August 2018 - Jane the Actuary

August 27, 2018January 12, 2025 Jane the Actuary Retirement

Forbes post, “Social Security And The Consequences Of Uncertainty”

Originally published at Forbes.com on August 27, 2018.

Fellow Forbes contributor Kate Ashford wrote an article on Friday, “How To Plan (Or Not Plan) For Social Security In Retirement,” that confirms what most of us already sense: there’s no easy way to figure out how to incorporate Social Security into our retirement plans when there is no certainty around the system’s future. She cites financial planners who advise their clients to assume that Social Security benefits will be two-thirds, or even only as much as one-quarter, of today’s benefits, or who don’t even build Social Security benefits into the client’s retirement plan at all, treating it as bonus income, should it materialize.

I’ve previously written that my preferred Social Security reform plan is a phase-in of a flat benefit paired with mandatory annuitized retirement accounts, a plan similar to what the United Kingdom is actually phasing in at the present, which is, in fact, a shift from a system that had been very similar to the American system. I’ve also written that, much as I’d prefer reform, the most likely outcome of the depletion of the Trust Fund will simply be a legislative fix in 2034, or whatever year this event comes to pass, enabling Social Security benefits to be paid out of general revenues rather than solely out of FICA taxes.

But Ashford’s article is striking to me because it highlights the fact that there is real harm being done in that we have an entire generation of workers unable to meaningfully identify savings targets, even if they wished to, because of the uncertainty around Social Security. And it’s not just a simple matter of the upper middle class planning for a Social Security-less future because they can afford to be cautious. As of 2015, 64% of 18- to 29-year-olds, and 63% of 30- to 49-year-olds, believed that they would not collect a Social Security benefit, according to Gallup.

Does this poll reflect the percentage of Americans who believe that Social Security will wholly disappear? Likely not – the poll gives two answer choices, “yes” or “no”, rather than a more common polling format of specifying the degree of confidence one has, so that the “no” could be taken as a general expression of worry. The question also asked specifically whether the individual thought the Social Security system “will be able to pay you a benefit” (emphasis mine), so some of the “no” responses might well come from people expecting that the system would still exist but be means-tested and they wouldn’t be poor enough to qualify.

To be sure, experts have always pooh-poohed all such concerns as foolish, and have insisted that all we need is a bit of tinkering here and there; some even say that the worries people have about Social Security are entirely the fault of Republicans who, in their narrative, sowed doubts in order to build support for individual account proposals.

But these uncertainties about Social Security have consequences.

Ashford reports on recommendations to plan as if Social Security doesn’t exist, but given the reports that younger Americans are far from saving at rates appropriate to fund their retirement needs in full themselves, there’s no reason to think this is happening on a large scale. What seems more likely to me is that rather than boosting motivation to save, the uncertainty around Social Security is sapping motivation, because if it makes the very idea of identifying a savings target too unknowable a venture, and the more unknowable the savings target or savings rate is, the more difficult it is to see this as a real, tangible, achievable goal. And the less tangible and achievable that goal seems, the more difficulty it’ll have competing with other spending and savings objectives.

Which means that, however clever I might consider myself to be for saying, “Eh, Congress will just pass a ‘Social Security fix’ when the time comes,” there is a real harm done to individuals, and to our retirement system more broadly speaking, when Congress creates this uncertainty by collectively declaring the issue non-urgent and deferring action.

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

August 24, 2018January 12, 2025 Jane the Actuary Retirement

Forbes post, “Why Chicago’s Pension Obligation Bond Plan Is Even Worse Than It Seems”

Originally published at Forbes.com on August 24, 2018.

The Wall Street Journal brought the Chicago pension obligation bond proposal, which I first addressed in an article last week, into the national spotlight yesterday, in a (nonpaywalled) article, “Chicago’s New Idea to Fix Its Pension Deficit: Take On More Debt,” which reports that:

Finance Chief Carole Brown said she would decide in the next week whether to endorse a $10 billion taxable bond offering that would be used to help close Chicago’s $28 billion pension funding gap. If the proposal is accepted by Mayor Rahm Emanuel and approved by the City Council, it would become the biggest pension obligation bond ever issued by a U.S. city.

