Recently there have been a lot of news stories on the massive changes needed and being imposed by Ford and General Motors to become competitive again. These stories also focus on the benefits that these two and other old line companies offer and extend to their retirees. Having grown up in Detroit and began my career starting with Ford and subsequently having worked at two parts suppliers, I have a soft spot and keen interest in the automotive industry.
The recent news stories are that the US auto industry is not competitive. The industry supports 2.2 retired workers for each active worker in the US. Depending on the source, health care benefits for retirees, which comes out of the operating budget of these companies, costs the US automakers $1,500 a car more than any of their foreign competitors.
It is easy to beat up on General Motors. They had over 50% of the US market share in the 1950’s and early 60’s. By 1996 it was 31%. In 2003, the market share had dropped to 23% and has stayed a point or two around this dismal level.
Ford is no better off. Their latest market share is 16, a long way from the high twenties it had achieved with the double barreled hits of the Taurus and the Explorer circa 1990.
Both companies have had to heavily incent their cars in the past year. Even with zero financing and “you pay what we pay” employee discounts to all, they have still lost share. Not only have they lost share but lately real cash. GM posted losses for the past five quarters culminating with a whopping $4.8B in Q4 2005. The total loss for 2005 was $5.6 B.
But this letter is not about the auto industry, quality, foreign competition, the Toyota Production System, or any other kind of analysis of the long slow slide of the US automotive manufacturers. No, this letter is about those, in my peer groups, who have worked at such companies their entire working lives and are on the brink of retirement. Well at least thinking about retirement, and wondering about the security of their pensions.
The biggest news regarding pensions was when IBM recently announced that they would freeze their pensions in 2008. Basically, they will turn off their program at that time. Whatever one had accrued in terms of pension stipend at that time will be all the company will pay no matter how much longer one might work for IBM. The company reported it would save $3B per year by doing this. That is real money.
In the January 22nd New York Times, there was an article entitled, When your pension is frozen. “The worst impact is generally felt by worker in late middle age whose pension is frozen.” Often these folks have worked for the company a long time, if not their entire working career. As being in my generation, they are starting to look forward to retiring, perhaps getting 50-60% of their end of career salary until they AND their spouse pass on. Some in this group claim they are not really interested in retiring or “in the 2 years, 3 months and 14 days” until they are eligible. I know many people, friends and family, reader of this letter, who have worked for either Ford or GM their entire careers. They are lifers. In Detroit, the auto companies dominate. Many people got into the companies and stayed. As they progressed in their careers, the lure to remain often became the pot of gold, or lifestyle, at the end of the rainbow.
Just as my contemporaries started working, the retirement threshold began dropping. It went from 65 to 62 to 60 and then the concept of “30 and Out” was negotiated into labor contracts and then instituted for white collar workers as well. The 30 and Out was really based on adding ones years of service and age. If that number, called points, was above 85 and ones age was at least 55, then one could retire. So, if you begin work at age 20 and worked for thirty years, you could retire at age 55. The company, depending on the plan, would pay you 50-60% of your last salary, depending on years of service and the particulars of the company plan.
This is a spectacular benefit. The benefit comes, however, at a spectacular cost. Imagine someone retiring at age 55 and getting an annual stipend of $50K. Imagine further that this retiree or his/her spouse living for thirty years. The total payout to this couple is $1.5M. That is real money. It has to come from somewhere.
Here are two factors to consider regarding the history of retirement and pension plans. The very idea of retirement is less than 100 years old. These concepts were born during the Great Depression. As written in a March 2004 Harvard Business Review article, It’s Time to Retire Retirement, “Desperate to make room in the workforce for younger workers, governments, unions, and employers institutionalized retirement programs as we know them today, complete with social security and pension plans.” Prior to this, people simply worked until they were physically or mentally incapable. Many worked until they died. The safety net was one’s family. Think of family farming as the best example of this.
The nature and designs of these plans were not conjured out of thin air. They were, in fact, designed on two assumptions that seemed valid at the time. First, the work force would continue to expand and, second, thr selection of 65 years of age as the retirement age. Both assumptions are no longer valid. Given that the plans have not adapted, they are essentially unsustainable. Hence the movement to eliminate or revamp pension plans, or, more drastically, to return to the more age old, though not necessarily more effective, model of self-reliance.
In considering the workforce expansion assumption, we must again look at the US auto industry. As stated earlier, specifically for GM and Ford, there are 2.2 retired workers for every active employee in the US. The pyramid these plans were based on, a very large number of workers supporting a small number of retirees is completely inverted. The workforce in most major industries has not expanded but actually declined due to automation and efficiency. For the US market, we also compound this trend with the movement of the most man-power intensive production work to the cheapest labor markets on the planet. These cheap labor markets do not have, and hence are not burdened, with the retirement and pension plans as found in Europe and North America. So in reality, production costs are even cheaper than simply comparing hourly labor rates.
