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Rep. Paul Ryan on Actuaries

“I’ve gotten to know [the actuaries].  It’s actually the highlight of my day when I meet with actuaries. I love those meetings. That’s the most interesting way I spend my time up here.”

First of many?

Prichard, Alabama — This struggling small city on the outskirts of Mobile was warned for years that if it did nothing, its pension fund would run out of money by 2009. Right on schedule, its fund ran dry.  Then Prichard did something that pension experts say they have never seen before: it stopped sending monthly pension checks to its 150 retired workers, breaking a state law requiring it to pay its promised retirement benefits in full. (Source: NYT)

ING

ING Groep NV began laying off 400 people in its US insurance operation as it prepares to sell the unit in an IPO.  The cuts amount to a 5% reduction at the unit, which will employ about 7600 people when the layoffs are complete.  In addition, ING is eliminating 200 open positions.

[...]

The plan involves the elimination of the unit's individual retirement wholesale distribution channel that sold annuities through broker-dealers. The company is also laying off workers as it continues to integrate CitiStreet, the administrator of retirement and benefit plans it acquired in 2008.

[...]

Executives of the parent company made a long-awaited announcement that it will most likely sell off its insurance operations in Europe and the US in two separate IPOs.  ING is being forced by the European Commission to sell them and nearly halve its balance sheet in return for getting approval for the multi-billion euro rescue it received from the Dutch government at the height of the financial crisis.  The selling of the insurance units, which it expects to complete before the end of 2013, will transform ING into a merely Europe-focused bank.

Source: Fox Business

Society of Actuaries 2010 Annual Meeting (NYC)

Monday, October 18
7:15-8:15 Session 9: Investment Section Breakfast
8:30-10:00 Session 13: Opening General Session
10:30-12:00 Session 23: De-Risking Pension Plans
2:30-4:00 Session 43: Derivatives and Alternative Investments for Pension Plans (Moderator)
4:15-5:15 Session 46: SOA Qualification and Continuing Education

Tuesday, October 19
7:00-8:15 Session 51: Pension Section Breakfast (Presenter)
8:30-10:00 Session 64: PPA Update
10:30-12:00 Session 78: Late Breaking Developments for Pension Plans
12:15-2:15 Session 88: Presidential Luncheon
2:30-4:00 Session 99: Behavioral Finance in DC Plan Design
4:15-5:30 Session 104: Assumption Setting for Pension Plans

Wednesday, October 20
7:30-8:45 Session 109: Health Section Breakfast
9:00-10:15 Session 118: Statutory Hybrid Plans
10:45-12:00 Session 134: ERM and its Application to Pension Plans

Aon to buy Hewitt

The wave of consolidation in the benefits consulting/outsourcing industry is accelerating.  There will now be only three major players - Towers Watson, Mercer, Aon Hewitt.

Aon Corporation will buy Hewitt Associates, for $25.61 in cash and 0.6362 shares of AON for each share of HEW, or $50 a share at Friday's closing prices, a 41% premium.  Hewitt Associates Aon Corporation's Aon Consulting subsidiary will be merged to create AonHewitt.  Note that Hewitt is about three times the size of Aon Consulting, which should be interesting for the merger.

ACS acquires eHRO from HP

As one might have guessed two years ago when HP acquired EDS, HP doesn't want to stay in the benefits outsourcing space.  In June of last year (hindsight: in preparation for its merger with Watson Wyatt) Towers Perrin sold its minority stake in excellerateHRO to HP, which presumably was just looking for 100% ownership in order to be able to sell the division.  That sale took place today, as ACS attempts to grow its presence in that market.

http://realbusinessatxerox.blogs.xerox.com/2010/05/25/966/

Added a link to my blogroll

www.insurecan.com is a Canadian life insurance broker's site. However, it has a bunch of historical actuarial research info including early work on disability waiver of premium, some of the earliest stuff on select/ultimate mortality rates, and a bunch of old mortality tables many of which aren't available elsewhere.

One view of hell

JPMC getting out of actuarial business

Aon Consulting agreed to buy the Compensation and Benefit Strategies division of JPMorgan Chase (i.e., the former Chicago Consulting Actuaries) for an undisclosed amount.

Open Letter to the SOA Board

Disagree with a portion of their new board policy.

http://home.comcast.net/~cscg/20100225OpenLetter.pdf

Pension Funding as of 12/31/2009

AAA on Health Care Reform

http://www.actuary.org/pdf/health/differences_jan10.pdf

Society of Actuaries 2009 Annual Meeting (Boston)

I'm leaving for Boston this morning; I'll be attending the Society of Actuaries Annual Meeting starting Monday. Below is a list of the concurrent sessions I plan to attend. If you see me, please come by and say hello.

Monday 26 October
Session 17: Why We Need to Transform Our View of Risk
Session 27: Impact of the Financial Crisis on Pensions and Investments
Session 38: Basic and Continuing Education Update

Tuesday 27 October
Session 43: Management & Personal Development Section Continental Breakfast
Session 59: Perspectives on the Financial Crisis and Enterprise Risk Management
Session 62: Using Corporate Bond Spot Yield Curves for Pension Discounting
Session 79: Market-Consistent Valuation of Pension Plans

Wednesday 28 October
Session 98: Education & Research Section Continental Breakfast
Session 111: Revised Qualification Standards and Continuing Professional Development (*)
Session 116: What's New in Employee Benefits Accounting Standards

(*) I will be one of the presenters at session 111; come hear about the new SOA CPD rules.

Modeling the Forward Surface of Mortality

http://longevity-risk.org/presentations/Workshop_Session6/6A_Daniel_Bauer.pdf

Plagiarist Doris Kearns Goodwin to speak at actuarial meeting

For all the gory details, you can go to:
http://authorskeptics.blogspot.com/2004/09/professor-doris-kearns-goodwin.html
Disgraceful!

Xerox to buy ACS for $6.4B

I wonder what this will mean for ACS's Buck Consultants actuarial consulting subsidiary.

Joint Announcement on Future Education Methods

The presidents of the CIA/CAS/SOA have issued a joint letter to share news of and request member feedback on a proposal for developing future education methods.

http://www.soa.org/files/pdf/fem-letter.pdf

http://www.soa.org/files/pdf/fem-faq.pdf

http://www.casact.org/admissions/FEM-Expanded-FAQs.pdf

I encourage anyone who cares about the actuarial profession to write the Society of Actuaries before the end of the comment period on September 10.

