Pension Risk News & Analysis : Pension Governance, LLC : Pension Risk & Investment

July 4 marks the U.S. version of Independence Day, a celebration of America's break from colonial England. Click to learn more about Independence Day in other countries.

Naturally, the question arises. How many of us are truly independent when it comes to financial resources? A recently published study, courtesy of the American Association of Retired Persons ("AARP"), suggests that a significant shift is occurring in terms of financial distress for individuals. Entitled "Generations of Struggle," authors Deborah Thorne, Elizabeth Warren and Teresa Sullivan make some worrisome observations:

• "Americans age 55 or older have experienced the sharpest increase in bankruptcy filings.
• The average age for filing bankruptcy has increased.
• The rate of bankruptcy filings among those age 65 or older has more than doubled since 1991."

Factor in another weak element of the three-legged U.S. retirement stool - the huge economic drag due to ballooning post-retirement entitlements - and things look grim indeed. A soon-to-be released documentary entitled "I.O.U.S.A." sounds the bell clear and loud. This 232 year old nation is on the verge of a financial meltdown. Visit YouTube.com to hear what director Patrick Creadon says about the serious message of his movie. The expected impact on the younger generation is undeniable. (Read our April 2, 2007 post entitled "New Fiction Book Advocates Radical Solution to Pension Crisis" for a quick synopsis of Boomsday by Christopher Buckley.)

In "The State of the Union's Finances: A Citizen's Guide to the Financial Condition of the United States Government" (June 2008), the Peter G. Peterson Foundation reports that entitlement spending is on the rise, with a 213% increase in what they call "Implicit Exposures: Future Benefits," between 2000 and 2007 (i.e. $13 trillion to $40.8 trillion). Putting this in context, the "Size of the Individual Burden Imposed by Major Fiscal Exposures" is currently about $400,000 per full-time worker. Refresh the U.S. National Debt Clock site several times to see how quickly the number climbs in just a few seconds. (The reported daily average increase in the U.S. national debt is almost $2 billion.)

So while we all enjoy a hotdog while watching the fireworks, it is worth asking - How independent are we truly, when our collective debt obligations resemble a runaway train?

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In response to our June 29, 2008 post entitled "California Pension Fund Investments in Tobacco," a consultant questioned CalSTRS' claim that the fund had suffered an opportunity loss of $1 billion by divesting itself of $238 million in tobacco stocks.

Sacramento Bee reporter Jon Ortiz sent the following text, excerpted from a CalSTRS report (page INV82, "Performance Review of the Modified Benchmarks"):

<< The performance of the modified benchmarks from inception to December 31, 2007, was
reviewed at the April 4, 2008 Investment Committee meeting. Over the seven and a half years,
since inception, it is estimated that CalSTRS has suffered slightly over a $1 billion opportunity
loss by not investing a market weighting in the tobacco industry. This calculation too is open for
debate, but it remains in Staff’s view that this is a reasonable approximation of the opportunity
loss. >>

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ERISA legal blogger, otherwise known as attorney Stephen Rosenberg, comments on our June 22, 2008 post entitled "Rights of Individual Plan-Holders Expanded by Sixth Circuit" with his usual insight. See below for an excerpt of his June 30, 2008 post.

"There are two particularly interesting side notes about this. First, it illustrates a particular point I - and others - made in a number of media outlets after the Supreme Court issued its opinion in LaRue, namely that, while it may not result in an avalanche of litigation that otherwise would not have been filed, the ruling is certainly going to lead to an increase in the filing of smaller cases on behalf of a few participants in circumstances that, in the past, would not have generated suits unless a class wide action could be brought. Second, the case presages what may be the dying off, by a thousand cuts, of the long held use of standing to cut off ERISA breach of fiduciary duty suits at the earliest stages of procedural wrangling, long before any litigation over the merits of a case, something which occurred at the federal district court level in the original LaRue case itself. Roy Harmon, over at his Health Plan Law blog, has a detailed analysis of this question, one I have been thinking about since LaRue was decided but which Roy has thankfully saved me from addressing in detail at this point.

Click to read the full text version of "From Preemption to ERISA Standing, and Lots of Things In-Between."

