United States: The Defined Benefit Pension Crisis Is Here And Very Real

This is not a major news story for most Americans, but if you participate in a defined benefit retirement plan, one where you are due to receive regular payments of a fixed amount monthly when you reach retirement; pay heed: Bad things are happening.

The current news relates to the International Brotherhood of Teamsters and their Central States Pension Fund. Ironically, irregularities in the fund's investment strategies are part of what caused Congress to codify pension reform in the 1970s with the Employee Retirement Income Security Act (ERISA).

The Teamsters started to collect and invest pension funds in the 1950s. In the 1970s it came out that many of these investments had lots to do with the needs of union management and little to do with those of pension beneficiaries.  One of the reforms brought about by ERISA was a requirement that pensions be separately managed from the unions or businesses which collected and invested the money.

The ideal pension plan collects contributions and has them independently and intelligently managed so that funds are there to meet all of the obligations the employer or union has promised. It all should make sense except that some assumptions once considered reliable just aren't reliable any more.  In the 1960 and 1970s when many contributions were made, the assumption was that most retirees would not collect beyond age 70 or 75 at the latest.  That's when people died back then.  Of course today, the number of retirees living and collecting into their 80s and 90s grows every day.  Problem 1 is that the plans were modeled on the wrong life expectancy assumptions.  Problem 2 is the stock market and its brother the real estate market.  Historically, pension contributions have been invested in securities and/or real estate because these investments could be relied upon to increase 7-8% per annum over the long term.  At these assumed rates, money doubles in value every 8 to 9 years.  Yes, we all know that some years are up and some are down but in the long term the 7-8% returns were thought reasonable.

Using the Standard & Poor 500 stock index as a benchmark stocks reliably increased from 1985 to 2000 when we had the Enron crash. They did not recover their 2000 values until 2008 and as soon as they did, that crash caused another huge decline.  Again it took us six years to get back to 2008 values or, as some would say, back to 2000 values.  Stocks snapped back and rose quickly until August, 2015 but since that date, values have been bouncing, bouncing, bouncing.  From February 2014 to February, 2016 the index made no real headway.

Pension plans need to liquidate investments like real estate and securities to pay benefits. They don't get to tell the retiree, "Hey we will pay later this year when stocks recover."  The money is due every month no matter what condition the market.

Today, the Central States Teamsters Pension Fund pays out almost $3.50 for every dollar it takes in. In theory, that should not make a difference because today's dollar in should not be paid out for many years.  But, some of the dollars paid in overtime not only haven't earned their 7-8% returns.  In fact some "lost" value, particularly those invested in hedge funds during the past 10 years.  What that means is that huge swaths of defined benefit plans are grossly underfunded.  The crisis the Central States Plan faces is that it has no place to go to secure enough to pay the benefits it promised.   So, there is now a very acrimonious debate underway involving Congress, crisis manager Ken Feinberg and the Teamsters over who will pay.  The Teamsters say the taxpayer should make up the shortfall.  Needless to say, Congress is not viewing those prospects with any contentment and Feinberg is saying top end benefits in particular need to be cut or the whole ship goes down.

State pensions are another animal. A state obligation to pay a retirement benefit comes with the guarantee that if the state lacks the money, the taxpayer will be assessed.  Pennsylvania has some of the worst funded pension plans in the United States.  The effect is that state contributions to pension payments have quadrupled in the past six years.  Underfunded obligations to public employees were 1.5% of state expenditures in 2010.  By 2019 it will be 10% by 2019.  If you think that's a problem take a look at Philadelphia's situation.  Today 20% of the city's budget is devoted to paying retirees.  At the state level, the pension fund actually declined in value in 2015.  When bond agencies see these kinds of problems, ratings are downgraded and interest rates soar.

So, why is this part of a divorce law blog? Because, if you or your spouse are due money in the future on a monthly basis, there is a very real possibility that you won't see all of it.  Yes, we just wrote that by law states cannot cut pension benefits because these are contracts for deferred compensation on services the state already got from its employee.  But much as with the situation in Puerto Rico and Atlantic City where governments are verging on default of their bond payments and other general obligations every day, these problems do not present easy solutions.  Taxpayers earning $4,000 a month are not going to quietly accept large tax increases to pay unfunded retirement obligations that often are double that amount.

If you are an attorney dividing a defined benefit pension, get your client to investigate how well funded that obligation is. And if there is a reason for concern, the retirement model for settlement or trial should consider sharing that risk.  This is not an easy evaluation in any circumstance.  Let's say that wife is a teacher with a defined benefit plan that has a $300,000 cash value, but she is five years away from retirement and the plan is only 70% funded.  Does that not arguably make it a $210,000 plan? Conversely, suppose she is married to a spouse with a $300,000 IRA who is also five years to retirement. In theory, during the next five years she can still be accruing benefits, albeit underfunded benefits, while spouse's IRA undergoes a 10% market correction that reduces his $300,000 to $270,000.  He may also be self-funding IRA contributions but they could decline as soon as they are funded if he invests in oil and gas or department stores or office supply chains.  There is no happy solution here but there is reason to model a retirement distribution where the risk is shared.  In other words, perhaps both the IRA and the defined benefit plan should be divided even though they are today, technically of equal value.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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