Contents: Nortel pension update, USSteel/Stelco reaffirms no private sector pension protection in Canada, ORPP or CPP- putting all the eggs in one basket? actuarial delusions? target-date funds glide-paths still not right- it depends, Vanguard: next 10 year 60/40 portfolio return expected in range of 3-5% real, income replacement ratio is not target retirement metric, fiduciary? longevity annuities-good, tontines-interesting.

Canada pensions

Nortel’s Canadian pensions

Three months ago in “Reflections upon Nortel’s Canadian pensioners’ prospects: July 2015 view” I wrote that the judges’ pro-rata allocation decision  “was the first piece of good news for Nortel’s Canadian pensioners since the 2009 bankruptcy…but the road ahead might still be long and treacherous given the remaining uncertainties: the appeals in progress and perhaps more to come, the claims that will be accepted by the regions/courts and how the ‘modified’ pro rata will actually work, the final cost of the legal and professional services, etc. As to the pension plan windup, its timing and outcome are fuzzy at best given the opacity of the current state of plan assets/liabilities relative deemed 2010 windup assumptions, and the apparent Ontario regulator/administrator plan to offer CVs of substantially lower value than cost of buying annuities.” So where are we now?

As far as the plan windup schedule is concerned, the October NRPC newsletter update indicates that Negotiated (union) plan members’ Option Letters will be mailed on November 16^th, while the Managerial and Non-negotiated pension plan preliminary report will be filed (presumably for FSCO approval) early November with option letters mailed to members some TBD months later. For the Negotiated Plan members there are three webinars planned late November, to be followed by town-hall meetings in a number of cities in December. The webinars will be posted at NRPC and Koskie Minsky websites for viewing by both Negotiated and Non-negotiated plan members. Potentially Managerial plan members might get some preliminary view on how commuted value option promised to Ontario members will be handled, one benchmark being, can one buy with the lump-sum offered an annuity of the same value on the open market from a highly rated insurance company.

As feared, the road is looking long and treacherous for the legal proceedings aimed at distribution of the USD $7.3B in the lockbox, having bogged down again in more motions, appeals in the courts (bondholders, PBGC, and other ‘supplicants’) and parallel mediation efforts. So the corrosive effects of the legal and professional fees might continue for many more years. The best anyone can honestly say is that we don’t know; more than 6 years have elapsed and $1.5B consumed by mostly legal fees so far. So while in July I became cautiously optimistic about the outcome for pensioner recoveries from bankruptcy proceeds, I will now just be cautious and return to the assumption that little or no additional funds will be forthcoming in the foreseeable future, and then perhaps be pleasantly (I guess I am still showing my naiveté) surprised.

Canadian private sector pensions

Federal and provincial governments come and go, for private sector pensioners in Canada (unlike the U.S., UK. and other developed countries), nothing changes; if your DB plan sponsor declares bankruptcy, you effectively have no protection. Nortel was the largest example, while USSteel/Stelco is the latest example to come to roost last month.

In The Hamilton Spectator’s “U.S. Steel Canada pensions underfunded by $1.6B- Shortfall is supposed to be eliminated by 2015” Steve Arnold wrote in September 2012 that according to a report released at the time “the U.S. Steel Canada plans have more than $2.5 billion in assets, they would be more than $1.6 billion short of what they need to cover all promised pensions if the company were to go bankrupt.” The article adds that one of the plans, the Local 1005 pension plan “has assets of more than $1.4 billion and liabilities, if the company were to close, of more than $2.4 billion, a shortfall of more than $1 billion. That means the plan has only 58 per cent of the assets it needs.” Arnold quotes a union spokesman that ”said under the terms of the deal that brought Stelco out of bankruptcy protection in 2006, and saw it sold to U.S. Steel a year later, the pension shortfall was supposed to be eliminated by the end of 2015.” However, by 2014 the Canadian unit of USSteel went into bankruptcy protection and by September 2015 U.S. Steel Canada asks court to stop some pension contributions. So a week later “Retirees, employees seek court order to halt U.S. Steel production move”, but in the Globe and Mail’s Court approves U.S. Steel plan to cut Canadian unit Greg Keenan reports that “The Ontario Superior Court has approved a United States Steel Corp. plan to cut loose its Canadian unit… The Canadian unit has debtor-in-possession financing of $75-million to carry on operations, but it faces a revenue hit in the fourth quarter because U.S. Steel has shifted production of high-value automotive contracts to its mills in the United States. U.S. Steel will make pension payments for the Canadian unit through the end of the year, but health care benefits to about 20,000 retirees and dependents have been suspended.”  And last week, in the middle of an election the “Industry minister warns U.S. Steel of court action over pensions” (I think I read this book before, but the victims were called Canada’s Nortel pensioners, and nothing was done for them either.)

