at JPMorgan in Tokyo, said the BoJ had “disappointed” by failing to cut rates. He said the pledge to overshoot the inflation target had come too late, at a time “when few people in the market believe that 2 per cent inflation will be achieved anytime soon”.

James Athey at Aberdeen Asset Management added: “The BoJ has reaffirmed its inflation target and will try to overshoot it. This in spite of the fact that it hasn’t hit its current inflation target, doesn’t seem likely to and hasn’t announced anything that might help it get there or beyond any time soon.

“The Bank has effectively told markets that it has a royal flush and the markets are questioning Kuroda’s poker face.”

Tracy Alloway and Sid Verma of Bloomberg also report, The Way the World Thinks About Easy Monetary Policy Is Changing:

It happened so quickly.

While analysts and economists had long debated the efficacy of quantitative easing — the central bank bond purchase programs aimed at lowering borrowing costs to stimulate the economy and stoke inflation — the narrative surrounding such efforts is rapidly shifting. In recent months, there’s been a growing recognition of the limits and downsides to this particular form of monetary easing, underscored by the Bank of Japan’s policy changes announced on Wednesday.

Some 15 years after first experimenting with QE, the BOJ announced that it intends to shift the focus of its policy framework to better finesse borrowing costs by, in effect, anchoring longer-term rates higher, and moving away from a rigid target for expanding the money supply. While market participants expect the central bank to further expand bond purchases and take the rate on a portion of bank balances deeper into negative territory in upcoming meetings, the BOJ’s move is a recognition that its daring strategy to dramatically expand the money supply to fight deflation has delivered a blow to the financial sector’s profitability.

“The biggest takeaway here is that the BOJ is now leading the world into a new era of central banking and is essentially making long-term interest rate, 10-year Japanese government bond yields a focal point in its central banking platform instead of negative interest rate policy,” analysts at TD Securities Inc. led by Mazen Issa, wrote in a note today. “The yield curve control program is an interesting but untested concept. It is one attempt to provide relief for pension funds, [life insurance companies], and banks.”

The program announced on Wednesday helped propel Japanese lenders’ stocks higher, underscoring the evolution in easy monetary policy. The BOJ plans to buy enough 10-year government bonds to keep the yield close to zero percent, while potentially purchasing fewer longer-dated bonds, in a move expected to boost profits for the financial sector and encourage them to lend and invest.

The Bank of Japan had doubled-down on its QE program in February with the surprise introduction of a negative interest-rate policy on a portion of bank reserves, sharply lowering long-term rates — as well as bank stock prices — amid a squeeze on net interest margins for lenders.

Despite the shock-and-awe strategy early in the year, the yen appreciated in the aftermath of the move, while deflation risk remains unabated — with CPI at minus 0.5 percent year-on-year in July — and long-term inflation expectations remain stubbornly low.

Though the BOJ has maintained the minus 0.1 percent charge on some bank balances, its yield-curve commitment — similarly deployed by the Federal Reserve from 1942 to 1951 to lower the U.S. Treasury’s post-war financing costs, but which remains unprecedented in modern times — represents a sea-change in the central bank’s thinking.

The BOJ’s newfound embrace of a yield-curve target is a belated recognition that NIRP can negatively impact financial intermediation and inflation expectations, say analysts.

“The good news is that BOJ has finally acknowledged that NIRP does have some negative impact on intermediation and potentially on inflation expectations – which the BoJ puts at the center of its policy goal,” Morgan Stanley economists led by Takeshi Yamaguchi wrote in research published last week, for instance. “The fear is that this negative impact will wax and positive impact wane. Once the evidence is clear, the result may already have had serious adverse consequence for the real economy.”

Hans Redeker, strategist at the U.S. bank, reckons a negative-yielding flat yield curve has reduced monetary velocity and pushed the yen higher, while a steeper yield curve — allowing financial intermediaries to borrow at low rates and invest at longer maturities — might unleash the animal spirits needed to increase risk-taking.

In a report last week, amid indications from officials that the BOJ would anchor long-end yields higher, Redeker wrote: “Financial sector balance sheets have been dismissed by central banks for too long,” adding that the central bank’s newfound focus on financial-sector profitability represents a belated recognition of banks in aiding the transmission of monetary policy to the real economy.

Tomoya Masanao, head of Japanese portfolio management at Pacific Investment Management Co LLC, in a research note last week, called on the BOJ to scale back JGB purchases at the long-end to steepen the yield curve and aid financial intermediation, arguing that negative long-end rates had facilitated the refinancing of existing debt rather than stimulating new productive investments.

Bankers argue low longer-dated yields and negative rates deliver a blow to their return on assets, offsetting the benefits of lower funding costs — and the BOJ’s apparent capitulation might embolden critics of monetary policy in other advanced economies.

Questions over the effects of QE have already extended away from policymakers at the BOJ. In the U.K., Monetary Policy Committee Member Kristin Forbes suggested in the aftermath of the Brexit referendum that further easing could end up tightening financial conditions rather than loosening them.

“People will earn less on their hard-earned savings — potentially cutting back on spending to reach a target savings pot. Banks will make less money on lending,” she wrote in an op-ed. “Pension and life insurance funds will have a harder time meeting their commitments. Companies may need to put more money into pension schemes — leaving less to spend on workers and investment.”

