(December 5, 2013) — aiCIO has analysed the investment tactics of the world’s largest pension lifeboats. After considering the financial position and investment strategies of the two heavyweights in yesterday’s article, which one has got enough life in them for the knock-out blow?

Ding, Ding! Round Three: Premiums/Levies

Which brings us to one of the biggest differences between the two lifeboat funds–and something any future lifeboat should consider before setting up.

The PBGC cannot set its own premiums. For years, the level set was far too low for the liabilities being covered by the pension fund, but it requires an act of Congress to push through any amendments.

In 2003, the US Government Accountability Office (GAO) added PBGC to its “High Risk” list of agencies, because it controls neither the benefits it pays nor the premiums it charges.

“Congress has repeatedly raised PBGC’s premiums, but they remain too low to fund our obligations. That’s why, 10 years later, we remain on GAO’s High Risk List,” the 2013 annual report says.

“Administrations of both parties have proposed putting PBGC finances on the same basis as other government insurance programs and private insurance, by making PBGC’s board responsible for setting premiums. Without the tools to set its financial house in order, PBGC may face for the first time the need for taxpayer funds. That’s a situation no one wants.”

There are two parts to the single employer premiums, the flat rate—based on the number of participants in a plan—and the variable rate, which is a risk-based levy and doesn’t consider the plan sponsor’s strength: it solely looks at the unfunded liabilities in the plan. Multi-employer plans only pay a flat rate levy, due to the lower levels of compensation provided.

Back in 2004 the flat rate for single employers was $19 per participant. Last year, after years of campaigning, it was finally lifted to $35 and it will go up to $49 in 2014. It is proposed to rise with inflation each year thereafter.

In 2004, the variable rate was $9 for every $1,000 of underfunding. From this year, that’s risen to $13 and it will rise again to $14 in 2014. Again, the plan is for it to be adjusted for inflation thereafter.

Despite the assertive premium rises, it doesn’t appear to have gone far enough. The multi-employer plans have yet to see significant rises in premiums, leading the PBGC’s annual report to warn that the multi-employer program will run out of money in the next 10 to 15 years unless changes are made.

Bridget Moser, manager at KPMG, notes: “You’ll see from the annual report that the deficit for single employer plans has fallen, but the multi-employer plans’ deficit hasn’t changed. That might be the PBGC hinting that multi-employer plans need to change.”

Raising premiums is a contentious issue in the US. Aon Hewitt’s Jacobs notes the issue is how to define the right level of premiums to sustain the business model without making the premium so high that the better companies who never plan to use the PBGC decide the charges are too high and move out of the system.

There’s also questions being asked around the methodology for setting the premium rates. “Over the years, other measures have been discussed but not implemented. Things like the credit rating of the company being used as a proxy. The investment strategy of the original fund has also been discussed as a way to set the premium, but it’s not in the legislation,” Jacobs adds.

The PPF does set its own premiums, or levies as the Brits know them. Despite being £1 billion in surplus this year, the UK lifeboat maintained the current levy levels, arguing the amount should be maintained in order to increase the chances of the PPF being self-sufficient by 2030.

Today, the levy provides an income of £695 million for the PPF. By comparison, the PBGC collects $3.2 billion in premiums a year. As a percentage, that means the PPF’s premiums make up 4.6% of its total assets. The PBGC’s premiums, by comparison, make up just 3.8% of its total assets.

When aiCIO asks if there was one thing he’d advise the Irish government to do if it were to set up a lifeboat vehicle, the PBGC’s Greenberg agreed that being able to control and amend premium levels was paramount.

Result: PPF takes the third. The UK’s lifeboat scores a knock-down by being able to set its own premium. The inflexibility and lack of control means the PBGC is on the ropes in this round.

Continues on page two…

Ding, Ding! Round Four: External Risks

The external risks both the PPF and the PBGC face are similar. Both are sensitive to political changes, although as discussed above, the PPF’s ability to set its own levies without having to get the government’s go-ahead puts it slightly ahead.

Despite this, Tim Barlow, principal investment consultant at KPMG, warns political risk is still a major issue for the PPF.

