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JakilaTheHun (99.93)

HNI: The Public Pension Plan Debate

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March 01, 2011 – Comments (8)

The Wisconsin Lie Exposed:  Taxpayers Contribute Nothing to Pension Plans, Forbes.com

The Hunnish News Invasion is pushing deeper into Roman territory and for today, we thought we'd look at the public pension plan debate.  The article above has been making the rounds lately, particularly amongst liberal Democrats.  The basic thesis behind it is that public employees contribute 100% of their own contributions and that it’s a myth that the taxpayers contribute to the funds.  Therefore, the author concludes, the Wisconsin governor is trying to lower the wages of the Wisconsin public employees.

There are a ton of flaws with the author’s reasoning.  It’s true that the public workers contribute 100% of the proceeds into the defined benefit plan, but the author completely ignores the fact that the funds guarantee some sort of expected return, regardless of the underlying reality behind the returns.   This is why the private sector has shifted to 401(k)s and IRAs; private companies realized that these defined benefit plans were created with an unsustainable premise.  This might not be that big of a deal if the expected returns were set at a reasonable level, but as history has told us, politicians have tended to set absurdly high numbers for this guaranteed return.   In effect, these pension funds have acted as patronage for the public sector unions.

I’m not sure what the figures for expected returns are in Wisconsin, but I know in some states, the expected return is in the 8% – 9% range, which is significantly higher than the long-term returns on the US stock market indexes, which tend to be closer to 5% – 7%, depending on the time frame. Also, keep in mind that it’s likely that the pension funds have some amount invested in lower-yielding bonds, as well, which means they should expect a lower return than the stock market.

If you take that math as a guide, 3.5% – 5% is probably a more reasonable expectation of return, yet, politicians are promising out twice as much and expecting future taxpayers to pick up the slack. Over the course of a few decades, these discrepancies add up. Workers aren’t expected to contribute more to make up for these ridiculous expectations embedded in the assumptions, either, so the “unfunded liabilities” that the taxpayers are on the hook for have become massive.

The author admits to this after criticism, but then falls back upon the flawed idea that the workers ‘fairly bargained’ for these returns. He seems to conveniently gloss over the fact that this is precisely why the governor wants to eliminate “collective bargaining” for the public sector unions. To call this a fair negotiation is laughable; in reality, these were one-sided negotiations where the unions looked out for their own self-interest and the politicians looked out for the unions’ interests, as well.

This is why there are major problems with the entire idea behind public sector unions. Private sector unions have to deal with corporate shareholders, so there are legitimately two sides in the negotiation. Public sector unions, on the other hand, are often on the same side as the politicians and simply decide to take all the money they want and pass the burden on to future generations.  Politicians, who are elected for 2- and 4- year terms, are normally long gone before the final bill is due.

This is precisely why we need to end public employee defined pension plans and replace them with something more analogous with the private sector, such as 401(k)s and IRAs.   These pension funds are not remotely sustainable.   And public sector unions are not economically useful, since they often end up being “on the same side” as the people they negotiate against.   In other words, it’s a patronage system, and we need significant reforms.

8 Comments – Post Your Own

#1) On March 01, 2011 at 12:17 PM, PeteysTired (< 20) wrote:

Well said, but they (union) are going to fight tooth and nail. 

In my state of MN, we will continue to kick the can down the roadt as our current governor wants nothing to do with taking on the most powerful union in existence. 

In the last election, they ran so many commercials (Educate MN) on tv about how they work hard for our children.  The show an anrgy middle aged balding white guy screaming and waving his hands and we are led to believe he is a tea partier (at least that is what I thought).  All the while they are telling us they will work harder for our children than this guy.  I kept thinking my tax dollars went into producing and running the commercials.

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#2) On March 01, 2011 at 12:43 PM, MegaEurope (< 20) wrote:

Jakila, I like Hunnish News Invasion because it has news.

I hope you don't turn into yet another political opinion blogger. CAPS has plenty.

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#3) On March 01, 2011 at 1:06 PM, L0RDZ (79.12) wrote:

Tax payer funded pensions should disapear ~ its ridiculous to guarantee someone a pension, instead the pay should reflect an added amount to which the employees can either spend or choose to invest.

When I read about all these promises to gov-beuo-ro-rat  employees its ridiculous ~ especially when they have rules where one can retire and get a pension while also working in another branch of the government.  And when they have the retirement being entirely funded by tax payers with zero employee contributions.

In one instance there was this one person who was receiving a pension as well as collecting disability payments all the while the person was also working in another gov job ~ a triple dip.

