The Pension Time Bomb is Ticking – Can it be Disarmed?
December 2004
By: ChartingTheEconomy.Com
There is a time bomb ticking in America of which most people are not aware. In 1974, Congress formed a quasi-governmental
agency called the U.S. Pension Benefit Guaranty Corporation (PBGC) and gave it the primary mission to protect/insure benefits in
private-sector traditional pension plans. The PBGC’s primary function is to: 1) oversee terminations of fully funded plans, and 2)
guarantee payment of basic pension benefits when underfunded plans are terminated. For the past several years many
corporations have been vastly underfunding their pension plans, and the problem is now at a critical level. Because of this it should
be no surprise that the backstop that was created to protect traditional private-sector pensions has become the real time bomb. If
the pension bomb goes off, you will likely be a victim regardless of whether you are a member of a pension or not.
The PBGC is not funded by tax dollars. Its funding comes from insurance premiums paid by companies whose plans the PBGC
protects. Funding also comes from PBGC’s investments and from its assets. However, don’t be fooled into thinking that this means
that your tax dollars are exempt when it comes to bailing it out, and it may come to that. At least this is looking more and more likely
everyday, especially if the Bush Administration and Congress do not act quickly to disarm this bomb. Furthermore, this issue is not
going away on its own. The PBGC’s Executive Director Bradley Belt in the release of their 2004 Financial Results stated that
“pressures on the pension insurance program are expected to continue.”
It should be quickly noted that the PBGC insures both multi-employer and single employer plans. The simplest way to describe the
difference is that multiemployer plans are sponsored by two or more unrelated employers who have collective bargaining
agreements with unions. Single-employer plans are on-their-own. The difference is important because all of the current PBGC
debt and the majority of the projected underfunding is caused by single-employer plans.
So what does this time bomb look like and how big is it? Like any time bomb the real threat is not just the magnitude of the issue,
but the trend. And in this case the trend is not your friend. The PBGC had been running a surplus for many years until 2001.
Starting that year the PBGC has quickly rolled up some extremely large deficits. The deficit for the fiscal year 2004 (PBGC is on
the federal government’s fiscal year calendar which ends on September 30) was in excess of twelve billion dollars. That’s right,
$12,000,000,000. As for the trend, the 2004 loss more than doubled the cumulative debt of the PBGC which as of September 30,
2004, stood at just over $23.5 Billion.
This time bomb needs to be disarmed and quickly because the current debt looks like a firecracker in comparison to the issue
looming on the horizon. The PBGC also tracks its reasonably possible exposure and its exposure to underfunded plans. As of
September 30, 2004, the reasonably possible exposure is $96.1 billion. As of the same time, the total underfunding is believed to
exceed $600,000,000,000. BOOM!
Why care? Because your tax dollars could be at risk if a bailout becomes necessary. This is what your share of the bailout could
look like.
The per household share of PBGC’s debt as of September 30, 2004, was just of $200. The per household share of PBGC’s
reasonable possible exposure and underfunded plans was over $800 and $5200, respectively. I believe a bailout is not imminent
or even necessary, yet. However, reform is critical - reform that may not be politically desirable in the short-term. Though, if reform
is not made a priority for the Administration and Congress in 2005, a bailout, which will be much more politically unpalatable,
becomes more likely.
If reform was easy, and not a economic and political albatross, it would have already been corrected. The PBGC Executive Director
Bradley Belt said, “When Congress reconvenes, the Administration will submit a comprehensive proposal that strengthens the
funding rules, rationalizes premiums, enhances transparency, and provides new tools to protect the insurance fund.” Okay that
sounds great. Let’s face it, the cause of the PBGC deficits is simple. They are paying out more in benefits than they are collecting
in premiums from corporate pension funds. The way I see it, there are three main variable that lead to the current crisis and can
lead us out of it. They are: 1) premiums, 2) benefits, and 3) pension funding rules. In short, all three have been completely out of
alignment, therefore causing the PBGC to take on far more risk and liability than it can afford.
Several simple observations quickly reveal the generosity of the PBGC toward corporate America. First, the annual premiums that
corporate pension plans pay the PBGC to insure worker pensions appear to be very low. The premiums are $2.60/worker or
retiree in multiemployer plans; and $19/worker or retiree plus $9/$1000 of unfunded vested benefits in single employer plans.
