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.
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.
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.
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.