Tag Archives: Unfunded Liability

Pension Reform Should Not Focus On All-Or-None Solutions

Remember the good ole’ days when retirement planning for most Americans involved income being illustrated as a three-legged stool where the legs of the stool represented 1) income from a pension, 2) Social Security, and 3) personal savings? The thought was that as long as the stool has three legs it will be strong enough to support the person sitting on it. Take one of those legs away, and the stool becomes much less stable. Take two of the legs away and you end up on your back.

So why is it that every time I read about pension reform the proposed solution is always an all-or-none scenario where the pension will be shut down in favor of individual 401(k) accounts? This solution completely removes one leg of the stool (the pension) and reduces the retirement readiness for everyone affected. At LAGERS, we believe everyone who works hard and plays by the rules deserves a secure retirement and that this is best achieved by the three-legged stool approach.

When 401(k)s were first conceived in the late 1970’s, they were never intended to replace pensions, but to supplement the pension plan while allowing employees to defer taxable income. This was originally a great concept – one that furthered the notion of the three-legged stool. But over time, employers have eliminated their pensions and gone completely to the 401(k). The supplement has now become the main retirement income vehicle for many Americans. And it isn’t working. Even if their employer offers a 401(k), two-thirds of Americans aren’t using it to save for retirement.

One of the reasons Americans aren’t saving more is because investing as an individual is hard. Nearly seven of ten Americans cannot pass a basic financial literacy test. The average American worker is just not equipped to know how much to invest, what to invest in, when to re-allocate, and then how to turn their savings into a lifetime stream of income. Also, many Americans simply don’t have the means to go-it-alone in 401(k) accounts. The recommended retirement savings rate for an individual without a pension plan is north of 10% of income. For low-to-middle income workers, this is a daunting, if not impossible task. Pension funds, on the other hand, are invested by professionals and benefit from pooling so that one individual is not taking on all of the market risks.

Watch: Pension vs. 401(k), What’s the Difference?

One argument for moving away from pension plans in favor of 401(k)s is that the individual accounts cannot create unfunded liabilities. This couldn’t be further from the truth. Both pension plans and 401(k)s can create unfunded liabilities. An unfunded liability is established when liabilities exceed assets. In other words, the money you owe is more than the money you have on hand. The presence of an unfunded liability is not necessarily a problem so long as there is a steady, predictable, and disciplined approach to making the required contributions. Individual savers create unfunded liabilities when they fail to save enough for their retirement. When more and more individuals enter into retirement without adequate savings and huge personal unfunded liabilities their only option to sustain themselves in retirement will be to seek public assistance.

The bottom line is this: we need pensions and we need 401(k)s (and similar programs). We should not be seeking solutions that eliminate any one leg of the stool, but rather, to make those legs work together to provide a more stable base for all Americans.

 

Jeff Kempker
Manager of Member Services

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The Unfunded Liability Nobody is Talking About

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You hear a lot in the news these days about the looming pension crisis and their mounting unfunded liabilities. When I try to imagine how I would react to these headlines if I did not work in the retirement industry, I imagine that the phrase ‘unfunded liability’ would sound absolutely terrifying, and that if I ever heard that phrase being thrown around when it came to my employers’ retirement plan, I would be concerned. At that point I would probably do what any normal person would do when they hear about something this scary: I’d Google it.

So this morning, I decided to do a little experiment: I typed ‘unfunded liability’ into my trusty search engine just to see what would come up, and the results were undoubtedly alarming. Headlines reading: “Unfunded public pension liabilities near $5.6 trillion”; “How pensions pass the buck to future generation”; and “$60 billion unfunded liability looms over Pa. as lawmakers move toward pension vote” were just the beginning of a laundry list of stories listed on the topic.

Now to be clear, I believe that every pension plan should have sound plan design with a solid funding policy, so that, like LAGERS (and many other well-run pensions across the county), the promised benefits are fully funded today and plan participants can go to work and retire with the peace of mind in knowing that their retirement will be secure. Pension plans that are not doing this should be fixed. But what I found most disturbing about my search was that in all the results that popped up about unfunded liabilities, there appeared to be one major unfunded liability that nobody is talking about….yours.