So the BOJ surprised everyone by not cutting rates or expanding asset purchases further. Instead, it chose to anchor long-term rates higher in an attempt to stoke “animal spirits” and hopefully finally lift inflation expectations higher.

Will it work? I’m highly skeptical and so is the market. As of this writing on Wednesday morning, the yen reversed course and is surging relative to the USD, up 1%, hovering around 100.68 (click on image; this can abruptly change this afternoon if the Fed raises rates):

Remember my warning to always keep an eye on a surging yen as it could trigger a crisis, including another Asian financial crisis because a stronger yen reinforces deflationary headwinds in Asia which can spread all over the world.

This is yet another reason why the Fed shouldn’t raise rates now but we shall see what it decides to do later today. One currency trader I talk to thinks the fact the BOJ didn’t cut rates or expand its asset purchases is a sign the Fed will surprise markets and raise rates on Wednesday.

And while the Bloomberg article above quotes someone as saying “it is one attempt to provide relief for pension funds, [life insurance companies], and banks,” I’d put the emphasis on banks and lifecos, less on pensions (central bankers don’t really care about pensions but they should if they want to stave off deflation).

In fact, if the BOJ fails to stoke inflation expectations higher, it will be forced to cut rates further into negative territory and this will negatively impact banks, life insurers and Japan’s pensions, especially defined-benefit pensions which are already reeling.

Garath Allan and Shingo Kawamoto of Bloomberg recently reported, Negative Rates Not All Bad as Mizuho Sees Pension Business Boost:

Negative interest rates aren’t necessarily all bad news for Japanese banks, as companies flock to lenders for advice on how to manage their pension programs under the policy, according to Mizuho Financial Group Inc.

The Tokyo-based bank sees an opportunity to earn more fees from employers that are shifting toward 401(k)-style retirement plans as sub-zero rates make it more difficult for them to meet existing pension obligations. It’s seeking to expand the 1.7 trillion yen ($16.6 billion) of defined-contribution plans it manages for companies’ employees by 30 percent over the next three years, according to Koji Imuta, a senior manager in the asset-management business development department.

Pension Strain

The Bank of Japan’s negative-rate policy is driving momentum for companies to reconsider their employee pension arrangements, Imuta said in an interview in Tokyo. “Our customers are acutely aware of this as an issue and inquiries are growing,” he said.

Even before the BOJ announced negative rates in January, years of plunging bond yields squeezed returns from retirement funds in a nation where the aging population is also placing a strain on the pension system. Imuta’s goal to increase retirement assets reflects a push by Chief Executive Officer Yasuhiro Sato to boost non-interest income amid the risk that the central bank may take rates further below zero, crimping loan profits.

By arranging pension plans for employers and investing the funds on their behalf, Mizuho will earn fees that could help to reduce the impact of negative rates on profit, Sato said in May, without providing specific targets. The bank has forecast the BOJ’s policy will crimp its net income by 40 billion yen in the year ending March.

More firms are seeking to switch to defined-contribution plans from defined-benefit arrangements because swelling retirement liabilities are jeopardizing their financial health, Imuta said. “We see this as an opportunity,” he said.

The total pension shortfall for listed companies in Japan expanded about 43 percent over the past year to 25.6 trillion yen as of March 31, according to Nomura Holdings Inc. Japanese government bonds with maturities as long as 10 years are yielding less than zero even after a recent steepening of the curve.

Making Switch

Defined-contribution plans exist on top of Japan’s public pension system, allowing employees to select how their money is invested. The amount retirees receive fluctuates depending on returns, unlike traditional defined-benefit pensions where employers must pay out a set amount regardless of how much they earn from investing the pooled funds.

Employers are tailoring their pension programs, with some fully making the shift and closing defined-benefit plans and others maintaining aspects of their existing arrangements, Imuta said.

A total of 5.5 million company employees had defined-contribution plans as of March, up 8.5 percent from a year earlier, according to Ministry of Health, Labour and Welfare figures. More than 5,000 companies including Skylark Co. and Panasonic Corp. offered these to their employees as of July, the data show.

Mizuho plans to take advantage of its April 2016 conversion to an internal company structure to bolster cooperation between its bank and trust units on the pension business, Imuta said. About 250 employees work in Mizuho’s retirement operation across the two units, which previously conducted the business separately.

As you can read, negative rates aren’t all bad news for some Japanese banks as they have been collecting huge fees as companies opt out of defined-benefit pensions into defined-contribution pensions.

Unfortunately this shift out of DB into DC pensions will only exacerbate Japan’s long-term deflation problem because it will shift retirement risk from employers to employees which will succumb to pension poverty once they outlive their savings. This is all part of the global pension crunch I recently discussed and it’s a frightening trend which policymakers will be grappling with for decades.

Now we can all wait for the Fed decision at 2:00 pm sharp. Even though the market isn’t expecting a rate hike, the recent actions from other central banks suggest the Fed might hike now. Stay tuned.

Update: A divided Federal Reserve left its policy rate unchanged for a sixth straight meeting, saying it would wait for more evidence of progress toward its goals, while projecting that an increase is still likely by year-end.

“Near-term risks to the economic outlook appear roughly balanced,” the Federal Open Market Committee said in its statement Wednesday after a two-day meeting in Washington. “The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives.”

