Comments on: Schwarzenegger’s pension math A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 By: TFF Wed, 01 Sep 2010 16:22:44 +0000 hsvkitty, pension padding is widespread (not just California) and a serious problem. It penalizes not only the taxpayers, but also those poor schmoes who don’t play the game. As a teacher, I was contributing 11% of my paycheck to a retirement system that was in dire straits because my (now retired) colleagues contributed at a 5% rate for their entire career and padded their annuity at the end. That is a big part of my reason for leaving public education.

curiosus, I don’t think the size of the annuity is as big a problem as the age. If those workers were receiving $3000/month at the age of 65, rather than at 55, then it would be a very different picture.

I’m still curious to find out more about how those benefits are funded (payroll deductions at what %) and whether they supplement or replace Social Security. Anybody familiar with the California system?

By: curiosus Tue, 31 Aug 2010 22:47:07 +0000 No-one seems to be questioning the presupposition of Schwarzenegger’s remark, which is that if public employees are getting a $3000/mo annuity, then that’s too much and they ought to have some of that taken away from them. He wants people to envy them, and to wish that they were getting less. Shouldn’t we be wanting everyone to have more?

By: hsvkitty Tue, 31 Aug 2010 22:14:32 +0000 I wanted badly to find a piece on pension padding in California that was in the news last month, which is one reason Arnold is squirming. I agree that Unions have a place to protect the employees, but when they abuse, it has to be stopped.

The story was about a lead supervisor for the state making 3 times his income by working overtime.. time and a half, etc in the last 2 (or 3) years so that his pension was inflated to more then his original salary and how he encouraged his colleagues and staff to do the same. All legal, yet a burden on the taxpayers for certain.

That abuse will be awfully expensive unless loopholes are closed and caps are put in place. Here is a recent story to remind you how pensions are being padded. 64UC20100707

By: Mike_N Tue, 31 Aug 2010 18:10:55 +0000 I agree with commenters who find no problem with Arnold’s numbers. I get an actuarial P.V. in the neighborhood of 700-800k, which including even moderate expense loading probably brings it close to $1m.

By: FifthDecade Tue, 31 Aug 2010 02:23:43 +0000 I can’t see any problems with Schwarzenegger’s numbers. Annuity rates are typically in that ballpark for the stated situation. It’s amazing how poorly even the best financial journalists understand the world of personal finance. In this case, even worse than an ex-World Champion bodybuilder. Don’t feel bad though, I’ve had Professors ask for advice on these issues before now. The world needs more financial education.

By: TFF Mon, 30 Aug 2010 21:35:52 +0000 DanHess, I’m a novice when it comes to hedging, but couldn’t you short Treasuries and buy the matching TIPS? The implied inflation is the difference in coupons, which this hedge would lock in.

By: TFF Mon, 30 Aug 2010 20:35:40 +0000 So to bring it back to the original question, we’ve determined that the public pensions described by the governor are worth between $700,000 and $1,000,000 depending on how you wish to value them. You might only be willing to pay $700,000 for the pension (since there is some risk it will not be paid), but the actual funding necessary to meet the stated obligations is likely to be closer to $1,000,000 (paid over many years, naturally, not all up front).

As the governor asked, how many private-sector employees have that much saved up? It is a pretty nice pension.

Relevant questions:
(1) How is it funded? Wholly by the state? Or do employee contributions play a significant role?

(2) Is this in addition to Social Security or in place of Social Security? A full Social Security pension is about 2/3 of that, I believe, though it doesn’t kick in until age 65. If the public pension replaces Social Security, then it saves California from paying that portion of the FICA taxes.

When I worked as a teacher, I was on track for a pension even better than that. I could have retired in my early 60s with a pension equal to 80% of my final salary (commonly boosted by gimmicks). However this was largely funded by a 11% payroll deduction, with the town savings on Social Security making up the difference. Frankly, I’m happier managing my own retirement.

By: tcolemanuf Mon, 30 Aug 2010 20:19:34 +0000 Darn. I saw something right up my alley, was so excited to answer and now I am late to the show.

I work at a life insurer in the corporate benefit funding department and our numbers for a 55 yo female would be 830K for a life only policy (life expectancy 30 years) 3,000 with a 2% COLA. If you gave us a million with the same plan we would start the pay out 3,616 and adjust upwards on an annual basis. Pretty good deal in uncertain times.

By: DanHess Mon, 30 Aug 2010 20:17:13 +0000 Thanks for the update, Felix! The quotes I got are without survivor’s benefits.

As for fact-checking, it is a little bit of an issue with blogs, no, with no editor around? Here is an interesting bit about how a questionable blog post went on a national tour, cycling into much major media including print before one iota of actual reporting got done.  /2010/08/its_always_a_sad_reporting.htm l

One more thing… You wrote, “I’m not convinced that the inflation adjustment should be so expensive these days, given that any life insurer should be able to hedge the inflation risk very cheaply right now.”

How would one hedge against inflation cheaply these days? The plainest inflation hedge is TIPs but they are very dear right now and offer little real return. Derivatives? Like what?

By: Greycap Mon, 30 Aug 2010 19:01:20 +0000 Beer_numbers’ point is well-taken, as far as it goes. But California pension obligations are unfunded. It is an error to ask what is the current market price of an annuity unless you are actually going to put on the hedge or sell the liability. Absent these intentions, you are not risk-neutral and have to compare the real-world expected liabilities to the real-world expected real discount rate. And it is unreasonable to assume that the current IR term structure, whether real or nominal, will be stationary for 30+ years.

What is reasonable? As it happens, 5% – 2% = 3%: remarkably close to the real rate at which the British government was able to borrow over most of the 18th and 19th centuries (it did a little better at the end of this period, but lets not assign California the best credit rating in history. After all, the discussion would be moot if they weren’t contemplating default on their pension obligations.)

As others have noted, the conditional life expectancy is somewhat longer than the conditioned; lets call it 85, so as to get a round 30 year annuity. Discounting 360 monthly payments of 3,000 at a monthly rate of 3%/12 = 0.25% gives a present value of about $712,000. Survivorship benefits might increase this slightly, but remember that the 85|55 assumption was somewhat conservative. Considering the creditworthiness of California compared to that of the pre-war British empire, this figure seems more like a maximum than a minimum.