Can You Afford to Retire?

bradley d. belt

photo of belt

Bradley Belt is the departing Executive Director of the Pension Benefit Guaranty Corporation (PBGC), the federal corporation responsible for insuring the pension plans of private companies. In this interview, Belt discusses the role of the PBGC, its growing budget deficit as more companies unload their underfunded pension plans and the challenges facing employees as they plan for retirement. This is an edited transcript of an interview conducted on February 10, 2006.

PBGC, the Pension Benefit Guaranty Corporation -- ... what is your agency about?

We act as the backstop for pension promises made by private-sector employers. In some respects, we are similar to the FDIC, the Federal Deposit Insurance Corporation, for the banking system. Any time you go into a bank, you see that sticker, "Deposits insured by the FDIC." We're the guarantee entity for pension promises that private-sector employers make to their workers and retirees.

When do you become engaged? What triggers your action?

When does the insurance coverage kick in? That happens when a pension plan is terminated and there are not sufficient assets in the pension plan to cover the benefits that the company has promised to its workers and retirees. In that case, PBGC will step in to make up the difference, subject to limits established by Congress and law. That is, not all the benefits that have been promised may be guaranteed. ...

In other words, the only reason you get called in is because [the pension plan is] not properly funded. Is that right?

We are irrelevant, even if the company defaults and goes out of business, if there are sufficient assets in the pension plan to cover the promises the company has made to its workers and retirees. ...

The funding rules that Congress has enacted don't actually require companies to fully fund their pension promises.

What's been the record recently? ...

In 2005, I believe we had about 120 plan terminations; that is, terminations that PBGC initiated to protect the insurance program or that companies themselves initiated -- what is known as the distress termination process. They determined they could not afford the benefits that they had promised to their workers and retirees. We had about 269,000 [pension plan] participants that were impacted by those decisions.

What does that mean in dollar terms?

It really varies from plan to plan. In the vast majority of plan terminations, the amount of underfunding may be relatively modest -- in the millions or tens of millions of dollars -- but it can be extraordinarily large in some cases. The largest claim to date by far was that of United Airlines, where the total amount of underfunding in their pension plans exceeded $10 billion, and the losses to the insurance program exceeded $6 billion.

What kind of bill does that put in the lap of your agency? ...

Our current deficit is about $23 billion. That's what we reported at the end of our last fiscal year. And that's just a snapshot, comparing the assets we have right now balanced against the promises that we are obligated to fulfill. ... The Congressional Budget Office last year issued a study looking at the long-term cost of the insurance program, and I believe they estimated that the program could cost as much as $142 billion over the next 20 years.

That's an enormous funding gap. ... Is this money that is being paid by taxpayers?

It is not. Although we are a wholly owned government corporation, we do not receive any taxpayer revenues. Our obligations ... are not backed by the full faith and credit of the United States government. We are financed primarily by premium revenues that come from all the plan sponsors in the system. In addition, we assume responsibility for all the assets that are in pension plans. When those plans are terminated, we use those assets to pay out the benefits that the companies have promised. ...

... But is there sort of a sword of Damocles hanging over the taxpayer that, in the end, if there are not enough premiums, it's going to have to come out of general tax revenues?

... To the extent that we run out of cash at some point in time and would no longer be able to cut benefit checks, Congress would be presented with a question: ... Does the PBGC just shut down because it's insolvent, or do you need to step up with taxpayer revenues or other monies? ... We have a $23 billion deficit now. We don't have, under current law, the ability to fund that deficit. The administration had proposed premium increases sufficient to begin to bring down that deficit, ... but if that doesn't happen, then monies are going to have to come from elsewhere. ... There is no money tree. There's no free lunch here.

The worry from a number of people, even people who advocate fully funding the pension plans, is that if the rules are tightened too far, that more and more companies will ... simply say, "Well, if we really have to do it, then we're not going to offer the benefit." Is there a risk [that] you're going to tighten the rules and force more and more companies out of the whole system?

