Guest Post: Work Till You Drop?

Submitted by Leo Kolivakis, publisher of Pension Pulse.

Sydney Freedberg and Connie Humburg report that Florida stands to lose $1 billion because of Lehman Brother’s bankruptcy:

A price tag is now emerging for what last year’s collapse of investment giant Lehman Brothers could cost the state of Florida: more than $1 billion.

The losses could make Florida and its citizens among the biggest casualties in the biggest bankruptcy ever.

More than $440 million disappeared from the pension fund that pays benefits for some 1 million retirees and public employees.

Counties, cities and school districts face a loss of more than $300 million for roads, sewers and schools.

The state has $290 million less to pay for everything from hurricane claims to health care, community colleges and care for infants with disabilities.

While the general losses have been expected, this is the first public accounting of the magnitude of the Lehman-related public losses for Florida.

The outlook is bleak in bankruptcy court. In years to come, the state will be lucky to collect pennies on the dollar.

In an interview, even the ever-optimistic Gov. Charlie Crist could not muster a sunny side: “It is, to say the least, an unfortunate situation.”

Florida can kiss that money goodbye. By the time the lawyers get their cut, they will be fighting over scraps. How many other pension funds lost huge sums when Lehman went bankrupt?

Howard Silverblatt writes in BusinessWeek, PENSIONS: Work Till You Drop – If You Have A Job (thanks to Jack Dean for posting this on Pension Tsunami):

I’ll start with the bottom line – pensions are severely underfunded and they aren’t getting better fast. Last year the S&P 500 was $63 billion overfunded, with companies making only minor contributions, shrugging off the Q4,’07 3% equity loss and projecting an 8% 2008 pension gain.

The reality of the market however was devastation: a 37% loss for 2008 produced a 43% gap between what was expected and what was delivered. Funding went from $63 billion overfunded to $308 billion underfunded – a $372 billion turnaround in just one year. As a group, the S&P 500 went from 4% over funded to 22% underfunded. Only 21 issues were fully funded, with 29 between 90% and full, 54 between 80% and 90%, and 231 falling below the 80% mark. By comparison, at the end of 1999, when the market was 56% higher, 296 issues were fully funded.

As 2008 came to an end corporations were faced with the potential of large cash infusions into their pension funds. With their 2009 expectation of low profits and concern over cash flow, they lobbied and received an executive order suspending the phased-in funding requirements from the Pension Reform Act of 2006 for one year. The result was that many companies were not required to shore up their funds after the massive market declines – basically doubling the bet on 2009.

Companies reacted to the decline by pulling money out of equities and into fixed income. The concept was safety, and the result will add some stability to the portfolios, but it will also reduce the overall returns, since over time equities do better than fixed income.

[Note: Read my last comment on big money suffering performance anxiety.]

Given the change, the slight drop in expected pension returns to 7.95% from last years 8.02% should actually be interpreted as a bullish statement by funds, and appears to imply that they expect a double-digit bounce back in the market. We suspect that there has already been a shift back to equities as the market has moved up, and that portfolios will experience more of a turnover this year.

So where does that leave us going forward – I have three sets of projection for 2009, none to them good. Remember that we are starting from a $308 billion deficit.

At this point in time, given the belief that (i) rates may slightly increase, (ii) that fixed income portfolios are properly positioned not to incur losses due to rate changes, (iii) a more normalized yield curve of utilized maturities and (iv) the hope that equity markets could prosper with a double-digit gain, it remains mathematically difficult to extrapolate an S&P 500 pension fund that will be anywhere near fully funded by year-end 2009. Given that I again expect to see calls for another postponement of scheduled funding in Washington later this year.

My current baseline estimate calls for pensions to remain at the current level of funding, ending 2009 at $313 billion underfunded. My optimistic estimate, based on an S&P 500 level of 1100, which is still 25% below 2007’s close and interest rates 50-75 bps higher across utilized maturities, calculates out to a pension improvement, but underfunding remains solidly in the red by $168 billion. My gloomy forecast, based on a return to the March 2009 low of 676, combined with slightly lower interest rates, increases the underfunding to $496 billion – half a trillion dollars.

As Americans live longer, the gap between existing benefits and personal wealth will widen. Directly or indirectly, the U.S. Government is the insurer of last resort, whether it is via the PBGC or as the medical provider via social or entitlement programs. Pensions and OPEB have become engulfed as a social and political issue, with the key questions being coverage, expense and how to pay for it. Eventually, the government, in conjunction with the private sector, will be forced to address the situation and take the necessary painful steps.

The concern is that neither the public nor the private sector has shown a tolerance for the pain associated with the type of action needed to address the problem. The longer the situation goes unaddressed or band-aided, the stronger the measures will have to be to solve the situation. In the end, individuals, either as taxpayers or consumers, will need to pay the bill, as well as live with the reduction in benefits and lifestyle.

The full S&P 500 Pension and OPEB report, including a full listing of issues and data is available at our web site.

Mr. Silverblatt is absolutely correct. We are ignoring the pensions timebomb at our own peril. Unfortunately, for far too many people this means that they will have to work till they drop – if they still have a job.

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  1. JO

    Hi Leo, Agree with the post. Unfortunately, if I understand correctly so far, some of the early pension changes made by such parties as the Ontario Teachers, and changes being mentioned amount to increasing contributions by younger workers and cancelling pensions for new hires, in order to allow the generous pensions of current retirees to continue to be paid.