The article further reports that the city is expecting a 5.25% interest rate for the bond; its bet is that it will earn more by investing those assets than it has to pay out in interest.

Easy money, right? Eh, not so fast.

The municipal pension valuation interest rate is currently set at 7%; it is the nature of government pension accounting that, in general, valuation interest rates are set at the plan sponsor’s assessment (working with investment advisors) of the expected long-term return on fund assets. This means that, based on the pension board’s own assessment, there isn’t much room for error. And, indeed, Thurston Powers, writing at ALEC (American Legislative Exchange Council), is skeptical:

Unfortunately, the pension funds’ return expectations are overly optimistic. The Chicago pension system’s assumed rate of return of 7.5 percent is well over the national average of 6.9 percent in 2017. The past 30 years of investment returns are, unfortunately, unlikely to mirror the next 30 years. Some leading financial analysts estimate that only a 5 percent rate of return can be safely expected.

It is always the case that there is no free lunch, and that the very reason why the stock market has, on average, higher returns than bonds, is because these are riskier investments.

What’s more, the WSJ notes that the projected bond interest rate is higher than you’d expect for a municipal bond because

The debt would be taxable since the federal government typically doesn’t allow cities and states borrowing for pensions to take advantage of the tax exemption usually afforded to municipal bonds.

And, at the same time, the bonds would be in the form of a “sales tax bond.” Since the city’s bond ratings are below investment grade (Ba1 at Moody’s, that is, one notch below investment grade), Chicago is now resorting to an alternate method of issuing bonds, in order to avoid the very high rates they’d otherwise have to pay: this is the use of future sales tax revenue as collateral. Regarding an issuance of bonds earlier this year via its Sales Tax Securitization Corporation, Reuters reported,

The bonds are rated AAA by Fitch Ratings and AA by S&P Global Ratings, both of which are several notches higher than the city’s GO ratings of BBB-minus by Fitch and BBB-plus by S&P.

This is the not good news it appears to be.

This means that, not only is the city mortgaging its future to try to cope with overpromised and underfunded benefits, it’s doing so in a way that traps residents far more deeply.

Chicago is not the first city to issue such bonds; again, the WSJ notes that Detroit, Stockton, and San Bernardino did so likewise, and subsequently declared bankruptcy. But pledging future sales tax revenue, in a manner that’s inescapable even in bankruptcy, in a city that’s already sold off (sorry, 100/75-year-leased) future Skyway toll road revenues and future parking meter revenues, to plug municipal budget holes — that makes the proposal far more worrisome than even the market risk of a conventional pension obligation bond.

August 21, 2018January 12, 2025 Jane the Actuary Retirement

Forbes post, “Are Employers Ready For Old Employees?”

Originally published at Forbes.com on August 21, 2018.

Here’s an article by a Forbes staff writer earlier today: “Employers Say 64 Is Too Old To Get A Job.” This headline is based on the replies employers gave in a survey conducted by the Transamerica Center for Retirement Studies, “Striking Similarities and Disconcerting Disconnects: Employers, Workers and Retirement Security” in response to two key questions in the survey, asking employers and employees both when a person is too old to work, and asking employers when a person is too old to hire. (The article, and the survey, also cover topics around 401(k) provision for employees and worth reading with respect to these other topics as well.)

Regarding the former, of those who answered, the median age that workers gave was 75, but the median age that employees gave was only 70. And regarding the latter question, of those who gave a response, the median age was 64 – bad news for unemployed workers who aren’t financially or otherwise ready to retire.

But there’s some possible good news: regarding who’s too old to work, 65% of employers answered, “it depends on the person” and 12% answered “not sure” – so that fewer than 1/4 of employers had a fixed idea of when a person is too old. With respect to “too old to hire,” 64% gave the “it depends” answer, and 12% the “not sure,” so, again, the large majority of employers are, at least for the purposes of a survey, unwilling to state that they’ll rule out employees based on their age.

