Thursday, August 31, 2006


Can Poor Pension Governance Land You in Jail?



In a riveting and timely article, senior Greenberg Traurig ERISA attorney Jeff Mamorsky provides a serious wake-up call to pension fiduciaries everywhere. (Click here to read "Is Today's Pension Plan Environment Cause for Concern?", CEO Magazine, August 2006.)

Mamorsky chronicles the parade of corporate horribles in the U.S. that eventually led to the Sarbanes-Oxley Act of 2002 (SOX). He points out the irony that "All this happened in the USA despite the fact that the federal pension law, the Employee Retirement Income Security Act of 1974 (ERISA), contains rules that require plan sponsors to establish internal control procedures to monitor compliance with the fiduciary responsibility requirements of ERISA."

In the spirit of the stick winning over the carrot, Mamorsky adds that "These rules were in some cases not followed since there were few real teeth in the law. It took SOX with its draconian certification penalties and ERISA's 'white collar' criminal penalty provisions to make plan sponsors take pension governance more seriously."

Emphasizing the nature of personal liability for pension fiduciaries, the article explains the critical, and undeniable, connection between SOX compliance and pension governance. In a rather ominous statement, Mamorsky warns "This liability has increased as the result of legislation such as SOX that requires a public company CEO, CFO or other responsible fiduciary to certify the establishment and adequacy of 'disclosure controls and procedures' relating to material items in the annual financial report. What companies sometimes overlook is that this SOX section 404 management assessment of the adequacy of internal control procedures requirement applies to pension and benefit expenses."

If you aren't scared at this point in the article, he goes on to describe SOX sanctions of money and jail - "$2m and up to ten years' imprisonment for non-wilful ($5m / up to 20 years' imprisonment for wilful) certification of any statement that does not comply with SOX requirements." Then there is the matter of heightened IRS scrutiny of pension plan governance (or lack thereof), a rise in litigation and general upset about the topics du jour, pension funding gaps, rescinded benefits and so on.

Mamorsky concludes that the rest of the world is starting to feel the pinch as the UK and other countries address governance as an important element of the "global pension world."

As an aside, our sister company, Pension Governance, LLC is soon to launch a pension litigation database, chock full of analyses and trends. We had planned to launch earlier but found many more cases than we originally anticipated.

A harbinger of days ahead in pension governance land?
posted by Susan Mangiero at 8/31/2006 09:15:00 PM | 0 comments | links to this post  

Wednesday, August 30, 2006


Pension Valuation Tower of Babel



In my June 22, 2006 post entitled "Will the Real Pension Deficit Please Stand Up?", I made the case that measurement ambiguity is dangerous. It prevents anyone from addressing a financial funding problem in any meaningful way. While ERISA plan metrics have often been the focus, it turns out that municipal plan analysis may be similarly difficult to interpret. New York Times journalists Mary Williams Walsh and Michael Cooper report that the use of multiple valuation methods can result in completely different assessments. (See "On Tracking of Pensions, No Consensus", August 27, 2006.) Their interviews with several rating agency professionals suggest concern and the need to supplement reported numbers with additional metrics.

Actuarial methods are called into question as well, especially if they result in overly optimistic investment return projections and artificially smoothed expenses over time. Though clarification would be a welcome relief, the reporters write that "The Governmental Accounting Standards Board, which sets the rules, is in the initial stages of reviewing the 12-year-old standard governments use when reporting pension values. Any changes are likely to take years."

In contrast, note what an anonymous blog reader has to say (with some minor edits).

The NYT article talks about valuing the pension liability using the appropriate municipal bond yield. Because this rate is lower than the current GASB-mandated rate, the liability balloons.

But municipal bond yields are low because they are tax exempt. I'd make the case for the same-risk corporate bond yield. (If NYC has Aa credit, use the Aa corporate bond yield.) This approach would reflect the risk of the pension liability, but not the tax shield. Since pension distributions are subject to taxation, the tax-exempt municipal yield is inappropriate from the pensioner's perspective.

Some might argue that public pension obligations are close to guaranteed since municipalities can raise taxes to pay bills. This suggests they should be valued at a risk free rate. If so, I'd argue that it should be a Treasury rate, not a Aaa muni rate.

As an Accredited Valuation Analyst, I think it's safe to say that reasonable people can disagree about assumptions as long as each appraiser employs logic and can defend, and document, the basis of his or her assumptions. Competing methodologies are a different story altogether when they produce outrageously divergent outcomes that are hard to support.

Perhaps this is the beginning of a new specialist career - pension valuation translator.
posted by Susan Mangiero at 8/30/2006 12:30:00 AM | 0 comments | links to this post  


Pension Blog News



Hi everyone:

1. I'd like to take a few minutes to thank you for your terrific emails and comments. Please keep them coming. I may not always be able to respond right away but know that every email is read. The blog is a labor of love and it's been personally gratifying to be able to provide information that our 15,000+ visitors have found helpful. The list of blog topics is long and getting longer every day. There is so much to say!

2. We are migrating to a new blog home in about four to six weeks. The URL stays the same, www.pensionriskmatters.com. We'll have many more functions. The goal is to make the blog easier to navigate for our readers.

3. We are creating thought leadership in the form of research papers and webinars for the fall with a special emphasis on investment risk, pension finance, shareholder impact, valuation and alternatives (hedge funds, private equity funds, etc). If you would like to be a guest speaker or contributing author and/or want to submit ideas, please contact us. You can send an email to pension@bvallc.com or call 203-261-5519.

4. The biggest challenge is knowing whether to provide more technical information or instead offer big picture analyses or both.

5. Though the blog was only created a few months ago, we look forward to a continued conversation about employee benefits.

