Posted on 08/26/2013 11:35:16 AM PDT by SeekAndFind
Having a pension plan has been part of the American Dream for millions of workers. Put in thirty or thirty-five years with a company, retire, and then the company will send you a check every month for the rest of your life—an attractive prospect. The amount of the check is pre-determined. It is a “defined benefit” promised to the worker.
Unfortunately, this simple vision has proved difficult to implement. The basic problem has been that pensions are a promise for the future, but nobody can guarantee the future. In our dynamic economy, the Schumpeterian process of “creative destruction” relentlessly weeds out the companies that no longer meet consumers’ most valued desires. As a result, one can work for a company for several decades, then see the company go broke, shut down, and—poof!—there goes the pension.
Theoretically, companies have been expected to set aside enough money to make good on their pension problems. This is easier said than done in competitive markets. In a year when revenues have fallen, does the company pay its suppliers or fund its pension when it can’t do both? Would employees rather take a cut in current pay so that the company could fund its retirement plan, or would they rather maintain current income and hope the company can find funds for the pension plan later? If the company raises its prices in an attempt to increase its revenue, the company may actually lose sales and revenues due to the elasticity of demand and the decision by marginal buyers to take their dollars elsewhere rather than pay higher prices.
When the Studebaker Corporation (if you’re a young reader, Studebaker made cars) closed in 1963 and many of its employees lost all or part of their promised pensions, it got the ball rolling for future federal involvement. A decade later, President Ford signed ERISA, the Employee Retirement Income Security Act. Among other provisions, ERISA initiated federal regulation of private pension plans, which included stipulating the extent to which defined-benefit pension plans had to be funded each year.
The crucial question is this: How much money should be set aside today in order to fully fund pension payments decades into the future? The feds understood that it would be impractical, if not impossible to set aside the full amount in the present, so they established guidelines based on discounting future obligations by an anticipated rate of return on current investments. While I can’t explain in detail how they compute the discount rate, the calculations include assumptions (i.e., guesses) about future interest rates, GDP growth, inflation and other unknowables. In other words, they totally winged it, and ended up assuming that pension fund assets would appreciate at a rate of 8% per year (now reduced to 7.5%). Oops. After the market collapse of 2008, many defined-benefit plans found themselves underfunded, and many employers have been forced to curtail other expenditures and deposit additional funds into their defined-benefit plans. Subsequently, the zero-interest-rate environment of recent years has rendered 7.5% an unrealistic rate of return.
As a result of these intractable difficulties, private-sector defined-benefit plans have become rare, replaced by defined-contribution plans whereby a company deposits what it has promised to deposit in employees’ pension plans today, and then has no further financial liability.
There is, however, one sector of the economy in which defined-benefit plans live on—in government. While private companies have found defined-benefit plans to be unfeasible due to their uncertain ability to increase revenues when needed, governments have retained defined-benefit pension plans, partly because they can (theoretically) raise taxes at will to obtain additional revenues, partly because it’s easier for them to promise generous pensions since it isn’t their own money that’s in play, and partly because politicians have a central bank to bail them out with newly created Federal Reserve notes to cover whatever red ink they spill.
Now this doesn’t necessarily guarantee that public sector employees’ defined-benefit plans are secure. The recent bankruptcy of Detroit is evidence of that. In fact, governments at all levels have jeopardized the defined benefit plans of government workers due to the profligate proclivities of politicians. According to Matthew Brouillette of the Commonwealth Foundation, here in Pennsylvania, the unfunded liability in the pension funds of public school teachers and state workers is a staggering $47 billion—assuming a 7.5% annual rate of return, which means that the total could be considerably larger. Other states are in even worse financial straits. New York State’s pension debts total $133 billion, Illinois’ $167 billion, and California’s $370 billion. The total for all fifty states lies in the $2.5-3.0 trillion range. Add the unfunded liabilities of the country’s cities, and the total swells to over $4.5 trillion. While chickenfeed compared to the tens of trillions of Uncle Sam’s unfunded liabilities, it’s still a huge deficit to make up. Brouillette calculates that the increases in Pennsylvania’s pension costs over the next four years comes out to approximately an extra $1,000 tax liability for every Pennsylvania family for the next four years.
The dichotomy of the private sector having predominantly defined-contribution pension plans while the public sector has predominantly defined benefit pensions raises serious questions about fairness. Why should government employees have the promised (though, as we have seen, not guaranteed) security of defined-benefit pensions while the defined-benefit plans of taxpayers are exposed to market risk? Further, when a local school district finds that its employees’ defined-benefit plan is underfunded, it is the local taxpayer who has who has to make up the entire difference. In effect, public teacher defined-benefit plans impose a blank check on future taxpayers, making teachers’ retirement plans a ticking time bomb for taxpayers.
