Congress will soon vote on a final version of a two-year highway spending bill. Press reports suggest the just-concluded agreement includes a “pension funding stabilization” provision from the Senate version of the bill. This means that any Member of Congress who votes for the final bill will be (a) shafting some future retirees in defined benefit pension plans and (b) increasing the risk of a future taxpayer bailout of a government-run corporation that insures pension plans. Congress can avoid both these bad things simply by removing this provision from the final version of the bill.
In a defined benefit (DB) pension plan firm managers set aside cash now to pay benefits later. The firm then invests that cash and hopes that future cash contributions, plus the investment returns on the assets, will be sufficient to pay these benefit promises in full. It’s a bit tricky to project future pension benefits, but the principal challenge is estimating the rate of return on investing the assets in the pension fund. If a firm manager assumes a high rate of return, then he doesn’t need to set aside a lot of cash now to pay future benefits and he can use that cash for other purposes now.
Of course if the investment returns fall short of his overly optimistic assumptions then the pension plan will be underfunded. There won’t be enough in the plan to pay future benefits. That becomes a huge problem if the firm goes bankrupt. Then the firm hands the plan assets and benefit promises over to a government-run insurance company, the Pension Benefit Guaranty Corporation (PBGC), whose sole purpose is to insure DB pension plans of firms that go bankrupt.
PBGC then takes those (insufficient) pension fund assets and distributes them among the firm’s retirees. Since the plan is underfunded, retirees have to take a “haircut” on their pension benefits. Someone who spent decades of his life working for a firm finds, in retirement, that the pension promise upon which he has relied is now broken.
If the assets are insufficient to pay full benefits, PBGC will fill in the gap in a retiree’s pension promise, but only up to a specified amount (about $56K/year in 2012). Above that the retiree is shafted. That is problem #1. Firm managers benefit while they are underfunding the pension plan. They have more cash on hand to use for other purposes: investing in plant and equipment, hiring workers or paying them more, paying themselves more, or paying dividends to the firm’s owners. Future retirees lose by bearing some of the risk of the firm going bankrupt and then short-changing the promised pension benefits.
Problem #2 is that the PBGC insurance plan for DB plans is also underfunded. Firms with DB pension plans must pay premiums to PBGC, and those premiums are set by statute. These same firm managers and their lobbyists persuade Congress not to raise the premiums, creating the PBGC underfunding problem.
What happens, then, if in the future a firm with a DB plan goes bankrupt, and PBGC doesn’t have the money to fill in the benefit gaps as it is required to do? Current law provides no answer, leaving two possibilities:
- That firm’s retirees with pensions below the cap ($56K today) will not be paid full benefits;
- Or more likely, there will be intense pressure on Congress to bail out PBGC so these retirees’ benefits can be paid by taxpayers.
To their credit, the new highway bill negotiators increased legislated PBGC premiums, but they allowed firms to underfund their plans more. While future retirees bear some of the risk of today’s underfunding, taxpayers bear the rest of it.
Here is how the scam works:
- Some irresponsible firm managers contribute to their DB pension plan the minimum amount required by law, even when their pension plan is underfunded.
- When asked about the underfunding, they say “We’re doing what the law requires,” even though the law does not require them to fully fund the promises they have previously made to their employees.
- Whenever they can, these same firms lobby Congress to increase the investment return they are allowed to assume, making their pension plan look healthier than it actually is and requiring them to contribute less cash.
- If Congress won’t change the allowed investment assumptions, then these firms lobby for legislated “contribution relief” that allows them to reduce or delay the rate at which they contribute cash to reduce their plan’s underfunding.
- They also lobby Congress not to raise the premiums they must pay to PBGC, even though PBGC doesn’t have enough cash on hand to cover its contingencies.
- If (when) one of these firms goes bankrupt, firm managers “dump” the pension plan on PBGC and wash their hands of it.
- Whatever underfunding exists in the plan falls on retirees above the PBGC cap, who see their promised pension benefits cut.
- If (when) someday in the future PBGC doesn’t have enough cash on hand to fill in benefits up to the cap, then firm managers and their retirees will demand a taxpayer bailout from Congress.
