There are few areas of government expenditure in the world that are more contentious than those associated with the payment of pensions. This includes “age pensions” in countries that have such things, as well as “employer pensions” from time spent with an employer.

There is a huge range of types of super funds available, with many older ‘legacy’ funds set up for specific purposes or departments, such as Defence Force personnel, University Staff, politicians and statutory entities such as Australia Post and others – so please keep in mind that the following article is intended only as a broad discussion of some of the issues surrounding funding the guarantees behind a superannuation pension. And remember the Great Disclaimer – nothing on this website is to be considered ‘personal advice’. It is general commentary and thoughts only, and cannot be used as a basis for any investment decisions. Obviously.

The Australian Super Experience

In Australia, we have far less exposure to employer pensions than other developed countries – especially when compared to the United States, where a guaranteed pension in retirement is the gold watch reward for years of service.

In Australia, most superannuation funds now operate on a “defined contributions” basis rather than a “defined benefit” basis. In other words, you can be sure of how much your employer must pay on your behalf but you must wear the risk and responsibility for what that money eventually grows to, and how it helps you in retirement.

Most of the larger “defined benefit” superannuation schemes were closed many years ago – with only those who remained as members as of some ‘cut-off’ date still being able to count on a definite pension level. Those fortunate few can sleep quite comfortably at night, knowing that even nil returns for 10 years won’t stop them from receiving their predicted retirement income – it’s guaranteed by the government. There are still some defined benefit schemes in the very large organisations but not many, so the bulk of such funds that remain are legacy government super funds.

West Australian Government Super Funds

In Western Australia, the State Government moved to close the old pension fund to new members, and eventually to close the “Gold State” fund to new members, and even later again to move from the “Westate” fund to the newer “GESB” fund. The Westate super was/is “unfunded”. That is, money for benefits is paid from revenue and there was no pool of dollars other than that contributed by members. The newer GESB accounts however, are fully funded by government contributions. This is a more sustainable type of account that better meets the modern version of an Australian superannuation fund. All of this has gradually moved the responsibility for retirement benefits from the West Australian government to the employees themselves.

Other states such as Victoria and New South Wales have had their own moments of terror, when looking at the “unfunded liabilities” (ie, the money that they have promised to pay as pensions but have made absolutely no attempt to put money aside to meet) from time to time. It’s a bit like starting a mortgage when you are 20, and just adding the interest each year until age 65… you don’t need to be a mathematician to know that the end result is going to be big. Not just big – but really, really big.

Australian Government Super Funds

The Federal Government used surpluses a few years ago to set up the “Future Fund” to help provide money to ensure Federal Government employees would receive the pension benefits they were promised. Why was this important? It was a step that had to be taken, as some of the underlying assumptions on which pensions are based have been called into question in recent times. For example, many government pensions are payable from consolidated revenue (those darned “unfunded liabilities”) – which means they are simply year-to-year costs, and no money has ever been put aside to meet the eventual cost of providing a guaranteed pension. Naturally, with rising wages, longer life expectancies and lower mortality rates, it becomes more and more and more difficult to provide for those accumulating promised pensions from the yearly budget. Eventually, such strains can send a budget into deficit or even bring the government into financial difficulty or bankruptcy.

In other words, in defined benefit super funds the government wore the risks – but nobody in government wanted to deal with the issue of funding the eventual payments, and so it was allowed to rollerball, until the issue was so big that eventually everyone was too afraid to tackle it – just leave the problem to the next government or the next generation of taxpayers! The Future Fund is an attempt at tackling some of these long term funding issues.

Australia’s movement to a defined contribution basis for super funds was pushed along by the ‘productivity super’ (a.k.a. ‘award super’, ‘superannuation guarantee charge’, superannuation guarantee levy) initiatives of the Hawke-Keating era. All these years later, Australians can be proud of what has been achieved in the superannuation area. As a country, we now hold the 4th largest pool of retirement assets in the world. Australians have ‘right of choice’ on where there super money goes, and how it is invested. If you don’t want risk – you can keep your super fund money in the super fund cash account. If you want lots of risk then it’s up to you to take that decision, and to wear the consequences of it – for better or worse.

The American Experience

And so we come to the point of this post – what is the real ‘guarantee’ underlying these promises of a future, fixed level of pension? These promises are usually legislated and sometimes built into the constitution of the respective government, so there are very high levels of certainty. However, there can only ever be 100 cents in a dollar, so there potentially can come a point where the government of the day simply cannot sustain the regular payments at levels that may have seemed realistic in earlier, happier times.

San Diego and San Jose have just held referendums/elections to ask the population whether the respective governments should have the right to reneg on the promises made through their superannuation funds. And the voters of both cities now have now given the governmen tof the day the ability to start to tackle these pension obligations that they simply cannot meet. That’s great if you are trying to balance the city books – for example, to pay existing Police salaries or keep fire stations open – but it’s just horrifying if you are the one receiving the pension, and you are now being told that the promises made many years ago no longer apply.