CalPERS chief actuary Alan Milligan, who is retiring, told top fund officials on Tuesday to consider lowering the fund’s discount rate to 7.25% by February.

CalPERS’ discount rate currently sits at 7.5%.

Milligan’s most recent report predicts a period of lower (6-ish percent) annual returns over the next ten years.

More from the LA Times:

Alan Milligan, who is stepping down as chief actuary of the California Public Employees Retirement System, told the agency’s directors that investment returns continue to come in lower than expected and the pension fund should recalibrate its long-term investment prediction — the “discount rate” — no later than February.

“If you were to adopt a lowering of the discount rate now, that would buffer the impact” on state and local government budgets, Milligan said at the meeting in Sacramento.

[…]

Milligan told the CalPERS directors that they should consider lowering the long-term discount rate to 7.25%, though his report on Tuesday projected the coming decade will only see an average return of 6.12%.

“The capital markets are simply not expecting to return as much in the next 10 years or so as they have historically,” Milligan said.

CalSTRS CIO Chris Ailman joined Bloomberg this week to discuss his fund missing its return target for a third consecutive year; and other problems facing the pension fund.

See the video, above.

Video credit: Bloomberg

CalSTRS CIO Chris Ailman joined Bloomberg this week and tackled several topics: the pension fund’s decision to dump thermal coal assets (video above), a move announced back in February; and Federal Reserve interested rates (video below).

Video credit: Bloomberg

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

Jack Dolan of the LA Times reports, The Pension Gap:

With the stroke of a pen, California Gov. Gray Davis signed legislation that gave prison guards, park rangers, Cal State professors and other state employees the kind of retirement security normally reserved for the wealthy.

More than 200,000 civil servants became eligible to retire at 55 — and in many cases collect more than half their highest salary for life. California Highway Patrol officers could retire at 50 and receive as much as 90% of their peak pay for as long as they lived.

Proponents sold the measure in 1999 with the promise that it would impose no new costs on California taxpayers. The state employees’ pension fund, they said, would grow fast enough to pay the bill in full.

They were off — by billions of dollars — and taxpayers will bear the consequences for decades to come.

This year, state employee pensions will cost taxpayers $5.4 billion, according to the Department of Finance. That’s more than the state will spend on environmental protection, fighting wildfires and the emergency response to the drought combined.

And it’s more than 30 times what the state paid for retirement benefits in 2000, before the effects of the new pension law, SB 400, had kicked in, according to data from the California Public Employees’ Retirement System.

Cities, counties and school districts across California are in the same financial vise. After state workers won richer retirement benefits, unions representing teachers, police, firefighters and other local employees demanded similar benefits, and got them in many cases.

Today, the difference between what all California government agencies have set aside for pensions and what they will eventually owe amounts to $241 billion, according to the state controller.

Davis, who was elected in 1998 with more than $5 million in campaign contributions from public employee unions, says that if he had it to do over, he would not support the pension improvements.

“If you’re asking me, with everything I’ve learned in the last 17 years, would I have signed SB 400…. no, I would not have signed it,” Davis, now 73, said in a recent interview at his Century City law office.

The law took effect in 2000, and that same year CalPERS investments were hammered by the bursting of the dot.com bubble. Eight years later, the housing market collapsed and the Great Recession set in, putting the pension fund in a deep hole.

CalPERS had projected in 1999 that the improved benefits would cause no increase in the state’s annual pension contributions over the next 11 years. In fact, the state had to raise its payments by a total of $18 billion over that period to fill the gap, according to an analysis of CalPERS data (click on image).

The pension fund has not been able to catch up, even though financial markets eventually rebounded. That’s because during the lean years, older employees kept retiring and younger ones continued to build up credit toward their own pensions. Pay raises and extended lifespans have magnified the impact of the sweetened benefits.

One of the few voices of restraint back in 1999 belonged to Ronald Seeling, then CalPERS’ chief actuary.

Asked to study differing scenarios for the financial markets, Seeling told the CalPERS board that if the pension fund’s investments grew at about half the projected rate of 8.25% per year on average, the consequences would be “fairly catastrophic.”

The warning made no discernible impression on the board, dominated by union leaders and their political allies.

“There was no real taxpayer representation in that room,” Seeling, now retired and living in a Dallas suburb, said in a recent interview. “It was all union people. The greed was overwhelming.”

The enhanced benefits stand in stark contrast to the financial insecurity facing most Americans in retirement. The vast majority of private sector workers have no pensions and very little retirement savings, and will depend largely on Social Security payments, which average about $16,000 per year.

Union leaders say their generous pensions are preserving the middle-class dream of a comfortable retirement.

“People should not have to work their whole life and never be able to retire,” said Dave Low, executive director of the California School Employees Assn.

“We need to fix the system … but fixing it doesn’t mean taking secure retirements away from the last people who have them.”

***************

State pensions are funded by regular deductions from workers’ paychecks and contributions from the state. CalPERS invests the money to cover future benefits.

The employee contribution, typically determined through collective bargaining, remains fairly constant. The employer contribution fluctuates based on CalPERS investment returns.

By far the largest group of state workers — office workers at the Department of Motor Vehicles, the Department of Social Services and dozens of other agencies — contributed between 5% and 11% of their salary in 2015, and the state kicked in an additional 24%. To fund their more costly benefits, Highway Patrol officers contributed 11.5% of pay and the state added 42%.

