When US Pensions Run Out of Money?

Katie Lobosco of CNN reports, What happens when your pension fund runs out of money:

Harry Van Alstyne and his wife Susan used to go out to dinner every Saturday night — until his pension was cut by 29% last October.

Now, they're thinking about selling their home and skipping their annual trip to Maine. They've already dipped into their savings.

This is not the retirement they planned for. After working for 30 years as a truck driver for UPS, Van Alstyne was promised $5,141 a month by the The New York State Teamsters Conference Pension and Retirement Fund.

"I hated the job from day one, but I stayed with it because I was promised a secure pension," said Van Alstyne, now 64.

When he retired in 2006, he was receiving his full pension. But the fund was hit hard during the financial crisis and never fully recovered. A 2016 report projected it would run out of money as soon as 2026.

To save it from going bust, the fund cut current retirees' benefits last year by 29%.

Van Alstyne's pension fell to $3,650 a month.

He is one of the first Americans whose pension benefit was cut after retiring.

Until now, cash-strapped plans have survived by reducing future retirees' benefits and asking employers to contribute more money.

Most at-risk funds are private multi-employer pension funds like Van Alstyne's that were negotiated by unions. These funds had a harder time bouncing back after the recession because many of their workers were part of declining industries, like manufacturing.

Some struggling employers have negotiated ways to exit the plans, or they went bankrupt, leaving remaining employers to cover unfunded liabilities.

"Understandably, the remaining employers left holding the bag haven't always been willing or able to pick up the slack," said JP Aubry, director of state and local research at the Center for Retirement Research at Boston College.

Currently, $76 billion is needed to shore up the multi-employer funds on the brink of insolvency, according to a report Aubry co-authored.

To help alleviate the problem, employers have put in more money and current workers have agreed to future cuts. A law passed by Congress in 2014 allowed some funds to reduce benefits for current retirees for the first time.

But it still hasn't been enough to make up for the shortfall for some of the funds.

Just four multi-employer pension funds have cut benefits to date, including the New York Teamsters. Some benefit reduction plans were rejected because the government found that they didn't go far enough to save the fund.

"Whatever you think of the law, it's not cutting it. There has to be another solution," Aubry said.

The question is: Who is going to pay for it?

Some proposals call for the government to provide struggling plans with subsidized loans. A bipartisan Congressional committee has been formed and charged with coming up with a plan by November.

Meanwhile, Van Alstyne and other Teamsters remain hopeful new legislation will reverse their cuts.

"When my wife and I were young and just starting out, we struggled to make a good life for ourselves. I was proud of what we accomplished. Now that we have retired, we are right back where we started — but this time we are struggling to keep what we worked so hard to achieve," he said.

I feel for Mr. Van Alstyne and his wife. He worked 30 years as a truck driver for UPS and they both thought they could count on his Teamsters pension which was a little over $5,000 a month, no small chunk of change by any pension standard.

But the 2008 financial crisis exposed how poorly governed all these US multi-employer pension funds were and in October 2015, Teamsters' Pension Fund told its members to prepare for big cuts.

I covered all of this, nothing new to me, the Teamsters' Pension Fund and other multi-employer pension funds were a disaster waiting to happen.

And look how important timing is. My mother's uncle left Greece at a relatively young age and worked as a truck driver in the US for many years. He and his wife returned to Greece during their golden years and enjoyed a great retirement based on his secure pension. They didn't live through a Great Depression or 2008 financial crisis during these years. They were lucky, his pension was never cut.

This I why I have been a vocal supporter of enhancing the Canada Pension Plan and think US Social Security needs to adopt the same governance and independent asset management model as we have in Canada. Despite the naysayers, CPP is a great deal for Canadians.

US multi-employer pension plans are a disaster. And the solutions to their problems range from cuts to benefits to the nuclear option, the Mother of US pension bailouts which I discussed last November. I'm serious, the US pension system has gotten so bad, Congress is actually planning for its failure.

But truth be told, the problem with all these pension plans is they weren't conceived properly to begin with and they definitely weren't managed properly. Unions promised their members generous pensions they knew were unsustainable and they did a lousy job managing these pensions, doling out huge fees to Wall Street sharks which delivered mediocre long-term results.

My best advice to Teamsters' Pension Fund is to contact OPTrust's CEO Hugh O"Reilly and ask him about their innovative new pension initiative. Unfortunately, this isn't available to US members yet but if it was, I'd tell Teamsters worried about their pension to JUMP on it! (alternatively, the time for Amazon Pensions has come!!).

The underlying problem with all these US multi-employer pension funds is lack of governance and until you tackle this and introduce some form of a shared risk model, these pensions will only get worse. You can throw all the money in the world at this problem but if you don't address governance and shared risk, they're all going to run out of money one day.

