How Promises Are and Are Not Kept

13Apr/102

How Promises Are and Are Not Kept

I used to work for TIAA-CREF, a non-profit corporation that runs pension plans for many universities. The original, core product of TIAA was a fixed annuity that one would contribute to while working [employer and employee], and then receive lifetime payouts in retirement.

The way these promises were kept over the decades is the way most long-term [and short-term] insurance works: reserves backing the promises are built up, where one values the reserves somewhat conservatively [for annuities, that means low interest rates and longer lives], and on top of that, the company needs to hold capital to provide protection from variations in experience. Various state departments of insurance oversee these valuations [TIAA is based in NY, and the NYS DOI is one of the most stringent out there on financial protection].

Should any insurance company become insolvent, the state DOI takes it over, sometimes transferring assets and liabilities to a different insurance company, sometimes having the liabilities and assets transferred to a state guaranty fund. Think of it as an FDIC for insurance companies. The allowable "fundedness" of an insurance company [ratio of assets to liabilities] is well over 100%. Reserves alone are definitely not enough. The assets backing reserves have a lot of restrictions as well in terms of allowable quality.

It is possible that policyholders might have to take something a bit less than originally expected, but if the state steps in before complete meltdown, there can be a good chance of being made whole.

Likewise, private pensions covered by ERISA have valuation and funding requirements. These are somewhat less conservative than valuation standards for annuities [understatement]. They have a few asset restrictions, I believe, in terms of how much own company stock can be in the plans, but unlike insurance companies, they're not required to have their portfolios be almost all fixed-income assets.

The fundedness requirement? Oh, surely you jest. The fundedness level is not allowed to go much over 100%, due to tax reasons. Anything between 80% and 100% is considered good. If you fall below 65%, the plan is taken over [usually]. These pensions can be offloaded in bankruptcy in a variety of means, but the FDIC/guaranty behind defined-benefit pensions are from the PBGC [Pensions Benefit Guaranty Corp]. Now, the PBGC caps the maximum pension, which is why in these plans the members keep a wary eye on both the fundedness of their plan and the financial strength of their company. Many current pensioners of bankrupt companies and plans are getting far less than they expected.

So far, so good: to pay for promises made for the future, there are a variety of requirements to make sure they are on track to actually being paid, and when that fails, there are these backstops where you might get less than originally expected, but it's not zero.

These do not apply either for multi-employer pension plans or public pension plans. They are not covered by the PBGC, public pension plans have absolutely no funding requirement [unless state statute specifies, but most states do not], and I'm not sure about MEPs, but looking at the fundedness levels of a lot of them, I don't see that they have any minimum requirement either. For MEPs, I believe there may be a cap on max level [for tax reasons], but that would be about it.

I will leave the MEPs for now. Let's look at public pension plans -- what happens when one of those fail due to underfunding? One can blame crappy investments or crazy benefit structures, but the heart of the problem is that not enough money was set aside to cover the promises at the time they were made. There are no rules at all to how much states need to contribute to fund their plans each year -- and the states that have written such laws have also opportunistically passed new laws to skip those payments at the very time when the funds are at their worst level.

When there's not enough money to back up these promises, why did the public unions think that their benefits were secure?

[more to come]

UPDATE: I asked some pension actuaries to correct any of my above statements, and I got the following information:

- Multiemployer plans are indeed covered by the PBGC, but they max out at a much lower benefit level. More here: CBO testimony on MEPs -- it's a little dated [2005] in terms of the maxima, but you get an idea of how they compare - max of $46K for single-life pension at age 65 vs. $13K.

- MEPs evidently have certain fundedness requirements. Here's their definition of an MEP insolvency from the above link:

A multiemployer plan is considered insolvent if, in a given year, it does not have sufficient funds on hand to pay promised benefits in that year.

Interesting definition for plans with such long-term promises. That's a much looser definition than single-employer plans.

- There are no fundedness maxima in terms of legality, but there are limits to what is tax deductible as a contribution to the plans. Obviously, most employers, whether public or private, don't have much interest in contributing beyond the level of that which is tax-deductible.

Meep

Meep is a member of the Irish Catholic mafia, having a suspiciously high number of green-eyed, red-haired friends. While she doesn’t have red hair herself [except when she goes into the sun (rare for any vampire)], she does have green eyes. She’s a raving Papist and is a life actuary on the side [i.e., she counts dead people]. An amateur pain-in-the-ass [willing to go pro!], she likes covering retirement, mortality, math, and education issues.