Pension Funding Relief On the Way?

While the Supreme Court was front and center making the big news of the day and the House of Representatives was busy finding Attorney General Eric Holder in contempt, the US Senate appears to have come to an agreement on a bill that would provide for more highway funding and for a better deal for students and prior students on student loans.

I know, what does this have to do with pension funding. Well, leave it to your Congress, because when they do stuff like this, I deny any linkage to them. Buried not so deep in this bill is so-called pension funding stabilization. You remember the pension reform law to end all pension reforms, the disastrous Pension Protection Act of 2006 (PPA), don't you? Well, it hasn't ended pension funding reforms yet and it doesn't look like it's close to doing so.

So, what is pension funding stabilization? Well, in a nutshell, PPA was supposed to do all of these things:

• Force companies to use current (or almost current) discount rates to value their liabilities
• Provide incentives for companies to get their plans better funded
• Get all plans essentially fully funded on a mark-to-market basis within 7 years

That was 2006. Things were rosy. The economy was booming. Interest rates were very low, but surely they were going to get at least a little bit higher.

Find the flux capacitor, Doc Brown. Where's the DeLorean? Let's go back to the future.

A few things have happened since 2006, including various types of pension funding reform. But, they haven't been enough. And, now, Congress in its infinite wisdom is working on legislation that, in my humble opinion, is very wrong.

Before I explain why it's wrong, let's look at the key provision of pension funding stabilization. Currently, companies (and their actuaries) in performing their pension funding calculations get to use an average of rates over the last 24 months. While this isn't quite a spot rate, rates have been in the same general range over the last 24 months, so it's far from abhorrent. And, putting in market-based funding was a cornerstone of PPA. 

Nearly six years after PPA's passage, however, we are in for a change. Should the bill become law, companies will get to average their rates over 25 years. That's a lot of years. 25 years ago was 1987. Rates on 30-year Treasuries, were, if memory serves me (because I am writing this remotely and am not in a position to look it up), in excess of 9% (for at least part of the year). What does 9% have to do with prevailing interest rates today? In fact, even if you believe that pension liabilities should be discounted at an expected long-term rate of return on plan assets, where can you get a consistent return of 9% these days?

If Congress wants to give pension funding relief, the way to do it is to still make companies pay for the cost of current year accruals, but let them pay off their unfunded liabilities on a basis slower than seven years. Instead, they are going to get to full funding on a basis that makes no sense.

Why is Congress doing this? Funding highway improvements and student loan writeoffs takes money. Pension contributions generally result in corporate tax deductions. So, the pension funding stabilization gets scored as a revenue raiser because the asinine rules of Congress look at only 10 years. As you and I know, the cost of a pension is the cost of a pension and no silly rules can change that. This means that those tax deductions are merely deferred. So, in reality, the government is once again spending money on stuff it has no way to pay for. 

Stupid bill!

Yes, stupid bill.

Much Ado About a Tax

The arguments among the cognoscenti have been going on for months. Does the Patient Protection and Affordable Care Act (PPACA or ObamaCare) violate the United States Constitution?

The arguments that I heard most frequently centered around whether or not the Act violates the Commerce Clause or the Necessary and Proper Clause.

Attorneys, especially those who practice constitutional law are far more versed in these subjects than I, but they are also far more versed than most of my readers. So, when they refer to Ayotte v Planned Parenthood or to Hooper v California, many eyes will glaze over. This is intended for those glazing eyes.

For those lay people who want to know what happened, here you go. Note: I have no formal legal training and I do not practice law.

Article 1, Section 8 of the Constitution discusses the powers given to Congress. Among them are the right to regulate commerce among the several states. Many argued that this would be the point on which the constitutionality of PPACA would turn. And, most of the experts seemed to believe that forcing an individual to make a purchase was beyond the scope of the Commerce Clause. The Supreme Court agreed.

Article 1, Section 8 also contains the so-called Necessary and Proper Clause whereby Congress has the power to make all laws which shall be necessary and proper for carrying into execution the other powers granted by Article 1, Section 8. Since there was nothing in that section which needed to be executed, the Necessary and Proper Clause did not apply.

