When Pensions “Go Ponzi”

June 5, 2012
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May 5, 2012

HAMILTON:Public sector employers faced with escalating pension costs are increasingly closing Defined Benefit (DB) pension plans to new employees, and enrolling them in Defined Contribution (DC) pension plans, cutting off the flow of new money into the DB plans.

Faced with having to pay all future benefits from the existing assets the underfunding of the plans is becoming clear and exposing the false accounting principles these plans have been based on.

“We call that ‘Going Ponzi’,” says Bill Tufts, pension expert and co-author of Pension Ponzi: How Public Sector Unions are Bankrupting Canada’s Healthcare, Education and Your Retirement (Wiley & Sons). California Governor Jerry Brown agrees.

“If you have to keep bringing in new members (to make the numbers work), then the current system itself is not in a sustainable position,” said the governor. “That tells you you’ve got a Ponzi scheme.”

DB plan payments are guaranteed by the employer (i.e taxpayer) regardless of market conditions, whereas DC benefits are limited to the money in the fund. In theory this eliminates future risk to taxpayers, but it also locks in the liabilities of prior plans. And these liabilities are now coming due.

The Saskatchewan Teachers’ Superannuation Plan (STSP) will be the first of many to “Go Ponzi”.

Created in 1930, by 1979 the fund was estimated to be short $1.29 billion of being able to pay expected benefits. Rather than increase contributions, the provincial government closed the plan to new hires and enrolled them in DC pension plans.

This locked in the deficit and left the old STSP plan stranded with retired teachers and the active teachers who were in the plan before 1980. The shortfall in the plan has blossomed to over $4 billion by 2011. Currently the plan has $900 million in assets, pays out $300 million a year in benefits and will run out in about 3 years. At that time it will become a pay-as-you-go plan which will be the responsibility of the taxpayers of Saskatchewan.

The plan currently has  about 1,500 active teachers contributing new funds with 11,000 receiving benefits. Members are required to contribute 7.85% of their salary and the provincial government matches this. The $4 billion shortfall will all be provided by the Province, however. Pension experts estimate that 35% of salary is required to fund a 70% of income pension. Last year the active teachers contributed $8.1 million towards the $300 million payout, an average of $5400 each. The fund is scheduled to pay each member an average of $391,000 in retirement.

This scenario is being repeated throughout the public sector as government departments close DB pensions and replace them with DC pensions. The alternative is to increase annual contributions, which is also being done, although only the employer is typically raising their ante.

McMaster University for instance, closed its DB plan for hourly workers and now has 340 retirees and 300 active workers in the plan. McMaster has chosen to start funding the shortfall now, and currently contributes $3.90 for every $1 that employees contribute. Employees are protected by union contracts that prevent them from being forced to pay more.

In it’s annual report, McMaster notes that these additional costs “are expected to increase significantly.” Meanwhile the DB plan for salaried workers, which is still accepting new employees, shows a $500 million deficit  with a $1 billion asset base.

Governments across the country are hoping for increased tax revenues from a thriving business sector, higher interest rates on fixed income investments and a long-term and dramatically spiraling stock market to generate high returns on their pension funds.

Without these improved returns, pressure will continue to mount to close DB plans and replace them with DC plans. If this were to happen to all public sector pension funds currently in deficit positions, they would all “Go Ponzi”, presenting the taxpayers with a bill currently estimated at $400 billion.

 

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