Thursday, April 30, 2009

Caisse Closed?


It didn't take Michael Sabia long to shake up the ranks at the Caisse, Canada's largest fund manager. Konrad Yakabuski of the Globe and Mail reports that Mr. Sabia is targeting risk controls:
The new head of the powerful Caisse de dépôt et placement du Québec has set the tone for his mandate by putting the emphasis squarely on risk management and a shift in the $120-billion pension fund manager's culture.

In an executive and organizational shake-up unveiled Thursday, Michael Sabia tapped Susan Kudzman to become the investment giant's chief risk officer and doubled the ranks of the risk management division. With the move, Mr. Sabia aims to “change the culture” of Canada's biggest institutional investor, which was rocked by massive losses last year.

“Risk management is not only a question for the risk management team,” Mr. Sabia, the former BCE Inc. chief executive officer named Caisse CEO in March, said on a conference call with journalists. “It's a challenge to change the culture” of the whole organization.

Much of the task will fall to Ms. Kudzman, who will see her division add 24 new positions and become responsible for implementing a series of measures – 60 in all – identified by the board of directors to enhance the Caisse's risk management practices.

Ms. Kudzman, an actuary by training, joined the Caisse in 2005.

She has been at the centre of criticisms that Caisse risk management practices were inadequate in recent years. She was previously executive vice-president, depositors and risks, but now cedes responsibility for relations with the 25 pension and insurance funds managed by the Caisse to focus exclusively on the revamped risk management efforts.

Mr. Sabia defended her promotion, insisting her “profound understanding of the challenges of our current situation and our milieu” would enable her to implement changes faster than an outsider could.

Of the 60 measures to improve risk management, 13 are deemed a priority, Mr. Sabia said, and 10 of them will be implemented before year-end. They include better preparation for unforeseen circumstances, such as last fall's market meltdown; a new approval process for investing in untested financial products, such as derivatives; and improving the methodologies used to evaluate risk.

Mr. Sabia's moves, which also include the departure of three top managers, aim to address criticisms that lax oversight of portfolio managers by senior executives was partly responsible for the fund's disastrous performance in 2008.

The Caisse lost 25 per cent of its value last year – almost $40-billion. Its performance was the worst among large Canadian pension funds, casting doubt on many of the investment strategies pursued under former CEOs Henri-Paul Rousseau and Richard Guay.

Under Mr. Rousseau, who left the Caisse in mid-2008 for a senior job at Power Corp. of Canada, the Caisse invested heavily in non-bank asset-backed commercial paper (ABCP) and has since written off about 40 per cent of its $12.6-billion investment in the now toxic paper. Mr. Guay, who served as chief investment officer under Mr. Rousseau, briefly succeeded him as CEO.

Mr. Sabia revealed Thursday that Mr. Guay, who remained a senior adviser at the Caisse after stepping down as CEO in January, is expected to leave the fund manager in the near future. “Richard is not currently a member of upper management,” Mr. Sabia told reporters. “He is preparing a transition to a new stage of his career.” The Caisse is also recruiting a new chief investment officer, Mr. Sabia said, hinting that the post would be filled by someone from outside the Caisse.

“The Caisse must adapt to the current reality of the financial markets, which is very different from that of recent years, and whose impacts include a decrease of activity in some areas, more volatile markets and more stringent risk management,” Mr. Sabia said in a statement.

The Caisse was caught off guard when markets tanked in October, as massive margin calls on futures contracts left it scrambling to raise cash. It was forced to sell equities in a down market and unwind its positions in currency and stock index futures. Overreliance on statistical risk management models left the Caisse unprepared to face unprecedented market volatility.

At least three top managers are leaving in the shake-up, including Michael Malo, head of hedge funds; chief strategist Christian Pestre; and François Grenier, the head of equity markets. Other top managers will take on added responsibilities, such as the head of private equity Normand Provost, who also becomes chief operating officer. The Caisse's hedge fund activities are also rolled into the private equity division, under Mr. Provost.

Jean-Luc Gravel was named executive vice-president of equity markets, replacing Mr. Grenier. He had been head of Canadian equities, overseeing the Caisse's only stock portfolio that beat its reference index in 2008. Its U.S. equity portfolio underperformed the market by almost seven percentage points last year.

Over all, the Caisse is cutting 31 of its 813 positions, once the 24 new risk management positions are taken into account.

The changes are the first major moves taken by Mr. Sabia, since he was appointed to run the Caisse last by Liberal Premier Jean Charest. His nomination was controversial in Quebec, given the anglophone Mr. Sabia's shallow roots in the province and mixed record running the telecom giant.

Some of my thoughts on these changes. I was not surprised to see Christian Pestre, Michel Malo and Francois Grenier let go, but if you ask me, the first executive vice-president that should have been asked to leave should have been Robert Desnoyers, Executive Vice-President of Human Resources and Organizational Development.

How can you possibly change the culture of an organization when you keep the same individual in charge of Human Resources and Organizational Development? That brings me to my second point. How can you say you are placing the priority on risk management when you are keeping Ms. Kudzman on as the Chief Risk Officer?

When a pension fund goes through a $40 billion train wreck, someone in charge of risk dropped the ball. It really was a Caisse of risk management theater. And it wasn't just Ms. Kudzman's fault. Her right hand man in risk management, Ernest Bastien, was in charge of the policy portfolio risk. It was his changes that allowed the Caisse to increase their exposure to non-bank asset-backed commercial paper (ABCP). Why is he still a senior risk officer at the Caisse?

Let's go through Ms. Kudzman's background:

Susan Kudzman joined the Caisse in 2005 as Senior Vice-President, Risk Management and Return. Previously, from 2000 to 2005, Ms. Kudzman was Chief Human Resources Officer and Chief Corporate Officer at BCE Emergis. She also worked for more than 15 years as an actuarial consultant for the firms of Towers Perrin and Mercer. Susan Kudzman holds a bachelor’s degree in Actuarial Science from Université Laval. She is a Fellow of the Canadian Institute of Actuaries and of the Society of Actuaries (United States).

I never met Ms. Kudzman, and hold nothing against her, but I do not see anything in her background to suggest that she should hold such a senior position in risk management at the Caisse. Given her background, maybe she would be better placed as Executive Vice-President of Human Resources and Organizational Development. I am pretty sure she can do a much better job than Mr. Desnoyers.

And there are other things that concern me. I read this CBC article which states the following:

As part of the reorganization, 55 positions will be abolished and 24 new ones will be created, mainly in risk management. The Caisse had 813 employees as of Dec. 31.

In the wake of the global financial crisis, many investment operations have been affected by a drop in activity, notably hedge funds, Sabia said. Therefore the Caisse has decided to combine all investment operations involving liquid markets into two departments: equity markets, and fixed income and currencies.

As a result, the position of executive vice-president, hedge funds, has been eliminated, and staff has been reduced. The Caisse is also eliminating the position of executive vice-president and chief strategist.

Normand Provost has been named chief operating officer, in addition to his job as executive vice-president, private equity.

Some good people fell victim to this "reorganization". People like Andrée Dion who for many years did an outstanding job reporting performance and Benoit Beauchemin who thoroughly researched what the Caisse's peers were doing in terms of asset allocation and other activities. These are good, solid employees that any organization should have on their team. I am truly shocked to see them go and to see other snakes survive at the Caisse.

And why is Normand Provost, the Executive Vice-President of Private Equity, named the Chief Operating Officer? This opens the door to serious conflicts of interests, namely, someone in charge of investments should not also be in charge of operations.

As far as shutting down internal and external hedge funds, I think this is a mistake too. In the sphere of alternative investments, I am more confident with certain hedge funds going forward than I am with private markets where I see the curtains closing for the next few years.

Importantly, if you really want to focus on risk management, you should develop your internal and external capabilities in liquid absolute return strategies. In the age of delation, this is where the future lies, not private markets.

Finally, a recent poll shows that Quebecers want the government to get more involved with the investment decisions of the Caisse de dépôt et placement du Québec. Pensions and pension funds are the topic of heated political discussions in Quebec and in Ottawa these days.

As I watch these big funds repeat the same mistakes over and over again, I am starting to think that the stewards have to step in and conduct thorough performance, operational and fraud audits by independent experts on all activities as soon as possible.

As for the basket Caisse, I hope it's not Caisse Sera Sera, but I have seen this movie before and it doesn't end well. As I told a friend of mine today, the "easy" part is to cut people. It's much harder building an organization around dedicated people who share your vision and values and want to see the organization thrive.

This is Mr. Sabia's most difficult challenge and it lies straight ahead. But if he is not careful, surrounding himself with knowledgeable, dedicated people who he can trust, his coup d'état might be short-lived and the Caisse's days could be numbered.

