Monday, March 9, 2009

Pensions - Past Their Prime

One thing that should be a clear to everyone tracking the current financial crisis is the new pension reality: Pensions as currently structured are completely unworkable in a global economy that is powered by the private sector.

This applies both to government pensions and benefits and to private sector pensions.

The current debate about what to do with the UAW contracts with Ford and GM is one part of a much bigger problem that has to do with human nature and the way our economic system works.

Whenever possible, people will tend to make decisions that are beneficial over the short-term rather than face up to unpleasant long-term realities. Auto executives, their management teams, and investors (which fittingly enough includes lots of pension funds) basically gave an IOU on pensions and retiree health care benefits in order to get labor to sign contracts in the near-term that would be beneficial to the bottom line. No one was really thinking about the consequences years out. The UAW and the companies were equally complicit and the federal government turned a blind eye when it should have stepped in more aggressively with appropriate rules and regulations.

The truth is that there isn't a person smart enough on this planet to accurately forecast retirement obligations given the uncertainty that exists around future health care costs, future competition, long-term investment returns, and future regulatory requirements. People who pretend that they can are simply passing the IOU to future generations to figure out.

No one in a global economic system can be guaranteed a specific return. What companies, governments, employees and labor unions can do is work toward agreement on retirement benefits that will be funded while the obligation is being created and then work together cooperatively to see that those funds are managed well. For most workers, barring on-the-job death or disability, the obligation should be funded completely while the employee is actively employed and then managed conservatively with the goal of matching inflation. This applies both to all funds that will be disbursed during retirement - including social security, Medicare, and any other retirement funds.

In the case of the UAW and the car companies, contracts they signed years ago should have required full funding of all future obligations. If the funding was to be invested in the stock market, it should have been explicitly stated that it was subject to the vagaries of the stock market. If it were to be invested solely in "safe" securities, like US Treasuries, it should have been explicitly stated that it was subject to the vagaries of inflation. Instead, it was invested in the future success of the companies themselves - and the companies have failed. Now that they have, the UAW and the companies are looking to the government to bail them out, which goes beyond what we have expected of government to this point and which simply shifts the burden from one group (the autoworkers and retirees) to all of us (taxpayers).

To do other than fund obligations fully at the time they're incurred is to tax future generations in a way that is immoral and should be illegal. When someone is dead, we don't allow that person's creditors to go after the deceased's children. Yet we seem perfectly willing to let mass obligations pass on to future generations of workers, investors, and taxpayers.

We need a new system for funding and managing retirement obligations - one that recognizes that we all have a responsibility to plan for and fund retirement during our working years and that we should all be working together toward a financial system where investors who want low risk/low valatility returns over the long term have options that make sense.

What this means is that whether you work for a private company or for a government agency, your pay stub should reflect the full cost of whatever obligations are being incurred on your behalf. Understanding those full costs is the only hope companies, investors and governments - and the people who rely on them - have for making smart decisions that will bring long term benefit.

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