Tom Curtis: Senator Schuring promises to protect retirees
Subject: 100209 Discussion With Sen Kirk Schuring
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Our nation's public pension and retiree medical benefits plans are facing a financial crisis unseen in this generation. Stock market losses in 2008 have reduced the funding ratios of the pension funds from 85 percent to about 70 percent. The remaining time to return them to full funding before baby boomers retire is getting shorter by the day. Retiree medical plans (known as OPEB for "other post-employment benefits") are in worse condition, almost entirely unfunded, because nobody ever bothered to set them up right in the first place. In many states, the cost of proper funding will be a 30 percent to 50 percent increase in pension and OPEB contributions in the next three years. In several states, the annual tab will double — at least.
Regardless of political ideology, most public policymakers agree that, given the current financial squeeze, something needs to change. Typically, those who seek to reform these systems begin with new employees, because they are invisible. Over the coming decades, younger workers are likely to receive lower benefits than current employees. But what about incumbent employees? Shouldn't they share some of the load?
Here it gets tricky for public managers. The law is pretty clear in most states: You can't reduce pension benefits of retirees. And in most states, a similar rule applies to the previously earned benefits of incumbent employees: They are entitled to what they have already earned for past service. It's a property right, especially for those who have achieved vesting status. But with respect to their future work and the compensation employees receive for their services in 2010 and later, there are vast interstate and ideological differences of opinion about legal rights as well as basic principles of fairness.
It gets even murkier when the focus shifts from pensions (which sometimes are constitutionally protected) to OPEB retiree medical benefits, which some states view as "subject to appropriation" — which means that elected officials could change their minds any time in the future, at least in theory. In fact, over half of the states have never bothered to create the legal structures necessary to properly fund retiree medical benefits, which adds to the argument of those who suggest that these benefits could be discontinued by an act of the employer and certainly could be discontinued with respect to unvested employees.
How can benefits be guaranteed by a previous legislature that never even bothered to set up a trust fund requirement to back up its promises? If a court were to hold that the legislature mandated those unfunded benefits for incumbents as a matter of law, but failed to provide the essential trust funding mechanism necessary to assure proper financing, then local governments should be able to sue the state for the unfunded mandate and a defect of statutory design.
Public managers now face a true dilemma as they seek to reduce retirement plan costs. If they only change the benefits plan for new employees, they produce very slim cost reductions in the next five years. Until these "new" employees become a significant portion of the workforce and aging baby boomers head off to pasture, the actuarial reductions will be minor in comparison to the swelling costs of providing current benefits to incumbent employees. But changing benefits for older workers — even for their future service — is a hot potato. In some states, the attorney general has ruled that it's off limits. The theory is that the benefits plan was part of the original wage bargain, sort of a social compact in the spirit of Rousseau and Hobbes. And at the very least, it is almost impossible to cut back benefits that are covered by a union contract until that contract expires.
So, what are the options for public managers and elected leaders seeking to rebalance their budgets and their governments' long-term capacity to pay benefits for retirement? The path of least resistance in many cases will be to bargain for or impose higher employee contributions. This strategy leaves the benefits for incumbents intact, but requires them to pay a fair share of the costs. I've written before about this strategy in a prior column and won't belabor the details here. Many would argue that this is actually the fairest solution because older workers typically earn more and will make greater contributions for benefits that they now value the most. A case could be made for age-based contribution rates that impose a higher percentage rate on older workers than younger workers, to reflect more accurately the higher value of their retirement benefits as they approach the age of eligibility. Actuaries can confirm that the cost and value of a defined benefit rise exponentially as retirement approaches, so age-based rates would align the senior employees' contributions with the increasing value of their higher benefit as it accrues in their later years.
