Gary Trennepohl presents "Financial Markets in 2014: Story Projects" during the Reynolds Center for Business Journalism's annual Business Journalism Week, Jan. 5, 2014. Trennepohl is the ONEOK Chair of Finance at Oklahoma State University. The annual event features two concurrent seminars, Business Journalism Professors and Strictly Financials for journalists. For more information about business journalism training, please visit http://businessjournalism.org.

1. Financial Markets in 2014:
Story Projects
Strictly Financials
Jan. 5, 2014

2. Donald W. Reynolds National Center
For Business Journalism
At Arizona State University
Strictly Financials

3. n
Gary Trennepohl, Ph.D.
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ONEOK Chair and President’s Council Professor of Finance
Oklahoma State University
Trustee, Oklahoma Teachers Retirement System
Member, OSU Foundation Investment Committee
gary.trennepohl@okstate.edu
Strictly Financials

4. Story Topics for 2014
n
Public pension plans – their status and impact on
state and local budgets and services.
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Social Security and Medicare – what are the issues?
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Preparing financially for retirement
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Addressing U.S. tax reform and budget deficits
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Corporate governance, pension funds and activist
investors
Strictly Financials

5. PUBLIC PENSION PLANS – IS THERE
A COMING CRISIS IN YOUR
COMMUNITY?
Strictly Financials

6. Ten “Best” and “Worst” States for
Pension Funding*
n
The Best:
1.
2.
3.
4.
5.
6.
7.
8.
9.
Wisconsin
South Dakota
North Carolina
Washington
New York
Tennessee
Delaware
Florida
Wyoming
n
99.95%
96.3%
95.3%
93.7%
92.7%
91.5%
90.7%
86.7%
85.6%
*Tinkadvisor.com; Sept. 9, 2013: Based on Funded ratio %
Strictly Financials
The Worst:
1.
2.
3.
4.
5.
6.
7.
8.
9.
Illinois
Kentucky
Connecticut
Louisiana
New Hampshire
Hawaii/RI
Kansas
Colorado
Alaska
43.3%
53.4%
55.0%
56.2%
57.4%
59.2%
59.2%
60.0%
61.9%

7. Ten “Best” and “Worst” Cities for
Pension Funding*
n
The Best:
1.
2.
3.
4.
5.
6.
7.
8.
n
Vancouver, WA
Lincoln, NE
Portland, Maine
Milwaukee, WI/Cheyenne, WY
Knoxville, TN
Dover, DL
Chattanooga, TN / Montpelier,
VT
Charlotte, NC / Greenwich CN
The Worst:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Little Rock, AR
Chicago, IL
Aurora, IL
Charleston, WV
Reno, NV
Springfield MA
Bakersfield, CA
Stockton, CA
Saginaw, MI
Portland, OR
*Thinkadvisor.com; Nov. 4, 2013: Based on pension costs as a % of tax revenues
Strictly Financials

8. Two Principal Types
Of Pension Plans
Defined Benefit Plans (eg. most public plans)
Defined Contribution Plans (eg. 401Ks)

9. Defined Benefit Plans
n
Employer assumes obligation to pay retirement
benefits defined by formula.
n Retirement benefits determined by a
calculation:
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eg. = (years service*2%*avg. 3 yr highest salary)
Market risk is carried by the state sponsor
The investments are professionally managed.
No asset available to transfer to heirs.
Most public pension plans are of this type
Strictly Financials

10. Defined Contribution Plan
n
n
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Employer only assumes obligation to pay yearly % of
salary (eg. 6%) into employee selected investment
vehicle (think 401-k).
Individual bears the market risk and is responsible for
selecting investment vehicles.
Retirement benefits determined by performance of
investment choices.
Most newer corporate plans are of this type.
Value of assets becomes part of estate that can be
transferred to heirs
Strictly Financials

11. Typical Pension Plan Sponsors
n
State or municipal employee plans (almost all
are defined benefit plans):
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Teachers (K-12, community colleges, universities)
State employees
Firefighters and Police
Judges
Local union plans (usually defined benefit
plans) also called Taft-Hartley plans.
Corporate plans (most have converted to
defined contribution plans)
Strictly Financials

