On November 15, 2020, in the back pages of the Wall Street Journal, an article, “San Diego Settles SEC Charges Over Pension Funds”, starts out:

San Diego agreed to settle Securities and Exchange Commission charges that it failed to tell municipal bond investors about the city’s mounting pension-fund obligations and its increasing inability to pay for those benefits.

The article goes on to say that municipal pension fund liabilities were $6 billion, while pension fund assets were only $4.5 billion. This represents a shortfall of $1.5 billion, or about $1,300 per homeowner in San Diego.

Municipal pension fund problems are primarily the fruit of unionization of public employees. Over the last generation, trade unions have turned from their traditional base of industrial workers (eroded by factory closings due to excessive labor demands) and have fixed on the juicy target of tax-supported government workers.

Now, an extra tax burden of $1,300 per San Diego homeowner doesn’t seem like a big deal — it’s less than 3% of median household income in the municipality — but Democrats now control Congress. We can expect unions to demand higher pay and benefits for ‘public servants’ which should lead to augmented defined-benefit pension burdens on residents of larger, older cities like San Diego.

This could result in higher interest on municipal bonds of cities with powerful government service unions, along with increased taxes, and downward pressure on real estate values. At the same time, there could be a tendency to further increase emigration from unionized locations to cities largely free of such exploitation, especially smaller, newer municipalities in US southern and central states.

As expected, the Pandora’s box called the “Pension Protection Act of 2006” is full of nasty surprises. The Wall Street Journal (October 25, 2020) reported that the new “Pension Law Shrinks Lump-Sum Payments” to workers.

See: New Pension Laws Will Alter Capital Flows

Here is how Congress managed to cheat American workers:

• Under the old law, when a worker retired with a ‘defined-benefits’ retirement plan, he or she usually had the option of choosing a lump-sum payment instead of a fixed pension for life from the employer.

• In calculating the value of this lump-sum payment, the law required the same conservative methods that private insurers use when pricing annuities. In other words, in valuing the worker’s pension, a low interest rate, based on government bonds, was used.

• By choosing a conservative rate in valuing an annuity, the present (lump-sum) value of that annuity is greater than it would be if a higher interest rate, based on the riskier corporate bond market, were used.

• One reason for a worker to take retirement benefits as a lump-sum payment would be to purchase an annuity from an insurance company in the private sector. With many company pension plans under-funded and with corporations impairing their future solvency by massive stock repurchases and excessive executive pay, the lump-sum payment option was often the prudent decision.

• Now, privately insured annuities are generally safer than company pension plans simply because the insurers don’t want to go bankrupt; they select the lowest safe rate of interest when pricing their plans. In other words, they use rates based on US Treasury securities.

• Now, the sardonically misnamed “Pension Protection Act of 2006″ has reduced the amount of lump-sum payments on workers’ pensions by allowing companies to use corporate bond rates, rather than US Treasury bond rates when calculating the value of the annuity.

• This means that a worker who tries to protect his or her pension plan by choosing a lump-sum payment and purchasing a privately insured plan, is now out of luck, because the insurance companies are not so stupid as to price their product at a higher, speculative interest rate of the corporate bond market. Therefore, switching from a company pension plan to a privately insured plan will mean workers will have a lower monthly payment to face their ‘golden years’.

Of course, a worker can elect not to accept a reduced lump-sum payment and put his or her trust in the financial solvency of the employer. However, if the company goes bankrupt, the pension plan will be taken over by the government’s misnamed, “Pension Benefits Guarantee Corporation”, which usually means that the value of the worker’s pension will be reduced.

Bad New For Life Insurance Companies

By reducing the lump-sum payments on workers’ pensions, Congress also reduced the potential flow of funds from company pension plans to privately insured annuities, thereby stiffing not only workers, but insurance companies.

By reducing the chances of workers’ shifting to private insurers, Congress also increased the chances of company pension plans being delivered unto the tender mercies of the already insolvent “Pension Benefits Guarantee Corporation“, thereby, in the last analysis, increasing the burden on the American taxpayer.

Stay tuned … More unpleasant surprises in the “Pension Protection Act of 2006″ are likely to be revealed as booby traps hidden by corporate lobbyists in this massive piece of legislation are uncovered.

On August 3, 2020, by a vote of 93 to 5, the US Senate passed the “Pension Protection Act of 2006″, already approved by the House of Representatives on July 28, 2020 and now going to President Bush to be signed into law.

This massive bill (907 pages) is a major piece of legislation that, like ERISA in the 1970s, will effect capital flows in the US market over the next generation.

Links to the full text of this law and related discussions can be found on BenefitsBlog.

A Boon For Wall Street?

The Wall Street Journal has already headlined some of the expected effects on capital flows.

In the lead editorial on August 4, 2020, “The Pension Era, R.I.P.”, the Journal announced that this law “signals the end of the old, defined-benefit pension era.”

In an article on August 7, 2020, the WSJ announced, “Pension Bill Promises Windfall for Fund Firms”, citing research by the Vanguard Group projecting an additional 5.5 million new savers in 401(k) plans.

The article also states that passage of the bill was helped along by heavy lobbying by the mutual fund industry trade organization, the Investment Company Institute. The Act allows, but does not require, automatic enrollment in 401(k) plans and permits employers to give “investment advice” to plan participants.

The Law of Unintended Consequences

History suggests that a law as complex as the Pension Protection Act of 2006 is likely to be laced with obscure provisions that will have unintended consequences.

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