Management Problem of the U.S. Pension Crisis - Essay Example

Addressing the Management Problem of the U.S. Pension Crisis The pension crisis is an ongoing concern among various nations on their economic ability to fund the pending pension benefits especially those of public employees. The problem began with concerns related to the increasing number of retirees and the limited contributions being remitted to the scheme. In the United States, the problem is being experienced in both the private and public benefit plans. The two forms of pension plans being used by the American workers include the defined benefit plans and defined contribution plans. The corporate bodies, with support from political circles, took advantage of the 2007 economic crisis to impose measures that undermined the defined benefit plans in the pretext of saving the pension crisis. Other challenges that the United States pension Scheme faces include providing for the retirement income and old age poverty and funding for the labor market participation and incentives for the old generation. Additionally, contributing to the low saving plans of the United States citizens and preserving the economic soundness of the local and state government as well as corporate pension schemes depletes the scheme. If left unreformed, the Social Security system will be faced with the shortage of financial resources as the life expectancy of the current generation increases. The number of workers paying the contributions is declining compared to the ones receiving the benefits. Problem Statement Underfunding is the prominent challenge facing the United States pension program. According to Horowitz (2004), the 2002 Pension Benefit Guaranty Corp (PBGC) balance sheet dropped from 7.7 billion to 3.6 billion dollar deficit with an estimated loss of 11.3 billion dollars. The figure was approximately five times compared to the previous year. In January, the Bloomberg Business Week, (2012) reported that financial estimates suggest that the PBGC could face a deficit of 120 billion dollars over the next decade. The PBGC also confirms that it required approximately 23 billion dollars over the same period. This implies that most pension plans will be lost and the taxpayers will be required to contribute in the bail out. Contributing in the Aletho news in July 3, 2012, Rasmus indicated that the crisis was not related to increases in pension benefits for workers. He attributed the crisis to the mismanagement practices and adoption of inefficient corporate policies. Factors that resulted from the mismanagement practices further aggravated the situation. They include the collapse of the economy, jobs and pension contributions, reduction in pension funding, stagnant jobs, and failure of the economic recovery. Almost all states have made cuts to the public-employee pension but the 900 billion dollar retirement funding deficit remains. The economic forces are reshaping the past rivalries in pension schemes, making the labor leaders and policy-makers become convinced that the past plans are unsustainable. This has cemented the unity between political leaders with the labor unions. According to the wall street journal research by Corkery, 2012, adoption of the labor laws on job cuts have only trimmed 100 billion out of the 900 billion dollar deficit between the amount the workers remit and the retirement benefits owed by the states. Additionally, the changes made to the pension scheme cater for the compensation of the most expensive benefits implying that most inexpensive benefits will take decades to be considered. The strategy of reducing the benefits for the current workers and retirees to cater for the pension crisis has failed due to the legal nature of the benefits. Causes of the Problem The prominent cause of pension crisis is the demographic shift. This is characterized by a growing number of retirees with proportional reduction in the number of people contributing to the fund. This problem can be minimized through increasing the retirement age in catering for the changing lifespan and increasing the contribution gap (Acharya, Philippon, Richardson and Roubini, 2009). Another causative principle is the inefficient management of the funds which has a detrimental effect on the stability of the scheme. The governments may make poor investment decisions that lead to the shrinkage of the scheme instead of promoting its growth. Most of them go to extent of borrowing funds to cater for the short term expenses without repaying them. The retirees face shortages of their investments when needed as most of the schemes are deeply immersed in debt. The change in the employment demographics in most regions is a contributory factor towards the problem as most workers have recently faced pay cuts. This has necessitated their incapability to make payments into the public employee pension schemes. The less number of public workers making these contributions has led to the deficit. Statement of Major Relevant Principles Most of the causes of pension crisis are a product of mismanagement and formulation of inefficient policies. The recessions and job recoveries that have haunted the United States governance resulted into extreme reduction in the contributions remitted on the funds. The pension holidays introduced by the government prevented the employers from remitting the pension contributions for their employees. This lowered the contribution pool of the pension fund. The off shoring and free trade reduced jobs and lowered the contributions to the scheme. Some of the legislative policies allow the diversion of funds to cater for 20 per cent the rising health care insurance costs for employers. The de-unionization of the workforce that led to suspension of the private pension plan for the new workers reduced the contributions. The last decade has also witnessed the decrease in the rates of return as a result of the protracted recession since 2008. The problem has also been aggravated by the shifting in the United States workforce to part time and contingency jobs that are from any contributions to the pension schemes. The reform ideas for the pension schemes are based on three basic categories namely addressing the worker retiree ratio, reducing obligations through shifting among pension types, and increasing the resources to fund the pension schemes. Addressing the worker-retiree ratio can be accomplished through increasing the retirement age and changing both the retirement and immigration