Video: New Thinking About Retirement Risk Sharing

The above talk was given by Peter Shena, Executive Vice President and Chief Pension Officer of the Ontario Pension Board, at the 2014 Pension Research Council Conference.

Shena speaks about “creative, progressive risk-share models” implemented in some European countries that go beyond defined-benefit or defined-contribution plans. He also talks about his concerns about the sponsor’s role in these plans.

Two Pension Bills Sitting in Pennsylvania Legislature Likely to Resurface In 2015


Pennsylvania’s outgoing governor, Tom Corbett, made reforming the state’s pension system his top priority over the last year. But his plan – which would shift new hires into a “hybrid” plan with characteristics of a 401(k) – failed to enthuse most legislators.

Still, two pension bills are still sitting in the legislature, and they are likely to be brought up again in 2015. The first bill mirrors Corbett’s “hybrid idea”. As described by the Scranton Times-Tribune:

The hybrid plan, proposed by state Rep. Seth Grove, R-York, would maintain defined benefit plans for current employees and retirees and shift new hires into a plan that has features similar to 401(k) plans.

The proposal has several provisions to help municipalities reduce pension deficits, including guaranteeing a rate of investment return and allowing any excess earnings to be used to reduce the pension plan’s unfunded liabilities, said Rep. Grove.


The bill was introduced in the last legislative session, but never made it out of the Local Government Committee. Rep. Grove said he plans to reintroduce the bill in the next session.

The other bill takes a different approach. From the Times-Tribune:

The other bill focuses on reforming Act 111, which requires binding arbitration when a municipality is unable to reach a contract with its police or firefighters unions.

State Rep. Rob Kauffman, R-Chambersburg, introduced a bill last year that would, among other things, require an arbitrator to consider a municipality’s ability to pay when issuing an award. It did not make it out of committee, but is expected to be reintroduced this session, said Rick Schuettler, executive director of the Pennsylvania Municipal League, which supports the legislation.

Municipal officials statewide have long-complained that binding arbitration is stacked in favor of the unions, with arbitrators often issuing excessive awards.

How likely are these bills to gain any traction? The second one has the better chance, because incoming Gov. Tom Wolf is opposed to changing the pension system to a “hybrid” plan.

New York Comptroller Candidates Square Off on Pensions

Thomas P. DiNapoli

The New York State Comptroller serves as the sole trustee of New York’s $176.8 billion retirement system. So it’s not surprising that pensions were among the first issues broached during Wednesday night’s televised debate between the two candidates for Comptroller, incumbent Thomas DiNapoli (D) and newcomer Robert Antonacci (R).

Antonacci voiced several of his gripes with the state’s pension system; he claimed the assumed rate of return was too high and that the system should take on more characteristics of a 401(k)-style plan. From the Democrat and Chronicle:

Antonacci, who since 2007 has served as Onondaga County comptroller, took several opportunities to criticize DiNapoli’s oversight of the system. The pension fund’s assumed rate of return of 7.5 percent, Antonacci said, was too high.

A certified public accountant, Antonacci also said he believes the state should move toward offering defined-contribution retirement plans — what many would think of as a 401k-style plan. State and local-government employees currently receive defined-benefit plans, in which the payout at the time of retirement is determined by a formula and not subject to the whims of the stock market.

“We have to make some fundamental changes to the pension fund, including talking about a defined-contribution plan,” Antonacci said.

DiNapoli disagreed, saying a move to a 401k-style system would hurt working New Yorkers. He touted the performance of the pension fund — which is consistently ranked as one of the best-funded public plans in the country — while acknowledging his office may decide to lower the assumed rate of return in the future.

“Moving to defined contribution would put more and more New Yorkers at risk of not having adequate income in their golden years,” DiNapoli said. “That would be a bad choice for New Yorkers.”

DiNapoli is leading in the polls by 28 percent.


Photo by Awhill34 via Wikimedia Commons

Study: Has a 400 Percent Increase in Alternatives Paid Off For Pensions?