... There's ultimately a balancing. What we're saying is, "Companies, if you made promises to your workers and retirees, fund those." If what they're saying is, "Well, if you actually make [us] fund the policies, we're not going to make the promises," I think we'll have to see how that plays out in the marketplace. ... We've estimated the total underfunding of the system on a settlement cost basis as $450 billion. It would be very costly for companies to actually exit the system, because they would have to either pay off lump sums or go to [an] annuity provider to settle those obligations, and that's the amount of money they would have to come up with. ...

You're saying that the current corporate pension system in the private sector today is underfunded by $450 billion?

That's if everybody were to try to terminate their pension plan today. ... It's unlikely, of course, that everybody would get out of the system at the same point in time.

That's a lot of money. Do you know, historically, whether the pension system has ever been this far underfunded?

The level of underfunding in the system as a whole, which we estimate at $450 billion today, is substantially more than it was just four or five years ago. It was less than $100 billion then. ... There's no question that the risks to the insurance program, however measured, have increased fairly significantly over the past few years. ... We have certainly experienced, in recent years, by far the largest plan terminations ... in the agency's 31-year history. In the first 28 years of the agency's existence, I think we had fewer than a dozen instances of plans that terminated with more than $100 million of underfunding. There have been, I believe, 28 such plan terminations in just the past three years. ... Of the 10 largest corporate pension defaults that this agency has experienced, at least eight or nine have occurred just in the past three or four years, if not all 10.

What's going on?

It's a combination of factors. It's primarily driven by the fact that the funding rules that Congress has enacted don't actually require companies to fully fund their pension promises, and when you had a downturn in the equity markets beginning in the spring of 2000, combined with falling interest rates, the funding gap widened fairly quickly over a short period of time. That gap has largely persisted since that point in time.

There are certain features of the current rules which have effectively allowed companies to avoid having to make up that gap. When companies get into difficulty, they will look to say, "Where are all my costs?," and, "Gee, I have a lot of cost here in these 'legacy' promises -- pensions and such -- that I've made to my workers and retirees. I can no longer afford those now that I'm in financial difficulty. Perhaps I can shift those costs to other parties."

It sounds as though if you're the insurance company for these companies, there's almost an incentive, if you're in trouble, to turn it over to the government agency and let the [PBGC] pay it.

There is what economists call a "moral hazard" that exists throughout the insurance system. ... It would allow you to take risks and when those risks cannot pan out, be able to collect on an insurance claim. That's true with homeowner's insurance, auto insurance, health insurance. That's why you have things like risk-based premiums. That's why you have things like underwriting standards in well-designed insurance schemes.

We are lacking some of those basic protections in the federal pension insurance system. ... There may be occasions when companies, and even labor [unions], have incentive to promise higher pension benefits rather than current wages, because they know that they have the backstop provided by the PBGC.

You mean both union and management can be thinking, well, we can promise more, and if we can't pay it, the government's going to pick up the tab?

... What goes on in the heads of management or union officials I can't attest to, but you certainly saw an example in United Airlines back in 2002. This was after 9/11. The company was already in some financial difficulty, and the company's pension plans were already substantially underfunded. The company and one of the unions negotiated several hundred million dollars of new benefit promises. ...

But you've also got the CEO of the company at that time saying, "United Airlines will perish unless the bloodletting stops."

Again, I can't speak to what the CEO was saying or thinking at that point in time, but the fact of the matter is that [if] you're in financial difficulty, cash is king: "We don't have money to provide in terms of additional wage compensation, but what we can do is provide more pension promises."

Sounds pretty cynical.

I'm not attributing motives to anyone. What I'm suggesting is that that's what the system allows. There aren't sufficient protections in place. That's one of the reasons why the administration, in its reform proposals this year, says: "Let's stop digging the hole deeper when you've already dug a deep hole. Let's not allow companies to make new pension promises when they haven't funded the old ones." ...

The ERISA [Employee Retirement Income Security Act] law that was passed in 1974, under which you operate, wasn't it designed to protect pensions and ensure that they would be there? How is it possible that a company like United can underfund its pension by $10 billion?

Because the funding rules under ERISA are fundamentally flawed. They are riddled with loopholes. That's why the administration put forward legislation last year that would strengthen the funding rules and eliminate those loopholes.

