Forbes Article, Gilt-Edged Pensions - How much are they really worth?

Forbes came out with an article last week about the lucky stiff retiring on a public sector pension. The article tells the story of the stiff retiring four years ago at age 42 with a $65,000 per year pension. The pension is indexed for life, that is guaranteed to increase every year. Forbes places the value of that pension at $2,000,000 and most of that will be funded by taxpayers today and into the future.

In the article Forbes notes that America is "creating a nasty social problem as well. America, in case you hadn't noticed, is dividing into two nations. The 22.5-million-strong public sector (that includes retirees) is growing ever larger, and enjoying ever greater wages and benefits often guaranteed by state constitutions." This nasty little problem is not only occurring the the United States but in Canada and most countries around the world.

I have followed the pension world for the past ten years with a focus on the large gap between public sector plans and those of the average Canadian worker. In the UK (England) they have coined the phrase Pension Apartheid for the two nations that are developing.

The compensation levels of the public sector have been designed to compensate public sector workers based on a need to avoid political confrontation. They have powerful unions and whenever there is an upcoming election they make their voices heard.

Originally the union propaganda was that the public sector was underpaid relative to the private sector. However, Forbes points out:
"In public-sector America things just get better and better. The common presumption is that public servants forgo high wages in exchange for safe jobs and benefits. The reality is they get all three. State and local government workers get paid an average of $25.30 an hour, which is 33% higher than the private sector's $19, according to Bureau of Labor Statistics data. Throw in pensions and other benefits and the gap widens to 42%."

This same analysis holds true in Canada and recently was reinforced by the Wage Watch report released by the CFIB - Canadian Federation of Independent Business.

The real bonus to public sector employment is the pension plan. The pension plan is not based on an accumulation of funds like your plan is, it is based on a continued stream of income into retirement. This stream of income is based on 70% of the wage rates at termination of employment. In the Forbes example, the worker had a pension worth about 72% of his final salary. His ending salary was $90,000 per year and he will receive a $65,000 pension indexed for life.

These type of pensions do not exist in the private sector, except for a few companies, most of which were once public sector and are now "Crown Corporations".

Forbes notes that "four in five public-sector workers have lifetime pensions, versus only one in five in the private sector. The difference shifts huge risks from government to private-sector workers." In Canada those numbers are about the same.

Check out the Forbes article it certainly will create much needed debate around this issue over the next few weeks. Gilt-Edged Pensions

Out of Town for one week in Mexico.

I will be out of the office for one week in Mexico.

Can Hear is an organization operated by Martin Heinrich. It provides hearing aids for poor chiildren in Latin America. We are in Mexico City fitting hearing aids on 45 children in the barrio of Iztalapan in Mexico City.

The trip is going well and it provides an opportunity to help others less fortunate. I realize what a great country we have in Canada.

All the best and I will return next week.

Bill

Who will bail out your pension? Pension reform needed.

Most taxpayers are funding as much into public sector pensions as they provide into their own!

There is the serious possibility of social upheaval that will result from the unfairness of these public sector plans because we have a two-tier system. One tier is for the public sector employee and the other is for the working taxpayer. The only problem is the taxpayer funds them both.

Gold-plated Pensions

Gold-plated pensions are those that are based on final-salary. These are typical of public sector plans. Most private sector plans are savings based; whatever is saved in the fund is available for retirement.

An article last year in the Daily Mail from the UK shows that taxpayers pay almost as much into public sector pension plans than they pay into their own.

In Canada there are a total of 4.6 million defined benefit pension plan members. In the public sector there are about 2.9 million defined benefit pension plan members. This leaves 1.6 million DB plan members in the private sector. Most of the DB plans in the private sector are not final salary, but we will leave that for another discussion.

