The Pension Benefit Guaranty Corporation (PBGC) announced several developments regarding its Special Financial Assistance (SFA) Program for multiemployer pension plans. Below, Capital Group’s Lead Pension Solutions Strategist Colyar Pridgen answers some commonly asked questions about the program. 

1. From an investment standpoint, what changed from the Interim to the Final Rule?

In essence, there have been three key changes from the Interim Final Rule period to the Final Rule period. First, most plans are eligible to receive additional aid. Second, all eligible plans are now less constrained in how they may invest SFA assets. Third, investment return prospects appear to be considerably more attractive today than in the recent past. Each of these changes improves the likelihood of SFA recipient survival to and beyond 2051 while allowing plans to reduce investment risk and/or set more ambitious long-term objectives.

2. What should SFA applicants use as a liquidity source for benefit payments and expenses?

It seems conventional wisdom that SFA recipients should source liquidity for their outflows first and foremost from SFA assets, while other sources should be tapped only after SFA assets are fully exhausted. This remains a great “Plan A” for most plans. However, it has become far less critical that plans stick to this approach in the new regime of PBGC’s Final Rule. Plans may be wise to retain the flexibility needed to adapt to a range of unpredictable circumstances over the years to come, as opposed to strictly prioritizing the payment of cash outflows from matching SFA investments.

3. How can SFA recipients best utilize the two separate interest rates when setting objectives?

It is necessary, but also potentially confusing and distracting, for plan representatives to deal with two distinct interest rates – one for SFA and one for non-SFA assets. I believe that plan decision-makers should derive a single effective interest rate from their unique SFA application details. This would be the single effective rate, or “hurdle rate,” that if earned by all assets, would result in plan survival until 2051. Awareness of this single effective hurdle rate can aid in critical objective-setting and asset-allocation exercises.

4. What should be the ultimate long-term objective for SFA-recipient plans?

The SFA program aims to enable recipient plans' survival until 2051. It currently appears that most such plans can reasonably seek to survive significantly beyond that date. The nature of the investment problem, as presented by PBGC’s Final Rule, should generally allow for solutions that pursue longer term solvency objectives while fostering prudence and diversification. A secondary objective of minimizing the probability of insolvency before 2051 may also be sensible. More precise objectives should be tailored to individual plans and informed by customized modeling and analysis that help assess the feasibility of the objectives.

5. What sort of modeling is most helpful in setting and refining SFA investment strategy?

The unique investment problem posed by the SFA program demands a custom-built modeling solution, rooted in deep actuarial and investment experience. Models should dynamically shift the relative proportions of SFA and legacy asset pools, as well as the constituent allocations within each, in response to both plan-specific cash flow projections and numerous economic and market scenarios. All must be modeled to maintain adherence to the intricacies of PBGC’s Final Rule. Since decision-making hinges at least as much on downside scenarios as on expected or median projections, robust stochastic modeling is essential for illustrating a probabilistic range of potential outcomes.

6. To what extent should plans utilize the 33% allowance for public equities within SFA assets?

While each plan’s circumstances and resulting investment decisions are unique, many plans are choosing to forgo their public equities allowance within SFA assets, at least initially. For plans closer to insolvency, a relatively low required return “hurdle rate” for survival beyond 2051 applies, so equity-like returns may not be necessary. For plans further from insolvency, including most recent applicants, there’s often sufficient capacity outside of SFA assets for any return-seeking assets they might want to hold. At the same time, the simplicity of a purely fixed income SFA portfolio may facilitate administrative and compliance efforts.

7. Is there any tangible benefit to plans from the Final Rule’s 33% equity allowance?

It is true that many plans tend to forgo the 33% equity allowance, but that does not render the allowance ineffective. What’s helpful for plans is the knowledge that if circumstances require it in the future, there is the possibility to later dial up risk within SFA assets. That flexibility, even if never acted upon, allows for a more holistic and more effective approach to investing the entirety of plan assets. Meanwhile, the 33% allowance can help fixed income SFA portfolios be managed with a broader opportunity set and higher potential for returns, particularly since the allowance also applies to debt securities that have been resold in an offering pursuant to Rule 144A under the Securities Act of 1933.

8. What key issues need consideration when cash flow matching in an SFA context?

Some SFA recipients are choosing to use SFA funds to create portfolios for which anticipated cash flows are aligned with expected benefit payment and expense outflows, something that paints an attractive theoretical picture. Cash flow matchers should consider:
 

• How are fiduciaries ensuring that the interests of both younger and older members are reflected in the investment strategy?
• To what extent will the cash flow matching pool be replenished from other assets as it rolls off, and will the liquidity requirements placed on other assets be relieved as intended?
• How will liquidity be optimally generated when those needs invariably differ from SFA application cash flow projections?
• How will the plan address practical implementation challenges like benchmarking outcomes, ensuring accountability, and maintaining ample diversification?

9. For plans pursuing more traditionally managed portfolios, what are some of the key considerations?

Some SFA recipients are choosing to use SFA funds to pursue (risk-adjusted) total returns and/or benefit-driven investing approaches. Such plans should consider:
 

• What is the appropriate vehicle, and how should the plan weigh the comparative strengths of separate accounts versus permissible (pooled) fund vehicles?
• Is an active or passive approach most appropriate, and how is the portfolio management team generating returns (e.g., bottom-up security selection via diversified, well-researched positions)?
• What target pattern of returns is most appropriate for SFA assets, and do investment managers appear to be well-positioned to pursue that (e.g., is it important for results to hold up in times of economic stress)?
• What sort of profile do investment managers pursue with regard to liquidity and portfolio turnover?

10. Can more detail be provided? Would you answer additional SFA questions?

Contact us at LDIteam@capgroup.com.

We would be pleased to share more information regarding these questions, with additional supporting arguments and charts. Also available by request are examples of custom-built modeling tools for SFA recipients. We would enjoy the opportunity to share observations on any other questions related to the SFA program or the investment of SFA funds.