Thoughts on DCPs and a few issues to consider

As mentioned in the previous article in this series, the CNMI government has hired the services of two consulting firms, Clark Consulting and the Wagner Law Group, and tasked them with making recommendations for the implementation of the government’s new “defined contribution plan,” which will require all government employees hired after Jan. 1 to voluntarily plan for, and assume the responsibility for their own retirement. I would hope that the government’s consultants would, at the very minimum, include in their report which is due on or after May 31 2007, the following as a rough indicative measure of the individual savings effort required in the defined contribution plan in order to achieve a reasonably comfortable retirement.

The much-touted advantage of portability of an individual’s investment portfolio aside, it is probably a safe assumption that many local people will continue the trend of the past and make a career in government their long-term employment goal.

I hope someone will write on the wall to remember to suggest that the consultants create a data table depicting estimated statistical projections for each age category displayed at 5-year increments from age 20 to 65 for a range of 10 average annual income levels in increments extending from $20,000 to $55,000 per annum, with each increment showing the varied percentages and dollar amounts each income earner’s age cohort should save on an annual basis to provide a sustained income after retirement equal for the provision of a standard of living comparable to that of the same income earner’s projected 10-year estimated, inflation-adjusted average annual salary. This would, of necessity, have to be a hypothetical data table—but it would provide a valuable indicative measure of the need to start a savings plan shortly after entering government employment.

Under the federal Employee Retirement Income Security Act of 1974, the federal government does not insure defined-contribution plans such as 401(k)s.

Perhaps the consultants will also address the possibility of the NMI government developing some form of backup “safety net” for participants, in the event of pension loss as a result of having invested in stocks that turn out to have been fraudulently manipulated as occurred with Enron, WorldCom and other investment schemes and debacles. A unique concept to be sure. This would be particularly valuable for the young unsophisticated investor. I mention this as a firm believer that island economies are far different and far more susceptible to damaging forces beyond local control than are, for example, mainland municipal and state economies. When left “hanging in the wind” in the middle of the Pacific as a result of some adverse economic event caused by off-island forces, there are often few mitigating alternatives for recouping or even acting quickly enough to “get out of the market” and limit the hemorrhaging of declining stock values given the differences in dates and time zones. I fear not enough consideration has been given the limitations imposed by the remoteness of Pacific geography.

It has been my observation that western Pacific economies take longer to respond to national structural interruptions and/or restructuring attempts, with the result that some national remedies can often be less effective or irrelevant to the recovery needs of islands. These small, largely self-sustaining economies at their basic level are not always susceptible to “broad brush” solutions designed to address mainland economic problems. An increase in the local minimum wage to the currently proposed federal minimum is such an example; currency rate adjustments are another.

Turning to another factor to consider in the retirement roster of issues, while one cannot predict how long one will live, planning for an appropriate length of time can help ensure that you don’t run out of money when you need it most. According to Fidelity company data, (http://personal.fidelity.com/) today there’s a 50 percent chance that one member of an average, healthy 65-year-old couple will live to be 92 years of age. That means the person who retires at age 65 will need approximately 30 years of retirement income, and even more if he or she retires early.

In terms of health care costs, medical advances have resulted in longer life expectancies, but health care costs have risen faster than overall inflation. Regardless of one’s current health and family history, anticipating the costs of health care in retirement means you’ll be better prepared for the unexpected.

Inflation is still the big factor to consider. Some retirement funding sources will keep pace with inflation, while others won’t. Social Security benefits typically rise as the cost of living increases, but many other sources of retirement income, such as fixed pensions, fixed annuities, or interest and dividend income from fixed income investments, generally do not keep pace with inflation. Other income sources such as some pensions provide a cost-of-living-adjustment, and variable annuities and stock investments may provide income which can increase over time to help offset the effects of inflation.

Here are several examples of the effect of the cancer of inflation: In 1970 monthly government Medicare insurance premiums paid by seniors was $5.30, today it’s $88.50—1,570 percent inflation. Today a person must earn $3.92 in order to purchase the goods and services that the CNMI’s minimum wage of $3.05 would buy in 1996. This represents a loss in purchasing power of 29 percent.

We have not lived in an inflation-free economy. It is scientifically impossible to predict the future rate of inflation, except for that short period of time already influenced by present and past monetary policy. Inflation is principally controlled by actions of monetary authorities, who in turn, often respond to unpredictable political factors. Thus, inflation is unpredictable and—in and of itself—creates a substantial risk.

Participants in any retirement program should remember these points:

—A dollar obtained in the future will almost always be worth less that one received today because inflation will have diminished its purchasing power. For example, less than 30 years ago the dollar would buy 9 pounds of rice but it will not do so today and certainly will have even less value in the future.

On Saipan, a dollar in 1976 was worth only 25 cents in purchasing power 20 years later in 1996. Some readers might remember those days when one could fly round-trip from Saipan to Guam for about $30 and for 33 cents you could purchase 100 yen or almost a gallon of gasoline (38 cents per gallon).

Lesson to be learned—a dollar obtained today should be invested in a manner to generate a fair return on the investment plus a rate equal to anticipated inflation to preserve its purchasing power.

It’s all just “food for thought” as a certain astute radio executive and prominent sage might say.

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