Pension funds are generally defined benefit, as opposed to defined contribution. This means that they guarantee a retirement benefit. The problem with that is the companies often invest a portion assuming an unrealistic growth rate. The problem is worse when you consider that the effects of the underlying under-investment won't be felt until the current workers retire and start drawing on their funds. In other words, the people making the investment decisions today likely won't be around for the reckoning. This leads to a situation where a business today could be held hostage by employees from 30 years ago forcing current employees to suffer, prior employees to have their benefits cut and newer companies without these legacy costs to benefit.
Defined contribution means the employer puts away a certain defined amount for every employee and the employee is entitled to that. This removes the risk of mismanagement of funds and gives employees responsibility to manage their own investments. An example is a 401k account. Most private businesses in the US switched over to defined contribution as its more sustainable and predictable. As an employee I also prefer defined contribution since my retirement is no longer dependent on the health of an employer a few decades from now.
> This leads to a situation where a business today could be held hostage by employees from 30 years ago forcing current employees to suffer
This is a very loaded characterization. You're describing pension beneficiaries as using some kind of leverage ("held hostage") to extract resources that current employees might have a better claim to ("forcing [them] to suffer").
But defined-benefit pensions are a form of deferred compensation. Those employees from 30 years ago accepted lower wages in exchange for future pension payments, and the company received something of value (employee labor) on partial credit. So pension beneficiaries aren't extracting rents from the company. They're creditors of the company, literally. There's nothing untoward about them expecting payment, and if the company has mismanaged funds, they're not the ones to bear that risk. (If the company flourishes and increases in value, pension payments don't increase. If retirees don't benefit from the upside, they shouldn't bear the downside risk, either, which is just another way of saying that pension obligations represent a debt, not any kind of equity.)
> Those employees from 30 years ago accepted lower wages in exchange for future pension payments, and the company received something of value (employee labor) on partial credit
That may be true, but that doesn't mean that another competitor without those legacy costs can come in and better compete, unless the benefit from being able to pay less for the workers from long ago is big enough to create a sustainable competitive advantage. I would also note that the term is likely much longer than many debt agreements (most debt is 5-10 years) and is not subject to the proper credit risk considerations as normal corporate debt.
> There's nothing untoward about them expecting payment, and if the company has mismanaged funds, they're not the ones to bear that risk
Employees are the ones that bear the risk as a company can always renegotiate or go out of business. I'm not sure where pension liabilities fall in bankruptcy, but I certainly wouldn't want to bet my retirement savings on my current employer's health 30 years from now.
> Those employees from 30 years ago accepted lower wages in exchange for future pension payments
That might or might not be true. You can pay everybody well now and give them a pension, leaving the next generation to figure out how to pay out the pension that doesn't have any money in it. There are laws in place that try to prevent this.
> But defined-benefit pensions are a form of deferred compensation.
Defined-benefit pensions are basically a scam. They promise you a lot of "guaranteed" money with hidden risks (what if the investment returns are lower than expected? what if the company's business fails?) and then the managers who made that deal are long gone by the time the workers find out whether the gamble that was quietly made with their retirement money actually paid out or not.
It's possible to structure them as an annuity from a financial institution that actually has the assets to back them up, but then the lower risk would be priced in, which reduces the ROI so much that it makes them highly unattractive compared to investment vehicles with greater variability and correspondingly higher returns.
People only like them because they're perceived as guaranteed even though they carry significant risk. It feels a lot like the mortgage crisis in that way -- people rating high risk mortgages as AAA because they expect to be long gone by the time the dust settles.
The DB deficit is mostly down to the accounting rules used I have had briefings (off the record Chattem house rules) for one of the UK's Largest DB schemes - One that recently sacked one of the Big 4 and now runs self managed.
You do wonder if the Accounting profession deliberately altered the rules around DB pensions to allow employers to shut them down.
Basically in the UK if the worst case scenarios that DB pensions have to match came true you would be talking about a major break down in civil society and making sure you had a shotgun to defend your stash of tinned goods.
The accounting rules were necessary to prevent understatement of liabilities, because as the previous poster wrote, today’s decision makers won’t be around when the problem happens 30 to 60 years into the future.
Employers shut them down because insuring such risks decades into the future is too costly, not to mention the inability to reliably predict events that far into the future.
Ah yes but are the accounting rules fit for purpose or where the accountants lent on to adjust the rules to deliberately make the alleged deficit bigger to give the employers an excuse.
If you think I am joking look at the recent audit scandals in the UK by the Big 4
If anything it was historically the opposite. You had pension funds assuming guaranteed 8% returns. Compare this to actual returns on low-risk investments like treasury bills.
You could historically get close to their targets with higher risk investments (although even then they were optimistic), but that involves the risk of losing a significant amount of the principal. Which doesn't mesh with providing a guaranteed payout to retirees. But if you stick to lower risk investments, the amount of the shortfall is enormous.
So it was historically fraud. They guaranteed a payout and then did things that may have resulted in them not having the money. Once you do the accounting accurately and restrict yourself to investments that can't result in being unable to make the promised payouts, it turns out the cost of a guaranteed payout is large.
> Why do you take what the accounting "profession" and employers /politicians at 100% face value - you don't see they may have an agenda here.
You don't have to trust them at all, you can do the math for yourself.
> and you are ignoring the fact that DB schemes are immortal or very very long lived.
That's the fraud. Nothing actually lasts forever. When you use today's payments to pay yesterday's benefits, you have nothing to pay what you owe to today's workers. If the company's business ever fails, the workers lose their retirement because the money they paid in was already paid out to their predecessors.
On top of that, companies with huge unfunded pension liabilities have a competitive disadvantage against newer companies without them, which makes it more likely those companies will fail.
And the same is true of governments. A state that promises retirees half its GDP is going to have low economic growth, low population growth because young people can't afford to start a family there, and reduced immigration because people won't want to to move to a place where they pay half their income in taxes to fund a retirement program that will be bankrupt by the time it's their turn to collect it.
My taxes going up because the government is severely underfunded and is sending 1 out of every 3 dollars to pay for labor from 30 years ago instead of funding schools, infrastructure, and quality of life for my kids.
It’s pretty well established that if you give a small group of people control of a large pot of money and the ability to fudge numbers decades into the future, it’s going to be corrupted and the future is going to end up paying.
Defined contribution means the employer puts away a certain defined amount for every employee and the employee is entitled to that. This removes the risk of mismanagement of funds and gives employees responsibility to manage their own investments. An example is a 401k account. Most private businesses in the US switched over to defined contribution as its more sustainable and predictable. As an employee I also prefer defined contribution since my retirement is no longer dependent on the health of an employer a few decades from now.