12. Actuaries are hired to evaluate
plans each year – they love it!
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They project future plan liabilities and income – key
factors are:
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Workforce demographics
Rate of return assumptions
Mortality rates – and we are living longer
Size of investment portfolio
COLAs – “cost of living allowances (eg. 2% a year)
They calculate the “ARC”, annual required
contribution, which is the amount that must be
deposited to the plan each year to fund the benefits
earned by participants that year.
Strictly Financials

13. Two Measures of Pension Plan
Health
n
The “Funded Ratio”
n
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The (“actuarial value” of assets)/(”actuarial value” of
liabilities). 100% indicates a fully funded program. A
funding ratio of at least 80% is considered “safe”.
Much controversy the past five years over the rate used to
calculate the present value of the liabilities for public plans.
The “Funding Period”
n
n
Number of years under current funding assumptions, it will
take for the plan to reach fully funded status
A plan currently fully funded will have a funding period of 1
year, while a poorly funded plan could have a period of
infinity.
Strictly Financials

14. Vested Interests Will Always Argue
Their Plan is the “Best”, But …
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Either plan will work if it is properly funded and the
participants are educated about pension “finance”.
Typically, public DB plans are under funded because
governments don’t contribute the ARC each year, or
add benefits without funding them.
DC plans may not produce sufficient retirement
income because yearly contributions are too small or
investment choices are poor.
Strictly Financials

15. Comparison of DB and DC Plans
n
Portability between employers:
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DC plan assets are portable and belong to the
recipient.
DB plans ARE NOT. They were designed for the
career employee.
Investment Management and Performance
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n
DC plans: Employees must make their own
investment decisions
DB plans: Assets are professional managed
Strictly Financials

16. Comparisons (cont)
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Market and Retirement Date Risk:
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Outliving your Retirement Investments
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DC plan: Employees bear all risk
DB plan: No market or retirement date risk
DC plan: Employee bears total longevity risk
DB plan: No longevity risk; funding is certain.
Costs:
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DC plan: Typically higher cost per account
DB plan: Lower costs per account
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17. What the Future Holds
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As the stock market causes funded ratios to improve,
will governments “underfund” pension plans to meet
other budget obligations?
Do politicians have the will to direct appropriate
funding to pension plans and hold the line on
retirement costs?
What will be the impact of Detroit’s bankruptcy
process on other cities and their pension plans?
Recent changes in GAAP requires states and
municipalities to show unfunded pension liabilities on
financial statements.
Strictly Financials

18. Story Ideas
1.
2.
3.
4.
What is the financial health of pension plans in your
area? (Public plans have to provide data.)
Are plan administrators considering actions to modify
plans? What resistance is expected?
What has been the financial performance of the fund
over time? Is it competitive with other plans?
What is retirement pay for high paid employees?

19. Resources
n
“Covering your local pension plan”
SABEW Teletraining, Dec. 5, 2011
n http://sabew.org/2011/12/covering-yourlocal-pension-plan/
n Detailed tutorial by David Milstead
n Advice from Barlett and Steele winner
Craig Harris of the Arizona Republic
n Overview from the National Council of
State Legislatures
n
Strictly Financials

20. WILL SOCIAL SECURITY
BE YOUR SECURITY?
Strictly Financials

21. Social Security and Medicare:
The Looming Political Crisis
n
Social Security (taxes paid on income up to
$113,700 in 2013)
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Provides retirement benefits for a worker and his/her spouse
to the second death
Provides disability benefits to injured workers regardless of
age
Provides survivor benefits to widows and eligible children to
age 19 (or 22).
Medicare (tax paid on total income)
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n
Provides hospital insurance at age 65 and above
Don’t forget to register before you turn 65!
Strictly Financials

22. FAQs Regarding the SSA
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How much can I earn and still receive
benefits?
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After reaching full retirement age (FRA), your SS benefits
will not be reduced, but…
If your income is over $44,000 (joint) 85% of benefits will
be taxable.
At what age should I start taking Soc Sec
benefits – 62 years, 66 years, 70 years?
n
Also, keep in mind that SSA and Medicare are independent
decisions. You have to sign up for Medicare at 65 but you
don’t have to start drawing SS benefits.
Strictly Financials