ETA 8/16: For the record, I am most strenuously opposed to handing ASAs to college graduates without external validation through the existing exam system. My letter to the board can be found at http://home.comcast.net/~cscg/OpenLetterBoard.pdf.

What is the Proper Role of a Consultant?

http://www.pensionriskmatters.com/2009/07/articles/pension-consultants/what-is-the-proper-role-of-an-investment-consultant/

So I'm studying for the PRM4 Exam

One of the case studies concerns WorldCom. When I finished reading it, I was left wondering if this was a WorldCom that operated in some other country with which I am not familiar. The case study is by Dennis Moberg of Santa Clara University and Edward Romar of University of Massachusetts at Boston (yes, I'm calling them out; willful blindness this blatant goes beyond the pale and needs to be exposed publicly). Here are some of the highlights...

WorldCom is just another case of failed corporate governance, accounting abuses, and outright greed. But none of these other companies had senior executives as colorful and likable as Bernie Ebbers.

No palace in a gated community, no stable of racehorses or multi-million dollar yacht to show for the telecommunications giant he created; only debts and red ink - results some consider inevitable given his unflagging enthusiasm and entrepreneurial flair.

Personally, Bernie is a hard guy not to like.

All this would be just another story of a successful growth strategy if it weren't for one significant business reality - mergers and acquisitions, especially large ones, present significant managerial challenges.

All this was put in jeopardy when, in 2000, the government refused to allow WorldCom's acquisition of Sprint.

I'm sorry. I'm really confused. According to wikipedia, the story of WorldCom and Bernie Ebbers includes the following facts, not one of which is mentioned in the PRM case study.

Beginning in 1999 and continuing through May 2002, the company used fraudulent accounting methods to mask its declining earnings by painting a false picture of financial growth and profitability to prop up the price of WorldCom’s stock.

It was estimated that the company's total assets had been inflated by around $11 billion.

Bernie Ebbers was found guilty of all charges and convicted of fraud, conspiracy and filing false documents with regulators.

Shame on PRMIA. This case study is a disgrace and should be pulled from their syllabus.

Public Pensions Cook the Books (Andrew Biggs, WSJ)

Here's a dilemma: You manage a public employee pension plan and your actuary tells you it is significantly underfunded. You don't want to raise contributions. Cutting benefits is out of the question. To be honest, you'd really rather not even admit there's a problem, lest taxpayers get upset.

What to do? For the administrators of two Montana pension plans, the answer is obvious: Get a new actuary. Or at least that's the essence of the managers' recent solicitations for actuarial services, which warn that actuaries who favor reporting the full market value of pension liabilities probably shouldn't bother applying.

Public employee pension plans are plagued by overgenerous benefits, chronic underfunding, and now trillion dollar stock-market losses. Based on their preferred accounting methods -- which discount future liabilities based on high but uncertain returns projected for investments -- these plans are underfunded nationally by around $310 billion.

The numbers are worse using market valuation methods (the methods private-sector plans must use), which discount benefit liabilities at lower interest rates to reflect the chance that the expected returns won't be realized. Using that method, University of Chicago economists Robert Novy-Marx and Joshua Rauh calculate that, even prior to the market collapse, public pensions were actually short by nearly $2 trillion. That's nearly $87,000 per plan participant. With employee benefits guaranteed by law and sometimes even by state constitutions, it's likely these gargantuan shortfalls will have to be borne by unsuspecting taxpayers.

Some public pension administrators have a strategy, though: Keep taxpayers unsuspecting. The Montana Public Employees' Retirement Board and the Montana Teachers' Retirement System declare in a recent solicitation for actuarial services that "If the Primary Actuary or the Actuarial Firm supports [market valuation] for public pension plans, their proposal may be disqualified from further consideration."

Towers Perrin and Watson Wyatt will merge

This will creat the world's largest employee-benefits consultancy, surpassing current leader Mercer.

Bang it goes again?

In the thunderous collapse of GM, one detail seems to have gone almost unnoticed. The old GM's US pension fund, with its near-$100bn of liabilities, is being transferred lock, stock and barrel to the new entity. As a direct result, the new GM could be bankrupt again in a very few years. GM's US fund is, of course, in deficit, but the company has made no contributions since 2003. Back then, it put in $18.5bn, which it raised through a bond issue. Since this counted as a pre-payment, GM is not obliged to pay any more for the next year or two. However, it will then have to start plugging the gap, under the new rules set down by the Pension Protection Act of 2006. This, Mr Ralfe calculates, would involve diverting $1bn to $2bn annually from operating cash flows. If GM cannot do that, bang it goes again. [Source: Financial Times]

Federal Regulation of Insurance?

At a hearing of the House Financial Services Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises, US lawmakers discussed what kind of role the federal government should have in regulating the insurance industry. "The events of the last year have demonstrated that insurance is an important part of our financial markets," said Rep. Paul E. Kanjorski, D-Pa., chairman of the subcommittee. "The federal government, therefore, should have a role in regulating the industry." [Source: InvestmentNews]

Social Security Trustees Report is Out

http://www.ssa.gov/OACT/TRSUM/index.html

Wells Fargo Freezes Pensions

From their most recent 10Q
https://www.wellsfargo.com/downloads/pdf/invest_relations/1Q0910Q.pdf

On April 28, 2009, the Board of Directors approved amendments to freeze the Wells Fargo
qualified and supplemental Cash Balance Plans and the Wachovia Pension Plan.

Pension Tsunami

Public pension plans around the country are entering an age of bankruptcies and broken promises. Some states realize they must make some hard choices. Some don't. When it all blows up blame will need to be laid which is what Milwaukee County [New Jersey] officials are doing this week as their lawsuit against their plan's actuary goes to trial. The trial will likely include actuarial arcana designed to confuse the jury to one side or the other but it really should come down to how much mute actuaries are to blame for the coming pension tsunami. Actuaries should be able to tell what a promised pension benefit would cost. But if they come up with too big of a number those benefits might not be provided which is bad for the government workers who won't get those benefits and bad for the government officials who will need to come up with some remuneration scheme that they won't be able to defer onto future taxpayers.

[Thanks to MPC for the link]

Potential PBGC problem: $13.5 billion GM liability

Pension & Investments:

A GM bankruptcy could become the PBGC's biggest nightmare because the automaker could dump as much as $13.5 billion in unfunded pension liabilities onto the PBGC — the largest ever from a single company — if GM were unable to fund its US defined benefit plans and terminated them. The claim would be almost twice as large as the current record of $7.5 billion from the 2005 termination of United Airlines pension plans.