‘My unfunded liability?’ you may ask. ‘I don’t have an unfunded liability.’  And that is where many of you would be mistaken. Like most Americans, you are probably planning to retire at some point in your life – either at a time of your choosing or perhaps for reasons beyond your control, such as failing health.  And when that time comes, you’re going to need to have income to live off of for the rest of your life.

In order to be able to quit working or to reduce your work hours in retirement, you need to be saving every month to ensure your nest egg will be large enough to sustain you for the rest of your life. Savers (especially those without pensions) who fail to set aside enough money each month for their retirement are creating a huge personal unfunded liability – a gap between how much they have saved and how much they will need in retirement.

According to the National Institute on Retirement Security, 45% of American households do not own any type of retirement account, with a disproportionately large number of low-income households saving nothing for retirement. Even more shocking, of households that do have retirement savings accounts, the average balance for individuals nearing retirement (age 55-64) is a mere $104,000; and if we included the households that are saving nothing, that average drops to just $14,500 saved by those who are at the doorstep of retirement.

This means that most Americans will be facing their own unfunded liabilities at retirement, and that presents a big problem. If I’m an average saver with $104,000 and I need to draw out $1300/ month to survive in retirement, my savings would not last 7 years…and that’s not even taking into account inflation or any unplanned expenses (such as a big medical bill). If I live 20 years into retirement, I need to have saved at least $312,000; and if I live 30 years, I better have $468,000 in the bank. Since I only have $104,000, I have a personal unfunded liability of over $360,000. While granted, my math is simplified, take that average times the estimated 80 million people who will be retiring over the next twenty years and you get upwards of 30 trillion dollars in unfunded liabilities in Americans’ personal defined contribution accounts.

I can’t help but think to myself, “What is going to happen when these folks can no longer work? What are they going to do when they cannot afford to retire?” As we usher out the era of private pensions, what is going to happen as more and more individuals enter retirement without adequate savings and with a huge personal unfunded liability? What is going to happen when they lose their home because they can’t make the mortgage payment, or go without food to be able to afford their medication? As a society and as taxpayers, what are we going to do?

It seems to me that many are suggesting that the solution to these pensions’ unfunded liabilities is to replace them with even bigger personal unfunded liabilities by forcing people to plan for retirement on their own. Pensions that have sound plan design and solid funding policies work, and they work well. They don’t pass cost onto future taxpayers because the liabilities (benefits) are prefunded, and participants can take advantage of longevity risk pooling and professionally managed investments. And while LAGERS members receive only a modest monthly benefit that often still requires some additional personal savings, their pension is the foundation of their retirement security, and it’s one they can count on.

The switch from pensions to defined contributions plans (e.g. 401(k)s) may indeed seem like a simple fix to all the mounting pension headlines, but until we start quantifying the unfunded liabilities in individual retirement plans, many Americans are going to be in for a big surprise when they are ready, but cannot afford to retire.

Elizabeth Althoff Communications Specialist

Elizabeth Althoff
Communications Specialist

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Changes are Coming, But Your Benefit is as Secure as Ever

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If you haven’t already, you may begin to hear about new accounting standards required of employers that participate in LAGERS.  These standards may make some LAGERS employers look worse off when it comes to their LAGERS pensions – even if they’re not. The important thing to remember is the only thing that is changing is the reporting and measurement of pension costs, not how much a pension costs.

As these new standards take effect, here are four important facts to remember:

  1. Neither actual pension costs nor obligations have changed, only the way in which they are measured and reported. The Governmental Accounting Standards Board (GASB) is the entity that sets such standards.  Historically, GASB standards have always held a close link between accounting and funding measures. As the new standards are implemented, accounting and funding measures will become disconnected.

 

  1. Some LAGERS employers may appear to be more under-funded as a result of these new standards, even if they’re not. One reason for this is that LAGERS-participating employers will now have to publish future pension obligations on their balance sheets.  For some employers, this will show up as a liability.  Pension liabilities have always been fully reported and transparent, but placing them on the balance sheets will make them more visible than before.  In addition, GASB now says that some employers may have to use a different discount rate to determine pension liabilities in today’s dollars.   In the past, pensions have calculated liabilities using the long-term expected rate of return on pension plan investments.  While most LAGERS employers will not be in this position, a few may have to discount at least a portion of liabilities using the municipal bond rate.  Since the municipal bond rate is lower than the long-term expected rate of return, this could make some participating employer pensions appear more underfunded than before.

