Private Pensions: Another Gradual Catastrophe

While the debt-ceiling debacle has rightfully underscored the crushing liabilities of Medicare and Social Security, it has failed to draw attention to another financial time-bomb: our equally defunct "private" pension system.

Defined benefit plans and the Employee Retirement Income Security Act (ERISA) have produced an unsustainable pension system which burdens corporations, the economy, and eventually the taxpayer. While the nuances of ERISA law are difficult to comprehend, what is not difficult to recognize is the dire need for pension reform.

The Employee Retirement Income Security Act was enacted in 1974 with the intent of protecting the benefits of insolvent pension funds. The act shelters the beneficiaries of defined benefit plans by holding companies liable for the returns under these plans, and not just their payments. Unlike defined contribution plans, the burden of defined benefit plans falls entirely on the employer. Payouts are determined by a fixed actuarial formula, usually compensating for factors such as hours worked and length of employment. If a defined benefit plan underperforms, employers are forced to compensate for the loss. Employers are unfairly held responsible for difficult market conditions, fund mismanagement, or even the bankruptcy of other fund participants.

Over the years, these plans have become more and more burdensome, as financial markets have failed to provide consistent positive returns. The Pension Benefit Guarantee Corporation (PBGC), which was chartered to insure most of the nation's defined benefit plans, has estimated the total unfunded liability of these plans to be over $300 billion, and those calculations were before the market's recent substantial losses. Of the 29,000 pension programs insured by the PBGC, approximately 17,000 are underfunded, 3,000 of which are less than 70% funded. This translates into a serious government liability as well as a major hindrance to economic growth. To make matters worse, the system disproportionately burdens some of our most vulnerable and depressed industries; over three quarters of the nation's defined benefit plans involve employers in either the manufacturing or air transportation sector.

The outlook for pension plans is especially bleak among the subset of multiemployer plans. While the PBGC oversees only 1,500 of them, they are on average six times larger than the standard single employer plans. In their latest report, the PBGC has classified 1400 of them as underfunded and identified over 100 multiemployer programs likely to face immediate insolvency.

Though the PBGC's insurance program for multiemployer plans doesn't provide the same type of comprehensive coverage as its single-employer plans, the multiemployer plans presents a much greater risk to the fiscal health of its participants. If a plan participant goes bankrupt, the other plan participants are required to cover the insolvent employer's pension obligation. This creates a liability domino effect whereby companies cannot afford to withdraw from the plan, as the withdrawal liability is too expensive; yet they're compelled to reduce their workforce because of increases in the pension liability per worker. Many companies wind up operating "ghost factories" which they can't afford to close; not quite the efficient allocation of resources envisioned under our system of capitalism.

Despite the arguably noble intent of defined benefit plans and the PBGC, these plans demand crippling contributions from employers and inevitably the taxpayer, and make little sense in today's market environment. PBGC's current deficit stands at $22 billion, and a long-term balance sheet recovery seems unlikely given the fiscal health of these industries and the retirement surge of the baby boomer generation.

While it may be politically unpalatable, defined benefit plans and the federal pension guarantee must be gradually phased out. These plans should be converted to defined contribution concepts so that recipients receive the same market returns as the general population and taxpayers aren't on the hook when the PBGC is unable to meet its hefty obligations. It is inappropriate and unsustainable to ask employers and ultimately taxpayers to guarantee unachievable market returns.