In appreciation of our readers,
Susan M. Mangiero, Ph.D., CFA, AIFA, FRM, AVA
posted by Susan Mangiero at 8/30/2006 12:04:00 AM | 0 comments | links to this post  

Tuesday, August 29, 2006


More Retirement Websites to Watch

Once our blog is upgraded in four to six weeks, we'll be able to include permanent links to other blogs and websites. For now, here are a few places you may find worth a visit. As always, please decide for yourself. These comments are not meant to be official endorsements of any particular site. We cannot guarantee the accuracy of the content or appropriateness of policies.

Thanks to a reader, Harold, I learned about another website for seniors, @Prime! The site describes iteself as "one of the leading age 50+ webservices designed to serve the more than 77 million Americans with the largest purchasing power of any single group in America today". Its creator, Mr. David J. Tananbaum "has been closely associated with the pre-retirement and, retirement industry for more than 35 years, and, is currently President/CEO of National Retirement Programs, Inc." and "a founding member of the American Society of Pension Professional and Actuaries." A nice feature is the array of articles about financial empowerment.

And speaking of which, Mr. Rick Meigs agrees with the view that people are saving too little and are in for a rude awakening when they finally decide to retire. (I had opined in the August 29 post that an average 401(k) account balance of $102,000 seemed meager at best, especially considering longer life spans.) President of 401khelpcenter.com, LLC, Rick and I had a long conversation about possible pension litigation trends in the aftermath of the Pension Protection Act of 2006. (Our sister company, Pension Governance, LLC wil be launching a pension litigation database in early fall.) You can go to the home page to sign up for a free newsletter that is chock full of links to other websites and timely articles.

An interesting site that looks at the impact of health habits on age is www.RealAge.com. A "consumer-health media company and provider of personalized health information and management tools", RealAge, Inc. features a calculator to determine your "real age" versus your biological age. Their Scientific Advisory Board Members have written extensively on topics having to do with health. After all, expected life spans of employees have a direct bearing on a plan sponsor's financial obligations.

BenefitsLink.com is another good site. Geared to "the people who administer, give compliance advice about, design, make policy for, or otherwise are concerned with, employee benefit plans in the United States sponsored by either private or governmental employers", you can likewise subscribe to a complimentary newsletter about either welfare or retirement plans or both. A prominent feature is a benefits job center that seems rather comprehensive.
posted by Susan Mangiero at 8/29/2006 11:04:00 PM | 0 comments | links to this post  


Retirement: Dreams or Reality?


Early August 2006 saw the launch of a new website, Eons.com. According to their press release, "Eons.com has interactive games to build brain strength, news on entertainment and hobbies for older people, a personalized longevity calculator and tips to live longer." A great idea from the founder of Monster.com, this networking community for the over fifty set boasts a section devoted to building a retirement dream list.(Thank you to the anonymous blog reader who sent us the URL. I later saw an article about this new site in Investment News.)

In stark contrast, a new study, courtesy of the Employee Benefit Research Institute (EBRI) and the Investment Company Institute (ICI), suggests that retirement dreams may be hard to achieve for the average person. In particular, Figure A6 paints a downright dreary picture, reporting an average 401(k) balance of only $102,000.

While some individual retirees will receive money from a defined benefit plan and/or Social Security, $102,000 is not much at all when you consider that large numbers of people are living well beyond fifty. While enjoying a short vacation in Arizona, I met several people who said they simply cannot afford to retire and are making adjustments. House-sharing, working more years and scaling back expectations are some of the options.

Eons' founder Jeff Taylor challenges seniors "to see how many friends and family you can inspire to live the biggest life possible. Be loud and be proud about your age." I hope people have the financial wherewithal to do what they dream, for as long as they can.
posted by Susan Mangiero at 8/29/2006 03:30:00 AM | 1 comments | links to this post  

Saturday, August 26, 2006


Freezing Pensions: Brrr!



Talking about defined benefit plans is a little like listening to the Beatles.

You say yes, I say no.
You say stop and I say go go go, oh no.
You say goodbye and I say hello
Hello hello
I don't know why you say goodbye, I say hello
Hello hello
I don't know why you say goodbye, I say hello.

While some advocate their use as a means to attract and retain employees, others intimate their inevitable demise. Either way, one thing is certain. More and more companies seem to favor plan freezes in order to cut costs.

Dow Jones Newswire reporter Steven D. Jones points out that the newly enacted Pension Protection Act of 2006 encourages freezes by compelling companies to fully fund their obligations within a prescribed period of time.

Whether a freeze is "soft" and shuts out new entrants or "hard" and also halts benefits from further accruing, current retirees are not typically impacted. On the other hand, people in the system could end up with less money when benefits are tied to time in the plan.

Even when companies are flush with cash, freezing may make sense. Retiree longevity comes with a hefty pricetag in terms of funded benefits. Moreover, forthcoming accounting rules will force disclosure of pension obligations onto the balance sheet, an unwelcome event for some, especially if it leads to loan covenant breach.

Even writing from a few sunny vacation days in Arizona, this author has to admit that the pension climate sometimes seems downright Arctic.

Jacket anyone?
posted by Susan Mangiero at 8/26/2006 07:39:00 AM | 0 comments | links to this post  

Thursday, August 24, 2006


Pension Weeds in the Garden State


Gregory J. Volpe reports that New Jersey property taxpayers may be on the hook after all for state pension promises, despite efforts to cut costs by rescinding employee benefits.

In his August 24, 2006 article, Volpe writes that "The Office of Legislative Services, a nonpartisan agency comprising state workers, told the Joint Legislative Committee on Public Employee Benefits Reform on Wednesday that any law the Legislature passes to diminish retirement benefits for retired or active workers with more than five years in the system would be unconstitutional."

Despite disagreement about whether pension benefits can be cut to keep property taxes in check and otherwise enhance the state's financial position, legislators offered that health care benefits may be next on the chopping block.

As we'll discuss in future blog posts, if you think the pension issue makes you sick, health care benefits are going to take center stage in both the private and public arena in very short order.

