Pension360

Chicago Mayor Rahm Emanuel this week released an actuarial report on his proposal to raise the city’s water and sewer tax and use the revenue to fund the city’s pension funds.

Emanuel is trying to prove to lawmakers that the windfall of new revenue from the tax will be sufficient to improve pension funding.

But some lawmakers are peeved that Emanuel waited so long to produce the hard numbers.

From the Chicago-Sun Times:

On the eve of a crucial Finance Committee vote, Mayor Rahm Emanuel released an actuarial analysis in hopes of proving to aldermen that his 29.5 percent tax on water and sewer bills will be enough to save the largest of Chicago’s four city employee pension funds.

It didn’t work with the anti-Emanuel Progressive Caucus that demanded the study of the mayor’s plan for the Municipal Employees Pension Fund weeks ago and was miffed about getting it hours before the vote.

“The numbers just don’t add up . . . In 2023, there will be a pretty huge gap. There’ll have to be some other source to pay for that gap,” said Ald. Scott Waguespack (32nd).

[…]

Civic Federation President Laurence Msall said the analysis shows that the infusion of $1 billion in new revenue from the new utility tax by 2023 will put the city’s largest pension fund in a “significantly better place.”

But Msall noted that even with that windfall — and continued contributions from property taxes, the corporate fund and enterprise funds that support operations of O’Hare and Midway Airports as well as the city’s water and sewer systems — the condition of the pension fund will continue to drop over the next five years with “more benefits going out than coming in.”

City CFO Carol Brown defended the proposal:

Budget Director Alex Holt and Chief Financial Officer Carole Brown acknowledged that increased funding will be needed after the “ramp-up” to a so-called “actuarially required contribution.”

[…]

Noting that the 29.5 percent tax on water and sewer bills would be phased in, Holt said, “It’s the growth over four years that gets us to the ramp. At the end of that period, there will need to be further savings or further revenue to fund the ongoing increase. There is room for further increasing the water-sewer tax. But there are other possibilities as well. The mayor has been big on further benefit reforms. Those may produce future savings. There are other options as well. Going from contributing $1 billion in six years to $3 billion in six years should help investment returns and allow them to not have to spend so much of their assets on benefits.”

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

Anthony Boadle of Reuters reports, Brazil’s new government buffeted by pension fund scandal (h/t, Suzanne Bishopric):

The government of Brazil’s new President Michel Temer scrambled on Tuesday to distance itself from a multibillion-dollar corruption scandal that broke less than a week after he took office, involving fraud in the country’s largest pension funds.

With the country already reeling from a sprawling bribery and kickback scandal at state oil company Petrobras, the new corruption case could hamper the conservative Temer’s efforts to restore credibility and turn the page on the leftist government of impeached President Dilma Rousseff.

Police on Monday arrested five people linked to fraudulent investments made by four huge pension funds of state-run companies. The investigation snared dozens of businessmen and fund managers suspected of involvement in a fraud scheme valued at around 8 billion reais ($2.5 billion), including the chief executive of the world’s biggest beef exporter.

The coveted appointments of directors to the funds’ boards were made by political parties and the probe is expected to spread to Brazil’s political establishment, where some 50 politicians are already under investigation in the Petrobras scandal.

Temer’s office said the appointments were made during the 13 years of Workers Party rule that ended with Rousseff’s removal from office last week, and the “irregularities” uncovered by the police had nothing to do with the current administration.

“The Workers Party appointed the pension fund directors from the moment it took office in 2003 and they were closely linked to the unions,” said a Temer aide who asked not to be named.

“The Workers Party was responsible for the big loss suffered, ironically, by the workers of the state companies who were saving for their retirement,” the aide said. “This has not even scratched the image of the new government.”

Temer’s government will press for a thorough investigation as it pushes through proposed legislation that will depoliticize the appointment to directors of state companies, he said.

The investigation focuses on investments in overpriced assets, including private equity funds with artificially inflated share prices, according to the federal police.

The Workers Party declined to comment on the investigation but its president, Rui Falcao, denounced as “arbitrary” a raid and seizure of documents at the home of the party’s former treasurer Joao Vaccari, jailed a year ago in the Petrobras scandal.

