I Want Your Input

It's time to beg my readers for some help. Please comment with the top 3 concerns (more is ok) for defined contribution sponsors and separately for defined benefit plan sponsors.

I would offer the best response a free subscription to this blog, but that probably wouldn't attract any additional answers.

Thanks in advance.

The Non-Event That is Making News ... The Supreme Court Doesn't Rule on Health Care Reform

It's the biggest benefits news of the day, and all because nothing happened. Attentive readers, as well as all other people who have not been hiding under a very large rock will recall that there are a whole bunch (I think 16 is the number) of lawsuits out there trying to have all or a part of health care reform (PPACA) declared unconstitutional. Some have gone the way of the Obama Administration. Some have not. This is to be expected. Anyone who has read the court decisions to date on this issue can see what is happening. District Court judges who tend to be viewed as liberal have found PPACA to be constitutional. District Court judges who tend to be viewed as conservative have found at least parts of PPACA to be unconstitutional.

Predictable, huh?

So, what happened now? Opponents of the law would like to have the Supreme Court rule on this once and for all. If the Supremes rule against the law, then states can stop the expensive process of implementation. Proponents of the law would be thrilled if the Supreme Court were to rule quickly in their favor, but obviously not so happy if the ruling went against them.

I'm showing my ignorance here as I don't know all the rules of procedure for the courts. I do know that in the ordinary course of things, a case that is ruled upon at the District Court level, if appealed, then goes on to the level of the Circuit Court of Appeals. The next level of appeal after that is the Supreme Court.

Apparently, there is a procedure referred to as fast-tracking whereby the Appeals Court gets circumvented and the case goes directly from the District Court to the Supreme Court. In this particular case, the Supreme Court had been petitioned to hear it immediately so that states would know whether to continue the PPACA implementation process, or not, as the case may be. And, for something with consequences this far-reaching, of course the Supreme Court would decide to fast-track this case, make a quick ruling, and let us move on. There was no doubt about it, was there?

Hold on. The Supreme Court essentially answers to nobody. We don't elect them. They don't have term limits. And, in their collective humble (or not) opinion, this case just doesn't merit fast-tracking.

The Supreme Court is not founded on convenience. It is not founded on the expenditure or saving of a few billion dollars. It exists to rule on matters of law, and historically, only those issues that are of extreme importance, AND where undue harm or duress could come as a result of their not fast-tracking a case have been fast-tracked.

So, your top headline for today is that nothing happened. But, now we know that nothing has happened with regard to the PPACA litigation. Presumably, this case will make it to the Supreme Court docket for the session beginning this fall. This means that we are likely to see a ruling next spring, or more likely, summer. That is right around the time of the presidential nomination conventions.

Oh, the speeches we will hear.

In the meantime, we can all go back and hide under our rocks. This case sits still for the moment.

Are CEOs Paid Too Much?

That's a simple question that I ask: "Are CEOs paid too much?" Or is it? I would bet that most people who read this have a fairly immediate answer, but unlike everyone having an immediate and hopefully unanimous answer to the question "Is the Earth flat?", in this case, I would not expect unanimity.

Last Thursday, CNN had an online article on the topic. Their headline stated that CEOs earn 343 times as much as typical workers. Later on, we learn that they are citing statistics from an AFL-CIO website.. Does the fact that these are AFL-CIO compiled statistics make this comparison incorrect? No! To the contrary, does that fact make the comparison correct? No!

The article tells us that the typical US worker for all occupations earned $33,190 for all occupations in 2009. This, they say, is according to data compiled by the Bureau of Labor Statistics (BLS). The comparison was made to the 2010 pay of Fortune 500 CEOs. The CEO compensation is proxy compensation which means that it includes the increase in value in pensions and deferred compensation. The BLS data does not.

Richard Trumka is President of AFL-CIO. His salary is roughly four times that of the 'typical' worker. He says that he will be happy when average CEO pay is at four times that of the typical worker.