NYT:

Decisions that the government will make soon on the future of GM and Chrysler could accelerate the decline of traditional pension plans. “If one of these companies solves its pension problem by shunting it off to the federal government, then for competitive reasons the others have to do the same thing,” said Zvi Bodie, a professor of finance at the Boston University School of Management and longtime observer of the government’s pension insurance system. “That is the death spiral.” For years, traditional pensions have been in a slow decline, with troubled sectors like aviation and steel shedding their plans in bankruptcy court as 401(k) plans have taken hold. But big sectors, particularly manufacturing and financial services, have clung to the old plans. The PBGC has roughly $67 billion in assets to cover the benefits of nearly 4,000 failed pension plans; GM has $84 billion just to cover promises to its own workers. For traditional pension plans, “maybe this is their last stand,” said Jeffrey Cohen, a partner with the law firm Ivins, Phillips & Barker in Washington who was chief counsel for the PBGC from 2005 to 2007. If the automakers’ plans fail, he added, “the biggest domino will have fallen for the PBGC.”

YRC aims to fund pensions with real estate

YRC Worldwide, the biggest trucking company in the US, is negotiating with its unions to allow it to suspend cash payments to its defined-benefit pension plan and to pledge real estate instead. It would be the first major US company to use its real estate to help meet its pension obligations.

I find this vaguely disturbing. Also, I'm surprised that no US source seems to be carrying this story.

Unprepared for retirement

Among workers without a defined benefit pension plan at work, 41 percent believe they have such a plan.

Mother Of All Bad ideas

In Florida, a plan recommended by the Citizens Property Insurance Corp. Mission Review Task Force would allow the state to borrow $2 billion from the state pension fund to back up the catastrophe fund in event of a hurricane.

What could possibly go wrong?

[Thanks to MPC for the link.]

FSA!

I became an FSA at 3:30 this afternoon. (The picture is from the conferment ceremony this evening.)

http://www.soa.org/files/pdf/edu-2009-03-fsa-names.pdf

Pension Relief For Companies With Strings

Corporations might get relief from stringent pension-law funding requirements — but with a big string attached that some experts see as a step toward a mandatory retirement system. Under a proposal now being considered by senior Democratic congressmen, companies with active plans would get a break from the 2006 Pension Protection Act's onerous new funding requirements, but only if they agree not to freeze their plans to new employees — perhaps for several years. Companies also would have to agree not to terminate their plans to get the funding relief. In addition, frozen plans would not qualify, even if those freezes apply only to new employees.

State Farm exercises nuclear option in Florida

Florida's largest private insurer is pulling the plug on homeowners' policies in the state, citing the losses suffered since the brutal 2004 hurricane season. The decision by State Farm Florida comes two weeks after state insurance regulators rejected the company's request to raise rates. The decision means State Farm Florida - a subsidiary of State Farm Mutual - will no longer renew policies for its roughly 1.2 million customers in the Sunshine State. "This is not an action we wanted to take, but one we must take given the realities of the Florida property insurance market," company President Jim Thompson said in a statement announcing the decision. The company said it has paid out $1.21 in claims for every dollar of premiums it has collected since 2000 and suffered billions in losses after the 2004 hurricane season, when four major storms hit the state. And it said its net worth had dropped by nearly 25% since 2006 even with no major disasters.

Thanks a lot, Gov. Crist! Any other bright ideas?

I want to be an actuary

Pension & Investments Article

Interest among US pension plan sponsors in Liability Driven Investing will reach a "tipping point'' within five years, with the development of more sophisticated strategies paving the way for near universal acceptance, a new report from Russell Investments predicts. That will happen despite short-term obstacles thrown up by the market trauma of 2008. For example, the severe underfunded status of many pension plans now will make it more difficult to aggressively implement an LDI program over the next year or so. Likewise, market mayhem will temporarily damp demand for essential hedging tools such as swaps, while setting back the development of pension buyout markets that had been picking up steam in countries such as the United Kingdom. In the end, the psychological impact of the market maelstrom that corporate pension sponsors are living through now will outweigh such short-term obstacles to LDI, predicted Robert Collie, director of investment strategy with Russell.

Mr. Collie said 2008 "is going to be one of those years which permanently changes the psyche of the people who lived through it,'' resulting in a generation of pension plan executives who will "see the world differently.'' At present, LDI is the "foundation'' for the investment strategies of perhaps 20% to 25% of US pension plans, and their experience over the past year is shaping the ongoing development of efforts to better match assets and liabilities. Part of the fallout from the past year's market fireworks will be a broadening of the scope of the risks LDI programs are designed to hedge against, moving beyond the preoccupation in recent years on interest-rate risk. For example, the mismatch that occurred between the valuations of the Treasuries anchoring many LDI programs and the high-grade corporate bond yield used to calculate the current value of future pension obligations has led to a much greater awareness of the need to take credit risk into account. Over the past year, investors seeking a safe haven have poured money into Treasuries, leading to higher prices and lower yields, while fleeing corporate bonds, which led to lower prices and higher yields. As a result, pension funds with LDI programs that added to their Treasury holdings have enjoyed an unexpected gain, as the value of their assets jumped while rising corporate rates slashed their liabilities. In effect, while LDI programs have failed to match assets and liabilities, they've done so in a way that has favored those pension plans - a lucky break. Still, the understanding that things could also have moved in an unfavorable direction has hammered home the point that "tactical considerations'' cannot be ignored, and a number of plans have taken steps to lock in the gains they've enjoyed.

Other risks that have come to the fore as a result of the past year include counterparty risk, which has lowered demand for swaps, and immunization schemes, such as pension buyouts. Underlying market demand will ensure that the current setbacks are temporary, even if the exact path for the development of key LDI components can't be sketched out with certainty today. It's clear that 20 years from now, there needs to be a long-term solution for companies that have frozen their pension plans and require a more cost-effective way to manage those assets than retaining an in-house staff, he said. Within three to five years, Russell officials expect depleted pension funding levels to have recovered, either by a rebound in equity markets or the significant contributions required under PPA. At that point, this battle-scarred generation of pension fund executives will begin implementing LDI programs in droves. Then, with 50% or more of pension plans adopting LDI programs, the herd mentality will kick in, and it will be a very short distance "from tipping point to game over."

