Pension Funding Issues ... Private Sector Profits are the Only Viable Solution

Let's look at two different situations --- one private and one public --- concerning pension underfunding and how different organizations are attempting to fully fund and then limit their future liabilities.

First up is GM Retirees to Decide on Pension Buyout:

"General Motors  will know Friday how many of its U.S. salaried retirees will take a pension buyout offer aimed at reducing the auto maker's massive retiree obligations.

GM, as part of a plan to overhaul its underfunded pension system, is giving 42,000 of its 118,000 salaried retirees the option of taking a one-time payment rather receiving monthly checks. Ford Motor is making a similar offer. . . .

It is part of a plan the auto maker disclosed last month aimed at reducing pension obligations by $26 billion by overhauling its U.S. pension plan for retired white-collar workers, cutting by nearly 20% the biggest drag on its balance sheet.

GM also signaled it could consider a similar reworking of its pension plan for U.S. union retirees, which is roughly twice the size of the salaried-worker plan.

The pension obligations are a drag on the Detroit auto maker because they rise and fall on such factors as interest rates and the life expectancy of pensioners. GM's $134 billion in global pension obligations, which face a $25 billion shortfall, have long been a concern of investors and debt-ratings firms.

GM said it would hand over all assets and obligations of its salaried retiree pension program and management responsibility to Prudential Financial through the purchase of a group annuity contract. Prudential could begin making pension payments starting next year. GM said retirees' payments won't change. But the Prudential benefits won't be backed by the Pension Benefit Guaranty Corporation, a fact that has angered many retirees.

GM, by year-end, will have eliminated traditional pension plans for all current salaried employees. Newly hired hourly workers already receive a 401(k), though veteran factory workers still get a traditional pension.

GM faces pressure from investors to address the $71 billion in obligations to union-represented factory workers. That plan is underfunded by $10 billion.

Over the last decade, many companies' pension liabilities have grown at a faster pace than the businesses themselves, and the value of their pension assets has also failed to keep up, forcing firms to take steps to address their pension exposures.

GM said it would spend roughly $29 billion to get Prudential to take over $26 billion in pension obligations. GM estimates the pension buyouts will cost around $3 billion."

{NOTE: Ask yourself where the $29 billion in cash originated. HINT: GM received a government bailout recently. But let's move along now.}

Beyond GM and the private sector, there's the issue of investment returns for public sector pension funds generally. Expect More Lousy Public Pension Returns has this to say about the larger issue:

"After the California Public Employees’ Retirement System this week reported a measly 1.0% return on its portfolio last year, Fitch Ratings tells investors to get used to the idea of lousy pension-fund returns.

“Given the disappointing market performance for the year that ended June 30, the fiscal year end, and actuarial valuation date for many major public employee retirement systems, Fitch expects numerous systems to report similarly disappointing returns,” Fitch says in a note Wednesday. “This is likely to further pressure pension systems’ funded ratios and lead to higher annual contributions for state and local governments.”

Most major statewide public employee retirement systems have historically relied on investment return assumptions averaging 8%, a level that Fitch calls “optimistic.” During the two decades prior to the 2008 recession, actual market performance often exceeded such 8% assumptions. But massive losses incurred in 2008 and 2009, and uneven returns in the years since then, have resulted in ongoing, often sizable year-to-year declines in funded ratios for pensions.

Fitch says many pension systems are still absorbing the losses of 2008-2009 in their actuarial funded ratios, and now the disappointing returns for fiscal 2012 will further weigh down funded ratios and pressure annual contributions. More from Fitch:

It is important to note that numerous pension systems have taken steps toward reforming their pensions, including by lowering their investment return assumptions. (CalPERS is one such system, having lowered its assumption to 7.50%, from 7.75%, earlier this year.) Continued weak performance of pensions’ investment portfolios is likely to underscore the need for additional changes to benefits, contribution policies, and assumptions including the investment return assumption. Fitch believes such actions, even if they result in lower funded ratios in the near term, ultimately improve the sustainability of pensions."

Discussion

If pension funds earn 8% on investments, then pensions may be affordable. However, they have only earned about 1% the past several years while assuming average annual rates of return of 8% or higher. That's GM's case. Thus, GM will buy annuities for retirees and rid itself of future investment responsibility for affording pension payments to its salaried retirees.

In the public sector, however, many plans haven't been properly funded, leaving aside the meager investment returns of the past decade. Thus, they've earned no money and invested no money. To "catch up" with GM, these public sector funds would have to make up for absent contributions this last decade or so. But doing that would only put them behind the same 8-ball where GM finds itself today as a result of poor investment results the past ten years or so.

Questions ... Who Makes the Payments and How?

Here's the question: Where did GM come up with the $29 billion to buy an annuity for its salaried retirees? And here's the answer: For all practical purposes, from the government bailout, of course.

Here's another question: But where would government get a few trillion dollars to purchase annuities to fully fund its public sector pension obligations? And here's the answer: Only from the taxpayers, of course.

That's the mess we're in as a nation with respect to our underfunded pension obligations.

Organizations, both private companies and governments alike, simply can't afford to take the risk of funding guaranteed pension benefits indefinitely while achieving only minimal investment returns on their pension funds.

The Only Viable Solution

And the private sector's prosperity is the only realistic way to fund these obligations--both private and public sector alike--in coming decades. It's all about private sector growth and profitability. And it's the exact same solution for how to get people back to work.

Government has no answers to the pension funding shortfall and neither does the above referenced Pension Benefit Guaranty Corporation (PBGC), a government agency funded in total by the private sector.

So let's quit playing silly government shell games and get serious about encouraging the private sector to lead the nation back to solid and sustainable economic growth and economic prosperity. Otherwise we're just kidding ourselves, and it's definitely no kidding matter.

Not for current workers and not for retirees of either the private or public sector.

And certainly not for We the People as citizen taxpayers.

Thanks. Bob.