U.S. Pension Lifeboat Sinking?
US pension lifeboat in need of ‘comprehensive’ reform:
The fund that deals with insolvencies of US “multiemployer” pension plans could be exhausted within just three years, a federal watchdog has warned.Brad Kalbfeld of the Washington Guardian also reports, Pension Tension:
Multiemployer schemes typically cover a number of employers across unionised sectors such as construction, trucking and transportation.
The report on Monday by the Government Accountability Office said the multiemployer unit of the Pension Benefit Guaranty Corporation, the US agency that acts as an insurance fund pension plans, is in need of “comprehensive” reforms.
The number of insolvencies among multiemployer schemes is likely to double by 2017, the report said.
As a result, the insurance fund for those schemes is likely to run dry in 10 to 15 years, the agency warned, but could be exhausted in just two or three years if there are two large insolvencies.
GAO said: “Congress should consider comprehensive and balance structure reforms to reinforce and stabilise the multiemployer system.”
The pension lifeboat is akin to the UK's Pension Protection Fund and covers both single and multiemployer pension plans.
Options for reform include higher charges for employers that leave multiemployer plans or reducing accrued benefits for plans likely to become insolvent, the report said.
Multiemployer schemes tend to be more popular in the US, with 1,500 multiemployer plans in the US covering 10 million workers. A major complication for those plans is the way risks are shared, so that if one employer goes bust, the remaining companies must pay for unfunded benefits of remaining workers. This compares with the UK where many multiemployer schemes are segregated to isolate risk.
The PBGC is a government agency that is privately funded by insurance premiums that are set by Congress as well as investment income, settlements from company bankruptcies and the assets of schemes for the agency acts as a trustee.
A number of US multiemployer schemes have taken steps to improve their funding status since the financial crisis, increasing employer contributions and reducing employee benefits.
Despite this, data from the agency shows that the number of plans that are already insolvent or are expected to become so within 10 years has increased from 90 schemes in fiscal 2008 to 148 plans in fiscal 2012.
As a result, the PBGC’s potential liability has shot up to $7bn in fiscal 2012 from $1.8bn in fiscal 2008. During that time frame, the fund’s assets have only reached $1.8bn.
Overall, the agency covers the pensions of 43 million workers and retirees.
The federal program that protects workers in multiemployer pension plans expects to be exhausted in 10 to 15 years, and the financial hit will most likely land on retirees, a new report said this week.Go back to read my comment on corporate America's pension time bomb. Multi-employer plans are also at risk and unlike large corporate plans, they are poorly governed which is why many risk insolvency unless comprehensive reforms are implemented.
The Government Accountability Office said the Pension Benefit Guaranty Corporation will be overwhelmed because so many multiemployer plans are so seriously underfunded that they will soon be unable to meet their obligations to retirees.
The plans have suffered from various factors, including losses in the stock market, the impact of the recession on the companies that sponsor the plans, and the growth in the ranks of the retired.
The report recommends Congress consider reforms to allow for the restructuring of the plans, in which a number of companies, bargaining with a union, join in a single pension plan for their employees.
There are about 1,500 such plans, covering more than 10 million workers, the report said. Workers affected are in such diverse fields as grocery stores, hotels, restaurants, theaters, construction and trucking.
GAO reported that 24 percent of the plans are critically underfunded, and an additional 16 percent are underfunded enough to be considered endangered.
“While most critical status plans expect to recover from their current funding difficulties, about 25 percent do not and instead seek to delay eventual insolvency,” the report said, citing figures from the 107 plans it surveyed.
The report says the number of plans that are insolvent is expected to more than double in the next four years. A plan is considered insolvent if it cannot pay pension benefits at federally guaranteed levels for a full plan year.
“PBGC is at risk of having neither sufficient tools to help multi-employer plans deal with their problems nor the funds to continue to pay benefits beyond the next decade under the multiemployer insurance program,” Joshua Gotbaum, director of the PBGC, told a House committee in December.
Beneficiaries are certain to feel the impact. Many plans, struggling to stay solvent, have already reduced benefits and increased employer contributions – which, in turn, reduced the amount of money employers could devote to pay raises or other benefit programs.
When a multiemployer plan becomes insolvent, PBGC sends it money to keep benefits flowing to retirees and to fund the plan’s administrative operation. The aid is nominally a loan, although the money is almost never repaid, the report said.
Two large multi-employer plans are currently expected to become insolvent within the next 20 years. If one of them becomes insolvent sooner, the PBGC could run out of money in as little as two to three years, the report said.
“Comprehensive action must be taken to shore up the PBGC for future generations of employers and retirees,” said the Partnership for Multiemployer Retirement Security, a partnership of business and trade groups, in a statement.
“There is no easy way to address some of the challenges facing these plans, the GAO recognized what we know to be true – we need balanced solutions supported by both business and labor that do not put taxpayers at risk,” the statement said.
The GAO report, based on input from representatives of the pension plans as well as other industry experts, recommends that Congress change the rules governing multiemployer plans to address the penalties employers face for withdrawing from the plans, and to ease the restrictions on the design of the plans’ benefits for retirees.