Bottom-line, another example of how little protection there is in Canada for private sector pension plans and another reason why Canada’s pension system is undeserving of the accolades reported in the Globe and Mail’s A report card for retirement income: What grade does Canada get?  with much fanfare (based on inaccurate and/or misinterpreted input and/or a flawed index). While Canada’s retirees might have protection against abject poverty (due to OAS/GIS), the pension system faced ‘top 80%’ of Canadians working in the private sector is inferior to most developed countries, and is undeserving of positive review reported in the Globe. Private sectors pensioners whose employer has gone bankrupt with underfunded pensions might even call positive (but deteriorating) reports about Canada’s pension system as nothing more than actuarial pornography. (For the record, I have stopped reading the annual Melbourne Mercer Global Pension Index years ago due to cognitive dissonance based my personal experience.)

The Globe and Mail initiated a survey in September in an article entitled Baby boomers: Are you ready for retirement? . I seem to have missed the results of the survey (anyone seen it?), but the ‘Comments’ are still well worth reading. Here are a couple to whet your appetite: “Expat pete: Yup, I’m ready. Why?—because I am tired. Do I have enough by typical Globe and Mail retirement advice column standards?—No, not by a long shot. Am I worried? –No. Worrying doesn’t change the math. Besides, it makes you feel ill at ease and destroys what could otherwise be a lovely day. You just adjust your living standard expectations. Or alternatively, I suppose you could keep slugging away forever in a failing world economy until you drop dead at work chasing a constantly moving target. Sometimes you need to realize that you can’t always have everything you want at every stage of your life—but you can usually get exactly what you actually need. Life goes on. Be happy with what you’ve got and make it work.”    And “independentlypoor: I couldn’t have said it better, expat pete. Like you, I don’t have anywhere near the $2 million or whatever that some advisors call for. But I’ve done the math and I can make it work. I’ve crossed a threshold where time is more valuable than money. The days I sell now to an employer while still in good health are gone forever. Decline is inevitable and at some point in the future all the money in the world won’t buy me another day for myself. A little bit of freedom before we die is priceless. Peace.”

In the Financial Post Fred Vettese “When it comes to retirement concerns, Canada and the U.S. are on equal footing” while some of the comparisons are debatable, the essential point on the inadequacy of the CPP in a world where the DB plans have essentially disappeared in the private sector is explained clearly to be as a result of the $53,000 vs. $118,500 pensionable earnings cap in Canada vs. US respectively: “A single person who is age 65 with final average earnings of $100,000 would receive a Social Security pension of $2,404 a month in the U.S. while a Canadian with the same earnings would receive only $1,629 from CPP and OAS combined…. This helps to explain why there is so much ongoing angst in Canada about the need to expand CPP while it is a non-issue in the U.S.” (Perhaps the reason the politicians (e.g. see Ousted politicians in line for golden pensions) and government bureaucrats don’t understand this is that in their world this is not the case …is it time to sensitize them?)

I am writing this blog post on Election Day in Canada but plan to publish only after the election results, to ensure that nobody will feel that I tried to influence readers who might be pension sensitive in their voting decision. The position on pension reform by the three major parties in the election were: (1) NDP support an expanded CPP  (see NDP’s support for expanded CPP is good: Unifor),  (2) Liberals support an expanded CPP (see Liberals pledge to enhance CPP (but Ontario Premier  Wynne may axe plans for Ontario pension  if the Federal Liberals win and implement an expanded CPP) and (3) Conservatives rejected expanded CPP (even though Finance Minister Flaherty proposed it initially), but then the federal government decided against it due to concerns about the economy, they even refused to provide CPP-based administrative support for the launch of the ORPP; but as the election season was getting under way they requested input on a Voluntary expanded CPP.

The Ontario government has committed itself to the ORPP and is in the midst of preparing to launch it in 2017. The rationale for the ORPP is articulated by the minister responsible for it in Mitzie Hunter on the ORPP  but three days later Ontario Premier Wynn indicated that she is prepared to drop it if the federal Liberals win and implement an expanded CPP Wynne may axe plans for Ontario pension . (Unfortunately, an expanded CPP does increases the risk for all participants, in fact many are already concerned about Canadians having too many eggs in the one (CPP) basket, especially given the aggressive active management approach being pursued there.)

US pensions

In the WSJ’s “Tax policies spur companies to offer pension buyouts” Chasan and Lin report that US based companies are taking advantage of  an IRS decision “to continue using its current life-expectancy calculations” before 2017 when the IRS is expected to shift to increased life expectancy assumptions requiring higher lump-sum payouts. Actuarial experts are advising clients, that if they want to reduce pension liabilities, to take advantage of the current mortality tables (which as is obviously known does not reflect current reality) before the new ones kick in.

