Thursday, November 20, 2014

Why Working With Actuaries is Desirable, In My Humble Opinion

Actuaries often get a bad rap. In my thirtieth year in the profession, I feel like I have heard it all. We are nerds. We are numbers geeks. We can't think outside the proverbial box. We are literal. outgoing actuaries look at YOUR shoes when they talk to you.

Despite all that, there is much to be said that is positive about the profession. An employee (not an actuary) of the US Department of the Treasury once said to me that actuaries were the single most honest and ethical profession that he has dealt with.

Many of us majored in college in something like actuarial science, risk management, math, or economics. Probably, a large number of us thought about a career in academia. I have a number of friends who have remained in academia and that I can think of, every one of them to my knowledge is an honest and ethical person. But, generally, that is because of who they are, not what their professions require them to be. For much of academia, codes of conduct tend to relate to embarrassing the college or university that employs them. In my personal experience, those codes of conduct are not overly stringent, at least not if we compare to the actuarial Professional Code of Conduct.

Recently, much has been in the news, or at the very least, the conservative news of a particular Professor of Economics at MIT, Jonathan Gruber. Dr. Gruber is highly regarded by his peers as one of the preeminent health care economists that we could find. Dr. Gruber also developed many of the econometric models put forth with the Affordable Care Act (ACA, PPACA, ObamaCare). He has been engaged by either or both of the United States Congress or the current presidential administration for his expertise as well as by a number of the states to consult on the economics of the ACA. By his own admission, he helped to deceive the public about the ACA and its costs and sources of revenues. Paraphrasing Dr. Gruber, he justifies this as being for the greater good. That is, he has proclaimed that the ACA was a good and necessary law to pass and that the goodness of the law justifies any deception.

Dr. Gruber may be right about that. Or, he may not be. You may have an opinion on whether he is right. I'm not here to express mine on that particular issue.

There are many actuaries who are qualified, given the appropriate data and choices of assumptions and methods, to project health care costs or the costs of a health care plan or plans. Those who fit that bill have attained initial qualification through examination and maintained it through continuing education. While this process has a different rigor than does the process of attaining a Ph.D., it has created a relatively small community of individuals who work in the field.

Actuaries tend not to be political animals. Part of the reason for that may lie in our Code of Conduct. Quoting directly,
An actuary shall act honestly, with integrity and competence, and in a manner to fulfill the profession's responsibility to the public and to uphold the reputation of the actuarial profession. [Precept 1] 
An actuary shall not engage in any professional conduct involving dishonesty, fraud, deceit, or misrepresentation or commit any act that reflects adversely on the actuarial profession. [Annotation 1-4]
Those are two strong statements. Actuaries who have failed to abide by the Code of Conduct have been counseled, censured, suspended, or even expelled from the profession. Many of those cases have been for violation of Precept 1 (and its annotations) among others.

So, while jokes have been told about actuaries regarding the variety of answers that we might provide, I suggest it is because ours is not an exact science. We use our experience to make sound professional judgments. But, we have a duty of honesty and of integrity. We have a duty to not misrepresent or deceive.

To me, this is laudable. It makes me proud to be a part of the profession. It's why there would not have been an attempt by actuaries to deceive the public had actuaries been used by the government to model the costs under the Affordable Care Act. It makes it desirable to work with actuaries.

Tuesday, November 18, 2014

Why 401(k) Plans May Not Be the Answer

Get a job. Find a new employer. Typical questions that get asked include compensation, health benefits, vacation, and do you have a 401(k) (or all too frequently, do you have a 401?)? Prospective employees usually don't ask about the 401(k) plan or about any other retirement plan, but simply want to know if there is a 401(k). Does it have a matching contribution? People don't ask.

According to a study from Aon Hewitt, 73% of those eligible are participating in 401(k) plans, but 40% of them are saving at a level below the full match level. Many of those plans have auto-enrollment, but that level of deferral is below the level required for a full matching contribution. Once people are enrolled at the automatic level, many tend not to defer enough to get a full match.