... What do you mean, "flawed" and "loopholes"? You mean Congress wrote a law that said, "Fund your pensions," and then, in effect, gave them a free pass?

I'm not sure you would characterize it as a free pass, but nonetheless, it does not require, the way it operates, companies to fully fund their pension promises. That's demonstrably the case. United is an example of that. Bethlehem Steel is an example of that. US Airways is an example of that. Kaiser Aluminum is an example of that. Whether it's provisions like credit balances, the smoothing of asset liability values, there are a host of things that have allowed companies to effectively take contribution holidays for years on end, notwithstanding the fact that their pension plan may have been underfunded and the funding gap may have been widened during that period of time.

You used the term "credit balances." What is a credit balance? When a company is funding its pension plan, isn't it putting cash into the plan every year? ...

It may be required to put in cash; it may not be. ... It depends on whether they have a credit balance available. Sometimes companies are able to generate credit balances if they put in more than the required minimum amount in any given year. ... If you were required to put in a million dollars and you put in $2 million, you generate a credit balance that you can use to offset future contributions. ... So there are companies that built up, particularly during the 1990s, very large credit balances, notwithstanding the fact that the asset values declined, in some cases precipitously, ... from 2000 through 2003. ...

So credit balances are phantom money?

In some respects that's right. ... If you looked at the United Airlines pilots' [pension] plan, I don't believe that they had put in any money ... since 2000, and they were not required to do so because of credit balances that had been built up, notwithstanding the fact that the pension plan was by that time underfunded ... and the funding gap was widening, and the company was getting into financial difficulty. That's the reason the administration [has] proposed eliminating credit balances.

The stock market plays a role here, right? ...

The point to understand here is that everybody, I think, became addicted to the stock market returns in the 1990s. We [had] essentially taken what is clearly a cost item, ... deferred compensation for work that has already been performed, ... and through the magic ... of pension accounting rules turned it into a profit center. ... People came to view their pension promises as being able to generate profits on the income statement, ... and it created its own set of perverse incentives. ...

... So companies are using stock market gains on the assets in their pension plan to make it look like they're making more profits to Wall Street?

That's what the current accounting rules allow. ... What had been an expense item was actually a profit center. One of the interesting aspects of pension accounting is that you're able to book your future returns, notwithstanding the fact that you haven't realized those returns. ... That's like saying, "I'm going to sell 100 widgets next year, because that's my historical experience," even though ... you only end up selling 80. It makes no sense. ...

What's the problem overall? How big is the overhang of credit balances?

I don't know the total dollar overhang. It would clearly be in the tens of billions, if not hundreds of billions of dollars in the aggregate, and maybe in the tens of billions of dollars for individual companies. ...

You referred to pensions as payment that's been earned by the workers. Some have said that companies are in effect borrowing money interest-free from their employees. What's your take on that?

That is essentially how the system works right now. There is work that has already been performed, and the company says: "Rather than paying all of your compensation at that point in time, we are paying [a] portion of it in current wages, and a portion of it we will defer paying until a later point in time. Once you retire, then we'll start paying some additional monies to you."

The issue is, how do you fund those obligations? The company could set aside enough resources at that point in time to fully [fund] that liability that has to pay out. ... If it doesn't fully fund that promise, it is, in effect, borrowing from its employees on a no-interest-cost basis.

Let's discuss these large defaults that you've talked about. Almost every one of those is connected with bankruptcy, isn't it? Or the bulk of them are?

The typical way in which companies terminate their pension plans in underfunded status is through the distress termination process in bankruptcy. There are occasionally terminations outside of bankruptcy, but those are relatively rare.

Is there a conflict between the bankruptcy law and the ERISA retirement law? It looks as though the bankruptcy law gives companies the right to override these obligations that they've undertaken.

There are a number of examples where the Bankruptcy Code and ERISA collide and do not interact very well. ... When a company fails to make contributions to its pension plan, if they're not bankrupt, PBGC is able to step in and enforce a lien for the amount of missed contributions. However, when the company is in bankruptcy, there are automatic stay provisions that kick. ... That is, when a company fails to meet its contributions in bankruptcy, there is no meaningful consequence.

