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December 16, 2004


Hal Varian has a nice piece about the troubles of the Pension Benefit Guarantee Corporation, a federal entity:

The New York Times > Business > Economic Scene: Burden Growing on Pension Group: Pension plans and companies sometimes become insolvent. Who back ups these promises? The Pension Benefit Guaranty Corporation was set up by the federal government 30 years ago to provide insurance for traditional pension plans. If an employer cannot pay the promised benefits, the pension agency steps in to cover the difference. In exchange for this insurance, the companies that offer traditional pension plans have to pay a fee to the agency.... The agency's biggest problem is that it faces significant potential liabilities. In 2000, it showed a net balance of assets over liabilities of $10 billion. By 2004, its financial position had deteriorated to a $23.5 billion deficit. If we add in other companies covered by the agency that face significant bankruptcy risk, the deficit could reach $96 billion. The problem, according to Mr. Bodie, is a mismatch between the assets and liabilities of the pension plans that the agency guarantees.... [W]hat is wrong with assuming a 9 percent [nominal] rate of return?... it is only an average.... That is where the pension guaranty agency comes in. Even if the stock market drops, the workers' pensions will be covered. This means that G.M. has every incentive to invest in stocks rather than bonds: it is heads they win, tails the pension agency loses.... [I]t is not so inexpensive to invest the pension in stocks after all. Either the employee runs some risk of not being paid the entire amount, or someone - the company or the Pension Benefit Guaranty Corporation - has to provide the put option. The problem is that the pension agency has a difficult time charging the actuarially fair price for the insurance it offers....

I had convinced myself that the PBGC's problems were not the result of moral hazard induced by its existence leading corporations to fund their pension funds with too-risky investments. I had convinced myself that the problem was that Congress (a) allows companies to take money back from the pension fund when stocks went up, while (b) letting them postpone putting money into the pension fund when stocks went down. It's not a market failure, it's a Capitol Hill failure.

Posted by DeLong at December 16, 2004 03:22 PM

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» Pensions, How Quaint from CasdraBlog
Atrios pointed me to this post by Brad DeLong about the Federal Government's Pension Benefit Guarantee Corporation:The agency's biggest problem is that it faces significant potential liabilities. In 2000, it showed a net balance of assets over liabil... [Read More]

Tracked on December 18, 2004 02:09 AM


Ah, the all-American way--privatize the profits, socialize the losses. I sure wish Congress would do this for me!

Posted by: Derelict at December 16, 2004 03:28 PM

And A Structural Problem ?

Five competitors, all with large pension obligations: One dumps its liabilities on the PBGC and immediately has a sounder balance sheet, is able to borrow at lower interest rates, can price its products or services lower, etc. Result: a structural incentive for companies 2-5 to dump their liabilities on the PGGC too.

Posted by: ArthurKC at December 16, 2004 03:35 PM

And to extend on what both Brad and Arthur are saying, a business cycle problem as pension financing needs are counter cyclical in nature, so when the company or at least the economy is flush with profits and cash, there is no need to contribute to the pension fund, but when the economy or cash flow is tight, there is an increased need for direct cash outlays into the pension fund. So yeah, the moral hazard problem as created by regulation in Congress is real, and it only exacerbates that counter-cyclical nature of cash flow requirements.

Posted by: fester at December 16, 2004 05:14 PM

but it's not true that the pension plan sponsor can remove assets from an "over funded" plan - there are severe tax penalties that effectively exceed 50% of any withdrawal of excess funds from a pension plan. as for "dumping" plan liabilities on the PBGC, this requires that the corporate sponsor file bankruptcy and "dump" all of the value of their equity into the shitter - not much of a career builder for management. the author has it correct in that the problem is that the PBGC cannot charge a market premium for the insurance it provides. there is another problem which is the dual roles of corporate plan sponsor officers as pension plan trustees - an obvious conflict of interest. btw, if pension liabilities are real corporate liabilities, why are pension plans allowed to fund them with anything other than debt?

Posted by: JDD at December 16, 2004 05:15 PM


Am I wrong in thinking that yearly, plan sponsors are permitted to recognize plan earnings in excess of "assumed rate of return" as corporate income? and since the earnings remain in the plan, no tax is due?

