The last three years have been probably the most destructive period in the whole history of the US pension fund business. Over a trillion dollars in assets under management have been lost according to a recent study by Greenwich Associates, the consulting firm based in Connecticut. And the worst is not over. To trouble private companies’ defined benefit (DB) funds there is not only the financial downturn, but also the increasing burden of insurance premiums they have to pay to the Pension Benefit Guaranty Corporation (PBGC). The risk – some experts warn – is that above a certain level, premiums become actuarially unfair and they will prompt sponsors of fully funded plans to terminate their DB plans and replace them with defined contribution (DC) plans, leaving PBGC with only under-funded plans in its programme. This in turn will worsen the problems of this quasi-governmental agency, which in 2002 has reached a record $3.6bn (E3.3bn) deficit after a $7.7bn surplus in 2001.
PBGC is a federal corporation created by the Employee Retirement Income Security Act of 1974 “to encourage the growth of defined benefit pension plans, provide timely and uninterrupted payment of pension benefits, and keep pension insurance premiums at a minimum”, as it states on its website. The agency is not funded by general tax revenues. It collects insurance premiums from employers that sponsor insured pension plans, earns money from investments and receives funds from pension plans it takes over when the sponsors can not manage them anymore, either because they go bankrupt or they experience another crisis.
PBGC currently guarantees payment of basic pension benefits earned by 44m American workers and retirees participating in about 32,500 private-sector DB pension plans. It spent the first 21 years of its existence in deficit, but for six years, from 1996 through 2001, the agency recorded a surplus. Last year was a ‘wake-up call’ according to Peter Fisher, undersecretary of the US Treasury and the Treasury’s representative to the PBGC. In fact the $11.37bn net loss is the largest in the federal pension insurer’s 28 year history. “The PBGC has sufficient assets to pay benefits to workers and retirees for a number of years,” reassured PBGC’s executive director, Steven A Kandarian. “But given the amount of underfunding in pension plans sponsored by financially troubled employers, we must examine every available option to strengthen the pension insurance programme for the long term”.
Of the $11.37bn in losses for 2002, completed and probable pension plan terminations accounted for $9.31bn, or more than 80% of the total, according to public data released by PBGC. All told, the steel industry accounted for $7.57bn of the $9.31bn in losses: among the very recent cases, the agency has assumed responsibility for the pension plans of two steel companies – National Steel and Bethlehem Steel – that together account for $5.16bn of the probable losses. Now the airline industry is going to pose new challenges to PBGC.
Another key factor in explaining the 2002 deficit was the decline in interest rates, which increased the agency’s liabilities by $1.65bn. On the investment side, the agency recorded a small gain from its portfolio of roughly two-thirds Treasury bonds and one-third stocks.
All single-employer pension plans pay PBGC a basic flat-rate premium of $19 per participant per year. Underfunded pension plans pay an additional variable-rate charge of $9 per $1,000 of unfunded vested benefits. A plan is underfunded when the actuarial smoothed value of the assets falls below the present value of the current liability discounted at 85% of the 30-year Treasury rate. “For every $100m of underfunded liabilities an annual charge of $900,000 will be applied. This charge represents an additional annual cost to the plan sponsor that is not recoverable or amortisable,” stresses Ronald Ryan of Ryan Labs, a research firm based in New York.
The discount rate is now in dispute. The ERISA Industry Committee (ERIC), the lobby group, says that a higher rate, based on the yield on corporate bonds rated double-A, should be used. This is about one-and-a-half percentage points above the Treasury-bond yield. Some experts guess that an increase of one percentage point in the discount rate at the end of 2001would have cut pension-fund deficits by 40%.
“The potential long-term concern for PBGC is a decline in revenues due to fewer DB plans,” observes Ron Gebhardtsbauer, senior pension fellow for the American Academy of Actuaries. “The agency has to be careful that in trying to solve its deficit problem it does not invoke the law of unintended consequences and create an even bigger problem by discouraging companies from having a traditional pension plan”.
Zvi Bodie, a finance professor at Boston University, advances several radical measures to be discussed: government could require plan sponsors to fund their plans only with US government bonds instead of equities; bond values and maturities would match those of sponsors’ pension liabilities. PBGC could charge premiums that vary with the volatility of assets sponsors use to back their plans. PBGC could use derivatives to give its equity assets the characteristics of fixed-income securities.
The experts agree on one point: even if PBGC is not funded by taxes, if the crisis gets serious ultimately taxpayers will get the bill.

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