Risk NON-Management

The credit crisis may be a year and a half old. But according to a new survey by audit firm KPMG, many bank executives are still struggling to find a seat at the table for their companies’ risk managers. In fact, despite hundreds of billions of dollars in write-downs of toxic assets, most bank executives continue to dismiss risk management. Indeed, three quarters of the risk managers polled said risk management is “stigmatized” at their institution. That group said risk management is seen as a mere “support function”—something akin to HR or IT. What's more, some 45% of the bank execs surveyed said their boards lacked expertise in managing risk. And barely half said they had senior managers with “deep practical risk management experience” working for their companies. “Risk management programs may have been in place at most banks, but the survey indicates there were shortcomings around the execution of those plans,” said Michael Conover, a principal in KPMG’s Financial Risk Management practice, in a statement. “Financial models don't prevent poor risk decisions, people do.”

Calvin & Hobbes

Passed FETE - My Last Fellowship Exam!

For posterity, here's the very long start-and-stop process that brought me to fellowship:

May 1996: Course 100
(which became Course 1 on 1/1/2000 and subsequently course P in the current system)

May 1996: Course 110
May 1999: Course 141
(these two combined to grant credit on Course 2 on 1/1/2000 and subsequently course FM in the current system)

May 2001: Course 3
(which converted to courses MFE and MLC in the current system)

November 2001: Course 4
(which converted to course C in the current system)

November 2004: Course 5
July 2006: Course 7
(these two converted to FAP in the current system)

May 2008: Course APMV

November 2008: Course FETE

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!

Marsh CEO Out

Marsh & McLennan has ousted its CEO, Michael Cherkasky, as part of a review that could lead to a break-up of the scandal-laden group. Mr Cherkasky was brought into Marsh & McLennan in October 2004 after Eliot Spitzer accused the company of colluding with competitors. The group in 2005 reached a settlement with insurance regulators and Mr Spitzer. The settlement caused Marsh & McLennan's profitability to collapse. Its shares have fallen by a fifth this year, while those of rivals such as Aon have advanced.

Investors such as KJ Harrison & Partners have been urging Marsh & McLennan to spin off some of its consulting businesses, including its Mercer human resources consulting unit and Oliver Wyman management consulting unit, arguing that they do not fit well with insurance broking.

Source: The Australian

Hewitt Is Sued Over Enron

Partial settlements in the litigation have resulted in $89 million for participants and beneficiaries in Enron's retirement plans. In 2006, Hewitt Associates was hired to allocate the money to the plans' approximately 20,000 members. Because of a flaw in Hewitt's computer system, the company miscalculated distributions, the suit alleged. The error was not discovered until late January 2007, when a participant questioned her allocation. In July, Hewitt accepted responsibility for its mistake in court, the suit says. Its lawyer told the judge the company's software used the wrong stock price to calculate the distributions and promised to fix the error. The company submitted revised calculations, but the numbers are still wrong, court papers said. Hewitt also refuses to fund any portion of the $22 million shortfall.

The Enron case is at least second time in recent months Hewitt has been sued by a client. In August, Schering-Plough alleged Hewitt had not met its contractual obligations after the company replaced Hewitt as its health-plan administrator.

Hewitt Associates launches Global Risk Services

Hewitt Associates announced the launch of Global Risk Services, a new initiative that will help pension plan sponsors manage the risks they face. [...] "A key differentiator of Hewitt's Global Risk Services is that we look at both sides of the equation — risk and return are just the two sides of one coin."

How on Earth is that a differentiator? Like nobody ever thought of risk and return as the two sides of one coin before?

Loss at Hewitt

Hewitt Associates reported a fourth quarter loss of $266 million, or $2.51 per share, compared with a profit of $23 million, or 21 cents per share, in the previous year. Total operating expenses grew to $1.05 billion from $685 million. Quarterly revenue was $768 million, compared to $728 million a year ago.

For the fiscal year 10/1/2006-9/30/2007, Hewitt posted its second consecutive yearly loss. This year's loss was $175 million, or $1.62 per share, compared with a loss of $116 million, or $1.08 per share last year. Full-year sales were $2.99 billion, versus $2.86 billion in the prior year.

Pensions Can Be Outsourced

From the LA Times...

Citigroup got the green light from the Federal Reserve for an unusual deal to take over the $400-million retirement plan of a British newspaper company. In exchange for getting its hands on all that cash, Citigroup will run the pension plan - investing the money, paying the benefits and taking on the liability previously borne by Thomson Regional Newspapers. And it's eyeing similar moves stateside. Other banking investment and financial companies, including JPMorgan Chase, also are exploring the idea of taking pension plans - and their billions of dollars of assets - off the hands of employers. At least three federal agencies are considering aspects of the idea, including its basic legality and safeguards for workers.

Advocates say such changes would be a win-win for retirees and employers, retaining all the protections of current law, while putting plans in the hands of sophisticated financial stewards. Plus, large banks are less likely to go out of business or face severe financial strains than smaller employers.

Yet other people worry that such setups could subject retirement benefits to new risks and jeopardize decades-old worker protections. They're concerned that the would-be pension managers are more interested in profit than in the security of retirees. Further, they fear that unwise investments could bring a crisis for which there is no simple solution.

And from the industry magazine Pensions & Investments...

Bradley Belt, the former PBGC chief, wants to take over your frozen pension plans — and he’s betting he can wring enough money out of the hundreds of millions of dollars now sitting in frozen plans in the US to pay off the existing liabilities and turn a tidy profit for his new company and other investors. “We’re very comfortable with our ability to manage the assets against the liabilities in a way that will allow us to earn a consistent return above the liabilities, but without taking inordinate risk in doing so,” said Mr. Belt, now chairman of Palisades Capital Advisors LLC, in an interview in the firm’s Washington office. There’s no precedent for pension plan liability buyouts in the US. So over the past several months, Mr. Belt has been meeting with federal regulators, pension plan sponsors and representatives of investment firms to encourage support for a concept that he argues could serve the best interests of plan sponsors, plan participants and the PBGC alike.

Of course, this isn't really news. The big banks have been making their plays in this space for years now, as seen in this story from January 2006 ...