More to come...
posted by Susan Mangiero at 8/24/2006 01:16:00 PM | 0 comments | links to this post  

Wednesday, August 23, 2006


PBGC Data Book Paints Grim Picture

In its newly released "Pension Insurance Data Book", the Pension Benefit Guaranty Corporation (PBGC) continues to show about a $23 billion deficit, adding that "typically, the plans trusteed by the PBGC are only about 50 percent funded on a termination basis. Very few of the claims against the agency (only 1.5 percent) come from plans that are at least 75 percent funded."

By way of background, the "PBGC is a federal corporation created by the Employee Retirement Income Security Act of 1974 to guarantee payment of basic pension benefits earned by workers. Its two insurance programs cover 44 million American workers and retirees participating in over 30,000 private-sector defined benefit pension plans, including some 1,600 multiemployer plans. The agency receives no funds from general tax revenues. Operations are financed largely by insurance premiums paid by companies that sponsor pension plans and by investment returns."

Could it get any worse?
posted by Susan Mangiero at 8/23/2006 12:52:00 AM | 0 comments | links to this post  

Monday, August 21, 2006


Pensions, Manhattan Style





New York Times reporter Mary Walsh and Michael Cooper offer a grim assessment of New York City's pension finances in their August 20, 2006 article entitled "New York Gets Sobering Look at Its Pensions". Their research suggests a funding gap as large as $49 billion or "nearly the size of the city's entire annual budget and the equivalent of the city's publicly disclosed outstanding debt."

A key point of contention is how to properly measure the true economic value of the city's pension obligations. According to the article, New York City employs a unique method that sets the pension shortfall to zero. By doing so, it is never clear whether the plan is in deficit and to what extent. Apparently the method started at a time of bounty, with the aim of preventing a raid by officials.

As this author has repeatedly said, you must be able to properly measure the pension liability. Otherwise, how can one identify what corrective action to take, if any, to set the plan right? (Written for private plans, the same commentary applies in concept to public plans. Good information is everything. Click here to read "Will the Real Pension Deficit Please Stand Up?")
posted by Susan Mangiero at 8/21/2006 01:09:00 AM | 1 comments | links to this post  

Saturday, August 19, 2006


Uber Vacation Blues



A recent article caught this author's eye because it speaks to why the pension "problem" is likely to be with us for a long time.

The Associated Press reports that an official suggestion to cut back vacations in order to satisfy rising health care and pension costs has been soundly rejected by German workers. (See According to "Less Vacation? Germans Say 'Nein'", August 18, 2006). Apparently, Germans average twenty-four vacation days per year.

A related survey suggests that twenty-seven percent of more than 6,000 respondents take a vacation once a year while more than 1,400 persons claim to rest only once every two to five years.

Vacations provide a great way to recharge and return to work, refreshed, productive and happpy. However, five or six weeks of vacation is arguably generous by most standards and even more so, when funding gaps exist. (Of course, Americans are often accused of "living to work" versus "working to live" and there is certainly a lot to say about living a well-balanced life.)

The U.S. Social Security Administration reports less than ideal conditions.

Sluggish economic growth, high unemployment, and worsening demographics are burdening Germany's public pay-as-you-go pension system, which currently claims monthly government expenditures of about 15 billion Euros (US$19 billion). The Social Affairs Ministry estimates that the pension system will have a deficit this year of 1.5 billion Euros (US$1.9 billion). Continued economic performance next year could result in not only a benefit freeze but additional actions being taken to fill the funding gap that the government estimates will reach 3.5 billion Euros (US$4.5 billion) in 2006.

Without massive reform, there is no way around reduced benefits, higher taxes or both.
posted by Susan Mangiero at 8/19/2006 09:01:00 PM | 0 comments | links to this post  

Friday, August 18, 2006


Is Having Children a Patriotic Duty?



Low birth rates, combined with large pension obligations, could spell trouble. That's why, according to several recent articles, many countries are now offering incentives to encourage natural parenting. Immigration reform is another approach.

Without change, countries such as Japan expect to cut pension benefits precipitously. Companies are worried too. A labor shortage could erode profitability in a big way.

There are so many questions. It's hard to know where to start.

1. Is it an invasion of privacy for national policy-makers to encourage individual lifestyle choices in order to preserve social benefits and promote "the greater good"?

2. Will working women respond to financial incentives to give birth or fret that it could deter them from climbing the corporate ladder?

3. Will child-free adults feel like social miscasts for not having children?

4. What should companies spend to create a "child friendly" work space and how will it impact shareholder value?

5. What is the nature of optimal immigration reform?

6. Should companies reach out to already retired workers and how could that affect the workplace dynamic between Generation X and Baby Boomers?

These, and a host of other queries, will keep politicians, sociologists and business professionals busy for months to come.

For background reading, try these articles.

1. "Cash Incentives Aren't Enough To Lift Fertility" by Mark Fritz, The Wall Street Journal, August 17, 2006

2. "Retiree benefits grow into 'monster'" by Dennis Cauchon, USA Today, May 24, 2006

3. "Low Japan birth rate may force pension cuts-report", Reuters, July 2, 2006
posted by Susan Mangiero at 8/18/2006 12:02:00 AM | 0 comments | links to this post  

Wednesday, August 16, 2006


Off to Fiduciary School



It's back to school time and that includes this author. I'm attending a training program to earn the Accredited Investment Fiduciary Analyst (TM) designation.

As we await Presidential approval of the Pension Protection Act of 2006, two and a half days spent discussing investment issues in a fiduciary context will keep attendees very busy.

Click here to access Financial-Planning.com's article about financial designations.
posted by Susan Mangiero at 8/16/2006 12:14:00 AM | 0 comments | links to this post  

Monday, August 14, 2006


Pension Risk Rollercoaster



In "All risk and no reward?", Peter Davy describes the shift to a risk-based paradigm which, for some fiduciaries, is a brave new world. No longer likely to be encouraged to look at returns only, decision-makers will need to revisit "risk 101" fundamentals and then some. Enthusiasm about liability-driven investing is one good sign. Evaluating pension issues in the context of corporate strategy is thought to be another step in the right direction.