CEM ChartA newly-released study by CEM Benchmarking analyzes investment expenses and return data from 300 U.S. defined-benefit plans and attempts to answer the question: did the funds’ reallocation to alternatives pay off?

The simple answer: the study found that some alternative classes performed better than others, but underscored the point that “costs matter and allocations matter” over the long run.

In the chart at the top of this post, you can see the annualized return rates and fees (measured in basis points) of select asset classes from 1998-2011.

Some other highlights from the study:

Listed equity REITs were the top-performing asset class overall in terms of net total returns over this period. Private equity had a higher gross return on average than listed REITs (13.31 percent vs 11.82 percent) but charged fees nearly five times higher on average than REITs (238.3 basis points or 2.38 percent of gross returns for private equity versus 51.6 basis points or 0.52 percent for REITs). As a result, listed equity REITs realized a net return of 11.31 percent vs. 11.10 percent for private equity. Net returns for other real assets, including commodities and infrastructure, were 9.85 percent on average. Net returns for private real estate were 7.61 percent, and hedge funds returned 4.77 percent. On a net basis, REITs also outperformed large cap stocks (6.06 percent) on average and U.S. long duration bonds (8.97 percent).

Many plans could have improved performance by choosing different portfolio allocations. CEM used the information on realized net returns to estimate the marginal benefit that would have resulted from a one percentage point increase in allocation to the various asset classes. Increasing the allocations to long-duration fixed income, listed equity REITs and other real assets would have had the largest positive impacts on plan performance. For example, for a typical plan with $15 billion in assets under management, each one percentage point increase in allocations to listed equity REITs would have boosted total net returns by $180 million over the time period studied.

Allocations changed considerably on average from 1998 through 2011. Of the DB plans analyzed by CEM, public pension plans reduced allocations to stocks by 8.5 percentage points and to bonds by 6.6 percentage points while increasing the allocation to alternative assets, including real estate, by 15.1 percentage points. Corporate plans reduced stock allocations by 19.1 percentage points while increasing allocations to fixed income by 10.5 percentage points (consistent with a shift to liability driven investment strategies), and to alternative assets by 8.6 percentage points. For the DB market as a whole, allocations to stocks decreased 15.1 percentage points; fixed income allocations increased by 4.3 percentage points; and allocations to alternatives increased by 10.8 percentage points. In dollar terms, total investment in alternatives for the 300 funds in the study increased from approximately $125 billion to nearly $600 billion over the study period.

The study’s author commented on his findings in a press release:

“Concern about the adequacy of pension funding has focused attention on investment performance and fees,” said Alexander D. Beath, PhD, author of the CEM study. “The data underscore that when it comes to long-term net returns, costs matter and allocations matter.”


“Many pension plans could have improved performance by choosing different allocation strategies and optimizing their management fees,” Beath continued. “Listed equity REITs delivered higher net total returns than any other alternative asset class for the fourteen-year period we analyzed, driven by high and stable dividend payouts, long-term capital appreciation and a significantly lower fee structure compared to private equity and private real estate funds.”

Read the study here.

Changing the Conversation About Pension Reform

conversation bubbles

Keith Ambachtsheer, Director Emeritus of the International Centre for Pension Management at the University of Toronto, wants to change the conversation around pension reform from “dysfunctional” to “constructive”.

In a recent article in the Financial Analysts Journal, Ambachtsheer explains how the reform conversation can be “re-framed” and become more productive. He writes:

The sustainability of traditional public sector defined benefit (DB) plans has become front-page news and the subject of acrimonious debates usually framed in stark terms of DB versus DC (defined contribution). This either/or framing is unhelpful: It simply perpetuates the strongly held views of the defenders and critics of these two opposing pension models. Moving the pension reform yardsticks in the right direction requires that we stop this dysfunctional either/or framing and move on to a more constructive conversation about what we want our pension arrangements to achieve and what that tells us about how to design them.


