Pension Agency to Cut Its Stock Holdings

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Pension Agency to Cut Its Stock Holdings

By Mary Williams Walsh, The New York Times

January 30, 2004

Ten years after it adopted an "all equities" strategy, the agency that insures pensions has decided it has taken on too much risk and will reduce stocks to as little as 15 percent of its total investments.

The decision is a striking attempt to reinforce a pension system crippled by blows from seemingly all sides - from companies trying to escape costly old promises, from accounting rules that turn risky behavior into profit, from global rivals that do not offer pensions, from retirees claiming benefits longer than actuaries expected, from low interest rates, from money managers who promise too much.

The agency's shift is also a contrarian move, coming as debate continues about whether workers should be allowed to invest some of their Social Security money in stocks. And it is likely to fuel further controversy among pension specialists about whether stocks are an appropriate investment.

Steven A. Kandarian, executive director of the Pension Benefit Guaranty Corporation, said yesterday that he was not trying to tell companies how to invest pension portfolios. He said the goal was to make sure that as the government takes on more obligations from failed company pension plans, it has enough money to pay benefits.

"We're managing our assets against liabilities that we have to make good on down the road," Mr. Kandarian said in a briefing.

The inspiration, Mr. Kandarian added, comes from the most earthbound of sources: the insurance industry. When life insurers offer pensionlike investments, called annuities, they cover themselves by investing in bonds. The administration has concluded that if the pension agency does not do the same, taxpayers will have to pick up the slack.

"If we didn't match our liabilities, but just sort of shot for the moon, if you will, the taxpayer would be providing portfolio insurance for our bets in the market," he said.

The agency plans a gradual reduction in its stockholdings, so that after two years, stocks will make up 15 to 25 percent of its investments. The agency's portfolio was worth $33 billion at the end of 2003. Stocks account for 42 percent of that.

The agency acquired many of these stocks in the last two years, when it took over the assets of a record number of failed pension plans. As the agency has taken them over, its own financial strength has deteriorated sharply. Its growing deficit has raised concerns that taxpayers might eventually have to bail out the system.

Treasury Secretary John W. Snow, who holds one of the three seats on the pension agency's board, has likened America's pension system to the savings and loan industry in the 1980's. It collapsed in 1989, requiring a huge bailout.

By curtailing its stock investments, the agency can keep from going further out of balance itself, Mr. Kandarian said. The new emphasis on fixed-income investments will deprive the agency of big possible stock gains, he acknowledged, and it might eventually require an increase in the coverage premiums companies pay. But it will also protect against losses and a bailout.

The agency performs the same core tasks as a pension plan, investing money for people's retirements and issuing benefit checks. But even now, its portfolio is much less deeply invested in stocks than a typical corporate pension fund. Most funds are said to keep about 60 percent of assets in stock. Pension managers have relied increasingly on stocks ever since the law requiring companies to fund their pension promises was passed in 1974.

Stocks are favored on the theory that they will produce higher returns over time, allowing companies to offer pensions at lower cost. Unions have embraced this, knowing that if companies paid less into the fund, there might be more available for wages. Neither labor nor management was overly concerned about market risk. If the strategy failed outright, the government insurance program was there to cover the loss.

The recent, prolonged bear market has cast a long shadow over these widely held views. A small number of pension specialists have long argued that investing in stocks increases the risk of collapse - but as more and more pension funds have done just that, policy makers have listened with growing interest. Pension assets melted away after the stock market fell, but employees kept on retiring and claiming benefits, right on schedule. Most funds have survived, but those sponsored by struggling companies - especially those with lots of older workers or rich benefits - have not.

Fixed-income specialists have been urging both companies and the pension agency to immunize portfolios against any recurrence of that disaster, by investing in bonds with durations that match the dates when benefits must be paid.

Mr. Kandarian said the agency had concluded that this was the correct approach, given its mission as the backstop for company pensions.
"Most companies take a considerable amount of equity risk," he said. "That's an important point for us to think about, as we manage our equity risk."

Since companies hold a high portion of stocks in pension funds, he explained, the agency is effectively doubling its exposure to market risk if it continues to hold stocks itself.

The pension agency divides its investments into two trust funds. One, which holds the premiums received from companies that offer traditional pensions, is already invested exclusively in bonds. It will remain unchanged.

The other, worth about $17 billion, holds the assets the agency receives as it takes over collapsing pension plans. In 1994, the agency decided to shift this trust's investments heavily into stocks - a policy that looked smart in the boom years. About $4 billion of the investments in this trust are "transition assets," Mr. Kandarian said - investments still in the same form as when the agency received them from defunct pension funds. Those will be the first shifted to bonds.