Baby Boomer Time Bombs

THERE ARE AT least five components to The Baby Boomer Time Bomb:

1. Social Security
2. Medical Expenses
3. Defined Benefit Pension Plans
4. The Stock Market
5. Other Savings

Defined Benefit Pension Plans: Social Security and Medicare

The nation’s health care and Social Security system is about to face a rude wakeup call as the first wave of baby boomers retire according to the following highlights from the Social Security and Medicare Boards of Trustees 2005 annual report.

· Annual cash flow deficits are expected to grow rapidly after 2010 as baby boomers begin to retire. The growing deficits will lead to exhaustion in trust fund reserves for Medicare Hospital Insurance (HI) in 2020 and for Social Security in 2041.

· Total Medicare expenditures were $309 billion in 2004 and are expected to increase in future years at a faster pace than either workers’ earnings or the economy overall.

· Medicare’s annual costs are currently 2.6 percent of GDP, or about 60 percent of Social Security’s, they are now projected to surpass Social Security expenditures in 2024 and to be almost twice as great as Social Security by 2079.

· To bring HI into actuarial balance over the next 75 years would require an immediate 107 percent increase in program income or an immediate 48 percent reduction in program outlays or some combination of the two.

· Medicare’s financial outlook has deteriorated dramatically over the past five years and is now much worse than Social Security’s. This is due primarily to a major change in the projected long-term growth rate of Medicare costs relative to that of the economy and, secondarily, to more rapid expenditure growth so far this decade than previously anticipated. In 2000 annual cash-flow deficits were projected to first appear for HI in 2010. But these deficits actually began last year, resulting in the projected exhaustion date for HI Trust Fund reserves moving forward from 2025 to 2020. HI costs are expected to rise so rapidly thereafter that trust fund income will be adequate to cover only 27 percent of program costs by the end of the 75-year period.

· Expenditures on health care can be expected to rise faster than non-health care expenditures for the foreseeable future. Prudence dictates action sooner rather than later to address the challenges posed by the financial outlook for both Medicare and Social Security.

According to The Boomer Project there are more Boomers than any other segment of the population.


Boomers are turning 50 years old at the rate of 10,000 a day and starting in 2006, the first Boomers will start celebrating their 60th birthdays. There is no looking back.

Defined Benefit pension Plans: Healthcare: America’s Other Pension Problem

On December 20th BusinessWeek Online wrote about America’s Other Pension Problem.

Companies’ financial obligations to retiring workers — in the form of pensions — have come into the spotlight recently. And despite concern that the pension plans of many companies suffer from underfunding, Americans can take some comfort in the fact that pension funding is regulated by the government and financial accounting oversight bodies. But another, lesser-known obligation may pose an even bigger problem for Corporate America — funding shortfalls for post-retirement health plans.

Other post employment benefits (OPEB), as these benefits are known, are receiving greater attention from lawmakers and regulators. On Nov. 10, 2005, the Financial Accounting Standards Board (FASB) unanimously voted to add pension and OPEB treatment to its agenda.

OPEB obligations consist mostly of medical costs paid to insurance companies (or special accounts for the self-insured) and pharmaceutical outfits for the benefit of retired workers. These benefits may be contractual or implied, and usually require retiree contributions in the form of monthly premiums and direct co-payments for services and products rendered.

Unlike with pensions, which are regulated, companies have no legal requirement to create a trust entity to fund the current or future OPEB costs. Additionally, specific tax treatments and credits set up to encourage pension funding do not exist for OPEB funds. For these reasons many companies have not created trust accounts to fund their OPEB obligations, and those that have done so fund them to significantly lower levels than required under current pension funding rules.

Pensions, while underfunded, have 88.3% of their obligations set aside in pension trusts, compared to 21.7% for OPEB obligations. The result: The underfunded OPEB liability of companies in the S&P 500 is significantly larger than the pension underfunding. For the 337 companies in the S&P 500 that offer OPEB, only 282 provided sufficient information for estimates. Those 282 had OPEB assets of $82.2 billion and OPEB obligations of $379 billion, resulting in an underfunding balance of $292.2 billion.

A fundamental difference between pensions and OPEB are that pensions have required funding and the Pension Benefit Guaranty Corp. (PBGC) behind them, while OPEB have no such requirement or quasi-government backing. Another dissimilarity: Over the last two years, additional disclosures for pensions have been added to assist investors in evaluations, while similar disclosure has not been enacted for OPEB.

The underfunding of both pensions and OPEB stems from a combination of low interest rates and specific accounting methodologies designed to smooth out market volatility. Pensions and OPEB, like debts, must be paid if a company is to remain credible. Their obligations are imperative in analyzing and evaluating ongoing concerns.

The FASB initiative’s first step, expected to take about one year, will add the net pension and OPEB status to the balance sheet. The second would actually change the methodology of pensions and OPEB, and that will likely take at least three years.

