Are Pensions going to destroy the West?

[andyandy]

Nothing like a bit of hyperbole to start a thread, but there seems to be a monumental and still increasing problem with pension provision:

To take three big companies -

BT has a pension blackhole of £9billion

BA has a pensions blackhole of £3.7billion

Royal Mail a pensions blackhole of £10billion

The scale of the deficit is staggering. And that's even ignoring the public sector pension liabilities which aren't even put on the balance sheet as liabilities - and so are in effect swept under the carpet:

Quote:

The total public sector pensions bill is now £810bn, a figure confirmed later in the day in the pre-Budget report. The majority of the state employees are on generous final salary schemes unattainable elsewhere in the UK.
This bill for key public sector workers' pensions has rocketed by 20pc between 2006 and 2008.
The Government Actuary's Department's estimate of the cost of the state pension due to all workers is £1,350bn as of 2005 – equivalent to almost 100pc of Britain's annual economic output.
The entire bill of around £2.2 trillion would more than triple the size of the national debt overnight. It is entirely unfunded, so will have to be paid directly by future generations of taxpayers, rather than out of a pot contributed to by the pensioners themselves.

If the stockmarket doesn't maintain the long term trend of massive real term gains (and why would it?), and if the aging demographic continues - inverting the population pyramid, then things are going to get much much worse....And yet, successive governments do nothing more than lipservice to the problem, 'cos it'll affect people long into the future.

So, just how big a problem does the pensions time bomb pose in the next 20-50years? What can be done about it? Will anything be done about it?

Discuss.

(I'm sure this could also go in the business/economics section, but i'm interested in the politics....)

[drkitten]

Originally Posted by andyandy

So, just how big a problem does the pensions time bomb pose in the next 20-50years?

Not much. Companies will simply default on their pension obligation. What are pensioners going to do about it, go on strike?

Note how GM handled its pension obligations; it spun them off into a separately funded entity to separate them from the current income stream, and then declared bankruptcy when it wasn't able to generate enough funding.

[geni]

Originally Posted by drkitten

Not much. Companies will simply default on their pension obligation. What are pensioners going to do about it, go on strike?

Bankrupt the company and end up owning it.

Quote:

Note how GM handled its pension obligations; it spun them off into a separately funded entity to separate them from the current income stream, and then declared bankruptcy when it wasn't able to generate enough funding.

Thats not a consistently viable aproach.

[geni]

Originally Posted by andyandy

So, just how big a problem does the pensions time bomb pose in the next 20-50years? What can be done about it? Will anything be done about it?

Discuss.

Retirement age will go up as that is the politicaly least painful option. In fact it's quite posible that the baby boomers may be the last generation able to retire before ill health forces them too.

[mhaze]

Should be one effect is that fewer people believe in reliance on pensions.

[Newtons Bit]

Originally Posted by geni

Retirement age will go up as that is the politicaly least painful option. In fact it's quite posible that the baby boomers may be the last generation able to retire before ill health forces them too.

Be able to? Some of us don't rely on pensions or social security to prepare for our retirement.

[ddt]

Originally Posted by andyandy

Nothing like a bit of hyperbole to start a thread, but there seems to be a monumental and still increasing problem with pension provision:

To take three big companies -

BT has a pension blackhole of £9billion

BA has a pensions blackhole of £3.7billion

Royal Mail a pensions blackhole of £10billion

Sorry if I don't understand. In Holland, big companies have founded separate pension funds in which they pay the pension premiums for their employees, and which administers and invests the collected monies. So has the government; the ABP is the biggest pension fund in the world, AFAIK.

Sure, the financial crisis has put a temporary dent in their coverage, getting it down to 90% or so, but this is already bounced back.

Is the situation different in the UK then?

[Francesca R]

Originally Posted by drkitten

Not much. Companies will simply default on their pension obligation. What are pensioners going to do about it, go on strike?

