Opinion

Bethany McLean

The Pension Destabilization Act

By Bethany McLean
August 13, 2012

From the wonder of the Olympics to the horror of Libor, there’s been plenty of news this summer. So maybe it’s not surprising that a 1,676-page bill called Moving Ahead for Progress in the 21st Century, which President Obama signed into law on July 6, has escaped attention. (Really? You’d rather watch Gabby Douglas win the all-around gold than read this bill? Shocking.) But buried within the bill, which is also known as the Highway Act, is a provision that matters to many Americans, a provision that sums up a lot of what’s wrong with Washington today, a provision that is not just bad finance but also reeks of the cronyism we should all fear.

The provision is called the Pension Stabilization Act, and really, it should be renamed the Pension Destabilization Act. Pensions are fairly unstable already, relying on markets of the future that smart prognosticators doubt are going to be as generous as the markets of the past. And yet, many pension plans are counting on similar rates of return anyway. In his August letter, Pimco’s Bill Gross pointed out that one of the country’s largest state pension funds says it will earn what sounds like a modest real rate of 4.75 percent. But as Gross notes, assuming a portion of that is in bonds yielding 1 to 2 percent, the pension would need stocks to return 7 to 8 percent after adjusting for inflation to hit its target. That is, as Gross writes, “very heavy lifting.” Nor are we heading into tough times with a cushion. Different sources put the funding deficit for large corporate pension plans at somewhere between $475 billion and $500 billion as of the end of 2011.

Given that, and given that corporate profit margins and cash balances are near all-time highs, you might think, or hope, that Congress would be cracking the whip. And it did, sort of, by passing the Pension Protection Act in 2006, which among other things generally required companies to fund their pension shortfalls over seven years.  But then the financial crisis hit, and companies begged for relief, and now, in 2012, we have the Pension Stabilization Act. While the math is complicated – Jim Moore, a managing director at Pimco, calls it a “Rube Goldberg contraption”– most people who have looked at it say that the overall effect is going to be, as JPMorgan put it in a recent piece, to “significantly reduce” the cash that companies are required to contribute to their pension plans in the next few years.  It does so, in essence, by increasing the discount rate that companies use to calculate their pension liabilities when they’re determining how much money they need to put in. Using a higher discount rate makes the liability look smaller, thereby decreasing the funding requirement.

Right after the bill was signed into law, Sears, which is controlled by multibillionaire Eddie Lampert and has a pension plan that, according to JPMorgan, is underfunded by some $2.3 billion, announced that it would contribute from $380 million to $430 million to its pension plan in its fiscal 2013, down from its previous estimate of $740 million. Alcoa is reducing its contribution by $100 million to $130 million. And so it goes. Overall, the Society of Actuaries predicts that the required 2012 pension contributions will be 43 percent less under the new law than they would have been under the previous law – $45 billion instead of $80 billion.

The idea is that in the future, when everything is coming up roses, companies will make the shortfalls. Or as Society of Actuaries puts it drily: “The solvency of plans would decline in the short term due to lower contributions, and would eventually return to the levels expected under current law as contributions increase.” That sounds good, and it’s true that providing troubled companies with some relief may give them flexibility to figure things out. But what happens if they don’t, and what if, when the time comes to pony up the cash, there is none? Given the troubled status of many pension plans, there’s a cliché that describes this situation perfectly: kicking the can down the road.

Now, if your company can’t pay your pension, there’s supposed to be a backup, which is called, appropriately enough, the Pension Benefit Guarantee Corporation. There have long been questions about its solvency. So as a sop to their constituents’ financial health, Congress did also increase the fees that companies have to pay the PBGC. (While the PBGC gets to count the increased fees as revenues, it doesn’t have to increase its reserves to account for the increased risk of default, as a normal insurer would. Go figure.) Again, the math is complicated, but the end result of Congress’s machinations is that stronger companies, those that are unlikely to need to get out of their pension obligations, will pay the PBGC just as much as companies that are likely to fail to meet them. This is why Pimco’s Moore writes that Congress “essentially extended a welfare transfer from the Haves to the Have Nots.” Or to put this a different way, whether you work for a strong company or a weak one, we really are all in this together.

