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Actuary numbers and pensions.
Old 08-19-2011, 03:14 PM   #1
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Actuary numbers and pensions.

I am amazed (not being a sophisticated math person) at how a few tweaks can fully fund a 30 billion asset pension system. My retirement system is about to limit COLAS from yearly inflation rate, to a 2% annual cola (80% cap) unless CPI goes to 5% which it will then allow a 5% cola for that year. By making this adjustment to the system, the trust fund goes from 80% to 100% funded. I was originally going to get 3.5%, but I will probably only get 2%. I'm not complaining, in fact I am pleased to know this will secure the fund as I don't want it to run out when I'm 75 and can't go back to work, and definitely don't want or expect to count on a tax payer bailout! I'm just amazed at how a slight change results in dramatic changes to the security of a pension system. I guess it also speaks on potentially how expensive cola pensions are to a retirement system
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Old 08-19-2011, 03:39 PM   #2
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There are not too many pensions that have a cola today outside of the government.

For that matter most companies have gotten rid of them in favor of a DC plan.
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Old 08-19-2011, 04:25 PM   #3
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One of the scary thing about pensions is that pretty much all have a 1/2 dozen assumptions which contribute to the long term sustainability of the fund and being off by a couple of percent is the difference from being ok to running out of money (the power of compound interest.)

A simplistic understanding why this would make a big difference is to consider the following.

Your pension plan assume a rate of return of probably around 8%, it also assume an inflation rate, generally 3%. This means it is assuming a real return of 5% (slightly more than 4% SWR used here.) By capping benefits at 2% the real return has increased from 5% to 6% which is a 20% gain and probably account for the difference in funding levels.
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Old 08-19-2011, 04:32 PM   #4
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As long as the plan is reasonably funded now and is willing to make small adjustments along the way like the one OP mentioned or reducing benefits for new hires, the plan is never going to run out of money. Its no different than what forum members here do when the markets turn sour for extended periods.
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Old 08-19-2011, 05:15 PM   #5
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Quote:
Originally Posted by clifp
One of the scary thing about pensions is that pretty much all have a 1/2 dozen assumptions which contribute to the long term sustainability of the fund and being off by a couple of percent is the difference from being ok to running out of money (the power of compound interest.)

A simplistic understanding why this would make a big difference is to consider the following.

Your pension plan assume a rate of return of probably around 8%, it also assume an inflation rate, generally 3%. This means it is assuming a real return of 5% (slightly more than 4% SWR used here.) By capping benefits at 2% the real return has increased from 5% to 6% which is a 20% gain and probably account for the difference in funding levels.
You got me thinking clifp. The assumptions mean everything don't they. I assume on my plan they are figuring 3% inflation, too. I know this sounds crazy, but what if inflation isnt 3%, but 5% one year, and 1% the next every year. This new system would actually cost the system money, as you would get a 2% on a 1% year, and the full 5% on a 5% year. While on the current system you would get a 1% and a 5%.
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Old 08-19-2011, 05:25 PM   #6
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Originally Posted by Mulligan View Post
You got me thinking clifp. The assumptions mean everything don't they. I assume on my plan they are figuring 3% inflation, too. I know this sounds crazy, but what if inflation isnt 3%, but 5% one year, and 1% the next every year. This new system would actually cost the system money, as you would get a 2% on a 1% year, and the full 5% on a 5% year. While on the current system you would get a 1% and a 5%.
So the 2% is not a cap, but rather a minmum yearly raise, and also a maximum, unless inflation in a given year goes to 5%.

These kinds of fiddles really sound like some back testing and curve fitting has been done, with the sole goal to report that the plan is fully funded.