***Announcement***

Before I forget, Amy Long of Two Sheps That Pass contacted me and wanted to pass along this message:

I wanted to let you know about a unique event happening during the upcoming Berkshire Hathaway shareholder’s meeting weekend, on Saturday, May 2nd, that I thought might be of interest to you and your readers.

Warren Buffett’s son, Peter, will be returning to his hometown for an evening of ‘Concert and Conversation’ at The Rose theater. All proceeds from ticket sales are going toward the Omaha-based foundation, Kent Bellows Studio and Center for the Visual Arts.

Peter’s ‘Concert and Conversation’ serves as an entertaining and informative look into the life of a man with a truly unique upbringing. His open discussion about the lessons he's learned as the son of one of the most noteworthy investors of our time and its effect on creating the man he's become, acts as a true testament that life is never a straight road. The evening will include live performances of selections from Peter’s album releases including his latest, Imaginary Kingdom, punctuated with videos from his film/television work and philanthropic activities.

EVENT DETAILS:

An Evening of Concert and Conversation with Peter Buffett

WHEN: Saturday, May 2nd at 7:30 pm

WHERE: The Rose, 2001 Farnam Street, Omaha, NE

TICKETS: $42, with $25 of the cost being tax deductible

http://rosetheater.org/season-events.asp

www.peterbuffett.com

www.myspace.com/peterbuffett

http://www.kentbellows.org/

Wednesday, April 29, 2009

Demystifying Pension Fund Benchmarks


Following up on my last comment on CPPIB getting grilled in Ottawa, I received a few questions on benchmarks. I will elaborate on benchmarks in this post.

But first, CPPIB contacted me to tell me that they posted Ms. Warmbold's opening remarks to the Standing Committee on Finance. I am still waiting for PSPIB to post Mr. Valentini's remarks on their website, but given that the last press release dates back to October 2007, I doubt they'll post his remarks on their website.

Anyways, back to Ms. Warmbold's opening remarks (added notes are mine):
Good morning, Mr. Chairman and Members of the Committee.

My name is Benita Warmbold, and I am Senior Vice President and Chief Operations Officer of the CPP Investment Board. With me today is Mr. Don Raymond, Senior Vice President and head of Public Market Investments.

When the federal and provincial ministers of finance successfully reformed the Canada Pension Plan in the mid-1990s, they endowed the CPP – and the CPP Investment Board – with a number of advantages. Three of those advantages have proven invaluable in the recent economic environment.

The first is the clarity of our investment mandate enshrined in legislation to maximize returns without undue risk of loss.

[Note: It is not that clear to me what is meant by "undue risk of loss". Specifically, how much active risk is CPPIB taking to generate 100 basis? Is it 400 basis points of active risk? 500 basis points?]

The second is a governance model that balances independence with accountability. The CPPIB operates at arm’s length from government and is overseen by an independent board of directors which approves investment policies and makes critical operational decisions. To balance that independence, the CPPIB is accountable to the federal and provincial finance ministers who act as stewards of the CPP. And we have a high degree of transparency so Canadians can see how their pension fund is managed.

[Note: CPPIB does have a high degree of transparency EXCEPT for stating what its benchmarks are in both public and private markets. This will be discussed below. As far as accountability, the stewards have not performed a comprehensive performance, operational and fraud audit of the CPP Fund. This will surely come in the next Special Examination.]

The third is stability, through the legislation that protects the CPP assets and governs the CPP Investment Board, which requires the cooperation of the federal and provincial finance ministers to change.

All of these advantages reinforce our ability to earn investment returns to help sustain future benefits for the 17 million Canadians who participate in the CPP.

To fulfill this objective, the investment strategy of the CPP Fund is designed to generate returns over decades and generations and as a result we have a long investment horizon.

That long-term focus is central to my remarks today.

[Note: Focus on the long-run but we should then have ten or twenty year rolling returns on your bonuses along with clawbacks and high-water marks in case you blow up in the short-run.]

The combination of our long-term focus and the funding structure of the CPP -- in which contributions are expected to exceed benefits through 2019 -- has proven extremely valuable in helping the CPP withstand a prolonged market downturn.

The assets of the CPP Fund have grown steadily as the portfolio has been diversified over the past 10 years. As at December 31, 2008, the CPP Fund had assets of $108.9 billion. That’s an increase of $71 billion as a result of investment returns and contributions from employees and employers.

The fund today is a broadly diversified portfolio of public equities, private equities, real estate, inflation-linked bonds, infrastructure and fixed income instruments.

[Note: Ms. Warmbold forgot to mention that CPPIB also invests in hedge funds.]

Just under half of the fund – about 49% -- was invested in Canada and the balance was invested globally as of December 31.

As recent results have shown, the CPP Fund is not isolated from the storms buffeting financial markets and the global economies. Sharp declines in global equity markets have negatively impacted our recent results. For the first three quarters of the fiscal year, the fund declined $13.8 billionreflecting a return of negative 13.7 percent.

While we recognize that Canadians may be concerned about these short-term results, our long investment horizon creates advantages and opportunities.

First, the portfolio we manage today is not being used to pay benefits today. In fact, it will be another 11 years before money from the fund will be required to help pay pensions.

Secondly, as a result of new cash flows for the next 11 years, we have the opportunity to invest in quality assets at attractive prices, when many other investors cannot.

And thirdly, our portfolio reflects our long term mission and is designed to generate returns over 4 year periods, rather than focusing on a single year.

Appropriately, our policy on management compensation reflects our long term investment strategy, our portfolio design and our long-term outlook.

The key principles are that compensation rewards performance over the long term as measured in 4 year periods; that pay for performance is based on two factors -- how the fund performs overall and whether we generate returns above a market-based benchmark.

[Note: There is a great deal of uncertainty regarding the long-run. Towers Perrin has today warned that the pensions industry will not recover from its exposure to the financial crisis for more than twenty years. Will you be around in twenty years if your long-term bets go sour? I doubt it, but you have no problem collecting millions in short-term and long-term bonuses based on four year rolling returns. Something does not add up there. Then there are reporters like Andrew Willis of the Globe and Mail who do not bother to analyze benchmarks in detail but just blindly shill on your behalf, stating that politics threaten CPP Investment Board's integrity. ]

Overall, the program balances pay-for-performance with the ability to attract and retain the best investment professionals to manage the fund.

[Note: It's a secular bear market in the financial industry. You can attract a lot of talent to CPPIB, paying them a fraction of what you are paying those senior VPs!]

In summary, the CPPIB is very confident that we have the investment strategy to generate the long term returns required to help sustain the CPP.

Given recent conditions, we know Canadians are placing an even higher value on a strong public pension system. We take very seriously our responsibility to help sustain one of Canada’s most important social programs for decades and generations to come.

Thank you.

As I stated in my last post, CPPIB does not disclose its benchmarks (read their latest investment policy; there is nothing on benchmarks), preferring to give returns of the broad asset classes and of the overall fund.

But without proper disclosure of all the benchmarks governing each and every investment activity, including hedge funds, private equity, real estate, and infrastructure, we simply do not know whether the managers are taking appropriate risks relative to their performance benchmarks.

So what is a benchmark? I take the following definition from PIMCO:
In most cases, investors choose a market “index,” or combination of indices, as their portfolio benchmark. An index tracks the performance of a broad asset class, such as the investment-grade bond market, or a narrower slice of the market, such as investment-grade corporate bonds. Because indices track returns on a buy-and-hold basis and make no attempt to determine which securities are the most attractive, they represent a “passive” investment approach and can provide a good benchmark against which to compare the performance of a portfolio that is actively managed. Using an index, it is possible to see how much value an active manager adds and from where, or through what investments, that value comes.
When talking about the stock market the typical benchmarks for large cap U.S. stock is the S&P 500. If your mutual fund is underperforming the S&P 500 (most of them do), then you are paying fees to someone who is not capable of returning "market" returns.

There are very few major disagreements when it comes to plain old stock and bond benchmarks. You might argue that the S&P 600 is a better index of small cap stocks than the Russell 2000, but they are both reflective of the performance of small cap stocks. Most institutions use the same indexes to track the performance of public markets.

Where things get tricky is in private markets and hedge funds, what we call alternative investments. There is no consensus on what constitutes the appropriate benchmark for private equity, real estate, infrastructure and hedge funds. It amazes me that global pension funds never got together to figure out what will be the pension industry's benchmarks for private market assets and hedge funds.

Instead, each fund uses their own benchmarks. For example, in real estate, some funds use a spread (typically 500 basis points) over CPI while others gauge their performance using a benchmark like IPD Market Indices which better reflect actual property transactions in commercial real estate by region. Other funds will use a stock market real estate index like the Dow Jones REIT Index.

