Posts Tagged ‘Gebhardtsbauer’

The Pension Crisis

Friday, January 21st, 2011

Ron Gebhardtsbauer, head of Smeal’s Actuarial Science Program (which was recently named a Center of Actuarial Excellence by the Society of Actuaries), was on Penn State’s public radio station, WPSU-FM, this morning discussing the underfunded pension problem facing Pennsylvania and many other state governments. According to an NPR report from last year, Pennsylvania’s unfunded pension liablities are expected to exceed $55 billion. And Gebhardtsbauer says a lot of other states are worse off.

Harrisburg recently made changes to the Pennsylvania pension system, cutting benefits and raising the retirement age. These changes only affect new workers, but Gebhardtsbauer thinks that they’re a good step in the right direction to ease the state’s current pension crisis.

You can listen to his complete interview online here.

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Smeal Faculty on the Fiscal Commission Recommendations

Tuesday, November 16th, 2010

The co-chairs of President Obama’s National Commission on Fiscal Responsibility and Reform last week released their preliminary recommendations for increasing tax revenues and reducing federal spending in an attempt to bring the deficit under control. Calling the debt a cancer that will destroy the country if not fixed, co-chairs Erskine Bowles  and Alan Simpson proposed cuts to everything from defense contracting to the White House budget to the federal workforce.

Below, Smeal faculty members Ron Gebhardtsbauer, Austin Jaffe and Anthony Warren weigh in on three of the recommendations.

Ron Gebhardtsbauer, faculty-in-charge of the Actuarial Science Program, on the commission’s Social Security proposals:

In the process of putting our fiscal house in order, the Obama Fiscal Commission also gets Social Security back in financial balance, which is great. The most important fix is indexing the retirement age to our increases in longevity, which makes Social Security sustainable, and encourages people to work longer.  Without indexing, Social Security’s finances go out of balance as we live longer.  And it’s not draconian at all.  They very slowly raise the normal retirement age for full benefits to age 68 in 2050 and around age 69 in 2074.  This won’t affect older workers, and middle age workers won’t be affected much.  Older workers in physically demanding jobs will be able to get disability benefits under an easier disability definition. 

I also like that they are finally making Social Security truly universal by covering the remaining state and local government workers (although that will be tough to get through Congress, as the large states have lots of power). 

There are many other fixes, which I’ll discuss in a later blog. 

Austin Jaffe, chair of the Department of Insurance and Real Estate, on the possibility of eliminating the mortgage interest tax deduction:

Perhaps the “sacred cow” of U.S. housing subsidies has been the mortgage interest tax deduction. Even when consumer interest was disqualified, interest deductibility from a mortgage was preserved. Recent discussion has raised the possibility that subsidizing mortgage interest payments is no longer a worthwhile policy. The Deficit Commission has suggested limits on mortgage interest deductibility: The benefit would only be available for primary homes, no interest would be deductible from home equity lines of credit, and no deductions would be available on mortgages larger than $500,000.

Here are some areas of current debate:

1.  The costs of lost revenue are being raised over and over again these days. The Joint Commission on Taxation estimated that it cost $80 billion in 2009 alone. About one-half of homeowners claimed tax benefits were a “major reason” to buy. Yet many households do not itemize their deductions (including about 50 percent of homeowners).

2.  Poterba and Sinai’s 2010 study found that 2.8 million households with annual income over $250,000 saved about $15 billion, while 19 million households with incomes between $40,000 and $75,000, saved only about $10 billion. The savings to middle- income households amounted to $542, or $1.48 per day. This is hardly sufficient to become a homeowner.

3.  Finally, commentators are now beginning to wonder if the deduction is a destabilizing force in housing markets. Inducing homeowners to borrow for consumption of housing services may add additional volatility to house prices since indebtedness adds financial risk to the system, especially when prices are dropping. This is another example of distortions created by providing incentives via the tax code.

There are other issues including the capitalization of tax benefits into current prices before the purchase takes place, comparisons of housing markets in countries without interest deductions, violation of horizontal equity of renters, and others.

After all of these years, it would truly be amazing if this well-liked tax subsidy would be rescinded even if the benefits are not as great as is typically thought relative to the costs.

Anthony Warren, director of the Farrell Center for Corporate Innovation and Entrepreneurship, on the Bowles-Simpson recommendation to merge the Department of Commerce with the Small Business Administration and cut the new entity’s budget by 10 percent:

For many years the Small Business Administration has been the poor cousin among government agencies with the result that small companies have suffered from inadequate representation in Washington.  Recently for example, the administration has supported larger corporations rather than the lifeblood of the economy, innovative job-creating small firms. Therefore there is a concern that smaller companies will now lose any voice that they may have had for the illusion of ever elusive cost cuts.  It would be better to double the Small Business Administration and half the Department of Commerce.

