The Pensions Funding Gap

Jack Rasmus

A PENSION CRISIS of major dimensions is growing in the United States across all three forms of defined benefit plans (DBPs) — public, private single-employer, and private multi-employer plans.

Corporate America and its political friends have begun to use the economic crisis that commenced in 2007 as an opportunity to initiate and expand yet another offensive, aimed at further undermining defined benefit pensions. Having already begun in 2009-10 with a new attack by governors on public employees’ pension plans, the corporate offensive over the subsequent 18 months has expanded to new coordinated attacks on private sector multi-employer and single-employer DBPs.

The dimensions of the DBP crisis is represented by the declining ratio of pension assets to liabilities. DBPs ratios in general have been progressively declining over the past decade. That decline has accelerated since 2007. But the crisis in pensions and the declining ratio of assets to liabilities has had nothing to do with benefit increases for the workforce, whether public or private, single or multi-employer. In many cases benefits have been frozen or reduced over the past decade, and especially so since 2008.

Rather, the crisis in DBPs has had everything to do with government and corporate policies over the past 30 years. These destructive practices have been intensifying in their impact on pensions during the past decade, particularly since the passage of the so-called “Pension Protection Act” in 2006 with stagnant jobs and wage growth for a decade, massive speculative investment losses by pension funds during the past decade and especially since 2007, the collapse of the economy in 2008, and the failure of the U.S. economic recovery to restore jobs and wages the past three years, 2009-12.

Brief Overview of the Funding Gap

Multi-employer plans are defined benefit pensions that are widespread in the construction, transport-trucking, retail and hospitality industries. A 2009 Report by the Pension Benefit Guaranty Corporation (PBGC), the quasi-government agency responsible for ensuring pension funds stability and solvency in the private sector, indicated that multi-employer plans that year had liabilities (i.e. benefit payout obligations) of $686 billion but assets (funds) of only $331 billion. That constituted a funding ratio of only 48% and a shortfall of $355 billion.

While that gap has improved somewhat, the overall funding ratio for multi-employer plans remains well below pre-2000 levels. Their steady deterioration has been a general rule over the past decade.

That funding shortfall of $355 billion in 2009 compares to a much smaller shortfall of $205 billion in 2008. Simple arithmetic leads to an obvious conclusion that the $150 billion additional shortfall in one year must have something to do with the collapse of the economy from late 2008 through 2009.

From 2004 through 2008, the shortfall annually held steady at about $200 billion on average, before nearly doubling to the $355 billion in 2009. Before that, in 2002, the shortfall was only $100 billion, less than half of 2002. And the year earlier, in 2001, it was $50 billion. In the latter half of the 1990s it averaged only about $30 billion.

A similar scenario applies to ratios and shortfalls in funding for single-employer pensions. A recent Standard & Poor’s report on pension funding for the 500 largest U.S. corporations shows a shortfall last year of $450 billion. About $43 billion of that sample of 500 come from corporations that participate in multi-employer plans, like Safeway Stores, and that number is part of the multi-employer pension shortfalls noted above. So the single-employer pension funds among the S&P 500 have a net shortfall of about $400 billion.

Private single-employer plans have also deteriorated for reasons of weak job and wage growth, exacerbated by a jobless recession from 2001-06 and the deep job and wage declines from 2008-10, as well as various additional factors to be noted below.

The highly respected Pew Center’s report for 2008 estimated that year’s public sector pensions gap at $452 billion. State plans were still a relatively healthy 84% funded, according to the Pew Report. (In 1999, they were 103% funded.)

In 2009, as the economy collapsed and state revenues with it, the ratio fell to 78% and the shortfall among states amounted to $660 billion. The shortfall continued to rise in 2010 but at a slower rate.

Public DBPs have been particularly impacted by the post 2007 economic crash and the chronic slow economic recovery. More than 600,000 public workers have been laid off, and wages of the remaining employed in many instances reduced, resulting in a devastating impact on pension contributions. Years of borrowing from the pension funds to finance health care costs, expenditures of billions of dollars on so-called “consultants and advisors” to public pension fund managers over the decade, and in particular deep losses after 2006 as a result of speculative investments with partners like hedge funds and private equity firms, have all devastated public DBPs.

Fundamental Causes of the Crisis

The deterioration in defined benefit pensions over the past decade — whether single, multi-employer, or public employee — has had virtually nothing to do with providing more generous benefits for workers. Nor are workers retiring in greater numbers all at once. The problem is on the “assets” or pension fund contributions side, not the “liabilities” or benefits payouts side.

Nevertheless, politicians, the press, and even a good number of pension fund managers (especially the company representatives) are intent on reducing the pensions funding gap by cutting benefits instead of addressing the real causes that lie on the insufficient assets-contributions side of the ledger.

The following is a partial summary short list of 17 reasons underlying the problem of insufficient contributions and assets, that in turn explains much of the pension fund asset shortfalls and falling ratios:

1. Two recessions since 2000 and two bouts of “jobless recoveries” (2002-05 and 2009-12) resulted in falling contributions to the funds.

