Angst in America, Part 4: Disappearing Pensions
“Companies are doing everything they can to get rid of pension
plans, and they will succeed.”
– Ben Stein
“Lady Madonna, children at your feet
Wonder how you manage to make ends meet
Who finds the money when you pay the rent?
Did you think that money was heaven sent?”
Wonder how you manage to make ends meet
Who finds the money when you pay the rent?
Did you think that money was heaven sent?”
– “Lady Madonna,” The Beatles
There was once a time when many American workers had a simple
formula for retirement: You stayed with a large business for many years,
possibly your whole career. Then at a predetermined age you gratefully accepted
a gold watch and a monthly check for the rest of your life. Off you went into
the sunset.
That happy outcome was probably never as available as we think.
Maybe it was relatively common for the first few decades after World War II.
Many of my Baby Boomer peers think a secure retirement should be normal because
it’s what we saw in our formative years. In the early 1980s, about 60% of
companies had defined-benefit plans. Today it’s about 4% (source: money.CNN).
But today defined-benefit plans have ceased to be normal in the larger scheme
of things. We witnessed an aberration, a historical anomaly that grew out of particularly
favorable circumstances.
Circumstances change. Such pensions are all but gone from US
private-sector employers. They’re still common in government, particularly
state and local governments; and they are increasingly problematic. They are
another source of angst for retirees, government workers who want to retire
someday, and the taxpayers and bond investors who finance those pensions.
Today, in what will be the first of at least two and possibly more letters
focusing on pensions, we’ll begin to examine that angst in more detail. The
mounting problems of US and European pension systems are massive on a scale
that is nearly incomprehensible.
I came across a chart that clearly points to the growing concern
of those who are either approaching retirement or already retired. This is from
the October 2016 Gloom, Boom
& Doom Report from my friend and 2017 SIC speaker Marc Faber.
The gap in confidence between younger and older Americans is at an all-time
high, after being minimal for many years. A survey by the Insured Retirement
Institute last year noted that only 24% of Baby Boomer respondents were
confident they would have enough money to last through their lifetimes, down
from 37% in 2011. This is the case even after a most remarkable bull market run
in the ensuing years.
Even though the equity market has more than recovered, the
compounding effect that everyone expected for their pension funds and
retirement plans didn’t happen as expected. If the money isn’t there, it can’t
compound. If your plan lost 40% in the Great Recession, getting back to even in
the ensuing years did not make up for the lost money that was theoretically
supposed to come from that 40% compounding at 8% a year. And, as I highlighted
in last week’s letter, the prospects for compounding at 8% or even 5% in the
next 10 years are not very good. Thus the chart above.
And speaking of Marc Faber’s joining us at the conference; let me
again invite you to come to Orlando for my Strategic Investment Conference, May
22–25. I have assembled an all-star lineup of financial and geopolitical
analysts who will help us look at what is likely coming our way in the next few
years. Then we’ll spend the final part of the conference examining various
pathways for the next 10 years and what we have to do to navigate them successfully.
There is truly no other conference like this anywhere. I’m continually told by
people who attend the Strategic Investment Conference that it’s the best
investment conference they’ve ever been to. You can find
out how to register here.
Let’s begin by defining some important terms. US law provides for
various kinds of tax-advantaged retirement plans. They fall into two broad
categories: defined-benefit (DB) and defined-contribution (DC) plans. The
differences involve who puts money into them and who is responsible for the
results.
Defined-benefit plans are generally the old-style pensions that
came with a gold watch and guaranteed you some level of benefit for the rest of
your life. Your employer would invest part of your compensation in the plan,
based on some formula. In some cases, you, the worker, might have added more
money to the pot.
But regardless, at retirement your employer was obligated to
send you a defined benefit
each month or quarter – usually a fixed-dollar amount, sometimes with periodic cost-of-living
adjustments.
(Note: There are defined-benefit plans that small, closely held
employers such as myself or doctors/dentists can create for themselves and
their employees that have significant retirement planning benefits but that
function more like defined-contribution plans. For the purposes of this letter
we’re going to focus on the more or less conventional types of plans rather
than the multitudes of retirement plans that creative accountants and
businesses have developed.)
