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Cypen & Cypen
April 12, 2012

Stephen H. Cypen, Esq., Editor

1.     STOCKS, BONDS, BILLS AND INFLATION 1926-2011:     An 86-year examination by Ibbotson of past capital market returns provides historical insight into the performance characteristics of various asset classes.  The following are compound annual returns for various classes of investments: 

  • Small stocks  …  11.9%
  • Large stocks  …  9.8%
  • Long-term government bonds  …  5.7%
  • Treasury bills  …  3.6%
  • Inflation  …  3.0%

As can be seen, small and large stocks have provided the highest returns over the past 86 years.  Fixed-income investments provided only a fraction of the growth provided by stocks.  However, higher returns achieved by stocks are associated with much greater volatility risk.  Government bonds and Treasury bills are guaranteed by the full faith and credit of the United States government as to timely payment of principal and interest, while stocks are not guaranteed and have been more volatile than the other asset classes.  Furthermore, small stocks are more volatile than large stocks, are subject to significant price fluctuations/business risks and are thinly-traded.  
The examination also graphically depicts the hypothetical growth of inflation and a $1 investment in the subject four traditional asset classes over the time period January 1, 1926 through December 31, 2011: 

  • Small stocks  …  $15,532
  • Large stocks  …  $3,045
  • Long-term government bonds  …  $119
  • Treasury bills  …  $21
  • Inflation  …  $13

So, what is the lesson?  Do not panic over returns for relatively-short periods of time. 
2.      MEASURING THE ECONOMIC IMPACT OF DB PENSION EXPENDITURES:   National Institute on Retirement Security has released “Pensionomics 2012 -- Measuring the Economic Impact of DB Pension Expenditures.”  Often overlooked is the vital role that Defined Benefit pensions play in stimulating the U.S. economy and creating jobs.  Virtually every state and local economy across the country is enhanced substantially from the spending of pension benefits.  This economic stimulus is particularly important given the economic downturn and high unemployment rate in the wake of the Great Recession.  Pension expenditures may be especially vital to small or rural communities, where other steady sources of income may not be readily found if the local economy lacks diversity.  In addition, reliable pension income can be especially important in stabilizing local economies during economic downturns, because retirees know they are receiving a steady check despite economic conditions.  In contrast, retirees only with 401(k)-type plans may be reluctant to spend down their nest egg, particularly if their savings are negatively impacted by market downturns.  Retirees with a DB pension need not worry about reducing spending with every dip in the stock market.  The study analyzes data on DB pension plans in both the public and private sectors to assess the overall economic impact of benefits paid by these plans to retirees.  For state and local plans, the author analyzed these impacts on a national level as well as in each of the fifty states.  The economic gains attributable to DB pension expenditures are quantifiable.  The study finds that, in 2009: 

  • Over $426 Billion in pension benefits were paid to nearly 19 million retired Americans.  Of that:
  • $187 Billion was paid to some 8 million retired employees of state and local government and their beneficiaries (typically surviving spouses); 
  • $67.6 Billion was paid to some 2.5 million federal government beneficiaries; 
  • $171.5 Billion was paid to some 8.4 million private sector beneficiaries. 
  • Expenditures made out of those payments collectively supported: 
  • 6.5 million American jobs that paid nearly $315 Billion in labor income; 
  • $1 Trillion in total economic output nationwide; 
  • $553 Billion in value added (GDP); 
  • $134 Billion in federal, state and local tax revenue. 
  • DB pension expenditures have large multiplier effects: 
  • For each dollar paid out in pension benefits, $2.37 in total economic output was supported; 
  • For every taxpayer dollar contributed to state and local pensions, $8.72 in total output was supported nationally. 
  • The largest employment impacts were seen in the food services, real estate, health care and retail trade sectors. 

3.      INSIGHT INTO DB PLANS:   Recently ai-CIO conducted a survey of over 100 corporate defined benefit pension plans across the United States.  The pool was diversified in terms of geography, industry and plan size.  The goal was to gain insights into investment strategies, risk tolerances and intentions of pension plans as they face market uncertainty, low interest rates and low funded ratios.  Respondents were also asked about their willingness to adopt a liability-driven investing approach and the thought process around implementing, waiting or shunning the strategy altogether.  The survey reached the following conclusions:  

  • The much-publicized demise of the traditional U.S. corporate defined benefit pension plan is overblown, as 72% of all survey participants intend to keep their plans open to new entrants; 
  • A growing percentage of plans is adopting some form of liability-driven investing strategy, although the percentage of plans and allocations remains small; 
  • There are emerging differences in asset allocations between those who have already adopted or plan to adopt LDI and those who have no plans to do so; 
  • On average, respondents are exposed to an outsized amount of risk, as defined by funded ratio volatility, compared to their stated risk tolerance. 

