Pick Your Pension Poison?

Norma Cohen of the FT reports, Study sees end of road for final salary pensions:

Britain's largest employers shut down pension schemes at such a rapid rate over the past year that if the current pace continues, traditional final salary pension benefits will soon become a thing of the past, a new study has concluded.

The report, to be published today by Pension Capital Strategies and JPMorgan Cazenove, looked at pension disclosures for FTSE 100 companies as at March 31.

It found that total service cost - the cost of providing the current year's pension promises - had fallen by 15 per cent over the past year. The drop reflects a decline in the number of workers who are earning final salary benefits.

At that rate, final salary pensions in the private sector will no longer be available within six years.

"The fact that a 15 per cent reduction in ongoing pension provision has come to light . . . is perhaps one of the clearest signs yet that we are coming to the end of the road for final salary schemes," said Charles Cowling, managing director at PCS.

Mr Cowling said that the trend was likely to increase pressure on government to close the gap both between private and public sector pension benefits as well as that between the sums pensioners are likely to earn and those that they will need to stay out of poverty.

Over the past year, employers have been doing the previously unthinkable; closing their pension scheme to existing workers. Such a step does not eliminate big deficits on its own but it allows any future contributions to be devoted to paying down shortfalls, cutting risks to plan sponsors.

Separately, the report also found employers racing to cut the investment risks in their pension schemes. The average scheme's weighting in bonds rose to 50 per cent, up from 40 per cent a year earlier and 34 per cent two years ago.

Mr Cowling noted that the shift is even more striking considering the strong rally in share prices over the past year that should have shifted the investment mix more towards equities.

In 2009, pension schemes suffered record deficits as equities markets fell and rates on government bonds - benchmarks by which liabilities are measured - fell sharply. The adverse market moves underscored the risks companies undertake by investing in assets that do not move in line with liabilities.

"This indicates that companies are realising that taking equity risk in a pension scheme does not deliver value for shareholders," Mr Cowling said.

The study also found there has been a significant rise in deficit funding, in spite of the profit and cash flow pressures in which companies find themselves.

Last year, deficit funding totalled £11.1bn, up from £4.4bn the year before, an increase of more than 150 per cent.

But there has also been an increase in the number of FTSE 100 companies where the size of the pension scheme now represents a material risk to the business. Nine have pension liabilities that are greater than their market capitalisation, and two of these, BT and British Airways, have liabilities that are more than three times their market capitalisation.

I am not surprised with the findings of this study. First, I have already discussed how private plans are reducing risk while public plans are increasing risk. I expect the gap between private and public pension plans will reach a boiling point in the next five to ten years. There will be a major backlash over guaranteed public sector pension plans which are backstopped by taxpayers.

And politicians all around he world are taking notice. I was skimming through articles on Jack Dean's wonderful site, Pension Tsunami, and ran across an article by Monique Garcia of the Chicago Tribune, Pick your pension poison:

When lawmakers return to Springfield to finish the budget later this month, they'll be greeted by the same major holdup that caused them to head home in frustration last week — how to make a nearly $4 billion state worker pension payment.

All of the options on the table remain unpalatable. They could borrow, but taxpayers would be stuck covering hundreds of millions in interest. They could skip, but the pension system would lose billions in investment. They could delay until after the election, but that only puts off the problem. Or they could cut the budget elsewhere, but that's unlikely given the size of the payment.

"The pension is a big chunk of the overall budget," said Christopher Mooney, a political studies professor at the University of Illinois at Springfield. "That's why it's so attractive to get rid of it, to borrow, to not pay it. Suddenly, 'Wow, our budget situation looks much better.' But all those are stopgap measures; nothing that has come close to passing or even really being seriously considered is going to be a long-term fix."

Here's a closer look at the General Assembly's options:

Borrowing. Gov. Pat Quinn wants to borrow to cover the pension payment. It's what lawmakers did last year. But it also carries a high price.

Last year's pension loan will cost $330 million in interest over five years. This year, another pension loan would cost about $1 billion in interest over eight years, according to Quinn's budget office. But that's only if the state can secure an interest rate of around 4.5 percent, which some say might be too optimistic given the state's shaky financial footing.

Still, Quinn budget director David Vaught said that's the best route to go to make sure a pension payment happens. And Quinn has made it clear he will fight for the borrowing measure he says is needed to free up money to prevent cuts to education and elsewhere.

"The governor believes that lawmakers should step up to the plate here on this one," Vaught said.

But Republicans have balked this time, a situation Quinn blames on his Republican rival for governor, Sen. Bill Brady, who says borrowing more would only add to the state's money woes. But Brady said he didn't need to convince his GOP colleagues that piling up debt is a bad idea.

"If (Quinn) wants to give me credit for killing his efforts to dig a deeper hole, I'll take it, but it's not necessary," Brady said. "Clearly, Gov. Quinn's failed policies of borrowing on the backs of our children are creating not only a record deficit of debt but also a poor job economy."

Skipping. Another option is to skip the payment altogether next year. That would result in billions in lost investment earnings for what is the most underfunded pension system in the nation. Some estimates put long-term losses as high as $37 billion.

The retirement systems are fighting back against that idea, which they say could drain pension funds faster than anticipated, though current beneficiaries will still receive their monthly checks without interruption.

Dan Long, executive director of the nonpartisan Commission on Government Forecasting and Accountability, warns that failing to make this year's payment would undermine recent highly touted pension changes aimed at saving billions in the coming decades by increasing the retirement age and reducing benefits.

"If you skip a payment, you lose the benefits of the pension reforms just made," Long said.

Cutting. This already has been tried, and it failed. House Speaker Michael Madigan, D-Chicago, perhaps to prove the point, called for a vote on a bill to cut nearly $4 billion. Ninety-nine of the 118 House members opposed it.

Delaying. Yet another possibility is that lawmakers delay the pension payment for six months, until after the November election. By then, voters will have picked a governor, and it would be up to the chief executive sworn in Jan. 10 to deal with the problem.

Rep. Frank Mautino, D-Spring Valley, predicts this is the path lawmakers will most likely take because there isn't enough support for borrowing. But he notes the state isn't likely to have any additional cash on hand in January, which means the pension payment problem will persist.

"It's the stark reality we have to face," Mautino said.

If Quinn is still governor, that could mean finally winning approval for the major income tax hike he's been pushing for more than a year. If Brady is governor, he said he would cut the budget and only borrow if the state's economic situation improves. But Brady would likely need support from Democratic lawmakers to make his plan stick.

"Buying time until after the election is a cynical ploy," Mooney said. "Somebody's going to have a problem."

What's going on in Illinois isn't unique. We are already seeing politicians from other states and countries picking their pension poison. They simply can't afford to delay tough political decisions. In this environment, if they don't pick their pension poison carefully, they risk killing their chances for reelection.

More worrisome, taxpayers risk being on the hook as public pension deficits balloon out of control. This is something which should concern us all because it will directly impact our future prosperity. It will also place an enormous burden on an already overstretched private sector which is increasingly called upon to support public sector pensions while their own pensions have reached the end of the road. Something has got to give as this situation is untenable.