Once your benefit was defined in this way, your employer was on
the hook to continue paying under the agreed-upon terms. DB beneficiaries had
no control over investment decisions. All they had to do was cash the checks.
Employers took all the risk.
This arrangement works fine as long as you assume a few things.
First, that your employer will invest the DB plan’s assets prudently. Second,
that your employer continues to exist and remains able to make up any
shortfalls in the plan’s liabilities.
DB plans work pretty well if those two things happen. It’s simple
math for actuaries to estimate future liabilities based on life expectancies.
They are uncannily accurate if the group is large enough. So the plan sponsor
knows how much cash it needs to have on hand at certain future dates. It can
then invest the plan assets in securities, usually bonds, calibrated to reach
maturity in the right amounts at the right times.
That all sounds very simple, and it was, but the once-common
scheme ran into trouble for reasons we will discuss below. First, though, let’s
contrast defined-benefit plans with the other category, defined-contribution
(DC).
DC plans are what most workers have now, if they have a retirement
plan at all. The 401(k) is a kind of defined-contribution plan (as are various types
of IRAs/Keogh/SEP plans, etc.). They are called that because regulations govern
who puts money into the plan, and how much. Typically, it’s you and your
employer. Your employer also has to give you some reasonable investment
options, but it’s up to you to use them wisely. Whether there is anything left
to withdraw when you retire is mostly up to you. Good luck.
Which type of plan is better? The more salient question is, which
is better for whom? Both have their advantages. People like feeling they have
some control over their future, but they also like certainty. Companies, on the
other hand, like being able to transfer risk off their balance sheets. DC plans
let employers shuck the risk.
The rub, of course, is that abundant evidence now shows that most
workers are not able to invest their 401(k) assets effectively. That reality
explains some of the retirement
angst we discussed two weeks ago. But DB plans are no bed of roses, either,
particularly when you put elected officials in charge of them and make
unionized government workers their beneficiaries.
Defined-benefit plans have issues going way back. The Studebaker
Motor Company had such a plan when it began shutting down in 1963. The plan
turned out to be deeply underfunded and unable to meet its pension obligations.
Thousands of workers received only a small fraction of what they had been
promised, and thousands more received zero.
That failure kicked off several years of investigations and
controversy that eventually led to the law called ERISA: the Employee
Retirement Income Security Act of 1974. It set standards for private-sector
pension plans and defined their tax benefits under federal law.
Important point: Neither ERISA nor any other law requires employers to offer
any kind of retirement or pension plan; it just sets standards for those who
do. Those standards have turned into something of a mess, frankly. The IRS,
Labor Department, and assorted other agencies all have their own pieces of the
regulatory pie. It is no wonder that many smaller companies don’t have
retirement plans. Simply doing the paperwork is a big job.
That aside, ERISA succeeded in bringing order to previously
inconsistent practices. Workers gained some protections that hadn’t existed
before, and employers had legal certainty about plan administration. ERISA also
created the Pension Benefit Guaranty Corporation (PBGC) to insure pension plans
from default and malfeasance.
Many experts believe the PBGC will run out of money in as little
as 10 years at its current funding levels. The PBGC is not taxpayer-funded
(yet) but exists as a classical insurance fund into which each retirement plan
pays roughly $27 per year per covered employee. That figure would need to
increase to $156 per year per person just to give the PBGC a 90% chance of
staying solvent over the next 20 years.
And if your plan goes bankrupt and you fall into the gentle hands
of the PBGC, your pension funding is likely to be cut by 50% or more. Plans
that were at one point quite generous could see their beneficiaries lose as
much as 75–80% of their previous monthly payouts.
ERISA was all to the good, but it couldn’t cure the biggest
headache: the growing amount of money that companies had to to contribute to
their plans to keep them fully funded. Plans that covered retiree health
benefits had an additional headache trying to project future healthcare costs.
Yes, that was a big deal even back in the 1970s.
In 1980, a benefits expert named Ted Benna discovered the 401(k).
