Can You Afford to Retire?

the end of lifetime pensions?

The traditional lifetime pension -- promising workers a guaranteed percentage of their salary for the rest of their lives -- is vanishing in corporate America. Troubled companies like United Airlines and LTV Steel have dumped their underfunded lifetime pension plans on the federal pension insurance system. Meanwhile, healthy companies like IBM are freezing their lifetime pension plans, replacing them with bulked-up 401(k) plans. Below, industry insiders and other experts talk about the history of the lifetime pension, the current state of pension funding, and whether the system can be fixed. These comments are drawn from FRONTLINE's extended interviews for this report.


David Wray
President, Profit Sharing/401k Council of America

The traditional defined benefit system grew up in a different economic environment. It grew up in a time when American business dominated the world economy. Very large companies especially owned whole segments of the world economy. The American automobile manufacturers were giants compared to anyone else, and they were able at that time to comfortably make very long-term commitments, because they were playing in a United States-only field, and ... you could make these long promises because everybody else was, too.

... That began to change. In the 1970s and 1980s, we talked about how Japan was going to take over. We had tremendous inroads made against American manufacturing worldwide. Competition got very intense. Other countries didn't have the same ... approaches to the labor force, so companies were pushed into a situation where they needed a lot more financial flexibility if they were going succeed long term. More and more companies found that it was difficult to maintain the long-term promise that they'd made.

Along with that was the fact that Congress changed the rules almost on an annual basis for these traditional defined benefit plans. Not only was it harder to look way out and know that you could make your funding promise, but you didn't even know what your funding promise was, because the rules were constantly being tweaked. ... The combination of this global economic competition and the constant changes in the rules made it tougher and tougher for companies to have defined benefit plans.

When we leap forward to today, the global competition is even fiercer. ... You have to have the financial flexibility to spend ... on [a] new redesign of some product, not putting money into a benefit plan. ...

Plus, there was a change in the dynamics in the workforce. The anticipation when these programs were put in place is that people would work in a single company. They would work there for 35 years; they would get a pension and a gold watch. We know today the typical employee works six, seven, eight years at each company. There's a lot of turnover. ... [A] defined contribution plan like a 401(k) is a much better retirement program for somebody who changes jobs several times during their lifetime. ...

In 1980, there were twice as many people in defined benefit plans, the traditional [pensions], [as] in defined contribution plans. That has flipped. There are now twice as many people in defined contribution plans as in defined benefit plans. There's been a complete reversal of what was true 25 years ago. ...

... Some companies are moving from a defined benefit plan to a defined contribution model to save money, because the demographics have caught up with them. In the 1950s, when a lot of young people were hired after World War II, ... a defined benefit plan was very inexpensive, because you had a very long funding curve. You could make very small contributions to the program.

It took a long time for people to work to retirement.

Right, and you had a long time to accumulate money. ... When your average workforce as a whole ages, the cost of the defined benefit plan goes up drastically. ... So yes, they're going to save money, but the reason they're saving money is because there wasn't enough money set aside to take care of this demographic aging of the workforce. ... In the 1990s, many companies with defined benefit plans made no company contributions to the plan whatsoever, so those plans were not costing anything, because the marketplace, the growth in equities was going up. ... Now they're faced with these enormous amounts, and they're looking for alternatives.



Bradley Belt
Departing Executive Director, Pension Benefit Guaranty Corporation

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

We are 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. ...

What's been the record recently? ... Have you had to step in[to] a lot of situations?

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

Our current deficit is about $23 billion. ... 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.

... 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. ...

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

I think about four years ago, you were looking at about $50 billion of underfunding on a settlement cost basis, as compared to the $450 billion today. ... 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.

John C. Bogle
Founder, Vanguard mutual fund firm

[P]rivate pension plans are underfunded by an estimated $400 billion, and the state and local government plans are underfunded by an estimated $800 billion. That's a $1.2 trillion shortfall between the assets the plans have and the liabilities they will have to the pensioners as they pay out their retirement checks over the rest of their lifetimes.

How do they get away with that? Don't they have to fund them?

No, they don't, because a lot of it is based on assumptions. Our corporations are now assuming that future returns in their pension plan will be about 8.5 percent per year, and that's not going to happen. ... Why? Because when they do it that way, corporation earnings become greatly overstated, and all the executives get nice, big bonuses. They are using pension plan assumptions as a way to manage corporate earnings and meet the expectations of Wall Street.

