America's Pensions in Peril?

John W. Schoen of CNBC reports, Funding shortfalls put pensions in peril:

These days, a pension just isn't what it used to be.

For generations, a defined benefit pension—a fixed monthly check for life—provided an ironclad promise of a secure income for millions of retired American workers. But today, that promise has been badly corroded by decades of underfunding that have undermined what was one of the cornerstones of the American dream.

The safety net that millions of retirees spent decades working toward has been fraying for some time. The Great Recession, and the market collapse that wiped out trillions of dollars of investment wealth, weakened the pension system further, though some of the damage has been repaired since the stock market rebounded and the economic recovery took hold.

Hundreds of billions of dollars in defined benefits are still paid out every year to retirees. State and local public pension benefit payments reached $242.9 billion in 2013, according to the most recent Annual Survey of Public Pensions. And a Towers Watson study of more than 400 major companies that sponsor U.S. defined benefit plans estimated they paid out nearly $97 billion in benefit payments last year, and another $8.6 billion went toward lump sum payments and annuities.

But that's nothing compared to the private employers' projected benefit obligations last year, which climbed 15 percent from the previous year to a whopping $1.75 trillion, while plan assets grew by only 3 percent.

Disparities like that help explain why so many pensions are in peril. Simply put: Obligations have outpaced fund contributions and growth for private and public plans. That means that even workers who have paid into pensions for several years may not get the level of benefits they expect. And many younger employees may never have an opportunity to participate in a pension at all.

The result is that, unlike past generations of Americans, many workers today bear the brunt of the investment risk that underpins their hopes of income security once they are no longer able to work.

In 1975, some 88 percent of private sector workers and 98 percent of state and local sector workers were covered by defined benefit plans, according to a 2007 report by the researchers at the Center for Retirement Research at Boston College. By 2011, fewer than 1 in 5 private industry employees was covered by a pension that paid a guaranteed monthly check, according to the Labor Department.

That historic shift has been blamed by critics for an estimated deficit in retirement savings of more than $4 trillion for U.S. households where the breadwinner is between ages 25 and 64, according to Employee Benefits Research Institute.

"You have this hole in what private sector workers have for retirement. We're coming up on this place where all these people are not going to be able to retire," said Monique Morrissey, a researcher at the liberal Economic Policy Institute.

That shift away from a guaranteed pension check has been slower to take hold among public sector workers, where some 83 percent still have access to a pension that promises to pay monthly retirement income for life after a career of service. But that's changing.

Faced with rising health costs and retirees living longer than expected, many state and local governments are failing to keep up with the annual payments. A CNBC analysis of financial data for 150 state and local pension plans collected by Boston College's research center found that 91 had set aside less than 80 percent of the money needed to meet current and future obligations to retirees. Only six were fully funded.

One big reason: State and local governments aren't making the annual contributions required to fund those liabilities. Of the 150 plans tracked by the center, 47 paid less than 90 percent of what's needed to keep pension benefits funded and 79 paid more. (There was no data available for 24 of the 150 plans.)

"People appreciate services: They want cops and firefighters, they want teachers and all that stuff," said Morrissey. "But if you're a politician in a budget crunch, the one way to not raise taxes is to just not pay your pension bill. In the states and cities where there's a big problem, it's not because they underestimated cost. They simply didn't pay the bill."

In New Jersey, which has averaged less than half its required annual contributions for over a decade, a state judge last month ordered Gov. Chris Christie to make a court-ordered $1.6 billion payment into the state's public pension system after it was withheld from his proposed $34 billion state budget. Christie is appealing the ruling.

In New York, state lawmakers plan to defer more than $1 billion in required pension contributions over the next five years. In Illinois, the state's new Republican governor, Bruce Rauner, last month proposed more than $6 billion in spending cuts—more than a third of which would come from shifting government workers into pension plans with reduced benefits.