Yes, he literally discovered
it in changes to the Internal Revenue Code that had become law two years
earlier. No one set out to create the kind of plans we now recognize as
401(k)s; Benna just looked at the new law and realized it would allow such a
thing. That’s where we got the defined-contribution plan.
The initial idea was that the 401(k) would be a supplement to an
employer’s DB plan, but employers soon realized that it could also be a
replacement. That was an attractive option for many companies, so they began
dropping their DB plans and instead expanded their 401(k) contributions.
Business owners will understand this well. I’ve been there, too. You
have enough headaches as it is. Having the benefits manager come around at the
end of a year when the market had underperformed, telling you to write an
additional giant check to the DB plan, was not fun. With a 401(k), in contrast,
you could add a little match to everyone’s checks on paydays and be done with
it. No one would pop up years later and tell you it wasn’t enough. That some
employees liked the idea of having control over their retirement accounts was
even better.
DB plans got even less compelling when Alan Greenspan began
pushing interest rates down ahead of Y2K. Lower rates meant employers had to
pitch in more cash to keep the plans funded at the necessary level. Or, they
had to take on additional investment risk and be ready to make up any losses
from the company’s resources.
None of that is attractive to most business
owners. Now DB plans are all but unknown in the private sector, the main
exceptions being union-run plans and those run by one-person professional
corporations like physicians and lawyers.
Note carefully: The risks and worries associated with retirement
plan funding have not disappeared. They have simply been dispersed from a small
number of employers to a much larger number of employees. As we discussed
earlier, very few of the latter are in a comfortable position. I don’t mean to
be flippant here, but it’s true: If DC plan owners aren’t worried, they should
be. The days of retiring with a gold watch and a guaranteed monthly check are
gone.
ERISA applies only to private-sector employers. Government
entities need not comply with ERISA’s many requirements, which is good because
many of them don’t.
They do, however, have massive retirement obligations to
their retirees and workers that simple math says will land them in some form of
default. The promises are too generous, and the resources to meet them are too
scarce.
The really frustrating part is that this impending crunch was
completely predictable, given what we know of politics in this country. Elected
officials make extravagant promises to attract votes or contributions. But
everything takes time in government, so politicians just delay making changes
long enough that everyone forgets or finds other things to worry about.
Pension promises aren’t like campaign promises to build new parks
or sewers; Governments can’t forget pension obligations. Pension plans are not
like other, more general public services. They involve specific amounts of cash
owed to specific people on specific dates. Those dates will arrive, and the
cash has to be there. State and local governments can’t run endless deficits
the way the federal government does.
That’s all obvious; yet, for some reason, two things happened in
recent decades:
State and local politicians kept raising pension benefits.
State and local workers believed the promises.
In fairness, we can’t expect city council members and firefighters
to be financial experts. But they have access
to experts. The unions that negotiate most public pension contracts have their
own lawyers, accountants, and actuaries. They should know whether they are
being offered unrealistic projections and promises. And elected officials
likewise have expert counsel, so they should know, too. So I’m not sure who is
more at fault.
By the way, I have a great deal of respect for the people who keep
our cities and states running. Those who protect citizens from harm or
otherwise provide public services deserve fair wages and benefits. Pensions are
part of that. However, we can’t make something from nothing.
One problem is that accounting rules permit governments to do
things private companies can’t. They calculate contributions to their
defined-benefit plans in, shall we say, aggressive ways that do not serve
anyone well. And, they can shop around for consultants who will tell them what
they want to hear. What they want to hear is that they can get away with adding
less to the pension fund so they can spend more on shiny new buildings or just
fix the roads and keep up with normal city services that make them look
productive.
Eventually the math catches up. Here’s a chart my friend Danielle
DiMartino Booth included in a Bloomberg
View article on this topic last month.
Here we see how state and local pension costs have soared in the
last decade. Total unfunded liabilities amounted to only $292 billion in 2007.
