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PBGC’s Underfunding Problem

PBGC’s Underfunding Problem. Beth Janus Jess Strilich. Funding Status from 1980 - 2004. Source: Paul Davies’ “Pension In Peril”. 2001: $7.73 billion surplus 2004: Approximately $23.3 billion underfunded 2006: Approximately $18.1 billion underfunded.

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PBGC’s Underfunding Problem

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  1. PBGC’s Underfunding Problem Beth Janus Jess Strilich

  2. Funding Status from 1980 - 2004 Source: Paul Davies’ “Pension In Peril” 2001: $7.73 billion surplus 2004: Approximately $23.3 billion underfunded 2006: Approximately $18.1 billion underfunded

  3. Steel Industry: The Beginning of the PBGC’s Problem • American steel companies had problems remaining competitive against foreign competitors • American steel facilities were outdated compared to foreign competitors • Foreign competitors’ labor costs ranged from $20 to $30 per ton, while American firms’ labor costs were $100 per ton

  4. Steel Industry: The Beginning of the PBGC’s Problem cont. • In order to stay competitive, the American steel companies used their free cash flow to update their steel mills • The steel companies implemented these changes too late and ultimately were forced into bankruptcy • As a result, the PBGC received more than $6 billion in claims from the steel industry • Bethlehem Steel - $3.7 billion • LTV Steel - $2.2 billion

  5. What caused pension plans to become underfunded? • Companies used accounting loopholes to satisfy minimum funding requirements • The major loophole: Funding Standard Accounts (FSA)

  6. Funding Standard Accounts • Companies use FSAs to monitor the health of its pension plans • When the pension plan performs well or gains interest, the company stores the increase on the plan’s assets in an account (FSA) to accumulate value and eventually uses these gains to offset any future liabilities

  7. Funding Standard Accounts cont. • Since many pension plans were generating high returns from 1995 - 2001 • Companies used its accumulated gains from the FSA to meet minimum funding requirements rather than cash contributions (perfectly legal) • From 1997 to 2002, cash contributions averaged only 42 percent of minimum required annual funding

  8. Funding Standard Accounts cont. • The companies relied heavily on the FSAs short-term benefits and did not prepare for an economic collapse • When steel companies ran out of FSA credits to fulfill minimum credits, the companies had no excess cash to fund their pension plans because they were spending their money to remain competitive

  9. PBGC’s Corporate Governance • The PBGC has three board of directors (BOD) • The Secretary of Labor, Chairman • The Secretary of Commerce • The Secretary of Treasury • The 2006 PPA requires the Senate to elect a Director to oversee the PBGC operations

  10. Criticism of the PBGC’s Corporate Governance • The BOD have only conducted 18 board meetings over the last 27 years • 10 of these meetings have been conducted after 2003 • The BOD still has not established formal policies and procedures for administration • The reason: The Department of Labor still heavily influences the PBGC

  11. How is the PBGC going to solve its underfunding problem?

  12. PBGC Recent Alternatives • PBGC increase premium to $33 for FY2008 • Will adjust for inflation based on the average wage index • Proposes Variable-Rate Premium • Underfunded plans require increased payments • Benefits to be measured as of the funding valuation date • Ensure premium is determined the same way and at the same time when the fund is valued, no estimation required

  13. PBGC Recent Alternatives • Propose adjusting the mortality assumption to determine benefit for beneficiaries • Update tables for interest factors to match the market annuity prices • Currently the tables no longer approximate the market annuity prices • Update using a fixed blend of 50% healthy female mortality rate and 50% healthy male mortality rate

  14. Criticism of PBGC’s Proposal • Premium Adjusted for Inflation: • Companies freeze its pension plans • Mercer study: Of the Fortune 200 companies approximately 20% have frozen its pension plans or closed to new employees • Pension decreased from 100,000 company plans in 1985 to less than 40,000 plans in 2006 • Companies rather than bear additional costs to fully fund and pay higher premiums opt for 401(k) • Shift retirement burden on workers.

  15. Variable Interest Premiums: Company performing subpar, difficult for firm to pay the increased PBGC premiums due to its increased risk Company focused on withstanding bankruptcy and producing net income Decreases companies incentive to maintain pension plan Criticism of PBGC’s Proposal

  16. Bush Alternatives for PBGC • Agree with the PBGC, the premiums do not match the associated risk of all companies • Propose PBGC’s board adjust the risk-based premium rate so that the premium revenue can cover potential expected losses • Goal DB plans to better reflect a plan’s risk and restore PBGC health • Potential Problems with Alternative • Bring question of who determines how much companies pay? • Who will monitor the premiums and fluctuations in pension funding? • 3 major board members • Congress will not approve b/c cede legislative authority to set premiums to administration agencies

  17. Our Alternatives • Of the companies that sent claims to the PBGC for funding needs, 90% had junk bond rating for the last 10 years • PBGC better prepare itself for company claims by monitoring companies pension liability bond rating • Difficult to solve for underfunding but need to plan for possible termination

  18. Our Alternatives • Incentive for companies to adequately fund pension plan • Through tax credits or tax deductions • Current law has penalty for funding large amounts in profitable years for tax purposes • Reduce this penalty so companies will fund and less stress on the PBGC • Discourages companies to make sufficient cash infusions b/c penalized for overfunded plans

  19. Our Alternatives • Companies should receive a tax credit for interest and gains in its liability account • Required to contribute a stated minimum level of cash infusion per year • Decrease risk of potential future pension plan failure in hard economic times • Help reduce the stress on the PBGC in the case of terminated plans

  20. Recommendations • Problem is difficult to solve • Agree with variable risk premiums • Insurance companies use similar method for pension insurance, government should do the same • Issue with potential frozen plans • Rather have 401K plan and phase out pensions than have an extremely risky pension plan • PBGC needs better risk management • 18 BOD meetings in last 27 years • Recently increased the number of board meetings but remain under prepared for large claims

  21. Questions??????

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