Column: Al Arends, My Point of View

Promises, promises, promises and sometimes they are impossible to keep. For 20 years, I was the consultant on more than 40 defined benefit pension plans. These were plans with 20 to 250 employees. I really enjoyed working with these employer-sponsored plans, and, until 1986, they were working well. However, Congress continually passed pension legislation that made these plans prohibitive from a cost basis and today, none exist. The promise to the working employees was terminated. The benefit that they had accrued for the length of time they had worked was paid to them. They received no pension credit from termination date of the plan until they retired. This left them with a seriously reduced pension unless they would begin contributing to an IRA or a 401(k) defined contribution plan.

The employer had made a promise, but he was unable to keep it. This sounds very cruel and heartless, but it came from necessity. It came down to the decision that the employer was going to have to reduce costs or go out of business. We have seen large employers take this same action. Many of our large airlines have had to terminate defined benefit pension plans and most of the foreign car companies producing cars in the U.S. do not have defined benefit plans. This makes them much more competitive with lower costs than American car companies. Many of these companies do offer a defined contribution 401(k) plan, but this type of plan limits the liability of the company and they can control their costs.

It is alarming that the public sector has not taken dramatic action to control the cost of pension plans in the public sector. It is said that nationally, state plans for public employees are under funded by more than $3 trillion. In Minnesota, we are told we have an unfunded liability of around $12 billion. To determine this, the state uses an 8 1/2 percent interest return on pension assets. Actuaries tell us using an 8 1/2 percent interest assumption is totally unrealistic. They use an interest assumption of from 4 to 6 percent to determine future obligations. If this were used, our unfunded liability would probably exceed $18 billion. Does this create a promise that cannot be kept? It is going to be very interesting how our politicians address this issue.

So, let’s look at some other issues facing the public employee pension system. If we use a realistic interest rate of 5 percent, it takes a lump sum of $467,500 at 65 (which is normal retirement in the private sector) to provide a retirement benefit of $3,000 per month. Now if we permit a full pension benefit starting at age 55, the lump sum necessary is $566,800. You can see what happens when you permit an early retirement date, it requires substantially more money.

There are other factors that dramatically affect the cost of defined benefit plans. One factor is inflation. If you have a benefit that increases with inflation, it substantially increases the cost and affects the unfunded liability. The other factor is life expectancy. Forty years ago, life expectancy for a person at 65 was approximately 12 years. Today, it is 21 years. What will it be 40 years from now? Will it be 10 or 20 years longer? How do you fund for that?

Just looking at the math will tell you that it is going to be hard to support the public employee pension system. This is the situation with state public plans. What is the situation with the federal employee pension system? We never hear about its solvency and I am very fearful about the demands the federal system may put on the private sector to fulfill their promises.

Promises, promises, promises, but where is the money?

Alan Arends was a co-chairman in 2010 for the Freeborn County Republican Party.