I think that Fortune 500 CEOs make a lot of money. Some of them make more than they deserve, in my opinion. Most that I know of work more than twice as many hours every week as the 'typical' worker. In fact, I don't even know if the typical worker, according to this data, is a full-time employee anywhere.

In any event, this is another example of the media (and they all do it) taking a story that has an air of sensationalism to it and making headlines. This is just wrong. At least the AFL-CIO paywatch website breaks down the compensation of the executives. Here is an excerpt from the AFL-CIO site.

2010 Average CEO Pay at S&P 500 Companies
Salary	$1,093,989
Bonus	$251,413
Stock Awards	$3,833,052
Option Awards	$2,384,871
Nonequity Incentive Plan Compensation	$2,397,152
Pension and Deferred Compensation Earnings	$1,182,057
All Other Compensation	$215,911
TOTAL	$11,358,445

I expect that data for the typical worker does not include all of these elements. For example, my observations lead me to conclude that most AFL-CIO workers have pensions, but they are probably not included in the compensation for a 'typical' worker. At some companies, at times, they have received equity awards. These are not included in their compensation.

Maybe you think that $11.4 million is too much compensation for the average Fortune 500 CEO (by the way, we don't know if average is mean or median here). Maybe I do as well. But, if someone is actually trying to inform, they will, at the very least, make an apples to apples comparison.

Here is the problem. What this really all goes back to are two things that I have written about in the past: Say-on-Pay and the Dodd-Frank Pay Ratio disclosure. Mr. Trumka has been an outspoken proponent of both, and he is certainly entitled to both his opinions and to his right to voice them. At this point, four companies have received a no vote from their shareholders with regard to Say-on-Pay. Given that only four have gotten that thumbs down, I think those companies deserve to be called out here:

• Beazer Homes USA
• Hewlett Packard
• Jacobs Engineering Group
• Shuffle Master

Perhaps, ultimately, the message to companies here is to communicate and to explain. Yes, there are things that are required in a proxy disclosure, but there is plenty of room for narrative. If there is a really good reason that executive compensation has increased dramatically, disclose it. If a particular component is going to look bad in print, but there is a perfectly good reason, disclose it.

And, if you can't figure out how to disclose things to make them understandable to your shareholders, you know how to find me.

Choosing Your DC Fund Lineup

How do you choose your defined contribution (DC) fund lineup? Do you follow best practices? Do you know what best practices are? More importantly, does your plan have an investment policy, and if it does, do you follow it?

I took an informal poll of some people on DC plan committees. Here are the questions that I asked them:

1. Does your plan have an investment policy statement?
2. If it does, do you follow it?
3. Would an impartial, outside arbiter say that you were following it?

The answers that I got surprised me, but perhaps I shouldn't have been surprised. To question #1, 14 people said yes, 5 thought they had one, and 1 didn't think they had one. To question #2, of the 14 who said yes on question #1, 9 answered yes, 4 were non-committal, and 1 said no. To question #3, of the 4 non-committal to question #2, all said no, and of the 9 who answered yest to question #2, 8 said no.

Perhaps the Department of Labor (DOL) would be an impartial arbiter. Perhaps a judge or jury would be an impartial arbiter. Only 1 in 20 thought they would get a seal of approval from such a person or group. That's pretty frightening, and the fact that I told each person that I questioned that my tallying of votes would be with tick marks only got some honest answers. Even in retrospect, I know the results of my poll, but I couldn't tell you who answered how. And, even if I could, I wouldn't. I won't tell you company names, industry classifications, or even the blood types of my respondents.

I took some time to reflect on this poll -- actually, I didn't take very much time. But, I did think about it. From my experience, here are some areas where I think that plan committees fall might short in following their written investment policy.