Somewhat surprisingly, a survey taken of mostly UK FTSE-listed firms by Mercer Human Resource Consulting and the Association of Corporate Treasurers ("ACT") indicates a low use of derivatives. ACT technical officer Martin O'Donovan suggests that trustees are dubious about "more complex strategies" and prefer avoiding what they don't understand. (Our survey results reflect a greater willingness to use derivatives.)

This blog's author is quoted as saying that "if the renewed emphasis on risk management means anything, it is that fiduciaries must be able to justify their investment decisions" and that "process is everything". The issue of a fiduciary duty to hedge is something worth pondering. (Click here for a nice piece by attorney Randall Borkus on the topic.) If pension fiduciaries are arbitrarily restricting use of any financial instrument without due consideration of the benefits and advantages, are they acting properly? (Readers are reminded to contact legal professionals for advice about what constitutes proper fiduciary duty discharge.)

One thing is certain. The next few years are going to mean breath-taking changes for retirement plan professionals.

Are you ready?
posted by Susan Mangiero at 8/14/2006 09:24:00 PM | 0 comments | links to this post  

Sunday, August 13, 2006


Pension Truth Telling


Wikipedia describes the Rashomon Effect, named after the 1950 classic movie, as the proper way to describe any situation "wherein the truth of an event becomes difficult to verify due to the conflicting accounts of different witnesses."

And so one wonders if the Rashomon Effect pervades in pensionland. After all, it seems that every day brings new headlines with gloomy news about pension losses. Can it all be bad?

Whether a pension crisis is upon us is an excellent question. Solving a problem is impossible without acknowledging its existence.

These thoughts arose a few days ago when a blog reader sent the following anonymous note:

Government plans are not covered by ERISA for sound constitutional reasons, state sovereignty, the 10th Amendment, etc. Take a closer look and you will see that most plans are soundly managed. They are also subject to multiple levels of state oversight. Don't buy the hype.

Importantly, one might have penned something similar about ERISA funds regarding what we read and hear. The focus of the newly passed Pension Protection Act of 2006 in all of its 907 page glory, and now awaiting Presidential approval, company pension headlines are often negative, replete with references to losses, rescinded benefits and/or impact on employee morale.

The National Association of State Retirement Administrators ("NASRA") has written extensively in support of municipal pension plan management. To illustrate, in an August 2, 2006 letter to federal lawmakers, they and other signatories wrote about the misperceptions of public pension finance and the benefits of a study by the Government Accounting Office to set the record straight.

There are fundamental differences between governments and businesses that result in critical distinctions between plans in each sector and the way in which they are accounted for and measured. These distinctions are often unknown or misunderstood.

Public plans are in sound financial condition and State and local governments take seriously their responsibility for paying promised benefits to their employees and retirees. Comprehensive State and local laws, and significant public accountability and scrutiny, provide rigorous and transparent regulation of public plans and have resulted in strong funding rules and levels. Public plans are backed by the full faith and credit of State and local governments. Additionally, a public plan participant's accrued level of benefits and future accruals typically are protected by state constitutions, statutes, or case law that prohibits the elimination or diminution of a retirement benefit, providing far greater protections than what is provided by ERISA or PBGC.

State and local retirement plan assets are professionally-managed and provide valuable long-term capital for the nation's financial markets. The $2.8 trillion held in plan portfolios are an important source of stability for the marketplace and are designed to withstand short-term fluctuations while still providing optimal growth potential.

The bulk of public pension funding is not shouldered by taxpayers.

The vast majority of public plan funding comes from investment income.

This author concurs that shedding more light on the financial health of public plans is a great idea. Ditto for ERISA funds.

Finger pointing is futile. Taxpayers, shareholders and plan participants just want to know what impacts their wallets.

1. Can I afford to retire?

2. Will my benefits be limited or, worse yet, pulled away once I've retired?

3. Will my taxes go up?

4. Will my equity investment fall in value because of a company pension problem?

Reasonable people want answers now, not later on when it's too late to do anything to salvage their financial stake. As mentioned many times before, a real dilemma is information - old, incomplete and/or difficult to interpret. (Click here to read "Will the Real Pension Deficit Please Stand Up?")

How can we get closer to the truth and then use it productively?
posted by Susan Mangiero at 8/13/2006 12:09:00 PM | 2 comments | links to this post  


Pension Scandal


If you haven't read about what has been happening in San Diego with respect to its pension plan, a trip to SignOnSanDiego.com is well worth a visit. There you will find a slew of documents and articles about the many problems that have now led to indictments and a $1.4 billion estimated pension deficit, which in turn have led to restricted capital market access for what some consultants describe as "Enron-by the Sea". In the final audit report, made public just a few days ago, one of its authors, Arthur Levitt Jr., former SEC chairman, emphasized the need for fundamental reform.

Some of the reviewers' recommendations are listed below. Notice the item about financial statement certification, a la Sarbanes Oxley. Along these lines, this author suggests that decision-makers at least ponder the idea of a pension "financial expert", analogous to SOX audit committee rules. While an honest debate about what constitutes appropriate educational and experience requirements for such a position is a must, the hiring process could encourage objective and independent outsiders to join.

Optimists say that trouble begets reform and that lessons learned go a long way to help others avoid losses. That would be a good thing!

Excerpted Suggestions:

Creation of a permanent three-member Audit Committee empowered to retain the City's independent auditors and to inquire into all aspects of City governance and financial reporting, as well as establish and monitor "whistleblower" complaints.

Two members should be independent of the City and have significant financial expertise in accounting, auditing and financial reporting.

