The Cat Food Dilemma

When I left the Army in 1973, it was to go to work for the Dupont Walston brokerage firm. Our training center was in Los Angeles about three blocks down Wilshire from the Ambassador Hotel when Sen. Robert Kennedy had been assassinated five years before.

There were 189 in my class all but four military veterans and in addition to all the lies about heroic achievements, there was a monthly convoy to the VA Hospital in Westwood for treatment of wounds and disease.

One of my classmates was a Canadian Scot who had also been a talented amateur tennis player so two to three times a week a group of us would play tennis at some public courts nearby.

After playing, we would go to a local supermarket and purchase cold drinks. One day as I was standing in line there was an older woman in front of me.

At first glance, she seemed well dressed although her tweeds seemed a bit heavy for the LA weather. On closer inspection, the hem of the skirt had come undone violating the symmetry of the garment, and the cuffs of the jacket were threadbare. The collar of her blouse showed signs of wear and lack of cleanliness and her hat was outdated and the worse for wear.

I got interested and noticed her shopping basket contained a head of lettuce, a tomato and can of cat food. In one of those flashes of intuition that can only be called an epiphany I realized that she was not going home to feed her cat and have a salad, this was her diner! A cat food salad!

Behavioral researchers tell us that there are four great fears in humans, public speaking, death, singing before an audience and being old poor and sick with no solution to the problem. From personal experience, I will tell you that public speaking isn't so bad, but public singing is a true terror. Having faced it a few times I can say that fear of death is greatly overrated. I have not experienced the last one and I hope I never do.

The lady in LA faced one of the great dilemmas of our age; she had run out of money before she ran out of life. When you are in that situation, the options are bleak if not miserable, in short; it is what I call the Cat Food Dilemma.

A great deal is being said about the effects of baby boomer retirement. In the financial services industry, literally, every article in our professional publications concerns the topic and you would think that was the only challenge we face. There is no doubt that this mass movement 78 million people from full time active work to semi or full retirement is and will continue to reshape the United States.

It is possible that a great number of the boomers particularly those in the early years of the generation will face the Cat Food Dilemma and it is possible that regardless of the best laid plans of mice and men some of the late arriving boomers will also have to decide feed the cat or themselves.

Recently we were doing some planning for a client and we decided to verify what we had heard anecdotally about lifespan. We came across the chart attached to the back of this letter. It shows the number of years of expected remaining life for a white male at various ages and at various times in history.

What is interesting is the dramatic change in remaining life span for a 40 year olds and 80 year olds. In the last 13 years, life expectancy for a 40 year old increased two years or 5.6% and for an 80 year old 12.6%! If that increase could be projected forward in a linear manner (always a dangerous exercise) in the next 13 years, it will add an additional 2.2 years to the average white male's life.

This increase in life expectancy has its roots in improved medical detection of the silent killers of men like testicular, prostate and colon cancer, improved treatment of heart disease, better diets and improved exercise routines. Those same reasons are likely to make the linear progression of life expectancy a fact rather than conjecture.

Lest you think, I am being chauvinistic by only using white males, females have always enjoyed longer lifespan and those numbers are increasing though at lesser magnitude. The continuation of longer life spans for women complicates the Cat Food Dilemma as in creates a long tail survivor class that needs to be funded. Some wits say that women live longer because men do not, but, whatever.

From a humanistic standpoint, these longer life times should be celebrated as they mean more contributions from each citizen in the form of taxes and cultural output. It means more children will spend more time with their grandparents but from a financial planning and social policy point of view, it will be a headache.

The improved, or extended, lifespan is most apparent in those 40 and older and the number of years increases the likelihood of it being quality life.

Longer life means people will have to stretch their money over more time, increasing the risk (if that is the right word) that they will live past the average mortality making their retirement plans useless. In other words running out of money before they run out of life.

Longer quality life means that people will be active longer than expected which raises issues around the labor force, generational migration, inheritance, estate tax issues, long-term care and medical costs as these longer lives will be expensive.

The answer would seem to be simple; everyone must save more during their working years. Increased savings may be harder to do however, since some of the structural problems with pension plans could necessi tate large tax increases to pay benefits to those already retired. Therefore, the apparent answer is easy again, push back the retirement age. However, older workers staying on the job stifles job opportunities for younger workers. If job opportunities are not created, the result is generational discord and social unrest.

