1937jenp

There is a pending disaster that I have been watching for years and it is not getting the attention of the press. The reason it has not been covered is that it is very complicated and therefore difficult to explain in a news broadcast. It involves pensions both public and private. In the past I have mentioned some personal experiences I had with pensions when I worked for Equitable. One was with the Grand Forks city pension and the other was the North Dakota state pension. In the years following WW 2, pensions came into their own and with the help of unions grew rapidly. These pensions were known as defined benefit plans, that is, they defined the benefit you would receive at some later date. Realize that this is no easy task. A typical pension plan would say that when you retire it will pay you one percent of your salary for every year you worked. This means that if you are 65 and retire after 30 years of service the company would pay you 30% of your salary. Just think of what kind of calculations and estimations are needed to make such a promise. First we have to determine how many people working here today will still be there at age 65. We then have to estimate what their wages will be at their age 65. We next have to estimate what kind of return on investment we would earn over these next many years. With all these uncontrolled variables the companies had to review the pension plan yearly to make the necessary adjustments. As time passed the government stepped in and in 1974 passed the landmark Employee Retirement Investment Security Act known as ERISA. Since that time pensions have been required to meet certain funding levels designed to protect the pensioners. Pension funds were audited in order to make sure there was enough money in the fund to provide the promised benefits.
Just look at one example say of a person who is age 25 and starts to work for company A. His salary is $30,000 and we have to project his future increases in pay so we used an average of 4% per year which means when he is 65 his salary will be $144,000. Now if our pension plan says he will get one percent for each of the 40 years he worked his pension will be $57,600 per year. Now we have to determine how much money we need to set aside each year to purchase a pension of that amount. We can use insurance tables that tell us that if we want to pay that much out for the rest of his life we will have to have about $950,000. In order to accumulate that much money over 40 years at 4% we must set aside $10,000 per year. But pension managers realized that they could put a smaller amount in during the early years and larger amounts in later years. In addition the plans were set up so that if you left the company you left most of your benefit behind which meant that with high turnover the company could get by putting in much less. The idea of a pension plan was to encourage employees to stay but the math gave a financial advantage to companies with high turnover but that is a problem for another day.
Now that the difficulties in determining pension contributions are exposed it becomes obvious that the ability to manipulate the numbers is tempting and of course this is just what has happened. The three big government pension funds in California are currently short of money to provide the promised benefits. How did this happen? Well instead of putting the proper amount into the fund the government used the money for other purposes and made the fund whole by raising the projected rate of return. They projected that they would earn 8% on the investments and everyone knows that 8% in today’s market is unrealistic. The state of California over the past 20 plus years has given money to city, county, state employees and teachers in the form of raises and has shorted the pension fund. They balanced out the shortage by increasing the projected rate of return on the pension fund. For example over a 40 year period the difference in earning 4% vs 8% on $1,000 per year contribution is the difference between ending up with $95,000 or $259,000.
Now that this practice has been exposed, not only in California but many others states, these states are looking to the federal government for bailouts and Obama still has about $400 billion in the stimulus to help them out.
This problem will not go away and the first step is to stop the bleeding and that can be done by switching away from defined benefit plans to defined contribution plans like 401K’s. Under these plans no future benefits are guaranteed by formula but each person has their own account and what ever money is there at retirement belongs to that individual.
There are some pensions that are called multicompany. One large union where the members work for various companies is the Teamsters. Their pension is underfunded and a good prospect for government bailout since both the union and the company will benefit. Senator Bob Casey has introduced a bill to move in this direction and he has the backing of both company and union.
This brings us to what economist refer to as a “moral hazard”. Since the managers of these pension benefit when they perform well, they are willing to take higher risk when they know that ultimately the government will back them up if they guess wrong which means that they will likely fail at some future point. It is the too big to fail idea that we saw in banks so get ready for tax payer bailouts.
As an interesting aside when I worked for Equitable the company was part of a fix up to a problem by the Teamsters. The fund for about one half million members was used as a slush fund for various illegal projects by the union bosses. Under the guiding hand of Hoffa the fund invested heavily in Las Vegas gambling casinos which is not allowed and they lost. They were all caught and the government asked The Equitable and other companies to straighten things out and get the fund back on track. This fund was so damaged that even after years of effective management they were never able to get out from under and to this day remain in danger. The longer the problem persisted the older the pensioners got and more and more were retiring and the payouts were more than the fund could handle. This will be one of the funds that Senator Casey’s bill will bailout. Who would have thought that Jimmy Hoffa would one day get into our pockets to take care of the people he shafted.
Just another day at the office. You see it doesn’t seem to matter much which political party is in charge because the problem is systemic in that big business, big unions and big government are corrupt and people are fed up and this and November could be a wake up call. I told you it was complicate.