Separately, the state pays for lifetime health insurance for retirees who worked at least 20 years.

State agencies don’t have a say in how much they contribute toward pensions. That’s determined by CalPERS, where unions have long had considerable influence. Six of the agency’s 13 board members are chosen by public employees; the others are elected officials and their appointees.

By 1999, the retirement system’s investments had grown to $159 billion, from $49 billion in 1990, making it the largest public pension fund in the country and one of the largest institutional investors in the world.

To labor representatives and their allies on the board, the time seemed right to fix what they described as years of “benefit inequity.” They saw Davis, a Democratic former Assemblyman and state controller, as a savior after 16 years of Republican governors.

His predecessor, Gov. Pete Wilson, took $1.6 billion from CalPERS accounts in 1991 to help close a state budget gap. Wilson also reduced retirement benefits for new state employees, effectively creating a second class of state workers.

In May 1999, board members started work on what became SB 400. The state’s formula for calculating pensions had not changed in 20 years, and retirees had lost ground to inflation, according to background material prepared for the board.

The board invited a long list of union leaders to weigh in. They talked about fairness and about employees’ desire to be treated with respect.

It fell to Michael Picker, an aide to then-state Treasurer Phil Angelides who was sitting in for him that day, to raise what he called the “rainy day question.”

“The bull market has been on such a good run for so long that I continually wake up expecting to find out that the bottom has dropped out from underneath us,” Picker said, according to meeting transcripts.

Picker suggested the board refrain from pushing for expanded benefits until Seeling, the CalPERS actuary, had come up with best- and worst-case scenarios for investments over the next decade.

Board chairman William Crist, an economics professor at Cal State Stanislaus and former president of the faculty union, interrupted with sarcasm.

“I guess the best case for the retirement system is everybody dies tonight,” Crist said, meaning the fund wouldn’t have to pay any benefits. “We could go through a modeling exercise where we make all sorts of different assumptions and make predictions, but that’s really more than I think we can expect our staff to do.”

Despite the objection, Seeling did the analysis, considering three different scenarios.

One assumed that the fund’s investments earned what CalPERS was expecting, an average annual return of 8.25% over the coming decade.

In that case, even with improved pension benefits, the annual contribution required from taxpayers would actually go down. By Seeling’s calculations, it would hover around $650 million a year — $110 million less than the state was currently chipping in.

A second scenario showed what would happen if the investments earned 12.1% per year on average: CalPERS would be so flush that the state would not have to contribute any money.

Then Seeling turned to his most pessimistic assumption: investment growth of 4.4% per year, about half the rate CalPERS was expecting.

That would be “fairly catastrophic,” Seeling said at a May 18, 1999, meeting of the board’s benefits committee.

The scariest part of that scenario was a hypothetical 18% one-year loss in investment value, which would require a multi-billion-dollar bailout from taxpayers.

The discussion was over in a few minutes, and board members did not revisit the issue, according to meeting transcripts. That summer, they approved the benefits expansion, the legislature passed it by overwhelming margins in both houses and the governor signed the bill in September 1999.

In November, CalPERS executives produced an in-house video congratulating themselves, Davis and the sponsoring legislators.

Crist appears, applauding the board for finding a way to ensure secure retirements for state employees “without imposing any additional cost on the taxpayers.”

The measure was “the biggest thing since sliced bread,” Perry Kenny, then president of the California State Employees Assn., says on the video.

No less enthusiastic were unnamed state employees interviewed on-camera. “I have so much I want to do, and I dreaded being too old to enjoy it,” says one, adding that the opportunity to retire comfortably at 55 “opens up a whole new world to me.”

The next year, 2000, the Dow Jones Industrial Average dropped for the first time in a decade, by 6%. The following year, it fell 7%, and then again the next year, by 17%.

CalPERS investments lost 3% in 2008 and 24% in 2009 — wiping out $67 billion in value (click on image).

Crist retired from the board and CSU in 2003. In 2010, his name surfaced in a pay-to-play scandal that rocked CalPERS. After retiring, he had accepted more than $800,000 from a British financial firm to help secure hundreds of millions in investments from the pension fund. Crist was not accused of wrongdoing

His wife said he suffered a stroke three years ago and was unable to respond to questions for this article.

His state pension is $112,000 per year, CalPERS records show.

***************

Although all state employees benefited from SB 400, none hit the jackpot quite like the 6,500 sworn officers then on the California Highway Patrol. Previously, their pensions had been calculated by multiplying 2% of their salary times the number of years they worked. SB 400 raised that to 3%.

It was an innocuous-looking change on paper, but it had a huge effect.

CHP officers who retired in 1999 or earlier after at least 30 years on the job collected pensions averaging $62,218, according to CalPERS data.

For those who retired after 1999, the average pension was $96,270.

The average retirement age for CHP officers is 54. Someone that age without a pension who wanted to buy an annuity to generate the same income for life would have to pay more than $2.6 million, according to Fidelity Investments.

Few Americans have that kind of nest egg.

About a third of those between 55 and 64 have no retirement savings, according to Alicia Munnell, who was an economic advisor to President Bill Clinton and is now director of the Center for Retirement Research at Boston College. For those with savings, the median was $111,000 in 2013, she said.

