Sunday, October 30, 2005

“Broken” Record

By now you have perhaps read – or at least been told about – the recent cover story in Time magazine titled “The Broken Promise.” The promise - one of retirement benefits and health coverage – has been broken by employers, with the complicity of government, according to the story’s authors. And, in fairness, if one is looking for trouble in the nation’s private pension system, there is trouble to find. Some of those “troublemakers” have been taken to task in this very column.

It isn’t just workers who have had “promises” reneged on, of course. Lawmakers have made significant changes to the laws regarding these programs over the years and, unlike the portrait painted by Time, they have frequently served to discourage both the funding of existing programs as well as the formation of new defined benefit programs. Generally, as in the current wave of “reform” legislation, they are targeted at the bad behaviors of a few – but come into effect well after those targets have skipped town. In effect, they punish those still trying to play by the rules for the misdeeds of others, which simply accelerates the rush to the exits.

Have you wondered how pension funding got to be such a big problem seemingly overnight? The problem with pension funding isn’t generally due to poor employer funding policies or lousy market returns, though both play a role. No, most of the “damage” to the system is a direct result of the elimination of the issuance of the 30-year Treasury bond – a decision that effectively undermined the rational basis upon which pension liability calculations had been predicated since the advent of ERISA. While this may have appeared to be good economic policy at the time, its impact on pension funding calculations has been enormous, unanticipated, and imposed upon employers without regard to its impact on those calculations. Congress was late to focus on the issue – and we’re still dealing with “temporary” replacements for this calculation.

As for retiree health care, lawmakers have refused to permit employers the kind of funding flexibility necessary to set aside funds for those obligations. Little wonder, given the dramatic double-digit increases in costs over the past several years – and the accounting changes imposed more than a decade ago - that a growing number of employers feel they simply cannot continue to support the expense. An expense that, certainly in some cases, seems relentlessly driven higher by the complacency of workers with a co-pay-only accountability for the financial implications of those decisions. Little wonder, too, that employers might look to offset their financial obligation by the amount of Medicare coverage, in much the way that they have for pension offsets with Social Security.

But the most significant “betrayal” of the pension promise, IMHO, comes from the accounting community – more specifically the Financial Accounting Standards Board (FASB) – which, in the “interests” of accuracy and transparency, have transformed the long-term nature of these commitments into short-term obligations. This space is too short to debate the merits of that approach – but one cannot credibly dispute that the accounting treatment of pension and retiree health-care obligations has undergone significant change since ERISA was passed, certainly since many of these promises were made. In a very real sense, employers made their pension promises based on a specific set of financial terms and conditions - that were totally, and dramatically, rewritten a decade later by the accounting profession.

None of that context addresses the very real plight of retirees who find themselves without the financial resources they had hoped for, or counted on, at the end of their working lives. For years employers have been expected to simply absorb the impact of these dramatic changes in policy, while changes in the underlying programs are widely pilloried as a betrayal of worker trust. Unfortunately, coverage like that in the Time article sheds no light on the root causes of the problem. Rather, it attempts to create a villain by caricature – the greedy employer – which it seeks to hold accountable for the challenges that confront us.

But by glossing over the real culprits and causes of the crisis it seeks to perpetuate, it contributes to the problem, rather than the solution.

Sunday, October 23, 2005

Peer Pressures

One of the most valuable skills in my profession - and perhaps in any profession – is an ability to discern trends early. Just as valuable is the ability to discern the sometimes fine line of distinction between what may be a trend, and what may, in fact, be nothing more than a fad. Most plan sponsors have a functional aversion to the latter, and the vast majority have no real passion for being too early in the adoption of the former. After all, nowhere in the fiduciary directive to do only things that are in the best interests of participants and beneficiaries can there be found an admonition to be first.

Notwithstanding those natural disinclinations, ours is a business in which trends – and fads – constantly emerge. Whether it is simply a function of the incessant "arms race" deemed necessary to cement a provider's position in the market, or a genuine pursuit of excellence, it seems as if there is always some new idea or product coming to market. That’s a good thing for journalists, but plan sponsors, and to some extent advisors, can find it to be somewhat discomfiting. After all, adhering to that other fiduciary admonition – the requirement that services offered to participants and the fees paid for them be “reasonable” - is most certainly a fluid determination as well.

So, how do plan sponsors make that determination? One must be careful in making generalizations about such things, of course. The difference between a fad and a trend is often no more than one of time and acceptance, after all, and each plan sponsor situation is based on hugely independent factors. Still, in my travels (and travails) in working with plan sponsors, I have found that a new idea/product can quickly evolve to become a trend if it:

Is cheap
Is easy
Solves a problem
Helps participants
Seems the right thing to do

As a corollary, things that cost money, seem complicated to introduce, or that don’t address a current perceived problem will naturally be a harder sell. But even if all the factors listed seem to apply, that new product/idea can be “trumped” by one simple factor – does it mean taking on additional risk for the plan, or the plan sponsor? And, IMHO (and in my experience), if it does, all the other factors don’t really matter.