policies. Obligations can be reduced through migrating from the defined benefit plan to defined contribution benefits and cut down of the future contribution rates. For instance, since 1979, the United States has witnessed the shift away from the defined benefits plan to defined contribution plans such as 401k (Norcross, 2010). The 1979 statistics indicate that 62 per cent of the private sector employees were covered by defined benefit plans while 17 per cent were covered by defined contribution plans. The 2009 figures portrayed a reversal in the figures with approximately 7 per cent to 68 per cent respectively. Resources required for the funding of the pension schemes can be increased through increasing the contribution rates and raising the taxes. Currently, most states have adopted the strategy of confiscating the private pension plans and merging them with the public plans. This taps a wide pool of contributors and increases the resources. These principles can be classified as those that address the dependency ratio and the ones that recognize the dependency ratio as an inevitable factor and instead address the finances. The principles that address the dependency ratio include introduction of part-time jobs for the aging workforce, extended retirement age, encouraging a higher birth rate and promoting the immigration of working aged people. The principles addressing the finance factor include reduction in benefits, higher taxes and encouraging personal savings. The burden for those who are not obliged to contribute towards the scheme is transferred to a few workers. The inclusion of all workers ensures that the burden will be shared, generating more funds to the scheme. Maintaining stability in the social security scheme requires addressing of the fiscal imbalance, lack of the house hold saving and lack of balanced redistribution of resources from high to low income earners. Redistribution of the reform plan guarantees political support that can transform the situation through manipulation of various policy tools among the taxpayers and the beneficiaries. With the aftermath of the pension crisis, the pension regulators have become more vigilant and careful when handling matters pertaining pension schemes. The areas where pronounced changes have been noted include risk obsession, regulatory flexibility, and application of countercyclical measures and empowerment of the clients. Most regulatory measures focus on the welfare of the sponsor before focusing on the recipients. The key risk that the regulators may face is the insolvency of the plan sponsor. This implies that they have to formulate ways of protecting the sponsor against insolvency and funding buffers. The focus should then be directed to the individual members whose key risks areas are the agency problems and the individual behavior. The methods applied in addressing the welfare of the individual members should offer client protection through use default strategies. Analysis Focus should be directed towards proper management of the schemes, which if not handled professionally may have detrimental effects. The management problem is reflected in the inefficiency of the strategies being applied in funding the pension program. While hosting the Talk of the Nation program in the National Public Radio in September 29, 2012, host Conan asserted that states, cities and countries are struggling to save enough money to cater for the pensions promised to the past, present and future workers. The lawmakers have been using the pension funds to cater for the financial requirements of other economic activities in a bid to avoid raising the taxes. This has led to accumulation of debts which has left the government with two reasonable options; raise taxes or cut funding for government services. The national statistics show that only 78 per cent of the retirement benefits have been funded, below 80 per cent threshold. For instance, the Illinois state has approximately 93 billion worth of accumulated debts with the rate increasing by billion dollars annually. This has led to the cutting of the money being channeled into the education sector. Earlier attempts by the state governor in 2007 to improve the situation through initiating a 10 billion pension bond failed. This is because the bonds were sold at an extremely low interest with most of the money being remitted back to finance state operations. Mismanagement caused the formulation of an inefficient legislation that provided loopholes for the enrollment of workers into the pension scheme who received the pension benefits illegally. The two main factors that the policy makers should consider when deciding on the nature of the pension scheme to be used is the mode of risk expected and benefit earning. Focus on the expected risk helps in the prior identification of the challenges that the scheme might face while benefit earning predicts the impact of the scheme to wards the workers or beneficiaries. The public support towards solving the crisis can be won through undertaking public awareness campaigns on the pension crisis. This will convince them to make sacrifices that would help in preserving the health of the system. Effectiveness in leadership is the prominent factor that overlays other management principles that can be applied in changing the situation. Other measures that the American policy makers can apply in addressing the crisis include borrowing money to replenish funds, development of alternative retirement investments and increase the retirement age. The prominent strategies necessary for the restoration of the pension scheme solvency is the creation of more jobs and increase in wages for the working employees within the United States workforce. The jobs should be created at an economically acceptable level. This requires economic growth and industrial prosperity that compensates for the previous stalling of the economy. Most people are excluded from the scheme due to lack of jobs or proper wages. Legislation should then be enacted to ensure that all the workers are enrolled in the pension scheme. The financial institutions should provide short-term loans to the pension funds in a temporary basis to those schemes whose funding is below 70 per cent (Holzmann, 2006). The funding provided should be of the same rate as those used in bailing out other financial institutions. This will assist the pension schemes in bailing out their clients as well as preventing bankruptcy. The pension schemes should be allowed to