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Pensions have become an increasingly talked about topic of late. With bankruptcies of cities, and most notably of Detroit, it is unsure whether people who worked their entire lives with the promise of a retirement will actually receive such. The trick with pensions is how does a company or city adequately plan for retirement costs decades into the future?
The process of determining the impact pensions will have has been flawed in almost every sector and industry. At different times, everyone from governments to automakers have had their difficulties maintaining a healthy balance sheet because of their pension promises. As of just this past year public pensions are underfunded by close to $1 trillion. Private companies for the most part have begun to move away from pensions for what appears to be obvious reasons. You are still able to find remnants of the old pension system, mostly in the manufacturing sector, where employees are promised that the company will take care of them when they are done working. As of two years ago the S&P 500 found that of the 338 companies that have defined-benefit pension plans, only 18 are funded completely.
Why have pensions spiraled so out of control? Pensions offer an interesting intersection between social factors and economics and because of this they operate in the section of behavioral economics. Pensions provided a great tool for management and unions to bargain with. Management was able to use it to sweeten collective bargaining deals with no real accountability. These pensions were to be paid decades in the future when the management teams probably would be in their own retirement by then. In a sense it kicked the can down the road so that today business could go as usual.
For many of the same reasons union bosses latched on to pensions as well. Obtaining lucrative retirement packages to take back to its members certainly made them happy and allowed the ones who struck the deal to proudly proclaim their victory. The issue arises when those pensions actually become due. The financial crisis of 2008 only magnified the problem pensions were in. Many of the funds used to pay pensions are based on investment methods where the interest is designed to cover the future payments. When stock markets tumbled it put many companies who were close to being adequately funded into the red and those already in the red were driven to even deeper depths.
These reasons are a big part of what drove many companies into chapter 11 bankruptcy and people’s entire retirement packages were wiped out. This has now spread to municipalities who find themselves with no conceivable way to pay their obligations and as a result are forced to declare bankruptcy in an attempt to try to alleviate their balance sheets. Previously mentioned, Detroit has been the biggest city to declare bankruptcy in the hopes of alleviating the crushing burden of their pension liabilities. This very well could be the final blow to pensions as we know them. New companies are avoiding benefit plans for contribution plans and that seems to be where all retirement savings are heading. The economics of defined benefit plans have not been successful of late and seem to be headed for extinction.
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