Reasons against Defined Benefit Pension Funds

The defeat of Elliot Spitzer as comptroller of New York City last week may be a real blessing for city workers and retirees. The reason has nothing to do with his personal life; rather it has to do with one of his campaign pledges. The comptroller manages the large public pension funds of current and retired city workers. The funds contain a large amount of stocks and Mr. Spitzer said he would use his power as a stockholder to hold Wall Street more accountable. In other words, Mr. Spitzer is more concerned about the political correctness of companies than in maximizing rates of returns on the funds he manages. Continue reading

The Danger of Defined Benefit Plans

The danger of public sector defined benefit plans is highlighted by the revelation that 92 Detroit retirees are collecting more than $80,000 a year from the government, with 23 of those collecting more than $100,000 a year. The city is locked into these extravagant commitments in spite of their desperate financial situation.

The desire to avoid situations such as this why private and public institutions alike are rapidly making the switch to defined contribution plans, instead of promising a lump sum they may not be able to deliver in the future. Whereas a defined benefit plan uses a formula to determine a designated monthly payout based on things like age, tenure and salary. The problem with such plans is that the payout is unrelated to the financial health of the institution offering the plan, and when the balances come due there is no guarantee that they will be able to meet their obligations.

Defined contribution plans address this difficulty by having employees and employers alike set aside a specified amount of money that will then be available for them when they retire, although without the promise of a specific monthly dollar amount.
The repeated failures of defined benefit plans may explain why we are now seeing record high enrollment in defined contribution plans, a number which will likely continue to increase as automatic enrollment becomes more popular and more companies and governments adopt such programs.

The California Secure Choice Retirement Savings Program

Aleta Sprague of the New America Foundation has a nice write-up on the California Secure Retirement Savings Program.  In essence, this program mandates that every California worker contribute to a state-run 401(k) program.  This is in response to the demise of defined-benefit pension plans and the reluctance of many to save for their retirement.  Currently the program requires that each worker contribute 3 percent of his or her own salary into the savings program.

At first glance the program is a good thing.  Data shows that many Americans are not saving enough for retirement.  Though it raise some concerns:

(1) Currently employers are not required to contribute to the fund (which is good).  How long before they are required to match workers contributions?  This would raise labor costs and make California businesses less competitive.
(2) The savings program is run by trustees appointed by the state government.  What happens if the rate of return on the contributions are not what was expected?  Will taxpayers have to bailout the system?

The good thing about this is that it is a state program.  If it doesn’t work, the citizens of the other 49 states don’t suffer.  If it succeeds, the others will follow.  Too often programs are created at the federal level and forced upon the entire country.

Check out an update to this post on May 20.

Retirement confidence lags leading indicators

Admitting you have a problem is the first step in recovery. It’s not news that people are living longer than they used to, and it’s certainly not news that workers often underfund their retirement expectations. What is news, is workers are starting to realize in larger numbers that they likely won’t be able to afford retirement at 65 if they continue saving–or not saving– as they have in the past. The Employee Benefit Research Institute (EBRI) just released its 23rd annual Retirement Confidence Survey, and it shows worker confidence resting on last year’s record low sentiment.

The economy has shown signs of improvement in the last year–albeit not overwhelming improvement–and one would think that like the stock market, retirement confidence would take the opportunity to show some exuberance. Not the case this time. The poor economy of the past few years seems to have woken up workers to the practical uncertainties of retirement, and its mounting cost. EBRI suggests that regardless of whether the actual savings and investment rate increased or decreased, this lowered retirement confidence is likely a result of the Great Recession as workers faced prolonged periods of unemployment, reduced wages, and lower rates of return (or more likely losses) during that period.

“One reason that retirement confidence has remained low despite a brightening economic outlook may be that some workers may be waking up to a realization of just how much they may need to save. Asked how much they believe they will need to save to achieve a financially secure retirement, a striking number of workers cite large savings targets: 20 percent say they need to save between 20 and 29 percent of their income and nearly one-quarter (23 percent) indicate they need to save 30 percent or more.”

In other words, workers have been badly shaken during this economic doldrums, and the lasting affect is workers rude awakening to previous under-saving. We’ll have to wait and see whether or not the fear translates to long-term improved savings rates.


Morning Reads: the longevity cost, doubling down, and silver parachutes

The WSJ says the increase in middle-aged workers planning to work past age 65 has significantly increased because of recent investment losses, stagnating wages, and spells of unemployment. These may be catalysts for individual decisions about retirement, but with ever-increasing longevity, retiring at 65 should cost more, since it is more retirement.

The Motley Fool thinks public pensions are not the appropriate place to double down on riskier investments.

