Friday, August 7, 2015

The Moral Hazards of Pensions

Since a few more thoughts on this have rattled lose I'll put them up. Defined Benefit Pensions inherently have several moral hazards among which are:

1. The Projected Benefit Obligation is the liability carried on the books that should represent the Present Value of what you have agreed to owe your pensioners. So say you are either an executive or an elected official what looks better on your books high liability or low? So you put your thumb on the estimates to assume low inflation and low life expectancy, suddenly you don't seem to need as much to fund your promises. Insurance annuities have a similar accounting but since their business depends on accuracy of estimates and the same entities that play similar games with their own pensions would prosecute them for the same degree of chicanery theirs are probably a whole lot closer to true.

2. Projected vs Actual plan growth. Since you need to estimate how much fund assets will grow to know how much money you need to set aside against assumed obligations you estimate the assets appreciation(the first of the Khan Academy videos goes over this a bit) The problem is that when actual performance doesn't match projected performance excesses are often treated as windfalls to be used in the present day, the most recently infamous was Detroit's public pension fund would send "surplus" checks to current workers. Shortfalls in projected vs actual growth however are merely shoveled into the Projected Benefit Obligation and are supposed to be actualized in future years before workers retire.

3. Ownership since Defined Benefit Pensions are an assumed obligation instead of an asset ownership of what assets a plan has are never transferred to the beneficiaries. Put simply you don't have a nest egg you have an IOU, one that is only as good any other bond issued by an organization. This leaves us with the great moral hazard of Other People's Money where risks aren't as daunting and corruption is almost inevitable.

All of these reasons are also combined with a horrendously more difficult accounting job explain why anybody in a marginally competitive industry has moved to Defined Contribution Plans where inputs and not results are promised.


  1. Only someone who knew they were not going to be accountable would ever agree to a defined benefit system. As I said in your earlier post it is generational theft with no legal or moral claim on those of us who have come after the great government redistribution and welfare employee circus. Allowing judges to rule on such things when they have direct personal interest in the outcome is in itself a moral failure as well. Let the unfunded liabilities rise a bit more and there will be repercussions.

    1. Most certainly on the repercussions, business go out of business over excess pensions(unless they are deemed "Too Big To Fail"), but for governments things get trickier and messy.

      In the meantime I see a period where states and local governments are going to try to pass this off to the Federal government in exchange for giving up some of their power. In the long run when you have the generational theft reach a tipping point is when you start having revolutions. Historically speaking this is only positive if exactly the right sort of people are organized and ready to step into the power vacuum.