The need to increase savings is not a new concept, having been mooted for years, but apparently, it has not resonated with the boomers. A recent study by Cap Gemini- Merrill Lynch indicated that outside of increases in home equity boomers are only saving 37% of what they will need to provide retirement income at 75% of their current income.

Okay a smart guy would say they would have to access their home equity. That is one possible answer but the issue is if it will be possible. The influx of homes owned by a substantial part of 78 million people to the real estate or reverse mortgage market has to depress prices, and as we all know when prices of real estate fall; it is the equity holder who takes the beating.

Some of this equity liberation may be underway in the successive waves of refinancing. What we do not know is if that equity is going to pay down debt, to purchase other real estate or if it going into investments or into consumer consumption.

Even for those who have worked at big firms all their life, retirement is dicey. There are two basic forms of retirement plans, defined benefit (DB) and defined contribution (dc). Many of the old industrial giants, almost all state and local governments and unions maintain db plans.

GM and UAL are the two poster children for what can happen to db plans. At the current time medical and pension obligations add $5,000 to the price of each GM car and GM's obligations are so large that in truth it is a pension fund running a car company. UAL realized that the only hope of curing its chronic financial problems (other than good management and not being in a crappy business) as well as it best chance to cut costs was to default on its db plans and allow the government to take over. IBM has frozen increases in benefits for its db plans. State and local governments are finding that funding their plans is difficult and as we go to press, Delta is discussing terminating its pension for pilots.

People covered by these plans may not be able to count on their projected future benefits. In the case of UAL, by law, the maximum pension that the Pension Guarantee Benefit Corporation can pay is $45,000 annually, not bad maybe but a long way from the $100,000 plus the pilots were getting before the default.

The other type of plan is the defined contribution plan (dc) which includes IRAs, the 401k, 403b and some other variations. The idea here is that rather than a company guarantee of future benefit amount, the company agrees to match employee contributions and the employee directs his or her investments.

These plans are likely to be the primary source of retirement income for the majority of the boomers. It is hard to get data on the saving rate in these plans, and it is impossible to get any figures on the performance of the accounts so their potential adequacy is unknown. What we do know is that the amount that can be contributed in fixed by statute.

The problem of providing for retirement is a balancing act between the factors of life expectancy, post retirement tax rates, investment returns pre and post retirement, inflation, time, pre retirement savings, post retirement living expenses, and demographics. The devilish side of the computation is that all the factors move constantly, the best that can be said is that some move in a predictable manner.

As an example, consider changes in the demographics of the nation. We know that the average number of live children born to white females in the United States is 1.8, less than the 2.1 needed to replace the population. If death rates and longevity remain constant and there is no in bound migration, population counts must decline. Therefore, each generation will be smaller providing less people to pay taxes and to work. In that scenario, the pension equation becomes insoluble.

However, life spans are increasing; people are having fewer children and those later in life so population should be constant right? Wrong, the rate of fall in the death rates is steeper than the number of children so population increases. This increases the pressure on pension calculations as fewer pay in and benefits are required for longer periods. Counter to all of this there is in bound migration adding population every day at least equal to the death rate.

When you deal with a number field of 300 million the numbers are so large that small changes have dramatic effects. If the fecundity rate increases to 1.9 the Social Security, system will be in surplus in the last quarter of the century. It is unlikely this will happen in the progeny of the largely white boomers, they are just too selfish.

Increased fecundity does however occur in that demographic collection called the minorities, African American, Native American, Hispanic and among religious groups such as Moslems, Mormons and evangelical Christians. In these groups, large family size is rewarded by cultural mores.

This being true it gives some hope that the demographic side of the equation may not be as stacked against success as it currently appears. Of course, one side effect of this is that the current minorities will not be minorities long, reminding one of that line from Gilbert and Sullivan "when everyone is someone then no one is anybody."

Then of course, there is the question of what happens if this lump of boomers does not retire at 60, 62, 65 or 67? I have a hunch that many will not retire at those magical ages since the increased life expectancy will also mean increased active life years. This hunch seems to be supported by a recent study indicating that 75% of boomers intend to work at least part time in the years after 65. Boomers get restless easily and they will not take well to enforced idleness.

