Looking ahead for the perfect (pension) storm’s next move
It is often said that pension sponsors are in the middle of a “perfect storm;” all the conditions that could possibly fuel a tempest are converging to maximize its intensity and devastation. Consider the following:
- By the end of the first Quarter of 2003, the bear stock market was into its 4th year, as brutal as any prolonged down period since the Great Depression — which has come along at a time of historically high pension fund equity exposure;
- March showed us how volatile markets can be with an eight-day rally stronger than any since 1896, but much of those gains were erased by month’s end;
- Whichever way this storm moves, the aging and retiring Baby Boomers will continue to cause increased cash flowing out of funds during these highly volatile times;
- Inflexible and rigid funding and accounting standards will increasingly limit plan sponsors’ flexibility to deal with these drastic up and down performance numbers;
- Many corporations are still reeling from investor backlash from aggressive and, in some cases, fraudulent accounting practices; and
- In the end, it seems the daily news regarding the troubled and uncertain current world events become the only reliable barometer for this storm.
Can you navigate your pension through this storm and survive? In a word, yes. But how?
Consider what happens when pilots are forced to navigate through a thunder storm. Do they just keep the plane on autopilot and proceed on the same course they began with?
Instead, they painstakingly monitor the aircraft’s present position and evolving course relative to the storm, and continuously update their predictions of the aircraft’s course and duration to navigate around the storm. Under normal weather conditions, they can keep their aircraft in autopilot most of the trip, and periodically review their instruments that reveal their present course, heading, airspeed, etc.
However, even if in autopilot mode, one thing all pilots do is receive and react to continuously evolving weather forecasts. If a perfect storm were to hit them, you can be sure that there were warnings well in advance.
Now consider the “pilots” of the pension industry — investment and actuarial consultants. Investment consultants report quarterly on the results of the fund assets and their managers, comparing results to other funds and managers. And the actuaries provide their clients with the “official status” of the fund based on the myriad of calculations they perform, but usually based on asset levels more than a year old, even though current assets are known. This type of reporting is analogous to flying a plane on autopilot, but with one major difference: the weather forecasts are not typically updated as they are for pilots.
It’s a good thing that the aviation industry is not run by the aviators of the pension industry. Regrettably, many pension consultants are not only still in the autopilot mode today, many unnecessarily wait for year-end results, while just peeking outside the window, they can see that the “perfect storm” is building up to violent strength. There is a far better way to warn plan sponsors and Trustees in advance about the direction this storm is heading and how it may affect them to give them more time to prepare and limit the damage (navigate around the storm).
For any pension fund it is increasingly important to know how their forecasts have changed each and every time they receive updated asset information. Waiting until the official actuarial valuation is done—up to 18 months after the fact—is risky, and for many funds far too late, as the delay may cut out any options that may have otherwise been feasible had the information been made available earlier.
Sadly, the economic storm has already hit some pension funds leaving them in an irreversible downward spiral. For those funds, a safe resumption of the flight is not possible even with an immediate and raging market turn around with returns in excess of 40%. Their only options now are to bail out of the plane by considering drastic changes: a tripling of contributions, a cessation of benefit accruals, or both.
But most funds still have time to prepare for the storm’s onslaught and navigate safely: Do not assume the “weather report” you’ve last received from your advisors (if you even got one) is even accurate anymore. It is critical for most funds to start receiving better and frequently updated long-range forecasts based on their most recent investment results and without having to incur significant costs.
Knowing soon after the latest asset returns are available what they portend for the future path and intensity of the “storm” in relation to your fund’s position is more important than simply getting a current airspeed of temperature reading (i.e., recent investment results). In particular, plans must start examining long-term projections beyond the typical baseline projections (as assumed level returns never happen). Stress testing a fund’s foundations under more severe weather conditions (raging bear or bull stock markets) is more realistic and revealing, and can flush out symptomatic problems that much sooner.
In this way, plans can see in their own forecast the changing probability of the storm hitting them, and its potential strength and timing.
Technology advancements have increasingly enabled consultants to provide improved and more effective prognosticating capabilities, and at affordable prices. The enhancements move the time honored traditional pension plan reporting methods out of the dark ages. An infrequent static projection, usually done after the bad news hits, is not the way to navigate through this economic storm.
To be sure that your pension emerges from the ongoing perfect storm without a catastrophic crash-landing, be sure your pension consultant has all the skills and equipment necessary to do the task. Your consultant should be able to tell you:
- How many dollars (not rates of returns) your investment advisors and managers have earned or lost for you;
- How the most recent investment results have impacted your plan’s prospective financial condition and likely actuarial forecast;
- How much value your investment advisors and managers have added, shown in real dollars gained or lost (net of fees) through diversification, manager selection and asset allocation;
- How your investment results have impacted your plan prognostics, using a long-term forecast of projected funding ratios, unfunded liabilities and contribution requirements based on your current investment assumptions, a short-term continuance of poor results, replicating both historical bull and bear market conditions, and your investment consultant’s assumptions about your portfolio’s expected return and volatility in returns.
Equipped with such information, all available from CHEIRON, it’s possible to improve one’s decision-making ability and make investment advisors more accountable.
With the perfect storm raging, it’s essential to know that your pension’s pilot is equipped with all the necessary skills and navigational tools to determine whether a new course is indicated, and if so, which one to take. Even when the storm begins to subside, all of the same skills will be needed to accelerate one’s path toward the final destination after being buffeted by the tempest.
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