Auditors urge rethink on pension calculations

Auditors are pressing companies to reconsider how they calculate their pension liabilities and urging them to use formulas that could give rise to much larger reported deficits than would be the case if they stayed with the current approach.

Critics say taxpayers may be paying for AIG's discounts

AIG is engaging in extreme price cuts to hang onto market share and may be using money from its federal bailout to pay for it, insurance insiders said. The CEO of Liberty Mutual said AIG is "doing some very stupid things" that are in danger of destabilizing the insurance market. An AIG spokesman denied that it is cutting prices.

Worker, Retiree and Employer Recovery Act of 2008

Was passesd by the House on Wednesday and the Senate yesterday. It is unclear whether Bush will sign it.

The Act

• Provides that shortfall amortization contributions will be based on a percentage of the funding target. The percentage will be 92% in 2008, 94% in 2009 and 96% in 2010, before reaching 100%. For example, under PPA a plan funded at 90% in 2008 had to establish an shortfall base equal to the entire 10% unfunded. Under the Act, this same plan would establish a shortfall base of only 2%.
• Permits asset smoothing.
• Provides that for the first plan year beginning on or after 10/1/2008 the test for the restriction on benefit accruals will be done using the greater of the current year or prior year AFTAP.
• Clarifies that plan expenses must be included as part of the target normal cost.
• Clarifies that target normal cost is reduced by the amount of mandatory employee contributions expected to be made during the year.
• Contains other provisions such as a waiver of age 70-1/2 distributions for 2009 for defined contribution plans, multiemployer funding relief, changes to maximum benefits for small employers and airline specific provisions. In addition, the Act includes some technical corrections.

NJ is insolvent due to pension plan

The state of New Jersey is insolvent. Bankrupt might be a better word. New Jersey is $60 billion in the hole on pension funding and the Governor is planning on skipping payments in a "pension payment holiday" until 2012 so as to not increase property taxes. To top it off, the ongoing plan assumptions are 8.25%. Sorry NJ, that simply is not going to happen.
[Reference: http://globaleconomicanalysis.blogspot.com/]

Earlier blog posts on the ongoing disaster with the NJ pension system:
June 15, 2007
April 12, 2007
April 6, 2007
March 16, 2007

Bad bad bad news for US pensions

On the expense side...

Assets of the 100 biggest US company pension plans, which account for 70% of defined benefit pension assets at corporations, fell by an estimated $120bn in October - the largest monthly loss in at least eight years. In 2008, PPA cash requirements were an estimated $32bn, which will likely rise to about $93bn in 2009.

On the funding status side...

If the spread between Treasuries and high-grade corporate bond yields hadn't more than doubled to 3.3 points over the past 12 months, the combined $60 billion surplus for S&P's 1,500 companies at the end of 2007 would now be a deficit of more than $400 billion. With the drop in liabilities due to a higher discount rate, however, the deficit as of Sept. 30 was only $35 billion.

Worker, Retiree and Employer Recovery Act of 2008 (WRERA)

Senate Finance Committee Chairman Max Baucus (D-Mont.) and Ranking Member Chuck Grassley (R-Iowa) were joined today by Senate Health, Education, Labor and Pensions Committee Chairman Edward Kennedy (D-Mass.) and Ranking Member Mike Enzi (R-Wyo.) in announcing legislation to help ease the financial strain on American families and businesses due to the lagging economy. The package includes important modifications to pension distribution requirements for seniors and businesses, as well as provisions included in the Pension Protection Technical Correction Act of 2008, originally passed by the Senate in December 2007 and the House in March and July of this year. The bipartisan package also extends for one year business tax relief that was included in the first economic stimulus package, and allows companies to write off a greater percentage of their investments in business assets to free up cash for payroll and other expenses.

Actuaries versus quants

A different angle than the stuff you usually see, from Paul Wimott.

Those working in the fields of actuarial science and quantitative finance have not always been totally appreciative of each others’ skills. Actuaries have been dealing with randomness and risk in finance for centuries. Quants are the relative newcomers, with all their fancy stochastic mathematics. Rather annoyingly for actuaries, quants came along late in the game and thanks to one piece of insight in the early 1970s completely changed the face of the valuation of risk.