By the way, this is an important lesson for all of you who think your defined-benefit pension is safe and secure. Even if your pension is managed by Ontario Teachers', HOOPP, OPTrust and other fully-funded pensions, I want you to cut your debt and save your money for your golden years because there are no guarantees.

This is especially true if you're getting ready to collect a pension from a US mutli-employer plan or even a public pension from Illinois, Kentucky and other American pension shitholes.

I've been warning all of you, there is a huge storm headed our way, and I'm not talking about Stormy Daniels and Donald Trump. That's an ongoing farce compared to the storm I'm worried about.

"Oh Leo, stop being such a melodramatic pessimist! The world is beautiful, the National Association of State Retirement Administrators has addressed the big myth of America's pension crisis."

Well, all I can say is maybe the situation isn't as dire as the naysayers claim but NASRA is still smoking some hopium if it thinks 7% or 8% is an achievable bogey going forward.

This morning, I listened to Warren Buffett, Charlie Munger and Bill Gates on CNBC. It was mostly a waste of time but I couldn't agree more with Bill Gates when he said the "risk-free nominal rate on the 10-year Treasury is hovering around 3% so in order to attain 8%, these public pensions are going to need to take on a lot more risk".

Of course, Gates didn't say it explicitly but I could tell he thinks the return assumptions at these US public pensions are still unrealistic and expose them to huge downside risks.

And remember what I keep telling you, pensions are all about managing assets and liabiities. Pensions' funded status are path dependent, when they're already chronically underfunded and taking on bigger and bigger risks to make up that shortfall, they expose their plans to big downside risks and if something goes wrong, they will never recover without taking drastic measures.

What are these drastic measures? Huge cuts in benefits, huge increases in the contribution rate, huge increases in property taxes and/ or a combination of all three.

"This can never happen in the USA". Open your eyes, it's already happening with multi-employer plans and we're one major financial crisis away from it happening at many US public pension plans that are already past the point of no return.

"Yeah but Leo, this is the US, not Greece, we can solve this problem easily by printing more money." True, the US isn't Greece where pensioners across the private and public sector took a massive  haircut, it can print the world's reserve currency and try to inflate its way out of mounting debts but that comes at a cost. More debt to pay pensions means less money to pay for other public services.

Lastly, since I'm discussing US pensions running out of money, I want to bring to your attention a comment Mark Miller of Reuters wrote, Low income shortens lives, putting Social Security in a bind:

Americans are all living longer, so it only makes sense to push back the eligibility age for Social Security - right?

Pushing back the age when workers can claim their full benefit may sound like the fair thing to do in a era of rising longevity - and it would help fix Social Security’s long-range financial imbalance.

But this easy-sounding fix masks two crucial problems. It makes a higher retirement age sound painless - when it actually would cut everyone’s benefits by moving back the goal posts on when you can claim full benefits. Just as important, a higher retirement age would be especially unfair to lower-income workers.

Average longevity has been rising in the United States, but all of the gains have been experienced in higher-income households. A number of studies have reached this conclusion in recent years - but now comes a report from the horse’s mouth, so to speak - the actuaries at the Social Security Administration.

By using mortality and earnings data from the agency’s massive database on American workers, this report confirms that lifetime earnings have a profound impact on longevity. The findings should help put the brakes on any proposal to solve Social Security’s long-range financial imbalance by lifting retirement ages.

The study examines five income segments (quintiles) using Average Indexed Monthly Earnings (AIME), a Social Security measure that averages your top 35 years of earnings when you reach age 60, indexed to reflect average wage growth in the economy. The SSA actuaries compared mortality (death rates) by sex and age. They found lower mortality (death rates) for retired worker beneficiaries with higher-than-average AIME levels, and higher death rates for retired-worker beneficiaries with lower-than-average AIME levels.

The differences are expressed as mortality ratios. An AIME mortality of 1.00 means death rates for a given group were equal to the group as a whole; ratios lower than that number indicate lower mortality, while higher numbers indicate - well, earlier curtains.

Just one example of how this plays out: in 2015, retired men age 62-64 in the highest income quintile had a ratio of 0.52, while those in the lowest income quintile had a ratio of 1.77. The comparable figures for women were not much different - 0.73 for the highest income quintile, and 1.54 for the lowest.

A BENEFIT CUT - NO MATTER WHEN YOU RETIRE

Yet rising longevity is cited routinely as a justification for raising the Social Security full retirement age (FRA). Consider, for example, the Republican-sponsored Social Security Reform Act of 2016. It repeatedly references rising longevity, and a cornerstone element would gradually raise the FRA to 69.

