Think: retirement plan with guaranteed investment results.
That is, those government workers lucky enough to receive a defined-benefit plan are guaranteed some minimum rate of annual investment return from the government-hired union Wall Street investors managing their money.
Now, when you think of the sharpest, meanest, hungriest Wall Street investors, who were raised by a single mother in a poor neighborhood in Brooklyn, where they would eat nails to make enough money for a nice dinner...you generally don't think of union government workers.
So it comes as little surprise that government-managed investments have historically done very poorly relative to the results of the highly paid professionals performing the same duties. As a result, taxpayers must then make up the difference from the poor performing government managers to equal the minimums required in a defined-benefit retirement plan.
In California, interesting conflicts arose out of the union pension liability, which the city owed to its local police force. A common game in the negotiations between unions and politicians revolved around retirement economics. Police could retire after 30 years of service and collect a pension for the rest of their lives. The deal didn't seem bad when the average cop lived to be 62. But then cops got organic, shunned the donut thing, and 82 was the new 62.
Compounding problems, police received as their pension 85% of whatever their total compensation came to on average, in the previous 3 years that they worked. So in those 3 years, cops put in massive amounts of overtime, often working the equivalent of double shifts for 3 years. As a result, salaries skyrocketed.
They then took 85% of that figure and promptly retired. Hey, wouldn't you?
Now, add to this liability pension obligations and a bunch of other costs like health insurance, and it created a crisis wherein cities explained that they simply could not afford the police force that they had. Instead of pointing to the bloated deals that were cut by lousy politicians with unions who negotiated beautifully, cities asked their constituents to be allowed to raise taxes. When the vote was emphatically "no," many cities were forced to fire their entire police and fire forces and "outsource" to hire a service which could negotiate much more favorable "in market" pricing.
Related or Semi-related Video
Finance: What are Pension Liabilities?23 Views
finance a la shmoop. what are pension liabilities? okay so if you haven't seen
our James Cameron directed and shmoop academy award-winning video called
what is a pension, we'll watch that first. before you continue. okay hi welcome back. [link to pension video]
a pension liability is not that different from a liability owed by any
corporation or even an individual. the corporations and governments both
provide pensions for their employees. very roughly an employee making say 75
grand a year might get 10% of a salary a year in pension contributions from the
employer. while pensions are divided into two
flavors. there are defined contribution pensions - one flavor of a 401k plan. in a
defined contribution plan the employee contributes say 10% of their salary and [defined contribution pension defined]
in this case that would be 7,500 bucks. and the employer might match it. that is
the employer takes 7,500 bucks off of their total salary that is calculated
for taxes so the employee instead of being taxed on 75 grand a year gets
taxed on sixty seven thousand five hundred they then defer the 7,500 bucks
they put into their 401k plan and well they'll still pay taxes on it eventually [equations on screen]
when they take it out but presumably when they're old and retired and poor
and thus likely to pay lower tax rates than they would in their heavy working
high tax hike tax rate era at the peak of their careers. so the employee saves
seventy five hundred bucks there or at least puts it away, and the employer
matches that 75 with seventy five hundred of its own. so from the employers
perspective that employee does not just get a seventy-five thousand dollar [equations on screen]
salary they cost the employer 75 grand plus another seventy five hundred bucks
of 401k pension matching expenses or eighty two thousand five hundred dollars.
and the employer pays it grumbling and wondering when the next version of robot
comes out so they can replace this worker ,well what happens to those
savings. well, employers usually provide employees with a menu of investment
choices they can hold all cash, they can invest in high-growth relatively risky [list of investment options shown]
funds, they can invest in balanced growth and income funds and so on and so on.
well the employee gets to choose from a supermarket of investment fund choices
or even buy individual stocks in their pension. the key takeaway at the
end of however many years or decades of working the employee is able to take out
from their pension whatever value that pension has accrued to be worth over
that time period. easy. in a defined contribution fund there is essentially [flow chart]
no pension liability. no pension liability to the corporation other than
each year doing the matching thing on that salary. okay?
the employee bears the stock market risk just like everyone else. the big
controversies you read about in the press revolve around the benefit flavor
of a pension, 2nd flavor here, called a defined benefit plan. in a defined
benefit situation a number of irresponsible financial dealings take [types of pensions listed]
place where taxpayer money is often just given away with no thought of fiduciary
duty or obligation to ,you know being respectful of the taxpayers hard-earned
money. a given government worker works for the state for 30 years eventually
making a hundred grand a year at the end having received pension contributions
all along the way just as in the defined contribution system that corporations [equation on screen]
use as outlined above .only in a government defined benefit program the
employee is guaranteed a minimum rate of return in many situations. that is the
employee is guaranteed say 10% a year in investment returns even if the stock
market is flat or down or bad for 7 ,10 15 ,years whatever. that happens all the
time, yet the taxpayers on the hook to give
them that guaranteed 10 percent a year compound rate. well at a 10 percent of [flow chart]
your compound rate after seven years well let's say the actual stock market
return was only 7 percent and the employee lagged 3 percent a year each
year compounded well that would be a lot that the state would then owe them so
that's one flavor of pension liability that could likely bankrupt California
and Illinois at some point not too far away because the pension liabilities [California and Illinois pictured.]
there are enormous. and it gets worse there are other irresponsible things the
states have done like guarantee retirement return minimums or investing
pension money in dead stock beanie babies. it was a really bad investment by
CalPERS there huh. so yeah pension liabilities are a
totally simple easy to understand uncontroversial thing and while they
can't possibly have an adverse effect on the world around us right? sorry hard to
keep a straight face there. [man talks out the side of his mouth]
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