The insight I refer to is the concept of dynamic hedging, first published by Black, Scholes and Merton in 1973. Before 1973, derivatives were being valued using the ‘actuarial method’, in a sense relying, as actuaries always have, on the Central Limit Theorem. Since 1973 all that has been made redundant. Quants have ruled the financial roost. However, this might just be the time for actuaries to fight back.

I am putting the finishing touches to this article a few days after the first anniversary of the ‘day that quant died’. In early August 2007, a number of high-profile and previously successful quantitative hedge funds suffered large losses. People said that their models “just stopped working”. The year since has seen a lot of soul searching by quants — how could this happen when they’ve got such incredible models?

In my view, the main reason why quantitative finance is in a mess is because of complexity and obscurity. Quants are making their models increasingly complicated, in the belief they are making improvements. This is not the case. More often than not each ‘improvement’ is a step backwards. If this were a proper hard science then there would be a reason for trying to perfect models. But finance is not a hard science, one in which you can conduct experiments for which the results are repeatable. Finance, thanks to it being underpinned by human beings and their wonderfully irrational behaviour, is forever changing. It is, therefore, much better to focus attention on making the models robust and transparent rather than ever more intricate.

As I mentioned in a recent blog, there is a maths sweet spot in quant finance. The models should not be too elementary so as to make it impossible to invent new structured products, nor should they be so abstract as to be easily misunderstood by all except their inventor (and sometimes even by them), with the obvious and financially dangerous consequences. Our goal is to make quant finance practical, understandable and, above all, safe.

When banks sell a contract they do so assuming it is going to make a profit. They use complex models, with sophisticated numerical solutions, to come up with the perfect value. Having gone to all that effort they then throw it into the same pot as all the others and risk-manage en masse. The funny thing is they never know whether each individual contract has “washed its own face”. Sure they know whether the pot has made money, their bonus is tied to it. But each contract? It makes good sense to risk-manage all contracts together but not to go into such obsessive detail in valuation when ultimately it’s the portfolio that makes money, especially if the basic models are so dodgy. The theory of quant finance and the practice diverge. Money is made by portfolios, not by individual contracts. In other words, quants make money from the Central Limit Theorem, just like actuaries, it’s just that quants are loath to admit it! Ironic.

It’s about time that actuaries got more involved in quantitative finance and brought some common sense back into this field. We need models people can understand and a greater respect for risk. Actuaries and quants have complementary skill sets. What high finance needs now are precisely the skills that actuaries have, a deep understanding of statistics, an historical perspective, and a willingness to work with data.

Thanks to CP for the link.

Insurance News

Hartford fell 10.24 (51.56%) to 9.62 after taking a $2.5 billion investment from German insurer Allianz.

In much more important news

The FDIC's powers could be expanded if Congress decides to shift insurance companies from state regulation to federal regulation, Sheila Bair said. The FDIC could start providing guarantees for insurance companies, much like it already guarantees the deposits of most US banks, if the insurance industry comes under federal regulation.

Florida Supreme Court Overturns Workers' Comp Attorney Fee Limits

The Florida Supreme Court announced its final ruling in Murray v. Mariners Health/ACE USA, reinstating hourly attorneys' fees in workers compensation cases.

In response to the announcement, William Stander, assistant vice president and regional manager of the Property Casualty Insurers Association of America referenced SB 50A passed during the 2003 Florida Legislative Session.

"Since the 2003 reform bill passed, workers compensation rates have decreased by over 60 percent, saving employers hundreds of millions of dollars annually," Stander said. "Eliminating hourly attorneys' fees, a key cost driver, was an integral component to the 2003 legislation." Stander added that the Oct. 23 decision will drive more litigation back into the system and drain more money from employers' pockets.

According to the Workers' Compensation Coalition for Business & Insurance Industry, the Court's decision could negatively impact Florida's employees through potential rate increases that will constrict job growth and employee raises. With the restoration of hourly attorney fees, the Court has revived one of the system's prime drivers of claim costs -- excessive attorney involvement, WCCBII added.

"Florida's workers' compensation system averted a crisis with landmark reforms in 2003, which eliminated unaffordable rates, widespread fraud and poor compliance with insurance requirements, while providing reasonably priced workers' compensation insurance that covered more employees than ever before," said Tamela Perdue, WCCBII chair. "As a result, injured workers continued to receive benefits, found legal representation when needed, and returned to work. Unfortunately, today's Supreme Court decision has put us right back into another potential crisis."

