Warning: This is not a SS hit diary ... so hold your fire.
The stock market meltdown, low interest rates, and credit downgrades are taking their toll on "retirement" as we used to know it.
It used to be so simple. Workers and companies contributed money to a "pension plan" that accumulated and invested that money to pay to the employees when they retired. Easy ... except that pool of money had to be "invested" somewhere and kept safe, if it was to be available in the future when it was needed. That is now problem, especially after days like today.
Losses on the stock market and low rates of return from bonds mean pension plans have been falling behind in their race to have enough money to pay out to retirees. That means that companies and workers will have to put aside a lot more money if the promised pensions are going to be paid.
Exploding pension fund shortfalls are blowing billion-dollar holes in the balance sheets of some of the Chicago area's biggest companies, forcing them to make huge contributions to retirement plans at a time when cash flow and credit are already under stress.
Boeing Co.'s shareholder equity is now $1.2 billion in the hole thanks to an $8.4-billion gap between its pension assets and the projected cost of its obligations for 2008. At the end of 2007, Boeing had a $4.7-billion pension surplus. If its investments don't turn around, the Chicago-based aerospace giant will have to quadruple annual contributions to its plan to about $2 billion by 2011.
That quote is just the tip of an iceberg of pension related stories that are starting to hit the media. In fact there is even a web site devoted purely to accumulating stories on the time bomb - Pension Tsunami
Let's look at some key points:
- Stock market losses: If a company had $10 million invested by its pension plan, and that plan lost 25%, then the company needs to make up $2.5 million to get back on track. This is not going to be easy in this type of environment. In addition it will place a drag on earnings (which investors use to value companies), so effectively keeping stock prices reduced. (kind of a vicious circle).
- Low rates of return: Many fund managers, in a flight to safety have moved a lot of money into government bonds, but these bonds are now barely paying any interest. Many pension plans assume an 8% return in their calculations. There is no way they are getting it in these markets. So, even if they are safe in Treasuries, they are falling behind on return.
- Risk: In an effort to try to get those 8% returns, or to make up for previous losses , pension fund managers may be tempted to take on additional risk, further putting at risk their plans.
- Public Plans: Few corporations still have the old style "defined benefit" plans where you are guaranteed a percentage of your salary based on years worked or some other metric. These plans now mainly exist in the public sector. Just like in the private sector these plans are falling behind, but unlike in the private sector, losses need to be made up by the taxpayer. Expect to see some big battles as unions fight to save their defined benefit plans from the cost cutting that is coming.
A point on Social Security:
Social Security has been managed as a cash cow for the federal government. Any money taken in in excess of what is paid out in benefits is added to government revenues, and also to what is owed to the Social Security Trust Fund.
Because the government has been running deficits, the Social Security excess funds reduce how much the government has had to borrow from the private sector. For example, if the government had a real deficit of $500 billion, and Social Security excess funds were $150 billion, the government would claim the deficit was only $350 billion. It would though borrow $350 from the private sector and $150 billion from Social Security. As long as Social Security is taking in more than it pays out the government has an easy source of funds. But this will not continue forever.
In fact, it seems that the recession, by reducing employment, and maybe increasing the number of people taking Social security, seems to be reducing the size of additions to the Social Security surplus, and thereby increasing what the government has to borrow from the private sector.
Here are the figure for the last 4 years:
Sept 30/2008 - Feb 28/2009 - $ 82 billion
Sept 30/2007 - Feb 28/2008 - $140 billion
Sept 30/2006 - Feb 28/2007 - $135 billion
Sept 30/2005 - Feb 28/2006 - $167 billion
So in simple terms, the government was, before this year, able to borrow $135-167 billion from Social Security over the 5 months from October to February. But this year, that amount is down to $82 billion, at a time where the government is already borrowing more than it ever has before. This trend seems to have picked up in the last few months. If it continues we could see Social Security start to draw on government funds sooner than predicted.
The Time Bomb: Expect to see more and more stories about the pension time bomb as we go forward. And, it is a time bomb. As any actuary will tell you, it is hard to make up for lost time, and this market meltdown has made those of us saving for retirement lose a lot of time.
It is also a long term time bomb. To make up for losses, consumers are going to have to save more, and companies are going to have to devote more of their profits to pensions, and governments are going to have to allocate more of their revenues to cover pension commitments. All of this will be a drag on the economy as it tries to emerge from recession some time in the future.