How We Got Into This Pension Mess

I’m an actuary, but not a Pension Actuary. I don’t understand the minutiae of pension law; I only know the basics. Where I have more punch than most pension actuaries is that I understand the investing side of pensions, whereas for most of them, they depend on others to give them assumptions for investment earnings. I’ve written on pension issues off and on for 15 years or so. I remember my first article in 1992, where I suggested that the graying of the Baby Boomers would lead to the termination of most DB plans.

I am here to recommend to you the book Pension Dumping. It is a very good summary of how we got into the mess we in today with respect to Defined Benefit [DB] pension plans. Now, much of the rest of this review will quibble with some aspects of the book, but that does not change my view that for those interested in the topic, and aren’t experts now, they will learn a lot from the book. The author, Fran Hawthorne, has crammed a lot of useful information into 210 pages.

The Balancing Act

One of the things that the book gets right is the difficulty in setting pension regulations and laws. In hindsight, it might have been a good idea to give pensioners a higher priority claim in the bankruptcy pecking order. But if that had been done, many companies might have terminated their plans then and there, because of the higher yields demanded from lenders who would have been subordinated.

She also covers the debate on the “equity premium” versus immunization well. Yes, it is less risky to immunize – i.e., buy bonds to match the payout stream. Trouble is, it costs a lot more in the short run. With equities, you can assume that you will earn a lot more.

She also notes how many companies were deliberately too generous with pension benefits, because they did not have to pay for them all at once. Instead, they could put up a little today, and try to catch up tomorrow.

Things Missed

• Individuals aren’t good at managing their own money. Even if a participant-directed 401(k) plan is cheaper than a DB plan in terms of plan sponsor outlay, the average person tends to panic at market bottoms and get greedy at market tops. DB plans and trustee-directed DC plans are a much better option for most people. That said, most people prize the illusion of control, and will not choose what is best for them.
• · Technological progress was probably a bigger factor in doing in the steel industry, and other unionized industries, than foreign competition. Nucor and its imitators did more damage to the traditional steel industry than did foreign competition. With commodity products, low price wins, and Nucor lowered the costs of creating steel significantly.
• · In the analysis of what industries could face pension problems next, she did not consider banks and other financial institutions. Most of those DB plans are very well-funded. Why? They understand the compound interest math, and the variability of the markets. But what if the current market stress led to financial firms cutting back on their plan contributions?
• · She gets to municipal pensions at the end, and spends a little time there, but those face bigger funding gaps than most private plans. Also, she could have spent more time on Multiple Employer Trusts, where funding issues are also tough, and plan sponsor failures leave the surviving plan sponsors worse off.
• She also thinks that if you stretch out the period of time that companies can contribute in order to fund deficits, it will make things better. In the short run, that might be true, but in the intermediate term, companies that are given more flexibility tend to get further behind in funding DB pensions.
• The book could have spent more time on changes in investing within DB pension plans, which are drifting away from equities slowly but surely, in favor of less liquid investments in private equity and hedge funds. How that bet will end is anyone’s guess, but pension investors at least have a long time horizon, and can afford the illiquidity. My question would be whether they can fairly evaluate the skill of the managers.

Summary

This book describes the motives of all of the parties in DB pension issues very well, and why they tend to lead to DB plan terminations. There are possible solutions recommended at the end, but in my judgment they might save some plans that are marginal, but not those that are sick.

If you are interested in the topic of pensions, buy the book, and if you buy it through the links above, I get a small commission. (If you buy anything through Amazon after entering from a link on my site, I get a small commission. That’s my tip jar, and it doesn’t raise your costs at all.)

Comments

[Crookedwood:]

The subject of pensions needs serious and critical study. Individuals need to understand the pension structure offered by their companies as it will have impact and in many cases devastating impact on lifestyle in retirement. Pensions promised to government employees are seriously underfunded and will require continuing increase in taxes to pay for the present to say nothing of the future.

2008 Apr 26 09:32 AM

[Afthought:]

crowdofcheerlead makes a good point. The irony is that by the time society gets around to euthanizing its elders, CofCheerlead will be getting close to the front of the line.

2008 Apr 26 11:50 AM

[opinionated:]

I'm 62 and crowdofcheerleads has a right to be angry. However, if they think euthanasia is a solution, they're actually part of the problem too. Euthanasia is the flip-side of abortion. Since 1973 abortion has killed at least 48 million future Americans. These citizens would have been contributing to social security, making it far less onerous on crowd and everyone else.

