The Pension Problem

[imoldernu]

It seems to me that one of the worst problems that America faces in the coming decades, is paying out pensions that have been promised, but not funded.
Whether Private, Federal, State or Municipal, the amounts quoted in the media are staggering. This sentence from Wikipedia caught my attention:

Quote:

On average, pensions consume nearly 20 percent of municipal budgets. But if trends continue, over half of every dollar in tax revenue would go to pensions, and by some estimates in some instances up to 75 percent.

Pensions crisis - Wikipedia, the free encyclopediaAs an added factor, the Wiki article includes Social Security as a "pension" entity.

While we know that the world will not come to an end, I am concerned that despite hundreds of news articles, just here in Illinois there doesn't seem to be any answer that will not result in very serious changes in the well being of those who have paid into plans, or have forgone pay raises for pension promises. At this point, the breaches of trust are almost immaterial, as solutions are sought. The money is not there, and there is no means of replevin.

As much as I have read on the general subject, and the proposals that have been made by different members of Federal and local government, there are no solutions that make sense to me. While I only have a small dog in this fight... (maybe 10 more years of SS) I wonder how others feel the overall problem will resolve.

Some of the "solution" proposals that I don't see happening are:
-Increasing the working age to 70 or later.
-Continuing to pay out as promised until the fund money is exhausted, leaving the younger people with no safety net at all.
-A return to the ultra high return rates of the derivatives boom era.

What is left is:
- A change from defined benefits to adjusted defined contribution
- Increased taxes and increased contribution
- Unlocking protected wealth
----progressive taxation
----sale of public owned assets
- A general lowering of federal and local government provided protections and services

We all look at this in view of our own situation, but whether we have a pension or not, and even if Social Security is not part of the retirement plan, the effects of the Pension Problem will have a major impact on the overall economy, and the health and welfare of all citizens.

We can address the Federal debt, and things like the future of the student loan program or healthcare, as all of these are part of the gloom/doom scenario, but pensions crises are becoming very common in more and more private firms, local municipal governments, states like Illinois. The implied government guarantee (Pension Benefit Guaranty Corporation) which covers 44 million workers, has a current estimated current funding shortfall of nearly 300 Billion.

One area of help could come from growing inflation, but COLA's could obviate much of this.

There are many members here on ER who know a lot more than I do about this subject. What do you see happening? More specifically, do you see a way (or a time) when promised pensions will simply NOT be paid.

Looking for some light at the end of the tunnel.

[utrecht]

Lowering benefits for new hires (which doesn't affect benefits already earned by anyone), drastically reduces the overall problem. Its a much easier fix than most people will have you believe. Why the entities with pensions in trouble don't make this one easy fix is beyond me.

My department which already has one of the most stable pension funds around did exactly that last year. New hire's benefits were reduced pretty significantly. It sucks for them, but at least they know the deal going in. If they don't want the job they don't have to take it. It does seem like we are getting less quality new people now which will be costly in non monetary terms later, but that's just my opinion and a pretty hard thing to measure.

[comicbookgujy]

My company lower pension contribution to 1.2% for new hire.

Existing employee still receive 1.7%.

Now we're going through another re-org with the parent company...don't know what will happen to the pension plan after re-org.

[Chuckanut]

My state has gone to a hybrid system for new folks: Half defined benefit, half defined contribution. Also, the very old gold plated plan has been closed to new members for over 30 years. Spiking is difficult because of the five year average used to calculate the pension. Double dipping by retiring and then getting hired back to do basically the same job has been restricted. Also, state and local employees all contribute to SS, unlike some states.

I suspect we will see more restrictions and reductions in the future in some of the public safety plans which are much more generous than the plan available to run of the mill state employees and teachers.

It is interesting to note that had we not gone over the financial cliff a few years ago, all the plans could be adequately funded from then current tax revenues.