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Since the inception of www.pensionriskmatters.com in late March 2006, we have never received any negative comments. To the contrary, feedback from readers around the world has been very positive and insightful. However, there is a first time for everything and I am not one to avoid taking responsibility for my actions. In this case, a reader took me to task for the use of the word "tubby" in a June 25, 2008 post about employee benefits and weight. Out of respect for that reader and anyone else who might have been upset (despite no intent on my part to offend - I have used the word to describe my own efforts to keep excess pounds at bay), I have retitled that post. Let me also apologize sincerely and thank that reader for sending comments our way.

The topic of employee benefit mix is an important one for many reasons. As timely news events occur, we will cover them in subsequent blog posts.

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In "UK Pension Fund Goes Green" (June 28, 2008 post), this blogger cites diversification as one element of the decision to allocate monies to "socially responsible" investments. Anticipated performance is another consideration and not just for "virtuous" stocks.

In "CalSTRS wavers on its ban on tobacco investments" (June 5, 2008) Sacramento Bee journalist Jon Ortiz writes that the board of the California State Teachers' Retirement System is mulling over whether to reverse its earlier divestment of $238 million in tobacco company equities. Thinking that the industry is no longer vulnerable to massive lawsuits and/or government mandates, the $169 billion public pension fund estimates it would have earned $1 billion more had it stayed the original course.

An excerpt from its "Statement of Investment Responsibility" puts "preservation of principal and maximization of income" as "the primary and underlying crieria for the selection and retention of securities." The "CALSTRS 20 RISK FACTORS" do not expressly preclude investing in any particular industry. According to "CalSTRS rethinks tobacco taboo" by Jon Ortiz (June 4,2008), gambling and alcohol company stocks remain part of the pension fund's equity portfolio.

While CalSTRS ponders an add-back of tobacco, the University of Toronto announced on April 9, 2008 that it will be dropping its investments for ethical reasons. According to "University of Toronto to Sell-Off Tobacco Industry Holdings," the school will be the "first institution of higher education in Canada to divest from the tobacco industry."

Editor's Note: For articles about tobacco-related investing, visit Tobacco.org. On a related note, and if you appreciate a good satire, check out a movie entitled "Thank You for Smoking." This gal has laughed through the film version of the popular Christopher Buckley novel at least four times.

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According to Institutional Investor ("Buying into Green Investing" by Henry Teitelbaum, June 2008), green is good for at least one large UK pension fund, the Universities Superannuation Scheme Limited ("USS"). Joined by three other organizations (Alliance Trust PLC, SNS REAAL N.V. and Mitsui & Co Ltd), this trustee company with 30+ billion GBP in assets is part of a 56 million GBP financing round for the Climate Change Capital Group, a London investment bank "dedicated to the low carbon economy." Teitelbaum adds that the USS is already sold on the commercial viability of environmentalism, demonstrated by its membership in the Enhanced Analytics Initiative. According to research done by this blogger, the USS is credited with taking "ethical, social and environmental considerations" into account when "assessing the merits of investment in a given company" as early as 2001. (See "Pension funds can get more from 'green investing' - SRI expert" by Nat Mankelow, bfinance, May 12, 2001.)

While few dispute the merits of considering a Socially Responsible Investing ("SRI") component for portfolio diversification purposes, it would be helpful to know how USS determines its strategic commitment to SRI economic interests as a separate asset class. Moreover, how does this pension giant consider "green" or "vice" factors before taking direct equity stakes in oil or tobacco companies? Top 100 USS equity holdings, as of March 31, 2008, include Royal Dutch Shell (position 1 with an estimated market value of 705.8 million GBP), BP (position 3 with an estimated market value of 625.2 million GBP) and British American Tobacco (position 14 with an estimated market value of 194 million GBP). This blogger is not maing a value judgment about investing in the stocks of these or other companies but rather simply thinking out loud about diversification analysis as it relates to SRI exposures.

Valuation is yet another consideration. As pension plans invest in environmental companies, how do (should) they properly determine the probability (and amounts) of revenue realization for start-ups and/or firms that depend on relatively new technologies to generate income? In the absence of accounting rules (across countries) or new regulations that mandate periodic assessments of value, the challenge is significant. Add the time pressures of compliance and these already important questions demand good answers.

