Trouble for federal agency that backs 44 million pensions

Imagine an insurance company that is facing today a deficit of billions of dollars. But its board of directors has not had a meeting since February 2008.

Meet the Pension Benefit Guaranty Corp., a federal agency that takes over underfunded pension funds from bankrupt companies and pays their retirees.

Going into this year, the PBGC was running a deficit of $10.7 billion as the premiums set by Congress and paid by on-going companies were less than the payments to retirees. Then, on Wednesday it said for the first half of 2009, the deficit had ballooned out to $33.5 billion, the largest in PGBC history. Now Congress, who has oversight over the entity, is worried about what might happen if some really large corporation—think auto industry—dumped pension liabilities on the PBGC. Some outside experts can envision a future deficit as high as $100 billion.

“This is going to blow up, it’s just a question of when,” says Douglas Elliott, a fellow at the Brookings Institution in Washington. “This will cost the taxpayers more in the end than AIG.”

On Wednesday, a US Senate committee, the Special Committee on Aging, headed up by Sen. Herb Kohl (D) of Wisconsin, will begin to look at the underpinnings of the PBGC. The provocative title of the hearing: “No Guarantees: As Pension Plans Crumble, Can PBGC Deliver?”

The problems at the PBGC could have larger ramifications. The retirements of some 44 million Americans under 31,000 separate pension plans are covered by the organization. Congress, which sets the benefit and premium levels, may have to make some tough decisions: increase premiums on business during a recession, lower benefits to workers, or ask taxpayers to pick up the difference.

“Legally, the US does not have to pick up the tab,” says one congressional staff member who works on the issue. “But the political pressure would be immense.”

That pressure could ratchet up even more if General Motors were to file for bankruptcy. Mr. Elliott, in a white paper released Wednesday, estimates GM’s pension shortfall is $20 billion.

“Right now, the bulk of that $20 billion will be paid for by the auto workers and retirees,” he says.

But, he adds, it’s not unusual for companies to stop making contributions while still providing benefits. “It’s not unheard of for an additional 20 percent to be underfunded, and almost all of that would fall on the PBGC,” says Elliott. “For the PBGC, the amount it will have to absorb from GM could go from $4 billion to $24 billion without a lot of crazy assumptions.”

The agency itself publishes what it terms “reasonably possible losses.” At the end of fiscal year 2008, the PBGC estimated those at $36.6 billion for the fiscal years 1987 to 2008.

Underfunded pension plans

Part of the problem is that corporations underfund pension commitments. Elliott estimates that the nation’s defined-benefit pension funds – those based on salary level and years of employment – are about 20 percent short of their requirements. The PBGC estimated that total underfunding for ongoing plans amounted to $500 billion at the end of 2006.

If there is any good news, it is the fact that many companies have changed their retirement plans from defined-benefit programs to more unstructured plans such as 401(k)s, which allow workers to save for their retirements with pretax dollars.

“Over the last 20 years, there has been a growth of alternative retirement approaches, both structured and unstructured, of people putting money away,” says Wayne Cutler, managing director at Novantas, a consulting firm for the financial industry. “The majority of retirement assets are controlled by individuals.”

However, he adds, there remains a multitrillion liability in defined-benefit costs, “and there is clearly a gap and PBGC has insufficient assets to support it if there are more bankruptcies.”

One way to narrow the gap would be to raise the premiums paid by participants. But business groups, especially smaller businesses, complain about the added expense. Of the 44 million people covered by the PBGC, 34 million work for small businesses.

“Until recently, the premium was a tax on small and mid-sized business,” says Kevin Kearns, president of the US Business and Industry Council in Washington.

When a big company went bankrupt, such as Bethlehem Steel Corp., the PBGC absorbed its pension shortfall. “The small guys are paying for these big guys,” complains Mr. Kearns.

But now, Kearns says, the problem is spreading to the medium and smaller businesses. He says companies in such areas as metal bending, electronics, heating elements, and anyone in the auto-parts field are preparing for bankruptcy filings.

“Literally, tens of thousands of small businesses are heading the PBGC way,” he says.

Questions about how assets were managed

In the past, the PBGC has managed its assets in a very conservative fashion. About 30 percent is in the stock market, and the rest in bonds, says Brookings’ Elliott. Congress requires the premium income to be invested in liquid Treasury bills.

But last year, the PBGC's then-director, Charles Millard, decided to embark on diversification, teaming up with “strategic partners” Goldman Sachs, Black Rock, and JPMorgan to invest $5.5 billion, or 10 percent of the PBGC’s assets, into real estate and private-equity investments. So far, Acting Director Vince Snowbarger says, no money has exchanged hands.

Mr. Millard, who has been subpoenaed, is expected to be asked about the diversification moves at the hearings Wednesday. The inspector general of the organization has alleged that Millard, who is no longer at the PBGC, improperly influenced the procurement process.

The last time Congress looked at the PBGC was in 2006 in the Pension Protection Act, signed by President Bush. Legislation regarding the organization called for “regular” board meetings. Now, according to a congressional staff member, it might specify a quarterly get-together.