Some may recall that the Obama Administration had pledged that those families earning less than $250,000 per year would not see a tax increase. Therefore, the amount that individuals who choose to remain uninsured would pay was written as a penalty, not as a tax.

But, and now for the legalese. the Court through the decision handed down by Chief Justice Roberts, looked to Hooper v California, which says in pertinent part that "every reasonable construction must be resorted to in order to save a statute from unconstitutionality." In English, that means that if there is any way to find a law to be constitutional, then that way should be found.

So, the Supreme Court labeled the penalty to be a tax. And, the first clause of Article 1, Section 8 begins that '[T]he Congress shall have the power to lay and collect taxes ..." So, to the extent that the penalty is, in fact, a tax, Congress was within its constitutional powers to impose said tax.

Much of the law becomes effective in 2014. Of course, we have a major election coming in November and its anyone's guess as to what this will do to the inhabitants of the White House and the Capitol building. If there are big changes, we could see changes to the law. If not, then this law will stand at the very least through 2016.

Newspeople Can't Figure Out What The Supreme Court Said

More later, but CNN has reported that the individual mandate in PPACA has been struck down and that the entire law has been upheld.

Who knows?

More later.

GASB Improves Public Pension Plan Accounting and Disclosures

Yesterday, the Governmental Accounting Standards Board (GASB) approved  two new standards  related to accounting and disclosure for public retirement plans. GASB 67 will change the plan level reporting and disclosure while GASB 68 will change the employer level reporting. This comes after much debate and public controversy as the media has had many a field day trumpeting the cumulative underfunding of public pension plans.

Statement 67, according to the GASB press release, enhances note disclosures and required supplementary information for public defined benefit and defined contribution plans. Among the new requirements are annual money-weighted rates of return and 10-year supplemental information schedules.

Here I warn the reader, particularly the unknowing one, about the value of the new requirement as compared to the cost of providing it. Any of these 10-year projections will be supplied by actuaries. Actuaries, as a group, are smart people. I am proud to say that I am an actuary. So, to be sure, I am not denigrating my profession here.

However, when an actuary presents various measures of plan liabilities and forecasts of future costs to a plan sponsor, be it a public sponsor or a private one, one thing we are sure of is that the numbers are not perfect. What they are is a best estimate based upon a set of actuarial assumptions and methods. Based upon our experience and training, our estimates will likely be better than yours, but the likelihood that the plan liability that we calculate will be a precise measure of the present value of benefits accrued to date is essentially nil.

So, consider what happens when, even with our level of training and experience, instead of looking one year into the future, we look ten years into the future. I don't know anyone who knows what will happen to the economy over the next ten years. The last 10 years or so illustrate this well. Suppose I had asked you on June 26, 2002 whether interest rates would increase, decrease, or stay relatively steady over the next 10 years. What would you have said? Well, in July 2002, I did ask that question to a group of roughly 100 professional asset managers. As a group, these people were pretty savvy about the economy. About half a dozen of them thought that rates would stay relatively steady over the next ten years; the remainder thought they would increase and most thought they would increase significantly.

Statement 68 makes three significant changes to accounting for public pensions:

• Projections of benefit payments will now include assumed projections of pay increases, projection of service credits, projections of automatic cost-of-living adjustments (COLAs) and projections of ad hoc COLAs if those ad hoc COLAs are nearly automatic. Over time, a meaningful number of public employers have kept their reported liabilities down by providing annual ad hoc COLAs rather than automatic ones. While they were essentially the same, the reporting for them was very different, but no more.
• Perhaps the single most key actuarial assumption used in calculating a pension liability is the discount rate. Statement 68 will allow generally well-funded public pensions (there aren't too many of them right now, but they do exist) to use an expected long-term rate of return on assets to discount the liabilities so long as the assets are invested in such a way as to reasonably expect that rate of return to be achieved. Plans that do not meet the criteria to use a long-term rate of return must use what is essentially a risk-free rate for governmental entities -- a yield or index rate on 20-year AA or higher-rated municipal bonds.
• Finally, plans are to be valued using an entry age [normal] actuarial cost method. To the extent that a plan is pay-related, this method should produce roughly a level percentage of pay annual cost. If the plan is not pay-related, the method should produce roughly a level dollar amount annual cost. To my mind, this is a significant improvement and a step that other rule-setting bodies including the United States Congress should [have taken] take a lesson from.