In Rhode Island, retirees are suing the state over a 2011 pension overhaul led by newly elected Democratic Gov. Gina Raimondo during her tenure as state treasurer. The reforms, which raised retirement ages and cut cost-of-living increases, were projected to save $4 billion over 20 years. (On Monday, the retirees accepted a proposed settlement that would reduce retirement benefits.)

With state and local politicians loathe to propose the tax increases needed to fund the shortfalls, many have overhauled their pensions systems instead by increasing the burden on public workers and retirees and cutting benefits.

"Nearly every state since 2009 enacted substantive reform to their retirement programs, including increased eligibility requirement, increased employee contributions or reduced benefits, including suspending or limiting (cost of living increases)," said Alex Brown, research manager at the National Association of State Retirement Administrators, a nonprofit association whose members are the directors of the nation's state, territorial, and largest statewide public retirement systems.

Those cuts range from about 1 percent for retirees in Massachusetts and Texas to as much as 20 percent in Pennsylvania and Alabama, according to a survey of state pension reforms last year by the association and the Center for State and Local Government Excellence.

For retirees like David Jolly, 90, that's mean getting by with a little less every year.

Jolly, who retired in 1986 as public works director for Island County, Wash., now lives with his wife on a combined monthly income of $1,888 from his state pension and Social Security. "Every time they try nibbling at it, it just makes it that much harder," he said. "They don't realize what the cost of living of older people is. ... It just keeps going up and the retirement pay just doesn't."

To close the pension funding gap, many state and local governments have also cut access to defined benefit pensions for new hires or increased contributions and minimum retirement age for active workers. "New employees can expect to work longer and save more to reach the benefit level of previously hired employees," according to a survey by the retirement administrators association.

While closing plans to new members may reduce benefit liabilities decades from now, it also cuts into the contributions from active workers to support retirees. For over a decade, the ratio of active workers to retirees has been falling, placing an added strain on the public pension system.

For workers and retirees in the private sector, where defined benefit plans are much less common, funding levels are generally in better shape.

Rising investment returns since the financial collapse of 2008 helped boost funding levels for private industry plans in 2013 to 88 percent of their liabilities, according to a survey of the latest available data by pension fund consultant Milliman. But that still left the 100 largest companies surveyed with a combined pension plan funding deficit of $193 billion.

The pension funding shortfall is even worse for a handful of so-called multi-employer pension plans, which typically cover smaller companies and unions and face a different set of financial challenges. Declining union enrollments, for example, mean there are fewer active workers to cover the cost benefits for retirees, many of whom are living longer than expected than when these plans were established.

Multi-employer plans also face the added burden of their pooled pension liabilities. When one member of the plan fails to keep up with contributions, for example, the burden on the other members increases.

About a quarter of the roughly 40 million workers who participate in a traditional "defined benefit" plan—those that pay retirees a guaranteed check every month—are covered by these multi-employer plans, according to the Bureau of Labor Statistics. In the last four years, the Labor Department has notified workers in more than 600 of these plans that their plans are in "critical or endangered status."

Last year, the Pension Benefit Guaranty Corporation, the government insurance fund for pension plans that go bust, reported that its program backing multi-employer plans was $5 billion in the red. It projected that unless Congress acted, there was about a 35 percent probability its assets would be exhausted by 2022 and about a 90 percent probability by 2032. (Single-employer pension plans are covered by a separate program that is on a much more solid financial footing.)

After funding shortfalls threatened the solvency of the governments' insurance backstop for multi-employer pension plans, Congress eased the rules allowing plan administrators to cut benefits last year. Proponents of the proposed pension guaranty corporation reforms argue that they will help prevent more multi-employer plans from going under and that retirees are better off with smaller monthly payments than none at all.

That's something beneficiaries of private and public pensions are hearing a lot these days.

As you can read above, America's private and public pensions aren't in good shape. There are a lot of reasons why this is the case and my fear is the worst is yet to come.

