The Welch Factor

There may be nine fallacies used to defend public-sector pensions but Dr. Jason Richwine of the Heritage Foundation propagates one major fallacy used to attack them when he avers:

Primarily because DB benefits are guaranteed to workers while DC benefits are not, public-sector retirement benefits are almost always more generous than those of comparable private-sector workers.

Nothing could be more misleading……or dangerous.

DB Benefits are certainly not guaranteed to all public employees.  Check with retirees in Prichard, Alabama or Central Falls, Rhode Island or Colorado or Minnesota or New Jersey.  In the public sector DB promises are only as solid as the ethical fiber of the politicians making them and the judges enforcing them.

The argument against DB plans is not that they are more generous* but rather that they are susceptible to severe undervaluation since all the stakeholders (taxpayers, actuaries, politicians, and even public employees) have their own incentives to believe DB costs are lower than they actually are.  This allows benefits to grow to unsustainable levels where the only alternative available would be to welch.#

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* A DC plan calling for 50% of salary to be deposited into a participant’s retirement account would be more generous than DB accruals for all but the most blatant pension-padders who are either very close to retirement age or only taking token salaries to build up service credits.

# Possibly the next innovation in actuarial science in the ongoing quest to lower contribution amounts (e.g. asset smoothing, open- amortization periods) is to factor in the probability that a government would renege on the promised DB benefits.  We are certainly building up enough data to support a welch factor.

18 responses to this post.

  1. Posted by Tough Love on February 13, 2013 at 4:07 pm

    John, More later, but for now ….. for the 30 year career Public Sector worker retiring at say age 58 (not atypical) the level annual total % of cash pay to fund the typical Public Sector DB pension over their working career (from both the employee & Taxpayers) is 20-30% for Misc workers, and 40-60% for Safety workers … depending on the richness of the Plan formula and provisions.

    With the employee generally paying about 1/5 of that total, leaving (if you use the midpoint of my ranges) 20% of pay and 40% of pay as the Taxpayers’ share for misc. and safety workers respectively, how can you conclude ….. when those %’s should rationally be compared to the 10-15% of pay 401K plus Employer’s SS contribution that is typically granted Private Sector workers toward their retirements …… that Public Sector DB Plans are not more generous that those typically granted Private Sector workers ?

    Reply

  2. Posted by muni-man on February 13, 2013 at 5:37 pm

    Fallacy 6 (last para.) pretty much sums it up. The percent of pension benefits accruing each year NOT covered by employees for which taxpayers are responsible, in the case of teachers, is about 84%. Taxpayers, therefore, kick in about $6 for every $1 publics kick in for pensions which is total BS. The link in footnote 18 goes on to show public school teacher compensation is about 52% more expensive than in the private sector. Why? – monopoly control over services and virtually complete insulation from any market-setting forces on salaries and benefits as a result. NJ continues to do the smart thing by underfunding pensions and eventually bringing this TP ripoff to an end.

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  3. Posted by Javagold on February 13, 2013 at 8:00 pm

    if you can not touch it, you do not own it !

    Reply

  4. Posted by Joe on February 14, 2013 at 4:11 pm

    Prichard, Alabama, and Central Falls, Rhode Island, stopped paying government employees their pensions because they went broke, bankrupt. So basically your argument is that government employees should get higher pensions because the pension obligations might make the governmental entity go broke.

    Reply

    • Posted by Al Moncrief on February 14, 2013 at 6:59 pm

      Joe, note that several state governments were included in Bury’s list. State governments cannot declare bankruptcy under federal law. You have mischaracterized Bury’s argument. I think he is making the point that contracts should be honored in the United States . . . that we live under the rule of law. Your preference may be for anarchy. You are in a minority.

      Reply

      • Posted by Tough Love on February 14, 2013 at 7:15 pm

        It’s not hard to see you on the other side of the argument if you weren’t on the receiving end of this excessive pension gravy train.

        Reply

        • Posted by Al Moncrief on February 16, 2013 at 2:17 pm

          Hi TL, I’m trying to imagine myself as a policy analyst for the Heritage Foundation. If I were in that position would I support the breach of contracts? I don’t think so. Note that in Colorado it was our hyperconservatives who fought most aggressively to prevent Colorado’s breach of its contracts. We had some noble Democrats who maintained their principles and opposed the 2010 contract breach, but most of the Democrats went along with the union lobbyists who wanted to protect their current dues-paying members. Republican or Democrat . . . we all must act within the strictures of the U.S. Constitution.