Just about now, you might be wondering why on earth Congress would include the Pension Stabilization Act in this particular bill. After all, “Moving Ahead for Progress in the 21st Century,” is also known as the Highway Act because it’s mostly about transportation. On the surface, that has little to do with pensions. Aha. It’s because decreasing the amount that companies have to contribute to their pensions helped make the Highway Act budget neutral – or at least, it appeared to do so, which in Washington is all that apparently matters. Here’s why. Pension contributions are a deduction from taxable income. So smaller contributions should result in higher corporate taxes. Presto! Indeed, according to JPMorgan, the Joint Committee on Taxation says the pension provisions in the Highway Act will raise taxes of $18.1 billion between 2012 and 2017. So our pensions suffer, but the budget looks better!

There’s one more twist, which is that the increased taxes may not materialize. Moore thinks that healthy companies will continue to fund their pension plans in excess of the minimum, meaning their taxable income will be what it would have been before the bill’s passage. It’s the unhealthy companies who will take advantage of the new rule – and it’s precisely the unhealthy companies that may soon not have any profits to tax anyway, particularly if the economy takes a turn for the worse. Which means that counting on increased contributions from them is, in a word, crazy. Or as Moore calls the whole thing, “A curious example of Washington’s twisted logic and dubious accounting.” Well said.

Comments
28 comments so far | RSS Comments RSS

It’s, and yet, another example of our corporate-owned Congress putting the interests of corporate bottom lines first. This has gotten so extreme that it’s a joke to refer to America as a Republic practicing democracy. We desperately need publicly financed elections, but that will be impossible without a revolution because it would threaten US corporation’s finely-tuned system of maximum profits, which is what they have now and which is the bane of the Middle Class.

We’ve let things devolved in such a way where we won’t be able to help the Middle Class without corporations taking a hit in some respect. That’s because, as mentioned above, they’ve been allowed to fine-tune our economy, and our government, in a way to produce maximum profitable benefit to them and naturally any change, any disruption, to anything that’s finely tuned will cause a setback for that which has been so carefully calibrated.

This is precisely why the Republicans swore their commitment to destroying the Obama Presidency before he even took the Oath of Office. It’s because Obama represented an agent of change and those in power, with the help of the Republican Party and, to some degree, the Democratic Party, forbid change. That’s why every little bit of change that Obama HAS been able to get through has been so absurdly difficult and politically costly.

So the current political dynamic is as follows: If you like what we have now, support the Republicans. If you want change, support the Democrats. But to be fair, there is a caveat that comes with the Democrats. Don’t expect a whole lot of change because they have to get everything through the better financed Republicans and through themselves, who also must rely on campaign contributions from the powerful agents of the status quo.

The only way we’ll get serious change is through a major, wholesale, grassroots movement. It will be extremely difficult because we’ll be out-funded every step of the way, and they have the media and propaganda on their side, convincing people that such a movement threatens our freedom, etc., etc. But talk about voting for 3rd party candidates or the Tea Party or anything utilizing our current system without changing the way our system finances elections is simply a waste of time. It won’t bring about the change we desperately need.

Posted by flashrooster | Report as abusive
 

Look at it like this: a marginally funded pension plan makes a firm less attractive to company builders and job creators like Bain Capital, so it may last a little longer before it’s financially drained, folds, and the average worker loses everything anyway.

Posted by PCScipio | Report as abusive
 

Look at it like this: a marginally funded pension plan makes a firm less attractive to company builders and job creators like Bain Capital, so it may last a little longer before it’s financially drained, folds, and the average worker loses everything anyway.

