Safety Net for Pensions

Many Israelis have their pension assets invested in mutual funds, which have lost much of their value this year, approximately 25% though of course it varies widely. The possibility exists that there will be further losses. Markets have no memory, and further declines are not less likely just because they were higher a few months ago.

As a result, the Treasury proposed a modest plan to create a safety net for pensions against future drops in the funds. The proposed safety net would have protected lower-income savers who are near retirement and for whom their pension fund is their main source of retirement income. On the one hand, this seems like a risky undertaking. (From a finance point of view, it is equivalent to giving away a put option on the stock at the current market price; in today’s market volatile environment, such options are going for a lot of money.)

On the other hand, we have to consider the other side. First of all, if the markets don’t decline further there is no cost. And if the markets do fall, some of the cost would have been borne anyway since the low income of some of the pensioners would entitle them to means-tested aid. (A similar point has been made in America. The bailout plan sounds very expensive, but in fact there is already a bailout plan in place, known as deposit insurance. Ultimately if the banks fail, the Federal Government will be in the hole for hundreds of billions of dollars one way or another.) A further argument has been made that a safety net can reassure the markets and sustain prices, thus obviating the need for paying out; given that this is a worldwide crisis I personally think that the idea that a few billion dollars in guarantees by the treasury of a tiny country will have an impact on securities prices lacks merit.

Of course these arguments can be turned on their head to argue that no guarantees are justified. After all, if the markets don’t decline further, the guarantees are not needed. And if the markets do fall, there is a built-in safety net already present in the form of existing means-tested aid. Furthermore, if the markets do fall, then the taxpayers will be asked to pay off the guarantees exactly when they themselves are in an extremely vulnerable position.

I would characterize the original Treasury plan as what Cato Institute head William Niskanen calls “mischief”, a term he uses for various wastes of public money which are poorly justified on economic grounds but within limits are comparatively harmless.

Following the announcement of this plan, Histadrut head Ofer Eini demanded that the Treasury expand its plan a lot. He wants the safety net to apply to losses that were already incurred, to individuals who are farther from retirement, and to people of higher income than the original plan. He also threatened a general strike if his demands are not met. The current situation constitutes in his view grounds for a labor dispute, though there is no claim that the employers are reneging on a single clause of a single contract.

This is not automatically invalid. Note that labor disputes can be economic as well as legal. In extraordinary circumstances, it is legitimate to call a dispute even when contracts are honored. An example is during high inflation, when the employer scrupulously abides by the pay agreement but where the value of the salary has been greatly eroded. Conversely, when the employer’s economic situation has deteriorated significantly it is legitimate to request “give backs” from the unions. In Eini’s view, a 25% extraordinary drop in the value of pension assets is similar to inflating away the wage and calls for a work dispute.

I am willing to credit this approach if Eini is willing to be consistent in his views. Let us consider the following opposite scenario: Suppose that a fair annual return on pension assets is in the range of 3-5%. Suppose also we have five consecutive years of outsize returns: sixteen percent, nine percent, thirteen percent, seven percent and eight percent. Workers’ pensions have now accrued 65% in only five years, for an extraordinary gain (beyond fair growth) of over 35%. (These are actual figures for the five years preceding 2008, based on figures published in The Marker.) The government decides that even though the Histadrut has abided by all of its contractual agreements, obtaining an outrageous 35% extraordinary addition to reasonable pension returns justifies a labor dispute. The Treasury demands a “safety ceiling” on returns: employees must give up future gains if the market continues to rise, and even give back some of their past yield. (Perhaps they will agree that the give-back will apply only in three years, a generous concession offered by Eini.) If the Treasury’s demands are not met, then a general lockout will take place in two weeks.

Would that be a fair demand on the part of the Treasury? I doubt it, but I’m not sure. Every country has its own rules of engagement for labor disputes. But whatever the rules are, they should be applied symmetrically. If an extraordinary decline in pension assets is grounds for additional payment by the employers, then an extraordinary rise should be grounds for a give-back by the unions. (Note that even given the 25% drop, average return for the last six years is around 3.5% — not stellar, but not disgraceful either.)

My view, as I have emphasized many times in this column, is that Israel needs to provide an adequate social safety net for all citizens to prevent them from falling below reasonable subsistence levels according to the standards of a modern advanced economy. This safety net should be equitable and means tested so that it is a true “safety net” for those who fall and would otherwise be harmed.

Once such a safety is in place, all other safety nets are presumptively unnecessary and inequitable. This applies especially to the Histadrut plan, which would be in large measure a transfer from the poor (those who will pay future taxes but haven’t accumulated hundreds of thousands of shekels of pension wealth) to others much better off.