They have more than quintupled since then, to $1.9 trillion. That’s due to a
combination of extravagant promises, poor investment results, and failure to
contribute enough cash to the plans. Danielle reels off some startling numbers:
Federal Reserve data show that in 1952, the average public pension
had 96 percent of its portfolio invested in bonds and cash equivalents. Assets
matched future liabilities. But a loosening of state laws in the 1980s opened
the door to riskier investments. In 1992, fixed income and cash had fallen to
an average of 47 percent of holdings. By 2016, these safe investments had
declined to 27 percent.
It’s no coincidence that pensions’ flight from safety has
coincided with the drop in interest rates. That said, unlike their private
peers, public pensions discount their liabilities using the rate of returns
they assume their overall portfolio will generate. In fiscal 2016, which ended
June 30th, the average return for public pensions was somewhere in the
neighborhood of 1.5 percent.
Corporations’ accounting rules dictate the use of more realistic
bond yields to discount their pensions’ future liabilities. Put differently,
companies have been forced to set aside something closer to what it will really
cost to service their obligations as opposed to the fantasy figures allowed
among public pensions.
The situation is actually far worse than the chart shows. The $1.9
trillion in liabilities presumes that the plans will earn far more over time
than the 1.5% return they actually made in 2016. Danielle says unfunded
liabilities are as much as $6 trillion by some estimates.
Anytime we see a liability, the unspoken assumption is that
someone is liable. Who is liable for public pension obligations? Probably you,
depending where you live or own property. State and local governments’ prime
asset is the ability to tax their residents.
We are financially responsible for
the poor and/or self-interested decisions of the politicians we elect. That’s
one reason we ought to pay far more attention to local elections than most of
us do. Congress and the White House matter a great deal – but so do state
legislatures, school boards, and city councils.
When we have a significant bear market during the next recession
(that is not an if
but rather a when),
that $6 trillion figure will balloon to double that amount or more.
And
remember, those are state and local obligations that must be paid from state
and local tax revenues. Paying them would require tax increases for many
municipalities and would more than double current tax rates.
Sound incredible? My own city of Dallas, whose Police and Fire
Pension System was advertised as solvent just a few years ago, is now so deep
in the hole that it would take almost a doubling of city taxes to plug the gap.
Note that I bought my Dallas apartment after that news was announced. I was not
pleased when I read that headline. Such an increase would make my taxes cost
more than my mortgage. Can you say taxpayer revolt? Houston is another city
with such problems.
Nationwide, state and municipal spending has risen from $730
billion in 1990 to $2.4 trillion in 2015. And yet the amount of money used to
fund pensions has risen only a fraction of the amount that other spending has.
The financial problems of Illinois and many California cities are well known.
Let’s turn to a chart listing some of the problem areas in the state of
Massachusetts:
(Note that most Massachusetts government workers are not eligible
for Social Security. This is going to be a serious tragedy when push finally
comes to shove.)
It is almost actuarially impossible for pension funds that are
less than 50% funded to catch up without massive tax hikes that are implemented
solely to allow increases in pension payments but that also result in
reductions in services, not only for retirees but for the general public as
well. Those pension-funding levels are going to be further eroded during the
next recession because more and more cities and states are increasing their
equity exposure, and low interest rates are not helping matters.
We have here the proverbial irresistible force/immoveable object
quandary. Government agencies signed contracts guaranteeing retirement benefits
to their workers. The workers did their jobs, many for decades, trusting that
the promises were solid. Now we see that they often weren’t.
It’s hard to imagine good outcomes here. Retirees want what their
contracts promised, but the money just isn’t there. Governments have little
recourse but to raise taxes, but the taxpayers aren’t captives. Higher property
taxes will make them move elsewhere. Higher sales taxes will make them shop
elsewhere.
My good friend Marc Faber generously let me use one of his
newsletters in Outside
the Box last week. In discussing household wealth, he notes
that while the nation’s $22 trillion in pension fund assets is a main component
of household wealth, much of it may be illusory. The illusion is slowly being
exposed, and not just with regard to public-employee pensions. Union plans are
in trouble, too. Marc explains with a February 2017 New York Daily News story.
Narvaez, 77, got a union certificate upon retirement in 2003 that
guaranteed him a lifetime pension of $3,479 a month.
