Going Over the Pension Cliff?
The federal agency that insures pensions for 43 million Americans saw its deficit swell to $34 billion in the past year, the largest in its 38-year history.The latest high profile company to terminate its defined-benefit pension plan as part of a liquidation is Hostess Brands. According to Business Insurance, the PBGC will assume its liabilities.
In its annual report released Friday, the Pension Benefit Guaranty Corp. blamed the growing shortfall on its inability to charge private employers adequate premiums for insuring pensions.
Citing the increasing deficit, PBGC Director Joshua Gotbaum called on Congress to give the agency power to set its own premiums. “We continue to hope that PBGC can have the tools to set its own financial house in order, the way other government and private insurers do,” he said in a statement.
The Obama administration has called on Congress to give PBGC’s board the power to set premiums. But those efforts have been unsuccessful, in large part because some members of Congress say that a new premium structure could significantly raise costs for companies whose retirement funds already are at risk of running out of money. Although Congress has raised PBGC premiums repeatedly in the past, they have not gone up in recent years.
PBGC is funded by a combination of insurance premiums from private pension plans, investment returns on its $85 billion in assets and recoveries from bankrupt companies. It receives no taxpayer money, and its leaders say it has has sufficient reserves to cover its obligations.
Overall, the agency saw its long-term liabilities increase $12 billion to $119 billion, while its assets grew by $4 billion over the past year.
If the shortfalls continue, Gotbaum warned, “PBGC may face for the first time the need for taxpayer funds. That is a situation no one wants.”
The agency has proposed setting premiums that reflect the perceived riskiness of the pension plans it insures, with financially shaky firms paying more to have their pension promises guaranteed by the agency.
But business lobbyists have branded the proposal a non-starter. They say any increases would work against the agency’s larger goal of enhancing the troubling retirement security landscape confronting many Americans by making it more expensive for the dwindling number of firms that have pension plans to insure them.
Currently, fewer than one in six private-sector workers are covered by defined-benefit pensions, a percentage that has been shrinking for three decades. More than half of private-sector workers have no retirement coverage through their employers.
Meanwhile, 53 percent of Americans are in danger of being unable to maintain their standard of living in retirement, according to the Center for Retirement Research at Boston College.
The agency’s deficit also has been fanned by low interest rates, which under accounting rules makes many troubled pension funds look even weaker.
In addition to its growing deficit, the PBGC said that at the end of 2010 it faced $332 billion in potential liabilities from fiscally unsound plans that could end up in its hands in the future.
In the fiscal year ended in September, the agency paid nearly $5.5 billion in benefits to 887,000 retirees whose plans have failed, and 614,0000 people are expected to collect benefits from the agency once they retire. In that year, the agency also assumed responsibility for the pensions of 47,000 people in newly failed plans.
The agency also is charged with discouraging financially trouble firms from jettisoning their pension obligations. Last year, the agency helped protect the pensions of 130,000 employees of American Airlines, which is in bankruptcy, according to the report.
It also helped preserve the pensions of 37,000 people whose companies have emerged from bankruptcy, including Houghton Mifflin Harcourt Publishing, the food retailer A&P, and the publishing company Lee Enterprises.
In her article, US pension insurer runs record $34B deficit, Marcy Gordon of the Associated Press notes:
The agency has now run deficits for 10 straight years. The gap has grown wider in recent years because the weak economy has triggered more corporate bankruptcies and failed pension plans.Melanie Waddell of AdvisorOne also picked up on the American Benefits Council's concerns that PBGC is overstating its liabilities, calling the deficit number misleading:
If the trend continues, the agency could struggle to pay benefits without an infusion of taxpayer funds.
Agency Director Josh Gotbaum said Friday that continued deficits "will ultimately threaten" the PBGC's ability to pay pension benefits to retired workers.
"There's no imminent threat that we're going to stop cutting checks," Gotbaum said during a conference call with reporters. However, he said, Congress must act "long before 10 years from now" to increase the insurance premiums that companies pay to the agency.
The Obama administration has proposed raising the premiums and tailoring them to the size of companies and their level of financial risk. Under the plan, bigger companies and those at greater risk of failing would pay larger premiums. The fees haven't been raised in six years.
Companies whose pension plans failed in the latest year, with the agency taking them over, included Friendly Ice Cream Corp., law firm Dewey & LeBoeuf and Olan Mills. Inc.
