PERA in a fix, and how to fix it

By Brian Ochsner Colorado's state employee pension plan, PERA, is in big trouble, according to this recent story -- and in need of serious repair, as prescribed in this story today.

The analysts' weather report, in brief, finds that over-optimistic estimates of investment returns, sharp increases in benefits, and a stock market downturn converged to create the “perfect financial storm.” To understand why PERA is almost set up to fail, you need to go back about 25 years.

That was when the first 401(k) plans (Defined Contribution, or DC) were phased in to replace traditional Defined Benefit (DB) pensions. DB plans guaranteed a retiree a specific dollar amount per month that the company would pay out upon an employee’s retirement. Corporate execs knew it would be difficult for a company to turn a profit while paying more of these DB pensions in the future. They shifted the responsibility from the company to the employee.

Companies like United Airlines, Delta, GM, Ford and others still have these DB pension plans. Bad management has definitely contributed to their challenges. However, the crushing financial weight of these pension obligations has been equally – if not more - damaging. Here’s how these four companies are doing:

United is coming out of bankruptcy in 2006…Delta just filed for bankruptcy this week …GM and Ford both had their bond ratings downgraded earlier this year to “junk” status by Standard & Poor’s and Moody’s.

Corporate debt ratings are like an individual’s FICO score. Translated, a ‘junk bond’ rating means a company has serious financial challenges – usually with large amounts of debt.

This means their ability to stay in business is seriously in doubt. The money they borrow in the future – if they can borrow more – will be at a much higher interest rate, compounding their financial problems.

The government’s pension ‘backstop,’ the Pension Benefits Guaranty Corporation (PBGC), has already taken over several of these plans from ailing companies, such as Bethlehem Steel. And PBGC is already under funded on these defaulted pension plans by approximately $63 billion.

If GM, Ford and other companies can’t deliver on their pension promises, and they default to PBGC, this figure will increase even more.

The PERA fund is identical to these defined-benefit pension plans. The way they’re setup, it’s very difficult – if not impossible – for these funds to deliver on the financial promises they’ve made. People are living longer, collecting benefits for a longer period of time, and putting a bigger financial strain on these funds.

If no changes are made, I see PERA meeting the same fate as these companies who were (and are) supposedly “too big to fail.” It may not occur in the next year or two, but PERA’s financial reckoning day will come.

PERA covers approximately 365,000 retirees in Colorado and around the country. Colorado has a population of over four million people. It’s not right that taxpayers have to cover the retirement of less than 10% of the state’s population.

This financial albatross will have the same effect on Colorado’s economy that traditional pension plans have had on Delta, GM & Ford. The only way this fund can survive is to scale down the benefits over time, and require public employees to contribute more from their own salaries.

I realize there will be an emotionally driven outcry to “save PERA” in its present form. But logical, financially responsible people should do what’s right – regardless of how loud big-government types yell. That’ll mean taking harsh financial medicine now…or swallowing a bitterer pill down the road.