- At that point Congress will have to choose between (a) shafting taxpayers and (b) allowing the government to default on its promise to backup the pension promises of these low and moderate-wage retirees (after their former employer has already failed to fulfill their original promise).
Now for the kicker: in many cases the labor leaders who represent the firms’ employees cooperate in this effort. Management and labor leaders team up, both to underfund the DB pension plan and to lobby Congress to allow them to do so. This frees up immediate cash in the firm, which management and labor then wrestle over. When they do this, labor leaders are prioritizing current wages and current benefits over future pension benefits, and at the same time shifting some of the risk associated with paying those future pension benefits to taxpayers.
The firm managers lobby Republicans in Congress and the labor leaders lobby Democrats. “Give us pension funding relief,” they argue. Members of Congress and staff, who are used to management and labor doing battle, are happy to see that at least on this issue they agree. There is then a strong bipartisan push for a legislative “fix” for pension funding “relief” which allows the continued underfunding of both the DB plans and the PBGC to continue.
No one lobbies on behalf of future retirees who face increased risk of having their pension benefits cut when their employer goes bankrupt. No one lobbies on behalf of the taxpayer who faces increased risk of paying for a future PBGC bailout.
The details and justification of the particular proposed legislative change, including the one now in play, are unimportant. This is a world of actuarial assumptions and accounting conventions that is at best complex and at worst obtuse and intentionally obfuscated by those trying to behave irresponsibly. The big picture is always the same: management and labor team up to change the legislated rules to allow the firm to pay less cash now to an underfunded DB pension plan. Future retirees and taxpayers bear the increased risk and cost of Congress allowing irresponsible behavior now by firm managers and labor leaders.
The lobbyists play a clever game depending on the financial environment. When financial markets are performing well they say “Look at what great investment returns we have been getting! Congress should change the law to allow us to assume these great returns continue, meaning our plans are no longer underfunded and we don’t have to contribute any more cash.”
When markets perform poorly, the lobbyists cry poverty. “Our firms are hurting. Yes, our investment returns have been poor, and yes, our pension plan is severely underfunded. But every dollar we put into our underfunded pension plan is a dollar we cannot spend to hire a worker or invest in plant and equipment. Congress should change the law to allow us to contribute less cash to our pension plans in the short run. Then when the economy has come back we’ll have more cash on hand to fill in the underfunding.”
In the past the preferred tactic was to legislatively change the rules for calculating the amount of underfunding. This is legislated lying — firms were allowed to make unreasonable assumptions and falsely show that their plans are not underfunded. Based on these spurious calculations they then had to contribute less cash. It also allowed them to tell their employees, “Based on the government’s rules for calculating pension plan funding, your plan is healthy.”
In 2006 the Bush Administration worked with a few responsible Members of Congress (most notably Speaker Boehner and Senators Baucus and Grassley) to change the law to bring more honest accounting to DB pension plans. We were largely but not completely successful. It is harder to lie about your plan’s underfunding than it used to be.
The pension provision in the Senate version of the highway bill does not change the way pensions are measured. It instead changes the method for calculating the required minimum cash contribution to a pension plan. If this becomes law it will allow those firms with the most underfunded pension plans to contribute even less cash toward closing their funding gaps. Congress will once again be complicit in allowing firm and labor leaders to violate promises made to workers.
Everyone says they hate taxpayer bailouts. The best way to stop taxpayer bailouts is not to block the bailout after the catastrophe has occurred, it’s to avoid creating the catastrophe in the first place. By stripping this provision (which was Section 40312 of the Senate bill) from the final highway bill, Congress can avoid making it easier for irresponsible firm managers and labor leaders to shaft future retirees. They can also avoid increasing the risk of a future taxpayer bailout of PBGC.
Some day in the future firms with defined benefit pension plans will go bankrupt, their retirees will be shafted, and Congress will be pressured to make taxpayers finance a PBGC bailout. Members of Congress will give angry speeches and everyone will ask how this could have happened. The answer will be in part that Members of Congress voted for and the President signed this highway bill containing this “pension funding stabilization provision.”
Congress, you have been warned.