Is it sensible to require DB plans to be fully funded?

[nun]

I don't see why a DB pension plan needs to be able to cover all current and future liabilities, so is the news about the underfunding of state DB plans just hype?

 

[MichaelB]

I don't see why a DB pension plan needs to be able to cover all current and future liabilities, so is the news about the underfunding of state DB plans just hype?

A well funded DB pension plan should fully fund the "current value" of all future liabilities. That is, the present value of the projected total future cost, pro-rated to employment years to minimize the steepening impact of final year service. It's hard to say if the news is hype, because it usually doesn't include the needed breakdown of real data, but most articles I've read don't have an acceptable definition of "well funded"

 

[nun]

A well funded DB pension plan should fully fund the "current value" of all future liabilities. That is, the present value of the projected total future cost, pro-rated to employment years to minimize the steepening impact of final year service. It's hard to say if the news is hype, because it usually doesn't include the needed breakdown of real data, but most articles I've read don't have an acceptable definition of "well funded"

I've seen 80% funding as an ok level. But surely states and Governments are very different from companies when it comes to assets an the risk of bankruptcy so I don't get the push to have them 100% funded like private schemes.

 

[Gearhead Jim]

It depends on whether you are a retiree or a stockholder...

The math used to analyze a currently operating fund by the accountants, and then later by the PBGC if it takes over a fund, are miles apart.

My fund was taken over by the PBGC just months before I retired, I'm told it was considered fully funded about two years before that but I'm actually getting about 1/2 of my expected funded benefit.

Fortunately, we had a big DC plan also, and the company put in some extra for some of us. Others were not so lucky.

 

[akck]

A well funded DB pension plan should fully fund the "current value" of all future liabilities. That is, the present value of the projected total future cost, pro-rated to employment years to minimize the steepening impact of final year service. It's hard to say if the news is hype, because it usually doesn't include the needed breakdown of real data, but most articles I've read don't have an acceptable definition of "well funded"

And that's the rub. They could use an unreasonable ROR/discount rate to show that they are better funded. And let's not get into the inflation rate for those funds that provide for it.

 

[Mulligan]

I've seen 80% funding as an ok level. But surely states and Governments are very different from companies when it comes to assets an the risk of bankruptcy so I don't get the push to have them 100% funded like private schemes.

Maybe it's better to stay a little under 100% with government pensions. Seems the last time many pensions (including mine) was over 100% funded, they approved additional payouts and higher multipliers, which obviously didn't help matters with the market downturn a few years ago. Staying under a 100% will keep people from lobbying for a bigger piece of the pie than is necessary, because "it's there".

 

[clifp]

I've seen 80% funding as an ok level. But surely states and Governments are very different from companies when it comes to assets an the risk of bankruptcy so I don't get the push to have them 100% funded like private schemes.

I don't know why government plans should be treated differently.

Take a state like CA where it is virtually impossible to raise taxes, we are already seeing a test case in Stockton bankruptcy. Who gets paid first the bondholders or the folks with a pension?.

While we haven't had a state go bankrupt yet, we are IMO only one financial crisis away from seeing CA, IL, or possibly RI, HI, or MI see a crisis in their pension plans, which could possibly result in a state bankruptcy.

Ignoring tax advantages, given my choice between buying a 30+ year bond in one of those states or a bond from Berkshire, Coca Cola, Exxon, or Johnson and Johnson I'll take the corporate bond every day.

 

[Independent]

I don't see why a DB pension plan needs to be able to cover all current and future liabilities, so is the news about the underfunding of state DB plans just hype?

Underfunding shifts the cost from the current taxpayers, who are presumably getting the gov't services provided by the current gov't workers, to future taxpayers, who don't get the services but pay the bills.

It's a version of borrowing - the state workers lend the state gov't money, relying on the state gov't to repay the loan by taxing some future generation.

It puts the workers and future taxpayers at risk of a declining economy - what happens if the state runs into a persistent decrease in population or taxable activities?

Some people say that future generations benefit from state services provided today, and that a persistent decrease in population/economy is impossible.

So, whether it's a "problem" depends on which of those views you buy.

 

[AndrewJackson]

I don't see why a DB pension plan needs to be able to cover all current and future liabilities, so is the news about the underfunding of state DB plans just hype?

I believe your comment really only applies to STRONG profitable corporations which have the ability to fund the liabilities when the pension plan is eventually drawn down upon. The problem are pensions that are backed by the tax payers in some shape or form, like in my defunct state of Illinois .

On the mandate for funding: How about we let failure take place and let reality run its course? Why am I in obligation to cover expenses for teachers in Illinois for the past 50 years now? What on earth did I do to deserve this liability. I don't owe anyone. What type of accounting system recognizes the true costs decades after the fact?

