HOFFMAN,
WHITE & KAELBER FINANCIAL SERVICES, LLC
INVESTMENT managers &
WEALTH Advisors
This is the March 2006 monthly Wealth Management
newsletter from Hoffman, White & Kaelber Financial Services, LLC. If you do not wish to be included in our
circulation, please reply indicating your desire to be removed and we will be happy
to oblige. Alternatively, any of your
friends or colleagues may receive this on a regular monthly basis by sending
their name and email address to
Depending
on your vantage point, I guess this question could be debatable. Yet, to me, it certainly seems like things
are about to get better! Want to know
why?
Maybe in
your parents’ generation, certainly for your grand-parents’ and possibly in
your great grand-parents’ day, one of the secrets for achieving “the good life”
was to work for a big company with a pension plan. Although fewer than half of private sector
workers ever had a defined benefit pension, it was one of the few trademark
features of the American dream.
Currently,
almost all federal employees and a large majority of state and local government
employees have defined benefit plans.
Yet, in the private sector, only about 20 percent of workers participate
in defined benefit pensions, and that number is expected to drop to the
vanishing point over the next ten years or so.
A Defined
Benefit retirement plan is one in which plan participants (employees) would expect
to receive a certain amount of money per month upon retirement determined by a
predefined formula. The formula for
calculating the promised benefit amount will usually depend on factors such as
age at retirement, number of years of service, and the amount of money earned
at or within a few years prior to the time of retirement.
Some would
say that, offering up a story about defined-benefit pension plans is akin to
discussing ancient history. While many
remain in existence, for the most part, defined-benefit plans are relics from a
bygone era when unions were able to negotiate prized retirement benefits from
employers. In the last twenty years, however,
401(k) plans have become the dominant form of employer-sponsored retirement
plans.
Unlike a
Defined Benefit plan, a Defined Contribution plan only stipulates that the
employee and/or the employer shall contribute a certain amount of money per year
into a tax deferred savings account for the plan participant (employee). Other than 401(k) plans, additional examples
of Defined Contribution plans include 403(b) and 457 programs, profit sharing
plans, SIMPLE’s, SEP’s and IRA’s to name a few.
As readers of my newsletters well know, wealth management is
the ultimate goal of all that we do at Hoffman, White and Kaelber. Yes, we promote our services; yet, you will find that we
always seek to present thought provoking topics that are relevant to our wide
audience.
This
month’s newsletter discusses some of the major challenges retirees face with
these retirement plans and how policy-makers in
What’s Wrong – What Needs Fixing?
Citing a February 2006 report by Charles Morris, of The Century
Foundation, “The first
realization that [Defined Benefit plan] pension promises were not ironclad may
have come when the Studebaker Co. folded in 1963 and defaulted on its pension
obligations. Congress eventually
responded with the Employee Retirement Income Security Act (ERISA) of 1974. ERISA established financing and accounting
standards for defined benefit pensions and created the federal Pension Benefit
Guarantee Corporation (PBGC) to insure private defined benefit pension
commitments.”
The Century
Foundation provides top-notch research and expert assessments on public policy
matters which it makes available to policymakers, journalists and concerned
citizens.
Under
ERISA, rather than having to fund current pension benefit payments out of
current cash flow, companies having a Defined Benefit plan are required to set
aside invested assets to fund their future pension liabilities. Morris’ report continues: “If the actuarially determined present value
of pension liabilities exceeds that of pension fund assets, the shortfall is
subtracted from the company’s net worth as if it were a debt... As of mid-2005, private companies have
amassed $1.8 trillion in assets to support their defined benefit pension
obligations, against future liabilities valued at about $2.2 trillion [a
projected $700 billion shortfall]… During the 1990s market boom, stock returns
were so high that many plans became over-funded, and pension funds actually
became an important driver of company earnings. When the markets reversed after 2000, pension
fund underperformance hammered plan profits, at the same time as falling
operating earnings reduced companies’ ability to increase plan contributions. Just as important…the steady fall in interest
rates after 2001 greatly ratcheted up the book value of future pension
liabilities.”
