Why Pensions Don’t Work: Isn’t it the Demography, Stupid?
While we’re on the subject of pensions, the reason that many people believe that the public sector needs to move away from defined-benefit pension plans to defined contribution type retirement plans (and that the government has to move away from a defined benefit Social Security system) goes beyond the rationale that “it’s the way the private sector does it”. Rather, the argument is basic demography.
In 1955, during the golden age for corporate pensions, the fertility rate in the United States was about 3.6 children per woman. By 1980, the fertility rate had dropped to 1.8 children per woman, and it has hovered around a rate of 2.0 since then. That’s a devastating change if you’re trying to structure a rational, sustainable defined benefit pension plan.
Defined benefit plans have to be supported by succeeding generations, but in 1955, this wasn’t a big problem. In 1955 each couple “contributed” 3.6 new people, on average, to the next generation. Jump forward 25 years, and each of those new couples added 1.8 people to the generation after that. That means, over two generations, there were 6.8 younger people per older citizen (3.6 in the first generation, plus 1.8 times 1.8 in the second generation, [i.e. the fertility rate of 1.8 in 1980 times half of 3.6, because it takes two to make a couple]) available to support a pension system.
However, starting with women of childbearing age in 1980, there were only 1.8 new people per couple in the next generation. There’ll be only 2.0 young’uns in the generation after that. The result is only 3.6 younger people per older citizen (1.8 in the first generation, plus 0.9 times 2.0) available to support defined benefit pension plans for the current generation entering/nearing retirement.
That means — even before accounting for increased life-expectancy — you have to whack people currently in the workforce twice as hard now as you did 25 years ago to pay for public sector pensions, because there are only about half as many people relative to the retiree population. And if the United States follows demographic trends in the developed countries of Europe, this problem will only get worse.
I don’t see the problem here. We can kick this can along until well after I get MY pension.
I am definitely not an economist, but isn’t it possible that some of the demographic changes are offset by increases GDP and other kinds of economic growth? (To use a stupid analogy, might there now be fewer slices of a bigger pie?)
Ah yes, but those eating the pie are taking bigger slices than the growing pie can accommodate. Plus, some of that pie (say, the crust) has been used to feed others!
OK, that was a total over use of an analogy. I will now stop.
Is the pie tin earth-friendly? Were the cherries given a CHOICE before they were picked?
And this is partly why social security will fail too, besides the point that people are living 30 years longer than anticipated.
Pish Posh, Josh. Social Security is just a boogieman that the Republicans use to try to privatize more of the government and give kickbacks to their friends in “Big Investment”.
>>Pish Posh, Josh. Social Security is just a boogieman that the Republicans use to try to privatize more of the government and give kickbacks to their friends in “Big Investment”.
Oh yeah? Just wait until it goes cash-flow negative in 5-10 years, and the Democrat voters go to the “Trust Fund” cupboard and find that it’s bare.
How about just letting ME have the choice of being in or out of Social Security – I’d gladly take my FICA “contributions” and take the “risk” of putting the money in an IRA that I OWN and so have a LEGAL RIGHT TO (there is no legal right to Social Security benefits – Congress can reduce or eliminate them at any time).
In other words, the real “risk” over the next 10-40 years is upon those depending upon future Congress’ not to “means test” and/or tax their “benefits” into nothingness.
But Tom W, if you make bad investments the government will not only have to support you but it will be out all the interest on the money you WOULD have put into the system. And we can’t introduce CHOICE into America unless you’re CHOOSING to have an abortion or join a union.
