The Domino Effect

Ailing pension plans could overburden the PBGC and send premiums soaring.

Indeed, when an underfunded employer negotiates a pension boost instead of a salary hike, it’s essentially borrowing money from employees in the form of a loan backed by the PBGC, argues Jeremy Gold, a New York­based consulting actuary. That arrangement hurts well-funded companies, too, he says, because the PBGC might have to raise its premiums if the “loans” become uncollectible. The two systems also share a lack of transparency, according to Belt. Thrifts hid their financial woes under generally accepted accounting principles with the banking system’s more lenient regulatory accounting principles; pension sponsors can obscure results by use of a dual-reporting system. Belt explains that operating under both GAAP and the Employee Retirement Income Security Act (ERISA), employers sometimes engage in “information arbitrage” — choosing whichever system tells a better story.

Thus, some sponsors may discuss their plans’ status under an ERISA provision called the “full-funding limit” rather than use GAAP’s mark-to-market measure. The ERISA metric enables them to employ an interest rate smoothed over the previous four years. “Companies then say, ‘We’ve met the full funding limit’ as if they are in fact fully funded,” says Belt, noting that there can be “a wide gulf” between the amount funded up to that limit and the actual settlement costs of terminating the plan.

Capturing Risk

With the history of the S&Ls in mind, some experts say the best way to avoid a breakdown of the pension system is to require pension plans to be fully funded at all times. The problem is that tightened funding rules could drive out stronger participants. “If we demanded instant soundness, many companies, especially weaker ones, would dump their plans, and that would be bad for the United States,” admits Gold.

For his part, Belt has been pushing Congress to enact legislation to keep the stronger plans in the system and to avoid a future collapse. In general, pension rules focus too little on the risk that companies will go belly-up, according to the PBGC director, who wants rule changes to capture the sponsor’s credit risk. “If a company is a triple-A credit, I’m not that concerned about the fact that it’s underfunded,” he says. “They’re going to be around a long time. If it’s borderline investment-grade, or if there’s been a deterioration in credit quality, I start worrying.”

To tilt the balance more toward better-funded sponsors, the White House wants to revamp the funding and disclosure rules and change the premium structure.

Belt contends that the stress on flat-rate premiums “shifts wealth from healthy companies to unhealthy companies.” The proof is that 70 percent of PBGC’s claims come from just two industries: airlines and steel. At the same time, the agency collects less than it might from plans with shortfalls because the ERISA full-funding requirement enables companies that are “fairly substantially underfunded” to avoid falling into the variable-rate premium pool, he says.

For the time being, however, well-funded sponsors have a good deal of latitude in their funding decisions. Many finance executives apparently choose to navigate between the minimum contribution needed to avoid paying variable-rate premiums and the top tax-deductible amount.


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