Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.
Vipal Monga and Heather Gillers of the Wall Street Journal report, Dow 20000 Won’t Wipe Away Pension Problems:
The 2016 surge in stocks and bond yields is a rare positive for U.S. company and public pensions. But it doesn’t solve their problems.
In November large corporate retirement plans gained back $116 billion needed to pay out future benefits largely because of dramatic market movements following Donald Trump’s Nov. 8 election win, according to consulting firm Mercer Investment Consulting LLC.
The S&P 500 soared and long-term interest rates rose, boosting asset values and lowering liabilities for pensions at 1,500 of the largest U.S. companies. The present-day value of future obligations owed by companies falls when interest rates rise.
Even with November’s gains, corporate pensions were left with a $414 billion funding deficit, $10 billion larger than it was at the end of last year, according to Mercer. Funding deficits occur when the value of assets in pension plans don’t equal the projected future payments to retirees.
“It’s been good, but not great,” said Michael Moran, pension strategist at Goldman Sachs Asset Management. “Things are better than where we were a month ago, but it’s still too early to declare victory.”
That tempered reaction indicates the magnitude of the funding gap faced by managers of retirement assets across the U.S. Pensions still haven’t recovered from the chronic deficits created by the financial crisis and perpetuated by low interest rates.
The largest corporate-pension funds lost more than $300 billion during the 2008 downturn, according to consulting firm Milliman Inc., and that loss wiped out the previous five years of gains.
Pension deficits are a big deal for companies, because firms must close funding gaps with cash they could use for other purposes. Companies such as General Motors Co., International Paper Co., and CSX Corp. have all borrowed money this year to pump funds into their pension plans.
Companies in the S&P 1500 have contributed $550 billion into their pension plans between 2008 and Nov. 30 of this year, according to Mercer. Even with those contributions, their funded status was 81.3% as of Nov. 30.
Although pension-funding levels fluctuate during the year, most companies lock in their pension obligations at the end of the year for accounting purposes. November’s run-up, if it continues into December, could help lessen the burden of what had earlier been shaping up to be a big drag on 2016 financial results.
Funding holes are a trickier problem for funds that manage the pension assets of public workers because market rallies don’t automatically help close the gap.
Public-pension liabilities have grown significantly over the past decade, with the 30 largest plans tracked by the Public Plans Database showing a net pension debt of $585 billion in 2014, compared with $186 billion in 2005.
Almost all public retirement systems engage in an accounting practice known as “smoothing” returns, meaning it takes time to fully recognize investment earnings that exceed expectations. That approach limits how much the funding status will improve this year even if strong stock markets help the plans earn a return above their targets.
“All we know is that interest rates have popped up a little bit and equity prices have run up over the last three weeks,” said Alan Perry, an actuary with Milliman. “How that’s going to filter into the ingredients that go into forecasting long-term returns, it’s too early to tell.”
The largest public pension in the U.S., California Public Employees’ Retirement System, is debating whether to lower its expected rate of return—currently 7.5%.
The fund, known by its acronym Calpers, absorbed substantial losses during the last recession and currently has just 68% of assets needed to pay for future obligations. It earned 0.6% on its investments in the fiscal year ended June 30, well short of its annual goal.
“It’s too early to tell whether this [recent improvement] is something that’s going to be sustained,” said California State Controller Betty T. Yee, who serves on Calpers’s board.
This is a good article which explains why big gains in the stock market and the backup in yields aren’t going to make a dent in America’s ongoing pension crisis.
First, let me split US private pensions apart from US public pensions. Unlike the latter, the former aren’t delusional when it comes to discounting their future liabilities. In particular, they don’t use rosy investment assumptions to discount future liabilities but actual AAA corporate bond yields which have declined a lot as government bond yields hit record lows.