[timwalsh300]

I imagine that we'll continue to see a shift toward the DC model in both the private and public sectors - programs frozen and existing cash values paid out. And I'm fine with that. My job (military) is covered by a generous DB pension program which many people seem to envy, but I've said many times that I'd prefer to have more money to save and invest now rather than a "promise" of money decades from now (which also results in the "golden handcuffs" problem).

Unfortunately, the DC model seems to be a disaster for the majority of people who don't hang out on this forum or at Bogleheads. For this reason, I don't see SS ever going away.

Tim

[ERD50]

This is a hot button in IL, one of the (or the?) State(s) with the biggest pension problem.

I was recently reflecting about how most people would not want to see any cuts to benefits earned, as it just does not seem fair.

But - if my MegaCorp went bankrupt, the PBGC (a Govt Program) would take over, and pensions would be capped at $57,477 per year (age 65 - no COLA). So is it so unreasonable to put this same cap on the public sector employees of Illinois, if IL essentially goes bankrupt? And the PBGC is funded by insurance payments from my employer - IL hasn't even made insurance payments.

The IL Constitution seems to say that promised benefits cannot be cut (subject to interpretation), but an amendment could change that. Something needs to be done. They have cut some of the benefits for new hires, but that will drizzle out over 30 years or so.

-ERD50

[Sittingduck]

Quote:

Originally Posted by Chuckanut It is interesting to note that had we not gone over the financial cliff a few years ago, all the plans could be adequately funded from then current tax revenues.

Not in the case of Illinois. The pension funding problem has been well publicized for many, many years before the recession. We are the poster child for how government can totally fail the people. Even with the recession they have no will to act to start addressing the problem. Borrowing rates are rising. The state is broke.

Patronage runs wild in Illinois. Pols have little incentive to correct anything that will negatively impact their private army of supporters -especially in an election cycle. The problem has become so massive now that cutting out future pensions for new workers, or limiting increases for current retirees won't be enough. The people who worked with an implied contract for a life long pension are going to get sucked down in the collapse.

Hopefully Illinois's predicament may be a helpful example and warning to others and prompt them to take action sooner .

[youbet]

Here's a recent and fairly objective article from Chicago Magazine regarding the situation with public pension funds in Illinois.

Illinois: A Long History of Underfunded Pensions

Quote:

[T]he state, led by governors and General Assembly members, has never really paid its fair share. “It’s a matter of never quite putting enough money into the piggy bank,” said Sandor Goldstein, who has been a public pension actuary in Illinois for more than three decades. You can think of an actuary as an accountant with a crystal ball: They use statistics to try and project how much stuff is going to cost ten, twenty, thirty years down the road – stuff like retirement benefits. But in Illinois, the state’s pension contributions are discretionary, so governors and lawmakers can basically contribute whatever they feel like. And lawmakers have been ignoring guys like Goldstein for decades. “I have some reports from these pension commissions that complain about the underfunding back as early as 1945,” he said, before plucking a shopworn paperback report from the shelf of his downtown Chicago office.

The state's most recent pension holiday was orchestrated by inmate ex-gov Rod Blagojevich. I'm not a religious man, but I pray every night that they put Rod Baby in a cell with "Bubba" who quickly develops an urge to "know" Rod (in the Biblical sense).

[scrinch]

Do you think SS will turn to means testing, turning the program into an insurance policy against old age poverty instead of entitlement for everyone who pays in? I'm not sure how much this would help, but it would be relatively painless from a financial perspective (but not from a political perspective).

[Masquernom]

You should see the mess the city of Detroit is in with their pensions.

[gauss]

For SS, I see the current point in time to be absolutely critical to the program going forward. The reason I say this is that the House is on the verge of passing the chained CPI revision cut to the COLA formula. In the past SS has been the third rail of politics, and those in power did not attempt to reduce currently accrued benefits to fix other problems.

Although incorrectly marketed as a technical change that is not a reduction of beneifts, I believe the chained CPI will reduce the NPV of my benefits on the order of 10% (staring at age 70, concluding at age 100, currently 48 years old). For a dual-income couple with close to 2M NPV in currently accrued benefits, this is a significant hit.