To shed
some light on the magnitude of this problem and how it has grown, lets turn the
clock back approximately eighteen months.
In August of 2004, Rep. John
Boehner, chairman of the House Education & the Workforce Committee,
released the following statement:
“The recent
decision by United Airlines to suspend contributions to its under-funded
pension plan, at least in the interim during bankruptcy proceedings, is another
very visible symptom of a broken defined benefit pension system that needs
significant reform. It’s an issue
The Pension
Benefit Guaranty Corporation (PBGC), which assumes responsibility for and
guarantees retirement benefits should a company falter, is concerned about the
pensions of United’s workers and retirees – and rightly so.
Unfortunately, it’s become an all too familiar problem. In recent years,
the PBGC has become liable for hundreds of pension plans and accumulated an $11.2
billion deficit. Although the agency has enough resources to pay benefits
in the near future, the possibility of a taxpayer bailout of the PBGC could be
necessary if the financial condition of the agency continues to deteriorate.”
Now to
understand how the problem has grown, lets fast-forward to Charles Morris’
report: “…Analysts at Credit Suisse/First
Boston (CSFB) recently published a list of twenty major companies with pension
liabilities that equal or exceed the company’s market value; the list includes
Delta Airlines (which has since declared bankruptcy), with pension obligations
13 times higher than its market value; General Motors, 4.7 times higher; Ford,
2.7 times higher; Lucent, 1.9 times higher; and U.S. Steel, 1.4 times higher. Mounting deficits at the PBGC are creating the
potential for a federal bailout on the scale of the 1980s Savings and Loan
crisis… More likely, companies will accelerate the process of extracting
themselves from their pension obligations. One path is the strategic bankruptcy. Shedding pension obligations has become
practically a standardized financial engineering tool in the hands of private
equity buyout managers—in steel companies, auto parts companies, and more
recently, a string of airline bankruptcies. Collectively, it appears that
United, Delta, and Northwestern airlines, and the auto parts maker
So much for
Defined Benefit plans. Now, let’s take a
look at one of the largest economic challenges occurring in the Defined
Contribution plan market. The following
comes from an August 2002 article from CFO.com entitled:
“Honey, I Shrunk the 401(k)”
“That
rumbling sound you hear in the distance is the growing chorus of very
disgruntled employees who now realize that 401(k) account balances can shrink
as well as grow — and who have discovered that they're not very good at
managing them, anyway…With the end of the bull market and the implosion of
Enron, employees have realized that their hard-earned savings can dwindle, if
not disappear, in a 401(k). New studies
have shown that 401(k) plans are underperforming the market and coming nowhere
near to replacing pre-retirement income for most employees…The problem is
exacerbated by employees' general lack of investment knowledge. A recent survey of defined contribution plan
participants by John Hancock Financial Services found that 40 percent of
respondents say they have little or no investment knowledge. Fifty percent say they don't have time to
manage their investments. "Human
nature may be the Achilles' heel of the 401(k) system," says survey author
Wayne Gates, general director of market research and development at John
Hancock…”
“The end
result of the shift to 401(k) plans is that employees have considerably less
money to retire on today than they had 20 years ago”, according to research
conducted by Edward N. Wolff, an economics professor at
Retiree’s can depend on Social Security benefits to
take care of them, can’t they?
There is a
great deal of confusion and concern about the federal Social Security System in
relation to Pension Plans. While Social
Security has some outward similarity to a Defined Contribution plan it is
neither a Defined Benefit nor a Defined Contribution Plan. The monies in the Social Security system are
not invested in the economy and do not grow in value with time. In fact, there is no money in an individuals
account in Social Security. The only
thing of “value” in a Social Security account is an IOU issued by Congress. And, Congress has borrowed this money to spend
on other programs. As a result, the
payments that an individual makes into Social Security are, in effect, taxes
paid to fund welfare payments to the elderly.
Information
on the Social Security Administrations web site reflects that, “Social
Security's financing problems are long term and are not expected to affect
today's retirees and near-retirees, but they are very large and serious. People are living longer, the first baby
boomers are nearing retirement, and birth rates are low. The result is that the worker-to-beneficiary
ratio has fallen from 16.5-to-1 in 1950 to 3.3-to-1 today. Within 40 years it will be 2-to-1. At this ratio there will not be enough workers
to pay scheduled benefits at current tax rates.”
