We Received Special Financial Assistance Funds. Now What?

Purpose of the program

The SFA program’s sole purpose is to assist financially troubled multi-employer defined benefit pension plans. The objective is to enhance the retirement security for millions of Americans by providing adequate funds in the amounts required for the plan to pay all benefits due through the end of the plan year ending in 2051. Unlike other forms of financial assistance for pension plans, the SFA funds do not need to be paid back. This presents an unprecedented opportunity to help both plan participants and plan sponsors. The PBGC estimates that under current conditions, the program will assist approximately 200 financially troubled plans with disbursements projected to total between $74.3 - $90.8 billion.

Final rule

Employers, unions and industry groups warned that the preliminary guidelines could threaten the economic recovery that Congress had promised. As a result, the PBGC has unveiled an updated, permanent rule that addresses many of their concerns. For brevity, we focus on a few of the key items in the final rule below.

• Permitted investments – allows plans to invest up to 33% of granted Special Financial Assistance funds in return-seeking assets (i.e., public equities), while 67% (or more) must be invested in investment grade fixed income. The PBGC believes this ratio appropriately considers the need to protect SFA assets in order to pay projected benefit payments, while allowing for potential growth to limit the total risk exposure of taxpayer-funded assistance.
• Two pools of assets – plans must segregate SFA assets from “other plan assets” and invest them separately. To accurately project how much SFA is required for the plan to pay all benefits due “through the end of the plan year ending in 2051,” a plan must use two separate expected rates of return (one for the plan’s SFA assets and one for the plan’s non-SFA assets).
• Interest rates for SFA and non-SFA assets – the final rule allows plans to use a separate investment-return assumption for SFA and non-SFA assets. The interest rate used for SFA assets now reflects the restrictions on investment for these funds and the returns plans can reasonably expect to earn on SFA assets. This adjustment supports the overarching goal of providing adequate funds to struggling plans to pay all benefit payments through 2051.

Considerations for plans receiving assistance

LGIM America understands the nature and purpose of the Special Financial Assistance funds is to enhance the retirement security for plans facing insolvency. These plans face a unique set of circumstances as they are set to receive a significant sum of capital and must ensure the funds are invested appropriately. This may be a “once in a generation” type of opportunity, and plan sponsors should rely on their investment consultants (if applicable) and other strategic partners to establish a plan that fosters stability and protects participants through 2051 and beyond.

As plans begin to receive SFA funds and conversations pick up on the appropriate investment strategy, we’ve outlined a few different approaches below to evoke thought and discussion.

1. Traditional fixed income approach – allocate 67% or more of SFA assets in traditional, market-based benchmark fixed income. Examples include US Long Duration Credit, US Credit, Intermediate Credit, among others (available through segregated accounts or pooled vehicles). Understanding the plan details and objectives will help guide toward the appropriate allocation and the type of manager best suited to oversee the investment. For instance, a plan with a longer liability duration may consider a longer duration fixed income allocation, like US Long Duration Credit, to better align with the liability characteristics. Additionally, understanding if the plan prioritizes a risk-controlled approach or a more active, high-turnover portfolio will help stakeholders understand the type of manager that is appropriate.
2. Custom credit approach – for the fixed income portion of the funds, use a custom credit portfolio to tailor the portfolio characteristics to the unique needs of the plan. One example would be to adopt a custom, cash flow matching corporate bond portfolio that aligns with upcoming benefit payments. The advantage of this approach is the proactive nature of the portfolio. One can avoid becoming a forced seller of risk assets in times of market turmoil as the portfolio is designed to allow principal and coupon payments to roll off and match benefit payments. If the goal of the Special Financial Assistance program is to provide funds to pay benefit payments through 2051, this approach could be a reasonable option.
3. Hybrid approach – implement a hybrid of options #1 and #2. Some pension plans, outside those receiving SFA funds, who prioritize liquidity, adopt a strategy where they cash flow match the first 3-5 years of benefit payments and use a more active fixed income strategy to hedge the residual risk. This approach allows the sponsor to cover near term benefit payments with a custom credit portfolio, but still allocate enough funds to an active credit manager where there is opportunity for growth.
4. Overlay approach – invest 100% of relief dollars in investment grade fixed income and adopt an equity overlay to achieve 33% exposure to growth assets. The advantage with this approach is the capital efficiencies that can be gained. The additional fixed income dollars can go toward matching benefit payments or merely to protect the SFA investments given the more conservative nature of the asset class. Overlays can be employed to help obtain equity exposure in a liquid, cost-effective manner.
5. Holistic approach (existing assets and relief assets) – while relief funds need to comply with required guidelines, overall risk exposure can be managed to plan risk preferences through the use of derivatives and alternative strategies.

Multi-employer plans should be excited about the opportunity that has been presented. At LGIM America, we are here to help plan sponsors navigate the various considerations of the SFA program.

Source: Pension Benefit Guaranty Corporation, “Special Financial Assistance” rules and regulations. https://www.pbgc.gov/sites/default/files/sfa/factsheet.pdf

Disclosures

This material is intended to provide only general educational information and market commentary. The material provided is for informational purposes and is not intended as a solicitation to buy or sell any securities or other financial instruments or to provide any investment advice or service. The information contained in this presentation, including, without limitation, forward looking statements, portfolio construction and parameters, markets and instruments traded, and strategies employed, reflects LGIMA’s views as of the date hereof and may be changed in response to LGIMA’s perception of changing market conditions, or otherwise, without further notice to you.

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