So you're saying that bankruptcy law trumps the ERISA retirement law.

At least as it's been interpreted by bankruptcy courts. Another example: ... There is a provision in ERISA that establishes the amount of PBGC's claim. ... The bankruptcy courts have ... ignored those provisions of ERISA and gone through their own process to determine the claim amount.

Do the employees and does your agency, PBGC, have a seat at the table in the bankruptcy proceedings?

We do. We are often the largest creditor, albeit an unsecured creditor. We are typically on ... the official committee of unsecured creditors. We tend to be very actively engaged in these matters. ... [But] we are at the bottom of the totem pole. ... We come behind all the secured creditors. ... The secured creditors get the lion's share. ... It's after they've divided up the pie that the general unsecured creditors, of which PBGC is one, get whatever remains. Our recovery typically is in the order of 5 to 7 cents on the dollar, whereas you may get 90 cents on the dollar for the largest, the most secured creditors. ...

So the banks have loaned money to the corporation. The employees have loaned money, in effect, to the company through their deferred payment, [their] pensions. But the banks get paid back 95, 96, 97 percent, and the employees get paid back 5, 6, 7 percent?

... It's the way the Bankruptcy Code allocates priorities right now. That's how Congress has set up the system. That's how our capital markets function. There are consequences to changing that. ... The question is, would credit [for distressed companies] dry up if you had a different set of rules? ...

Are you aware that there are a number of other nations which say in bankruptcy companies have to satisfy their obligations to employees before they can deal with any other creditors?

There are countries that have that. ... In the Netherlands, they don't have any federal backstop at all. They simply require that companies keep 105 percent of assets to cover the promised benefits, and they rigorously enforce those funding requirements, so there isn't any need for [a] federal backstop.

One of the things we've seen is these bankruptcies that affect pension plans throughout industries. Steel and the airlines have been a couple that are pretty salient. LTV [Steel] was one of the first really big steel companies to go under after 2000. ... What was the significance of that case? ...

There were a couple things that were notable about the LTV case. The first is its size. There were a large number of participants affected. The amount of [pension] underfunding was about $2 billion, which I believe was the largest claim in the agency's history to that point. It's now, I think, the fourth largest claim; [it's] been superceded by United Airlines, US Airways and Bethlehem Steel.

It was also notable because it led to a Supreme Court decision that was very important from the agency's perspective. The Court ... said that the PBGC had the authority to step in and take action to address certain abuses of the insurance program that occurred. ... Essentially, the company had offered a set of benefits following plant terminations that were designed to make up for all the insurance losses, and the PBGC stepped in to restore [the original] pension plan. ...

The other thing it signaled was what could happen in a particular industry sector if a key player was able to offload a significant portion of its labor cost under the federal pension insurance program. That put extraordinary competitive pressure on all its rivals and ... became a bit of a domino effect in the steel industry. You've seen that play out to some extent in the airline industry as well.

[And] what's the significance of the United Airlines case?

I think the United case is important for a couple of reasons: one, its size. The loss to the insurance program is almost three and a half times what we had in LTV. It's by far the largest claim in the agency's history. The total amount of underfunding, as I mentioned previously, was about $10 billion. The loss to the insurance program [was] over $6 billion, [with] $3 billion of lost benefits to the participants in the United pension plan.

But perhaps more importantly, it really exemplifies the problems that exist under current law, ... and that's why the administration is so committed to strengthening these funding rules, addressing the problems that we can see very visibly in the United case and making sure that we don't get to that point again. If the funding rules worked, you would not have had a situation where a company could present a $10 billion [under]funded benefit liability to the pension insurance program. We need to change that.

As the United bankruptcy unfolded, late in the game it became apparent that United was going to default on its pension plans. ... At some point here, PBGC moved in and actually negotiated with United and terminated the plans. What did you do, and why?

The settlement agreement that PBGC entered into [with] United was fairly late in the bankruptcy process. ... This followed the company's decision to seek termination of all its pension plans, and ultimately reflected the fact that that's what the Bankruptcy Code and ERISA allow. They allow companies to seek to terminate their pension plans if they can demonstrate to a bankruptcy judge that they would not be able to emerge from bankruptcy with those plans intact. ...