Bloomberg sheds some light on Governor Coumo’s pension “reforms.”

Lawmakers’ retirement hay-day coming to an end in Kentucky… for future lawmakers, maybe.


Non-Sequitors: Catching Up

The Economists‘ Buttonwood blog comments on retirement, longevity, and inherent inequity in a universal pension age.

Michael Barone of American Enterprise Institute foresees an end to the entitlement age, while his AEI colleague Andrew Biggs discussed public pension reform with former San Diego city councilman Carl DeMaio, after San Diego made some painful, but needed reforms.

Some wise words about personal responsibility in planning for retirement from the Wall Street Journal… let’s just say these resolutions are obviously sound practice, but easier said than done.

According to the Washington Post‘s Michael Fletcher the American worker is borrowing from tomorrow to pay for today–which means less leisure, retirement, what-have-you tomorrow.

The Washington Post‘s Jim Tankersley writes that the global economy has pulled American manufacturing into an age of weak labor, and thus weak unions… something to keep in mind during the Social Security and pension reform discussion.

Video with Chuck Jaffe of WSJ‘s MarketWatch in re avoiding the Personal Retirement Cliff.

NPR finds that the government isn’t only struggling with the question of homo sapien retirement as a growing population of research chimps are hanging up their lab coats for country living.


House Subcommittee Looks at Problems Facing Multi-employer Pensions

On Wednesday, the House Education and Workforce Subcommittee on Health, Employment, Labor, and Pensions held a hearing, “Challenges Facing Multi-employer Pension Plans,” to examine the status of multi-employer pensions. Joshua Gotbaum, director of the  Pension Benefit Guarantee Corporation (PBGC) was the sole witness to testify. The purpose of the hearing is summed up by two quick paragraphs of Mr. Gotbaum’s testimony:

After all the events of the past decade, the financial health of these plans varies widely. The majority are recovering, in part by relying on the tools and authorities provided to plans under the Pension Protection Act of 2006 (PPA) and subsequent legislation, as the economy and the financial markets improve. Some plans, however, lack the necessary economic base and will not, absent changes, be able to avoid eventual insolvency.

As a result, PBGC’s multiemployer insurance program will need a fresh look. Although the timing is uncertain, currently PBGC is at risk of having neither sufficient tools to help multiemployer plans deal with their problems nor the funds to continue to pay benefits beyond the next decade under the multiemployer insurance program. (Emphasis added).

This statement is important because the PBGC is not funded through general revenues, but through premiums paid by participating companies in multi-employer plans. The logic here being that if one company were to fail, and miss its retirement benefit obligations, the PBGC is able to pick up the tab. Unfortunately, this plan only works if premiums are high enough to cover all the failed business pension obligations, and that enough businesses remain to pay those premiums. As the economy waned, and has been on the slow drudge to recovery, it isn’t so clear that the system will not collapse around the “final man standing.”

The Private Pension Cliff

Coinciding with the public “fiscal cliff” consisting of looming tax increases and across-the-board federal spending cuts there is a private pension cliff. Although the effects of the funding gap in private pensions is not likely to result in one sudden and dramatic economic event, if left without remedy these shortfalls will cause widespread financial pains for workers and retirees when those unfunded obligations come due. Milliman’s Pension Funding Index for November shows some improvement from October, but unfunded obligations could still set a new record by the end of the year.

Public Pension Plans Face Insolvency

Reposted as published by the 4% Growth Project.

The Federal Reserve’s unprecedented policy of lowering interest rates to nearly 0% and promising to keep them there indefinitely has certainly had an impact on the economy, although not nearly as much as the fed initially expected or desired. Badly damaged balance sheets at banks and newly empowered regulators, hoping to evade blame should another financial crisis occur, have combined to create a situation where even interest rates near 0% fail to have much of an impact on business loans.  While it’s impossible to measure the precise change in economic activity that has resulted from the historic monetary expansion, few would dispute that it has been relatively slight.

However, as with any grand policy experiment, there are always unanticipated impacts. The Fed’s expansionary policies are no different, and one of the unintended impacts has been on the long-term solvency of the various state and local pension plans that are currently underfunded, a category much larger than the one labeled “fully funded.” The vast majority of these were already under-funded prior to the Great Recession, in many instances owing to short-sighted governments inflating benefits for retirees at the peak of the stock market bubble in the late 1990s.  The ridiculously early retirement ages that come with most plans (for instance, in Illinois most teachers retire before age 55) and the lengthening of longevity for senior citizens have only made these problems worse.

The Great Recession cratered the stock market, and along with it the value of most pension plans in the U.S. whether public or private, leaving all but the strongest state and local pension plans well short of what is needed to meet the promised benefits to current and future retirees.

