Thursday, January 22, 2015

Consulting With the Flavor of the Month

I've worked for several firms in my career and had the privilege of serving a large number of clients.Different consultants have different ways of serving their clients and different firms have different expectations of their consultants. Some of these practices generate what is to me a problem. Consultants bring their clients the flavor of the month, or worse yet, they bring them last month's flavor of the month.

What do I mean by that?

Suppose you or I are a consultant with a firm that tends to generate its ideas out of a centralized practice. As consultants in that practice, we find ourselves essentially required to talk to each of our clients and "check the box" saying that we had a conversation with them about January's flavor. I've been in that situation. And, while there are definitely right ways and wrong ways to do this, a consultant could easily find himself in a competing situation.

Consider that the January brainchild is a really cool and innovative idea around health plans. There will be companies that this idea is right for, but the idea is complex and therefore, probably a good idea only when a company's employees are particularly active participants in their own health outcomes and where they are financially savvy enough to know how to play the game, so to speak.

Because of this, I as a consultant working for one of those firms (I have, but I currently do not) may have competing goals leading to a conflict for me. Suppose I bring this idea to each of my clients as I am told. One of my clients, hypothetically, is a large chain of fast food restaurants that sits mostly along interstate highways in rural areas. The employees of this company, generally, earn minimum wage or just a little bit more, so they are not financially savvy. Additionally, most of what they eat is fried food and what I have learned over the years is that they really don't understand their own health.

My main contact, the Vice President of Human Resources absolutely loves my firm's idea. She took this position as a step up in her career after being a Benefits Manager at a large pharmaceutical company. There, the employees did take a role in their own health outcomes and the sophisticated group of scientists did have enough financial acumen to understand any pitfalls of this new design. I am left with competing interests:

  1. I can do right by my client and tell them that I just wanted to let them know what some other companies are doing, but that this idea might not be right for them and here's why; or
  2. I can sell the assignment because it will go a long way toward helping me to meet or exceed my goals.
I'd like to think that when faced with this conflict that I have always taken option 1. But, even if I have, I know people who have not.

There is something far worse than the flavor of the month consultant, however. Consider the consultant who pitches the flavor of last month, or even worse, the flavor of last year. This is the person who learns through the grapevine that the reason that his client base is gradually leaving him is that he didn't bring them any new ideas. So, he goes back to the handouts from meetings he attended earlier in the year and starts to pitch those ideas. He doesn't really understand them, but he is practicing (poorly, I might add) defensive client management. 

As an example, without going into great detail, Curtis O'Nsultant learned at the annual meeting of the Really Smart Consultants of America of a great new idea that works very well in a rising interest rate environment. Back in 2013, Curt lost a few clients because other companies marketed this idea to his clients. He wasn't aware of the idea then and he still doesn't understand it. But Curt knows that failing to bring the idea to his client base was costly, so he decided to bring it to his remaining clients in late 2014 to seemingly ensure that the rest of his client base would be safe. If he is lucky, or perhaps unlucky, enough to sell this idea to any of his clients, we know how that story will play out.

I'm thrilled to say that I don't have to deal with that now. I work with some really smart and creative people who come up with some great ideas. But, rather than telling me that I need to bring those ideas to my entire client base, I am asked to consider what an appropriate client would like and which of my clients fits that definition of appropriateness. Those are the clients that I will bring this new idea to.

Think about it.

Thursday, January 15, 2015

The Recommended Pension Contribution

For years, I have seen in many pension plan actuarial reports a line item that the actuary or the actuary's firm refers to as the "recommended contribution." When reviewing these reports, that item has always been an anomaly to me.

Sometimes, what it represents is spelled out in the report; sometimes, it's not. But, when it is seemingly well-defined, where does it come from? Many times, it is equally to the minimum required contribution under ERISA. Other times, it looks like the actuary through a dart at a sequence of numbers between that minimum required amount and the maximum amount that the plan sponsor can deduct on its corporate tax return.

I'm not saying that an actuary should not recommend a particular level of contributions. But, what I am saying is that it's not so simple. It's certainly not based on the same formula for every plan. In fact, there are lots of elements that should go into that recommendation.

