PBGC’s Underfunding PBGC’s Underfunding ProblemProblem

Beth JanusBeth Janus

Jess StrilichJess Strilich

Funding Status from 1980 - Funding Status from 1980 - 20042004

Source: Paul Davies’ “Pension In Peril”

2001: $7.73 billion surplus

2004: Approximately $23.3 billion underfunded

2006: Approximately $18.1 billion underfunded

Steel Industry: The Steel Industry: The Beginning of the PBGC’s Beginning of the PBGC’s

ProblemProblemAmerican steel companies had American steel companies had

problems remaining competitive problems remaining competitive against foreign competitors against foreign competitors American steel facilities were outdated American steel facilities were outdated

compared to foreign competitorscompared to foreign competitorsForeign competitors’ labor costs ranged Foreign competitors’ labor costs ranged

from $20 to $30 per ton, while American from $20 to $30 per ton, while American firms’ labor costs were $100 per tonfirms’ labor costs were $100 per ton

Steel Industry: The Steel Industry: The Beginning of the PBGC’s Beginning of the PBGC’s

Problem cont.Problem cont. In order to stay competitive, the American In order to stay competitive, the American steel companies used their free cash flow steel companies used their free cash flow to update their steel millsto update their steel mills

The steel companies implemented these The steel companies implemented these changes too late and ultimately were changes too late and ultimately were forced into bankruptcyforced into bankruptcy

As a result, the PBGC received more than As a result, the PBGC received more than $6 billion in claims from the steel industry$6 billion in claims from the steel industry Bethlehem Steel - $3.7 billionBethlehem Steel - $3.7 billion LTV Steel - $2.2 billionLTV Steel - $2.2 billion

What caused pension plans to What caused pension plans to become underfunded?become underfunded?

Companies used accounting Companies used accounting loopholes to satisfy minimum funding loopholes to satisfy minimum funding requirementsrequirementsThe major loophole: Funding Standard The major loophole: Funding Standard

Accounts (FSA)Accounts (FSA)

Funding Standard Accounts Funding Standard Accounts

Companies use FSAs to monitor the Companies use FSAs to monitor the health of its pension planshealth of its pension plansWhen the pension plan performs well or When the pension plan performs well or

gains interest, gains interest, the company stores the the company stores the increase on the plan’s assets in an increase on the plan’s assets in an account (FSA) to accumulate value and account (FSA) to accumulate value and eventually uses these gains to offset any eventually uses these gains to offset any future liabilitiesfuture liabilities

Funding Standard Accounts Funding Standard Accounts cont.cont.

Since many pension plans were generating Since many pension plans were generating high returns from 1995 - 2001 high returns from 1995 - 2001

Companies used its accumulated gains from Companies used its accumulated gains from the FSA to meet minimum funding the FSA to meet minimum funding requirements rather than cash contributions requirements rather than cash contributions (perfectly legal)(perfectly legal) From 1997 to 2002, cash contributions averaged From 1997 to 2002, cash contributions averaged

only 42 percent of minimum required annual only 42 percent of minimum required annual fundingfunding

Funding Standard Accounts Funding Standard Accounts cont.cont.

The companies relied heavily on the The companies relied heavily on the FSAs short-term benefits and did not FSAs short-term benefits and did not prepare for an economic collapseprepare for an economic collapse

When steel companies ran out of FSA When steel companies ran out of FSA credits to fulfill minimum credits, the credits to fulfill minimum credits, the companies had no excess cash to companies had no excess cash to fund their pension plans because fund their pension plans because they were spending their money to they were spending their money to remain competitiveremain competitive

PBGC’s Corporate PBGC’s Corporate GovernanceGovernance

The PBGC has three board of The PBGC has three board of directors (BOD)directors (BOD)The Secretary of Labor, ChairmanThe Secretary of Labor, ChairmanThe Secretary of CommerceThe Secretary of CommerceThe Secretary of TreasuryThe Secretary of Treasury

The 2006 PPA requires the Senate to The 2006 PPA requires the Senate to elect a Director to oversee the PBGC elect a Director to oversee the PBGC operationsoperations

Criticism of the PBGC’s Criticism of the PBGC’s Corporate GovernanceCorporate Governance

The BOD have only conducted 18 The BOD have only conducted 18 board meetings over the last 27 yearsboard meetings over the last 27 years10 of these meetings have been 10 of these meetings have been

conducted after 2003conducted after 2003

The BOD still has not established The BOD still has not established formal policies and procedures for formal policies and procedures for administrationadministrationThe reason: The Department of Labor The reason: The Department of Labor

still heavily influences the PBGCstill heavily influences the PBGC

How is the PBGC going How is the PBGC going to solve its to solve its

underfunding problem?underfunding problem?

