Pensions

Seen in the New York Times:

When the FedEx Corporation slimmed down its pension plan last year, it softened the blow by offering workers enriched 401(k) contributions to make up for the pension benefits some would lose. But last week, with Americans sending fewer parcels and FedEx’s revenue growth at a standstill, the company said it would suspend all of its contributions for at least a year.

“We will have to work more years and retire with less money,” said Lee Higham, a 44-year-old senior aircraft mechanic at FedEx, who has worked there for 20 years. “That’s what we are up against now.”

FedEx is not the only one. Eastman Kodak, Motorola, General Motors and Resorts International are among the companies that have cut matching contributions to their plans since September, when the credit markets froze and companies began looking urgently for cash. More companies are expected to suspend their matching contributions in 2009, according to Watson Wyatt, a benefits consulting firm.

Note that termination of employer match of 401(k) contributions comes after the slaughtering of the asset values shown on those ever-popular quarter-end statements.

This move, as well as the trend of the past two decades to shift from defined-benefit pensions to 401(k) accounts, are understandable, if unfortunate.  With revenues down and credit lines dried up, it’s very understandable that companies are doing whatever they can to conserve operating cash.  And the decline of pensions is (in my inexpert opinion, since I’m a P&C actuary not a pension actuary) seems like a logical response to the increasingly dynamic nature of our economy, reduced tenures, and increased longevity.

It’s a good thing that we have Social Security to fall back on…at least for another 30 years or so.

For those of you who are so inclined, the current issue of the American Academy of Actuaries’ magazine, Contingencies, has an article in which four pension actuaries share their thoughts on how they would redesign Social Security.

For those of you who have an interest in demography, immigration, Social Security, sustainability and/or just the general shape of the future, you might be interested in a lengthy article in this Sunday’s NYT Magazine discussing the causes and potential impact of Europe’s record-low birthrate.

Some of the points raised in the article

• In parts of Europe, the birth rate has dropped to roughly 60% of the rate needed to maintain a static population (ignoring migration).
• Demographers in Europe are particularly concerned about the sustainability of pension schemes in an environment where the worker-to-retiree ratio is so low; some European countries are toying with workforce-expanding measures including increasing retirement age to the unthinkable (?!) age of 65.
• Several towns in eastern Germany are apparently de-developing unused neighborhoods and districts, downsizing and combating urban blight to better support their smaller populations.
• In Western societies, it’s theorized that birth rates are increased when either there is extensive social support for working mothers (e.g. subsidized daycare, and extensive maternity and paternity leave in northern Europe), or when society doesn’t penalize working mothers who take a few years off from their career (e.g. the United States).  Countries where society expects mothers to stay at home with the children (Italy, Greece) see the lowest birthrates.

It’s a fascinating read.

About $6 billion, apparently.   From the Boston Globe:

Massachusetts lawmakers are proposing bigger pensions for state and municipal employees that could cost $6 billion or more, according to some estimates, triggering a chorus of complaints from fiscal watchdogs and local leaders who say the money is not there to pay for it.

The union-friendly, election-year maneuvers by the House and Senate would increase the annual cost-of-living adjustments that retirees receive as part of their pensions.

The individual numbers are seemingly small, a boost of about $120 a year more for every retiree, which advocates say is well-deserved. But multiplied by over 100,000 former teachers and state workers in the state’s pension system as proposed by the House and by 86,000 municipal retirees as envisioned in a Senate amendment, it would add up fast, say critics.

There is a phrase that is used to describe one danger of a representative democracy:  “bread and circuses”.    Lacking true accountability, and without proper checks and balances in place, politicians are at risk of supporting fiscally irresponsible or short-sighted proposals, solely to gain popularity among enough voters to extend their term in office.

I don’t want to begrudge anyone a COLA on their retirement income, but if there is money to burn, shouldn’t it be spent on other purposes, including shoring up pensions that are currently underfunded, investing the money in services and infrastructure that will be needed for the future, et cetera?

It’s good to be loved.

Seen in the New York Times:

By firing its actuarial consultant last week, the New York State Legislature shone a light on one of the public sector’s deepest secrets: All across the country, states and local governments are promising benefits to public workers on the basis of numbers that make little economic sense.

The numbers are off-base for a variety of reasons. Sometimes there is a glaring conflict of interest, as there was in Albany, where the consultant was being paid by the workers seeking richer benefits. More often, there is subtle pressure on the actuary to come up with projections that make the pension fund look good.

Most of all, public pension actuaries use old methods that have fallen far out of sync with the economic mainstream. That does not necessarily mean their figures are wrong, but it does make them vulnerable to distortion, misunderstanding and abuse.[...]

The article provides a few examples, in which the Times, to its credit, does note that the actuaries involved opined in a manner that likely didn’t quite register with their audiences.   For example, regarding New Jersey’s pension mess:

Two years later, a state senate committee called back the actuary, Robert D. Baus, for questioning, to make sure all was well. Senator Peter A. Inverso noted that a $4 billion deficit had appeared in the pension fund. “That frightens me,” he said. But Mr. Baus said that while the deficit had grown, “it does not change the fact that the system is funded.” He said New Jersey would have to close the shortfall at some point, but in the meantime, “it does not mean that there is not enough money to cover the liabilities right now. There is more than enough.”