This is where we might see a difference between an Enrolled Actuary who happens to label himself or herself as a consultant and an excellent consultant who is also an excellent actuary. The consultant will focus on the client's business needs in working with the client to develop a recommendation. Some very key questions to which the consultant needs to understand the answers might include these:


  • Where will the money come from to make any contributions? Will they come out of free cash flow? Will the sponsor need to borrow. If so, at what rate? Will that borrowing cut into the company's borrowing limits to the point that it may encumber their ability to run their business?
  • Do the potential tax deductions with respect to these contributions have value to the company? Is the company paying income taxes currently? There are a variety of reasons that it may not be. The company may not currently have positive net income. It may already have sufficient deductions to offset all of its income. Does the company have what are often referred to as NOLs or Net Operating Loss carryforwards?
  • Will the company be better positioned to make contributions in excess of the minimum required amount in some future year than it is this year? Perhaps this year, the cash would be better used elsewhere, but the company's forecasts indicate that it will have free cash flow to make up its funding deficit in 2016. 
  • How will any of this affect the company's risk management strategy? What sorts of risks are in that strategy?
  • How will various stakeholders react to a large, but not legally required contribution?
  • Will the effects on financial accounting expense (ASC 715 for those who care) matter? Sometimes, the decrease or increase in pension expense attributable to making or not making additional pension contributions (actually the return on those assets) looks like a big number. However, when we look at that change divided by the number of shares of company stock outstanding, the effect does not move the needle enough to change the company's reported earnings by share by even a penny. In other words, it goes away in the rounding.
  • How about loan covenants? Oh, Ms. or Mr. Actuary, do you know about those? Does the company have any? (I'm pretty sure they do.) Do any of them relate to the pension plan? Maybe they do; maybe they don't. 
And, finally, the plan sponsor needs to act in the best interests of plan participants. While it doesn't seem likely that making any contribution to the plan at least equal to the ERISA minimum required amount would fail to meet that requirement, those interests need always be top of mind for the individual or committee making such decisions.

This is by no means an exhaustive list of the issues that the plan's actuary should consider, but it's a start. When your actuary "recommends" a contribution amount, have they made sure that they understand the answers to questions like this?

If not, perhaps we need to talk. If not me, then contact one of my colleagues.

Wednesday, January 7, 2015

Proxy Hysteria Coming For Companies With DB Plans

You read it here first. During the upcoming proxy season, there is going to be hysteria over the executive compensation disclosures in proxies for companies with defined benefit (DB) plans, especially those with nonqualified plans for their named executive officers (NEOs).

What's going on? As part of an NEO's compensation, filers are required to include the increase in the actuarial present value of DB plans. The actuarial present value is a discounted value of the anticipated payment stream just as it was a year earlier. While there are many assumptions that actuaries select in determining an actuarial liability, two, in particular, have changed for many companies from 12/31/2013 to 12/31/2014. One is the discount rate which will have decreased by somewhere in the neighborhood of 100 basis points and the other is the mortality assumption. Late last year, the Society of Actuaries (SOA) released its newest mortality study and many companies elected to adopt the new tables.

The effect of the change in discount rate will vary, largely on the age of the NEO in question, but it's not unreasonable to think that for most NEOs that just that discount rate change will have increased the actuarial liability attributed to them by 8%-12%. Yes, Americans are living longer. Mortality assumptions should be updated from time to time. But, for proxy purposes, the year of the update causes an additional spike in the liability attributed to the individual NEO, perhaps an additional 5% depending upon age and gender.

So consider an NEO whose 2013 compensation included $1,000,000 due to the increase in the actuarial present value of accrued pension benefits. If that person is still an NEO at the end of 2014, he or she will have had an increase in liability due to surviving one more year (interest and mortality totaling perhaps 6%), an increase due to increases in included compensation (a large bonus could have increased even 3-to-5 year average compensation by 25% (recall that in the case of a 5-year average that 2014 which was a good year for many businesses replaces 2009 which was a dismal year for many businesses)), and increases due to changes in discount rates and mortality assumptions.

So, with no changes in compensation practices, our NEO who had $1,000,000 of compensation attributable to him or her in 2013 might see that turned into an increase of $1,500,000 in 2014.

There will be outrage. Proponents of the pay ratio rule of Dodd-Frank Section 953(b) will point to these increases and say that the rank-and-file got 2%-4% increases. The media will not understand what happened. Congress, and this might be the year that it matters as the new Republican control has suggested that it will try to repeal some parts of Dodd-Frank, will not understand.

But those people who chose to read my ramblings will get it. Companies that foresee the issue can address it. It can't be solved in its entirety, but it can be managed.

I know how.

Do you?

Thursday, January 1, 2015

I've Joined The Savitz Organization

Effective January 1, 2015, I've joined The Savitz Organization in their Dunwoody, GA (Atlanta) office. I'll be a consulting actuary with additional responsibility for business development and the growth of the Atlanta office. I'd love to meet with you in person to discuss your needs. Please e-mail me or call me (for the time being, it will have to be my personal e-mail or phone).

http://www.savitz.com

Happy New Year to all.