The real thing that frightens me the most is what will come next if this is allowed to pass. Once the demonstrated third-rail of politics has been removed, I believe that we will be in store for a regular assault on earned benefits. My analogy to this is in the corporate world where our pensions were modified as follows:
- 1988 removal of ER SS bridge payments for new hires
- 2006 convert from exponential Final Salary formula to linear Career Average Salary Formula for all.
- 2012 cease of accruals of pension credit for all.
- 2012 transfer of pension liabilities to Insurance company thus removing any PBGC protection and ERISA rights to information

-gauss

[clifp]

With the caveat that I have absolutely no clue what the politician will do or in a State like Il. what the could do. Here is my RX for fixing the public pension plans.

Short-term
- Eliminate spiking by averaging the last 3 or 5 years and excluding vacation, sick leave, and excessive overtime. Most plans have started to do this.
- Make sure thing like early retirement reductions, purchasing service credits, and lump sums vs annuities are actuarially sound. Virtually every time someone with a Public pension plan asks the question on the forum, "Lump sum or pension?". The monthly pension is a better deal and offers far more generous income than you could get purchasing an SPIA from a private company. This leads me to conclude that either all the private insurance companies are badly ripping off annuity purchasers,or the rate of returns public pension plans are assuming are too high. My money is on the latter.
- Adopt the Federal retirement system for new state and local employees, modest pension ~1%*years of service, low cost 401K, and Social Security.
- Increase pension contributions by the states and cities, this almost certainly means higher taxes.

Medium term. My guess is that for worse funded fund public pension perhaps as much as 1/3, just screwing new workers and making the above fixes won't be enough. We also have to decrease benefits for current retirees.
- Freeze COLAs for a 1-3 years
- Change future COLA to be a function of inflation, the pension fund returns, and the economic status of the city or state.
- Require all public pension plans to have 5-10% of their assets in local or state bonds.
- Finally make sure that the pension plans of anyone involve with negotiating public employee contracts, Mayors, Governors, School Board superintendents, as well as union officials are highly tied to the health of their pension pension plans. Such that any freezes, reductions, future tax increase, cost them twice as much as anybody else.

[utrecht]

How about pass a law that says every pension fund must be run by an outside agency or financial firm? Most every pension fund that is in trouble is in trouble because they were mismanaged by politicians.

[imoldernu]

A little more background on what happened to many pension funds that underlies the current underfunding.
Back in the late 1970's and the 1980's interest rates were very high. The bank prime rate topped out at 21.5% in 1980. During this long period of run up in rates, most pension funds were at or over 100% funding, based on the projected net present value. In both the private and public sector, this looked as if money was being wasted.
In one case that I am familiar with, a Chicago firm, finding itself overfunded at 125% of needs, petitioned and was granted a rollback, with the overfunded amount being returned to stockholders. The approved formula for future pension funds input was based on a return rate of 15%, not unusual in the light of then current rates. The problem here was that the projected income formula was never changed, and as interest rates declined, there was no move to adjust.

At the same time, with the heat on the tax increases being forced by inflation, both businesses and government found it easier to ignore the pension funding... not only by failing to increase the capital, but by offering pension "bennies" in lieu of pay raises. This meant COLA's, early retirement offers, and pensions based on "last working year pay". That meant much overtime as well as pay increases during the final year of work.

The protection of pension plans is provided by ERISA which defines the overall regulatory requirements as follows.

Quote:

-Requires plans to provide participants with information about the plan including important information about plan features and funding. The plan must furnish some information regularly and automatically. Some is available free of charge, some is not. -Sets minimum standards for participation, vesting, benefit accrual and funding. The law defines how long a person may be required to work before becoming eligible to participate in a plan, to accumulate benefits, and to have a non-forfeitable right to those benefits. The law also establishes detailed funding rules that require plan sponsors to provide adequate funding for your plan. -Requires accountability of plan fiduciaries. ERISA generally defines a fiduciary as anyone who exercises discretionary authority or control over a plan's management or assets, including anyone who provides investment advice to the plan. Fiduciaries who do not follow the principles of conduct may be held responsible for restoring losses to the plan. -Gives participants the right to sue for benefits and breaches of fiduciary duty. -Guarantees payment of certain benefits if a defined plan is terminated, through a federally chartered corporation, known as the Pension Benefit Guaranty Corporation.