POLITICAL INTERFERENCE

Political observers in Brasilia doubt that Temer’s Brazilian Democratic Movement Party will emerge unscathed from the new scandal, since it shared power with the Workers Party during the years the fraud allegedly took place. The party has also been deeply implicated in the Petrobras scandal.

The state-company pension funds, flush with cash, have long been vulnerable to political interference and dogged by suspicions of fraud, said political risk consultant Andre Cesar.

“The 8 billion reais is just the tip of the iceberg. They have opened a Pandora’s Box and names of politicians will inevitably appear sooner or later,” Cesar said.

Even if nobody in Temer’s government is implicated, the new scandal underscores some of the unsavory ties between business and political interests in Brazil that have undermined confidence in Latin America’s largest economy.

“What are voters going to think? We just got rid of one government and corruption continues just the same in the new one,” Cesar said.

The pension funds caught up in the investigation are those of state-run banks Banco do Brasil and Caixa Economica Federal, the postal service Correios and oil company Petrobras, or Petroleo Brasileiro SA. The funds have said they are cooperating with the investigation.

The funds, which controlled 280 billion reais in assets last year, have been an important source of investment in Brazil’s credit-starved economy, now in its second year of recession.

I just finished writing a comment on the global pension crunch, going over China and Chile’s pension woes, and the hits just keep on coming.

The latest pension scandal coming out of Brazil shouldn’t surprise us. Brazil and other Latin American countries are fraught with political corruption, and it’s no different in other emerging markets. These scandals typically come to the surface after a big boom turns into a big bust.

I discussed my thoughts on this recently when I went over Ontario Teachers’ Brazilian blunders:

Investing in emerging markets isn’t easy. You need to find the right partners and make sure they’ve got the right alignment of interests and aren’t con artists. I don’t trust many fund managers in Brazil and think there are a lot of blowhards there selling snake oil. Then again, Brazil is home of 3G Capital, arguably the best private equity fund in the world (at least Warren Buffet thinks so).

And while there’s no denying Brazil has huge potential, it’s currently experiencing a lot of political and economic turmoil, highlighted by the fact that the 2016 Rio Olympic Games are in dire straits.

The lesson for Canada’s large pension funds? Choose your investment partners very carefully in emerging markets like Brazil, Russia, China and India but no matter how well you vet them, be prepared for headline risk if things go awfully wrong.

Now, I don’t want to beat up on emerging markets like Brazil because the truth is scandals happen everywhere, including the United States and even boring old Canada (we just don’t hear about them every time because they are swept under the rug).

The key difference — and I keep harping on this — is that Canada’ radical pensions have adopted world class governance standards precisely to avoid undue political interference and corruption in their day-to-day operations.

Importantly, Canada’s large public pensions have an independent, qualified investment board overseeing their operations but not responsible for taking investment decisions or other decisions that are the responsibility of senior pension managers who get compensated extremely well if they deliver outstanding long term results.

Is it perfect? Of course not. No governance system is perfect and even in Canada, I can tell you there are shady things going on at large public pensions to varying degrees. It can be as “innocent” as a new CEO coming into power and placing all his people in key positions (basically, shoving them through the front and back door) on to more serious stuff like pension fund managers accepting bribes from external managers or third party vendors, service providers and brokers (to be fair, this is extremely rare but shady things do occur at large Canadian funds too).

Still, even though the governance at Canada’s large pensions is far from perfect, I would take our governance model over that of any other country, including the United States where public pensions are crumbling and many are facing disaster.

So the next time you hear of Brazil’s pension scandal or that of another country, just remember the root cause is poor governance which allows for public pensions to be easily corrupted or influenced by politicians who don’t have the pension’s stakeholders best interests at heart.

Of course, there’s outright corruption and then there’s what I call “systemic and legal corruption” like in the US where poor governance allows for undue political interference at public pensions, basically ensuring external fund managers can rake them on fees. This symbiotic and perverse relationship has been going on for years but now that the pension Titanic is sinking, the chicken has come home to roost, threatening the very foundations that Wall Street was built on.

