IMHO: “Thinking” Caps

While the spate of revenue-sharing suits has—for the moment, anyway—faded into the background, fees remain one of the most hotly debated topics in our industry.   

 

If anything, the intensity has heightened in recent weeks, as we near the Form 5500 filing deadline for December plan-year ends, even as we anxiously await the new 408(b)(2) fee disclosure regulations from the Labor Department—regulations that might well have been at some odds with legislation proposed by Congressman George Miller (D-California) that rode through the House as part of that extenders bill before being dropped by the Senate. 

The urgency behind these initiatives is two-fold: to force those who provide services to these plans to more fully and accurately disclose their fees to plan fiduciaries, and to provide participants with some idea of the monies that are being netted from their investment returns (and taken from their accounts).  Ultimately, it is about helping people make better, or at least more informed, decisions about their retirement plan investments—and these initiatives are all predicated on the notion that these fees are not adequately disclosed, or sufficiently understood, at present. 

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That said, a report recently issued by the Transamerica Center for Retirement Studies (from its 11th Annual Retirement Survey) paints a somewhat different picture (see 401(k) Participants not as Knowledgeable as Employers Think). 

Asked whether they would like to receive more information from their retirement plan provider about fees and expenses associated with their plan, two thirds of the roughly 600 employers surveyed (and these were not limited to clients of Transamerica) said no, and half of those strongly disagreed with that proposition (smaller firms were somewhat more likely to disagree strongly).  Now, that’s a startling statement in view of the characterization of the current state of 401(k) fees by many in Congress and most in the media—not to mention a few in the industry itself. 

Asked if those in their firm who were responsible for overseeing the retirement program had a “clear understanding of the fees and expenses associated with the retirement plan,” nearly all—94%—at least somewhat agreed with that proposition.  Nearly three-quarters of those at (277) larger firms strongly agreed with that statement, as did nearly half of the smaller firms (271).  Could it be that these employers weren’t interested in receiving additional disclosures because they felt they already understood? 

Moreover, strong majorities of employers felt that their workers had a similarly clear understanding of the fees associated with their account; one in five strongly agreed with that statement, while roughly half were willing to say they “somewhat agreed” with the proposition.  Those results, of course, stood in some contrast with workers, where only about a quarter were willing to say they were aware of fees that may be charged to their account (admittedly, nearly as many weren’t sure, while about half said they were not aware). 

These are the kinds of results that tend to work legislators, consultants/advisers—and journalists—into a lather.  The “common wisdom” is, of course, that retirement plans are being gouged; that retirement plan sponsors are complacent, if not complicit in the theft; and that plan participants are oblivious to it all. 

We may draw some comfort from the reality that most retirement plan fees are drawn from the expense ratios applied to the various funds, ratios that are generally disclosed, if somewhat imperfectly, to plan fiduciaries and participants alike (we may not yet know the apportionment, but the gross amount is certainly ascertainable).  And yet, most advisers would likely view the Transamerica Center results with scepticism, if not downright cynicism.  I can hear many of you saying to yourself right now, “They may THINK they know what they’re paying, but they really don’t.” 

That said, don’t YOUR clients know what they are paying?   

It’s hard to know exactly what inferences to draw from the research. Perhaps the plan sponsors are being misled or maybe misinformed; perhaps they do have a workable, if imprecise, idea of the plan costs.  Improbable as this might seem, they might even happen to be a uniquely well-informed segment of plan sponsors.  We may know what they are thinking, but we do not know what they think they are paying, much less how realistic that assessment. 

Regardless, more disclosure is surely coming and—whether they think they know and don’t, or think they do and are correct in that assumption—IMHO, it’s hard to imagine that those disclosures won’t be a positive contribution to the exercise of their fiduciary responsibilities.   

Here’s hoping it keeps us all thinking, rather than leaving us all guessing. 

2009 Respite Brief for S&P 500 Pensions: Report

The 34% global market rebound of 2009, while a welcome respite, only slightly improved the funding status of S&P 500 pension plans, according to a recent analysis.

 

According to S&P 500 2009: Pensions and Other Post Employment Benefits (OPEB) by Standard & Poor’s, the underfunding status of those programs improved to a US$ 261 billion short fall from a short fall of US$ 308 billion, and the pension funding rate increased to 81.65% from 78.10%. 

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The report also noted that the discount rate declined to 5.81% from 6.29%, and the expected return rate declined to 7.83% from 7.95%, compared with a year ago.

However, laid-off workers, who otherwise might have remained with their employers, have added additional unanticipated expenditures to pensions as early retirees, and while a noted shift back to equities from the relative safety of fixed income helped in 2009, the current market pullback shows the dangers attendant with that approach.

As Medicare and Medicaid obligations dwarf Social Security’s issues, the report cautions that OPEB underfunding remains “massive”, even as underfunding was reduced to US$ 215

billion from US$ 257 billion.

