Private Pension Plans: The Next “Bubble”

The pain in the pension

Pension plans have been hit hard by the current crisis. The stock market is in a volatile up and down race to nowhere; commercial real estate is still in trouble, and there’s a huge crisis in Europe.

Not only that! World War II baby boomers are now retiring. People are living longer. And the Bush administration was quite successful in helping businesses switch from providing their employees with defined benefit plans (i.e, pensions) to defined contribution plans (i.e., 401Ks, 403Bs etc.).

Unfortunately, defined contribution plans haven’t worked out so well. AARPs newsletter is full of articles about older people unable to retire because they have not made enough money in their 401Ks to do so. Many seniors previously had to take money out of their 401(b)s because of an emergency or illness. And many simply lost money trying to learn how to invest, a skill most Americans aren’t taught in our public schools.

Private pension funds are managed by experts in investing and actuarial statistics. 401(k)s, on the other hand offer products created by investment companies and insurance companies to lure people who know nothing about investing into turning over their money to these companies, companies which define workers’ contributions but not what benefits, if any, those employees will ever receive for their contributions.

In “Insurance Company 401k Mutual Funds; The Poor Man’s Derivatives” I wrote about a major insurance company’s defined contribution plan that my employer at the time the offered years ago. The products offered had the same name as real mutual funds, but when I inquired about why I wasn’t earning the same amount that those mutual funds were paying, I was told the truth. My insurance company’s mutual funds in my 403(b) were “knock-offs”.  The company person claimed they did not take out fees. Clearly their imitation mutual funds simply weren’t as good as the actual products sold on stock exchanges!

Where’s a government when you need it?

Given the problems of so many seniors, the defects of 401(k) plans, and the current intention in Washington to make cuts to Social Security, wouldn’t you think our national government would be concerned about maintaining private pension plans?

Well, apparently not! AMR, the holding company that owns American Airlines is on its way into bankruptcy court. But this is not your ordinary bankruptcy. This bankruptcy is differs from most bankruptcies in US history. This bankruptcy ranks seventh in terms of the number of employees impacted.

American Airlines’ pension plan owes money to 50,000 retirees plus 80,000 employees. And the company is now talking about jettisoning American Airlines’ pension plan because that plan keeps American Airlines from being ‘competitive’ with other airlines.

In other words, “They don’t have to have pension plans so why should we?”

You can’t blame the executives who think that way. Their job is to cut costs and raise revenues for their company. They run a business.

And there are some think should be the way government does business as well. But if that’s the case, one has to wonder why we should even bother with having a government.

The purpose of have the government we have was pretty well spelled out on July 4, 1776 in the Declaration of Independence.

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable rights, that among these are life, liberty and the pursuit of happiness. That to secure these rights, governments are instituted among men, deriving their just powers from the consent of the governed. That whenever any form of government becomes destructive to these ends, it is the right of the people to alter or to abolish it, and to institute new government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their safety and happiness.

The last three words sum up the guarantee promised to the American people by their government: “safety and happiness”.

Except when they are at work?

Most employees of an American corporation have no say at all in how that company is run. A business is not the same as a democratic government. And that is why we have government – as a “check and balance” against business with its narrow focus on making money.

But our government isn’t using its power to check corporations from dumping employee pension plans during bankruptcy.

Here’s how that works. When a company fails, the Pension Benefit Guarantee Corporation (PBGC) covers the the shortfall in the pension obligations of that company. The PBGC is funded by premiums from all the US companies that offer defined benefit plans. At present the PBGC guarantees the pensions of 44 million employees.

American Airlines has only $8.3 billion to cover its employees out of 18.5 billion in obligations it has to the 130,000 participants in its pension plan. But PBCG is $23 billion in the red already. It doesn’t need, and says it may not even be able to handle, another $10 billion for taking care of American Airlines’ employees.

The Pension Benefit Guarantee Corporation is an independent agency of the US government created by the Employee Retirement Income Security Act of 1974 (ERISA). It operates like a mutual insurance corporation. Whenever one company fails, all the other companies in the insured pool of companies with pension plans pick up the tab for the failed company’s plan members.

Well, that’s how it is supposed to work, but you can see clearly that it is not going to.

Moral bankruptcy?

Every time a giant corporation fails, other corporations and businesses have to take up its burden through increases in their premiums. The burden of paying back employees  the pensions they earned while working for their employer can’t be simply dismissed like the way debts owed to the company’s creditors are. By law those pensions have to be paid.

But the camel’s back can’t carry the heavy load that’s being dumped on it. The PBGC is itself on the verge of failure. As each company declares bankruptcy and simply decides it doesn’t want to pay its employees the pensions those employees earned, every other company has an increased incentive to do the same thing.

In economics and finance, this is called “moral hazard“. There has been a lot of concern about fostering moral hazard when it comes to bailing out banks with taxpayer money, but no one seems concerned about “moral hazard” when it comes to allowing employers to dump their employees’ pension plans during bankruptcy. Yet, who will ultimately pick up the tab for private pension funds of corporations that declare bankruptcy if the PBGC can raise enough from its member companies? The taxpayers, of course.

And who will pick up the tab for the massive failure of defined contribution plans to enable employees to take care of themselves when they need to retire? That may well be the question of the century. Today it’s pensions that are going the way of the dinosaur; you can bet that tomorrow it will be 401(k)s.

If you have or hope to get a pension from a private employer, the writing is on the wall. Our government doesn’t care if you ever get that money or not. Our government is too busy arguing with itself about which group of taxpayers ought to pick up the tab for the obligations that corporations don’t want to pay.

Follow Nancy Humphreys on Twitter @brucenomics