Being an economist, I like using benchmarks that reflect the opportunity cost of an invesment. If a pension fund is investing in large U.S. buyout funds in their private equity portfolio, then the benchmark governing these asset class should be some spread above the S&P 500 like S&P + 500 basis points
and lag it by on quarter for valuation purposes. The spread is there to reflect the illiquidity of these investments and the embedded leverage of private equity deals where general partners borrow to finance their purchases of private companies.

If you are investing in private real estate or infrastructure investments, then try to benchmark these assets relative to some market index of real estate or infrastructure stocks that captures the "beta" of these investments and add a spread for illiquidity and lag it by on quarter for valuation purposes.

Unfortunately, it's not always possible to find the appropriate benchmarks that fits all pension funds in each of this alternative asset classes, but that is why you need a comprehensive performance audit to make sure they are not gaming their benchmarks to easily beat them.

Take hedge funds for example. Some strategies are liquid, others are illiquid, some use leverage, others use no leverage, and so on. Using an absolute return benchmark of T-bills + 500 basis points might seem appropriate, but what if your pension fund manager is investing in highly leveraged illiquid strategies? Up until last year, they would have trounced that benchmark, reaping huge bonuses, but then the music stopped and credit markets seized, effectively killing these strategies.

As I discussed before, it's all about the benchmarks stupid! Unless the benchmarks reflect the risks, beta and leverage of the underlying investments, then you simply do not know if the value added your pension fund manager is claiming to add is really that or just a free lunch.

Let me end by looking at specific examples from pension funds. First, let's look at PSP Investments' Policy Portfolio from their latest investment policy:

(Click to enlarge:)


You will notice that all the public markets indexes are properly disclosed but when it comes to private markets like private equity, real estate and infrastructure, PSP states that "for competitive reasons these benchmarks are not disclosed."

What are these "competitive reasons"? Who is PSP Investments competing against? For crying out loud, it's a public pension fund and a Crown corporation, not some secretive hedge fund! It is absolutely scandalous that they and CPPIB are refusing to disclose their private market benchmarks but see it fit to say that they added "significant value" in private markets when it comes time to collect their huge bonuses.

W
hat's a clear indication that a benchmark does not reflect the risks of the underlying investments? Again, take a look at the 2007 real estate returns from the large funds:

(Click to enlarge:)

You'll notice that while OMERS, CPPIB and PSPIB "significantly outperformed" their real estate benchmarks, the Caisse underperformed it. This is because the Caisse policy benchmark for real estate is a lot tougher to beat because it accurately reflects the underlying beta, liquidity and leverage of their real estate investments.

The Caisse's Policy Portfolio is clearly presented on page 32 of its 2008 Annual Report:

(Click to enlarge:)


The Caisse is not perfect. The benchmark governing non-bank asset backed commercial paper clearly did not reflect the risks of these investments and it ended up costing the Caisse billions.

[Note: Those of you who read French, should read Francis Vailles' article in La Presse concerning the risks portfolio managers were encouraged to take in ABCP to reap huge bonuses.]

The message behind this short synopsis of pension fund benchmarks is that no fund is perfect. Some are more transparent in most areas but fail to disclose their benchmarks in public and private markets (CPPIB), some are much better with their real estate benchmarks but screwed up on their money market benchmark (Caisse), some are excellent with their public market benchmarks but their private market benchmarks are totally inadequate (PSPIB).

And the travesty in all this is that we have reporters like Andrew Willis telling us to leave these public pension fund managers alone and keep compensating them with millions of dollars because they are the experts and they are governing in the best interests of their beneficiaries.

If only that were true, I could then stop writing my blog and go to sleep early every night.

Monday, April 27, 2009

Pensions' Death Spiral?


The New York Times reports that the plight of carmakers could upset all pensions:

Decisions that the government will make soon on the future of General Motors and Chrysler could accelerate the decline of traditional pension plans, which have sheltered generations of workers from an impoverished old age.

Pension experts predict that a government takeover of the two giant plans would spur other auto companies and all types of manufacturers to abandon such benefits for competitive reasons.

For hundreds of thousands of retired auto workers, a federal pension takeover would mean sharply reduced benefits. For the federal agency that insures pensions, it would mean a logistical nightmare in the short term — and most likely a slow demise eventually as fewer and fewer small plans remain in the system and pay premiums.

So far, the prospect of a grueling grind through bankruptcy court has been a major deterrent to companies that might want to rid themselves of pension obligations. But retirement and labor specialists are watching closely to see whether the administration’s auto task force will give either of the auto companies an easier way to shed their huge pension funds, blazing a simplified trail for others to follow.

With or without a bankruptcy filing, the government is quietly making the preparations that would be needed to take over Chrysler’s pension plan, with its 255,000 participants, according to government officials.

Even if Chrysler manages to strike a deal to sell many of its assets to Fiat, perhaps in conjunction with a bankruptcy filing, experts doubt Fiat will agree to take on its pension plan without extraordinary assistance. One possibility being considered is a cash infusion of $1 billion from Daimler, which previously owned Chrysler and had agreed to backstop a pension failure for several years.

The future of General Motors’ pension plan is also unclear. G.M. has until June 1 to come up with an acceptable business plan. If it declares bankruptcy, it still may try to keep its pension plan afloat. G.M.’s plan for hourly workers, which covers 485,000 people, was in reasonably good shape until last fall’s market turmoil, and would not require cash contributions until 2013.

If one or both of these plans collapse, the federal agency that insures pension benefits, the Pension Benefit Guaranty Corporation, will lose a big source of the premium revenue it collects from companies with pension funds. But more important, the demise of the bellwether auto plans might set a template for other companies seeking to cut costs and stay competitive.

“If one of these companies solves its pension problem by shunting it off to the federal government, then for competitive reasons the others have to do the same thing,” said Zvi Bodie, a professor of finance at the Boston University School of Management and longtime observer of the government’s pension insurance system. “That is the death spiral.”

Though the automakers’ plans each have a gap between what they have on hand and what they owe their retirees over the years, if they failed, most of that shortfall would be made up by workers in the form of smaller benefits — not by the companies or the government.

The government estimated that Chrysler’s plan was $9.3 billion short as of last November — but said it would be responsible for only about $2 billion of that. Most of the shortfall would be sliced from workers’ benefits. At G.M., the estimated shortfall was $20 billion as of last November, but the government would assume $4 billion of obligations and G.M.’s workers would lose the rest.

When Daimler sold a majority stake in Chrysler in 2007 to a private equity firm, Cerberus, it promised to pay $1 billion into the government’s pension insurance program if the pension plan failed within five years. The Treasury could try to persuade Daimler to put some of that money into the plan to avoid a failure.

For years, traditional pensions — those that shield workers from market risk — have been in a slow decline, with troubled sectors like aviation and steel shedding their plans in bankruptcy court as new types of individually managed benefits like 401(k) plans have taken hold.

But big sectors, particularly manufacturing and financial services, have clung to the old plans. The Pension Rights Center, a consumer group in Washington, estimates that 18 million Americans are still building up such benefits every year, and millions more retirees are receiving guaranteed payments from their former employers.

“Those that are fortunate enough to have those plans are sleeping soundly,” said Karen Ferguson, director of the center.

The loss of the auto pensions would be devastating partly because Detroit sustains many other businesses and partly because of their history. It was the United Automobile Workers union, more than any other force, that pushed Congress to enact laws forcing companies to put money behind their pension promises and creating the federal guarantor. The failure of a major auto workers plan would be a blow to the whole system.

Not only would Ford have reason to opt out of the expense of maintaining a pension plan, but so would Toyota and Honda, which also have pension plans at their American plants, said Teresa Ghilarducci, a professor of economics at the New School for Social Research and former member of the P.B.G.C.’s advisory board.

Professor Ghilarducci said she believed the Obama White House had selected people for its auto task force who understood these stakes, and would strive to find some middle ground.

The pension insurance agency, currently operating with an $11 billion deficit, has long viewed the automakers’ plans with anxiety, though its officials declined to discuss the situation. G.M.’s plan alone is bigger than the guarantor. The agency has roughly $67 billion in assets to cover the benefits of nearly 4,000 failed pension plans; G.M. has $84 billion in trust just to cover promises to its own workers.

In a failure of that size, the agency’s immediate challenge would be logistical, not financial. Its insurance covers a simple benefit, not the much richer pensions negotiated over the years by the U.A.W. It would have to process applications from thousands and thousands of workers, most of whom would get the bad news that they were going to get less than promised.

The government’s maximum benefit is $54,000, but coverage falls off rapidly for workers who are younger when their plan fails. For a 62-year-old the maximum is $42,660, and for a 55-year-old, it is only $24,300.

Calculating which workers would bear how much of the losses would be fiendishly complex. The government’s rules favor older participants and contain tripwires and arbitrary cutoffs that can leave similar workers with sharply different benefits.

None of this can be sorted out in advance, because the calculations also depend on the amount of money in a pension fund on the day it terminates — something the pension benefits corporation does not yet know.

