Experts offer tips on what PBGC needs

Simply changing the investment policy of the Pension Benefit Guaranty Corp. won't give the agency a fighting chance of slashing its mushrooming budget deficit, some industry investment experts and former PBGC officials contend.

What the agency really needs is legislative authority to raise the premiums plan sponsors pay for the PBGC's pension insurance policy, they argue. One went so far as to advocate abolishing the PBGC.

“It will almost be impossible to reduce the deficit dramatically through an investment policy alone,” said James Keightley, a partner in the law firm Keightley & Ashner LLP, Washington, and a former PBGC general counsel.

The PBGC's budget deficit, which soared to an all-time high of $33.5 billion as of March 31, is at issue because the PBGC board earlier this month confirmed it had suspended a policy adopted during the Bush administration and is considering a new, as-yet undefined policy (Pensions & Investments, Aug. 10).

Under the earlier policy, adopted in February 2008, 45% of the agency's $48 billion in investible assets were to be in equities, 45% in fixed income and 10% in alternatives.

Before 2008, 75% to 85% of the PBGC's assets were in a liability-driven investment strategy, with the balance invested in stocks.

Asked by P&I what they would do if they ran the PBGC, investment experts' responses ranged from switching back to the LDI-like policy or retaining some variation of the more aggressive investment policy adopted during the Bush administration.

At the same time, they warned that the agency's deficit has become so large that it is extremely unlikely it can be eliminated through investment returns alone.

“I don't think investment policy will make a difference” to the PBGC's deficit, said Robert Arnott, chairman of Research Associates LLC, Pasadena, Calif. “It's deck chairs on the Titanic. Plug the hole before you rearrange the deck chairs if you want to stay afloat.

“PBGC's biggest issue is not investment policy but liability management,” Mr. Arnott said.

“Congress has boxed PBGC in with contractual pricing of insurance, and no powers to enforce adherence to insurance policies the way a private insurance provider would be able to,” he continued.

Said Bradley Belt, chairman of Palisades Capital Advisors LLC, Washington, and PBGC executive director from April 2004 through May 2006: “The pension insurance program is structurally defective.

“As structured, it (the PBGC) has limited ability to control its financial well-being. Essentially, it is required to take over underfunded pension plans and incur losses,” he said.

“In contrast to private-sector insurers, it doesn't have the unilateral authority to adjust insurance premiums to make up for the losses.”

Among the experts recommending the PBGC shift back to an LDI strategy are Mr. Belt and Zvi Bodie, a professor of finance and economics at Boston University School of Management.

“I implemented a liability-driven investment strategy,” while at the PBGC, Mr. Belt said. “I continue to believe that's an appropriate policy for the agency.”

“My own view is that the purpose of the assets is to satisfy the liabilities, and it is not appropriate for a governmental entity to be taking on significant investment risks on behalf of the taxpayers,” he said.

Mr. Bodie said he believes the PBGC board could use any asset allocation strategy it wants, as long it also uses derivative overlays to match its asset and liability exposures. “You use a derivatives overlay or swap contracts to completely neutralize the risks,” he said.

Jonathan Waite, director, investment management advice and chief actuary, SEI Institutional Group, Oaks, Pa., said he believes the timing might be wrong for a PBGC return to LDI now. He also said he thinks the more aggressive investment policy seems reasonable.

“I would expect that once they (the PBGC board members) have reconsidered their asset allocation, they will look closely at considering opportunities in the alternative space,” Mr. Waite said. “I would recommend that they strongly consider that because of the opportunity for return and the opportunity to get that return in a manner not correlated with their other assets ... ”

The PBGC board is composed of the secretaries of Treasury, Labor and Commerce.

The key policy dilemma for the PBGC, according to attorney Mr. Keightley: “If you invest conservatively, you risk locking in your loss. If you invest aggressively, you increase your risk of a bigger deficit.”

As far as the prospects of slashing the PBGC's deficit go, the agency has two major sources of revenue: investment returns and premiums, Mr. Keightley said.

“It's a huge (deficit) gap and getting bigger, and more plans are getting into trouble and PBGC is taking them over, increasing PBGC's underfunding,” Mr. Keightley said.

Mr. Keightley add that while he is no investment expert, he would invest the agency's assets conservatively: “I'm not sure the market is going to go up aggressively.”

But SEI's Mr. Waite warned that raising premium levels could spur plan sponsors to get out of the defined benefit business, leading to a smaller group of contributors to the premium pool. “It's a very difficult balancing act,” Mr. Waite said.

Meir Statman, a professor of finance at Santa Clara Calif.) University's Leavey School of Business, recommended the federal government forget balancing acts and just ax the PBGC — a move that he said would encourage migration to the defined contribution system.

“Pull the plug (on the PBGC) over time, with a transition period such that the people who are now dependent on it are not left out in the cold,” Mr. Statman said.