Some think using market rates artificially inflates pension deficits at America’s corporate defined-benefit plans and there is some truth to this argument. But one thing is for sure, if reported corporate pension deficits are higher than they should be at private corporations, US public pension deficits are woefully under-reported using a silly and delusional approach which discounts future liabilities using a pension rate-of-return fantasy.
Now, it’s in US corporations’ best interests to over-report their pension deficits just like it’s in the best interests of US public plans to under-report them. How so? Aren’t pension deficits a noose around the neck of US corporations?
Yes, they are which is why they are trying to offload the risk onto employees and get rid of defined-benefit plans altogether for any new employees. What concerns me is that they are shifting everyone into defined-contribution plans which will only ensure more pension poverty down the road. That is the brutal truth on DC pensions, they aren’t real pensions employees can count on.
Interestingly, in an email exchange, Jim Leech, the former president of the Ontario Teachers’ Pension Plan, agreed with Bob Baldwin’s comments on Canada’s great pension debate and added this:
“My recollection is that the Tories were lobbied hard for this after New Brunswick succeeded in its reform and reluctantly introduced the TB concept. I say reluctantly because they were more interested in promoting their group DC plan – forget the name (it was PRPPs).
So drafting was in works by civil servants before Liberals won. The Canada Post labour strife put back on front burner as TB is most helpful answer there but unions are fighting tooth and nail. Liberals likely thought there would be no outcry as there was none when Tories announced originally.
Still amazed that GM/Unifor went straight to DC instead of adopting TB.”
What Jim is referring to is that sponsors are shifting employees into defined-contribution plans without first assessing the merits of target or variable-benefit plans.
Of course, TB plans are not DB plans and this is something that employees should be made aware of and something Bob Baldwin explained further when I asked him where he considers various plans (like OTPP, HOOPP, OMERS, etc.) fall in the spectrum:
“I would reserve the term Target Benefit for plans in which all accrued benefits (i.e. accrued benefits of active members, retirees and deferred vested benefits) are subject to adjustment based on the financial status of the plan. Aside from the New Brunswick’s shared risk plans, the best examples of this type of plan are the union initiated multi-employer plans. I would describe OTPP and HOOPP as plans that are largely but not purely DB. They are not purely DB because they have shifted some financial risk from the contribution rate to the benefits.
The fact that you asked the question is important to me. It speaks to the reality that pension design is more like a spectrum of choice rather than a binary choice between DB and DC or even a three way choice among DB, DC and TB. There are any number of ways that financial risk can be allocated. Unfortunately, when the reality that confronts us is a spectrum, the language we will choose to describe it will almost always be more categorical than the reality itself. That’s why in my earlier email urged paying more attention to how risk is allocated and less to the labels we use.”
I agree with Bob Baldwin and might add that even though OTPP and HOOPP are fully or even over-funded, not every public pension plan can do what they’re doing either because they don’t have the governance or because their investment policies don’t allow them to take the leverage that these two venerable Canadian pension plans take.
Also, while I like their use of adjusting inflation protection partially or fully to get their respective plans back to fully-funded status, former actuary Malcolm Hamilton made a good point to me yesterday that in a low inflation world, adjusting for inflation protection becomes a lot harder and less effective (God forbid we go into deflation, then there will be no choice but to raise contributions, cut benefits or increase taxes).
I highly recommend every state plan follows CalPERS and gets real on future returns but I recognize this will have ripple effects on the US economy and deter from growth over a long period.
The problem is ignoring the elephant in the room and waiting for disaster to strike (another financial crisis) will only make the problem that much worse in the future and really deter from US growth.
President-elect Trump is meeting with tech executives today. I think that is great as America needs to tackle its productivity problem, but something tells me he should also meet with leaders of US pension plans to discuss how pensions can make America great again.
One thing is for sure, Dow 20,000 or even 50,000 under Trump isn’t going to solve America’s pension ills or make a dent in America’s ongoing retirement crisis. And if we get another financial crisis, deflation, Dow 5,000 and zero or negative rates for a very long time, all pensions are screwed, especially US public pensions.