Some pension specialists, aware of these difficulties, are hoping the Obama administration’s auto task force will spare at least the G.M. pension fund. Not only would that let laid off workers keep receiving full benefits, but it could also break the death spiral among other plans.

For traditional pension plans, “maybe this is their last stand,” said Jeffrey B. Cohen, a partner with the law firm Ivins, Phillips & Barker in Washington who was chief counsel for the Pension Benefit Guaranty Corporation from 2005 to 2007. If the automakers’ plans fail, he added, “the biggest domino will have fallen for the P.B.G.C.”

This article has been revised to reflect the following correction:

Correction: April 25, 2009
An article on Friday about the implications of possible pension plan failures at General Motors and Chrysler misstated the maximum benefit guarantee under the federal government’s pension insurance program. The maximum is $54,000, for a person who is 65 or older when a company pension plan fails — not $42,660, which is the maximum for a person who is 62.

Late Monday night, Reuters reports that Daimler reaches deal to offload Chrysler:
Daimler AG on Monday reached an agreement with Chrysler, the U.S. automaker's owner Cerberus Capital Management, and the U.S. Pension Benefit Guaranty Corp to exit its 19.9 percent stake in the company.

Daimler had sold an 80.1 percent stake in the U.S. automaker to private equity firm Cerberus in 2007, ending a stormy decade long relationship with the struggling U.S. carmaker that is operating under U.S. government aid.

In Canada, auto workers made a historic concession to pay into their own pensions:

Newly hired Canadian workers will contribute $1 for every hour worked or about $1,700 a year, a change that comes after the subject of pensions for members of the Canadian Auto Workers, and who pays for them, became a hot-button topic among Canadians and a toxic issue for politicians during the debate about whether taxpayers' money should be used to keep Chrysler and General Motors of Canada Ltd. from collapsing.

Angry constituents complained to politicians in Ottawa and Toronto after GM said in a restructuring plan submitted to the federal and Ontario governments in February that it was being crippled by pension payments.

"We heard what people said, but I don't go by that," CAW president Ken Lewenza said in an interview yesterday after ratification meetings with workers from Chrysler's Brampton, Ont., and Windsor, Ont., assembly plants. "It's really how do we send a message to the companies that we recognize the [pension] challenges going forward?"

He noted that newly hired members of the United Auto Workers at Detroit Three plants in the United States will have no pensions, so the CAW needed to act to maintain Canada's competitive position.

The direct costs of pensions for existing employees will still be carried by the companies and the union argues that in previous rounds of bargaining, workers could have won higher wage increases or improvements in benefits but agreed instead to pension payments by the companies.

All three companies are retrenching in Canada, so they're not likely to be hiring new employees for some time. But the principle of auto workers paying directly for their own pensions is now established.

The pension move is just one of several major concessions the CAW made in the first agreement to take away hard-won benefits since the union agreed in the early 1980s to cut wages by about $1.15 an hour to help keep Chrysler from plunging into bankruptcy.

"Sacrifices have to be made because we have a cannon at our head," Mr. Lewenza told Brampton plant workers and retirees.

Other changes - which will apply to all three companies in Canada - include a freeze on wages and cost-of-living pension increases until 2012; an end to company coverage of semi-private hospital rooms; increases in health-care co-payments; and an increase in the amount of time it takes newly hired workers to reach full wages.

The concessions will cut Chrysler's labour costs by about $240-million annually.

That meets the demand set by Ottawa and Ontario that the company cut its labour costs to $57 an hour from $76 to match those of Toyota Motor Manufacturing Canada.

Chrysler has received $750-million of a planned $1-billion loan from the two governments and its parent company is in negotiations with Italian auto maker Fiat SpA on a strategic alliance. The Canadian and U.S. governments require the company to have a Fiat deal in place by Thursday.

And it's not just car companies. Royal Dutch Shell PLC said Monday that the ratio of assets to liabilities in its pension fund is now only 80% following the slump in global equities, and it has increased contributions to fill the gap:

Shell's contribution to the fund has risen from 5% to 23.6% and the employee contribution has risen from 2% to 8% of salaries, the company said in an update posted on its Web site Saturday. The increased payments should bring the pension's funding ratio to 105% within three years and 127% by 2023, the company said.

The pension fund is also reducing its exposure to investments in equities, which it considers to be higher risk. The fund will now comprise 30% shares, 50% fixed interest and 20% alternatives, compared with the previous 55-30-15 mix, the statement said. Exposure to emerging market shares has been cut by five percentage points to 20% of shares.

Public plans are not faring better. John Bury writes that on an actuarial basis the New Jersey state pension plan is a funding disaster. In the U.K., public sector pensions are in disarray:

As many across the UK take time out to consider their own pension arrangements it has been revealed that the UK taxpayer will be taking on a significantly increased burden in the medium to longer term. Figures buried in the back of this week's budget showed a £2.3 billion shortfall in public sector pension payments which was covered by the Treasury using taxpayer's money. This was for the year 2007/08 with the figure set to rise to a staggering £4.1 billion this year.

All in all, the cost of maintaining gold plated pension schemes, alternatively known as defined benefit schemes, will rise to a staggering £4.6 billion a year in 2010/11 and is set to increase year-on-year for the foreseeable future. All in all the UK taxpayer will have pumped in an extra £14.1 billion between 2006 and 2011 in order to maintain defined benefit pension payments for those working in the public sector.

As more and more non-public sector workers in the UK struggled to maintain their pension fund contributions it appears that the fat cats of the public sector are licking their lips. How ironic that we saw Gordon Brown introduced new pension regulations which will see billions of pounds a year taken from taxpayers pension schemes while public sector arrangements maintain their status quo.
In Ireland, government plans to deal with insolvent pension funds have received a muted response from interest groups. In Canada, the wolves are at the pension door:

Dalton McGuinty says Ontario doesn't have the resources to put more money into its pension safety net (Save Our Pensions, Auto Workers Urge McGuinty - April 24).

Yet, we have all the resources necessary for public service (and MPP) pension plans: They are funded from tax revenue. But apparently the Ontario Pension Guarantee Fund cannot fulfill even the meagre guarantee that was made for private defined-benefit pension plans - support to the $1,000 per month level.

The fact that members of defined-benefit plans have been restricted in their allowable contributions to RRSPs throughout their working lives makes it all the more invidious.

It seems a double standard, whereby public sector pensions are 100 per cent protected, while private-sector pensioners can be thrown to the wolves.

These same wolves are the so-called experts that have wreaked havoc on our global financial system. [Note: You should read the Barricade's latest comment on the tyranny of experts.]

In New York, Comptroller William Thomson released a list last Friday of “placement agents” — middlemen who collect fees from private firms investing pension funds. Attorney General Andrew Cuomo is looking into whether these agents took fees as illegal kickbacks:

On the list were firms either owned by or employing three former city pension fund managers. A New York Post report questioned Thompson’s role as their former boss. Jeff Simmons, a Thompson spokesman, said yesterday, “Any suggestion of improper actions is simply untrue.” The former workers, two of whom also made contributions to Thompson’s mayoral campaign, followed city rules by waiting more than a year before taking business with the pension funds, he said.

Last week Thompson called for a ban on placement agents, but that requires approval by the boards of each of five city pension funds, all “chaired by City Hall representatives,” Simmons said.

The New York Post reported on Friday that the investigation into the New York State pension fund has spread to Israel.

With few exceptions, all around the world, pension plans are in poor health. As fears of globally spreading swine flu cases spurred the World Health Organization to raise its pandemic alert to an unprecedented level, maybe it's time we also sound the alarm on the pension pandemic which is leaving global pensions in a death spiral.

Sunday, April 26, 2009

Is the Recession Affecting Your Health?


Today is my birthday. I am now 38 years old. No big deal, it is just another Sunday for me. I woke up, had a cup of java and watched ABC's This Week with George Stephanopoulos.

There was an interesting interview with Iran's President, Mahmoud Ahmadinejad. The roundtable discussed President Obama's first 100 days and George Will stated he is convinced that the $9 trillion of public borrowing will lead to "stagflation" four years from now and this will be reflected in the polls, hurting Obama.

Poor George Will. Love listening to him but he is always wrong when it comes to economic prognostication. Four years from now, we will be in the midst of the longest debt deflation episode in post-war history (you can quote me on that!).

But today is my birthday and I wanted to discuss health issues. First, I read an interesting article in the Telegraph stating that adult stem cells 'able to reverse symptoms' of Multiple Sclerosis (MS):

Some have been left free from seizures and better able to walk after the treatment.

Researchers said that the results suggest that the "very simple" injection of their own cells can stimulate the regrowth of tissue damaged by the progression of the disease.

The preliminary findings add to the growing evidence that stem cells could be used to treat the crippling neurological disease, which affects about 85,000 people in Britain.

