What is Critical and Declining Status?

If you are a participant in the Musicians’ Union Pension, the AFM-EPF, you may have received an email this week that said that thanks to good investment performance, the plan would remain in Critical status but not move into “Critical and Declining” status. The message notes that it is still possible that the plan will become “Critical and Declining” next year or in the future. What does this mean to the future of the plan if you are an active participant or a retiree? Here’s what you need to know.

The US Department of Labor’s Employee Benefit Security Administration (EBSA) is charged with enforcing ERISA regulations regarding retirement plans, including multi-employer pension plans, such as the AFM-EPF. Under ERISA Code Section 305, multi-employer plans which are underfunded fall into three categories. Here is a simplified summary:

  1. Endangered Plans have a funded percentage under 80%. They are required to adopt a Funding Improvement Plan to increase the plan’s funded percentage.
  2. Critical Plans have a funded percentage under 65%. Plans in Critical Status (“red zone”) must implement a Rehabilitation Plan which will enable the plan to emerge from Critical Status.
  3. Critical And Declining is reserved for plans which are projected to become insolvent within 15 years (or in some situations, 20 years).

The current 2016 Rehabilitation Plan from the AFM-EPF indicates that Milliman (the plan actuaries) now projects that the plan will not emerge from Critical Status. The steps taken in 2010 will not be sufficient for the plan to remain solvent.

Once a plan is in the Critical And Declining category, the plan administrators are allowed (but not required) to reduce current and future benefits in order to try to save the plan or increase the amount of time that assets will last. They can reduce benefits to no lower than 110% of the Federally guaranteed minimum under the Pension Benefits Guarantee Corporation (PBGC) rules. Please read my previous article on how to calculate the PBGC guarantees.

As independent fiduciaries, I believe the pension administrators would legally need to consider reducing payouts, even to current retirees, if the plan was labeled as Critical and Declining. Their duty would be to try to save the plan. Needless to say, no one wants to see the pension cut payouts which were promised to participants and retirees. However, the actuaries have already said that the Rehabilitation Plan is not going to work and we should now take “reasonable measures to forestall possible insolvency.”

If you are 80 years old, you might not live to see the plan terminate. But if you are 50 years old, the plan might be taken over by the PBGC before you retire and then you may face a big cut in benefits. For active participants, you would want cuts now to try to save the plan or delay for as long as possible its insolvency. Current participants are already receiving less than 1/4 the payout, $1 versus $4.65, for every $100 contributed compared to contributions made before 2004.

For a retiree, however, having the pension renege on the payment they were promised could be financially devastating. At least the current participant has the option of working longer or getting another job. But in the end, if the plan becomes insolvent, all participants will be reduced to the PBGC payout regardless of what we had been promised or had “earned”.

Unfortunately, there is no easy solution to this mess. We are seeing the same situation in pensions around the country, not just multi-employer plans, but also municipal plans like the Dallas Fire and Police Pension, and even Social Security faces insolvency in less than 20 years. The Pension Industry made fatal mistakes in what they thought they could provide and now participants are going to be left holding the bag. There are only two choices, reduce payouts or increase contributions. But the amount of increases that would be needed to make pensions whole is unfeasible, so I believe we will be forced to accept cuts at some point in the future. The question is whether we will make these changes in a deliberate, well-planned manner, or if we are going to continue to deny the problem until the ship has sunk.

What Would Happen If The AFM-EPF Fails?

Pensions offer what may be the ideal source of retirement income. I have written a number of times about the critical status of the American Federation of Musicians Employer Pension Fund (AFM-EPF), a multiemployer pension plan which covers 50,000 professional musicians in America. Given that the Actuaries do not believe that their rehabilitation plan will enable the plan to emerge from critical status, you may wonder: What would happen to your pension if the plan were to terminate or fail?

The AFM-EPF is covered by the Pension Benefit Guaranty Corporation, a federal agency that was chartered to protect pension plan participants. The PBGC is funded through required employer contributions and receives no tax dollars.

Even though the pension plan is insured, there are limits on the amount of coverage available to individuals through the PBGC. If a plan terminates and you are vested, but not yet retired and receiving benefits, you would be covered only for your currently vested benefits and would not receive any further credit for future work. This is important: The PBGC will only cover vested benefits and a plan termination will halt the accrual of future benefits.

