In few areas where public and private interests meet is the accounting as obscure, rigged and unrealistic as in the world of traditional defined benefit pensions, both public and private. We got another glimpse of this last week when the Wall Street Journal reported that the pension liabilities of bankrupt American Airlines have become a point of contention between the company and the Pension Benefit Guaranty Corporation, the government entity that ensures private pensions, which is on the hook for as much as $8 billion if the airline shuts down its current pension plan.
As the paper reported, Congress helped make Americans pension hole even deeper than it should be by granting the airline and other carriers an exemption to new pension rules for private businesses, which allowed them to contribute less to their plans. Heres how it worked. Back in 2006 the airline industrys established carriers were under profit pressure from rising fuel costs and intense competition from new carriers with lower costs. One of the biggest burdens of older airlines like American were their traditional defined benefit pension plans, the kind where a company agrees to pay a worker a fixed pension for the rest of his life based on a formula calculated by factors such as years of service and final working salary.
But Congress, some of whose members seem to believe there was once a golden age of employee benefits when everyone could count on a predictable, regular income in retirement, wanted to encourage the airlines to preserve their plans, so Washington gave the industry exemptions from rules governing how to fund these pensions. In particular, Congress allowed the airlines to assume an aggressive future rate of investment return from the assets in their pension plans, somewhere above 8 percent, compared to a more conservative 4 percent to 5 percent return for private sector plans. By magically assuming that their investment managers would make a higher return in the market, the businesses were able to reduce their own annual required pension contributions.
But what Congress couldnt do, of course, is ensure that the stock market would cooperate. Today the market is lower than it was in 2007 and the pension plans achieved nothing close to those aggressive predictions of investment returns. The result is hundreds of millions more in additional underfunding for the plans, so that American is now considering dumping its pension while in bankruptcy, a move that saddles the PBGC with the bill.
What should be worrying to average Americans is that Congress transparently bad pension math is exactly the same kind of math that states and cities have been applying in their pension systems, with the taxpayer as the backstop. Last week Sen. Orrin Hatch, the ranking Republican on the U.S. Senates finance committee, issued a report noting the rising unfunded liabilities of state and local defined benefit pension plans, and which illustrates the potential impact of those liabilities on the taxpayer. Pointing out that local governments unfunded retirement obligations may now approach $4 trillion, the Hatch report noted that the failure of a few big public sector pension plans could spark a credit “contagion” that would make it difficult for all governments in America to borrow money. Federal safety-net programs like Medicaid and food stamps might be strained if retirees in government pensions saw their benefits cut sharply, as they have been in a few municipal bankruptcy cases, like those of Pritchard, Al. and Central Falls, R.I.
There are many culprits in the state and local crisis, from politicians in search of electoral support who promised much to public employees without worrying about the costs, to a flawed system that allows government pension funds to engage in the same kind of unrealistic projections that Congress employed in the American case, to consistently relying on stock market returns that might have even made Bernie Madoff blush.
Hatch thinks that states and localities have been irresponsible enough with their pensions that federal legislation is needed to head off massive defaults. Although there are constitutional issues involved, the federal government does grant certain tax advantages to these pension funds which have encouraged the states to continue them. There are any number of ways for Washington to change the incentives to prompt the states to be more responsible, which could very well prompt some states to switch to more affordable defined contribution plans. But Hatch will have a tough time convincing a Congress where some members seem to believe that the defined benefit pension was once the gold standard of retirement income, and should be again.
The reality is actually quite different. Although defined benefit plans date back more than 100 years, when a few big employers like railroads began offering them, they were never widely used for very long. In the 1930s only about one-quarter of America workers enjoyed such plans. The post-World War II economic boom encouraged more businesses to start DB plans, so that by 1960, some 50 percent of the private workforce enjoyed them. But the burden of those plans quickly began to weigh on companies. So did 1970s federal legislation designed to protect employees in these plans, which created a whole menu of requirements that added to the cost of operating them, including the obligation that companies make insurance payments to fund the PBGC.
Over time, more and more firms switched to 401(k) style pensions, where an employer makes an annual contribution to a retirement account for a worker and the employers liability ends there. Today, only about 20 percent of private workers are covered by defined benefit plans. In other words, the so-called golden age of pensions when a majority of workers had DB plans didnt even last through the working and retirement years of a single cohort of American workers.
Only in one area did traditional pensions continue expanding, in government, where the taxpayer is the backstop when these plans get in trouble. Today, some eight in ten public workers are covered by DB plans, though governments have done such a poor job of funding their promises to workers that one analysis predicts that without reform the pension systems of 11 states would exhaust their assets by the end of this decade.
Instead of encouraging private and public employers to assume obligations that wind up crushing them, Congress ought to be pointing the way toward a system where the costs are transparent, the liabilities are not open-ended, and where retirees can count on plans that will remain solvent so that the money will be there for their retirement. The kind of accounting that Congress relied on in the American Airlines case violates all of those principals.
Original Source: http://www.realclearmarkets.com/articles/2012/01/18/congress_pension_math_doesnt_add_up_99467.html