A number of municipalities in California have already turned to Chapter 9 bankruptcy protection because of oppressive pension obligations, and these are merely the first of many that will likely occur across the country. States do not have recourse to bankruptcy, at least not right now, which could result in a future administration and Congress facing some uncomfortable choices a few years from now if California and Illinois continue on the path to perdition.

How have states addressed this shortfall thus far? The operative word would be “timidly.” A few states have implemented minor reforms that mainly serve to reduce pension obligations for future employees, but that is of scant help in the next 30 to 40 years, when most of these pensions are due to fall.

Plan B for public pensions has been to chase returns by investing in hedge funds. Rather than passively investing in various stocks or bonds, they have been paying handsomely for the privilege of having various high profile investors attempt to beat the market, usually in vain. While some hedge funds are always wildly succeeding, virtually none of them manage to do that consistently despite the exorbitant cost of their services.

Since 2008 the stock market has almost returned to its pre-crash levels, although this is scant consolation for investors who have plans on retiring any time soon. With the stock market roughly in the same place it was in 2000, most people who owned stock during that time have a right to be disappointed with returns below inflation for a 12-year period.

The problem that the Fed’s monetary expansion creates for pensions — and many others to boot — is that there is no way for anyone to get decent returns without accepting considerable risk.  Pension managers who attempt to match their pension obligations with the term structure of their investments are going to be forced to buy a whole lot of low yield, short-term government bonds and slightly-higher-yielding long-term bonds, neither of which generate anything near the amount necessary to get back into the black.

If states aren’t going to reduce their obligations for the next generation or two, then all that’s left to stave off insolvency is to take some chances — or to hire managers to take those chances on the behalf of the pension.

If there is another financial crisis that comes remotely close to the 2008 debacle, we may see no small number of pensions simply going broke, with a tanking stock market (and a surfeit of retirees) making short thrift of their remaining assets. And then we’ll have a problem on our hands that makes the 2008 crisis look like small potatoes.

Indiana Uses Surplus Revenues to Strengthen 5 State Pensions

As announced earlier in the year, Indiana will be using surplus tax revenues to make payments to five public pensions. Of all Indiana’s public pensions, all but the Pre-1996 pay-as-you-go teachers pension is considered fully funded. Today, Governor Mitch Daniels released the details of these payments. The five state pensions are the Judges’ Pension Fund; Conservation, Gaming, and Excise Officers’ Pension Fund; Prosecutors’ Pension Fund; State Police Pension Fund; and Pre-1996 Teachers’ Pension Fund. The Teachers’ Fund will receive the largest portion with a payment of $206.8 million of the $360 million total. Another $360 million will be distributed to taxpayers–$100 per filer ($200 per joint filer)–on next years tax returns.

Goldwater Accuses Actuarial Assumptions of being to Rosy

Actuaries use rate-of-return assumptions to forecast pension liabilities. These forecasts provide estimates of unfunded obligations carried by pension systems. These estimates are only as good as the margin between the assumed rate-of-return and the realized rate-of-return for a pension fund. After a decade of slower than assumed growth, many pensions are in worse shape than the accounting would suggest. Such is the case in Arizona.


Report Recommends Iowa Reform Public Employee Benefits

Aon Hewitt recommends incentive reforms to Iowa’s public employee health benefits package. The current plan offered to state employees provides insurance coverage without a monthly premium payment from employees. This plan provides no incentive (beyond the one that should already exist in a personal desire to be healthy) for employees to spend wisely, or shop carefully for health care services.

The report concludes that reforms including shared premium of 20% for employees, higher co-pays, new deductibles, and wellness incentives would save Iowa millions in health care costs. The report comes shortly before a new collective bargaining agreement will be negotiated, raising allegations that the report is merely leverage for the nearing discussion.

State Pensions Recieve Much Needed Reforms

This week, both Ohio and California legislatures passed reform measures to improve the positions and sustainability of public worker retirement plans. The reforms in both states increase employee contributions and the working year requirements to receive full benefits. States have contemporaneously picked up the cause as the national discussion of federal entitlement reform has heated up in recent weeks with the addition of Rep. Paul Ryan to the VP slot on the Republican presidential ticket.

While public worker unions have taken a hit in the public eye recently as these reforms and the teacher strike in Chicago have pitted public worker benefits against a growing recognition from taxpayers that earlier benefits promises were too generous to continue without hurting other valued government programs in the near future. These debates highlight the significant difference between public and private pensions; there is a third party–taxpayers–that carry risk for state employers and employees if pension funding does not meet the pension obligations.