2. Structural unemployment due to offshoring and free trade has reduced contributions in many industries, especially technology and manufacturing.

3. Pension surplus “skimming” in the 1980s and constant “pension contribution holidays” since the 1990s have lowered the contributions base of the pension funds.

4. Single employer and public employer manipulation of actuarial assumptions, such as phony overstated rates of return and projected hirings that never happen, covered up the growing pension shortfalls.

5. Rules since the 1990s have allowed the diversion of pension funds to cover 20% of rising employer health care insurance costs.

6. A deep depression in the construction and transport sectors over the past decade has intensified since 2007, with devastating effect on multi-employer plan funds.

7. De-unionization of the workforce has further allowed employers to exit multi-employer plans, further reducing contributions — similarly for unionized single employer plans and, increasingly as Republican governors get their way in many states, for public employee plans as well.

8. U.S. job markets have shifted to part time and temp “contingency” jobs for tens of millions of workers, who are excluded from participating (and thus contributing) to DBPs.

9. Government policy now emphasizes growing 401K plans, and encouraging and subsidizing employer shifting from defined benefit pensions to 401K and other defined contribution plans.

10. Legislation and court decisions over the past decade have promoted and permitted “Cash Balance Plans” as convenient hybrid transition forms from defined benefit plans to 401Ks.

11. Phony business bankruptcy policies have permitted easy dumping of pensions on the PBGC, the Pension Benefit Guaranty Corporation that ensures DBPs.

12. Easing of restrictions facilitate companies leaving multi-employer plans, and single employers exiting the PBGC.

13. The Pension Protection Act of 2006 allowed pension funds to partner with high-risk speculators like hedge funds, resulting in pension funds’ headlong rush into speculative investing in subprime mortgages and other high risk real estate and financial markets, the consequence of which was massive fund losses in 2000-02 and again in 2008-10.

14. Low rates of return in general over the last decade on investments by pension funds, attributable largely to protracted recession after 2008 as well as the Federal Reserve Bank’s policy of zero interest rates for four consecutive years now, has forced many pension funds to seek and take high risk investing, as they try to “chase” the necessary 7.5% rate of return on investment.

15. Funds are drained by the practice of paying excessive million dollar fees to pension advisers and consultants, especially in the public sector.

16. New financial regulations introduced in 2010, requiring valuation of funds at actual market value, exclusive of smoothing and fraudulent actuarial assumptions, have “torn the veil” from the exaggerated assumptions of pension fund earnings, forced funds to value at actual market rates, and thus opened up even greater funding gaps.

17. Corporations have been allowed to divert retained earnings, which should otherwise have been contributed to their pension funds, and are used instead to buy back company stock and make dividend payouts.

Corporate Manipulation of the Gap

Corporations have not hesitated to take advantage in recent years of the funding gap that they (and politicians) have worked to create over the past three decades. The deep problems of the U.S. economy over the past decade and especially since 2007 have exacerbated the collapse of contributions to the funding gap, as jobs and wages have both declined steeply and then failed to recover for the past four years.

Seeing the opportunity to exploit the funding crisis of DBPs, corporate America has intensified its offensive. On the multi-employer side, the manipulation is evident in a series of banks’ reports claiming that the funding gap is even greater than it is.

The battle revolves around pension assumptions, in particular about rate of return on pension investments. By making extreme low-ball assumptions on returns, banks’ research departments and corporations argue that the gap for multi-employer plans is significantly higher than the PBGC has even estimated. Their conclusion is that major reductions in pension benefits are required — even though benefit payments are not the source of the problem.

This strategy of overestimation of the funding gap, by cherry-picking the worst assumptions and then extrapolating the losses in a straight line out for decades, has been adopted as well by public DBPs, state politicians in general and Republican governors in particular.

An extreme over-exaggeration, alarmist case is New Jersey governor, Chris Christie, who has estimated a $2.5 trillion funding gap in 2010. Christie’s answer to the shortfall in New Jersey is a massive gutting of public employee pension benefits. Christie fails to explain, however, how a total benefits increase of only 0.6% in 2010 for public workers somehow added $1 trillion to the combined states’ pensions shortfall.

Christie also conveniently ignores the fact that his state, New Jersey, only made 31% of the required contributions to its employee pension fund in 2009 (in contrast to New York’s 100%), thus contributing significantly to its relatively low funding ratio of 66%. That ratio was worse only in Illinois, with a 51% ratio, and West Virginia and New Hampshire — also dominated by Republican governors — with ratios of 56% and 58%.

In other words, those governors complaining the most about state pension funding gaps are typically those who created those gaps by refusing repeatedly to make the required contributions to their pension funds in the first place.

Single-employer pension funds are also under direct attack, exemplified by the latest efforts of American Airlines to project massive losses in its fund as a way to justify dumping its pension on the PBGC, the latter already experiencing rising losses and demands to take over private plans.

American Airlines would add $9 billion to the PBGC’s already projected losses of $26 billion. Their game here is to force Congress to bailout the PBGC at taxpayer expense, thus in effect having American’s pension fund “socialized.”

