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Social Security Reform Thursday: Week Forty-Five -- Defined Benefit Pension Plans.


Thursdays are good days for reform, because they fall between Wednesdays and Fridays. And reform is a long-haul process, not a fleeting event. So we're going to keep plugging along with the case for reform, even as the issue goes off the political radar screen.

That's why WILLisms.com offers a chart or graph, every Thursday, pertinent to Social Security reform.

This week's topic:

Defined Benefit Pension Plans.

Some thoughts from Milton Friedman:

At the end of World War II, government spending was 15–20 percent of national income. Then it went up dramatically so that by 1980 it hit 40 percent largely because of programs ranging from Medicare to environmental regulation to Social Security. From 1980 until 2005, it has remained static. We haven’t beaten the tendency or rolled it back. We’ve just stopped the growth. This is an argument that supports your thesis, I’m afraid.

On aging societies, there is no reason why a country that has a lot of old people can’t be prosperous if, during their working lives, individuals provide for their retirement. The only reason there is a crisis about Social Security in the US and pensions in Europe and Japan is that you cannot maintain a “Ponzi” scheme indefinitely. We have collected from today’s young to pay today’s old and counted on tomorrow’s young to keep doing so. That was a fine scheme as long as the number of young people was rising faster than old people. When that ratio comes to an end, such a system also has to end. It all would have been much better if individuals saved for their own old age.

Why is it that private insurance companies are not in trouble because people are getting older? Aren’t they subject to the same demographics? The difference is that they’ve accumulated a fund, not a pay-in, pay-out system.

A defined benefit pension plan (Social Security is one of those) does not and cannot meet its promises when it relies on a pay-as-you-go intergenerational wealth transfer (again, that's Social Security).

Ironically, one hurdle Social Security reform faces is public fear and confusion. We hear quite a bit these days about failing corporate pensions. And not just the blue collar union pensions, either. We're talking IBM, Verizon, Sears, Hewlett-Packard, Motorola, and many more large, well-established, well-respected companies in solid financial health, abruptly doing away with defined benefit plans, often to the disgruntlement of thousands of employees.

In other words, companies in good shape currently are learning lessons from the airlines and car manufacturers and other heavily-unionized industries (which once were, but now aren't, in good shape), and instead of hoping the problem goes away, are doing something about it before it becomes crippling (bankrupting, even).

The Center for Retirement Research at Boston College released some interesting data just this week, noting how prevalent the shift away from defined benefit plans has been in recent years in the corporate world (.pdf):


Some point to the trend in the corporate world away from defined benefit plans and toward defined contribution plans as proof that we need to keep Social Security "the way it is" in order to buffer the harsh realities of the global economy. As if that's an option, keeping Social Security "as it is."

Social Security is broken. There's no keeping it the way it is. It's broken mainly because it is so troublingly similar to those broken corporate defined benefit plans the corporate honchos are fleeing. Thus, without reform, we're looking at a serious lack of a buffer against the harsh realities of the global economy.

The factors that have caused the problems in Social Security, and the factors that have caused problems in defined benefit plans are eye-poppingly similar. Most obviously, the promises in both public and private defined benefit plans are made to an ever-growing number of people, all of whom are, on average, living longer than ever.

Meanwhile, most corporations are leaner and meaner than before. They have less currently productive workers.

Where have we heard this before?

America's present workforce, relative to the number of retirees, is shrinking every day as the first wave of Baby Boomers begins to retire and draw pensions and Social Security benefits.

More retirees. Less workers. It's not complicated math. At all.

The National Economic Council's Charles P. Blahous offers another striking similarity between Social Security and corporate defined benefit pensions:

The defined benefit pension system has often gotten into trouble because it has opaque accounting that overstates the assets that are really in the system and leads to a false sense of security about an employer's retirement situation. We have seen over and over again in the employer defined benefit world, you have these employees, and they go to work every day, and are told every year, year after year, that your pension is funded, or 90% funded, or 95% funded, and according to federal laws/regulations, it is.

And then the pension plan terminates. And then everyone is shocked to find that the plan was only 50% funded, with respect to the cost of termination. We've seen this in very vivid and painful ways over the past couple of years. People lost benefits, pension benefits, that they were counting on, because the system has misled them as to what was really in the system, what assets were really there to pay for benefits.

The Social Security system suffers from a very similar problem in that regard. We have a system that actually really overstates the financial health of the system. Trust fund accounting is very problematic in terms of being straight with the public about what is actually involved with paying benefits. The trust fund, if there are assets in the trust fund, they are debt to the rest of the federal government to an exactly equal degree. And to treat it as a net asset, a net pot of money, to sort of pay benefits, overstates the actual cash on hand and the actual cash coming in to pay benefits in a way that is going to be a very rude shock to people in 2017 and beyond, when the system enters its cash shortfalls.

So both systems suffer from this problem of overstatement of assets, understatement of liabilities, and overstatement of the funded capacity-- and opaque accounting.

Moreover, there's another very troubling similarity. In the defined benefit pension system, people have got into trouble because they have been either required or heavily incentivized to have all their eggs in one basket. You look at the Enron situation, or any of these plans that went belly up. We have all these people that are invested in the company's stock. They didn't diversify, they weren't diversified, and when something went wrong, that basket, then they were out of luck.

Social Security has a very similar problem. People are not allowed to diversify, they're not allowed to choose investments outside of what's the equivalent of company stock, which is the federal government investing in itself. Everyone is being compelled to have all their eggs in one basket. That exposes them to a tremendous amount of risk as a consequence of their inability to diversify their investments and have some money that's not under the control of the sponsoring entity.