If you are retired and already receiving benefits, the PBGC has limits on the monthly benefit they would cover. If a plan terminates and is taken over by the PBGC, you could see your monthly benefit drop by a significant amount. The PBGC provides different levels of coverage for single-employer plans and multiemployer plans. All the information below relates to multiemployer plans, such as the AFM-EPF.

(If you are also a participant in a single-employer plan, you can find information on PBGC coverage here: PBGC Monthly Maximum Tables.)

For participants the AFP-EPF, your maximum coverage under the PBGC is based on your years of service. If your pension benefit is above the monthly guaranty amount, and the plan were to fail, your benefit would be reduced to the PBGC maximum. Here’s how the PBGC calculates their coverage:

PBGC formula for Multiemployer Plans
100% of the first $11 of monthly benefits,
Plus 75% of the next $33 of monthly benefits,
Times the number of years of service.

The maximum monthly benefit under the PBGC then is $35.75 times the number of credited years of service. For example, if you were a participant for 30 years, your maximum benefit would be $1072.50 a month, or $12,870 a year. And in order to get $35.75 from the PBGC, you’d have to be receiving at least $44 from the pension. In other words, to get the PBGC benefit of $12,870 a year, your pension benefit amount would need to be at least $15,840.

Please note that this example is based on 30 years of service; if you had more or less than 30 years of service, your benefits under the PBGC could be higher or lower. The amounts for Multiemployer plans are not indexed for inflation and do not receive Cost of Living Adjustments. There is no plan to increase these amounts. Link: Multiemployer Benefit Guarantees.

Musicians need to have multiple legs on their retirement plan: pension, Social Security, investment accounts including IRAs, and other sources of income. If you try to have a plan that rests entirely on one leg, you are potentially asking for trouble. The trustees of the AFM-EPF are looking to forestall possible insolvency, but the plan actuaries do not calculate that the plan will ever recover to a fully funded status. In your planning, please consider not only the benefit offered by the EPF, but also make sure you understand and calculate what your benefit would be if the plan were to terminate and be taken over by the PBGC.

AFM Pension Plan Slide Continues

Participants in the AFM Employers’ Pension Fund (AFM-EPF) received the annual funding notice and notice of critical status this week. Unfortunately, this year’s report is not good, and this notice does little to explain why.

Each year, pension administrators are required to evaluate their plan’s “funded percentage” as a measure of the plan’s financial capacity. The funded percentage is the actuarial value of the plan’s assets divided by the actuarial value of its liabilities. A funded percentage of 100% or higher would indicate a fully funded plan. Our plan has been in critical status since 2010, as have many plans, following the crash of 2008-2009 which greatly impacted asset values.

Two years ago, the AFM-EPF, reported a funded percentage of 85.7%. This declined to 81.6% last year, and then to 76% this year, which means that the plan presently has only 76 cents for every dollar of future benefits promised. The funded percentage is based on “actuarial” values, which means that these numbers are actually adjusted to smooth out stock market fluctuations and to discount future benefits back to today’s dollars. Also alarming is a large decline is the actual, “fair market value” of assets.

The fair market value of plan assets sat at $1,823,000,326 as of 3/31/2014, and stayed fairly level over the following year, to $1,818,080,945 as of 3/31/2015. Over the past year, however, assets declined by $114 million to $1,703,971,000, a drop of over 6%. During the most recent plan year (April 1, 2015 to March 31, 2016), the S&P 500 Index delivered a total return of 1.78%, so this wasn’t due to a terrible stock market environment.

It is also worth noting that the fair market value of assets is substantially lower than the actuarial values. As of April 1, 2015 (the most recent value made public), the actuarial value of assets was listed as $2,066,699,976, or $248 million more than the fair market value. That is a quarter billion dollars in smoothing! Over time, as we get further away from 2009, this gap should narrow. The actuarial values should eventually decline towards the fair market values – meaning that the funded percentage is unlikely to improve significantly even if the market performs strongly next year.

Over this same time period, the actuarial value of liabilities has been steadily increasing, from $2.39 billion in 2013 to $2.46 billion in 2014 and $2.53 billion in 2015. Increasing liabilities and decreasing assets are why the funded percentage has worsened.