We've talked to all the major unions at United. One of the things the flight attendants have contended -- and they cite your agency as support -- is that United could have afforded financially to continue funding the flight attendants' pension plan and that they should not have had their pension plan ... defaulted on, as the others [were]. Is it correct that at one point PBGC said that United could afford to sustain the flight attendants' plan?

We had advised the bankruptcy court back in December of 2004 that based on the information that was available at that time -- the market conditions, the company's business plan -- we thought the company could afford to maintain one or more of its pension plans. As you may recall, [the] situation or conditions deteriorated continually over the next several months. The company lost about a billion dollars that quarter; fuel prices continued to go up fairly rapidly. ... And at that point in time, it became fairly clear that the company would meet the distress determination criteria under current law.

I feel very strongly for the flight attendants and for workers and retirees in every pension plan that is terminated. That's why we need to change current law. That's why the administration is so committed to making sure that companies set aside enough resources to fund their pension plan so this doesn't happen.

Have you had cases where, in fact, a company had multiple pension plans with different categories of employees, and some of them have been terminated and others have not been?

There have been cases.

So why couldn't that have happened in the United case?

It depends on the facts and circumstances in a case. I understand the angst and the anger felt by the flight attendants, as well as other employees. ... There have been multiple, multiple lawsuits on this, [and] the courts have upheld the decision made by PBGC as being ... in the best interest of the pension insurance program and all its stakeholders, and that the actions taken by United fully complied with bankruptcy law and ERISA. ...

Another big issue in the United case was the executive compensation: what share of the stock of the new company coming out of bankruptcy would be held by management. Initially, the United proposal was 15 percent. What was your reaction?

I didn't have a reaction. My role is not to set levels of executive compensation for [the] private sector. ... I believe the unsecured creditors committee took the view at the time that that compensation was excessive, but I wasn't sitting on the unsecured creditors committee, so I don't know the conversations that occurred around that.

What's interesting is that LTV is a liquidation; the company disappears, gets sold off. United Airlines is a reorganization; the company re-emerges. But in terms of employees and their pension plans, it doesn't make any difference whether or not the company is liquidated or whether the company is reorganized. The employees still lose their pension plan and their health benefits for retirees.

There's a different situation, obviously, presented in a reorganization ... than a liquidation. ... I think one can certainly make the argument that the insurance should only kick in if there's a liquidation. ... That's not current law, however. Current law contemplates that companies can emerge from the reorganization, emerge from Chapter 11 without their pension plans, having shifted those obligations onto the federal pension insurance program, with all the adverse consequences for workers, retirees, other companies that have acted responsibly, and perhaps the taxpayer.

... In many respects, ... it's too easy to kind of come in, land at the PBGC's doorstep, offload some of this baggage that you don't want, and take off again. ... It's another example of the moral hazard, of the perverse incentives that exist in the pension insurance system. ...

Where are we, more broadly, looking at the retirement situation of Americans? You have major companies like IBM and Verizon -- profitable companies which have for years been providing lifetime pension guarantees to their employees -- freezing their plans. And there have been others before: Hewlett-Packard, Motorola, ... some of the premier companies in America. This was a retirement system that built up over decades. What does it mean, as we look forward as a nation, to retirement and income security for the baby boomer generation?

I don't think we know yet. Clearly we have a challenge, as a nation and individuals, to set aside enough resources to meet our future obligations and commitments, and we haven't been doing that. We have a negative individual savings rate.

... We need to look at strengthening all our retirement systems, whether it's Social Security, whether it's defined benefit pension plans, whether it's defined contribution pension plans, whether it's individual savings mechanisms like IRAs, or, [as] has been proposed by the president, lifetime savings accounts. ... There are a lot of things that we need to be doing to make sure we begin to provide today for our future obligations and commitments. ...

You've heard David Walker, the comptroller general, talk about the fact that as a nation, we have $44 trillion of unfunded obligations if you look at Social Security, Medicare and a host of other programs. That's a challenge that we, as a nation, need to begin to grapple with.

