The pension problem

October 13, 2005|By MICHAEL J. RILEY

The future of thousands of traditional corporate retirement plans of 44 million workers and retirees is at financial risk. The entire system of 31,000 private-sector "defined benefit" plans that pay a fixed percentage of final salary as retirement pay and are insured by the government is in trouble.

The federal government's pension insurance agency took over bankrupt United Airlines' huge pilot pension plan months ago. Before that, the government assumed the pension plans of other bankrupt airlines and steel companies. Now, as part of their recent bankruptcy filings, Delta and Northwest airlines could be the next to default on their large underfunded pensions and dump them on the federal Pension Benefit Guaranty Corp. (PBGC).

This is bad enough, but in addition to airlines, many other large manufacturing companies have significantly underfunded pension plans, totaling $354 billion, according to a June PBGC report - up 27 percent from a year earlier. Their assets covered only about 69 percent of their liabilities. Those plans are at risk, too, because of the underfunding.

Not only that, but the PBGC itself is in big financial trouble because of footing too many bills for bankrupt corporations. It had a deficit in fiscal 2004 of $23 billion, and that is without the United Airlines bailout. Workers and retirees of some insured plans might not get all their pension even if the PBGC takes over a plan.

The PBGC pays up to a certain amount of a pension as set by law, a maximum of $45,614 a year at age 65 and well below that at early retirement. Also, the worse the PBGC's own financial problems, the less it might be able to take over other troubled plans.

Even if you don't have a private defined-benefit pension, you should be concerned. Taxpayers might have to pick up the tab if the situation isn't reformed.

One cause of all of this is the poorly performing stock market and the slow economy of recent years, with the end of the high stock returns of the go-go '90s hurting many plans' investments. In addition, premiums charged by the PBGC haven't been high enough to cover payouts by the agency.

Also, many companies didn't put much cash into their pension plans, using various legal accounting gimmicks instead. One problem is that the IRS limits the amount of cash that can be put into pensions without paying a penalty.

There are various bills in Congress poking at the situation, mainly by stretching out airline pension funding over many years. The Bush administration has a proposal that chiefly would increase PBGC's premiums. Neither would solve the underlying problems.

Congress needs to revamp the whole system.

PBGC insurance premium increases large enough to solve the agency's financial gap aren't politically or economically feasible. Modest further premium increases as proposed by the Bush administration are needed and would help in the short run, but that is not enough.

The major problem is that current rules are loose in requiring cash contributions by companies to pension plans. Many, not just troubled airlines, don't make them and substitute accounting credits instead, thus the massive underfunding. From 1995 to 2002, according to the Government Accountability Office, each year, on average, 62.5 percent of sponsors of the 100 largest pension plans made no annual cash contributions to their plans.

Each company should be mandated to put aside significant cash for each pension each year - perhaps 3 percent of wages and salary. Rapidly growing companies with generous plans could be allowed to put aside up to 20 percent if they want. The IRS' harmful rules limiting cash put into pensions should be ended. Congress should put a hefty extra tax on companies that put in no cash or too little cash.

The main long-term solution, though, would be to encourage companies to move to defined-contribution plans such as 401(k) plans. Such plans are often preferred by employees, who appreciate the ownership and control and that the plans can produce more for them. The government should encourage such a switch. PBGC premium increases would help spur that.

Dramatically increasing 401(k) contribution limits also would help, as would requiring that top executives and workers be in the same plan for their entire retirement savings.

These reforms would help avoid future massive assumptions of underfunded pension promises by the government and an eventual taxpayer bailout. They also would give workers and retirees security and more control and responsibility over their pension investments.

Michael J. Riley, a former chief financial officer of the U.S. Postal Service, is assistant dean of business and management studies at the University of Maryland, University College in Adelphi.

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