Are we having fun yet?
The political scene in Washington, D.C. recently has lurched from an unsavory and perhaps a bit embarrassing battle over the federal debt ceiling to a cautious and uncertain reaction to the recent ratings downgrade of our country. On Friday, August 5, 2011, Standard & Poor’s (“S&P”) announced the reduction of the credit rating of the United States from a AAA rating to an AA+ level. This was the first such rating downgrade in the history of our country (the United States initially was awarded the top credit rating by S&P in 1941). While not claiming the United States is suffering from liquidity problems, S&P’s actions are rooted in a concern that the debt ceiling agreement (hardly a positive civics lesson) would not do enough to tame the country’s record deficits. So far the other major rating services have reaffirmed their AAA ratings levels for the United States.
The demand for debt instruments issued by the United States Treasury remains strong even with the downgrade. It seems investors see few credible investment alternatives in an era of sluggish or nonexistent worldwide economic growth and as concerns about sovereign debt in Europe dominate the news. Still experts worry about a negative impact the downgrade will have on an already fragile United States economy in the form of increased costs of borrowing (reflected in mortgages, credit cards and other forms of business and individual lending).
This recent action by S&P raises the issue of how employee pension plans should — and perhaps must – react to the downgrade. While not explicitly mandated under ERISA, many pension plans have adopted investment policy statements that specify what investments can be acquired and held by the plans. These statements tend to vary considerably as to the specificity of the investment guidelines. It certainly is possible that some existing investment policy statements, as currently written, might set a minimum rating level of AAA for government securities. The developments of the last few weeks most likely would not have been contemplated when these statements were drafted. In fact, anyone who did anticipate the recent news probably is better suited for a career in off-track betting!
As discussed in a recent blog, ERISA fiduciary responsibility with respect to investments is about the process, not a particular result. If you are a plan sponsor (or, if applicable, an investment committee member), you need to know what, if anything, your investment policy statement provides as to qualifying asset standards. In the event those statements require government securities to carry a AAA rating, plan sponsors would face difficult choices—all under the cloak of ERISA fiduciary responsibility. They could either consider the disposition of no longer qualifying plan assets or they could consider amendments to their investment policy statements. In fact, regardless of whether the policy specifically addresses credit ratings, recent events (including substantial stock market volatility) suggest that this is a good time to consider whether any strategic investment changes are needed. While choosing to do nothing is an option, it helps to have a record of that decision being reached — as discussed in our recent blog, While there may not be one absolute correct answer, we recommend this review be thorough (including aid from qualified advisors when needed) and that sponsors record the process and the conclusions reached as the best demonstration of a prudent process in these very difficult times.