Are Pensions Merely Ponzi Schemes?
(This is the third and final installment of a three part series.)
If it walks like a duck, swims like a duck, and quacks like a duck, it must be a duck. So, are pension plans, in general, “ducks”? Previously, we discussed the particular fiduciary foibles of public pension plans (see, “The Golden Goose Lays an Egg: Fiduciary Issues with Public Pensions,” FiduciaryNews.com, August 27, 2014). Lawrence J. McQuillan, PhD, a Senior Fellow & Director of the Center on Entrepreneurial Innovation at The Independent Institute in Oakland, California and author of the forthcoming book titled California Dreamin’: Resolving the Public Pension Crisis, says, “The longevity of defined benefit public pension systems have made them more of a ticking time bomb because of the increased longevity of the members. As members live longer in retirement, benefits must be paid for more years. Public pensions have done a very poor job of factoring in increased longevity and increasing contributions accordingly. As a result, public pension debt continues to increase.”
Longer life expectancies have increased pension liability across the board. Daniel J. Dingus, President and Chief Operating Officer and Director of Portfolio Management at Fragasso Financial Advisors in Pittsburgh, Pennsylvania, says, “Longevity is probably the number one reason for pensions. It’s the ‘longevity liability’ of public and private pensions, and in many ways very similar to the issue social security faces. This is not a country made up of an over-70-year-old workforce.”
The conflicts-of-interest within the public employee plan structure and the longevity liability have, in some states, created very obvious looming crises. “The bill is coming due and the one option that our government more times than not looks to is the American taxpayer,” says Robb Hill, President of R Hill Enterprises, Inc. in Aurora, Illinois. “Pensions nationwide are underfunded both public and private.”
Matthew Reischer, Esq., CEO of LegalAdvice.com, New York, agrees with the concern that “the longevity of public pensions only made them a more ominous ‘disaster waiting to happen?’” But, as popular as that feeling is among many Americans, can we paint all public pensions with the same broad brush?
“The ‘disaster waiting to happen’ is really a state by state issue,” says Tom Scanlon, a financial advisor at Raymond James in Manchester, Connecticut. “Some states are woefully behind in their funding, particularly after the economic meltdown of 2008-2009. Wisconsin’s plan is almost 100% funded while Illinois brings up the rear with a little over 40% of its obligation being funded. Much of the easy steps like states raising taxes have already been done. Now the difficult part comes, trying to trim budgets and go back to the bargaining table with the employees. The final outcome of the City of Detroit bankruptcy case will be very instructive.”
Increasing it appears those “last out” of pension plans may be left holding an empty bag. If you think this sounds like a Ponzi Scheme, you are not alone. Joe Gordon, Managing Partner at Gordon Asset Management, LLC in Raleigh-Durham, Chapel Hill, North Carolina says, “Pensions are funded by employers or public systems; the Ponzi victim is the employee, who pays little if any at all into the system.”
At first glance, then, pensions appear less malicious than Ponzi Schemes as the victim’s only harm is a broken promise, not a loss of capital. That’s only one way to look at it, though. McQuillan says, “Defined benefit public pension plans are worse than Ponzi schemes because they force taxpayers to backfill loses when investment earnings are insufficient to pay pension obligations. At least people who participate in Ponzi schemes join voluntarily. They are similar in that both public pension funds and Ponzi schemes try to keep everyone in the dark regarding the true financial health of the enterprise.”
Some prefer to judge based on the facts on circumstances of the specific pension plan. Still, that judgment hinges on the pension’s “true financial health.” Ilene Davis, Financial Independence Services of Cocoa, Florida, says determining if a particular pension plan is honest or merely a Ponzi Scheme depends on “whether or not it is fully, realistically funded using conservative discount rate and realistic life expectancies.”
Does Ponzi guilt rise from original desire or actual outcome? “Ponzi Schemes are an intent to defraud,” says Dingus. “Clearly the intent of a pension is to provide a stable income stream in retirement, so it’s not fair to compare one with the other. Ponzi Schemes typically run afoul when new money is not enough or slows down to a point where it can’t support the initial investors. That basic tenet can be found in some pension plans and, therefore, underfunding occurs.”
Again, if it walks, quacks, and swims like a Ponzi Scheme, what’s the dissimilarity between a poorly funded pension plan and a Ponzi Scheme. Hill bluntly says, “The difference between a pension plan and a Ponzi Scheme is that for the latter you go to jail.”
Given the hard to avoid temptation to turn public employee pensions in a pay-to-play re-election bonanza, does it make sense to ban them? Scanlon says, “A Ponzi Scheme is illegal. A pension should not be. If pension plans are mismanaged or not funded properly then you could have issues and not be able to meet your obligations. For current and future retirees let’s hope we are not writing pension checks that they can’t cash.”
