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In this blog I and multiple commenters have broached the subject of the suspect constitutionality of PSPRS' replacement of the old perma...

Tuesday, March 4, 2014

Why PSPRS is underfunded and Warren Buffet is rich

They do not call Warren Buffett "The Oracle of Omaha" for nothing.  In 1975 Mr. Buffett sent the letter posted below to Katharine Graham, the CEO and Chairman of the Washington Post.
While most of the letter details his ideas on how to invest the Post's pension assets, it is in the first five pages (which I highly recommend) of the letter where Mr. Buffett makes his most important points.  The most amazing thing about the nearly 40-year-old letter is how prescient it was, anticipating many of the problems we have today with defined benefit pensions.  I especially appreciate the straightforward and understandable manner in which Mr. Buffett writes to Ms. Graham, herself a legendary businesswoman.  Too often we trust supposed experts, whether politicians, union representatives, or investment professionals, who can not clearly explain what they do to those of us they are supposed to serve.  Here you have an obvious expert in finance, actuarial science, and human nature with a 50+ year track record of success giving clear, common sense advice to an accomplished CEO, and he does it without even a hint of condescension.
Among the important points made by Mr. Buffett are the lack of understanding of actuarial science by otherwise knowledgeable business people, the permanence of pension benefits, and the fallibility of actuaries' assumptions.  Mr. Buffett's oracular genius can be summed up in one passage:
There is probably more managerial ignorance on pension costs than any other cost item of remotely similar magnitude.  And, as will become so expensively clear to citizens in future decades, there has been even greater electorate ignorance of governmental pension costs.  Actuarial thinking is simply not intuitive to most minds.  The lexicon is arcane, the numbers seem unreal, and making promises never quite triggers the visceral response evoked by writing a check.
Remember this was written in 1975!

However the most crucial point made by Mr. Buffett is that a pension "promise" is nothing more than a cost that needs to be accountable, calculable, and payable.  If it can not be accounted for, calculated, or paid, you should be very careful when committing yourself to it.  Mr. Buffett contrasts a pension which promises to pay $500 per month for life versus one that promises to pay 1,000 hamburgers a month for life, assuming a present hamburger price of $0.50.  Mr. Buffett calculates the actuarial value of the $500/month annuity at $65,000, but writes:
You won't find an insurance company willing to take the 1,000-hamburgers-a-month obligation for $65,000 - or even $130,000.  While hamburgers equate to $0.50 now, the promise to pay hamburgers in the future does not equate to the promise to pay fifty-cent pieces in the future.
Donald Rumsfeld would probably call the future price of a hamburger a known unknown.  These known unknowns need to be controlled for to the greatest extent possible, and unknown unknowns, say a new disease that wipes out the world's beef supply, need to be eliminated completely.

This does not mean, of course, that politicians and others with a financial stake in a pension would not blithely guarantee a pension paid in future hamburgers.  After all, future costs are an abstraction, and there will always be tax revenue coming in to pay any "unexpected costs."  This is how we end up with things like immutable COLA formulas, the DROP, and unlimited pension spiking.  If these drain PSPRS, those who made the promises can honestly claim ignorance since they probably never carefully quantified in dollars the promises they made.

And I am sure they never read Warren Buffett's letter.  In case you were wondering, at the time Jeff Bezos purchased the Washington Post newspaper from the Washington Post Company last year, its pension had a $1 billion surplus.

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