Sunday, January 11, 2009

Pension Protection Fund?


Slumdog Millionaire took the Golden Globe award for best picture. Directed by Danny Boyle , an 18-year-old Indian orphan who has spent his life scavenging on the streets, lands as a contestant on the Hindi version of Who Wants to Be a Millionaire, and he wins big.

I wonder if Steven Spielberg will make a movie of the Bernie Madoff scandal now that he was named as one of the many victims of the fraud. Hollywood already made a picture back in 1989 called Weekend at Bernie's, but if Spielberg wants to make a film on Madoff he can call it Slimebag Billionaire.

Speaking of Madoff, Bloomberg reports that losses at municipal pensions are spurring an investment warning:
Municipal-pension managers shouldn’t give money to advisers who invest it in funds run by others, a practice that sparked $14 million of losses tied to Bernard Madoff, labor union investment official Richard Ferlauto said.

“We generally recommend that investors be very careful when using a fund-of-funds strategy,” Ferlauto, director of pension- investment policy at the American Federation of State, County and Municipal Employees, said in an interview today. “They can’t be sure that the investment manager is doing the due diligence necessary on every asset manager they use.”

Municipal workers from New Orleans to New Mexico lost money after their pensions gave funds to advisers who invested with Madoff. The 70-year-old New Yorker was charged last month with directing a $50 billion Ponzi scheme in which returns came from money collected from new participants rather than from investments.

The City of New Orleans Employees’ Retirement System, which has $300 million of assets, had about $400,000 with Madoff through three so-called funds of funds, according to Jerry Davis, chairman of the trustee board.

Davis said in an interview today that the system had $175,000 invested with Union Bancaire Privee, a Swiss private bank that invested with Madoff through Ascot Partners LP and the same amount with Meridian Capital Partners through Tremont. He said he had a “tiny” amount with Silver Creek Partners, another fund that fed money to Madoff’s firm.

‘Aggressive Action’

“We expect the funds of funds to take aggressive action to recover the losses,” said Davis. “It’s extremely unlikely we would take direct legal action. It’s too small an issue for us. It’s aggravating to be stolen from, but sometimes you just have to depend on the law.”

The $1.5 billion Baltimore Police and Fire Pension Fund lost $3.5 million on Madoff investments, said Stephan Fugate, its chairman. New York-based UBP Asset Management invested about 5 percent of the $73 million it held for the pension fund with Madoff, Fugate told the Associated Press last month.

The town of Fairfield, Connecticut, said last month that its pension fund had about $42 million invested with Madoff through the Maxam Absolute Return Fund.

Bigger funds “have advance due diligence systems,” Ferlauto said. “They do a lot of work before they make investments that are usually directly with a manager and directly into funds. They don’t employ what I think is this riskier strategy of relying on someone else to do the due diligence.”

New Mexico

He said large funds including Ohio, the Connecticut state system, the California Public Employees Retirement System and the State of New Jersey, probably don’t have Madoff-related losses through funds of funds.

“I wouldn’t expect to find anything there,” he said.

The New Mexico Educational Retirement Board, the pension fund for about 96,000 active and retired teachers in New Mexico, had exposure of $9.7 million to Madoff, Bob Jacksha, chief investment officer for the board said in an interview.

That represents about 0.2 percent of the fund’s $6.5 billion. The board invested through Austin Capital Management’s Safe Harbor Fund.

“It will not affect the payment of retiree benefits,” the board said on its Web site.

Jesse Evans, the assistant manager for the New Orleans system, said the Madoff experience would probably lead to more due diligence from investment managers.

“When you hand money off to a manager, you’d better find out what he or she is doing once that money leaves their hands,” he said.

The worst hit town in the Madoff fraud was the town of Fairfield, Connecticut which recently fired its pension consultant:

In the wake of the Bernard Madoff investing scandal, the town's joint pension boards voted Thursday to end its contract with New England Pension Consultants, which advised the town on its pension funds.

The town had a contract with the Cambridge, Mass.-based firm since 2006.

Fiscal Officer Paul Hiller and First Seletman Kenneth Flatto declined to comment on the specific reasons for the contract's termination.

I will repeat my warning, the Madoff Mayhem is the Tip of the Iceberg. There are many pension funds out there that did a poor job scrutinizing their hedge funds or funds of hedge funds managers and they will get socked for their sloppy due diligence.

With regards to pensions, the news keeps getting grimmer. In Canada, struggling pension funds are calling on the government to relax the funding rules:

The uncertainty that accompanies an economic recession and stock market meltdown is extending from the work world into a time of life that many consider to be a haven of worry-free relaxation: retirement.

A series of reports released last week show many of Canada's corporate pension plans are struggling to stay afloat amid plunging stock markets that eroded a good chunk of the plans' wealth in 2008.

Defined-benefit plans, under which employees are guaranteed a reliable and steady income after retirement, are in trouble as companies are under pressure to make up huge shortfalls through higher contributions.

Meanwhile, defined contribution plans, where retirement benefits are not guaranteed by employers and are based on investment returns, face even bigger problems.