Defined Benefit Pension Plans: Local Healthcare Problems

The International Herald Tribune is writing about the healthcare retirement time bomb.

Since 1983, the city of Duluth, Minn., has been promising free lifetime health care to all of its retired workers, their spouses and their children up to age 26. No one really knew how much it would cost. Three years ago, the city decided to find out.

It took an actuary about three months to identify all the past and current city workers who qualified for the benefits. She tallied their data by age, sex, previous insurance claims and other factors. Then she estimated how much it would cost to provide free lifetime care to such a group.

The total came to about $178 million, or more than double the city’s operating budget. And the bill was growing.

Mayor Herb Bergson was more direct. "We can’t pay for it," he said in a recent interview. "The city isn’t going to function because it’s just going to be in the health care business."

Duluth’s doleful discovery is about to be repeated across the country. Thousands of government bodies, including states, cities, towns, school districts and water authorities, are in for the same kind of shock in the next year or so. For years, governments have been promising generous medical benefits to millions of schoolteachers, firefighters and other employees when they retire, yet experts say that virtually none of these governments have kept track of the mounting price tag. The usual practice is to budget for health care a year at a time, and to leave the rest for the future.

Off the government balance sheets – out of sight and out of mind – those obligations have been ballooning as health care costs have spiraled and as the baby-boom generation has approached retirement. And now the accounting rulemaker for the public sector, the Governmental Accounting Standards Board, says it is time for every government to do what Duluth has done: to come to grips with the total value of its promises, and to report it to their taxpayers and bondholders.

"It’s not going to be pretty, and it’s not the fault of the workers," said Mayor Bergson, himself a former police officer from Duluth’s sister city of Superior, Wis. "The people here who’ve retired did earn their benefits."

The new accounting rule is to be phased in over three years, with all 50 states and hundreds of large cities and counties required to comply first. Those governments are beginning to do the necessary research to determine the current costs and the future obligations of their longstanding promises to help pay for retirees’ health care. Local health plans vary widely and have to be analyzed one by one. No one is sure what the total will be, only that it will be big.

Stephen T. McElhaney, an actuary and principal at Mercer Human Resources, a benefits consulting firm that advises states and local governments, estimated that the national total could be $1 trillion. "This is a huge liability," said Jan Lazar, an independent benefits consultant in Lansing, Mich. "If anybody understands it, they’ll freak out."

Defined Benefit Pension Plans: Defined Benefit Broken Promises

The LA Times is reporting on Broken Promises of defined benefit plans.

On October 8th October 8 Delphi Chief Executive Robert S. "Steve" Miller, citing global competition and crippling "legacy costs," ushered the $28.6 billion-a-year company into one of the largest industrial bankruptcies in U.S. history. In short order, Miller called for slashing workers’ compensation by almost two-thirds, threatened to void the company’s union contracts, and hinted broadly that he would follow the playbook he had used elsewhere of pushing responsibility for paying the firm’s pensions to the federal government and dumping its retiree health benefits altogether.

Since 1980, the fraction of the full-time private sector workforce covered by pensions has fallen from 35% to under 20%, according to the Employee Benefit Research Institute, which is sponsored by big business.

One in every six to 10 companies that still offer pensions have frozen their plans by limiting or eliminating employees’ right to accrue additional benefits or no longer covering new hires, according to studies by the Pension Benefit Guaranty Corp.

In a nutshell, America is quickly converting from a defined benefit society to a defined contribution one. Explanations for why such a deep-running change is occurring vary widely. In Delphi’s case, Miller has said the answer is simple: The firm’s competitors don’t provide generous pensions or retiree health benefits, so it can’t either.

The switch from traditional pensions to 401(k)s is the most clear-cut example of the risk shift underway in America from business and government to working families. But it hardly is the only one.

Across the country, safety nets that working people once depended on to shield them from economic dislocation – for example, unemployment compensation, disability insurance, job training and healthcare coverage – have been scaled back or eliminated. At Delphi, the battle lines have formed not just over retirement, but also wages, benefits, job security, indeed the company’s very survival.

Until the last few years, they could have rested easy that the Pension Benefit Guaranty Corp. would ensure that they got paid. But that was before many of the nation’s steel companies and some of its biggest airlines declared bankruptcy and dumped their pension obligations on the government. Among them: Miller-managed Bethlehem Steel, whose retirement promises will cost the pension agency $3.7 billion.

Suddenly, the Pension Benefit Guaranty Corp.’s $9.7-billion surplus in 2000 became a $22.8-billion deficit, and some analysts suggest that this was just the beginning of the trouble.