No one asked exactly when the shortfall would have to be closed. Instead, legislators kept withholding pension contributions, even as they increased benefits again and again. Over the years the imbalances in the fund finally snowballed.

Now the fund is so deep in the red that Governor Jon S. Corzine’s administration cannot find the cash to catch back up. The Securities and Exchange Commission is investigating.

One other comment which caught my eye:

Actuaries worry their profession cannot withstand too many large lawsuits. The board that writes actuarial standards has been working on revisions in how to make economic assumptions.

But change is coming at a creep. There are still a large number of actuaries for public plans who vigorously defend current methods.

If you’d like to see a little discussion within the actuarial community about the article, you might be interested in this thread at the Actuarial Outpost.

I’m not a pension actuary, so I’m perhaps not the best person to comment on the specifics in that article.

However, I can note that as a profession, we actuaries are frequently lacking when it comes to communication skills (the NYT article has a “muted warnings” comment in one example).  And, while we are comfortable with the language of risk and the concept of potentially widely varying outcomes, it’s all too easy to remember that our customers and the general public aren’t as well traveled in the land of randomness.

Mere non-actuarial mortals want a point estimate.  A number.  The One True Answer Fixed and Unchanging For Evermore™.

That’s a problem.  An honest answer in our line of work is rarely just A Number.   It’s a range of values, along with a discussion of what influences might impact where the outcome might be, and perhaps a few words around how to monitor the chaos to get a better indication of the final outcome as the situation evolves.

A lot of folks, sadly, aren’t equipped to handle that.

Thus, we have the real challenge of our profession — how to phrase our opinions in a way that educates our customers…or at least minimizes the potential harm from misuse of our opinions.

One thing’s for certain: the rule of thumb we were taught in the session of the CAS’s professionalism class I attended years ago — how would this look if it appeared on the front page of the New York Times? — seems very appropriate right about now. 

Seen in the New York Times:

Senator Hillary Rodham Clinton of New York unveiled the second biggest domestic policy idea of her Democratic presidential campaign today, proposing to spend $20 billion to $25 billion a year to create 401(k)-style retirement accounts for all Americans and provide federal matching money of up to $1,000 to middle-income people.

Under the plan, the government would give a dollar-to-dollar match for the first $1,000 saved by Americans who earn up to $60,000 annually. For those who earn $60,000 to $100,000, the government would provide a 50 percent match, or $500 for the first $1,000 saved.[...]

My initial reaction to this was that this is an IRA plus a federal match. I’m OK with the idea of incenting folks to save more, but I’d prefer to see it structured via tax credits or deductions, rather than as an explicit, entitlementesque handout, but I do have to admit that it’d be the same.

Supposedly, the funds for the handouts would come from not fully phasing out the estate tax. I’ll give Hillary credit for trying to demonstrate fiscal responsibility with that statement, but I would be remiss if I didn’t point out that Washington has a bit of a problem with spending money it doesn’t have, and such creative accounting ought to be addressed before…or at least in conjunction with…contemplating new social expenditures.

I’m also a little disappointed that this would seem to add to the alphabet soup we have of tax-advantaged specific-purpose savings mechanisms in this country. One of the challenges for lower and middle income folks who want to use such advantaged plans is the whole process of allocating limited savable funds to specific needs.

I’d much rather see a clean-up of the alphabet soup down into one catch-all tax-advantaged savings plan, for use for retirement expenses, income replacement in the event of unemployment or disability, major medical expenses, education, etc. Let folks of modest means work on attempting to save what they can, and spare them the hassle of a financial planning exercise every time benefits enrollment comes around at work.

And perhaps there is some hope for my dream. Quoting from the same NYT article:

Mrs. Clinton said that Americans could also tap into the savings accounts to buy a home or pay for college, and that she was considering allowing workers to access the account “during tough times, like an illness or accident.”

It’s a start.

Over the weekend, the Financial Times ran an article reviewing the threat of changes in mortality rates (or the estimation thereof) on life insurance, dating back from the old tontine schemes of the 17th centrury, up through the uncertainties raised about pandemic risk and pension funding shortfalls.

Over on the P&C side of the insurance house, some insurers have dabbled in the securitization of catastrophe risk, as a means to gain access to additional risk capacity as well as investors who might wish to diversify their portfolios.

It sounds like the life and pension folks are starting to get into the act too:

Insurance companies have followed suit, launching “mortality bonds” that bet on whether death rates will rise - usually due to something such as bird flu. Axa, the French insurance group, issued one of these last year where investors purchased bonds, and received a cash flow with a value that fell if the level of deaths among Axa policy holders rose. The price of a mortality bond is thus tied into the chance of a pandemic.

