Retirement-plan crisis means bailout of PBGC, though years away, is likely
When the agency that insures traditional pension plans is running a $33.5 billion deficit -- the largest in its 35-year history -- should you be worried? If you're a worker or retiree counting on a traditional pension, the answer is probably not. But if you're a taxpayer, start worrying.
Though it will likely take years, it's all but inevitable that at some point the Pension Benefit Guaranty Corp., the agency responsible for guaranteeing pension benefits for some 44 million Americans, will need to either cut those benefits or raise a lot of cash, experts say.
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Given that slashing payouts to older people is considered political suicide, the likely scenario is that the U.S. government will pony up funds to shore the agency's finances.
Pensioners "don't have to worry," said Douglas Elliott, an author of numerous studies on the PBGC and a fellow at the Brookings Institution, a Washington-based public-policy think tank.
"The taxpayer has to worry. There is no way politically that Congress would let the PBGC fail to send checks to Grandma and Grandpa. Just like they rescued the savings-and-loans years ago without the legal obligation to do it, just like they rescued a number of banks without the legal obligation to do it, they'll do the same thing with the PBGC if necessary," Elliott said.
Still, even if the weak economy gets worse before it gets better, and even if more companies with underfunded pension plans go belly up, the PBGC has years before its liabilities become an issue.
"Even in an Armageddon scenario, we've got 10 or 15 years," Elliott said. "Even a badly funded pension plan that gets taken over usually has enough money to pay its claims for 10 to 15 years. The problem is it needs to keep paying for 60 years."
So far this fiscal year, which ends Sept. 30, PBGC has taken on 94 pension plans, up from 74 in fiscal 2008 as the big pension plans of failed auto-industry firms join those of airlines and steel companies on the long list of takeovers.
A Decade of Large Pension Failures
Currently, the PBGC doesn't receive tax revenues; instead, it's funded by company premiums and investment returns, plus it collects the remaining and often substantial assets of any pension plans it takes over. But after already taking on nine of its top 10 largest claims since 2001 -- the largest claim ever, in 2005, consisted of four United Airlines' pension plans with a total cost to the agency of $7.2 billion -- the current economic downturn has knocked out another swath of companies with traditional pension plans.
Those failures -- most notably in the auto-supply industry -- have helped triple PBGC's deficit to $33.5 billion from $11 billion in just the six months from September 2008 through March 2009. Delphi, the nation's largest auto-parts maker (it spun off from General Motors in 1999), entered bankruptcy four years ago. This July, the PBGC took over its pension plans, at a cost to the agency of about $6.2 billion.
All told, about $11 billion of the PBGC's higher deficit in recent months is from actual or expected plan terminations. Another $7 billion is from a drop in the interest rates used to calculate how much the agency owes beneficiaries over time. (Lower interest rates push higher the figure for future outlays.) Investment losses drove $3 billion of the deficit.
The agency has been on the congressional hot seat this year since it came to light that former director Charles Millard in 2008 aimed to shift the agency's assets more heavily into stocks and alternative investments. The agency has since put that investment policy on hold. In April, the PBGC's portfolio consisted of about 30% equities, 68% fixed-income securities and 1.5% alternative investments.
More Like Social Security Than FDIC
The PBGC resembles the Federal Deposit Insurance Corp., another quasi-government agency that's facing financial straits and relies on company premiums to protect regular people -- bank customers in the FDIC's case. The FDIC may need a cash infusion sooner rather than later, given the high number of bank failures recently and the fact that the FDIC must pay out cash to depositors almost immediately.
The PBGC has decades before its liabilities become due.
"There's a point where the Social Security fund starts to run out of money if they don't change anything. That's a similar analogy to the PBGC," said David Kudla, chief executive of Mainstay Capital Management LLC, an investment advisory firm that often works in the auto industry. "At some point, they either need to charge higher premiums or reduce benefits to current beneficiaries or have a capital infusion from the U.S. government," he said. "The third [option] is probably the most likely."
The fortunes of the PBGC rise and fall in concert with the broader economy: When it hits a rough spot and company bankruptcies increase, the pension agency is forced to take over more retirement plans. And as companies start failing, their pension plans usually worsen.