For some companies with defined benefit plans, the pension shortfall creates a vicious cycle: the financial crisis is forcing them to make millions of dollars in extra payments at a time when the economy is in recession and they don't have the money to do so.

Under current federal pension rules, plans are routinely valued by government regulators - based on long-term interest rates and their current financial condition - so there is enough money to pay retirement benefits to all members of the plan into the future.

If these actuarial valuations show a major shortfall, companies are required to put cash into the plan to make it sound again. Pension plan shortfalls don't affect benefits paid to current retirees, who will continue to receive their promised pensions.

But they can wreak havoc on a company's finances when promised benefits to future retirees are calculated.

An extended repayment period could make a significant difference for many companies. For example, a company that faces a $50-million shortfall in its pension plan would have to top that up under the current five year rule by paying $10 million a year. If the repayment period was extended to 15 years, the company would only have to pay $3.3 million a year, or 67 per cent less.

Bryan Hocking, CEO of the Association of Canadian Pension Management, said the sudden financial reversal at many pension plans is causing Canadians to wonder just how secure their retirement will be.

"I think probably a few years ago most of the public wouldn't have even paid any attention to any of this," Hocking said.

"Now that it affects them directly, or has the potential of affecting them directly, I think they're paying a lot of attention to it".

Several federally regulated Canadian companies have been lobbying Ottawa to change the regulations to give them a longer period to top up shortfalls in their defined-benefit plans".

They argue that such a move would not be a bailout or require any government money, but would allow affected companies to spread out payments to their pension plans over a longer period.

In his economic statement last fall, federal Finance Minister Jim Flaherty said the government would extend the repayment period to 10 years from the current five, but many in the industry say that's not enough.

Several provinces have approved or are considering similar changes.

On Friday, the Department of Finance released a discussion paper asking Canadians how regulations governing corporate pension plans can be improved.

Flaherty said the government will also consult with the provinces with the goal of making permanent changes to the rules this year.

Many companies and pension experts are looking for Flaherty to include measures in his Jan. 27 federal budget to help companies cope with the financial pressures caused by troubled pension plans, at a time when the recession is already eating away at corporate finances.

Paul Forestell, retirement profession leader at financial advisory firm Mercer LLC, said he would like to see a 15-year repayment period so companies aren't forced to cut costs in other areas. Many in the industry fear there could be widespread layoffs if companies are forced to squeeze operations to generate extra cash to top up their pension plans.

Experts warn that some plans in deep financial trouble could be required by regulators to be wound up - which would lead to lower benefits for all plan members - and in a worst-case scenario, companies could go out of business if their pension burden becomes too great.

Forestell also added that without a longer repayment period some companies may be forced to delay salary increases or ask employees to increase their monthly contributions.

"The problem will be with the credit markets the way they are right now, (companies) may have trouble generating that cash or it will have to come at the expense of something else," Forestell said.

But most Canadians shouldn't start delaying their retirement plans, he added.

"I think if you're working for a company that is still operating and not struggling a great deal, then you have nothing to worry about, the plans will get funded back to 100 per cent," Forestell said.

"But if you're working in an industry where the company itself is struggling to survive, then there's a bigger risk that the plan would be terminated without sufficient funds to pay the benefits and you'd see a cut in what you're getting paid."

Last week, two reports confirmed plunging stock markets eroded billions of dollars from Canadian pension plans in 2008".

Watson Wyatt Worldwide said the ratio of a typical pension plan's assets compared with its solvency liabilities plunged 27 per cent in 2008, from 96 per cent last January to just 69 per cent at year's end.

Meanwhile, Mercer reported its Pension Health Index fell 23 per cent from the beginning of 2008 to 59 per cent - the biggest drop since the index was created 10 years ago.

Pension services company RBC Dexia will release its report detailing pension plans' rate of return in 2008 in late January, said Don McDougall, director of advisory services. He added he expects the numbers to be "the worst on record".

"In 2008, there were 1,350 registered pension plans in Canada, of which 351 were defined benefit plans with 391,000 members and $109 billion in assets."

According to the OECD , Ireland's pensions were the worst performing funds in 2008 of any in the developed world with losses of up to 35 per cent being inflicted on some, drastic steps are needed to halt collapse of pensions:

As the country faces a major pensions crisis in 2009 with a number of high-profile company schemes expected to collapse by June, the Government looks set to have to bail out or supplement schemes that are now in deficit.

The news will strike fear into thousands of workers nearing retirement age who have seen their personal funds decimated in recent months.

According to the new figures from the OECD, Ireland's pension crisis is now worse than the United States, Britain, Japan, Canada and even Iceland, whose bank sector had to be rescued. In real terms, the value of Irish funds fell by 33 per cent during the first 11 months of last year.

On Friday, Hewitt Consultants, in their latest report, said Irish funds dropped by three per cent alone in December alone.

The sharp decline of Ireland's pension performance was blamed on the level of exposure to shares and experts have said that to protect people's retirement funds, Ireland must further diversify where it invests its money. For several years, Irish equities were among the strongest performers on the markets but they were hit hard during 2008 and that fall has hit pensions badly.

To illustrate, for every €100,000 a person had invested at the start of 2008, it is now worth between €65,000 and €70,000. In a double whammy, thousands of people who made additional contributions to their funds have also seen them badly affected.

