Last month, Sens. Chuck Grassley (R., Iowa) and Lamar Alexander (R., Tenn.) unveiled a comprehensive proposal to shore up multiemployer pension plans. Congress will have little choice but to consider such a proposal soon, to address a burgeoning crisis affecting workers in America’s multiemployer pension system. These workers face the loss of their retirement benefits as not only their own pension plans but the insurance system that supports them heads toward insolvency. This piece explains the nature of the crisis and what must be done to solve it.
First, some brief background on multiemployer pensions. Multiemployer pensions are private-sector defined benefit (DB) pensions, administered by employers and unions for workers. These pensions are governed by boards of trustees consisting equally of management and labor representatives. Multiemployer pensions are distinguished from single-employer pensions principally by what their respective names imply: namely, a multiemployer plan is sponsored by multiple employers together, typically in a common industry or geographic region, rather than by just one employer. A foundational principle of these pensions is that a worker’s benefits continue even if her specific employer goes out of business. In that circumstance, the exiting employer is supposed to make a withdrawal liability payment to the plan covering its share of the plan’s unfunded vested benefits. Thereafter, the plan’s remaining sponsors are obliged to pay the pension benefits accrued by the withdrawing sponsor’s employees. In practice, things do not always work out so neatly, as will be described later in this piece.
There is a system of insurance for private-sector pensions, operated by the Pension Benefit Guaranty Corporation (PBGC). Employer sponsors of pensions are required by law to pay premiums to the PBGC in return for its insurance of a portion of their workers’ pension benefits. There are important differences between the insurance programs for single-employer and multiemployer pension plans respectively. One difference is that single-employer pension insurance covers much more of workers’ benefits—for example, up to $69,750 annually for a single 65-year-old worker. Multiemployer pension insurance by contrast covers only $17,160 in benefits for a worker with 40 years of earnings. Another difference pertains to what happens when a plan becomes insolvent. If a single-employer plan becomes insolvent, it is terminated and PBGC assumes its assets as well as the responsibility for paying benefits. If a multiemployer plan becomes insolvent, however, PBGC simply props it up by providing financial assistance in the form of “loans” that in practice are not repaid.
The policy rationale for these insurance differences is that multiemployer plans were assumed to be more secure than single-employer plans, because they disperse funding risk among several cosponsors. Accordingly, it was not thought that nearly as much PBGC insurance would be necessary for multiemployer plans. Thus, not only are PBGC’s benefit guarantees much smaller for multiemployer plans, but so are the premiums multiemployer sponsors pay. Single-employer sponsors pay a flat rate of $80 per worker, plus a variable rate premium if their plan is underfunded. Multiemployer sponsors pay only $29 per worker, and face no variable rate premium at all. Because of these different premium rules, multiemployer plans pay average premiums per participant that are less than one-eighth what they are for single-employer plans. But the policy rationale underlying these differences, that multiemployer plans pose far less risk to the pension insurance system, has proved wrong—indeed, catastrophically wrong.
PBGC faces an enormous shortfall in its multiemployer pension insurance program, estimated at $65.2 billion in present value in PBGC’s latest report. This huge deficit contrasts with an $8.7 billion surplus in PBGC’s single-employer program. The multiemployer insurance program shortfall reflects systemic underfunding in multiemployer pensions nationwide— most recently estimated at $638 billion. As dramatically underfunded multiemployer pension plans draw upon PBGC’s financial assistance, their claims will swamp the insurance program’s limited resources. PBGC projects that by 2025, its multiemployer insurance program will be insolvent.
This crisis poses a direct threat to the financial security of American workers who were promised and are depending on these pensions. As multiemployer pensions fail, workers will lose all benefits promised above and beyond the levels PBGC guarantees. Moreover, if the PBGC’s insurance program goes belly-up, even workers’ ostensibly insured benefits wouldn’t be paid. Some estimates are that if the insurance program runs dry, affected workers could lose 90% of their promised pension benefits.
Why has this crisis occurred?
To understand the situation, one must first dispense with certain myths about why the crisis has arisen, some of which have been promoted by interested parties seeking an expensive federal bailout. In this mythical portraiture, sponsors of these plans have done nothing imprudent, and there is no need for fundamental changes to federal pension funding rules. These myths attribute the crisis to factors outside the pension system’s control, such as the financial market crash of 2008 and the declining percentage of active workers in the pension plans of industrial America.
Both the financial market crash and the aging of America’s industrial workforce are real phenomena. They did not, however, cause the multiemployer pension crisis. One can quickly see this simply by contrasting the very different situations currently facing single-employer and multi-employer pension insurance.
Single-employer pension plans operate in the same financial markets as multiemployer plans. Yet during the very same period that the multiemployer pension insurance deficit has skyrocketed, the single-employer system has developed a surplus. It bears emphasis that the multiemployer insurance deficit has exploded at a historical moment when the stock market is reaching historic highs.