What will this ultimately do for public pensions? I suspect that we will see a better picture of the levels of underfunding of public pension plans, but will not unfairly punish those that have been funded responsibly. The new standards are not perfect, but in my opinion, this is a step in the right direction.

Compensation Risk

I was reading Mike Melbinger's blog today about compensation risk assessments (if you want to read online legal analysis of compensation issues, I strongly recommend his blog) and I got to thinking that oftentimes, the people who may be assisting clients with this assessment may not know much about risk. You see, in evaluating compensation risk (and the SEC doesn't really tell us what that means), companies are to look at all elements of remuneration for both executives and for other employees. So, that includes things like deferred compensation which includes both qualified and nonqualified retirement plans.

I've written a lot about risk in retirement plans from the employer standpoint. How much cost variability is there? Does this benefit properly align with corporate goals? In an enterprise risk framework, where do these plans fit in? Is there compliance risk? Is there risk associated with having retirement benefits that are so large that you can't get employees to leave when you'd like them to? Is there risk associated with not having a defined benefit plan when some of your competitors for talent have them?

That last question is confusing, isn't it?. But, think about it. Defined benefit plans to favor older workers, not because they are discriminatory, but because of the shorter discount period until retirement date. So, if you sponsor a generous 401(k) plan and your top competitor sponsors a generous defined benefit plan, then a knowing employee might work for you until they get to be about 45 and then just when they really know the business, take off to your competitor who has a generous defined benefit program. It just makes sense.

So, compensation risk isn't only what you probably think it is. If you want to do a really thorough analysis and consider all of your rewards programs, consider people who have sufficient expertise to help you through the process. You might just learn something about your programs that you hadn't thought of before. And, it might be really useful.

Tunnel Vision Doesn't Always Work

I've been a consultant for a long time now. While I probably don't read as much of it as I once did, I still read a lot of IRS guidance (I know, that makes me a boring person, but somebody has to do it). In fact, in this business, a lot of us read a lot of IRS guidance, so I guess we are all boring people. But, the point of this post has nothing to do with being boring, it's about solving problems.

You see, lots of IRS guidance is extremely complex. So, there are two ways of reading that guidance -- you can either know the 20% that applies to 80% of the problems, or you can learn the other 80% as well that might apply to the other 20% of the problems.

We get accustomed to solving problems using that first 20% and that's what I am referring to as that tunnel vision. But, for those of us who have learned the rest of the guidance, sometimes we have to look outside that tunnel for a solution.

I've faced such a situation in the last day or two and for obvious reasons, I can't disclose the details. But, without going into any detail, I'll provide an overview.

Client X is reviewing certain of its benefits and compensation programs. They have a very specific problem and they have a pretty good idea what the optimal solution looks like. So, I went back to the law and thought about what its original purpose was. From there, I concluded that if the regulations matched at all with that original intent, then while we might not hit the optimal solution, there should be a big improvement.

Voila, there in the regulations, it looks like there was an answer. But, it wasn't in the 20% that lots of people know. It was in the other 80%. In fact, it was buried about as deeply in the other 80% as one could put it.

Not all of us take the time to read and understand the other 80%. But, if you do, you might as well take the opportunity to use that additional expertise. Perhaps we might say it's where we get by taking a different route -- outside of the tunnel.

401(k) 3.0?

Mark Iwry (pronounced eevry) gave a speech at the 2012 PLANSPONSOR National Conference in Chicago. I wasn't there, so I am taking PLANSPONSOR's reporting on it as the gospel. Mr. Iwry apparently spoke on the topic of version 3.0 of 401(k) plans.

Before discussing Mr. Iwry's recommendations, I think it's appropriate to provide a little of his impressive resume for those who don't know. Currently, he is senior adviser to the secretary and deputy assistant secretary (retirement and health policy), U.S. Department of Treasury. If you were unable to work it out from the title, that means he is a policy adviser for the federal government. Previous to that, he has been a Principal with the Retirement Security Project, a Senior Fellow with the Brookings Institution, and Counsel with the Department of Treasury. The two roles previous to his current one were related as the Retirement Security Project appears to be a part of the Brookings Institution.

