This is an excerpt from a study prepared by Thinking Outside the Boxe. Click here to download the full study.
Just as the Social Security system of the United States faces major long-term financial and stability problems, the private defined benefit pension plans offered by many companies as well as the Pension Benefit Guaranty Corporation (PBGC), the government sponsored safety net for private pension plans, also face significant financial issues. With the PBGC reporting a $23.3 billion deficit for the fiscal year 2004 and an estimated underfunding of roughly $450 billion by the single employer plans that it insures, it should be clear that there is a major crisis looming for the future of defined benefit pension schemes. Though proposals have been made by the Congress, there is still a great risk that defined benefit pension plans and the PBGC may require a government bail out, much like the savings and loan crisis in the early 1990s...
...The PBGC’s total deficit for fiscal year 2004 (ending September 30) was over $23.5 billion, twice the $11.5 billion deficit in the prior year. The total net loss for 2004 was over $12 billion as compared to an $8 billion net loss the previous year.
The PBGC operates a single-employer insurance program and a multiemployer program for defined benefit pension plans. The single-employer insurance program covers pension benefits when an underfunded plan is terminated. This program covers over 34.6 million workers and retirees in 29,600 defined benefit pension plans. The single-employer program experienced a net loss of $12.067 billion in 2004 as compared to a $7.6 billion loss in 2003, resulting in deficits of $23.3 and $11.2, respectively. As of the end of fiscal year 2004, the single-employer program paid benefits to 517,900 participants, up from 458,800 in 2003 and 344,310 in 2002. There were 3,469 plans trusteed or pending trusteeship by PBGC at the end of fiscal year 2004, higher than 3,277 in 2003 and 3,122 in 2002.
A multiemployer plan is a pension that is sponsored by two or more employers who have collective bargaining agreements with one or more unions. Multiemployer plans are common in trucking, retail food, construction, and textiles. The multiemployer program covers the payment of benefits at a guaranteed level when the pension is unable to do so, rather than when a plan is terminated. When the plan is insolvent, the PBGC provides financial assistance to the pension plan rather than assuming the liabilities, as when a plan is terminated. The multiemployer plan currently covers about 9.8 million workers and retirees in 1,600 insured plans. The multiemployer program had net income of $25 million in 2004 compared to a $419 million loss in 2003. The multiemployer program deficit for 2004 was $236 million as compared to $261 million the prior year. There were 320 participants receiving monthly benefits from the PBGC and twenty-seven plans receiving financial assistance at the end of fiscal year 2004, as compared to 390 participants receiving benefits in 2003 and twenty-four plans receiving financial assistance.
It is evident from this, then, that the bulk of the PBGC’s financial problems stems from the single-employer program that covers underfunded plans that have been terminated...
...Though companies such as Exxon Mobil are able to currently service their pension plans with little difficulty, a downturn in the energy markets could precipitate a fall in earnings which could endanger the company’s ability to fund its pension programs. However, companies such as Ford and General Motors are confronted with a more serious situation. GM reported a quarterly loss of over $1.1 billion in the first quarter of 2005, due to falling sales and rapidly rising healthcare costs . With healthcare and pension costs now a larger share of expenses that its steel costs and a downgrade of its credit rating to junk bond status, GM could have difficulties raising funding in the future and meeting its pension plan obligations.
United Airlines’ transfer of $6.6 billion in pension liabilities to the PBGC in April 2005 was the largest transfer of liabilities in the PBGC’s history, significantly higher than the $3.6 billion claim by Bethlehem Steel in 2002 . As a result of the termination of four of its pension plans and the assumption of the liabilities by the PBGC, United agreed to issue the PBGC $500 million in senior subordinated notes, $500 million in convertible notes, and up to $500 million payable in eight tranches of notes to be issued after 2008 if the reorganized United meets performance targets. This could result in the PBGC becoming the largest shareholder in the reorganized United, once it emerges from bankruptcy.
The PBGC also owns an equity stake in US Airways, which it received after the airline terminated its pilots’ pension plan, and is the airline’s largest unsecured creditor The PBGC also assumed $2.3 billion in liabilities from US Airways in April.
Shifting pension plan obligations to the PBGC likely gives those companies (such as United and US Airways) a competitive advantage over other companies in the industry that may still be burdened by their own pensions. As a result, these companies (such as Delta and Northwest) may also be tempted to pass on their pension obligations to the PBGC in order to become more competitive. Though this may help the companies in the industry, the ripple effect of their actions would only compound the financial instability of the PBGC.
The Congress has been examining this issue in light of the potential bankruptcy filing of Delta Airlines and Northwest, both of which face competitive disadvantages stemming from their pension plan obligations. A bill in the Senate proposes allowing airlines, which have suffered from higher fuel costs and soaring pension obligations, to stretch payments for underfunded pensions over the next fourteen years (as opposed to the twenty-five year time frame originally proposed by Senator Johnny Isakson and Senator John D. Rockefeller).
