The Drowning Pool

Part of James A. Klein’s job as president of the American Benefits Council is to keep an eye on the Pension Benefit Guaranty Corp., the federal agency that insures those retirement plans. To understand what he sees, picture the PBGC as a pool. It is one, of course, of the insurance variety. But for the moment, imagine it as the real thing–a nice clear pond in the woods.

    Klein says that when a major company terminates its pension plan and dumps it into the PBGC, it’s like dropping a rock in the water. It sets off unsettling ripples. The first to feel that queasy bobbing are the employees and retirees of the defaulting company. They’ll receive federally guaranteed benefits, but not necessarily all of what they would have received if the company plan survived. The ripples move on to the other employers that sponsor plans and pay premiums into the PBGC. With a major default, they think that “maybe they should exit the pension system before they find themselves facing higher pension premiums and more onerous pension-funding rules,” Klein says.

    That’s the effect of one stone. What hit the PBGC recently is a payload of boulders dropped from 30,000 feet.

    In August, United Airlines announced plans to terminate its four pension plans. The PBGC would be required to pick up $6.4 billion worth of those obligations. The agency, which was running a $9.7 billion deficit, would suddenly find itself in a $16 billion hole. The PBGC, understandably, has objected to United’s plan.

    In September, financially troubled Continental Airlines said it would skip contributions to its pension plan this year. Then came U.S. Airways’ bankruptcy filing, which raised fears that it too would ultimately default on its plans. The Center on Federal Financial Institutions predicts that the PBGC will go broke by 2020 if things go on like this, according to a story in The New York Times.

    I asked Klein if the airlines’ actions, along with such longer-standing problems as the courts’ hostility toward cash-balance plans, portend the end of the defined-benefit system altogether. He wanted to sound hopeful. “The outlook is very bleak. There is still hope. There are still things Congress can do to save this system.”

    The next question is whether the defined-benefit system warrants saving. Even without the current crisis, companies have been switching to defined-contribution plans for the last 20 years. In 1985, there were approximately 170,000 defined-benefit plans. Now only about 29,000 companies have them. So maybe it’s just Darwinism in action.

    That’s not it at all, says Don Fuerst, a retirement consultant with Mercer Human Resource Consulting. “There’s a huge lemming effect in corporate America,” he says, meaning that if it looks like everyone is getting out of the pension business, companies blindly follow suit. If companies were really smart, he says, they might take a different tack. By keeping (or starting) a defined-benefit plan, they may have a competitive advantage in the marketplace, particularly among older workers who are discovering how bare their 401(k) cupboards can be.

    A well-run traditional pension is a much better deal for employees, Fuerst says. First, it’s not their money that’s being invested–it’s the company’s. Second, investment professionals are running the show. Most people simply don’t have the time or expertise to manage assets as skillfully as a pro would. Finally, pension plans pool longevity risk, ensuring that a retiree will not outlive his assets.

    Fuerst thinks that defined-benefit plans could swing back into favor if they get some help from Congress in the way of more predictable funding rules. That would be good news for companies that, for the sake of their employees, don’t mind staying in the pool as long as they’re sure they won’t get drowned in the process.

Workforce Management, October 2004, p. 12 — Subscribe Now!