Posted by PCScipio | Report as abusive
 

this law was made for companies like GM’ & FORD’ Salaried employees pensions were under the protection of the federally insured PBGC, the fund is in the hands of Prudential, Prudential calls it an annuity, but there is no inflation protection, no cost of living increases, theres probably also a very large management fee for maintaining the funds’ distribution, if these retirees do not accept the lump-sum buy out, theres really not alot of pension guarantee from Prudential. Washingtons’ law was created to to stabilize or destabilize a deficient, nothing else

Posted by running | Report as abusive
 

this law was made for companies like GM’ & FORD’ Salaried employees pensions were under the protection of the federally insured PBGC, the fund is in the hands of Prudential, Prudential calls it an annuity, but there is no inflation protection, no cost of living increases, theres probably also a very large management fee for maintaining the funds’ distribution, if these retirees do not accept the lump-sum buy out, theres really not alot of pension guarantee from Prudential. Washingtons’ law was created to to stabilize or destabilize a deficient, nothing else

Posted by running | Report as abusive
 

this law was made for companies like GM’ & FORD’ Salaried employees pensions were under the protection of the federally insured PBGC, the fund is in the hands of Prudential, Prudential calls it an annuity, but there is no inflation protection, no cost of living increases, theres probably also a very large management fee for maintaining the funds’ distribution, if these retirees do not accept the lump-sum buy out, theres really not alot of pension guarantee from Prudential. Washingtons’ law was created to to stabilize or destabilize a deficient, nothing else

Posted by running | Report as abusive
 

this law was made for companies like GM’ & FORD’ Salaried employees pensions were under the protection of the federally insured PBGC, the fund is in the hands of Prudential, Prudential calls it an annuity, but there is no inflation protection, no cost of living increases, theres probably also a very large management fee for maintaining the funds’ distribution, if these retirees do not accept the lump-sum buy out, theres really not alot of pension guarantee from Prudential. Washingtons’ law was created to to stabilize or destabilize a deficient, nothing else

Posted by running | Report as abusive
 

this law was made for companies like GM’ & FORD’ Salaried employees pensions were under the protection of the federally insured PBGC, the fund is in the hands of Prudential, Prudential calls it an annuity, but there is no inflation protection, no cost of living increases, theres probably also a very large management fee for maintaining the funds’ distribution, if these retirees do not accept the lump-sum buy out, theres really not alot of pension guarantee from Prudential. Washingtons’ law was created to to stabilize or destabilize a deficient, nothing else

Posted by running | Report as abusive
 

this law was made for companies like GM’ & FORD’ Salaried employees pensions were under the protection of the federally insured PBGC, the fund is in the hands of Prudential, Prudential calls it an annuity, but there is no inflation protection, no cost of living increases, theres probably also a very large management fee for maintaining the funds’ distribution, if these retirees do not accept the lump-sum buy out, theres really not alot of pension guarantee from Prudential. Washingtons’ law was created to to stabilize or destabilize a deficient, nothing else

Posted by running | Report as abusive
 

this law was made for companies like GM’ & FORD’ Salaried employees pensions were under the protection of the federally insured PBGC, the fund is in the hands of Prudential, Prudential calls it an annuity, but there is no inflation protection, no cost of living increases, theres probably also a very large management fee for maintaining the funds’ distribution, if these retirees do not accept the lump-sum buy out, theres really not alot of pension guarantee from Prudential. Washingtons’ law was created to to stabilize or destabilize a deficient, nothing else

Posted by running | Report as abusive
 

this law was made for companies like GM’ & FORD’ Salaried employees pensions were under the protection of the federally insured PBGC, the fund is in the hands of Prudential, Prudential calls it an annuity, but there is no inflation protection, no cost of living increases, theres probably also a very large management fee for maintaining the funds’ distribution, if these retirees do not accept the lump-sum buy out, theres really not alot of pension guarantee from Prudential. Washingtons’ law was created to to stabilize or destabilize a deficient, nothing else

Posted by running | Report as abusive
 

this law was made for companies like GM’ & FORD’ Salaried employees pensions were under the protection of the federally insured PBGC, the fund is in the hands of Prudential, Prudential calls it an annuity, but there is no inflation protection, no cost of living increases, theres probably also a very large management fee for maintaining the funds’ distribution, if these retirees do not accept the lump-sum buy out, theres really not alot of pension guarantee from Prudential. Washingtons’ law was created to to stabilize or destabilize a deficient, nothing else

