MEP - The PBGC’s perfect storm

The Pension Benefit Guaranty Corporation—the government organization that insures private pension plans—announced this month that its deficit grew to $36 billion, but some industry groups have taken issue with that number, saying it is artificially inflated.

The PBGC has been in trouble since the Great Recession hit. Add artificially low interest rates, a volatile stock market and the many corporations filing for bankruptcy and it has been the perfect storm for the PBGC.

Josh Gotbaum, director of the PBGC, said in the agency’s 2013 annual report that its premiums are “both too inflexible—so that some plans are unfairly paying for the risks of others—and too low to cover PBGC’s benefit guarantee levels.”

Multiemployer plans have become a major issue, with many of them suffering due to economic changes and investment market declines.

“Although the Employee Retirement Income Security Act (ERISA) allows some flexibility to avoid insolvency, for many plans that won’t be enough. Without additional changes, we project that plans covering hundreds of thousands of people will fail,” Gotbaum said. “Sadly, PBGC’s own funding is itself inadequate to pay benefits if their plans fail.”

The Government Accountability Office has listed the PBGC as at-risk since 2003, in part because unlike other government agencies, like the Federal Deposit Insurance Corporation, it doesn’t have the power to set its own premiums. It must rely on Congress to set premiums for Congress has repeatedly raised PBGC’s premiums, but they remain too low to fund the PBGC’s obligations, said Gotbaum. He did admit that the organization still has very substantial assets, so it won’t run out of money for a few years. He predicted its multiemployer program would become insolvent within 10 to 15 years.

The GAO said in a report released Nov. 7 that the PBGC could benefit from a redesigned premium structure that could better align rates with risk from plan sponsors. It recommended that the PBGC continue to explore possible redesign options.

The American Benefits Council, a national trade association for companies concerned about federal legislation and regulations that affect all aspects of the employee benefits system, has been very vocal in its disagreement with the assumptions PBGC used to come up with its $36 billion deficit figure.

The problem is that the PBGC wasn’t founded to operate as an insurance company. It was set up as a safety net so that employees of defunct companies wouldn’t lose their retirement benefits, said Lynn Dudley, senior vice president retirement and international benefits policy for the American Benefits Council (ABC).

When figuring out its deficit, the PBGC uses as its main assumption the immediate payout of all of the obligations that are its responsibility, she said. “They don’t do that. They pay them out over 50 or 60 years. These are not obligations that are paid immediately. Why they would assume they would need to go out and [buy] an annuity for every single person on a single day….it is not the way it works,” she said.

“The PBGC’s deficit is a ‘snapshot’ measure of current assets minus liabilities. As a result, it does not accurately reflect the funded status of active ongoing plans,” said James Klein, president of the ABC in a statement. “All pension fund liabilities, including the PBGC’s, are overstated by the historically and artificially low interest rates of recent years. Keeping interest rates low is good policy to stimulate the economy, but it has the perverse effect of making very secure pension funds and the PBGC’s own situation appear underfunded.”

By continually raising premiums, the ABC is concerned that companies will just opt out of the system. They will stop paying into the PBGC because their payments are so huge they won’t be able to participate anymore.

In December 2012, the Social Security Administration asked the Retirement Research Consortium—three multidisciplinary centers housed at the University of Michigan, Boston College and the National Bureau of Economic Research—to evaluate the data, assumptions and methods underlying models of the PBGC’s pension plan insurance programs and related models of pension funding and sustainability.

In response to the SSA request, the National Bureau of Economic Research (NBER) and the Brookings Institute conducted an analysis of the PBGC’s Pension Insurance Modeling System (PIMS) and found that it was state-of-the-art when it was first developed 20 years ago. That said, several components of the model haven’t been updated to reflect the availability of new tools, new insights from academic literature or even new data, the report stated.

It also found that some of the model documentation is internally inconsistent and outdated and the process for updating data and model parameters appears ad hoc to outside observers. It also found that there does not appear to exist any publicly available, systematic inventory of the robustness checks that have been performed. Other long-term models that are important to federal programs, like the actuarial models used in the Social Security and Medicare programs, regularly undergo an external review by a technical panel of outside experts.

The PBGC also needs to take into account risk factors arising from the macroeconomic environment that are likely to substantially understate the degree of fiscal risk to PBGC’s insurance programs. For instance, during economic downturns it is reasonable to expect more plan sponsors to experience financial distress and more plans to be underfunded. The PIMS model doesn’t account for negative or positive extremes, the report said.

“Recognizing the true economic costs of these correlated risks and how they affect the broader fiscal position of the U.S. government, therefore, has potentially important implications for program design, the average level of premiums, the question of whether to risk‐adjust premiums, and other important policy parameters which are well beyond the scope of this narrow technical review of the PIMS model,” the report’s authors said.

The Pension Research Council of the Wharton School at the University of Pennsylvania also reviewed the PBGC’s Pension Insurance Modeling System. It believes that the agency could incorporate changes into its model that would improve the entire system, including the incorporation of mortality risk; including new asset classes, like commercial real estate, private equity funds, infrastructure and hedge funds, that are typically found in defined benefit plan portfolios; developing a more complex model for the term structure of interest rates and incorporating an option value approach to pricing the insurance provided.

The PBGC also could do more to communicate the range of uncertainty and potential for problems associated with the agency’s financial status, the report found. This could include additional information like an intermediate, optimistic and pessimistic set of projected outcomes, as well as the expected date of exhaustion for assets backing pension benefits insured by the PBGC.

Source: Benefits Pro