Your information is not correct. Have to break my posting boycott to respond to this one. Simply put, you do not understand how defined benefit plans work. While Social Security does fit your description of a system funded by current workers (as it was desinged to, with all the flaws you noted), that in NOT how defined benefit plans work or are supposed to work. Contributions to DB plans are made by the employer, and in public sector plans, by employees, and those contributions, combined with the return on investment of the invested funds, are used to cover the payments to retirees. In the case of the teacher and state employee retirement plans, had the state kept to the original funding schedule and not played various games over the years, the system would now be fully funded and, even before the reductions in the recent plan design changes, the entire management contribution for the teacher system would have been less than 3.5% and for state employees, less than 0.5% (with those employees still contributing 9.5% and 8.75% of salary, respectively). This would have freed up million of dollars for programs, tax reductions, etc. and been an excellent benefit at a reasonable cost. The unfunded liability must be addressed even if the plan went away tomorrow. The fact that they associate payments to address the unfunded liability with the current employee population is an artifical construct – if we increased the teacher populationn tenfold (have fun with that concept, Greg and Tom W), the management contribution as a percentage of salary would drop significantly – if we cut the population in half, the management contribution as a percent of salary would increase. Those payments need to be made either way. The one demographic change that I agree had to be addressed… Read more »
>>But Tom W, if you make bad investments the government will not only have to support you but it will be out all the interest on the money you WOULD have put into the system. And we can’t introduce CHOICE into America unless you’re CHOOSING to have an abortion or join a union.
The investment return argument is a red-herring. Simply require people to invest the money in a set of index funds, similar to the “lifecycle” funds of funds in many 401K plans. This will generate a far better rate of return than Social Security (which for younger people is absolutely going to generate a negative return).
The abortion “choice” argument is also a red-herring. It leaves out the “choice” of the unborn child. Abortion isn’t a form of choice, it is a form of assault / manslaughter.
As for joining a union, it SHOULD be a choice. In closed shops it is not – join the union or lose your job. Ditto, it should be as easy for a group of workers to decertify a union as it is certify one. Unfortunately, organized labor is opposed to such choices.
I am a public sector union member in R.I. and I have NO fear of 401-K – like retirement plans. Here is why. The 70 year return on investment for the S+P 500 is about 10.5% !!!! The dollars pouring into such an Index Fund for someone in a 401-K like plan are also PRE-TAX dollars !!! Such designs also stimulate the economy which in turn helps the return on investment. Because they lessen the tax burden, MORE wealth is created. Everyone wins. Mr. Walsh also touches upon a great problem when government is trying to take control of pension plans when he says, ” had the state kept to the original funding schedule and not played various games over the years, the system would now be fully funded and “…. The problem is that with government you are depending upon someone else ( who always is in pursuit of the next vote ) to determine and carry out the ‘right’ policy. We will always be disappointed in this scenario. I think public sector employees would be better off having direct control of their retirement plans AND their health plans ( through Consumer Driven Designs that have Health Savings Accounts ). At a minimum, we deserve a choice.
Cool, now I am a Union hack! Dude, funny once, more than that its ad hominem .
Now, as to the math.. Marc, you leave out the rate of return that is designed to flux with the demographics.
Face it, the Righties who abandoned their responsibility did it to pocket the cash themselves.
Tom W. – try getting your facts straight. No wonder nobody respects the Valley Breeze. But no, that wouldn’t fit the style.
>>Tom W. – try getting your facts straight. No wonder nobody respects the Valley Breeze. But no, that wouldn’t fit the style. And exactly what facts do you allege that I didn’t get straight??? >>The unfunded liability must be addressed even if the plan went away tomorrow. The fact that they associate payments to address the unfunded liability with the current employee population is an artifical construct … Not quite. If the plan was frozen so that there was NO ADDITIONAL vesting of benefits, the unfunded liability would greatly decrease, if not be eliminated entirely. As to association with current employees, this is no more unfair than increasing Social Security tax rates on current workers to support current retirees – which occurred in the 1980’s, and is being promoted again by Democrats via an elimination of the earnings cap on Social Security taxes. >>The one demographic change that I agree had to be addressed (and was addressed) was unreduced early retirement independent of age – that was unsustainable, and it was changed. Correct me if I’m wrong, but I believe that it was only changed prospectively for new hires, not for the state employees / teachers then (and now) employed. So it was merely tinkering at the margins and, in effect, the “artificial construct” you decried of associating the next generation of employees with the liabilities incurred to support current employees and retirees. >>Simply put, most of the DB benefit that current workers earn is paid for by the workers themselves. You need to understand the math to discuss the policy. Yes, the current workers “contribute” toward it, but it is not “paid for” by them – IF IT WAS THEN THERE WOULDN’T BE ANY UNFUNDED LIABILITY, NOW WOULD THERE? >>had the state kept to the original funding schedule and… Read more »
Oh Tom.