Ha
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Old 08-19-2011, 05:46 PM   #7
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You got me thinking clifp. The assumptions mean everything don't they. I assume on my plan they are figuring 3% inflation, too. I know this sounds crazy, but what if inflation isnt 3%, but 5% one year, and 1% the next every year. This new system would actually cost the system money, as you would get a 2% on a 1% year, and the full 5% on a 5% year. While on the current system you would get a 1% and a 5%.
It depends if they are trying to actually fix the long term funding problem or play games like HaHa is suggesting.

A real fix would look like this algorithmically.
If CPI< 5% then the COLA is the smaller of (80% * CPI) OR 2%.
If CPI > 5% then COLA is 5%

A BS fix is something like you describe and it is not at all crazy to think this way. From the perspective of the politician negotiating this change he can tell everybody. "The government workers union have agreed to make changes that will ensure the pension plans long term financial health". Meanwhile the the union negotiator can tell the members, "it looks like we are taking a cut, but really if inflation continues low we are actually coming out ahead".
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Old 08-19-2011, 06:05 PM   #8
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Originally Posted by haha
So the 2% is not a cap, but rather a minmum yearly raise, and also a maximum, unless inflation in a given year goes to 5%.

These kinds of fiddles really sound like some back testing and curve fitting has been done, with the sole goal to report that the plan is fully funded.

Ha
Ha, I think you are spot on. The state legislature mandated to the retirement system to ensure future financial fitness of the system. Originally they were developing a two tiered system for incoming teachers having a reduced multiple and work more years. Then all the sudden the retirement system comes up with this plan. I imagine they are trying to implement it this way to keep the legislatures out of it, by saying we got it taken care of. I hope they know what they are doing! I've been reading about a lot of states either implementing or already adjusting pension plans. Its good they are addressing them now instead of later. I was reading about Illinois teacher retirement, it was like 40% funded. This is purely anecdotal, and not representative at all, but I saw an public school English teacher had a $153,000 annual pension in Illinois. How did that happen?I have never even heard of a teacher making 6 figures, net alone that amount for a pension!
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Old 08-19-2011, 06:13 PM   #9
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It depends if they are trying to actually fix the long term funding problem or play games like HaHa is suggesting.
I'm missing the point entirely. Why is one playing games and the other an actual fix? (The COLA for state government workers here in Hawaii, by the way, is not a CAP or a minimum, but just a fixed yearly raise.)
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Old 08-19-2011, 06:16 PM   #10
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Quote:
Originally Posted by clifp

It depends if they are trying to actually fix the long term funding problem or play games like HaHa is suggesting.

A real fix would look like this algorithmically.
If CPI< 5% then the COLA is the smaller of (80% * CPI) OR 2%.
If CPI > 5% then COLA is 5%

