pbgc’s underfunding problem
DESCRIPTION
PBGC’s Underfunding Problem. Beth Janus Jess Strilich. Funding Status from 1980 - 2004. Source: Paul Davies’ “Pension In Peril”. 2001: $7.73 billion surplus 2004: Approximately $23.3 billion underfunded 2006: Approximately $18.1 billion underfunded. - PowerPoint PPT PresentationTRANSCRIPT
PBGC’s Underfunding PBGC’s Underfunding ProblemProblem
Beth JanusBeth Janus
Jess StrilichJess Strilich
Funding Status from 1980 - Funding Status from 1980 - 20042004
Source: Paul Davies’ “Pension In Peril”
2001: $7.73 billion surplus
2004: Approximately $23.3 billion underfunded
2006: Approximately $18.1 billion underfunded
Steel Industry: The Steel Industry: The Beginning of the PBGC’s Beginning of the PBGC’s
ProblemProblemAmerican steel companies had American steel companies had
problems remaining competitive problems remaining competitive against foreign competitors against foreign competitors American steel facilities were outdated American steel facilities were outdated
compared to foreign competitorscompared to foreign competitorsForeign competitors’ labor costs ranged Foreign competitors’ labor costs ranged
from $20 to $30 per ton, while American from $20 to $30 per ton, while American firms’ labor costs were $100 per tonfirms’ labor costs were $100 per ton
Steel Industry: The Steel Industry: The Beginning of the PBGC’s Beginning of the PBGC’s
Problem cont.Problem cont. In order to stay competitive, the American In order to stay competitive, the American steel companies used their free cash flow steel companies used their free cash flow to update their steel millsto update their steel mills
The steel companies implemented these The steel companies implemented these changes too late and ultimately were changes too late and ultimately were forced into bankruptcyforced into bankruptcy
As a result, the PBGC received more than As a result, the PBGC received more than $6 billion in claims from the steel industry$6 billion in claims from the steel industry Bethlehem Steel - $3.7 billionBethlehem Steel - $3.7 billion LTV Steel - $2.2 billionLTV Steel - $2.2 billion
What caused pension plans to What caused pension plans to become underfunded?become underfunded?
Companies used accounting Companies used accounting loopholes to satisfy minimum funding loopholes to satisfy minimum funding requirementsrequirementsThe major loophole: Funding Standard The major loophole: Funding Standard
Accounts (FSA)Accounts (FSA)
Funding Standard Accounts Funding Standard Accounts
Companies use FSAs to monitor the Companies use FSAs to monitor the health of its pension planshealth of its pension plansWhen the pension plan performs well or When the pension plan performs well or
gains interest, gains interest, the company stores the the company stores the increase on the plan’s assets in an increase on the plan’s assets in an account (FSA) to accumulate value and account (FSA) to accumulate value and eventually uses these gains to offset any eventually uses these gains to offset any future liabilitiesfuture liabilities
Funding Standard Accounts Funding Standard Accounts cont.cont.
Since many pension plans were generating Since many pension plans were generating high returns from 1995 - 2001 high returns from 1995 - 2001
Companies used its accumulated gains from Companies used its accumulated gains from the FSA to meet minimum funding the FSA to meet minimum funding requirements rather than cash contributions requirements rather than cash contributions (perfectly legal)(perfectly legal) From 1997 to 2002, cash contributions averaged From 1997 to 2002, cash contributions averaged
only 42 percent of minimum required annual only 42 percent of minimum required annual fundingfunding
Funding Standard Accounts Funding Standard Accounts cont.cont.
The companies relied heavily on the The companies relied heavily on the FSAs short-term benefits and did not FSAs short-term benefits and did not prepare for an economic collapseprepare for an economic collapse
When steel companies ran out of FSA When steel companies ran out of FSA credits to fulfill minimum credits, the credits to fulfill minimum credits, the companies had no excess cash to companies had no excess cash to fund their pension plans because fund their pension plans because they were spending their money to they were spending their money to remain competitiveremain competitive
PBGC’s Corporate PBGC’s Corporate GovernanceGovernance
The PBGC has three board of The PBGC has three board of directors (BOD)directors (BOD)The Secretary of Labor, ChairmanThe Secretary of Labor, ChairmanThe Secretary of CommerceThe Secretary of CommerceThe Secretary of TreasuryThe Secretary of Treasury
The 2006 PPA requires the Senate to The 2006 PPA requires the Senate to elect a Director to oversee the PBGC elect a Director to oversee the PBGC operationsoperations
Criticism of the PBGC’s Criticism of the PBGC’s Corporate GovernanceCorporate Governance
The BOD have only conducted 18 The BOD have only conducted 18 board meetings over the last 27 yearsboard meetings over the last 27 years10 of these meetings have been 10 of these meetings have been
conducted after 2003conducted after 2003
The BOD still has not established The BOD still has not established formal policies and procedures for formal policies and procedures for administrationadministrationThe reason: The Department of Labor The reason: The Department of Labor
still heavily influences the PBGCstill heavily influences the PBGC
How is the PBGC going How is the PBGC going to solve its to solve its
underfunding problem?underfunding problem?