 

  1. Benefits for employees and retirees are still as secure as they have ever been. LAGERS has a 50 year history of sound, structured, stable funding procedures.  These new GASB accounting standards will not affect any of that.  Retirees will continue to be paid on-time, each month and members can expect their earned benefits to be fully paid for without interruption.

 

  1. LAGERS employers will not have to pay more for their benefits. LAGERS participating employers diligently pay their full bill each and every month.  This will continue, as normal, with no changes whatsoever in this process.  LAGERS will be providing new reports for employers to comply with the GASB standards in the Fall of each year and employers will work with their auditors to comply, but the month-to-month funding mechanisms and calculation of employer contributions will remain in place.

Initially the new GASB standards may cause some headaches for participating employers.  But we will be here every step of the way to help.  LAGERS has set up a page dedicated to GASB on our web site. Employers can refer to this page for updated information on resources that are available regarding these changes.

 

Jeff Kempker, RPA, CRC

Jeff Kempker
Manager of Member Services

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HOW TO MAKE AN UNFUNDED LIABILITY DISAPPEAR

Dock, Beach, Ocean

 

Rolla Municipal Utilities wanted to improve the benefit package for its workers in an effort to help recruit and retain quality employees.  So in 2008, the board of RMU decided to enhance LAGERS benefits to the 2% multiplier.

“In 2008 we had a very well-funded plan, another reason it made the change a little easier at that time was the fact that we were slightly overfunded,” said Rodney Bourne, General Manager of RMU.

Being overfunded basically means that RMU had completely paid off its unfunded liability and, at that time, had slightly higher assets in LAGERS than it had liabilities for retirement benefits.  But that all changed when the recession hit later that same year.

“In the combination of changing plans and the markets going down, we went from being slightly overfunded to significantly underfunded in a matter of two

Rodney Bourne

Rodney Bourne

years,” Rodney said.  “A lot of that was attributed to the markets.”

RMU again had an unfunded liability.  And even though LAGERS provides a sound, structured method to pay of this liability, RMU had other plans.

“We knew the markets, over time, would recover but what we chose to do is to make additional payments toward our unfunded accrued liability to help in that recovery,” said Rodney.

So in 2010, RMU decided to make monthly payments to LAGERS, in addition to its normal contributions, until it was once again fully funded.

“Our goal is to again be 100% funded.  With the markets coming back slowly and our additional contributions, we’ve been able to recover back to 90% funded in 2014,” Rodney said.  “So now we’re at a funded status that looks a lot better and that has reduced our monthly contribution rate.”

LAGERS proven process for funding benefits isn’t broken.  As participating employers make their required monthly contribution, their liabilities are paid for over a pre-determined time frame, very similar to the way that a house is funded through a mortgage.

However, some employers, such as RMU, believe funding this obligation faster is a good business practice and one that takes some planning.

“You need to take a steady approach and think about how LAGERS is going to perform,” Rodney said.  “[LAGERS] performance on our investments has been outstanding.  So we were confident between the markets improving, the performance of LAGERS and making these additional contributions that we could achieve our goal of recovery in five to 10 years.”

RMU believes that by taking these steps, they are demonstrating that they take their employees’ retirement security seriously.

“We could have let it languish, each year it coming up a couple percent and it would have slowly recovered.  But we became very proactive and wanted to let our staff know that bringing that funded percentage back up to where we think it should be is very important,” said Rodney.

But it doesn’t stop there.  RMU is serious about customer service as well.  And providing good benefits to help attract and retain quality workers ultimately will reflect in the quality of service the utility provides.

“It takes our employees a long time to develop the skills necessary to do the work and to do it safely,” Rodney said.  “We’re serving our citizens every day.”

 

Jeff Kempker, RPA, CRC

Jeff Kempker
Manager of Member Services

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