More urgent than fixing social security, is preventing the bankruptcy of the Pension Benefit Guaranty Corp (PBGC). The US Congress thinks so and is willing to discuss new legislation - the pension protection act (PPA) - to avoid a public bailout of private pension funds that could dwarf the $200bn (e164.5bn) saving-and-loan disaster of the 1980s.
According to a report by the same PBGC, the combined deficit of the 1,108 weakest defined benefit (DB) pension plans with unfunded liabilities in excess of $50m each, reached a record $353.7bn in 2004, up 27% on the previous year. In 2000 there were only 221 severely underfunded plans with a total $19.91bn deficit. In five years the funded ratio of the troubled plans has dropped from 83% to 69%.
And according to a report by Merrill Lynch analyst Gordon Latter, the current situation is likely to be even worse because, last September, when PBGC elaborated its data, “the combination of poor asset performance and a further 80 basis point flattening in the yield curve would increase this estimated deficit to $500bn and drop the funded ratio to 62%”.
DB plans are sponsored by companies: the weaker the company, the likelier it is to operate a pension fund that is also weak, explains a study recently published by the government accountability office. In the end, if a company has to be liquidated, its pension plan is turned over to the PBGC, which is a quasi-governmental agency created in 1974 after some high-profile auto industry bankruptcies left retirees without pensions. In fact the agency’s mission is to guarantee DB plans up to a point. It currently administers about 3,500 plans with one million participants.
A company can also ask a bankruptcy court to turn over its plan to the agency in order not to be shut down. That was the case with United Airlines (UA), which obtained the bankruptcy court’s permission to default on four underfunded pension plans and give $6.6bn liabilities to PBGC.
The UA was a wake-up call, according to PBGC executive director Bradley Belt. “We have to have tougher funding rules, we need more transparency in the system, and we need to address risk in a more meaningful way,” he said. In fact, the question is what happens if other major airlines ask for the same provision in order to be competitive? And what if other troubled sectors, primarily the automotive industry, tried to get rid of their pension promises?
At the end of 2004 the pension agency was already $23.3bn in the red, double the previous year’s gap. If the PBGC has to take over more DB plans at the current pace the deficit will likely more than triple to $71bn in the next decade, according to the
congressional budget office. Eventually the PBGC itself would need to be rescued, because US taxpayers will be the insurer of last resort.
To prevent this, the PPA has been introduced by republicans John Boehner and Bill Thomas in an attempt to close current loopholes in the system.
First, under the new rules a DB plan would not be allowed to run deficits for a long time and skip contributions even though the funding status was well below 100%. Plans would be required to fund to a target of 100% of liabilities, discounted with a bond yield curve based on a three-year weighted average of investment-grade corporate bond interest rates. The shortfall between current liabilities and assets would be amortised over seven years. The bill would also gradually raise the premium the companies pay to the PBGC to $30 per employee per year from $19.
Companies whose pension plans were less than 80% funded and were at risk for default would see their premiums step up to $30 from $19 over three years; the others would see their premiums increase more slowly over five years. Employers and labour unions would be prohibited from negotiating increased benefits to employees or paying lump sum distributions to employees if their plans were less than 80% funded.
“Although the bill does an adequate job of providing incentives (disincentives) to maintain funded (unfunded) plans, in its present form it will likely do little to change investment behaviour,” Latter wrote in a report. “The bill is watered down from its original form, as a result of tremendous pressure from both labour and business.”
The bill has already been commended by the ERISA Industry Committee (ERIC), a trade association that represents the retirement plans of the largest employers in the US. “It avoids some of the worst pitfalls proposed in the original administration approach,” said Janice Gregory, ERIC’s senior vice-president.

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