A BS fix is something like you describe and it is not at all crazy to think this way. From the perspective of the politician negotiating this change he can tell everybody. "The government workers union have agreed to make changes that will ensure the pension plans long term financial health". Meanwhile the the union negotiator can tell the members, "it looks like we are taking a cut, but really if inflation continues low we are actually coming out ahead".
I think the retirement system is trying to reform the system without having to go through legislative changes. Current law says CPI 0-1.9% a cola may be granted. 2-4.9% a cola must be at least 2% but up to 5%. 5% or above it has to 5%. Ultimate cap of 80% of original pension. By granting a fixed 2% or 5% if CPI is above 5%, they stay within current statutory law, thus not having legislature involved to change it. I think that is why all the wiggling is going on. My guess is by avoiding legislature, they minimize risk of future pension cuts for future employees. where that is the prudent thing to do I don't know. I just hope the actuary people weren't previously employed at Enron and Lehman Brothers!
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Old 08-19-2011, 06:25 PM   #11
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I'm missing the point entirely. Why is one playing games and the other an actual fix? (The COLA for state government workers here in Hawaii, by the way, is not a CAP or a minimum, but just a fixed yearly raise.)
Greg, although our pension is under government law, it is really a trust fund invested through 14% contribution from the school district and 14% from the employee. The state does not directly fund the system, so the pensions and such have to fit within the confines of the reserves and investment money it makes. The state will not cut the check for the cola. In fact the retirement system board of directors determines the cola each year within the guidelines of the law. Last year for example they did not grant a cola because CPI was 1.1%, under the 2% threshold. They stated the reason being a negative CPI the previous year, and saving the retirement system $110 million dollars to help make up for previous losses from the 2008 downturn.
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Old 08-19-2011, 07:23 PM   #12
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Originally Posted by Mulligan View Post
I am amazed (not being a sophisticated math person) at how a few tweaks can fully fund a 30 billion asset pension system. My retirement system is about to limit COLAS from yearly inflation rate, to a 2% annual cola (80% cap) unless CPI goes to 5% which it will then allow a 5% cola for that year. By making this adjustment to the system, the trust fund goes from 80% to 100% funded. I was originally going to get 3.5%, but I will probably only get 2%. I'm not complaining, in fact I am pleased to know this will secure the fund as I don't want it to run out when I'm 75 and can't go back to work, and definitely don't want or expect to count on a tax payer bailout! I'm just amazed at how a slight change results in dramatic changes to the security of a pension system. I guess it also speaks on potentially how expensive cola pensions are to a retirement system
I'm not an actuary but I did work in corporate finance, oversaw pension funding and am quite familiar with these calculations. This is not an actuarial fix or game playing. These "few tweaks" are quite powerful, and this is a "highly probable" reduction in future benefits. If inflation were 3% and the COLA were 2%, over 30 years the real value of the pension would decline by 25%. Even if inflation is only 2.5% (just a tiny bit over the COLA) the real value of the pension declines by almost 15%.
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Old 08-20-2011, 12:34 AM   #13
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I think the retirement system is trying to reform the system without having to go through legislative changes. Current law says CPI 0-1.9% a cola may be granted. 2-4.9% a cola must be at least 2% but up to 5%. 5% or above it has to 5%. Ultimate cap of 80% of original pension. By granting a fixed 2% or 5% if CPI is above 5%, they stay within current statutory law, thus not having legislature involved to change it. I think that is why all the wiggling is going on. My guess is by avoiding legislature, they minimize risk of future pension cuts for future employees. where that is the prudent thing to do I don't know. I just hope the actuary people weren't previously employed at Enron and Lehman Brothers!

I agree these are all very sensible changes. A couple of other comments the combined contribution of 28% (14% each from employee/employer) is quite large and unlike the vast majority of public pension plans within my rule of thumb which says traditional pension need to have a combined contribution rate of 25-35%/year.

The key words to me is that if inflation is 0-1.9% than there MAY be a COLA increase and the fact they didn't have it last year would give me confidence that administrators are serious about keeping the funding sound. A lifetime cap 80% COLA adjustment also strikes me as being very sensible. In contrast a Hawaii cop/firefighter who retired after 20 years in his early 40s will see his pension double when he is in his 80s, due to the automatic 2.5% increase. I suspect that not having the taxpayers on the hook for the pension is why the contribution levels are so high and why they are are already making adjustments to the benefits.

It is also serves as warning to other pension funds if your contributions are lower, and your benefits are higher maybe there is a problem.


I am curious what state is this?
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Old 08-20-2011, 03:04 AM   #14
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I'm missing the point entirely. Why is one playing games and the other an actual fix? (The COLA for state government workers here in Hawaii, by the way, is not a CAP or a minimum, but just a fixed yearly raise.)
Interesting.

Are the increases really 'fixed', if so what is it? If it is a COLA raise then surely it is variable, linked to a COLA index such as CPI.
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Old 08-20-2011, 03:38 AM   #15
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Interesting.

