I started to write a post about this topic this morning, but deleted it in frustration. Instead, I'm just going to bang out a short and simple one on the topic: Muni Bankruptcies.
Here's the bottom line - the current talk about municipal bankruptcies is designed to fix the past problems - obligations we've already rung up - but doesn't address the underlying problem which, uncorrected, will guarantee that we have this discussion again in 15, 30 or 50 years. That problem is defined benefit pension plans which are based on overly aggressive underlying return assumptions.
All the bankruptcy chatter is designed to alleviate the past obligations - but we also need to fix the FUTURE obligations, and I don't see that being addressed. I come from a family of teachers - my father, my mother, my sister, my brother in-law - all teachers. My sister says "But I contribute more to my pension than Mom did," and I reply, "Yeah, but that extra 2% doesn't make up for the fact that the return assumptions internal to your fund are higher than reality is likely to deliver." I've addressed that part of the equation previously. Switch to defined contribution plans (and yes, taxpayers, once the deficits are shored up, can provide matching funds if needed), and let the employees invest it however they want, or even have the pension fund manager invest it for them. That way, if the return assumptions turn out to be accurate, they'll reap the benefits anyway.
End defined benefit plans in favor of defined contribution plans. Otherwise, we're destined to repeat this pension boom-bust cycle indefinitely.
-KD
ps - There are other modifications that should be made too, of course, like ending the "gaming" of baseline salary numbers by employees who collect massive amounts of overtime in their last few years of work and receive annual pensions based upon an inflated baseline.
16 comments:
BTW, KD, you might be on this already, but did you see the headline on VZ moving $20 billion worth of losses into the past--it could go into your Real vs. Onion file. . .
BWDIK - i didn't see that. link?
http://finance.yahoo.com/news/Verizon-moves-202B-in-pension-apf-1148047506.html?x=0&sec=topStories&pos=6&asset=&ccode
@bwdik - ugggh.
"The accounting change does not affect Verizon cash flow or pension funding requirements. Its pension and post-retirement benefit obligations totaled $59 billion at the end of 2009, the latest figure reported. The plan assets are $27 billion less. The accounting change means that some of that shortfall won't weigh on future results, though Verizon will still have to contribute cash to pay for benefits."
whatever that means.. it won't effect the cash flow... but they'll still have to contribute the cash...
non-cash balance sheet items. blah.
Agree that return assumptions need to be realistic and long-term. However, DB plans provide value-add that DC plans in many cases do not. They allow more efficient investment returns (assuming the plan sponsor is competent) relative to the fees and expenses extracted through the mutual fund industry and poor decisions at the participant level.
The alternative to this crisis would be a different crisis with DC plans: Much more unequal distribution of retirement wealth and a smaller pie overall.
---Actuary in CA
KD -- It's not as though many other companies haven't done the same thing or worse. I just liked the headline--if only I could do this with my trades :>) The headline writer must be new--I hope he/she doesn't get canned for this.
Actuary in CA - there's no reason why we couldn't have a firm that managed defined contribution pension assets in the same way. Ie, it could be an allocation in your portfolio: "National Pension Management Fund"...
Some municipalities did not make annual pension fund contributions during years of higher-than-expected market returns. Would this be possible with public DC plans? (I assume NY contributes 3% of my salary to the state pension fund every year, but I can't easily verify that.)
Also, do you think they'd do an employer match for public DC plans?
Pat - with defined contribution plans, the municipality wouldn't need to make contributions - except for employee matches, which could certainly be arranged.
@ Pat,
There is a lot to the notion that DB plans didn't contribute during periods of good market performance.
My DB plan is dead. The cause of death was two fold, 1) allowing current retirees to take unreasonably large lump sums, and 2) failure to contribute during good markets.
In the case of the "2", since we're a DOD contractor, we were actually prevented from contributing to the plan in part because the plan was "over funded" based on the computation of current liabilities.
(In the case of "1", it turns out that people with PhD's from MIT cannot do simple DCF math... Makes me soooo angry. Though I choose to believe this instead of the alternative, which would be to believe they knew they were allowing unreasonable lump sum payouts)
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I think the solution is for all government employers to get out of the business of maintaining pensions/retirement plans of any sort. Push it entirely onto the employee. We shouldn't be asking the taxpayer to fund the retirement of public workers.
... and further, might be a good idea to teach basic economics and financial planing in 5th grade...
Thanks for your insight, guys. A data tidbit for you. . .
New York:
Average pension for cop and firefighter retirees in FY 2010: $39,808
Average pension for other municipal employee retirees in FY 2010: $18,300
Let's start by reforming cop and firefighter pensions before we get at desk jockeys like me.
http://www.osc.state.ny.us/pension/snapshot.htm
KD - There is a DC-like plan design called cash balance DB. Also, other issues can be addressed in plan design: career avg pay instead of final avg pay to avoid the "overtime" issue, better conversion options to avoid lump sum pay problems.
However, if your goal is still to provide a consistent level of benefits across all workers during retirement years relative to their contribution to the municipality, DB is the way to go by definition.
DB allows trans-generational diversification (sharing) of investment returns. Simply having your career in the 1960-1980 period is going to have vastly different effects on DC equity returns than working 1980-2000.
With a well designed DB, you can avoid this boom/bust and maximize collective utility.
I think the key is putting legislation in place to create a reserve fund for pensions (@CTE95) that cannot be touched by political/union influences only looking forward to the next election. Funds should be able to withstand a drop in assets relative to the one we have seen in this last credit cycle and by definition should be over-funded during most cycles.
---Actuary in CA
actuary - this is a very interesting (And accurate) statement:
"DB allows trans-generational diversification (sharing) of investment returns. Simply having your career in the 1960-1980 period is going to have vastly different effects on DC equity returns than working 1980-2000."
the problem is the next sentence:
"With a well designed DB, you can avoid this boom/bust and maximize collective utility."
in reality, that's really hard to do. because everyone is always looking forward to the next election...
You're never going to find a solution without addressing the root of problem - lack of long-term vision... whether it be in government or corporations.
---Actuary in CA
Actuary, I am not going to take this comment thread in this direction, but I think that you and I probably have a fundamental difference in opinion as to the value of redistribution of wealth, especially across generations.
Actually, I do not feel too strongly one way or another about distribution of wealth (I believe there should a balance of both ideals.)
I do feel that DC plans extract more value out of the system having been involved in the implementation of both systems.
My main point is that the problem is not the tool itself (DB), but the planning (or lack thereof) and implementation. The long-term investment assumptions seem silly because there are no strong saving incentives during periods of surplus.
---Actuary in CA
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