Companies' pension-fund deficits "get worse, sometimes dramatically worse, in the last year or two before they go bankrupt," Elliott said. Companies may stop paying into the plan, shift assets into riskier investments, or, as in the case of United Airlines, promise larger pension benefits to some workers in exchange for pay freezes.
By the time the PBGC steps in, the promised benefits of a plan usually far exceed its funds. Of course, the PBGC doesn't always pay what the company has promised.
The maximum PBGC benefit payout for a 65-year-old is $54,000 in 2009 (the maximum generally changes annually). That should be of particular concern to auto workers. PBGC estimates that it guarantees just $42 billion of the $77 billion in unfunded pension liabilities at auto-industry companies.
"Participants in auto-sector pension plans and the other stakeholders of the pension insurance program are at substantial risk of loss if these plans are terminated," said Vincent Snowbarger, the PBGC's acting director, in testimony to lawmakers in May.
Meanwhile, the fate of GM and other carmakers looms on PBGC's horizon. Despite some positive economic news of late, it's too soon to tell whether the carmakers are completely out of the woods. GM's pension plan performed better than many through the downturn, but was still underfunded by $20 billion according to PBGC estimates in November.
Still, even if the PBGC were to take on that plan, it could help the agency in the short term. "Ironically, if they were to take over some big pension plan like GM's, it could conceivably be a little longer" before a bailout becomes necessary, Elliott said. "It can turn into something like a Ponzi scheme. They take on more obligations than they can meet, but they get a bunch of cash up front because they take over the assets of the pension plans that are underfunded."
Meanwhile, PBGC's balance sheet will get a more certain boost when interest rates rise again, because higher rates reduce what the agency must set aside to cover future liabilities.
"You end up with a history of the PBGC's deficit bouncing up and down fairly wildly based on what happens to the markets and to the economy," said Dallas Salisbury, president of the Employee Benefit Research Institute, a Washington-based nonprofit group.
"If interest rates go down then suddenly you have a bigger liability. If rates go up then your liability magically shrinks," said Salisbury, who was an assistant to the PBGC's executive director in the late 1970s.
Also, some note the PBGC is on better financial footing than its looming deficit indicates because the agency's method for calculating its liabilities may overstate its obligations.
"They do a survey of insurance companies to get the prices of group annuity contracts. Those are generally pretty low rates, so that increases liability," said Mark Warshawsky, director of retirement research at consulting firm Watson Wyatt, and former assistant secretary for economic policy in the Treasury Department.
A Bigger Board of Directors?
Even as the agency faces its largest-ever deficit, some in Congress are calling for a change to the agency's governance structure. The agency's three-member board is comprised of three Cabinet-level appointees, the heads of busy departments -- Treasury, Commerce and Labor. That's cause for worry, according to a recent GAO report.
"It's very difficult for a three-member board that has so many other responsibilities to provide the kind of attention to the corporation that it really needs," said Barbara Bovbjerg, director of education, workforce and income security issues at the GAO. The GAO recommends a larger board that doesn't turn over when a new administration comes into office.
"Governance isn't going to be the answer to PBGC's financial problems, but they face so many challenges that it's really a necessary ingredient of managing the challenges that they have," Bovbjerg said. Senator Herb Kohl, D-Wis., and others introduced a bill in July to change the agency's oversight structure.
Still, a PBGC spokesman and others noted that each board member has a representative who works full time on PBGC issues.
Retirees: What's Next?
Given the upheaval at companies that offer traditional pensions, people who expect a pension should monitor their company's financial health, Kudla said. It's prudent to assess how a PBGC takeover might affect your future payments, he said.
Kudla suggests some people might do better taking a lump-sum distribution from their company before that happens -- if that option is available. He also suggests keeping an eye on the PBGC maximum. If your expected pension is at or below the maximum, a PBGC takeover should not change your benefits.
If taxpayers do eventually bail out the PBGC, it could be a bitter pill for some of them. "You would be getting a bailout from taxpayers who never had a defined-benefit plan," Bovbjerg said. "If you have a 401(k), you don't have guarantees like that," she said.
"It's easier to talk about funding rules and the PBGC than to bring up the broader issue of secure retirement. But really that's what is fundamentally at issue. What are Americans going to live on in their old age?"
Andrea Coombes is an assistant personal finance editor for MarketWatch, based in San Francisco.