No wonder things like daily valuation (which, at least on the outside, seemed to be both cheap AND easy), burgeoning fund menus, and, more recently, lifestyle funds seem to become the “norm” almost overnight. Little wonder, too, that things like self-directed brokerage accounts, wireless PDA delivery of participant account information, automatic enrollment, and, yes, even offering advice to participants, are harder sells. It also helps explain why things like offering advice can, over time, be seen in a new light – to wit, that the risks of not offering advice may be greater than doing so.

There is, however, one additional factor that influences plan sponsors in their decisionmaking process, and as odd as it may seem, it is a factor that influences most of us from a very young age. For as surely as plan sponsors are understandably reluctant to be first to embrace a new concept, as human beings we also have a tendency to go with the flow, to follow the crowd. Fads become trends sometimes for no reason other than the rationale offered by teenagers everywhere for occasionally aberrant behavior – because “everybody is doing it.”

Plan sponsors rely on advisors not only to keep them abreast of current trends, but to help them cut through the clutter and “spin” of the latest hot product pitches, and to help them fulfill their fiduciary obligations to act in the best interests of participants by providing access to services (and services at fees) that are reasonable for their needs. The best advisors resist the siren call of the crowd, while helping plan sponsors understand both the pros – and cons – of new concepts.

Or, as I’m sure your mother once told you – “So, I suppose if everyone else jumps off a bridge, you're going to?"

Sunday, October 16, 2005

Simply, Stated

I don't get the Roth 401(k).

More accurately, I don't get the need for the Roth 401(k).

I understand that there is an emerging common wisdom that tax rates in the future will be higher than they are at present. I also understand that some may well believe that they are in a better position to pay taxes now than they may be in the future. Bottom line, I understand the appeal of the Roth IRA. I just don’t get why we need to clutter up the 401(k).

Let’s be honest here. The folks most likely to benefit from the Roth 401(k) (other than a myriad of personal finance columnists) are, quite simply, those who are better-off financially. Not that I am against benefits for this group (I am, and hope to remain, among this constituency). However, given how many arcane rules and strictures exist in qualified plans to prevent them from benefiting unduly at the expense of the plan, the Roth 401(k) strikes me as peculiarly targeted.

It’s not exactly a "giveaway" for the rich, who won’t be able to contribute more to the Roth 401(k) and their pre-tax account than they previously could to the pre-tax account alone. Indeed, proponents claim the Roth 401(k) gives highly-compensated executives who were beginning to look askance at their need for a tax-deferred savings vehicle a new reason to support the workplace program. There’s nothing that precludes the non-highly compensated individuals from taking advantage of the convenience of the account in their 401(k), after all, nor are employers even obligated to offer the option to participants. Those worried about that burgeoning federal deficit may even draw comfort from the fact that the Roth 401(k) is a projected money maker (the US government gets tax revenues now, rather than later).

Like self-directed brokerage accounts, it will no doubt find an enthusiastic constituency among some professional service firms and for a handful of executives across a broader spectrum of employers (unlike those self-directed brokerage accounts, however, the costs will likely be born by the entire plan, not just those who avail themselves of the option). And like those accounts, many of those who will benefit most, and who will be most intrigued, will have availed themselves of the services of a financial advisor. My best guess is that one will be hard-pressed to find a provider who will not offer the capability - and, having spent some amount of time and energy building the facility, we can count on a steady promotional drumbeat extolling the virtues of the additional flexibility.

Still, at its best, the Roth 401(k) seems a dalliance for those the federal government generally deems too wealthy for such deference, IMHO. Moreover, it will be expensive to develop, complicated to explain, and at least marginally problematic to administer.

At a time when our industry is clamoring for greater simplicity - when the current complexity of choices already stymies the participation of so many – additional cost and complexity is surely the last thing we need.


- Nevin Adams

Monday, October 10, 2005

Fly “Buy”

Last week, in Washington, DC, a couple of senators that most of you may never have heard of brought a rush to pension “reform” to a screeching halt – and may have killed it for this session. Senator Mike DeWine (R-Ohio), along with Senator Barbara Mikulski (D-Maryland), used a procedure that allows individual senators to stop legislation from advancing to the full Senate. The bill, co-sponsored by Senator Charles Grassley (R-Iowa), contains a number of pension reform provisions, including increasing the insurance premiums paid by defined benefit plans, expanding and enhancing funding level disclosures, changing some of the rules on how funding levels are determined, making it easier for companies to contribute more to those plans, and imposing tighter requirements on underfunded plans to address the situation.

Senators DeWine and Mikulski took issue with a particular provision in the bill – one that would have assessed higher funding requirements on pension plans based on the credit rating of the firm, rather than on the funded level of the pension plan – a determination that DeWine, at least, saw having a negative impact on steel and auto companies out of proportion to their actual commitment to their pension plans. Earlier in the week, Senator John Cornyn (R-Texas) also took steps to block consideration, though his concerns revolved around some of the special protections the bill provides airlines in bankruptcy regarding their pension funding. He was also expressing the concerns of his constituency – in this case American Airlines and Continental Airlines – who are trying to compete with airlines that would benefit financially from the law’s provisions.

