This has been quietly building into a potential crisis for awhile now – too many companies have been looking to the government handling of Social Security as a role model for how to treat their own pension programs – the government is the end-of-the-line guarantor for these programs, which is scary… [Note: Calling this the “Next S&L Crisis” presumes that Fannie Mae and Freddie Mac don’t have serious problems beforehand…]:
The Next S&L Crisis
November 22, 2004; Page A14
A surprise it wasn’t. Last week the Pension Benefit Guaranty Corporation, the quasi-government agency that insures private pension plans, announced a record deficit of $23.3 billion. A growing deficit has been baked in the cake for the past several years as an increasing number of large companies off-load their pension plans. But the figure itself is now high enough to rivet attention.
Actually, it was large enough last year, too, and the Bush Administration made a sensible stab at pension reform. The idea was a trade-off between granting some short-term relief to underfunded companies and then requiring all companies to put their funding on a sound basis for the long term. But Congress flubbed the challenge and the White House caved in an election year.
The proposal’s immediate boost came in allowing companies to continue using an index of corporate bonds, instead of 30-year Treasuries, to discount pension liabilities. Since rates on corporate bonds are higher than Treasuries, liabilities appear to be lower and funding appears plumper. The long-term fix would have required companies to match discount rates to the terms of liabilities, introduce more transparency in funding and stop underfunded companies from improving pension benefits.
Congress promptly dumped the long-term provisions, voted in the short-term relief and – doubling up on the largesse – gave a special break to seriously underfunded plans like those in the airline and steel industry. This last provision was a truly staggering example of short-term mindlessness. It allowed plans to ignore something called “deficit reduction contributions,” which required companies with under 90% of funding requirements to close the gap over a three-to-seven year period. By permitting these companies to stretch out catch-up payments to up to 30 years, this provision insured that funding shortfalls would grow. Since most of these companies will terminate their plans anyway, it also sticks the PBGC with an additional multi-billion dollar burden.
In other words, Congress and the White House produced a big, fat bailout for the most financially shaky companies, and some of those same companies are now joining the queue to dump their liabilities on the feds. Meanwhile, PBGC’s deficit was left to balloon, as it now has – by $12 billion with 155 company plans terminating.
The agency still has a positive cash flow and can pay the benefits for the 1.1 million workers and retirees who are dependent on it. The cash flow itself is generated by a combination of the premiums paid by companies and income from the agency’s assets of about $40 million. But for every one dollar PBGC takes in premiums, it pays out about three dollars in benefits. Income from assets reduce but do not close that gap. At the current pace of pension plan takeovers, PBGC could run out of money in 16 years.
One popular solution is to raise the premiums paid by companies – which haven’t been increased since 1994 – along with adjusting those premiums for risk. But a premium increase would make it more likely that healthy companies will drop out of the system, and risk-adjusted premiums give those financially fragile companies a strong incentive to terminate their plans.
The big problem is that the agency, by insuring private pension plans, has created its own moral hazard. Essentially, PBGC is writing a put option for which any private plan that is not fully funded is in-the-money; therefore, exercising the put by dumping liabilities onto the PBGC is attractive. Ultimately, of course, the put is written by taxpayers to the tune of tens of billions of dollars.
This slow motion train wreck is almost a perfect re-enactment of the thrift crisis in the 1980s. Back then, the government kept trotting out short-term fixes that deepened the problem until, finally, the thrift industry collapsed, presenting taxpayers with a $200 billion bill. Republicans in Congress are now promising a comprehensive overhaul early next year. They don’t have a moment to spare