Editor's Note: According to the EAI website, membership is "open to institutional investors and asset managers who commit to allocate individually at least 5% of their brokerage commissions to extra-financial research" or said, another way, the assessment of externalities on long-term investment performance. Most members are non-US organizations. The New York City Employees' Retirement System ("NYCERS") is a member.)

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In response to my June 25, 2008 post ("Is There a Link Between Weights and Benefits?") about the fiduciary ramifications of asking employees to lose weight or otherwise change their lifestyle, law professor Paul Secunda writes the following:

<< I agree with Susan on this, of course, but wouldn't it be funny hearing someone say: "I am not going to eat that muffin because I might get fired or my health premiums may go up?" >>

Check out what else the creator of the popular "Workplace Prof Blog" has to say on this topic. 

• "Do Workplace Smoking Bans Have a Multiplier Effect?" (April 25,2008)
• "Higher Insurance Premiums On the Way for Obese Workers?" (July 9, 2007)
• "Obesity Regulation in the Workplace?" (November 24, 2005)

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Sacramento Bee investigative journalist Jon Ortiz reports that the giant California Public Employees' Retirement System ("CalPERS") has just announced an 8 percent rise in "its Kaiser basic premiums." According to "Rate outlook dismal for individual health plan subscribers" (June 24, 2008), roughly 2.5 million individuals will feel the pinch. Citing Dr. Michael Kraten, Connecticut-based industry expert, relatively healthier baby boomers and cheaper generic drugs have helped to stave off premium increases, but not for long. Even if large organizations like CalPERS are able to drive a hard bargain, "Whatever price breaks the big players get are passed down the line as providers haggle with doctors and hospitals over payment for services and raise or lower rates on other policy purchasers."

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A few weeks ago, en route to speak at a valuation conference about hedge fund issues, I sat next to a health-conscious surgeon. For nearly an hour, he spoke passionately about spiraling hospital and pharmaceutical costs, due in large part to what he described as an obesity epidemic. He offered several compelling examples of procedures that could have been done at a much lower cost, had patients been smaller in girth. Though I consider myself a healthy person (low-fat diet, regular exercise), I do admit to a few pounds of excess baggage. You can therefore imagine my discomfort as I munched on my Power Bar, wondering - Is he addressing non-skinny people like me or outright weight-challenged children and adults?

It was no surprise then that this Sunday's New York Times addressed this problem, said to be costing employers big-time. In her piece, reporter Kelley Holland links to an "aha moment" map, courtesy of the Centers for Disease Control and Prevention. Based on 2006 data, all but four of fifty states clearly struggle with obesity, with at least 20 percent of adults having a Body Mass Index ("BMI") in excess of 30. (According to the Department of Health and Human Services, BMI is a gauge of body fat. BMI numbers above 25 place an individual in the overweight category. Use the online calculator to get a rough estimate of your BMI.) Holland continues to grab attention with some sobering statistics.

• More than 25 cents of every dollar spent on medical services is due to excess weight complications (based on research conducted by Emory University Professor Kenneth Thorpe).
• The corporate tab for too many muffins is $45 billion per year (according to a Conference Board report). See Medical News Today, April 10, 2008.
• Obesity links to chronic health problems more than smoking or excess drinking (based on Rand Corporation research by economist Roland Sturm).

 "Waistlines Expand Into a Workplace Issue" is a scary read. Citing examples of employers that offer incentives to visit the gym and otherwise slim down, Holland writes that more needs to be done, despite the fact that it is a "sensitive" issue. While I'm the last to make a value judgement about weight, some disturbing thoughts come to mind.

• How are longevity patterns (and the related cost of offering healthcare benefits and a traditional pension) impacted when plan participants are officially deemed overweight?
• Do employers experience lower costs if their pension plan covers mostly unhealthy participants?
• For employers that offer both health insurance and a defined benefit plan, do they deem an "optimal" mix of healthy versus not so healthy plan participants? (This assumes that healthier individuals who live longer push pension costs up but keep a lid on healthcare benefit expenses.)
• Should employers figuratively serve "in loco parentis" or does this expose them to allegations of discrimination?

Ban the coffee cake. Carrots anyone? 

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