Blame a different bogey man.
“Correct me if I’m wrong, but I believe that it was only changed prospectively for new hires, not for the state employees / teachers then (and now) employed. So it was merely tinkering at the margins and, in effect, the “artificial construct” you decried of associating the next generation of employees with the liabilities incurred to support current employees and retirees.”
No, Tom. It was changed for all “non-vested” workers. That is , everyone who had ten years of service or less. That is 50% of all state workers and teachers. And when you do the math, the non-vested workers get NOTHING from the State. They only pay for their own benefit.
So, like I said, get your facts straight, Tom.
Pat said. “Face it, the Righties who abandoned their responsibility did it to pocket the cash themselves.”
I’m confused. Is that the right wing of the Democratic party that has controlled the state since the mid 1930s?
Bob, I agree, in the ideal that… Contributions to DB plans are made by the employer, and in public sector plans, by employees, and those contributions, combined with the return on investment of the invested funds, are used to cover the payments to retirees. …but if those ideal conditions always held, then there would be no essential difference between defined-benefit and defined-contribution plans, and very little controversy about switching people from DBs to 401(k)s. The advantage of a defined-benefit plan (for the beneficiary) is that there is assumed to be a pool of additional money that can be tapped to make up any shortfalls when ideal conditions don’t occur (including, as you pointed out, state governments doing funny things with their pension funds). However, in 1980, finding the additional funding, (i.e. raising the taxes) needed to cover mistakes and shortfalls could be spread out over roughly twice as many people in the workforce as there are now. Because of demographics, the margin of error for defined-benefit pension plans is shrinking, and probably will continue to shrink. (My point in the original post might have been clearer if I had said “defined benefit plans have to be supplemented by succeeding generations” instead of “defined benefit plans have to be supported by succeeding generations”.) Put another way, and correct me if I’m wrong, but I find it hard to believe that the current pension crisis is the result of bunches of individual politicians in different states being that much dumber than the bunches of individual politicians in the generations that preceded them. Doesn’t there have to be some sort of systemic explanation? Oh, BTW, since you mentioned that you’re breaking your commenting embargo to correct a specific error, I’ll take that to mean that we’ve been absolutely and irrefutably right on every… Read more »
>>”Correct me if I’m wrong, but I believe that it was only changed prospectively for new hires, not for the state employees / teachers then (and now) employed. So it was merely tinkering at the margins and, in effect, the “artificial construct” you decried of associating the next generation of employees with the liabilities incurred to support current employees and retirees.”
>>No, Tom. It was changed for all “non-vested” workers. That is , everyone who had ten years of service or less. That is 50% of all state workers and teachers. And when you do the math, the non-vested workers get NOTHING from the State. They only pay for their own benefit.
Pat,
My post was clear that I wasn’t sure, hence the invitation to “correct me if I’m wrong … I believe”
I find it hard to believe that 50% of all state workers / teachers have less than ten years in, but we’ll leave that aside for the moment.
As for non-vested workers getting “nothing from the state” and only paying “for their own benefit” – what is your source? Is there data to this effect? Have AFSCME / NEA etc. told their members about this?
And if this is the case, after already being burned once by the state / General Assembly, shouldn’t the unions who are charged with represent these people and advocating for their best interests be pushing for a defined contribution plan with a contribution match by the state, so that once that match is in each union member owns the money in their own account that no future General Assembly can monkey with???
