Since I’ve written about some pension funding issues in previous postings (example), let me point readers to a couple of news articles. From today’s Wall Street Journal, “Pension Gaps Loom Larger”, about how public and private pension funds are assuming 8 percent return on investment over the coming decades. And today’s New York Times has “The Illusion of Pension Savings”, about Enron-style accounting gimmicks that enable states to look slightly less bankrupt.
In some ways the WSJ article is more interesting. Here in Boston an 18-year-old hired by the MBTA can retire at age 41 and is entitled to an inflation-adjusted pension from age 41 until death at perhaps age 100. So the pension fund managers need to be looking out for about 80 years. The assumptions that they’ve made are that the U.S. needs to grow about as well for the next 80 years as it did during the years 1920-2000 (and the 2000-2010 period needs to be chopped out!) or the fund and therefore the company or state goes bankrupt. Not only does the U.S. need to continue to be doing great, but returns to investors need to continue to be high. The flood of savings from newly wealth Chinese, Brazilians, and Indians, for example, cannot result in competition that reduces the return to capital below what it was in, say, the 1950s. When you think about it, the risk that these guys are comfortable with is rather breathtaking. Without a letter from God promising that the next 80 years will look like the 1920-2000 period, why do we allow corporate managers and politicians bet the future of their organizations?
The more I read stories like this, the more I believe that defined benefit plans are evil. Not just for the organization supporting it. They’re also bad for the retiree.
If I have a defined contribution plan, I can monitor how it’s doing and adjust my lifestyle over a longer period of time. I will make sure the plan is capable of supporting me when I no longer have the capability to make lifestyle changes or earn extra income.
With defined benefit plans, I’m merrily living my life, until one day the plan is insolvent. At that point in my life, I probably can’t make adjustments to my expenses, or can’t go out and earn supplementary income.
I really believe that for the future of our economies (I’m Canadian), we need to transition to defined contribution plans only.
Being half-Greek, I have a pretty good idea how it’s going to end for residents of states like Illinois and California: My mom, godfather, uncles and 40-something cousins (yes!) are all taking material hits to their retirement income.
Right now, I’m polling relatives on the most equitable way to get their country back to a rational standard of living. Haven’t heard any solutions more creative than ripping off the band-aid quickly.
I can’t imagine a scenario where we have made the astounding medical and public health advances necessary for a typical Boston bus driver to expect to live to 100, but our economy has had only anemic growth.
And on a separate note, public employees generally do not get Social Security, so before deriding the generosity of the plans you need to mentally subtract a significant chunk.
EZ: Is it too much to ask you to use Google before commenting? This mass.gov page, an easy result from Googling “mbta employees social security”, says “MBTA employees also pay into the Social Security system”.
Can an MBTA bus driver live to 100? GM, at the time of its bankruptcy, was paying pensions to retirees as old as 115. A person who retires at age 41 should live significantly longer than average since that person won’t suffer the health problems associated with a sedentary job. A bus driver hired today at age 18 will reach his 100th birthday in the year 2092. Do you want to bet the future of a state on the premise that there won’t be any significant improvement in medical/longevity technology by the year, say, 2085?
at the risk of providing some potentially content-free commentary, I recall seeing a recent infographic, perhaps from a UK newspaper, showing the life expectancy of a child born today. the graphic split the results by country. the life expectancy for a child born today in the US, the nordic countries, the european countries listed, etc, was all at 100 years old on the button, or slightly over.
oh, fine, fearing censure, I used google. I came up with this:
http://www.guardian.co.uk/society/2009/oct/02/babies-likely-to-live-to-100
not the article I remembered, as I most distinctly remember a map and pie chart graphic, but probably the same people involved. so, it’s speculative, and it’s not strictly life expectancy, but it doesn’t seem to be particularly unhinged and crazy to my eyes.
us census data appears to indicate that life expectancy was around 70 in 1970, and estimated to be 78 in 2010.
http://www.census.gov/compendia/statab/2010/tables/10s0102.pdf
I am not sure how to factor out those dealt the short straw of death before age 18 (the hiring age of our mbta employee, and thus the set we care about – those promised pensions), but obviously the numbers would be higher without the dead young folks included in the average. if we assume the optimistic doctors to be a high bound (which may not be true – it may be a low bound, who knows?) and the perhaps conservative census to be a low bound, the necessity of pension planning for 80 years seems completely reasonable.