One thing I can tell you, the attack on U.S. public pensions continues unabated. Andrew Biggs, a resident scholar for the conservative American Enterprise Institute wrote a comment for the Wall Street Journal, Pension Reform Doesn’t Mean Higher Taxes:

The Pennsylvania State House held a hearing on Tuesday about reforms that would shore up the state’s public-employee pension program. The hearing was overdue. Annual required contributions to the state’s defined-benefit plan have soared to more than 20% of employee payroll from only 4% in 2008. Legislators in the state, like many elected officials nationwide, are looking for a way out.

State Rep. Warren Kampf has introduced a bill to shift newly hired government employees to defined-contribution pensions similar to a 401(k) plan. Defined-contribution pensions offer cost stability for employers, transparency for taxpayers and portability for public employees.

But the public-pension industry—government unions and the various financial and actuarial consultants employed by pension-plan managers—claims that “transition costs” make switching employees to defined-contribution pensions prohibitively expensive. Fear of “transition costs” has helped scuttle past reforms in Pennsylvania, as in other states. But the worry is unfounded.

The argument goes as follows: The Governmental Accounting Standards Board’s rules require that a pension plan closed to new hires pay off its unfunded liabilities more aggressively, causing a short-term increase in costs. Thus the California Public Employees’ Retirement System, known as Calpers, claimed in a 2011 report that closing the state’s defined-benefit plans would increase repayment costs by more than $500 million. Similar claims have been made by government analysts in Minnesota, Michigan and Nevada. The National Institute for Retirement Security, the self-styled research and education arm of the pension industry, claims that “accounting rules can require pension costs to accelerate in the wake of a freeze.”

But GASB standards don’t have the force of law; nearly 60% of plan sponsors failed to pay GASB’s supposedly required pension contributions last year. That includes Pennsylvania, where the public-school-employees plan last year received only 42% of its actuarially required contribution. GASB standards are for disclosure purposes and not intended to guide funding. New standards issued in 2014, GASB says, “mark a definitive separation of accounting and financial reporting from funding.”

In fact, nothing requires a closed pension plan to pay off its unfunded liabilities rapidly, and there’s no reason it should. Unfunded pension liabilities are debts of the government; employee contributions are not used to pay off these debts. Whether new hires are in a defined-contribution pension or the old defined-benefit plan, the size of the unfunded liability and the payer of that liability are the same.

More recently, pension-reform opponents have shifted to a different argument: Once a pension plan is closed to new hires, it must shift its investments toward much safer, more-liquid assets that carry lower returns. Actuarial consultants in Pennsylvania have claimed that such investment changes could add billions to the costs of pension reforms.

This argument doesn’t hold. It is standard practice for a pension to fund near-term liabilities with bonds and to pay for long-term liabilities mostly with stocks. A plan that is closed to new entrants stops accumulating long-term liabilities. As a result, the stock share of the plan’s portfolio will gradually decline. But that’s because the plan’s liabilities have been reduced. Plans would not be applying a lower investment return to the same liabilities. They would apply a lower investment return to smaller liabilities.

Many public pension plans apparently believe that a continuing, government-run pension can ignore market risk, while a plan that is closed to new entrants must be purer than Caesar’s wife. The reality is that all public plans, open and closed, should think more carefully about the risks they are taking. But the difference in investment returns between an open plan and a closed one should be a minor consideration for policy makers considering major pension reforms.

Shifting public employees to defined-contribution retirement plans won’t magically make unfunded liabilities go away. Pension liabilities must be paid, regardless of what plan new employees participate in. But defined-contribution plans, which cannot generate unfunded liabilities for the taxpayer, at least put public pensions on a more sustainable track.