More like force the company into insolvency. Under IAS19 (FRS17 in the UK) companies can't default on defined benefit pension obligations without going bankrupt themselves, which puts the obligation to the state (I believe in some cases, limited liability can be pierced first, but it is a while since I have been involved in this).

Quote:

Note how GM handled its pension obligations; it spun them off into a separately funded entity to separate them from the current income stream, and then declared bankruptcy when it wasn't able to generate enough funding.

And it had a public bailout for that, which does not look viable for several thousand GMs.

The insurance and asset management industries offer partial solutions to buy-out DB pension obligations from companies and take the investment, inflation and longevity risks themselves. But not for free and companies with large shortfalls can't afford it.

I suspect that current law in respect of private DB plans will have to change, because I don't think it can ultimately handle the outworking of current trends.

[Francesca R]

Originally Posted by ddt

Sorry if I don't understand. In Holland, big companies have founded separate pension funds in which they pay the pension premiums for their employees

IIRC pensions are much more highly funded in the Netherlands than elsewhere.

[Francesca R]

Originally Posted by mhaze

Should be one effect is that fewer people believe in reliance on pensions.

Promises made by governments and corporations in the golden age look increasingly un-keepable, without imposing non-viable costs on current and future generations.

[Francesca R]

Originally Posted by andyandy

If the stockmarket doesn't maintain the long term trend of massive real term gains (and why would it?) [ . . . ]

*cough* The peak level of the FTSE-100 was touched on 30 Dec 1999 and was 23% above where it is now.

[Francesca R]

Originally Posted by Newtons Bit

Be able to? Some of us don't rely on pensions or social security to prepare for our retirement.

But "all of us" can't do that, unless everyone can earn well above average income and/or raise their personal saving rate big time without crushing economic growth. For the population as a whole, working longer is just about all that is feasible. Fortunately, with increases in health and life expectancy, that's exactly what the population can do. (And since rising life expectancy is the primary thing that has caused the pension shortfall problem, there's a certain logical symmetry to it. The inequitable thing is that the golden-age generation has been lucky enough to walk off with a disproportionate share of the gains)

[MikeMangum]

Simple answer: defined contribution retirement accounts.

[mhaze]

Originally Posted by Francesca R

Promises made by governments and corporations in the golden age look increasingly un-keepable, without imposing non-viable costs on current and future generations.

That's a rather polite way to put it.

Probably what we are going to be looking at here is a hundred separate and parallel methods of trying to extort money from the general consumer, tracable back to the public pension funds' ravenous appetite for immediate cash, and various court actions thereof.

For example, a municipal water supply which is strapped with pension burdens might have no recourse once litigation began on this issue, to increase water rates. But that decreases use of water. And people move away to other areas when tax burdens get too high.

The "bad" option is for the governments to be the insurer of last resort, which jacks these liabilities from local to state, and then to federal. Better for the failures to actually happen locally.

[Francesca R]

Originally Posted by MikeMangum

Simple answer: defined contribution retirement accounts.

Correct, and almost all non-public sector employers have closed DB schemes, some quite a while ago. (The public sector is in much worse shape).

But that change has happened too late to prevent the shortfalls already in the DB schemes that are already in existence (and who have dwindling numbers of active contributing members and growing--at the moment--numbers of retired (withdrawing) members). An employer can't legally tell them all to go whistle.

And DC pensions transfer the risks (which are poorly understood by most of the public) to individuals of course. When individuals screw up (which many will) they just become liabilities of the welfare system all over again.

[Francesca R]

Originally Posted by mhaze

The "bad" option is for the governments to be the insurer of last resort.

It doesn't have a lot of choice in that, but I agree. In particular, for governments to resolve it with ever-increasing income transfers from the labour force/consumers/investors to retirees is an unstable and terminally risky proposition, even though it has the proximity of higher voter-friendliness.