Most private sector employees in Canada are winding down their DB pension plans. Of the Top 25, in asset size, pension plans in Canada only 4 are not taxpayer funded. Two of the companies who have DB pension plans in this group are in serious financial trouble and several business observers have indicated the company problems are a direct result of these pension plans. Also known as Legacy Costs, we are familiar with the problems at General Motors and Air Canada.1

It is interesting how this report – The Taxpayers Alliance - from Ireland, reflects the same trends occurring in Canada and the associated risks of the high costs of public sector pensions.

Quotes from the report state:

The high level of local authority pension contributions is symptomatic of a growing problem of over-generous and unaffordable public sector pensions, which does not bode well for future financial stability: Demographic changes are putting pressure on pension provisions:

- Life expectancy for men is projected to increase from 77.6 years currently to 85.5 years by 2056, while life expectancy for women is projected to increase from 81.7 years currently to 88.7 years by 2056.9

- There are currently almost four people of working age (aged 20-64) for every pensioner (aged 65+). By 2056, that ratio will fall to just over two people of working age for every pensioner.10 Public sector pension arrangements are not responding to these

Demographic challenges:

- Between 1995 and 2004, the proportion of public sector workers enrolled in final salary pension schemes has increased from 78 per cent to 88 per cent. At the same time the proportion of private sector workers has declined from 23 per cent to just 16 per cent.11

These are almost the same statistics that the CFIB uncovered in their analysis of the public pensions situation in Canada.

It is interesting how Canada has allowed the public sector to retire as virtual millionaires! Currently the amount of money required to fund the OTTP for current plan members is $ 825,000 per member. The same amount would be applicable for Federal workers that earn an average of $71,000 per year. This assumes a pension target of 70% of their last year’s working wages. They need the same $800,000 in their pension accounts at retirement.

Just for fun, calculate how a government worker earning $71,000 per year could potentially put aside $ 800,000 into a retirement plan. Calculate how much you would have to save to create the same pool of money after 30 years working and earning 5% rate of return. Then index the thing for inflation.

Anyways, get back to work; we need your tax dollars!!! Lets just hope this dialogue can begin in Canada as well.

References:
1 - Michael Bloomberg mayor of New York city was quoted as saying "Detroit's expensive pension plans are part of the reason why the automakers are teetering on bankruptcy and pleading for a bailout in Washington." - http://www.nypost.com/seven/12182008/postopinion/opedcolumnists/why_pension_reform_is_fair__vital_144747.htm

http://www.statcan.gc.ca/daily-quotidien/080704/dq080704a-eng.htm
http://www.statcan.gc.ca/daily-quotidien/090109/t090109a2-eng.htm
http://www.dailymail.co.uk/news/article-505583/Gold-pensions-public-staff-outnumber-private-sector-5-1.html

Public Sector Pension Reform Urgent

A recent report from one of Ireland's most influential business The Irish Business and Employers Confederation (IBEC)has called for immediate reform of public sector pensions. Pension Reforms Urgent

All public sector pension plans, either in Ireland or Canada, work the same way. They are based on final salary. They are not true pensions but a guaranteed payment of income in retirement. A public sector employee is guaranteed an income in retirement based on 70% of their final working salary or wage. This income replacement is guaranteed for life and guaranteed to increase every year.

The cost to all taxpayers of these plans is unsustainable.

In Ireland the cost of the public sector wage and pension package is over 50% of all government expenses. In Canada it is higher than 50%. For every tax dollar paid over half of it goes to pay for wages and pensions of public sector workers. The pay is 35% higher in the public sector compared to the private sector and the public sector employee retires with a retirement income equivalent to a million dollar retirement fund.

The same basics apply to public sector pensions in Ireland and Canada. In fact, most public sector pensions around the world work the same way. What is needed is a complete overhaul of the system. The IBEC recommends a series of reforms.

* New entrants into the public sector should be entitled to the same type of pensions as most of the private sector that is defined benefit plans. Not guaranteed final salary plans. The taxpayer in the private sector only collects what will be in his savings plan at retirement but the public sector has their continuing income plan guaranteed by the taxpayer.