Recruiters in New York and London say corporate pension deficits are driving demand for actuaries who can help match pension fund assets to ever mounting pension liabilities. As the problem becomes more acute, so demand is likely to rise. “Banks are keen to strengthen their offering in this space,” says Kim Yates, a director at London-based search firm Principal Search. She says, “There are several clear leaders, and others are seeking to challenge them.” The leaders are Goldman Sachs and Morgan Stanley, which formed so-called ‘pension advisory groups’ in the late 1990s and now have large teams devoted to the business. More recent entrants include ABN AMRO, which founded its pension advisory group in 2004.

What a mess at ACS

Affiliated Computer Services, caught in a bitter battle between members of the company's board and its chairman, said in a statement November 1 that five board members had resigned after initially refusing to do so. [...] Now that the five independent board members have resigned and two potential buyers are gone, it's unclear how ACS will proceed, sources say.

The dispute began several weeks ago when Mr. Deason and private equity firm Cerberus Capital Management withdrew their $6.2 billion bid to buy the company, saying that the board had dragged its feet on the offer while the credit market dried up. Mr. Deason then demanded the resignations of the five independent board members, accusing them of mismanagement. The departing members are Robert Holland III, J. Livingston Kosberg, Dennis McCuistion, Joseph O'Neill and Frank Rossi. In a separate action, board member John Rexford also has resigned from the board but will remain as executive vice president at the company. ACS also said Wednesday that the directors have agreed to withdraw their lawsuit against the company and Mr. Deason.

SOA Weighs in on financial mess

http://www.soa.org/library/newsletters/the-actuary-magazine/2007/october/edi2007oct.aspx

Start New Job Today

I start a new job today as an honest-to-goodness actuary at a major management consulting firm.

Quit my job

I quit my job in the outsourcing arena. Today is my last day.

Public pension funds take *ANOTHER* risky gamble

The executive director of the Montana pension system is considering recommendations that the nine pension funds in the system invest in hedge funds to boost investment returns. He is not terribly comfortable with the idea but is looking at it. Boomers are getting ready to retire. Montana needs a higher return of investment. The California Public Employees' Retirement System, New Jersey retirement system, Virginia pension fund, and San Diego County Employees Retirement Association are just a few public funds invested with hedge funds. (The Washington Post, 24-Jul-2007, p. D1)

So reality is finally setting in that the contributions put into the plan are insufficient to pay the promised benefits. But instead of sucking it up and making more contributions, they'd rather take a gamble on better returns. And if the bet goes bust, somebody else will be cleaning up the mess. Nice. And look who's among the funds taking this ridiculous risk - two of the funds that are already quite screwed up: NJ and San Diego.

Public pension funds take a risky gamble

Bear Stearns is hawking the riskiest portions of collateralized debt obligations to public pension funds. At a sales presentation of the bank's CDOs to 50 public pension fund managers in Las Vegas, Jean Fleischhacker, Bear Stearns senior managing director, tells fund managers they can get a 20% annual return from the bottom [i.e., riskiest] level of a CDO. Many pension funds, facing growing numbers of retirees, are still reeling from investments that went sour after technology stocks peaked in March 2000. Fund managers buy equity tranches, which are also called first loss portions, even though those investments are never given a credit rating by Fitch, Moody's or Standard & Poor's.

Seven percent of all the equity tranches sold in the U.S. in the past decade were purchased by pension funds. Public pension funds have bought more than $500 million in CDO equity tranches in the past five years, The California Public Employees' Retirement System, the nation's largest public pension fund, has invested $140 million in such unrated CDO portions. Citigroup sold the tranches to Calpers. The New Mexico State Investment Council, which funds education and government services for children, has $222.5 million invested in equity tranches. The council decided in April to buy an additional $300 million of them. The General Retirement System of Detroit holds three equity tranches it bought for $38.8 million. The Teachers Retirement System of Texas owns $62.8 million of them. The Missouri State Employees' Retirement System owns a $25 million equity tranche.

More Leadership Changes at Hewitt

Hewitt Associates announced four key leadership appointments in its Consulting business:
• Monica Burmeister to global chief of Consulting Operations
• Richele Soja to North American Consulting leader
• Andrew Bell to global leader of Hewitt’s Talent & Organization Consulting business
• Joanne Dahm to North American practice leader of TOC

Some Numbers Regarding NJ Pension Early Retirement

Over the last 20 years (most recently in 2002), NJ has granted special early retirement benefits to employees five times. Payrolls had to be trimmed to plug budget gaps. But in every single case, the early retirement plans cost New Jersey more than it saved. In 2002, more than 5500 workers took the package, more than double the number the state had projected. Many of the retirees were in federally financed jobs so the state did not actually recognize any savings in salaries. To make matters even more absurd, nearly all the vacancies were filled quickly. Only 210 remained vacant at the end of fiscal 2003.

A special ten-member panel appointed to examine pension-related bills, didn't review the 2002 bills. In fact, it never met. The bill passed in just 18 days. Legislators now admit they didn't really consider how to pay for the special benefits. It is now estimated, the feel-good 2002 program will cost the state $617 million, not the $278 million projected in 2002.

Employee Benefits Spring Meeting

Wed May 30
Pension Protection Act Part 1 – PPA Overview
Pension Protection Act Part 2 – Benefit Restrictions Under PPA
Pension Protection Act Part 3 – 10 Biggest Unresolved Issues with PPA

Thu May 31
Accounting Part 1 – What Hath FASB Wrought?
Financial Economics Part 1 – Learning the Ropes
Financial Economics Part 2 – Making It Real

Fri Jun 1
Future of Retirement Part 1 – Report from the Meeting – Headlines
Late Breaking Developments
Future of Retirement Part 3 – Stakeholder Tensions – What do you think?
Dialogue with Treasury and IRS

Ceridian Going Private - Who's Next?

The $5.3 billion buyout of Ceridian makes the company the latest among a number of HRO providers to go private. The offer was made by private equity firm Thomas Lee Partners and Fidelity National Financial and is expected to close in the fourth quarter. The price represents a 5% premium.

ACS founder and chairman Darwin Deason has been working to take his company private. Similarly in March, Kronos was acquired by private equity firm Hellman & Friedman Capital Partners for $1.8 billion.

"My immediate thought is, who is next?" says Neil McEwen, managing consultant at PA Consulting. "And my immediate answer would be Hewitt Associates." Rumors have been circulating for months that Hewitt, which has been struggling to revive its HR BPO business, might go private to get away from shareholder scrutiny. Jennifer Frighetto, a Hewitt spokeswoman, declined to comment.