• They are too slow to 'fire' a fund. If a fund has a good name or historically has performed well, but then has a significant period of time where it inexplicably underperforms, committees are slow to replace it.
• They bow to pressure from recordkeepers to use proprietary funds because of the 'credits' that they get for it (lower recordkeeping fees because of a larger offset).
• They don't look closely at style changes/style drifts in funds. Oversimplified, if the investment policy says to offer one mid-cap value fund and one mid-cap growth fund and the value fund has gradually drifted to growth, committees are slow to replace the no longer value fund.
• They don't follow the investment policy when choosing target date funds (this one deserves a longer write-up than just a bullet point).

So, what's the problem with target date funds (TDFs)? They are not inherently bad, but especially after PPA (2006) established the concept of a qualified default investment alternative (QDIA) for which TDFs fit the bill perfectly, they became the next big money maker for everyone who could find an angle. For proprietary TDFs, most are just funds of proprietary funds, but the level of fees is a bit higher than it would be for someone who just invested in the proprietary funds and rebalanced periodically themselves. I guess what the participant is paying extra for is the discipline of rebalancing.

If you decide to have TDFs in your plan lineup, but don't want to use proprietary funds, there are plenty of people out there who will design TDFs for you. They will tell you that they will choose from among only the best performers in each asset class to create these custom TDFs. And, for that, they will often charge you a pretty penny. This, of course, will be in addition to the fees that participants get charged. From what I have observed, most of the providers who are offering this service don't have the discipline that the proprietary TDFs do. They may not rebalance quite on schedule. They may make bets on the market that are probably inappropriate.

At the end of the day, though, when you, as a committee member, are evaluating candidates to be the TDFs for your plan lineup, do you consider the plan's investment policy statement? Will you change TDFs if they are underperforming? For that matter, what does it mean for a TDF to underperform? Does your plan's investment policy statement tell you? Do you have a way of monitoring whether the TDF is staying true to its stated style, its stated goals? If you do have that way, do you use it?

In theory, TDFs are a wonderful idea. In practice, however, in my opinion, generally, they remain flawed. Some are better than others. And, they do tend to avoid haphazard practices such as market timing, but I have not seen one yet that some smart, unbiased person couldn't poke holes in. Does this mean that you, as a fiduciary, are in trouble once you put a family of TDFs in your fund lineup? It could, but it doesn't have to. Make sure your investment policy statement is clear with regard to TDF selection and TDF monitoring. Then, follow that policy statement, and document it. Did you read that part? Document that you have followed the investment policy statement.

What is the Risk-Free Rate?

For years, when looking at an expected rate of return on a pension trust, I have been asked to look at things like real rates of return, risk premiums, and the "risk-free rate." The risk-free rate has always been defined as the yield on US Treasury debt instruments, the safest investment in the world. Yesterday, the fine folks at Standard & Poor's gave a negative outlook on the US. They said that this means that there is at least a 1 in 3 chance that the United States' AAA credit rating will be downgraded within the next two years. S&P gave as its reason the potential inability of the government to get together and find a way to control the spiraling federal debt.

There remain a number of debt instruments, according to S&P, with a solid AAA rating. Interestingly, they all seem to yield more than US Treasuries. Should they become the risk-free rate? What is going on here? What is the risk-free rate?

I spoke with a few friends and acquaintances with more economic training than I. The consensus was that this was simply S&P's way of lighting a fire under Congress' and the President's collective posteriors. Surely, no US-based company can be more credit-worthy than the country in which it is domiciled. If the US economy is that weak, then how can individual companies be that strong?

As I meander back to my more customary topics, I look at the implications for pension plans. Surely, this action by S&P will cause the US borrowing rates to increase. This, in turn, would suggest that the yield on high-quality fixed income investments will increase. But, this will cause discount rates on public and corporate pension plan liabilities to increase which will decrease those liabilities and give the plans that support those liabilities better funded statuses.

What? Does that mean that this is a good thing? Are the collective state and local and pension plans really far less than $3 trillion underfunded?

It seems that this is a quandary worthy of the legendary Scotsman immortalized by the Bard of Avon: "Fair is foul, foul is fair."

