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 ...

CEO Pay in 2010 Up From 2009

I couldn't think what to call this blog post. What brought the topic up for me was an article from the 4/10/11 (yesterday) edition of the New York Times. You may have seen it already as it certainly made the rounds on the social networking sites yesterday.

Here are some of my general comments on the article:

• Many corporate CEOs make far more money than they deserve.
• Shareholders now have an opportunity to speak their collective minds on that through the Dodd-Frank Say-on-Pay vote, but only four companies have had the shareholders reject their compensation plans for top executives.
• The pay that the New York Times article cites appears to be "Total Annual Compensation" from the proxy statements. This is not pay the way you and I think of it.
• Dodd-Frank has a section which will require companies to show the ratio of such pay to that of the median employee in the company, and while this particular calculation is misguided, it does lend some insights into CEO pay.
• You probably don't know what goes into this Total Annual Compensation number. Did you know that it goes up and down from year to year due to things like timing of equity awards, underlying discount rates, and corporate performance?

Let's revisit that last question. CEO pay tends to go up when the return on a shareholder's investment improves. Duh! What exactly are the major goals of most corporate CEOs? Isn't one of them to provide a better return on investment for shareholders? So, as a general concept, what is the problem with compensating CEOs better for better performance?

With regard to another item, CEO Total Annual Compensation tends to have more variability than it used to because more of their compensation is tied to shareholder return and stock price. How did this happen? Well, corporate governance models have suggested that significant portions of CEO compensation be in equity and that even for cash compensation, large portions be tied to performance. Hmm, you ask corporate America to adopt a model, they adopt it, and you criticize them for the results of your demand -- what's wrong with this picture?

Where I do have a problem though is with trends. Unemployment figures in the US have stayed high. Yes, they have come down a little bit, and whether you believe that decrease in unemployment to be truly reflective of positive employment figures or not, far too many people remain unemployed. In a nutshell, most large corporations are not doing much hiring. At the same time, pay raises for the rank and file have been horrible. While inflation numbers have been low for the last two years as well, those numbers have so much embedded convolution that they are not, IMHO, remotely reflective of changes in the cost of living for average Americans.

Further, suppose we look at real pay for working Americans. It has gone down, and that decrease has been significant. "How can you say that, John?" you ask. Well, let's consider. If CEO pay is to include the total value of the reward that they receive for doing their job, than perhaps so should yours and mine (the fact is that the value of employer-provided healthcare benefits is one of the items that is excluded). Here is how I would like to look at trends in pay for you and me. Given consistent behavior (you don't change your benefits elections), has our take-home pay gone up or gone down? For many of us, meager pay raises combined with increases in our share of the cost of benefits, and further coupled with cuts in the value of  those benefit programs means that at the end of the day, we are seeing less value from our employers, even in times of high corporate profits. Aren't you and I, or at the very least, the collective we composed of all the little people at a company, contributing to that excellent corporate performance? If we're not, then how and why are our employers succeeding?

This is what people should be upset with. If the wealth is being spread among all contributors and shareholder's are seeing expected (or better returns), than all is well. But, when the wealth is being spread among just a few, then things are wrong. Sadly, the Times article devoted only one small paragraph to this.

Author's Note: My current employer is a small, private firm that to my knowledge has not followed the large corporate trend of cutting real employee pay.

Funded Status of Corporate Pensions Improves Due to Increased Funding

Each month, Mercer does an analysis of the funded status of pension plans sponsored by S&P 1500 companies. Based on the Mercer study, the aggregate funding deficit as of March 31, 2011 was about $213 billion, down from $256 billion a month earlier. Mercer said that one of the primary reasons for this smaller deficit is that pension plan sponsors continue to make significant contributions to the plans. This is especially true for corporations with high quality debt where the current extremely low cost of borrowing for these companies has caused many to choose to borrow to fund up those plans. Also notable in the Mercer study is that the aggregate funded status for the same plans increased from 81% to 87% during the 3-month period ended March 31, 2011.

What's going on here? While I haven't had the opportunity to discuss this issue with all of the finance heads, many of whom are presumably the ones who are making this decision, let's consider a very plausible rationale. Suppose you sponsor a pension plan that is underfunded by $100 million. In simple terms, this leaves you with a $100 million liability on the balance sheet. Now, if you turn around and borrow that same $100 million (or some piece of it) at today's very low rates, you 'move' the liability on the balance sheet from the pension plan to more standard corporate debt, and you do it a low rate.

