Trends in the news

I thought I might take this post to highlight a series of articles that detail various trends that I see as being big stories over the next few years.  The bolded titles are also links to the original article.

Canadian pension plan funding dips in 2010

Back in my 2011 predictions I made the following statement:

The (un)sustainability of defined benefit pension plans becomes a major topic of media focus in Canada, the US, and Europe.  Most big Canadian DB pensions will switch to defined contribution by 2015, though we’ll see the seeds for that nasty conversion sown this year.

Despite a stellar year in most asset classes, many big pension funds are still losing ground.  As the article notes,

“Canadian pension funds saw their funded status drop in 2010 despite a second straight year of strong stock market returns.”

“… A typical Canadian pension plan was 73 per cent funded at the end of 2010, down from 74 per cent a year earlier”

I see several issues facing many pension plans.

First and foremost is demographics, which weighs heaviest on defined benefit plans common in the public sector.  Think about it for a moment:  After 25 years of service, you can retire in your mid 50s and for the next 35 years live off a indexed-to-inflation pension that pays you more than a 7th or 8th year worker in your profession.  It’s an absolute pipe dream to think that these plans can fund themselves in perpetuity with demographics what they are and life expectancy rising.

Look no further than one of the country’s largest plan, the Ontario Teacher Pension Plan.  The average Ontario teacher retires at 57 years old and has a life expectancy of 90.  The pension pays those who receive full, unreduced benefits 70% of the average of their best 5 years salary, indexed to inflation……FOR LIFE!  Given that teachers in the top pay bracket in most school boards make over 90K per year, we’re talking yearly pension benefits of over 60K per year.  Sustainable?  Not bloody likely.  Behold!

Note that in 1970, the average newly retired pensioner was expected to be drawing benefits for 20 years and was supported by 10 active members all paying into the plan.  No problem.  Not to mention that interest rates were actually at market rates, making returns on the fixed income portion of the portfolio much more robust.

Fast forward to 2009.  That same newly retired pensioner will be drawing benefits for 30 years and now has 1.5 working teachers contributing to the plan.  Ouch.  Add to that the fact that interest rates are at historical lows meaning reinvested fixed income proceeds earn them a pittance.  And with both bond prices and stock prices inversely correlated with interest rates, a sudden rise in interest rates won’t immediately solve the problem either.

No wonder the plan currently has a $17 billion shortfall.

It’s not just provincial DB plans that are massively unsustainable.  You may recall that earlier this year, the CD Howe Institute calculated that unfunded federal public sector pension liabilities are some $208 billion.

Let me say that if you are under 35 in one of these public sector DB pension plans and you’re planning on retiring in your early 50s with a hefty annual pension……think again.

Public sector pensions should all be defined contribution plans to save both the taxpayer and those involved in the plan from nasty surprises when these promises can’t be kept.

California budget pain

Four words being uttered in California that will soon ring in our own ears:  Deep cuts, higher taxes.

“Gov. Jerry Brown on Monday will unveil his plan to lead California out of the fiscal wilderness and back to prosperity: a politically charged mix of deep cuts and higher taxes.”

Austerity is coming to municipalities, most provinces, and certainly the federal government.  Count on it.

As a whole, we’re not nearly as screwed as California is.  But I have no doubt that Ontario will be first in line for a bond market drop kick to the chops if they don’t get their act together.  Of interest, earlier this year Mish compared the fiscal situations in Ontario and California.  It’s worth the read.

Portugal in the bailout crosshairs

After seeing their bond yields soar over the past few weeks, it’s becoming pretty obvious that the debt contagion is spreading to Portugal.

Germany and France are now stepping up pressure on Portugal to accept a bailout before their funding costs become too onerous.  As also noted in my 2011 predictions…

European debt concerns (will) spread to the core.  Spain and Italy will see continued rise in bond spreads over German bunds.  Collectively they are far too big to bail out.  With that realization and the realization that large global banks have substantial exposure to Euro debt, expect bond yields to rise throughout Europe while European bank shares get whipped like a bad mule.

Let it begin!  As the debt contagion spreads, expect bond holders of all sovereign debt to take the magnifying glasses out and start asking some tough questions.

