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Pyramid Schemes and Pension Plans

October 4, 2014
borrowing for infrastructure, debt funding, economy, innovation, Leadership, local government, planning, politics, Responsibility, Revenues, sanitary sewer, sustainability, Uncategorized, utilities, Water Funding
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A Ponzi scheme is an illegal program whereby investors are promised big return son investments in a short period of time, and where the underlying basis for this return is deliberately mis-stated.  We continually find people who perpetrate Ponzi schemes and when they are finally caught, they get put in jail.  For those unsure, a Ponzi scheme is defined as a scheme where the scheme operator says they will pay a high return to its investors from their original investment, but instead uses money from new capital paid to the operator by new investors rather than from profit earned by the operator.  Hence it is a flow through of money from people putting money in to people who are getting out.  To get returns on the investments for the earlier investors, the pool of new people must increase with time, so that there are always more people paying in that there were previously.  It that does not occur, then we have a problem.

What is a retirement system?  A retirement system is a form of deferred compensation used to attract and keep workers, by deferring a portion of their pay 10, 20 30 or 40 years from now.  It is part of the compensation to the employee.  With a retirement system, people pay into a program, where their money is invested.  A retirement system tends to rely on the fact that the number of people paying in increases exponentially so that the actual invested dollars are never touched, instead the new proceeds exceed the monies paid out.  For a pension, plan it assumes your invested dollars remain invested and profitable, and that the revenues from the new people in the system, exceed the monies paid to retirees.  What is the difference?  Well, the retirement system actually supposedly has assets while Ponzi scheme does not.  Otherwise, the systems work similarly – dollars paid in generally go out to others, and there is an assumption that the number or payees increases exponentially (a percentage every year).

So what happens to a pension plan when the number of employees decreases from 6.7 million to 4.4 million over 40 years?  Would you expect there to be a pension plan problem?  And if so why?  And who is at fault?  That is exactly what has happened to federal government employees since 1967.  And many states have seen reductions in the last 20 years as well.  So it is any wonder why these pension systems might be at risk?  The push to privatize services ensures that the basic assumption that the number of payees in a pension plan increases exponentially will be violated, which makes the pension plan vulnerable.  And ho is at fault.  I would suggest the people pushing privatization, who look only at short term consequences as opposed to long-term impacts.  Perhaps this needs to be part of any such discussion going forward.  Just a thought…

Are Pensions Really Broke?

May 28, 2013
funding, Leadership, management, Uncategorized
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Are Pensions Really Broke?

Nearly 10 years ago it was predicted that the water industry would experience a large exodus of experienced workers.  It did not happen; likely it was only delayed by the 2008 financial crisis.  If that is the case, will there be an acceleration of retirements in the next few years?  If so, what are the plans the plans for knowledge capture? GIS, work orders, MMIS, and other programs will help, but capture is important as the next “generation” of employees will not have the advantage of years of experience in finding valves, and pipes, etc.  We need to plan ahead for the knowledge capture issue, develop training for newer employees and figure a means to access lost knowledge in the future.  Capture is a big issue, but what we hear more of is the potential for a drain on our resources for funding these retirements?  The news is full of stories of dire consequences of retirement defaults coming for the public sector.  Keep in mind many utilities are publically owned and these employees are part of the public retirement systems.  Is this real or a political position for another agenda?  Do we need to be worried?

Interestingly it depends on whether you were looking before 2008 or after.  This picture was very different.  Even in my state of Florida, the pension system was fully funded before 2008, dropped just after, but has returned to near full funding as a result of the improvement in investment returns.  Most of these systems rely on investment returns so changes can cause the system solvency to change rapidly over short periods of time.  Looking only at a short instant in time belies the long-term truth and  it is the longer view we need to look at.  Good thing Wall Street normally goes up, but the impact of poor investment strategies by a limited few (2008) has significant impacts across society in everyone’s pension programs.  Look at all the 401k programs – those incurred crushing blows just as pension programs did.  So yes there may be problems, but many of these pension systems are not nearly as strapped as you would be led to believe in part because they have always relied on people continuing to pay into the system.  Hence they always have cash flow, unlike personal accounts.

The long-term view or the impact on personal accounts doesn’t faze the “fixers” who have many ideas to “fix” the pension problem.  One of the concepts championed is to change enrollment to a 401k vs a fixed benefit system.  Another camp suggests privatizing.  But both radically change the long-term solvency of vested employees and here’s why.  Under the current concept for public retirement systems, your employer and often you, pay matching amounts into the system.  According to a study done some years back in Florida, over 80% of people who get public sector jobs do not stay long enough to become vested in the system.  That means that while they get their contributions back, the retirement system keeps the match, reducing long term costs to the public.  All full time employees pay into the system. Retirement systems rely on cash flow from current employees for payouts to retirees, thereby protecting the invested funds and allowing the system to “weather” periodic financial difficulties.  That’s why the system solvency will based on what is happening on the stock market.  The system is designed to grow at a given rate, so if you reduce the people paying in, you accelerate the use of invested dollars because the cash flow diminishes.  In many respects that is what happened to some of the industrial pension systems –automation and outsourcing jobs overseas cut down the payees so much that the pension system could not sustain itself.  So it’s relatively easy to demonstrate that both cutting jobs through privatizing and 401k type programs accelerate the crisis and will create future burdens on the taxpaying public.  These two solutions sound great, but are simply unsound.

There are other ways to mess up retirement systems.  The federal workforce has decreased from 6.6 million in the late 1960s to 4.5 million today.  Clearly the reduction in employees contributing will have an impact on significant federal pensions.  Florida and many other states, with the windfalls on the late 1990s, reduced vesting from 10 years to 5 or 6.  That means that a greater percent of people will become vested, which means more future obligations.  That’s not a solution for solvency.  Florida’s legislature changed the contributions from only the government entity paying (a total of 10.4%) and required employees to contribute.  The employee match is their money and they get it back with interest, meaning only 7./4% remains in the system.  If experience with social security and other states is an indication, both shares will have to increase so that their combined total will be in the 13-14% range.  How did hat save anyone money?

So what’s the solution?  Two things.  First, the initial way these pension plans were set up were actuarially sound.  They should be revisited for contribution amounts, vesting period and expected return rates on investments (one of social security’s issues is that they own so many Treasury bonds that pay under 2% that it is hard to get a valuable rate of return).  This is a project for experts, not policians to consider and evaluate.  The big issue though is age for retirement. I know this is not popular, but let’s talk social security here as an example.   The text of the 1935 Social Security Act says that benefits were to be granted at age 65 (Section 202).  However the average age that people live to was 60 for men and 64 for women, meaning the average person NEVER collected social security.  Now it is 76 and 81, which means they collect for 12 to 15 years, tremendous difference in the obligations.  We all appreciate good medicine and most look forward to retirement, but keep in mind it comes with a price.  Since 50 is the new 30, we probably will all probably can be working longer.

Water and sewer workers like police and fire, are vital to thriving communities. So, let’s act with caution when looking at fiscal impacts that may come to utilities in the future. Since many of these folks have, and have worked hard to secure a retirement package, it will need to be funded.  But we must act judiciously when making changes to the current program.  Cut off payees – and ratepayers will make up the difference.  Change the type of program, and the potential for major losses occurs.