Thursday, January 22, 2015

Consulting With the Flavor of the Month

I've worked for several firms in my career and had the privilege of serving a large number of clients.Different consultants have different ways of serving their clients and different firms have different expectations of their consultants. Some of these practices generate what is to me a problem. Consultants bring their clients the flavor of the month, or worse yet, they bring them last month's flavor of the month.

What do I mean by that?

Suppose you or I are a consultant with a firm that tends to generate its ideas out of a centralized practice. As consultants in that practice, we find ourselves essentially required to talk to each of our clients and "check the box" saying that we had a conversation with them about January's flavor. I've been in that situation. And, while there are definitely right ways and wrong ways to do this, a consultant could easily find himself in a competing situation.

Consider that the January brainchild is a really cool and innovative idea around health plans. There will be companies that this idea is right for, but the idea is complex and therefore, probably a good idea only when a company's employees are particularly active participants in their own health outcomes and where they are financially savvy enough to know how to play the game, so to speak.

Because of this, I as a consultant working for one of those firms (I have, but I currently do not) may have competing goals leading to a conflict for me. Suppose I bring this idea to each of my clients as I am told. One of my clients, hypothetically, is a large chain of fast food restaurants that sits mostly along interstate highways in rural areas. The employees of this company, generally, earn minimum wage or just a little bit more, so they are not financially savvy. Additionally, most of what they eat is fried food and what I have learned over the years is that they really don't understand their own health.

My main contact, the Vice President of Human Resources absolutely loves my firm's idea. She took this position as a step up in her career after being a Benefits Manager at a large pharmaceutical company. There, the employees did take a role in their own health outcomes and the sophisticated group of scientists did have enough financial acumen to understand any pitfalls of this new design. I am left with competing interests:

  1. I can do right by my client and tell them that I just wanted to let them know what some other companies are doing, but that this idea might not be right for them and here's why; or
  2. I can sell the assignment because it will go a long way toward helping me to meet or exceed my goals.
I'd like to think that when faced with this conflict that I have always taken option 1. But, even if I have, I know people who have not.

There is something far worse than the flavor of the month consultant, however. Consider the consultant who pitches the flavor of last month, or even worse, the flavor of last year. This is the person who learns through the grapevine that the reason that his client base is gradually leaving him is that he didn't bring them any new ideas. So, he goes back to the handouts from meetings he attended earlier in the year and starts to pitch those ideas. He doesn't really understand them, but he is practicing (poorly, I might add) defensive client management. 

As an example, without going into great detail, Curtis O'Nsultant learned at the annual meeting of the Really Smart Consultants of America of a great new idea that works very well in a rising interest rate environment. Back in 2013, Curt lost a few clients because other companies marketed this idea to his clients. He wasn't aware of the idea then and he still doesn't understand it. But Curt knows that failing to bring the idea to his client base was costly, so he decided to bring it to his remaining clients in late 2014 to seemingly ensure that the rest of his client base would be safe. If he is lucky, or perhaps unlucky, enough to sell this idea to any of his clients, we know how that story will play out.

I'm thrilled to say that I don't have to deal with that now. I work with some really smart and creative people who come up with some great ideas. But, rather than telling me that I need to bring those ideas to my entire client base, I am asked to consider what an appropriate client would like and which of my clients fits that definition of appropriateness. Those are the clients that I will bring this new idea to.

Think about it.

Thursday, January 15, 2015

The Recommended Pension Contribution

For years, I have seen in many pension plan actuarial reports a line item that the actuary or the actuary's firm refers to as the "recommended contribution." When reviewing these reports, that item has always been an anomaly to me.

Sometimes, what it represents is spelled out in the report; sometimes, it's not. But, when it is seemingly well-defined, where does it come from? Many times, it is equally to the minimum required contribution under ERISA. Other times, it looks like the actuary through a dart at a sequence of numbers between that minimum required amount and the maximum amount that the plan sponsor can deduct on its corporate tax return.

I'm not saying that an actuary should not recommend a particular level of contributions. But, what I am saying is that it's not so simple. It's certainly not based on the same formula for every plan. In fact, there are lots of elements that should go into that recommendation.

