Some entertaining pension reading (not an oxymoron!)

While we wait breathlessly for legislative shoes to drop on Colorado PERA pension reforms, we can pass our time perusing interesting writing on public sector pensions. And no, believe it or not, that is not an oxymoron.

We recently came across this interesting economics-focused online newsletter, aimed primarily at “pension geeks.” It’s written by Allison Schrager, a New York-based economist and writer. It’s worth perusing. She seems to be non-partisan and non-ideological, which should be refreshing to most readers in this day and age. She also has a nice, breezy style.

Here are a couple of excerpts from her latest installment, focused on pension economics.

The holidays featured a series of poorly reported stories about pensions. They highlighted many reporters’ inexplicable defined benefit (DB) fetish. As you may know, I am pension-type agnostic. Under certain circumstances, a good DB plan can be better than a good defined contribution (DC) plan. But I’ll take a good, or bad, DC plan over a bad DB plan. If I ever change jobs, I’ll even take a bad DC over a good DB…

Here’s the real deal: DB benefits are expensive because they cover both longevity and market risk. These benefits are expensive to guarantee and there is always an incentive to underfund pensions because the benefits are paid far in the future, when the people who designed these guarantees are gone—just look at public sector pensions…

Many things killed DB plans in the private sector; a main culprit was ERISA, legislation which forced employers to recognize these costs and properly fund DB benefits. Firms weren’t just greedy or screwed by Wall Street. Finally, they had to realize the true cost of their promises…

I am curious how it will all work out. Many plans are underfunded and cutting benefits is unusual, or even illegal. The state, or corporate, DB benefits individuals actually get aren’t that large. Once people can’t work and are vulnerable, it seems especially cruel to cut their benefits. Older people also have time to assemble and lobby—all of this means pension benefits are hardly ever cut…

A lot of people think a pension fund manager’s job is to score the highest possible return. Some managers behave this way, and this is often how they are judged. Actually, their job is to meet their obligations with as little risk as possible. This is the tension, as more risk increases the odds of paying benefits, but risk also increases the odds of a big shortfall.

Low interest rates make the job harder because managers need to take more risk to make their return targets. The problem is that even stocks are expensive. What to do? Take even bigger risks with alternatives and private markets. There are higher expected returns (allegedly), but also illiquidity and high fees. I am sure that will work out.

No Comments

Post a Comment