United States
The White House has released the final terms of Special Financial Assistance (SFA) to struggling multi-employer pension plans, initially provided under the American Rescue Plan Act (the Act) last year.
Consistent with our initial feedback, we believe the changes address the Act’s key shortcomings and now facilitate “liability-aware” strategies that can help multi-employer plans meet their obligations for the next 30 years and beyond.
The final rules address our main criticism
We believe the interim final ruling contained a key flaw - it required use of a discount rate that was significantly higher than the yields that could be achieved with permissible SFA investments. This implies an exclusively investment grade portfolio would have been eroded by outflows well before 30 years. The Pension Benefit Guaranty Corporation (PBGC)’s rules now acknowledge this.
The PBGC has sought to address this problem in two ways:
- Plans can now use a discount rate for determining grant amounts for SFA portfolios more in line with market bond yields (this will increase the SFA grant amount for many sponsors)
- Plans can now invest up to 33.0% of the SFA portfolio in certain return-seeking assets, including equities.
A "liability-aware" strategy is now affordable
The PBGC will now pay higher levels of SFA assistance to plans, given the lower discount rate used to calculate grant amounts.
We believe that a bond portfolio can now be structured to provide the income the plan needs to reliably meet benefit payments until at least 2051, as intended. Further, as bond yields have re-priced considerably higher since the interim final rules were released a year ago, it is easier for plans to generate compelling cashflows without taking undue risk (and increasing the certainty of the meeting their obligations).
We believe plans should ensure they match their cashflow obligations for the next three to five years in shorter-term, high quality bonds, to avoid the risk of “forced selling” assets at potentially inopportune times.
Return-seeking assets may only need to play a minor role
The PBGC is now allowing a limited scope of risk assets for up to 33.0% of the SFA portfolio, allowing plans to further increase prospective returns (albeit by taking on more risk).
Permitted assets now include:
- Equities (US dollar common stock only)
- 144A fixed rate US dollar investment grade bonds
- High yield bonds, if they were investment grade at the time of purchase
- Fixed rate CDOs/CLOs/CMOs (albeit most of these markets are floating rate)
- Publicly-traded equity REITs
We believe these are favorable changes, particularly the decision to allow plans to retain so-called “fallen angels” (bonds downgraded to high yield), as it can help plans avoid “forced selling” downgraded bonds. Further, we believe fallen angels are an attractive asset class in their own right.
Although the decision to allow equity investments will no doubt gain a lot of attention, we believe that in this current macroeconomic environment, SFA portfolios will not need to allocate a large amount to common stocks and REITs. Similarly, we believe that the cashflow certainty of investment grade bonds makes fixed income instruments a more prudent and efficient proposition for plan sponsors.
What's next?
Many plans have already received SFA funding under the terms of last year’s interim final ruling but can still benefit from the new rules (including the possibility of additional grant money and the broader universe of permissible investments) by filing a supplemental application.
Plans with an SFA application already under review can either withdraw and resubmit (or proceed under the interim final rule with the corresponding supplement). However, this will likely reset the 120-day period between review and approval and impact the proposed timing of the SFA funding.
At Insight, we will continue to monitor any developments. If you have any questions or would like to discuss the rule, please do not hesitate to contact us.