Cheers

Ben

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10 Responses to Trends in the news

  1. pricedoutfornow says:

    “Let me say that if you are under 35 in one of these public sector DB pension plans and you’re planning on retiring in your early 50s with a hefty annual pension……think again.”

    Exactly. I worked in the public service from age 23-30. Many coworkers in my age group had already decided what date they were going to retire (usually their 55th birthday after 30 years of service). They looked at me strangely when I said “Dream on guys, it’s not going to happen.” But it was happening every day in our workplace as 55 year olds retired with decent financial lives for the next 30 years. Too bad it’s not sustainable and people are going to wake up to this reality in the coming years.
    Another great post! 🙂

  2. LRM says:

    Great post Ben !!
    These defined pension plans are certainly a time bomb. I really get sick when I think of the attitude of many public service employees regarding this sense of entitlement. However, I don’t see any way the taxpayer can escape this “BILL” . There will be much kicking and screaming like a 2 year old temper tantrum by the entitled and much capitulation by politicians wanting to get elected. Today, the tax payer will get bullied by the public service and the public service will win. Taxes will get to 100% for the real producer before the public service gives up the fight. Who is going to stop this “MATH” problem? The most read literature for the public servant is the employee manual and that book has the pages wore out and it will be a hard copy not that digital stiff !!

  3. Wilco says:

    When looking at revamping public union entitlements, it is not fair to to change the entitlements for folks who started out working under these assumptions. However, any new hires should definitely get new plans that are more in line with the private world. Wages, on the other hand, could be adjusted across the board to reflect private sector wages.

    • Mr. Poppinfresh says:

      Do you think the fact that it’s “not fair” to alter retiring workers’ pensions retroactively changes the fact that younger workers are factually incapable of supporting those entitlement benefits?

      You might as well say that, since Boomers all voted to give themselves the right to demand young workers fly on command, then by God those whippersnappers should get on the roof and start flapping their arms.

      One generation fundamentally misunderstanding (or willfully ignoring) fundamental economics should not be a curse on the next generation forevermore.

      • There’s no easy solution. I certainly don’t have the answer on this one. Converting all current DB pensions to DC pensions would involve paying significant lump-sum benefits which would be a massive one time cost. The government certainly doesn’t have the means to pay out of their coffers so they would rack up significant debt in doing so.

        By no means am I fond of that solution, but I do feel for those who have planned their life around a pension that will be pulled out from under them. I could certainly support a reduction in benefits, but they are still entitled to some of the benefits they have paid for, even if those plans can’t honour all of them.

        There’s no easy answer.

      • Wilco says:

        I think that changing the entitlements of those who are near retirement will create another layer of trouble. People who are to retire in the next 10 years or so will have a hard time to put in enough voluntary contributions to make their retirement realistic. Younger people do have that ability. Perhaps there should be an arbitrary cut-off line, i.e. if your earliest retirement date is more than xx years out, you get switched to the new reality but otherwise you get to stay on the old one. Just because governments and voters were silly enough to agree with all demands that unions made doesn’t necessarily mean that those now relying on the resulting entitlements should suffer. The way those folks can contribute is perhaps by more significant wage cuts.

        I think governments will wake up soon enough – there is enough noise in the media as well as general upset building that they will soon have to start acknowledging the issue at hand. The economist also has a very insightful article in their most recent issue which further discusses the pros and cons. If you’re interested in the subject I’d highly recommend you read it.

    • LRM says:

      No it is much more fair to charge the bill to the tax payer . Better for the tax payer to have to adjust to a change than upset the plans of the far mare important public service .

  4. Chad in Burnaby says:

    You can’t really blame the employee. It’s the pension administrators and employers that need to wake up. The facts that Ben highlights so well are all clear for the pension trustees and employers to see but they continue to hire new staff (at my workplace, for example) with DB as a major benefit in the package. What’s the employee going to say: “no, please give me a DC pension package instead?”

    • LRM says:

      The employee here is the government remember and they “need” to keep the public servants happy to get elected. This won’t change until the cheque bounces

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