Last year experts suggested that stem cell therapy could be a "cure" for MS within the next 15 years.

Patients' symptoms were still improving up to a year after the treatment, the new study shows.

One, a 50-year-old man, who had suffered more than 600 painful seizures in the three years before treatment has not had a single one since the infusion of his own cells.

Another patient's ability to walk, run and even cycle are still improving 10 months after the therapy.

MS is caused by the destruction of myelin, a fatty protective sheath surrounding the body's central nervous system.

Sufferers typical experience fatigue, difficulty walking or speaking and pain and there is currently no known cure.

Dr Boris Minev, from the University of California, said: "All three patients in our study showed dramatic improvement in their condition.

"While obviously no conclusions in terms of therapeutic efficacy can be drawn from these reports, this first clinical use of fat stem cells for treatment of MS supports further investigations into this very simple and easily-implementable treatment methodology".

He added: "None of the presently available MS treatments selectively inhibit the immune attack against the nervous system, nor do they stimulate regeneration of previously damaged tissue. We've shown that [the] cells may fill this gap."

Earlier this year another study in 21 patients injected with their own bone marrow stem cells, found that 81 per cent saw significant improvements to their disability.

A spokesman for the MS Society said: "The preliminary research presented in this literary review is intriguing and we would be interested to see if what is shown in these case studies can be repeated in properly controlled clinical trials."

The three case studies are described the Journal of Translational Medicine.

Meanwhile scientists are claiming a major breakthrough in generating safer stem cells from adult cells.

Scientists usually use a virus to make the switch but this makes the resulting stem cells incredibly dangerous for use in humans as they can cause cancer.

Now a team at the Scripps Research Centre in California, which published its findings in Cell Stem Cell journal, claim they can use harmless proteins to carry out the same task.

This discovery has the potential to spark the development of many new types of therapies for humans, for diseases that range from Type 1 diabetes to Parkinson’s disease, they claim.


MS is a disease that I am intimately aware of. I was diagnosed with it twelve years ago. Luckily, my disease course progressed slowly, but it progressed. I now limp and there are days where walking 500 meters is a challenge.

But I remain hopeful, and for all the frustration the disease has caused me, it has also taught me how to appreciate the simple things in life, to remain positive and to fight and persevere in face of what often seems as insurmountable obstacles.

Earlier this week, we learned of the tragic death of David Kellerman, Freddie Mac's CFO, of an apparent suicide. What you might not know is that there is a rise in male suicides in this recession:

As the recession continues, it often seems that male workers are bearing the brunt of the downturn. Yesterday's announcement of David B. Kellerman's suicide highlights part of the impact that the economy is having on men, but hints at a societal shift whose effects may linger long after the unemployment crisis ends.

While the Freddie Mac CFO's death has garnered more attention than most, it is indicative of a much larger trend. This year, hardly a month has gone by without the newspapers reporting on a horrific murder/suicide involving an unemployed male. In locales as far apart as Washington state and Maryland, California and Massachusetts, the stories have been remarkably similar: a father is unable to support his family and, in a fit of depression, kills himself and members of his family. In some cases, the man is reported to have had previous psychological problems; in others, not. Most of the men are poor, but many are wealthy. Sometimes, as in the case of Kellermann, they occupy a prominent place in their society.

The rise in male suicide is among the most eye-catching news stories of the recession, but the trend only represents the tip of a very large iceberg. According to the Financial Times, 80 percent of the 5.1 million jobs lost in the recession were previously held by men. Consequently, while the female jobless rate is currently 7 percent, the unemployment rate among men has risen to 8.8 percent.

As in anything that divides the genders, the FT's survey has become somewhat controversial. The paper itself pointed out that a large part of the reason for the disproportionate split is the fact that the industries hardest hit by the recession -- construction and manufacturing -- are dominated by men. More traditionally female jobs in education and health care have emerged relatively unscathed.

Some have used the current downfall of male workers as an impetus to question what they see as "male dominance" in the workplace, as if men had this coming to them. The reasoning here is that, it's only because women were underpaid relative to their male counterparts that they're now more cost-effective and have been able to keep their jobs. Some have even gone so far as to aver that the "hidden sector" of the female unemployed who worked off the grid has skewed reporting, suggesting that the recession is not only robbing women of their jobs, but also of their voices.

However, for those whose analysis is based more on mercy and less on gender warfare, it's clear that the recession has been devastating for the male of the species. While the past 30 years has done a great deal to modify traditional gender roles, many men still feel a strong responsibility to be the primary breadwinners in their families. The inability to do so has has wide-ranging effects that are only beginning to be noticed. On the whimsical side, it has resulted in the "recession beard" trend, in which the recently unemployed assert their masculinity by indulging their ability to grow whiskers. On the darker side, as DF's Jonathan Berr noted yesterday, it has resulted in a spike among calls to therapists and suicide hot lines.

For some men, however, talking to a therapist is yet another sign of weakness, which means that many victims of the recession -- and the economic troubles that underlie it -- have been loath to seek help. Unfortunately, this masculine stereotype is particularly well-entrenched in Wall Street and in low-income communities, two areas that have been especially hard hit. Another "macho" group, military recruiters, has also been struck by a rash of suicides in recent years. Beset by work pressures and encouraged to repress their emotions, it is hardly surprising that so many men have been lashing out in inexplicable ways.

While economic estimates about the next few years vary wildly, it seems likely that the recession will bring about a broad-based reconsideration of vulnerability. As the tragic story of David Kellerman demonstrates, the people who seem strongest sometimes need the most help.

My father and brother are psychiatrists and what you should all know is that mental illness often goes unreported or isn't taken seriously. Importantly, despite the economic downturn, in any given one year period, depression strikes 10% of the population.

This is why you should learn to recognize the signs of depression and if you or a loved one suffer from it, get help as soon as possible. Employers should also start discussing mental illness more openly and offer services to their employees who might be very stressed out.

No matter where we are in the economic cycle, my advice is to always make your mental and physical health a priorirty. I invite you to read Ashton Embry's site on the best bet treatment for MS (lots of excellent nutritional information there) and to always scope out the latest health news. And sometimes what seems healthy isn't really very healthy for you. For example, I was surprised to hear about how fruit juice doubles the risk of obesity.

I think like anything else in life, you should approach things in a sensible manner. You should exercise (even moderately), eat very well, sleep at least seven hours, and try to maintain a positive outlook on life.

But if you need help, do not be embarrassed to seek it out. The old myth that "men do not need psychologists" is just that - a myth that might end up costing you your life.

Recession or no recession, never take your mental or physical health for granted. Always remember that life is short and while you can replace money and things, you can't replace your health as easily.

Saturday, April 25, 2009

The Pension Killer?


Writing in the Financial Post, Stephen Donald, a consulting actuary with Buck Consultants, reports on the pension killer:

When I started my career in 1973, the economy promptly went into a recession. The S&P 500 fell 48% and took four years to get back to break-even. At the end of 1973 near the market peak, Warren Buffet said he could not find any stock bargains and returned investors their money. Companies had large deficits in their pension plans and had to start making large contributions, and that was before solvency funding! 2009 is déjà vu with the average solvency-funded ratio below 70% and many large well-known companies on the brink of chapter 11 bankruptcy. How did pension plans get into this mess?

Back in the ’70s, actuaries assumed conservative discount rates at least 1% less than expected, and this represented a margin in the order of 20%. At the same time, the market woes of the mid-’70s resulted in large company contributions going into their pension plans. Then we had a string of remarkable investment returns, and in the early ’80s pension plans returned to surpluses — and large ones at that. Some plans were wound up for business reasons and, to the shock of those companies, trust laws were interpreted by the courts such that the surplus belonged to the members.

Wednesday, April 22, 2009

Time for a New Universal Pension Plan?


Morneau Sobeco released the results of its Performance Universe of Pension Managers’ Pooled Funds for the first quarter of 2009:
According to the report, in the first quarter of 2009, diversified pooled fund managers posted a median return of -2.2% before management fees.

According to Jean Bergeron, a Principal in the Asset Management Consulting practice at Morneau Sobeco, “the pension plans’ situation stabilized somewhat in the first quarter of the year mainly because of the stock market rebound that we experienced in March.

However,pension plans’ financial positions will probably continue to be difficult for quite sometime. Actuarial valuations of pension plans will be completed in a few months and will show large deficits. The contributions that will be required to eliminate these deficits will create substantial pressure on plan sponsors.”

On average, pension fund managers added value when their performance is compared to the benchmark portfolio. In fact, the managers’ median return of -2.2% was 0.3% higher than the -2.5% return of benchmark portfolios used by many pension funds (45% fixed income and 55% equity). For the whole year, the managers’ median return was also lower than the benchmark portfolio.

Canadian equity

In the first quarter of 2009, Canadian equity managers obtained a median return of -2.6%, compared to a return of -2.0% for the S&P/TSX.

