Miles to Go, Promises to Keep: The Economics of Military Pensions

Pensions matter. The type of pension determines personal financial planning, and personal finances drive our American consumer economy.  Payments from a defined benefit program are predictable, last throughout a person’s retirement, and make household budgeting easier people  — including retirees from our Armed Forces.

So, members of our military at Nellis AFB or the Fallon Naval Air Station are expecting to retire with defined benefits, our promise to members of the U.S. military and to their families.  At this point it’s advisable to step back and look at what the major political parties are offering in terms of Defense spending and how this might impact members of our Armed Forces and future retirees.

On the Republican Side

The Republican Platform is long on rhetoric, and very short on specifics.  We do know that the GOP is calling for military spending equal to 4% of our Gross Domestic Product. [CPI]  The Bureau of Economic Analysis reports  the GDP is now $15,075.7  (add three sets of zeros and we get  $15.075 trillion.) The platform specifically calls for an increase in the nation’s nuclear weapons arsenal, and there are suggestions that spending be increased for a form of nuclear defense shield, although one such program was cancelled for inefficiency.

The Medium Extended Air Defense System (MEADS) is under scrutiny for its current shortcomings:

The Pentagon decided to keep paying until the program attained a “proof of concept,” a status that falls well short of production and deployment but would in theory allow the U.S. or its foreign partners to restart the project later if they chose. DoD requested a total of $804 million over 2012 and 2013. But Congress disagreed, and agreed to fund only the first year. [CPI, May 2012]

So, while the GOP Platform is long on “strong America” talk the lack of specificity and the paucity of comments on veterans leads to the conclusion that the military spending envisioned by the Republicans is mainly for nuclear missile systems and missile defense systems.   Page 43 of the Republican Platform for 2012 (pdf) addresses veterans’ issues, and touches upon retirement:

“…we believe compensation and conditions for our Armed Forces in place at the time military service is initiated should be sufficient to attract and retain quality men and women as we honor our promises and commitments to veterans, retirees, and their families. These shall continue and not be reduced or otherwise diminished while in service, or upon separation, or retirement.”

Readers should assume that “these” refers back to the “promises and commitments” to members of military families.

On the Democratic Side

The Democratic Platform is different in focus and emphasis in terms of military spending and priorities.  The document refers to actions taken by the Obama Administration in terms of national defense and foreign policy and continues:

“These actions have enabled a broader strategic rebalancing of American foreign policy. After more than a decade at war, we can focus on nation-building here at home and concentrate our resources and attention abroad on the areas that are the greatest priority moving forward. This means directing more energy toward crucial problems, including longstanding threats like nuclear proliferation and emerging dangers such as cyber attacks, biological weapons, climate change, and transnational crime. And it means a long-overdue focus on the world’s most dynamic regions and rising centers of influence.”

The section on members of the armed forces is as follows:

“President Obama and the Democratic Party are committed to keeping the sacred trust we have with our troops, military families, and veterans. These brave men and women and their families have borne the burden of war and have always made our military the best in the world. We will not only continue to support them in the field, but we will also continue to prioritize support for wounded warriors, mental health, and the well-being of our military families and veterans. We will keep working to give our veterans the health care, benefits, education, and job opportunities that they have earned. That’s why the President and the Democratic Party supported the Post-9/11 G.I. Bill to provide opportunities for military personnel, veterans, and their families to get a better education.”

Both sides seem in general agreement that benefits and services to veterans, including retirement should not be reduced.  What is troubling is the lack of specificity from either camp on the “shape” of the benefits for retired members of the Armed Forces, the current defined benefit program or a new 401(k) type program?  The lack of specific support for the defined benefit program opens the door for consideration of defined contribution plans which have problems of their own.  Both platforms state promises should be kept, thus the question becomes — What Promises?

The 401(k) Epidemic

As institutions as varied as the National Football League (in the dispute with its officials)  and the Department of Defense look at ways to reduce costs, pension plans nearly always come into play.  The current military pension plan calls for defined benefits — a 2011 proposal by the Defense Business Board is suggesting a 401(k) style defined contribution plan for members of the military.

“The proposal comes from an influential panel of military advisors called the Defense Business Board. Their plan, laid out in a 24-page presentation “Modernizing the Military Retirement System,” would eliminate the familiar system under which anyone who serves 20 years is eligible for retirement at half their salary. Instead, they’d get a 401k-style plan with government contributions.”  [CBS]

The presentation (pdf) begins with rationales for changing to a defined contribution system, including:

“…in light of the budget challenges facing the Department of Defense, the military retirement system appears increasingly unaffordable. In FY11, the retirement plan will accrue 33 cents for each dollar of current pay, for a total of $24 billion.

According to the OSD Office of the Actuary, annual military retirement payments are forecasted to increase from $52.2 billion in 2011 to $116.9 billion in 2035. As of today, the total life cycle program costs will grow from $1.3 trillion, of which only $385 billion is presently funded, to $2.8 trillion by FY34 (see Appendix D of the final presentation). Increases in inflation and life expectancy will further increase military retirement benefit costs. Moreover, as presently structured, any increase to base pay has an automatic and dramatic impact on future retirement liabilities.”