[Thanks to DVD for the article]

AIG DEAD

I have been writing a lot of these "dead" headlines lately, haven't I?


http://financeinvestments.blogspot.com/2008/09/interesting-day-on-wall-street.html

http://www.ft.com/cms/s/0/271257f2-83f1-11dd-bf00-000077b07658.html?nclick_check=1

AIG Downgrades

AIG downgraded from AA to A. This of course increases the amount of capital they need to raise.

AIG in BIG trouble

May follow Lehman and Merrill into the dustbin of history before too much longer. Shares down 50% to $6 a piece. AIG needs to borrow $40B (their losses over the last three quarters) from the Fed window just to survive. I would be very concerned if the Fed opened their window to an insurer; that's unprecedented.

Cobb County Pension Plan

Citing a $115 million gap in its employee pension fund, Cobb County told workers late Thursday that it wants to alter its pension formula to increase employee contributions and reduce some benefits, among other changes. With about $349 million in assets and about $578 million in obligations, the plan is under-funded by about 40%, one of the worst ratios in the metro area. To meet acceptable standards, it must cut that rate to 20%.

[Thanks to MPC for the link]

Aon buying Benfield

After this deal goes through, the top four reinsurance brokers would be:
1. Aon = $1.615 billion
2. Guy Carpenter = $902 million
3. Willis Re = $606 million
4. Towers Perrin = $156 million

Passed APMV

I just learned that I passed the Society of Actuaries Portfolio Management exam I took on May 9th. Just one more exam to go to earn Fellowship in the Society.

ING buys CitiStreet

As reported in this blog back in February, CitiStreet was on the block. ING closed on its purchase of the company today. Price tag: $900M.

Northrop Grumman Closing Pension Plan

Northrop Grumman will stop offering its cash balance plan to new employees (generally effective 7/1/2008) but instead is moving them into an existing defined contribution plan with a matching contribution. New employees will receive an automatic company contribution of 3% to 5% of base pay per pay period based on age to a retirement account in the Northrop Grumman Savings Plan. Existing employees still have the cash balance plan, but the company is decreasing the pay-based credit component of the payout formula depending on the employee’s age.

HP and EDS discussions complete

Hewlett-Packard will buy EDS for $13.9 billion in a deal that will turn it into a more-formidable rival to IBM but will also likely entail significant job cuts in order to achieve the necessary cost savings. The combination would make HP the second largest global provider of IT services after IBM. Under terms of the deal, H-P will pay $25 a share in cash for EDS and expects the deal to close in the second half of 2008.

Again, I am wondering where ExcellerateHRO measures up in all this.

Edited (6/9/09) to add: Towers Perrin has sold its 15% stake in ExcellerateHRO to HP. I wonder if HP will keep the company as a division of its business or spin it off?

HP and EDS in "advanced discussions"

HP and EDS confirmed that they are in "advanced discussions" that could result in HP acquiring EDS to create a more formidable competitor to IBM. Such a deal could be worth between $12 billion and $13 billion. The news sent EDS shares surging $5.27, or almost 28%, before a halt closed trading at $24.13. The rumored value of the deal would imply a price between $24 and $26 a share for EDS, a level the stock has not traded at since last August. HP's stock fell $2.48, or 5%, to $46.65 [before also being halted, something the story doesn't mention].

Source: MarketWatch

This could be interesting for the HR outsourcing industry. EDS owns 85% of ExcellerateHRO; I doubt this is a business HP wants anything to do with that particular business. I'd wager they will put their interest in ExcellerateHRO on the block as soon after buying EDS as their contractual obligations allow.

Khan Leaves Hewitt - You Heard It Here First

Rohail Khan, Leader of North America Benefits Outsourcing, is no longer at Hewitt. The prediction in this blog that he would be gone within a year turned out to be correct with a margin of error of one week.

Wachovia Fires Hewitt BPO

Wachovia is shifting HR functions that it outsourced in 2005 to Hewitt Associates back in-house or to other vendors. HR head Shannon McFayden said the bank will transition tasks such as payroll, pay-related customer service and human resources technology back to Wachovia or to other vendors. Benefits administration and benefits customer service will stay with Hewitt. Moving HR functions back in-house will take up to 18 months. Bank spokeswoman Christy Phillips-Brown could not comment on Hewitt's performance, but Wachovia and Hewitt "agreed this was the best decision for our companies." Hewitt spokeswoman Amy Wulfestieg said the company will work closely with Wachovia in the transition and looks forward to "building on our long-standing partnership together."