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That Other Retirement Problem

Thursday, June 17th, 2010

Yesterday, Smeal’s Ron Gebhardtsbauer weighed in on the funding of American pensions and their insurer, the Pension Benefit Guaranty Corporation (PBGC). Below, Gebhardtsbauer continues the topic of retirement, addressing what he considers to be far more important reforms:

As I noted yesterday, the underfunding of the private pension system is not the biggest retirement problem facing our country.  It is only a concern for some workers at a small number of companies that will go bankrupt while sponsoring an underfunded pension plan. 

The major problem is elsewhere.  At one time, about 40 percent of workers had traditional pensions through their employer, but today it is less than 20 percent.  Half of employees don’t have any retirement program.  The remaining employees have 401(k)s, in which they provide most or all of the contributions.  Since most people don’t save enough (and have no idea how much money is needed to retire), average 401(k) balances are around $50,000 for older workers, which is nowhere near enough to retire. 

What would a retiree get with $50,000? Investment advisers suggest retirees withdraw 4 percent of their money ($2,000) in their first year of retirement, and increase the “programmed withdrawal” by the inflation rate each year.  An annuity purchased from an insurance company with $50,000 could provide $3,000 per year indexed to inflation or $4,000 flat per year—up to twice as much as a “programmed withdrawal,” but still nowhere near enough to retire. 

Thus, the bigger problem is not underfunded pension plans, but a lack of pension plans (or adequate savings), and that will come to haunt our country in the 2030s, when baby boomers are in their 80s and running out of money.  Not only will that create problems for the individual retirees, but it will be a huge drain for the country when Medicaid (i.e., taxpayers) will have to pay the nursing home costs.  The Medicaid moral hazard is magnitudes larger than the PBGC moral hazard.

So what is the solution?  We recently passed a major health care reform bill because the cost of uninsured health care was making our companies uncompetitive on world markets.  This could be a similarly huge problem.  We have tried educating the public.  It helped, but didn’t come close to solving the problem.  Now we are trying automatic defaults which enroll employees in the company 401(k), but not enough companies are trying it, and employees don’t realize that they need to save a lot (e.g., 10 percent of wages in many cases).  The solution is to mandate workers (or their employers) save more for their retirements, and the fix is needed now (2030 is way too late).  Additionally, people will have to work longer and retire later.  One important signal for doing that would be to raise Social Security’s normal retirement age above the current 66 (67 for those born after 1959), but that won’t be easy (even though it would also be very helpful for making Social Security sustainable). 

Many baby boomers are working longer, because it gives them a sense of worth, and keeps them energized, but many others won’t like this idea.  If that’s the case, they should work for an employer that has a pension plan, or save more when they are working, but that’s easy for me to say.  I enjoy teaching, and I have a good pension and good saving—of course, I’m an actuary.  But that’s not true for a huge proportion of our population that hates their job, didn’t earn much, is worn out, and didn’t save.

What do you think we should do?

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Fixing America’s Pension Insurer

Wednesday, June 16th, 2010

Last week in The Wall Street Journal, Charles Millard, former director of the Pension Benefit Guaranty Corp. (PBGC), wrote about the challenges facing American pensions and made four recommendations to help the PBGC better insure underfunded pensions. Smeal’s Ron Gebhardtsbauer, faculty-in-charge of the Actuarial Science Program, responds below. Gebhardtsbauer is the former chief actuary for the PBGC and served as the senior benefits adviser for the U.S. Senate Finance Committee when Millard directed the PBGC.

From Gebhardtsbauer:

Charles Millard makes a good point in the first sentence of his WSJ editorial when he says that some workers’ pensions may be in jeopardy because the private pension system is underfunded.  However, it is not as big a problem as his readers may infer, and it’s definitely not the biggest retirement problem. 

In the PBGC’s 36-year history, it has been called on to pay the pensions of about 1.5 million people, a number that is much larger than desired, but still less than 1 percent of the workforce.  It is small, because, for starters, most companies don’t go bankrupt and most workers don’t have a traditional pension.  Another reason why this is a problem for only a small group is the PBGC generally pays the full pension to over 90 percent of its retirees.

However, as Millard notes, there is a moral hazard in the pension funding rules.  A weak company with a fully funded pension plan can invest all of their pension assets in stocks and be 60 percent funded after a major crash, and then dump their pension promises on the PBGC. 