After all, if they’re paying for the entirety of their own benefit now, then getting a match from the state would be a big improvement over what they currently have.
Oh, Andrew. What a Pandora’s Box you have opened with this thread! Let’s start with Bob W’s ideal world. The basic arguments in favor of a DB pension include (a) the amount of your pension is theoretically guaranteed (which assumes that any shortfall in expected investment returns will be made up by either increased contributions by current workers/employers and/or growth in the number of members in the plan; and (b) professional investment of the funds, which in theory should avoid many of the mistakes to which individual investors are prone. The arguments against DB pensions include (a) abuse of “final salary schemes” in which your pension amount is a function of your average comp over the last three years of employment — the source of much loading up on overtime during your last three years of employment; (b)the lack of portability — if you’re not vested in the plan and you switch jobs, you lose; and (c) the lack of any requirement that a public sector employer make adequate contributions to the DB plan each year to ensure that it remains adequately funded (private sector plans are governed by ERISA, which is much stricter). So DB plans, and particularly DB plans in the public sector, have some clear pros and cons. But that’s not the problem we face today in RI. Many of our municipal plans are underfunded — and that is before the unfunded liability for future retiree health care benefits is included. When that is taken into account, most if not all state and municipal employee plans in RI are grossly underfunded. That, of course, leaves three fundamental choices. (1) You can reduce the size of the future liabilty by cutting retiree pension andhealth care benefits and/or raising the age at which employees become elibible to receive them.… Read more »
Too late tonight to respond to all the points, but there are some basic differences between DB and DC plans – in a DC plan, you are alone in your investments and playing some fairly long odds (and paying higher fees to do so) – you can win bigger, but are much more likely to lose bigger as you can not be fully diversified in a meaningful way from day one and have nothing to help smooth over the market vagaries the way a large DB plan can. SO, to be safe, you need to save even more. Also, you are making one significant trade (that makes the go it alone types nuts) – basically, the game is over when you die (except for spousal survivor benefits, which the actuaries keep cost neutral) – in the risk pool nature of a DB plan, you trade the security of a lifetime benefit for the tradeoff of collecting little if you “check out” early. Run the numbers anyway you want and it becomes a decent benefit at a fair price (remember it also essentially builds in disability insurance as well – also remember over half the teachers are not in Social Security, so this is it for them and it is saving the local districts 6.2% of salary.)
That said, there are other structural issues that should be dealt with in the current plan – another topic for another day, but probably soon when you see tomorrow’s headlines . . .
And yes, Andrew, I have always felt that your posts were absolutley “right” – even if the ProJo will not give Anchor Rising that moniker!
But Tom, when do you rant and rave, cast aspersions, call people names, make things up, but then say,
oh, but if I am wrong….
See, in negotiations, thats called bad faith.
And you can read the actuary reports of the Treasurers office to find out if my numbers are right about funding their own pension.
And yes, more than 50% of the workforce is in the non-vested group.
And no, they should be pushing for a defined contribution. See , two wrongs don’t make a right. Pushing for a better system is better than abandoning everyone still in the plan, never
mind how bad it would be for all of us as taxpayers if the pension system collapsed.
And Chuck R, thats why I didn’t refer to them as Republicans. It’s not the party.. it is the belief system. See Tom W and that ilk who cry about how the Unions run things in the G.A. don’t realize how bad the GA screwed Unions in the pension reform (‘tinkering around the edges” HA!) or how bad they screwed them when they level funded education this year. But hey, if you like the story, keep telling it to yourself.
John, you hit it – those are the three fundamental choices. And gosh, increasing taxes on any level is such a good idea as we are already the fourth or seventh highest taxed state.
SeanO is correct; the biggest problem is (paraphrasing him) that our elected officials keep making too many promises to too many people. I am genuinely puzzled 1.) by the Dem leadership’s refusal, even in the face of dire fiscal travails, to touch our exceedingly generous (and personally corrosive) social programs and 2.) that the public labor unions continue to allow them to do so.