23. What About the Social Security
Trust Fund?
n
“There’s a lockbox that keeps and invests the
FICA taxes you pay.” No, not really
n
n
Taxes paid by current workers are used to pay the benefits
of current retirees. You don’t have an individual account
with your money in it, just a ledger balance at the SSA.
Surpluses are deposited in the “Social Security Trust Fund,”
which then buys non-marketable U.S. Government bonds.
In reality, this goes directly to fund the Federal deficit.
Strictly Financials

24. Current Status of Social Security
Trust Fund
(from the 2012 Social Security Trustees Report)
n
In 2010, Social Security costs exceeded income from
payroll taxes for the first time
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Recession reduced payrolls
Baby boomers started to retire (we already know this –
they’ve been around for 65 years)
It’s estimated that by 2037 the trust fund will be
exhausted and yearly SS tax revenues will fund 78%
of promised benefits.
If payroll taxes immediately were raised by 1.92%
(ie. .96% each for worker and employer), the 41%
benefit level could be maintained to 2086.
Strictly Financials

25. Will Social Security be Around When You
Retire?”
n
“I don’t count on Social Security because it
will be broke when I retire.” Not True.
n
n
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This is a legal obligation of the U.S. Government,
which it really can’t choose not to pay.
Do you really think the government can renege on
its promise to pay your benefits that you have
already paid for?
What if your employer decided it was not going to
pay your retirement benefits that you had been
promised?
A politically explosive issue
Strictly Financials

26. What Can Congress Do?
(Its really just a
math problem with difficult political solutions.)
n
Increase SS retirement age?
n
n
Increase income tax on SS benefits?
n
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Currently, if your taxable income exceeds $44,000 (joint),
85% of SS benefits become taxable.
Uncap the wage level for payroll taxes (set at
$113,700 for 201)?
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n
Originally set at 65 in 1935, its 67 for those born after 1954
but life expectancy has dramatically increased.
Medicare taxes currently are uncapped
Increase the payroll tax?
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By 1.96% total as shown earlier
Strictly Financials

27. What About Medicare And
New Healthcare Legislation?
n
n
The real economic issue is spending on
healthcare.
Future Social Security benefits/costs can be
mathematically determined so it becomes a
political problem to solve; medical costs
cannot be estimated with any accuracy.
Strictly Financials

28. Information about Social Security
n
n
Center for Retirement Research at
Boston College. http://crr.bc.edu/
List of publications at:
http://crr.bc.edu/social_security/social
%2520security%3bbriefs.html
Strictly Financials

29. Story Ideas
1.
2.
3.
Do your readers believe that Social Security will pay
them retirement benefits?
Do they favor changes to the system that will insure
its survival – (1) increase retirement age, (2)
increase taxes, (3) increase taxable wage base?
How does Social Security fit in your retirement
planning?

30. PREPARING FINANCIALLY FOR
RETIREMENT – HOW’S YOUR
401K?
Strictly Financials

31. How Much do you Need to be
Comfortable in Retirement?
n
The standard “80% Replacement Ratio” Rule of
Thumb
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You need 80% of pre-retirement income to maintain your
life style after retirement.
Sources of funds for retirement
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Social Security – today, about $57,000/year for a married
couple at full retirement age and maximum benefits
Employers retirement Plans
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401-ks, defined benefit plans
Your own IRAs and other tax shelters (401-ks, 457-k’s)
After tax investments you have made
Strictly Financials

32. Yearly Income Calculation*
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Assume a married couple, with one spouse having
maximum social security contributions.
Assume they made $122,500 just before retiring
n
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The “replacement ratio” amount is 80% or $98,000
Social Security will provide $57,000/year*
*($38,000 + $19,000 = $57,000)
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Your shortfall is $98,000-$57,000 = $44,000
Will you be able to generate $44,000 of income from
other sources?
*All amounts calculated “before Income Taxes
Strictly Financials

33. What Size of Nest Egg is Needed?
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As an approximation, use the “4% Rule”
To generate $44,000/year requires a “nest
egg” of $44,000/.04 = $1,100,000.
With $1,100,000 to start, you can withdraw
$44,000/year and have less than a 5%
chance you will ever deplete your fund.
n
This assumes your are invested in at least a 60%
stock/40% bond portfolio
Strictly Financials

