Multiemployer pensions are in crisis. Lawmakers established a joint select congressional committee in February 2018 to address the problem, but it was unable to forge an agreement by its November 30 deadline. Recent reports suggest no solution will be legislated this year, and that pension sponsors will push aggressively for an expensive ($30-$100 billion) taxpayer-financed bailout when Congress returns in the new year. This outcome would represent a costly public policy failure, and lawmakers should exert every effort to prevent it.
First, some brief background. Multiemployer pensions are private pensions cosponsored (as the name suggests) by multiple employers typically in the same industry. Funding for such a pension is negotiated with a union through a collective bargaining agreement. A foundational principle of multiemployer pensions is that if a worker’s sponsoring employer goes out of business, that worker can continue to accrue benefits if hired by another employer participating in the same plan. Even if the worker is not rehired and becomes a so-called “orphan worker,” the vested benefits that worker has accrued are still paid by the plan, financed by the remaining employer sponsors. This joint multiemployer responsibility to finance worker benefits is supposed to provide plans with an additional source of financial stability, relative to a pension sponsored by a single employer.
These intended financial safeguards, however, haven’t panned out. Multiemployer pension benefits are currently underfunded by more than $600 billion, with the result that projected insolvencies of certain multiemployer plans will surpass what the nation’s pension insurance system, operated by the Pension Benefit Guaranty Corporation (PBGC), can cover. The latest projections are that PBGC’s multiemployer insurance program faces a $54 billion shortfall and will be insolvent by 2025. If the pension insurance system goes belly-up, American workers will lose even benefits that were ostensibly insured. I have written previously about the causes of the problem and have outlined a framework for possible solutions.
Different experts and stakeholders have different perspectives on what would constitute a reasonably fair and effective solution to the crisis. I agree with those who argue that an imperfect solution now is better than a massive bailout later under chaotic crisis conditions. No one will get everything they want in bipartisan action on multiemployer pensions. Lawmakers should therefore focus on ensuring that at least the minimum necessary repairs are included in any corrective legislation.
One indispensable fix is correcting the mismeasurement of pension liabilities, which has done more than anything else to spur systemic pension underfunding and precipitate the current crisis. Specifically, this means fixing the discount rate that pension plan trustees use to translate future liabilities into present-value terms.
Why is something seemingly so technical as a discount rate so important? The reason is simple: a sponsor won’t fund a pension liability that it doesn’t recognize. When sponsors employ inflated discount rates, they shrink the apparent size of future pension liabilities, making them appear smaller in today’s terms than they actually are. Accordingly, whenever liabilities are mismeasured, employers don’t contribute enough funding to meet them. This is perhaps the single strongest reason why multiemployer plans have promised over $600 billion in benefits more than their contributions can fund.
Importantly in the current context, no solution will hold if the discount rate isn’t fixed. Reasonable people can disagree on what to do at this late point in the game; they can disagree on how much of the shortfall should be met by additional sponsor funding contributions, how much by additional premium assessments, how much through scaled-back benefit promises, and on whether federal resources should be tapped to pay orphan worker benefits. But it is not reasonable for plan sponsors to ask others to bail them out of their own benefit promises to their workers, while continuing to misreport their future obligations. It is especially unreasonable for sponsors to ask legislators to shoulder the enormous political risk associated with controversial pension rescue legislation, while at the same time continuing to misreport liabilities in a way that must create mounting pressure for more expensive future bailouts.
There is no significant disagreement among economists over how to properly measure pension liabilities. It is widely agreed that liabilities should be discounted according to their risk of nonpayment – which in this context would mean, at the very highest, a high-quality corporate bond rate matched to the duration of the pension liability. But plan actuaries and trustees have routinely disregarded these well-established economics principles, instead discounting their liabilities for funding purposes at rates of 7% or higher. As Northwestern professor James Naughton notes, “actuaries and standard setters have long known that this approach understates the actual obligations of the plan,” an understanding reflected in current financial accounting standards. “The [economics] profession has been nearly unanimous,” adds Stanford professor Joshua Rauh, that these inappropriate practices understate actual pension liabilities.
One should be aware that we have been down this road before. In 2005 (see Figure 1), the PBGC’s single-employer pension insurance program faced a solvency crisis. One of the critical reforms included in the 2006 PPA was to discount single-employer pension liabilities using a duration-matched “yield curve” of corporate bond interest rates.
During negotiations over the PPA, employer sponsors complained loudly about having to accurately measure their pension liabilities for funding purposes. But lawmakers held firm, and the fruits of their doing so can be seen in Figure 1: by the time of PBGC’s 2018 annual report, the deficit in PBGC’s single-employer pension insurance system was completely gone.
Unfortunately, the PPA did not include similar reforms for the multiemployer system. It was assumed that multiemployer plans could afford to have more lax funding rules, because multiple employers stood in the way of an insolvent multiemployer plan’s liabilities being dumped on the PBGC. But with PBGC’s multiemployer program now facing projected insolvency due to employers’ inability or unwillingness to fund their plans, any rationale for allowing multiemployer plans to continue to mismeasure their liabilities is long gone.
An objection raised by some sponsors is that accurately measuring their pension liabilities will result in funding contribution requirements that are both too onerous and too volatile. This argument was also made prior to the 2006 PPA reforms. It was wrong then and it is wrong now. Measurement accuracy and statutory funding requirements are two different things. If contribution requirements are too harsh and too volatile, this is a problem: but it is not a problem properly fixed by mismeasuring plan liabilities.
A plan’s liabilities are what they are; we don’t get to change their values simply to arrive at the funding schedule that we want. The appropriate way to tweak a contribution schedule is by adjusting the amortization periods over which funding standards must be met, as well as possibly placing a statutory cap on variance in annual contribution requirements.
Now, there may indeed be instances where, once a plan’s liabilities are properly measured, there is simply no funding schedule that can be devised over a reasonable time frame that does not result in contributions too onerous for the sponsor(s) to bear. If that is the case, however, it simply means that the sponsors cannot afford to fund the plan, and provision should be made for its orderly, least-cost termination. In that regrettable situation, nothing is gained by pretending the liabilities don’t exist; such pretense only makes the inevitable termination of the plan more protracted and more expensive. It should be remembered: once a sponsor asserts, “We cannot manage our plan if our liabilities are discounted at corporate bond rates,” they are confirming, in effect, “We cannot keep this plan solvent.” If that statement is made and accepted, it should close off any further discussion of subsidies, loans or other means of propping up inevitably insolvent plans.
Multiemployer pension reform is too difficult to allow the perfect to become the enemy of the good. Any bipartisan legislated solution is likely to leave some serious problems unfixed, and much of sponsors’ wish lists unfulfilled. But as Rauh puts it, what “the finance profession agrees is the right way to measure the solvency of a pension system should not be controversial.” Before legislators try to do anything else, they should agree right off the bat to measure pension liabilities correctly. If they don’t, nothing else they try is likely to work.
Charles Blahous is the J. Fish and Lillian F. Smith Chair and Senior Research Strategist at the Mercatus Center, a visiting fellow with the Hoover Institution, and a contributor to E21. He recently served as a public trustee for Social Security and Medicare.
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