Category Archives: political economy

A Thought on Defined Benefits vs Defined Contributions

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The Wall Street Journal described some of the problems with defined benefit plans—pensions.

When United Parcel Service Inc said last month that it was taking a noncash charge of $3 billion tied to its pension plan, the package-delivery giant blamed what might seem like an unrelated event: the downgrade last summer of several big banks by Moody’s Investors Service.

But the connection between the two incidents illustrates the complexities of calculating pension liabilities—and how little power companies have in keeping them under control.

UPS is typical, though, not at all unusual, in the problems they’re encountering with their pension plan:

Across America’s business landscape, the gap between the amount that companies expect to owe retirees and what they have on hand to pay them was an estimated $347 billion at the end of 2012.  That is better than the $386 billion gap recorded at the end of 2011, but the two years represent the worst deficits ever, according to JP Morgan Asset Management.
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A big source of the problem: persistently low interest rates, set largely by the Federal Reserve.

I’ve written about the impact of those artificially low rates here and here.

There are additional major factors in arming this defined benefit bomb.

Putting a value on a pension liability is tricky business. Benefits for individual workers typically are based on their pay and years of service.  A company must also take into account how long retirees are likely to live.

And

Pension liabilities change over time as employees enter and leave a pension plan [including]…the fact that people are living longer.

And

For financial-reporting purposes, companies use a so-called discount rate to calculate the present value of payments they expect to make over the life of their plan.

The discount rate serves as a proxy for the hypothetical interest rate that an insurance company would expect on a bond today to fund a company’s future pension payments.  The lower the discount rate, the greater the company’s pension liabilities.

Boeing’s discount rate, for example, fell to 3.8% last year from 6.2% in 2007.  The aircraft manufacturer said in a securities filing that a 0.25-percentage-point decrease in its discount rate would add $3.1 billion to its projected pension obligations.

That discount rate falls out of those artificially depressed interest rates the Federal Reserve Bank is imposing on our economy.  And that, at the indicated drop in the discount rate works out to a nearly $30 billion increase in Boeing’s defined benefit—pension—liability over those intervening half-dozen years.

Here’s how Moody’s (entirely appropriate) bank downgrade enters into all of this:

Moody’s decision last summer to lower the credit rating of big banks hurt UPS and other companies by booting those banks out of the calculation [because those banks no longer were “safe” enough to have their rates included in the suite of rates used to estimate a discount rate].   And because bonds issued by some of those banks carried higher yields than other bonds used in the calculation, UPS’s discount rate fell 1.20 percentage points.

On the bright side, though, the WSJ article at the link suggests that

…just as falling interest rates have created a massive hole in pension funding, pension plans could quickly recover if interest rates started to climb.

This is a chimera, however.  When the Fed’s already long-term artificially suppressed interest rates are coupled with its massive money printing operation of the last few years, those interest rates will rise, but sharply, in an environment of explosive inflation.  All those dollars that will be paid out to (fixed income) retirees from their nominally recovered defined benefit plans will be worthless as prices those retirees pay with their dollars rise dramatically from that inflation.

Converting to defined contribution plans, like 401(k)s, removes all of these uncertainties from the companies’ liabilities—strengthening them, making them stronger competitors in the market, more stable employers, and so on.  In addition to this, a company’s failure to plan accurately, to fund appropriately its defined benefit plan given that planning, or just to avoid bad luck severely impacts all of its employees (its future retirees) and all of its current retirees.

In contrast, placing these retirement plans into defined contribution plans will let each employee make his own decisions about funding what is now his plan (rather than his employer’s catchall plan), how he wants to accumulate retirement savings, and all in accordance with his own goals and imperatives.  He can tailor his plan to his needs and desires, rather than being dependent on a plan that his employer must drive from a company liability perspective more than from a good for the employee perspective.

Also, should an individual employee fail to plan accurately, to fund appropriately his retirement plan given that planning, or just to avoid bad luck, he only impacts himself and a very few others.  The damage from failure of an individual’s defined contribution plan is enormously circumscribed compared to the damage from failure of a defined benefit plan.