As the corporate pension issue has escalated, those U.S. companies that have been able to do so have increased the average funding level to 88% in 2004 from 84% in previous years. However, Towers Perrin, an independent consultant, estimates that the deferred cost for the largest eighty-one defined benefit pension plans in the U.S. increased to $252 billion. In addition, the average Fortune 100 company has more than $3 billion in deferred pension costs that may have an adverse impact upon future financial performance . These factors, combined with the increase in pension obligations each year, could create significant financial strains on companies in the future as they seek to fund their pension obligations. As these reductions from future earnings begin to materialize, this could have an adverse impact upon the share prices of those companies, which could, in turn, erode much of the net wealth that has accrued to American investors in the equity markets.
In addition to the mounting pension problems, Americans have been saving less of their disposable income, choosing consumption that fuels the economy instead. Since 1974, the savings rate has fallen from roughly 10% of disposable to less than 1% of disposable income in 2004, with Americans saving roughly $0.40 per every $100 of disposable income. As a percent of nominal GDP, the United States ranks towards the bottom of industrial countries with respect to savings: Gross national savings as a percent of nominal GDP is over 25% in Japan, over 20% in Canada, France, and Germany, and nearly 20% in Italy. The United States and United Kingdom rank at the bottom at just under 15% gross national savings as a percent of nominal GDP. This low savings rate places many Americans in jeopardy should their pensions be reduced upon retirement as a result of underfunding or termination of the plan.
However, despite the low savings rate, Americans have benefited significantly from the gains in real estate and stock portfolios, which have added over $9,400 billion in household wealth over the last two years. Net wealth is now 550% of annual disposable income, well above the 478% average since 1952 . This may seem to mitigate the need for increased savings, but capital gains are not actual gains until the real or financial asset is sold. As many investors learned, quite painfully, in the late 1990s and early 2000s, paper capital gains can be quickly eroded by a market turndown in equities. The current low level of savings in the U.S. could become a serious problem should a market downturn in equities or real estate erode the wealth created over the last several years—wealth that many Americans may be counting upon to supplement their retirement.
It should be clear, then, that corporate America faces a great number of challenges with respect to defined benefit pension obligations. This situation is much the same as that confronted by the United States government in dealing with the long-term solvency of the Social Security system. As pension obligations continue to rise, many companies may be tempted to offload their pension obligations onto the PBGC, further compromising this institution’s already weak financial condition. Clearly, these pension obligations are the responsibility of the companies that originated the plans; they are not the long-term responsibility of the PBGC, the United States government, or the taxpayers.
Pension reform must be undertaken to ensure the long-term sustainability of both the PBGC and the corporate pension system. Private pension reform is not the responsibility of the taxpayers; it is the responsibility of the company that commits to the pension obligations. Any reform must ensure that workers are protected as much as reasonably and economically possible whilst also placing the burden of fixing the defined benefit pension problem upon the companies that have made these promises to their workers...
...Based on our assessment of the pension situation, Thinking Outside the Boxe believes that any pension reform plan should place responsibility for funding defined benefit pensions plans upon the companies that have such plans. Furthermore, companies should be encouraged to have fully funded plans by penalizing those firms whose plans are underfunded. Therefore, Thinking Outside the Boxe proposes the following options for a pension reform plan:
• Risk-based Premium System—A risk-based system of premiums payable to the PBGC. As the level of underfunding increases, the premium increases substantially. This should provide an incentive to fully fund the corporate pension plan.
• Discount Rate Standard—A standard discount rate should be used across the board in calculating the pension obligations of private defined benefit pension plans.
• Mark-to-Market Standard for Assets—A mark-to-market standard for valuing pension plan assets provides a more conservative method of determining a plan’s under/overfunding. Moving away from assumptions regarding the plans’ future returns prevents distortions from aggressive accounting assumptions and may provide a clearer picture of the plans’ funding status.
• Minimum Funding Requirements—A minimum level of funding requirements for a defined benefit pension plan should ensure solvency of the plan for the long-term.
• Tax Free Contributions to Pension Plans—A company’s contributions to its defined benefit pension plan should be tax deductible to provide management with an incentive to fully fund their plans...
...There can be little doubt based on the PBGC’s annual report that the financial future of the government sponsored safety net for private defined benefit pension plans is clearly in jeopardy. As the system currently stands, companies are, in many cases, able to achieve competitive advantages by shifting their pension plan obligations to the PBGC through bankruptcy. This places a strain not only on the PBGC but upon other companies as well, encouraging those with the competitive disadvantage to push their own pension liabilities onto the PBGC (as in the case of the airline industry).
In the absence of reform to the PBGC, which should include a more risk-based approach to insurance premiums, the private defined benefit pension system in the United States threatens to strain the finances of the PBGC and may require a government sponsored bailout. Thinking Outside the Boxe has repeatedly stated that honouring the promises of the defined benefit pension plan is the full responsibility of the company that makes those promises. Thinking Outside the Boxe’s proposals for pension plan reform are focused on encouraging companies to maintain fully funded plans, thus providing for the long-term viability of the PBGC, and ensuring the financial stability of the PBGC as well as their own pension plans.
See www.thinkingoutsidetheboxe.com for the full study on this important issue.
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