Pension troubles

Last week, the Canadian government announced a reduction in eligibility for the Old Age Security Benefit from age 65 to 67 starting in 2023. This means all Canadians age 54 and younger today will receive less retirement income from the federal government. We should expect more of this to come as pensions worldwide struggle with mounting deficits, thanks to poor investment management and insufficient contribution levels over the past 15 years. Now deficits are compounding thanks to zero-bound interest rates courtesy of central bankers everywhere.

This week one of the largest Canadian pension plans, the Ontario Teachers’ Pension plan, announced a 9.6 billion shortfall in capital needed to fund pension obligations. In response Ontario’s Finance Minister advised that the cash-strapped government is not prepared to increase employer contributions to the teacher’s plan: “We are saying benefits have to be cut”, was his official statement.

This is the inevitable outcome of more than a decade of can-kicking in the pension management area. The demographic cost of the aging boomers was easy to predict and calculate. But the numbers were simply not attractive to those looking to spend their way to prosperity.

The solution of choice was for employees and employers not to increase contributions, but to hire investment managers who promised to make a mountain out of a mole hill. I am reminded of some pension presentations I was asked to give over the past 10 years, where my recommendation was to discard static allocation models, lower equity exposure to control risk and lower return targets to a more realistic level in the 5% range. No pension boards hired our firm after these presentations. All the managers who were happy to promise higher returns got these jobs.

Assumed annual returns of 8%+ were plugged in and everyone hoped for the best. Except 12 years into this secular bear in stocks, investment returns have been under-performing target for more than a decade. The deficits are finally getting too large to overlook. Benefits are likely to be reduced for future recipients, as well as pushing out eligibility triggers.

Yesterday I met with some long-term clients who are members of OMER’s, another large Ontario pension plan.  After more than 30 years, they are now eligible to retire on full pensions of 60K a year, indexed. I pointed out that these were incredibly valuable assets: at current rates, one would need to have in excess of 2.5 million dollars invested in a balanced portfolio to generate that kind of income for life.

They were surprised as few people understand the math of how much capital it takes to generate livable income today. I assured them that they and their co-workers were very fortunate to have this rare asset in a world where few defined benefits plans still exist. “But I am the only one in my department to still have a pension” she replied. “Remember 5 or 6 years ago when our employer offered us the option of cashing out a lump sum commuted value? Everyone in my office took that option and gave the funds to financial advisors. They all told me I was crazy for not doing it.  But they have all lost money and now most have just thousands in their retirement accounts.”

“Even $500,000 today may sound like a lot, but at current yields, 500K will give you a maximum of about 15,000 a year of income”  I said. “Thank God you were smart enough not to cash out. “Well”, she smiled, “don’t you remember–you told us not to–we have always taken your advice.”

Sorry for the self-indulgence here, I need it to make this point.  This was a highlight of my day.  But I also felt sad and frustrated for my clients’ co-workers who had taken the advice of the financial sales force and cashed out their life savings into the peak of yet another stock market bubble in 2006-2008.  I had seen many teachers harmed by the same bait in the late 90’s.

Over more than 20 years of advising, I have been a party to many financial decisions that make a huge difference to personal fortunes in the end.  Many of these recommendations add value not captured in the annual performance reports of our investment accounts.

Sound financial advice over time is incredibly useful to those who are willing to hear the truth and execute accordingly.  But it takes wise, unbiased counsel (those not paid to sell products) and disciplined clients to win this race. It is not always easy to do the right risk management things, but over time I have seen that it is incredibly rewarding for real life families. Once again, I am heartened and grateful for the gift of valuable work.

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4 Responses to Pension troubles

  1. Andrew says:

    Good post.
    Re: the 60K indexed pensions being worth 2.5 million in capital
    This is very true if the portfolio were started today but in these pension plans they probably have assets that have higher yields and returns and lower relative fees so they may be worth less, something like $1,250,000 with a 4.8% return. The other thing is these pensions are probably fully indexed so they are more valuable.

    Even still it is usually better to assume lower rates of return.
    It is scary the degree of financial repression and distortion that ZIRP policy is having in what amounts to a war between savers and speculators.

  2. dave says:

    Obviously the teachers pensions were are are way too rich. I now many retired teachers many of them couples that live a lavish lifestyle. As you outlined this is changing now and will change more in the very near future.

  3. Paul Murphy says:

    Not all pension plans are the same, even the defined benefit ones. The benefit is after all “defined”, but defined as what? The assumed return of my pension plan used to be 7.5% in the early 2000s, but then it dropped to 7% and has kept falling. The contribution rates therefore have been rising with another increase just 4 months before I retired 2 years ago with 9.9% up to CPP YBE, 8.1% then up to YMPE and then back to 9.9% above YMBE. So the parameters have been shifting in unison with the reality of the markets. You don’t see this mentioned at all when defined benefits pensions are derided in the media. Although we have 2% per year of service, we have only partial indexing (0.6%) for the first 2% of CPI after age 65 so early retires take a beating for 10 years if they go at say 55 with no indexing and at 65 , you still take a beating if CPI goes anywhere losing 40% for the first 2% CPI and 100% after that. So after 39 years paying into one of those “destroying our economy” defined benefit pension plans means that I will watch my income decrease in its purchasing power pretty constantly over the rest of my life – aka the value of future money. Maybe I can fall back on my multi-million dollar golden handshake and my stock options? Oops, I didn’t get either of those! Oh my , oh my! Maybe if we examine the realities of defined benefits pension plans, they are not reality-ignoring Shangri La that will reduce our economy to tatters, but a reasonable long-term savings plans shepherded by actuaries (those number crunching, brainiac business types) for people who have been wise enough to select an intelligent employer. If you think way back when Danielle was just a twinkle in her parents’ eyes, government and some employers didn’t have the money for wages and the defined benefit pension was the sop that attracted good employees into the government and these industries. Now that the high-flying industries that once paid pots of money have squeezed their employees (no effective wage increases since the early 80s) so that government wages are now equal, they are disparaging the government and some employers’ pension plans in a dizzying spiral to the bottom. Throwing future employees into private sector pension plans where the employer pays in nothing or very little and the employees investments are guided individually by the same financial planners who crashed us in Fall 2008 is, to me, creating a plush marketplace for those planners in the immediate future and a catastrophic disaster for our kids’ economy in 20 to 30 years. But then who listens to me.

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