Wachovia is taking back a number of HR processes it had outsourced to Hewitt Associates, a potential blow for the BPO provider. The contract, which was one of a slew of wins for Hewitt in the wake of its Exult acquisition, was valued at $450 million. The deal was consummated in Hewitt’s glory days, when both buyers and vendors had high expectations of BPO. “I believe that this was one of those deals signed in the heyday with entirely too much optimism on both sides,” says Naomi Bloom, an industry consultant. Since then, Hewitt has admitted to struggling with its HR BPO business. “They haven’t made a mystery of the fact that they had gotten bogged under by a number of the contracts that they signed in the months after the Exult deal,” IDC analyst Lisa Rowan says. Many of these deals were “lift and shift” transactions, where the buyers expected the vendor to just take over all of their HR processes and do them at less cost. The Wachovia contract was one of these deals, according to one person familiar with the arrangement. It might actually be a relief for Hewitt to be able to offload some of this work and focus on what it does best, which is benefits administration, Rowan says. “If I had to get out my crystal ball, I would say they are going to go back to their sweet spot and just do benefits administration going forward,” she says. But Hewitt maintains it is sticking to the business. But whether Hewitt will be able to turn around its HR BPO business at the pace that shareholders want still remains to be seen.

CitiStreet for sale

CitiStreet, the record-keeping and administrative services firm co-owned by Citigroup and State Street, is for sale, according to banking and private equity sources familiar with the situation. Sources said investment bankers from Goldman Sachs have been hired to find a buyer for CitiStreet. Citigroup spokesman Michael Hanretta and CitiStreet spokesman Michael Bezdek declined to comment. Calls to officials at State Street were referred to CitiStreet. Executives at Goldman Sachs couldn’t immediately be reached for comment. CitiStreet has $230 billion in assets under administration. The firm serves corporate and public retirement plans with 12 million participants.

AIG Headlines

AIG says needs to clarify disclosures regarding CDOs - MarketWatch
AIG still calculating loss on some credit products - MarketWatch
AIG unsure of value of some of its credit derivatives - MarketWatch
AIG auditors cite "material weakness" in financial reporting - MarketWatch

That can't be good. Stock has been pretty much in freefall since the opening bell, as of 10:30 it is down 11.2% at $45, although the last few ticks indicate that might actually be the bottom.

Beck v PACE

The Supreme Court unanimously reversed the ridiculous 9th Circuit decision in Beck v PACE which stated that a merger is a permissible means of plan termination, much to the amazement of the Department of Labor, and that the company therefore had a fiduciary obligation to seriously consider a merger proposal, which it had failed to do.

Justice Scalia, writing for the Court, started off by presenting the fiduciary issue and then went on to acknowledge the plausibility of PACE’s argument. He immediately sidestepped the interesting fiduciary issue and launched into a non-fiduciary analysis from which it would never return. The Court restricted its analysis to whether a plan can be terminated through a plan merger. Ultimately, the answer was no.

It's a shame that the Court chose not to take up the fiduciary question. I swear more bad law comes out of the 9th Circuit than all the other courts of appeal put together. I would have liked the Court to go on record that BOTH parts of the decision were ludicrous, rather than restricting themselves to just one part of the decision.

Reference: http://www.thompson.com/public/headlines.jsp?id=71

Acquisitions Gone Bad

Hewitt Associates To Sell Cyborg Unit To Vista Equity

Worst. Idea. Ever.

Borrowing against your nest egg is becoming as easy as stopping at an ATM. A growing number of companies now offer employees the option of being issued a debit card that taps a 401(k) loan. The card, called ReservePlus, allows workers to withdraw funds from their 401(k)s.

What happens when the idiots who do this have $0 in their 401(k)? Are they going to tax those of us who don't have shit for brains to "help the poor"? Seriously, I feel like just tattooing sucker on my forehead.

Hang on ... it's going to be a rough ride!

The first baby boomers start collecting Social Security benefits today!