Friday, November 30, 2012

Suppose the Actuarial Code of Conduct Applied to Congress

Suppose the Code of Conduct that applies to the actuarial profession in the US applied to Congress. Just suppose. What would happen?

Let's consider Precept 8. Quoting directly,
An Actuary who performs Actuarial Services shall take reasonable steps to ensure that such services are not used to mislead other parties.
I guess that, in theory, anyway, Congress does provide services to its constituency.

Today, I am going back to an old target of mine, the rules under which the Congressional Budget Office (CBO) is required to operate. Now, understand, I don't hate the CBO. It's made up of some pretty smart people. And, as far as I know, they are also very honest people.

But, they don't set their own rules. You see, when the CBO "scores" a bill, that is when the CBO determines the cost of a bill that is introduced into a house of Congress, it is required by Congress to determine that cost over a 10-year period without regard to a dynamic economy. In other words, there is to be no inflation considered, no growth -- just whatever we have right now is what we are assumed to continue to have.

Quoting directly from President Lincoln in his famous Gettysburg Address:
Now we are engaged in a great civil war, testing whether that nation, or any nation so conceived and dedicated, can long endure. We are met on a great battle-field of that war. 
Surely, it's not what the President intended, but the so-called fiscal cliff negotiations going on right now feel like some sort of great civil war. People are not perishing from it, but jobs may. And, leaders of both parties are acting like babies.

From what I have read in major print media and heard on major broadcast media, proposals include

  • no increases in tax rates for anyone
  • increases in tax rates only for the "wealthiest 2%"
  • no spending cuts for the first 4 years of the 10-year period that the CBO would be considering (this is to be balanced by generally as yet undetermined spending cuts to occur beginning in 2017)
  • continued reductions in FICA taxes
People, we have an 'official federal debt' of approximately $16.3 trillion. Through the magic of the way the CBO is required to do its calculations, the bulk of the savings from these proposals is not likely to ever come about. If a credentialed US actuary performed calculations in the manner that Congress requires, he or she would be required to also do the calculations on a reasonable basis or to at the very least estimate the difference in results if the calculations were done on a reasonable basis. Failure to do so might subject said actuary to any number of disciplinary options including expulsion from actuarial organizations.

What would it take to discipline most of Congress in such a manner.

FULL DISCLOSURE: If the actuary disclosed that calculations were being performed using assumptions chosen by the Principal (Congress in this case with respect to the CBO) and that the actuary did not agree with the assumptions and further disclosed that said calculations could only be used for the specific purpose for which they were intended, the actuary would likely be compliant. But in that case, at least the user would know that the actuary disavowed the results.

Thursday, November 15, 2012

Does Your Plan Have Undue Risk?

An actuary friend of mine was complaining about upcoming end-of-year DB disclosures and the fact that his clients had funding calculations coming up that were going to be based on low interest rates and equity markets that have plummeted since the election. I further heard that the underfunded plans that he works with were overfunded as recently as September 1.

I asked him about de-risking, liability matching and things like that. He said that his clients give up too much upside return by doing that. I guess they would rather have underfunded plans.

In about 2002, I gave a speech to a bunch of pension investment professionals. In it, I espoused long duration fixed income investments in DB plans despite that everyone knew that interest rates couldn't go any lower. Of course, they also knew that this would take interest rate risk out of the equation, but people treated me as if I had some sort of strange disease.

I know of a few plan sponsors who did what I said. They are the ones with well-funded plans now. I don't know about you, but I'm not smart enough to know where interest rates are headed on any particular day. Frankly, I have expected them to be headed upward for that entire 10-year period, but that's not the point. The point is that there are a number of risks inherent in DB plans in the US. Some are outside of the sponsor's control, but others fall within it.

Shouldn't a sponsor consider controlling the ones that they can.

Wednesday, November 7, 2012

The Election Happened, Now What?

As the politicians like to say, the people have spoken. Now what?

There are lots of things I could say here about the policies of either side and what I think is right, wrong, or beyond comprehension, but that would be as worthless as much of the blather that occurs inside the Beltway.

What we have now is the same President that we have had for the past four years, roughly the same makeup of the Senate, albeit very slightly more left-leaning it appears and the same House of Representatives although perhaps slightly more right-leaning in its ideology. What we also have is an Administration which no longer needs to be in campaign mode. This means that policies and regulatory agendas which perhaps were on hold for political or non-political reasons may move forward.

Before moving forward, I caution you that what I am about to write is nobody's opinion but my own and that it is only my opinion on the morning of November 7, 2012. It may be different this afternoon, tomorrow, or some other day, but I hope that it doesn't change too much.

