Broken Promises

I fully realize that I too often cite the New York Times as my source of information. I really need to change that, but until that happens, there is an excellent article on the state of pensions in the US.

The article talks extensively about the "moral hazard" that has resulted from the government's pension insurance program (PBGC). Because the Pension Benefit Guarantee Corporation exists, individual firms have been playing fast and loose with the funding of their pension plans. Currently, it is believed that the unfunded gap in corporate pension plans is $450 billion dollars. That is over two times GM's annual revenue (note GM is a potential major pension defaulter).

There are many reasons why this has occurred.

1. Corporations face to real penalty for failing to meet their pension obligations. Look at companies that have default recently like United and US Airways. They continue to operate, free of their pension plans, much more comfortably than their competitors. They have no obligation to turn over their profits to fund the gaps that existed in their benefits plan when it was turned over to the government. Instead United CEO took home over $1million in salary plus bonus.


2. Executives who either make the decision to increase pension benefits or default face no scrutiny. Take Robert Miller, the current CEO of Delphi, who is navigating his company through bankruptcy filings, chance are high Delphi's employee pension plan will have to be taken over by PBGC. However, this isn't the first time a company under Miller's helm has done been unable to fulfill their obligations. The same thing happened at Bethlehem Steel. Yet here he is CEO of yet another company -- a cat with nine lives.


3. Sure GM and Ford may have been pressured by the UAW into providing pensions despite their serious misgivings. However, companies are now effectively using pensions to increase their bargaining power with employees.
• Companies increase pension benefits, yet do not fund them. To retain employees and extract concessions from Unions, firms promise to increase benefits. This is a tactic used by capital-poor companies who cannot afford to increase wages or need to cut employees. Pensions do not come due until far into the future, so the companies either assume that they will recover and be able to fill the gap or that the government will pick up the slack.
• Just days before asking for emergency funding from Congress, United Airlines increased pension benefits for a subset of its employees by 40%. Soon after they filed for bankruptcy and their pension plan was turned over the the PBGC.
  

The PBGC is already underwater, and there are additional defaults expected to come with Delphi, Northwest Airlines, and Delta Airlines which have all declared bankruptcy. And with pension liabilities an increasingly large burden on employer balance sheets we cannot expect the trend to change. In fact, to stay competitive, other companies will also feel compelled to turn the administration of their pension plans to the federal government.

For once, and I want to bold this, I agree with the Bush administration. Something needs to be done to address the rampant abuse that is going on in major organizations. Like Bush, I believe that companies with junk bond status should not be able to promise increased benefits for any reason if they are no fully funded. Similarly, these companies should cap the years of service employees can accrue to limit their overall liability. This changes are necessary to prevent the burden of Union and Management mistakes from falling on the shoulders of the American tax payer.

One key area where I disagree from the administration is on the idea of private investment accounts as a replacement for corporate pension plans. Corporate pension funds are designed such that each month pensioners receive a check for the duration of their life. However, if private accounts were used instead, how would people know where to invest the money? How would they spread the money over the remaining years of their lives? Pensions as they stand are sophisticated financial devices with short and long-term horizons. Within companies and externally at financial institutions trained professionals are daily making informed investment decisions. Will the general public be able to do the same?

I am not sure what the solution to this problem is. But it is clearly begging for one.