This c.v. would seem to establish that Mr. Iwry is an intelligent man. He has spent a career working in positions in the government and in think tanks that require significant intellect. But, note something that is missing in Mr. Iwry's resume -- he appears to have never been employed by a traditional corporate entity. None of his employers have been focused on profits.

According to the PLANSPONSOR summary, Mr. Iwry laid out five ideas as part of 401(k) version 3.0:

1. Increase the use of automatic enrollment and do it at higher levels than 3% [presumably through automatic escalation]. Use automatic enrollment for existing employees as well as new ones.
2. Stretch the match by doing something like providing a 33 cents on the dollar match on the first 10% of pay deferred instead of a more traditional 50 cents on the first 6%.
3. Give lower-paid employees a higher rate of match.
4. Decrease the eligibility waiting period, or at least decrease it for employee deferrals.
5. Accept rollovers from other plans.

You see, there is a reason that I laid out Mr. Iwry's resume. While any of these ideas might improve the ability of our workforce, taken as a whole to retire, most have another side of the proverbial coin.

Automatic enrollment works really well in some cases. However, I have looked at a lot of 401(k) data. Two things have jumped out to my eyes with plans that use automatic enrollment:

• New employees tend to defer at the automatic rate.
• When automatic enrollment is forced on existing employees, a large number wind up decreasing their deferrals, because they simply do not read their communications from HR and they get-auto-enrolled at levels lower than those at which they were deferring.

Mr. Iwry's second idea may have a lot of merit. In fact, I blogged about it more than 18 months ago. In that post, I discussed a Principal survey based on their client base. It suggested that changing from a match of dollar for dollar on the first 2% deferred to a match of 25 cents on the dollar for the first 8% deferred tended to cost the employer less, but left employees better prepared for retirement. I would love to see similar data prepared by other 401(k) recordkeepers to see if it holds true across a broader universe. 

The third idea is nice. Theoretically, it's nice. Many companies would tell you, however, that it does not make business sense to do this. In fact, I called a corporate Vice President of Human Resources while I was working on this post. He told me, under promise of anonymity, that this is a nice idea, but makes no practical sense. He went on that that there are two ways to accomplish this -- either increase the match for lower-paid employees which cost more money, or cut the match for high-paid employees which hurts morale among the producers.

In my experience, many companies that have a waiting period for a particular benefit do it for one of three reasons:

• It's expensive to set up a record for someone who may not be around for long.
• It's a waste of money to provide a benefit to someone who may not be around for long (yes, I know that they can put a vesting schedule on a match).
• They have so many new employees who don't last long that the increased level of paperwork would overburden HR.

Accepting rollover contributions seems to be a no-brainer. For plans of any meaningful size, the only reason not to do it is the additional fees that a plan might be paying on the additional asset base. But, there is an answer to this. Negotiate up front that this won't cost extra money. If you can't negotiate it out, decide if you can live with the extra cost.

However, 401(k) 3.0? These are not a bunch of revolutionary ideas. There is nothing in here about investments. There is nothing in here about lifetime income options. It just doesn't seem that new.

Hard or Soft?

I'm going to make this a fairly short post. At least, I think I am.

Hard or soft? I can think of lots of connotations for those two, but I won't go into all of them. What I am really worried about here is the distinction between hard costs and soft costs.

What's that? Let's consider an example of where the soft costs may outweigh the hard costs. But, first, let's define hard costs to be ones that go directly to the financial statements and soft costs to be ones that may affect the financial statements, but are far more difficult to quantify.

Most calculations deal with hard costs. They can usually be quantified fairly easily. Soft costs can't be handled that easily.

Suppose XYZ Company pays Really Big Strategy Firm (RBSF) to do a strategy study for them. RBSF decides that among other things, XYZ needs to cut their workforce by 15%. In their analysis, RBSF quantifies lots of things:

• Payroll costs.
• Benefits costs.
• Real estate costs.
• Infrastructure costs.
• Overhead costs.
• Many more.

However, RBSF neglects all these:

• Damage in customer relationships.
• Morale.
• Continuity.
• Brand damage.
• Many more.

It's simple. The soft things matter. Don't forget them.