Monday, December 17, 2007

Retirement Planning and the PBGC

As we approach the new year, we will no doubt hear the verse “auld lang syne”. The reference to the phrase, thought to have first been coined by Robert Burns (1759-1796), actually translates into “once upon a time”. When we begin the discussion on pensions in the book, we look thoughtfully back to an era when the obligation to employee was more than simply wage-based, it was a lifelong agreement with the firm.

Guy Lombardo played this song on a 1929 radio broadcast forever associating it with the passing of the New Year.

David McCarthy, author of numerous papers and as the book notes, a lecturer at the Oxford Institute of Ageing, at Oxford University (what the book doesn’t say is that he has since changed that position and is now a lecturer in the Finance group at the Tanaka Business School) studies the role of pensions in business.

His belief that pensions have an important life cycle is the cornerstone for much of his work. When the Employee Retirement Income Security Act of 1974 altered the way companies treated pensions – which are not an obligation under the law, the interaction, not to mention the relationship the employee may have had with the employer, changed forever as well.

The life cycle Dr McCarthy wrote of saw workers entering into an agreement with their employer when they were the most vulnerable cash-wise but had the most to offer from a human capital point of view. Pensions, through their conservative nature offered these employees a beginning at a future they might have ignored otherwise. When the human capital was at its lowest point, the pension was there to help.

Pensions unfortunately do not come with property rights. If a company is sold, dissolved through bankruptcy, or simply goes out of business, the employee can run the risk of losing most of their pension. This was the argument made for the 401(k) plan and was used by President Bush as the basis for his privatization of Social Security.

There are some safe guards in place. The PBGC, or Pension Benefit Guaranty Corporation insures against total loss but has not only a limited reach (companies need to participate in the program by paying premiums for the insurance guarantees.)

Here’s a recent example of how the PBGC works with smaller, lesser know companies.
    ”Tom's Foods filed for Chapter 11 protection in April 2005. In October 2005, it was purchased by Charlotte-based Lance Inc. for $40.2 million plus the assumption of some company liabilities. The transaction did not include the pension plan.”

    Also noted in the article by Steven Taub for was this comment about the transactions: “because Tom's Foods missed nearly $4.5 million in required pension contributions and the pension plan will be abandoned as a result of the sale of substantially all of the company's assets.” PBGC has guaranteed no interruption in pension payouts for current retirees and guarantees the pension for those that have vested.

How much pension you receive should your former employer face such events depends on when you retire. Recently, the PBGC, which was created by ERISA, raised its maximum pension payout for those retiring at 65 years old in 2008 to $51,750 (that is a 4% increase over the previous limit of $49,500 for plans ending in 2007.)

The maximum amount of payout for an individual who retires at 75 is $157,320 with a guaranteed benefit of $12,938 for those who retire at 45.

There are ways to check to see if your pension is at risk of being under funded. One is to ask for a health record of your plan. Troubled plans usually rely on optimistic projections of the underlying investments or worse and secondly, because of poor performance of the company leaving the plan with no funding to meet its obligations. Those obligations by the way are a result of actuarial tables used to determine the life span of the workers. If you sense your company is in trouble, plan for the worst – even if your pension payout is guaranteed.

Monday, December 10, 2007

Retirement Planning and Income Inequality

Let’s spend a moment looking at income inequality and the idea of retirement. This, whether you are aware of it or not, works against the notion of how you view some of the social programs you may have been counting on in your retirement years.

One of the most popular measures of this was developed by almost a century ago. The Gini index was developed by the Italian statistician Corrado Gini and published in his 1912 paper "Variabilità e mutabilità" ("Variability and Mutability).

There are several ways to express the degree of income inequality in a society. The simplest way is to arrange whatever units you choose persons, families, or households in rank order, from poorest to richest; divide the hierarchy into fifths (quintiles) or tenths (deciles); and compute either the average income by decile or quintile or the share that each grouping has of the society's total income. Then, the shares or averages of rich and poor can be compared.

The chart above puts the poorest person at zero and the richest at one. The curved line represents all of those who fall in-between those two points

A low Gini index suggests that there is a great deal of income equality while a high number would show a society that has great disparity in income distribution. This is expressed as a number from zero to one.

But like all attempts to measure the economy and the persons who live in it, the Gini index has both its pluses and minuses. Let’s first consider why it works.

The Gini index does not consider the “who earns what” in its calculations nor does it take into consideration the size of the economy. The population of an entire country being measured is not accounted for in the index. The transfer of wealth, as would happen from the rich to the poor is measured in the changes of inequality over a period of time.

But the Gini index is a general measure that does not hold up well when the attempt to drill these numbers down to regional observations. This would force the index to compensate for purchasing power, which might be better for some in areas of the country that were more developed as opposed to other regions where the ability to spend wealth may be hampered.

Efficiency is also a consideration. Generally speaking, wealthier households use money better than those who must make living standard decisions about each dollar available to spend. In other words, one household could own half of all the available wealth and the country might have the same index reading as one where distributions were divided equally – one household with no income compared to one household with.

How does this measurement, which often does not take into consideration how much social assistance a household might receive, affect retirement planning.

Consider a study made by Harvard and Berkeley, done separately but with the same attempted goals. Absolute standard of living, a measure of how well you do as it corresponds with death rates found that income distribution did have an effect on not only how well you live, but how long and what social services you might need as a result of your shorter life span and the causes.