The problem of unfunded public employee pension plans is enormous. PA Gov. Tom Corbett’s 2012-13 budget proposed increasing payments into state pension plans to $1.6 billion, a breathtaking 60% increase from the previous year’s $1 billion. By 2016, projected state and school district pension payments will balloon to $5.6 billion, an increase of more than 400% in just five years. And that’s just at the state level.
State and local governments’ need for significantly more tax revenues creates a politically explosive situation. Local taxpayers, most of whom have a defined-contribution pension plan—if, indeed, they have any pension plan at all—have seen their plans struggle in recent years, and many self-employed people have seen their incomes decline. There is going to be a lot of pushback when local school boards try to raise taxes on people who have been experiencing economic hardship in order to meet the looming shortfalls in the teachers’ defined-benefit plans.
In sum, defined-benefit plans beguiled us. Attractive on the surface, they were inherently flawed due to the impossibility of knowing the future. Now it appears that they will cause a huge amount of strife and divisiveness in communities and states across the country in the coming years. There will be a lot of pain, and the political struggle will be over how that pain is distributed. It may take decades to sort out the mess, but ultimately, the only fair and viable (though still imperfect) system would be for everyone to have defined-contribution pension plans. Getting from here to there isn’t going to be easy.
Too bad the ERISA does nothing about the Federal Reserve deliberately inflating away the value of the dollar and destroying the pension security of millions along the way.
I absolutely agree with the final conclusion.
In the mean time, legislation should be enacted that requires all those involved in pensions to send the beneficiaries statements as to what their pensions would be “as if” they were in a defined contribution plan. In short, they should be told what they would be entitled to if their pension fund was to close down today. At least this would provide a dose of reality and a means of informing beneficiaries just how bad the situation is.
The main thrust of the article is how defined plans are not viable because no one can predict the future. The author's final statement completely contradicts the main thesis. Does no one teach critical thinking or writing any more?
Don't live in a state where they take your money to pay off the Government Pirates of Pension, and don't own property, since it's not yours anyway.
Starve the .gov monkeys, as Tom Baugh says. I do know that the children are going to flip out very soon when they find out that they're working for 12-15 backs an hour to pay a retired Pension Pirate who gets paid 20-30 bucks an hour to walk out to the mailbox twice a month. Along with The Golden .Gov retiree health care, that the children will be paying out of their healthy young hides for...
Every time I think about it, it just blows my mind.
Are confusing defined benefit and defined contribution?
All men have beards.
Socrates is a man.
Therefore, defined pension plans should be available to all workers.
Just state a few statements which might possibly be true, then follow up with a non-sequitor which you wish were true. Maybe some folks will fall for the illusion that is all hangs together. QED.
As he pointed out, it's DEFINED BENEFIT plans that are not viable.
Defined contribution plans are money shoveled to the receiving peasant every paycheck.
Defined benefit plans are why the .gov pirates have excrement-eating grins on their faces.
I'll bet my best friend in high school, who worked as a state forester, is retired and making 25-30 bucks an hour (from his defined benefit pension) - in his 50s.
See my post #10
Too bad Mel Brooks doesn’t make a movie about the unfunded liabilities..
Oh wait. Where’s the humour in that?
Ticking financial time bombs across the land..
Now that is some series comedy.
I feel foolish. I missed that crucial distinction. Thanks.
That's why he's for defined contribution plans.
Perhaps when they began the pension program, the communities should have had to put aside money for these workers kinda like the Post Office does. But of course instead of blaming the politicians, we blame the actually workers. Well too bad. They did what they were told and deserve their pensions.
The Pension Pirates, of course, spend most of their later career pouring their promised gold through their fingers.
They KNOW how much they'll be hornswoggling the taxpeasants for.
The failure of business to pay pensions will just keep driving citizens to more and more government. Combined with health care that’s the future. Those that expect to rely on private savings are screwed because inflation will erode savings when you expect to use them.
Politically, as business limbos lower to avoid pension and health costs people lose confidence in business and resort to government. Republicans are screwed.
He’s talking about defined-benefit versus defined-contribution. Another factor to consider is that many retirees received defined-benefit checks, without cost of living increases (colas), and they failed to keep up with inflation. A check received in 1985 that was okay barely allows one to live in 2013. That spurred unions to demand more so colas were inplemented, along with huge benefit payouts. The unions cut their own throats.
So did Teach's swabbies on the Queen Anne's Revenge. Doesn't make them any less pirates...
True. In the old days, government bled their best and brightest workers to the private sector, and receiving training and experience. That turned around over the last 15 to 20 years. Thousands would apply for a few open government positions, because of the inflated defined-benefit pensions and the insecurity of private jobs. It's those new workers who are the pirates, getting big payouts under generous terms versus long-time workers who put in 30 or more years.
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