One of the most significant changes to the plan has been dramatic reduction in the Benefit Multiplier. Put bluntly: the current participants are going to receive less than one-quarter of the benefits promised to previous beneficiaries and are going to bear the pain of the rehabilitation plan, while older participants will still receive their full benefits. Over time, the lower Benefit Multiplier should help improve the funded percentage.

The Benefit Multiplier is used to calculate a monthly payment for each $100 that has been contributed to the plan in your name. The multipliers below are all for retirement at age 65, and contributions earned in the following dates:

  • Before 1/01/2004: $4.65
  • Between 1/01/2004 and 4/01/2007: $3.50
  • Between 4/01/2007 and 4/01/2009: $3.25
  • Between 4/01/2009 and 1/01/2010: $2.00
  • After 1/01/2010: $1.00

Over this time period, the monthly benefit fell from $4.65 per $100 contribution to $1.00. I have to admit, I am baffled how the old payout was ever going to work. Someone who had $100 in contributions in 2003 and retired in 2004 at age 65 would get $4.65 a month, or $55.80 a year for the rest of their life? From $100?

I studied Pension Accounting in the CFA Program, and I understand how these decisions were made. The assumptions are crucial decisions. They assume a rate of return, a number of new and retiring participants, wage and contribution growth, and even the life expectancy of the average beneficiary. Unfortunately, many of these assumptions have proved overly optimistic, not just for the AFM-EPF, but for many pension plans. The rate of return has been lower in stocks since 2000, and is going to be much lower in bonds, going forward. Participants are living longer than the mortality tables (created decades ago) predicted. Growth in contributions and inflation make what seems like high pension payments possible in the future. Unfortunately, employers in music – specifically orchestras and the recording industry – are not areas of high contribution growth either in the number of musicians employed or in covered wages.

The EPF created the Rehabilitation Plan in 2010, which the Actuaries originally thought would enable the plan to emerge from critical status by 2047. Today, they no longer believe that the rehabilitation plan will work, only that it should forestall insolvency for at least 20 years. Past 20 years, they say that it is difficult to predict. This is a troubling development, and it’s not information which was shared in the plan mailing. If you want to find this information, you have to go online and download the June 27, 2016 update to the Rehabilitation Plan. On page 9:

“Currently, Milliman does not project that the Plan will emerge from critical status. Accordingly, the objective of the Rehabilitation Plan is to take reasonable measures to forestall possible insolvency.”

What does all this mean to you?

  1. The plan remains in critical status, and may worsen. The plan actuaries now believe that the rehabilitation plan will not enable to the plan to emerge from critical status. The funded status would be even worse if they used the fair market value of assets rather than the actuarial value.
  2. The plan has already slashed benefits going forward, but may need to lower payouts further if they want to guarantee solvency.
  3. Each year that the funded ratio declines, we are closer to the eventual possibility that the plan will be taken over by the Federal Government, via the Pension Benefit Guarantee Corporation, or PBGC. Note that the PBGC provides a reduced benefit and has a maximum guarantee of $35.75 times the number of years of service. (For example, if you participated for 30 years, your maximum monthly benefit would be $1072.50, even if the AFM-EPF had planned to pay you $2,000 a month.)
  4. Even in the best case scenario, musicians who joined the plan since 2010 will receive a small fraction of the benefits paid to those who had earnings before 2004. Newer participants had better have other sources of retirement income.
  5. The conversation we are having now on the AFM-EPF, all Americans should be having about Social Security. It is also in jeopardy and will not work as originally designed. Benefits promised cannot be delivered. We must make changes, including lowering benefits, lifting the retirement age, and increasing personal savings.

I trust our AFM Leadership to take the steps to fix the EPF. As a multi-employer plan with contribution rates determined by hundreds of CBAs and union agreements throughout the country, increasing contributions further is not a feasible option. Getting the plan to be fully funded may require tough decisions about cutting benefits. If you are concerned about your retirement, whether it is next year or 35 years away, give me a call and we will create a plan for your needs and goals.

The AFM Pension Plan: What Every Musician Needs to Know

If you’re a professional musician in the US, you likely received your annual statement from the American Federation of Musicians Employers’ Pension Plan in the past several weeks. The main purpose of the mailing is to verify your Covered Earnings from the past year. Professional musicians often have basic questions about the AFM Pension, in part, because the annual statement doesn’t tell you very much about your personal situation other than your reported earnings and the amount your employer(s) contributed to the pension fund.