Other voices agreed, including Douglas Holtz-Eakin, recently the chief economic policy adviser to 2008 presidential candidate Senator John McCain:

“Douglas Holtz-Eakin, former director of the Congressional Budget Office says it’s very important that the military attack its retirement issues. “We’re talking about an underfunding that starts to look like hundreds of billions of dollars in the next 20 years. And if you want to maintain the core mission which is to defend the nation and have the strategic capabilities we need, we can’t have all their money tied up in retirement programs.” [CBS]

There are some positive arguments to be made concerning adjustments in the military retirement program — such as how to compensate service which does not extend to 20 years.  The question now becomes: Where DO we want money “tied up?”  Another question might be: Is the 401(k) format the only option, or the best option, by which to address the need to keep our promises to members of the military concerning their retirement income?

The first thing almost any competent investment adviser will say to a client considering a 401(k) plan is that it is market driven.

“Your money, when placed into a 401k, does not have the benefit of being insured. In fact, depending on the investments that you’ve chosen, you could actually lose money while it is tied up in a 401k. If you see that you’re starting to lose money on a particular investment, you might want to consider changing it.”  [InvestHub]   — or to put it less optimistically:

“Hopefully your money is safe in a 401k plan, although you don’t have the luxury of having your investment protected by the Pension Benefit Guaranty Corporation (PBGC) which safeguards the assets of most pension plans. And ultimately your money is only as safe as the investments and funds that you invest it in – any investment plan carries some degree of risk and uncertainty.”  [Essortment]

Any financial adviser who doesn’t almost immediately mention the market based foundation of 401(k) accounts should be avoided in the interest of financial health and safety.  There’s one other point to consider, besides the intrinsic financial market related issues, there are management fees which also impinge on 401(k) account performance.

Here again we meet our old friend — market volatility — a benign face to the Wall Street trading desks, but a real question mark for retirement planning.  Consider the performance of 401(k) plans in the private sector in 2011, as Bette Davis once advised — Buckle Up:

“The average 401(k) balance tracked the year’s bumpy market returns. At midyear, it reached $72,700, the highest since Fidelity began tracking balances in 1998. The average dropped 12 percent over the next three months, amid growing worries about the global economy and the European debt crisis. Those fears eased late in the year, sparking stocks to climb and boost the average account 8 percent in the fourth quarter.

Typically, about two-thirds of annual increases in 401(k) account balances are the result of workers’ added contributions and company matches. It’s only the final third that’s the result of investment returns, said Beth McHugh, vice president of market insights at Boston-based Fidelity.”  [CSM]

Less elegantly phrased, Manic Mr.  Market, buffeted by the rumors and realities of the financial sector in 2010 and 2011, didn’t add very much to 401(k) investors’ accounts.   If the proposed military retirement 401(k) accounts aren’t augmented by much more than more enrollments or company (Defense Dept.) matching contributions, then members of the Armed Forces would do almost as well simply putting their money in a good old fashioned savings account at the local bank.   This statement might even be more unfortunately accurate if Manic Mr. Market behaves badly at just the moment the service member retires.

Yes, the Pentagon could save some $250 billion over the next 20 years, BUT what might have happened to a soldier’s 401(k) account if that individual’s retirement date was — say, March 9, 2009 when the DJIA bottomed at a measly 6507.04?    If there is inequity in the current system, how much more inequity might there be between the unfortunate soul who retired on March 9, 2009 and the person who retires today when the DJIA is at 13,266.99 and the Nasdaq is at 3130.94?

The backgrounds and affiliations of several members of the Defense Business Board make it clear that most are well aware of Manic Mr. Market’s behavior.  There are representatives of Accenture, Veritas Capital, Citigroup, Renaissance Strategy Advisers, Lovell Group Venture Capital, Fall Creek Management, the Regency Group, and Providence Equity Capital.   There’s even an “Outsourcing Superstar” from NEOGROUP.  [DBB]  What can we infer from their presentation about the efficacy of their proposal?

There’s always one clue to how enthusiastic so-called reformers are about the plans they are hawking — do they recommend immediate implementation?  If something is the End and Be All of Hot New Ideas, then why not put it into effect with alacrity?  If something may not be so good, or faces some stiff opposition, then the “phase in” language appears.  However, if some proposal has some really large question marks attached to it — then we get phrasing like this from the Defense Business Board:

This plan would apply to Reserve and Active Duty personnel. Retired and disabled personnel would be unaffected.”

If we all think we’ve heard this somewhere before — it’s because we have.  The Republican proposals for turning Medicare into a voucher/coupon program are all couched in “this doesn’t apply to current enrollees” verbiage.

If we expect a veteran’s retirement planning to be predictable, and his or her household and other expenses based on a “floor” of defined benefit payments after retirement, then we could do much better than to agree to a plan to make those retirement benefits driven by Manic Mr. Market and his contemporary penchant for volatility.  This election season would be as good a time as any to ask candidates what they think of a plan to privatize military retirement plans?  Plans that could be miles from the promises we should be keeping.

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