The former short-haul trucker – who carried local freight around
the city – started hearing talk in 2008 of sinking finances in his union’s
pension fund.
But the monthly checks still came – including a bonus “13th check”
mailed from the union without fail every Dec. 15.
Then Narvaez, like 4,000 other retired Teamster truckers, got a
letter from Local 707 in February of last year.
It said monthly pensions had to be slashed by more than a third.
It was an emergency move to try to keep the dying fund solvent. That dropped
Narvaez from nearly $3,500 to about $2,000.
“They said they were running out of money, that there could be no
more in the pension fund, so we had to take the cut,” said Narvaez, whose wife
was recently diagnosed with cancer.
The stopgap measure didn’t work – and after years of dangling over
the precipice, Local 707’s pension fund fell off the financial cliff this
month. With no money left, it turned to Pension Benefit Guaranty Corp., a
government insurance company that covers pensions.
Pension Benefit Guaranty Corp. picked up Local 707’s retiree
payouts – but the maximum benefit it gives a year is roughly $12,000, for
workers who racked up at least 30 years. For those with less time on the job,
the payouts are smaller.
Narvaez now gets $1,170 a month – before taxes.
This is stunning. The union worker they mention went from a $3,479
monthly benefit, supposedly guaranteed for life, to $1,170 a month. That’s a
66% pay cut. Worse, it seems to have happened with almost no warning, to a man
in his late 70s with a cancer-stricken wife. What an awful situation – and it
will be an increasingly common one for anyone depending on a union pension. The
story quotes one union pension lawyer:
“This is a quiet crisis, but it’s very real. There are currently
200 other plans on track for insolvency – that’s going to affect anywhere from
1.5 to 2 million people,” said Nyhan. “The prognosis is bleak minus some new
legislative help.”
I am sorry to disappoint Mr. Nyhan, but “legislative help” is not
on the way. Legislatures have their own pension headaches. So he’s right that
the prognosis is bleak. PBGC doesn’t have infinite resources. The only answer
is some combination of benefit cuts for current retirees and higher
contributions from current workers.
That $156 annual per-worker hike that I mentioned above for the
PBGC? As more and more companies and governments abandon their defined-benefit
plans, there will be fewer and fewer people to make those contributions, which
means that future contributions to the PBGC will potentially need to be much
higher still.
Nowhere to Hide
So we have seen that both public employees and union workers are
right to worry about their pensions. We saw in part 3 of this series that
millions more have no significant retirement savings. What about private-sector
pensions? As noted, defined-benefit plans are disappearing, but many companies
still have legacy plans covering current retirees and those approaching
retirement. Marc Faber is not optimistic for them:
So, whereas prior to the 2008/2009 crisis S&P 1500 companies
were fully funded, today funding
has dropped below 80% (see Figure 7 of the October 2016 GBD
report). I also noted that I found the deteriorating funding levels of pension
funds remarkable because, post-March 2009 (S&P 500 at 666), stocks around
the world rebounded strongly and many markets (including the US stock market)
made new highs. Furthermore, government bonds were rallying strongly after 2006
as interest rates continued to decline. My point was that if, despite truly mouth-watering returns
of financial assets over the last ten years, unfunded liabilities have
increased, what will happen once these returns diminish or disappear
completely? After all, it’s almost certain that the returns of
pension funds (as well as of other financial institutions) will diminish given
the current level of interest rates and the lofty US stock market valuations .
What if returns over the next seven years look like these
projections from Jeremy Grantham of GMO (whose accuracy correlation has been running
well north of 95%):
The deeper you look, the worse this pension situation gets. Angst
is a perfectly reasonable response for anyone who is retired or thinking about
retiring in the next decade. People don’t have sufficient IRA or 401(k)
savings; Social Security will be of limited help; defined-benefit pensions are
unlikely to be as generous as advertised; and healthcare costs keep climbing.
All of the above will keep taxes rising, too, even as the economy remains mired
in slow-growth mode at best or enters a long-overdue recession.
I want to end this letter on a positive note. Can we see any
glimmers of hope? Some, yes. As I noted last week, one answer for older workers
is to work longer and delay retirement. That gives you more years to save and
fewer years to consume your nest egg. It doesn’t have to be drudgery if you
plan ahead and design your encore career strategically.