PBGC Recent AlternativesPBGC Recent Alternatives
PBGC increase premium to $33 for PBGC increase premium to $33 for FY2008 FY2008 Will adjust for inflation based on the Will adjust for inflation based on the
average wage indexaverage wage indexProposes Variable-Rate PremiumProposes Variable-Rate Premium
Underfunded plans require increased Underfunded plans require increased paymentspayments
Benefits to be measured as of the Benefits to be measured as of the funding valuation datefunding valuation dateEnsure premium is determined the same Ensure premium is determined the same
way and at the same time when the fund is way and at the same time when the fund is valued, no estimation requiredvalued, no estimation required
PBGC Recent AlternativesPBGC Recent Alternatives
Propose adjusting the mortality Propose adjusting the mortality assumption to determine benefit for assumption to determine benefit for beneficiariesbeneficiariesUpdate tables for interest factors to Update tables for interest factors to
match the market annuity pricesmatch the market annuity pricesCurrently the tables no longer Currently the tables no longer
approximate the market annuity pricesapproximate the market annuity pricesUpdate using a fixed blend of 50% Update using a fixed blend of 50%
healthy female mortality rate and 50% healthy female mortality rate and 50% healthy male mortality ratehealthy male mortality rate
Criticism of PBGC’s ProposalCriticism of PBGC’s Proposal
Premium Adjusted for Inflation:Premium Adjusted for Inflation:Companies freeze its pension plansCompanies freeze its pension plansMercer study: Of the Fortune 200 companies Mercer study: Of the Fortune 200 companies
approximately 20% have frozen its pension approximately 20% have frozen its pension plans or closed to new employeesplans or closed to new employees
Pension decreased from 100,000 company Pension decreased from 100,000 company plans in 1985 to less than 40,000 plans in plans in 1985 to less than 40,000 plans in 20062006
Companies rather than bear additional costs Companies rather than bear additional costs to fully fund and pay higher premiums opt for to fully fund and pay higher premiums opt for 401(k)401(k)Shift retirement burden on workers. Shift retirement burden on workers.
Criticism of PBGC’s ProposalCriticism of PBGC’s ProposalVariable Interest Premiums:Variable Interest Premiums:
Company performing subpar, difficult for Company performing subpar, difficult for firm to pay the increased PBGC premiums firm to pay the increased PBGC premiums due to its increased riskdue to its increased risk
Company focused on withstanding Company focused on withstanding bankruptcy and producing net incomebankruptcy and producing net income
Decreases companies incentive to Decreases companies incentive to maintain pension planmaintain pension plan
Bush Alternatives for PBGCBush Alternatives for PBGC
Agree with the PBGC, Agree with the PBGC, the premiums do not the premiums do not match the associated match the associated risk of all companiesrisk of all companies Propose PBGC’s board Propose PBGC’s board
adjust the risk-based adjust the risk-based premium rate so that premium rate so that the premium revenue the premium revenue can cover potential can cover potential expected lossesexpected losses
Goal DB plans to better Goal DB plans to better reflect a plan’s risk and reflect a plan’s risk and restore PBGC healthrestore PBGC health
Potential Problems Potential Problems with Alternativewith Alternative Bring question of who Bring question of who
determines how much determines how much companies pay?companies pay?
Who will monitor the Who will monitor the premiums and premiums and fluctuations in pension fluctuations in pension funding?funding?
3 major board 3 major board membersmembers
Congress will not Congress will not approve b/c cede approve b/c cede legislative authority to legislative authority to set premiums to set premiums to administration administration agenciesagencies
Our AlternativesOur Alternatives
Of the companies that sent claims to Of the companies that sent claims to the PBGC for funding needs, 90% had the PBGC for funding needs, 90% had junk bond rating for the last 10 yearsjunk bond rating for the last 10 years
PBGC better prepare itself for PBGC better prepare itself for company claims by monitoring company claims by monitoring companies pension liability bond companies pension liability bond ratingratingDifficult to solve for underfunding but Difficult to solve for underfunding but
need to plan for possible terminationneed to plan for possible termination
Our AlternativesOur Alternatives Incentive for companies to adequately fund Incentive for companies to adequately fund
pension planpension planThrough tax credits or tax deductionsThrough tax credits or tax deductions
Current law has penalty for funding large Current law has penalty for funding large amounts in profitable years for tax amounts in profitable years for tax purposespurposesReduce this penalty so companies will fund and Reduce this penalty so companies will fund and
less stress on the PBGCless stress on the PBGCDiscourages companies to make sufficient cash Discourages companies to make sufficient cash
infusions b/c penalized for overfunded plansinfusions b/c penalized for overfunded plans
Our AlternativesOur Alternatives
Companies should receive a tax credit for Companies should receive a tax credit for interest and gains in its liability accountinterest and gains in its liability account
Required to contribute a stated minimum Required to contribute a stated minimum level of cash infusion per yearlevel of cash infusion per year
Decrease risk of potential future pension Decrease risk of potential future pension plan failure in hard economic timesplan failure in hard economic times
Help reduce the stress on the PBGC in the Help reduce the stress on the PBGC in the case of terminated planscase of terminated plans
RecommendationsRecommendations
Problem is difficult to solveProblem is difficult to solve Agree with variable risk premiumsAgree with variable risk premiums
Insurance companies use similar method for Insurance companies use similar method for pension insurance, government should do the samepension insurance, government should do the same
Issue with potential frozen plansIssue with potential frozen plans Rather have 401K plan and phase out pensions than Rather have 401K plan and phase out pensions than
have an extremely risky pension planhave an extremely risky pension plan
PBGC needs better risk managementPBGC needs better risk management 18 BOD meetings in last 27 years18 BOD meetings in last 27 years Recently increased the number of board meetings Recently increased the number of board meetings
but remain under prepared for large claimsbut remain under prepared for large claims
Questions??????Questions??????