"Pension Liabilities - The Piper Must be Paid"

Sydney M. Williams

Thought of the Day

“Pension Liabilities – The Piper Must be Paid”

October 13, 2011

Lost amid the Tsunami of concerns emanating from the European sovereign debt crisis and the continuing mortgage debt problems in the U.S. is the growing deficits accruing to both public and private pension funds. It would be my guess that an implicit deficit of even greater magnitude exists in the self-managed 401K and IRA world. The losses in the former are a consequence of over-the-top promises, along with underperforming markets. In the latter, insufficient funds in self-managed funds are due to ignorance as to future needs, inadequate savings and poorly performing markets. This shortfall in assets, in my opinion, is likely to become the direst problem confronting our country over the next few decades.

According to a report in the January 18, 2011 issue of the Financial Times, the shortfall among public pension funds was $2.5 trillion. Mercer Financial Strategy Group puts the shortfall for corporate defined benefit plans for the S&P 1500 companies at $512 billion as of the end of September 2011. But, as indicated above, those numbers understate the scope of the problem, especially the problem for those working in the private sector. Eighty-eight percent of public employees participate in defined benefit programs. However, only 15% of private sector workers participate in employee-based defined benefit plans, according to the Employees Benefit Retirement Institute (EBRI.) One could easily assume, therefore, that the real unfunded liability for those who self-fund in the private sector is closer to 6.7 times that number, or closer to $3.5 trillion. The combined shortfall of about $6.5 trillion (a little more than 10% of total U.S. capital markets) provides some sense of the problem facing this country over the next few decades. In fact, in a piece I wrote last January it was suggested that the needs over the next twenty years could approach $27 trillion . As a country, we must become far friendlier towards capital and its formation.

While personally I question both the spontaneity and the motivation (if there is one) behind the Occupy Wall Street protests, I do believe there are deep-seeded frustrations with the seeming inability of our country to provide opportunities for millions of people. Most of the protesters – the ones not displaying hate-filled anti Semitic signs, or selling drugs – believe the fault lies with the capital system. My personal belief is that the fault lies more with government, and specifically with those programs that did so much to encourage sub-prime borrowers to buy homes they could not afford, and with the Federal Reserve keeping interest rates so low that it encouraged borrowing and discouraged savings. The fact is that, as a nation, we are capital poor, not rich. That is seen in the need to reach out to China for funds. Obviously, the first need is to provide jobs; but the second is to encourage Americans to invest capital. The economy only works when both labor and capital are growing. To demonize one is to forsake the other, and to ignore the goal of a growing economy.

Shortfalls in corporate defined benefit programs will have to be made up by shareholders. In a piece out on Tuesday, Credit Suisse writes: “Higher pension costs could cause an earnings headwind for 244 companies going into 2012; as a result earnings estimates may have to come down.” In aggregate, according to an October 5 report in the Wall Street Journal, American companies are holding $2 trillion in cash. Thus corporations, or at least most, would appear to have adequate means to repair their pension liabilities. But cash spent on pensions is cash that cannot be spent on dividends, acquisitions or buybacks. The Credit Suisse report estimates that S&P companies will have to contribute $91 billion in 2012, an increase of 76% over the expected 2011 contributions. Coming off the recession earnings have been surprisingly strong; nevertheless markets are nervous, so any shortfalls may not be received well.

The more critical questions are those facing public unions and the millions of people who have inadequately prepared for their own retirements. States such as New Jersey and Wisconsin have visibly and vocally prepared their constituents, including their public employees, as to the magnitude of the problem. Accepting reality, however, is far from a slam-dunk, as we have seen in those two states and others. Additionally, the contagion of bankruptcy which began in Central Falls, Rhode Island in July has now spread to Harrisville, Pennsylvania, which, according to an article in today’s Journal, filed for bankruptcy yesterday under Chapter IX of the bankruptcy code. The fact is that municipal and state unions over the years promised their members benefits that will be impossible to fulfill. The debate will be determining who is at risk – bond holders, the beneficiaries of unrealistic promises, or both?

The more worrisome concern is the one that receives little mention and that is the needs of the 85 million working Americans who rely principally for their retirement on some form of a defined contribution plan. The people in these plans are dependent for retirement upon voluntary contributions and the performance of their investments. A report out last month from EBRI suggested that 67% of early Boomer households without defined benefit plans (and 59% of late Boomers) are at risk of having insufficient retirement income. We live in a country that encourages consumption, not savings and for almost a dozen years we have been in what I would term a secular bear market. Neither factor is promising of a comfortable retirement. An estimated 55 million people will reach retirement age over the next seventeen years. The funds they will require to retire without worry, coupled with the size of our capital markets, suggest that needs dwarf availability.

Next week I will be out of the country, so your inbox should be alleviated from inundation of my Thoughts of the Day, at least for a few days.