Thursday, December 18, 2014

Federal Spending Bill Brings Multiemployer Pension Changes in Through the Back Door

It never seems to fail -- Congress needs a way to spend money or make a bill budget-neutral and pensions are the ugly stepsister. I expressed my opinion on this just last month. So, what did they do this time? Our legislators appear to have found a different stepsister this time in multiemployer pensions. I'll talk more about what happened later, but first I'll provide some background for people who aren't as familiar with multiemployer plans. For those who like names, the new law is known as the Multiemployer Pension Plan Reform Act of 2014 (MEPPRA, until someone gives me a better name).

Multiemployer pension plans were authorized by the Taft-Hartley Act. In such an arrangement often found in industries where individuals may perform jobs for a variety of different employers (construction, trucking, mining, etc), employers contribute a negotiated amount of money per unit (hour worked, mile driven, etc) of work. Unlike single-employer plans, multiemployer plans are run by a group of trustees evenly balanced among collective bargaining units or unions and management. Benefit levels are theoretically set when the trustees determine that the plan's assets are sufficient to support an increase. And, once employers choose to participate in a multiemployer plan through the collective bargaining process, it may be difficult to exit as withdrawing sponsors are subject to significant payments known as withdrawal liability.

The first really significant changes to multiemployer rules came into being with the Multiemployer Pension Plan Amendments Act in 1980. The rules were largely unchanged until our legislators saw fit to treat well funded multiemployer plans differently from more poorly funded plans in the Pension Protection Act of 2006 (PPA). PPA introduced the colored zones dependent theoretically on a plan's level of danger of not being able to support its own benefit promises.

So, what does MEPPRA do and what level of concern should participating employers have? As is often the case these days, one of the primary purposes of MEPPRA is to protect the Pension Benefit Guaranty Corporation (PBGC), the governmental agency that protects private pension benefits.

One of the most important tenets of ERISA-covered pension plans has been that benefits accrued by a participant cannot be reduced by plan amendment. This has long been one of the sacred cows of defined benefit plans (DB). Under MEPPRA, certain very poorly funded plans may be able to reduce accrued benefits of participants including those who are already retired and are receiving benefits. Such reductions are subject to a "rejection vote" by plan participants (active and no longer active), but in the case of "systemically important plans" (those where the PBGC projects it will be on the hook for at least $1 billion), the Treasury Department can override the vote of plan participants.

At the same time, premiums paid to the PBGC on behalf of each plan participant will double next year from $13 per participant to $26, further demonstrating PBGC's influence on our legislators. And, in a move that I think could bring further controversy when the rule is applied, the PBGC will have the ability to "facilitate" mergers of two multiemployer plans in order to improve their aggregate funded status.

Consider that last provision. As an example, let's say that there are two widgetmakes multiemployer pension plans and that the one for workers in states with at least four vowels in the names of those states is poorly funded while the one for workers in more vowel-challenged states is pretty well funded. In an effort to improve the aggregate funding, the PBGC comes in and facilitates a merger of the two plans. As a worker, how would you feel if you were suddenly in a poorly funded plan when you had not been previously. Perhaps the reason is that the people in the other plan have much better benefits than you do. So, the previously responsible management of your plan will be bailing out the less responsible management of the other plan. That might just make you want to say "Hmm" or perhaps something worse.

There are a number of other changes that are highly technical related to funding and to withdrawal liability (the amounts that an employer who chooses to cease participating in the plan must pay in order to get out) calculations, but these are quite complex and far beyond the scope of most readers. And, in case you were wondering, reading about those calculations will not bring chills of excitement.

All that said, what should an employer do to react to the passage of MEPPRA? There is no perfect strategy, but for employers participating in reasonably well funded plans (green zone), there should not be much that is needed. For the remainder (red zone or yellow zone) of plans, however, employers may need to weigh their options. They might consider doing some or all of the following:


  • Review all of their collective bargaining agreements that cause them to be participating sponsors of multiemployer plans. Pay particular attention to the size of the plan and the plan's current zone status.
  • If withdrawal from the plan is an option, request a withdrawal liability calculation to see how painful that strategy might be.
  • Consider the pros and cons of remaining in the plan as part of the company's overall risk management strategy.
  • Consider engaging an independent actuary (not affiliated with the plan's actuary) to assist with any strategy decisions. To the extent that the company is contemplating a strategy that could potentially inflame relations with one or more unions, it could make sense to engage this actuary through counsel.
Stay tuned. I'm sure it won't be long before pensions get to be an ugly stepsister once again.



Wednesday, December 10, 2014

Frightening Data on DC Plan Ownership

According to an article in this morning's News Dash from Plan Sponsor, fewer families had an individual account retirement plan (defined contribution or IRA) in 2013 than in 2010. However, on the bright side, average account balances have increased over the same period.