You don’t have to go to China or India to see the burden a company like General Motors faces with this disproportionate number of retirees. GM has 459K manufacturing retirees in North America. In contrast, the North American operations of Honda, Nissan, and Toyota have only 1,500, 400, and 100 respectively. Even if the health care and pension benefits were the same, it is easy to see the advantage these three companies have over GM.
Just after World War II, workers in the United States could withhold their labor to achieve economic gains. In those heady days, management would grudgingly concede because US manufacturers essentially had a monopoly because the industrial infrastructure in Europe and Japan were blown to bits in the war. This period of intense and seemingly limitless prosperity lasted until the Oil Crisis of the 1970’s when it also became clear the Japanese were providing higher quality and cheaper electronic and automotive goods. It was about this time that the unions were actually beginning to advocate for a four day work week having already achieved total healthcare (zero/minimal co-pay medical, dental, and vision care), COLA (Cost of Living Adjustments to compensate, and probably adding to, inflation), and the aforementioned 30 and Out. There has been a steady decline in the leverage of American labor and thus an erosion of benefits since then.
The second part of the assumption, age 65, is no longer valid either. Government statistics (National Vital Statistics Reports, Life Expectancy Tables) readily available on the internet reveal some surprising facts. 65 years old was chosen because in 1930, a person aged 20, i.e. entering the workforce, was expected to live 45.94 years more or to the age of 65.94. Life expectancy at birth in 1910 of these same twenty year olds was 51.49 years. The difference in life expectancy was due to the high level of infant/youth mortality back then from diseases we now have better control over. The retirement age of 65 was simply chosen because half the workforce was predicted already have passed on by then.
Consider my generation, our life expectancy at birth, circa 1950, was 68.27 years. When we became 20 in 1970, our life expectancy grew to 73 years old. In 2000, when people in this group turned 50, they were expected to live another 30 years or to a whopping 80 years old.
The point of these geriatric demographics is that we are living longer. Pensions plans created in the early 1900s were designed to kick in when about half the population had already passed on. Not only do people live longer, but the retirement age has dropped from 65 to 62 then 60 to 55 for the luckiest of us. The cost per retiree to companies has grown dramatically because of this.
The wealthiest, most successful, of us will still be able to retire due to stocks, options, and well funded 401(k) plans. My boss recently quoted a most surprising statistic from Money Magazine that said the median worth of 401(k)s is a paltry $55K. For people in their 50s, the median value jumps to $100K. Assuming that the saving level is consistent for those with and without pensions, this basically means more than half the people not on a traditional pension plan will not have enough savings to retire. Or at least, they will not easily be able to retire at age 60. One of the fixes for Social Security, which is basically a contributory retirement plan, is simply to “up” the age at which benefits begin to 70. So much for 30 and Out…
Pension plans are fading away rapidly. Most major corporations, at least those I know about, stopped offering them to new hires in the late 1980s. For employees with earlier dates of hire, the companies usually offered employees the option of staying with the pension program requiring some employee contribution or to go with the new annuity plan which besides requiring the employee to fund had a portability factor. Most legacy employees stayed with the pension plan and thus committed to remain with that company until retirement.
In the past 20 years, the number of traditional pension benefit plans in the US has dropped from over 100K to 31K. The 31K plans still cover 44M people. Of these 31K plans, 1,108 were in distress as of June 2005. They are in distress because their assets are $50M below that needed to deliver on their promised benefit. In total, these plans are $354B short. That is real money
Not to worry, however. The US government is there to help. Besides Social Security, which suffers the same pressures as any traditional pension plan, there is the Pension Benefit Guaranty Corporation, more affectionately known as the PBGC. The sole purpose of this agency, as far as I can tell, is to provide the insurance safety net should companies mismanage their way into bankruptcy and drain their pension funds in the process. The PBCG is under funded by $23.3B. If one major company defaults, the PBCG would probably go under.
The government is looking at ways to shore up the PBGC. There are numerous bills in congress as they realize that this issue can quickly became the hottest issue in politics should people perceive their futures are in jeopardy. Senator Ted Kennedy has even introduced a bill putting a moratorium on the freezing of pensions until Congress can deal with these issues. We saw how President Bush’s idea privatizing the Social Security System was still born. It will be real interesting to see how the political ramifications unfold as the baby boomers are now retiring. Any government solution would probably involve taxing the children and grandchildren of the boomers and most of these generations will have no pension type retirement benefits and maybe no social security. “The rising cost of entitlements is a problem that is not going away!” President Bush just uttered these words in his state of the union address just as I was about to send this letter out.
Me? My retirement plans? At this time, besides buying the occasional lottery ticket and standing in front of the mirror and repeating, “Welcome to Wal-Mart,” my plans are to keep working.