These premiums can only be increased with Congressional approval. I don’t think it takes an insurance underwriter to see that
purchasing insurance on just about anything that is unfunded and vested for $9 on the $1000 is a deal. Chart 3 shows how
premiums have not kept pace with benefits over the past several years.
Second, the maximum guaranteed benefit payment by PBGC for 2004 was $44,386/year. What is more is that the maximum
payment has been increased at a rate that far exceeds increases in median income and overall wages and salaries in the U.S. for
the past twenty years. Chart 4 below shows that PBGC’s maximum benefit guarantee has increased more than 130% in the past
twenty years while median income and wages/salaries have increased about 100%.
Third, funding rules for traditional pension plans have basically allowed corporations to legally underfund their pension plans, and
then go out and purchase insurance at rates that don’t take into account the inherent risk of default.
In fact, in recent years the funding rules have allowed corporations to put fewer dollars into their pension plans – not more. The
first was the Job Creation and Worker Assistance Act of 2002 which increased the interest rate cap that pension funds could use to
determine the future earnings on their investments during 2002 and 2003. Next was the Pension Funding Equity Act of 2004 which
increased the cap again for 2004 and 2005 by allowing pensions funds to use a rate tied to corporate bond yields instead of the 30-
year T-bill. By using higher interest rates to calculate future returns pension funds look like they are better funded then they
otherwise would be. So what this equated to was an accounting change that reduced underfunding on the books of pension plans.
By some accounts the Pension Funding Equity Act may produce as much as $80 billion in relief for corporations. That means
without putting an extra penny into their pension plans their plans look like they have $80 billion more in them. Yes, without these
rule changes the underfunding numbers in Chart 2 and Chart 3 above would have looked even worse.
The rule changes, however, now mean pension plans have a higher bar to clear when it comes to future returns on their
investments. And they need to hit these higher returns just to have the underfunding problem I have described. If they do not,
then the problem becomes much worse.
The funding rule changes also make the PBGC’s underfunding issue look better but make it worse. PBGC shows billions of dollars
less in underfunding for insured plans though the plans actually have no more money in them than they did prior to the rule
change. In return PBGC premiums are reduced because the premium is partly based on how much unfunded vested benefits they
are insuring.
For the most part, all other issues affecting the PBGC’s deficit flow back to the issues of premiums and benefits. For example, the
increase in life expectancy has been causing projected benefit payments to increase and, therefore, causing underfunding of plans
to increase. In fact, one of the largest contributing factors to the 2004 deficit was a change in mortality assumptions that caused
$1.5 billion in actuarial adjustments. What this means is that pension plans are getting a deal. PBGC’s premiums and benefits are
not aligned to reflect the potential liabilities of the plans they insure.
It seems simple enough, just increase premiums, reduce benefits, strengthen funding rules, or some combination of the three. This
is easier said than done. Economically and politically these are NO WIN issues in the short-term. Simply put, that is why we did not
see a Bush Administration proposal during the 2004 election year. In fact, we saw relaxed funding rules for corporations. The
good news is we now have a lame duck President who does not have to worry about reelection. As a result, I believe the
Administration will quickly get a proposal to Congress. However, Congress which is always worried about being reelected will have
to make some hard choices.
Let’s think about some of their choices. First, increase premiums on pension plans. This will reduce corporate profits by causing
companies to pay more into the PBGC. In the Republican lead Administration and Congress anything that reduces corporate
profits is sacrilege. In addition, corporations argue that increasing premiums could force more companies into “distressed
terminations” in which case PBGC becomes the trustee of more pensions. This would have the negative effect of increasing PBGC’
s liabilities. I don’t buy it. As I have shown above premiums have been lagging benefit payments by a long way. What that means
to me is that corporations have been getting a free ride (or at least a heavily discounted one) and that needs to end. In fact, it is
extremely unfair to corporations that don’t have traditional pensions to give the ones that do a free ride. It gives these corporations
a leg-up in attracting employees relative to corporations that don’t have pension plans, and the advantage is subsidized by the
PBGC.
Second, Congress could reduce benefits to individuals. I don’t think I need to go into detail about the economic and political
backlash of this. Remember the PBGC covers over 44 million workers and retirees (the 34.6 million in the single-employer plans
are the ones in real trouble). Currently, there are close to 1.1 million participants receiving or owed benefits. Think about running
for reelection on that campaign platform.