... As you see the system that you're overseeing and insuring eroding, either through bankruptcy or through freezes, what are the implications for tens of millions of Americans and for the country as a whole?

If they save enough through defined contribution plans or ... through other mechanisms, and they prudently manage those assets, then there may not be any adverse implications. If they don't, then there may be adverse implications for individuals and the nation as a whole.

One of the powerful features of defined benefit plans is the mutualization of longevity risk. Some people will ... live to be 90 or 100 years old, and they can continue to collect those benefits. Others will die, unfortunately, much earlier, maybe in their 60s. They won't collect any benefits. But defined benefit plans mutualize those risks.

Spread them out.

That's right. Defined contribution plans don't do as good a job at that. You can obtain those benefits of mutualization if you buy annuities; that's choice right now. ... The fact of the matter is defined benefit plans used to be much more pervasive. They used to cover about 40 percent of the workforce. They cover less than 20 percent today, and that's all happening under current law. There's been a steady erosion out of defined benefit plans over a period of time, but even ... back 20 years ago, they didn't cover more than half the workforce. ...

We should be looking to encourage some form of defined benefit plan as part of an overall retirement security fabric, but ultimately it's an issue of what do employees want? ... Are employees demanding defined benefit plans? ... If the best and brightest workers do so, then ... companies will have to offer that.

One of the things we keep hearing ... is that 401(k) plans and defined contribution plans were, by and large, introduced as a supplement to the defined benefit, lifetime pension plan, not as a replacement for [it]. The worry ... is that 401(k) defined contribution plans are now being put in as a substitute, and they are not as sturdy a vehicle.

I think there is a misconception out in the marketplace that ... defined contribution plans are inherently more risky than defined benefit plans or [vice versa]. Neither of those [is] true. Both depend on how the programs are designed. ... You can offer a very generous defined contribution plan. You can offer a very low-cost defined benefit plan.

[But] you've got companies like IBM freezing their plans and converting; they say, "We expect over the next five years to save $3 billion." So theoretically what you're saying is true, but in fact that's not the case. The companies themselves are saying they expect to save substantial amounts of money, running into the billions. ...

I think perhaps too much of the emphasis is placed on deferred compensation. It appears that companies are re-evaluating more broadly their overall cost structures, trying to ... be competitive in today's competitive global marketplace. Certainly companies that have offered defined benefit plans are looking at characterizing those as a legacy cost: "Can we continue to promise the same level of benefits we promised in the past?" Many of them appear to be concluding that the answer to that question is no.

Where does that leave the retirement structure? It leaves an increasing share of the burden and, if the current trend continues, maybe all of the burden on the individual employee.

Individuals need to take responsibility for their financial futures. There's no question about that, regardless of whether they participate in a defined benefit plan or not, because a defined benefit plan may not provide a level of adequate financial security. ... They need to take advantage of employee matches and other retirement saving vehicles, set aside some resources to make sure that you're going to be able to enjoy the lifestyle you want when you retire.

... But the expectation was that the employer would provide for employee health care and pension, to some degree, in retirement. That expectation now has changed.

But it's not just an expectation from the employer side. I think it's also an expectation from the employee side. I'm not sure how many employees, when they enter the workforce, expect to be working for the same employer for 20 or 30 or 40 years. ... They want greater mobility. They need a retirement structure that accommodates their needs, interest[s] and concerns. The market was responding to that with structures like cash balance plans that married up the best aspects of defined benefit plans and 401(k)s. That'swhat we need to focus on. ...

... But there are real needs out there, Brad. The question is not what their expectations are. The question is, if people want to live at roughly the same standard of living they've had while they were working during their retirement years, are they in the next 10 years going to be as well off as their parents were 10 or 15 years ago?

That depends on the actions that they take now. If people don't set aside, if we as a nation and individuals ... don't step up to the plate, then there will be problems. That's why we need to take action now to strengthen all retirement systems. We can't continue, obviously, to persist with a negative savings rate. ... You can't consume more than you have in savings and have that be sustainable over a long period of time. ...

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