Don't count on getting a pension when you reach retirement age
By Raul Ilargi Meijer
We have been saying for a long
time that anyone in the western world who's 10-15 years away from collecting
their first pension payments, shouldn't expect to get much, if anything, when
the time comes. This is because, obviously, the economy has deteriorated as
much as it has. It's also because, in essence, pensions plans are the ultimate
Ponzi schemes.
What doesn't help are the
central bank and government policies that are in fashion today that are based
on pushing interest rates about as low as they can get.
The reactions to all this are
interesting in their range of variation. Last week I picked up an article (more
on that later) that made me refer back to a series of bookmarks I had made over
the past month or so. Here are a few quotes that, when put together, paint the
picture pretty accurately; you add up the details and numbers and you get an
idea of what's going on. Not necessarily for the faint of heart. First, Michael
Aneiro for Barron's:
The California Public
Employees' Retirement System, the nation's biggest public pension fund at $233
billion, reported a mere 1% return on its investments in its fiscal year ended
June 30. Earlier this year, in an attempted acknowledgment of today's realities,
Calpers had lowered its discount rate–an actuarial figure determining the
amount that must be invested now to meet future payout needs—for the first time
in a decade, to 7.5% from 7.75%. That represents combined assumptions of a
2.75% rate of inflation and a 4.75% rate of return.
Needless to say, a 1% annual
return didn't come close to hitting any of those figures and doesn't engender
confidence in the assumptions of institutional or individual investors alike.
Calpers was quick to note that its 20-year investment return is still 7.7% and
that the past year was challenging for everyone. But Calpers is a bellwether,
and other systems are expected to report similarly disappointing returns,
necessitating higher annual contributions in the years ahead to meet funding
needs.
Later in the week, S&P Dow
Jones Indices said that the under funding of S&P 500 companies'
defined-benefit pensions had reached a record $354.7 billion at the end of
2011, more than $100 billion above 2010's deficit. The organization reported
that funding levels at the end of 2011 ran around 75%, on average, and that
future contributions will constitute a "material expense" for many
companies.
Fitch Ratings later released
its own study of 230 U.S. companies with defined-benefit pension plans and
found that median funding had dropped to 74.4% in 2011 from 78.5% in 2010, and
that corporate pension assets grew just 2.9% in 2011 amid sluggish returns and
a 6% decline in contributions.
This is not pretty. What we
see is hugely unrealistic annual return assumptions combined with equally huge
underfunding. Both ends burning. More from Marc Lifsher at the Los Angeles
Times:
Corporate and public pension
funds across the country are seriously underfunded, threatening the retirement
security of workers and straining the financial health of state and local
governments, according to a pair of independent studies.
In 2011, company pensions and
related benefits were underfunded by an estimated $578 billion, meaning they
only had 70.5% of the money needed to meet retirement obligations,
according to a report by S&P Dow Jones Indices.
Funds generally don't need to
have all the money needed pay future pensions because returns on investments
vary over the years and people retire at different ages and with different
levels of benefits, experts said. But a funding level in the 70% zone
is considered dangerously low.
The looming shortfall, and the
move by corporations to 401(k)-type plans in which the level of investment is
controlled by employees, could keep many aging baby boomers from retiring, said
Howard Silverblatt, a senior S&P Dow Jones Indices analyst and the report's
author.
"The American dream of a
golden retirement for baby boomers is quickly dissipating," Silverblatt said.
"Plans have been reduced and the burden shifted with future retirees
needing to save more for their retirement.
"For many baby boomers it
may already be too late to safely build up assets, outside of working longer or
living more frugally in retirement."
While the cost of retirement
is out of reach for many older workers and growing more expensive for younger
ones, it's becoming less of a burden for employers, according to the report
issued Tuesday.
Employers are paying less into
pension funds despite the fact that company cash levels remain near record
highs and cash flows are at an all-time high," Silverblatt said.
Meanwhile in the public
sector, a separate pension-related report by the national State Budget Crisis
Task Force warned that public pension funds in the U.S. are underfunded
by $1 trillion to $3 trillion, depending on who's making the estimate.
There's no consensus on the
amount by which pensions funds are underfunded. According to Reuters' Jilian
Mincer, the funding shortfall may be as high as $4.6 trillion (2011 numbers).
Public pension funds are
expected to report poor annual returns in the coming weeks, results that are
likely to increase calls for more realistic retirement promises for teachers,
police officers and other public workers.
At least three of the nation's
largest U.S. public pension funds have already announced returns of between 1%
and 1.8%, far below the 8% that large funds have typically targeted.
The fund's targets have been
"unrealistic," said Michael Lewitt, a portfolio manager at Cumberland
Advisors in Sarasota, Florida. "They've been fooling themselves because
there is no realistic case they can make that." [..]
Low returns will further
aggravate funding shortfalls for hundreds of pension plans, adding to pressure
on cities, counties and states that are already facing lower tax revenue and
rising costs.
