Over 100 US Multiemployer Pension Plans Face Insolvency

Despite rising funded status trend, many plans will run out of assets within 10 years.

While many US corporate pension plans have enjoyed steadily rising funded levels over the past couple of years, others are still struggling to stay afloat, as 107 multiemployer pension plans are projected to become insolvent over the next 20 years, according to a report from the Society of Actuaries.  

By most accounts, corporate pension plans have been moving toward full funding levels in recent years, and have seen significant improvements in their status since being devastated by the financial crisis 10 years ago.

Consulting firm Milliman reported earlier this month that the aggregate funded ratio of all multiemployer pension plans in the US reached 83%, the highest since 2008.

And Goldman Sachs Asset Management estimates that the funded level of the 50 largest US defined benefit plans in the S&P 500 surged to 85.4% at the end of 2017, from 81.1% at the end of 2016.

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The Society of Actuaries report looked at the pending insolvency on 115 “critical and declining” multiemployer pension plans, their participants, and contributing employers. The plans cover approximately 1.4 million participants, 719,000 of whom are retired and receiving annual benefits totaling more than $7.4 billion. Approximately 11,600 employers contribute to the plans, many of which are at risk of becoming insolvent within fewer than 10 years, according to the report.

The current estimated liability for the 115 plans covered is approximately $98 billion using the minimum funding requirements’ approach. Some $57 billion of that is not funded, for an overall funded ratio of 42%. When using a discount rate of 2.90%, it is $108 billion, according to the report. The discount rate of 2.90% represents a liability-weighted average of Treasury rates in April.

The report forecasts a steady increase in the number of insolvent plans: by 2028, 50 plans are projected to become insolvent, increasing to 91 by 2033, and 107 by 2038. The 21 plans projected to become insolvent by 2023 will cover approximately 95,000 participants at that time, and include 350 contributing employers. The 50 plans projected to become insolvent by 2028 will cover approximately 545,000 participants, with about 2,700 contributing employers.

The 91 plans projected to become insolvent by 2033 are expected to cover approximately 920,000 participants, and about 5,100 contributing employers; and the107 plans that are projected to become insolvent by 2038 will cover roughly 875,000 participants and approximately 11,350 contributing employers.  

Although the number of insolvent plans increases over time, the report found the number of participants in insolvent plans will decline after 2032, at which time deaths among the aging participants are expected to outpace the number of new employees among the ongoing plans.

The report also said that freezing benefit accruals, or closing plans to new entrants or new benefit accruals has little effect on either the timing or financial impact of insolvencies among the plans over the next 10 years.

Additionally, closing a plan to new entrants and freezing accruals “would deny the plan future contributions associated with active participants,” said the report, “which could outweigh the value of their future benefit accruals.”

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Opinion: Funds Could Increase Their Expected Rates of Return

Fiduciaries may have overlooked a very simple and lucrative source of expected returns.

Declining yields globally over the last 15 to 20 years have severely impacted the funded status of pension funds. Further, weak potential global economic growth has greatly reduced the return expectations for all assets. These pressures are forcing US public pension funds to lower the 10-year expected returns and has dire consequences for the sponsor of the fund, because it requires additional contributions at an inopportune time.

We argue that things are not as dire and, if one wanted to be controversial, there is a case for even raising the expected returns. Fiduciaries may have overlooked a very simple and lucrative source of expected returns that innovative pension funds captured with no change in policy or manager lineup.

Forecasting expected returns involves projecting a static Strategic Asset Allocation (SAA) for a given level of risk. Today, that static SAA is generally expected to deliver a 6.5% to 7.5% p.a. return. To raise that SAA return would require increasing allocations to illiquid assets or adding leverage, resulting in a commensurate increase in risk—an unpopular choice in the current market environment. But this static approach ignores a simple, yet potentially lucrative, source of expected return that is already baked into the SAA of every fund, requires no policy changes, and that some innovative funds have been capturing for years–Policy Ranges.   

Dynamic markets cause a portfolio to drift around its SAA, so when approving a SAA policy, a board also approves allowable policy ranges before a rebalancing is triggered. While this policy range is generally viewed from the standpoint of risk (potentially 0.5% to 1.5% annualized risk), it also represents an overlooked source of potential return. We argue that policy ranges offer positive expected returns, and that most funds have ignored this “proper value” when calculating expected return assumptions.

Traditionally, plans implement a calendar- or range -based approach to manage the risk of portfolio drift. Such traditional rebalancings are a coin toss and represent arbitrary, reactive decisions based on behavioral biases. Worse, they can actually serve to exacerbate drawdowns in bear markets as was the case in 2008.

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Previous claims that traditional rebalancing approaches were actual strategies—buy low, sell high or a form of volatility pumping— and were also not market timing are all easily disproved. The percent change in an asset’s allocation caused by drift is not just a function of that asset’s performance since the last rebalancing—it must also be viewed against the performance of all other assets in the portfolio over that same time period. In short, was the fund tilted to the right asset classes at the right time? In reality, simplistic rebalancing approaches have missed that point and taken funds in the wrong direction.

Instead of letting a portfolio aimlessly drift until some happenstance trigger occurs, a clearly identified staff member could take ownership of the asset allocation decision and make adjustments in an explicit, rules-based, and informed manner. Such asset allocation decisions contribute 80-90% to total fund risk and should be actively measured, monitored, and managed. We call this informed rebalancing, different from traditional rebalancing. The responsible individual uses simple but detailed relative value analysis to determine when and which assets to over- and underweight, and specifically by how much, within ranges already approved by the board.  

Utilizing an informed rebalancing approach can add anywhere from 0.5% to 1.0% p.a. to the entire fund.  For example, it has been independently verified that for the nearly 12 years ending January 2018, an innovative public fund has added approximately 1.2% p.a. to total fund returns (or about $1 billion) from informed rebalancing. Moreover, this potential can be tapped by large and small funds alike, with small or large teams, and each fund can develop a bespoke approach to managing this decision. This is how proper value is extracted.

The informed rebalancing approach differs from GTAA and other market-timing strategies in that it is custom built for the fund’s SAA and objectives rather than the GTAA provider’s needs. Informed rebalancing requires a modest but steady series of portfolio adjustments, none of which requires the investor to bet the farm. It is also rules-based, objective, and separate from the manager’s emotional estimation of the state of capital markets. 

The informed expected return of a fund equals static SAA (6.5%-7.5%) plus proper value (0.5% to 1.0% depending on ranges). Just as the static SAA will go through cycles and have good and bad years, so too will the proper value; but an innovative public fund and other funds that have adopted this approach have reaped its long-term rewards.

Fiduciaries must tap every opportunity to maximize fund results. Incorporating proper value analysis and informed rebalancing holds the promise of additional return without any change in investment policy or governance. Pension funds can (and should) raise their expected returns.

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