(Employees, on the other hand, were less likely to say “it depends” – 54%, or “not sure” – 4%, presumably because they were thinking more concretely of their own future situations.)

Employers also recognize that their employees are likely to want to work past a traditional retirement age, with 70% of them responding that they somewhat or strongly agreed that “many employees at my company expect to work past age 65 or do not plan to retire.” They also, at a rate of 82%, claimed that their companies are supportive of late retirement, and 70% of employers reported that they consider their company to be “aging friendly.”

At the same time, employees envision being able to gradually phase into retirement: 30% want an opportunity to work reduced work hours as they approach retirement age, and 17% want to transition by means of a role change to one that is less demanding or more personally satisfying, both of which come under the header of “phased retirement.” However, over half of all employers (54%) say that they neither now have nor plan to institute in the future any sort of formal “phased retirement” program. While this, in principle, leaves open the possibility of informal arrangements, only 31% of employers said they enable employees to reduce work hours and shift from full-time into part-time, and only 21% of employers said they would allow employees to change to less stressful or demanding roles.

And, further, employers do recognize the value of older employers. Despite stereotypes of older workers as hopelessly behind-the-times, only 15% of employer-respondents criticized age 50+ workers as being “less open to learning and new ideas” and an even smaller percentage, 9%, said they had “outdated skill sets,” compared to 59% valuing them as “bring[ing] more knowledge, wisdom, and life experience” and 49% considering them “a valuable resource for training and mentoring.”

So which is it? Are employers ruthlessly discriminatory when it comes to older workers? Is the age discrimination alleged at IBM and in Silicon Valley more generally, widespread, leaving older workers trapped in “bad jobs,” as Teresa Ghilarducci reports, or are employers open-minded, particularly during a tight job market? From what I see, the picture is much more complex, and whether the report is bad news or good depends on one’s perspective. The retirement age is increasing, and has exceeded age 65 for college graduates (65.7, to be precise), three years greater than for high school-educated workers. Their unemployment rate, in absolute terms, is below average, though remember that the unemployment rate excludes those who have left the labor force, and it’s difficult, once one hits Social Security and Medicare eligibility age, to differentiate between folks who have retired do to lack of satisfactory employment vs. purely due to personal choice.

To a large degree, we will all simply have to wait and see how it plays out, and try to put policies which will enable older workers to stay productively employed longer. Some of this is a matter of ongoing efforts at understanding how best to stave off physical and cognitive decline. But at the same time, consider that, for workers over 65 at companies with over 20 employers, it’s the employer that’s still the primary payer for healthcare benefits, even after that worker becomes eligible for Medicare, and even when that worker, if retired, would collect full Medicare benefits. Given that these healthcare benefits can become an increasing burden on employers, a change that would lighten this burden, and encourage employers to keep them employed, would benefit not just the workers but the rest of us, too.

But employers could also benefit from thinking proactively about how to help their employees be as productive as possible, whether it’s through flexibility for personal issues, or provision of training opportunities, or rethinking job roles to best use their workers’ skills.

August 16, 2018January 12, 2025 Jane the Actuary Retirement

Forbes post, “Public Pensions And Public Trust”

Originally published at Forbes.com on August 15, 2018.

What should states be doing with respect to retirement benefits for their workers? Is it just a political debate, like everything else? Red vs. blue, left vs. right? Here in Illinois, at least, it’s a much more fundamental issue, one of public trust.

Recall that our state plans are among the worst-funded in the nation. Local municipal plans are also in terrible shape and the source of massive tax hikes and shortfalls in city services. A recent analysis by the Illinois Policy Institute documented the degree to which pension spending is sucking up property tax revenue that would otherwise go to providing services.

And the reason is not simply deferred contributions, but benefits which far exceed the private sector in their generosity after multiple increases in benefit levels, reductions in retirement age, increases in COLA (see my prior listing of benefit increases at the state level) — increases which, to their credit, legislators tried to remedy with a Tier II benefit for new hires starting in 2011, but by then the horse was already out of the barn, in terms of benefits already guaranteed to state workers, amounts which are simply massive.