The appointment of a Monitor to oversee implementation of the remedial actions being recommended. The Monitor should make quarterly reports to the City's permanent Audit Committee and to the Division of Enforcement of the SEC. These reports should also be available to the citizens of San Diego.

Accountability for fiscal decision-making and disclosure must be built into the City's financial reporting system. To do this, the City must strengthen the role and accountability of the Chief Financial Officer who should be the individual primarily responsible and accountable for the accuracy and timeliness of the City's financial management, reporting and disclosure functions. Assisting the CFO should be a Comptroller, with experience in government accounting, and a Director of Financial Reporting, with specific responsibility for preparation of the City's financial statements. The CFO should also supervise a Director of Budget and Planning to be responsible for assisting the CFO in budget preparation and financial analysis. The Mayor and the CFO should annually include with the City's financial statements a statement of the City's responsibility for establishing and maintaining an effective system of internal control over financial reporting. Similarly, certain heads of each City unit, including its pension board, should be required to certify their stand-alone financial statements.

The City should provide increased pension system independence, accountability, and transparency, through, among other things, the reduction of the pension system board to nine members, five of whom should be mayoral appointees. The chairman of the pension board and its principal executive should be required to include a signed management report addressing accuracy of the Comprehensive Annual Financial Report, effectiveness of internal controls, and other relevant issues.

The City should support the Mayor's initiative to develop a five-year financial plan for City government. Each year the City Council should require a final budget that compares actual to budgeted performance, accompanied by written explanations by each department manager for variances.
posted by Susan Mangiero at 8/13/2006 12:17:00 AM | 0 comments | links to this post  

Friday, August 11, 2006


401(k) Plan Spotlight

CNN senior writer Jeanne Sahadi describes increased limits, automatic enrollment (encouraged but not mandated) and greater flexibility with respect to selling company stock held in a 401(k) plan as only a few of the many elements of the Pension Protection Act of 2006 that bode well for the future of what the IRS describes as "the most popular type of retirement plan used today." (The Act still requires the President's sign-off.)

By way of background, a "401(k)" plan takes its name from a section of the Internal Revenue Code. According to the 401(k) Resource Guide, created and made available by the IRS:

A 401(k) plan is a qualified (i.e., meets the standards set forth in the Internal Revenue Code (IRC) for tax-favored status) profit-sharing, stock bonus, pre-ERISA money purchase pension, or a rural cooperative plan under which an employee can elect to have the employer contribute a portion of the employee’s cash wages to the plan on a pre-tax basis. These deferred wages (elective deferrals) are not subject to federal income tax withholding at the time of deferral, and they are not reflected as taxable income on the employee’s Form 1040, U.S. Individual Income Tax Return.

Since this blog deals with pension risk, it is worth mentioning that defined contribution programs such as 401(k) plans are not a risk-free alternative for employers. See Myth #4 of this author's article entitled "Pension Risk Management: Necessary and Desirable".
posted by Susan Mangiero at 8/11/2006 10:31:00 AM | 0 comments | links to this post  

Thursday, August 10, 2006


Lawsuit Over Hidden Pension Fees



How much does a plan participant really pay in retirement plan fees and what is the impact on economic investment performance?

A report from Bloomberg.com describes "behind the scenes" currency exchange fees as one culprit.

The class action complaint, filed August 2 in Canada, questions a bank's practice of charging foreign exchange fees on stock trades in retirement accounts, alleging secrecy, "in breach of the defendants' contractual and fiduciary duties."

Pundits predict a more intense focus on the issue of 401(k) fees stateside, and abroad, for 401(k) look-alike products.

Several reasons account for this. For one thing, financially strapped retirees seek to minimize costs for fear of having insufficient funds to pay for their golden years. Losses or sub-par performance will only add to their upset and fees could be a big component. Second, disciplined investors plan ahead by making certain assumptions about future returns. They need to incorporate all relevant costs. Third, the Pension Protection Act, likely to become U.S. law, increases the likelihood that financial firms will sell more customized (but often costlier) retirement products to defined contribution plan participants.

Not surprisingly, regulators have expressed concern about fees and urged disclosure. This may only be the beginning of a "fee frenzy".
posted by Susan Mangiero at 8/10/2006 12:14:00 AM | 0 comments | links to this post  

Wednesday, August 09, 2006


State Pension Plan Storms Ahead



If her intent was to scare, New York Times journalist Mary Williams Walsh succeeds. Her August 8 front page story entitled "Public Pension Plans Face Billions in Shortages" cites a Barclays Global Investments calculation that "if America's state pension plans were required to use the same methods as corporations, the total value of the benefits they have promised would grow 22 percent, to $2.5 trillion" with only $1.7 trillion having been set aside to meet these obligations."

Importantly, municipal plans are not covered by the Pension Benefit Guaranty Corporation ("PBGC") nor does the Employee Retirement Income Security Act ("ERISA") apply. If a state, county or city government comes up short, taxpayers are on the hook.

At a time when many taxpayers are struggling to save for their own retirement, how happy will they be to get someone else's tab? We cautioned that taxpayer blues may soon be upon us. (Click here to read "Tea Party Redux: State Pensions in Turmoil", posted on July 27, 2006.)

Mary Walsh is right when she decries the absence of oversight and "comparable systems of checks and balances." This author finds it particularly appalling that Congressional lawmakers spent hours wrangling over the Pension Protection Act without word one about government plans.

What will it take for taxpayers to really "get it" and vote for fiscal prudence?
posted by Susan Mangiero at 8/09/2006 12:02:00 AM | 1 comments | links to this post  

Tuesday, August 08, 2006


12,000 Visitors to Our Blog and Counting


As we prepared to pat ourselves on the back at having reached 10,000 visitors last week, things got a bit hectic and we were delayed. Since then, we've added 2,000 more visitors to PENSION RISK MATTERS (SM). Clearly, the topic of pension risk (and related issues) resonates with readers and for good reason. Changing accounting rules and regulations around the world mandate a focus on investment, operational and governance policies, procedures, strategies and lessons to be learned. Pension fiduciaries understand that they can be found liable on a professional and personal basis in the event of breach.