The vast majority of states
have cut pension benefits or increased contributions from workers, or are
trying to.
"Failing to understand
the scope of the pension crisis sets taxpayers up for a bigger catastrophe in
the future," said Bob Williams, president of free-market think-tank State
Budget Solutions, in Washington. "Without government action, states, counties,
cities and towns all over America will go bankrupt," he said. [..]
Major public pensions
typically assume an average return of about 8%, but the median annual return in
2011 for large pension funds was roughly half that amount, 4.4%, according to
data provided to Reuters by Callan Associates.
Median returns were only 3.2%
for the last five years and 6% for the last 10. Before the 2007-09 recession,
market performance was often above the 8% assumptions. Average returns for the
last 20 or 25 years as a whole still reach that level. But with losses in 2008
and 2009 and uneven returns since then, analysts say pension funds should
adjust to what seems to be a new reality. [..]
The funding status of public
pensions has dramatically slipped over the last decade. Barely more than half
were fully funded in 2010. At the end of that year, the gap between public
sector assets and retirement obligations had grown to $766 billion, according
to a report by the Pew Center on the States.
Ratings agency Moody's
Investors Service calculated this month that if it used a 5.5% discount rate, a
rate closer to the way private corporations value their pensions, it
"would nearly triple fiscal 2010 reported actuarial accrued
liability" for the 50 states and rated local governments to $2.2 trillion.
Other estimates put the
shortfall even higher. State Budget Solutions estimated it in a recent study at
$4.6 trillion as of 2011.
In San Francisco, they don't
mince words, writes Heather Knight at SFGate:
A preliminary report of how
the city’s pension fund performed in the fiscal year 2011-12, which ended June
30, shows it earned a meager 1.6% — far below the assumed rate of return of
7.5%. For a fund currently worth $15.3 billion, that’s a big difference.
"This is even worse than
anyone predicted," said Public Defender Jeff Adachi, who offered a
competing, failed pension reform measure that would have raised more money
through employee contributions. "If this was a movie, it would be
a disaster movie called ‘Pension Armageddon.’"
Canada, which faces similar
problems ("massive shortfalls"), despite an ostensibly far better
performing economy (how on earth does that add up?), apparently takes a
somewhat different approach than the US, where, essentially, the favorite approach
is moving the goalposts, which "lets companies use a 25-year
average of the discount rate rather than two years".
You don't have to be a genius
to see that the - financial - world was a totally different place 25 years ago
than it is today. So using 25 year old stats to calculate today's required
pension funding rates is a highly risky affair. If you find two years too short
a period, you can go for 5 years, perhaps, I can see an argument being made for
that. But 25? That looks like a desperate attempt at a cover-up more than a
serious effort to find accurate accountancy methods.
Well, Canada resists such
desperation. So far, at least, and despite strong opposition, that wants a
sweet deal like the US gets. Louise Egan and Susan Taylor for Reuters:
Canada is taking a different
tack than Washington on the thorny issue of helping companies fund their
widening pension gaps, shrugging off corporate pleas for relief even as the
United States lets businesses slash their contributions.
A frightening prospect for
workers, retirees and companies, yawning pension deficits have gone from arcane
accounting entries to front page news on fears that massive shortfalls could
even cause some corporations to fail.
As a growing number of
employers look to roll back benefits to the alarm of unions, others are pouring
cash into their pensions funds only to see the hole get deeper.
Canada is not unique, and as
in the United States, generous public sector pensions are a hot-button issue.
But the federal government is taking a more hands-off stance than U.S.
President Barack Obama, who signed a bill last month that changes how companies
calculate what they must contribute to their pension funds, effectively
allowing them to pay less.[..]
Softening the rules implies
letting plans stay underfunded for longer, a risk financially prudent Ottawa
may be reluctant to accept. After all, the country’s conservative banking
culture helped it survive the global financial crisis better than most.
As in other countries, the
scope of the Canadian problem is huge. 90% of the roughly 400 defined-benefit
pension plans overseen by Canada’s federal regulator are underfunded, meaning they
cannot meet their liabilities should their plans be wound up today, as is
required by law. [..]
Historically, Canada has
preferred relief measures such as lengthening amortization periods. Permanent
rule changes in 2010 let companies average their solvency ratios over a
three-year period instead of one, so that a sudden bad year doesn’t force them to
make big cash infusions.
But some critics say it is
dancing around the real problem – the very low "discount rate" used
to assess a plan’s solvency, which is the focus of the recent measures in the
U.S., Denmark and Sweden. This rate, based on long-term government bonds, helps
actuaries judge how much assets will earn over time.
Companies complain the rate
has never been lower and artificially inflates a plan’s deficit. The lower the
discount rate, the bigger the deficit. Air Canada’s chief financial officer,
Michael Rousseau, told analysts on a recent conference call that a 1.5% or 2%
rise in the rate would eliminate more than $3-billion from the airline’s
deficit.
