Correct, I’m from the UK. Plus, as mentioned, I’m only semi-trained in actuarial. Mostly on the mathematical bits, plus some pensions admin experience. Just out of curiosity, what’s your background?

In the UK I think it’s usually possible to transfer benefits between schemes. (Although, as you say, since DB schemes don’t accrue linearly, switching jobs is not good for your benefits.)

Pension plans see vastly lower administration costs than individual investors do

I thought this was what unitised passive funds were for? Haven’t really got much experience with the investment side of actuarial work, though, so happy to take your word for it.

Point taken regards the 401(k)s. I don’t think the situation in the UK is comparable – we’re at a different point in the scandal cycle. The last big one for us was Maxwell in ’95, which gave a lot of people the feeling that it’s best to keep your employer’s hands off your pension’s investment strategy.

As for the rest, WI’s pension plan is nice, but it’s not hugely rich. I’ve seen the details.

Ultimately this is the important point. If the returns from the Wisconsin scheme (sorry, “plan”) are comparable to what you’d get from a well-run DC plan with similar cashflows and risk profile, then the state should not be out of pocket on this.

Lacking any specific knowledge of the plan, I am happy to take your word on this. 🙂

A Ponzi scheme is, by definition, fraudulent. Social Security runs exactly as advertised.

True. But both have the potential to crash messily. And both are pro-cyclical – they get harder and more dangerous to support as the economic situation gets worse. That’s why Madoff’s scheme ran fine for a decade or two but collapsed when the recession hit

In the case of Social Security, the risk of it crashing is less, because it has the entire US govt backing it. But this guarantee is not as valuable as you might think, because any economic situation where Social Security was crashing (e.g. a Japan-style greying population) would be very bad for the government’s general ability to meet its debts.

Benefits under DB plans have almost exactly zero portability in the U.S. The most common type of benefit formula under traditional plans is service at that employer times average pay at the end of of that service times some multiplier. These two facts combine to disadvantage workers who change employers by locking in lower average pay amounts for various chunks of service. Someone who sticks around long enough to be vested in their benefit doesn’t lose that service, but the service doesn’t grow in value as pay continues to rise (for inflation if nothing else) at the next employer.

That’s what makes DC plans appealing to workers who move around. Those funds continue to (presumably) grow in value over time.

What makes DB plans a better bang for the buck is not any ability to do funky accounting or hide risk. The Pension Protection Act went a fair way toward adding clarity on the question of risk, and the aftermath of Enron did a fair amount to reestablish the somewhat adversarial relationship between companies and the auditors who oversee the trusts in which private pensions in the U.S. are held. The biggest problem with risk right now in U.S. pensions is that companies are working to insure themselves against risk. There’s nothing wrong with that in and of itself, but when the big risks are return-related and the unregulated investment companies driving much of that risk are also insurance companies, companies aren’t likely to find much solace in the face of another catastrophic financial failure.

No, there are two things that make a pension fund able to get better returns than 401(k) investors can get. The first is expertise. Most 401(k) investors don’t have the training to make investment decisions (no, a quarterly newsletter does not count). Those who make the decisions on pension funds do. They’re less likely to move money the wrong direction after markets have made big shifts. They’re more likely to match risk and return to the actual payouts of the plan. Even “lifestyle” or “target date” funds in 401(k) offerings don’t match the amounts of risk suggested for long-term investment. They can’t because the average investor doesn’t have the education to understand that much risk.

The biggest reason, however, that companies get better returns out of their retirement investments is simply that investing costs money. Beyond that, it costs more money the less money you have to invest. Pension plans see vastly lower administration costs than individual investors do, both for that reason and because until recently companies had no particular stake in bargaining for good rates for their 401(k) plans. Those were paid by the individual investors. The situation was bad enough a few years ago that companies were sued for being fiscally irresponsible with their employees money.