Moreover, an American citizen isn’t as mind-numbingly stupid as our Progressive objectors to defined contribution plans make him out to be.  He’s at least as capable as a company—or a government—in making his own decisions about his future.

Who’s Responsible?

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The company who made and sold the product, or the company that bought the product from a third party which actually did the development?

That’s a somewhat convoluted statement of the question, isn’t it?  Maybe that’s what confused the Alabama Supreme Court.

This body of judges has decided that brand-name drug makers can be held liable for injuries caused by the generic versions of their products.  The particular case has a plaintiff buying a generic drug—a copy of a patented drug—developed and originally manufactured by Wyeth.  Pfizer Inc later acquired Wyeth, and Schwarz Pharma Inc also acquired rights to the drug.  The plaintiff sued, among others, Pfizer and Schwarz Pharma, and the Alabama Supremes let the suit against these two go forward.

Imagine that.  They didn’t make the product, but they’re responsible for anything that goes wrong.

As Pfizer notes,

Alabama’s decision would allow generic-drug makers “to reap the profits of drug sales while leaving brand manufacturers with the liability” and violate the basic legal tenet that a manufacturer is liable only for its products[.]

Chris Hood, plaintiff’s lawyer said, without a particle of irony,

The Alabama Supreme Court is the first and only supreme court of any state to adopt the theory of liability we advocate.  It correctly identified and applied basic tort principles overlooked by numerous lower courts which rejected similar theories.

Progressive “Capitalism”

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The Wall Street Journal describes some concerning our illustrious Treasury Secretary nominee.

The terms of Mr Lew’s original employment contract with Citi included a bonus guarantee if he left the bank for a “high level position with the United States government or regulatory body.”

Most companies include incentives for top employees not to leave, but in this case the contract was written to reward Mr Lew for treating the bank like a revolving door.

There’s more:

…former Treasury Secretary Robert Rubin, who was paid more than $115 million while encouraging the risk-taking that would have destroyed Citi if not for a taxpayer rescue.

Mr Rubin was Mr Lew’s patron at the bank.  Mr Lew’s contract suggests that Citi knew from the start that Mr Lew was headed back to a powerful job in Washington, and that it wanted him to remember the bank fondly when he left.

Hmm….

 

h/t Falkenblog

The Deficit Has A Silver Lining?

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Dr Alan Blinder, Princeton University Professor of Economics and Public Affairs, had some thoughts on this.  His piece is fundamentally optimistic, but a few of his remarks jumped out at me.

Congress and the president have managed to agree on several measures that reduce the projected 10-year deficit considerably.

Reduced the 10-year deficit.  He writes of this as if it’s a good thing.  He writes of this as though that continued 10-year deficit, representing as it does an enormous expansion of an already ruinous debt, is a good thing.

Meanwhile, Republicans are talking far less menacingly about either shutting the government down or precipitating a debt crisis.

For which cynical straw man he declines to provide a single quote from a Republican—or Conservative—wherein such a one ever talked about shutting down the government or precipitating a debt crisis in recent history, other than in the context of Progressives manufacturing such things so they can decry them.

That law [the Budget Control Act of 2011] created land mines like the fiscal cliff, but it also cut spending by over $1.9 trillion once you include the associated interest savings, as you should.  (Here and elsewhere, I use the 10-year budget window 2014-2023 and recent estimates from the widely respected Center on Budget and Policy Priorities.)  That was all spending cuts, no tax increases.

Here Blinder is simply being disingenuous.  There were no spending cuts in that Act.  A reduction in the rate of spending increase is still a spending increase.  A Professor of Economics, even one at Princeton, knows that.

Then came the New Year’s Day agreement that averted the cliff. The headline number then was about $600 billion in tax increases.  But if you add in the spending cuts and the associated decrease in debt service, it came to another $850 billion or so.

See above.  And he’s exaggerating the magnitude of the spending increase reduction.

But imagine that our legislators agree instead on a smarter package of spending cuts and revenue raisers that amounts to the same amount of money [as the present sequester cuts].  After all, it’s only about 0.6% of GDP.  Then we’ll have achieved the $4 trillion target.  The Center on Budget and Policy Priorities estimates that doing so would be enough to stabilize the debt-to-GDP ratio at about 73%, which is a sensible goal for now.