* Ending the pay parity link, where public servants are guaranteed pensions based on the ongoing salary of the job they held. Most public sector employees earn their highest levels of income in the past few years. This is what the guaranteed retirement income is based on. Check the sidebar in this blog for the Sunshine List. This is the list of all public sector workers in Ontario earning more than $100,000 per year. All of the employees on this list will earn 70% of this income in retirement.

* The government should set a contribution rate cap after which employees would fund liabilities on an equal basis. In Canada the true cost to fund these plans is about 30% of income. Most public sector employees contribute only 8% or 9%, you the taxpayer contribute the rest. As a private sector worker the most you can contribute into your retirement plan is 18%. Most Canadians contribute only about 5% into and RRSP.

* All public servants should contribute to the costs of funding benefits. The employee benefits paid to the public sector are far an above what is paid in the private sector. Taxpayers fund most of this.

These reforms are included in the article in the link above. The rest of this news article shows the determination with which the public sector will defend their gold-plated pensions and benefits.

Bill Tufts

St John NB Pension Problems

St John has been dealing with some issues in its city employee pension plan.

Taxpayers are concerned that despite increasing tax rates the quality of services provided from the city are falling. One of the areas of city spending that requires constant increases is the city pension. As a result of some investigations by a city councilperson some pension irregularities were identified. The pensions irregularities were a very small part of the problem with St John pensions.

Problem with pensions
The real problem with the pension is the very nature of public sector pensions. As cited in Global Economic Trend Analysis there are several reasons these pension are not sustainable. Basically in a nutshell, they are too generous in what they offer to public sector employees.

Many governments and businesses around the world are fighting to control the cost of pensions. We have seen the effect of huge legacy costs and their impact on business. Many large businesses that offer these types of pensions are staggering under the weight of their pension obligations.

The pensions in the private sector pale against public sector pensions. Recently the mayor of the city of New York called for pension reform. Michael Bloomberg in his comments on government pension reform stated that: "The Big Three automakers offer some of the best pension plans in the private sector, yet even they cannot match the generosity of New York state government (all public pensions are the same from Alberta to Zimbabwe). And Detroit's expensive pension plans are part of the reason why the automakers are teetering on bankruptcy and pleading for a bailout in Washington."

Two types of pensions
One of the issues that makes pensions difficult to understand is the ways in which income is received from pensions.

Most Canadians save over their working career into a plan and what ever is in the plan at retirement becomes their retirement income. They draw down on the savings over the course of their retirement years. A public sector pension works on a completely different concept. It guarantees a certain level of income in retirement. These are two quite different types of pensions.

Definition - Pension
The Oxford dictionary gives two definitions of pensions. It describes the differences in the two plans well.
1) a regular payment made by a government to people above a specified age... or to such a person's surviving dependents - Public Sector pensions
2) a regular payment from a fund to which the recipient has contributed - private sector pensions - Private Sector pensions

As a result of the different concepts pension apartheid is created. The public sector pension is designed to provide pensions based on 70% of income at retirement. A private sector pensions will payout based on what is in the fund at retirement, usually substantially less. But the taxpayer funds them both.

Most taxpayers fund more into public sector employee plans than they fund into their own. Fair Taxes Now estimates that the city contributes over 14.5% of salary into city worker's pension plans. In the St John plan employees add another 8% to the city contribution. This 23.5% is still short of the true 30% that is needed.

The limit in the private sector is 18% and most Canadians put less than 5% into their RRSP plans. These huge gaps between the public and private sector pensions create the pension apartheid.

The CD Howe report A Pension in Every Pot shows the impact of the two different ways of calculating "pensions".

Two Pension Families, Two Results

* A typical private sector worker family retires with a fund valued at $ 255,000

* A typical public sector worker family retires with a fund valued in excess of $ 1,200,000

Unfairness of the system
It is unfair to ask the taxpayer to fund into a public sector gold-plated pension plan when their's will be considerably less than gold-plated.