PPACA (health care reform or ObamaCare if you prefer) remains the law and it will remain. Whether they like the law or not, companies must prepare for 2014 when many of the key provisions of the law will take full effect. As an American, I hope that most employers do not make the decision to convert many employees from full-time to less than 30 hours for the sole purpose of excluding those employees from semi-mandatory coverage, but that is a decision that some will make.

The President is a strong believer in nationalized benefits programs (see, for example, ObamaCare). Look for his Administration to put forth a proposal for mandatory employer-provided retirement coverage with the option being contributing to a national retirement exchange. Retirement plans will look much more portable in this proposal. And, more coverage means more tax expenditures which must be paid for. Look for them to be paid for with tax savings generated from reductions in 415 limits and 402(g) limits. In other words, the highest earners will not be able to save as large a percentage of their incomes for retirement.

Historically, the Democrat Party has favored defined benefit (DB) plans more than the Republican Party. Republicans as a group have viewed that such plans are not representative of individuals taking responsibility for themselves. However, unless Congress really seeks the assistance of outside experts, do not look for any sort of resurgence in the DB world. Every effort from Washington to promote DB plans has been fraught with agency intrusion that moves employers away from DB.

At the same time, look for the President to leave Ben Bernanke in charge of the Federal Reserve and Tim Geithner in charge of Treasury. This will likely mean continuing low interest rates in an effort to spur the economy. The pension funding stabilization provisions of MAP-21 have, in the short run, allowed companies to not have exorbitant expenditures to fund their DB liabilities, but accounting disclosure often attached to loan covenants and credit-worthiness of companies that sponsor the plans will be unaffected by funding rules. In fact, companies that choose to make the MAP-21 minimum required contributions will have their accounting disclosures look worse.

President Obama has made it clear that he plans to raise taxes on high earners. We've previously written here about the FICA tax increases under ObamaCare as well as the 2013 combination of tax increases sometimes referred to as Taxmageddon. When marginal tax rates increase, deferred compensation becomes more valuable. Look for more companies to focus on nonqualified deferred compensation plans for their executives.

Similarly, the estate tax, or death tax, if you prefer, is due to return with a 55% top rate. Individuals who have accumulated significant wealth will be looking for ways to transfer that wealth to their heirs. Privately-owned companies will frequently look to ESOPs perhaps through so-called 1042 exchanges to plan for wealth succession.

Executive compensation is going to be a huge issue. As tax rates increase and the limitations in qualified plans likely decrease, deferred compensation will be become a bigger issue. With increases in deferred compensation come larger risks both for the executive and the employer. Funding such plans has become increasingly difficult while failure to fund them leaves unmitigated risk for both parties.

Dodd-Frank was one of the hallmark laws of the first Obama Administration. Seven key executive compensation provisions remain unregulated, but look for all of them to be regulated soon. Particularly critical among them are:

  • Policy on erroneously awarded compensation
  • Disclosure of pay versus performance
  • Pay ratio disclosure
Look for the Administration to consider policies that would cut the million dollar pay limit under Code Section 162(m). While the original 162(m) codification probably backfired, most Americans would not consider it particularly controversial to limit the amount of compensation that is not performance-based that top executives receive.

Finally, in all areas, look for increases in required disclosures. Thus far, regulatory guidance in this arena has gone to levels under the Obama Administration not seen before. For employers, this means additional administrative burden. For employees, unless disclosures can be more useful, this will mean more stacks of paper for the trash bin.

And, look for gridlock once again as each side blames the other. Who will blink first? I'll report on the first blinkage here.

Monday, November 5, 2012

Suppose You Couldn't Have Your Annual Shareholder's Meeting

In 2010, Congress passed and President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) into law. Billed as a reaction to the financial crisis and abuse by the financial services industry of the public trust, Dodd-Frank has been more ... much more. Whether that more and much more has been good for the public or for anyone else is a matter of opinion. My opinion, as it is with most laws is that there were good parts, and there were less good parts. But, as is often their wont, Congress attacked a problem with far too broad-reaching a weapon.

Many of the more controversial provisions of the nearly 3000 page law lie in Title IX dealing with executive compensation and paramount among those may be the Shareholder Say on Pay (SSOP). Under these provisions, shareholders have the opportunity to weigh in, albeit in a non-binding fashion, on executive compensation proposals.

As is often the case with such provisions, plaintiff's bar views provisions such as these as an opportunity to litigate the matters. In one case, in California, in order to get a temporary injunction lifted, a company was forced to delay the implementation of their executive compensation proposal, file a revised and more detailed definitive proxy (Form 14A) and pay plaintiff's attorneys more than half a million dollars.

Suppose they hadn't done this. Then a state judge in California was precluding the company from conducting its annual meeting.

And, this was not because the executive compensation package was viewed as being outlandish, but simply over a few provisions that MAY not have been worded perfectly.