There are a couple of things here.  “Cuts and revenue raisers” that achieve the same degree of…something.  Serious cuts in Federal spending would get the government out of the way of the economy, and its recovery—its enthusiastic performance—would raise plenty of revenue for the government, more so than it’s collecting now.  But Blinder and his fellow Progressives, with these demands for more taxes as the only possible revenue raisers are simply demonstrating their contempt for a free market and the wisdom of the individual Americans participating in it, preferring instead an economy centrally directed by Know Better Progressives.

The other thing is that stable debt-to-GDP at 73% nonsense.  This is an amazing thing even for a Princeton Professor to say.  There’s nothing at all stable about such a debt level.

Some of this “cost control” [in his claimed slowing rise in the cost of health care] is due to the weak economy: Hard times lead people to postpone or cancel some medical care.  But health-care inflation began to fall years before the recession began, which suggests that deeper forces are at work.  If we can somehow slow health-care costs to the rate of GDP growth, our long-run budget problem is basically solved.

On the effectiveness of President Barack Obama’s poor economy in holding down cost increases, well NSS.  “If we can somehow slow health-care costs…,” well the answer here is obvious—let a free market work its will in a competitive environment.  But, such an answer truly is not obvious to one who disdains the free market and that wisdom.

…fixation on reducing the budget deficit, to the exclusion of all other national goals, seems strangely anachronistic.  The nation has other priorities, too—such as faster growth and more jobs.

This also is an amazing thing.  The nation does have as critical economic and security imperatives faster growth and more jobs.  But these are not possible to achieve until the budget deficit is eliminated and the debt it drives reduced.

Obama’s Health “Insurance” Hiring Disincentives

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Here’s the Obama Job Sharing Plan.  As a result of the looming rules of President Barack Obama’s Obamacare,

a local McDonalds has hired employees to operate the cash register or flip burgers for 20 hours a week and then the workers head to the nearby Burger King or Wendy’s to log another 20 hours. Other employees take the opposite shifts.

That’s because 30 hours counts as a full-time employee, and low-margin industries can’t afford the added costs of Obamacare insurance for full-timers.  Holding the employees further under that threshold—to 20 hours, for instance—gives those part-timers room to get another part-time job and so to have a full week’s worth of work and income.  Just with no employer-provided health insurance.  (Whether this is good or bad is a separate post; I’ll just say here that the “good” of it is far from established.) This is not atypical.

[Obamacare] requires firms with 50 or more “full-time equivalent workers” to offer health plans to employees who work more than 30 hours a week.  (The law says “equivalent” because two 15 hour a week workers equal one full-time worker.)  Employers that pass the 50-employee threshold and don’t offer insurance face a $2,000 penalty for each uncovered worker beyond 30 employees.  So by hiring the 50th worker, the firm pays a penalty on the previous 20 as well.  [Emphasis added]

That’s a $40,000 penalty for hiring the 50th worker.  The WSJ lays it out starkly:

If a company with 50 employees hires a new worker for $12 an hour for 29 hours a week, there is no health insurance requirement.  But suppose that worker moves to 30 hours a week.  This triggers the $2,000 federal penalty.  So to get 50 more hours of work a year from that employee, the extra cost to the employer rises to about $52 an hour—the $12 salary and the Obamacare tax of what works out to be $40 an hour.

That encourages hiring, all right.

There are other implications.

Businesses that hire young and lower-skilled workers are also starting to put a ceiling on the work week of below 30 hours. These firms are…”29ers.”  Part-time workers don’t have to be offered insurance under Obamacare.

These young and low-skilled workers are at the point of their careers where they’re starting to accumulate the work experience and habits that can lead to better jobs at higher pay.  Only they’re not accumulating them at the rate they otherwise could.  Which puts them well behind the job competition power curve compared to those who’ve managed that jump.

So much for upward mobility in the Obama régime.

Also with the Obama Job Sharing Plan, health insurance accessibility, for good or ill, is actively reduced.