Jon Hamm, the recently retired chief executive of the California Assn. of Highway Patrolmen, is widely regarded as the father of the “3 at 50” formula, which has been expanded to cover prison guards, police and firefighters across the state.

Hamm said he now worries that “pension envy” could lead to a backlash against public employees.

“If I was in the private sector just struggling to get by, had no dream of retiring, would I be upset?” Hamm asked during a recent interview. “Yeah. And we have to understand that’s a reality.”

Joe Nation, a former Democratic assemblyman who teaches public policy at Stanford’s Institute for Economic Policy Research, sees the same reality bearing down on public employees. He believes their sweetened pensions are not sustainable.

“There’s no way to close this gap without some sort of hit, or financial pain, for those employees,” he said.

He pointed to Detroit, where pensions were cut by nearly 7% after the city went bankrupt in 2013.

California labor leaders insist that could not happen here because state courts have ruled that pension benefits promised on the day an employee begins work can never be reduced.

Pensions have not been cut in any of the three California cities that declared bankruptcy in recent years — Stockton, San Bernardino and Vallejo.

But a number of rulings in those and other California cases have paved the way for a state Supreme Court showdown on whether bankrupt cities can treat retirees like other creditors, forcing them to stand in line hoping for pennies on the dollar of what they are owed.

Nation said he has been vilified by labor leaders for suggesting public employees voluntarily surrender some of their benefits. He comes from a family of public employees and was a union representative in the 1980s when he worked as a flight attendant for Pan Am.

“It’s hard to believe anyone would consider me anti-union,” Nation said. “I’m just a Democrat who can do math.”

***************

When the legislature considered SB 400 in 1999, Democrats championed the expansion of pension benefits. Most Republican legislators voted for it, too — a reflection of the economic optimism of the time.

Dan Pellissier, then an aide to Republican Assembly leader Scott Baugh, said he was surprised that CalPERS thought it could afford such generosity toward future retirees, himself included. But he was not inclined to doubt it.

“It came down to everyone wanting to believe that CalPERS were masters of the universe,” said Pellissier. “I figured, who am I to substitute my judgment for theirs?”

He feels differently now. Pellissier is president of an advocacy group called California Pension Reform, which is seeking to curb retirement benefits.

In the Assembly, Democrats voted unanimously for the bill, as did 23 of 32 Republicans.

Lou Correa, then a freshman Democrat who carried the bill in the Assembly, said he fell victim to inexperience. He remembers seeing actuarial reports and assuming he’d “kicked the tires” and asked the right questions.

Correa, now running for Congress in Orange County’s 46th district, said he should have sought independent financial advice.

In the Senate, it took Deborah Ortiz less than 45 seconds to pitch SB 400 to her colleagues on Sept. 10, 1999. She sponsored the bill because her Sacramento district had the most state workers.

Ortiz recited a few changes to complicated retirement formulas and then pointed to the security staff, the sergeants-at-arms, noting their retirements would be enhanced with a yes vote.

The measure passed unanimously, without debate.

Ortiz now runs a Sacramento nonprofit that resettles refugees and victims of human trafficking.

In a recent interview, she said CalPERS’ assurances that investments growth would cover the costs “made sense at the time,” and there was no real opposition from any of the state government’s financial analysts.

“All of the assumptions across the board were wrong,” Ortiz said. “I don’t think it was anything nefarious. Everyone was just wrong.”

Davis said he took “with a grain of salt” assurances that SB 400 wouldn’t cost taxpayers anything extra. Still, he recalled, CalPERS had seen steady gains in its investments and at the time had billions more than it needed to meet its obligations.

“I believed, when I signed it, it was sustainable,” Davis said. “I knew it might take some tweaks here and there…but nobody on the planet Earth predicted we’d be going through what 2008 brought us.”

In 2003, months into his second term, Davis became the first California governor to be recalled from office. His successor, Arnold Schwarzenegger, tried to rein in pension costs but failed. He blamed fellow Republicans in the legislature for voting against his proposal in return for contributions from the state prison guards union.

In 2012, Gov. Jerry Brown, a Democrat, persuaded the legislature to raise the retirement age for new employees and reduce their benefits slightly. That will save money decades from now, when those employees retire, but it will not reduce the cost of benefits already locked in for active and retired workers.

Lawmakers blocked Brown’s broader effort to create a hybrid retirement system, with some of the state’s contribution steered to 401k accounts, which are much less costly for employers because they don’t guarantee benefits.

Brown also failed in his bid to add independent members to state retirement boards — people with financial expertise and no ties to public employee unions.

The outcome didn’t surprise Ron Seeling. If the board had included truly independent financial experts in 1999 — the state treasurer and controller, he noted, are elected officials dependent on campaign contributions — they might have pushed to save the extra money from the boom years for a “rainy day,” he said.

“They had that surplus, and there was an incredible push to spend it,” said Seeling who collects a $110,000 state pension after a 20-year career at CalPERS.

“Politics and pensions just don’t mix. That’s all there is to it.”

This is a superb article on California’s pension crisis and demonstrates why so many state pensions are crumbling, forcing a looming showdown with taxpayers to bail them out.

