A war is brewing between State and local employees and tax payers.

Oh Yes There Is!

There Is No Pension Crisis

Nearly seventy million American workers and their families rely on defined-benefit (DB) pension plans for retirement income. In 2011, twenty-eight million worked in state and local government, and another forty million were in the private sector.

Wikipedia

[A defined benefit pension plan [DB] is a type of pension plan in which an employer/sponsor promises a specified pension payment, lump-sum (or combination thereof) on retirement that is predetermined by a formula based on the employee's earnings history, tenure of service and age, rather than depending directly on individual investment returns.

Traditionally, many governmental and public entities, as well as a large number of corporations, provided defined benefit plans, sometimes as a means of compensating workers in lieu of increased pay.]

They are the lucky ones. About half of the workforce has no pension at all. 

Employers are trying to slash compensation, and pension benefits represent one component of this package. Enemies of the working class often couch their attacks on pay in practical terms: a worker hurts her company and herself by expecting a high salary, for example. When it comes to pensions, they argue that the funds are bankrupt, implying that the funds should be closed and the benefits terminated.

DYI:  No doubt about it since September 2, 1974 when IRA’s were codified into law corporations now had a way to shed the burden  and costs of maintaining and funding a pension plan for their respective employees.  When 401k’s were established in 1978 the race was on as one corporation after another began replacing DB plans for new employees.  State and local government workers are now in the beginning stage of having DB plans replaced with 401k type programs.

 The bankruptcy charge becomes a special problem for public sector workers, since politicians — who control their pay packages — are influenced by these perceptions. Moreover, politicians and corporate managers can seize on the predicted bankruptcy to do what they wanted to do all along. Senator Daniel Moynihan once pointed out that if people think Social Security is broke, it’s easier to shut it down.

In a recent article, Doug Henwood and Liza Featherstone posed a legitimate question: do DB plans overestimate their future returns? I don’t think they made the case. (You can read an initial critique from me, and the authors’ rebuttal, here and here.) Their chief error, in my view, was contrasting a possibly high estimate with an undoubtedly low estimate based on relying only on supposedly risk-less assets (US Treasury bonds) with correspondingly low returns.

Henwood and Featherstone insist that assumptions of excessively high rates of return are being used to mask the funds’ insolvency. They call estimates in the range of 7 or 8 percent annual returns unrealistic and suggest that 2 or 3 percent — which reflects returns on risk-free government bonds rather than stock market projections — would be preferable.

DYI:  A defined benefit plan [DB plan] has a stated and contractually obligated dollar amount that is paid out to the retiree.  This money is needed to be there and as the expression goes “come hell or high water.”  I agree for funding purposes the interest rate estimate should be the current yield of the 30 year Treasury bond [currently 3.09%] as opposed to the assumed stated rate of 7%or 8%.  Why?  Purchasing 30 year T-bonds and other T-bond maturities as well assets to liabilities can be mathematically computed with a high degree of certainty.

The issue here is really not seven versus two. It is whether it is better to assume returns to equity (stock) or returns to Treasury bonds. The implications are twofold: for reporting practice and for the fund’s investment policy.

Since 2008, the stock market (going by the S&P Index) increased from about 890 to as high as 2,865. Where you mark your time period can make a huge difference: if you only look at the past few weeks, relying on the stock market seems risky indeed. But over very long periods, returns to equity will far exceed those of risk-free bonds. Why shouldn’t a pension fund undertake such investments? And if it does, why shouldn’t it report its future condition based on assumptions of those returns?

DYI:  Let’s put that to the test by going to Money Chimp using their calculator to estimate future returns at today's valuations.  Plugged in Shiller PE of 33.14 with a current dividend yield of 1.80% the estimated average annual return for 30 years is 4.28% and for 40 years is 4.91%.  Whether using 30 year T-bond at 3.09% or 30 year estimate for stocks at 4.28% THESE PENSION PLANS ARE UNDERFUNDED.  Unless additional monies are injected into these plans retirees will require a haircut on promised benefits.

But over very long periods, returns to equity will far exceed those of risk-free bonds.

DYI: Not true; it is completely dependent upon current valuations.  Valuations are now so high stock market investing at least here in the U.S. and with an assumed 8% return will not be achieved.  Only until valuation return to more favorable level will an 8% return is possible.  However in order for improved valuations to occur at an acceptable level at a minimum a 50% decline would be required.  If DB pension plans are underfunded now “you haven’t seen nothing yet!”  A war is brewing between State and local employees and tax payers.  People tell me all the time they are not interested in politics but when taxes are attempted or succeed in being “jack up” substantially to conform to their contractual obligations the average citizen is going to be mad as hell.

 DYI