According to results from a survey co-sponsored by Pension Governance, the RiskMetrics Group and Ulysses Partners, seventy-seven percent of respondents said that they "feel that institutional investor fiduciaries are more vulnerable to being sued in the aftermath of recent corporate, government and non-profit scandals." (To view other results about external money managers, risk management, derivatives, governance and fees, see "Survey Shows That Institutional Investors Are Worried", July 28, 2006.)

Thank you so much for your continued support and suggestions. While our list of blog ideas is long and growing every day, we'd love to hear from you. Simply click here to send an email.
posted by Susan Mangiero at 8/08/2006 12:06:00 AM | 1 comments | links to this post  

Monday, August 07, 2006


Side Pockets and Valuation



What's inside your side pocket? The answer may shock you. That's the gist of a recent article about investments that are tucked away, not to see the light of day until the positions are sold or marked down in anticipation of bad news. In "Street Sleuth: 'Side-Pocket' Accounts of Hedge Funds Studied" Wall Street Journal, August 4, 2006, reporters Gregory Zuckerman and Scott Patterson write that funds have been known to place large chunks of their portfolio in side pockets. Any investor seeking to withdraw money may find it difficult, sometimes facing "limits on their ability to withdraw their money, terms that are put in place so a fund can avoid being forced to sell investments at a sizable loss if a number of investors suddenly want their money back."

They cite Securities and Exchange Commissioner Roel Campos who addressed side pockets as part of his remarks before the SIA Hedge Funds & Alternative Investments Conference on June 14, 2006.

Hedge funds may hide poor-performing assets in side pocket accounts to exclude such assets from the fund's valuation for purposes of calculating performance fees. Some hedge funds require leaving some of the investment in side pockets as a condition for redemption, even though the condition was not disclosed in the investment agreement. On the larger scale, there is the potential for excessive leverage, the concentration of positions, the dependence of valuations upon complex proprietary models, and operational risks for settlement and clearance systems. There is also the risk that hedge funds will all exit at the same time - as purportedly occurred in the 1997/8 Asia Financial Crisis. Performance fee structures give hedge funds an incentive to engage in risky strategies that may not be fully disclosed, and some advisers may not have sufficient risk management processes in place.

Complicating things is the fact that a hedge fund can have multiple side pockets. For a fund of funds manager, the situation could be daunting if he or she allocates money to a large number of funds, each with multiple side pockets.

Supporters of side pockets argue that valuing investments under less than ideal conditions is worse than putting them aside for awhile. They advocate the use of side pockets so that investments they describe as carefully selected have a chance to grow.

Nevertheless, there are things one can do. Even when formal valuations are not performed by an independent appraiser, the use of a qualitative risk driver matrix offers a relatively low-cost form of discipline to get investors thinking about scenarios that might spell trouble. The idea is to both identify factors that could depress value and think about the likelihood of occurrence. For example, the value of equity issued by a closely-held airline company that does not hedge will no doubt drop as oil prices rise. (This author is surprised by the number of investors who have not taken this rather simple step in assessing the risk elements of their portfolio.)

More and more pundits describe a blurring of the lines between hedge funds (some of them anyhow) and private equity funds. The Mid-Atlantic Hedge Fund Association is devoting an entire meeting to this topic on October 12. Founding member and chairman of the board of this educational organization, Dechert attorney Brian Vargo describes the three-hour program as a lively discussion that is sure to include valuation as one of several challenges associated with the trend towards convergence.

In case you missed it, the author wrote about the importance of getting independent opinions of value or having an outsider review the valuation process already in place on June 18, 2006. Click here to read the post.
posted by Susan Mangiero at 8/07/2006 12:11:00 AM | 0 comments | links to this post  

Sunday, August 06, 2006


Courts Want Evidence of Valuation Expertise


Judges continue to expel experts (and their reports) when they are unable to demonstrate relevant credentials and experience. In a July 2006 case involving the fair market value assessment of private company equity, the U.S. Tax Court wrote: "We are not obligated to pay any regard to an expert opinion that lacks credibility" and criticized the report for not adhering to the Uniform Standards of Professional Practice, otherwise known as USPAP.

Within the last few weeks, the IRS released valuation guidelines, a product of the Valuation Policy Council. "The VPC was established in 2001 to assist IRS leadership in setting direction for valuation policy that cuts across functional lines, and in identifying process improvements to improve compliance and better utilize resources." (Click here for a copy of the new guidelines and here for a credential comparison chart.)

As pension funds increase their exposure to private company stock, the valuation issues are profound. The last thing pension fiduciaries should want is to pay someone to render an opinion of value and have the court toss it out for lack of substance. Ditto for regulatory enforcement and arbitration proceedings.
posted by Susan Mangiero at 8/06/2006 08:00:00 AM | 0 comments | links to this post  


Private Equity, Mutual Funds and Valuation


Wall Street Journal reporter, Eleanor Laise recently wrote that an increasing number of mutual funds are "venturing into the risky world of private-equity investments", "because of the prospects for higher returns." While SEC rules limit assets to no more than fifteen percent in illiquid holdings, Ms. Laise describes potential problems. Higher legal expenses for more complex deals, difficulty of unwinding a position and valuing private investments are far from trivial challenges. She cites one SEC investigation of a mutual fund that allegedly undervalued its private company positions to give the impression that it had not breached the fifteen percent limit. "The SEC also has charged funds with inflating the value of illiquid investments. Mutual-fund managers have an incentive to overestimate the value of these holdings because they collect fees that are calculated as a percentage of total assets in the fund." (See "Mutual Funds Delve Into Private Equity" by Eleanor Laise, Wall Street Journal, August 2, 2006.)

