Pension

Wednesday, April 07, 2010



Hi All,



In the news today it was revealed that three state employee union pensions in California were underfunded in the amount of 500 billion dollars. Pensions came into prominence after WW 2 and were called defined benefit plans. What this means is the pension has a formula percent usually between one and two percent. The formula says that at normal retirement afe you will receive 2% of your salary for every year that you’ve worked. If you retire at age 65 and you have worked there for 30 year you get 60% of your salary for your pension. When a company sets up such a plan they have a number of unknown variables they must contend with, for example, how many people will make it to retirement, how much will they be earning at that time and what kind of interest will the company earn on the pension plan money. This can be very tricky to say the least. Let us say that you will earn 3% over the next 30 years so that if you put in one dollar every year you will have 47 dollars but if you only earn 2% you would have 41 dollars. When it comes time to pay out and you earned less than predicted you would not have enough money to pay the pensioner and your plan would be underfunded. This happened in the late 70’s when we had 13% inflation and wages went up faster than expected. At that time it was estimated that all of the pension plans in the country were underfunded by 400 billion as compared to three funds in California currently underfunded by 500 billion.

How did this happen? Over the past 30 years the unions negotiated contracts with the states to increase their pensions. Since the state funds did not earn as much as they needed they increased the expected rate of return which today is set at 8% when in fact they have been earning less than 3%. Using the above example we see that one dollar per year invested at 8% yields $113 and the same dollar at 3% earns only $47 and thus the current shortage. There is a board of directors who oversees these pension calculations and they have been derelict in their duties since they are supposed to be conservative in their projections and 8% is out of line with current investment returns. If California was a company like General Motors they could file bankruptcy and the federal pension guarantee fund would come in and make the fund good. The money in this fund comes from company contributions but in the case of California the money will come from taxpayers, most likely from the Obama slush fund known as stimulus. Of course California is only one of many states who will need this type of help and so the rest of the taxpayers will end up paying for the retirees in those states.

While the California case is getting lots of attention, pension manipulation is not a new thing. I offer one example based on personal experience. When I was a financial planner I approached the city auditor in Grand Forks, ND where I lived regarding the city pension plan. At that time the pension factor was 1.2% and the plan was with Aetna. I worked for Equitable and we could offer 1.4% based on our investment returns. The auditor, a man by the name of Don Tingum, was a decent person and thought it would be good for the plan to switch. When Aetna got wind of the change they increased the benefit to 1.6% and the city remained with Aetna. This was in the early 80’s and Tingum was retiring after 35 years with the city. His salary at that time was $20,000 so his retirement increased from 49% of his salary to 56% of his salary or an increase from $9,800 to $11,200 per year.

About a year before that I contacted a Mr. Al Persons who was in charge of the North Dakota State pension and told him that Equitable would invest the pension fund for him and would guarantee 12% interest for ten years and he refused saying that Equitable would take the money out of state. His job was to put the money in the State Bank and use it to make loans to local farmers and businessmen that would promote North Dakota business. In was only later that it occurred to me that with the prime interest rate at 20% no one was borrowing any money and Mr. Persons real concern was that I would be eliminating his job. This one man was allowed to keep that money in the local bank earning nothing while passing up a chance for 12% return and thus punishing the pension plan for several thousand people.

I believe that in the near future we will begin hearing reports that cities, counties and states have been using pension funds to pay for on going expenses which is not legal but will be overlooked. We shall see.



Jack