Posted by running | Report as abusive
 

this law was made for companies like GM’ & FORD’ Salaried employees pensions were under the protection of the federally insured PBGC, the fund is in the hands of Prudential, Prudential calls it an annuity, but there is no inflation protection, no cost of living increases, theres probably also a very large management fee for maintaining the funds’ distribution, if these retirees do not accept the lump-sum buy out, theres really not alot of pension guarantee from Prudential. Washingtons’ law was created to to stabilize or destabilize a deficient, nothing else

Posted by running | Report as abusive
 

this law was made for companies like GM’ & FORD’ Salaried employees pensions were under the protection of the federally insured PBGC, the fund is in the hands of Prudential, Prudential calls it an annuity, but there is no inflation protection, no cost of living increases, theres probably also a very large management fee for maintaining the funds’ distribution, if these retirees do not accept the lump-sum buy out, theres really not alot of pension guarantee from Prudential. Washingtons’ law was created to to stabilize or destabilize a deficient, nothing else

Posted by running | Report as abusive
 

this law was made for companies like GM’ & FORD’ Salaried employees pensions were under the protection of the federally insured PBGC, the fund is in the hands of Prudential, Prudential calls it an annuity, but there is no inflation protection, no cost of living increases, theres probably also a very large management fee for maintaining the funds’ distribution, if these retirees do not accept the lump-sum buy out, theres really not alot of pension guarantee from Prudential. Washingtons’ law was created to to stabilize or destabilize a deficient, nothing else

Posted by running | Report as abusive
 

this law was made for companies like GM’ & FORD’ Salaried employees pensions were under the protection of the federally insured PBGC, the fund is in the hands of Prudential, Prudential calls it an annuity, but there is no inflation protection, no cost of living increases, theres probably also a very large management fee for maintaining the funds’ distribution, if these retirees do not accept the lump-sum buy out, theres really not alot of pension guarantee from Prudential. Washingtons’ law was created to to stabilize or destabilize a deficient, nothing else

Posted by running | Report as abusive
 

this law was made for companies like GM’ & FORD’ Salaried employees pensions were under the protection of the federally insured PBGC, the fund is in the hands of Prudential, Prudential calls it an annuity, but there is no inflation protection, no cost of living increases, theres probably also a very large management fee for maintaining the funds’ distribution, if these retirees do not accept the lump-sum buy out, theres really not alot of pension guarantee from Prudential. Washingtons’ law was created to to stabilize or destabilize a deficient, nothing else

Posted by running | Report as abusive
 

this law was made for companies like GM’ & FORD’ Salaried employees pensions were under the protection of the federally insured PBGC, the fund is in the hands of Prudential, Prudential calls it an annuity, but there is no inflation protection, no cost of living increases, theres probably also a very large management fee for maintaining the funds’ distribution, if these retirees do not accept the lump-sum buy out, theres really not alot of pension guarantee from Prudential. Washingtons’ law was created to to stabilize or destabilize a deficient, nothing else

Posted by running | Report as abusive
 

this law was made for companies like GM’ & FORD’ Salaried employees pensions were under the protection of the federally insured PBGC, the fund is in the hands of Prudential, Prudential calls it an annuity, but there is no inflation protection, no cost of living increases, theres probably also a very large management fee for maintaining the funds’ distribution, if these retirees do not accept the lump-sum buy out, theres really not alot of pension guarantee from Prudential. Washingtons’ law was created to to stabilize or destabilize a deficient, nothing else

Posted by running | Report as abusive
 

this law was made for companies like GM’ & FORD’ Salaried employees pensions were under the protection of the federally insured PBGC, the fund is in the hands of Prudential, Prudential calls it an annuity, but there is no inflation protection, no cost of living increases, theres probably also a very large management fee for maintaining the funds’ distribution, if these retirees do not accept the lump-sum buy out, theres really not alot of pension guarantee from Prudential. Washingtons’ law was created to to stabilize or destabilize a deficient, nothing else

Posted by running | Report as abusive
 

I agree that this change in the regulation of private pension plans should have been decoupled from Moving Ahead, if only to be voted on separately.

