Friday, April 17, 2009

The threat is not underfunding; it is underfunding in companies that go bankrupt.

TO BE NOTED: From the FT:

Vampire pensions could be a corporate nightmare

By Charles Millard

Published: April 16 2009 21:57 | Last updated: April 16 2009 21:57

While economists worry about “zombie” banks holding back lending, vampire pension plans may soon be stalking a company near you. The underfunding of America’s corporate defined benefit pensions poses a daunting challenge, threatening not only their 40m beneficiaries but the entire US economy.

Recently enacted funding rules require underfunded pension plans, and that’s most of the big ones, to suck needed cash from salaries and jobs just when suffering companies need scarce resources to survive. Under 2006 legislation, companies that have underfunded pensions must put extra funds into their pension plan to close the gap within seven years. After precipitous drops in assets, most plans now have serious funding gaps.

For example, according to Watson Wyatt consulting, at the end of 2008 the pension system in the US had approximately $2,100bn (€1,589bn, £1,407bn) in liabilities but only $1,600bn in assets. That was before the downward gyrations of the capital markets this year.

Closing this gap could cost $50bn-$100bn in additional annual pension contributions at a time of unprecedented reduced corporate earnings. Some large companies have stated that such funding commitments would drive them to file for bankruptcy.

The new law was drafted to help protect pension recipients from discovering too late that their bankrupt ex-employers had seriously underfunded pension plans. When this happened at Bethlehem Steel the Pension Benefit Guaranty Corporation (PBGC), the federal corporation that insures pensions, saw its funding deficit soar by nearly $4bn, while workers missed out on $600m in pension promises. Among the problems the new law sought to deal with were:

A significant portion of pension liabilities may not be insured above PBGC’s limits.

Pension plans rescued are frozen, so workers over 50 see no increase in benefits during their remaining working years. This means that untold billions of dollars of expected benefits are never earned and never owed – but also never received.

As PBGC pays the benefits it does insure, its own deficit increases by the amount of underfunding in the plan.

Avoiding these situations made a lot of sense. However, like everything else in our system, these rules were not designed with the extreme current emergency in mind. The very law that was designed to protect worker pensions runs the real risk of draining the very companies workers depend on for their livelihood and retirement benefits. Congress must change the law – and quickly.

The threat is not underfunding; it is underfunding in companies that go bankrupt. Our goal at the moment should not be to force plans towards full funding at all costs; it should be to prevent companies going bankrupt. Certainly, we should prevent pension funding rules from contributing to the companies’ – and ultimately the pensions’ – demise. But the goal should be to help responsible companies succeed, so they can fulfil their obligations to workers.

Unfortunately, current law provides only one real option to a company that cannot meet its payments. Other than woefully inadequate and inflexible funding waivers, the only choice is to seek a “distress termination” and dump the underfunded plan on PBGC – a solution that is bad for everyone.

PBGC should have the situation-specific flexibility that the Pensions Regulator has in the UK. There, companies and the regulator can reach deals that provide temporary relief. If companies can afford their contributions, even in this environment, of course they should make them. If they cannot, we need the option of the UK model. The PBGC would not have to terminate and take over plans and corporations would not have to make payments on a current basis that they cannot afford.

This kind of intermediate relief would have to come with conditions that prevent shareholders and executives from improperly benefiting while pension plans are underfunded.

Inserting a quasi-governmental authority into such negotiations is problematic.

But it is far superior to enduring the burden of a misfit law designed to protect pension benefits which instead weakens them at a time of crisis.

In their 401(k) private pensions, Americans can put in less this year if they need the money to pay bills. During this crisis, corporate pensions should be allowed to do the same.

The writer was director of the PBGC from 2007 to 2009"

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