The New York Times has a fascinating article with more details here.

To me, this is an inevitable outcome of such schemes. Demographics in developed countries simply do not stack up in favour of making promises that far into the futre. There are so many variables that can come into play when trying to estimate what you can or cannot do in 20, 30 or 40 years time that the guarantee behind the promise is a bit like a parent “guaranteeing” the future happiness and security of their child by sending them to the best private school… it’s a great start, and a helpful way to build discipline, knowledge and contacts – but there simply is no guarantee that any of those dollars being spent are going to ensure the future happiness and security of the child. It’ll improve the odds – but that ain’t no guarantee….

The idea behind benefit promise funds is that the guarantees are realistic, and based on actuarial calculations of future mortality, morbidity, longetivity, retirement ages, member contribution levels, anticipated rates of return and the impact of any likely taxation imposts. That’s a lot of areas for potential variations – and with the longer time frames of super funds, it’s a bit like aiming a sniper’s rifle… if the sighting scope is just a little fraction out of sync then there’s very little hope of hitting a target a kilometre away.

Some pension funds actually require employers to pay in amounts each year that are actuarially calculated as being appropriate when taking into account all of those variables. Again, that works just peachy when things are good – but is a recipe for disaster when things go bad. Such as the circumstances that faced General Motors during the Global Financial Crisis (“GFC”). The company was struggling with lower car sales, heavy competition from smaller overseas models, rising petrol costs scaring consumers, significant drops in value of the existing super asset pool, reduced assumptions of future earnings, reduced contributions by members, ZERO PROFITS from which to top-up payments… and all this in the face of minimum levels of guaranteed payments being made to an ever longer-living group of ex-workers, with rising inflation making this years payments even bigger than last years.

Guess how big General Motor’s pension liabilities are…?

How about a global pension liability of $134,000,000,000… And they are currently $25,000,000,000 short of that required figure on current actuarial estimates.  How do you balance that kind of imbalance with the rights, needs and aspirations of individual workers?

The Wall Street Journal recently covered moves by the company to cut its obligations through renegoiating various aspects of the fund. The pension liabilities eventually become a pivotal issue on the survival of the company itself during the GFC meltdown. That’s how big these issues can become.

The UK Super Pension Experience

How about the United Kingdom – are they finding it any easier to deal with long term pension funding?

Here’s an article from the Telegraph, titled “Pension Liabilities May Double Under EU Rules” which points to EU rules that will force companies to pay up more money to make their pension funds more ‘robust’. The end result will most likely be some hard decisions, a lot of angst, and the closure of a lot of guaranteed benefit pension funds.

The UK government “unfunded liabilities” for pension funds amounts to £1 trillion across 1,500 public bodies, against £808 billion of outstanding UK government bonds. That points out just how big these “unspoken” debts are, and how much impact they will have in coming years.

Europe’s Pension Experience

It’s no secret that the whole of Europe is currently struggling to come to terms with dollar issues. These are not usually crouched in demographic terms – but that is the reality. When you have a steadily aging population, with most wealth tied up in property and are asking the reducing workforce to fund a growing retiree population, you’re going to have trouble.

Here’s the maths…

If you combine 19 of the 27 or so European Union countries debt problems, the state-funded pension obligations of those 19 countries add up to about FIVE TIMES THEIR COMBINED GROSS DEBT! Given that ‘stated’ debt is already a major issue causing global problems, how many problems will be caused by these pension obligations. For the nerdy, the actual figure is € 30,000,000,000,000. That’s 30 TRILLION dollars…!

Bloomberg has all the grotty facts in its article “Europe’s $39 Trillion Pension Risk Grows As Economy Falters“. It’s a good read. Here’s a fascinating little fact –

“Life expectancy in Europe is increasing at the rate of five hours a day, according to Charles Cowling, managing director of JLT Pension Capital Strategies Ltd. in London”

Of course, it’s his job to stir up a bit of fuss about pension funding – but putting that little bias aside, there is still a major issue brewing here. Maybe even ‘simmering’ more than just brewing…

What are the maths behind funding retirement?

You have probably worked out by now that the real issue here is how retirement benefits are calculated. This impacts the ability of you, your employer or anyone else to be able to rely on any guarantees that may be suggested from time to time.

The points raised above show that even a sovereign government, with the ability to print its own money, is not immune from the certainties that go along with basic retirement mathematics.

There are lots of calculators available for working out how much money you need in retirement. Many people just start with a figure – such as $600,000 or $1 million – but even theses figures have to be based on something, don’t they? We’ll cover that in another post, for those who are bored or who have trouble sleeping at night.