If employees are unwilling to pay an increased share of the benefits, however, there is only one other way to balance the books actuarially without busting the budget: Change the earnings formula for work to be done in the future. Before heading down this path, however, public managers must brace for legal challenges and would be wise to first understand their state's constitutional and statutory environment with respect to retirement benefits for public employees. Then there is the issue of negotiating a benefits reduction for older workers when the union representatives usually are (you guessed it!) older workers. Then add to the mix the problem in many public agencies that the managerial people on the employer's bargaining team representing taxpayer concerns are (you guessed it!) older workers who would themselves have to eat whatever they cook at the bargaining table. So there are conflicts of perspective and even conflicts of interest to overcome.
Elected officials must take the lead here. I see countless examples of diligent, conscientious public finance professionals who already see the handwriting on the fiscal wall and try to present a rational case for plan reforms to elected officials — who want to simply wish away the problem by procrastinating. It's easier for politicians to pass the buck to the next generation. But in this case, the imminent rising costs of retirement benefits are about to hit the operating budget with hurricane-force winds during the terms of today's newly elected leaders. So it's time for some serious study sessions to discuss the options, understand the laws which apply and set strategy. Every newly elected official's orientation session should include a 20-minute introduction to the imminent retirement finance problems they face during their careers in public service.
One thing I can predict with certainty: Employers who fail to bill incumbent employees for part of the cost of their retiree medical plans before 2012 will regret their delays. That's because the U.S. Congress will inevitably raise the Medicare tax, as I have explained in a prior column.
Failure to act on the benefits and contributions of baby boom workers will allow tens of thousands of near-retirees to enjoy a free ride at the expense of future taxpayers and future employees. That's an outright slap in the face of intergenerational equity — and another burden we will leave to our grandchildren. If ever there were a time to take the proverbial bull by the horns, it would be now
TREASURY BONDS PROVIDE TRUE DIVERSIFICATION
This is a correction to my previous post resulting from reader feedback. The information corrected is in italics near the bottom.
The following has been written in response to the questions and comments I have received due to promoting a larger percentage of Treasury Bonds in the STRS asset allocation. It has been overly simplified to provide a basic understanding for those that have none.
Be aware that using Treasury Bonds as diversification in a portfolio requires substantial effort, especially if traded short term on the secondary markets, and becomes substantially more complex than described below. While reading the following, please keep in mind that supply and demand also effect the price fluctuation on the secondary market.
Most inexperienced investors know that the purchase of a Treasury Bond will pay the indicated interest rate until it matures.
However, the inexperienced investor is not usually aware or very knowledgeable with respect to the trading of Treasury Bonds on a secondary market and that their price fluctuates according to interest rates and demand.
For example, in early 2008, the interest rate for a 30 year Treasury Bond was approximately 4.50%.
The par value of the bond would have been $100.
Therefore, the purchaser would receive $4.50 per year on each $100 unit until maturity.
Bear in mind, that $4.50 is received no matter how future interest rates are adjusted. If interest rates go up to 6%, $4.50 is still received. If interest rates go down to 2%, $4.50 is still received.
On the secondary market where one could buy and sell Treasury Bonds, the price of a given bond is adjusted to reflect current interest rates according to its ORIGINAL CASH YIELD.
The price of the bond purchased at $100 yielding 4.5% will go up if the interest rates go down. It will go up so that the new interest rate matches the $4.50 that is received until maturity.
Therefore, after the September of 2008 CRASH, interest rates on the 30 year Treasury Bond fell to as low as 2.8%
If you sold your 4.5% yielding bond when the interest rate was 2.8%, the price would have reflected that you receive $4.50 in cash and would be adjusted so that the buyer would be receiving 2.8%.
Because it continues to pay $4.50 per $100, that would put the purchase price of the 4.50% bond mathematically at approximately $160. $160 times 2.8% equals $4.48
However, that premium of $60 would have to be distributed over the time period that it would take the bond to mature, and the actual selling price would be more in the neighborhood of $130-$135.
That would produce a profit of at least 30% while collecting a 4.5% return.
TREASURY BONDS NOT ONLY FUNCTION AS A SAFETY FACTOR, but will often appreciate to OFFSET LOSSES in RISK EQUITIES!
From Mario Iacone, October 1, 2009
Received the following comment with respect to the Treasury Bond Post.