The S&P/TSX Small Cap Index posted a return of -3.7% in the quarter compared to a return of -4.2% for the S&P/TSX Completion Index that represents mid-cap stocks, and also -1.5% for the large-cap S&P/TSX 60 Index.

Foreign Equity

Foreign equity managers’ median returns and appropriate benchmark indices in the quarter were:
  • -8.8% for U.S. equities versus -7.8% for the S&P 500 Index (C$)
  • -11.6% for international equities versus -12.3% for the MSCI-EAFE Index (C$)
  • -9.2% for global equities versus -10.2% for the MSCI-World Index (C$)
  • 3.3% for emerging markets equities versus 3.0% for the MSCI Emerging Markets Index (C$)
Canadian bonds

In the first quarter of 2009, managers obtained a median return of 1.5% on bonds compared to a return of 1.5% for the DEX Universe Bond Index.

Long-term bonds had a return of 0.3% in the quarter, while medium- and short-term bonds posted returns of 2.6% and 1.7%, respectively. High yield bonds achieved a return of -15.0%, while real return bonds provided a 4.7% return in the quarter.

Alternative Investments

The CSFB/Tremont Hedge Fund Index (C$) posted a return of 4.4% during the first quarter of 2009.

The Performance Universe covers approximately 311 pooled funds managed by more than 47 investment management firms. The pooled funds included in the Universe have a market value in excess of $140 billion.

The results of Morneau Sobeco’s study are based on the returns provided by leading portfolio managers, ranging from independent investment management firms to insurance companies, trust companies, and banks. The returns are calculated before deduction of management fees.

The quarterly Performance Universe results are produced by the Asset Management Consulting team at Morneau Sobeco. This team provides independent consulting services on all aspects of asset and liability management of pension funds, endowment funds, and other institutional investment funds.

These results are Canadian, but global stock markets have also rallied sharply, up over 20% since March 9th. However, as discussed above, pension plans' financial positions will continue to deteriorate and the contributions that will be required to eliminate these pension deficits will create substantial pressure on plan sponsors.

Perhaps this is why according to a new poll, 88% of Canada's CEOs say a pension funding crisis looms:

Almost nine out of 10 Canadian CEOs say pension funding is in trouble, according to a new survey released Monday.

Compensation experts Watson Wyatt said 88 per cent of Canadian chief executives surveyed now believe that defined benefit pension plans are underfunded, 42 per cent higher than the number who held the same feelings in 2008.

The global financial and equity market slump in 2008 and 2009 has hurt the returns for existing funds, forcing firms to pony up more cash to maintain their pension plans, whether of the defined contribution or defined benefit variety, Watson Wyatt said.

"The severity of financial threats, particularly the cost and volatility of maintaining DB plans, has increased substantially in the current financial climate," said the consultancy in its annual survey of CEOs' attitudes toward pensions.

In 2008, 62 per cent of executives — a relatively low level — thought Canadian pension plans were inadequately funded. Of those responses, 34 per cent of CEOs said the problem was long-lasting while another 28 per cent believed the funding woes were related to cyclical downturns in financial markets.

But in 2009, more than half of CEOs, 53 per cent, believed the pension crisis is long-term in nature and needs government to fix the rules surrounding these plans, while 35 per cent of respondents said the 2009 pension crisis was cyclical and likely would ease once equity markets rose to higher levels.

"These companies are being hit with huge cash requirements [because of the economic recession]," said Laura Samaroo, Watson Wyatt's retirement practice leader, Western Canada.

New rules needed

Currently Ottawa, Ontario, Alberta and British Columbia are examining whether to change their existing pension rules, Samaroo said. (The federal government regulates pensions as does every province except Prince Edward Island).

Right now, some pension authorities are easing the existing requirements concerning how quickly companies have to eliminate any shortfalls in their plans.

But nearly 90 per cent of the executives said one possible solution is for governments to push back the point at which firms with underfunded plans need to get member approval to maintain a shortfall status.

Changing that deadline would give companies more time to make up for the shortfall through stock market returns rather than higher corporate contributions, experts said.

Of course, the longer the funding period, the more likely that the pension plan will face a larger financial shortfall due to a stock market crash within that time frame.

Samaroo said, however, establishing overly onerous requirements for funding pensions could threaten a firm's solvency and lead corporations to get out of the retirement business entirely.

"There isn't any mass exodus [in terms of companies winding up their pension plans]. But, the real concern is that companies not provide pension plans," Samaroo said.

One-third of the 156 CEOs who replied to the questionnaire said they would make substantial cuts to their capital spending programs in order to cover their pension plan shortfalls.

Less spending on new equipment often places firms at a competitive disadvantage with companies that are updating their production, economists said.

Let's go back to Susan Eng's proposal for a universal pension plan. A new CARP poll finds members overwhelmingly support a new Universal Pension Plan:

CARP released a poll of 3,700 of its members and found "overwhelming support for a universal pension plan" for the roughly one in three Canadians without retirement savings. CARP is also calling for a Pension Summit that would include First Ministers and Finance Ministers. Pension reform can no longer be the "quiet preserve of pension experts," Eng said, "Canadians are looking to all levels of government for bold leadership to ensure hat protection of their retirement security remain the top public policy priority."

CARP cites a C.D. Howe Institute estimate that 3.5 million Canadian workers -- or 25% of the workforce, mostly middle-income, working for smaller employers -- are most likely to be on "an inadequate retirement savings track" and would thus benefit from access to a supplementary pension plan. C.D. Howe has suggested the creation of a new savings vehicle called the Canada Supplementary Pension Plan, or CSPP.

Features of a UPP

CARP says pension experts agree retirement income from all sources must replace between 60 and 70% of working income. Currently, the CPP provides at most 25% of Year's Maximum Pensionable Earnings (YMPE): $46,300 in 2009. Thus, for those without employer-sponsored private pensions, the maximum CPP benefit this year is $10,905.

CARP suggests gradually phasing in a UPP so that coverage would eventually cover 70% of pre-retirement income to a maximum pensionable earning limit of $116,667 (which is the 2009 limit for Registered Pension Plans). Like the CPP, the UPP would be a mandatory enrolment plan. CARP is wary of any version that would let individuals "opt out."

CARP has 330,000 members. In March, it made a joint submission on Private Pension Reform jointly with the Common Front for Retirement Security, which includes 21 organizations representing 2 million Canadians. CARP says there are 14.5 million Canadians 45 years of age or older, representing 42% of the total population. There are 4.6 millon Canadians over age 65, making up 13.3% of the population.

Canada's savings shell game

Coincidentally, the Post's lead editorial today (Tuesday) was entitled Canada's savings shell game. It points out that workers who counted on the "pension promise" from long years at a single employer are in danger of being short-changed in the case of corporate bankruptcy.

The more money you can put into an employer-sponsored pension, the less you can save in an RRSP. This is the Pension Adjustment, a number that appears on your T-4 slip and which you enter when you're preparing your annual tax return. The one point not made by the editorial writer is that there may be recourse to a PAR, or Pension Adjustment Reversal but the problem there is you still need the money to make a giant catch-up RRSP contribution.

Meanwhile, by overtaxing "safe" interest income, we are tempted to put money into riskier equities which are taxed less harshly -- but can generate huge losses, as many have suffered in their non-registered portfolios the last year.

Before you dismiss the idea of a universal pension plan, consider what is happening right now. The Toronto Star reports that pension costs are weighing down autoworkers.

Soaring pension costs are also weighing down other companies. The FT reports that Lockheed Martin, the world's largest defense contractor, reported first quarter profit down 8.8 per cent as rising pension costs offset higher sales of defense electronics and computer services.

While people worry about the cost of a new Universal Pension Plan, I submit to you that over the long-run the benefits of secure and stable retirement income outweigh the costs.

In fact, as I stated at Tuesday's hearing, although I am against expanding the CPP (I prefer to have a few large DB plans that are capped at a certain size), I am all for a new Universal Pension Plan because i believe it will enhance Canada's productivity over the long-run.

Policymakers tend to be myopic focusing on short-term costs, but as Ms. Eng stated the additional cost would not be exorbitant. Moreover, we have to come to grips that the current retirement system is an abysmal failure, leaving too many people to fall victim to the whims of the stock market.

Speaking of the stock market, my former colleagues at the National Bank of Canada looked into how long it takes for stocks to return previous peaks following a financial crises (click on chart above to enlarge). They found that financial crisis recessions hit harder and require longer recovery:

If you want to know how long you'll have to endure the current stock market slump, consider the source of the downturn in the first place.

A chapter of the International Monetary Fund's upcoming World Economic Outlook, which the organization prereleased last week, shows that over the past 50 years, recessions triggered by a financial crisis - as the current one was - are longer, deeper and slower to recover than recessions driven by other factors.