Why might this be good? In and of itself, it might not be, but suppose you use that new level of funding to help de-risk the pension plan. You are now taking what many consider to be a risky, highly volatile (this has been addressed over and over again here and in many other places) liability and replacing it with a stable, less risky liability. In today's world, where risk is bad and risk management is king, this is highly desirable. My employer has been at the forefront of such risk management efforts in pension plans since our inception.

Frankly, it's not just funding that has decreased deficits and increased funded statuses. Equity investments have generally performed well year-to-date and underlying discount rates have remained relatively stable.

I haven't seen the gory details of the Mercer study, but I must wonder to what extent the Pension Protection Act (PPA) funding rules have been behind these contributions as well. With plans being as poorly funded as they have been recently, and CFOs having the knowledge that PPA does require particularly rapid (7-year) funding of the underfunded, might they not be simply opting to throw cash at the plans when the cost of cash is low? Better, perhaps to do it this way, than to fund only when it is required when their borrowing costs may be higher.

So, the large corporate world seems to be getting this under control. If only sponsors of public pension plans could fix their underfunding as easily.

Congress, with Apologies to The Beatles

Music by John Lennon and Paul McCartney
Lyrics by John Lowell
To the tune of "Fool on the Hill"

Day after day,
Alone on the Hill,
The 535, the can't pass a budget bill
But nobody votes against them
Even though they are just fools,
And, they can't break their stalemate

But the fools on the hill,
See the government shutting down,
And they don't seem to care,
If the debt should go down

Bills introduced,
Must smell like dung,
535 screaming at the tops of their lungs
But nobody hears the others
The sounds they appear to make
They don't seem to notice

But the fools on the hill,

See the government shutting down,

And they don't seem to care,

If the debt should go down

Nobody seems to like them

We know not what they do

And they don't have any feelings

But the fools on the hill,

See the government shutting down,

And they don't seem to care,

If the debt should go down

Ooh, ooh,

Down and down and down,

And they never listen to us,

They know we think they're fools

They know we don't like them

But the fools on the hill,

See the government shutting down,

And they don't seem to care,

If the debt should go down

Ooh,

Clowns and clowns and clowns

Sanity on the Hill for a Change

UPDATE: It's the law now. The President signed it.


Former House Speaker Nancy Pelosi (D-CA) asked us to wait until the bill was passed to see what was in it. We all know that this refers to the Patient Protection and Affordable Care Act (Health Care Reform or PPACA). Most observers would say that the bill (now law) had a number of good things in it. Most observers would also say that it had a number of bad things in it. With regard to some of those elements, however, there was near unanimity. One, in particular, is the requirement that businesses and landlords file a Form 1099 with the IRS for all goods and services purchased with value above $600. Surely, this has something to do with either patient protection or affordable care, but the connection escapes me.

In the House of Representatives, the bill passed by a vote of 314-112. In fact, in addition to Representative Dan Lungren (R-CA) who introduced the bill, there were 273 co-sponsors. That was enough to get it through the House without any of the non-sponsors voting for it. The co-sponsors were from both parties. No Republicans voted against the bill. The Democrats were fairly evenly split with roughly 40% of them supporting passage of the bill.

Yesterday, the Senate acted on the bill, introduced by Senator Mike Johanns (R-NE) and co-sponsored by 10 others representing both major parties. The Senate passed the bill by a vote of 87-12. The Library of Congress website has not yet reported the vote, so I can't report to you who the 12 with particularly lame brains are, but if you find the need to know yourself, check here and click on 'major congressional actions' when that link becomes active.

The bill now goes to the President who I expect will sign it. Now that this is over with, perhaps we can have a budget for Fiscal 2011 before Fiscal 2011 ends.

Executive Compensation and the Tax Code -- the Knot that Won't Untie

Do you remember when a company could pay an executive what it wanted to? Do you remember when the market decided how much a company would pay its executives? It wasn't that long ago. There weren't a lot of rules.

So, what happened? Things got out of hand. You can place the blame where you like. You can put it with executive compensation consultants, and surely, there is a group of them (not all of them) that deserve a lot of the blame, as everyone in the industry knew that a key to getting a new engagement was promising a company's management that you could get them more. You can blame it on Compensation Committees, as they didn't seem to care how much their company's executives got so long as a consultant could support it. You could even choose to blame it on me, although that would be misguided.

