The $300 Billion Pension Funding Shortfall

As if the economic downturn’s lingering fallout of layoffs, budget cutbacks and sagging employee morale didn’t give human resources professionals enough to worry about, there’s another dark cloud looming on the horizon: underfunded pension plans.

    The situation is ominous. Over the past three years, thanks to the combination of a struggling stock market and low interest rates, companies have seen the value of the stock and bond portfolios in which they’ve invested their pension reserves plummet by nearly $1 trillion. The nation’s corporate pension plans are $300 billion short of what they’ll eventually need to cover the benefits for 44 million active and retired workers, according to federal government estimates.

    It’s a shortfall that threatens to wreak havoc with corporate balance sheets and dangerously strain the federal government insurer that backs up companies unable to make good on their pension commitments. But while it’s obvious that something must be done about the pension-underfunding crisis, nobody can agree on a solution. Congress is pondering controversial changes to federal pension regulations that proponents say would make it easier for companies to weather the crisis, though critics say the changes also might ultimately leave pension plans even more dangerously short of money.

   Meanwhile, millions of workers–some of whom have already received unsettling notices informing them that their companies’ plans have dipped below federal funding requirements–are left to worry about whether they’ll have enough money to live comfortably in their retirement years. The loss of worker confidence in pension plans could have a ripple effect, with a negative impact on everything from recruiting and retention to succession planning, according to compensation and retirement expert Brent Longnecker, president of the Houston area-based Resources Consulting Group. “There’s been a lot of focus on the financial side, but every way you look at it, this is a big human resources problem as well.” He says it’s crucial for human resources leaders to plan for how they’re going to deal with potentially pervasive impacts of pension underfunding, because the problem may well get worse before it gets better.

    Clearly, executives are already worried about the damage that pension underfunding may cause to the overall health of their businesses. In a recent survey of 151 companies by SEI Investments, a consulting firm in suburban Philadelphia, 68 percent of the participants said the crisis had already had a negative effect on corporate finances. Fifty-eight percent said they’d posted lower profits as a result; and 75 percent were concerned about future impacts ranging from cash-flow problems and lower profits to a decrease in the value of company stock. Some prominent companies already have taken a major financial hit. General Motors, for example, found it necessary last year to put up $5 billion in cash and to raise billions more through bond offerings to pump up its retirement fund, according to a report in BusinessWeek.

    The government is just as alarmed. In July, a report by the General Accounting Office, the investigative arm of Congress, concluded that the Pension Benefit Guaranty Corp., which regulates and insures pension plans against failure, is in dire financial straits itself. Thanks to corporate bankruptcies, the PBGC’s reserves have diminished from a $9.7 billion surplus in 2000 to a $3.6 billion deficit in fiscal year 2002, and the number of employees whose pensions the PBGC had to cover rose from 268,000 in 2001 to 400,000 last year, according to news reports. Already, some observers are drawing ominous analogies to the savings-and-loan crisis of the early 1990s, when the federal government was forced to spend hundreds of billions of dollars to bail out collapsing S&Ls. “It’s mind-boggling,” Longnecker says. “Years ago, I would have said, sure, there will always be companies with underfunded pensions. But none of us ever imagined a situation this bad, where the PBGC itself would be in trouble.”

    Companies have been lobbying for a legislative fix that they think would help them to weather the crisis, at least for the short term, until the stock market recovers and pension funds’ investments can recoup some of their losses. HR 1776, the Pension Preservation and Savings Expansion Act, introduced this past spring by Rep. Benjamin Cardin (D-MD) and Rep. Rob Portman (R-OH), would do this through bookkeeping. The Cardin-Portman bill would change, for at least the next three years, the complex method by which the government calculates corporate pension funds’ liabilities, shifting the standard from 30-year Treasury bonds to the long-term rate for corporate bonds. The practical result, experts say, would be that companies wouldn’t have to put as much money into their pension plans to meet the federal standards for being adequately funded.

    Deanna Keim, communications director for the American Benefits Council, which represents corporate pension plans, says the change would give a more accurate picture of companies’ pension liabilities. Since the 30-year Treasury bonds were discontinued by the Bush administration, Keim says, they have an artificially low interest rate and no longer are a fair benchmark. As a result, she says, companies are being forced to sink too much money into their funds to comply with federal funding standards. In 2002, according to the council’s calculations, companies had to contribute $43.5 billion to their plans–more than they had contributed in the previous three years combined. In 2003, they may have to shell out as much as $83 billion. It’s money that companies might put to other uses–upgrading their technology, paying workers instead of laying them off–that could result in higher profits. That, of course, might ultimately contribute to higher stock prices, which in turn would lift the value of the assets in pension-fund portfolios.

    Critics of the Cardin-Portman bill deride it as essentially a bookkeeping trick, and warn that over the long run, allowing companies to make smaller contributions will result in pension plans that are even more seriously underfunded. “Basically, companies are using this as an opportunity to reduce their costs,” says the Pension Rights Center’s John Hotz. “But they’re not doing anything about fixing the actual problem, which is just going to keep on getting worse.” Hotz isn’t too sympathetic to companies’ complaints about the financial pressure of pension underfunding. In the 1990s, he says, many companies took advantage of arcane loopholes in pension regulations to reduce their payments and even divert surpluses from pension funds to other uses, making the blithe assumption that the rising stock market would enable them to cover their obligations. “They’re basically at it again,” he says. “But this time, the consequences are even more dire for future retirees.”

    It’s unclear if the Cardin-Portman bill will make it to the House floor for a vote, though Keim says that could conceivably happen late this month. The Bush administration is advocating an even more complicated alternative, which would use the yield curve of corporate bonds and workers’ ages to calculate a company’s pension liability. But that proposal–which also includes more stringent reporting requirements for companies with underfunded plans–has met with a cool reception from business leaders.

    If a stalemate develops, Keim says, the result could be grim. “If we don’t get a solution to this problem, more companies may decide that in the future they can no longer fund that type of [defined-benefit pension] plan,” she says. “They’d freeze the plans, so their existing employees wouldn’t receive any more accruement of benefits, and new employees would no longer get pensions at all.” SEI’s survey data backs her up. Nearly a quarter of the companies polled said they were considering discontinuing their pension plans and/or replacing them with defined-contribution plans, such as 401(k) accounts.

    Defined-contribution plans, in which companies can pay into investment accounts controlled by the employees, are advantageous for companies because they don’t have to continue paying benefits after workers retire, and because the workers, not the company, assume the risk that the investments may not generate enough return. As Hotz and others note, employees tend to have a lot more qualms these days about them, after watching several years of tumbling stock and mutual fund values. “It all looks so risky to people now,” he says. “They’re realizing how much they want the security of having a pension plan.”

    But no matter which scenario plays out, Longnecker expects that employees’ uncertainty about their pension plans will have troubling effects on companies. When recruiters talk to job candidates, for example, they’re going to have to be careful what they tell them about their companies’ retirement benefits, as there’s an increasing chance that the programs will change. If workers begin to doubt companies’ commitment to providing for their retirement, they’ll be more inclined to shop elsewhere for a better deal, and corporate loyalty and retention rates may suffer a serious hit. Other employees, Longnecker says, may decide that they can’t afford to retire at all, which will interfere with succession planning. “I’m not sure what the solution is [to pension underfunding],” he says, “but everyone has to start thinking now about how they’re going to deal with the impact.”

Workforce Management, September 2003, pp. 76-79 — Subscribe Now!