Than there are ridiculous rules that allow for employees to work ridiculous overtime hours in the last 2 years before retirement in order to pad the basis on which they will receive retirement benefits.

The higher up the chain the worse and more abusive the practices, anyone recall those city mayors in california that were making close to a million a year and qualified for million dollar yearly retirements.

 

 

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#4) On March 01, 2011 at 1:28 PM, JakilaTheHun (99.93) wrote:

MegaEurope, 

I've always interspersed the news articles with a little bit of commentary, but generally focus on the articles.  If I see a highly inaccurate or misleading article that gains traction, though, I am liable to counter it.  This pension article has been popular amongst certain political partisans, but it's extremely misleading and ignores the actual issue at hand ("unfunded liabilities" in pension funds).

Moreover, I think this will become a bigger issue over this decade.  These pension funds have been effectively bankrupt for awhile, but no one started paying attention to the state budget crises heated up. To see a piece that tries to spin this as a "non-issue" is really a disservice. 

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#5) On March 01, 2011 at 7:02 PM, Borbality (50.12) wrote:

Something must be done, just as with social security and medicare. As a member of the younger working generation I have little hope for anything being done before it's too late or without severe pain.

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#6) On March 02, 2011 at 11:39 AM, Rehydrogenated (32.17) wrote:

I don't see why guaranteeing a "high" (if you consider 7-8% to be high) rate of return on a pension is a problem. The only reason people invest in a company/government pension plan is either because they are forced to or because it offers them a greater rate of return than they could get on their own. Of course if the actual return on that money is not enough, it creates a compounding unfunded liability, but that is a financial error made by the state. Why doesn't the state ever consider putting more money into funds (INVESTING) than minimally necessary. They know what their liabilities are, why do they act like they have to make up the entire unfunded liability overnight? If they used finance 101 and overfunded pension plans initially, compounding interest would be on their side instead of against them. 

Don't get me wrong, I don't like pension or even 401Ks. I believe everyone should be taught in high school the skills necessary to save for retirement and invest wisely (at least how to buy an index fund!). I just don't see the state failing to run a proper pension fund as a reason to eliminate collective bargaining. When both sides of the negotiation are on the same side that is a huge problem, but not one that is hard to solve. Boy politics is hard when there is more than one side...it would be so much easier if we just had one party...

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#7) On March 02, 2011 at 2:13 PM, JakilaTheHun (99.93) wrote:

Why doesn't the state ever consider putting more money into funds (INVESTING) than minimally necessary.

This is the entire controversy.  It's supposed to be 100% employee funded, but that theory only works if you assume that the "expected return" is realistic.  It's not; at least, not under the parameters that the funds are allowed to invest. 

The only way the pension funds could met the required return is to act more like a hedge fund or private equity fund; but then you'd have a few funds that would lose a ton of money, and people would be infuriated, as well.  They'd ask, why is the government taking huge risks with all my  retirement money?

So it's a giant Catch-22 for the pension funds.  They know the government's mandate is completely unrealistic, but they have to make due as best as they can.  Meanwhile, the politicians pretend it's not a problem. 

Many of these pension funds can only afford to pay 50 cents on the dollar right now.  The entire idea of "unfunded liabilities" should be eliminated.  People should retire on what the fund earns ... not what they'd like the fund to earn in a magical world where everything pays off handsomely, while also having low risk. 

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#8) On March 02, 2011 at 4:45 PM, Rehydrogenated (32.17) wrote:

Many of these pension funds can only afford to pay 50 cents on the dollar right now.  The entire idea of "unfunded liabilities" should be eliminated. 

I totally agree.

People should retire on what the fund earns ... not what they'd like the fund to earn in a magical world where everything pays off handsomely, while also having low risk. 

I think it is ok to offer people a pension with a defined payout, even one that is greater than than the average market return. It is a great benefit to say "Normally the risk free return has an average of 4% per year, but we will give you 6.5% if you put your money in our pension fund." We give this benefit at our company and everyone loves it because they get to invest and don't have to think

But just thinking about what I just wrote, states make a huge financial mistake by promising a payout based on the market (which is extremelly high risk) instead of a risk free rate. State pension funds are limited in how much risk they can take (much more so than private companies) and so I agree their expected rate of return is too high. 

All I can see is blatant financial errors, I don't really see how eliminating collective bargaining would fix the problem. It seems like they just want to eliminate state pensions, which is fine by me. If they can't figure this basic finance out, why should government employees trust them with their money?

(Answer: They shouldn't. Which is why the unions force the state to guarantee a return, or else all the funds would be malinvested and the state employees would have to pay for the malinvestment).

 

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