Fundamental Solutions to the Crisis

Pension funds are financial institutions. They are financial intermediaries. They perform much like commercial banks in lending to other non-financial institutions.

In 2008-09, the Federal Reserve bailed out the banks to the tune of $9 trillion. They did this by providing zero interest loans to banks for nearly four years now. The Fed did it also by buying up bonds, especially mortgage notes, from the banks at their full purchase value instead of depressed market values. They did it by buying bonds from the banks, for which it injected real cash.

The Fed in this manner not only bailed out banks and investment banks, but big conglomerates like GE and GM and their credit arms. So why shouldn’t it bail out DBPs, which are also financial institutions, in similar fashion?

The Federal Reserve therefore should:

• Provide short term 2, 5 and 10-year bridge loans to pension funds whose funding falls below 70%, at the Fed’s current “bank bailout” rate of 0.25% interest.

• The Fed should further allow pension funds to issue their own bonds, much as corporations now issue bonds, and the Fed should purchase those bonds to provide additional funding as necessary to DBP funds, much as the Fed directly purchases Fannie Mae/Freddie Mac mortgage bonds today to aid other bank mortgage originator and mortgage servicer companies.

In addition to Federal Reserve action, additional measures to defend DBPs must include the following:

• Pension funds should be prohibited from partnering in investments with hedge funds and other high risk taking financial institutions and financial instruments.

• The Pension Act of 2006 should be fundamentally amended to discourage or prevent single employer plans’ conversion of DBPs to hybrid Cash Balance Plans and 401Ks.

• Cities and local municipalities should be reimbursed for losses due to banks’ fraudulent promotion of derivatives and interest rate swap deals of the last decade, much as other institutional investors have been reimbursed for fraudulent subprime mortgages of recent years.

• Pension funding contribution holidays should be legally banned. Diversion of pension funds resources to health and welfare funds should be further prohibited.

• Corporate bankruptcy laws should be amended to prevent dumping of single-employer plans. All non-pension assets in bankruptcy should be ruled subordinate to pension assets, requiring all other assets disposed of before pension funds are considered.

• Restrictions on employers exiting from multi-employer plans should be strengthened.

• Public employee DBPs expenditures on paid consultants should be limited by law to no more than 1% of funding levels.

• Employers should be prohibited from exempting “contingent” workers from participation in DBP plans and should be required make pension fund contributions for all part time and temporary (“contingent”) workers proportional to their total hours worked.

• Federal legislation should establish a national 401K pool and require all current 401K plans to be transferred to such pool, to be administered as a supplement to the social security system. Employers’ future contributions to the pool should be funded by a business-to-business intermediate goods value added tax of 1%.

• Restore jobs and wage growth. The most important long-run source of restoration of pension fund solvency is the creation of jobs at an historically acceptable rate, as well as policies to ensure the labor force annual wage gains are equivalent to average annual productivity gains.

• A sustained economic recovery — not the current three-year “stop-go”  economy —  would raise rates of return on normal pension fund investments to restore losses of recent years, and eliminate the incentive of pension funds chasing high-risk “alternative” investments in speculative financial instruments.

Context and Conclusions

To summarize, the crisis in Defined Benefit Plans is a crisis that has been brewing for decades but has appreciably worsened since 2000, and significantly further deteriorated after 2007. It is fundamentally a crisis of falling and insufficient contributions, not of excess liabilities or benefit payments. The solution therefore must address the true causes of the crisis, and not the false causes of excess or unaffordable benefit levels and the cutting of those benefit levels.

Employers, both private and public, are now using the crisis they created that reduced contributions for decades to attack benefits. Fundamental solutions to the pension funding problems in DBPs must rectify the source problems on the contributions side of the fund ledger.

In a broader context, the attack on DBPs should be viewed and understood as part of the even greater attack on workers’ wages in America ongoing now for more than three decades. Pension fund contributions are simply “deferred wages.” Workers make contributions from their wages to their pension funds, and have employers make corresponding contributions to pensions that would have otherwise been paid to them in direct wages.

Workers’ average hourly wages and weekly earnings have not risen since 1982, adjusted for inflation. This has been accomplished by various means: free trade, destruction of unions, lagging minimum wage adjustments, tens of millions of full time permanent jobs replaced with part time, temporary “contingent” jobs, offshoring of manufacturing and services, elimination of overtime pay for millions, the generalization of two-tier wage structures, accelerating technology displacement of jobs encouraged by tax policies, and the failure to create jobs in general over the past decade.

There were roughly 100 million private sector nonsupervisory production and service jobs in the U.S. economy in 2000, and there are approximately the same 100 million today, despite a growth in the population of more than 20 million over the period. Thus the crisis of defined benefit pensions is, in the long run, more than any other reason a consequence of the failure of the U.S. economy to create jobs and to ensure long-run wage and income growth of the more than 100 million nonsupervisory production and service workers at the heart of the economy.

July/August 2012, ATC 159