OPEB Trust Creation, Implementation, and Management and Hybrid DB-DC plans

Transcription

1 OPEB Trust Creation, Implementation, and Management and Hybrid DB-DC plans Asset Management LLC San Francisco CA Los Angeles CA April 20, 2011 CMTA Presented By: Girard Miller, Senior Strategist Asset Management

2 Agenda I. Creating an OPEB Trust II. Management of an OPEB Trust 1

3 Creating an OPEB Trust Types of Trusts Rationale and Structure Governance Considerations Role of Advisor(s) T P E S O T Y P E S F T 2010 Asset Management LLC 2

4 Types of Trusts VEBA 401(h) Section 115 Structure Voluntary adoption by employers Separate account under pension trust Governmental trust No IRS Approval Required No IRS Annual Filings No Contribution Caps Accounting and Nondiscrimination Flexibility Investment Earnings Nontaxable Benefits Non-taxable 2010 Asset Management LLC 3

5 Common OPEB Trust Components Regardless of Governance Model Governing Body Authorization to Create the Trust OPEB Trust Document Tax ID Number Private Letter Ruling (not required but some employers prefer) Investment Policy and Asset Allocation Hire Custodian Form W-9 Authorized Signers 2010 Asset Management LLC 4

6 OPEB Trusts Why Create an OPEB Trust? Provide systematic long term funding for retiree medical benefits Improve the balance sheet impact of GASB 45 and reduce your ARC Receive employee contributions to mitigate employer costs (Big deal in The New Normal Economy and pension-reform era) For Trust assets to be considered as directly offsetting the OPEB liability: Assets must be remote from creditors Assets must be for the exclusive benefit of participants and beneficiaries Implications on Trust Governance Models Generally, it is expected that assets will be deemed to be remote from creditors if they are controlled by someone other than the governmental entity. Generally, two options are most prevalent in fulfilling this goal: Trust asset investment is directed by a trust board with substantial representation of outside or unaffiliated members not commonly used in California except CERBT Trust assets are held by a bank trustee and managed by a discretionary manager or at direction of an oversight body 2010 Asset Management LLC 5

7 Non-Discretionary Advisor (Consultant) Model Not typically a fiduciary overseeing holding of assets Fiduciary with direct responsibility for investments Not typically a fiduciary over all aspects of investments Provides independent valuation of assets 2010 Asset Management LLC 6

8 Discretionary Manager Model Fiduciary overseeing holding of assets General Oversight, but no direct investment duties Fiduciary overseeing investment functions Provides independent valuation of assets 2010 Asset Management LLC 7

9 Differentiated OPEB Trust Components Non-discretionary Model Initial Responsibilities Create Governance Charter Create By-Laws Board Member Selection (with substantial/majority of unaffiliated members) Hire Investment Managers (Two to Ten) Ongoing Responsibilities Periodically Review Results Hire/Fire Investment Managers Report to Governing Body Discretionary Manager Model Initial Responsibilities Hire Discretionary Manager (One) Ongoing Responsibilities Periodically Review Results Hire/Fire Investment Managers Report to Governing Body 2010 Asset Management LLC 8

10 Management of OPEB Trust 2010 Asset Management LLC 9

11 Alternatives for Investing OPEB Assets Operating Funds & Reserves Typical state investment guidelines Fixed income securities allowed under California Code including: Treasuries Federal Agencies High-quality corporate securities Municipal notes Money market funds Local Government Pools Investment procurement Self-directed Investment advisor OPEB Assets in Irrevocable Trust Typical trust investment guidelines under California Code Fixed income securities Equities Real Estate International securities Inflation-protective assets Investment procurement Other investment alternatives Managed programs Separate accounts Mutual Funds Self-directed investments 2010 Asset Management LLC 10

12 Investment Alternatives: Role of Advisor Discretionary Program Complete, turnkey solution including trustee, investment management and custodial services Discretionary advisor makes all manager selection and rebalancing decisions Broad asset allocation and access to institutional asset managers Competitive all-in pricing Common model for OPEB management in California Non-discretionary Program (Investment Consulting) Requires stricter legal separation of trust from employer to invest in equities Greater ongoing involvement required by the governing board of the trust Broad asset allocation and access to institutional asset managers Service provider choice Not often seen in California plans under $100 million in assets 2010 Asset Management LLC 11

13 Asset Allocation Strategies One size fits all Example: CalPERS CERBT Over 70% in equities, allocated similar to pension fund Assumes all employers have similar risk profiles, objectives, demographics and benefits structures Yet prior Governor s own commission reported that one size does not fit all Cookie cutter allocations Vendor offers selection from model portfolios or prepackaged allocations E.g., conservative, aggressive portfolio blends Usually driven by feel and not quantitatively grounded Can simplify the process and provide rough justice or good enough for government solutions Customized asset allocation Every employer establishes a unique strategy and allocation More labor intensive but more precise and defensible for fiduciaries 12

