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Can Markets Save the Pension Promise?
Scot Blythe of Benefits Canada reports, Why markets can’t save the pension promise:
With
most Canadian private-sector workers lacking access to a defined
benefit (DB) pension plan – and with the ones who do facing
Nortel-like catastrophes – naturally attention turns to the apparently
greater resources of the state. Hence the preference of many union
and retiree advocates for a beefed-up CPP, rather than encouragement
for greater private savings through opt-out defined contribution (DC)
plans such as the proposed Pooled Registered Retirement Plan.
This
misses the point that higher CPP contributions must take away from RPP
and RRSP savings room – unless the federal government wishes to
increase significantly its tax expenditures for retirement savings,
which, theoretically, are now at 27.9% of earnings.
In
any case, state resources are not infinite. As the developed world
ages, pensions are becoming the defining issue in state policy, all the
way from early retirement provisions to higher contribution rates to
the transfer of risk from taxpayers to consumers.
Leo Kolivakis at the Pension Pulse blog notes some recent developments in Sweden and Utah.
The Globe and Mail
recently reported on Swedish pension arrangements. “Swedes contribute
18.5 per cent of their pay to the system: 16 per cent to the NDC and
2.5 per cent to a private account where money is invested in mutual
funds of their choice.” What’s interesting, for a state pension, is
that while the contribution rate is fixed, the benefit, above a
certain threshold, is not. It depends on market returns.
Thus,
as a consequence of the global meltdown, “[p]ensioners, who had
enjoyed years of higher payments following the changeover to the new
system in 1999, suddenly faced a cut of 3 per cent in 2010 and 4.3 per
cent in 2011.”
The widely praised Dutch model
faces similar difficulties. Apart from state benefits, there is a
mandatory occupational scheme, which is now banging up against higher
longevity costs, leading to a decision over whether to provide
inflation protection. And then there’s underfunding, which, for some occupational plans, means lower pension benefits for existing retirees.
Those are European examples where benefit rates are being reduced to match investment returns.
In
North America, however, the options seem rather more limited.
Reducing benefit rates for pensioners is not on the table – short of
bankruptcy. So the solution is a two-tier pension system, DB for
existing employees, DC for new hires – even in the public service, which
has generally cleaved to a DB model.
In Utah, it’s looking grim, reports the Wall Street Journal:
“Utah’s constitution bars pension changes for current workers—short
of an imminent financial crisis in the fund—so the legislature created
a defined contribution plan for all new hires starting this year. The
state contributes 10% of each worker’s salary (12% for public safety
workers and firefighters), a generous amount by private company
standards. If they wish, new workers can choose a defined benefit plan,
but the state contribution to such a plan is no longer open-ended but
is legally capped at 10%.”
But it’s grim across the United
States, as Capitol Hill legislators whisper about modified insolvency
models for the states – which are not permitted to go bankrupt – at
least partially in order to renegotiate the pension promise for
underfunded plans, according to the New York Times:
“Unlike
cities, the states are barred from seeking protection in federal
bankruptcy court. Any effort to change that status would have to clear
high constitutional hurdles because the states are considered
sovereign.
“But proponents say some states are so burdened that
the only feasible way out may be bankruptcy, giving Illinois, for
example, the opportunity to do what General Motors did with the federal government’s aid.
“Beyond
their short-term budget gaps, some states have deep structural
problems, like insolvent pension funds, that are diverting money from
essential public services like education and health care. Some members
of Congress fear that it is just a matter of time before a state
seeks a bailout, say bankruptcy lawyers who have been consulted by
Congressional aides.”
Of course, that will wreak havoc on states’
abilities to go to the capital markets. But with talk of sovereign
defaults in Europe no longer improbable, former World Bank chief
economist (and Nobel Prize winner) Joseph Stiglitz suggests there is
life after sovereign debt restructurings. But for whom?
DC, DB, PRPP, RRSP, as the saying goes, there’s no free lunch. Market returns are no substitute for inadequate contributions.