I know, I sound like a hopelessly arrogant, cynical and critical Greek-Canadian jerk who needs to give everyone the benefit of the doubt when it comes to pensions but I’m not here to coddle people in power and you’re not reading me for the sanitized version of pensions and investments.

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

Yawen Chen and Nicholas Heath of Reuters report, China’s pension funds under pressure with rising payments:

Many Chinese pension funds are under renewed pressure to break even as local governments race to increase pension payments to meet central government requirements, state news agency Xinhua said in a commentary on Tuesday.

The central government has ordered pension payments for corporate retirees to be increased by around 6.5 percent in all provinces, Xinhua said.

China’s northeastern region of Liaoning has implemented a 6.75 percent rise in pension payments, which is estimated to cost the fund around 11 billion yuan ($1.65 billion).

Liaoning’s pension fund deficit was 10.5 billion yuan in 2015, Xinhua said, citing an annual report published by China’s Ministry of Human Resources and Social Security.

Pension funds in six provinces, including all three rustbelt provinces Liaoning, Heilongjiang and Jilin, already struggled with deficits in 2015, according to the report.

Despite the pressure to balance rising costs, the article said “systematic fiscal stipends would ensure costs to be balanced and that all retired corporate employees would receive full pension payments on time”.

China’s State Council, or cabinet, said late last year that dividends and income from state enterprises would be used to fill in gaps at pension funds and other social security funds, as part of plans to reform its inefficient and heavily indebted state-owned sector.

Xinhua said the coastal province of Shandong has spearheaded this effort, with Shandong transferring a sum of 18 billion yuan ($2.7 billion) so far and Shanghai planning to put no less than 19 percent of state enterprise income to subsidize the fund.

The last time I discussed China’s pension gamble was back in April when Beijing announced that it will allow state pension funds to invest in stocks, with the hope of lifting returns and aiding equity-market liquidity.

Now we see Beijing has much bigger problems to contend with in terms of funding its underfunded state pensions. Even in China, government bureaucrats know better than messing around with pension benefits.

But if you ask me, this is just the beginning of China’s massive pension woes. Sure, the Chinese have money to patch up their pension deficits but until they reform their state pensions and introduce real governance in terms of investment decisions, their underfunded state pensions are only going to become even more underfunded and this will be a huge problem for them in the future as their population ages.

And let’s not forget, China is at the center of Asia’s deflation crisis:

Research from the Hong Kong Monetary Authority on regional deflation has concluded that China lies “at the heart of the region’s deflation challenge” – with ramifications that could ripple across Asia.

A new white paper published by the HKMA’s monetary research institute has taken a look at declining producer prices across Asian economies. Policy wonks can find the full paper here, but in short its authors suggest their model’s findings confirm that spillover effects from China are one of the key determinants of Asian producer price deflation.

They go on to argue that a trifecta of issues in China – declining corporate profits, overcapacity and heavy debts – could undo recent rises in factory gate prices across Asia’s biggest economy. These factors increase the risk of producer price deflation, which the paper notes could ultimately lead to consumer deflation, kicking off a vicious cycle of deterioration for all of the above indicators.

Since the three issues outlined are more severe at China’s state-owned enterprises, the authors’ proposed fix centres on said government-run outfits:

[Besides] fiscal and monetary policies, supply side reforms such as tightening the overall credit growth, converting corporate debt into equity, and closing down non-profitable zombie firms, or any combination of these measures to reduce overcapacity and debt level, and improve the efficiency and profitability of state-own enterprises are required to avert a deflationary spiral.

The authors stop well short of suggesting major deflationary pressures are on the cards in the near term. But they warn that comprehensive reforms to address overcapacity and supportive policy to bolster demand are needed to avert a hard landing that could result in serious deflation throughout Asia.

One of the major policy reforms that China and the rest of the world need to address is to make sure as more and more people retire, they don’t succumb to pension poverty because that is extremely deflationary.

And China isn’t the only country struggling with its pensions. In the United States, the pension Titanic is sinking and many public pensions are crumbling. But unlike China, there is no more money left to throw at the problem, which is why we are seeing pitchforks and torches come out in cities like Chicago.

Of course, the pension problem is global in nature, a function of historic low rates, longer lifespans and terrible investment decisions guided by lousy governance standards.

