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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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I must admit...sometimes I am tempted ;-)
I'm tempted at least twice/day.
The Vikings had it made. Our society is designed to drive you nuts.
Generation x was an underground british rock group in the seventies.
Ah, the good'ole pension debt. (Shit, I meant to write "debate", but since we are such a debt shit hole, I'll leave my freudian slip as written.)
1st Think about living in China. You are on your own. So, since you will only have yourself to rely on, you save 30% of your income over your life and pray to Confucius you work long enough that you don't have to beg for food when your old.
2nd Being a Western Twat, you rely on some politician (who takes out 5% out of your pay check) and tells you that you will be able to retire when your 50 years old to a life of luxary (look, I'm so dumb and gullible, I can"t even spell luxury, I just assume it!)
3rd The crazy thing about all your posts Leo, is that everybody is running around still using the 8% a year gain assumption. In the future, the 8% gain will only happen if we in the Western World enter hyperinflation or those Chinese saving 30% a year say, "Fuck it! I already drank toxic water, ate glowing noodles and I have 1 year left to live. LETS FUCKING PARTY WITH SOME WHITE CHICKS!"
8 percent?..hahaha! If the plans are still projecting 8 percent real growth over the next five years we are in deeper doodoo than i thought. That means they need 12 percent real stock returns to make up for their bond portfolios. We will be lucky to get 6 over the next 10 years of real return, unless the chinese start spending like mad.
Hey, old people,
Time to head off to Carosel. It is your final duty.
You mind if we kill a few crooks before we leave? We will do it just for you. We owe you that much.
That would be so fucking awesome.
Salute.
good pension fund managers are first and foremost good risk managers.
Why would anyone believe that it's easier to find honest (much less good) managers for a defined benefit plan rather than a mutual fund? It's the same pool of money managers.
Maybe you haven't been reading the ZeroHedge site much, as there have been lots of tales about folks at GS and the the other big players selling absolute crap to pension funds, and then betting against the product they just sold.
There are good mutual fund managers but their interests are in asset gathering, not risk management. As for the stuff sellside firms sell pension funds, it's up to pension fund managers to do their due diligence. Sometimes it merits an investment, other times it's just crap they're looking to unload.
The big problem with db's is not whether or not there are good, honest and competent managers. It is that the promise being made to the employees is one that no one knows if it can or will be fulfilled in the future. The db saddles future managers (private) and taxpayers (public) with an obligation which they will have no control over inasmuch as they cannot see nor predict the future.
Db's are obligations that are put on future employees and taxpayers to support and backstop the pensioners if the actuaries/fund managers/markets fail and that is the real problem.
+1
Greenhead,
Agreed, investment projections at US DB plans were wildly optimistic and STILL are. But I can turn around and tell you that society as a whole will end up paying higher taxes in the future to make up for increased welfare costs stemming from pension poverty. Telling people to fend for themselves in these wolf markets is immoral, IMHO. They're going to get slaughtered.
leo is perpetually behind. that's his shtick.
Quite the contrary, I saw the 2008 crisis back in 2006 when I started researching CDO-cubed and it cost me my job! I know investment banks sold crap to many pension funds, but good pension fund managers steered clear away. Just cause they're peddling it, doesn't mean you have to buy it!
Fiduciary responsibility used to mean something. The executives, administrators and actuaries who allowed pension funds under their control to reach this sorry state should, as a minimum, be fired. Fraud and malfeasance should be investigated and prosecuted -- some people need to be in prison for these reckless acts.
If you want a model for pension reforms, look at the system in Chile. The private pension funds there are supervised by a government bureau that takes a harsh, adversarial approach. The government auditors assume the funds are cheating and make them prove otherwise to retain their licenses. None of the crazy, geared investment schemes are permitted, and their system is more stable and solvent as a result.
"Fiduciary responsibility used to mean something. The executives, administrators and actuaries who allowed pension funds under their control to reach this sorry state should, as a minimum, be fired."
And there is the nub of it...right there.
Exacta-f~@#ing-mundo.
Sorry Leo, but thanks to clowns like you who voted for the muzzie, Barry Hussein Osama f*cked the world. It's over. Your examples are Canada, Sweden and Holland? Good luck with that. If you live in America, you live in Zimbabwe post Nov 2008. Canada, Sweden and Holland are not totally corrupt shitholes run by leftist vermin and pals of the elites.
Bush may have sucked but at least he had 5% unemployment.
Freddie, I am Canadian but was looking forward to an Obama administration. I got all emotional when he won and then reality kicked in and realized that while the players change, the game remains rigged. -)
i will junk to Harare any sentence containing the following,
"Bush....but at least"
FUCK Bush.
Eternally.
Its impossible for the markets to assume a parabolic rise and bail out pension funds (unless all charts look like Netflix), people in Florida are aghast when hearing our new Gov: http://www.sun-sentinel.com/news/broward/fl-pension-react-strategy-20110202,0,3102184.story Like Chris Christie, "I don't have the money!" My asshole neighbors think they can believe the promises made, they were made by people who HAVE NO CLUE as to where the money will come from, they were idiots too.
"The people who promised you these benefits were COMPLETE MORONS", sue them.
Unfortunately, there are absolutely no penalties for financial crimes done by banks or insurance companies. So if you think you are entitled to money drawn from thin air, go stand outside, look up, and click your heels 3 times.....Good Luck, my kids ain't paying your pension, damn , I ain't paying your pension. I'll get a job off the books, for cash, before I pay SS,Medicare, State & Fed taxes for wars & banksters. Sorry. GFY, have a nice day!
That is the spirit! Someone who realizes the boomers are trying to squeeze us as hard as they can. Fuck you boomers. About a third of my expenditures are untaxed and off the books and with a little more effort i can make it 50 percent. It is your duty now to avoid taxes anyway you can and lets bring this intergenerational war the boomers declared on us to a head.
Yes, they're much more fun camped out on your lawn than in an old folks home.
Somebody trying to 1099 you at the rest stops? Outrageous!
Avoiding the futile and criminal ponzi is to be applauded, but I would suggest you watch the overheated rhetoric. Once the hated boomers wake up to the fact that they don't have a chair when the music stops, you probably don't want to be leading the pack of slack jawed morons up to their door with your middle fingers hoisted.
Thanks Leo, bottom line is the markets MUST save the pension system. IMHO half the market's ramp is to create the illusion that all is well. the other half is the thry know pension systems world wide collapse in on themselves if the markets crumble and they can't have that. Bottom line is the US could get anihilated by 50,000 nukes, but the markets will still be ther rising at will traded by the bots. They can not let the markets fail or everything goes with them.
Can markets save the pension promise?---No, they cant't. Next question ? (that one was awfully easy). Oh, the reason; the reason is that the premise rested on an inflationary economy and "irrational enthusiasm" to begin with.
abolish defined-benefit plans
ok