TOPICS > Economy

Pension Gamble

September 25, 2003 at 12:00 AM EDT


PAUL SOLMAN: America’s pension system is in trouble. A prime example: A pension move made recently by General Motors.

We’re going to use the classic business board game, Monopoly, to help explain it.

Over the decades, GM, like many solid companies, promised hundreds of thousands of workers when they retired some 6 percent of their annual income. This so-called “defined benefit pension” was guaranteed for life.

And every year as the employees “passed go” and collected their salaries, GM also put aside money in a pension fund to invest for their retirement.

The key is, how GM invested this money. Not as safely as it could have, in bonds, in the old “community chest,” but by taking something of a “chance.”

Here’s what GM did just this year: Borrowed $200 million for its pension fund at an interest rate of 7.5 percent, and invested the money in stocks. Then, following standard accounting practice, it assumed the stocks would earn their historical average, 9 percent. So GM reported a 1.5 percent profit on the borrowed money, about $3 million, even though it hadn’t yet earned a dime on the money, and would actually lose if the market went down.

This is the kind of move motivating the Bush administration to propose changing the rules of the game.

PETER FISHER: There are some oddities, that’s why we’re in favor of comprehensive reform.

PAUL SOLMAN: Peter Fisher has been the Treasury Department’s point man for pension reform.

PETER FISHER: We have now a system that doesn’t work. It really is broken. It’s like a Rube Goldberg machine with multiple wheels flying off the side, and that complexity is like almost like a shell game — hiding the ball, where is the money?

PAUL SOLMAN: Fisher wants firms to report more openly, salt more money away, afraid that if what he calls “the shell game” continues, we taxpayers will wind up with the tab.

Pensions like those at GM and 33,000 other firms are, it turns out, insured by a government agency: the Pension Benefit Guarantee Corporation. The PBGC charges companies insurance premiums in return for a pension guarantee of up to $45,000 a year per worker.

But the agency is under siege. It’s been taking over more pension promises, or liabilities, than it has money to cover.

STEVEN KANDARIAN, Executive Director, PBGC: The problem is, the liabilities are up a lot more than the assets recently. In the last 30 months, there’s been a $15 billion swing to the bad. We were $10 billion over-funded, in essence, we had $10 billion more in assets and liabilities, and now we’re $5 billion in the red.

PAUL SOLMAN: “In the red”…meaning?

STEVEN KANDARIAN: Means our liabilities are $35 billion and our assets are $30 billion.

PAUL SOLMAN: Actually, since this interview, the PBGC shortfall has grown from $5 billion to nearly $6 billion. The defined benefits pension system it insures is now some $400 billion under-funded. The agency does get whatever is left in the pension fund when a company goes bankrupt, but troubled firms often under-fund their plans.

STEVEN KANDARIAN: And eventually, those plans will come in to us, and if they’re highly under funded, our deficit grows and grows to the point where either with the raise premiums dramatically on the remaining companies in the system, which could drive out the good companies, or in a worst-case analysis, the federal taxpayer has to come to the rescue.

PAUL SOLMAN: The problem is, with pension funds invested in the chancy stock market, they may not have enough in reserve for their future retirees. Since the market’s still well below its highs of a few years ago — when the assumption was the pension money would keep growing.

PAUL SOLMAN: But when this picture worried pensioners about to retire, like 56-year-old former steel worker Melvin Schmeier, they were treated like Chicken Little.

MELVIN SCHMEIER: And we were told, well, if the… “the sky would have to fall before you would lose a big part of your pension.” Well, evidently, the sky did fall, because we’re going to lose it.

PAUL SOLMAN: Bethlehem Steel is the government’s biggest bailout to date. The PBGC took over its $4 billion pension fund, but also assumed $8 billion in pension promises.

And even that’s far less than workers from Bethlehem Sparrow’s Point plant, just outside Baltimore, were expecting. Given the concessions they had made to keep the mill open, in return, they thought, for a better pension.

HARRY GOODWIN: We combine jobs, we took cuts in pay, we bought worthless stock at $32 or $35 a share that we haven’t got nothing for. We were supposed to get that when we retired. I mean, we got raped, in a sense. I guess that’s the best word I could describe it by.

PAUL SOLMAN: Moreover, once the PBGC takes over, its guidelines don’t count the overtime these men work to build up the pay on which their pensions were to be based: 16-hour shifts in a steel mill.

FORMER BETHLEHEM STEEL WORKER: Sometimes you can’t see 20 feet, there was so much coal dirt in the air, and smoke.

PAUL SOLMAN: Could you breathe?

FORMER BETHLEHEM STEEL WORKER: You had to wear a respirator to breath. And in the summertime, it’s so hot up on top of the ovens, you had to wear wooden shoes over your work shoes so they wouldn’t catch on fire. It was actually that hot up there.

PAUL SOLMAN: The work took its toll, especially since everyone had to rotate through swing shifts, working days for a week or two, then nights.

SAM BATTS: I have a slight case of asbestos now, and we have silicosis in that mill, red lung, black lung. It’s a lot of various ailments and toxics all around us. So, in the swing shift, will cut your life expectancy by seven to ten years, I’ve read.

PAUL SOLMAN: These workers retired early, getting pension bonuses to help save Bethlehem. When the company failed, though, the PBGC wasn’t required to honor the bonuses. Harry Goodwin’s deal was for $32 hundred a month, plus health insurance.

HARRY GOODWIN: Last year, December 18, the PBGC took over the fund, and that’s going to knock my pension down to $1,965 a month, plus I’m paying my own medical insurance. I paid $159.27 a month.