So, What’s
In 2005, with Social Security reform having gone nowhere
early in the year, pension plan reform quickly took center stage on Capital
Hill. It might have seemed that defined
benefit plan issues dominated the legislative agenda, but defined contribution
issues started gaining traction as pension reform moved through the House and
the Senate. The result of this focus
produced both the Pension Security and Transparency Act (PSTA, S.1783),
approved by the Senate on November 16th and the Pension Protection
Act (PPA, H.R.2830), approved by the House on December 15th. As you might expect, the House and Senate
bills differ significantly and further negotiations are required.
But, before
we move on, it is important to know that these Acts are considered “bills” at
this time. A bill is a legislative
proposal before Congress. A bill must be
passed by both the House and Senate and then be signed by the President before
it becomes law.
As posted on the Senate’s Democratic Policy Committee
website, PSTA S.1783 was summarized as follows:
“The
Pension Security and Transparency Act of 2005, would strengthen the funding
requirements for single-employer defined benefit pension plans, create new
rules for multiemployer plans, provide the airline industry and financially
troubled plans special provisions to avoid plan terminations, enhance financial
disclosure requirements for pension sponsors, expand retirement savings options
for employees working for firms facing bankruptcy or corporate scandals,
provide workers access to investment education tools and independent investment
advice, and address concerns relating to women, spouses, survivors, and older
workers.”
And Rep. John Boehner (R-OH) posted on
AssetBuilding.org, a project of the New America Foundation, the following about
PPA H.R. 2830: “This comprehensive pension reform
bill from the Republican leadership is based on some of the Bush
Administration’s proposals. The bill
would provide real-time information for workers on the health of their
pensions; a structure for identifying troubled multi-employer pension plan with
a system of benchmarks to move them towards better health; and would allow
employers to provide all workers with access to investment advice as employee
benefit. In addition, the bill will raise employers’ premiums who participate
in PBGC to cover rising costs. With
regards to the new structure the bill proposes to gauge pension health based on
how well funded it is, pension plans funded at 65 to 80 percent receive a
“yellow” or warning status and must adopt a program to improve within ten
years. If they fall below 65 percent funded, they would be at “red” status and
face additional benchmarks.”
Concluding
Thoughts
After
looking over the details of both of the bills discussed above, a couple of
things seem fairly clear about the direction of pension reform. First, both bills seem to be encouraging an
orderly dismantling of the defined benefit plan system and, at the same time,
discouraging large plan sponsors from extracting themselves from their pension
obligations through a strategic bankruptcy process. Second, it would seem that 401(k) and similar
plans (defined contribution plans) are being favored for use as the primary
retirement plan vehicle and there seems to be a big push for defined
contribution plan sponsors to engage qualified investment advisors for the
benefit of their employees.
As the push
for engaging qualified investment advisors evolves, it wouldn’t surprise me if
plan sponsors began migrating from offering participants investment choices to
hiring an investment manager to invest plan funds. This type of arrangement would certainly make
the most sense, from a cost benefit perspective, for all parties involved.
Hoffman, White & Kaelber Financial Services Investment
Performance Update
Consumer
confidence declined in February, and the housing market appeared to be slowing
a bit, according to end of month reports that led some economists to suggest
slower growth ahead. In its consumer
confidence report, the Conference Board said its index of consumer sentiment
fell in February to 101.7 from 106.8 in January. Also, the National Association of Realtors
said existing home sales dipped 2.8% last month to an annual rate of 6.56
million. The inventory of unsold homes
rose to a 5.3-month supply.
Regarding
the other side of the globe, the International Monetary Fund will likely revise
its forecast of 2.0% growth for
We were
very pleased to finish the month of February on a positive note. It’s hard to believe that it’s been three
years since we started. For the month
ended
Is a comfortable retirement or preservation of wealth important to
you?
Want better long-term results from your investments?
Choose Us As Your Investment Manager!
Research us on the web at www.hwkfs.com