And, then what happened? Congress found a new whipping boy so to speak. The first key change was when they decided that deferred compensation should be subject to FICA tax. In a vacuum, this is probably the correct thing to do within the context of public policy. Your wages should be subject to a payroll tax (taking the broad leap of faith here that a payroll tax is appropriate) in the year that you earn them to some reasonable degree of certainty. What was the problem with that? I don't think that Congress actually knew what they intended. Did they really mean to FICA tax company-provided nonqualified plans? I bet they didn't know. In 1983, it probably didn't matter. The Social Security Wage Base applied equally to the OASDI (old age, survivor, and disability) portion of FICA and to the HI (Medicare) portion. It wasn't until much later that they pay cap on HI taxes was removed.

Then came Code Section 162(m). Congress decided that no disqualified individual (that's a fancy term for the people they are targeting) should earn more than $1 million in a year. But, wait, suppose an executive performed really well. That might merit more pay. So, performance-based compensation was exempted from Section 162(m), so long as whoever crafted the plan got the design just right. Companies found ways to skirt this one pretty easily.

And, then came the nightmare before Christmas, Code Section 409A. I've written about it here many times before. The worst thing is that it was part of a jobs bill, the American Jobs Creation Act of 2004. If you don't work in this area or if you have been living under a rock, I'll give you the brief summary of how Section 409A creates jobs.

Ready?

It places additional 20% income taxes on nonqualified deferred compensation that doesn't meet some of the most convoluted rules that even the Treasury Department has ever come up with. And, what is worse, the more time that passes, the more problems that are uncovered with respect to plans subject to 409A ... all in the name of creating jobs.

Well, I have done a detailed statistical analysis (remember, I'm an actuary and I have training in this area), and I have determined with a particularly high confidence level exactly how many jobs were created (outside of government jobs to regulate and enforce this mess and attorneys to find ways around it) by Section 409A.

Zero. Zilch. Nada.

But, it has taken some perfectly innocent plan designs and made them seem like they were created by scoundrels the likes of which even Gordon Gekko has never seen. Imagine this: suppose that an employer provides its CEO with restricted stock units (RSUs). And, further, suppose that the restrictions lapse (the units vest) after 10 years, or after bona fide retirement on or after age 65. Lots of critics think that this is a desirable design of an executive compensation program. It ties executive compensation both to company stock performance and to the executive staying with the company.

Oops, the fact that the RSUs could vest upon retirement (seems innocent enough to me) makes the plan subject to Section 409A, and as often as not, nobody worked this out in advance, so the plan fails to comply with Section 409A and there are draconian tax penalties on the executive ... all because the company thought it was fair that he or she should have access to his or her earnings upon retirement from the company. The nerve of the CEO!

Excuse me, the nerve of Congress.

Come on Congress, Do Useful Stuff

I usually try to stay away from being political in this blog. And, I should probably restrain myself this time as well, but I feel the urge to write on this one.

The House Ways and Means Committee has approved by a vote of 22-14, HR 1232, which would add to taxable income of an individual any Flexible Spending Account or Health Savings Account reimbursements for abortion-related expenses. There would be an exception for abortions necessitated by rape or incest. It would also not apply where the mother's life is in danger if the pregnancy continued.

Where do I stand on the abortion issue? It doesn't matter for the purpose of this discussion. My views on the matter are a personal decision. And, you know what, no matter how strong (or not) my convictions in this area, to the rest of the country, it probably doesn't matter.

There is a key reason for this. Last I checked, I do not sit on the Supreme Court of the United States. It's been a lot of years, but the Supreme Court has already ruled on the issue of abortion. It's now what the learned or wannabe learned among us call stare decisis. For those among us who prefer to read the English rather than the Latin, it means to stay with what has been decided. Now, there is nothing to say that the Supreme Court cannot hear a new case where it changes its collective mind, but frankly, this is pretty rare.

So, my message here to Congress is that we have a federal debt that now exceeds $14 trillion. We have troops deployed in combat in nations far from our shores. Unemployment is high. The cost of energy grows every day.

And, you elected buffoons waste your time on HR 1232. Shame on you, it's stare decisis.