In February, the National Coordinating Committee for Multiemployer Plans issued a proposal of its own, called “Solutions not Bailouts,” which recommends changes in regulations to allow for more flexibility in plan design and a broader ability to limit benefits when a plan is in deep financial trouble.
While some pension plans are set up and maintained by single employers, in multi-employer plans, beneficiaries who work for a number of companies are pooled into a single plan, with the terms negotiated by a union. The plans allow smaller employers to share risk, and allow workers to keep their pension benefits if they move from one company to another, as long as both companies participate in the plan. Single-employer plans are protected by a different PBGC trust fund.
The GAO report is the latest in a series of studies of the health of private pension plans, the impact of the 2008 financial crisis, and the steps the plans have taken to shore up their solvency. All of the studies have pointed toward a looming crisis that cannot be handled under the current legal and regulatory rules.
As far as the PBGC is concerned, there is no doubt they will be very busy in the next decade, especially if rates stay persistently low or fall further if deflation develops in the United States and around the world (again, go back to read my comment on corporate America's pension time bomb).
And some are questioning whether PBGC is a good fiduciary. Timothy O'Toole and Michael Khalil of the law firm of Miller & Chevalier Chartered in Washington, wrote an op-ed for Pensions & Investments, Is PBGC a better trustee?:
When a company is in bankruptcy or facing financial hardship, at some point it might have to face the question of whether to terminate its defined benefit pension plans. This is a difficult decision, and hard as a plan sponsor tries, termination might turn out to be the only option.Whether or not you agree with these comments, the authors raise some excellent points in regards to administrative burdens on the PBGC and the inherent conflicts of interests because of the way PBGC is currently funded.
But there is a related question that frequently does not get the same level of attention, much to the detriment of the plan's participants. In the event the plan is terminated with insufficient funds, who should serve as the trustee of the terminated pension plan, ensuring the remaining plan assets are fairly distributed to the plan's participants?
Congress passed the Employee Retirement Income Security Act of 1974 as a way to address a number of perceived flaws in the pension system, including termination of pension plans leaving participants without the pensions upon which they had been depending. Title IV of ERISA established the Pension Benefit Guaranty Corp. to administer a mandatory government pension insurance program, guaranteeing pension payments of underfunded terminated plans up to legal limits. In addition to the insurance guarantee, ERISA provides another layer of protection for employees by allowing for the appointment of a successor trustee to administer the plan.
The successor trustee has a number of critical fiduciary responsibilities, including exercising a broad array of powers over the remaining plan assets and how they are distributed to participants, serving as the eyes and ears of the plan participants, investigating and identifying potential financial claims that might be brought on behalf of the plan, bringing lawsuits in connection with those claims when appropriate and generally ensuring that the participants receive as large a share as possible of the benefits they earned.
ERISA establishes a framework for the appointment of the successor trustee, making clear the federal agency responsible for insuring the failed pension — the PBGC — “may request” its own appointment. But the statutory scheme, and particularly the provision authorizing compensation for the trustee, also suggests Congress did not expect the PBGC would routinely act as the trustee. Nonetheless, since its creation in 1975, the PBGC invariably has sought and secured the role of trustee in connection with the terminated pension plans it insures, almost always by agreement with the prior plan administrator. In most cases, plan administrators readily agree to the PBGC's appointment, probably assuming they have no choice in the matter, and that the PBGC will be a competent trustee.
In the past decade, the problems of allowing the PBGC to serve as plan trustee have become increasingly apparent. Two fundamental problems are evident.
The first is that serving in this dual role — as both the federal agency responsible for guaranteeing pensions and as the fiduciary trustee of the participants of the terminated plan — has imposed overwhelming administrative burdens on the PBGC that are, unfortunately, beyond its ability to handle. The PBGC serves as the trustee for more than 4,300 terminated plans and 1.5 million beneficiaries. Predictably, the logistics associated with such large numbers has proved too much for a single trustee, with the agency taking up to a decade to make its final benefit determinations as to plan asset allocations in the larger and more complicated plans. Because participants may not challenge their share of the asset allocation until the benefit determinations are finalized, these excessive delays impose a significant hardship on plan participants, and it is common for a plan participant in a larger plan to pass away well before the PBGC finalizes his benefit determination. Even then, the determinations are not only slow, but rife with errors, often as a result of the PBGC outsourcing the work to unqualified contractors. These errors have been the subject of numerous critical reports by the PBGC's inspector general, who recently described the PBGC's audit process as “seriously deficient,” noting that problems originally detected in 2007 continue unabated.
The second problem with agreeing to the appointment of the PBGC as the plan's trustee is that the PBGC has an inherent conflict of interest. ERISA makes clear the statutory trustee is a “fiduciary,” whose guiding concern is supposed to be the welfare of plan participants. But the PBGC's insurance program is funded by plan sponsor insurance premiums, and because of this lack of public funding, the PBGC is often concerned with its own fiscal bottom line. This can create a conflict because there are many times in the process where the best interests of the participants are completely counter to the financial interests of the agency. One good example of this is when it comes time to estimate the remaining plan liabilities and assets. A true fiduciary would want as accurate an estimate as possible, in order to ensure the participants get every conceivable penny out of the funds that were contributed by the sponsor for their benefit. The PBGC, however, has the exact opposite incentive; any underestimation of plan assets, or overstatement of plan liabilities, works to the PBGC's benefit, at the direct expense of the participants' rightful share of plan assets.
