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Jubak's Journal
Recent articles:
• Jubak: Hedge risks with Canadian energy stocks , 3/24/2004
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Coping with the incredible shrinking retirement
We all know about shrinking pensions, and we're worried about Social Security. But health-care benefits may be disappearing faster than anything else. Medicare must be fixed. But we also need to honor our promises to retirees.
By Jim Jubak
The voice on the other end of the phone was angry. Theres something wrong with my retirement check, the man said. His monthly pension check, which had netted him $350 a month for years, was suddenly just $180 -- a drop of nearly 50%.
My dad lives very frugally on his pension and Social Security checks. He saves the income from his investments for emergencies, big ticket items like getting his house repainted and extravagances like holiday presents for his grandchildren. And he makes annual (and much appreciated) contributions to their college funds. So, this drop of income was a big deal.
It didnt take me long to track down the source of the problem. Rising health-care costs have forced us to ask our retirees to pay more for their health insurance, the very nice woman at the corporate retirement benefits service center told me. From now on, my dad would have to pay $170 more a month for the private health insurance that picks up where the federal governments Medicare coverage leaves off. And, of course, theres no guarantee that this years increase will be the last one, either.
Pay more, get less
Welcome to the wonderful world of the incredible shrinking retirement benefit. Millions of retirees are seeing their current retirement benefits erode as the government and private employers cut back cost-of-living increases AND boost the costs that retirees must pay for benefits like health insurance. The real value of benefits that millions of people still working will receive is falling daily, even before they begin to collect, as cash-strapped governments and private employers recalculate future retirement payouts or just simply walk away from commitments altogether.
In my March 2 column, A recovery built on retirees backs, I wrote about one part of what I call a war on retirement. These include proposals to cut the value of future Social Security payments by reducing annual cost-of-living increases by either refiguring how inflation is calculated or by shifting to another, lower definition of inflation entirely.
As the March 23 annual report of the Medicare board of trustees to Congress makes clear, however, Social Securitys contribution to the incredible shrinking retirement pales in comparison to the squeeze contributed by Medicare. The situation gets even worse when you add in the equivalent trends in the private sector that are reducing the value of those retirement benefits.
As Medicare board member John L. Palmer put it, The problems of Social Security are manageable, compared with those of Medicare.
Broke by 2019
How bad are the problems at Medicare? Very bad. They include:- Tax revenues for the Medicare hospital trust fund will fall short of outlays beginning in 2004. The boards 2003 annual report had estimated that the shortfall would begin in 2013.
- Medicares hospital insurance trust fund, which pays for inpatient hospital care, will be out of money in 2019 -- seven years earlier than was estimated just a year ago.
- Projected annual Medicare costs will exceed those of Social Security by 2024.
- Medicare will grow faster than the economy as a whole, growing from 2.6% of gross domestic product in 2003 to 3.7% in 2010 and nearly 8% in 2035.
These estimates are probably still too optimistic since they assume that the current Medicare fee for doctors services will be cut 5% annually from 2006 to 2012 as required by current law.
And dont think the problems are limited to the public sector. Companies that are profitable enough but have unionized work forces that retain some clout face staggering liabilities. Companies that arent profitable enough, or where workers cant stop the change, are simply walking away from their health-care promises to retirees.
Let General Motors (GM, news, msgs) stand as representative of the first group. In its recently issued annual report for 2003, the company said that its liability for retiree health-care costs rose to $63.4 billion, an 11% increase.
And that increase came despite the accounting effects of the new Medicare prescription-drug bill. This will provide a government subsidy for companies that maintain existing retiree drug benefits and an assumption that, over the long haul, health-care costs will increase at just 5% a year. (For 2004, General Motors projects an 8.5% increase.)
Let Bethlehem Steel (BHMSQ, news, msgs), now in bankruptcy and awaiting sale to International Steel Group (ISG, news, msgs), stand as representative of the other group. When Bethlehem Steel went into bankruptcy, its pension plan was about 50% under-funded, according to the Pension Benefit Guarantee Corp., the government agency that will wind up holding the bag. But that bag contains money only for pension payments, not for retiree health care. For that, retirees are at the mercy of Bethlehems new owner. International Steel has set up a Voluntary Employee Beneficiary Association fund to pay for retirees health insurance benefits at other steel companies, such as LTV, that it has bought out of bankruptcy. But theres a big catch. According to documents filed with the U.S. Securities and Exchange Commission (SEC), International Steel intends to scrap retiree health-care benefits after the current union contract expires in 2008. In 2002, Bethlehem calculated it had a retiree health-care benefits liability of $3.1 billion. Those liabilities will never be paid, and retirees will never collect them.
The demographic time bomb
What has led us to this point?
Quite simply, the pool of workers who support entitlement programs is shrinking while the retiree population is increasing. At individual companies in consolidating industries, demographics havent created a slide so much as an avalanche. For example, Bethlehem had 167,000 workers in 1957. By the mid-1980s, that number was down to 55,000. By 2001, it was just 11,500.
Meanwhile, the number of retirees and their dependents kept climbing. To 70,000 in the 1980s, or more than one for every Bethlehem worker. And to 120,000 in 2001, or 10 for every worker.