I
agree, market returns are no substitute for inadequate contributions.
But I also have strong views on preserving and enhancing existing
defined-benefit plans. In my opinion, defined-contribution (DC) plans,
RRSPs, PRPPs, and tax-free savings accounts (TFSAs) are no substitute
for a well funded, professionally managed defined-benefit (DB) plans.
Why?
Let's start with the obvious, fees. Most investors are getting raped on
management expense ratios (MERs) on their mutual fund investments. It's a
scandal, especially since the majority of mutual funds underperform low
cost exchange traded funds (ETFs) which basically deliver market
returns. As an example, if you're paying some fund 100 basis points (one
percent) a year than over 30 years, these expenses eat away a good
chunk of your gains.
In contrast, large defined-benefit plans
pool billions in assets which gives them leverage to negotiate lower
fees with funds. Moreover, they have professional money managers
in-house which are able to reproduce strategies like enhanced indexing
or fundamental stock selection at a fraction of the cost that would be
required if you went to external funds.
There are other
reasons why DB plans are much better than DC plans. Large DB plans are
able to invest in both public and private markets. This means that those
contributing to these plans have access to some of the best public and
private fund managers in the world. Individual investors are stuck with a
plain stock/bond portfolio, which may not be that bad, but is not as
well diversified over the long-run and can't capitalize on potentially
lucrative gains in private markets (the so-called illiquidity premium,
which is often overstated but still exists) or on other absolute return
strategies (internal and external hedge funds).
But the most important reason why DB plans are better is because good pension
fund managers are first and foremost good risk managers. As one senior
Canadian pension fund manager recently told me: "...it's not about
scarcity on capital, it's about scarcity on risk". In these volatile
markets, I can't stress enough the importance of risk management. Over
the weekend, I will show you why now more than ever, risk management is
critical. Things are starting to get bubbly again in the stock market,
and I fear it's only the beginning.
»
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Leo Kolivakis is basically arguing BIG pension structures are best. Yes everything is so much better with big centralised committees isn't it Mr K? Govt is better when it's big, banking is better when it's big, pensions are bigger when they're big. BS Mr Kolivakis.
People should take their money OUT of everything BIG. Because big is unaswerable, big is dumb, big is corrupt, big is slow and big is a weak centralised structure when the shit hits the fan.
Use small pension providers or even better do it yourself. Look after your own interests because the bigger the structure you use, the less important you are and the less competent and answerable they are.
Big is OVER Mr Kolivakis, like your credibility
What credibility??
Preach it, Zero. You rock.
Let the word "pension" be stricken from every book and tablet, stricken from all pylons and obelisks, stricken from every monument of America. Let the word "pension" be unheard and unspoken, erased from the memory of men for all time.
There, fixed...
With the work force on a 10 year decline there isn't a choice. Defined beneifts are just a Ponzi scheme that will go bye bye when the younger generation of public workers realize their salaries & benefits will never been what those hired before them will be. It will be not just a financial problem, but a political one as the private sector & new public employees finally gain a political consensus.
Should markets save the pension promise?
Leo, in my view, DB is just not a workable solution - not then, not now and most certainly not tomorrow. You can't promise a future (and that is really the crux of the biscuit) and any attempts to do so are at best disingenuous.
Trust, Leo, trust - there isn't any. Even the union members are throwing their own to the wolves when it comes to cutting pay or cutting jobs.
I say this as a boomer who intends to work until he can't, the last thing a society needs is for the efforts of its workforce and the bulk of its public expenditure be for the benefit of those who are not in the workforce. That's not a future, that's suicide.
"Leo, in my view, DB is just not a workable solution"
>That's exactly what the banks, mutual funds and insurance companies want you to believe. "It's all a big Ponzi scheme". Bullshit! You can make it work. DB plans were the norm for over 50 years but now they're getting assaulted by private sector interests who see big opportunities in gathering more assets. These interests have powerful lobbies and they will do whatever it takes to destroy DB plans because they are threatened by them.