Seizing on the agency’s estimate of a $450-billion mismatch between the assets and liabilities of all of the nation’s private pension plans, these analysts say that a financial crisis of the magnitude of the savings-and-loan fiasco of the 1980s is in the offing. Others say that a second, similar-sized crisis is on the way for state and local government pensions, which the Pension Benefit Guaranty Corp. does not insure, but which carry a kind of implicit public guarantee.

Coming atop President Bush’s concerns about the solvency of Social Security, the new warnings seem to suggest that America has over-promised; that even if current and near retirees like Montgomery and Seibert get their pensions, younger workers won’t get – or even be offered – anything similar; that the era of defined benefit protection is coming to a crashing close.

The big problem is that almost no one in Washington can agree on precisely how to manage it.

Defined Benefit Pension Plans: Defined Benefit Plan Participants

Following are a pair of charts on private sector defined benefit plans.


Notice how the number of defined benefit plans as well as the number of active participants have been shrinking. This is a result of small and mid-sized employers dropping their pension plans or shifting to defined contribution retirement plans (such as the 401(k) plan). The total number of participants has increased slightly because pension plans typically pay benefits for the life of the retiree. In the public sector, defined benefit plans have remained the predominant type of retirement plan. That is going to be a huge problem as we shall see later.

Defined Benefit Pension Plans: Pension Plan Underfunding

Somehow the stock market has, for now anyway, ignored the problems at GM, Delphi, and the earlier dumping of benefits on the Federal Government (taxpayers) by steel companies and airlines, as well as all the other underfundings depicted in the above chart. By the way, those figures are understated since small companies are not included in the totals. The correct number is closer to $450 billion.

Looming much larger but perhaps a bit further out on the horizon are state and local pension plan problems. Many are in serious trouble already with hardly anyone paying attention. Let’s take a look.

Focusing on problems addressing states Stateline.Org writes Pensions pose time bombs for budgets.

The aging of baby boomers in the state government work force is prompting fears that pension payouts will bust state budgets and is spurring efforts from Alaska to Massachusetts to reform public employee retirement systems.

Experts say states, counties and cities are short $292.4 billion in money promised through their public employee retirement systems, makes them ticking time bombs for state and local budgets.

"Folks are really not paying that much attention. … It’s something that warrants far more scrutiny," said Sujit CanagaRetna, a fiscal analyst with the Council of State Governments, a bipartisan umbrella organization for state government officials.

To limit their pension debts, five Republican governors this year championed proposals to mimic the private sector by moving state employees from traditional pension programs — with guaranteed payouts — to 401K-style programs, where the state contributes a set amount each month to an employee’s investment fund. When employees retire, the money in the fund is theirs.

But [with the exception of Alaska] their proposals also faltered in the face of fierce opposition from public employee unions, which say the 401K-style plans provide less comprehensive retirement security for state and local government employees.

At least 40 percent of current state employees in 20 states will be eligible for retirement by 2015, according to a 37-state survey released earlier this year by the Government Performance Project. Washington, Maine, Tennessee, Michigan and Pennsylvania will have the most employees reaching retirement age in the next 10 years.

In addition to an aging workforce, CanagaRetna of CSG said other factors are creating unfunded liabilities in state pension programs. For example, states such as Illinois, New Jersey and North Carolina decreased payments into their retirement systems to help balance their books during the fiscal crisis and are now scrambling to catch up, he said.

Currently, the majority of state and local employees are covered by traditional defined-benefit pension plans.

Daniel Clifton, chief economist with Americans for Tax Reform said: "You’re not going to have enough new workers to replace the older workers. That’s a recipe for fiscal disaster. … I believe personally it’s a pension time bomb waiting to happen."

Defined Benefit Pension Plans: Did Wall Street Wreck United’s Pension?

In what appears to be foolish attempt to gain extra "yield", a common practice these days with everyone assuming the government can and will bail out anyone and everyone that fails, a July New York Times article wrote How Wall Street Wrecked United’s Pension.

Hearings have been convened in the wake of United’s default, chief executives examined under oath, bills introduced in Congress, numbers crunched. But virtually everyone is looking at the rules covering how much money a company puts into a pension plan every year – not at what happens to the money after that.

While the money managers and other pension professionals who ran United’s pension plan walked away from the wreck unscathed – indeed, they collected about $125 million in fees over the last five years alone, records show – the ones who will have to pick up the bill for the advisers’ collective failure will be the airline’s 130,000 employees and pensioners, the federal pension guarantor and probably, someday, the taxpayers.

Pension investing is largely unregulated, even though the federal government effectively covers the investment losses when a defined-benefit plan fails. At United, this freewheeling approach gave rise to investments in junk bonds, dot-coms and even what appears to be an energy venture in Albania.

The Securities and Exchange Commission recently said that more than half of the consultants who help pension funds invest their money have outside business relationships that could taint their advice.

Please read part II later this week!
Until then ~ Mike Shedlock "Mish"

January 03, 2006

The Daily Reckoning