PAUL SOLMAN: Larry’s Redemen’s $3,100 promise was cut in half.

LARRY REDEMAN: We lost everything, and we were kicked to the wayside by everybody, the way I feel about it, everybody kicked us to the wayside.

FORMER BETHLEHEM STEEL WORKER: It all angers me, you know, because Bethlehem deceived me, and sometimes I think that they may have wanted to go that way.

PAUL SOLMAN: To you mean to get out of contractual obligations they had to people like you?

FORMER BETHLEHEM STEEL WORKER: Exactly. All the top management, they got off easy. And who gets stuck, the average “Joe Six-Pack,” the average worker loses all the time.

PAUL SOLMAN: Meanwhile, because of the PBGC’S tight rules, some retirees, like Len Shindel, won’t get anything for years.

LEN SHINDEL: I had 29 years and nine months on December 18, when Bethlehem’s plan terminated. And because I didn’t have the 30 years, which are required to receive a pension, I now have to wait until I’m 62 years old to receive it. I’m 53, I’ll be… I was 53 last week.

PAUL SOLMAN: But PBGC’s boss says it was nothing personal.

STEVEN KANDARIAN: That’s unfortunate that people get cut off that close to the goal line, if you will. But that’s beyond our control at the agency. That’s set by law, in terms of what Congress has set for, what kind of benefits we do and don’t guarantee.

PAUL SOLMAN: In fact, the PBGC says it will make good on 90 percent of the Bethlehem claims, only half of which will be covered by the company’s pension fund.

PAUL SOLMAN: And that brings us back to the key issue behind this story: Why there wasn’t enough money in the company fund; why today’s defined benefit pension funds as a whole are some $400 billion under-funded.

So, back to General Motors. Remember that GM, like the steel companies and pretty much everyone else in the system, took a chance on its pension fund by investing in stocks, instead of safer U.S. government bonds.

And for years, the chance seemed to pay off. Stocks performed so well, in fact, GM built up more than enough to cover its retirees. Its pensions were over funded. Having apparently made money on its investments, GM reported it as profit.

Then came the recent stock market swoon. GM’s pension fund went down so much, it became under funded, with too little money to cover the defined benefit obligation. But — the critical but of this story — under-funding need never have happened, says pension expert Zvi Bodie.

ZVI BODIE, Economist: The purpose of the assets in a pension fund is to serve as collateral for the promises that have been made. And for those promises to be truly credible and risk-free, the collateral always has to be at least equal in value to what has been promised.

PAUL SOLMAN: As Bodie argues in a new book, if pension funds are simply invested in U.S. government bonds, they truly guarantee full pension payments to us workers. But that requires putting a way more money up front, which companies have resisted.

ZVI BODIE: The companies have been saying, “look, we’re willing to provide defined benefit pensions, as long as we can invest in something that’s going to provide a high return, relatively high return, so we don’t have to put that much money in to fund it.”

PAUL SOLMAN: That’s the key from their point of view?

ZVI BODIE: That’s the key. And they get the actuaries, who are the professionals, who basically consult on these issues, by saying, “oh, yeah, in the long run, stocks aren’t really risky. So what we’re going to do is…” In other words, they may go down today, but they’re going to, for sure, come back.

PAUL SOLMAN: Well, in fact, stocks over the decades have returned what the pension funds are assuming.

ZVI BODIE: That’s the theory, okay?

And the fact remains that if these companies go bankrupt, okay, which is happening, okay, the assets are worth what they’re worth, and the PBGC inherits those assets, which are not enough to pay for the promises.

PAUL SOLMAN: Mark Ugoretz, however, who represents various corporate pension plans, insists the problem is just temporary.

MARK UGORETZ: As we move out of this recession, these pension plans will continue to earn more and more money. Historically, pension funds have earned anywhere from 10 to 12 percent in the marketplace.

PAUL SOLMAN: So, you mean it’s a temporary phenomenon, as the stock market goes up, everything is okay?

MARK UGORETZ: If the stock markets goes up, things will get better.

PAUL SOLMAN: And if it doesn’t go up? Well, says Ugoretz, if companies were required to fully match tomorrow’s promises with today’s cash instead of investing in the market, they’d stop funding guaranteed plans altogether. Meanwhile, the administration has proposed new accounting guidelines to better reflect the value of pension funds.

PETER FISHER: Some of it will be painful to deal with, companies will have to reach into their pockets deeper, and there may be some workers who won’t get the benefits they were looking for.

ZVI BODIE: People want the impossible, they want a free lunch. The only way you can get a free lunch: Wishful thinking.

PAUL SOLMAN: And wishful thinking, to critics like Bodie, is the key to pension moves like GM, assuming they’ll earn more than enough to cover their promises by investing in the stock market.

Now, in fairness, as we speak, wishful thinking seems to be paying off. Stocks are up more than the 7.5 percent GM had borrowed at. But can we count on the recent trend?

The steel workers remember counting on the guy who promised, even after Bethlehem had gone belly-up, that he would revive the firm.

LARRY REDEMAN: He was going to pull out of Chapter 11, he was going to turn the company around and everything. You know, he had … I mean, that was, I would say, wishful thinking, but …

PAUL SOLMAN: But you wanted to hear it?


PAUL SOLMAN: Wishful thinking, expecting the economy to thrive. Long term, it’s proved to be a pretty useful attitude for American industry.

But the fate of Big Steel is a reminder that wishful thinking can also cause pensions to become under funded.

And if too many companies collapse, it’s the taxpayer that will have to make up the difference.