Leo,
Way back in 1950 Paul Poirot wrote a wonderful little book titled "The Pension Idea" and interestingly, he predicted the pension problems GM, and other db's would have.
So, even though the "norm" 50 years ago might have been db's, there were people who had insight into where they might lead and who saw the problem with those types of programs.
Your premise seems to be that folks can't take care of themselves and their families. That without big government or big pensions they will be miserable in their old age.
Being dependent and hoping for a series of competent pension managers and a successful investment outcome and proper funding along the way is an abdication of personal responsibility. To encourage folks to give up control and responsibility is imho immoral. If, if, if, is what I hear you say. It hasn't worked and taxpayers have already been saddled with the problems. Why would it be any different the next go round? Oh, wait, trust me, this next time will be different! Ha!!!
I was recipient of a top heavy defined benefit plan that converted to a 401K plan after my retirement simply because it was no longer affordable to the firm. This is happening throughout the economy and is really unfair ,inequitable but nevertheless unavoidable because our economy is no longer growing. Reliance on stock market and hedge fund managers to overcome this reality is frought with danger especially since markets are artificially juiced by Fed and bankers as well as unduly leveraged by hedge fund magicians. Global Economy also presents a contradiction. Most growth is now overseas in emerging markets which attracts stock market investments overseas rather than to US industry. Even worse it encourages Fed to increase deficits to maintain consumption. So how can stock market help pension portfolios under these circumstances ?
isnt it funny how every solution i read, is the boomers answer is always to GRANDFATHER (prefect name here) all the pigs who already are getting theirs and fuck the rest of the suckers left holding the bag......i know the world is now upside down, but how is paying those who ran the pension ponzi scam into the ground and screwing the younger generation who is supposed to pay for it........perhaps the next civil war will be 25-49 YO private vs. 50-80 YO public employees , that would be fun to participate in.......hold your fire until you see the gray of their hair !
How many times have we read about how people in New York wine and dine these state pension fund managers while they steal the people's money? They bought crappy MBS stuff and didn't say a word, not to mention all of the other junk that got pawned off on them.
That is what happens when you have incompetent pension fund managers who are not compensated properly (ie. with alignment of interests!!!). They should have never bought that junk in the first place but the Wall Street thieves who sold them this stuff don't care because they made off like bandits, collecting huge bonuses.
Incompetent, and crooked are not the same thing, Leo. But, it doesn't matter.
Cronyism means they will win, every time, when the govt. runs things.
If it is, I will side with the old. And I am not a boomer.
End Liberalism and we can talk. Otherwise, choose a side and let's cull one another's population. Either way works.
I will be dead before I stand by and watch old folks suffer so we can pay for welfare mothers, or emergency room visits by illegals.
Nice sentiment and a very powerful tool.
Consider this: What happened to family in this country? I submit it was destroyed by consumerism and individualism. How much money is being squandered on frivolous unnecessary crap that instead should be spent on caring for ones own health and family and yes, retirement?
The real issue is priorities.
My mom, who has senile dementia, lives in my home. It is not easy.
Duty is heavier than a mountain, while death is lighter than a feather.
I'd claim family was destroyed by socialism. First with SS, and then Welfare. The State knows, if it can get 51% of the population addicted to free cheese, it will reign supreme.
1. i will participate in the underground economy
2. i will move to a well run state
3. i will move to a well run country
4. i will fight to the death against those who are corrupt and entitled and believe they deserve my children (who made no promises) to work for their retirement, all because they had a public job
Damn, I'm only two of four.
Most Fed pensions are not over the top. State and city pensions are just crazed.
Pensions sprung out of a time when the demographic pyramid actually had looked like a pyramid. It would seem obvious that as the highly unusual bulge of boomers inverts the pyramid, pensions would fail to function as they were designed to do. That practically every pension is under-funded illustrates that they were ill conceived for the current non-growth environment. Heck, when fiat money itself is doomed why even bother having hope for pension longevity.