Helping on that front will be some truly amazing medical
breakthroughs. I see them in the biotechnology research Patrick Cox and I
follow. I spent two days in Florida with Patrick and a few biotech
revolutionaries last week, and it is hard not to be very encouraged. You should
begin to see some of what we learned become publicly available in the next year
or two. These developments will increase both lifespans and health spans,
letting us stay active well into our 80s and beyond.
Finally, someone responded to part 3 of this series by pointing
out that the Baby Boomer generation is still set to receive trillions in assets
held by their still-living parents. That could help. The oldest boomers are now
72, which means their parents are likely in their 90s.
That said, if your retirement plan consists of waiting for your
parents to die and leave you their house, you are still in a very risky
position. For one thing, how much is the house really worth? How much will it
be worth as more people like you try to sell houses like that one? Who will buy
them?
I talked in part 3 about our tendency to deal with immediate needs
first. So many other things seem like higher priorities than retirement
planning and saving. What do you do?
Theodore Roosevelt may have had the best answer: “Do what you can,
with what you have, where you are.” Angst frequently paralyzes us. Don’t let
it. Maybe you can’t do everything it takes, but you can do some of it. Start
there.
I will have a quick daytrip to Houston next week, but my calendar
looks amazingly clear for almost a month, except for a flurry of conference
calls. The next big event seems to be the Strategic Investment Conference May
22–25! You really should plan on joining me there.
Being at home for a while is good, because I have so many
deadlines and so much research and reading to do that I really need some time
to catch up. I glance at the inbox on my computer, and I find that I have
achieved a personal all-time high number of unanswered messages at 602 – which
is not exactly something I should be proud of. I probably owe a bunch of you
responses. Hopefully I will get to them in the coming weeks. Plus, I have a
number of deadlines, both business and writing, that are looming in the next
month, so not traveling might actually enable me to meet some of them.
In my defense, I did mostly unplug while I was at the Masters
(which, if you are a golfer, is as awesome as you think it would be). And this
year’s final day shoot-out was just the stuff of legends. What a great Masters
to attend! It was really fun to watch Sergio against one of the greatest young
golfers in a head-to-head battle. That, and I had some of the greatest hosts
you could possibly want to have. They asked me not to mention their names, but
they know they are, and Shane and I are thoroughly grateful.
And then I ended up spending an extra day in Florida, delving into
the future of biotechnological research and aging. Things seem to be happening
a lot faster than I expected just a few years ago. Or maybe I’m thinking it was
just a few years ago when I last caught up with this field, and it was actually
more like 10. In any event, I’m convinced that if you are younger than 55, you
really do need to plan to work longer than you expected to. And those of us who
are older need to take better care of ourselves so that we have a chance for
some of these new developments to actually make a difference for us.
When I heard Ray Kurzweil say some 15 years ago that it was his
goal to live long enough to live forever, I sighed. Now, I am no longer
sighing. I am actively planning how to go about doing that very thing. No, I
don’t want to be a 105-year-old shriveled up ghoul, barely able to move about.
The promise that induced
tissue regeneration seemingly holds for reversing the effects of
old age within my lifetime is astonishing, and what was impossible now seems
potentially doable. There still a long way to go, but there are
researchers who believe they can see a path where none existed before.
So for now, let’s hope that some of the true antiaging drugs that
are in the labs actually turn out to be useful. But there are some things we
know now: A healthy diet, working out and getting plenty of aerobic exercise,
taking the medicines that we know are helpful (like blood pressure medicine),
keeping mentally active and involved, and maintaining healthy relationships
will go a long way to increasing our life and health spans.
There’s nothing you can do about accidents, genetic diseases, and
so forth. Yet. But I just hope that I can be writing this letter for a very
long time and that you will be with me as we figure out how to manage an
ever-changing and ever-more-interesting world.
Have a great week and make it your Easter resolution to get into
the gym more.
Your not planning on going gently into that good night analyst,
John Mauldin
0 comments:
Publicar un comentario