Interestingly, over the weekend, Andrés Velasco, a former presidential candidate and finance minister of Chile, and Professor of Professional Practice in International Development at Columbia University’s School of International and Public Affairs, wrote a comment for Project Syndicate on Chile’s Pension Crunch:

Defined-benefit pension plans are under pressure. Changing demographics spell trouble for so-called pay-as-you-go (PAYG) systems, in which contributions from current workers finance pensions. And record-low interest rates are putting pressure on funded systems, in which the return from earlier investments pays for retirement benefits. The Financial Times recently called this pensions crunch a “creeping social and political crisis.”

Defined-contribution, fully-funded systems are often lauded as the feasible alternative. Chile, which since 1981 has required citizens to save for retirement in individual accounts, managed by private administrators, is supposed to be the poster child in this regard. Yet hundreds of thousands of Chileans have taken to the streets to protest against low pensions. (The average monthly benefit paid by Chile’s private system is around $300, less than Chile’s minimum wage.)

Chile’s government, feeling the heat, has vowed to change the system that countries like Peru, Colombia, and Mexico have imitated, and that George W. Bush once described as a “great example” for Social Security reform in the United States. What is going on?

The blame lies partially with the labor market. Chile’s is more formal than that of its neighbors, but many people – especially women and the young – either have no job or work without a contract. High job rotation makes it difficult to contribute regularly. And it has proven difficult to enforce regulations requiring self-employed workers to put money aside in their own accounts.

Moreover, the legally mandated savings rate is only 10% of the monthly wage, and men and women can retire at 65 and 60, respectively – figures that are much lower than the OECD average. The result is that Chileans save too little for retirement. No wonder pensions are low.

But that is not the end of the story. Some of the same problems plaguing defined-benefit systems are also troubling defined-contribution, private-account systems like Chile’s. Take changes in life expectancy. A woman retiring at age 60 today can expect to reach 90. So a fund accumulated over 15 years of contributions (the average for Chilean women) must finance pensions for an expected 30 years. That combination could yield decent pensions only if the returns on savings were astronomical.

They are not. On the contrary, since the 2008-2009 global financial crisis, interest rates have been collapsing worldwide. Chile is no exception. This affects all funded pension systems, regardless of whether they are defined-benefit or defined-contribution schemes.

Lower returns mean lower pensions – or larger deficits. The shock and its effect are large. In the case of a worker who at retirement uses his fund to buy an annuity, a drop in the long interest rate from 4% to 2% cuts his pension by nearly 20%.

The rate-of-return problem is compounded in Chile by the high fees charged by fund managers, which are set as a percentage of the saver’s monthly wage. Until the government forced fund managers to participate in auctions, there was little market competition (surveys reveal that most people are not aware of the fees they pay). A government-appointed commission recently concluded that managers have generated high gross real returns on investments: from 1981 to 2013, the annual average was 8.6%; but high fees cut net returns to savers to around 3% per year over that period.

Those high fees have also meant hefty profits for fund managers. And it is precisely the disparity between scrawny pension checks and managers’ fat profits that fuels protest. So, more challenging than any technical problem with Chile’s pension system is its legitimacy deficit.

To address that problem, it helps to think of any pension system as a way of managing risks – of unemployment, illness, volatile interest rates, sudden death, or a very long life span. Different principles for organizing a pension system – defined-benefit versus defined-contribution, fully funded versus PAYG, plus all the points in between – allocate those risks differently across workers, taxpayers, retirees, and the government.

The key lesson from Chile is that a defined-contribution, funded system with individual accounts has some advantages: it can stimulate savings, provide a large and growing stock of investible funds (over $170 billion in Chile), and spur economic growth. But it also leaves individual citizens too exposed to too many risks. A successful reform must improve the labor market and devise better risk-sharing mechanisms, while preserving incentives to save. It is a tall order.

Chile’s system already shares risks between low-income workers and taxpayers, via a minimum non-contributory pension and a set of pension top-ups introduced in 2008 (as Minister of Finance, I helped design that reform). Subsequent experience suggests that those benefits should be enlarged and made available to more retirees. But the Chilean government has little money left, having committed the revenues from a sizeable tax increase two years ago to the ill-conceived policy of free university education, even for high-income students.