Two years might not sound like much - but recall that we already have raised the FRA as part of the last set of Social Security reforms, enacted in 1983. At the time, Social Security faced a real crisis, with the program due to run out of funds within 18 months. The 1983 reforms gradually raised the FRA from 65 to 67 for workers born in 1960 or later.

Make no mistake - a higher FRA is a benefit cut, no matter when you retire. To understand how that occurs, it is helpful to take a quick refresher on how the timing of your claim affects benefits.

To determine your benefit amount, the SSA starts by translating your AIME into something called the primary insurance amount (PIA). This is a weighted formula that gives a higher benefit relative to career earnings for a lower earner than for a high earner - a bit like income tax brackets. You receive 90 percent of AIME for the first segment (up to $895 for 2018), 32 percent for the second bracket (up to $5,397) and 15 percent for any amount of remaining AIME.

If you wait until the full retirement age (currently 66), you would receive 100 percent of PIA. If you start at 62 (the earliest opportunity), you will receive a reduced benefit for the rest of your life - 25 percent lower. By waiting until after full retirement age (66), you would get the delayed retirement credit, which is 8 percent for each 12-month period that you delay. The credits are available until age 70.

But raising the FRA reduces benefits no matter when you claim. How does this play out? A 2015 report by a group of policy experts for the National Academy of Sciences (NAS) expresses it simply: If we raised the FRA from 67 to 70, a worker claiming benefits at age 67 would receive 100 percent of PIA before the reform, but 80 percent afterward - in other words, it is a 20 percent benefit cut.

How about workers with higher mortality rates?

The NAS study examined the impact of the changing gap in life expectancy by income over time, comparing workers born in 1930 and 1960. The researchers found that raising the FRA to 70 would fall disproportionately on lower-income workers. For men born in 1930, lifetime benefits would fall by 25 percent ($31,000) for the lowest-income workers, and 22 percent for the highest-income group ($50,000).

One solution is to revise the Social Security bend points to restore lost benefits to lower-income workers. But whatever solutions are considered should push beyond all the loose talk about averages.

I asked two of Canada's best (now retired) actuaries to give me their thoughts on this article. Bernard Dussault, Canada's former Chief Actuary, shared this with me:

Actuaries have for a long time been well aware of the longer longevity of higher income people (and vice versa). However, that inequity could well, and possibly should, be addressed in a national pension scheme by reducing lower income contributors' contributions or increasing their benefit amount, which should provide reasonable legitimacy to any longevity increase-related increase in the full retirement age (FRA), i.e. retirement pension commencement age at which benefits are not reduced or increased.

And Malcolm Hamilton who worked as a senior actuary at Mercer before retiring shared this:

As Bernard says, the fact that low income workers have shorter life expectancies has been known since I was a child - probably longer.

What, if anything, can or should be done about this?

The fact that there is a link between low income and high mortality does not mean that one causes the other. When I studied statistics 50 years ago the professor pointed to a link between the incidence of drowning and the consumption of ice cream. Both increase in the summer. Warm weather influences both the incidence of drowning and the consumption of ice cream, but neither causes the other.

There are many behaviors that correlate with both income and poor mortality - smoking for example, although less so now that smoking has become so expensive. Should smokers get a better deal? Maybe, but don't hold your breath!

Defined benefit pension plans tolerate many inequities. Women live longer than men. Everyone knows this. No one suggests that men should have larger pensions or smaller contributions due to their shorter life expectancies. Would we feel differently if men lived longer than women? Probably, but not for any good reason.

The author makes one point that is very important. Increasing the age at which unreduced pensions are payable (the eligibility age) is simply a way to cut benefits without admitting that this is what we have done. Governments love increasing eligibility ages and blaming the public for living so long. In fact, Social Security programs have long made provision for mortality improvement in their projections. Consequently, they can be sustained without dramatic contribution increases or benefit reductions. The reason that governments want to increase eligibility ages is not the rising cost of public pensions, it is the loss of tax revenue when well-paid employees become less-well-paid pensioners. Governments can afford to let citizens retire, but perhaps they cannot afford to let them stop working as population aging ratchets up the cost of medical care.

Understandably, governments don't want to admit this.

Great insights from two of Canada's best actuaries. I did however mention to Malcolm that while women live longer than men, they definitely (on average) receive less pension benefits over their lifetime for all sorts of reasons, chief among them, they still don't get equal pay for equal work (here I mean equal responsibilities).

Below, Berkshire Hathaway CEO Warren Buffett, Vice Chairman Charlie Munger and Microsoft Co-Founder Bill Gates speak to CNBC's Becky Quick about some of their personal investments.

Listen to what Gates says about what he expects in terms of returns, he's spot on (update: sorry, CNBC didn’t provide the beginning where Gates talked about what investors can expect in terms of returns).