14 The Case for Custom-Fit Asset Allocations Customized asset allocations begin with the numbers: Starts with an asset-liability analysis Portfolio decisions should align with the plan s liability structure This protects the plan sponsor from claims of underperformance based on cookie cutter solutions For example, why would a plan with 50% or more of its liabilities aligned with retirees with an average expected life of 9-10 years invest 74% of its portfolio in stocks, equities, and real estate? Would any rational and prudent financial adviser suggest to a 65-year old that a portfolio like that is suitable under FINRA regulations? Asset allocation decisions then take into account employer s specific risk tolerances and perspectives Advisor then interacts actively with your decision-makers to develop a customized Investment Policy Statement with appropriate asset allocation targets and ranges 2010 Asset Management LLC 13

15 Case Study: Asset Liability Analytics Vested Participant Liabilities Unvested Participant Liabilities $14.6 million 56% $11.8 million 44% Multi Asset Class Managed Fixed Income / Cash Observation: CalPERS and other cookie cutter asset allocations do not fit this fact set 2010 Asset Management LLC 14

16 Another Employer s Participant Profile AAL Based on 200x OPEB Valuation 2010 Asset Management LLC 15

17 Migration Investment Strategy Initial Employer Contribution Baseline Initial Contribution Equity Fixed Income Cash Equivalent Active Participants 70% 30% 0% Retirees < 65 years 50% 40% 10% Retirees > 65 years 20% 65% 15% Combined 55% 40% 5% Cash Equiv. 5% Fixed Income 40% Domestic Equity 31% International Equity 19% Other Equity 5% 2010 Asset Management LLC 16

18 Migration Investment Strategy Ongoing Future Contributions Reflect Demographics Ongoing Contributions Equity Fixed Income Cash Equivalent Normal Cost 70% 30% 0% UAAL Active Participants 70% 30% 0% Retirees < 65 years 25% 25% 50% Retirees > 65 years 0% 50% 50% Combined 60% 32% 8% Cash Equiv. 8% Fixed Income 32% Domestic Equity 33% Other Equity 6% International Equity 21% 2010 Asset Management LLC 17

19 Migratory Asset Allocation Example 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Year 0 Year 5 Year 10 Year 20 Year 30 Equity Fixed Income Cash Equivalent Year 0 Year 5 Year 10 Year 20 Year 30 Projected Return 7.94% 8.03% 8.05% 8.07% 8.08% Standard Deviation 9.37% 9.58% 9.64% 9.69% 9.70% Projected returns are based on Investment Committee long-term asset class projections. Standard deviations are based on the historical standard deviation of the underlying asset classes and do not take into consideration actual portfolio holdings Asset Management LLC 18

20 Migration Investment Strategy Analytics A conservative initial funding level can still produce satisfactory returns Initial Contribution Strategy Ongoing Contribution Strategy Asset Allocation Domestic Equity 31% 33% International Equity 19% 21% Other Equity 5% 6% Fixed Income 40% 32% Cash Equivalent 5% 8% Risk / Return Statistics Projected Return 7.94% 8.14% Standard Deviation 9.37% 9.85% 10 Year Projections 67th Percentile Returns 9.38% 9.65% 50th Percentile Returns 7.94% 8.14% 33rd Percentile Returns 6.81% 6.96% Probability of Returns > 7.75% 55.30% 57.75% Projected returns are based on Investment Committee long-term asset class projections. Standard deviations are based on the historical standard deviation of the underlying asset classes and do not take into consideration actual portfolio holdings Asset Management LLC 19

21 Building the OPEB Trust s Long-term Portfolio Construction RETURN Treasury Mortgage Agency High Yield Corporate Small Cap Equity International Equity Large Cap Equity RISK 2010 Asset Management LLC 20

22 Illustrative Portfolio Planning Tool - survey Task Benefit Customized portfolio questionnaire designed to assist staff and Committee members in gaining consensus around investment and financial decisions Catalyst for interactive discussion between, Staff and Committee members Achieve expectations for future portfolio strategy and manager decisions 1. How often are you prepared to accept the probability of a loss of greater than ( 10%)? Once every? a. Three years b. Five years c. Ten years d. Other 2. Another measure of risk tolerance is the extent to which the fund s financial decision makers are comfortable with year to year volatility of investment returns. How concerned are you with variability in the market value of the pension fund? a. Very concerned with variability in the fund value b. Somewhat concerned with year to year variability, but more concerned with long term growth c. Focused on the long term growth of the fund, unconcerned with short term variability 3. The time frame selected to meet your return goal will affect your ability to do so. Due to the cyclical nature of the market, the longer the time frame, the more likely you are to meet the goal. This is because market upswings and downswings will average out. What period of time do you think is reasonable to wait to achieve your return goal? a. Three years b. Five years c. Ten years d. Market Cycle 4. Investment "risk" can be viewed in many different ways. Please circle any of the following which most closely define your view of risk. a. The possibility of not achieving a targeted rate of return. b. Wide swings in the market value of your portfolio over short (1 year) periods of time. c. Wide swings in the market value of your portfolio over long (3 years) periods of time. d. Loss of principal 2010 Asset Management LLC 21

