Switch to DC set to continue

More politics for state pension funds, more cuts for corporate defined benefit (DB) plans. This is year 2007 in a nutshell for the US retirement industry. With only one year away from the 2008 presidential election and a bullish Wall Street helping assets’ growth, state retirement systems feel less the pressure to improve their financial performances and more the need to get political credits.

On the other hand corporations are focused only on reducing their pension liabilities, by switching from DB schemes to defined contribution (DC) plans, like 401(k) plans.

The latest example of this trend for big corporations, after IBM and General Motors, is Citigroup, which has decided to freeze the DB plan that covers its 150,000 US employees
from 2008. At the same time the bank will give more to the alternative accounts: it will match up to 8% (from the current 3%) of annual salary for 401(k) contributions made by employees who earn less than $100,000 (€75,379), and it will provide them with free financial advice with Ernst & Young International. Bottom line, Citigroup will save $80m with the change.

Also in the case of a state pension fund there was an attempt to convert it into a private-sector-style 401(k)-type plan. Last November, in the race to the New York state comptroller’s position, the Republican challenger Christopher Callaghan proposed the switch and the Democratic incumbent Alan Hevesi rejected it as inadmissible.

The latter was confirmed, despite the scandal about his abuse of state money for his wife’s private chauffeur. More important, notwithstanding the fact that most state pension funds badly need a change, according to Thomas J Healey, senior fellow at Harvard University’s Kennedy School of Government.

Healey says that state pension programmes - which cover 12.8m Americans and manage assets worth $2.3trn - face a larger shortfall than corporate DB plans, which cover 44.1m participants but possess fewer assets, about $1.7trn.

He suggests that if state pension plans used as their discount rate the 10-year Treasury yield - at about 4.5%, instead of the current average 7.89% they can use - they would be only 64% funded (the current official figure is 86%).

One way to bridge the gap is to look for extra performance, for example investing more into alternative assets. This is the direction taken by the largest fund, California Public Employees’ Retirement System (Calpers), which manages $220bn (83% funded ratio according to the latest available estimates). Calpers has just decided to create a $500m pilot commodities investment programme “to further diversify the assets and take advantage of long-term market opportunities for positive returns in the resources sector”, explained Rob Feckner, Calpers board president. The programme will start with swaps and futures, but chief investment officer Russell Read said that in future up to 50% of Calpers private equity investments (currently at $13bn or 6%of its fund) could be concentrated in the energy and raw materials sectors.

Alternative investments with a political flavour are in Texas governor Rick Perry’s mind too.

The $100bn Texas teacher retirement system’s board is discussing Perry’s idea of “Texas investing in
Texas”: providing venture capital money - up to $600m - to early stage technology companies that already receive money from the Texas Emerging Technology Fund (TEMT), one of the governor’s key initiatives.

The TEMT was established by Perry in 2005 to boost Texas companies in industries of the future; most of its portfolio’s companies have little or no revenue. So some critics have attacked the proposal as “completely arbitrary”, especially because the Texas teacher pension fund has a $13bn shortfall and hasn’t increased benefits for retirees since 2001; the state pension fund should instead invest globally with the goal of producing the best returns, according to dissidents like Greg Poole, member of its board of trustees.

Actually the new chief investment officer Britton Harris IV, just hired by the Texas teacher retirement system, looks quite set to expand the alternative investment strategy; in fact he has a reputation as an aggressive investor with expertise in assets such as hedge funds and venture capital.

Social and political issues are top of the agenda of another big state pension fund, North Carolina’s ($70bn assets), whose treasurer Richard Moore is a likely Democratic candidate for governor in 2008.

He has decided to divest $24m invested in nine companies supporting the Sudanese government and consequently the Darfur genocide.

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