More than 20 years ago, I was tapped to manage a private defined benefit pension plan
. My first order of business was to read the prospectus. What I read shocked me.
I was astonished to learn that the fund was responsible for generating a guaranteed annual rate of return of 8 percent to the beneficiaries. To that I responded: it cannot be done.
Developments over the past five years suggest the same.
Back then, it was my sense that the pension system would fail. Guaranteeing annual returns of 8 percent while realizing much less is a certain recipe for failure over the long term.
Private firms that invested in private defined pension plans for their employees are responsible for the shortfall. As a result, proprietors faced significant cost increases and lower sales value to potential suitors. It is not uncommon for a small-to-medium-sized business to lose millions of dollars in complying with these onerous pension-funding requirements.
However, defined benefit pension plans guaranteed by government have met this shortfall in the past by tapping unsuspecting taxpayers in the form of tax increases, additional debt or cuts in other benefits, services and programs to the general public.
For many decades that was the case — until now.
Detroit and Illinois are on the path to setting major precedent in this regard. In both cases, these jurisdictions are attempting to right this pension ship that has gone incredibly awry over many decades.
In Detroit, Federal Judge Steven Rhodes recently ruled, "Pension benefits are a contractual right and are not entitled to any heightened protection in a municipal bankruptcy," according to The New York Times. He was clear in suggesting that public employee pensions are not sacrosanct in a federal Chapter 9 bankruptcy despite the Michigan Constitution that claims otherwise.
In Illinois, there is an underfunded pension liability of more than $160 billion. The democratically controlled Illinois state legislature recently voted in bipartisan fashion to eliminate this debt over the next 30 years. The Senate, comprised of 40 Democrats and 19 Republicans, passed the resolution 30-24. The House, with 71 Democrats and 47 Republicans, affirmed the measure 62-53. Moreover, the Democratic Gov. Pat Quinn praised the bipartisan leadership on achieving this very important agreement.
Approximately $60 billion of the pension fund deficit will come from state funds. The remaining $100 billion balance will be derived from curbing benefits that include: 1) lowering the cost of living increases, 2) reducing the maximum salary in the calculation of annual pension payments and 3) increasing the retirement age to begin receiving pension benefits by as much as five years.
President Obama is entitled to $383,535 in lifetime pension benefits for his eight years of service in the Illinois State Senate and $191,000 each year for life for his service as President of The United States of America, according to The Illinois Policy Institute.
Typically, workers qualify for pension benefits after 20 years or more of service. According to Kristina Rasmussen, executive vice president of the Illinois Policy Institute, if Obama "had worked as an ordinary state worker, he wouldn't have been eligible for a dime in pension payments," The Huffington Post reported.
More prudent management of pensions going forward will serve society well. Recent events suggest this is a real possibility in the near term. It is a strong step toward undoing decades of financial mismanagement that seriously undermined our economic infrastructure.
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