“They shouldn’t be banned,” says Leavitt, who is running for Nevada State Assembly in district 7 (North Las Vegas). He says, “They do need insight and they need follow through with how most government plans are supposed to work. One of the big issues we have in Nevada isn’t just the public officials being the ones voting for their own interests, but we have politicians who are also government employees, so we are stuck in a horrible cycle of conflicts of interest. Also, we have unions who collect money from their members who in turn create PACs and give money to certain candidates and it is a never ending cycle. The DB plan isn’t thing causing the issue, the issue is the closed door meetings and the fact that friends are given the funds to administer. Hence my first response is to make the plans be shopped regularly and require open bid laws to be enforced.”
Davis agrees, but with some important common sense caveats. She says, “I do not feel public employee retirement plans should be banned, but I do believe that they should be no better than the average plan of the taxpayers whose tax dollars are ultimately funding that benefit. I can support a defined contribution plan, similar to those in private company sector, where in general employees must contribute in order to get a tax match, and where public employees, just like most of the taxpayers who are paying their salary, bear most of the responsibility. Bottom line, the cost to taxpayers should be clear and accessible; however, if a majority of taxpayers do not have any kind of employer retirement plan, then I would have a hard time supporting matching dollars for those employed by those taxpayers.”
Scanlon acknowledges the political reality taxpayers face when trying to alleviate the public employee pension liability. He says, “The public pension plans have been driven by negotiated contracts. Absent changing these, the federal, state and municipalities are stuck with these until they expire. When they do expire shifting from the defined benefit pensions plan to a defined contribution plan like a 403(b) plan would make sense.”
We already have working models on how to handle the conflict-of-interest problem. Implementing these requires no contract negotiations and, in some cases, executive rather than legislative action. Gordon would like to “require DOL-like fiduciary standards and IRS regulations as to service and benefits, rights and features” in public plans.
Longer term, though, many agree we need to adopt a two-step process in order to make the transition as smooth as possible. Dingus says, “The best solution is some type of combination with a defined contribution plan that allows the pension to unwind without imploding. Easier said than done, but I see no other option.” McQuillan concurs, saying, “The best solution is to freeze defined benefit public pension plans, pay all earned pension benefits as of the freeze date, and switch all public employees to reasonably priced defined contribution plans going forward. Most private companies have already done this.”
On this issue, we see quite strong feelings tied to deep-seated philosophy on the nature and role of the citizen and the government. Hill says, “Personal responsibility first. Our government is too big; they have too many functions. I believe that 90% of government activity should be privatized.”
If Hill, who is located in the heartland of America, represents the broader concerns of our country, the concept of either state or Federal government trying to compete with the private retirement industry appears to be a non-starter. “Government has already done enough,” he says, “if anything we need government to get out of the way and let the free market take its course. Government is the reason for the entitlement mentality that permeates every area of our nation and this needs to be eliminated. The main risk to retirement is not having enough money, period.”
Indeed, Hill may be on to something. The Federal government, through ERISA, even now has a stake in the private pension market. Scanlon says, “Governments should not take over private pensions. The Pension Benefit Guarantee Corporation (‘PBGC’) is already in place. We don’t need even more regulation.”
Even still, the track record of government leaves few wanting to bet their entire retirement savings on its ability to overcome a history of dysfunction. “Politicians and politics have already screwed up Social Security and Medicare,” says Davis. “Can you imagine a bunch of politicians with access to private pension plans? There was already some suggestion in the past to require taxation on internal buildup of plans. If this happened, you could pretty much kiss America goodbye. Just look at Social Security. It was never supposed to be taxed. Now you have it means-tested by another name. Or look at Obama wanting to limit value in retirement accounts – making even more people dependent on government handouts….”
Worse than incompetence, however, is the proven record of fiduciary failure. Politicians just cannot avoid the temptation of conflicts-of-interest. McQuillan says, “Governments have proven that they cannot run defined benefit pension plans responsibly and without politics influencing decisions. These problems would be magnified if governments also took over private pension plans. If governments were to guarantee pension benefits, taxpayers would be exposed to potentially massive debts. And governments would be tempted to manage the funds politically and corruptly, as we have already seen with CalPERS in California.”
Such government corruption is limited neither to the only the retirement arena or the state of California. “The feds have proved they cannot run anything without massive fraud, theft and cronyism,” says Gordon. “Medicare is reported to suffer over $120 billion annually in fraud and theft. The private DC system is fine but tax reform can improve it a lot more. Not sure the USA is ready for Australia’s superannuation.”
Dingus sums up the opinions of most experienced observers when he says, “Governments taking over the private pension business is a bad idea. Public pensions are a disaster and combining private pensions with them is the equivalent of ‘tying two rocks together and hoping they will float.’”
And, from the venerable Python, we now only two things float.
Interested in learning more about important topics confronting 401k fiduciaries? Explore Mr. Carosa’s book 401(k) Fiduciary Solutions and discover how to solve those hidden traps that often pop up in 401k plans.
Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.