4.      CORPORATE DB DEFICIT IMPROVES:   Milliman, a global consulting and actuarial firm, has released the results of its latest Pension Funding Index, which consists of 100 of the nation’s largest defined benefit pension plans.  In March, these pensions experienced a $58 Billion improvement in pension funding thanks to a $4 Billion improvement in asset value and a $54 Billion reduction in the pension benefit obligation.  In March, the PBO for these pensions reached $1.526 Trillion, as interest rates rose from 4.69% to 4.88%.  The overall asset value grew from $1.295 Trillion to $1.299 Trillion.  Looking forward, if these 100 pensions were to achieve their expected 7.8% median asset return and if the current discount rate of 4.88% were to be maintained throughout 2012 and 2013, these pensions would narrow the pension funding gap from 85.1% to 88.3% by the end of 2012 and to 93.5% by the end of 2013. 
5.      FUNDED STATUS OF U.S. PENSIONS RISES MORE THAN 3 PERCENTAGE POINTS IN MARCH:   The best quarter for U.S. equity markets in a decade helped drive the funded status of a typical U.S. corporate pension plan in March 3.6 percentage points higher, to 79.8 percent, according to BNY Mellon Asset Management.  U.S. stocks have now risen for six consecutive months.  Pension plans also benefited from an increase in the Aa corporate discount rate, which resulted in lower liabilities.  The funded status of the typical corporate plan has now increased 7.4 percentage points this year!  Assets for the typical corporate pension plan in March rose 1.3 percent, and liabilities fell 3.2 percent.  The decrease in liabilities was due to the Aa corporate discount rate rising 25 points to 4.58 percent.
Plan liabilities are calculated using yields of long-term investment grade corporate bonds.  Higher yields on these bonds result in lower liabilities.  Both equity markets and interest rates moved in the right direction in March, helping moderate risk corporate pension plans approach a funding level of 80 percent.  Further improvements in funded status could encourage plans to increase their hedge against interest rate moves. 
6.      PENSION PLAN FUNDING REBOUNDS:   Pension plan funding among some of the nation’s largest companies continued to rebound in March, according to a Mercer report.  Pension plans sponsored by S&P 1500 companies saw their aggregate deficit fall to $336 Billion, a 30.4% decrease from the 2011 year-end aggregate.  The drop corresponds to a rise in the plans’ aggregate funded ratio, to 82% for the month of March 2012, from 79% in the previous month.  Analysts estimated the aggregate value of S&P 1500 pension plan assets at the end of 2011 at $1.45 Trillion.  The plans’ estimated aggregate liabilities were $1.93 Trillion.  Improving funded status likely would prompt more plan sponsors to begin shifting their asset allocation philosophy.  Weighted average allocations to fixed income investments rose to 40% at the end of 2011, up from 37% in the prior year.  That trend should help reduce volatility in the market, but also signals a reigning in of sponsors' expectations regarding investment returns. 
7.      STATE AND LOCAL GOVERNMENTS’ FISCAL OUTLOOK:   The state and local government sector continues to face near-term and long-term fiscal challenges that grow over time.  The fiscal challenges confronting the state and local sector add to the nation’s overall fiscal challenges.  The fiscal situation of the state and local government sector has improved in the past year as the sector’s tax receipts have slowly increased in conjunction with the economic recovery.  Nonetheless, total tax receipts have only recently returned to prerecession levels of 2007, and the sector still faces a gap between revenue and spending.  The sector faces long-term fiscal challenges that grow over time.  The fiscal position of the sector will steadily decline through 2060 absent any policy changes.  One of the primary factors contributing to the near-term improvement in the fiscal picture of the state and local government sector is the increase in tax receipts following the decline during 2008 and into 2009.  Specifically, from the second quarter of 2009 to the third quarter of 2011, total tax receipts increased nearly 11 percent.  Income and sales taxes accounted for most of the growth, increasing about 18 percent and 10 percent, respectively, over the same period of time.  However, property tax receipts, which had grown more than 3 percent from the second quarter of 2009 to the third quarter of 2010, flattened in 2011, increasing less than 1 percent from 2010 to 2011 as real estate values remained depressed.  In addition, as most outlays from the American Recovery and Reinvestment Act of 2009 have already occurred, the state and local government sector will continue to adjust to a reduced level of federal assistance provided by the Recovery Act.  U.S. Government Accountability Office has updated its model to incorporate the near-term changes for both revenues and expenditures, but focuses primarily on the long-term fiscal outlook for State and Local Governments as a sector.  In the long term, the decline in the sector’s operating balance is primarily driven by rising health-related costs of state and local expenditures on Medicaid and the cost of health care compensation for state and local government employees and retirees.  Since most state and local governments are required to balance their operating budgets, the declining fiscal conditions shown in GAO’s simulations suggest that the sector would need to make substantial policy changes to avoid growing fiscal imbalances in the future.  That is, absent any intervention or policy changes, state and local governments would face an increasing gap between receipts and expenditures in the coming years.  GAO-12-523SP (April 2, 2012). 
