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The Future of Pension Plans

February 05, 2015

The future of pension plans and the governance and financial challenges facing the Pension Benefit Guaranty Corp (PBGC) are not issues that many people are aware of. Before I began my summer internship at the Ways and Means Committee, I had never heard of the PBGC and had only a theoretical understanding of pension plans as liabilities from my Wharton finance classes. However, as I read and discussed pension liability valuation and the PBGC’s financial position with policy experts, I realized how important the issue of pension underfunding is. It is necessary the government works to safeguard pension benefits so the PBGC is not the next government agency to be the recipient of a bailout. 

By Katherine Baker, W’16

In 1974, the Employee Retirement Income Security Act (ERISA) was passed to govern private-sector retirement and health plans. ERISA established new requirements for private sector defined benefit pension plans and established the PBGC as a federal corporation.[1] Within the PBGC, there are two insurance programs, single-employer and multiemployer, that safeguard retirement benefits. For many years, single-employer plans were the focus of attention because their total underfunding was much greater and some very large plans had been terminated, whereas only a few multiemployer plans had failed.[2] However, in recent years, the situation reversed and the position of multiemployer plans deteriorated quickly.

On June 30, 2014, the PBGC released its’ FY 2013 Projections Report. The report assessed the financial condition for the coming decade of the single-employer and multiemployer programs. The report highlights significant improvement in the single-employer program, shrinking the projected deficit in FY 2023 to $7.6 billion from last year’s projected deficit of $32.5 billion in FY 2022.[3] Despite substantial economic and market gains, the PBGC estimates that the deficit for the multiemployer program will widen to almost $50 billion by 2023 from less than $9 billion in 2013. Both the PBGC and the Congressional Budget Office project the multiemployer fund will run out of money by 2021.[4] Thus, the question is: how did this current situation come about and how can it be fixed?

PBGC's Deficit Continues to Worsen 

The problem with pension trusts is they continue to have assets that are sizably below the value of their liabilities. These unfunded liabilities create a risk for the employee that the sponsoring employer may go bankrupt and therefore would be unable to fulfill its obligation. The PBGC was created to protect employees and retirees from the risk of losing pension benefits as a result of such bankruptcies. When a firm goes bankrupt and cannot meet its future pension obligations, PBGC assumes control of the pension trust’s investment assets and takes over responsibility for the delivery of promised benefits.[5] As an insurer, PBGC relies on premiums and on investment income to meet the net costs of claims from bankrupt companies.[6] Unlike most insurers, however, PBCG does not set its own premium rates. Although it has frequently asked Congress for the right to do so, Congress instead has retained the power to set premium rates by amending ERISA from time to time as it chooses.[7]

In the early 2000s, PBGC faced severe financial difficulties, leading Congress to pass the Pension Protection Act of 2006. The Act strengthened funding requirements for most existing pension plans and also raised premiums for plan sponsors with underfunded or newly terminated plans.[8] Since 2006, Congress has continually raised PBGC’s premiums, but still they remain too low to fund the PBGC’s obligations. As stated in Forbes, “its premiums are woefully inadequate to cover its payouts because they are set by politicians in Congress…this undermines the very purpose of premiums: pricing risk, as determined by market signals. Moreover, the politicized premium-setting regime practically guarantees that premiums will tend to be too low.“[9] Thus, one of the solutions to the deficit problem is Congress could fundamentally reform how the PBGC sets premiums.

PBGC's Premiums Don't Cover The Benefits We Pay

Alternatively, employers could change or cut benefits and accordingly, reduce the expected deficit. One way to do this is to replace the defined benefit pensions that PBGC supports. A defined benefit plan pays out a fixed amount, regardless of the value of the pension fund. Thus, a more stable solution is to switch to defined contribution plans. In a defined contribution plan, investment risk and underfunding risk have been off-loaded to employees. In a defined benefit plan, the plan sponsor or employer owns the risk – that is, the employer ‘owns’ the surplus or the deficit in plan assets over plan liabilities.[10] Today, most defined benefit plans are underfunded due to historically low interest rates, which cause plan liabilities to increase. Employers who keep these underfunded defined benefit plans must then make up the deficits. Additionally, employers could cut promised benefits so as to reduce their current liabilities. This would not be a favorable solution for employees.

PBGC’s massive, mounting deficit makes it a very likely target for a federal bailout. The question is, however, whether taxpayers should have to bail out the PBGC, even though most taxpayers do not have pensions, or should Congress let the PBGC go bankrupt, cutting off the pensions of millions depending on the money for retirement?[11] If Congress does not find a solution through premium or benefits reform sooner rather than later, policy makers will have to answer that question and face a difficult decision.

[1]  “Basics of the Pension Benefit Guaranty Corporation (PBGC).” Employee Benefit Research Institution. http://www.ebri.org/pdf/publications/facts/0107fact.pdf

[2]  “PBGC Annual Report 2013.” Pension Benefit Guaranty Corporation.http://www.pbgc.gov/documents/2013-annual-report.pdf

[3]  “PBGC Report Shows Improvement in Single-Employer Plans, but Underscores Increased Risks to Some Multiemployer Plans.” Pension Benefit Guaranty Corporation. http://www.pbgc.gov/news/press/releases/pr14-08.html?CID=CPAD07ACJUN3020141

[4]  “Keeping the PBGC from being the next bailout recipient.” Pensions & Investments. http://www.pionline.com/article/20140804/PRINT/308049999/keeping-the-pbgc-from-being-the-next-bailout-recipient

[5]  “A review of the Pension Benefit Guaranty Corporation Pension Insurance Modeling System.” Brookings. http://www.brookings.edu/~/media/research/files/papers/2013/09/11%20pension%20benefit%20guaranty%20elliott/pbgc%20review%20brown%20elliott%20gordon%20hammond%20final%2009112013.pdf

[6] Id.

[7] Id.

[8] Id. 

[9]  “The Pension Benefit Guaranty Corporation’s Real Crisis.” Forbes. http://www.forbes.com/sites/realspin/2012/02/22/the-pension-benefit-guaranty-corporations-real-crisis/

[10]  “The future of defined benefit plans will change dramatically – for the better.” Pentegra Retirement Services. http://www.pentegra.com/media/27742/the%20future%20of%20defined%20benefit%20plans-single%20employer%20version%20draft1%20(2).pdf

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