23 Illustrative Asset Allocation Analysis Task Benefit Creation of customized portfolio options specific to the goals, objectives and risk tolerances of each entity Quantify trade-off between risk and return to create efficient portfolios Extend diversification of investment strategies and money managers Portfolio and organization/headline risk management 20% Distribution of Projected 5 Year Returns Expected Return % 14.9% 17.8% FRONTIER BASED ON HISTORICAL ASSET CLASS RETURNS International Equity Large Cap Domestic Equity Small/Mid Cap Domestic Equity Return (%) 10% 5% 12.4% 9.2% 7.0% 4.9% 12.2% 10.6% 8.7% 7.9% 5.3% 5.4% Portfolio 3 Real Estate Portfolio 2 Portfolio 1 FRONTIER BASED ON ADVISORS LONG-TERM PROJECTIONS Commodities 5.5 0% 2.0% 1.5% 0.5% Conservative Balanced Aggressive 5.0 Aggregate Fixed Income Standard Deviation (Risk) 2010 Asset Management LLC 22

24 Illustrative Investment Manager Selection Task Benefit Due diligence and selection of best of breed investment managers for each component of asset allocation on a global basis Achieve scale in investment research and due diligence Leverage brand and assets under advisement to gain access to top managers at lowest cost LARGE MID SMALL Fiduciary All Cap Value VALUE 2010 Asset Management LLC SAMPLE CLIENT US EQUITY LINEUP Cornerstone Advisors Frontier Capital Appreciation Ironbridge Small Cap Core CORE Times Square Mid Cap Growth GROWTH Manager Due Diligence in: U.S. Equity International Equity Fixed Income Commodities Real Estate Hedge Funds Private Equity Real Assets Emerging Markets Etc. 23

25 Establish Communication and Reporting Standards Monthly statements from Custodian Regular Manager and Strategy Updates Quarterly Performance Reporting Include: Capital market review Plan performance Manager performance Detailed Manager Analysis Ongoing Trustee Education Annual Investment Policy Review 2010 Asset Management LLC 24

26 Summary When setting up an OPEB Trust Ensure that the trust and governance documents are appropriate for you Clearly separate the trust and asset management from the employer to protect assets from creditors Create an investment policy that takes your specific liability profile into account, if your plan profile is not average Separate church and state and assure checks-and-balances with clear functions of advisors, managers, custodians, trustees, etc. Balance simplicity with good governance When managing an OPEB Trust Make sure you have a competent investment manager/advisor to help mitigate your potential liabilities Decide if your manager/advisor should migrate the asset allocation to match the liability profile over time Monitor your manager/advisor for compliance with your investment policy 2010 Asset Management LLC 25

27 Hybrid DB-DC plans: What to consider For pensions CalPERS has minimum DB option at 1.5% Social Security compliance issues Need greater flexibility DC providers can be same as 457 IRS is reviewing Orange County request to permit current employees to transfer: constructive receipt issues For OPEB DC may be best option for new hires Hybrid has potential for current employees Beverly Hills buyout strategy could provide a template Limited DB benefit in a hybrid could be a 20 year service reward from employer with a DC component for employees Will DC plan cannabilize employee contributions in short run? 26

28 Hybrid DB-DC plans Plan design expertise is helpful Very few knowledgeable municipal experts in both pension and OPEB space Will frequently involve labor relations work also Likely to be an emerging industry once revenues perk up Hybrids will likely be the Goldilocks solution for future years Need comprehensive solutions, not partial solutions 27

29 Questions? Girard Miller CFA

30 Disclaimers Any investment advice in this document is provided solely by Asset Management LLC. Asset Management LLC ( AM ) is an investment advisor registered under the Investment Advisers Act of Advisors is a division of Asset Management LLC. Public Financial Management Inc. is not providing and is not responsible for any investment advice herein. This material is based on information obtained from sources generally believed to be reliable and available to the public, however Asset Management LLC cannot guarantee its accuracy, completeness or suitability. This material is for general information purposes only and is not intended to provide specific advice or a specific recommendation. All statements as to what will or may happen under certain circumstances are based on assumptions, some but not all of which are noted in the presentation. Assumptions may or may not be proven correct as actual events occur, and results may depend on events outside of your or our control. Changes in assumptions may have a material effect on results. Past performance does not necessarily reflect and is not a guaranty of future results. The information contained in this presentation is not an offer to purchase or sell any securities Asset Management LLC 29