A New Way to Fix Pension Shortfalls

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Many American companies face severely underfunded pensions, and now, so do many states. But a new solution unfolding in Rhode Island may offer both groups ideas on how to fix that problem.

Rhode Island's situation is unenviable. Thanks to poor design, poor management, and generous benefits for public retirees, public pension plan ranks among the lowest-funded in the U.S., with a $6.8 billion shortfall. It's supporting more retirees right now than public workers, and many of those retirees are collecting more per year now than they ever earned while working. Making matters worse, Rhode Island's recent unemployment rate of close to 11% is the third-highest in the country.

A thankless job
Given all that, who would ever want to be the state's treasurer? Well, Gina Raimondo did. Since her election last November, she's impressed many people by taking a different approach to the problem.

Whereas other states have tried to force pension reforms from above, with a sledgehammer, she's seeking buy-in from the retirees and union members themselves, arguing that it all comes down to math, not politics or emotions. Meeting with state union members, she recently explained, "This system as designed today is fundamentally unsustainable, and it is in your best interest to fix it." If the program's flaws aren't repaired, it might eventually go completely broke, leaving retirees with nothing. In that light, the certainty of a lower payout still looks better than the likelihood of nothing at all.

The big picture
According to one estimate, U.S. states face a public pension shortfall of roughly $2.5 trillion. Many American corporations are also in trouble. According to Standard & Poor's, the overall pension status of S&P 500 companies improved over the past year, but it's still about 84%, underfunded by $245 billion. Still, many companies face huge shortfalls, not all of which are shrinking. General Motors' (NYS: GM) plan reduced its underfunding from $16.2 billion to $11.5 billion between 2009 and 2010, but Ford's (NYS: F) shortfall rose from $6.2 billion to $6.7 billion.

In a mid-2010 report, Fitch Ratings listed some of the most underfunded private plans as of 2009, including Devon Energy (NYS: DEV) , Marathon Oil (NYS: MRO) , and Lubrizol. By contrast, plans at Texas Instruments (NYS: TXN) and Sherwin-Williams (NYS: SHW) had strong funding levels. Lubrizol may have solved its problem in a particularly clever way, by being purchased by cash-rich Berkshire Hathaway (NYS: BRK.B) .

Companies in trouble may not be able to use Raimondo's approach, but it's worth considering. The Milken Institute has essentially vouched for it, suggesting that employers and workers be permitted to negotiate reductions in promised benefits: "Current law prohibits reductions in accrued benefits, but employees might rationally conclude that a reduced annuitized benefit and additional job security would be preferable if the ability of the employer to meet its obligations over the long-term is less certain."

Many companies are growing much faster than most states, so they have an advantage there. One way or another, pension shortfalls need to be corrected.

If your own pension looks shaky, or you don't have one, considerbuying your own pension-- it can be done!

At the time this article was published Longtime Fool contributor Selena Maranjianowns shares of Berkshire Hathaway and Ford, but she holds no other position in any company mentioned.Click hereto see her holdings and a short bio. The Motley Fool owns shares of Ford, Devon Energy, Texas Instruments, and Berkshire Hathaway.Motley Fool newsletter serviceshave recommended buying shares of Berkshire Hathaway, Sherwin-Williams, General Motors, and Ford. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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