The degree to which these responsibilities have been followed might be judged by the current status. (Theoretically, the PBGC is not government funded, nor a direct government financial responsibility). In any case, it is about $300B underfunded.

More info on ERISA and Pension Plans here:
http://www.dol.gov/ebsa/faqs/faq_com...e_pension.html

I suppose this qualifies for a "hair on fire " designation, and more unnecessary tension to heap on the worries of those with a long retirement ahead. Many of the proposals in previous posts could ameliorate the problems, but what bothers me the most, is that I don't see significant action in the works, either here in Illinois, or in the country as a whole. Kudos to clifp for putting together some really good ideas that don't seem to have gotten to our Illinois politicians.

What triggered my concern was a discussion with one of my sons, who tells me that just a year ago, his pension plan was reported to be funded at a 110% level, but that this year's update indicates funding at 77%. Not a crisis overall, but the "internals" of the fund are not obvious to the average employee. My guess would be that most persons are not deeply knowledgeable about the intricacies of their own plan and even less able to do anything about it.

So, back to the original question: Do you see a day when promised pensions will not be paid?

[travelover]

Quote:

Originally Posted by imoldernu ........... So, back to the original question: Do you see a day when promised pensions will not be paid?

Sure. Watch what happens in Detroit under the emergency manager Kevyn Orr in the coming months.

Quote:

Orr’s proposal to restructure Detroit’s more than $17 billion in debt and long-term obligations includes cutting pension payments, ending cost-of-living increases, removing some workers from the system and making the rest pay more.

Detroit Pensions Begin Talks Over Plan to Cut Benefits - Bloomberg

[youbet]

By far the biggest issue in Illinois is failure of the state to make the required contributions. And even in the rare year when "pension holidays" were not taken, the contribution amount was not actuarially determined but simply the result of a "suggestion" by the ruling politicians.

We do need behavioral reforms here. Spiking, buying service credit too cheaply, pensions to cronies, hefty donations to majority party political campaigns, etc., cost money and need to be eliminated. But until the state joins the employees in regularly making contributions to the pensions funds, those reforms will only have a minor impact.

Currently, Illinois employees more or less fund their own pensions yet have no control. They have 9+ percent deducted from each check and that always happens without exception, ever. The state is supposed to contribute 7+ percent but frequently takes "pension holidays." This has resulted in the fund being at only 43% of the actuarial goal.

If I were a new hire in Illinois, I'd prefer to have no pension but be made part of SS. I could invest my 9% on my own and the Feds would enforce Illinois contributing their portion of my SS. Right now the employees are on their own in terms of trying to make Illinois contribute the state's portion to the existing pension plan and obviously they have been unable to do so.

The politicians in Springfield claim they cannot afford to have employees on SS (instead of the current pension system) because they could not afford to pay the 6+ percent employer contribution. That would be much more expensive than the 7+ percent contribution to the current pension fund which is not mandatory.

The politicians here have been so inept and so corrupt, it boggles the mind. Perhaps that's why so many of them are in jail. The percentage caught and prosecuted is tiny, but when there are so many a few eventually wind up behind bars.

[youbet]

Quote:

Originally Posted by ERD50 But - if my MegaCorp went bankrupt, the PBGC (a Govt Program) would take over, and pensions would be capped at $57,477 per year (age 65 - no COLA). So is it so unreasonable to put this same cap on the public sector employees of Illinois, if IL essentially goes bankrupt? And the PBGC is funded by insurance payments from my employer - IL hasn't even made insurance payments.