So all these problems lead to similar problems in the defined benefit pension system and in Social Security, and the difficulties we've seen in the defined benefit pension world are an omen in what is to come in Social Security if we do not reform the system.

The demise of defined benefit pension plans, far from being a weapon in the demagogic anti-reform arsenal, ought instead to serve as impetus for Social Security reform as soon as possible. Before it's too late.

It's time for reform.

The clock is ticking:


Previous Reform Thursday graphics can be seen here:

-Week One (Costs Exceed Revenues).
-Week Two (Social Security Can't Pay Promised Benefits).
-Week Three (Americans Getting Older).
-Week Three, bonus (The Templeton Curve).
-Week Four (Fewer Workers, More Retirees).
-Week Five (History of Payroll Tax Base Increases).
-Week Six (Seniors Living Longer).
-Week Six, bonus (Less Workers, More Beneficiaries).
-Week Seven (History of Payroll Tax Increases).
-Week Seven, bonus (Personal Accounts Do Achieve Solvency).
-Week Eight (Forty Year Trend Of Increasing Mandatory Spending).
-Week Nine (Diminishing Benefits Sans Reform).
-Week Ten (Elderly Dependence On Social Security).
-Week Eleven (Entitlement Spending Eating The Budget).
-Week Twelve (Benefit Comparison, Bush's Plan versus No Plan).
-Week Thirteen (Younger Americans and Lifecycle Funds).
-Week Fourteen (The Thrift Savings Plan).
-Week Fifteen (Understanding Progressive Indexing).
-Week Sixteen (The Graying of America).
-Week Seventeen (Debunking Myths).
-Week Eighteen (Debunking Myths).
-Week Nineteen (Reform Needed Sooner Rather Than Later).
-Week Twenty (Global Success With Personal Accounts).
-Week Twenty-One (GROW Accounts: Stopping The Raid).
-Week Twenty-Two (Millions of Lockboxes).
-Week Twenty-Three (Support for Ryan-DeMint).
-Week Twenty-Four (KidSave Accounts).
-Week Twenty-Five (Latinos and Social Security).
-Week Twenty-Six (AmeriSave).
-Week Twenty-Seven (Cost Of Doing Nothing).
-Week Twenty-Eight (Chile).
-Week Twenty-Nine (Entitlement Spending Out Of Control).
-Week Thirty (Reform Better Deal Than Status Quo).
-Week Thirty-One (Social Security As A Labor Cost).
-Week Thirty-Two (Social Security And Dependence On Government).
-Week Thirty-Three (Social Security, Currently A Bad Deal For African-Americans).
-Week Thirty-Four (Longer Life Expectancies Straining Social Security).
-Week Thirty-Five (Howard Dean & Salami).
-Week Thirty-Six (Growing Numbers of Beneficiaries Draining Social Security).
-Week Thirty-Seven (The Crisis Is Now).
-Week Thirty-Eight (Disability Benefits).
-Week Thirty-Nine (Broken Benefit Calculation Formula).
-Week Forty (German Social Security Disaster).
-Week Forty-One (Crumbling Pyramid Scheme).
-Week Forty-Two (Overpromising, Globally).
-Week Forty-Three (Demographic Wave).
-Week Forty-Four (The Jerk Store).

Tune into WILLisms.com each Thursday for more important graphical data supporting Social Security reform.

Posted by Will Franklin · 9 February 2006 12:53 PM


I admit my math skills are not the greatest... BUT even I can see the problem and figure out the longer we wait the worse off everyone will be!... I sure wish we had some people in Washington who wanted to do some real work! On real issues like S.S. reform!

Posted by: Zsa Zsa at February 10, 2006 05:47 AM

Unfortunately, the President's proposal would have given Social Security an entirely new set of problems, much like those faced by defined benefit pension plans.

Right now, many of these defined benefit pensions are severely underfunded. They can get away with this now, because they don't need to be paying out the benefits. But as soon as all these Baby Boomers start to retire, they're going to need to pay those benefits. And what these pensions are kind of banking on right now is the same idea that the President had for Social Security. You invest in the stock market, and you allow those gains to make up the difference. You know, so you're expecting these higher gains and these higher rates of interest that are going to make up the difference in the long run. Unfortunately, I don't think that's going to happen.

Because you've got these corporations with underfunded pensions using those pension assets to purchase stock in other corporations with underfunded pensions. You know, that doesn't make any sense.

And as the Baby Boomers start to retire, the problem will only get worse. It's going to turn into this vicious cycle, because you've got normal retiring people drawing money out of the stock market to pay for their retirements, then you've got these corporations who are counting on these gains, but suddenly these gains are now going to be less due to several factors. So that means the corporations are going to have to start coming up with more money out of their own pockets to pay these defined pension benefits. And as corporations use their profits to make up the difference to cover these pension liabilities, that's going to further decrease corporate profit margins and consequently stock returns.

So suddenly the next younger generation is going to say, "Hey, all these profits are being eaten up by these pension liabilities. Why should I invest my money in the stock market? This no longer seems like such a good idea." And this will only make the situation worse.

Can you see the vicious cycle there?

Posted by: Adam at February 10, 2006 05:50 PM

The entire United States government is a "pay-as-you-go" system, and it will face the same financing issues as Social Security when the Baby Boomers start to retire. Not only will these retired people be collecting Social Security and Medicare benefits, but they will also be contributing less in income taxes than they are right now. Meanwhile, the government can't even manage to balance the budget while these Baby Boomers are still working and earning.

By the way, Social Security is NOT a Ponzi Scheme.

Posted by: Adam at February 10, 2006 06:15 PM