In response to the recent protests, the government has proposed an additional risk-sharing scheme: some (thus far undecided) part of a five-percentage-point increase in the mandatory retirement savings rate, to be paid by employers, will go to a “solidarity fund” that can finance transfers to people receiving low pensions.

The goal is correct, but, as usual, the devil is in the details. In the medium to long run, it seems likely that wages will adjust, so that the effective burden of the additional savings will be borne by employees, not employers. One study estimates that workers treat half of the compulsory savings as a tax on labor income, so too-large an increase (especially in the funds that do not go to the worker’s individual account) could cause a drop in labor-force participation, a shift from formal to informal employment, or both. Chile’s economy does not need that.

There are no easy answers to the pensions conundrum, whether in Chile or elsewhere. Chilean legislators will have to make difficult choices with hard-to-quantify tradeoffs. Whatever they decide, irate pensioners and pensioners-to-be will be watching closely.

Mr. Velasco raises many excellent points in his comment but the key point I want to hammer in is the brutal truth on defined-contributions plans is they are by and large a miserable failure from a policy perspective and will only ensure widespread pension poverty.

The only long term solution to the pension conundrum is to follow Canada’s radical pensions and adopt the governance model that has allowed them to thrive over the very long run.

I know I sound like a broken record but mark my words, unless the world goes Canadian on pensions, the global pension crunch will only get worse.

Future county board members in Illinois won’t be receiving pensions unless they meticulously documents their work hours and pass a certain threshold, according to a statewide law signed by Gov. Bruce Rauner.

The law follows a controversy around board members claiming their pensions without working the required amount of hours.

The law received a rare showing of bipartisan support in the state legislature.

From the Chicago Tribune:

[State Rep. Jack Franks] got pension fund officials to investigate whether McHenry board members were improperly claiming the pensions despite not working the required 1,000 hours a year.

Eighteen of the 24 board members signed affidavits saying that they had worked enough hours to qualify. But when pension fund Executive Director Louis Kosiba asked to verify their claims, board members said they could not go back and document all their hours, noting that much of their work occurs outside of official settings, reading documents and talking to constituents.

In general, county board members are required to work at least 600 or 1,000 hours each year, varying by the county, to qualify for the Illinois Municipal Retirement Fund pension.

The retirement fund guidelines stated that a 1,000-hour limit — equal to about 20 hours a week — would make it “highly unusual” for any county board members to qualify.

Franks objected that county board members were trying to get a full-time taxpayer benefit for part-time work.

Massachusetts PRIM’s senior investment officer talked to Bloomberg BNA this week about the board’s success using managed accounts to change the landscape of its hedge fund portfolio.

Among the benefits: lower fees and greater transparency. From BNA:

Hedge Fund Transparency

[…] Managed accounts provide full transparency over what a hedge fund is doing with PRIM’s investments, said Nierenberg.

This enables PRIM, which has about $6 billion—or about 9 percent of its assets—in hedge funds and related investments, to “see in virtually real time” whether a hedge fund has been doing what it was hired to do.

PRIM may learn, for instance, that it needs to “fill in the gap” with other investments to account for what the hedge fund hasn’t been investing in, he said. Such transparency allows PRIM to accurately know how much risk exposure it has at any given time.

Negotiating Lower Fees

Many investors, including public plan trustees, have been concerned about the high fees charged by hedge funds, which commonly charge 2 percent in fees in addition to 20 percent of the hedge fund’s gains.

Nierenberg said that PRIM has been able to keep fees down by negotiating fee structures that are much lower than those typically charged to commingled account investors.

He said that the typical fee structure assessed in commingled arrangements may give way to something more like a 1 percent management fee and a 10 percent of gain carry. “Both the management fee and the carry are separate forms of manager compensation that can be negotiated,” he said.

In addition, Nierenberg said that PRIM has negotiated lower fees by customizing the services it gets in its managed accounts. For example, sometimes expenses that should be absorbed by the fund will get passed on to commingled account investors, he said. In managed accounts, the PRIM can negotiate the specific expenses that it will pay for, he said.