Posted by: Ellen1910 at December 16, 2004 05:42 PM

Lately in my area, Horizon Energy, formerly Ashland Coal, was permitted in a bankruptcy to (whats the proper word?) renounce its pension obligations on the grounds that nobody would buy the bankrupt company if they had to take the pension liablities also. One Horizon mine was bought by Massey Energy. Don Blankenship, president of Massey personally contributed over 2 million dollars to help elect a pro-business candidate to the WV supreme court.

This is an instance of a long standing pattern of small companies operating coal mines as contractors, building up liablilities and not paying taxes and workers comp premiums, then going bankrupt leaving the pension funds empty and workers comp fund insolvent and the big corporation that actually made the profit from the coal protected by the sacred "corporate veil". Bethlehem Steel, the airlines and others are using the same theory to dump thier retirees. Bethlehem Steel ran coal mines also.

Posted by: pragmatic_realist at December 16, 2004 07:49 PM

pragmatic_realist: That sounds like "moral hazard meets investment fraud", or some such. Do we already have a catchy word for this? We should, as it is in no way a new phenomenon.

Posted by: cm at December 16, 2004 10:40 PM

"So the financial position of the pension agency continues to deteriorate. Sooner or later, Congress will probably have to step in to fix it. The sooner it can put the program on a sound financial footing, the less it will cost the taxpayers in the long run."

Gee, that could have been said about Social Security too.

Posted by: Patrick R. Sullivan at December 17, 2004 06:49 AM

Arthur, its more insidious: If the company knows that, in the future, PBGC must step in because its obligations are already too large, then it has incentives to promise over-large pensions in exchange for decreased compensation today. Employee unions like the pension benefits, the company gets a reduced (or slower-growing) payroll.

Then, when the pension is taken over by PBGC in the course of a bankruptcy, employee pensions are higher than they would have been, at no cost to the company! PBGC has some rules to prevent this, but not nearly enough. Mostly, they rely on the fact that PBGC pensions can be markedly smaller than those that would have been available had the private company pension remained solvent - so unions might prefer to accept wage cuts WITHOUT pension increases, as long as there is a chance the company won't go under.

In any case, it's wrong: the company's failure to fully fund the pension shouldn't result in these extortionate ploys.

Posted by: Silent E at December 17, 2004 08:41 AM

But the person saying it would be incorrect. SS is in fine shape for the next 50 years, and 1)anyone who thinks that making solid plans based on small discrepancies in 50+-year economic estimates is a fool 2)even if those estimates were correct the benefits in 50 years would exceed current benefits and 3)that minor shortfall could easily be erased with minor adjustments.
One patient needs an immediate quadruple bypass. The other has mildly elevated cholesterol levels. Just because the first needs surgery doesn't imply that the second does. To postulate an equivalence based on some discrete analysis (ie they both have problems, so they're equivalent) is just poor logic.


Posted by: Carleton Wu at December 17, 2004 01:08 PM

And they wonder why thousand will lose their heads during the average revolution.
Is someone keeping the list of these community leaders who are perpetrating such fraud?
Perhaps a strict list of criteria , and a structure for keeping the consequences to only a certain number of generations would be appropriate. Millions suffer for their profits, thousands die in their wars...how sorry am I going to feel?

Posted by: siegestate at December 19, 2004 02:24 AM

Ellen - you're correct that the corporate sponsor can recognize as earnings the "excess" returns of a pension fund over the assumed return. But the assumed return must be consistent with the actual assets in the plan (an equity return for equity assets or a bond return for bonds) - so over time there should not be large differences between the expected returns and actual returns. btw, the "excess" returns are amortized over a long period (I think its 10 years) for recognition to earnings. Losses in the pension plan require additional contributions which reduce corporate earnings.

The point is that the existence of the PBGC may have permitted corporate management (or more accurately plan trustees) to invest in riskier assets by misleading plan beneficiaries that they had insurance (if only partial). Corporate management (and equity owners) benefitted from taking risk in the plan while market returns were outsized and contributions were minimized (reducing corporate expense). But management could not recover the excess returns (without punitive taxes). Shedding the plan liabilities requires bankruptcy and a total loss of shareholder value. So corporate manageement is not really incented by the PBGC to mismanage the pension funds. Employees (as plan beneficiaries) are now aware (and should have known before) that the PBGC insurance scheme was only partial and that not requiring their fund to invest in high quality bonds left them with a residual exposure to systematic market risk.

Posted by: JDD at December 19, 2004 06:30 AM

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