United Parcel Service, Inc. (UPS), Ford Motor Company (F): The True Crisis Over Public Pensions

Page 1 of 2

Public pensions have gotten a huge amount of attention ever since the city of Detroit declared bankruptcy last month. Concerns have focused on whether pension funds can generate adequate returns to support their long-term payouts while maintaining their promised benefits, especially in light of the many recipients who aren’t eligible for other forms of financial assistance, most notably Social Security.

Some analysts, including Fool contributor Morgan Housel just last week, don’t think the pension crisis is a crisis at all. They argue the pension crisis has gotten blown out of proportion, with investors and workers all overreacting to the financial stresses that the 2008 recession and market meltdown put on the pension system. As those stresses have lessened, the argument goes, pension funds will see their conditions improve.

One study from the Center for Retirement Research strongly supports the non-alarmist point of view, with hard evidence that the measures that state and local pension funds have taken to shore up their finances will ensure their survival. But the way in which those conditions will improve will itself have big ramifications for employees, potentially causing a retirement crisis among workers who were led to expect much more from their pensions.

When the cure is worse than the disease
The CRR study took a look at 32 pension plans across 15 different states to see exactly what responses the plans made during the financial crisis. Far from concluding that all pension plans themselves shared the views of CalPERS CIO Joseph Dear that “there is a reasonable basis to be confident” about the poor performance of its pensions, all but three of the 32 plans have made at least some reforms.

The most popular reform, made by three-quarters of the plans, was to adjust age and tenure requirements. Most of the plans did so on a new-hire basis only, but four plans made adjustments for all employees. Similar changes to the average salary period used to measure pension benefits and reductions in the benefit accrual factor were largely targeted at new hires, although some existing workers were also affected.

United Parcel Service, Inc. (NYSE:UPS)Yet several of the measures had a major impact on longtime workers. Of the plans, 14 increased the amount of money they require employees to have taken out of their paychecks in order to cover their pension costs, with most of those doing so for all employees. For instance, the Texas Employees Retirement System boosted employee contributions by a full percentage point, raising withdrawals to 7%. Also, reductions in the way that benefit payments reflect cost-of-living adjustments hit 15 of the plans, again with the majority of those imposing COLA changes on all employees and even on current retirees.

Solving one problem, creating another
From the perspective of the plans, these reforms have been wildly successful. The CRR now estimates that pension costs as a percentage of state and local government budgets will actually fall over the long run, as reform efforts have an increasingly large impact over the next 15 to 35 years. One big question remains whether future returns will live up to expectations, especially as public pensions have followed the moves in past years by private companies United Parcel Service, Inc. (NYSE:UPS), Ford Motor Company (NYSE:F), and Lockheed Martin Corporation (NYSE:LMT) by increasingly raising allocations to bonds in their respective pension portfolios. But despite some sensitivity to return assumptions, the CRR study found that governments would likely be able to absorb some deviation from expected returns.

Page 1 of 2