November 14, 2008

Public Sector Pension Indexing at Risk

Those who depend on BC's public sector pension plans, college, municipal, public service and teachers', are at risk of losing all or part of their cost of living adjustments as a result of the downturn in equity markets. In mid-October notices were made available under the "what's new" section of the website for each plan with much the same message for plan members, your basic pension is safe, but they also said:

"However, as a plan member, your pension benefit includes indexing. Although not guaranteed, indexing, or inflation protection, increases the basic pension to keep pace with the cost of living, subject to available funding. Unlike your guaranteed basic pension, indexing is only provided if there is enough money in the account from which it is paid. Upturns and downturns in investment markets may impact the plan's ability to continue to fund full indexing. Keep in mind, your basic pension payment comes from another account altogether and is guaranteed."

Those without fully indexed defined benefit pension plans might not have a lot of sympathy, but tens of thousands of pensioners believed that they could budget on the basis of an indexed pension. Consider what happens to the real value of a pension for someone who retires at age 65 and lives to age 85 with no indexing to offset average inflation of 2.5% per year. By age 70, for every $1,000 per month the pensioner received at age 65, the pension's real value (in dollars with the same purchasing power as the pensioner had at age 65) is worth only $884, by age 75, the real value is only $781, and by age 85, for every $1,000 per month the pensioner had at age 65, she has a real value of only $610, a loss of 39% of the pension. Of course, if inflation is much higher, as it was in the 1980s, anyone without index protection can see their pension virtually disappear.

The various public sector pension plans in BC diminished the value of the special funds set aside for indexing by also paying for medical service premiums, dental insurance and extended health coverage out of those funds. The Campbell government increased MSP premiums by 50% and eliminated some MSP benefits such as physiotherapy, which had an impact on extended health plans. The pension plans reacted by eliminating MSP coverage, and gradually reducing other health benefits. Attempts to fight those cuts in court did not succeed, but by stopping the practice of paying for health benefits out of the funds used for indexing, there may be more money available now to weather the loses of 30% or more in the equity markets.

The markets have had a few good days, like November 13th, but none of the rallies have persisted. Those who flog mutual funds for a living have been sending out newsletters assuring investors that recoveries that follow bear markets are frequently quick. Others offer the view that it depends on what time period one examines. It is possible to pick decades during which long term government bonds provided superior performance. The point is no one knows how long it will take pension plans and endowment funds to recover what they've lost.

Since BC's pension plans issued "assurances" in mid-October about the value of the basic pensions, the TSX index has had only two days when it closed over 10,000. During that month it also closed under 9,000 twice. It has a long way to go to reach its last 52 week high of 15,154.

At the end of June 2008 the inflation accounts had $294 million in the college plan, $4.080 billion in the public service plan and $2.885 billion in the teachers' plan. I couldn't find the June 2008 inflation account balance for the municipal plan, but on December 31, 2007, it had $4.6 billion in its inflation account. Relative to the amounts held for the basic pension, the inflation accounts range from 14% of the basic amount for the college plan to 30% of the basic amount for the public service plan. It looks like the amounts set aside for inflation in the public sector plans are big, but a substantial portion will have disappeared since June 2008. Investments in equities as of the last date reported range between 40% and 50%. A loss of 30% on equities translates into a loss of 12% to 15% of total assets. Since June is the most recent date for which information is published, we may have to wait a year before anyone sees the actual size of the bath that was taken on the market downturn.

It says something that the plans issued notices in October reminding members that indexing is not guaranteed in their pensions. At the earliest possible time, the plan's trustees need to provide an actuarial report on the adequacy of the inflation accounts to provide ongoing indexing. If they fail to do so, the government should force prompt reporting on the inflation accounts.

One of the factors that has harmed the economy is a loss of consumer confidence and a downturn in retail sales. Public sector pensioners are not likely to contribute to renewed confidence unless they can be assured that they aren't going to gradually lose their pensions to inflation. There is a precedent for public sector unions negotiating additions to the inflation accounts in their pension plans. It is likely that demands for protecting the pension plan inflation accounts will be part of the next round of bargaining.

Addendum: November 15, 2008

Thanks to the reader who made me aware that a class action is still proceeding on the matter of eliminating the provision of health benefits as part of the Public Service Pension Plan. Some details regarding that class action are at http://www.bcgrea.com/pdf/QandA_ClassAction_9Jan2008.pdf