Archive for June, 2010
Monday, June 21st, 2010
Have you driven past an empty BP gas station lately only to refuel at a Chevron, Exxon, or Shell station? According to dozens of media reports, motorists bypassing BP to fill up with alternative brands of gasoline are hurting the local owners of the BP-branded stations and having little effect on the oil giant itself. What’s more, these boycotters may still be purchasing fuel manufactured by BP.
Smeal supply chain professor Terry Harrison, who studies the management of renewable natural resources, clarifies the gasoline supply chain below. According to Harrison, BP-manufactured gasoline could end up at gas stations not flying the BP flag, and BP stations are not necessarily selling BP-manufactured fuel—making the boycotts of BP stations a lot less painful for the corporation.
Virtually all firms that refine petroleum into gasoline execute “exchange agreements” with other firms.
Gasoline is a fungible product. That is, gasoline refined by one firm is equivalent to gasoline (of the same grade) refined by another. Only when additives are introduced does the gasoline become differentiable.
The basic idea of exchange agreements is that Refiner A has a refinery near Refiner B’s customers and vice versa, and they trade product. So, rather than trucking Refiner A’s product from their refinery all the way to the customers near Refiner B, Refiner A executes an exchange agreement and draws gasoline from Refiner B’s refinery. At Refiner B’s refinery, Refiner A keeps a loading platform with Refiner A’s additives. Refiner A loads up on Refiner B’s gas, then drives under the additives loading point, inserts Refiner A’s additives and now has Refiner A gas on the truck even though it was manufactured at Refiner B. The truck then satisfies demand for Refiner A’s customers on a local basis. Refiner B does the opposite at Refiner A’s refinery. Both win in that the trade in product has resulted in lower production costs since the transportation costs are reduced.
Thursday, June 17th, 2010
Yesterday, Smeal’s Ron Gebhardtsbauer weighed in on the funding of American pensions and their insurer, the Pension Benefit Guaranty Corporation (PBGC). Below, Gebhardtsbauer continues the topic of retirement, addressing what he considers to be far more important reforms:
As I noted yesterday, the underfunding of the private pension system is not the biggest retirement problem facing our country. It is only a concern for some workers at a small number of companies that will go bankrupt while sponsoring an underfunded pension plan.
The major problem is elsewhere. At one time, about 40 percent of workers had traditional pensions through their employer, but today it is less than 20 percent. Half of employees don’t have any retirement program. The remaining employees have 401(k)s, in which they provide most or all of the contributions. Since most people don’t save enough (and have no idea how much money is needed to retire), average 401(k) balances are around $50,000 for older workers, which is nowhere near enough to retire.
What would a retiree get with $50,000? Investment advisers suggest retirees withdraw 4 percent of their money ($2,000) in their first year of retirement, and increase the “programmed withdrawal” by the inflation rate each year. An annuity purchased from an insurance company with $50,000 could provide $3,000 per year indexed to inflation or $4,000 flat per year—up to twice as much as a “programmed withdrawal,” but still nowhere near enough to retire.
Thus, the bigger problem is not underfunded pension plans, but a lack of pension plans (or adequate savings), and that will come to haunt our country in the 2030s, when baby boomers are in their 80s and running out of money. Not only will that create problems for the individual retirees, but it will be a huge drain for the country when Medicaid (i.e., taxpayers) will have to pay the nursing home costs. The Medicaid moral hazard is magnitudes larger than the PBGC moral hazard.
So what is the solution? We recently passed a major health care reform bill because the cost of uninsured health care was making our companies uncompetitive on world markets. This could be a similarly huge problem. We have tried educating the public. It helped, but didn’t come close to solving the problem. Now we are trying automatic defaults which enroll employees in the company 401(k), but not enough companies are trying it, and employees don’t realize that they need to save a lot (e.g., 10 percent of wages in many cases). The solution is to mandate workers (or their employers) save more for their retirements, and the fix is needed now (2030 is way too late). Additionally, people will have to work longer and retire later. One important signal for doing that would be to raise Social Security’s normal retirement age above the current 66 (67 for those born after 1959), but that won’t be easy (even though it would also be very helpful for making Social Security sustainable).
Many baby boomers are working longer, because it gives them a sense of worth, and keeps them energized, but many others won’t like this idea. If that’s the case, they should work for an employer that has a pension plan, or save more when they are working, but that’s easy for me to say. I enjoy teaching, and I have a good pension and good saving—of course, I’m an actuary. But that’s not true for a huge proportion of our population that hates their job, didn’t earn much, is worn out, and didn’t save.
What do you think we should do?
Wednesday, June 16th, 2010
Last week in The Wall Street Journal, Charles Millard, former director of the Pension Benefit Guaranty Corp. (PBGC), wrote about the challenges facing American pensions and made four recommendations to help the PBGC better insure underfunded pensions. Smeal’s Ron Gebhardtsbauer, faculty-in-charge of the Actuarial Science Program, responds below. Gebhardtsbauer is the former chief actuary for the PBGC and served as the senior benefits adviser for the U.S. Senate Finance Committee when Millard directed the PBGC.
Charles Millard makes a good point in the first sentence of his WSJ editorial when he says that some workers’ pensions may be in jeopardy because the private pension system is underfunded. However, it is not as big a problem as his readers may infer, and it’s definitely not the biggest retirement problem.