Considering the number and state of the growing number of private pension plans being dumped on the Pension Benefit Guaranty Corporation these days, it is hard to argue against the need for serious reforms. It seems logical to increase insurance premiums in this environment, and if the proposal would nearly double them – well, they haven’t been increased in more than 20 years. It seems similarly evident that changes are called for in how funded status is determined, and we surely need a better system for knowing that a plan is in trouble, and responding, than is currently deployed. Given the complicated nature of these calculations (which, IMHO, are still largely projections based on assumptions predicated on best guesses about events a generation in the future), I think one could well argue that a determination based on a firm’s credit rating says more about the ability to sustain that obligation than the need to do so. Similarly, a determination based solely on the current projected funded status says more about current assumptions than it does a firm’s commitment to fulfilling those promises (this is the presumption contained in a comparable pension reform bill in the House of Representatives). Surely the best answer is a common sense evaluation that considers both funded status and credit rating – and we can certainly hope that, should the Senate bill proceed, this would be incorporated as part of the reconciliation with the House version.

There seems, however, to be this notion in the Senate that the airline industry – more accurately, certain carriers in that industry – are entitled to a special dispensation from these obligations. The Senate bill would give those troubled airlines twice as long (14 years) to fix their pension funding problems as any other industry. This concern is no doubt driven by a sense that the industry faces a unique set of challenges, that those airlines are truly committed to fixing the funding issues, and that failing sufficient time to do so, they will simply dump those massively underfunded obligations on the PBGC.

All of this may be valid – but, given these airlines’ track record, I cannot imagine how any credence can be given to the view that giving them more time does anything more than postpone the inevitable. Consider the actions of United and its unions earlier this year in trying to pull one over on the pension system (see IMHO: Left Holding the Bag?), their last (successful) attempt to buy some more time (see IMHO: Wait Loss), or even their response to the September 11 terrorist attacks (see IMHO: The Aftermath). Yet here we are again, according certain players in a specific industry a “gimme” that will no doubt come home to roost in the next 24 months – with interest.

The private pension system needs some reforms – and some help. But I, for one, am sick of being “played” by these airlines as some kind of financial patsy. The sooner the Congress stands up to this kind of financial blackmail, the better.

Sunday, October 02, 2005

An Unnatural Disaster

There are few things more unseemly than watching an elected official pander to his or her constituency – unless it’s an elected official who has made a political misstep trying desperately to get back on the right side of the issue. Far be it from me to disparage the motivations of all the political responses to the devastation of Hurricane Katrina – but surely some were of dubious origins.

There were, of course, many well-intentioned and truly helpful responses, and surely Katrina – and more significantly, the flooding that followed – was a disaster of historic proportions, at least on an aggregate level. Still, I was stunned to watch the Internal Revenue Service and Department of Labor jump into assistance mode, dramatically lowering barriers to the withdrawal of retirement savings in response. With the stroke of a pen, they qualified distributions in the impacted area as hardships, waived the 10% early withdrawal penalty, waived the 20% withholding requirement (but not the eventual payment of taxes – who are we kidding?), doubled the maximum amount available for a plan loan (to $100,000), and liberalized the repayment schedule on those loans.

No doubt the extent and expeditious nature of the relief will be appreciated by those in the disaster area, and certainly there are those who desperately need the help. Moreover, unlike the mammoth amounts of government aid and assistance already targeted for the area, this relief is funded by the very pockets of those impacted by the disaster.

Of course, while the breadth of the disaster may have been historic, the depth wasn’t, at least not on an individual basis. Was the loss of a Jefferson City Parish home any more devastating to its owners than one flattened by Hurricane Frances a year ago? What about that tornado that touched down in Illinois last May? The ones burned to the ground by wildfires in California? The fact is, on an individual level, there is no difference in result.

Sadly, in its effort to respond compassionately to the tragedy of the situation, the Bush Administration has, IMHO, opened a potential Pandora’s Box. For just as surely as Katrina’s devastation wrought severe hardships, distributions related to dealing with that kind of life-altering event are entitled to hardship status. But so are those wildfires in California, that tornado in Kansas, that flood in Kentucky.

It’s hard to question the desire to allow those in desperate need to tap all available financial resources to restore their lives, even at the risk of placing their eventual retirement at risk. However, it would be the epitome of shameless political pandering to treat only those in Katrina’s path with that kind of deference, while ignoring those so similarly impacted in other geographic areas (many of whom, it should be added, will receive no assistance other than personal resources).

Personally, I think it was a mistake to liberalize the loan limits, to waive the hardship penalty, and to suspend the 20% withholding. These limits serve a real purpose, and they have been in place for a long time and through many disasters. Having lowered the bar, it seems to me that the Administration has, pardon the reference, opened the floodgates.

- Nevin Adams