At the heart of what many of us expect, is the presence of some social support. Janet Yellen, president and chief executive officer of the Twelfth District Federal Reserve Bank, at San Francisco believes that support comes with a paradox. You can have generous social insurance programs and employment protections, much as they do in Europe, but are they efficient or equitable? In order for these types of programs to be equitable, they would need to be good for everyone. Efficiency suggests programs that take the nation as a whole into consideration.

Why is this important to retirement planning? Two reasons come to mind. First, the US is seen as highly productive, social mobile, and economically innovative. On the flip side of that coin is Europe. Because of its guarantees to its workers, many companies have stagnated creating higher-than-necessary unemployment. This restricts growth.

The second reason we should all consider is referred to as the American Business Model, which does not treat companies as living entities but as tradable and expendable. In some ways, the employee can get caught up in this kind of thinking making retirement planning more of a personal endeavor rather than a state sponsored or even company sponsored reward for long years of toil.

While Europe may be criticized by America business and folks like Ms. Yellen for what it does for its workers, there has to be a happy medium that allows for both equity and efficiency. Unfortunately, that is not likely to happen.

To see how the Europe (currently) supports its citizenry through its social programs, here is a list:

Country Summaries

Albania | Andorra | Austria | | Belgium | Bulgaria | Croatia | Cyprus | Czech Republic | Denmark | Estonia | Finland | France | Germany | Greece | Hungary | Iceland | Ireland | Italy | Liechtenstein | Lithuania | Luxembourg | Monaco | Netherlands | Norway | Poland | Portugal | Russia | Serbia | Slovak Republic | Slovenia | Spain | Sweden | Switzerland | Ukraine | United Kingdom

Thursday, December 6, 2007

Retirement Planning, Long-Term Care Insurance and Lying

Carl Sagan once said: “One of the saddest lessons of history is this: If we've been bamboozled long enough, we tend to reject any evidence of the bamboozle. The bamboozle has captured us. Once you give a charlatan power over you, you almost never get it back.”

The lie. As we continued our discussion about insurance and retirement planning, we are faced with falsehood. In all fairness, insurance companies are not necessarily liars but without a good indication of what the truth is, you have little hope in distinguishing whether or not what you are being told is true.

Oddly, the insurance industry feels just as strongly about you. Long-term care insurance, a policy that is bought well in advance of actual use, and sometimes by folks who trust that the policy they purchase is the right one for them, are often denied the claims they make and for reasons that seem to the average eye, simply minutiae.

“Nothing is easier than self-deceit. For what each man wishes, that he also believes to be true.” Demosthenes

In the book I wanted to emphasize the possibility that LTC insurance sales people were not as truthful about the product they are selling. I wrote “Back in 1965, noted psychologist/anthropologist Paul Ekman believed that human facial expressions were individual and not the result of some sort of evolutionary step that made the message we portray on our faces somehow universal.

Darwin published his work “The Expression of Emotion in Man and Animals” in 1872. The work suggested that particular emotions are attached to particular expressions in humans and in principle, to animals. What Darwin failed to understand was the nature of the falsehood. In fact, Darwin gave but one reference to the subtle art of deception when he wrote: “They [the movements of expression] reveal the thoughts and intentions of others more truly than do words, which may be falsified”.

Margaret Mead disagreed with Darwin suggesting that expressions were a result of culture not some universally inherited trait. This led Mr. Ekman on a worldwide journey to find the truth about what would later be a blueprint for falsehood. He showed pictures of faces experiencing a variety of emotions to a wide variety of people around the world and recorded their reactions.

But the experiment, he realized after a time was flawed. The people he had hoped would show some sort of innate reaction, one that was universal had been tainted by their contact with the outside world. Because, even in 1965, the world had shrunk considerably, many of his test subjects had seen Charlie Chaplin or John Wayne and understood what those faces meant. He needed to find subjects who were untouched by outside influences, a peoples who were technologically remote. He found just such a group in Papua, New Guinea.

Mr. Ekman found that there was a certain universality to how we express ourselves, confirming what Darwin suggested. From his study this remote tribe, he found that anger, disgust, fear, joy, sadness and surprise were universal expressions developed without outside influences. The ultimate goal: how to find out if someone was lying. He never, at least to my knowledge, applied his study of those 43 facial muscles, the ones that offer telltale glimpses into truth and lies to that of the insurance industry.

“Falsehood is easy, truth so difficult.” George Eliot

The reason you should be as skeptical as I am of this particular corner of the insurance industry has less to do with its relative newness as a product but rather with its aggressive selling by the industry. When a product comes to market, it is always promoted to the widest audience available. It is not different with insurance.

Trouble is, we only come face-to-face with an agent who represents a company and a product and that product is something we might not need in the near future. Long-term Care insurance is bought on good faith, research and soul-searching” and because of the time an effort most of us put into the purchase, we expect it perform flawlessly.

A large number of the claims the companies denied were due to paperwork not filled out properly or the right forms were not submitted. They also cited denial of claims were a result of the facilities the clients chose for care were not appropriate or acceptable for nursing care – although all of the people who had filed complaints had used state licensed facilities.

This is cause for concern among current and future policyholders. If Congress can offer incentives such as tax breaks to the industry to encourage people to buy the product, federal oversight may be necessary. This would take the industry’s current overseer, the state, out of the regulation game.

Even as states begin their own market investigations into the practice of long-term care, it adds another layer of concern about whether this industry is too young to be an important part of your retirement planning.

“Always tell the truth. That way, you don't have to remember what you said.” Mark Twain