The CFIB produced a report called the Pension Predicament and the conclusion of the report is that "Canada’s pension predicament is one of fairness between the public sector and the private sector...There is no valid reason why Canadian taxpayers are on the hook for public sector pension plans when in fact half of the Canadians working in the private sector will not even benefit from any private pension plan upon retirement. The unfairness has gone on long enough."

Other problems in St John
Part of the allegations against the pension plan is St John is that the pension plan was used to deal with long term disability cases within the city. If this happened it would be highly irregular and should be investigated or audited.

Part of the problem with public pensions is that the people who are entrusted with making the decisions about them usually have a vested interest because they will be paid a pension themselves. It is my opinion that if the taxpayers is paying over 70% of the bill for the pension they should have equal representation on the board of trustees of any pension plan.

Without proper checks and balances in place governments are free to negotiate with public sector unions without any accountability to the people they represent. For example, the provincial government recently negotiated that taxpayers fund an additional $131 million into provincial public sector pension plans. This was done without any consultation with taxpayer groups or general public consultation. The government justified this because of poor market performance last year. Was this decision made by members of the provincial pension plan? How much did they fund into your retirement plan?

Recommendations for public pension plans

1) Regular forensic audits - these should be conducted in addition to the regular every three year actuarial report which shows the funding in the plan. The audit should check such things as compensation paid to plan advisors, conflict of interest issues of trustee advisors, use of pension funds against unapproved uses

2) Trustee committees should be representative of the groups funding them. If they are totally funded by employees, then very well have plan member trustees but if the taxpayer is funding them then the taxpayer should be entitled to representation

3) Many jurisdictions around the world disclose the value of pensions being received by plan members. These are set up similar to the public disclosure for salaries for public servants.

Bill Tufts

Public Sector Reform Will Be Tough

The people, not the public sector, are sovereign - Independent of Ireland

At a time when all Canadians are feeling the effects of our current economic situation governments seem reluctant to contribute to our economic recovery.

It is not unrealistic to expect that cutbacks, layoffs and salary reductions should be shared by the public sector. Despite the belief by most taxpayers that changes are necessary, making any substantial changes to government spending seems an impossible task.

There are a couple of good examples of attempts made by governments to control their costs and give taxpayers a break. One of them is the City of St John NB and the other is the country of Ireland.

In St John city spending has been highlighted by a pension issues that has caused grief for taxpayers. You can follow the saga in the link on the sidebar.

Totten gives council what it's looking for

In Ireland the initiative to cut back government spending was as a result of several initiatives over the past few years. A major one was the benchmarking of the public sector to the private sector. The results were the start of bringing public sector benefits and wages back to the level of those in the private sector.
Ireland Public Sector Benchmark Report

The report lead to announcements this week of actual plans for controlling the cost of the public sector.
We Have No Option

Lets hope that these efforts are the start by all levels of government to control government spending and share in the pain to be felt by all taxpayers this year.

Bill Tufts

Pension Storms All Around Us

Sadly pensions have become top news in many newspapers, government offices and coffee shops. The discussions are around the recent meltdown in value of these plans and the potential implications this crisis has for retirees.

The talk is mainly of defined benefit pensions. Those are pensions that guarantee the retiree a continued stream of income after they retire. These pensions exist for almost all public sector employees and a few private sector employees, mainly large ones.

These types of plans are in trouble for several reasons.

The promises made by defined benefit plans are unsustainable. They began in the 1960's when there were more than 10 workers for every retiree. Within a few short years there will only be 4 workers for each retiree.

The amount of money required to fund into these plans is a huge burden on all levels of government. The CD Howe Institute estimates that 30% of salary needs to be contributed into these plans. A typical retiree will retire with a pension fund value close to $1,000,000.

The recent performance on the stock markets has caused the vale of many of these plans to collapse. In the coming few weeks sound of discussions about pensions will rise into a roar heard across the country and the world.

There is a simple solutions to the problems we will be seeing. Public sector pensions need to be reformed. It will be a very difficult battle to reform these pensions. The public sector unions have billions of dollars at risk.