So, how do I propose to change the conversation about pension reform from dysfunctional to constructive? By reflecting on the implications of five pension design realities:

1. All good pension systems have three common features.

2. All pension systems have embedded risks that must be understood and managed.

3. Some of these risks have an intergenerational dimension.

4. Pension plan sustainability requires intergenerational fairness.

5. Achieving this fairness has plan design implications.

The three design features common to all good pension systems are:

1. inclusiveness—all workers are afforded a fair opportunity to provide for their retirement;

2. fitness-for-purpose—the system is purposefully designed to start paying a target pension for life on a target retirement date; and

3. cost-effectiveness—retirement savings are transformed into pension payments by “value for money” pension organizations.

Surely, no rational person would disagree with these three features. So far, so good.

Ambachtsheer goes on to talk about the failings of DB plans in recent years – but says it would be a “tragedy” to scrap them for DC plans:

Remember how we talked ourselves into a “new era” paradigm as the last decade of the 20th century unfolded? As it ended, most DB plan funded ratios were well over 100%. Did we treat these balance sheet surpluses as “rainy day” funds to see the plans through the coming lean years? We did not. Predictably, we spent the surpluses on benefit increases and contribution holidays. After all, was this not a new era of outsized economic growth rates and stock market returns? Was taking on more risk not synonymous with earning even higher returns?

A decade later, we know that the answers to these turn-of-the-century rhetorical questions are no and no. On top of these stark economic realities, red-faced actuaries are now confessing that they have been underestimating increases in retiree longevity for quite some time.

Given the current poor financial condition of many public sector DB plans, it should come as no surprise that people on the far right of the political spectrum want to do away with this type of pension arrangement altogether. Doing so would be a tragedy. I agree with Leech and McNish that none of these weaknesses need be fatal if we repair them now.

But how to repair DB plans? Ambachtsheer offers the idea of defined ambition (DA) plans. He writes:

It seems to me that ditching the dysfunctional DB/DC language is the best way to start these repairs. Political leaders in the United Kingdom, the Netherlands, Denmark, and Australia have already done so. They now speak of defined ambition (DA) pension plans. Vigorous debates on how best to design and implement DA plans are taking place in all four countries.3 In my view, a good DA pension plan has six critical features:

1. A target income-replacement rate—how much postwork income is needed to maintain an adequate standard of living?

2. A target contribution rate—given realistic assumptions about working-life length, longevity, and net real investment returns, how much money needs to be set aside to achieve the pension target?

3. Course correction capabilities—the plan provides regular updates on progress toward targets and offers course correction options when needed.

4. Fully defined property rights and no intergenerational wealth shifting—the plan design is tested for intergenerational fairness and clear property rights.

5. Long-horizon wealth-creation capability—the pension delivery organization can acquire and nurture healthy multi-decade cash flows (e.g., streams of dividends, rents, tolls) through a well-managed long-horizon investment program.

6. Payment-certainty purchase capability—plan members can acquire guaranteed deferred life annuities at a reasonable price.

The entire article, which contains more analysis than excerpted here, can be read here.


Photo by AJC1 via Flickr CC License

Think Tank Director: Corbett’s Pension Proposal Would Increase Pension Debt and Reduce Benefits

Tom Corbett

Stephen Herzenberg, the executive director of the Keystone Research Center, took to the newspaper on Monday to counter Pennsylvania Gov. Tom Corbett’s argument that the best bet for saving the state’s pensions would be to switch new hires into a 401(k)-type plan.

Herzenberg claims in an op-ed that such a plan would provide no savings for the state, reduce benefits for retirees and actually increase the state’s pension debt.

Herzenberg starts by talking about the fees and other costs associated with 401(k) plans. From the op-ed, published in the Patriot-News:

For two years, Governor Corbett has advocated a shift from pooled, professionally managed, defined-benefit pensions to a system where each employee manages an individual account, similar to a private sector 401(k) plan.


How does the efficiency of today’s defined benefit pensions system translate, in bottom-line terms, measured by the level of contributions required to fund retirement? According to the National Institute on Retirement Security, individual 401(k)-style accounts cost 45% to 85% more than traditional pooled pensions to achieve the same retirement benefit. That’s a big efficiency gap.