The Aon Hewitt study does not, as far as I could tell, explore why this may be. Is it a lack of employee education? Is it an inability to budget for a higher amount, especially in a time where costs of raising a family are increasing, but pay often is not? Is it a fear of the plan?

We can do the math. If a young worker (someone recently out of college, for example) participates in a 401(k) at a meaningful level throughout their career, and especially if there is a good matching contribution to go with it, those workers can eventually retire with a very good retirement income.

But, what about the ones who participate at a lower level, so that they get less than the full match? What about the ones who face temporary unemployment as so many of us do these days and may have to withdraw their 401(k) for funds to live on?

As Roth 401(k) plans have become the rage, this has become even more of a problem. While in a traditional 401(k), access to funds is essentially limited (large tax penalties) prior to age 59 1/2, in a Roth, that inaccessibility largely disappears after the employee money has been in the plan for 5 years. This means that practically speaking, Roths, for all their benefits, may be less retirement plans than their better known predecessors.

If these trends continue, 401(k)s in any form will not be the answer. In fact, for those people who are not using their plans to the fullest extent that they were intended, retirement may be nothing more than a pipe dream.

35 years ago, the answer was defined benefit plans. They provided retirement income pure and simple. But, do to Congress' ongoing efforts to protect pension plans, or so they would have you believe, that dinosaur is nearly extinct. But, 401(k)s will do the trick for only a small percentage of the workforce. For the rest, retirement planning is imperative. And, when they do the modeling, they may not like the future that they see.

Friday, November 14, 2014

Pensions: Are They Just a Toy For Congress to Play With?

In 1963, Studebaker, once a large and proud American auto maker closed its doors in the US for the last time. With that door closing, as legend has it, New York Senator Jacob Javitz had the idea that the retirement income promised to employees needed more security. So was born in his mind the law that in 1974 became the Employee Retirement Income Security Act (ERISA). While it did far more than take steps to make pensions more secure, that was purportedly its primary purpose.

ERISA provided a framework for corporate retirement plans. And, in 1974, before paragraph (k) had been added to Section 401 of the Internal Revenue Code, the predominant employer-provided retirement income came from defined benefit (DB) plans. Unions bargained for them, and what the unions got, management wanted. Also, back in 1974, it was not unusual that if there was a company that an employee worked for in their mid-to-late 20s that that employee would eventually retire from that company. If you, as an employer, promised that employee a pension, you could expect 30 or more years of loyalty from that employee.

So, ERISA set up a minimum funding regime regime for DB plans. If you were using what is known as an immediate gain (or loss) actuarial cost method (if you know what that means, you don't need an explanation and if you don't know what it means, you don't want an explanation), then your minimum funding requirement for the year was the sum of these elements:

  • The normal cost or the actuarial present value of benefits accruing during the year
  • Amortization over 30 (or 40) years of the unfunded liability remaining from inception of the plan or transition to ERISA
  • Amortization over 30 years of the actuarial liability emerging due to changes in plan provisions, the thought likely being that you got 30 years of value from the amendment
  • Amortization over 30 years of the actuarial liability emerging due to changes in actuarial assumptions
  • Amortization over 15 years of the actuarial liability emerging due to actuarial gains and losses (deviations from the expected)
  • A few other elements that rarely came up
By the mid-1980s, DB plans were generally pretty well funded, and most of those that were not yet fully funded were getting much closer than they had been. The exceptions, for the most part, were plans sponsored by companies in dire financial straits that often convinced their actuaries to use fairly aggressive actuarial assumptions, or companies that frequently provided large benefit increases that had not yet been funded.

In 1986, we were graced with the Tax Reform Act (TRA86), a massive and sweeping change to the entire Internal Revenue Code -- so massive, in fact, that the Code was renamed from the Internal Revenue Code of 1954 to the Internal Revenue Code of 1986, a moniker it keeps to this day. A not insignificant portion of TRA86 included changes to pension funding rules. Amortization periods were shortened. For the most part, this increased required contributions for underfunded plans, which in turn increased corporate tax deductions.