Are the increases really 'fixed', if so what is it? If it is a COLA raise then surely it is variable, linked to a COLA index such as CPI.
Yes one would think that it was linked to something but the government workers union is quite strong in paradise so it is not. The 2.5% increase is fixed. I am not sure if that 2.5% on the base pension or compounded, Greg will know that.
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Old 08-20-2011, 03:56 AM   #16
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Yes one would think that it was linked to something but the government workers union is quite strong in paradise so it is not. The 2.5% increase is fixed. I am not sure if that 2.5% on the base pension or compounded, Greg will know that.
Thanks.

In school I learned about constants and variables but in real life I discovered that constants aren't and variables don't
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Old 08-20-2011, 10:46 AM   #17
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Originally Posted by clifp

I agree these are all very sensible changes. A couple of other comments the combined contribution of 28% (14% each from employee/employer) is quite large and unlike the vast majority of public pension plans within my rule of thumb which says traditional pension need to have a combined contribution rate of 25-35%/year.

The key words to me is that if inflation is 0-1.9% than there MAY be a COLA increase and the fact they didn't have it last year would give me confidence that administrators are serious about keeping the funding sound. A lifetime cap 80% COLA adjustment also strikes me as being very sensible. In contrast a Hawaii cop/firefighter who retired after 20 years in his early 40s will see his pension double when he is in his 80s, due to the automatic 2.5% increase. I suspect that not having the taxpayers on the hook for the pension is why the contribution levels are so high and why they are are already making adjustments to the benefits.

It is also serves as warning to other pension funds if your contributions are lower, and your benefits are higher maybe there is a problem.

I am curious what state is this?
Clif it is the Missouri teacher retirement system. Your last comment I think is telling and a warning sign for people with pensions. My retirement system has stated on record there is no way to earn their way out of the 2008-09 investment losses. And our system called PSRS was won system awards for their investing. I wouldn't be surprised if any pension funds haven't been looking at changes, they probably are whistling through the graveyard, unless it was way overfunded prior to the downturn.
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Old 08-20-2011, 10:59 AM   #18
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Regardless of the thread (as related to private/public pensions), the "facts" in my little world reveal that both my FIL and BIL lost their pensions - more specifically they were turned over to the PBGC after their respective companies (in business, over 100 years) went under.

FIL has passed, but BIL still has a part-time job (to pay for medical needs) in his late 60's, with no intention to retire at all.

IMHO, government pensions as related to local government are/will face the same challenge in the years ahead. I'll argue against additional taxes that I may be expected to pay due to "poor planning".

Those that count on a pension should not count on a pension, IMHO.

As one who retired (from a private company, without a pension), my view is not to support those in the public sector with additional tax revenue to cover a "promise" that was made, without my direct input - or opinion.

Heck, my private company (who had a pension) decided one fine day just to eliminate it, and replace it with a defined contribution plan, even though I had been working there for more than a few years.

Working in the private sector, I'm expected to pay for my own, along with public retirement plans, via continuing increasing taxes. Sorry, I'm covering my own plan - I have no pity on those in the public sector that don't cover theirs.

If you have a problem with your pension/defined benefit plan - please cry to somebody else that gives a dam*...
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Old 08-20-2011, 11:07 AM   #19
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Yes one would think that it was linked to something but the government workers union is quite strong in paradise so it is not. The 2.5% increase is fixed. I am not sure if that 2.5% on the base pension or compounded, Greg will know that.
It's not compounded -- 2.5% of the initial pension amount. The government workers unions are strong, but I'm not sure this feature is a win for them (or is even negotiated by them). I'd rather get inflation-adjusted dollars.
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Old 08-20-2011, 10:37 PM   #20
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My pension (Nevada) adjusts but is not tied to CPI.

It stays the same years 1, 2, and 3.
Then goes up 2% years 4, 5, 6.
3% years 7, 8, 9.
3.5% 10, 11, 12.
4% years 13 and 14.
And 5% year 15 and every year beyond that.

(That's part of the reason I'm thinking about retiring a decade before eligible and taking a hit on the amount I'm getting, to max the COLA earlier).

I do not know (on my questions to ask) if it is compounded or on the base amount.
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