Moody’s: Expect Pension Risk Transfer Surge to Beat New Mortality Tables

A surge of pension de-risking is expected before the end of the year, as US corporate sponsors aim to beat new mortality tables that could push total liabilities up by $100 billion, rating agency Moody’s has said.

In a note about a bulk annuity deal that saw Motorola offload $3 billion in assets and liabilities last week, Moody’s considered the extra expense the company would have faced if they had waited another three months.

“Had Motorola waited until 2015, the changes in mortality assumptions would have required the company to offer larger lump sums to retirees,” the note said.

Current financial reporting and funding rules use mortality assumptions that are more than 14 years old. The Society of Actuaries undertook a four-year project to update these tables and intend to publish an updated set on October 31.

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“Most actuaries expect these new tables to add between 3% and 8% to pension benefit obligation (PBO), with some actuaries even predicting increases up to 10%,” Moody’s said. “From a financial reporting perspective, companies will likely be required to use the new tables when calculating pension obligations for the fiscal years ending after 31 October.”

At the end of 2013, Moody’s entire rated universe of non-financial corporate issuers had a combined PBO of $1.8 trillion. Applying a 5.5% increase—the midpoint of the 3%-8% consensus estimated increase— would increase PBO by approximately $100 billion.

Moody’s warned that the increase was “not just a theoretical accounting change that does not affect economics”. Rather it warned that companies would be required to pay down this $100 billion increase over seven years, which would result in “a credit negative”.

“Given this impending large increase to PBOs and cash drains, we expect more Motorola-like announcements in the coming months,” Moody’s concluded.

The nine trustees of the San Diego County Employees Retirement Association (SDCERA) are set to vote on Thursday whether to terminate its outsourcing contract with Lee Partridge’s Salient Partners—a deal they passed eight to one in June.

“It is well documented that we’re paying exorbitant, outlier-type fees with no incentives except to grow the fund,” said SDCERA Trustee Begovich.The outcome is too close to call, according to several sources familiar with the matter. Three trustees have consistently backed and defended the arrangement, including David Myers and David Moore, while three others adamantly oppose it. A September 18 motion by Dianne Jacob initiated the vote, seconded by new member Samantha Begovich. In June, Dan McAllister alone came out against the contract. The positions of the final three trustees remain unclear.

In the event of a majority vote to dismiss Salient, the board is expected to nominate consultant Wurts & Associates as interim portfolio manager. A partner from recruiting firm Korn/Ferry is also slated to present about its recent search for an internal CIO for the California Public Employees’ Retirement System. According to the agenda, the board may then vote on whether to solicit proposals from recruitment firms to undertake their own search.

No other public pension fund in the country approaching SDCERA in size ($9.9 billion as of March 31) has wholly outsourced its portfolio to an external CIO, as the San Diego board chose to in June. Two vocal critics of the strategy emerged shortly thereafter.

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Trustee Begovich, a deputy district attorney and chair of the Stanford Law Society, began serving in July. Hers is one of four trustee seats elected by plan members. According to meeting records, she began researching the newly inked outsourced-CIO (OCIO) deal, and felt it did not align with members’ interests.

“It is well documented that we’re paying exorbitant, outlier-type fees with no incentives except to grow the fund,” Begovich said in a September 4 meeting. “A contract with no ties to performance is something that I cannot support. And so I will be voting ‘no’ on that when the time comes.” Begovich declined to comment further when reached by CIO.

In the same meeting, Jacob, who had supported the contract months earlier, said she believed she had been misled on its terms. She likewise disputes that the board’s eight-to-one vote in June approved the contract, as the press release stated, as opposed to “accepted” it. The new contract set Salient’s annual fee at 11.5 basis points of assets under management for the first six months and 10 basis points after that. The firm also agreed to employ SDCERA’s three investment staff members.

Weeks later, Jacob stated she could no longer support the arrangement and successfully motioned for a vote to terminate it.

Meanwhile, a series of articles critiquing SDCERA’s performance, the fees paid to Salient, and leverage involved in its risk parity allocations appeared in the local newspaper U-T San Diego. In an editorial titled “Scary New Chapter on County Pension Front,” the paper’s board described leverage as “an aggressive investing tactic that is loved by hedge funds but disdained by such investment experts as Warren Buffett and by pension funds in general.” It closed with a warning: “If things go awry, the county will be in a far worse hole than before… So be nervous, county taxpayers and pensioners—very nervous.”

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For some stakeholders and investment professionals, the credible possibility of a vote to terminate Salient and reverse SDCERA’s investment strategy has made them much more nervous than leveraged exposure to treasury bills ever did. In meeting after meeting and several public statements, Salient founder Lee Partridge and supportive board members have stressed that the board-approved strategy is performing exactly as promised.

“All of our board members were fully aware of the investment portfolio structure and how it would perform in an equity bull market,” wrote Trustee Myers, a Salient supporter, in response to the conflict. Likewise, “all understood, or at least I thought they understood, that it is the long term sustainability and performance of the retirement fund is what matters.”

Myers continued to say he was “flabbergasted” at the proposal to fire Salient and exit its investment strategy “without thinking through all of the implications and any form of a backup plan or approach. There are many terms to describe such proposals, but I would not describe them as ‘measured,’ ‘well thought out’ or even ‘analytical.’”

An alternative asset allocation to replace Salient’s has not been put forth by trustees. Much criticism has centered on fees, complexity, underperformance relative to equity markets, and the use of leverage and derivatives. In discussions with CIO, several industry observers expressed alarm at the notion of shifting to a traditional, largely passive portfolio at this stage in the business cycle. Relative to risk-parity heavy strategy like SDCERA’s, they questioned the wisdom of dialing up equities exposure five years into a bull run.

Salient itself has, at least externally, appeared one of the least nervous stakeholders in the entire affair. When reached for comment about the impending vote, the firm stated that it serves “at the pleasure of the SDCERA board of trustees.” As always, it said, “we continue to implement the asset allocation and exposure guidelines mandated by the board. We look forward to further discussions with the board as they reconsider their guidelines.”

The vote is scheduled for the morning of October 2.