In Numbers We Trust
In the May 8th edition of Barron’s—reprinted on page 36 in this edition of Surplus Record―Thomas Donlan wrote that the 2005 cost for Medicare, Social Security, and Social Security disability programs will reach 40% of total federal revenues, and about 7% of gross domestic product. But by 2040, this number is expected to reach 14% of overall GDP. This is a huge sum by any standards, and one that is not sustainable. In his article, Donlan cites reports which claim the “unfunded promises to retirees and disabled persons have a present value of more than $39 trillion over the next 75 years.” To put that number in perspective, it represents roughly one-hundred times what Wal-Mart, one of the world’s largest companies, sells annually.
Despite the massive size of this obligation, it is a future cash need that we can predict with a strong degree of certainty thanks to the actuarial work of thousands of number crunchers who look at such metrics as the forecast number of retirees, life expectancy, and healthcare inflation (relative to overall inflation). The numbers portend a scary future for our country—but at least with this type of analysis we have the foresight to take action before it is too late. For example, one proposal that is making the rounds in Washington is to provide a set cash payment on a yearly basis to those who turn a specific age and mandate that they invest the money in retirement funds and healthcare rather than offering the promise of future government payouts in the future. This would essentially amount to a massive (four or five figure) rebate on Federal taxes each year, and would provide market-driven flexibility and returns.
Whether you agree with this idea or not, at least intelligent minds are debating what to do about our looming entitlement crisis. But the same cannot be said about many private sector companies that also have an actuarial crystal ball that is predicting a similar, scary situation down the road—and in some cases, not that far down the road. Like the Federal government, the automotive, steel, and airline industries have ignored their legacy cost structures, choosing to shun the work of actuaries whose job it is to predict with near certainty on what future cash obligations will be based. For example, in 2003 alone, pension under-funding at “major U.S. companies rose 27% to $353.7 billion” according to a Reuters news report.
But pension costs are only one predictable feature of future cost drivers. Labor, healthcare, and other related obligations—especially if unions are involved―represent obligations which are nearly impossible to cancel without significant penalty. Consider how Delphi, a tier one automotive supplier, currently in bankruptcy, is offering to buyout contracts for all of its union workers, representing five, six, and even seven figure offers so that these employees just walk away. Despite the costs, at least Delphi has come to terms―through bankruptcy lawyers, albeit―with its actuarial-predicted cash obligations, and is taking action as a last ditch effort to save itself.
Airlines have similar retirement and labor issues as well, but also face the additional cash challenge of oil prices. As a result, the International Air Transport Association forecasts that the industry will lose approximately $3 billion this year. Losses like this are not sustainable. But they are predictable. It is time to listen to the work of actuaries who are paid not to forecast doom and gloom scenarios, but to take an objective look at the future costs of current obligations and operating expenses. If steel executives listened to their actuaries in the past decades, they could have averted the bankruptcies that nearly destroyed the industry, enabling them to ultimately ride the wave of rising steel prices. The question is now whether our Federal government and the aviation and automotive industries will follow a similar path, or whether they can learn from the mistakes of the past. Regardless, at least one thing is for sure: we know that in numbers, we can trust.