Litigation and Statistics -- The Wal-Mart Case

I had planned to have written a long piece by now about the long-awaited ruling in Dukes v Wal-Mart. Why am I so slow? Well, it's not me, in this case, it's our court system. The courts seem to have adopted a rhythm with which to hear cases that is reminiscent of the words of Oliver Wendell Holmes, the suggestions of Felix Frankfurter, and attributed by many to Earl Warren in Brown v Board of Education : "with all deliberate speed."

But that doesn't mean that I can't write about this case yet. There are interesting aspects, whether we have a decision or not. First, some background. If you are not at all familiar with this case, then you probably don't may much attention to labor issues. A class of more than one million women seeks standing to sue Wal-Mart for gender discrimination. What is at issue before the Supreme Court, at least as I understand it, is not whether there has been gender discrimination, but whether the group of female employees and ex-employees of Wal-Mart have standing to sue.

That's for the lawyers. I'm not one of them.

But, I have read a number of purportedly learned articles on the subject. The more right-leaning of the bunch say that Wal-Mart certainly has the right to compensate its employees based on any reasonable criteria that it finds appropriate. The more left-leaning point to data showing that this class of women, on average, have been compensated $1.17 less per hour than their male counterparts.

I haven't read the pleadings. I haven't heard the oral arguments. So, I don't have all the information that the Supreme Court justices do. And, I'm not here to tell you whether this class should have standing to sue as a class, or whether if they do have standing to sue, they should prevail on the merits. What I am here to tell you and I've said this before is that statistics, at least when used improperly or cherry-picked, lie.

Is a $1.17 per hour pay differential between the genders material? At Gibson, Dunn & Crutcher (the lead firm defending Wal-Mart in this case), it's probably not. Data that I have seen suggests that they pay their employees well enough that $1.17 per hour is just not meaningful. It's a bit like trying to find $500,000,000 in the US budget. Nobody seems to care.

But, similar data suggests that Wal-Mart does not pay its rank and file quite as well as Gibson, Dunn does. Supreme Court Justice Ruth Bader Ginsburg appears particularly passionate that the females of Wal-Mart have been wronged. One of the more conservative justices (I would call him out if I could remember which justice it was, but I don't) has said that $1.17 per hour just isn't material (my choice of words, not his).

I don't know, but I strongly suspect that neither of these justices is qualified to discuss statistics, sampling, margins of error or the like. Don't get me wrong, they are none brilliant scholars -- even the ones that I personally don't think much of are smarter than the average bear (sorry, Yogi, I know that's really you). But, I have seen the way that they toss around statistics. They generally don't get it.

I suspect that if this case does ever go to trial on the merits that lots of said statistics will be tossed around. And, this particularly cynical observer (who? me?) thinks that all will be meant to deceive rather than to inform.. Do you want to do a truly meaningful comparison? Then, compare similarly situated employees. As an example, consider all of the Wal-Mart employees who are between the ages of 40 and 50 who have been with the company as store clerks (my name not theirs) for between 5 and 7 consecutive years in stores in affluent suburbs in the southeast United States. Now compare the pay of men and women. Is it the same, on average. Is it different? Is it different beyond a margin of error given the sample size?

Methinks the courts don't care. They don't understand such mathematical minutiae and frankly, they are probably not worried about it.

So, the right will throw statistics around. The left will throw statistics around. Little of it will make any sense, and the courts will decide.

It just doesn't seem quite right to me.

To Market Value or not to Market Value

Author's Note: As usual, this blog does not necessarily represent the opinion of my employer, my profession, or any other organization of which I am a member. In fact, by the time I get done, it may not represent my opinion either, but if by the time you get done, I've caused you to think, to ponder, to smirk, and to laugh, then I have done my job well.

As some of you know, I've recently returned from actuarial March Madness sometimes known as the Enrolled Actuaries (EA) Meeting. If you are an Enrolled Actuary and you've never been, you should attend. It's not a boondoggle. It's an action-packed meeting (well, maybe not action-packed, but it is packed with more learning activities per hour of attendance than any meeting that I know of) with lots of expert speakers. At this meeting the last fairly large number of years, there have been three General Sessions (plenary sessions if you like the idea of showing your audience that you can use a fancy word when a simple one will do better) and eight tracks of Breakout Sessions, as well as a usually entertaining luncheon speaker on the first day. That's nearly 13 hours of continuing education in 2.5 days, but since actuaries get to count 50 minutes as an hour for these purposes, we think it's more like 15 hours.