But, more immediately, the city of Chicago and Mayor Rahm Emmanuel have proposed issuing Pension Obligation Bonds to the tune of $10 billion. As explained by Adam Schuster at the Illinois Policy Institute, the city is marketing this as, basically, free money, with the expectation that they’ll be able to gain more money in investment earnings than they’ll spend in interest payments on the bonds — a sort of shell game which wouldn’t fly as a means of generating cashflow for ordinary city spending and shouldn’t be on the table here, either. What’s more, due to the city’s credit rating, Schuster writes,

Officials suggest the plan may leverage a financial vehicle known as securitization, putting taxpayers on the hook by dedicating specific revenue streams to ensure the bonds are repaid. In other words, bondholders would be guaranteed repayment while taxpayers face the prospect of service cuts or tax hikes in the event of a downturn.

Does this mean that investors are guaranteed their return even in case of bankruptcy? I’m not expert enough to know.

And Chicago’s pensions are even more poorly funded than those of the state of Illinois, with a funding ratio of 27% across all City of Chicago plans, due to the same combination of generous benefit promises and poor funding.

This is a violation of public trust.

In order to gain the short-term benefits of public approval for their spending initiatives without the pain of taxes, in order to get union support for their re-election campaigns, in order to promise everything now, without regard to the impact of their actions on future generations, politicians in Chicago and in Illinois happily increase benefits and defer funding. And, again, the Democratic candidate for governor, and likely next governor, has no intention of remedying the situation.

I had previously written that public pension pre-funding is vital as a matter of good governance and fiscal responsibility. But I’ll be honest with you: the example of Illinois and Chicago make me very dubious that we can rely on states to follow through on whatever commitments they make with respect to funding their pension promises from year to year. Whether that’s by simply not making required contributions, or developing delusionally-optimistic contribution schedules, the temptation is simply too great to borrow from future generations in ways that are hidden and conform, on paper, to balanced-budget requirements.

Now, perhaps in other cities and other states, these games are incomprehensible. It is true that there are a few bright spots in public pensions, such as Wisconsin’s risk sharing pension (watch this space . . . ), but Illinois is hardly the only such state; New Jersey is similarly troubled, as outlined in an op-ed even just today. And politicians now in office might defend themselves by arguing that it was their predecessors that got created this problem, but that doesn’t remedy our current situation.

The bottom line is that I simply don’t see any path forward other than removing states and municipalities from the business of running pension plans. If unions don’t want their members subject to the risks of individual accounts, let them run plans for their members and take on the risk themselves, negotiating with employers for fair contribution levels in line with the private sector and educating their membership on the need for additional voluntary contributions. But we can’t keep the system as it is.

August 13, 2018January 12, 2025 Jane the Actuary Retirement

Forbes post, “What Is ‘Financial Literacy’ And Why Does It Matter?”

Originally published at Forbes.com on August 13, 2018.

Americans aren’t saving enough for retirement.

That’s a trite statement.

Precisely how great the shortfall is, is in dispute, of course, as is the question of what remedies, if any, should be undertaken.

But what’s the reason for this savings shortfall? Discarding specifics like “no more traditional pension plans,” there are three potential reasons, each taking some portion of the blame, and each interconnected with the other:

Americans don’t have the knowledge needed to save for retirement.

Americans don’t have the self-discipline to save for retirement.

Americans don’t have the excess funds to save for retirement.

“Financial literacy” is the catch-all name for initiatives around education that, it’s hoped, will remedy the first of these problems — education that, it’s hoped, will occur in schools, through high school graduation requirements which exist or are slated to come into effect in 21 states, according to Pew, but also through employer-sponsored programs, which are in place at 63% of employers according to the publication Plan Sponsor.

And just how financially illiterate are Americans?

