It's Not Too Late to Save the Pension System

Thursday, 24 Mar 2011 07:14 AM

By Jacob Wolinsky

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I had the chance to interview financial author Roger Lowenstein.

While Lowenstein isn't a household name, he has written several best-sellers on various topics in finance. Lowenstein testified before the official Financial Crisis Inquiry Commission, which was formed by the government to investigate the causes of the financial crisis.

Lowenstein in 2004 wrote a book about pensions warning about the coming pension crisis, which is now unfolding before our eyes. In my interview, Lowenstein had some interesting points about pensions and unions.

Lowenstein had the following insight about pensions: "Pensions are in many senses an ideal savings vehicle. They collectivize the various risks of retirement."

"Think about the risks of retirement. If you’re saving for yourself, you have to worry you might live until 110 and consequently you’ll have to over-save. The beauty of a pension plan is that it saves for a whole group of people and you can actually make a pretty good guess that the average won’t live until 110," he said. So you just save until the average of 84 (or whatever the average mortality is).

Lowenstein stated that the retirement age must be raised. It wasn't intended for people to retire early and take a second job, like many people are doing today.

Lowenstein had some great points that got me thinking about pensions.

The average person won't save for retirement or be able to invest properly for it. According to “Financial Decisions for Retirement,”
without Social Security, nearly 50 percent of American senior citizens would be living in poverty. It clearly isn't a viable solution.

So is there a way to make pensions work?

The answer is yes. First, the retirement age for public pensions must be raised. I have stated in the past that it is simple logic that as people live longer, they will have to work longer. If people are living until 110 in 50 years, it is unrealistic to work from ages 25-50 and retire until they die at age 110.

There is another way to strengthen the pension system itself. I spoke to the CFO of a large privately held company. He informed me that as long as a company or state’s pension assumptions are in line with other companies' pensions assumptions, it would be perfectly legal.
This shocked me.

If most pension plans are assuming 15 percent returns, then all pension plans can do the same. This is absolute insanity: 15 percent returns are high above the stock market average return of 10 percent  a year. 

And of course as stocks rise, pension plans increase their assumption returns, when they should be doing the exact opposite. For example, as a bull market goes, pension funds assume their returns will be higher even as the market becomes more overpriced. They should be doing the opposite, as they get higher returns they should assume that future returns will be lower.

Since states are too beholden by union pressure, the federal government should institute a law that requires pension plans to assume future returns based on current rates on 10-year Treasury bonds, and current stock-market valuations.

Right now, bonds and stocks are very overvalued by almost every metric.

However, according to The Wall Street Journal, the majority of public pension funds are assuming returns of 8.00 percent. Most pension plans have a 50/50 portfolio consisting of stocks and bonds, this would mean bonds would appreciate 6 percent a year and stocks 10 percent a year.

The current yield on the 10-year U.S. Treasury bond is 3.4 percent, it is absurd to assume that bonds will return 6 percent in the coming years.

The federal government rarely does a good job getting involved in state affairs. However, making a federal law requiring pension assumptions based on market returns would do a lot to rectify the situation the states have put themselves in.

This action, in addition to raising the retirement age would put the states back on the right fiscal track, while protecting senior citizens who depend on their pensions for retirement.

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