That wishful thinking
effectively became reality last month, not for Canadian companies but for their
U.S. competitors. The new law there lets companies use a 25-year
average of the discount rate rather than two years.
In Europe, Denmark and Sweden
have tinkered with how the discount rate is used and the United Kingdom is
thinking of following in their footsteps. [..]
Bob Farmer, who represents
250,000 pensioners as president of the Canadian Federation of Pensioners, says
softer rules for companies mean bigger risks for workers. Tough luck about the
low yields, he says. "That happens to be the world we’re living in."
[..]
"The biggest social issue
in the next 10 years is going to be pensions," said Rick Robertson,
associate professor at the Richard Ivey School of Business, part of the
University of Western Ontario. "What do I tell the 64-year-old person who
may not have a chance to rebound if the company doesn’t succeed. Who’s my duty
to? There’s no easy answer."
Whereas in Japan, with the
world's fastest ageing population, the world's biggest pension fund has taken a
dramatic route: selling off assets. It hopes to make up for this by moving into
riskier assets. That's of course a big gamble no matter how you look at it.
Monami Yui and Yumi Ikeda at Bloomberg:
"Payouts are getting
bigger than insurance revenue, so we need to sell Japanese government bonds to
raise cash," said Takahiro Mitani, president of the Government Pension
Investment Fund, which oversees 113.6 trillion yen ($1.45 trillion). "To
boost returns, we may have to consider investing in new assets beyond
conventional ones," he said in an interview in Tokyo yesterday.
Japan’s population is aging,
and baby boomers born in the wake of World War II are beginning to reach 65 and
become eligible for pensions. That’s putting GPIF under pressure to sell JGBs
to cover the increase in payouts. The fund needs to raise about 8.87 trillion
yen this fiscal year, Mitani said in an interview in April. As part of its
effort to diversify assets and generate higher returns, GPIF recently started
investing in emerging market stocks.
Now, remember that the level
of funding for US public pension plans has fallen as low as 70% or thereabouts.
And that brings me to the article from last week which made me return to the
pension topic.
In the Netherlands, pension
funds are by law required to maintain a 105% funding level. And there is little
enthusiasm for changing this. Right after the autumn 2008 crisis peak, some
leeway was provided by the government, but only for a short period. Now, there
are other steps being taken:
One of the biggest pension
funds in the world, the Dutch civil service fund ABP, may have to cut pensions
next year and again in two years time in order to keep its finances in order,
the Volkskrant reports on Wednesday.
The paper bases its claim on
confidential documents from the pension fund, which covers some three million
workers and pensioners.
The current method of
calculating pension funds’ coverage ratio - the amount of assets needed to meet pension
obligations - could mean ‘reductions mount up to between 10% and 15%’,
the document states.
The fund has already agreed to
cut pensions by 0.5% next year. However, talks are under way between ministers
and the central bank on changing the way interest rates used to determine the
coverage ratio is calculated.
The document also states that
if nothing is done to change the calculations,premiums for 17 big funds
could rise by 28.5%.
Hundreds of thousands of
pensioners are likely to get smaller pay-outs next year because pension funds
have been hit by lower interest rates and the economic downturn.
There is no need to explain
how tough it will be for many people to see 15% cut off their fixed income. And
that will be just the beginning. Some pensions plans may temporarily do better
if and when they're allowed to invest in risk(ier) assets, but just as many
will do worse for that exact same reason. Changing coverage ratio calculations
is not a magic wand; it's just another layer of creative accounting, and we've
already got plenty of that.
For younger generations, which
over a broad range have lower income jobs, if they have any, seeing pension
plan premiums rise 28%, and then some more and so on, will become unacceptable,
fast. They will soon figure out that the chances they will ever get any pension
decades from now are close to zero. So they’ll ask themselves why they should
pay any premiums, from the pretty dismal wages they make in the first place.
Over the next few years, this
is a battle that will play out in our societies, and it will have no winners.
We need to be very careful not to let it tear those societies apart. In a world
where just about everyone has to settle for much less than they have or thought
they would have, that will not be easy. Realistic accounting standards would be
a good first step, but they will also be very painful. It will be very tempting
to hide reality for as long as we can, in the same way we already do with
issues ranging from Greece to real estate prices to bank losses to derivatives
to our own personal debts.
The best, or even only, advice
for those of us who belong to younger generations is: don't count on getting a
pension when you reach retirement age. It’ll probably have been moved to age 85
or over by the time you get there anyway.
This is not something that can
or will be fixed overnight. It was doomed from the moment baby boomers started
producing the number of children they have. It simply hasn't been enough to
keep the pension Ponzi going. And those baby boomers, with far too few children
to provide for their pensions, have only just started to retire now, as the
plans are already in such disarray. I'm sure you can see where this will lead.
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