The average financial crisis recession lasted six quarters, then needed another six quarters to return to the previous peak of economic output.

The financial crisis recession is simply a nastier animal than the garden-variety economic slump.

The IMF's findings suggest that when stock market investors want a guide to the current market downturn, it does them little good to look at average depth and recovery time for equities in all recessions. The focus needs to be on the financial crisis recessions in order to gain some clarity.

MEANER THAN AVERAGE BEAR

In a research note this week, National Bank Financial assistant market strategist Pierre Lapointe looked at the 15 recessions, in various parts of the world over the past 50 years, that the IMF identified as financial crisis driven.

He found that the average stock market decline was nearly 40 per cent - and those declines have dragged out over an average of 21 months.

The current downturn has already been deeper than the typical financial crisis (a 56-per-cent loss in global equities at the early March lows), though the bear market has so far lasted 17 months - still four months short of the average.

To some, that might imply that even for a financial crisis bear, the markets had become oversold, and that based on history, we may be within spitting distance of the end.

However, it's important to keep in mind that this is no "average" financial crisis. It's the most severe financial crisis to hit the global economy since the Great Depression.

As the IMF noted, the "Big Five" financial crises of the past 50 years - Finland (1990-93), Japan (1993), Norway (1988), Spain (1978-79) and Sweden (1990-93), which represent the previous worst banking crises in the past 50 years - triggered longer and deeper recessions than the average.

Mr. Lapointe's data also show that the Big Five accounted for some of the worst stock market slumps in terms of depth, length and recovery. (Indeed, Japan is still waiting to return to its pre-crisis market highs.)

THE PATIENT NEEDS PATIENCE

Even the average financial crisis market slump has taken 25 months to recover all its losses. That suggests to Mr. Lapointe that investors shouldn't get too excited about the 20-per-cent-plus rebound in equities in the past six weeks.

"If history is any guide, patience will be needed before we see equities at precrisis levels," he said.

Patience indeed. If my forecast is correct, we are heading into a long bout of debt deflation in the developed world. Also, watch for another round of goods deflation coming out of China as their economy slows.

All this means that this is likely to be the longest recovery ever, possibly taking five or more years. I expect stocks to be volatile over this period and while some sectors may shine, the overall stock market indexes will trade sideways.

In the meantime, most people will not be able to rely on hefty gains in the stock market for their retirement income.

The time has come to introduce a new Universal Pension Plan. Hopefully, this time around, we'll get it right.

Tuesday, April 21, 2009

Pension Hearings at Parliament Hill



I was invited to Ottawa today to speak at the Standing Committee on Finance on matters relating to pensions.

I was there as an independent analyst. This was the first time I ever attended one of these committees so I was a bit nervous. I had lots to talk about and it had to be condensed in a short five minute speech. I was feeling under the weather but determined to show up and talk about pension governance.

Joining me was a prestigious panel including Claude Lamoureux, the former president and CEO of Ontario Teachers' Pension Plan. Mr. Lamoureux was there as a Special Advisor to the Canadian Institute of Actuaries to present the actuarial profession's views on the long-standing issues that continue to challenge the retirement savings system in Canada.

Other speakers included Susan Eng, Vice-President, Advocacy at the Canadian Association of Retired Persons and three speakers representing the Federally Regulated Employers - Transportation and Communication (FETCO): Siim Vanaselja, Executive Vice-President & Chief Financial Officer at BCE and Bell Canada; Brian Aitken, Chief Financial Officer at NAV Canada; and John Farrell, FETCO's Executive Director.

FETCO has been pushing Ottawa for pension reforms so I knew what to expect from them. Mr. Lamoureux is widely respected in the pension industry and his presentation was solid. The person who impressed me the most was Ms. Eng, the only non-pension expert at the panel because she was eloquent, well prepared and offered proposals that merit serious consideration.

James Rajotte chaired the committee and several members were present including Thomas Mulcair, Wayne Marston, John McCallum, Ted Menzies, Jean-Yves Laforest, Daryl Kramp, Carolyn Bennett, Massimo Pacetti, Maxime Bernier, Bob Dechert and Mike Wallace. There were other members present.

You can click here to watch the entire two hour hearing and transcripts will be available once the translation is completed.

I was the last speaker of the guests, rushing to beat the world record in speed talking. In case you did not hear everything clearly (I have a tendency to mumble), you can read my full comment below:

Thank you for inviting me. I’m grateful for the opportunity to be here today.

I would first like to emphasize that I am here as an independent analyst who is very concerned about the current pension crisis. The views and opinions expressed today are solely mine and do not represent those of my current employer or any other organization.

Let me begin with a brief introduction on my background. I was a senior investment analyst at two of the largest public pension funds in Canada, the Caisse de dépôt et placement du Québec (Caisse) and the Public Sector Pension Investment Board (PSP Investments). My experience allowed me to gain valuable knowledge across traditional and alternative investments such as stocks, bonds, hedge funds, private equity and commodities.

In 2007, I completed a detailed report for the Treasury Board Secretariat of Canada on the governance of the Public Service Pension Plan (the ‘Plan’). This report was an independent review of the Plan’s governance structure to address some concerns raised by the Office of the Auditor General of Canada.

* * *

Let me now get to the matter at hand. Last year was a particularly difficult one for global pension funds as very few funds escaped the stock market rout. The OECD-weighted average ratio of private pension assets to the area’s GDP reached 111.0% in 2007. By October 2008, total OECD private pension assets were down to about US 23 trillion, or about 90% of the OECD’s GDP.

The impact of the crisis on investment returns has been greatest among pension funds in countries where equities represent over a third of total assets invested, with Ireland the worst hit as it was the most exposed to equities, at 66% of total assets on average, followed by the United States, the United Kingdom, and Australia.

For their part, Canadian pension funds suffered the steepest decline on record with an average loss of 15.9%, according to RBC Dexia Universe. The Office of the Superintendent of Financial Institutions (OSFI) released the results of its latest solvency testing of federally regulated private pension plans. The results show that the average estimated solvency ratio of federally regulated defined benefit private pension plans at December 31, 2008 was 0.85, a decrease from 0.98 as reported in June 2008.

The financial crisis exposed some serious governance gaps among Canadian private and public pension funds. I will now outline some of the more important governance gaps and make some recommendations on how we can address them.

* * *

By governance, I am referring to the system of structures and processes implemented to ensure both the compliance with laws and the effective and efficient administration of the pension plan and fund.

The six key governance areas in a pension plan are: oversight, compliance with legislation, plan funding, asset management, benefit administration, and communication. Given the time constraints, I will focus on three of these key areas: oversight, asset management and communication.

Pension oversight has always been important, but perhaps never more so than today. Several public and private pension plans are in financial trouble, the regulatory environment is rapidly changing and market volatility is constant.

At the large Canadian public pension plans, pension oversight is the responsibility of the plan sponsor who nominates an independent board of directors to oversee all activities of the pension funds. The integrity of the nomination process varies, but the intent is to keep political interference out of key investment decisions by public pension funds.

The cornerstone of pension oversight is risk management, defined in the broadest sense to take into account investment, operational legal and fraud risks. The board of directors oversee the investment activities of internal and external investment managers and they must make sure that controls are in place to mitigate against all these risks.

In order to do this, the board of directors need to have the requisite knowledge on all these risks as such risks can expose a fund to serious material losses. Importantly, the board of directors have a fiduciary responsibility to ensure that activities are being conducted in the best interests of the key stakeholders.

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The failure of diversification strategy in 2008 highlighted the consequences of incomplete or poor oversight. The significant losses suffered at the large Canadian defined-benefit plans are the consequences of poor risk controls and compensation packages that rewarded speculation or performance based on bogus benchmarks.

By shifting assets out of safe government bonds, first into equities and then alternative investments like hedge funds, private equity, real estate, commodities and other risky investments, pension funds have contributed to systemic risk of the global financial system.

This process is what I have dubbed the global pension Ponzi scheme because pension funds were investing billions into alternative investments, ignoring the securitization bubble and without due consideration of how their collective actions are affecting the soundness of the global financial system.

Pension funds claim that the shift into alternative investments was done for diversification purposes, to “smooth” overall returns and to deliver absolute returns. However, there was another reason behind the shift to alternative investments: it allowed senior executives at pension funds to game their policy benchmarks so they could collect huge bonuses, claiming they are adding value to overall returns. This is of critical importance because such executives have clear fiduciary responsibilities, and that is to their plan sponsor and beneficiaries.

The reality is that senior executives are able to reap huge bonuses because they are beating bogus benchmarks that are not reflecting the risks of the underlying investments. Bonuses are based on, and awarded annually, on achievement versus benchmark. However, these bonuses are never clawed back when in subsequent years these investments fall well short of expectations.

