By Brian Ochsner firstname.lastname@example.org A recent article by Congressman Ron Paul (R-TX), “The Perils of Economic Ignorance,” warns of approaching danger. If America doesn’t make swift and decisive changes from our federal fiscal follies, Paul contends, bad things lie in wait the next 10-20 years.
His warning is equally applicable to policies at the state level – specifically Colorado’s PERA pension plan. I’ll explode the myth that PERA, Social Security and other defined-benefit pension plans will be available in full for retirees when they hit their golden years. The reasons include the mass retirement of Baby Boomers, and the investment scheme of an Italian immigrant in the 1920s.
All defined-benefit pension plans are modeled after the Social Security plan. Franklin Roosevelt signed the Social Security Act in 1935, which covered workers in commerce and industry. Social Security was started with the retirement age of 65, because very few people reached this age back in the 1930s.
Thus actuarially cushioned, the system would be solvent for many years to come. But advances in medicine, health, and nutrition gradually these earlier assumptions false, putting a heavier financial strain on the system. (See also Congressman Paul’s has excellent article on Social Security.)
To better understand the rationale behind defined-benefit plans, you need to go back to 1920 and study a man named Charles Ponzi. This Italian immigrant promised investors that they could double their money in only 90 days.
Ponzi saw how he could increase the value of money by converting cash to stamps or International postal orders. He wasn’t able to exactly duplicate this in his plan, but he had enough money from later investors to pay earlier investors and make it work. Favorable press and word-of-mouth referrals helped fuel a steady stream of new money, and the good times kept rolling. That is, until a front page story in the July 26, 1920 edition of the Boston Post questioned the legitimacy of this strategy.
The authorities convinced Ponzi to stop taking new investments, and got permission to audit his financial records. After examining the books, auditors and banks declared on August 10, 1920 that Ponzi was definitely bankrupt. Several days later he was arrested by federal authorities, and later freed on $25,000 bond.
He was sentenced to five years in prison for using the mail system to defraud investors. Massachusetts authorities tacked on an additional seven to nine years of prison time for other charges. This is the condensed version of the story; here’s the link for the complete history of the Ponzi scheme.
I realize it’s a harsh indictment, comparing PERA to a Ponzi scheme. However, defined-benefit pension plans work exactly the same way. If you have more money coming in from contributions than benefits being paid out, everything’s fine. If this isn’t the case, well, you’ll have a lot of unhappy later investors who won’t get everything they were promised.
With a current deficit of $12.8 billion and lots of Baby Boomers still waiting to retire, this plan will not deliver the promises in full for all future retirees. That is, if the PERA board maintains the status quo.
The trustees of the board need to take at least one - and probably all - of these steps if they really want to keep PERA afloat:
1) Increase the age at which a retiree is eligible for benefits 2) Freeze or reduce retirement benefits for new enrollees in the plan 3) Increase contributions from plan participants 4) Base retirement benefits on a retiree's income outside of his or her pension – also known as means testing. 5) Eventually phase PERA into a 100% defined-contribution plan, with individual employee accounts – just like a 401(k) or IRA in the private sector.
What I’ve described is pretty strong medicine; some middle-aged and older readers may be ready to come after me with pitchforks. That’s because Americans have been conditioned to expect a company or the government to take care of them in their golden years. However, if tough decisions on PERA aren’t made today, tougher ones will have to be made in the future.
Another big assumption is that the funds held in the plan will continue to increase in value. PERA has an expectation of an 8.5% annual increase in stock-based investments. Based on the upcoming mass retirement of Baby Boomers, this long-term prediction is a long-shot at best.
The stock market boom of the late 90s was caused by Wall Street PR, new technology, and a surge of Baby Boomers who flooded the stock market with new money. When the Boomers start taking more money out of the stock market than younger generations put in - sometime in the 2010s - it won’t be good for American stock and mutual fund values.
If this is the case, what’s state government’s solution? Given Colorado government’s voracious appetite for new taxes and spending (Amendments 23 & 35, and Referendum C), I’m almost certain we’ll hear a hue and cry to ‘Save PERA’ in 2007 or 2008. Translation: More money from your pocket to pay the PERA piper.
The latest trial balloon being floated is an extra $400 million a year from Colorado taxpayers. That’s a big chunk of change, but it still won’t be enough to fix the problem in time. According to David Milstead of the Rocky Mountain News , the current deficit between PERA assets and obligations is about $12.8 billion. Even if you make the Evel Knievel-over-the-Grand Canyon leap of faith that the deficit won’t grow over time, you’re still looking at 32 years to get the plan back to even.
Emotional attachments to a financial dinosaur shouldn’t overrule using good judgment to deal with financial realities. That’s why companies started making the change from defined benefit to defined contribution plans - such as 401(k) and Individual Retirement Accounts (IRAs) – around 1980. Employers realized that they couldn’t turn a profit and provide a guaranteed pension for its retired workers.
Instead of being guaranteed a certain dollar amount every month during retirement, the employee is responsible for contributing to his/her own account, and investing responsibly. It’s not a perfect solution, but it’s still better than doing nothing.
All work – whether in the public or private sector – is noble. However, public employees shouldn’t expect to be treated like royalty after their years of service are done. Yours truly, John Andrews, Mike Coffman and other responsible Coloradoans are telling people that the PERA emperor has no clothes. The question is, will enough folks realize it, and take the correct action in time?