“The PPF board can reduce pension in payment and reduce the total amount of benefits they pay out, but they need approval from the Chancellor to amend anything, so there are political sensitivities if they find themselves in a hole,” he explains.

In the US, politics can cause serious interference too. A well-placed source, who asked to be kept anonymous, assures aiCIO that a change in administration in 2008 caused havoc with the PBGC’s investment strategy.

Previously agreed changes to asset allocation—which would have seen equities account for 40% of the portfolio, fixed income account for 40%, and alternatives and property take up the remaining 20%—were kyboshed after a new set of reluctant secretary generals arrived in the Treasury. Rather than sign off on a new, untested strategy, they felt safer retaining the status quo. If that’s true, as mentioned above, that political interference has cost the PBGC billions of dollars.

Both funds also have to remain vigilant to regulatory changes, including regarding investment, and the impact they will have on their funds.

But the real challenge is something which is seriously difficult to mitigate. “There’s only one risk the PPF doesn’t hedge, and that’s another economic crisis, which would cause more companies to fall into the lifeboat,” says Barlow.

“It could do something about it by hedging the credit risk, but that would mean a change in the levy to pay for the premium. And there’s huge political sensitivity around that and around keeping a stable levy.”

A new financial crisis would also play havoc with the PBGC. “The biggest risk the PBGC faces is that the markets and companies stop performing well and start putting their pension funds into the PBGC,” says KPMG’s Moser.

Greenberg wryly jokes that he is constantly worrying—“We worry all the time… we wake up and we worry, we go to bed and we worry…”—but he genuinely admits to “always being worried about taking new plans in”.

Hedging credit risk is similarly unappealing for the US lifeboat fund, so what, if anything can they do?

Both funds have taken on the art of negotiation, specifically with plan sponsors, to prevent more pension funds falling into their care.

Greenberg describes this aspect of the PBGC as increasingly important. His colleague Mudd says each company that enters Chapter 11 enters into a dialogue about whether it can afford its pension liabilities, and there have been some big wins for the PBGC over the past couple of years.

Recent case studies include American Airlines (it had four defined benefit plans with assets of $8.3 billion and liabilities of $18.5 billion), which agreed to freeze the existing pension plans and retain the responsibility for them, and the Eastman Kodak Company, where the PBGC worked as a member of the unsecured creditors’ committee to help the company maintain its plans and protect the benefits of workers and retirees.

In the UK, the PPF has an assessment period for all company pensions which apply to enter the lifeboat fund. This relatively lengthy process allows it time to determine if the company has enough assets to support its pension fund or not.

Sometimes, it’s possible for funds to find enough assets to cover the pension liabilities or to secure the benefits through an insurer buyout, and avoid going into the PPF, where benefits paid to members can be reduced significantly.

In April, the UK arm of the Kodak pension fund was given control of parts of the business involved in areas such as the photo kiosks, speciality photo services, and scanners, in return for releasing the parent company and its affiliations from $2.8 billion worth of pension claims in court. 

A new scheme was subsequently launched by the UK trustees that  provided less generous benefits. The deal prevented the UK scheme from falling into the PPF.

At other times, the UK’s Pensions Regulator can be invoked to pursue companies for financial contributions to top up the fund.

It’s not all smooth sailing: it took all the way up until this summer for the courts to agree that the Pensions Regulator could pursue companies for financial support for their pension funds after they had become insolvent. And there are still Upper Tribunal cases to be heard on this issue, so it’s still not quite cut and dried.

Result: An honourable draw—both funds recognise the external risks facing them, and are doing all they can to mitigate it as much as they can.

Decision: On points, the PPF is a clear winner, but it has a shorter history and has been able to learn from the PBGC’s mistakes. Whether the nimbler newcomer can retain its prize-winning ways is yet to be seen, and the crowd will have to watch out for the older, lumbering welter-weight taking on a still unsteady corporate US.

On both sides of the Atlantic, however, the lifeboats will be nervous of another financial crisis that could deliver each a lethal KO.