 

[pb4uski]

I don't see why a DB pension plan needs to be able to cover all current and future liabilities, so is the news about the underfunding of state DB plans just hype?

Pension plans would tend to be less funded during challenging economic times and fully or overfunded during good times. However it seems to me that the underfunding of state and municipal pension plans is as much due to inadequate pension fund contributions in the past as it is to disappointing investment performance and the time to pay the piper for those inadequate contributions is imminent. One problem is that the people who made the poor decisions of the past in underfunding (knowingly or not) are for the most part not around to be held accountable for their poor judgement (they are retired )

 

[brett]

I view it simply as a form of state borrowing except that the powers that be, for political reasons, are reluctant to call it borrowing. The bottom line is the same....we are putting a significant financial burden onto our children. Just like the federal governmen debt and the tragic social security funding model. We continue to elect weak politicians who do not have the intenstinal fortitude to deal with the financial issues.

NPR had a very good report (about two years ago)on the status of pension funding, state by state. It was interesting to see the huge differences in funding levels and in the amount of total liabilities.

 

[Texas Proud]

I don't know why government plans should be treated differently.

Take a state like CA where it is virtually impossible to raise taxes, we are already seeing a test case in Stockton bankruptcy. Who gets paid first the bondholders or the folks with a pension?.

While we haven't had a state go bankrupt yet, we are IMO only one financial crisis away from seeing CA, IL, or possibly RI, HI, or MI see a crisis in their pension plans, which could possibly result in a state bankruptcy.

Ignoring tax advantages, given my choice between buying a 30+ year bond in one of those states or a bond from Berkshire, Coca Cola, Exxon, or Johnson and Johnson I'll take the corporate bond every day.

States can not go BK... I don't know what happens when they can not pay their bills, but there is no law allowing them to BK...

 

[Texas Proud]

The simple answer to your questions is YES...


All pension plans should be 100% funded....


The problem is with market drops... say a plan dropped 20% in the market downturn.... do you require the entity to fund the plan to get it back to 100% If so, that is a big hit to expenses... heck, it might be more than a company gets in total revenue... or a gvmt entity in taxes...


But what would you do now, when the market has turned and returns have been great the last few years Allow them to take the money out?

The devil is in the details..... but, I still say they should be 100% funded as a rule...

 

[Bestwifeever]

The simple answer to your questions is YES...

All pension plans should be 100% funded....

The problem is with market drops... say a plan dropped 20% in the market downturn.... do you require the entity to fund the plan to get it back to 100% If so, that is a big hit to expenses... heck, it might be more than a company gets in total revenue... or a gvmt entity in taxes...

But what would you do now, when the market has turned and returns have been great the last few years Allow them to take the money out?

The devil is in the details..... but, I still say they should be 100% funded as a rule...

Interesting. DH's frozen private pension plan was just above 80 percent funded at the end of 2011. By the end of 2012 it was 99 percent funded with nary a corp contribution.

I imagine a private plan could be more than fully funded, but maybe public plans cannot have a surplus against a rainy day. Complicated financial planning, these pensions.

 

[MichaelB]

I've seen 80% funding as an ok level. But surely states and Governments are very different from companies when it comes to assets an the risk of bankruptcy so I don't get the push to have them 100% funded like private schemes.

States are not different than businesses when it comes to accounting principles. How they are applied is a different discussion (unfortunately).

If we’re talking about what “should be”, the future benefit of an employee is part of current “total cost of employment”. Accounting norms say that costs should be recorded when they are incurred and large one-time costs can be amortized over the life of an economic good. So a future pension cost should be amortized, or expensed (accrued) as part of the ongoing employee cost, which is when it is earned. Because the DB pension formula is heavily end-weighted, accounting principles also suggest the total lifetime cost should be more evenly spread over the entire employment period.

The full economic cost should always be quantified, because it has been incurred. How much of that should be funded? I think 100%. Less than that might make sense when the opportunity cost of funding surpasses some threshold, but that case should be specific and measurable, and limited in application.

 

[MichaelB]

I imagine a private plan could be more than fully funded, but maybe public plans cannot have a surplus against a rainy day. Complicated financial planning, these pensions.

[-]Pensions are not so complicated, but the people who manage them certainly are. [/-]

On second thought, yes, pensions can be complicated. Regretfully, more effort is put into exploiting than reducing the complexity.

 

[Running_Man]

In reality there is no such thing as fully funding. It is the same question as do I have enough to retire? Only on a grander scale. The corporation must estimate future salary increases, how long employees will stay, future interest rates and future discount rates.

