GM, Nortel...Public Pensions?

At an event last night, somebody remarked to me that he would not be confident as a participant in a public pension; this from an individual who earlier confessed that in the past he was envious of friends who were teachers and their pension plans.

At issue is a lack of confidence in the entire retirement system and the individuals running pension assets. Also at issue is the lack of knowledge of risk on an integrated basis: risk which includes both assets and liabilities. Finally, with respect to public plans, at issue is the ability to beat an inflation-tied liability.

Is my friend's fear justified?

Partial Solution to the Pension Crisis

Recent headlines include CPP cutting benefits for those retiring before age 65, while BP is closing their defined benefit plan to new employees due to adverse results arising from (among other obvious issues) increased life expectancy.

I have held to the notion for a long time that the only way my peers and I will ever see benefits from CPP is if the retirement age is raised. It is only after reading about BP's situation that I realize this is a necessary fix for all DB plans. Some other side benefits incude:

• allowing defined contribution participants extra years to make up for recent poor performance
• demographically, it keeps more participants in the work force which will reduce the strain we will find ourselves in as baby boomers retire
• for US participants, reduced health care costs as active members of the work force are less likely to complain of ill health
• adjust to the new realities of longer life span
  

The solution must be implemented gradually, but to me it is obvious that beginning in 2010 the entire world should begin a 5 year campaign of raising the legal retirement age to 70. Anyway, when was the last time you saw an ad for "Freedom 55"?

GM Pension

Who else out there is concerned about the precedent the GM pension bailout creates?

If you were a member of a company on the verge of bankruptcy with an underfunded plan, what would you think?

S&P Resistance

200 d moving average proved too formidable and I suspect we test the lows over the summer. May not be lead by financials this time, but I would look to hedge downside risk here.

GM Pension

In case anyone has missed it, pensions have become the centrepiece of negotiations on GM's potential bailout.

I understand why the unions have negotiated so hard for better pensions; what I am not sure is why they were so comfortable with the risks in the plan as of a year ago. The plan's deficit apparently exploded from 4.5B to over 7B under the watchful eye of the Investment Committee, GM executives and union representatives.

The lesson from this saga is clear (even if the provincial or federal government participate in teh pension bailout): union representatives must oversee all aspects of compensation for their members. This surely includes monitoring the future viability of those benefits. Time for union officials to read up on pension fund risk.

VAR

Is VAR broken? Frequently debated, it is the equivalent of trying to determine whether the entire past 10 years of financial innovation has been a mere column of smoke. The answer is Yes and No. It really depends on the application and the user.

Let's take an example of a firm that used a 95% VAR so that 1 day in 20 the P&L should exceed the VAR number in terms of gains and losses. This firm saw over the end of 2007 20 days in 60 where P&L exceeded VAR and 18 of the 20 times it exceeded VAR in the plus column. Management chose to ignore this fact because gains are far more appreciated than losses and why stop a trader on a roll. Management consciously avoided tough risk management decisions - can we really blame VAR for this failure?

VAR is not a holy grail. There are many shortcomings due to the many assumptions in the number. But much of the blame for VAR should fall on the shoulders of management who did not understand or chose to ignore the many signals that VAR was giving.

UTAM

The Globe has a revealing piece on University of Toronto Asset Management. Surely this is a debate throughout North America:

• are previous asset management methodologies no longer tenable?
• were 2008 returns predictable or within model expectations?
• do we fully appreciate risk?
• in an effort to make finance more quantitatively elegant have we made assumptions that are unrealistic?

Basically, is the model broken?

While I think we all recognize that many assumptions in our models are unrealistic, the real question is do we adjust for it? Are we equipped to interpret the data provided by our risk management systems and then make the mental adjustment for where we intuitively realize the risks in our portfolio exist?

In your organization: does management really understand the numbers put out by the risk system and do they know the limitations of said numbers?