The problem with this Wall Street Journal article is it's factually wrong. Jim Keohane, CEO of the Healthcare of Ontario Pension Plan (HOOPP), sent me these comments:

I read the clip from the WSJ you included on your blog, and I thought you would be interested in a piece of research on the subject which was completed by Dr. Robert Brown (click here to view the paper). This is a fact based piece of research which looked at the cost of shifting from DB to DC. Proponents of a shift from DB to DC, such as this article, portray this as a win-win situation, but when Dr. Brown looked into the facts, what he found was that this is in fact a lose-lose situation. The liabilities in the existing plans are very long tailed and putting these plans into windup mode causes the costs and risks to go up, so there are no savings to taxpayers – in fact the costs go up, and the individuals are much worse off having been shifted to DC plans because they end up with much lower pensions.

When I read these articles in the Wall Street Journal, it makes my blood boil. Why? Am I a hopeless liberal who believes in big government? Actually, not at all, I'm probably more conservative than the resident "scholars" at the American Enterprise Institute (read my last comment on Greece's lose-lose game to understand the effects of a bloated public sector and how it destroys an economy).

But the problem with this article is that it spreads well-known myths on public pensions, and more importantly, it completely ignores the benefits of defined-benefit plans to the overall economy and long-term debt profile of the country. Worse still, Biggs chooses to ignore the brutal truth on defined-contribution plans as well as the 401(k) disaster plaguing the United States of Pension Poverty.

Importantly, pension policy in the United States has failed millions of Americans struggling to save enough money to retire in dignity and all these conservative think tanks are spreading dangerous myths telling us that DC plans "offer cost stability for employers, transparency for taxpayers and portability for public employees."

The only transparency DC plans offer is that they will ensure more pension poverty down the road,  less government revenue (because people with no retirement savings won't be buying as many goods and services), and higher social welfare costs to society due to higher health and mental illness costs.

And again, I want make something clear here, I'm not arguing for bolstering defined-benefit plans for all Americans from a conservative or liberal standpoint. Good pension policy is good economic policy. Period.

This is why I wrote a comment for the New York Times stating that U.S. public pensions need to adopt a Canadian governance model (less the outlandish pay we pay some of our senior public pension fund managers) in order to make sure they operate at arms-length from the government and have the best interests of all stakeholders in mind.

But the problem in the United States is that politicians keep kicking the can down the road, just like they did in Greece, and when a crisis hits, they all scramble to implement quick nonsensical policies, like shifting public and private employees into defined-contribution plans, which ensures more pension poverty and higher debt down the road.

Finally, while most Americans are struggling to retire in dignity, the top brass at America's largest corporations are quietly taking care of themselves with lavish pensions. Theo Francis and Andrew Ackerman of the Wall Street Journal report, Executive Pensions Are Swelling at Top Companies:

Top U.S. executives get paid a lot to do their jobs. Now many are also getting a big boost in what they will be paid after they stop working.

Executive pensions are swelling at such companies as General Electric Co., United Technologies Corp. and Coca-Cola Co. While a significant chunk of the increase is the result of arcane pension accounting around issues like low interest rates and longer lifespans, the rest reflects very real improvements in the executives’ retirement prospects.

Pension gains averaged 8% of total compensation for top executives at S&P 500 companies last year, up sharply from 3% the year before, according to data from LogixData, which analyzes SEC filings. But the gains are much larger for some executives, totaling more than $1 million each for 176 executives at 89 large companies that filed proxy statements through mid-March. For those executives, pension gains averaged 30% of total pay.

The gains often don’t represent new pay decisions by corporate boards. Instead, they reflect the sometimes dramatic growth in value of retirement promises made in the past. Nonetheless, they are creating an optics problem for companies at a time when executive-pay levels are under greater scrutiny from investors and the public. Companies now face regular shareholder votes on their pay practices that can be flash points for broader concerns, leaving them sensitive about appearing too generous.

New mortality tables released last fall by the American Society of Actuaries extended life expectancies by about two years. That, as well as low year-end interest rates, helped push pension gains higher than many companies had expected. The result is much higher current values for plans with terms like guaranteed annual payouts, which are no longer offered to most rank-and-file workers.

