Tuesday, June 16, 2009

Defined Demise - Is This The End for Old Style Pensions?

A long time ago, in a galaxy far, far away, someone created the first defined benefit pension plan. They were probably a well paid actuary and wanted to ensure they had a comfortable retirement.

This may or may not represent the origin of the DB pension plan, but you can almost guarantee that recent developments are foretelling the beginning of the end. If you want to understand the whys you need to know the what's first. As mentioned in a previous blog, the defined benefit pension (gold-plated) is just as it sounds. The payout, when it comes time to collect, is fixed to a certain formula. The formula is typically a combination of years of service multiplied by a percentage of your average salary over the last several years of service. For example, someone working for the federal government for 35 years, will collect roughly 70% of their "average" income during their retirement years. The average usually reflects an average of the best 5 out of the last 8 years worked. Suppose the final average income was $60,000. That means the person would receive $42,000 per year. The amount is often indexed to inflation. So what does this cost. Let's look at an example.

We have a married woman age 60. Her husband also is age 60. The pension amount she is entitled to is for $3500 per month, indexed at 2% per annum. If she passes away, the survivor benefit of $2100 per month is payable for life to the husband. In any case, a minimum of 10 years payments will be made either to the wife, her husband or a beneficiary. The cost for such a plan? Would you believe slightly over $750,000. That is the amount that the government and the employee would need to set aside over her career to fund her pension.

The interesting thing as we are finding out of late, is that all of the risk falls within the hands of the "employer". If there is insufficient funds in the plan, all the employer can do is put more money into the pension. They can ask the employee to contribute more, but usually that means dealing with union headaches. In the case of GM Canada, their pension plan is so badly underfunded, it is estimated that for the roughly 43,000 employees past and present, the plan only has enough money to pay 56.5% of the pensions. The scariest part is this - these numbers were based upon estimates from November 2006. Can you imagine the shortfall with the market declines of late 2008. Are they below 50%?

Former CAW head Buzz Hargrove (right) must wonder what he was thinking last August. Hargrove and GM executives insisted pension fears were unwarranted. A worst-case scenario that would trigger pension reductions is "so remote a possibility it's not worth speculating on," said Hargrove. As we have seen over the past 10 months, the situation is far worse than old "Buzz" ever believed or acknowledged. The actual dollar figure they are short by? GM Canada's defined-benefit plan for hourly workers was underfunded by $1.5-billion as of Nov. 30, 2007, the last filed valuation.

Published reports suggested the shortfall was as high as $7-billion. For a provincially regulated pension plan like GM Canada's, the government sets aside funds to ensure that pensioners are not left penniless. The problem? There is not enough money in Ontario's pension plan safety net to support GM pensioners if the company goes bankrupt, Premier Dalton McGuinty warned.

"The money available in that is very, very modest," McGuinty said, noting the Pension Benefits Guarantee Fund totals about $100 million – not nearly enough to cover the billions of dollars involved in the automaker's pensions.

So let's summarize - the plans are fantastic if you are the person in the plan. For everyone else they are expensive to run, dangerous for the employer due to unpredictable costs and uncontrollable markets. With more and more Canadians working for themselves and for "smaller" companies, most pensions offered today are "Defined Contribution plans". In these plans, the risk is with the employee, the costs are known ahead of time, and the general public will never be expected to bail them out. In looking at many pension plans, a recent study found that the aggregate deficit exceeded a staggering $250 billion.

The mere fact that defined benefit pension plans still exist is an affront to average Canadians. The federal government in both Canada and the US is "buying" an ownership position in car makers. They are doing it with your tax dollars. Do you want your tax monies spent to ensure that someone gets a fantastic no-risk pension? When will the government wake up and realize the astronomical costs associated with these plans. This is not likely as the government employees would be cutting their own throats. It will take the collective efforts of all Canadians to end the insanity that is the Defined Benefit pension plan. Will it happen? I don't expect it to occur in my lifetime. Too many vocal groups would be against it. Unions would be up in arms. Is there a solution? Sure there is - make the employees/unions and companies equally responsible for any shortfalls and have no government assistance program for companies who don't meet this criteria.

Stay Well and Pay It Forward.

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