For example, a colleague who is retiring in six years time received his statement last week for the AVCs (additional voluntary contributions) he has been making for the last 20 years or so to supplement his pension. In July 2007 his savings invested with a leading pension fund stood at €119,900, last July they had shrunk to €92,000 including the €4,000 he had put in during that year.

His fund is now probably down to a fifth of its July 2007 level. And this comes at a time when he should be converting from a fund based on the stock market and equities into a more secure cash fund picking up deposit interest. Now he doesn't have that security and must ride out the next few years wondering if the market might recover or a substantial part of his pension proviso will be totally lost.

In the last couple of years he has already been called to make substantial extra contributions to his main pension provider which, like all company-based defined benefit schemes, is under severe financial pressure.

In total, defined-benefit pension schemes, where employers carry the investment risk, have lost a third of their value in the last 12 months amounting to €20bn. Investment losses are also serious for members of defined-contribution schemes who bear all the investment risks.

Ronan Smith, a pensions expert, said Ireland's woes are incredibly serious and that drastic action is now required from government and from employers to ensure the safety of pension funds.

"The problem was that when we joined the euro we didn't spread out our dependence on Irish equities, as we should. For a while those Irish equities were doing well but we got hammered when it emerged there was a lack of funding. Now what must happen is that government and the employers must ensure any deficits are met and honoured," he said.

The pension crisis was quantified in a leaked cabinet memo sent by Social Welfare Minister Mary Hanafin in late November which warned that up to 50 per cent of schemes could collapse during 2009 if trends continue. She warned of the threat of thousands of Irish workers seeing their retirement funds wiped out within six months and said urgent action was now required.

At present, around 250,000 Irish private sector employees and 90,000 pensioners are in generous defined-benefit schemes, where the employer has to guarantee the end amount paid to the employee. Over 90 per cent of defined-benefit schemes -- the most common type of pension scheme in Ireland -- are expected to be in deficit when they report on their solvency to the Pensions Board.

Due to the difficulties in funding defined benefit schemes, many leading companies have in recent years closed these schemes to new entrants in favour of less expensive defined contribution schemes, where the onus is on the individual not the employer to ensure the safety of the fund.

No wonder the Irish Times writes that pension protection is required urgently:

When companies fail, all the stakeholders lose out. Shareholders lose their investment. Workers lose their jobs. And, if these are employees of a company based in Ireland, they could also lose some - and perhaps all - of their pension benefits.

Many hundreds of current and former employees in Ireland of Waterford Wedgwood, which is in receivership, find themselves in that unenviable position. Their British-based counterparts at Wedgwood are better placed. Workers in the UK have a safety net in the shape of the Pension Protection Fund. There, when a company with an underfunded pension plan fails, the State partly guarantees pensions. Fifteen months ago, the Green Paper on pensions suggested the Government might consider introducing a similar scheme here. But no action has been taken.

Waterford Wedgwood is a loss-making company with a very large hole in its pension fund. The value of the scheme's liabilities exceeds its assets by more than €100 million. The collapse of the company has meant its pension scheme will, most likely, be wound up. Its assets will be distributed according to a strict set of rules.

This could mean that existing workers and those former workers at Waterford Glass who have yet to reach retirement age receive meagre pension benefits, possibly none. For the pension deficit is huge and in winding up the scheme payments to retirees have priority. Indeed, if funds are insufficient to pay full pensions to those in retirement, their payments will also be cut.

The inequities of the current pension system are obvious and Waterford Wedgwood provides a casebook example of the inadequacy of legislation. A worker there who was close to retirement, who had spent a lifetime at the company and who had paid into its pension plan, could end up with nothing. For that employee, the loss of job and pension means reliance on a State contributory pension plus any personal savings to finance many years of retirement.

For more than a decade successive governments have talked about pension reform, yet done very little to advance it. The failure to consider pension insurance legislation, similar to that operating in Britain, is symptomatic of this.

In 12 months unemployment has risen by 71 per cent. The December live register figures recorded the biggest one-month increase since 1987. Virtually all unemployment has occurred in the private sector. There, wage cuts are seen increasingly as a necessary part of the adjustment to the greatest financial and economic challenge the world has faced since the Depression of the 1930s.

But, as Waterford Wedgwood has demonstrated, where a company fails and where its pension fund is greatly underfunded, the result is not just job losses but loss of pension benefits as well. In this regard, the contrast with the public sector could hardly be greater.

As yet, there have been few job losses there, no wage cuts except those volunteered by some senior civil servants and no adjustment to public sector pension benefits. And the taxpayer provides a pensions safety net which is missing in the private sector. The Government must now provide this via a pension protection fund.

I think it is time the G7 take the global pension crisis seriously and start implementing measures that will bolster defined benefits plans. Companies can opt out of a DB plan, but this only shifts the onus on individuals and ultimately the state.

Urgent action is required but too many governments are not taking the pension crisis seriously, perhaps (foolishly) believing that the stock market will come roaring back in the next few years. If that's what they're hoping for, they are in for a very nasty surprise.

No comments:

Post a Comment