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Steve Forbes: Olivia, good to have you with us. A timely topic you’ve achieved expertise in –with 79 some-odd million Baby Boomers – you head up, among other things, the Pension Research Council.
Olivia Mitchell: That’s right, at the University of Pennsylvania, at The Wharton School.
Pension Bailout
Forbes: In terms of pensions, let’s do a broad question first. I’m old enough to remember, unlike you, the late-’70s, when there was very real concern about pensions. And then, in effect, what bailed us out was that inflation was conquered, a booming stock market – interest rates came down, asset values shot up.
Any hope of that in the future? Or say, if it happened, put aside the moment the public plans. If that happened, wouldn’t that take a lot of pressure off? You get more realistic discount rates? You would get asset values growing again.
Mitchell: Certainly the pension structure in the U.S. is in grave trouble. State, local and municipal pension plans are underfunded by about $3 trillion – probably about 65% funded, if you do the math their way. Probably about 30% funded, if you do the math, I think, the more accurate way. Corporate plans that have traditionally been of the defined benefit variety are also in trouble. They invested a lot of their assets in equity, and they haven’t contributed what they should have contributed over the years. So, yes, if markets went up again, that would help for sure.
But the more fundamental question is, “Are we valuing the promises correctly? And are we contributing enough to pay those promises?” I have grave doubts about the ability of individual employers to manage capital market risk, interest rate risk, longevity risk and so forth.
Changing Definition Of Retirement
Forbes: Let’s first deal with the question: Are we going to have retirement? You’ve pointed out that a hundred years ago you just worked till you dropped. Now you say, especially with younger Baby Boomers, they may be working a lot longer than they anticipated.
Mitchell: I think the definition of retirement has changed dramatically from even 20 years ago or 30 years ago. When my parents’ generation reached retirement age, they had a pretty comfortable social security, reliable Medicare and their house value had stayed up. They had a nice pension and good retiree health. If you look at the Baby Boomers – and I’m one – what we face is a much more fragile public sector set of promises, Medicare and Social Security.
I have never had a defined benefit plan in my career – it’s always been a 401(k) or a 403(b), which you see rise and fall. Our housing values are in trouble. And very few companies are offering retiree medical. So I call it a great insecurity that we face, rather than retirement security.
Forbes: And let’s start first with the public plans. You say $3 trillion? That assumes a low interest rate discount?
Mitchell: The $3 trillion estimate assumes that you use something close to what we used to call the Treasury risk free rate. I say “used to,” because Treasuries have become a little bit sketchier lately. But the number is somewhere in the $2 trillion to $3 trillion range, I would suggest, based on the best evidence.
The problem is that the states and the municipalities have been using much higher discount rates. Which makes those promises far away seem very small right now. They used numbers that come from their estimated returns or their expected returns on their assets. I believe those are overly optimistic.
Forbes: 7% or 8%?
Mitchell: Sometimes even higher, that’s right.
Longevity
Forbes: And longevity’s been greater than they anticipated? Or they just willfully ignored longevity tables?
Mitchell: Longevity is a tricky issue. Because obviously every pension scheme and every medical scheme has to project how long we’re going to live to be able to figure out what the expense will be. And longevity has increased about a month a year for the past 30 years.
So we have some idea of that progression. Now, I will agree some plans have just arbitrarily selected an old fashioned, out of date mortality table, which means they’re going to run short, for sure. Looking into the future, what we’re not sure about is whether the improved health of our cohort, due to less smoking, will be offset by the decreasing health of our cohort, due to more obesity and more sedentary lifestyles. So there’s a huge debate now among the actuaries about which way this will go.
Forbes: Now, on the public side, what is to be done? Are you going to see more fights on raising the retirement age, more co-contributions, finding ways to change constitutions? Is that going to work?
Mitchell: It’s very interesting to have watched over the last year what’s been emerging. Some states surely are raising contributions by employees, and I think that’s inevitable. Of course, many of these plans are collectively bargained, which means that the union has to be brought in to the negotiation. In some cases, states are trying to either raise their retirement age or increase the number of years needed to vest. What you’ve started to see happen is a reduction, or even an elimination, of the cost of living adjustment associated with the pensions. And even though I’m an economist not a lawyer, the argument seems to be those cost of living adjustments are not part of the base benefit, so that doesn’t take changing the constitution. What worries me even more, however, is that some states that are very underfunded are going for broke.
They’re undertaking extremely risky investments, hoping that on the upside they’ll make money. On the downside, well, they’re already in trouble. And that, I think, is something taxpayers should pay a lot more attention to, since they’re going to be the ones that might have to fill in the gap if there is one.
Sates Buying Lottery Tickets
Forbes: Can you name the states that are, in effect, buying lottery tickets?
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