Disability Benefits in Sweden

In recent years, there has been a boom in sickness and disability in Sweden. Thirteen percent of working-age Swedes live on some type of disability benefit. That is the highest proportion in the world. Yet, Swedes are the healthiest people in the world, according to the WHO. There are several dynamics at work. Sweden has a very generous welfare system. The government trusts people to be honest. Benefits are easy to get. Therefore, fraud has crept into the system. [This is known in the insurance business as moral hazard.]

But things are changing. The system cost too much and cannot be sustained. The government is cracking down. People are losing their benefits. People are being told to return to work, the gravy is over. For example, Lotta Landstrom has lost her sick benefits after two years. (Lotta is allergic to electricity, says her doctor.) Unfortunately, the government is having to provide training to people who need it because they have been out of the labor force for so long. [Ain't socialism grand, folks?]

[Wall Street Journal]

More Outsourcing Industry News

ACS has received a revised proposal from Darwin Deason, Chairman of the Board of ACS, and Cerberus Capital Management LP to acquire, for a cash purchase price of $62 per share, all of the outstanding shares of the company's common stock, other than certain shares and options held by Deason and members of the company's management team that would be rolled into equity securities of the acquiring entity in connection with the proposed transaction.

Mercer HR Services announced that Mary Tinebra, who has played an integral role in the growth of the firm’s outsourcing business, has been appointed Global Leader of Sales and Alliances. Sean Andersen has joined Mercer HR Services as the Leader of Organizational Effectiveness Practices, and Joe Mehringer (formerly of Hewitt Associates) has joined as the Total Retirement Product Manager.

Hewitt Associates Makes More Changes in Executive Team

Jay Rising is the new president of HRO. He succeeds Julie Gordon, who has served as acting president. He most recently served as president of field operations at RightNow Technologies, a customer experience software company. Prior to that, he spent nearly ten years at ADP.

Julie Gordon was appointed to the new position of president of client & market leadership. In her new role, she will oversee Hewitt's overall client relationship strategy, with particular focus on its largest clients, most of which use both Hewitt's consulting and outsourcing services.

Steven Fein has been appointed to the newly created position of sales and product strategy leader ... Rohail Khan will continue as leader of operations.

http://www.hewittassociates.com/Intl/NA/en-US/AboutHewitt/Newsroom/PressReleaseDetail.aspx?cid=3996

WSJ weighs in on Florida insurance situation

It isn't easy to put one of the more well governed states on the path to fiscal ruin in a mere three months, but it seems Florida Governor Charlie Crist is exceptional. His campaign to socialize Florida's insurance market has placed the Sunshine State one big hurricane away from financial disaster.

Not that you'd know this from Mr. Crist's approval ratings, which remain in the stratosphere thanks in part to his populist turn bashing insurance companies. The Republican campaigned last year on promises to do something about his state's property-insurance premiums, which have climbed in the wake of some recent nasty hurricanes. Economists know that these rising costs are necessary, and in time beneficial, because insurers must build reserves against the more frequent storms hitting ever-more-populated coastal areas.

But Mr. Crist is a man on a poll-driven mission and his line has been that greedy insurers are ripping off his constituents. In January he convinced the Republican legislature to pass a "reform" designed to lower the price of insurance by making the state a larger player in the market and undercutting private insurers. The new law allows state-run Citizen's Property Insurance -- intended to be an insurer of last resort -- to compete directly with private companies.

This exercise in Cuban economics is already gutting Florida's once-competitive insurance market. Private insurers know the law will artificially depress rates, forcing some to operate at a loss. Many have responded by cancelling policies, prompting Governor Crist to issue an "emergency" order freezing premiums and barring cancellations. Yet even this hasn't stopped the bleeding.

USAA last week became the latest to significantly restrict the number of new policies it issues in the state, and to drop 27,000 second-home policies. This follows pullbacks from AllState, State Farm, Nationwide and others. The storms and new regulation have also forced some insurers out of business, leaving thousands of policyholders with no coverage and fewer options for getting it.

Large numbers of homeowners are now turning to Citizen's, which itself is only able to offer lower premiums because of its implicit taxpayer guarantee, and because its actuarial assumptions reside in la-la land. Citizen's likes to say it will have $8 billion with which to pay claims, but it rarely notes that much of this is a line of credit. Between such credit and its bonding authority, what Citizen's really has is the potential to rack up huge liabilities that will have to be paid by someone when the next storm surge comes ashore.

Most likely, that someone will be all Florida homeowners, who, in the event of a Citizen's collapse, will be on the hook for large assessments. This tax is likely to be levied on every homeowner, including those who don't live in areas at high risk for storm damage. Another option would be for the state to provide a bailout, putting all taxpayers on the hook. The risk of a taxpayer bailout is also high for the state's hurricane fund: The new law doubled its risk-bearing capacity to $32 billion in business, thus allowing insurers to purchase reinsurance at cheaper rates than on the open market. However, the fund has only $1 billion in cash on hand, and thus no way to cover its new business if disaster strikes -- short of dunning taxpayers.

In sum, what Mr. Crist has done is concentrate the risk of future hurricane losses within his own state government, rather than spreading it around the world through the insurance industry. This is astonishing, given that the Sunshine State accounts for 27% of all hurricane-exposed property in the U.S., worth some $2 trillion. After Katrina, private insurers paid more than $40 billion to 1.7 million policyholders in Florida. But the state government and its taxpayers may end up paying for the next big one largely by themselves.

At least other states are learning from the Florida meltdown. Rather than create state competitors to the private market, Mississippi and South Carolina have taken steps to expand their markets of last resort. Louisiana's Governor and insurance regulator have talked openly of the need to rebuild the private insurance market, rather than transfer risk to taxpayers. Even the liberal Atlantic Coast states, usually the first to turn to new regulations, have largely rejected attempts to socialize their storm risk.

For now, many Floridians are thrilled that their rates are falling and so the Governor is popular. He recently asked for new legislation to give Citizen's even more power to compete with private underwriters. However, Mr. Crist and his fellow Republicans had better hope that predictions of more frequent hurricanes are wrong. Because when they hit, and taxpayers discover there's no such thing as free insurance, what could get blown away is their governing majority.

Summary of 2007 Social Security & Medicare Annual Reports

For the first time, a “Medicare funding warning” is being triggered [...] By law, this warning requires that the President propose, and the Congress consider, remedial action.