    This is particularly concerning to any non-retired working family or individual. The problem is serious and will set the showdown between the old and young. I, for one, do view the pension time bomb as tragic and needing a fix, but am disgusted with the early attempts to use taxpayer money (auto workers), take more from young workers (Teachers), and other ideas floating around that amount to the same so that a bunch of retirees on generous payouts can keep up a very comfortable lifestyle at the expense of the younger workers tyring to raise families and pay bills despite being taxed very high.

    This issue, more than any other, is what irks me and many I know. It is not right. Bottom line, a balance will need to be achieved. Those retired (past 5 yrs ?) on inflated benefits (many bring in 40-50K/year) will need to take a cut of sort, some taxpayer assistance will be needed, and pension managers will need to be held to account. The pain has to be spread to all parties, not only on the working young.


  2. Dee

    But Jo, that would require people would have to live within their means. (sarcasm) :)

    There has been a complacent attitude about pensions and with this latest euphoric crash/incident I believe more people are aware that their retirement years may not be so golden. My guess is they don't want cat food as the main staple of their diet in their golden years.

    I know a number of people who take lower paying jobs because the benefits/pensions make it worthwhile to do so. They enjoy the security it provides. Take that security away and people will pull back on their consumption. The mantra from the business/economic community 'how do we get people spending again' is, well, frustrating.

    Governments have been dodging the issue for years thinking that somehow it will disappear. My personal hope is that people will begin to question their quarterly statements and do their own research instead of relying on investment/pension managers. However, some people find the process too complicated and need a course in pension 101. They're too afraid to ask the right questions because they don't want to look like fools. That's where blogs like yours help.

    Keep up the good work Leo.


  3. scepticus

    An age-war is definitely brewing.

    Remember that boomers are by definition the crest of a huge demographic wave. The upside of this wave has stimulated the economy and asset prices throughout their entire lives.

    As they start to retire we see the downside of the same wave, which reveals that reality : recent prosperity has been the result of a population pyramid dividend rather than an actual increase in intrinsic wealth.

    The accumulated 'wealth' (in reality asset price inflation) cannot be sold to generation X at anythnig like it's face value, since there are less of generation X and they have less money.

    And what makes this time different is that there is no new demographic boom in the future to saves us – that is what the demographic transition is all about.

    I have always felt that the bubble of the last 20-30 years including the debt explosion has always been fundamentally driven by demographics.

  4. wmartin46

    While an interesting article, there are some fundamentals left out that might cause this article to be a bit misleading. What's missing is just how costly pensions have become to the corporations/governments offering them. Governments have seen wages just to significantly higher than the private sector, in many cases. When pensions are linked to these high salaries, the pension payouts can easily exceed the amount paid during an employees working years.

    It's not uncommon to see pensions start at $100K for public safety personnel. So consider:


    Pension: $100K
    10-Years: $1.1M
    20-Years: $2.7M
    30-Years: $4.9M

    Pension: $150K
    10-Years: $1.8M
    20-Years: $4.3M
    30-Years: $7.6M

    Pension: $200K
    10-Years: $2.5M
    20-Years: $5.9M
    30-Years: $10.5M

    While the author may argue that current pension funds are underfunded–when the next generation of retirees start drawing from the pension funds–then these funds will be very underfunded. Currently, CalPERS enrolled members average about $22K per retiree. However, with California cities (like Vallejo) paying public safety personnel salaries that often exceed $100K (salaries which seem to double every 10-12 years), then it's not hard to see penions in the $100K-$200K becoming the norm here in California in the next 10-20 years.

    The alternative is to recognize that the US can not afford to pay people in their retirement years more than they made when they were working. In short, the whole pension idea has to be rethought from the ground up and the top down.

  5. Aki_Izayoi

    I'd categorize this in "free markets and their discontents."

    I do not think more people in the form a demographic boom will help. We need an advancement in technology.

  6. Tortoise

    I agree with wmartin46. Pension commitments (or should I just call them mere promises) are sky high. When a person retires at a certain age and is promised a pension of R dollars per year, one can make an actuarial computation of what the present value of this commitment is, which is c times R, where c depends on age interest rates, adjustment for inflation or not, etc. (It is, about, the lump sum a private company would get to promise the same pension.)

    For example, say that Overvalued, a municipality in California, promises a 200K per year pension to Joe Goodposition. Joe retires at 65. It is like on the day of his retirement, the City of Overvalued forks out 2.8M dollars to Joe, assuming that c=14. That is how IT SHOULD BE COMPUTED.

    Of course, pension overcommitments is a global phenomenon and I am not sure how it will be resolved. It is definitely a problem much bigger than the Social Security shortfall. State governments in the US and foreign governments have a huge problem.

  7. orguy

    Well, maybe. But the "optimistic" approach in the article might be insufficiently optimistic. Given all the Keynesian pump priming going on, what happens to the pension deficit if the S&P 500 goes to 1200? To 1300? To 1400? That said, I agree the pension benefits for many public workers (and some private workers) are ridiculously generous.

  8. Tortoise

    There are two separate issues.

    Number 1: Due to volatility of market values, the apparent degree or over- or under-funding can change a lot within a full economic cycle.

    Number 2: Have too much been promised?

    I think that issue 2 is the important one. One should try to evaluate the degree or under-funding using an average of asset prices and obligations, say from 2002 to 2009. Leo, can you do that?

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