A lot of this efficiency gap results from the fees that financial firms charge holders of individual accounts – for administration, for financial management and trading stocks, and for converting savings at retirement into a monthly pension check guaranteed until the end of life – an “annuity.” In essence, these fees are transfer from Main Street retirees to Wall Street. In an economy with stagnant middle-class incomes and all the gains for recent growth already going to the top, such a transfer seems like the last thing we need.

Given the high fees and low returns of 401(k)-style accounts, it is hardly a surprise that actuaries who have studied the Governor’s proposal for an immediate switch to them – or a more gradual switch under a new “hybrid” proposal that the Governor now supports – don’t find any savings.

Far from providing savings, in fact, this switch could result in a large upfront transition costs – because the investment returns on the existing pension plans would fall as the plans wind down. The Governor’s plan was projected to have a $42 billion transition cost.

He goes on to write that Corbett’s plan would be “highly inefficient” and would actually reduce retirement benefits. From the op-ed:

The switch would also reduce retirement benefits. This is not only bad for teachers, nurses, public safety personnel, and other public servants. It could also require a future wage increase to enable the state and school districts to attract and retain high-quality staff – another cost to taxpayers.

In his recent book on inequality, economist Thomas Piketty worries that high returns and low financial management costs are only accessible to massive pools of wealth. This means that the assets of the wealthiest individuals and families grow faster than the wealth of the rest of us. It reinforces the drfit back towards Gilded Age levels of wealth inequality.

But in the context of public sector retirement plans, defined-benefit pensions give taxpayers and the middle class the ability to grow their pooled retirement savings in the same manner as Warren Buffet and Bill Gates.

If define benefit pensions are poorly managed, as they have been in Pennsylvania, they do create some challenges. As with paying a credit card bill, if you don’t put in the required contributions you can run up a large expensive debt. But the way to fix that problem is to pay the required contributions, not to switch to a highly inefficient retirement savings vehicle.

Read the entire column here.

Funded Status Of Canadian Pensions Falls in Third Quarter

Canada blank map

The funded statuses of Canada’s defined benefit plans collectively fell in the third quarter to 91.1 percent, marking a 4.9 percent decline over the last three months; at the end of the second quarter, plans were 96 percent funded.

The data comes from Aon Hewitt, who surveyed 275 of Canada’s defined benefit plans, both public and private.

From MarketWired:

[The DB plans’] median solvency funded ratio — the market value of plan assets over plan liabilities — stood at 91.1% at September 26, 2014. That represents a decline of 4.9 percentage points over the previous quarter ended June 30, 2014, a 5.5% drop from the peak of 96.6% reached in April 2014, and a 3.1% increase over the same quarter in 2013. With the decline, this quarter’s survey results reverse a trend throughout 2013 and 2014 of improving solvency positions for the surveyed plans. As well, approximately 23% of the surveyed plans in Q3 were more than fully funded at the end of the third quarter this year, compared with 37% in the previous quarter and 15% in Q3 2013.


“Canadian DB plans have strung together a nice run of winning quarters, but as we have been saying for some time now, market volatility continues to present significant risks and plan sponsors should be implementing or fine-tuning their de-risking strategies in order to stay current and optimized in the face of ever-changing capital market conditions,” said William da Silva, Senior Partner, Retirement Practice, Aon Hewitt.

“Now that we have seen plan solvency decline for the first time in over a year and a half, hopefully this will serve as a wake-up call to all plan sponsors to consider their funding and investment strategies with risk management as their key objective. Overall Canadian plan solvency is still relatively strong compared to where things stood just a few years ago, so there is still time to act. But with new mortality tables coming into effect, we expect material increases in liabilities for many plans. Clearly, that is another signal that the time to act is now.”

The 4.9 percent drop in funding was the first funding decline in nine quarters, or over two years.

Funding Status of Largest Plans Falls in August


The funded ratios of the largest pension plans in the country collectively fell during the month of August, according to a Milliman report. Reported by Pensions & Investments:

The funded status of the 100 largest U.S. corporate pension plans fell to 84% in August, down from 84.8% in July, said the latest Milliman 100 Pension Funding index.