Applying a version of the transitive property from mathematics, the implication is clear. Some pension funds have increasing exposure to private equity investments that do not trade in a ready market.

1. Pension funds allocate money to mutual funds.

2. Mutual funds buy private equity.

3. Pension funds are exposed to private equity as an asset class. (This is in addition to any direct allocation by pension funds to private equity.)

The message is clear. For those pension funds investing more money in private equity (indirectly or directly), the valuation issues are real and cannot be overlooked.
posted by Susan Mangiero at 8/06/2006 07:30:00 AM | 0 comments | links to this post  

Saturday, August 05, 2006


Operational Risk and Over-the-Counter Derivatives


The term "operational risk" is typically defined as the risk that results from incomplete, poor or failed internal controls, people and/or systems. Sometimes the term is used as part of a discussion about business continuity.

Operational risk is often cited as a key element of the use of over-the-derivatives. For one thing, the growth in over-the-derivatives market continues to break records, with the Bank for International Settlements reporting global use, in terms of notional amounts, in excess of $284 trillion at year-end 2005. Interest rate contracts such as forward rate agreements, options and interest rate swaps dominate, with an estimated notional amount of approximately $215 trillion. Additionally, operational snafus account for several large derivatives-related losses. Check out the Wheel of Misfortune for some interesting case studies.

A July 2006 survey conducted by Investit Intelligence confirms continued interest in the topic, with investment company COOs citing most concern about technology and operational risk.

Others feel similarly. Timothy F Geithner, president and CEO of the Federal Reserve Bank of New York described improvements such as "greater dispersion of credit and market risk, the improvements in risk management, the size of the capital cushions, and the improvements in many parts of the payment and settlement infrastructure", while cautioning market participants to "make the investments necessary to improve the operational infrastructure that underpins the credit derivatives and broader OTC derivatives market."

Why is this important to pension funds? Given the giant size of the derivatives market and their prevalent use by mutual fund managers and hedge fund managers, pension fiduciaries should be asking tough questions about operational risk policies and procedures.

Of interest may be two articles on what this author refers to as the Five C Approach to Risk Management (SM). In the absence of a disciplined, and carefully crafted, organization-wide strategy, identifying, measuring and managing derivatives-related risk is difficult at best. (Click here to read "Pension Risk Management: The Importance of Oversight" and here to read "Five Keys to Risk and Risk Management.")

If used properly, financial derivatives can provide users with flexibility, the ability to transform risk and possibly even lower costs. Evaluating, and effectively dealing with, operational risk is a big part of prudent practice.
posted by Susan Mangiero at 8/05/2006 05:31:00 PM | 0 comments | links to this post  

Thursday, August 03, 2006


Senate Thumbs Up for Pension Reform

Reuters reports that the Senate, with a vote of 93 to 5, has just passed a pension reform bill that now goes to President Bush. The Washington Post reminds readers that the U.S. House of Representatives approved this bill last week with a 279 to 131 vote.

Major elements of the Pension Protection Act of 2006 are listed below.

1. Sponsors will have to fully fund defined benefit plans within a seven year period, starting in 2008.

2. Airline companies get more time to satisfy obligations.

3. Hedge funds will find it easier to manage ERISA money before being subject to fiduciary requirements.

4. Financially weak plans will have to contribute additional amounts of cash.

5. Providing 401(k) plan investment advice by financial companies will be relaxed.

Comments and analysis will follow in the next few days.
posted by Susan Mangiero at 8/03/2006 11:46:00 PM | 0 comments | links to this post  

Wednesday, August 02, 2006


Form 5500 Revisions


According to PENSION AND BENEFITS, a CCH Business & Corporate Compliance publication, "EBSA, the PBGC and the IRS have proposed revisions to the Form 5500 Annual Return/Report forms. The goal is to modernize the ERISA fund disclosure process. While mandated by law, the current reporting system is in need of major improvements, something this author has described in several articles elsewhere.

What are some of the problems with the current reports? There is a long lag time between when data is submitted to the U.S. Department of Labor and when the information becomes available for public consumption. To illustrate, this author did a quick search of Freeerisa.com for several large U.S. companies and found data up to and including 2004 but nothing for 2005. As investors and beneficiaries know all too well, things can go downhill pretty quickly in which case a stale Form 5500 would be of no use whatsoever.

Moreover, the Form 5500 (Schedule H for large plans) provides scant details about a plan's investments. Nothing is provided about valuation methodology nor is any information proffered about risk measurements or risk mitigation strategies.

A welcome change is the expansion of information about service provider compensation. CCH reports the following.

The DOL has determined that it is appropriate to modify the Schedule C reporting requirements to ensure that plan officials obtain the information they need to assess the reasonableness of compensation paid for services rendered to the plan. As proposed, Schedule C would consist of three parts. Part I of Schedule C would require the identification of each person who received, either directly or indirectly, $5,000 or more in total compensation (money or anything else of value) in connection with services rendered to the plan or their position with the plan during the last plan year. This requirement would no longer be limited to the 40 highest paid service providers.

Filers would also have to indicate, for all service providers, whether the service provider received any compensation attributable to the person's relationship with, or services provided to the plan, from a party other than the plan or plan sponsor. Thus, if a fiduciary or anyone on a list of service providers received, directly or indirectly, $5,000 or more in total compensation and also received more than $1,000 in compensation from a person other than the plan or plan sponsor, then the Schedule C would have to provide information identifying the payor of the compensation, the relationship or services provided to the plan by the payor, the amount paid, and the nature of the compensation.

For further information, check out these sites.