Now people in the capital markets are wondering whether this idea can be applied further. If bond purchasers are willing to bet against catastrophe or mortality, why not longevity? A couple of years ago, the European Investment Bank and BNP Paribas made one attempt to do just that. The EIB marketed a 25-year bond, worth £540m, which produced cashflows that were designed to be a mirror image of a pension fund’s liabilities for a hypothetical pool of 65-year-olds. The details of the scheme were complex, but the essential idea was that the payout to bondholders would fall each year, according to the rate of deaths. In other words, the higher the death rate, the less money the bondholders would receive. The investors were expected to be pension funds looking for a way to balance their risks.

The article mentions that the longevity bond described in the second quoted paragraph hasn’t caught on yet, presumably due to the complexity of the risk.

Combine that with the report several months ago that Axa was securitizing the risk of part of its auto insurance book, I can’t help but wonder if in a few decades, insurers and agents might be reduced to being essentially brokerages, writing policies that are then bundled and re-tranched into securities sold in the capital markets.

This sobering reality-check is brought to you by The Day:

The unfunded liabilities for the [Connecticut] teachers’ and state employees’ pension funds now virtually equal the total state budget for the year. There’s a $7.9 billion shortfall for the state employees’ pension fund and $6.9 billion for the teachers’ pension account.

The two funds have $14.8 billion in unfunded liabilities. The state budget for 2007 is about $15 billion.[...]

The state is funding the state employees’ pension fund at only 54 percent of the required level. The teachers’ pension fund is at 63 percent of the actuarial table.

The language in the column is a little rough and imprecise, but it does serve as a worthy reminder that there are many issues looming on the horizon when it comes to retirement funding.

As seen at the Columbian in Clark County, Washington:

While it is Sohn’s job to determine how much money we have, it is the actuary’s job to determine how much money is needed. The actuary helps keep the state’s public pension system fully funded and actuarially sound.

To that end, the actuary recently found that the mortality assumptions used to determine contribution rates failed to take into consideration the fact that people are living longer. He immediately recommended another $64 million in state money for the 2007-09 biennium to cover future costs.

While the $64 million is not an enormous amount when you’re talking about a $30 billion state budget, the compounding effects over a 25-year period to state and local governments are worth noting: $4.2 billion. Like the man says, “Can you hear me now?”

This is the whole reason for having a state actuary in the first place: to reveal problems while they are small and can be handled. Public and private pension systems across the nation are making headlines every day for being underfunded or failing altogether. It’s in our state’s and our state workers’ best interests to have a firm grasp on our state’s future legal and financial obligations.

But, for political reasons, the actuary’s recommendations are being ignored. And this is not the first time.

While this editorial by Senator Joe Zarelli pertains only to one pension program in the State of Washington, it’s a discussion that could well be applied in dozens of other situations around the country, all the way up to the looming deficits in the federal Social Security and Medicare programs.

It does no good to have someone work to provide advance warnings of big problems that could be easy to fix if caught early, if you’re going to ignore those warnings.

The Wall Street Journal has a good article in today’s paper (subscriber link) on the merits of Roth 401(k)’s:

Thanks to the new pension law, Roth 401(k) plans are no longer slated to disappear in 2011 — and that means a lot more companies will consider offering these plans.

Want a shot at tax-free investment growth? Here’s why you should phone up human resources and put in a request for the Roth 401(k).[...]

[I]magine you are eligible to stash $15,000 in your employer’s 401(k), your marginal federal and state tax bracket is a combined 35%, and you also expect to be paying taxes at 35% when you tap the account 20 years from now.

Given your 35% tax rate, you would need $23,077 in pretax income to contribute $15,000 to the Roth. Over the next 20 years, let’s assume this $15,000 triples in value to $45,000. You could then cash out this $45,000 tax-free.

What if you plunked your $15,000 in a regular 401(k) instead? Assuming you bought the same investments, your account would also be worth $45,000 after 20 years. Trouble is, when you cash out, you would owe 35% in taxes, or $15,750, leaving you with $29,250.

“Unfair example,” you cry. “With the Roth, you really contributed $23,077, or $8,077 more.”

True enough. To make the comparison fair, suppose you invested $15,000 in a regular 401(k) and then looked to sock away an additional $8,077 in a regular taxable account. You would have to pay 35% in taxes on this $8,077 of income, leaving you with $5,250 to invest. If this $5,250 also tripled in value, you would have $15,750 after 20 years, enough to cover the tax bill on the regular 401(k).

All even? Not quite. The problem: You will owe taxes on the investment growth enjoyed by the taxable account’s $5,250, so the money won’t fully cover the tax bill on the regular 401(k) — and thus the Roth wins.

There are other advantages to Roth accounts discussed in the article. However, the above was one of the better descriptions of the nuances in the tax differential between regular retirement accounts and Roth accounts.

However, they didn’t discuss one of the reasons I find Roth accounts attractive. The idea of tax-deferral works only as long as general levels of taxation remain relatively consistent.

Looking at the unfunded obligations in the government’s future…it’s difficult to imagine that tax levels won’t be greater in the future than they are today. If that fear proves correct, wouldn’t it be better to pay taxes now, when taxation is low, rather than in the future, when higher rates prevail?