Monday, October 19, 2015

Pension restructuring: What will it take?

It is no secret that our public pensions are deplorably underfunded.  Given the magnitude of the gap, it is unrealistic to expect that all of the shortfall will be made up by increased funding by legislatures or by stellar return on investment.

The other avenue is to restructure the pension payouts.  That is typically forced by bankruptcy proceedings.  There are reasons to restructure sooner than the 11th hour.  It is better to restructure when the pension is 80% funded rather than when it is 50% funded.

A lot of assumptions must be made to make this topic understandable.

For the purposes of this essay, we will assume that every public employee works until age 56 and then gets a $3000/month pension.  Further, we will assume that the pension payout grew by 3% every year before our 56 year old retired.  We will assume that the pensions are NOT indexed to inflation.  Finally, we will assume that the morality rate of state workers follows the mortality data published by the CDC for the year 2007.

Equality of outcome

This scenario seems as likely as any.  It is equally distasteful for nearly all parties.

Equality of outcome creates a ceiling on the maximum pension benefits any retiree can receive per month.  This seems to disproportionately impact the younger retirees because they lose a larger percentage of the pension they are expecting.

This curve assumes an annual 3% pay raise very year and no inflation indexing for past retirees..
The reason younger retirees have to take a bath is because they represent the lion's share of the cost not just because of their higher pensions, but because the grim reaper has not thinned their ranks.  There is no way to address pension shortfalls without severely impacting the younger retirees.

Based on the CDC link listed earlier.
Combining the higher pension payments with the higher population per bin give us this.
If my math is right, the first 9 cohorts are responsible for 50% of the pension obligation.  It is almost mathematically impossible to address funding shortfalls without impacting them in a huge way.  Proponents of Equality-of-Outcome will point out that younger retirees are more capable of picking up a job to make up the difference while older retirees have less flexibility in that regard.

So what happens when an underfunded pension hits the wall and "Equality of Outcome" is applied?

Three bands.  100% is the average pension payout for the most recent cohort.  Reorganization of a 70% funded pension results in every retiree under the age of 78 having their monthly pension reset to to the level received by a 79 year old.  Everybody over the age of 78 is untouched.  Reorganization of a 50% funded pension  results in every retiree under the age of 91 being reset to the level received by a 92 year old.  The red line is for a 60% funded pension.
In a table using $3000 per month as a basis.

As a point of clarification:  It does not matter how much you received per month, in the "Sixty Percent, Equality of Outcome" scenario NOBODY would receive more than $1200/month.  You would make less if your before-restructuring check was less, but nobody would ever get more.

$3000 a month may sound like a big pension, but these are aggregate numbers.  That $3000/month also includes the executives and the people who were able to "game" their pensions higher via cashed in sick-days and overtime.

Don't play chicken

One of organized labor's favorite tools is to play "chicken" and make the other guy blink first.  There are some good reasons to abandon that strategy when talking about pensions.

Unless something significant is done to bolster an underfunded pension, it slowly drifts downward as pay-outs are made.  The pay-outs are made out of capital, not earnings.  The pension that is 80% funded drifts down to 70% funded, then 60% funded.  The downward drift becomes a steep dive as there is less and less capital to create income/growth.  The pension that could have been reorganize at 80% funding would have impacted nobody over age 73 and those who were younger than 73 would still be getting checks for $1800 per month.

Playing chicken and waiting for the pension funding to drop below 50% means that virtually everybody will take a hit and they will be receiving checks for $1000 a month, not $1800 per month.

People, being what they are, will not be able to see this except in hindsight.  Pity.

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