The curious jumps in drug prices
Surging health-care costs have played a huge role as well. The annual increase in medical care, measured by the Consumer Price Index, peaked near 10% in the early 1990s and then fell to less than 3% in 1997. But medical-care costs have been back on the rise again since then. In February 2004, they grew at an annualized rate of 5.4%, according to the Bureau of Labor Statistics.
And, strangely enough, the price of medical care, especially of drugs, has surged since a Medicare discount card to cover them was proposed in 2001. Pfizer's (PFE, news, msgs) Celebrex pain killer, for example, is up 23% in that time. The companys cholesterol drug, Lipitor, is up 19%. Consumer group Families USA estimates that the prices of drugs used most by the elderly have climbed nearly 3.5 times faster than inflation between January 2002 and January 2003.
And finally, as corporate cost cutters continue to trim, slash and hack at costs since the capital spending bubble burst in 2000, theyve made retiree health-care costs a major target. Retirees are being charged more for coverage, whether in the form of higher co-pays, requirements that they pick up more of the premium or extra charges for the coverage of spouses and dependents.
The arithmetic is as clear: All these costs and charges and fees continue to shrink the real value of monthly pension checks.
We have an obligation to fix the problem
Do we need to fix this problem? Absolutely, and not just in the name of abstract economic justice, although I have to admit that I find that argument alone compelling. Workers put in their years at their jobs in expectation of a certain set of payoffs in retirement. No one can argue that those expectations are set in stone; times and economic conditions do indeed change. I think, however, its best for our society and for the workings of our capital markets to honor as many of those commitments as possible. I further believe its important to be clear to current and future retirees about what they can reasonably expect.
Hoping to hit the lottery
The more uncertainty that we introduce into an individuals future planning, the more likely he is to pursue extreme financial strategies.
On the risky end, investors can come to resemble the poor man who buys a lottery ticket even though he understands that the odds are stacked against him.
The extension of this to the financial markets is what Id call irrational risk-taking as investors reach for unrealistic returns no matter what because there is no reasonable alternative that produces a comfortable old age.
Save more and spend less has downsides
On the conservative end, investors can decide to react to uncertainty by saving more and by spending less. Its true that we in the United States could and should save more. But a psychology of fear about the future that reduces spending below some critical level is the explanation that economists most likely offer for how recessions get started. So much of economic growth is predicated on an optimistic belief in future growth that I find it hard to believe that a psychology of uncertainty would improve U.S. productivity and growth in the coming years.
So what do we do to fix the incredible shrinking retirement? Two things.
- Create stricter regulations to force companies to fund their pension plans. If they go under, they wont dump the burden on taxpayers and the Pension Benefit Guarantee Corp. Also, fund the PBGC so that workers can be certain that this minimal safety net isnt about to unravel. We are in a transition between a system of defined benefit retirement plans -- where the payments a retiree receives are fixed -- to a system of defined contribution plans where the payments a retiree (or his boss) makes are fixed. And we need to make a commitment to taking at least some of the pain out of that transition.
- Fix Medicare.
Retirees and future retirees need to be able to count on a predictable level of retirement health care whatever else happens to the retirement system. The method isnt as important as the strength and predictability of the guarantee. And within limits, the level of benefits set isnt as important as the strength and predictability of the guarantee. To influence individual behavior, its more important that individuals believe in the promise, rather than how many MRIs (magnetic resonance images) and how many days of hospitalization the promise covers. Or whether the health care is delivered by a government agency or some public/private partnership.
We need to move relatively quickly. Right now, most of us planning for retirement still think of it as an achievable goal, even if it means working a few more years or saving more. That faith in the possibility of a reasonably comfortable old age, so unusual in human history, isnt something we should squander thoughtlessly.
New developments on past columns
Bull market in metals is just beginning
I think investors are reading too much into Rio Tintos (RTP, news, msgs) decision to sell its stake in Freeport-McMoRan Copper & Gold (FCX, news, msgs) back to the company. Freeport-McMoRan shares dropped 5.4% in the two days after the announcement as some investors decided that the deal meant Rio Tinto has decided that shares of Freeport-McMoRan have topped out. But the deal needs to be seen in a wider context. Rio Tinto has been busy selling minority stakes in order to raise cash to invest in core businesses. And Freeport-McMoRan chief executive Richard Adkerson apparently doesnt believe the stock has topped. In March, Adkerson bought 164,000 shares in the company. He now has 459,000 shares. Freeport-McMoRan shares were up nearly 1% today.
5 buy-and-hold stocks to sell -- and 5 to snag
In my March 19 column, I asked if buy-and-hold favorite Walgreen (WAG, news, msgs) deserved a second look because the shift to prescriptions by mail at many corporate health plans would cut into foot traffic at the drug stores. Not yet is the clear answer from the companys quarterly report for the period that ended on Feb. 29. Sales in the quarter jumped by 16% from the same period in 2003 and the all important sales-at-stores-open-at-least-a-year number grew by 11.5%. Wall Street analysts were disappointed, however, that more of the strong sales growth didnt go straight to the bottom line, as earnings climbed just 15%, to 41 cents a share, a penny below projections. The cause of the miss: heavy spending on increased customer service at its stores and a concentration on opening more expensive 24-hour pharmacies in prime locations. To me, it seems like the company is spending just where it needs to so it can meet the competitive threat from drugs-by-mail plans.
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Freeport-McMoRan Copper & Gold and Pfizer. He does not own short positions in any stock mentioned in this column.
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