          Public pension policy makes for some of the oddest of bedfellows. Al

          Reply

      • Posted by Anonymous on February 14, 2013 at 8:44 pm

        Al, I think in a nutshell what is being said is that the public pensions are nothing more than ponzi like scams for a myriad of reasons and that the publics expecting pay dirt are guaranteed nothing as we have been seeing across the nation. Rule of law@ What does law matter when there is no more money? If politicians had been following the constitutional laws of our country and states, we would not be in this mess to begin with. I wouldn’t hold your breath. Much more irresponsible to string the publics along than to make the hard decisions for reform now.

        Reply

        • Posted by Al Moncrief on February 16, 2013 at 2:22 pm

          Hi Anon, if there is “no more money,” how are these state and local goovernments going to pay for their corporate contracts? Should corporations refuse to sign a contract with any governmental entity since there is “no more money” for those governments to meet their contractual obligations? As to your point about “following the constitutional laws,” our state and federal constitutions do not preclude governments from becoming a party to a contract. Agreed, make the “decisions forr reform;” however, assure that those decisions conform with the U.S. Constitution. Al

          Reply

          • Posted by Anonymous on February 26, 2013 at 2:23 pm

            Al. Let me clarify. When employee costs past and present take up the lions share of a budget (state, local) there is not awhole lot left for much else in the way of public services. Many private contractors have been stiffed for payment from the government–havent you been reading about all those bankruptcies? And yes, any entity should be very wary of doing business with the government especially those dependent on it for retirement. We have hardly heard the last of this.

      • Posted by muni-man on February 15, 2013 at 12:30 pm

        Welch away NJ! No ‘pension are contracts’ status here; no ARC’s required; absolutely nothing to prevent NJ from reducing/eliminating benefits going forward; NJ can move unilaterally – no need to get approval to do any of this from unions. NJ’s got a lot a flexibility to rock ‘n roll. NJ got it right.

        Reply

  5. […] The Welch Factor burypensions.wordpress.com […]

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  6. Posted by Anonymous on February 15, 2013 at 8:40 pm

    Thank God NJ did one thing right and welch away they will!

    Reply

    • Posted by Tough Love on February 15, 2013 at 10:34 pm

      While I too hope for the JUSTIFIED cutbacks, I’m concerned we may go into PAYGO for a short period as the Unions SCREAM “We’re entitled as, we paid our share”.

      Of Course that’s nonsense (based on the absurd generosity of these Plans and the VERY small portion of the total cost they are paying), but it may take some time for the Taxpayers to sufficiently protest the abuse before our elected officials read the writing on the wall and throw their Union benefactors under the bus.

      Reply

      • Posted by muni-man on February 16, 2013 at 1:46 pm

        The huge tax hike required with a paygo scheme and it’s permanent nature would trigger severe TP backlash. It would likely hit businesses negatively in a lot of ways too and that would make it anathema to them as well. I’m not saying the pols won’t try it, but I just don’t believe it’s politically doable because the TP backlash will scare the hell out of them. That’s why I think continued underfunding is the way to go since it will eventually force NJ to scrap DB pensions once and for all.

        There are other pressures on gooberments too that are gonna start hitting publics hard. Tax bases aren’t really growing because of stagnant wage growth in the private sector and high unemployment. These have become secular, not cyclical, in nature and will be around for a long time, especially as technology continues to replace many formerly decent paying jobs. Massive existing debt is gonna limit gooberments’ ability to do much about anything. The education cartel is gonna be increasingly hard pressed to dream up new loopy logic to justify their bloated numbers and cost. Higher education is gonna take a serious hit before the decade’s out as more people, especially employers, are now realizing the value of a degree today is increasingly spurious as many graduate with academic bona fides equivalent to Cro-Magnon Man. Degrees aren’t automatically translating into better careers anymore like they used to; the proliferation of online education is gonna whack the ivory tower crowd very hard too in the future. Basically, gooberment is gonna stall/shrink right along with the tax base, both nationally and locally.

        Reply

        • Posted by Tough Love on February 16, 2013 at 11:12 pm

          Quoting…”That’s why I think continued underfunding is the way to go since it will eventually force NJ to scrap DB pensions once and for all. ”

          To have a MATERIAL financial impact,, the DB Plans must be scrapped for the future service of all CURRENT workers (including safety). Doing so is certainly going to be a Malox moment for our gutless politicians.

          Reply

  7. […] that the obligation to provide the promised benefits must be met” preclude the use of a Welch Factor, however […]

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