Underfunded Pensions and Super Recession Will Stall US Go-Go Kids

Mar 8, 2010
Howard Bryan Bonham

Writing in the “Washington Post” of May 7, 2009, David Ignatius called it the “ultimate generational bummer.”

First they are facing retirement years woefully underfunded, using annuities most will purchase when they cash in their investment accounts. A cruel corollary is that sucking so much money out of the stock market impairs chances of a long bull rally for stock they continue to own.

The second whammy is those who decide to work post retirement are caught in a recession, second in length so far to the Great Depression of the 1930s.

Even more sobering is the broader picture that Ignatius suggests; only half of Americans can lay claim to a pension plan of any kind, either defined-benefit or defined-contribution.

Financial Condition of PBGC Mirrors Boomer Troubles

Probably no picture reflects how serious the Boomer situation is as clearly as the financial trends lately posted by the Pension Benefit Guaranty Corporation (PBGC).

PBGC is a federal corporation created under the Employees Retirement Income Security Act (ERISA) of 1974. It could be called an employee’s ultimate financial umbrella, a cover for that rainy day when an employer sponsoring a defined-benefit retirement plan becomes insolvent, and can no longer contribute to the retirement of its work force.

That has been happening a lot lately. When it does occur, PBGC takes over the pension plan as a trustee, by sponsoring a modified plan as a manager. The employee, or new employer, then pays premiums to PBGC in exchange for providing the amended plan as a financial nest egg at retirement.

Private Traditional Defined-Benefit Pensions Are Disappearing

However, the benefits are not nearly as grand, in most cases, as were the original emoluments. That is because premium costs and benefits in the reconstituted plan include only the “basic benefits” of the defunct plan. Benefits like health, dental and vacation pay are excluded.

The federal guarantee program is funded by assessments collected from corporate sponsors of defined-benefit plans. And therein lays the catch-22, for as hard times force bankruptcies of companies with plans, and PBGC steps into the breach, taxpayer dollars are likely to be requested for the plans in trust.

The attrition rate for traditional pension plans is staggering. In 1980 there were nearly 100,000 single-employer defined contribution plans in effect. By the mid-1980s, the number peaked at 120,000 as ERISA accelerated to full gear in popularizing reliable pensions.

Rising Costs and Business Failures Reduced Defined-Benefit Plans

But within a few years, rising retirement costs triggered defections by employer sponsors out of defined-benefit plans. Many converted to cheaper defined-contribution plans, not covered by PBGC, or dropped plans altogether. That and ensuing business failures decimated the number of defined-benefit plans in effect to slightly over 20,000 in 2008 – a plunge of 83 percent!

Of course, many of the disappearing plans were victims of corporate business failures. By the end of fiscal 2009, PBGC had paid $4.5 billion in benefits to 744,000 retirees in 3,399 assumed plans.

In 2009 the federal insurer of last resort lost $10.3 billion. The loss was its fifth since 2000. Its net position of -$21.1 billion – a deficit 96% greater than in 2008 – was the eighth consecutive position deficit. A position deficit occurs when the present value of future benefits (PVFB) owed exceeds total assets.

New Director of PBGC Has Major Issues to Settle

Joshua Gotbaum, President Obama’s choice for Director of PBGC, awaiting confirmation hearings in the Senate, faces a daunting task if confirmed. Not only must he address the $22 billion deficit, but he must implement an order from the board to suspend the new investment policy of increasing to 45 percent the portion of insurance reserves invested in equities.

That would be extremely high for a private insurance company. In mid-2009, the equity portion of the investment portfolio had risen to 30 percent equities. The inference by the board is that financial problems are, at least, partly the consequence of too much stock market exposure.

There also existed a cloud over the lack of objectivity in dispensing stock purchases. Hence a new Director.

Boomer Plight Could Instigate Congress to Involve Taxpayer

PBGC management has requested no taxpayer funds so far. In fact, the ERISA act prohibits that. But interim management has suggested that some adjustment in funding will be necessary to sustain deficits in the future.

As Ignatius inferred in his article, the massive Boomer retirements and the apparent underfunding of their pensions could be a lightning rod that ignites a fire under Congress to legislate help for deficient Boomer retirements. The generation has been a political tour de force since infancy, when Gerber’s baby food was the beneficiary.

Might Social Security be Expanded to Include Pensions?

What might follow such an act of benevolence? It is not difficult to imagine that, in this experimental spell of centralized government to cure the US economy’s ills, a groundswell could rise that Washington D.C. should be responsible for funding all those floundering Boomer pensioners.

Actually that might appeal to some lawmakers. Rather than debate ground-breaking new taxpayer legislation, always risky for incumbents, they could simply amend the Social Security Act of 1935 to include private plans.

But that’s risky too, for Social Security is considered the most popular federal program by Americans, often referred to as the “third rail” of American politics. That is what former Speaker Thomas “Tip” O’Neill first called it, during the Reagan presidency.

He was comparing the program with the third rail in an electric railway that carries high-voltage electricity. Touch it and you risk political electrocution.

*The writer is a Chartered Financial Analyst (CFA).