2008 Apr 26 01:02 PM

[smithoos:]

Tell 'em bear. Hey, crowdowhateryourhandle is, you're taking about your mother and father here. Not everybody hates their parents. Grow up.

2008 Apr 26 02:16 PM

[Xyrus:]

This is amusing. In a single post, I've seen the two extremes on SA. The older, wiser individuals, and the young naive idiots who think they know all that and more.

Crowdofcheerlead, you are an idiot. And I mean that in the nicest possible way. You've obviously not read up on the history, nor do you even know why the decisions made were made. Without the basic understanding of the times in which these decisions were made, not only do you sound like a braying ass, but you also learn absolutely nothing and may be doomed to repeat those mistakes.

Put simply, these systems were put in place (like social security) based on the assumption (which seemed quite valid at the time) that more workers would be entering the workforce than leaving the workforce over time.

What no one knew then (and are only recently realizing now) is that if the cost of living goes up, the population growth slows down. At least in developed countries. Our population growth is almost flat, and if it wasn't for immigration it probably would be so. A flat population growth (or negative like in Russia) is very bad for systems like social security. But no one at the time ever thought that population growth in the US would flatline like it has.

Killing all the old people, as crowd so gently put it, would solve nothing. The problem is people know the system is broken and no one is doing anything about it, including infants like crowd. The old people are the reason why you have internet, tv, and computers. There also the reason why you have a job, and unless you were grown in a test tube, the reason your alive.

Try getting an education and some perspective, least you sound like a modern day Hitler.

~X~

2008 Apr 26 02:20 PM

[Little Joe:]

AT&T Pension Moneys in 1948, we were told, was protected by law.It was guessed to be an amount the Law Makers could smile and say, "Their Moneys will be waiting, when they retire". Gradually, as the Pension Funds grew into "Trillions", by leaps and bounds, The Law Makers began to believe it was their responsibility to get that money into the economy, simply because telephone people had come to be known to live forever and spend little more than a dime for a cup of coffee. Enter, the age 65 retirement Law, followed by the SIPP, 401K Plan, IRA, Roth IRA, Mutual Funds, Open and Closed End Funds, Eras. The breaking up of the AT&T Company and her Baby Bells was, likely, the next Law Makers' step in a carefully laid plan, "to open the whole can of beans". The step or steps that came to pass after the beans were open, seems to slip from my memory. When "The Men In Black" flash that mirror in your face, the most we can do is sign on to the Internet for an online purchase. "Save Until It Hurts", my Dad kept saying. I am the first to say that he was right. I am still saving and yet to feel any hurt.That "Run-a-way Train" slows, occassionally, for those few that still have courage to ride a ride of ups and downs. My advice, "Coffee never cost a dime and nobody lives forever". Curse the Law Makers. Just remember, "Somebody's got to do the dirty jobs that we wouldn't want to do". Stay out of politics ! Little Joe.

2008 Apr 26 02:38 PM

[Robert Sczech:]

The pension crisis is one of the easiest problems to solve: Increase the retirement age gradually to the point where the average retiree does not live longer than 3 years in retirement. When SS was introduced, the retirement age was placed deliberately at an age which most workers did not reach alive. The crisis is not in lacking pension savings. The crisis is in the increasing disparity between retirement age and average life expectancy.

2008 Apr 26 09:45 PM

[locke:]

The fact that retirees with no personal savings can afford to drive cars proves that we are already paying them too much. If Gramps could no longer afford auto and gas payments, and took the bus instead, countless innocent lives would be spared.

2008 Apr 27 11:07 PM

[jimmy46:]

65% of social security pension money goes to women,
they don't work very long,
they don't pay much into the system
they live a long time
they take out too much.

Either raise the retirement age for them or make them
pay their share.
the current system is a transfer of wealth from one
sex to the other.

2008 Apr 28 01:38 PM

[thecadean:]

Who cares???? really since when have over funding or underfunding of pensions, especially Government pensions ever been a real problem. All corporations have to do is file for BK and let the government take over... then the government prints more $$$$. Until all teh idiots stop buying T-bonds we have no problem. Hey George W. can you turn up the presses we're running a little short this month?

2008 May 10 02:17 PM