issue their own bonds and allow for long-term purchase of the bonds to provide the additional funding required for the pension funds. The pension funds should not be used for investment in high risk sector and unstable financial institutions. This prevents the loss of these funds in shady business deals and ensures their availability upon need. In the process, corruption is minimized as contact with the resources will be minimized. The local and city municipalities should be reimbursed for the money lost through fraudulent banking activities such as false promotion of derivatives and interest rates of the past swap deals. Reimbursing is possible because institutional investors are occasionally bailed in case of fraudulent subprime business deals. Pension funding should only be carried out consistently without imposing grace periods such as holidays. Consistency contribution remittance ensures that the workers do not feel uncomfortable when contributing their money in unusual cycles. Banning pension holidays increases the amount of money contributed these as well as eliminating any deficits. According to Bloomberg Business Week, (2012), deficits can also be eliminated through prohibiting the diversion of the pension funds in other resources meant to subsidize the employer health plans. The pension funds should only be handed out to retirees and not being diverted to other investment activities that may compromise the mode of channeling back to the beneficiaries. The government should strengthen the restrictions imposed on the employers escaping the PBGC and other multiemployer plans. This ensures that they maintain their employees on the pension plans to avoid the wanton membership deficits that are prominent causes of the crisis. The laws regulating corporate bankruptcy should be amended and strengthened to avoid the elimination of the single membership plans. In the event of a bankruptcy, the solid assets should be considered for auctioning as the first priority before embarking on consideration of the pension benefits for loan or debt repayment. Much of the pension funds are being lost in the hands of the auctioneers as most workers may ignore or evade loan repayment with pension benefits in mind, which may not be available at the present (Zakaria, 2012). The amount spent on engaging consultants by public employees should not exceed one per cent of the annual contribution to the pension schemes. This ensures that the annual pension contribution does not fall below the threshold. The pension scheme should be legally amended to include all workers inclusive i.e. permanent and temporary depending on the rate of their working hours and their earnings. This enables equal contribution across all the employee quarters and more income from the increased number of contributors. The increased reserves are sufficient for the clearance of the debt owed to the retirees. The increased reserves will also improve confidence among workers Conclusion The onslaught of the economic crisis and the expectation that it will experience enormous budget deficits in the near future has prompted the increased rigor in the reform of America’s entitlement programs. If left unreformed, the Social Security system will be depleted of financial resources as the life expectancy of the current generation increases. The number of workers paying the contributions is declining compared to the ones receiving the benefits. Other challenges that the United States pension Scheme faces include providing for the retirement income and old age poverty and funding for the labor market participation and incentives for the old generation. Additional challenges include contributing to the low saving plans of the United States citizens and preserving the economic soundness of the local and state government as well as corporate pension schemes. Solving the pension crisis requires a wide scope of strategic planning, control, and decision-making. The prominent causes of pension crisis include demographic shift that has seen the reduction in the number of employees contributing to the funds compared to the beneficiaries, inefficient management and employment demographic due to pay cuts. Some of the radical strategies that can be involved in solving the pension crisis include reforming the state pension, re-branding of the scheme to disassociate it with the traditional malpractices, promoting flexibility of pensions and encouraging longer working periods through increasing the retirement age. The pension scheme can be restored from solvency through the creation of more jobs and increasing the wages for the working employees. The scheme can sustain itself through prohibiting the diversion of the pension funds in other resources meant to subsidize the employer health plans. References Acharya, V., Philippon, T., Richardson, M., & Roubini, N. (2009). The Financial Crisis of 2007-2009: Causes and Remedies. Financial Markets, Institutions & Instruments, 18(2), 89-137. Bloomberg Business Week, (2012). A much deeper pension hole? Retrieved from http://www.businessweek.com/stories/2005-05-18/a-much-deeper-pension-hole Corkery, M. (2012), Pension Crisis Looms Despite Cuts, The Wall Street Journal. Retrieved from http://online.wsj.com/article/SB10000872396390443890304578010752828935688.html Holzmann, R. (2006). Pension reform issues and prospect for non-financial defined contribution (NDC) schemes. Washington, D.C.: World Bank. Horowitz, C. F. (2004), Pension pain: The other social insurance crisis. Ludwig Von Mises Institute. Retrieved from http://uspolitics.about.com/gi/o.htm?zi=1/XJ&zTi=1&sdn=uspolitics&cdn=newsissues&tm=467&f=20&su=p284.13.342.ip_&tt=15&bt=0&bts=0&st=37&zu=http%3A//tinyurl.com/8m5x5 National Public Radio, (2012). U.S. pensions in crisis, but not in Rhode Island. Retrieved from http://www.npr.org/2012/09/24/161696119/u-s-pensions-in-crisis-but-not-in-rhode-island Norcross, E. (2010). The economist on the U.S. pension crisis, Mercatus Center at George Mason University. Retrieved from http://neighborhoodeffects.mercatus.org/2010/10/14/the-economist-on-the-u-s-pension-crisis/ Rasmus, J. (2012). The real causes and real solutions to the U.S. pensions crisis. Aletho News. Accessed July 3, 2012. Retrieved from http://alethonews.wordpress.com/2012/07/13/the-real-causes-and-real-solutions-to-the-u-s-pensions-crisis/ Zakaria, F. (2012). Why We Need Pension Reform, Time Magazine. Retrieved from http://www.time.com/time/magazine/article/0,9171,2117244,00.html Read More