The
Global Demise of Pension Plans
by Raul Illargi Meijer
27
August, 2012
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
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 underfunding 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." [..]
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.
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:
massive shortfalls
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
"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:
up to 15%
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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