This is where we might see a difference between an Enrolled Actuary who happens to label himself or herself as a consultant and an excellent consultant who is also an excellent actuary. The consultant will focus on the client's business needs in working with the client to develop a recommendation. Some very key questions to which the consultant needs to understand the answers might include these:

  • Where will the money come from to make any contributions? Will they come out of free cash flow? Will the sponsor need to borrow. If so, at what rate? Will that borrowing cut into the company's borrowing limits to the point that it may encumber their ability to run their business?
  • Do the potential tax deductions with respect to these contributions have value to the company? Is the company paying income taxes currently? There are a variety of reasons that it may not be. The company may not currently have positive net income. It may already have sufficient deductions to offset all of its income. Does the company have what are often referred to as NOLs or Net Operating Loss carryforwards?
  • Will the company be better positioned to make contributions in excess of the minimum required amount in some future year than it is this year? Perhaps this year, the cash would be better used elsewhere, but the company's forecasts indicate that it will have free cash flow to make up its funding deficit in 2016. 
  • How will any of this affect the company's risk management strategy? What sorts of risks are in that strategy?
  • How will various stakeholders react to a large, but not legally required contribution?
  • Will the effects on financial accounting expense (ASC 715 for those who care) matter? Sometimes, the decrease or increase in pension expense attributable to making or not making additional pension contributions (actually the return on those assets) looks like a big number. However, when we look at that change divided by the number of shares of company stock outstanding, the effect does not move the needle enough to change the company's reported earnings by share by even a penny. In other words, it goes away in the rounding.
  • How about loan covenants? Oh, Ms. or Mr. Actuary, do you know about those? Does the company have any? (I'm pretty sure they do.) Do any of them relate to the pension plan? Maybe they do; maybe they don't. 
And, finally, the plan sponsor needs to act in the best interests of plan participants. While it doesn't seem likely that making any contribution to the plan at least equal to the ERISA minimum required amount would fail to meet that requirement, those interests need always be top of mind for the individual or committee making such decisions.

This is by no means an exhaustive list of the issues that the plan's actuary should consider, but it's a start. When your actuary "recommends" a contribution amount, have they made sure that they understand the answers to questions like this?

If not, perhaps we need to talk. If not me, then contact one of my colleagues.

Wednesday, January 7, 2015

Proxy Hysteria Coming For Companies With DB Plans

You read it here first. During the upcoming proxy season, there is going to be hysteria over the executive compensation disclosures in proxies for companies with defined benefit (DB) plans, especially those with nonqualified plans for their named executive officers (NEOs).

What's going on? As part of an NEO's compensation, filers are required to include the increase in the actuarial present value of DB plans. The actuarial present value is a discounted value of the anticipated payment stream just as it was a year earlier. While there are many assumptions that actuaries select in determining an actuarial liability, two, in particular, have changed for many companies from 12/31/2013 to 12/31/2014. One is the discount rate which will have decreased by somewhere in the neighborhood of 100 basis points and the other is the mortality assumption. Late last year, the Society of Actuaries (SOA) released its newest mortality study and many companies elected to adopt the new tables.

The effect of the change in discount rate will vary, largely on the age of the NEO in question, but it's not unreasonable to think that for most NEOs that just that discount rate change will have increased the actuarial liability attributed to them by 8%-12%. Yes, Americans are living longer. Mortality assumptions should be updated from time to time. But, for proxy purposes, the year of the update causes an additional spike in the liability attributed to the individual NEO, perhaps an additional 5% depending upon age and gender.

So consider an NEO whose 2013 compensation included $1,000,000 due to the increase in the actuarial present value of accrued pension benefits. If that person is still an NEO at the end of 2014, he or she will have had an increase in liability due to surviving one more year (interest and mortality totaling perhaps 6%), an increase due to increases in included compensation (a large bonus could have increased even 3-to-5 year average compensation by 25% (recall that in the case of a 5-year average that 2014 which was a good year for many businesses replaces 2009 which was a dismal year for many businesses)), and increases due to changes in discount rates and mortality assumptions.

So, with no changes in compensation practices, our NEO who had $1,000,000 of compensation attributable to him or her in 2013 might see that turned into an increase of $1,500,000 in 2014.

There will be outrage. Proponents of the pay ratio rule of Dodd-Frank Section 953(b) will point to these increases and say that the rank-and-file got 2%-4% increases. The media will not understand what happened. Congress, and this might be the year that it matters as the new Republican control has suggested that it will try to repeal some parts of Dodd-Frank, will not understand.

But those people who chose to read my ramblings will get it. Companies that foresee the issue can address it. It can't be solved in its entirety, but it can be managed.

I know how.

Do you?

Thursday, January 1, 2015

I've Joined The Savitz Organization

Effective January 1, 2015, I've joined The Savitz Organization in their Dunwoody, GA (Atlanta) office. I'll be a consulting actuary with additional responsibility for business development and the growth of the Atlanta office. I'd love to meet with you in person to discuss your needs. Please e-mail me or call me (for the time being, it will have to be my personal e-mail or phone).

Happy New Year to all.