By Mike Clark, Consulting Actuary, the Principal Financial Group
If imitation is the sincerest form of flattery, then single-employer defined benefit (DB) sponsors would blush after reading a draft of the Rehabilitation for Multiemployer Pensions Act (RMPA) recently introduced in the House by Representative Richard Neal (D-MA).
That is because RMPA proposes to address multiemployer DB risk using two strategies single-employer plans have increasingly implemented over the past decade:
- Purchasing annuities to transfer risk permanently to an insurance company
- Hedging interest rate risk using liability driven investing (LDI) strategies featuring high quality, duration matched bonds
Fund, Hedge, Transfer
Indeed, annuities and LDI can both be highly effective at reducing the overall risk of a DB plan. That is why their popularity has been increasing so quickly in the single-employer world. But the problem with fully hedging or transferring risk is that you first have to fund the liability. Single-employer sponsors have poured considerable amounts of cash into their plans since the financial crisis just to reach a point where these actions make financial sense.
Multiemployer plans as a group, however, are significantly underfunded1. Liabilities of the system practically double the assets available to pay the benefits. (Thus the inclusion of the word "Rehabilitation" in the bill's title.)
And since multiemployer plans don't use market value funding rules, buying annuities or shifting to an LDI strategy could result in higher funding requirements due to either actuarial losses or a lower long-term expected return of the portfolio. (This connection to total returns is also a significant driver of the relatively low take-up of multiemployer LDI strategies to date.)
The Twist…Government Funding!
Enter the RMPA. According to the language in the draft, the bill would establish a new Treasury agency called the "Pension Rehabilitation Administration" (there's the "R" word again!) to solve the funding part of the equation.
The PRA's mission would be to issue loans to multiemployer plans in "critical and declining status" or insolvency. Funding would come from the "Pension Rehabilitation (again!) Trust Fund", which would be populated by treasury bond transfers by the the Secretary of Treasury.
Mandatory Risk Management
The loans come with a catch though. Proceeds would need to be used to either buy annuities or invest in LDI duration matching portfolios for current plan retirees and beneficiaries. (Money can't be used to simply fund up the plan and chase total returns.)
In essence, the plan would become a pass-through vehicle for the government to fund the liabilities with the knowledge that future risk would be reduced or eliminated. (An outcome that is beneficial to both plan participants and the beleaguered PBGC multiemployer insurance program.) The responsibility of using the new cash to purchase annuities or obtain an LDI strategy would remain with the sponsor.
Not a Bailout?
Representative Neal was clear in stating that the assistance, "is not a bailout. These plans would be required by law to pay back the loans they receive from the PRA - the federal government is simply backstopping the risk."
But a close reading of the bill reveals that the loans have a 30-year balloon structure with only interest payable for the first 29 of those years. PRA is also granted authority to renegotiate repayment terms or forgive debt.
The primary reason rehabilitation is required in the first place is a long term trend of declining multiemployer plan participation and contributions. Unless this trend were to unexpectedly reverse itself over the next three decades, it seems very likely that the default rate on PRA loans will be significant.
RMPA isn't perfect, but it's undeniable that the multiemployer pension systems needs attention. Putting the uncertainty of the PRA loan repayments aside, the bill protects retiree pensions better than anything else being proposed.
At this writing, it appears the RMPA has enough support in the House to pass, and the Senate will likely be working on their version this year. Though it's still just a bill, the solution seems reasonable enough - and the crisis urgent enough - that passage of RMPA or something similar this year isn't out of the question. (RMPA language suggests loans should be made available no later than April 30, 2019.)
The risk hedging and transfer concepts of the bill are sound. Tried and tested by thousands of single-employer plans across the US, it is a pension risk management model worthy of imitation.
The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, investment advice or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.