Despite encouraging signs of recovery in the stock market and elsewhere, one aspect of corporate health is likely to remain in "critical" condition for some time. The Pension Benefit Guaranty Corporation (PBGC), a quasi-public institution that insures private pensions, continues to face falling income, rising liabilities and expected losses that could exceed its assets.
In addition, the pension programs of the companies insured by the PBGC have alarming levels of underfunding. The General Accounting Office classifies the PBGC as a "high risk" program requiring urgent transformation and reform. Tough luck for pensioners getting ready to retire? Not yet, but someone else--the American taxpayers who guarantee their pensions--should be worried right now.
During the past two years, falling asset prices and failing manufacturers have eroded the financial foundation of the PBGC, and the crushing weight of the troubled programs it insures portends a potential collapse that would obligate taxpayers to rescue them. The plans of the companies in the Standard & Poor’s 500 that offer defined-benefit pensions face deficits totaling at least $182 billion, and possibly more if the economy performs erratically.
Furthermore, pension failures have been on a rising trajectory. In 2002 and 2003, the PBGC sustained losses significantly greater than its assets and posted the worst deficit in its 29-year history. The PBGC manages more failed pensions than ever before, and the yearly benefits it disburses have more than doubled over the past two years.
In the past, the agency covered bankruptcies with little difficulty because its premium income exceeded the losses. However, losses sustained from completed and probable terminations of pension plans increased nearly 50-fold over the past two years, and the PBGC estimates that it will sustain a $35 billion loss from plan terminations in 2003. Unfortunately, its assets total only $25.43 billion, making its projected losses for the current year 138 percent of its total assets.
Why such huge shortfalls? As interest rates decrease, a company must place more money in its pension program to guarantee its ability to meet its future pension obligations. Most companies did not take this step as interest rates fell during the end of the last decade because the significant appreciation of the equity assets in the funds covered the assumed future decline in returns from a lower interest rate. Because of this poor planning, a study by Goldman Sachs reports, these firms may have to direct $160 billion toward their pension plans over the next two years to reach an adequate level of funding.
Recent changes in interest rates notwithstanding, certain structural issues surrounding pensions themselves will ensure that PBGC’s headaches won’t go away.
For one, the defined-benefit pension plan is fast becoming a relic of past decades in which workers spent their entire careers with the same company. The PBGC was designed for that rigid employment structure, and is struggling to stay ahead of the changing demographics, which threaten to stretch the agency’s responsibilities beyond its resources.
The PBGC manages more failed pensions than ever before, and the yearly benefits it disburses have more than doubled over the past two years.
Further exacerbating the flight from the traditional pension system is the fact that healthy firms, responsibly managing their pensions, essentially cover the losses incurred by mismanaged funds. As a result, these "good corporate citizens" understandably restructure their pension programs into defined-contribution plans to eliminate the cost of subsidizing poor performers through insurance premiums.
Moreover, the average length of retirement increased 20 percent between 1975 (the year of the PBGC’s inception) and 2000. Consequently, the number of beneficiaries supported and the amount of benefits paid by the agency continue to grow at accelerating rates. In the past two years alone, the benefits paid by the PBGC increased by 140 percent.
Where to begin
Clearly, reform is necessary to prevent a taxpayer-financed bailout. One place to start is correcting the PBGC’s pricing to better reflect risks. Current insurance premiums ($19 per pension participant, plus a small charge on underfunded plans) don’t adequately account for the differences in management style among plan administrators.
Conversion to defined-contribution plans to ease long-term fiscal pain is another measure worth taking. This would eliminate the PBGC "risk subsidy" and help end a market distortion that may be dissuading some from making the retirement-benefit choice that best suits their individual circumstances.
Finally, competition should be instituted. This creates healthy market-based pricing, which increases consumer choice and minimizes risks to taxpayers. The modern insurance industry is capable of underwriting pension risks and freeing the federal government from an outdated, unnecessary obligation.
Government-sponsored enterprises are renowned for their economic inefficiency, and the PBGC is no exception. Congress must reform its regulation of the private-pension system to ensure the security of pensions (correction), expand the personal pension choices available to employees (conversion), and remove the potential cost to taxpayers (competition). Solving the PBGC’s conundrum may not be as easy as A-B-C, but remembering the Three Cs is sure to save tax dollars and give lawmakers a valuable economics lesson to boot.