by George F. McClure

The risk that bankrupt United Airlines might not make required contributions to its defined-benefit (DB) pension plans ($4.1 billion over the next five years) has highlighted the Pension Benefit Guaranty Corporation’s (PBGC) role in guaranteeing some portion of single-employer pension plans (www.nytimes.com). Four of the 10 largest claims that PBGC has taken over — not including United — are from airlines.

Before the Employee Retirement and Income Security Act of 1974 (ERISA), few rules governed defined-benefit pension plan funding, and participants had no guarantees that they would receive the benefits promised. When Studebaker-Packard’s pension plan failed in the 1960s, for example, many plan participants lost their pensions¹. Such experiences prompted the passage of ERISA to protect retirement savings of Americans covered by private pension plans. Along with other changes, ERISA established PBGC to pay benefits — subject to certain limits — to participants when employers could not. PBGC, a quasi-public agency, functions as an insurer; it collects premiums from employers with DB pension funds and uses those premiums to make payments to participants, if the pension plan sponsor defaults².

PBGC Benefit Limits

A statutory limit exists on the amount of a plan’s benefit that PBGC can guarantee. Under the single-employer program, PBGC adjusts the limit annually based on changes in the Social Security contribution and benefit base. The base is permanently established for each pension plan based on the date the plan terminates. For plans with a 2004 termination date, for example, the maximum guarantee is $44,386.32 yearly ($3,698.86 monthly) for a single-life annuity beginning at age 65 (www.pbgc.gov/about/BENEFITS.htm).

PBGC also limits its guarantee to certain benefits, including so-called shutdown benefits — significant subsidized early retirement benefits triggered by layoffs or plant closings that occur before plan termination. The guarantee does not generally include supplemental benefits, such as the temporary benefits some plans pay to participants from the time they retire until they are eligible for Social Security benefits.

Airlines Pass the Buck

When US Airways tried to terminate its pilots' pension fund as apart of its bid to emerge from its first bankruptcy, the Air Line Pilots Association (ALPA) fought the more vigorously in U.S. Bankruptcy Court. ALPA charged that the company was "attempting to force pilots to bear an unacceptable and unjust burden that permanently harms pilots' retirement income." But despite ALPA's objections, US Airways successfully passed responsibility for the pilots' pension fund to PGBC. Underfunded by $2.5 billion, it is the sixth largest pension fund PBGC assumed in its 28-year history. (www.pbgc.gov/news/press_releases/2003/pr03_32.htm).

Because of the financial transactions associated with the breakup and sale of Pan American Airways assets in 1991, some employees with pension credits received less than they thought they were entitled to. These employees have formed an association that continues to dispute the PBGC settlement (www.panam.com/afpae.asp).

Reform Before Crisis

Twenty percent of private-sector workers are covered by defined-benefit plans. Although the majority of DB pension plans insured by the PBGC are well funded, a significant minority of plans — primarily those in the airline and steel industries — are underfunded. And unfortunately, underfunding levels in these plans continue to grow.

In its most recent financial report, the PBGC reported a $278.6 billion deficit in pension funding by companies with more than $50 million in unfunded liabilities — up substantially from $18.4 billion reported in 1999. Although lump sum payments may be more expensive for a plan than the comparable annuity, this minimum funding deficit does not take lump sum payouts into account. The average funded ratio is less than 70 percent of total liabilities (www.pbgc.gov/news/press_releases/2004/pr04_53.htm).

PBGC has sufficient assets on hand to pay benefits for several years. But serious structural issues exist that require fundamental reform to the defined benefit system now. In addition, PBGC’s deficit is the largest in its history and is still growing. It behooves us to address these matters before the deficit reaches a crisis point. Current pension funding rules have acted to delay needed pension funding. Employers find that they are being hit with substantial funding requirements when they can least afford them. Deferring action would risk subjecting the entire pension system to similar but much more serious strains in the future.

PBGC Program Listed as “High Risk”

The U.S. General Accountability Office (GAO), an arm of Congress that acts as a watchdog over the federal Executive branch of U.S. Government, has found that the health of PBGC’s single-employer insurance program requires policymakers’ attention. The office pointed to several systemic problems that pose serious risk to PBGC. For example, the insured participant base continues to shift away from active workers, falling from 78 percent of all insured participants in 1980 to only 53 percent in 2000. In addition, GAO noted that the insurance risk pool “has become concentrated in industries affected by global competition and the movement from an industrial to a knowledge-based economy”  (www.pbgc.gov/news/speeches/testimony_101403.pdf). In 2001, almost half of all program-insured participants were in plans sponsored by firms in manufacturing industries.

Because of PBGC’s extraordinary one-year loss, the dramatic increase in pension underfunding, and the risk of additional large claims on the program, GAO recently placed the single-employer insurance program on its “high risk” list (www.gao.gov/new.items/d031050sp.pdf). This designation should spur reforms to protect primary stakeholders in the pension insurance system — participants and premium payers. The PBGC is not authorized to use taxpayer funds to pay private pensions. Should the demand on PBGC assets exceed funds available, Congress might have to step in to make up the shortfall. Unfortunately, no current law permits Congress to fund such a bailout.

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