In any event, this tells me that its time for the United States to employ some of the strategies that many have been preaching about at corporate levels for the last two decades. Our country is a large enterprise. Is it time for us to practice some sort of enterprise risk management? Should the Department of Homeland Security report up to the Secretary of Risk? Or is the Secretary of Risk just another name for the President?

I don't know, but perhaps it is useful food for thought.

Getting Ready for the Budget Debate

I can see it coming now. Its magnitude and its long-term effects could dwarf them all -- Lincoln-Douglas, Kennedy-Nixon, Reagan-Mondale, Bentsen-Quayle, Burr-Hamilton (well, that one was really more of a duel). I'm talking about the budget debate of 2011.

The war has started. I'm not sure just what the first shot was. Was it the failure of the 111th Congress to send a budget to the President? Was it the Tea Party forcing the more traditional Republicans to insist on cuts for the remainder of fiscal 2011? Was it Paul Ryan's (R-WI) proposal to cut roughly $6 trillion from the budget over 10 years, not leaving untouched the sacred cows known as Social Security and Medicare? Was it President Obama's proposal to similarly make some significant budget (and tax) changes, perhaps in response to the Ryan proposal?

For purposes of this post, I'm going to focus a bit on the Ryan proposal. As I read it, his proposed budget would make fairly sweeping changes to both Social Security and Medicare. With regard to Social Security, I think I'm safe. That "Fund", and I use the term loosely as it operates as nothing more than a bookkeeping entry is not in as bad shape as its younger sister, so the biggest changes appear to be set up to come in 25 year chunks. As I will be eligible for my unreduced Social Security benefit before 2025, I only need to worry about the program's ability to pay. But, for me, this will almost be found money, as I have assumed for years that I would never see a dime from Social Security (and I still may not, but that is for another day).

Medicare, on the other hand, that "Fund" is about as bankrupt as bankrupt can be. When President (Lyndon, not Andrew) Johnson signed it into law, nobody with a voice that could be heard figured that we would have the changes in health care that have occurred. Double-digit health care inflation wasn't even a nightmare, it just wasn't a possibility. Longevity improvement just wasn't a consideration. And, now look what's happened.

All of those employer-provided retiree medical plans - companies had to start accruing costs for them, and they all but disappeared. It's ok, Medicare is there. Well, for those of us not yet age 55, as I understand the Ryan budget proposal, Medicare may not be there, at least not in its current form. Yes, it needs changes, but like the rest of the people in my age cohort, I've paid a lot of money into that system, and I actually have expected, probably naively, that it would take care of a pretty good portion of my health care costs when I make it to age 65. I am beginning to feel betrayed.

It's not just me, though. For as long as I have been in this business, employer-sponsored retirement programs (including health care) have been designed with the presumption that both Social Security and Medicare will remain largely as they are. In these times of a down economy (yes, on the record, I think the economy is still down), global competition, and mark-to-market accounting fanaticism, companies are not feeling the need to provide better and more costly (to employers) health care benefits.

I'm a fan of what Congressman Ryan is trying to do. He is trying to cut runaway spending. I think it's common sense that if your goesoutas (expenditures) exceed your comeintas (revenues, generally from taxes) that you have to either cut your goesoutas or increase your comeintas or both.

Well, in round figures, the federal debt is about $14 trillion and the GDP is about $15 trillion. My very rough analysis of some graphs that I found online say that the economy is healthiest when debt as a percentage of GDP is in the range of 40% to 55%. Let's take a number in the middle, say 50%, because that makes my math easier. That would imply that we need to cut the debt by $6.5 trillion if the GDP doesn't grow. Frankly, growing at about 3% per year, it's change is not that significant to the equation.

So, let's do some math. The population of the United States is about 310 million. Cutting $6.5 trillion from the debt could be accomplished immediately if each American would be kind enough to contribute about $20,000 to Uncle Sam.

Ain't happening.