A second graph shows that single-employer plans were hit every bit as hard as multiemployer plans by the Great Recession. The main difference is that single-employer plans were better-funded to begin with, and have also used periods of market recovery to rebuild their funded status.
Nor is the problem that multiemployer plans are uniquely beset by a decline in their percentages of active workers. While it is true that funding deficiencies tend to be worse in plans that have a smaller percentage of active workers, this percentage decline is not a distinguishing feature for the multiemployer plan universe relative to other DB pensions. In fact, single-employer plans have an even smaller percentage of active workers than multiemployer plans, despite being much healthier financially.
The real reasons that multiemployer plans are in much worse shape than single-employer plans boil down to two:
- The rules governing multiemployer plans are far too lax: Plans are not required to accurately measure their assets and liabilities, they are not required to meaningfully reduce underfunding as it emerges, and they are not charged adequate premiums. Most notably, multiemployer plans were excluded from the funding rules reforms that were applied to single-employer pension plans in the 2006 Pension Protection Act (PPA), which did much to restore the single-employer pension system to health.
- Multiemployer plans face the unique problem of so-called “orphan worker” liabilities. These are benefit obligations owed to workers whose previous employers have since exited a plan. Various loopholes in federal law permit this situation to occur without sufficient withdrawal liability payments having been made to cover these workers’ benefits, leaving the remaining employer sponsors holding the bag for worsening funding shortfalls.
No legislation will resolve the multiemployer pension funding crisis unless it deals with these two issues. A bailout leaving these problems in place risks ultimately putting taxpayers on the hook for over $600 billion in multiemployer pension underfunding— or likely more, as employers reduce their funding contributions in anticipation of federal bailout money to come.
I have published research detailing the actions necessary to stabilize the multiemployer pension system. Here I will mention a few core principles warranting extra emphasis:
- Measurement accuracy. No solution will hold as long as plans are permitted to misstate their assets and liabilities. A pension obligation that is not recognized will not be funded. Pension obligations should be discounted at rates no higher than high-quality corporate bond rates, as is required of single-employer plans. The discount rate is not an appropriate subject for negotiation, to be manipulated ad hoc until the desired funding schedule is reached. Rather, liability discounting is either correct or it is not. Only if liabilities are accurately measured can a plan’s true funding status be known, and then after successfully taking this measurement step, current statutory funding contribution requirements should be recalibrated to operate within reality. Without accurate measurements, even reformed funding rules will be ineffective, because they will not generate the contributions necessary to improve the true funded status of a plan.
- Appropriate premiums. Multiemployer premiums should reflect the risks plans pose to the pension insurance system. The Grassley-Alexander proposal offers several useful reforms to the PBGC premium structure, including aligning multiemployer and single-employer flat-rate premium levels, introducing a variable rate premium for underfunded multiemployer plans similar to that for single-employer plans, and broadening the base for premium assessments. These reforms would provide much-needed revenue to the multiemployer pension insurance program, more nearly reflect the risks that it faces, and improve incentives for adequate funding.
- Limiting the moral hazards associated with any federal intervention. The Grassley-Alexander proposal, like some others, would attack head-on one of the problems facing the multiemployer pension system: namely, orphan liabilities. It would do so by empowering PBGC to partition and relieve troubled plans of their orphan liabilities, contingent upon the continuing plans being made solvent indefinitely. Such interventions can only succeed if continuing plans’ liabilities are (as previously described) accurately measured, and fully funded. The Grassley-Alexander proposal would also give PBGC increased authority to initiate the terminations of plans inevitably headed towards insolvency, as PBGC already does with single-employer plans. It would also strengthen safeguards against troubled plans increasing unfunded benefits (better still would be a mandatory hard freeze on benefit accruals in badly underfunded plans, as proposed by Rachel Greszler). Grassley-Alexander would also strengthen withdrawal liability payment requirements, to slow the accumulation of future orphan liabilities. The proposal could be improved by explicitly limiting any partition relief only to true orphan liabilities: no employer sponsor should be permitted to make others pay for benefits they have promised to their own workers, as long as they continue to operate a pension plan.
Partitioning plans and providing orphan liability relief has the greatest chance to succeed if combined with strengthened, simplified and streamlined general funding rules, similar to those that already apply to single-employer plans. But no matter what provisions are enacted, their efficacy will only be as strong as pension measurements are accurate –meaning specifically, if there is no understatement of liabilities through the use of artificially inflated (i.e., exceeding high-quality corporate bond) interest rates.
The multiemployer pension crisis will not resolve itself absent forceful action by lawmakers. Whether on Grassley-Alexander or on a parallel approach, lawmakers must act. A fix for the multiemployer pension problem is only likely to be effective if it reforms the premium structure, confronts the orphan liability problem, strengthens the funding and withdrawal liability rules, and above all, accurately measures plans’ assets, liabilities, and funded status. Working from these elements, lawmakers have an opportunity to avert a crisis and secure a significant bipartisan policy achievement.
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 previously served as a public trustee for Social Security and Medicare.
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