An interesting proposal, but there are differences between your MegaCorp's DBP plan and the Illinois plan. MegaCorp's plan is likely a true DBP with MegaCorp contributing all the money to the fund. MegaCorp must meet funding requirements and standards and pay insurance premiums to qualify for PBGC insurance.

The Illinois pension funds are supposed to be funded by a combination of employee payroll deductions and state contributions, although the state has missed its contributions many times. The state plans are not really DBP plans but more of a hybrid between DBP and DCP. You would think, therefore, that the money left in the Illinois pension funds would be targeted to pay employee pensions and not used to bail the state out of financial woes, possibly even bankruptcy. As it stands, the teachers fund is good until 2029. Unless the state is successful in grabbing more of the employees' contributions and redirecting them towards other state needs, bankruptcy is 13 years away for he fund. The state may be closer.

It will be interesting to observe if Illinois does go belly up, if the courts order the employee contributed funds remaining in the pension funds to be distributed to the states creditors or will money the employees contributed towards their pensions remain guarded for that purpose.

I'm sure long retired public employees in Illinois are going to participate in the pain and wind up with reduced pensions. The numbers really are that bad. But the difference between that and the PBGC-like cap you suggest is that in the case of the public employees, most of the benefit they will lose will be a benefit they paid for out of direct payroll deduction from their pay checks. The private employees at MegaCorp would be losing benefits paid for by MegaCorp as part of a DBP plan. Of course, the painful result is the same in either case.

I'd also add that Illinois would never qualify for PBGC insurance because they refuse to make actuarial based contributions preferring political based estimates (going as low as zero) instead. The last three recent proposals for "pension reform" coming out of Springfield have all included a clause which continues to call for employee contributions to be mandatory and direct deductions from pay checks while the state's contribution will be "flexible."

It's almost hard to believe...........

[NW-Bound]

Wow, that's pretty bad. One would think we are in a 3rd world country.

I was about to say that people got the government they deserved, but then perhaps the often jokes about election fraud are not jokes after all.

Bleak, bleak...

[Chuckanut]

Where were the public employee unions in Illinois when all this was going on? Supposedly, they are so phenomenally powerful that they could have demanded generous contributions to the pension and got them. Or were they part of the problem?

So, an underfunded pension, no SS benefits to speak of, and politicians and union leaders who don't seem to give a hoot. Well, time to get that 2nd job and work until at 70 or more. At least they probably won't get Alzheimer's.

[nash031]

As an active duty military member, I am pretty rare amongst my cohorts in that I frequently advocate for the military (really all public employment) dumping pensions in favor of defined contribution plans. I have been serving for nearly 14 years, so I know that (assuming I finish out my full 20) I will have a nice COLA'd pension waiting for me. But the situation is untenable and outdated as far as the federal government goes.

I believe opening the Thrift Savings Plan to the military was the first step in driving the military toward defined-contribution retirement, and I do think it's the way to go. That said, military pay is a sacred cow - what politician is ever going to advocate for reducing military benefits substantially, and particularly in an all-volunteer force? Talk about political suicide.

Still, it needs done, in my opinion. Offering "early" pensions is seen as an easier way out, but it's just a band-aid.

I think they need to modify the system sooner rather than later. Grandfather anyone who is beyond their initial term of service (usually 4-5 years, sometimes up to 8 years depending on their line of work) into the defined benefit pension. Anyone in their first term of service or who signs up from this day forth is entitled to defined contribution, and those currently serving in their first term may be retroactively compensated (including a market-matching interest sum) back to their first day in the service. This money would be added to their tax-sheltered TSP, and they can then choose how they want to continue forward from there. Educate the troops about saving for their retirement and the benefits of defined contribution, and move on saving the taxpayers billions.

Of course, because I would be grandfathered under this plan, I doubt it would ever be taken seriously coming from me, but I get the sense there are some people in higher places who are starting to think along these same lines. The question is, who is going to be brave enough to do what needs to be done to fix the federal public pension system? Hell, do the military last since they're arguably most deserving, but either way, the system is outdated an financially irresponsible.