As to the former, of course, a politician’s first concern is his re-election. It is difficult to believe, however, that if social benefits were cut by as much as half or even more, that all encumbants would not be re-elected. In short, if I ran for office, I’d rather have the support of the public labor unions than the poverty industry.
Oh gads, now Bob Walsh is going to get a swelled head …
Bob Walsh said “in a DC plan, you are alone in your investments and playing some fairly long odds (and paying higher fees to do so)”
Why is that? I’ve had a 401K for 20+ years. The employer can limit the range of choices. How about a US Treasury bond fund, a Treasuries money market and broad market index fund? Does the state have lower expense ratios than Vanguard’s 0.2% for its index fund? Is that mix too risky for you? How about an annuity offering that allows you to select your investment choices and then guarantees a certain rate of return? Do you trust, for example, Hartford or Aetna more or less than you trust the RI GA and Senate? Also, if this is such a bad idea for public sector employees, how do you explain the US government’s Thrift Savings Plan G, F, C,S and I funds with $74 billion under management and pretty good returns? Their aggregate expense ratio is currently under 0.10%. You can find them here:
http://www.tsp.gov/forms/comparison.pdf
These are one of three legs of the Federal retirement plan which includes SS benefits, a basic benefit and these TSP benefits. Actually, a pretty decent plan.
Pat,
I’m confused [insert anti-conservative one-liner here]. Are you telling us that the non-vested group of employees is having only half as much deposited into their pension fund as the others? But if it’s a defined benefit plan, and the state has stopped making extra contributions, doesn’t that just mean that extra money to pay the mandated benefits is going to have to be taken from some future source, when it’s time to start making payouts?
Or are you telling us that the non-vested group now has to make twice as big a contribution as other employees? Or something else entirely?
John,
Let me put the same question to you that I put to Bob. I find it hard to believe that politicians from the previous generations were that much smarter than the ones we have now. So even though RI may be worse off than some other states, doesn’t there still have to be some systemic explanation of why so many different pension funds in so many different places have gone belly-up at about the same time?
shorter Andrew – Ponzi schemes always blow up after a while, doesn’t matter how good a money manipulator you are. All these pension plans have run out of ‘investors’, ie, private sector workers to support the retirees.
>>And yes, more than 50% of the workforce is in the non-vested group … Tom W and that ilk who cry about how the Unions run things in the G.A. don’t realize how bad the GA screwed Unions in the pension reform. Oh really? The unions have been screwing the taxpayers a/k/a “working families” of Rhode Island for decades. Gee, the poor state employees who have less than ten years in won’t get a “no minimum retirement age” pension like their predecessors. Poor babies! WHERE IS IT WRITTEN THAT “BENEFITS” CAN’T BE CHANGED, EXCEPT UPWARD, FROM WHATEVER THEY ARE ON THE DAY SOMEONE IS HIRED???? This just demonstrates how out of touch you public sector types are, as well as your sense of entitlement. If as you say 50% of the state / public teachers workforce is less than ten years / non-vested, then ALL THE MORE REASON TO FREEZE THE PENSION VESTING TODAY AND CONVERT TO A DEFINED CONTRIBUTION PLAN – TODAY! Those non-vested workers have 20-30 years of potential working life left, and so have plenty of time to adjust their retirement plans AND ADJUST THEIR EXPECTATIONS. Those with more than ten years will still have what they are currently vested in – and since those employees who have more “seniority” are also vested at a much greater level, the impact on them will be proportionately lower. And for us working stiff out there pulling the freight because WE pay the taxes, the unfunded pension liabilities created by the DEMOCRAT (i.e., union supported and elected) General Assembly will be greatly reduced, eliminated or perhaps even show a surplus. How about asking your union puppets like Amy Rice and Pauly Moura about sponsoring legislation to freeze the pension system … if not for the good of the state, then… Read more »
Andrew,
I’d say the absence of ERISA for public sector pensions is an important root cause of the behavior we’ve seen, not just in RI but all over the country. Politicians with short horizon who knew that the real consequences of underfunding would also bite long after they spent the funds elsewhere were another factor. And a population of unionized employees who either didn’t understand the implications of continual underfunding (even as promised benefits were increased) and/or didn’t want to rock the boat by speaking up was another factor. The leadership of the public sector unions also has to share part of the blame, as they accepted sharp increases in social welfare spending (as the price of maintaining the Democrats’ control of the General Assembly), even as pension underfunding worsened. Or maybe they just thought they could raise taxes to fix the problem “later on down the road.” No shortage of reasons we are where we are today. But that doesn’t change the stark choices we face.