In a nutshell, Ron Seeling — CalPERS’ former chief actuary, and the person whose dire investment scenario was completely ignored back in 1999 — is absolutely right, politics and pensions don’t mix well.

I will keep my thoughts brief and to the point but make sure you read them to understand why so many state pensions are in such dire straits:

• First, almost all US state pensions are delusional, clinging on to their pension rate-of-return fantasy (of 8% or 7% nominal rate) in order to avoid hard choices which come along with lowering their investment assumptions which is what they use as a discount rate to value future liabilities.We can argue whether state pension deficits hover around a trillion dollars or whether there is a six trillion pension cover-up, but there is no arguing that they exist and are placing increasing pressure on public finances diverting money from other critical areas (education, infrastructure, etc.).
• After my conversation with HOOPP’s Jim Keohane last week,  Leo de Bever, AIMCo’s former CEO, told me the problem with using funded status as a measure of a pension plan’s health is US state pensions use expected returns to discount their future liabilities and he thinks 7% or 8% nominal expected return is “too high” in this environment. He’s too kind. Neil Petroff, Ontario Teachers’ former CIO once told me bluntly: “If US state pensions were using our discount rate (now less than 5% nominal), they’d be insolvent.”
• Third, state governments are also to blame for this mess as they went years without topping up their public pensions, and that was a very costly mistake. In order to combat the problem, state governments tried (unsuccessfully) to cut benefits or worse still, to shift new employees to defined-contribution plans, which will only exacerbate pension poverty in the United States.
• Fourth, US public sector unions have also contributed to this mess by asking for benefits which quite frankly border on the insane and are unsustainable. The list of public sector US pensioners collecting $100,000++ in retirement benefits is growing and it makes you wonder, what planet do these people live in?!?
• In Canada, defined-benefit pensions are managed much better because they got the governance right (and politics out of pensions), the discount rates used to discount future liabilities are much more realistic, many plans are fully-funded because they have adopted a risk-sharing model where plans sponsors and beneficiaries share the risk of the plan equally, and the pension payouts, while solid, are nowhere near as lavish as what you see in the United States.

When I look at what is going on the United States, it doesn’t surprise me one bit the pension Titanic is sinking. Unsustainable return assumptions and unsustainable pension benefits all add up to an unsustainable retirement system which is flirting with disaster.

In some cities, like Dallas, disaster has already hit their public sector pensions, but that is only the tip of the iceberg. Wait until the next financial crisis hits bringing about global deflation, it will decimate pensions, especially chronically underfunded US public pensions.

And for all of you wondering why Canada’s senior pension officers get compensated extremely well, ask yourself this, would you rather be part of a HOOPP, Ontario Teachers’ or other large Canadian defined-benefit pension, bringing you great news in a tough environment for all active managers, or would you rather be part of an Illinois Teachers Retirement System teetering on collapse, forcing taxpayers to shore it up to the tune of of $421 million next year?

Sure, Dallas, Chicago and Illinois public pensions are among the worst of the bunch, but there is clearly a big, if not huge, public pension mess in the United States that has yet to be addressed adequately. And mark my words, the next financial crisis will expose the US pension crisis once and for all.

What else? As I keep warning you, pension deficits are also a problem for the economy because they are deflationary. More taxpayer money to top up public pensions means less money for goods and services and shifting public pensions into defined-contribution plans, a proposal being discussed in Missouri and elsewhere, will only exacerbate this deflationary trend because it will exacerbate inequality.

Also, DC pensions are NOT DB pensions, they are savings plans which are subject to the vagaries of public markets and are not in the best interests of pension beneficiaries or taxpayers over the long term.

I better stop there but take the time to think through my comments above.

The Illinois State Board of Investment, which oversees several state pension funds, voted on Thursday to axe all active managers in the portfolio of the state-administered 401(k) plan.

About 52,000 residents are enrolled in the defined contribution system, which can be chosen by workers instead of a traditional defined benefit.

The shift came down to two things: performance and fees.

More from the Wall Street Journal:

The Illinois State Board of Investment, in a 7-to-1 vote on Thursday, jettisoned mutual funds sold by T. Rowe Price Group Inc., Fidelity Investments, Invesco Inc. and four others.

The pullback means roughly $2.8 billion of Illinois state-employee retirement assets—representing roughly two-thirds of the $4 billion fund—would now be in the hands of Vanguard Group and Northern Trust.

The shift would dramatically reduce outside management fees paid plan-wide, dropping from more than $10 million annually to $1 million, Marc Levine, the board’s chairman, said in an interview. On a per-participant basis, it equates to fees being shaved to about one-fourth of the previously paid total.

[…]

The shift means Illinois state workers, legislators and judges—those participating in the 401(k)-style fund—would choose from between seven categories of investments rather than 16. All the holdovers will be so-called “passive” funds that strive to imitate, not outsmart, the markets.

“We’re taking all that complexity out,” Mr. Levine said.

A tax on sewer and water usage, revenues from which will go to Chicago’s four pension funds, received final approval from city lawmakers on Wednesday.

This move comes on the heels of several other tax hikes designed to help improve the funding of the city’s pension funds, which are flirting with insolvency.

From Reuters:

The tax, passed in a 40-10 city council vote, is projected to raise an estimated $240 million a year once it is fully phased in over five years, helping Chicago gradually increase contributions to its municipal retirement system, which is projected to run out of cash within 10 years.