The PBGC joined with unions at American Airlines earlier this year to oppose the company's plan to terminate its pension plans. The move would have dumped billions of dollars of new obligations on the agency. American ended up freezing pensions for most workers instead of terminating them.
The American Benefits Council, which represents businesses, called the $34 billion deficit figure misleading and said it was based on faulty math.
"The public should not be led to believe the PBGC is in danger of a bailout, and Congress and the Obama administration should not use this number as a pretext to raise (insurance) premiums," the group said in a statement. The group has been critical of the PBGC.
The public, “should not be led to believe the PBGC is in danger of a bailout and Congress and the Obama Administration should not use this number as a pretext to raise premiums paid by pension plan sponsors,” said ABC President James Klein. “As employer pension plan sponsors have repeatedly pointed out, all pension fund liabilities—including the PBGC’s—are overstated by the historically low interest rates of the past several years. Keeping interest rates low is good policy to stimulate the economy, but it has the perverse effect of making very secure pension funds—and the PBGC’s own situation—appear underfunded.”Mr. Klein is absolutely right, before employers pay higher premiums, the PBGC should explicitly state the assumptions and models used by the agency to calculate the deficit.
To determine the PBGC’s financial situation based on today’s “incredibly low interest rates is irresponsible,” Klein added. “It is no more accurate to assert a large deficit today, than it was to claim an $11 billion surplus about a decade ago when interest rates were high. Neither of these skewed ‘snapshot’ assessments accurately reflects the long-term condition of the pension system, nor the PBGC’s financial situation.”
ABC believes the methodology used by PBGC to calculate its deficit is “seriously flawed” and has never been fully examined by Congress. “Before we can determine PBGC’s true financial position, the assumptions and models used by the agency to calculate its deficit must be scrutinized, especially if PBGC is using them to charge its customers higher premiums,” Klein said.
Having said this, today's "incredibly low interest rates" reflect weak economic growth around the world and could signal trouble ahead. Importantly, if central banks lose the titanic battle over deflation, these low rates can go lower and stay at historic lows for decades.
If debt deflation hits, the PBGC, private and public pension funds will be in deep trouble. It's equally irresponsible to think that historic low rates are about to head much higher. Maybe they will but what if they don't? In that case, taxpayers will be on the hook to shore up public and private DB plans.
Also worth noting, the Government Accountability Office (GAO), recently issued a report stating that Congress should consider the PBGC's request to switch to a more risk-based premium structure for the defined benefit plans it insures:
GAO analysts found that a risk-based system would shift premium costs among DB plans, with financially healthier sponsors paying less and riskier ones paying as much as $257 more per participant, depending on level of risk.I'm not sure about a risk-based system. All I see are companies going bankrupt, terminating their DB plans, shifting workers to DC plans, paying lump-sum pension payments or offloading pension risk to insurers.
Despite resistance from some pension plan groups, which worry that it could push some companies to stop offering DB plans, the GAO recommended that Congress authorize the revised premium structure, as PBGC officials continue modeling of various premium redesign options, while evaluating the potential impact on plan sponsors.
Despite administrative challenges, “there are merits to a risk-based system, and a lot of agencies do it, said Charles Jeszeck, GAO director of education, workforce and income security, in an interview. “We think it could help keep some plans in place.”
Joshua Gotbaum, director of the Pension Benefit Guaranty Corp., has made it a priority to rethink how the chronically underfunded agency can recalculate its premium-setting formula to reward healthy plans and have riskier ones pay more.
The GAO report was requested by Sen. Tom Harkin, D-Iowa, chairman of the Senate Health, Education, Labor and Pensions Committee.
In other words, it's a huge mess and the people who end up getting squeezed are workers and future generations who will never know what retiring with dignity and security means. They'll just have to stock up on cat and dog food -- and even that may be too expensive.
Of course, I'm exaggerating, but once you expose the magnitude of the catastrophe, it's hard to see how long the PBGC can go without needing taxpayer funds. This just confirms my long-standing views that defined-benefit pensions should be managed by large, well-governed public pension plans, not companies. The government ends up backstopping these DB plans, so why not do it right from the beginning?
The simple answer to my last question is politics. Just look at the reaction Obamacare received. To lower costs significantly, the US should have moved more forcefully to a Canadian-style single payer healthcare system. It's far from perfect but better than what they have now.