Over the past few weeks I have been following a debate about pensions in St John NB. The history of the debate can be followed at the sidebar with the terrific editorial cartoon. Check for my letters printed in the Telegraph Journal.

Thanks for checking out my blog. Any comments you have for me would be greatly appreciated.

Bill Tufts

The Challenges of Restructuring the Costs of the Public Sector

Public Pensions have toppled and society needs to reassemble pensions for employees in the public sector. The next largest cost associated with government is the cost of benefits.

Costs of running government pensions and benefits plans are no longer sustainable. The problems that have been created as a result of trying to sustain an unsustainable system are problems that will potentially topple all of our society. It needs to be restructured but how?

Politicians are the ones who will have to change the rules that govern how our public sector pension plans. It is a difficult task that cannot be done over night but must begin now.

For politicians the task will be daunting. Part of the problem is that the system is very hard to understand and it is guarded by a public service very protective of their entitlements. Politicians cannot get the perspective and information that they need in order to make informed decisions about the changes that are needed.

Some tools in the form of reports have been created by Canada's economic think tanks and business lobby groups. Many of these policy reports are very informative and contain the information politicians need to change the system but they are too detailed for he average person. The reports are written by professionals who have a technical insight into the problems and can explain them but describe them in technical terms. These technical terms can be very confusing for the non-expert.

Most of these report contain very broad policy statements about the problem and have identified the problem but do not provide the specific details needed to proceed with changes.

What I will attempt to do here is to define the problem and make it easy for the non-expert to understand.

Issues

The Cost of Pensions and Benefits

For most of our government organizations the single biggest cost of operating expenses is the wages, benefits and pensions packages. These costs vary at different types of government operations. But for all of them the single biggest expense they have is the compensation package.

City Hall - The costs of the compensation package for City Hall is usually close to 50% of total operating expenses. This makes it the single largest expense item.

Hospitals - For most hospitals the compensation package is %60 to 70% of total expenses.

Universities - The cost to Universities of the compensation package is in the 60% range

School Boards - For School Boards the compensation package accounts for over 75% of total expenses.


Benefits
Benefits are an associated cost of hiring the public sector. The include the typical health and dental benefits but also have a component that makes them difficult to understand in unpaid benefits and future liability benefits.

In order to find ways to save money the best comparison is usually to be found by contrasting the public sector against the private sector. A benchmark comparison with other government organizations will not provide a realistic analysis because the benefits negotiated have already been negotiated against other government groups' settlements.

The CFIB in their report Wage Watch found for example a difference in compensation between the Federal Government and the private sector of 41.7%. This means that the federal government pays a compensation package 41.7% richer than the private sector. Some of this is salary (17.3%)but the biggest portion is for pensions and benefits.

Some of the benefit differences that account for the wide variation between the public sector and the private sector are:

Paid Working Hours - Usually the work week within the public sector is shorter than the private sector. Compare a average 34 work week in the public sector with a private industry standard of 40.4 hours.

Paid Vacation - The vacation time off negotiated by public sector unions far outstrips the private sector. For example at the City of Hamilton ...

Paid Sick Days - The standard in the private industry is if needed you are able to take sick days. Sick days are allocated on an annal basis and if not used are not carried over. In the public sector these days are actually paid. They are also carried over to the next year. They accumulate by the concept that if you don't use them this year they accumulate at a full days pay rate. They can then be carried into the next year. If not used for the next year they can be accumulated and carried forward again. The cumulative effect of this policy is that many public sector workers have a large accumulation of these days paid out to them at retirement. Find out from your Human Resources department what some of the payouts for accumulated sick days have been.

For example: The City of Hamilton has built up an accumulation of these days payable to employees of over $36,000,000 dollars. This is the equivalent of a one time 4% tax hike.

Retirement or Retiree Benefits - These benefits are paid to retirees who have not yet reached the age of 65. The benefits are very generous compared to the working benefits of the private sector. Most private businesses provide very limited and basic retiree benefits. By bringing in line the level of these benefits substantial cost savings can be obtained.