It’s the plan actuary which makes assumptions based on the fund’s investment allocation which is agreed to by the employer or trustees. Second, on an annual basis the plan actuary is going to be looking at actuarial gains and losses, one of those things being studied will be mortality. If there is a consistent loss then a mortality study has to be done. No actuary has a crystal ball with respect to longevity. We only have mortality tables which are based on past experience. Lastly, the investment assumption should also be looked at annually. If there is consistent loss or gain then the actuary should suggest an assumption change.
I don’t agree that defined contribution is the way to go because most people are not financially asstute enough to manage their own assets in retirement and are prone to making really stupid investment decisions.
In my opinion you need both instruments. Both have their pros and cons, but one gives you some down side protection and the other rewards if care is taken. And if no pension plan is offered by the employer, there should be a federal based defined benefit plan with pension benefits based on contributions.
OmarF,
Agreed, but government retirees need not worry if their pension managers are overly optimistic. After all, if the money isn’t there to pay retirees, state law here in Illinois says those retirees get their money no matter what. The only people that really have to worry about the collapse are the poor smucks in the private sector saving every penny because when a Chicago teacher who is still teaching full time and collecting her pension (very common) comes up short, Illinois law says we have to go after the poor schmuck. This is true for most states.
Of course the states will eventually go bankrupt, but as we have seen these last two years, all that means is that the Federal govt will just jump in and bail out the states with the money its printing. At some point the money will become worthless, but that won’t help the poor schmuck saver.
It really doesn’t matter if they estimate 8% or 80%. If my portfolio loses 30% of its value, then I’m out 30%. If a retiree with a defined benefit loses 30% of his portfolio, it’s no real skin off of his back. It just means that the poor schmuck will have to cover the difference for the retiree–by law–before he is allowed to start saving for himself again.
Stop saving money. Start saving ammo. I joke of course!
Douglas,
So defined benefit is just evil in a different way when the pension plan is backstopped by government!
Something I should mention, I’m Canadian and comfortable with our social security (Canada Pension Plan) system as a part of my retirement plan. It’s just a back stop for subsistence living if everything I do falls apart. I’m not even bothered that it’s not a fully funded plan, although it is on far better legs than your equivalent. Since our program isn’t fully funded, it’s a hybrid pension/tax system. Those that hate the plan tend to believe it should be 100% a pension system. Some others get upset that wealthy people are drawing money. Those people believe it should be a 100% tax transfer system.
I just don’t think that defined benefit should be how private industry sets up the pension plans. Businesses come and go, they grow and they shrink, plans have good years and bad. If the retiree isn’t on top of their own plan, it seems to come down to third parties (the people who fund the government) to provide the funding for them. In Ontario, there is a system in place to help cover plans that are failing. There is some discussion whether the government is obligated to backstop that system. I don’t think it should.
That leaves public employee plans. I honestly don’t know how to think. They should still be defined contribution, but the reality is they never will be. And yes, I will benefit from that as well, as my wife has one of those.
I don’t know about this throwing out the db benefit plan business. The people who generally benefit from defined benefit are blue collar, with little to no financial planning knowledge. Based on what I’ve seen those retirees need those checks to pay for health care, and basic living expenses. You take away their pensions, or cut them you’re increasing foreclosures and bankruptcies. How does that sound?
You can help the goverment DBs in a number of ways. Increase normal retirement age, tie plan year accrual rates to investment performance, have stepped accrual rates, increase service requirements, eliminate early retirements, decrease early retirement benefits, etc. D.C would need these state plans to be audited at least biannually and testplan A in State S, if you’re below X% funded, you have to implement some steps (like those I have listed) immediately until you’re at least X% funded. Then the probability the working shmuck isn’t over taxed is minimized.
Mark,
I don’t want to beat this to death. I am surrounded by blue collar types (probably am one myself in a way). They understand savings, and would understand declining account balances better than you might think. I think most would adjust their standard of living on the first sign that their retirement plan is heading the wrong direction. I do see a difference with the service workers that I know and acknowledge your point. I want to give these groups of people some incentive to learn about and understand pension plans as they will be the ones affected by a failing plan.
My argument is based on the difficulty for private plans to stay solvent in markets that range from -20% to +20% with companies that may be growing or shrinking during these swings. I want to put the onus back on the recipient which should simplify things again. What I don’t want is to have someone else’s retirement backstopped by me because the plan administrators weren’t able to anticipate every possible market condition.
It’s hard to believe I’m arguing this position. I’ve always thought I had a somewhat liberal political leaning. Must be my middle age creeping in!