[…]

Chicago has already authorized a phased-in $543 million property tax for its police and fire retirement systems and a telephone surcharge increase for its laborers’ pension fund.

For the municipal fund, an actuarially required funding level would be reached in 2023, when the payment would spike to nearly $879 million from $577 million in 2022, according to city documents. The aim of the plan is to bring the retirement system’s funded level to 90 percent in 2057.

Some aldermen have raised concerns that even with the new tax revenue, the city will be short $300 million in 2023.

The city’s next step involves the Illinois Legislature, which will be asked in November to approve the new funding schedule for the municipal system, as well as one for the laborers’ fund.

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

The Ontario Teachers’ Federation put out a press release, Surplus funds will further restore inflation protection for retired teachers:

The Ontario Teachers’ Federation (OTF) and the Ontario Government, joint sponsors of the $171.4 billion Ontario Teachers’ Pension Plan (Teachers’), will use a portion of the $13.2 billion surplus in the Plan (as of January 1, 2016) to partially restore inflation protection for teachers who retired after 2009.

“Conditional inflation protection has proven to be an effective tool for managing Plan deficits and now, for the third year in a row, the sponsors will use some of the surplus to partially restore indexing that pensioners lost in recent years,” said OTF President Mike Foulds. “The remainder of the surplus will be kept in reserve to provide benefit and contribution rate stability against future funding challenges such as low interest rates and increasing longevity, both of which increase the Plan’s liabilities.”

Pensioners who retired after 2009 will receive a one-time increase in January 2017 to restore their pensions to the levels they would have been at, had full inflation protection been provided each year since they retired. They will also receive a slightly higher inflation increase next year for the portion of their pensions earned after 2009. Cost-of-living increases for this portion of pension credit will equal 90% of the annual increase in the Consumer Price Index (CPI), up from the current level of 70%. Pension credits earned before 2010 remain fully inflation-protected.

Pensioners who retired before 2010 are unaffected by these latest changes because pension credits earned before 2010 receive full inflation protection. Working members are also unaffected because annual inflation adjustments are determined after retirement.

Last March, Teachers’ reported its third surplus in a decade. A preliminary funding valuation showed that the Plan was 107% funded at the beginning of 2016, based on current benefits and contribution rates.

About Teachers’

With $171.4 billion in net assets as of December 31, 2015, the Ontario Teachers’ Pension Plan is the largest single-profession pension plan in Canada. An independent organization, it invests the pension fund’s assets and administers the defined benefit pensions of 316,000 active and retired teachers in Ontario.

About OTF

The Ontario Teachers’ Federation is the advocate for the teaching profession in Ontario and for its 160,000 teachers. OTF members are full-time, part-time and occasional teachers in all publicly funded schools in the province – elementary, secondary, public, Catholic and francophone.

On Monday, I went over a recent conversation with HOOPP’s Jim Keohane where we discussed markets and I brought up an article he had written with Hugh O’Reilly, President and CEO of OPTrust, which discusses funded status as a better measure of a pension fund’s success.

In that comment,  I stated the following:

No doubt, you need to pay your investment officers properly, especially in private markets like private equity, real estate, and infrastructure which require unique skills sets, but the message that Jim Keohane and Hugh O’Reilly are conveying is equally important, pensions need to focus first and foremost on their funded status, not taking huge risks to beat their policy portfolio benchmark.

The nuance here is that you can’t blindly compare the performance of one pension plan to another without first understanding how their liabilities are determined and what their funded status is.

For example, Ontario Teachers and HOOPP are widely regarded as two of the best pension plans in Canada, if not the world. They both use extremely low discount rates (HOOPP’s is 5.3% and Teachers’ is just below 5% because it’s a more mature plan and its members are older) to determine their liabilities, especially relative to US pensions which use expected returns of 7% or 8% to determine their liabilities (if US pensions used the discount rate HOOPP and Ontario Teachers use, they’d be insolvent).

In 2015, Ontario Teachers returned 13% as growth in its private market assets really kicked in while HOOPP which is more heavily weighted in fixed income than all of its larger Canadian peers only gained 5.1% last year.

A novice might look at the huge outperformance of Ontario Teachers as proof that it’s a better managed plan than HOOPP but this is committing a fatal error, looking first at performance, ignoring the funded status.

Well, it turns out that HOOPP’s funded position improved last year as it stood at 122%, compared to 115% in 2014, placing it in the top position of DB plans when you use funded status as the only real measure of success (less contribution risk relative to other DB plans). And unlike others, HOOPP manages almost all its assets internally and has the lowest operating costs in the pension industry (it’s 30 basis points).

Now, to be fair, Ontario Teachers’ is a much larger pension plan and it too is now fully funded and does a lot of the things HOOPP does in terms of internal absolute return arbitrage strategies and using leverage wisely to juice its returns, but the point I’m making is if you’re looking at the health of a plan, you should focus on funded status, not just performance.

Yes, the two go hand in hand as a pension that consistently underperforms its benchmark will also experience big deficits but it’s not true that a pension plan that consistently outperforms its benchmark will enjoy fully or super-funded status.

Why? Because as I keep hammering on my blog, pensions are all about managing assets AND liabilities. If you’re only looking at the asset side of the balance sheet without understanding what’s driving liabilities, your plan runs the risk of being underfunded no matter how well it performs.