Since a good deal of today's work is less physical than in past generations there is no reason for people to be forced into retirement. Another side to this is that boomers have workplace skills not easily replaced and they may be recruited to work longer just to maintain productivity.

While through a glass and darkly a path can be seen by which Social Security's failure can be mitigated (increased migration, increased fecundity, longer work life) the danger to other pensions is real and one of those secrets not discussed by decent people, which is no barrier for us.

There are few places more idyllic than San Diego. Few places have been the home to more financial stupidity and the areas are currently in the midst of one of those very stupid times. If they were businesses, they would be bankrupt. It is hard to believe that a place where 1200 square foot homes, which can see the water only by reflection, sell for millions can be bankrupt but it is true.

They are bankrupt because of the fecklessness of leaders in handling the pension investments for city and country workers. Somewhere along the line, the genius consultants to the plans and the unions came up with the idea that any yearly gain above the projected minimum growth rate necessary to pay benefits should be shared in the form of higher benefits.

Let us examine this paragon of investment reasoning. Fact, a portfolio's value will vary. Fact, trend line growth is determined by averaging out a series of yearly results to determine the mean. Fact, any gains above the trend line are transitory. Fact, increased pension benefits are not transitory. Conclusion, sharing a transitory benefit to create a permanent liability is stupid, and eventually leads to bankruptcy.

It would be nice if it ended there but it does not, most municipal and teacher plans have similar features. With the markets unlikely to produce the golden goose returns of the past 18 years, most of these plans are under funded. Ergo, the pensions of state and municipal workers are unstable. Solutions, cut benefits, raise taxes or default; which do you think will happen first? Any choice municipalities and big business make to shore up their plans will lead to higher taxes and more strain on the dc plans of individuals.

If the above sounds scary and difficult it is not due to my soaring literary talents, it is because fact is scarier than fiction. The decisions we making (and I include myself in this we) are going to be the most important long-term decisions of our lives. Woody Allen once made the following comment:

"we are at a fork in the road, down one path lies nuclear war and the physical destruction that follows, down the other is social disintegration and anomie. Let us hope we have the wisdom to choose correctly.

The cross roads we face is not so clear-cut. We all have the option of taking charge of our futures. They really do not make the big decisions about your life in Washington DC or Sacramento or Olympia they are made between your ears.

So what do we do? First, get over your fear of death, it is going to happen. Being afraid of dying means that you did not live your life correctly.

Second, if you are younger than 50 stop thinking that Social Security will be part of your retirement. It might be but that is in the hands of politicians and therefore unstable and not subject to good thinking. Third, plan for longer life. Survey your blood family and determine the ages of death and the conditions of your predecessors it will give you a clue to your expected life, but whatever the result, add years to your life.

Fourth, make some decisions about how you want to grow old. Do you want to be independent until you die, do you have family that can care for you in your declining years, what level of medical intervention is acceptable to sustain life. Determine what your definition of living with dignity is and communicate that to your children, their spouses, and to the executors and powers of attorney.

Understand that even though you may retire at 62 you may have as much as 40 years of life left. A century ago, that was an entire lifetime. What are you going to do with those years?

Fifth, demand that your financial advisor turn his or her brain on. The industry has gotten very soft in the easy times of the last 20 years; the going will not be so easy in the next few years. Your financial advisor needs to be thinking ahead for you and using the benefits of their experience and knowledge to create pathways to success in the new environment. If they are not turning their brain on or are incapable of that sort of action, fire them.

Sixth, save more money.

Seventh, explore your options spend at least as much time on that exploration as you do exploring options for vacation. Eighth, if you feel you might not be prepared and you are afraid don't whine; do something about it you all have time left to make change.

STOP THE BOOMER TRAIT OF PROCRASTINATION, THERE WILL BE NO MAGIC BEANS OR MUSHROOMS TO TAKE YOU AWAY FROM THE SITUATION, THE GREATEST GENERATION IS NOT GOING TO RESCUE YOU. DO SOMETHING AND DO IT NOW!

Remember finally, this paraphrase of that great Australian philosopher Crocodile Dundee "cat food, you can live on it sure, but it tastes like S - - t."