Problems with Pensions

An article by New York Institute of Finance pensions instructor Larry Morgan.

Odds and ends that have come to attention in recent days:

(1)  The funding status of both public and private defined benefit (DB) pension plans has improved in 2013 because of favorable market action.  Primarily this is because of the very strong performance of equities prices.  The stock rally in the U.S. and elsewhere, which has been astonishing because it has gone far beyond the mediocre economic growth rate, has greatly increased the value of assets in pension plans.  

According to a Bloomberg report on 6 August U.S. public plans saw a 12.4% gain in portfolio values for the last 12 months and an 11.4% per annum gain for the last three years. Reportedly this has benefited public plans more than private plans since the public plans have allocated a larger portion of their assets to equities (45% the article says, citing Wilshire Associates data). Wilshire reported that corporate plans saw a 10.1% median return for fiscal 2013, foundations and endowments 11.3%. 

(2)  Rising bond yields have also helped the funding status of the plans, but from the liability side of their balance sheets.  DB plans use bond yields in some form to discount future pension liabilities, so higher bond yields mean heavier discounting and a lower present value of liabilities.  Mercer reported that the aggregate funding gap for S&P 1500 corporations actually declined during July by $10 billion to $212 billion, producing an average funding ratio of 89%.  According to Mercer, since the beginning of 2013 the rise in yields reduced the present value of liabilities by $160 billion while the value of assets increased by $170 billion.

(3)  The CIA – not that CIA, but the Canadian Institute of Actuaries – has just issued a draft set of new mortality tables for Canada, based on the experience of Canadian pension funds, that estimates impressive increases in the expected lifespan of Canadian men and women. The authors of the study calculate that a 60-year old man can expect to live 27.3 years more (the previous estimate was 24.4 years – an increase of 2.9 years); a 60-year old woman 29.4 years (previously 26.7 years, a 2.7year increase).  (I haven’t seen a similar report for the United States.)

As I discussed in the June edition of this blog, increasing longevity presents a problem for pension funds, particularly DB funds, since they will have to provide benefits to retirees for a longer time than they have been planning and the estimate of more beneficiaries in future years and  longer lives in retirement will increase plan liabilities.  This in turn will require adjustments:  larger contributions by the plan sponsors (implying lower profits for corporations and maybe lower share valuations) or by current workers (which could also lead to wage disputes), reduction in benefits, retirement at a later age than workers had planned on or hoped for, etc. The authors of this study figured that this new information may increase pension liabilities by 5% to 10% -- a substantial impact.

This has implications for defined contribution (DC) plan participants, also.  Workers may have to work longer, as mentioned, and would almost certainly have to make larger contributions to their retirement fund. That could be larger contributions from their employers, also, if they match employee contributions to some degree.

Parenthetically, this general tendency to greater longevity is one factor in a growing trend for companies to convert DB plans to DC plans. This will be the topic of the September blog.

(4)  I would be remiss not to make some mention of the Chapter 9 bankruptcy filing by Detroit.  As has been widely reported, of the total Detroit long-term debts of $18.2 billion, $9.2 billion is unfunded retirement benefits. Many other American states and cities face similar, if less severe, problems, which have been known and fretted about for a long time.  But outright bankruptcy in a major metropolis and how that will be resolved pushes this crisis – I don’t think that is too strong a word – to the forefront of public discourse.  It even became the cover story in The Economist two weeks ago (“The Unsteady States of America “ July 27th – August 3rd).  The pure financial aspects of this are relatively straightforward, but the political and social aspects are difficult, perhaps intractable.  And now even more unavoidable.   

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