In NBC News’  “Can Americans ‘Piggyback … on Canadian Social Security’? Ads Say So” Tom Anderson warns readers not to fall for advertisements (promoting a financial newsletter) claiming that Americans can piggyback on Canada’s Social Security by exploiting a potential loophole to ‘begin collecting ‘work-free; income checks running from $400 to $47000 per month.” (Completely false! Appears to be a scam to sell financial newsletters.)

In the WSJ’s Giant U.S. Pension Fund to Propose Shift Away From Stocks, Bonds Timothy Martin reports that the $191B Calstrs pension fund is proposing to shift 12% or  $20B of the portfolio from stocks (now representing 55% of the portfolio) to “U.S. Treasurys, hedge-funds and other complex investments” to reduce losses from future stock volatility. (Moving to hedge funds and other complex investments will help? Highly unlikely.) Another even larger fund down the street (CALPERS) “decided last year to exit all hedge-fund investments as a way of reducing its reliance on complex holdings”.

Generic pension topics

In the Financial Times’ Interest rate rise would fix pensions crisis John Authers writes that the falling interest rates have been a disaster for DB plans and rising interest rates would cure the disease. Unless rates start rising companies with significant pension plan shortfalls will start seeing lower credit ratings (perhaps not a problem in Canada where if you decide not to honour pension obligations, just declare bankruptcy and the court will forgive the pension obligations). Companies are increasingly forced to buy high priced bonds with low interest rates to get some semblance of asset liability matching to de-risk the plans, and they are accusing governments for of “financial repression” as a way of forcing corporation to lend to the governments at low rates. The chase for higher yield however results in forcing pension plans to higher risk instruments. The impact is similar for DC plans, except that the shortfall risk is taken by the individual plan members. Historically, many took annuities at retirement, however the attraction of annuities are even more muted at the current lower interest rates. The article concludes that higher interest rates could fix most of the pension plan problems.

But in the Financial Times’ “Sandwich casualties of the pension time-bomb” Sophia Greene discusses opposing views on whether the likely impact of rising dependency ratios will lead the U.S. to end up looking like Japan: “low interest rates, enormous (and growing) government debt, and deflation” or the opposite “not only inflationary pressures as labour supply falls and wages rise, but also higher interest rates as central banks fight to control inflation”. If the latter scenario prevails, it would make the pension crisis even worse, because if people are currently not saving enough given the assumption of lower inflation or even deflation, then they would have to save even more if inflation was higher than expected. The article also expresses concerns about the impact on home prices if boomers will start selling their homes to pay for care later in life, further reducing expected available assets to pay for retirement.

In the Financial Analysts Journal’s “How public pension plans can (and why they shouldn’t) ignore financial economics” Lawrence Bader warns that “Public pension plan sponsors claim that their perpetual existence and taxing power exempt them from financial economics. They therefore ignore current market conditions and rely on patience and intergenerational risk sharing to overcome risk. The author shows that their use of discount rates that far exceed current market levels produces financial opacity, retirement insecurity, and intergenerational inequity, leaving the solvency of these plans dependent on the systematic mistreatment of future generations of taxpayers.” In support of his arguments he discusses the use of (delusional) high discount rates “with a consequent failure to recognize and manage the true cost of these plans”, the use of (inappropriately) risky portfolio on the assumption that risky assets are riskless in the long-term when in fact “the variance of accumulated return increases in proportion of the length of the measurement period” and “the current generation take the premium and the next generation takes the risk”, and most importantly the “the benefit of the long government time horizon is not that it overcomes risk but, rather, it delivers a steady supply of future involuntary risk bearers on whom the government can exert its taxing power”. (Canadians are already living this, having had their CPP contributions increased from about 6.5% (the expected cost of promised CPP benefits) to 9.9% of insurable earnings just to make up for payout to previous generations of CPP beneficiaries before the plan was funded for that payout; a clear demonstration of intergenerational inequity with no end in sight?)

Retirement income

In the WSJ’s A Bracing Year for Target-Date Funds  Michael Pollock discusses the ongoing debate (again triggered by TDF losses associated with recent market losses) on what’s the appropriate glide-path (risk profile or asset mix) to be used for $1T (trillion) worth of 401(k) assets invested in such funds. (The missing consideration here is that there are different glide-path requirements for funds intended to operate to-retirement (i.e. annuitization is intended at retirement) vs. through-retirement (i.e. a systematic withdrawal approach to generating income is planned post retirement from an individually tailored risky portfolio which may or may not be 60/40).  An individual Investment Policy Statement, which includes a risk tolerance assessment, would go a long way to determine what the appropriate glide-path is for each individual.)

And for those still saving for their retirement and those already retired but using a systematic withdrawal approach will be interested in Vanguard’s year-end 2014 report on capital market expectations entitled “Vanguard’s economic and investment outlook” which opined that “average annualized returns of a 60% equity/40% bond portfolio for the decade ending 2024 are expected to center in the 3%–5% real-return range, below the actual average real return of 5.6% for the same portfolio since 1926.” (Still, a lot better than ‘risk-free’ government bonds or GIC/CDs, but a lot riskier.)