Yet despite this systemic failure, unions, government, and money handlers cling to the dream that it can still work. If we can just reform it just a little bit more. If we could just get the markets recover one more time. If we could just force people to give up even more of their wages. If we can just reduce their benefits a wee bit more. And so on. It's time to accept the fact that promising pensions was a clever way of deferring wages which had immediate benefits for the employers and provided a means for unions to gain benefits that would have been impossible if the money promised was provided up front. And now we are realizing that promises are easily made but much harder to deliver.
Pension funds should never have been allowed to get in the stock market. At one time, they were not allowed to invest like that. But they changed the law. They did this to get access to all of that baby boomer money that had been saved up and continued to be saved up. The stock market used to be the play pin of the rich where who always enjoyed gambling and could afford to lose money. When the pension funds got in the market because they changed the laws on it, the markets began their upward trend. Without this money, the markets would never have reached the high Dow Jones averages we have seen, in the last several years. They stole a lot of the money in 2008 and they will get a lot more, because the bozos at these pension funds are frantically trying to figure out how to get all of that money back they lost. They cannot and never will. So now they double down on the very thing that got them in trouble in the first place. So far so good with these manipulated markets, but I fear, that another big drop is coming very soon and this will finish off many pension funds and will destroy most of whatever is left of the baby boomer savings. It was all done on purpose and it was all a master plan. Poor people have no power. The middle class is being destroyed day by day. Anyway, that is my view on it all.
PS. don't look now, but I think they have a usage for those 100 year bonds that little timmie is talking about now. they will just combine all of the pension funds and SS in one big pot and then make everyone buy those bogus 100 year bonds. Yep its coming. They want all of the money that the baby boomers have saved up and the reason for this is simple. Power over the people and control of them. We can sit here and argue why this is happening and what needs to be done, until the cows come home, but nothing will every change on it, until there is a bloody , and long revolution.
I admit that I waffle between believing that pensions were designed to be abused, in which case they are operating exactly as intended, or simply a product of a faulty design but with good intentions. Same with bankers and politicians. Evil or ignorant? The more time that passes the more I am inclined to fall into your camp. There is no honest discussion or recognition of the problems that feature here on a daily basis.
Winisk,
This is a defeatist statement, a total cop-out! Any way you look at it, defined-benefit plans with solid funding based on realistic investment assumptions and excellent governance will always be better for society than the private sector bogus solutions which ensure pension poverty. Unless you are the next Soros or Buffett, good luck navigating in these markets. We need to take a long-term view on pensions and stop this nonsense that pensions are inherently evil and doomed to fail. This total bs and it serves to promote private sector interests - ie. big banks, mutual funds, and insurance companies who would love nothing more than to see defined-benefit plans disappear.
I don't have the answer Leo. No one does. That's the point. It's a conundrum that doesn't go away with wishful thinking. We will muddle through this somehow but it will inevitably involve coming to terms with the reality that promises will be broken. I refuse to trust the architects of failed systems. That's not defeatism. I want new ideas. Something that recognizes reality and doesn't rely on financial wizardry.
I didn't junk you.
ObamaCare is designed to bring back the pyramid.
But , but , but, obama care has been declared unconstitutional by at least two federal judges so far, so I am just sayin......
Obama has been ruling as a dictator and getting away with it. We, therefore, have a de facto dictatorship.
The rule of law only applies to the proles. The US is done.
and is exactly why all the politicians and public employee unions were allowed NOT to participate...welcome to Animal Farm
We need to get the horse and Snowball wised up early this time.
I...uh...haven't seen Benjamin in awhile... ;)
This is the same guy that praised the Swedish model for adjusting payouts to market returns, then told us in the same essay that the actual cuts to pensioners were made up with special payments from the government. Sheesh!
Oh, and if DB plans are so well run that they should be saved, why the hell are they underfunded? What is really needed is defined contribution plans that pool large numbers of contributors. Oh, wait, we have those- they are called 401Ks, and like DB plans, there are good deals for workers and bad ones.