PBGC Recent AlternativesPBGC Recent Alternatives

PBGC increase premium to $33 for PBGC increase premium to $33 for FY2008 FY2008 Will adjust for inflation based on the Will adjust for inflation based on the

average wage indexaverage wage indexProposes Variable-Rate PremiumProposes Variable-Rate Premium

Underfunded plans require increased Underfunded plans require increased paymentspayments

Benefits to be measured as of the Benefits to be measured as of the funding valuation datefunding valuation dateEnsure premium is determined the same Ensure premium is determined the same

way and at the same time when the fund is way and at the same time when the fund is valued, no estimation requiredvalued, no estimation required

PBGC Recent AlternativesPBGC Recent Alternatives

Propose adjusting the mortality Propose adjusting the mortality assumption to determine benefit for assumption to determine benefit for beneficiariesbeneficiariesUpdate tables for interest factors to Update tables for interest factors to

match the market annuity pricesmatch the market annuity pricesCurrently the tables no longer Currently the tables no longer

approximate the market annuity pricesapproximate the market annuity pricesUpdate using a fixed blend of 50% Update using a fixed blend of 50%

healthy female mortality rate and 50% healthy female mortality rate and 50% healthy male mortality ratehealthy male mortality rate

Criticism of PBGC’s ProposalCriticism of PBGC’s Proposal

Premium Adjusted for Inflation:Premium Adjusted for Inflation:Companies freeze its pension plansCompanies freeze its pension plansMercer study: Of the Fortune 200 companies Mercer study: Of the Fortune 200 companies

approximately 20% have frozen its pension approximately 20% have frozen its pension plans or closed to new employeesplans or closed to new employees

Pension decreased from 100,000 company Pension decreased from 100,000 company plans in 1985 to less than 40,000 plans in plans in 1985 to less than 40,000 plans in 20062006

Companies rather than bear additional costs Companies rather than bear additional costs to fully fund and pay higher premiums opt for to fully fund and pay higher premiums opt for 401(k)401(k)Shift retirement burden on workers. Shift retirement burden on workers.

Criticism of PBGC’s ProposalCriticism of PBGC’s ProposalVariable Interest Premiums:Variable Interest Premiums:

Company performing subpar, difficult for Company performing subpar, difficult for firm to pay the increased PBGC premiums firm to pay the increased PBGC premiums due to its increased riskdue to its increased risk

Company focused on withstanding Company focused on withstanding bankruptcy and producing net incomebankruptcy and producing net income

Decreases companies incentive to Decreases companies incentive to maintain pension planmaintain pension plan

Bush Alternatives for PBGCBush Alternatives for PBGC

Agree with the PBGC, Agree with the PBGC, the premiums do not the premiums do not match the associated match the associated risk of all companiesrisk of all companies Propose PBGC’s board Propose PBGC’s board

adjust the risk-based adjust the risk-based premium rate so that premium rate so that the premium revenue the premium revenue can cover potential can cover potential expected lossesexpected losses

Goal DB plans to better Goal DB plans to better reflect a plan’s risk and reflect a plan’s risk and restore PBGC healthrestore PBGC health

Potential Problems Potential Problems with Alternativewith Alternative Bring question of who Bring question of who

determines how much determines how much companies pay?companies pay?

Who will monitor the Who will monitor the premiums and premiums and fluctuations in pension fluctuations in pension funding?funding?

3 major board 3 major board membersmembers

Congress will not Congress will not approve b/c cede approve b/c cede legislative authority to legislative authority to set premiums to set premiums to administration administration agenciesagencies

Our AlternativesOur Alternatives

Of the companies that sent claims to Of the companies that sent claims to the PBGC for funding needs, 90% had the PBGC for funding needs, 90% had junk bond rating for the last 10 yearsjunk bond rating for the last 10 years

PBGC better prepare itself for PBGC better prepare itself for company claims by monitoring company claims by monitoring companies pension liability bond companies pension liability bond ratingratingDifficult to solve for underfunding but Difficult to solve for underfunding but

need to plan for possible terminationneed to plan for possible termination

Our AlternativesOur Alternatives Incentive for companies to adequately fund Incentive for companies to adequately fund

pension planpension planThrough tax credits or tax deductionsThrough tax credits or tax deductions

Current law has penalty for funding large Current law has penalty for funding large amounts in profitable years for tax amounts in profitable years for tax purposespurposesReduce this penalty so companies will fund and Reduce this penalty so companies will fund and

less stress on the PBGCless stress on the PBGCDiscourages companies to make sufficient cash Discourages companies to make sufficient cash

infusions b/c penalized for overfunded plansinfusions b/c penalized for overfunded plans

Our AlternativesOur Alternatives

Companies should receive a tax credit for Companies should receive a tax credit for interest and gains in its liability accountinterest and gains in its liability account

Required to contribute a stated minimum Required to contribute a stated minimum level of cash infusion per yearlevel of cash infusion per year

Decrease risk of potential future pension Decrease risk of potential future pension plan failure in hard economic timesplan failure in hard economic times

Help reduce the stress on the PBGC in the Help reduce the stress on the PBGC in the case of terminated planscase of terminated plans

RecommendationsRecommendations

Problem is difficult to solveProblem is difficult to solve Agree with variable risk premiumsAgree with variable risk premiums

Insurance companies use similar method for Insurance companies use similar method for pension insurance, government should do the samepension insurance, government should do the same

Issue with potential frozen plansIssue with potential frozen plans Rather have 401K plan and phase out pensions than Rather have 401K plan and phase out pensions than

have an extremely risky pension planhave an extremely risky pension plan

PBGC needs better risk managementPBGC needs better risk management 18 BOD meetings in last 27 years18 BOD meetings in last 27 years Recently increased the number of board meetings Recently increased the number of board meetings

but remain under prepared for large claimsbut remain under prepared for large claims

Questions??????Questions??????