Now, to be fair, I should also point out that unlike Ontario Teachers and HOOPP, most of Canada’s large pension funds (like bcIMC, the Caisse, CPPIB and PSP) are NOT pension plans managing assets and liabilities. They are pension funds managing assets to beat their actuarial target rate of return which is set by their stakeholders who know their liabilities.

Also, unlike many other pension plans, HOOPP, Ontario Teachers and a few other Ontario pensions (like OPTrust and CAAT) have adopted a risk-sharing model which basically states the members and the plan sponsor share the risk of the plan if a deficit occurs. This effectively means that when a deficit persists, members can face a hike in contributions or a reduction in benefits.

In a follow-up comment going over the executive shakeup at CPPIB, I clarified something:

I also want to stress something else, when I compare Ontario Teachers’ to HOOPP, it’s not to claim one is way better than the other. Both of these pension plans are regarded as the best plans in the world so comparing them is like comparing Wayne Gretzky to Mario Lemieux. They also have some key differences in size and maturity of their plans which makes a direct comparison difficult, if not impossible.

The point I’m trying to make, however, is anyone looking to be part of a great defined-benefit plan would love to be a member of HOOPP or Ontario Teachers and I don’t blame them.

As far as CPPIB, I trust Mark Wiseman’s judgment which is why I trust that Mark Machin and his new senior executives are all more than qualified to take over and deliver on the fund’s long term objectives during the next phase which will be far more challenging in a ZIRP and NIRP world.

So the next time you hear some reporter lament about a big shakeup at CPPIB, please refer them to this comment and tell them to relax and stop spreading misleading information.

Ever notice how reporters love reporting BAD news? I guess it sells more newspapers but it’s equally important to report GOOD news.

And this latest decision to use a portion of the surplus funds to restore inflation protection for Ontario teachers who retired after 2009 is great news.

When I went over Ontario Teachers’ 2015 results, I actually spoke to Ron Mock, Teachers’ CEO, about what they are going to do with surplus funds.

I told him it’s best to save the surplus for a rainy day. He agreed but he also told me that this decision is up the Ontario Teachers’ Federation and Ontario’s government and that OTPP can only make recommendations.

I guess everyone got a little something in this decision and they wisely only used a portion of the surplus (what percentage is confidential) to restore inflation protection to teachers who retired after 2009.

Of course, to even contemplate restoring inflation protection, pension plans need a surplus to begin with, and most pension plans are struggling with deficits and can only dream of achieving the funded status of an Ontario Teachers or a HOOPP.

This decision also highlights something else I’ve been discussing, the importance of implementing a shared-risk model so beneficiaries and plans sponsors equally share the contribution risk of the plan if a deficit occurs and enjoy benefits (like lower contribution rate or full inflation protection) when the plan has a surplus.

It’s not rocket science folks. You need good governance, a shared-risk model, an independent and qualified board overseeing qualified investment officers who can deliver outstanding results over the long term and get compensated properly for delivering these stellar returns.

This is why I firmly believe the solution to any retirement crisis centers around large, well-governed defined-benefit plans. If you aren’t convinced, just look at the success of HOOPP and Ontario Teachers’ Pension Plan. The proof is in the pudding, it’s right there staring all of us in the face.

Ontario’s teachers and healthcare workers are very lucky to have their retirement managed by world class pension plans. Unfortunately, too many Canadians don’t have this luxury and fall through the cracks after they retire with little or no savings.

This is why I kept pounding the table to enhance the CPP so more Canadians can retire in dignity and security but a lot more needs to be done.

I’ll give you some examples. Some people don’t contribute directly to the Canada Pension Plan and if they manage to save for retirement, they can only opt for mutual funds that can only invest in public markets and charge huge fees. Why shouldn’t they be able to invest their hard earned savings in the CPP so their retirement can be managed by the CPPIB which invests directly in public and private markets all over the world?

What else? The Registered Disability Savings Plan (RDSP) is a Canada-wide registered matched savings plan specific for people with disabilities. It’s a fantastic plan for people with disabilities and parents who care for children with disabilities. Again, why not offer these people the chance to invest in the CPP so their disability savings can be managed by the CPPIB?

[Note: Of course, the financial services industry wouldn’t be to happy competing with CPPIB or any of Canada’s large, well governed pensions.]

In my last comment going over the 2016 Delivering Alpha conference,  I stated the following:

What are long-term investors like pensions suppose to do? Well, they can read the wise insights of Jim Keohane, Leo de Bever and others on my blog but I have to tell you, there’s no magic bullet in a low growth environment where ultra low and negative rates are here to stay.

I’ve long warned all investors to prepare for lower returns and think it’s going to get harder and harder for large hedge funds and private equity funds to deliver alpha in a ZIRP and NIRP world.

In this environment, I believe large, well-governed defined-benefit pensions with a long-term focus have a structural advantage over traditional and alternative active managers who are pressured to deliver returns on a short-term basis.

So, if you’re retirement savings are being managed by a HOOPP, OTPP, CPPIB, Caisse, PSP, OMERS, bcIMC, AIMCo, OPTrust, and other large, well-governed pensions, you’re very lucky. For the rest of you, try to save a nickel for retirement and prepare for pension poverty.