The Demise of the Pension Benefit Guaranty Corporation

The Pension Benefit Guaranty Corporation was created by the government in 1974 with the passage of the Employment Retirement Income Security Act. The corporation’s responsibility is to insure corporate-based pension plans (not to be confused with employee controlled 401(k) plans, which are not insured) so that, should a company fail or neglect to fully fund an employee’s pension, he or she can still retire with benefits intact.

Unfortunately, the economic turmoil of the last three years and a series of bankruptcies in key industries throughout the 1990s, has upset the financial stability of single-employer pension programs within the PBGC. Late last month, a member of the board of directors for the PBGC, secretary of labor Elaine Chao, indicated that the PBGC’s future was at risk.

The steel industry is the immediate cause of PBGC’s financial instability. As a result of the bankruptcy and consolidation of three major steel corporations in less than two years, PBGC has been saddled with some severely underfunded pension plans. National Steel, which went bankrupt in 2003, was only 54 percent funded and has a $1.3 billion claim; LTV Steel (bankrupt 2002) was only 50 percent funded and has a $1.9 billion claim; finally Bethlehem Steel, the last of the three to fail, was only 48 percent funded and has a $3.9 billion claim—the largest in the PBGC’s history.

The bankruptcies throughout the steel industry are rooted in the “1998 import crisis” during which such countries as Russia, Brazil and Japan were accused of violating U.S. trade laws by dumping steel on U.S. markets. The cheap imports fed the United State’s demand for steel during this time, while U.S. steel corporations sat on the sidelines with uncompetitive prices. A second round of bankruptcies that struck the steel industry in 2001 prompted the U.S. government to issue a series of tariffs to protect U.S. steel in March 2002. Despite these efforts, however, bankruptcies in the industry have continued into 2003.  

In addition to the flagging steel industry, the automotive and airline industries have also been a burden on the PBGC. In a speech given this past April, Steven Kandarian, the executive director of the PBGC, noted that “because PBGC has now absorbed most of the steel plans, the airline and automotive sectors represent our biggest exposure.” The airline industry has $26 billion of pension underfunding and automotive sector underfunding exceeds $60 billion. Largely due to these failures, the single-employer program defined benefit system lost $11.3 billion during the 2002 fiscal year, and achieved a $3.6 billion deficit, according to the PBGC.

While these statistics illustrate the disproportionate burden the steel, automotive, and airline industries are placing on the PBGC, they by no means imply that underfunded pension plans are only associated with these industries. A 2002 Watson Wyatt study concludes that only 37 percent of corporations had fully funded pensions. This is a significant drop from the 84 percent that were fully funded in 1998.

To some extent, the unnerving drop is the result of poor accounting. Many companies promised employees higher pension benefits instead of higher wages, even though many did not have fully-funded pension plans. This allowed them to put off financial obligations. 

Other factors also contributed to the pension problem. Most employers also invested their employee’s money in the stock market. And people are living longer, and making good use of their benefit packages.

There are potential solutions to the problem, but they are unlikely to be undertaken. A government bail out will not necessarily occur because the PBGC is not funded by federal tax dollars. The bulk of its assets result from premiums, investments, and the confiscation of assets associated with the pension plans it takes over. While the PBGC is capable of borrowing $100 million from the Treasury, it is not entitled to keep those funds. 

Likewise, the PBGC is not going to ask Congress to increase premiums to fund its pension plans. If premiums are raised too high, corporations with well-funded pension plans will feel burdened and see fewer incentives to purchase pension insurance. The only companies buying insurance might be those with underfunded plans.

Kandarian has pointed out that many pension plans have lax requirements regarding employer contributions because projections of future liabilities are overly optimistic.  He stressed the need to permanently replace the 30-year treasury rate with a more accurate gauge of future pension liabilities.  In his speech he warned against adopting a “smoothed long-term bond rate for the thirty-year treasury rate” because this would “allow plan funding to fall below the already low levels permitted under the current law.” 

On a similar note, at the end of July, Peter Fisher, a treasury official, spoke out against smoothing when calculating future pension liabilities, and suggested that, when predicting future liabilities, the economic climate of the previous ninety days should be taken into account—not the previous four years as the smoothing method proposes. 

In addition to projecting more realistic pension liabilities, it also seems likely that Kandarian will urge employers to invest more conservatively in bonds, instead of in the stock market. If he does suggest this, it will mark a dramatic shift in the investment policies of pension planning. During the 1990s, when the stock market was doing well, such a suggestion would have been laughed at. In these more troubled times it seems like sound advice.

Gregg Raho is an editorial intern at Risk Management Magazine.