Reducing retirement benefits/eligibility and raising working ages is the only just way to fix the systems around the world, but this is moving at a snails' pace (check Greece)

[Newtons Bit]

Originally Posted by Francesca R

But "all of us" can't do that, unless everyone can earn well above average income and/or raise their personal saving rate big time without crushing economic growth. For the population as a whole, working longer is just about all that is feasible. Fortunately, with increases in health and life expectancy, that's exactly what the population can do. (And since rising life expectancy is the primary thing that has caused the pension shortfall problem, there's a certain logical symmetry to it. The inequitable thing is that the golden-age generation has been lucky enough to walk off with a disproportionate share of the gains)

Of course, not that's why I said "some of us". There are those of us in the West that were raised to live within our means. I saved almost half of my total salary (not take-home pay) of the first three-years I was employed and bought a house with 20% down. And I made slightly less than the national average income during those three years.

It's simple to do: don't buy you don't need. I shudder to think what would happen if the common man stopped doing that, though. Our economy would collapse. Perhaps afterwards we could build one that's based on a more responsible foundation.

[daenku32]

This is why I stated in the other thread that we cannot expect savings returns greater than GDP growth rate. During the late part of 90s 401k was all the rage because you could get 14% annual returns. That pipe-dream crashed with the economy. Yet the "privatize social security" folks kept believing it and pushing it during the last decade, and still continue to believe it.

Now this isn't the UK, but I imagine the pensions there are in trouble for the same reason 401k won't work. Expectations on the returns are too high.

[mhaze]

Originally Posted by daenku32

This is why I stated in the other thread that we cannot expect savings returns greater than GDP growth rate. During the late part of 90s 401k was all the rage because you could get 14% annual returns. That pipe-dream crashed with the economy. Yet the "privatize social security" folks kept believing it and pushing it during the last decade, and still continue to believe it.

Now this isn't the UK, but I imagine the pensions there are in trouble for the same reason 401k won't work. Expectations on the returns are too high.

But this is false, unless it assumes 100% of the investment is in the currency and in the country of which the "GDP growth rate" is being considered.

There would be many cases in which for various reasons, a prudent investment manager would not find that to be wise.

[daenku32]

Originally Posted by mhaze

But this is false, unless it assumes 100% of the investment is in the currency and in the country of which the "GDP growth rate" is being considered.

There would be many cases in which for various reasons, a prudent investment manager would not find that to be wise.

Not at all. Look at any index and you'll see it doesn't beat GDP when averaged over time.

A prudent investment manager can make money in anything, if they just try hard enough, or are lucky. But a whole group of them will have losers as well as the winners, and the losers will bring down the averages.

[Francesca R]

1. Equity returns do beat national income growth over time. Google the equity risk premium.

2. Investment managers don't outperform the aggregate investable market by being "prudent".

[Giz]

Originally Posted by MikeMangum

Simple answer: defined contribution retirement accounts.

The problem with defined contribution ("DC") accounts is not so much that they transfer risk (which could of course be bad) but that when the switch is made it is normally an excuse for cost cutting.

i.e. Suppose there is a defined benefit ("DB") plan and its actuary tell the sponsoring company that they need to contribute the equivalent of 15% of payroll each year into the pension fund in order to meet its benefit obligations. If the company switches to a Defined Contribution plan then the new DC plan might only see 5% or so of pay contributed by the company each year. This has two effects:
Firstly, as mentioned by a prior poster, the risks from investment, mortality etc are transferred to individuals rather than being professionally managed in a large pool.
Secondly, and what I think is perhaps more important, the funds being accumulated towards providing retirement benefits are often very much smaller (in this example 5% as opposed to 15%) and that will directly impact the level of retirement benefits that can be provided.

There is no such thing as a free lunch, just because DB contibutions go into a pooled fund while DC contributions will go to an individual account doesn't alter the fact that benefits still need to be paid out of funds that (along with investment returns) come from contributions. Less contributions… less benefits.