So if a company overstates the value of its pension plan assets, it makes the company look better to Wall Street, so there's an incentive to kind of exaggerate, if not cheat.

That is precisely correct. And let me [be] clear on the cheating: It's legal cheating; it's not illegal cheating. In other words, you can change any reasonable set of numbers -- and corporations have done this, have raised the pension assumption from 7 percent to 8.5 percent -- and all of a sudden that corporation will report an earnings gain for the year rather than an earnings loss that they would otherwise have. Simple, legal.

Bradley Belt
Departing Executive Director, Pension Benefit Guaranty Corporation

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. ...

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? ...

...[T]he 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. ...

Elizabeth Warren
Professor, Harvard Law School

You have to remember who wrote [ERISA]. Our representatives in Washington got together, largely with the companies they were going to regulate, and they wrote a statute that wasn't one that the employees were happy about; it was one that the companies would be happy about.

What that meant was maximum flexibility for the companies. Maximize the number of tax breaks they get, and maximize the control they are going to have over that money so that they can use it for whatever business purposes they want to use it for, and not be in violation of the law. ... That was the whole design.

Bradley Belt
Departing Executive Director, Pension Benefit Guaranty Corporation

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. ... 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? If a company has assets in its retirement plan, ... it's investing them over time. ... I'm just wondering if it's proper to link the credit balances concept with the gains in the stock market in the late '90s?

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. ...

Elizabeth Warren
Professor, Harvard Law School

Let's just be as blunt as we can. They got away with it because the regulators let them get away with it. In all those years in the '90s, when we were doing well, when it was boom times, the big companies kept a sharp eye on what pleases the investors. ... It did not please the investors to put money aside for the employees, and so the big corporations simply didn't do it.



Bradley Belt
Departing Executive Director, Pension Benefit Guaranty Corporation

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.

David Wray
President, Profit Sharing/401k Council of America

... There is pension legislation in Congress right now that deals with the funding of defined benefit pension plans. It's uncertain how those issues will be resolved. A lot of companies are watching that carefully, and so if you put the two together, you might have action. ...

Are you saying that if Congress significantly tightens the rules to really push companies to fund their defined benefit plans, companies are going to bail out of those plans?

Companies are in a particular position because of past laws, and if Congress changes the law and does not give companies a sufficient transition period to deal with those changes, the companies will have no choice.

John C. Bogle
Founder, Vanguard mutual fund firm

Sooner or later we've got to get some sense of reality, and it begins with accounting rules. We have to have much stronger rules on what kind of future rates of return you can assume, how often you have to report the value of your pension plan. Do you realize that in corporate annual reports, they don't even have to report the returns in their pension plan? ... I think we need much better disclosure. On the other hand, ... that's going to make companies very leery of continuing their pension plans simply for, if you will, accounting reasons.

Bradley Belt
Departing Executive Director, Pension Benefit Guaranty Corporation

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. ...

Elizabeth Warren
Professor, Harvard Law School

Well, many people think the defined lifetime benefit plan is going the way of the dodo, a cheerful offshoot that lasted for a while but is gone. But ... unlike the dodo, it's not gone because of natural forces. It's gone because Congress wrote a series of laws that killed it off. It's taken 30 years from ... the bankruptcy laws and the ERISA laws, but the combination will get rid of the defined benefit pension plan. It will be gone.

John C. Bogle
Founder, Vanguard mutual fund firm

But this is really the thing that's most bothersome of all: All of our retirement system is faltering. We all know that Social Security is faltering. We all know that state and local governments are faltering, not just corporations. And we all know that the corporation pension plans are faltering. We know that 401(k) is faltering, and we know that people aren't making nearly adequate use of individual retirement accounts [IRAs]. We have a system that is troubled, and I don't see that our administration or our Congress is giving it the attention that it really has to have. I don't think anybody has a crisis kind of an attitude towards this. ...

The perfect storm comes into New Orleans, and the citizens of this country are going to pay something like $100 billion to repair the damage from Katrina. I would say that $100 billion would be cheap to repair the damage to our retirement system. I think it's going to cost more than that.

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posted may 16, 2006

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