They are underfunded because they are relying on rosy investment assumptions and because the governance at these plans is terrible, especially in the US (read my comment to Gordon Freeman above).
And who, exactly, is making the rosy investment assumptions? Isn't this the essential problem with defined benefit programs- the ability to promise something without actually having to actually pay for it up front? Your complaint about defined contribution plans is also about governance. Why should we favor better governance of DB plans over better governance of DC plans? I read your contributions here often, and yet I have never once seen you address this question.
Dogs...steaks...no assembly required.
Just who are these all-knowing, omniscient, sainted DB pension fund managers, Leo? You mean the ones that promised 8% to infinity? The ones that bought the subprime CDOs? You, Leo??
Fuck you, you malignant little self-righteous geek.
Watch your language. I'm not here to get into pissing matches with morons. There are no magical solutions. Part of the problem with defined-benefit plans, especially in the US, is that they got the governance all wrong. Civil servants running multi-billion dollar pension funds relying entirely on the crap pension consultants were feeding them is a recipe for disaster. US public pension funds should adopt the Canadain governance model, with independent boards and compensate their pension fund managers properly so their interests are aligned with their stakeholders' interests.
Oh Canada!
Our population is around 310 million. Our available work force is around 150 million. Of that, some of that number are government employees or contractors who derive their income from taxation.
From that starting point alone, do the math.
Now, what government programs do you want to cut in order for government workers to keep getting the same "promises" as in the past?
Leo, let's face it: defined benefit pensions tip the scales against those who don't have defined benefit pensions and there's a limit to how many people can be in the cart vs. pulling the cart.
The only way you can have reasonably generous defined benefits for public employees is to have damned few public employees. You can't have generous defined benefits and a large public sector.
So get out your cake knife, you can't have both.
They all should have to wait until they are 65 to retire just like everyone else.
Mercury,
You are wrong. You can have defined-benefit plans for everyone, not just the public sector, as long as you get the funding right and you rely on realistic investment assumptions. Think about the abysmal failure of defined-contribution plans or 401K plans. If we rely on that model -- one that places the retirement onus entirely on individuals -- we are virtually guaranteeing more pension poverty in the future. This means an increase in welfare costs which means more taxes. Net, net, defined-benefit plans are no panacea but they are way better than the alternative. And all of you who are screaming against public sector workers should stop and think who you want in these jobs. Do you want morons teaching children, protecting society and making policies at governments (no sarcasm here)? Part of the appeal of getting these low paying jobs is the pension promise. Sure there is abuse (pension spiking, double dipping), but for the most part, most retired public servants are living off modest pensions.
"Think about the abysmal failure of defined-contribution plans or 401K plans. If we rely on that model -- one that places the retirement onus entirely on individuals -- we are virtually guaranteeing more pension poverty in the future."
Ummm...I'm doing quite well thank you. You assume individuals to be stupid or frozen with fear to move to a defensive posture.
"Do you want morons teaching children, protecting society and making policies at governments (no sarcasm here)?"
;-)
"Part of the appeal of getting these low paying jobs is the pension promise."
The "promise" was made between bureaucrats & unions, not the taxpayers.
"Sure there is abuse (pension spiking, double dipping), but for the most part, most retired public servants are living off modest pensions."
The best way to reduce the abuse is for individuals to manage their own funds.
And no one is sittin around saying we want pensioners to live in tents & starve...we won't let it happen no matter what you think of me/us. We live with these people...they're not inanimate objects on some bean counters ledger book to us.
But the system as it is will change...it's not affordable, rational, or fair to have ever spiraling costs put to the ones pulling the cart as Merc says.
We pay all their salary/medical, including their retirement investments, so it's patently unfair to subsidize any of their losses.
Most public school teachers are morons. But they know it, so they are greatful they can cut a fat hog in the ass by their union raping tax payers on their behalf.