As for the rest, WI’s pension plan is nice, but it’s not hugely rich. I’ve seen the details. In the U.S., we do have plenty of people paying attention to negotiations with public unions. They’ve been a favorite whipping-boy of our conservatives for at least the last four decades. A Ponzi scheme is, by definition, fraudulent. Social Security runs exactly as advertised.

Sorry, that should read “running SS unfunded”. I’m going to shamelessly blame any typos like this on the mild fever I’m currently fighting off, which is doing Bad Things to various parts of my cortex.

Feel free to make the obvious joke about the rest of my comment 🙂

I’m also going well beyond my training, so please consider this a private-citizen kind of comment rather than an Official Actuarial Opinion.

The biggest reason to favor DB retirement plans in the public sector is that they are a much more efficient way of providing retirement benefits–more bang for the buck–for employees who do not change employers many times during their career.

I think you’re conflating two different issues. DB schemes are harder to transfer into, but I understood that to be mostly because a DB scheme’s transfer value has little relationship to its share in the scheme’s assets. So it’s harder to tell if the person transferring in is getting a bargain at the expense of other members.

Under some regulatory regimes, DB schemes can also give better apparent returns. My understanding is that this is largely because they are able to keep a lot of risk off the books, in a way that would get an insurance company ritually sacrificed by the regulator. So they can generate high returns, but there’s a gamble in there somewhere. Who precisely gets it in the shorts if things fall through will depend on jurisdiction; in the UK it’s usually the taxpayer one way or another.

[The state] gets to renegotiate the terms of participation with every negotiation cycle.

And that is what the state of Wisconsin is trying to do here (if I’ve understood correctly). And it’s getting eaten alive by the pundits, thus demonstrating my point #2.

• Nobody in a union vests […] in a day.

  My actual point was in the last line: “Nobody really noticed until recently.” The point I was trying to make is that the media and general public are very bad at understanding what it means for a pension benefit to be unusually good or bad. The PM was just the most obvious illustration that sprang to mind.

• Fraud always sucks. Your point, aside from the fact that we should make sure our politicians read the reports they’re given?

  Again, I was using this as an extreme illustration of a more general principle: pension scheme negotiations pit motivated union officials against unmotivated public officials. The unions tend to come out ahead, especially since they can often bring political pressure to bear too.

  For example, in the UK, the large public-sector union Unite was actively campaigning for one political party during the last election, presumably because they were deemed the easiest to get concessions from. No-one round here campaigns for lower pensions.

  Obviously I’m talking only about public sector schemes here – corporations have less incentive to be pushovers. Which, I would contend, is why most corporations these days run DC schemes.

• By your reasoning, Social Security is nothing but a Ponzi scheme since the funds aren’t held in marked accounts.

  I wouldn’t be the first person to draw that parallel. Note that Ponzi schemes (at least as I’m using the term) are not necessarily a bad thing, as long as you understand that the chain will probably end at some point, and the last person to join will probably be a bit unhappy…

  If Social Security were to close down, chances are that it would get bought out at taxpayer expense. The actuarial approach would be to put that liability on the books now, which I expect would cancel out the apparent benefits of running SS.

Those people you’re considering screwing over every time the economy wobbles are the people who keep it moving.

Since I haven’t actually expressed an opinion on Wisconsin in particular, I’m going to assume you’re referring to my preference for DC schemes. The thing is, every time the economy wobbles, it creates risk. Someone has to take on that risk; I simply prefer that the transaction be made as explicit as possible. If people are happy to keep that risk in their pension, DC allows them to buy equity-linked funds. If people prefer to de-risk their pension, they can invest more in fixed-interest securities and gilts.

By contrast, in DB, people invest in the asset mix the trustees decide on, which in the case of an unfunded scheme is implicitly 100% government debt. Since there is no attempt to place a market rate on this debt at point of purchase, it will never be clear if they’re over- or under-paying for it.

If they’re over-paying then this is clearly not fair on them; if they’re under-paying then it is clearly not fair on all the other taxpayers. Either way, people don’t have any choice what to do with their own money.

Well played, Mr. Laden.