In my testimony before the Senate HELP Committee in October, I noted that the pension funding rules are pretty good (in fact, they are too rough for the typical healthy company), but Congress needs to close the above loophole for weak companies.  One way would be to charge weak companies a large risk premium if they want to hold a large percentage of stocks.  However, the weak companies then might not pay the premium, so in that case, the PBGC would need the authority to prohibit too much stock in the pension plans of weak companies. 

The PBGC should also be given the authority to require a special workout with the weak company (just like banks do with corporate borrowers that can’t pay off their loans).  The PBGC could keep the company responsible for their pension promises, give them a temporary reduction in their pension contributions, and reduce the largest pension promises to top brass. 

I also agree with Millard’s third recommendation to allow the PBGC to go back to investing in more equities (even though that’s the reverse of what we recommend for private sector pension plans).   I had a tough time getting others on the Hill to appreciate his point in 2008, because the stock market wasn’t doing well.  Currently, some members of Congress (particularly the Democrats) are criticizing Millard (a Republican) for encouraging the PBGC to hold equities when he headed up the PBGC.  It’s a surprising twist, because when I was the PBGC’s chief actuary in the 1990s, the political parties were on the reverse sides of the debate. 

I’ll also note that if the PBGC had followed Millard and invested in stocks in 2009, it could have $10 billion more in assets today.  Now I know there are good studies that say the PBGC should immunize (invest only in bonds that match their liability payouts), but the PBGC is not a private sector company that has to have assets greater than liabilities, so it can wait out the down market cycles.  In fact, the PBGC’s assets are large enough for it to pay benefits for at least a couple decades.

In addition, the bond idea locks in the PBGC’s deficit, so the bonds-only supporters would need to increase taxes and/or premiums immediately, but I don’t hear them supporting that idea. A reason the PBGC should not invest in equities might be if we think there is no longer a risk premium for investing in stocks, but I don’t think there are many people who believe that for the United States.  Japan has had terrible experience in its stock market for 20 years, but I don’t think we are in the same situation as Japan, either. 

I’ll be interested in what others think about this last point, since it is the most controversial one. Please comment.

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Social Security Still Ill

Tuesday, May 12th, 2009

[This entry has been modified to include the new data released by the SSA. Changes are noted in strikethrough text. As expected, the date at which Social Security funds is projected to be exhausted has moved up to 2037 (four years earlier than before, but not as bad as the 2029 exhaustion date projected in the 1997 Trustees Report).  An earlier date than last year’s projection was expected because: (1)  The 5.8 percent cost-of-living adjustment to benefits this past January was higher than expected due to high oil prices in 2008, and (2) the unemployment rate is higher, which means that less payroll tax money is coming in (compared to what they expected in their report a year ago).]

The following is a primer on Social Security, its ailments, and options for fixing it by Ron Gebhardtsbauer, faculty-in-charge of Smeal’s Actuarial Science Program. Prior to joining Smeal, Gebhardtsbauer was senior benefits adviser for the U.S. Senate Finance Committee. He also served as senior pension fellow for the American Academy of Actuaries.

Members of Congress frequently call Social Security the most successful program of the federal government. It provides income to 50 million Americans and helps stabilize the economy.  It helped reduce poverty rates among the elderly from 35 percent in the late 1950s to 10 percent (which is also the poverty rate for Americans of working age).  Some negatives might be that it encourages people to leave the work force while they are still able to work, and it has been accused of breaking down the multi-generational American family (although the elderly and their adult children both like their independence).  My folks like their Social Security income the best, because it increases each year by the CPI.  They also like it better than their assets, because it comes in the form of an income, while they are afraid to touch their assets (which just fell 50 percent due to the stock market crash).  In summary, they don’t worry about their Social Security benefit decreasing or stopping, no matter how long they live and no matter how bad the markets are.

Social Security is huge. The Social Security Administration (SSA) will collect $700 billion in taxes this year and pay out $625 $672 billion in benefits (1/3 of which goes to survivors and disabled workers).  Their administrative expenses are less than 1 percent of benefits ($5.8 $6.1 billion), even though the benefit calculations are complex and the disability program is very difficult to administer.   This is much, much cheaper than any insurance company or mutual fund. 

Unfortunately, Social Security has financial problems due to our living longer, and not having as many children.  SSA actuaries project that their assets could be exhausted around 2041 2037.  Their taxes at that time will pay just 78 76 percent of benefits.  Even worse are the budget consequences.  Social Security tax income is currently $75 billion last year was $64 billion more than outgo, but this “annual surplus” is decreasing rapidly as the baby boomers retire.   By 2017 2016, outgo will exceed income, so we will have to increase our Income Taxes (and/or debt) to pay SSA its money back (since we borrowed and spent the surpluses).  In fact, we need to reform Social Security before 2017 2016. 


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