Andrew, no the contributions remained the same, that is the sad part. They get a readically reduced benefit and they pay the same as the other folks.
When you calculate what they pay over a career, and what they get in return when they retire, the amount they have put in is equal to what they get out. The State’s entire contribution is going to the unfunded liability, not to the workers.
Andrew, no the contributions remained the same, that is the sad part. They get a radically reduced benefit and they pay the same as the other folks.
When you calculate what they pay over a career, and what they get in return when they retire, the amount they have put in is equal to what they get out. The State’s entire contribution is going to the unfunded liability, not to the workers.
>>Andrew, no the contributions remained the same, that is the sad part. They get a readically reduced benefit and they pay the same as the other folks. When you calculate what they pay over a career, and what they get in return when they retire, the amount they have put in is equal to what they get out. The State’s entire contribution is going to the unfunded liability, not to the workers. Assuming for the sake of argument that this is all true: Do you really believe that the union bosses weren’t at least acquiescent to this behind closed doors? Despite their public protestations spinning the rank and file, the bosses knew / know that the present system is unsustainable. When “concessions” are unavoidable, unions are notorious for, when possible, sticking it to those with less seniority or the “yet to be hired” (therefore “yet to be ‘dues payers”). This was simply standard operating procedure in the unions’ playbook. This is why I asked you in a previous post if the public sector unions have told their own non-vested members that under the current pension system they’re only getting back what they’re paying in. If the unions aren’t disclosing / discussing this with their rank and file, then I submit to you that this is a big clue – Montanaro et als. public protestations notwithstanding – that the union bosses were involved in a “deal” that resulted in the “radically reduced benefit.” Thank about it, do you really believe that the DEMOCRAT General Assembly would have instituted such a change without the involvement to the public sector union bosses? And had it done so, don’t you think the unions in the last cycle would have found a bunch of sycophants to run primary challenges against the offending Democrats? I don’t… Read more »
shorter Andrew – Ponzi schemes always blow up after a while, doesn’t matter how good a money manipulator you are. All these pension plans have run out of ‘investors’, ie, private sector workers to support the retirees.
Posted by chuckR at July 12, 2007 11:32 AM
XXX
That says it all so concisely.
The pension contribution has nearly tripled (9%-25%+) in just 8 years. That is geometric proportions and can’t be sustained for more than a very few years. Certainly the tax burden cannot sustain another tripling (to 75%) over the next 8 years. They can raise the capital gains only so much-people will leave the state or move their investments offshore. They can raise the cigarette tax only so much-people will buy their smokes online from Indians. They can raise the sales tax only so much- people will buy online or go to Seekonk/Atlleboro. They can raise the property tax only so much-people will abandon their properties (or torch them) and RI will become Detroit or Newark or Gary.
My guess is that the GA will hold their nose and shift to 401 K’s in January 2009-as far away from an election as possible-and the wrath of the Walsh’s, Reback’s and the rest of the leeches.
The end is nigh ….
Providence Journal: Pension costs to soar 14 percent in coming year
http://www.projo.com/news/content/pension_rates_07-13-07_8A6BG2A.355fb50.html