The standard measurement, as developed at the Global Financial Literacy Excellence Center (GFLEC), is a set of three questions. In May I wrote about a recent study comparing Americans’ ability to answer these questions, relative to the rest of the developed world. 74% of Americans answered a survey question about compound interest correctly (about average globally); 53%, one on inflation (the global average was 63%); and 46%, one on risk diversification (again, right about at the average).

Are these valid questions, and valid measures of financial knowledge? The experts in the field certainly believe so. But here’s the actual text of the questions:

Suppose you had $100 in a savings account and the interest rate was 2 percent per year. After 5 years, how much do you think you would have in the account if you left the money to grow? Answer choices: more, less, or exactly $102.
Imagine that the interest rate on your savings account was 1 percent per year and inflation was 2 percent per year. After 1 year, how much would you be able to buy with the money in this account? Answer choices: more, less, or the same as today.
Do you think that the following statement is true or false? “Buying a single company stock usually provides a safer return than a stock mutual fund.”

The first of these seems obvious. Surely everyone ought to understand about how interest works, right? An older version of this type of survey, from 2015, has an available download that breaks down the answers given; there, 75% gave the correct answer of “more than $102,” 8% said “exactly $102,” 5% “less than $102” and 12% said “don’t know.” One might attribute the “exactly $102” answers to a careless reading of the survey question, but what of the other wrong answers? Or are these answers simply in line with general innumeracy among a certain segment of the population?

It does strike me, though, that we have lost the very basic means of learning about interest, the humble savings account. Yes, it still exists. Yes, Americans are encouraged to have a savings account. But the interest earned in the year 2018 is so low that it might as well not exist; parents who want to teach their children about the concept of interest sometimes resort instead to creating the Bank of Mom and Dad to credit interest to money their children “save.” And if you don’t have any understanding of interest, how can you likewise understand that high interest rates on money that you borrow can add up substantially?

What of the inflation/interest rate question? In the 2015 survey, 59% answered correctly, 20% said “don’t know,” and 10% each answered more or less than today. [Edit: this was a goof, of course. The correct answer is “less than today” and the two incorrect answers which each had 10% of the replies, were “more than today” and “exactly the same.”] To be honest, I can’t get all that worked up over this result given its abstractness. If I could, I’d prefer to ask something like “if you get a 3% raise, and inflation is 3% for the year, are you better/worse off, or neither?”

And the final question, about mutual funds, it seems to me, showed a general lack of understanding of the term “mutual fund” with 46% answering “false,” 10% “true” and 44% replied “don’t know” — which seems believable enough. After all, if you’re offered a 401(k) at work, you might invest there. If you watch TV, you’ll see ads for E-trade and other brokers. But it’s not obvious that people would know what a mutual fund is without directly being told about them.

But when we look at issues of financial literacy and financial education, we’re really talking about two distinct topics. First, do Americans have a good understanding of how to wisely budget their money to stay out of debt and build up reserves, and, second, do Americans understand what to do with their money, that is, how to invest rather than merely save?

The reality is that Americans continue to report living paycheck-to-paycheck. In the 2015 report, only 40% of Americans reported spending less than they earned, so as to build up a cushion. Even among the college educated, only 48% reported building up savings, and among those earning $75,000 or more annually, only 53% reported this. How much of this is because they don’t understand the long-term effect of debt, and the cost of interest?

One assumes that college-educated, $75,000+ earning households are not living in the sort of financial distress that means that unavoidable everyday expenses absorb their entire income. But there are other families which are locked into a given level of spending due to American middle-class culture and a longstanding “financial miseducation”: the encouragement by experts for years and years that the “financially responsible thing to do” is to is to attend the most prestigious college to which you can gain admittance, regardless of the loans required, and to buy the most expensive home in the highest-rated school district for which the bank will give you a mortgage, for instance, as well as the need, to preserve one’s social standing, to spend on travel sports and lessons for the kids. A recent report at Bloomberg lamented that “Homeowners are sitting on a record amount of equity, but this time they’re stubbornly reluctant to borrow against it.”

So I’m all for financial education to build a core of knowledge around financial topics — not just at school, not just at the workplace, but also in the community, say, at one’s church or the local library. But that’s just a start.