34. A Sample Diversified Portfolio
MLPs, 5%
Other, 5%
Allocation
Large Cap
Stocks, 30%
Real Estate,
10%
Large Cap Stocks
Small Cap Stocks
Int'l Stocks
Bonds
Real Estate
MLPs
Bonds, 20%
Other
Int'l Stocks,
15%
Small Cap
Stocks, 15%
Strictly Financials

35. ISSUES REGARDING THE U.S.
BUDGET AND TAX POLICY
Strictly Financials

36. Strictly Financials

37. Strictly Financials

38. Strictly Financials

39. Will Congress Address the Budget
Deficit and Tax Policy
n
Is the deficit a problem of too much spending
or too little tax revenue?
n
n
Both sides are entrenched in their positions
Will Congress tackle tax reform? (it was last
accomplished in 1986)
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Spending policies reward constituent groups
Tax policies reward constituent groups and it can
be hard to uncover who benefits
Strictly Financials

40. CORPORATE GOVERNANCE
Strictly Financials

41. What is it?
n
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Larcker – “… the collection of control mechanisms that an
organization adopts to prevent or dissuade potentially selfinterested managers from engaging in activities detrimental to
the welfare of shareholders and stakeholders.”
Who are the stakeholders?
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Customers
Suppliers
Unions
Media
Regulators
Board
Community
Creditors Others?
Other Governance mechanisms –
n
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Efficient Capital Markets,
Regulatory Enforcement
Legal tradition
Societal and cultural values
Accounting standards
The following slides are from: Standford GSB, CBRP-16 01/11/2011. Prepared by Larcker and Tayan.
Strictly Financials

42. Three Key Corporate Governance
Players
n
Management – in most companies management is
separate from owners (shareholders). This creates the
“principal – agent” issue.
n
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Directors – are they truly independent?
n
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Does management they truly seek to maximize the value
of the firm for the shareholder or act in their own selfinterest.
Are they “inside” or “outside”
Characteristics and qualifications
Shareholders
n
n
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Active or Passive?
Institutional or individuals?
Company founder or new investor?
Strictly Financials

43. What Are “Agency Costs”
n
n
Agency costs are costs incurred by shareholders to
monitor behavior of management:
n Inflated compensation or excessive perks
n Manipulating financial results
n Creating an “empire” rather than creating value
n Poison pills to protect job
The agency problem is how to control the behavior of
self-interested management.
Strictly Financials

44. Three Misconceptions about
Corporate Governance

45. Does The Structure of the Board Equal
the Quality of the Board?
n
Independent chairman
Independent directors
Lead independent director
Board size
Diversity of directors
Busy boards
no evidence
no evidence
some evidence
mixed evidence
mixed evidence
negative
n
Boards “appointed by” the CEO
negative
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Note that it is really difficult to empirically demonstrate that any
of these factors impact share value or stockholder’s returns.
Strictly Financials

46. Does Regulation Improves Corporate
Governance?
n
n
What has been the impact of Sarbanes-Oxley
(SOX) of 2002?
What will be the impact of Dodd-Frank
(2010)?
n Proxy access
n Say-on-pay
Strictly Financials

47. Are “Best Practices” the solution?
n
n
n
Larcker calls this the most destructive myth in
corporate governance.
We cannot prove that there are “best practices” that
lead to superior outcomes and stock price
performance.
Corporations operate in a very complex environment
– both internal and external. A large number of
variables interact to affect their success or failure, so
once again its very difficult to prove a relationship
between governance and outcomes.
Strictly Financials

48. Institutional Investors as
Activist Shareholders

49. Institutions as Shareholders
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Who are Institutional Investors?
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Private & Public Pension funds
Mutual Funds
Insurance Companies
Bank Trust Departments
They hold about 70% of publicly traded
shares.
For many large companies, institutions hold
more then 50% of their stock.
n
Microsoft (69%), GE (55%), Intel (70%)
Strictly Financials

50. Share Voting by Institutions
n
Many institutions rely on “proxy advisory
firms” for guidance on how to vote their
shares.
n
n
n
n
RiskMetrics/ISS
Glass-Lewis
Since many institutions are fiduciaries should
they try to impose governance changes?
If they do, whose interests should they
pursue?
Strictly Financials