In fact, according to the analysis, only 18 issues were overfunded in pensions for 2009 compared to 296 issues ten-years ago. Only four issues were overfunded in OPEB in 2009, with just one of those issues overfunded in both pensions and OPEBs.

Industry Analysis

The report notes that while defined benefit pension plans are more common among large corporations, they are not universal with respect to sector representation, specifically that companies in Information Technology (a relatively new sector with high employee turnover) were least likely to have those programs in place, while companies in the Utilities and Materials sectors were most likely to have those DB plans.  Additionally, S&P explained that funding levels also vary across sectors; that, over the past several years, the Telecommunication Services sector remained the sole sector with overfunding (a legacy from the AT&T breakup). 

However, the report states that the massive losses of the 2008 recession have served to strip the Telecommunications sector of its unique status, and have left it underfunded for both 2008 and 2009.  On the other hand, the Financials sector, which has arguably suffered the most during the recession, reported the least negative underfunding (8.26%), along with fewer employees, according to the report.  Ironically, the Energy sector, which the report says has performed (relatively) well with respect to market prices, earnings, and cash flow, is the most underfunded sector – with a 28.56% underfunded status (improved from 39.46% underfunded in 2008).

“Ironically, the Telecommunications Services sector, which traditionally has been overfunded in pensions, has gone through so many reductions in their work force where early retirement was permitted that it now finds itself paying for those “humane requirements,” according to the report.

Asset Allocations

Pension funds have US$ 1.16 trillion in assets, with 86.1% invested in U.S. concerns and 13.9%

invested abroad, percentages which S&P says have changed little over the past several years.  However, the report notes that, over the past few years, the asset allocation matrix, however, has changed significantly.  S&P notes that for 2009, pension funds reallocated their assets out of equities (63.1% in 2008 to 43.7% in 2009) and into fixed income (32.3% in 2008 and 42.9% in 2009); a shift resulting from what S&P termed “the new balance between perceived safety (fixed income) and acceptable risk (equities), inspired by the Bear market and the Financial liquidity crises”.  That said, while assets may have shifted, the overall pension fund portfolio return declined only slightly; from 8.02% to 7.95%.

Then as the bull market of 2009 took hold, funds again shifted their allocation, this time back to equities, “chasing higher returns and accepting the higher risk associated with the shift,” according to the report authors. The year-end 2009 result is that allocations to equities increased back up to 50.40%, while fixed income allocations dropped back to 38.03%.  “Given the equity gains of 2009, the ending asset allocation value suggests that fund managers may have taken some equity profits along the way, limiting the upward rise in equity allocations, and reducing corporate contribution,” according to the report. For 2010, S&P 500 issues are estimating that they will contribute US$ 32.1 billion. “Given the change in allocations, the current market correction will have a greater impact on pensions. Based on the 7.83% estimated 2010 return, the aggregate year-to-date projections are US$ 66.2 billion short of their goal,” according to the report.

The report acknowledged that legislation resulting in the temporary suspension of pension funding requirements in December 2008 “reduced the short-term obligations of many corporations, but did not change the requirements or schedule for current and future payments,” and also that the resulting one-year suspension of accelerated payments “did not give the market (or funds) sufficient time to recover from their massive downturn.”  More succinctly, “While the band-aid helped, it has now been removed.”

The report notes that, to some extent, the long-term funding rate may depend more on the discount rate used than the actual returns, and that while short-term rates are expected to slightly increase, it is generally believed that once the economy is strong enough, longer-term rates will rise – and that the resulting higher discount rate will reduce the future liability and improve funding - at least on paper.  “The side-bar joke is that if rates go up high enough, full pension funding would be accomplished and success declared,” according to the report.  However, it also notes that “the reality is that you can write as many paper checks as you want, but the bank will only clear the ones for which you have enough cash”.

“It should be noted that while plans may be deficient, companies are awash in cash, with Q1 2010 setting a new cash and equivalent record for the S&P Industrials (Old), at US$ 837 billion, the equivalent of 72 weeks of expected operating income.”  That said, in view of the demographics, the report says “it remains mathematically difficult to extrapolate an S&P 500 pension fund that will be fully funded within the next several years”.   

S&P’s optimistic estimate, based on an S&P 500 at 1310 (which is 20% above the current close) and interest rates 50 bps higher (across utilized maturities) calculates out to a pension

improvement, but underfunding remains solidly in the red by US$ 150 billion. On the other hand, the “gloomy forecast”, based on the current market correction turning into a Bear market combined with slightly lower interest rates, increases the underfunding to a record US$ 395 billion.”

The report noted that, given reduced benefits, reduced personal and retirement accounts, and increased retiree longevity, workers who have a choice will delay retirement, change lifestyles, and accept that retirement as they envisioned it may not exist.  However, the report also noted that, while pensions remain significantly underfunded, the record level of cash held by S&P 500 companies makes the obligation a business item, not a retiree problem.

The report is online at http://www.standardandpoors.com/indices/index-research/en/us

 

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