The PBGC's conflicts and limitations as successor trustee were on full display in February as the agency fought against its removal as trustee for the US Airways Pilots Plan. After the PBGC issued formal benefit determinations in the US Airways Plan in 2007, participants contacted the PBGC to ask that it investigate potential claims that might exist on the plan's behalf. In 2009, the union representing the US Airways pilots sued the PBGC in federal court, alleging the PBGC had failed meaningfully to investigate or prosecute claims on behalf of the plan, and asking the court to replace the PBGC with an independent fiduciary. In February, the court held a three-day bench trial on the pilots' allegations, during which the court heard testimony from a number of witnesses regarding the agency's practices in dealing with its trusteed plans. The court also heard testimony from the PBGC's expert witness (a former general counsel of the agency) who sought to defend the PBGC by arguing that, because of the PBGC's conflicting interests, its fiduciary obligations as a statutory trustee are less than the obligations of other fiduciaries. Indeed, the crux of her argument was that while independent trustees must act solely in the interests of a plan's participants and beneficiaries, the PBGC by definition cannot do so because it has competing statutory obligations, and that its fiduciary obligations must therefore be less. The court has not yet issued its ruling, and the plaintiffs have offered a significant amount of legal authority to dispute the notion that the PBGC's fiduciary obligations are less than those of other trustees; nonetheless, it is clear that however the court rules, plan administrators are now on notice that the PBGC believes that it cannot and will not afford plan participants and beneficiaries with the same level of fiduciary care that an independent fiduciary would render.
These concerns were likely why Congress made the appointment of the PBGC as trustee merely optional, and did not envision its uniform and routine appointment. They also illustrate why the current practice of appointing the PBGC as trustee in every case should be revisited. An independent fiduciary will not suffer these same distractions or conflicts.
It is accordingly important that, when a pension plan's termination is considered, the administrator of the current plan considers whether it truly is in the best interests of the participants to agree to the PBGC's appointment as statutory trustee. Great care should be given to whether the appointment of a different trustee would better serve the participants. In fact, the current plan administrator's failure to at least consider the option of appointing an independent trustee can open a fiduciary up to potential liability during the plan termination process.
However, there is some indication that plan administrators are beginning to question the wisdom of such action. For example last year, as the law firm Dewey & Leboeuf LLP began the process of liquidation, the PBGC sought the firm's agreement to have the plan terminated and have itself appointed as the successor trustee. Firm management (the named administrator of the plan) refused, initially opting to appoint an independent fiduciary to deal with the plan's administration. Ultimately, the PBGC was able to convince Dewey to agree to its appointment as successor trustee as part of a broader settlement, but the fact that the trusteeship issue was part of the settlement discussions at all suggests that prudent plan administrators are beginning to see that the question cannot just be taken for granted.
While the level of compensation for a trustee is not specified in the statute, ERISA does anticipate that successor trustees will need to be compensated, and indeed the statute's only requirement is that both the PBGC and the court play a role in setting the compensation level to ensure that plan assets are not unnecessarily depleted. In larger plans with significant assets, the revenue that the plan assets generate (post-termination) is more than sufficient to fund a reputable independent fiduciary. While the PBGC currently uses the investment returns from trusteed plans for its own operations, a fiduciary could certainly conclude those returns could be put to better use in retaining a dedicated independent fiduciary who did not face the same conflicts and institutional inefficiencies that plague the PBGC.
A plan administrator, acting as a fiduciary, will want to undertake with great care the responsibility of implementing a decision to terminate a plan to ensure the termination process ultimately chosen does the least harm possible to employees who have earned their pensions over the course of a lifetime.
Editor’s note: Miller & Chevalier Chartered is representing retired US Airways pilots in a lawsuit (Thomas G. Davis, et al., plaintiffs, vs. PBGC) accusing the Pension Benefit Guaranty Corp. of unlawfully depriving benefits to the group. Mr. O'Toole is a counsel in that case. The law firm isn’t involved in the case mentioned in this commentary.
Nonetheless, it's important to note that for the most part the PBGC is doing a great job but the agency is at risk of being completely swamped as they are called upon to take over more and more plans at risk of being terminated. Unless reforms are implemented, I'm not sure the agency will be able to absorb all these plans if another financial crisis hits the United States (go back to read my comment from November 2009, Risks Rising at the PBGC).
Below, Josh Gotbaum, Director of the Pension Benefit Guaranty Corporation, talks with Bloomberg Law's Lee Pacchia about the agency and its role in maintaining pension benefit plans in the event of a company's inability to pay. Gotbaum also comments on his expectations for the year in bankruptcy and the broader debate surrounding the concept of private pension benefit plans (from January, 2012).