In contrast with the well-documented financing shortfalls in Social Security and state/local/Puerto Rican pensions, another pension funding problem generally receives less attention: private sector employer-provided pensions insured by the Pension Benefit Guaranty Corporation (PBGC). Unlike defined contribution (DC) retirement saving plans such as 401(k)s, which are fully funded by definition, defined-benefit (DB) pensions can exhibit sharp differences between benefit promises and funding capability. Whenever DB funding is insufficient to finance promised benefits, someone is in for an unpleasant surprise: very possibly the worker who depends on those benefits, and potentially the taxpayer later called upon to make up the shortfall. Employer-provided pensions are increasingly facing such threats, as the following backgrounder explains.
PBGC insures employer-provided pensions. The PBGC is a government-chartered corporation that insures single-employer and multiemployer DB pensions. Many employers promise such pension benefits to their workers and are required by federal law to contribute funding to them under certain rules. These employers are also required to pay premiums to the PBGC to finance insurance for these benefits.
Single-employer and multiemployer plans are treated differently under law. A single-employer plan is as the name implies: a pension plan provided by a single sponsor. If such a pension plan becomes insolvent (e.g., because the sponsor goes out of business), the PBGC assumes its assets and liabilities, paying the benefits up to a statutory cap (about $59,000 annually for a 65-year-old). A multi-employer plan is “a pension plan maintained by two or more unrelated employers under collective bargaining agreements with one or more unions.” Notably, “workers accrue pension benefits in the plan even when they change employment from one contributing employer to the other.”
The nature of PBGC’s insurance coverage is different in the multiemployer case. If a multiemployer plan sponsor goes out of business, other sponsors of the same plan are in effect left holding the bag for any inherited liabilities. PBGC’s multiemployer benefit guarantee is only triggered when the plan becomes insolvent, usually “after all contributing employers have withdrawn from the plan, and the plan has spent almost all of its assets.” This benefit guarantee is much lower in the case of multiemployer plans (less than $13,000 annually for a typical 30-year worker) than for single-employer plans.
PBGC’s insurance program is in financial trouble. In its annual report for FY2015, PBGC estimated a net deficit (liabilities exceeding assets) of $76.3 billion in its combined insurance programs, consisting of a $24.1 billion deficit in its single-employer program and a $52.3 billion deficit in its multiemployer program. Both the total deficit and the multiemployer program deficit were the largest in history. A more recent update projected a median deficit of $52.9 billion and a mean deficit of $55.5 billion in the multiemployer program. The specifics are startling: the fiscal year 2015 $52.3 billion deficit estimate consisted of $54.2 billion in liabilities against only $1.9 billion in assets. On June 17, Labor Secretary Thomas Perez wrote to Congressional leaders to state that “insolvency of PBGC’s multiemployer insurance program would devastate the retirement benefits of 1 million to 1.5 million participants and their families,” and that “we must address the funding and other challenges of the multiemployer insurance program before it is too late.”
The financial troubles are rapidly growing worse. Figure 1 shows the reported deficits in each of the PBGC’s last ten annual reports. The problem has been serious for some time, but it became newly urgent in the 2014 report. This was largely due to a new forecast that two very large multiemployer plans were likely to be terminated with a net combined cost of $26.3 billion, and 14 other plans terminated with a net combined cost of $9.0 billion. In the 2015 report, 17 other plans were added to the probable termination list, with a net combined cost of $4.6 billion (changes in interest rates accounted for some of the further deterioration in the outlook).
Figure 1: Annual PBGC Estimates of Insurance Program Shortfalls
Funding problems are caused largely by lax funding rules and inadequate premium assessments. The primary reason the insurance program takes a substantial hit when a pension plan terminates is that sponsors are not generally required to keep their plans fully funded. Related to this, the value of the insurance provided by PBGC far exceeds the premiums assessed on employers. For example, even with a substantial increase in multiemployer insurance premiums having taken effect in 2015, premium levels going forward would have to be quadrupled merely to reduce the risk of program insolvency to less than 50 percent over the next twenty years. President Obama’s latest budget submission includes a proposal to give PBGC’s Board additional authority to increase multiemployer insurance premiums.
Employer pensions are not backstopped by the taxpayer – yet. The foundational concept underlying the employer-provided pension system is that employers (not taxpayers) will pay for workers’ pension benefits. Accordingly the system receives no tax dollars, and PBGC’s outlays do not appear on the federal budget. This arrangement, however, only works as long as the insurance system can fulfill its obligations. A 2014 law was intended to give sponsors of severely troubled plans flexibility to reduce benefits subject to federal government approval, but one recent high-profile attempt to do so was rejected by the Treasury Department on the grounds of unrealistic actuarial assumptions. This has led to proposals for a taxpayer bailout. The ultimate cost of a bailout to maintain full benefits in all such plans would be considerably larger than the PBGC deficit, because as noted the PBGC currently only guarantees pension benefits up to a statutory cap. According to one recent PBGC estimate, over half of future workers would face benefit reductions even if PBGC were able to meet its projected obligations; therefore, avoiding all such benefit reductions would cost considerably more.
Periodically legislated pension funding relief has worsened the problem. A big contributor to the current problem is that lawmakers have periodically enacted legislation to reduce pension funding requirements. In 2010, for example, legislation allowed plan sponsors several additional years to make up recent investment losses. More recently lawmakers enacted funding relief in the form of “pension smoothing” (basically, allowing sponsors to postpone funding contributions otherwise required) as a revenue source for a highway bill. Budget watchdogs cried foul over scoring funding relief as a federal revenue gain, pointing out that it only results in more revenue earlier (when employers make fewer tax-deductible pension contributions) but less later (when employers must make up the foregone contributions). More damagingly, as Keith Hennessey and I have each pointed out, costs increase when pension sponsors receive funding relief before their plans go insolvent. Current federal budgeting rules do not attempt to capture the extent to which such legislation increases the risk of a taxpayer bailout of employer-provided pensions.
PBGC’s accounting methods provide some early warning but time is nevertheless short. The reported PBGC deficit accounts not only for plans already terminated but for those projected to become insolvent within 10 years. In such cases, there is theoretically still time to avert plan insolvency and a hit on the insurance system. Nevertheless, as Secretary Perez’s letter notes, this still offers only “very short period in which to address a problem of this magnitude.”
In sum, systemic underfunding in employer-provided pensions remains an enormous challenge facing plan sponsors. Unless it is successfully addressed, it threatens to become a still bigger problem confronting millions of workers and potentially federal taxpayers as well.
Charles Blahous is a senior research fellow for the Mercatus Center, a research fellow for the Hoover Institution, and a contributor to E21. He recently served as a public trustee for Social Security and Medicare.
Interested in real economic insights? Want to stay ahead of the competition? Each weekday morning, E21 delivers a short email that includes E21 exclusive commentaries and the latest market news and updates from Washington. Sign up for the E21 Morning Ebrief.