That said, this story omits the following facts.

1. This story only concerns private employer defined benefit pensions plans. All such plans are pre-ERISA (1974) legacies. All corporate pension plans begun since then are 401ks or the like, for which this law is completely irrelevant. By 2030, corporate defined benefit plans will be but a memory.

2. Pension contributions are tax deductible, meaning that $1 of contributions costs the stockholders only 65 cents… if the firm is making a profit. If the firm is not making a profit, and is unsure of making a profit any time soon, then there are no tax benefits to pension contributions, unless one gets lucky with tax loss carryforwards. The tax benefits of pension contributions should be a refundable tax credit, not a deduction.

3. It is easy and low cost for an employer to “dump” on the PBGC its current and future pensioners under its defined benefit plan. Privately, the President and the Congress expect this to happen in many cases. The resulting taxpayer cost? We’ll cross that bridge when we come to it… I am surprised that the PBGC, created by ERISA 40 years ago, has not yet required a bailout.

4. The issues discussing in the article are third order compared to the looming insolvency of half or more of state & local govt. defined benefit plans. I agree with Joshuah Rauh when he argues that the unfunded liabilities of such plans are on the order of US$4.5 trillion. Under current law, these pension liabilities cannot be dumped on the PBGC.

5. The only pension plan that can be fully trusted is an IRA invested partly in bonds, and partly in a stock index fund. The IRA contribution limit should be raised to $10K/person/year.

Posted by ConcernedCynic | Report as abusive
 

Thank you for writing this. I think I’ll go and listen to that old Genesis tune, Land of Confusion.

Now did you read the news today
They say the dangers gone away
But I can see the fires still alight
There burning into the night.

Posted by Missinginaction | Report as abusive
 

I give about 10-15 more years of this Corpocracy we have for a government until we look like the Russian modeled society. It’s not the money we spend it’s the priorities that we spend it on and who benefits from the policy our government creates. Until people inform themselves of the corporate malfeasance that exists and votes accordingly we will continue to be squeezed to financial dust.

Posted by djt04 | Report as abusive
 

We will fix this when it hurts bad enough. Until then we will just continue to put band aids on it until it is so infected that we have to go to the Dr. And, if we wait to long, the doc may have to amputate something important, like our some of what’s left of our freedoms.
Whatch your politician people and hold them accountable for making good financial decisions or pay the price later.
Best to all,
g

Posted by SeaStar1 | Report as abusive
 

This should not be news to anyone. The same thing is happening in the public sector. We are broke. Simple as that. It is the end of the debt supercycle or the debt bubble or whatever you want to call it. The entire world is sliding into what will most likely be a long and unpleasant economic contraction. This is just the beginning of the difficulty, not the end. Events on the horizon include a european economic collapse and war with Iran. Buckle up my friends. It’s going to be a rough ride.

Posted by gordo53 | Report as abusive
 

Yes, but what would John Galt….er, Paul Ryan do?

That’s the real question.

@gordo53 The only thing broke is your courage. If we are so broke, why are so many rich people living it up right now? They got their pensions funded just fine. And even more so now since they dont have to contribute to yours at all anymore. Wait, you probably dont even have a pension, do you? Oh, sorry.

Posted by krimsonpage | Report as abusive
 

So the result is to make privately run pensions less solvent and put more money in the federal government run PBGC? Any guarantee that the money going in there stays there, or is it just a pile of IOU’s like the SS fund?
Just another case of federalizing everything. George Orwell would be proud!

Posted by TOTL | Report as abusive
 

Where were the people when Clinton, Rubin, Reich and Larry Summers agreed to rob the pension funds back in the early 1990s? Now we see the result of that. CEOs convinced our politicians that we needed to rebuild infrastructure and use that sitting pension money just for that. Well, the infrastructure did not happen and you can imagine where all that money ended up. Transfer of wealth started a long time ago and you still think we have two parties!

Posted by vperry | Report as abusive
 

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