That is a huge reason for companies to switch from DB to DC. Sure, the balance sheet volatility under DB is harmful, but it is (due to increased life expectancy) the increased cost of providing the same level of income whilst in retirement that is really causing DB to seem unsustainable (especially when that coincides with volatile market returns). The problem for workers is that in order for companies to keep making profits while the cost of providing lifelong retirement benefits, many companies are seizing the chance when switching from DB to DC to implicitly cutting the level of benefits available in retirement.

This could well be the least harmful option (better a company that provides poor retirement benefits than one that went bust) but people should be aware of the trends and people currently working need to save more for retirement than their parents generation did - they cant rely on the company plan and the state to give them the same standard of living.

Hopefully the above doesn't sound too gloomy, perhaps we should sit back and remind ourselves that this problem is largely due to us all living longer! Hurrah!

[daenku32]

Originally Posted by Francesca R

1. Equity returns do beat national income growth over time. Google the equity risk premium.

2. Investment managers don't outperform the aggregate investable market by being "prudent".

Check out this:
http://www.moneychimp.com/features/market_cagr.htm

Inflation adjusted returns are between 6-7 percent. And that is considering the infusion of wealth into stock market when IRA and 401k were created. That's a retirement investment bubble that has been inflated for the past 30 years. A very, very huge bubble.

[commandlinegamer]

How did we manage to pay pensions up till the Noughties? (That's when all these holes seemed to start appearing). The only major pension scandal I can recall before that is when Cap'n Bob helped himself to the Mirror Group one.

[geni]

Originally Posted by commandlinegamer

How did we manage to pay pensions up till the Noughties? (That's when all these holes seemed to start appearing). The only major pension scandal I can recall before that is when Cap'n Bob helped himself to the Mirror Group one.

By haveing far fewer retired people or people about to retire.

[Giz]

Originally Posted by commandlinegamer

How did we manage to pay pensions up till the Noughties? (That's when all these holes seemed to start appearing). The only major pension scandal I can recall before that is when Cap'n Bob helped himself to the Mirror Group one.

People kept living longer. Which led actuaries to update their mortality tables. That meant that pension funds started to assume that they would have to pay Joe Bloggs until he was 80 instead of 75. (Assuming he retired at 65, that's 15 years of sending him cheques rather than 10 years). So whenever they updated that assumption, their next actuarial valuation of the assets and liabilities of their pension plan would show a big increase in liabilities (probably without a corresponding increase in assets; hence a funding shortfall developing).

There were other reasons around that time too (Stock market falls from the internet bubble bursting, and a low interest rate environment which increased the present value of long term liabilities).

[Giz]

Originally Posted by geni

By haveing far fewer retired people or people about to retire.

That's a big looming problem for the pay-as-you-go unfunded state plans. And it sounds like it is if anything a bigger problem for a lot of European countries.

[andyandy]

Originally Posted by Giz

That's a big looming problem for the pay-as-you-go unfunded state plans. And it sounds like it is if anything a bigger problem for a lot of European countries.

I'm currently in a final salary state scheme, but i doubt it'll actually still be anything like its current rates when i retire (in many many years time!) Firstly, the retirement age will almost certainly be a minimum of 70, secondly, the provision is simply not sustainable. Goodness knows how the state goes about backing out of pension provision though - it'd topple any government. I think Europe is in a worse state because, (1) we have a bigger public sector and associated final salaries, (2) we have a slower rate of net immigration and thus a more rapidly aging workforce....

[Jaggy Bunnet]

Public sector is going to have to accept that final salary pension schemes are a thing of the past. That will not be a pleasant process.

[daenku32]

I don't think "retirement"--in the way we think of it--is going to survive without handouts.

[Thunder]

employee contributions to pension funds need to increase. the less pensions are a giant Ponzi scheme and more of a long-term personal retirement investment, the more stabile these systems will be.

[geni]

Originally Posted by Giz

That's a big looming problem for the pay-as-you-go unfunded state plans.