1. IRS Form 5500 Corner

2. U.S. DOL "Troubleshooter's Guide to Filing the ERISA Annual Report (Form 5500), Part I"

3. U.S. DOL "General Guidelines for Completing Form 5500 and Schedules A, C, D, G, H and I"

4. Freeerisa.com (You can register for no charge and then search over 270,000 new filings.)

5. Article entitled "Deciphering Risk Management Disclosures" (While the article does not address Form 5500, it describes some important transparency issues.)
posted by Susan Mangiero at 8/02/2006 08:32:00 PM | 0 comments | links to this post  

Tuesday, August 01, 2006


Legislative Matchmaker: Hedge Funds and ERISA



A provision in the pension bill just passed by the U.S. House of Representatives could permit hedge funds to increase Employee Retirement Income Security Act ("ERISA") holdings before having to wear the fiduciary hat (for those that don't voluntarily assume the role now). The current limit is twenty-five percent of a hedge fund's total assets. The precise way ERISA assets are calculated is likewise expected to change.

According to Greenberg Traurig hedge fund attorney Nir Yarden, "an ERISA fiduciary is tasked with many responsibilities not otherwise required, some of which could significantly impact hedge fund strategy, investment mix, fees and reporting."

As one can imagine, advocates and critics are plenty. A healthy debate is good. After all, a particular hedge fund may be perfect for one defined benefit plan but wholly inappropriate for another. (To date, hedge funds are typically not offered as a 401K investment choice.)

What is important is that hedge fund (or fund of funds) managers who become ERISA fiduciaries truly understand what that means.

For example, with respect to the use of derivatives, a U.S. Department of Labor guidance letter is pretty clear.

As with any investment made by a plan, plan fiduciaries with the authority for investing in derivatives are responsible for securing sufficient information to understand the investment prior to making the investment. For example, plan fiduciaries should secure from dealers and other sellers of derivatives, among other things, sufficient information to allow an independent analysis of the credit risk and market risk being undertaken by the plan in making the investment in the particular derivative. The market risks presented by the derivatives purchased by the plan should be understood and evaluated in terms of the effects that they will have on the relevant segments of the plan's portfolio as well as the portfolio's overall risk.

Plan fiduciaries have a duty to determine the appropriate methodology used to evaluate market risk and the information which must be collected to do so. Among other things, this would include, where appropriate, stress simulation models showing the projected performance of the derivatives and of the plan's portfolio under various market conditions. Stress simulations are particularly important because assumptions which may be valid for normal markets may not be valid in abnormal markets, resulting in significant losses. To the extent that there may be little pricing information available with respect to some derivatives, reliable price comparisons may be necessary. After entering into an investment, a plan fiduciary should be able to obtain timely information from the derivatives dealer regarding the plan's credit exposure and the current market value of its derivatives positions, and, where appropriate, should obtain such information from third parties to determine the current market value of the plan's derivatives positions, with a frequency that is appropriate to the nature and extent of these positions.

Valuation is another touchstone. Fiduciary duties require a thorough assessment of everything related to plan investments. In "Hedge Fund Valuation: What Pension Fiduciaries Need to Know", this author emphasized the need for an independent assessment of valuation and/or valuation processes, including, but not limited to a check of price data collection, accuracy of pricing models and existence of controls that are meant to separate the trading and payment functions. The central role that valuation plays is becoming all too apparent as regulators and auditors ask tough questions.

Valuation drives nearly every investment activity. It is impossible for hedge fund managers to make meaningful decisions about asset allocation, portfolio re-balancing, risk management, fee assessments and performance evaluation in the absence of good valuation numbers. It is equally difficult for the pension fund investor to evaluate managers, decide whether to redeem or subscribe, verify calculated incentive fees charged by the typical hedge fund and otherwise carry out their mandated fiduciary duties. (Click here for a copy of the article.)

Any hedge fund or fund of funds manager, seeking additional ERISA money, should think about creating a laundry list of MUST DO items required by law and reflecting best practices. This would necessarily include a process check of risk management and valuation policies, procedures, along with reporting methodology. (A sign of the times, we've been fielding a lot of inquiries of late on these topics.)

Fees are another issue altogether and deserving of an additional post or two. (Read what we wrote in May 2006.)

So Congress plays matchmaker. Whether hedge funds and ERISA plans will represent a marriage made in heaven or a relationship destined for divorce court critically depends on prudent process.

Two little words that mean oh so much!
posted by Susan Mangiero at 8/01/2006 11:34:00 PM | 0 comments | links to this post  


California Dreaming: Pension Bill Fails



A recent legislative attempt in California has apparently caused quite a stir. Assembly Bill (AB) 2122 sought to preclude companies from paying dividends to shareholders before satisfying pension obligations and to "make directors and officers of a corporation jointly and severally liable for improper distributions" under certain circumstances.

Refer to the July 13, 2006 post entitled "Dividends, Pensions and California Chaos".

Blogger Jerry Kalish provides a novel suggestion.

The proposed bill - and the politics behind it - conveniently ignores the massive unfunded pension liabilities in California, e.g, the California State Teachers' Retirement System faces a $24 billion unfunded pension liability.

But we got them beat in my home state of Illinois which at $35 billion has the largest unfunded pension obligation in the country. The Fitch Rating service released a "negative outlook" for Illinois finances - one of only three negative outlooks issued by the rating service in its review of the states. The other two? Louisiana dealing with the aftermath of Hurricanes Katrina and Rita and Michigan dealing with massive problems in the automobile industry.

Um! Should there should be a law that no more salary increases occur for state legislators until pension liabilities are met?

So where does this attempt stand now?

According to the website that tracks California legislation, the bill failed passage on June 22, 2006 with "reconsideration granted".

While laudable to encourage prudent pension funding, there are a host of problems associated with this type of reform.

Is Milton Friedman right when he said that "the government solution to a problem is usually as bad as the problem" and that "there's no such thing as a free lunch?" Notwithstanding the law of unintended consequences, empirically validated time and time again, there are a variety of better, and arguably more efficient and cost-effective ways to solve the pension "crisis" than putting state legislators in charge of a company's capital structure.
posted by Susan Mangiero at 8/01/2006 12:02:00 AM | 0 comments | links to this post