Its true, I got out of high school in 1969. It was starting to happen then. The dumbing down of the American student. Heck I will say that everyone who got out when I was there could read and write and function in society. But no more. There is a copy of a test from the late 1800's around on the net and it is shocking to see the difference between what was required reading and knowledge back then, compared to now. With the seventies we got forced racial integration. This caused the white students to fall down to the level of the black students and not the other way around. They knew this would happen. Now the school where I went is like some building in the ghetto with stabbings and muggings and teacher assaults going on all the time and whitey is the target of opportunity. Sad but true. The old saying, garbage in and garbage out holds true when talking about public schooling. Dumb stupid people are easier to control and join the military without questioning a nation's motives because they have lost the ability to think rationally about things. I get sick and tired of Jesse over at the Americain cafe talking about how great a guy FDR was. God that man should do some serious reading on the subject before he writes that kind of crap. FDR was one of the biggest traitors this country ever had as president and it was during his administration while the nation was preoccupied with a war(that he promised us we would not go in) that so many dangerous and deleterious laws were passed concerning public school education, and it was all done by plan too, similar to cultural marxism. We read in the good book. Hosea 4:6 My people perish for lack of knowledge and we see the public school system as it is and say, yes Almighty God, you are right , again, as always. When will we listen to the words written so long ago? When will we ever learn?
Leo, I prefer to have high quality public sector workers and I don't mind paying them well or even extending generous, defined benefit packages to them but I just don't want that many of them mostly because the math dictates that we simply can't have that many of them.
I suppose everyone could have some defined benefits but they just can't be very big and they can't make assumptions that are beyond the market's long term ability to deliver (like anything near 8-11% returns). The solution is probably something akin to keeping defined benefits high enough to provide reasonable comfort but low enough to keep the incentive in place for individuals to make additional long term preparations on their own.
The biggest impediment toward solving this problem is public sector unions which I think are by definition contradictory to the more general public interest.
I do actually appreciate your valiant efforts to present what I consider to be the other side and of course you're not all wrong...
Dogs will only guard your steak for so long before they say screw this, and eat it.
Waving away abuse means you get more of it and it all collapses again.
Human nature dooms socialism. Always.
Apparently the plan has been to abolish any defined benefit plan for anyone younger than 48. Just about the line between gen x and baby boomers. Baby boomers dont have to sacrifice, only the rest of us who now have delayed ss benefits and no access to defined benefit plans, at least the overgenerous ones. Now gen x and the rest has to bust their ass for overall lower projected pay raises, less benefits, and delayed social security retirement. The boomers sacrifice nothing here while the rest subsidize their retirements. Fuck you boomers. When we get into power you will pay. The intergenerational war has been declared and so far boomers are winning with the greatest intergenerational wealth transfer in history projected over the next twenty years unless the rest of you do something about it.
Oh goody...class warfare...I wonder who's purpose this serves ;-)
"Baby boomers dont have to sacrifice, only the rest of us who now have delayed ss benefits and no access to defined benefit plans, at least the overgenerous ones."
You're hopeless.
You should be directing your anger at DC who takes what you pay in now, spends it all & leaves an IOU in it's place. There is no "trust fund" and it is not voluntary.
It's a socialized ponzi scheme that you're ranting and raving about being left out of?
Boomers have been stolen from their entire lives and you come on here begging for the government to steal from you as well?...ROTFLMA!...you should be trying to end it instead of promoting it.
"The government I live under has been my enemy all my active life. When it has not been engaged in silencing me it has been engaged in robbing me. So far as I can recall I have never had any contact with it that was not an outrage on my dignity and an attack on my security."
HL Mencken
Communism, like any other revealed religion, is largely made up of prophecies.
H. L. Mencken
Every normal man must be tempted, at times, to spit on his hands, hoist the black flag, and begin slitting throats.
H. L. Mencken
Mencken was the epitome of the old school American.
He and Kipling are in my pantheon of demi-gods.