During the same period, investments returned 1.92%, the second best monthly return of the year, Mr. Wadia said, surpassed only by February’s 2.3% return. Assets rose to $1.47 trillion in August from $1.45 trillion in July.

If the pension funds achieve a median 7.4% annual return and the discount rate remains at the current 3.89%, the funded status would increase to 84.9% by the year’s end, still a 3.4-percentage point drop from 88.3% in December 2013, according to Milliman.

“The reason (the funded status) hasn’t fallen more (year-to-date) is because of positive asset growth,” Mr. Wadia said. Assets have returned 7.5% year to date Aug. 31.

The largest corporate defined-benefit plans, on the other hand, improved in August, as funded status improved from 88.3 percent to 88.4 percent.

Controversy Surrounds Pensions of Retired Detroit-Area Politicians

Detroit, Michigan

Some Michigan residents are questioning the retirement package of Detroit-area politician Robert Ficano, who lost re-election last month after becoming embroiled in several scandals but still retired with a 401(k) worth between $1.5 and $2 million.

But experts say the retirement package is relatively “normal”, and the public’s outrage should be directed at a policy implemented by Ficano that sweetened the pensions of his appointees. From Detroit News:

[Ficano’s deal] allowed workers to use retirement savings to buy into defined benefit plans that guaranteed them a percentage of their best years’ salaries.

In 2011, he upped the offer to his appointees, waiving rules that required retirees to be at least 55 and allowing them to buy years of service at a discount.

Among others, the plan created pensions that paid former Ficano adviser William Wolfson $124,000 per year at age 50; personnel director Tim Taylor $118,000 per year; and former chief of staff Matt Schenk $96,711 per year at age 41. Schenk’s plan alone will cost taxpayers $4 million over its lifetime if he lives to be 82.

Pension officials say the deals strained the retirement system, which is funded at 48 percent.

The average pension for county retirees is about $22,000 per year. Retired workers don’t feel bad for Ficano, said Joyce Ivory, president of AFSCME Local 1659.

“Our workers suffered tremendously under Bob,” said Ivory, whose 700-member union represents clerks, wastewater treatment workers and others.

“So there’s no sympathy for his retirement plan. It’s just ‘goodbye.’ ”

Ficano declined requests for comment.

Documents obtained by Detroit News contain estimates that Ficano contributed about $100,000 to his 401(k) during his career.

The Accounting Implications of Job-Hopping and the Shift to 401(k)s

401k savings jar

Two trends have been building in recent years, and now they are set to collide: on one hand, employers are increasingly shifting workers into defined-contribution plans. On the other, workers are becoming more likely to move between companies numerous times over the course of their working lives. Those trends together are bound to butt heads. Canover Watson writes:

As with many other major Western economies, the US in recent decades has seen its pensions landscape shift away from “defined benefit” (DB) to “defined contribution” (DC) plans […] The move from the former to the latter is unmistakable. […] DB plans tend to favour long-tenured employees, are not transferred so easily between employers, and so are less suited to a highly mobile workforce.

The effective result of this transition is that individual savings accounts, originally intended to supplement DB plans, have ended up supplanting them. This has rendered the question of optimizing returns from investments a cornerstone of the pension debate, as these returns now directly dictate the employees’ eventual retirement income.

Present and future retirees’ exclusive dependence on 401(k)s has upped the ante for all stakeholders–these funds need to achieve consistent returns required to provide liveable, income during retirement. But different funds and managers operate in different ways, and those differences are amplified when a worker switched employers numerous times. From Canover Watson:

What is required is the consistent application of a single accounting approach to underpin accurate portfolio valuations. The answer to achieving this, as with many things in our modern world, lies partly with technology and automation-namely the adoption of a master accounting system at the level of the pension fund.

The shift to DC plans and the multimanager model, both represent a step forward: the creation of a more sustainable, efficient system for ensuring that citizens are able to generate sufficient income for their retirement years. Yet, unless these changes are met with a more sophisticated, automated approach to accounting, pension returns ultimately will be short-changed by the march of progress.

To read the rest of this journal article, click here.

The article was published in the Journal of Pension Planning and Compliance.

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