Faulty Retirement Expectations

Only 41% of workers said they or their spouse have a traditional defined benefit pension plan from their current or previous job, but 62% expect they will receive retirement income from a defined benefit pension plan.

Workers expressed a level of confidence in their retirement-readiness that didn't jibe with reality. For instance, 24% of workers who said they were "very confident" about their financial security in retirement are not currently saving for retirement, and 43% of "very confident" workers have less than $50,000 in savings.

Only 60% of workers are currently saving for retirement; and only 66% say either they or their spouse have saved for retirement, according to the study. Not surprisingly, younger workers were more likely than older workers to have a smaller retirement nest egg; 68% of workers younger than 35 had total savings and investments less than $25,000, compared to 31% of workers older than 55.

More on the NJ Pension Situation

State senators from both political parties said at a hearing that they had been shocked to learn that they had voted again and again in recent years for measures that had left the state pension in great distress, and they faulted the state treasury for failing to explain to them the risks of what they were doing. “I had no idea we were in the company of some of the same corporations that I have condemned for not funding their pensions,” said Sen. Shirley Turner (D - Mercer County). “And now, it seems, we’re in the same boat, and sinking.”

The hearing, by the Senate Budget and Appropriations Committee, was called in response to a report in The New York Times last week that described how New Jersey has diverted hundreds of millions of dollars that should have gone into its pension fund, using unorthodox steps authorized by governors from both parties over a number of years. In response to the article, Gov. Jon Corzine has said that the state will change certain accounting procedures. He has also asked the state attorney general to investigate, with outside actuarial help, whether tax requirements, securities laws or other rules have been violated. The attorney general, Stuart Rabner, will have to walk a careful line in such an inquiry, however. He is currently representing the State of New Jersey in lawsuits, filed by several employee groups, that accuse the state of failing to fund workers’ pensions lawfully. In those cases he is arguing that the state has acted legally.

The office of the attorney general has also said in audited financial statements that the state’s pension plans are “qualified” as tax-preferred plans. Normally, only the IRS can issue a ruling that a pension plan is qualified, after reviewing it to make sure it complies with the tax code. But New Jersey’s annual reports state that its pension plans are qualified “based on a 1986 declaration of the attorney general of the State of New Jersey.” The IRS said it had no record that New Jersey had ever requested to have its pension plans qualified. “Just because the attorney general says it’s qualified does not mean it meets the requirements of the Internal Revenue Code,” said Andy Zuckerman, director of employee plans, rulings and agreements at the IRS.

In the hearing, the state treasurer, Bradley Abelow, tried to calm the senators’ deepest concerns about potential legal and financial problems facing the pension fund. But at the same time, he argued that their complaints of being kept in the dark were unfounded. “The financial position of the system’s funds is transparent, and stated in various publications in accordance with the required accounting standards,” he said. He brought a list of places where information about the pension fund was available, including annual actuarial reports and monthly updates to each plan’s board of trustees.

But Sen. Barbara Buono (D - Middlesex County) said that was not enough. “There is not full disclosure to the Legislature,” she said, “perhaps not intentionally.” Sen. Buono also said she thought many of her fellow legislators had failed to live up to their responsibility to understand the implications of what they vote on.

Some senators wondered whether any of the outside professionals helping with the pension fund were at fault, expressing confusion about the roles played by actuaries, auditors, lawyers and others. “If you’re paying someone who is consistently giving us bad advice, why do we continue to pay them?” Sen. Turner asked. “Many times, you can find the financial people to give you the advice you want, so that you can do the things you want.” She said she wanted to know, for example, who had prepared bond offering statements that wrongly showed that the state had made hundreds of millions of dollars’ worth of pension contributions in years when it had really contributed nothing.

Frederick Beaver, director of the Division of Pensions and Benefits, defended the outside actuaries. He recalled that when he joined the division in 2003, people had been asking the actuarial consultants whether they could “push the envelope” and save more money by diverting pension contributions. The actuaries advised against it, he said.

Fidelity Eliminating Pension

Fidelity Investments is eliminating its traditional pension plan for roughly 32,000 of its employees.

This is particularly interesting since Fidelity is one of the big players in the outsourcing market for companies that have traditional pension plans.

More News on the NJ Pension Fund

NJ has been diverting billions of dollars from its pension fund for state and local workers to other government purposes for the last 15 years. It has also been using a variety of unorthodox transactions to hide the sleight of hand. For example, in 2005, NJ put either $551 million, $56 million or $0 into its pension fund for teachers. The state records the $551 million contribution in a bond offering. The $56 million dollar figure appeared in an audited financial statement. The $0 appeared in an actuarial report. How much money is in NJ's pension fund? Nobody seems to know for sure.

ACS Going Private? This time for real!

Story 1

Affiliated Computer Services Chairman Darwin Deason has joined with investment partner Cerberus Capital Management in a cash bid to take the troubled business process outsourcing company private. Cerberus has put an offer on the table to take ACS private in a US$5.9 billion buyout. That translates to $59.25 per share, a 15.5 percent premium over the ACS closing price on Monday of $51.29.

ACS has been a likely acquisition target for some time. It has been beleaguered by a backdated stock options investigation that cost the company millions of dollars and prompted the resignation of two top executives last year. Also, its image was tarnished after it languished on the market when it failed to be acquired by private equity investors at the end of 2005.

Little wonder then that the market loves the proposed deal. Shares of ACS were up 16.8% to $59.91 a share on Tuesday after Dow Jones reported that the private equity fund and ACS Founder Darwin Deason planned to buy the company. "The reaction in the market is interesting, because it has pushed the stock price above the takeover price. This is somewhat unusual. Normally, one might expect to see the stock move higher, but not quite to the takeover price -- since there is always a risk of a deal falling apart." In this case, it appears that investors are confident that ACS will fetch the full buyout price. The Dow Jones report indicates that Citigroup is funding the deal and has issued a letter stating that it is highly confident that it will obtain the necessary financing.