The same goes with pensions. Instead of pretending companies can manage pensions in the best interests of employees and taxpayers, or that 401(k)s are the solution, they should adopt a radical rethink to address America's looming retirement crisis.
One way or another, pension losses will be socialized so it's best to introduce meaningful reforms now, bolstering defined-benefit plans for everyone.
Finally, on the question of reform, Doug Whitley, president and CEO of the Illinois Chamber of Commerce, wrote an op-ed for the Southern, Illinois’ last chance at pension reform:
In Washington, the talk has turned from the election to the “fiscal cliff” now facing our nation. We have our own cliff in Illinois, and as our pension debt mounts and our credit ratings plummet we are speeding faster and faster toward the edge.I don't agree with everything Doug Whitley states above as he conveniently ignores the seven truths about public employee pensions.
The legislative session in January will be the time to slam on the brakes.
Pension reform won’t be easy. The debate itself has already generated a great deal of anger. A recent poll by the Chicago Tribune shows that the majority of voters blame politicians, not workers, for the state’s pension fiasco. Their anger is well-placed.
According to a recent report by the Civic Committee of the Commercial Club of Chicago, inadequate state funding caused 44 percent of the growth in unfunded pension liabilities from 1996 to 2011. However, it is important to note that the other 56 percent was caused by a combination of lower-than-expected returns on pension fund investments and changes that affected actuarial assumptions, such as improvements in life expectancies and benefit enhancements.
While we can’t get back those skipped pension payments, we can and should work to address other factors within our control that affect Illinois’ $85 billion unfunded public employee pension liability. Of those, one of the most important is ensuring our state’s retirement systems project realistic rates of return on their investments.
A common misconception is that public employees shoulder the burden of funding public pension systems. In fact, investment income accounts for the majority of Illinois state retirement funding.
For instance, according to the State University Retirement System’s 2011 Annual Report, the average SURS employee who retires after 20 years will get back his “share” of his pension fund within three years of retirement. After that, he receives a combination of the state’s contributions and investment income.
So when pension fund investments do not meet expectations, we get into deep water very quickly. While the nation went through the worst recession in modern history, Illinois’ public pension funds were still projecting healthy returns with their heads firmly in the sand. Those projections continue to remain too high today.
For example, the Illinois Teachers Retirement Fund, the state’s largest public pension fund, just reported a return on investment of only 0.76 percent for this last fiscal year despite an 8.5 percent predicted rate of return. We can’t continue down that path. While TRS recently agreed to lower its rate by 0.5 percent, it remains excessively high.
We need to look to best practices from the private sector and industry experts to gauge a realistic rate of return. The Center for Retirement Research at Boston College uses a 5-percent rate of return when evaluating assets held in pension funds. Others have suggested projecting rate of return numbers based on 15-year Treasury bonds — closer to 3 percent.
Public pension fund administrators have historically projected high rates of return from investments because the higher the promised returns, the lower the amount of taxpayer dollars required to satisfy the employer’s contribution. A more accurate picture is necessary to honestly reflect the solvency of the retirees’ benefit payments.
To achieve real reform the General Assembly must also address the structural flaws within the pension systems. The annual Cost of Living Adjustments must be reined in, future benefits adjusted and early retirement policies reevaluated.
Life expectancies have improved. To keep the systems healthy the retirement age and employee contributions must be increased accordingly. The fact that most public retirees recoup the sum of their pension contributions after only a few years suggest the systems are woefully out of balance.
Our legislators’ refusal to restructure and restrain these costs has saddled Illinois taxpayers with the largest debt obligation of all the states. Illinois is on the brink of fiscal insolvency. The public employee pensions cannot be sustained and must be recalibrated for the sake of the pensioners and taxpayers.
But Whitley is bang on about US public pensions using rosy investment projections to determine their discount rate (still, the 5% or 3% he's proposing is way too low) and how other factors like longevity risk and cost of living adjustment need to addressed in the reforms. Unfortunately, he ignores the most important risk, governance risk.
Below, Lloyd Blankfein, CEO of Goldman Sachs, speaks with CBS News' Scott Pelley on avoiding the fiscal cliff. Blankfein talks about reforming entitlement spending and raising taxes but avoids discussing the pension cliff. Not surprising given that Goldman and other banksters are still hard at work, milking the pension cow.