Third, Congress could strengthen pension plan funding rules. As shown above they have been doing just the opposite during the
past several years. Why? Because it was politically easy. By making a simple accounting change they where able to make the
pension funding issue look a lot better and save corporations a lot of money. That made everyone happy in the short term.
However, it masked the long-term problem. The theory is that by giving corporations temporary relief they will have more money to
fund plans in the future and will be less likely to have their plans default to the PBGC. The problem is that it is just as likely that the
money gets spent on something else. If history is any indication, Congress is going to have a hard time changing course on this
one. Remember strengthening funding rules could reduce corporate profits and that will just not happen in a Republican
dominated Congress. But remember, as I just stated above, allowing some corporations to underfund their pensions, and then
insuring them at bargain rates is more harmful to those corporations that don’t offer pensions. Why? Because it equates to a
subsidy from the PBGC, and if a bailout is necessary, a subsidy from you and me.
So doing nothing may be easier for Congress, but the political backlash of a bailout would be far worse than the backlash from
increasing premiums, reducing benefits, or overhauling the pension funding rules now. In Chart 2 above I show what the average
household would have to pay to cover the PBGC’s underfunded pensions. Simply put, a bailout would cause the majority of the
population that doesn’t have a pension covered by PBGC, and likely doesn’t have a traditional pension at all, to write checks to
those that have pensions covered by PBGC. Actually, you would write a check to the government and the government would send
it to the PBGC. Having people that do not even have pensions subsidize individuals that do has to be political suicide. Of course
the government could just add the bailout to the growing national debt and not ask taxpayers to immediately fund it, but that cannot
be the right answer.
So where do we go from here? The Bush Administration needs to propose rule changes in 2005 that: 1) strengthen funding
requirements for traditional corporate pension funds, 2) increase premiums, and 3) reduce benefits. The rules should be phased in
over some period of time. By requiring this set of actions, no one group will have to shoulder the entire burden. The corporations,
workers/retirees, and PBGC all share in the recovery of the program. I do not know if the Administration’s plan will do this, but I do
believe they will send a proposal to Congress sometime in early 2005. The problem is that this issue is very politically charged for
Congress. Will Congress be able to agree on a bill to send back to the President, and if they do, how watered down will it be?
First, corporations need to fund their traditional pension plans appropriately assuming realistic future returns on equity. They have
a choice here. They can increase their contributions to fund their plans, or they can adjust their plans to promise more realistic
pension payments to their workers and retirees.
Second, the PBGC’s premiums need to increase. At the very least their current premiums need to cover current benefit payments.
Seems reasonable, but this has not been the case recently. In 2004, PBGC paid benefits of just over $3 billion and collected
premiums of just under $1.5 billion. A risk adjusted payment structure should also be considered. Just like with any insurance you
or I purchase, the higher the risk the higher the payment.
Third, benefits should be reduced. This may be the most undesirable reform and most unlikely to be enacted. To make it more
palatable I would recommend a temporary reduction until the underfunding issue is under control. Another alternative could be to
cap the maximum payment guarantee at the 2004 level for a number of years. Remember the maximum payment guarantee has
been increasing much more quickly than wages and salaries in the U.S.
Finally, reforms should start in 2005 and be phased in over three years with a goal of eliminating PBGC’s debt within a reasonable
timeframe, say ten years. The reforms should also give the PBGC a range of parameters under which to adjust premiums and
benefits without an act of Congress (which is required today).
Congress should not cave to the argument that they will be putting an undo burden on corporate America. In actuality they will be
leveling the playing field for all corporations. If corporations cannot afford their pension plans, it is better to know it now then to find
out when the problem is about to explode. Let us hope Congress is up to the challenge of disarming this bomb. If not, seek cover,
and open up your wallet.
Sources:
Pension Benefit Guaranty Corporation – Performance and Accountability Report Fiscal Year 2004
PBGC 11/15/04 – “PBGC Releases Fiscal Year 2004 Financial Results
U.S. Bureau of Labor Statistics
U.S. Census Bureau (data on number of households was through 2001 with estimates thereafter)
U.S. Treasury Department and IRS
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