Story 2

New questions have arisen about the stock option backdating practices at ACS. An internal probe blamed the backdating on two ousted former executives and another former CEO. No other company executives or directors were involved, according to the company. But a handwritten note by ACS Chairman and founder Darwin Deason discussing the practice of "always" picking the "lowest prices" in a quarter to award stock options puts those assertions in question. Attorneys for Mr. Deason say the note does not imply backdating, nor does the note imply Deason did anything illegal. News of the note comes at a sensitive time. Earlier this week, Deason joined with Cerberus Capital Management to make an offer to take ACS private. Some observers have questioned whether Deason is trying to scoop up the company at a bargain price while its stock is depressed. (The Wall Street Journal, 22-Mar-2007, Midwest ed., p. A4)

NJ Pension Underfunding Substantially Understated

Douglas Love, a prominent member of the council that oversees investments by New Jersey's public pension funds, contends the state has been vastly underestimating how much money it should have to pay for retirement benefits promised to employees. Love says the state has been using inappropriate methods to calculate the value of the benefits promised. He says benefits already earned total $132 billion or more - substantially higher than the $91 billion officially reported. He says a more realistic calculation of the unfunded liability is $56 billion -more than three times as much as the $18 billion included in a recent state report.

HP Pension Plan

Hewlett-Packard will be phasing out its defined benefit pension plan for new employees and replacing it with a 401(k) plan.

Post-Retirement Health Benefits

According to new GASB rules, all 50 states as well as the United States' largest cities will soon have to disclose the value of health care benefits promised to retired workers. That has many governments scrambling. Cities and states that have already calculated the numbers don't like what they are seeing. The numbers are alarmingly higher than expected. Taxpayers are angry. Bond ratings are imperiled.

[NYT]

From the Washington Post

The US has a bad habit of building in areas that don't make sense environmentally or actuarially. That habit has been aided and abetted by public officials who bend to the will of developers and their customers, despite storms, floods, earthquakes and other natural calamities that destroy lives and break banks. The latest example of this can be found in Florida. By rolling back insurance rates, spreading the risk and fiddling with its catastrophe fund, the Sunshine State has invited more development in dangerous places.

Florida is the country's first pin in hurricane alley. The major storms of the 2004 and 2005 seasons and their respective $20 billion and $10 billion payouts sent the insurance industry fleeing from the state. Those that stayed either stripped high-risk policyholders of coverage or jacked up premiums. So here's what the state government did: The state-run insurer of last resort, Citizens Property Insurance Corporation, which is also the state's largest property insurer, rolled back planned rate increases. It will try to spread the risk by offering other policies, such as fire and theft. And it will offer its subsidized rates to commercial property. We live in an era with the potential for destructive storms. Everyone - from politicians to the voters they aim to please - must understand that there is a cost to offering below-market insurance that fuels unrestrained building in high-risk areas.

State Farm retreats in Gulf

State Farm retreats in Gulf; won't offer new policies in Mississippi. State Farm's decision Wednesday to stop writing new home and commercial policies throughout Mississippi could prompt other insurers to retreat further from the Katrina-battered region, industry groups and legal experts say. State Farm — which insures about one of every three Mississippi homes — is the first company since Hurricane Katrina to stop offering new policies throughout a state in the Gulf Coast area. Its move underscores the precarious nature of the region's insurance. Since the hurricane, insurers have cut back on homeowner policies in affected coastal areas. The decision Wednesday is one State Farm came to "reluctantly," says company spokesman Phil Supple, partly because of the torrent of lawsuits and rulings in Mississippi since Katrina and the uncertainty of pending legal battles. The move doesn't affect existing policyholders, at least for now.

This morning there was a story on CNN where some talkinghead was making a big stink about how this was unfair. I don't understand.

Here's how I see the matter. State Farm obviously is in the insurance business to make money; surely nobody expects them to write unprofitable business. Insurance in hurricane-prone areas is unprofitable, prompting State Farm to pull out. One's first thought might be that rather than pull out State Farm could instead try to make the business profitable by raising prices (although that might prompt the talkingheads to call *that* unfair).

So why doesn't State Farm raise prices? Because the market won't bear it. Essentially the economics of the matter are that homeowners in hurricane areas want the perks of living by the water, etc., without collectively assuming financial responsibility for the casualty losses that accompany this decision. Clearly homeowners in areas not subject to hurricanes are not going to accept higher premiums which would essentially subsidize those living in hurricane areas. Hence, the only economically viable decision is to pull out. Eventually, the supply of insurance dries up and prices will go up. Economics 101. Why are CNN and other news sources are acting like something horrible is going on here?

New Position at Hewitt - SVP of Corporate Development & Strategy

Hewitt Associates today announced that it has appointed Matthew Levin to the new management position of senior vice president, corporate development and strategy, effective immediately.

That will certainly add fuel to the fire of the rumors that Hewitt is planning to divest its HRO business.

Matt Levin's resume:

IHS Group - September 2004 to September 2006 - Senior Vice President of Corporate Development and Strategic Planning, in which role he was responsible for 10 (very small) acquisitions as well as the company's 2005 IPO

Hudson Highland Group - July 2003 to September 2004 - global operations officer for the human capital solutions business (quite a step up from his previous job at Sibson)

Management consultant (about 2 years) specializing in strategic planning and organizational effectiveness at Sibson & Company, which back then was a unit of Nextera Enterprises and is now a unit of Segal

Graduate of the First Scholar Program at First Chicago (now JPMorgan Chase), where he worked (about 2 years) in corporate finance covering the energy and media industries

MBA from the University of Chicago, BA from Northwestern University

Some additional background that may be of interest:

Steven Denning, Chairman of the investment firm General Atlantic LLC, sits on the boards of both Hewitt and IHS. General Atlantic is IHS's largest shareholder (14.3%) and Hewitt's second largest shareholder (13.3%).

Schwarzenegger reverses direction

California Gov. Arnold Schwarzenegger proposed a sweeping plan to mandate universal health care in the nation's most-populous state, putting forth measures that would require employers to pay into the health-care system as well as tax hospitals and doctors to help offset medical coverage's spiraling costs.

[The whole story can be found in today's WSJ.]

Last year, Schwarzenegger vetoed a bill by California's Democrat-controlled legislature that was not much different from what he is now proposing himself.

CRUSAP publishes final report

www.crusap.net

A lot of the sillier recommendations did not make it into the final draft. That's good. The ridiculously over-long 13-page executive summary is now 15 pages long. That's bad. Who said actuaries are bad communicators?

CRUSAP

Critical Review of the U.S. Actuarial Profession

The main paper is 72 pages long; the executive summary is 13 pages. No wonder so many people think actuaries are poor communicators.

It's a very worthwhile read, though, if you are interested in the "State of the Profession." Comments are welcome through October 31st.