Most of the abuses in benchmarks are concentrated in private markets like private equity and real estate, but similar abuses are also present in other alternative investments like hedge funds.

Illiquid asset classes are typically valued infrequently by external (and in some cases internal) auditors. With few exceptions, the benchmarks used to evaluate the performance of these asset classes do not reflect the risks of the underlying investments. For example, leverage is commonly used to boost the returns of illiquid assets (private equity, real estate, and infrastructure) and yet the benchmarks used to compensate senior executives at public pension funds do not reflect these risks.

Benchmark abuses also occur in public markets. The case of non-bank asset-backed commercial paper (ABCP) was an example of how some pension funds invested in assets which allowed them to handily beat performance benchmarks in their cash reserves, ignoring important liquidity risks that arise between the ABCP conduit’s assets and liabilities. Hedge fund benchmarks that do not take into account liquidity risk or leverage of underlying strategies are another example of abuses occurring at public pension funds.

Worse still, some pension funds used government balance sheets to sell credit default swaps (CDS), which are basically insurance policies on credit default obligations. Unlike AIG, they did not sell CDS on subprime mortgages, but once the credit crisis spread to all credit tranches, including tranches with AAA credit ratings, it exposed these funds to material losses.

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In a recent speech, the Governor of the Bank of Canada, Mark Carney, stated that “as liquidity in many funding markets has dried up, so has embedded leverage in many pension funds”. I submit to you that the opaqueness of many of the large public pension funds, and their increasing exposure to complex derivatives and internal and external investment strategies, is hiding the true embedded leverage of these funds.

In conclusion, I want to end with a series of recommendations.

First and foremost, we need to legislate greater transparency in both public and private pension funds. In particular, there should be full disclosure of benchmarks used to evaluate all internal and external investment activities; performance results in public markets need to be reported every quarter and results for private markets on a semi-annual basis; finally, the minutes of the board of directors should be publicly available for public pension funds.

Second, financial audits conducted by auditors need to be augmented by comprehensive performance, operational and fraud audits by independent industry experts. These audits should be conducted on annual basis and the results should be publicly available.

Third, pension plans need to implement sound risk management policies. Plan sponsors have a responsibility to communicate their risk tolerance for the overall fund, focusing on minimizing the downside risk in the policy portfolio. Importantly, pension fund managers should get compensated for active risk based on clear benchmarks that reflect the risks of the underlying investments – i.e. risk-adjusted returns.

Fourth, whistleblower policies need to be strengthened so whistleblowers are encouraged to come forth and disclose any wrongdoings at public pension funds.

Fifth, regulatory authorities need to augment their resources to deal with the challenges at private and public pension funds, as well as other institutions of the “shadow banking system” (e.g. insurance companies and unregulated hedge funds). It is time for the Canadian government to invest more in bolstering regulatory bodies so they can attract more qualified people who understand the increasingly complex investments that these institutions are investing in.

Finally, I have not discussed my thoughts on dealing with the crisis at private pension plans , but my thoughts are that we need to seriously consider scrapping private defined-benefit and defined contribution plans, replacing them with a series of large public defined-benefit plans that are subjected to highest governance standards.

I thank you for your time, and welcome your questions and comments.




There were a few excellent questions but the format of these committees is such that it's hard to really get into all the complex issues governing pensions.

For example, I think it is crucial to complement financial audits with independent performance, operational and fraud audits. I was surprised that members did not ask questions on that.

Importantly, financial audits fail to address serious governance gaps at large public pension funds, and until this is addressed, pension funds remain vulnerable to abuses.

Mr. Mulcair asked me about the regulatory framework and the composition of the boards of directors. As I have argued in this blog, you need to have qualified independent board of directors.

The problem now is that the boards at most public pension funds are populated by financial industry people who scratch each other's back. It's one big club and this is a huge problem because they all have vested interests to maintain the status quo of compensation levels.

This is why I stated that you need to have some independent people, including academics with no ties whatsoever to the financial industry. At one point, Mr. Pacetti suggested some non-experts should be part of the board. I think he makes a good point since sometimes the non-experts have a lot more common sense then the so-called experts.

For its part, FETCO argued that Canada's solvency funding rules are too onerous and alluded to those of the U.S. and the U.K. to make their case for extending the amortization period of solvency funding from five years to ten years.

But as I have argued here, all this does is buy some time without dealing with the underlying structural deficiencies that are at the heart of pension deficits. Ms. Eng brought up the point that extending the deficiency funding rules troubles her because there is no "protection for pensioners".

Notice how FETCO neglected to mention the Netherlands which have the tightest solvency funding rules in the world. If a Dutch pension plan is underfunded, by law they have to present a detailed plan to their pension regulator on how they will reach fully funded status and over a certain defined period.

Speaking of pension regulator, both Ms. Eng and myself think it's high time to have a single national pension regulator. Ms. Eng also discussed a single national securities regulator and emphasized enforcing the actual securities laws.

FETCO argued that the discount rate for corporate pension liabilities should be based on AA corporate bond yields, not government of Canada bond yields. Because these rates are higher, they reduce the present value of future liabilities compared to a discount rate based on government of Canada bond yields.

[Note: This is just a mathematical PV formula where discounting using a higher yield lowers the present value of future liabilities. I say keep the government of Canada bond yield for everyone.]

Mr. Lamoureux brought up several excellent points, inlcuding the fact that young people are under-represented in pension plans, especially when members want to improve benefits. He also brought up an excellent point on how rules where you can only accumulate a surplus up to 10% of liabilities hindered the funding of many pension plans by exacerbating funding volatility. He advocates that this corridor has to be extended and then extend the amortization period.

Ms. Eng proposed a universal pension plan, stating that only a fraction of the population has access to a DB plan. She favors expanding the Canada Pension Plan - an idea proposed by Keith Ambachtsheer.

[Note: A new CARP poll finds members overwhelmingly support a universal pension plan. My only disagreement was that I am against expanding CPP and prefer to see many large defined-benefit plans that are capped at a certain size. After a certain scale, it becomes harder to deliver the required returns.]

She was questioned on the costs of this universal plan and she said this proposal will not be funded by taxpayers but by the employers and employees. Using estimates from Mr. Bernard Dussault, the former Chief Actuary of Canada, she said that the estimates are it will cost an additional 10% over current CPP contributions.

On the costs of the plan, Mr. Lamoureux brought up the segment on 60 Minutes discussing 401 (k) plans in the U.S. (the equivalent of defined-contribution plans in Canada), stating that they did not serve their members well. In Canada, fees on management expense ratios (MERs) and investment management fees (IMFs) have also eaten up most of the returns of defined-contribution plans.

Mr. Lamoureux was also quick to point out that Ontario Teachers' beat its benchmark portfolio over the last ten years, lowering the cost of the plan. Of course, Mr. Lamoureux neglected to mention that the value added was primarily concentrated in private markets (private equity and real estate) where benchmarks did not reflect the underlying risks of the investments.

At the end of the session, I introduced myself to Mr. Lamoureux outside the room and he mentioned that I got the compensation issue all wrong, and that "if you don't know what you are talking about, you should just shut up."

I was surprised he made such a rude remark in front of someone else representing public sector unions and a colleague of his (not to mention this was the first time he ever met me!), but I ignored it and offered him an opportunity to counter my points on bonuses based on bogus benchmarks in alternative investments by writing a guest commentary on my blog.

Mr. Lamoureux declined my offer stating that "he is too busy", but I obviously touched a deep nerve on benchmarks, compensation and clawbacks. Keep in mind that Mr. Lamoureux was the highest paid pension fund manager when he was at the helm of Ontario Teachers', reaping several million dollars a year in short-term and long-term compensation.

[Note to Mr. Lamoureux: My offer still stands. Any time you or any other pension fund president wants to write on how benchmarks in private markets and hedge funds accurately reflect the risks of the underlying investments, you are more than welcome to come here and post your comments.]

On the contentious issue of bonuses, I responded to a question by Mr. Mulcair stating that no pension fund should have doled out any bonus in 2008 given the catastrophic losses they suffered.

It's not only the size of the losses, but where they lost money and the risks they took. The Caisse did not pay bonuses following their disastrous 2008 results and I don't think any of the other pension funds should have either.

[Note: My father, brother and friends who are doctors can't claim that over a four year period they didn't screw up so they deserve a huge bonus. Neither can teachers, police officers or nurses and other hard working people.]

Let me end by thanking the members of the committee and the participants. I enjoyed today's meeting and I hope we can continue our discussion on pension matters in the future.

As I left, I noticed more than 30,000 supporters of the Tamil community in Sri Lanka gathered for a massive demonstration on Parliament Hill. I stood there for a moment and enjoyed watching this protest (see pics above).

I also wondered if in the future, hundreds of thousands of protesters will gather there to protest the cuts in benefits of their defined-benefit plans. Let's hope we never see that day.