GE Chief Executive Jeff Immelt’s compensation rose 88% last year to $37.3 million. Meanwhile, excluding $18.4 million in pension gains, his pay actually fell slightly to $18.9 million.

The company says about half of the pension increase came from changes in its assumptions about interest rates and life span. About $8.8 million, however, comes from an increase of nearly $490,000 a year in the pension checks he stands to take home as his pay has risen and he approaches 60 years old, the age at which top GE executives can collect full pension benefits.

In all, Mr. Immelt’s pension is valued at about $4.8 million a year for life. The company puts its current value at about $70 million, up from around $52 million a year ago.

A GE spokesman said that much of the gain reflects accounting considerations and that Mr. Immelt’s recent salary increases reflect balanced-pay practices and board approval of his performance.

The SEC is particular about how companies report pay in their proxy statements. There is a standard table that breaks out salary, bonuses and pension gains, along with totals for the past three years, and other details. GE, encouraging investors to overlook the pension gains, added a final column to the table to show what top executives’ total pay would look like without them. The company says investors find the presentation useful in making proxy voting decisions.

Lockheed Martin is also asking investors to look past pension gains when considering its executives’ total pay.

At Lockheed Martin Corp., CEO Marillyn Hewson’s total pay rose 34% to $33.7 million last year, with $15.8 million of that stemming from pension gains. An extra column in the proxy statement’s compensation table strips out those gains, showing her pay up about 13% to $17.9 million.

Lockheed says that $5 million of the pension gains can be traced to changes in interest rates and mortality assumptions. Most or all of the remaining $10.8 million probably stems from increases in the payments she would receive in retirement: about $2.3 million a year now, up from about $1.6 million a year under last year’s proxy disclosure. Ms. Hewson’s pay rose sharply with her ascent to CEO in 2013 and chairman last year, increasing her pension benefit significantly.

Overall, the company’s obligation for future pension benefits for executives and other highly paid employees totaled $1.1 billion last year, up from $1 billion at the end of 2013.

A Lockheed Martin spokesman said the company broke out a nonpension compensation total in the proxy statement to provide more context for pay.

Executive pensions generally don’t consume the attention that pensions for the rank and file do. For years, as costs of traditional pension plans have risen amid low interest rates and longer lifespans, big companies have been closing them to new employees or even freezing benefits in place, often continuing with only a 401(k) plan for all but the oldest workers.

Last June, Lockheed Martin told its nonunion employees that it would stop reflecting salary increases in their pension benefits starting next year, and that the benefits would stop growing with additional years of work starting in 2020.

“It eliminates a lot of the variability that defined-benefit pension plans can create in our cost structure,” Chief Financial Officer Bruce Tanner told investors during a Dec. 3 conference presentation.

In 2011, GE stopped offering new employees traditional defined-benefit pensions and replaced them with 401(k) plans. At the time, Mr. Immelt cited recent market downturns and lower interest rates as being among the reasons for the shift.

In a cruel twist of irony, America's top CEOs are now enjoying much higher pension payouts while they cut defined-benefit plans to new employees and increase share buybacks to pad their insanely high compensation. I guess longer life spans are fine when it comes to CEOs' pensions but not when it comes to their employees' pensions.

Lastly, my comment on the 401(k) experiment generated a lot of comments on Seeking Alpha. Some people rightly noted that looking at 401(k) balances distorts the true savings because it doesn't take into account roll overs into Roth IRAs. When you factor in IRAs, savings are much higher.

While this is true, there is still no denying that Americans aren't saving enough for retirement and that 401(k)s are an abject failure as the de facto pension policy of America. It's high time Congress stops nuking pensions and starts thinking of bolstering and enhancing Social Security for all Americans, as well as implementing shared risk and serious governance reforms at public pensions.

Below, the pension terminator, Arnold Schwarzenegger, asks Warren Buffett his advice on how to handle unfunded liabilities of public pensions. Listen carefully to the Oracle of Omaha's reply, he understands the dire situation better than most people.