If a fund is 80 percent funded you are most likely ok and in no danger at all of the fund running out of money any time soon. If you are already retired, say over 55 and the fund is 80 percent funded, there no doubt is also funding for employees younger than you and worst case you as the older retiree will consume their pension.

As a matter of fact if you are working for a company the closer to 100 % funding or if over 100% funding there is, the greater the incentive to end the plan, pay out the participants or move to an insurance company and drop the pension.

 

[Finance Dave]

And that's the rub. They could use an unreasonable ROR/discount rate to show that they are better funded. And let's not get into the inflation rate for those funds that provide for it.

Companies cannot just choose any discount rate they want...there are guidelines. I worked in a Fortune500 company Treasury department for 5 years. Although I was not in the pensions area, my very close colleague was and we talked about these things several times.

 

[clifp]

States can not go BK... I don't know what happens when they can not pay their bills, but there is no law allowing them to BK...

Well in theory sovereigns states can't go bankrupt either, but in reality they do default, hosing creditors in the process just as effectively as any bankruptcy court. A lesson that large depositors in Cyprus learned very recently.

Companies cannot just choose any discount rate they want...there are guidelines. I worked in a Fortune500 company Treasury department for 5 years. Although I was not in the pensions area, my very close colleague was and we talked about these things several times.

A major problem with state and local pension plans is precisely this, that are allowed make any assumptions they wish about future returns, future wage growth, number of employees, attrition rates etc. AFAIK about the only thing that private and pension plans calculate the same is actuarial life expectancy. It is not much of exaggeration to say that private companies pension managers could go to jail for doing the stuff that is routine in the public sector.

For instance private company have to set aside money for retiree health insurance (if they offer it). On the other hand almost no states bother with more than token contributions to retire health plans which are in worse shapes than pensions.

Especially with public pensions, "80% funded" for State A, may only be 70% for State B, and 50% for a private pensions

 

[pb4uski]

.....As a matter of fact if you are working for a company the closer to 100 % funding or if over 100% funding there is, the greater the incentive to end the plan, pay out the participants or move to an insurance company and drop the pension.

I wouldn't agree with this. The purpose of providing a DB plan is to attract/retain good employees and full funding doesn't change that at all.

 

[growing_older]

But fully funding a plan does change it's effectiveness in attracting and retaining employees. Employees may be attracted to a company with a DB plan, but if that plan is weakly funded they will tend to discount it. This is similar to bonus plans that provide conditional compensation. Companies with plans that pay regularly and consistently find that employees view the bonus as part of compensation when evaluating job offers. Companies that offer a bonus that pays irregularly or pays based on conditions outside of an employee's control find that employees don't consider the bonus, or discount it heavily, when evaluating job offers.

 

[pb4uski]

But fully funding a plan does change it's effectiveness in attracting and retaining employees. Employees may be attracted to a company with a DB plan, but if that plan is weakly funded they will tend to discount it. This is similar to bonus plans that provide conditional compensation. Companies with plans that pay regularly and consistently find that employees view the bonus as part of compensation when evaluating job offers. Companies that offer a bonus that pays irregularly or pays based on conditions outside of an employee's control find that employees don't consider the bonus, or discount it heavily, when evaluating job offers.

+1 good point

 

[Texas Proud]

Well in theory sovereigns states can't go bankrupt either, but in reality they do default, hosing creditors in the process just as effectively as any bankruptcy court. A lesson that large depositors in Cyprus learned very recently.

Do you mean nations I most definitely agree... they can default, but you had said BK for the states...


The difference to me is that there are rules in a BK... when it comes to a sovereign defaulting, they get to make up the rules...

 

[utrecht]

But fully funding a plan does change it's effectiveness in attracting and retaining employees. Employees may be attracted to a company with a DB plan, but if that plan is weakly funded they will tend to discount it. This is similar to bonus plans that provide conditional compensation. Companies with plans that pay regularly and consistently find that employees view the bonus as part of compensation when evaluating job offers. Companies that offer a bonus that pays irregularly or pays based on conditions outside of an employee's control find that employees don't consider the bonus, or discount it heavily, when evaluating job offers.

That makes sense logically, but I would bet that no more than 5% of prospective employees would even think to look at the funding level of the companies pension plan. Most people dont even know how much money is in their 401k or what funds they are invested in.

 

[MichaelB]

Being able to attract the best (highest potential) prospective employees is an excellent reason to have an adequately funded plan. In that same line, being able to attract the best (lowest) lending rates and the most committed (long term) investors are just as important. The same reasoning applies to public pensions.