Anyway, Session 002 (or GS-2, if you prefer) was a public pension plan debate. Even if you have been under a rock, you have likely heard that public pensions are in a state of crisis. Hell, everything is in a state of crisis these days. I know that's a fact because I've heard it on TV. The economy is in a state of crisis, the War on Terror is in a state of crisis, Japan (sadly, this is true) is in a state of crisis, the middle east is in a state of crisis, kids are in a state of crisis, adults are in a state of crisis. Well, many of them probably are, but after the EA Meeting, I don't know about public pension plans.

Why is that? Well, as is within the norm for a general session, we heard from three experts, a think tank person who says that public pension plans in the US are about $500 billion in the whole, a think tank person who says that US public pension plans are more than $3 trillion in the whole, and a person who represents the state pension plans in the US who I think told us that it doesn't matter.

I digress. What are think tanks and what do think tank people get paid for? I think that the think tank takes a position and then asks its think tank people to think of things to make people think that this particular think tank has correct thoughts. I can think. Maybe this is something for me to do after I have had enough of my current career.

Anyway, back to the subject at hand. The big difference between the $500 billion thinker and the $3 trillion dollar thinker, other than $2.5 trillion, is that one of them thinks that a concept called market value of liabilities is the only thing that matters and the other one thinks market value of liabilities doesn't matter at all.

Who's right? We'll come back to that later.

First, let's explore what Market Value of Liabilities (MVL) is. Back in the early days of ERISA, and the current days for public pension plans (for the most part), actuaries got to discount pension plan liabilities at a rate representative of the expected long-term rate of return on plan assets. So, if you thought your plan assets could return 10% over the long haul, then you discounted at 10%. Gradually, in the world of corporate plans, that opportunity disappeared. Prevailing wisdom, or at least opinion, among those who legislated and their advisers began to move those discount rates toward a risk-free rate. What's that? Well, for the sake of argument, we usually assume that US Treasuries are risk-free instruments, because if the US government starts to default on its obligations, not much else will matter. And, since nothing else is truly risk-free, even many MVL advocates suggest that discount rates can be tied to the yield on very high-rated (Aa or better from Moody's) corporate debt instruments.

That may all be fine. But, here is where I have a problem. For each purpose (funding, accounting), a plan, usually through its actuary does a valuation of assets and liabilities. And, for each valuation, there is a measurement date. And, we are required to value the assets and the liabilities as of the measurement date. On the liability side, that means that we choose actuarial assumptions, including a discount rate that are appropriate on the measurement date. If the measurement date is December 31, and on December 30, the duration-weighted yield on corporate Aa bonds is 5.75%, but on December 31, it is 5.50%, then we are to use 5.50%, even if it's back up to 5.75% on January 2. This is nuts. I realize that we have to pick something, but why one moment in time should get to ruin a plan/fund/company/city/state for a year is beyond me.

How bad can this example be? Suppose we have a plan that on December 30 of some fine year is fully funded with $1 billion each of assets and liabilities (using a 5.75% discount rate). Let's assume that December 31 is a bad day for pensions. Discount rates decrease by 25 basis points and the value of the funds in the plan's trust fall by 1%. This has happened before, by the way. Then, assuming that the plan's liabilities have a duration of 12 (very reasonable by the way), at the close of business on December 31, liabilities will be approximately $1.03 billion and assets will be about $990 million. Stated differently, our funded status is now barely more than 96% and our plan is $40 million in the hole. So, which one is correct? Are we fully funded or 4% away from that? Are we fully funded or $40 million to the bad?

I think that the answer is neither one, at least not for purposes of reporting to the world at large, and not for purposes of doing calculations that affect the next year. MVL is a nice concept. Choosing assumptions that you think are long-term appropriate is a nice concept. Neither one is perfect; in fact, both have significant flaws. But, just like in every thing else being debated, the vocal ones are those toward the fringes.

In the case of public pension funds in the US, I think they are more than $500 billion underfunded, but I don't think they are nearly $3 trillion underfunded. Assets fluctuate. Discount rates are not static. Assumptions used for many public pension funds are way too aggressive.

Market value accounting is a good guide to choosing reasonable assumptions, just as is a prudent longer-term view. Did you hear that? Both are good guides, but nobody seems to want us to consider both and pick something appropriate. Perhaps it's because they think we've shown we can't. But, there is a bit too much hysteria right now.

It's time for a happy medium. I think we should call it reality value.