What do we learn from this? It's difficult to know for sure, but as is my wont on my blog, I'm going to take a shot at working it out.

Why are average account balances up? Well, the equity markets have performed pretty well over the last few years. Combine that with the fact that there has been time for additional contributions to those accounts and this makes sense. When we combine this, however, with my rationale for the prevalence of accounts decreasing, it may look troubling.

That the number of families with individual account retirement plans is decreasing suggests underlying issues with the economy. What I suspect is that many long-term unemployed or under-employed have had to liquidate accounts that they had a few years ago in order to survive. People laid off from jobs have taken distributions rather than rollovers to live on. I suspect that more often than not, these have been total distributions from smaller accounts. By eliminating some of the smaller account balances, the average and median accounts have grown in size.

That only about 50% of families have individual retirement accounts and only about 65% have any retirement plan at all is not good news for our future economy. How will the remaining 35% live? Moreover, among those 65%, will they have enough to survive in retirement?

The way it looks to me is that for people who are able to fully utilize their 401(k) or other retirement program for their entire working lifetimes, retirement may be comfortable. But this data suggests that this will be a substantial minority. For the rest, the retirement system is failing us.

30 years ago, defined benefit (DB) plans were the bulwark of the corporate retirement system. After years of Congressional meddling, many employers consider DB plans to be impractical. At the same time with further emphasis on individual responsibility, the burden of providing a retirement benefit has been shifted largely to employees.

If you are good at Googling or Binging, you can easily find projections from lots of smart people showing that a good 401(k) plan will be sufficient for responsible employees to retire on. In my opinion, most of these projections are deficient. You just don't see projections that consider leakage including:

  • Unemployment for a meaningful period of time
  • The necessity to take a job for a short or long time that does not have a savings plan
  • Increased cost-shifting of all benefits to the employee which may reduce an employee's ability to save
  • High-deductible health plans which force employees in many cases to pay significant amounts out-of-pocket for health care
This data is frightening. The retirement system is severely broken. Too many times, the public policy behind the retirement system has been abused by tax policy. We are left with retirement plans being a toy for Congress to make bills seemingly budget neutral

The ability to retire is part of the 21st century American Dream. This data suggests that the retirement part of the dream may be just that -- a dream.

Not pretty ...

Tuesday, December 9, 2014

Possible Delay of Pay Ratio Regulations -- Practical or Political?

Right before Thanksgiving, the House Committee on Financial Services sent a letter to the Chair of the SEC asking that guidance on the so-called Dodd-Frank Pay Ratio rule (Section 953(b)), and therefore implementation as well be delayed. The letter called this implementation a low priority. No similar correspondence has come from the Senate or any of its committees.

Gee, what a surprise that is. House committees are controlled by Republicans currently while Senate committees are in the hands of Democrats for few more weeks. Dodd-Frank was another bill and then law praised by Democrats and loathed by Republicans. The letter points out that the law does not specify a time by which the SEC must promulgate a rule on this issue. Additionally, the letter tells the SEC that the pay ratio disclosure has little value and that knowing the pay ratio for publicly traded companies back in the 2006-2008 timeframe would have done nothing to avert the financial crisis.

Let's regroup for a moment. For those who don't know, Section 953(b) of the Dodd-Frank law requires that registrants disclose a single number -- the ratio of the pay of the median-paid employee in the company to that of the CEO. Pay for this purpose is pay as defined in the executive compensation section of the proxy. I have argued that while such relative information may be useful to some that this calculation is the wrong one and needlessly burdensome. Last year, the SEC issued a proposed rule on the pay ratio calculation. While it provides a means of simplification for many companies, companies that do take advantage of the sampling techniques proposed will not find them simple by any means.

So, is the single number valuable? I don't think so. If one insists that such a comparison is valuable, then to me, it would be far more instructive to show CEO compensation and a chart of commonly held jobs within the company showing a compensation range for actual or hypothetical full-time employees(if no full-time actual employees exist for such job classifications) for each of those jobs alongside the CEO compensation.

Advocates of the pay ratio point out companies in the fast food industry. They note that CEOs make many millions of dollars while most fast food workers earn minimum wage or only slightly more. In this case, is the pay ratio valuable? To me, it's not. Running a multi-billion dollar business and defining its strategy to compete and grow has no similarities to monitoring a drive-thru window. Comparing the compensation of two such individuals makes no sense to me.

Currently, the SEC has three Democrats and two Republicans. The Chair is a Democrat. The commissioners still have meaningful Dodd-Frank work to do whether they make 953(b) a priority or not.

I don't know what they will do, but thus far, they have not shown a predisposition to act quickly on ensuring that the pay ratio is disclosed for registrants.