“you did not indicate the decline in market value (depreciation) of the Treasury bond in your rise in interest rates to 6% example. Your readers probably need to know the market value of Treasury bonds can go both up and down”
I wish to clarify and elaborate.
A long term commitment was assumed although they can be traded short term to enhance the overall yield and take substantial profits.
Such would require building a ladder of bonds with additional purchases as rates go up. Assume a purchase at the rate of 4.5%.
Further assume that interest rates would begin to rise and continue to rise. For the sake of example, let’s assume rates rise to 6%.
One method of building a long term commitment would be to add to your bond purchases in equal amounts as rates rise. Purchase at 5%, 5.5%, and 6%.
Bear in mind, that the value of the original purchase at 4.5% has gone down because interest rates have gone up. But, with a long term approach, it would not be necessary to sell at a loss. The worst case scenario would be that you hold the bond until maturity when you will receive your original investment amount and received a return of 4.5% until that maturity date.
However, Treasury Bond rates have cycled on an average of 12 years. Remember, interest rates rose to 6%. When they come back down, say 4%, the value of that 4.5% bond will appreciate above your original purchase price. Should you choose to sell, a profit will be made on your original purchase price in addition to the 4.5% return while you held it.
Meanwhile, when the interest rate falls to 4%, the purchases made at 5%, 5.5%, and 6% would have gone up significantly in value because their interest rates are higher than the current rate of 4%.
WHAT’S MY POINT?
A consistent long term approach to Treasury Bonds can produce lucrative returns.
TREASURY BONDS NOT ONLY FUNCTION AS A SAFETY FACTOR, to STABILIZE ASSET ALLOCATION, but will also provide good returns and appreciate to OFFSET LOSSES in RISK EQUITIES!
(COLUMBUS, Ohio) – Ohio Attorney General Richard Cordray announced today that the Lead Plaintiff group in a securities class action lawsuit against Bank of America has filed a consolidated amended complaint. The complaint alleges that statements made in 2008 by Defendants regarding the Bank of America merger with Merrill Lynch failed to disclose billions of dollars in known losses at Merrill Lynch and Bank of America and billions more in accelerated agreed-upon bonuses to be paid to Merrill Lynch executives and employees.
“They were concealing billions of dollars in losses with one hand and clearing the way for extravagant bonus payments with the other,” said Attorney General Cordray. “This case gives the public pension funds and other shareholders a chance to stand up against Wall Street.”
The Lead Plaintiff group includes: the State Teachers Retirement System of Ohio; the Ohio Public Employees Retirement System; the Teacher Retirement System of Texas; Stichting Pensioenfonds Zorg en Welzijn, represented by PGGM Vermogensbeheer B.V.; and Fjärde AP-Fonden.
The lawsuit alleges that Bank of America, during merger negotiations, agreed to allow Merrill Lynch to pay up to $5.8 billion in discretionary year-end bonuses to its executives and employees, but failed to disclose that material information important to shareholders.
Additionally, in the two months just prior to the shareholder vote on the merger, Merrill Lynch suffered billions in losses. The complaint alleges that senior executives at both Merrill Lynch and Bank of America were aware of these massive and highly material losses but did not disclose the information to investors prior to the vote.
Even after the shareholder vote, according to the complaint, the Defendants continued to conceal highly material information from investors and knowingly made false and misleading public statements through press releases, investor calls, interviews and speeches. Not until the end of the class period, did the Defendants disclose the losses and bonus payments. Indeed, as alleged in the complaint, former Merrill Lynch CEO John Thain recently asserted that Bank of America agreed to these bonus payments and their acceleration, and if the bank stated to the contrary, it was “lying.”
The merger closed on January 1, 2009. Later that month, when the investment community learned of the billions in losses and bonus payments, Bank of America shares lost more than half their value. The New York Times described it as “one of the greatest destructions of shareholder value in financial history.”
The caption of the case is In re Bank of Am. Corp. Sec., Deriv. & ERISA Litig., No. 09-MDL-2058 (S.D.N.Y.) (Chin, J.). View the consolidated amended class action complaint.