In the Financial Post’s “This isn’t your grandfather’s retirement! Why the 70% income target no longer makes sense” (not because one might not need 70%, but because it is not possible based on current realities) Fred Vettese explains why the 70% income replacement is unrealistic (i.e. it cannot be achieved) as we shift to 1-1.5 years working instead of the 4-5 years working for each year in retirement, and lower expected future returns. (That might all be true but replacement of a percentage of pre-retirement income is not the right way to think about the problem. It never made sense even before, because it is not about income replacement but about covering expenses, pre and post retirement. It’s not about income, but about lifestyle management; specifically, retirement finance is not about income (what you make) but about savings (what you keep), so it is about expenses. Expenses (spending both fixed/needs and discretionary/wants) govern what you save from income and which in turn will drive the assets that will be available in retirement to cover your retirement expenses (needs and wants), the less one spends pre-retirement, the more they’ll have for retirement, and the less they’ll need/want in retirement having gotten used to a lower standard of living (needs/wants)). In a follow-up article “Forget 70%: How to calculate your actual retirement income target” Vettese actually discusses the subject of understanding pre- and post-retirement expenses.

In InvestmentNews’ “Advisers need to brush up on plan participants’ risks when taking lump sum distributions” Blaine Aikin (who runs fi360, a firm specializing in training and standards pertaining to fiduciary advisers) notes the level of care that those advising clients must observe. In the U.S. there are two changes in the landscape: (1) more companies are looking at de-risking their pension plans (or more precisely transferring the risk to an insurance company or by making lump-sum offers to employees and pensioners, and (2) pension plan ERISA fiduciaries including the sponsor and advisers who provide individualized advice (especially with the expected (now pushed out to mid-2016) rollout of the DOL fiduciary standards) must insure that advice is consistent with the best interest of the client. To take lump-sum or pension is one of the most important decisions a client will make.

In InvestmentNews’ Longevity annuities could boost retirement readiness, study finds Hazel Bradford reports that according EBRI, the use of QLACs (which longevity insurance products now allowed in 401(k) plans) improve retirement readiness for the longest living retirees; this is even true with the current very low interest rates. (This makes sense and it should be part of Canada’s RRSP/RRIFs, but a couple of long overdue changes are required to enable this: (1) exempting these payment from minimum distributions and insurance companies to start offering these still unavailable longevity insurance products in Canada.)

And finally, in The Washington Post’s “It’s sleazy, it’s totally illegal, yet it could become the future of retirement” Jeff Guo discusses tontines, referencing a recent book by Moshe Milevsky who has been encouraging a fresh look at these very popular products a century ago, but illegal today. “Tontines, you see, operate on a morbid principle: You buy into a tontine alongside many other investors. The entire group is paid at regular intervals. The key twist: As your fellow investors die, their share of the payout gets redistributed to the remaining survivors. In a tontine, the longer you live, the larger your profits — but you are profiting precisely off other people’s deaths. Even in their heyday, tontines were regarded as somewhat repugnant for this reason.” Unlike an annuity which pays a constant income stream for life, a “tontine would pay you more and more as time went on because other people would be dying and you would be accumulating their shares”.  “A simple modern tontine might look like this: At retirement, you and a bunch of other people each chip in $20,000 to buy a ton of mutual funds or stocks or whatever. Every year, the group withdraws a predetermined amount and divides it among the remaining survivors. You might get a bonus one year, for instance, because Frank and Denise died.” Some consider a tontine as a cheap annuity, where you cut out the insurance company (no reserves, can invest more aggressively, no cost of guarantees, etc), or looking at it another way “a tontine abandons certain payouts for much higher returns”. A tontine is another way to share risk and reward with the sponsor of the pension plan, so it could be a rebirth of the dying DB plans. (I guess you could think to tontines as a fund designed for systematic withdrawal whereby the units of the fund return to the fund (investors still alive) when the owner of the units dies. Tontines are an interesting idea worth exploring if: you have no desire to leave an estate, figure out mechanism of how to manage such a pooled portfolio, create mechanisms to allow for differences in age (life expectancy) and  risk tolerance among participants, and tax considerations of a pooled fund; before you know it you are back to needing an insurance company (like for immediate or longevity annuity) or some other financial institution (like for pooled funds) with its associated corrosive costs eating up most of the advantages of the idea. While tontines are under development(?) and until we assess them not to be corrosive to our wealth, why not use instead “The only spending rule article you’ll ever need” by Waring and Siegel- A review , and if you really need the mortality credit kicker it just add a longevity annuity to get some benefit of pooled mortality?)