In the PBGC’s 36-year history, it has been called on to pay the pensions of about 1.5 million people, a number that is much larger than desired, but still less than 1 percent of the workforce. It is small, because, for starters, most companies don’t go bankrupt and most workers don’t have a traditional pension. Another reason why this is a problem for only a small group is the PBGC generally pays the full pension to over 90 percent of its retirees.
However, as Millard notes, there is a moral hazard in the pension funding rules. A weak company with a fully funded pension plan can invest all of their pension assets in stocks and be 60 percent funded after a major crash, and then dump their pension promises on the PBGC.
In my testimony before the Senate HELP Committee in October, I noted that the pension funding rules are pretty good (in fact, they are too rough for the typical healthy company), but Congress needs to close the above loophole for weak companies. One way would be to charge weak companies a large risk premium if they want to hold a large percentage of stocks. However, the weak companies then might not pay the premium, so in that case, the PBGC would need the authority to prohibit too much stock in the pension plans of weak companies.
The PBGC should also be given the authority to require a special workout with the weak company (just like banks do with corporate borrowers that can’t pay off their loans). The PBGC could keep the company responsible for their pension promises, give them a temporary reduction in their pension contributions, and reduce the largest pension promises to top brass.
I also agree with Millard’s third recommendation to allow the PBGC to go back to investing in more equities (even though that’s the reverse of what we recommend for private sector pension plans). I had a tough time getting others on the Hill to appreciate his point in 2008, because the stock market wasn’t doing well. Currently, some members of Congress (particularly the Democrats) are criticizing Millard (a Republican) for encouraging the PBGC to hold equities when he headed up the PBGC. It’s a surprising twist, because when I was the PBGC’s chief actuary in the 1990s, the political parties were on the reverse sides of the debate.
I’ll also note that if the PBGC had followed Millard and invested in stocks in 2009, it could have $10 billion more in assets today. Now I know there are good studies that say the PBGC should immunize (invest only in bonds that match their liability payouts), but the PBGC is not a private sector company that has to have assets greater than liabilities, so it can wait out the down market cycles. In fact, the PBGC’s assets are large enough for it to pay benefits for at least a couple decades.
In addition, the bond idea locks in the PBGC’s deficit, so the bonds-only supporters would need to increase taxes and/or premiums immediately, but I don’t hear them supporting that idea. A reason the PBGC should not invest in equities might be if we think there is no longer a risk premium for investing in stocks, but I don’t think there are many people who believe that for the United States. Japan has had terrible experience in its stock market for 20 years, but I don’t think we are in the same situation as Japan, either.
I’ll be interested in what others think about this last point, since it is the most controversial one. Please comment.
Monday, June 7th, 2010
Bloomberg BusinessWeek recently reported on Wal-Mart’s efforts to control deliveries from manufacturers, which will allow the retailer to carry more goods per truck and ensure greater efficiency of its deliveries.
“The retailer aims to take over U.S. transportation services from suppliers in an effort to reduce the cost of hauling goods,” write the authors of the article. “Under the new program Wal-Mart will increase its use of contractors, as well as its own vehicles, to pick up products directly from manufacturers’ facilities.”
While this move may make it possible to reduce prices in the stores, increased costs could be passed on to other retailers, according to Smeal’s Robert Novack, associate professor of supply chain and information systems. Below, Novack takes a closer look at Wal-Mart’s new transportation strategy and the impact this decision has on cost, competitors, and control.
Wal-Mart’s initiative to take over transportation from its suppliers to its distribution centers and stores has several interesting components. First, Wal-Mart has a very large private fleet (6,500 tractors and 55,000 trailers), which is used primarily to move product from its distribution centers to its stores. Getting the trailers to return full from the stores to the distribution centers is a challenge. So, using the private fleet to pick-up from suppliers and return to the distribution center full is very cost efficient and environmentally friendly.
Second, this initiative is getting some attention from other retailers with suppliers in common with Wal-Mart. All shippers use volume of product in a freight lane as leverage when negotiating freight rates with carriers. With Wal-Mart pulling freight volume from these shippers’ freight lanes, their freight costs could go up. These cost increases could be passed on to other retailers.
Third, many retailers have their own private fleets and have the same empty mile problem as Wal-Mart. The question then becomes should these retailers follow suit and start to take over inbound moves from their shippers. Although this sounds like a logical idea, shippers want to control their freight movements and are hesitant to give up control of outbound shipments. How does Wal-Mart get away with it? Volume. Wal-Mart represents a significant percent of most large manufacturers’ revenues. As such, they are in a position to take whatever action is going to save them money. Other retailers don’t have nearly as much leverage with these manufacturers.
Finally, this is not Wal-Mart’s first attempt at controlling more of its inbound logistics operations. It has initiated a program to increase its percentage of imports to the United States by dealing directly with overseas contract manufacturers, thereby increasing ownership and control and eliminating the role of the U.S. manufacturer.
Globally, retailers have been hit hard by the economic downturn. Wal-Mart’s actions are intended to decrease its costs so it can reduce prices to consumers at the stores. This is what business is all about. However, do these actions actually increase overall supply chain costs? This question has yet to be answered