Those new rules were revamped quickly. Just a year later, embedded in the Omnibus Budget Reconciliation Act of 1987 (OBRA87) was the Pension Protection Act of 1987. OBRA87 was the annual budget bill. And, has become the trend, each powerful legislator had his own pet spending project. To pay for all that pork, either a revenue generator or a decrease in tax expenditures (a fancy name for deductions) was needed. OBRA87 found a useful tool in DB pension plans. How is that? Just change the funding rules to decrease required contributions and tax deductions will go down which in a backhanded sort of way increases revenue for the government. of course, this was thinly veiled in a complex set of new requirements that applied only to underfunded plans.

A star was born!

Congress needs a revenue raiser? Change the funding rules. Cut the maximum benefit limitations. Change required interest rates. 

With this new toy, Congress looked at changes in pension rules at least every other year. It created uncertainty for employers. Yes, they could plan and budget based on current rules, but they lived in fear that the rules would change. That's a tough way to run a business. Many of those plan sponsors froze their pension plans. Many of them wanted to terminate their plans, but interest rates were so low that the cost of terminating those plans was too high. 

Fast forward to 2006. Coming out of the economic malaise and stock market tumble at the beginning of the decade, many plans were underfunded on an accrued benefit basis using market-based discount rates. It was time to protect pensions yet again. Thus was born the Pension Protection Act of 2006 (PPA), the most sweeping change to corporate pensions since ERISA. It provided a regime that essentially ensured that underfunded plans would be fully funded within 7 years. Employees would get their pensions. 

But, those extra contributions from employers are tax deductible. That's an extra burden on the government. And, it was just one year later (falling from its October 11, 2007 peak) that the markets crashed yet again. Employers couldn't afford these new levels of required contributions. But. Congress had an agenda to help those employers and help themselves. 

Welcome pension smoothing in the form of several laws since then. PPA brought us 7-year funding based on "fair market" conditions and assumptions. Pension smoothing undid that and then undid it again and undid it again as Congress invoked its favorite toy at least 3 times in the period following the signing of PPA. Employers had funding relief. Congress had its decrease in tax expenditures. Employees in pension plans had less funded benefits and the rules got so complex that almost nobody wanted to sponsor a pension plan anymore.

And, the places that pension funding relief gets buried are just amusing. I think the 2014 relief is my favorite -- the Highway and Transportation Funding Act of 2014 (HATFA). That's right. Congress decided it was time to improve our roadway system, but new roads don't come for free. So, to help pay for this, Congress invoked its favorite tax toy, pension funding relief.

Shame on them!

Thursday, November 13, 2014

Executives Need Retirement Education, Too

It's been a long time since I blogged. I needed a break. I needed some fresh ideas. I didn't feel like writing on anything technical. I didn't feel like offering my opinions. I just needed to stop writing for a little while.

This morning, however, I saw an article in the News Dash put out by Plan Sponsor. It stressed that plan sponsors feel that perhaps the biggest issue in nonqualified plans is participant education. Citing from the article, one in five said that education was a top challenge while 18% cited participation and appreciation. I think that they are essentially the same thing, so that makes 40% (rounded) and that's enough for me to conclude that this is a major issue.

Why is this? Executives generally make a lot of money (whatever a lot is). They are generally used to dealing with financial matters. They already have their qualified plans. What makes these plans so different?

There's a lot. Taxation is different. They usually don't have a real pool of assets that they can play with. They don't get the same level of disclosures. They don't understand Code Section 409A. And, they generally don't know if what they are getting is good compared to what their peers at other companies are getting or not.

What's the answer?

I suggest rewards education for executives. In my experience, it is rare that this can be done internally. Internal people are often considered to have a bias or an agenda. It comes better from the outside.

Who or what should that outsider be? It should be an independent person, one who has no horse in the race, so to speak. It should be a person who can speak to all facets of executive rewards -- cash compensation, deferred compensation, equity compensation, retirement compensation, change-in-control agreements, and the like. Unfortunately, there are not too many of them around.

Oh, wait, I can do all that!