Why Do Pensions Exist if the Future is Discounted?

December 17th, 2013 by Potato

In today’s post at Michael James on Money, he mentions that we can’t extend generous government pensions to everyone.

Here’s something that I’ve never really understood: how is it that there are so many defined benefit pension plans? The news seems to be full of stories of underfunded pensions (another one today about Canada Post’s), and while I can see the logic that led to underfunding, due to the management of the plan and various incentives, I’m amazed that the plans exist at all. The issue is that people are terrible discounters of the future. I would think it should be easy to convince someone to take a minor increase in pay now over a future pension obligation. I would also think that the individual workers would be worse at that kind of math than the corporations and governments employing them.

Yet pensions exist, so what’s wrong with this thinking?

Perhaps an additional factor to future discounting is uncertainty: having a pension means people don’t need to wade into the dark waters of investing: their future will be taken care of, and that certainty (and service of freeing workers from saving and investing on their own) might trump their over-discounting of future payoffs.

Or maybe the organizations suffer from the discounting more than I had thought. Perhaps the present seems so make-or-break that they figure if they don’t keep current costs low (and thus make expensive future promises), they won’t be around to have to deal with the pension. It could be a dissociation between the organization and those negotiating in the present: the elected officials or car company negotiators figure they won’t be around when the bill comes due, so make some deals that are cheap in the short term.

If the certainty is a large factor in making workers value pensions, that might present an interesting opportunity and psychological approach for helping people think about their future selves and save/invest more on their own.

5 Responses to “Why Do Pensions Exist if the Future is Discounted?”

  1. Michael James Says:

    I think the answer to your question has two parts. The first is that at one time there was some genuine altruism on the part of people running companies. It may be less prevalent now, but some corporate leaders feel responsibility for taking care of their employees (their family in a sense). Another part of the answer is that workers see pensions as a form of safety. They may not be able to properly value a pension, but they can imagine getting old and can dream of not having to work. This can cause many workers to value a pension highly.

  2. Potato Says:

    Yes, the fact that they and their outcomes are very easily visualized (whereas “buying an RRSP” is not) might help people value them. Good point.

  3. B Says:

    My first thought was that although individuals may discount the future, Union’s (where you find many (most?) DB plans) and union negotiators may have a better grasp of the value of a DB plan.

  4. Potato Says:

    Another good point: the union negotiators may just be better.

  5. save. spend. splurge. Says:

    Or, based on what they earn over their lifetime, the government takes a percentage of that (10% or 20%) and puts it away under their SIN # in an account that they can see grow — then they can invest it in mutual funds or the government sticks it in index funds for them.

    I’ve always liked that idea (above).. it’s forcing people to save for themselves and you get exactly what you put in.