The 'Vicious Cycle' of PBGC Hikes | Chief Investment Officer

The new budget deal reached between the US congressional leaders and the White House on Monday proposes a 22% jump in Pension Benefit Guaranty Corporation (PBGC) premiums over the next four years.

The 144-page bill, which must be approved by the House and the Senate, would raise premiums for single-employer corporate pension plans to $68 per person for 2017, $73 for 2018, and $78 for 2019, and then re-indexed for inflation.

The PBGC also announced Monday it had increased the flat-rate premium to $64 per person for 2016.

“The new bill’s new round of premium rate increases sends a signal to defined benefit (DB) plan sponsors,” Bob Collie, Russell Investments’ chief research strategist, told CIO. “It’s becoming more difficult and more expensive for plan sponsors to keep a DB plan.”

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“The new bill’s new round of premium rate increases sends a signal to DB plan sponsors. It’s becoming more difficult and more expensive for plan sponsors to keep a DB plan.”The latest proposal—largely an effort to balance and squeeze revenue into the budget—is also likely to affect plan sponsors’ decision making in a variety of ways.

According to Charles Millard, formerly director of the PBGC and currently head of pension relations at Citi, higher PBGC premiums could push plan sponsors towards pension-risk transfers (PRT).

“PBGC premiums are increasingly important to corporate plan sponsors and they’re a crucial element in the equation when a plan sponsor considers whether to transfer a pension plan to an insurance company,” Millard said.

And pension-risk transfers have been popular over the last eight years, according to Prudential’s latest research.

More than $260 billion in pension liabilities have been transferred since 2007, the firm found. At least 40 pension funds in the UK, US, and Canada have also executed transactions of over $1 billion in the last eight and a half years.

Furthermore, the new bill’s proposed increases in variable-rate premiums would incentivize plan sponsors to fund the plan at lower rates, Collie added. Other plan sponsors unable to keep up with premium hikes will accelerate freezing their DB plans.

However, Collie also warned continued increases in premiums could put PBGC in a worse economic position.

As more and more plan sponsors turn to PRT and freezing their plans, there would be fewer plans actually paying the PBGC premiums.

“It’s a vicious cycle,” Collie said. “It could do more harm to the PBGC revenue base than good.”

Leave exacta betting at the racetrack, wrote Cliff Asness in his latest blog post.

The AQR founder argued that it is difficult enough to be right once, let alone twice, making exacta-style investing—gambling on two separate, but related outcomes, such as which horses will place first and second in a race—more risky than it is rewarding.

“This type of two-step bet is usually a bad idea,” Asness wrote. “At the very least, it is worse than the original, simpler, one-step idea.”

“It’s hard enough to be right. It’s much harder to be right multiple times in a row.” —Cliff Asness, AQR Asness defined the two-step bet as when investors forecast a specific event—inflation, for example—and then invest in companies based on which they believe will benefit or decline, should that forecast come true. Rather than buy or sell currency, these investors buy or sell stocks based on how companies might perform should a currency go up or down.

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This means that in order to profit, two things need to occur: First, the forecasted event must come to pass. Second, stocks have to react the way the investor predicted.

By hinging a bet on two separate events, Asness argued, investors face a much lower probability of winning than if they had simply bet on the first event.

“It’s hard enough to be right,” Asness wrote. “It’s much harder to be right multiple times in a row.”

At least in horse racing, Asness added, gamblers are promised a hefty payout to compensate for the decreased probability of winning. In the financial markets, however, there’s rarely a bonus for taking on extra risk.

“If, somehow, you are really sure where the dollar is going, or where interest rates will be,” Asness concluded, “place your bet on the dollar or interest rates.”