Not as much as the nonminaly funded company plans. The state can if all else fails dig itself out with a law change. Companies cannot.

Quote:

And it sounds like it is if anything a bigger problem for a lot of European countries.

Hard to say. Europe has more dirrect state issues but US has more indirect state issues (the stopping people staving in the street problem) and quite a collection of companies sitting on financial time bombs. It's also a serious problem with US universities.

[Francesca R]

Originally Posted by daenku32

[ . . . ] Inflation adjusted returns are between 6-7 percent. [ . . . ]

Exactly--significantly above GDP growth.

[Francesca R]

Originally Posted by Giz

The problem for workers is that in order for companies to keep making profits while the cost of providing lifelong retirement benefits, many companies are seizing the chance when switching from DB to DC to implicitly cutting the level of benefits available in retirement.

Logically there is no more reason to tie private retirement insurance to employment as there is for private health insurance. The tax breaks and the "reliance on the company plan" are generally distortionary and contribute to the public poorly understanding the risks. There are (or were) practical reasons for it being set up this way in the past, but demographic changes and actuarial miscalculations have turned them into highly impractical ones now.

[lionking]

Originally Posted by Jaggy Bunnet

Public sector is going to have to accept that final salary pension schemes are a thing of the past. That will not be a pleasant process.

Absolutely. People who have left the public service in Australia (like me many years ago) have had their deferred benefit compulsorly cashed out, and all new public servants have been put on private sector-type schemes for quite some time. This still leaves a lot of serving public servants eligible for a percentage of their final salary on retirement, but the government set up the "Future Fund" to cover this.

As for the non-public servants, compulsory employer contributions of 9% of salary into staff superannuation accounts should leave most with livable retirement income.

[Francesca R]

Originally Posted by andyandy

Goodness knows how the state goes about backing out of pension provision though - it'd topple any government.

Governments can back out; it's companies constrained by the law that can't. Governments tend not to back out quickly enough, but planned increases in state pension entitlement age are a form of backing out. So was the switch from average earnings indexation to inflation (which is lower) in the UK (although the Tories have promised to reverse that, which will probably be a mistake)

[mhaze]

What is the right question to ask?

It seems to me that would be not, are various compensatory mechanisms going to be put into place to stop or slow down exploding pension fund costs and liabilities - of course they will be.

But is the offloading or uploading of some large fraction of these liabilities to the respective governments going to cause yet another huge cranking up of the printing presses?

[JJM 777]

Originally Posted by andyandy

how big a problem does the pensions time bomb pose in the next 20-50years? What can be done about it?

Option 1) Import more work force from the Third World.

Option 2) A Socialist revolution will wipe the problem off the table: the average standard of living of population will be whatever it will be, and that is certainly enough, no matter what.

[Alt+F4]

Originally Posted by Newtons Bit

Of course, not that's why I said "some of us". There are those of us in the West that were raised to live within our means. I saved almost half of my total salary (not take-home pay) of the first three-years I was employed and bought a house with 20% down. And I made slightly less than the national average income during those three years.

It's simple to do: don't buy you don't need. I shudder to think what would happen if the common man stopped doing that, though. Our economy would collapse. Perhaps afterwards we could build one that's based on a more responsible foundation.

Many people who are financial responsible get hit with things like: aging parents, disabled children, spouses with cancer, unemployment due to downsizing, and a thousand other expensive, uncontrollable circumstances that can wipe them out financially through no fault of their own.

[commandlinegamer]

Originally Posted by Newtons Bit

It's simple to do: don't buy you don't need. I shudder to think what would happen if the common man stopped doing that, though. Our economy would collapse. Perhaps afterwards we could build one that's based on a more responsible foundation.

Isn't this the very essence of supply-side economics, so beloved of Thatcher et al? Produce as much as you can, then manipulate the poor sods into buying it. As much as I love the Eighties' fashion, music, movies, I say bugger the economics of that time (which of course we're still living with today).