8.      THE REAL VALUE OF A DEFINED BENEFIT PENSION:   A 35-year-old in the United Kingdom joining a defined contribution pension fund today would have to contribute more than 10 (ten) times the annual contributions of his colleague in a defined benefit pension fund to build an equivalent pension at retirement, according to Pension Corporation, a provider of risk management solutions to defined benefit pension funds.  The numbers would equate to a contribution each year of 55% of gross salary for the DC member (which in 2011 would have amounted to a contribution of £14,000 for someone on average earnings), compared to the average 5.1% annual contribution rate saved by the DB pension fund member.  After 30 years at these accrual rates, combined with employer contributions, the DB scheme member might have built up an index-linked pension promise of 50% of final pay.  An individual with a DC pension would require a pot of approximately 17 times final pay to secure that level of pension at current annuity rates.  In practice, at current average contribution rates of 8.9% in total, the DC scheme member might end up with a total pension pot of just 2.7 times earnings after 30 years (£70,000 for someone retiring in 2011).  This amount would buy an annual pension of just 8% of final pay at annuity rates.  The average DC pension pot used to buy an annuity in 2010 was actually only £25,874.  (At this time, one British pound was equal to about $1.60.) 
9.      STOCK ACT BANS MEMBERS OF CONGRESS FROM INSIDER TRADING:  In his State of the Union Address, the President laid out a blueprint for an economy where everyone gets an equal shot, everyone does his fair share and everyone plays by the same set of rules, including those who have been elected to serve the American people.   On April 4, 2012, the President signed into law the Stop Trading On Congressional Knowledge Act, a bipartisan bill that prevents Members of Congress from trading stocks based on nonpublic information they gleaned on Capitol Hill.  While the Act is a good start, the President will continue to work with Congress to do even more to help fight the destructive influence of money in politics, and rebuild the trust between Washington and the American people.  The Act expressly affirms that Members of Congress and staff are not exempt from insider trading prohibitions of federal securities laws, and gives House and Senate ethics committees authority to implement additional ethics rules.  The Act makes clear that Members and staff owe a duty to the citizens of the United States not to misappropriate nonpublic information to make a profit.  The Act amends the Ethics in Government Act of 1978 to require a government-wide shift to electronic reporting and online availability of public financial disclosure information.  The Act requires Members of Congress and government employees to report certain investment transactions within 45 days after a trade date.  The Act will require Members and certain high level government officials to disclose terms of personal mortgages.  The Act limits participation in Initial Public Offerings by Members and senior government employees to purchases available to the public generally.  The Act requires that Members of Congress and senior federal employees file a written notification with their ethics office when starting a job negotiation to leave the government.  And, most significantly, the Act requires forfeiture of a federal pension if a Member of Congress commits one of several corruption offenses while serving as an elected official.  Current law forfeits a Member’s pension for conviction of offenses committed while serving in Congress.  The Act expands forfeiture to apply to misconduct by Members committed in other federal, state and local elected offices, and adds further federal crimes, including insider trading, for which forfeiture will be required.  Good show. 
10.    GOLF WISDOMS:    Confidence evaporates in the presence of fairway water.          
11.    PARAPROSDOKIAN:  (A paraprosdokian is a figure of speech in which the latter part of a sentence or phrase is surprising or unexpected in a way that causes the reader or listener to reframe or reinterpret the first part.  It is frequently used for humorous or dramatic effect.):  “If I could say a few words, I would be a better public speaker.” -- Homer Simpson       
12.    QUOTE OF THE WEEK:   “It is often wise to reveal that which cannot be concealed for long.”  Friedrich von Schiller 
13.    ON THIS DAY IN HISTORY:  In 1938, first U.S. law requiring medical tests for marriage licenses (New York). 
14.    KEEP THOSE CARDS AND LETTERS COMING:  Several readers regularly supply us with suggestions or tips for newsletter items.  Please feel free to send us or point us to matters you think would be of interest to our readers.  Subject to editorial discretion, we may print them.  Rest assured that we will not publish any names as referring sources. 
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Items in this Newsletter may be excerpts or summaries of original or secondary source material, and may have been reorganized for clarity and brevity. This Newsletter is general in nature and is not intended to provide specific legal or other advice.

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