For example: The City of Hamilton offers retiree benefits that have accumulated a liability of over $ 84,000,000.

Welcome to 2009 - Many Challenges to Come

The past year provided a gut-wrenching sequence of events that will have extreme consequences for 2009. Leo Kolivakis in his Pension Pulse provided and excellent recap of 2008. He also highlights some of the potential implications of last year's events for pensions in this coming year.

One of the first challenges of the year will be to find ways to drive the Canadian economy in a period of serious recession, if not depression. All governments have come together under the mantra of more spending to stimulate the economy. This means choosing which groups in society will be chosen for bailing out. Unfortunately it will be those sectors of our society with the most cohesive and powerful political voices who will prevail.

We will see a melt down in the value of our countries pension plans based on the results of equity performance in 2008. If predictions of further troubles in commercial real estate and private equity come true, the losses will be even greater. This will mean some tough choices for the countries policy makers on what to do about pensions and retirement for Canada's Babyboomers. Recently they have been started to be called Zoomers.

As the value of the SP/TSX capitulated 35% this year, most Canadians have seen a substantial loss in their retirement savings plans. The public sector on the other hand are anticipating increasing their wages and pensions 3% to 4% this year. It is expected that growth in the Canadian economy will be negative. Many businesses have already implemented hiring freezes, unpaid days of leave and reductions in benefits to control costs.

The public sector gives themselves a raise while the private sector shrinks and the taxpayers fund it all.

There will be huge losses on Canadian pension plans this year. To check out how bad it will be see the list of equities invested by the Ontario Teachers Plan and check the stock performance at Google Finance. You can see the billions that have been lost on the equity portion of the plan. Like the dozens of other public sector plans in Canada this will be a tough year. But they do not have to worry as the pensions are "back-stopped" by the taxpayer. That means you will pick up any shortfall in the value of these funds. You need to ask your politician who will "back-stop" your pension?

Value of Pensions
One concept that most Canadians cannot understand is the value of a public sector pension.

Most Canadians have some idea of how a pension works. You save money while you are working and then draw down on it in retirement to provide you with income. However, a public sector pension does not work like this. This type of pension guarantees a continuing stream of income into retirement based on the your income at retirement. These income streams usually start after 35 working years although some exist that begin after 30 years. Of course they are indexed, meaning they automatically increase every year.

These pensions are designed to provide 70% of income retirement salary. for example this year it was announced that an elementary school teacher will earn over $90,000 at the highest level. This equates to a retirement income of almost $ 63,000. In order to provide this level of retirement a pension value over $1,000,00 is required. Yet the taxpayers funding this retirement will not have anything near this amount saved for their retirement.

Time for a Change
In 2008 there was some recognition of the problems in our retirement programs in Canada. The CFIB (Canadian Federation of Independent Business) and CD Howe Institute produced some research papers on pensions and retirement. The Canadian the press was slow to pick up on the issues but by years end many articles were being written about some of the challenges.

The trend towards recognition of the problems will continue this year and hopefully be drawn more into the public forum.

One promising trend for the reform of our system is that usually pension issues are discussed in Europe first and migrate across he big pond to Canada. Last year it was France in the spotlight e where Sarkozy was elected on an agenda of public sector reform. We saw fiery riots in Greece initially started by pension reform. In Thailand the public sector shut down the economy, after a reform government was elected, and shut down the country until finally the government was overthrown.

Currently in the UK the pension and public sector reform issue is front and center. This had been triggered by huge pension shortfalls and recognition of the cost of the public sector. Talk has begun on ending pension apartheid, as it is known as the cost of the public sector threatens to swamp the economy.

Why is Reform Needed?
A fair chance for retirement is needed for all Canadians. The level of taxation in Canada has risen to the point that most will never be able to save for their own retirement. Despite this fact, taxpayers are forced to fund gold-plated pensions for the public sector.

Awaiting with interest the New Year,
Bill Tufts