Among the people who want tax cuts, they surely don't want to see an increase. And among those who are calling for tax increases, very few are saying that those increases should start with their wallets.

So, Social Security and Medicare may truly need some huge changes. And, these changes will have a significant impact (for all the real grammarians and wordsmiths out there, I know that impact implies a physical collision, and because of that, I rarely use the word impact where affect or effect will suffice, but I feel a physical collision here) on benefit plan design and retirement income planning. And, after all, those are among the topics of this blog.

So, we'll try to keep you updated here, and occasionally attempt to both humor and educate the readership with some analysis, but in the meantime, to paraphrase President Reagan, I'm not sure that I am happy that Congressman Ryan wants to make my youth an issue in his campaign.

Doing as They are Doing, Not as They are Saying

Trivia buffs could tell you that the only X-rated movie ever to win the Oscar for Best Picture was Midnight Cowboy (I know, it wouldn't have been X-rated 10 years later, but they had different standards back then). Many who know that would know the theme song from the movie, but paraphrased slightly and with apologies to Harry Nilsson, it could also be the theme for today's defined contribution (DC) plan sponsors:

Everybody's talking at us, But we don't here a word there saying, only the echoes in our minds

Great song if you're one of the six people who has never heard it. But, why, you might ask is this lunatic who hasn't been blogging this week (I talk some time off for the birth of a granddaughter) writing about a 40+ year-old song? Aon Hewitt did a survey of DC plan sponsors and found that only 3% plan to add in-plan annuity or insurance products to their plan in 2011. But, in other surveys, those same plan sponsors are saying that such products are a hot topic and that they are on of their highest DC plan priorities.

Get the song reference now?

Instead of going down what they are hearing and even know is the right path,

They're going where the sun keeps shining, through the pouring rain, they're going with what's closest to their nose

The simple fact is that nobody wants to be first. Yeah, I know, somebody has to be first, but that is often a road fraught with mine fields. But, there was a first 401(k) plan. There was a first cash balance plan. There was once a first target date fund, and now, flawed as they are, very few sponsors are afraid to walk that road once less traveled.

So what are the holdups? In my opinion, it all falls under the category of risk. Once upon a time, if there was no regulatory guidance, the prevailing strategy was to just go out and do it, but no more. With apologies to The Shadow, who knows what evil lurks in the hearts and minds of plaintiff's bar? Litigation is rampant. As a plan sponsor, even if you know you can win, the cost of defense may be prohibitive.

And, look at the guidance that we do have.While we don't have to worry about the safest available annuity rules for DC plans since PPA, the DOL's annuity guidelines for DC plans don't leave much more room for exploration. Having one of these products in your plan is a fiduciary decision. Title I of ERISA is fruitful ground for litigation. Is your plan ready to be the test case?

What happens when your employees leave your company? Can they actually roll these new-fangled products into their new employer's plan? That's a tough one, but as of today, the answer is probably that in most cases, they will have to find a way to keep that option when they leave.

So, everybody seems to want something, but nobody's doing it yet. What might change that?

1. A safe harbor for these products in DC plans so that fiduciaries going down this path will have less worry of regulatory or even litigation issues.
2. A more fertile field of products which will only come when more plan sponsors adopt these sorts of products for their plans.
3. A requirement that DC plans have some sort of lifetime income option as compared to just lump sums (taken by virtually all participants) and installment options. Of course, participants, even those who know that a lump sum has no longevity protection, are currently unlikely to consider anything else.
4. Reasonable fees. The risk for insurers in offering products of this sort are high, especially when there is anti-selection among the group of people electing them. Insurance companies are not in business to lose money, so fees and expenses are currently high. As the market becomes larger, so perhaps will fees and expenses become more competitive.

We're not there yet, but to complete your lyrical madness for the day, perhaps sometime soon, plan sponsors will be moving from where they are and 

Backing off of the lump sum wind, sailing on annuity breeze, skipping over ERISA like a stone ...