ARTICLES BY TOPIC ¦ PENSION BENEFIT GUARANTY CORP. (PBGC)



Op-Ed ¦ December 13, 1993
Too much reform for still-manageable problem

By David Langer

As members of Congress begin to consider the package of 20-plus reform proposals for the Pension Benefit Guaranty Corp., developed by the task force formed by Secretary of Labor Robert B. Reich, they need to ask, Where's the fire?

The reforms, the outgrowth of six months of deliberations by the task force, seek to correct what the group considers a dangerously weakening financial outlook for the PBGC.

But a careful examination of the size and trend in the PBGC's deficit does not support what Secretary Reich and the PBGC ask the public to believe: that the deficit poses a "threat to the ability of the PBGC to safeguard pension benefits."

The sweeping reform proposals, based on suspect data and assumptions, would impose an unnecessary and harmful overlay of additional complexity on pension law and regulation. The summary of the proposed PBGC changes in the law, sponsored in Congress by Reps. Dan Rostenkowski, D-Ill., and William Ford, D-Mich., as HR 3396, is 46 pages long.

If, as it appears, the facts and assumptions are not as stated, less drastic measures should be contemplated.

In announcing the proposals, Secretary Reich noted, "There has been dramatic growth in underfunding (of pension plans) . . . expected to exceed $45 billion . . . pos(ing) an unnecessary and unacceptable risk for workers and retirees. And PBGC, already facing a $2.7 billion deficit, is further jeopardized by this growing underfunding."

The deficit, the most prominent figure the PBGC cites to demonstrate the seriousness of its financial problems, needs a closer examination. Ordinarily, a deficit is arrived at by deducting assets from liabilities. But the PBGC modifies the calculation by adding in "probable net claims." These claims represent the PBGC's estimate of claims it is likely to have to assume in the near future from plans expected to terminate because the sponsors are in dire financial straits.

However, such claims are not actual, and substantially increase the deficit. For example, as of Sept. 30, 1992, the PBGC estimated its deficit at $2.7 billion, inclusive of $1 billion in probable net claims. Subtracting out the latter, the true PBGC deficit is $1.7 billion. The $1 billion in probable net claims thus added 59% to the true deficit.

Oddly, the PBGC does not include other highly probable transactions -- such as premium and investment income and benefit and expense payouts -- that on balance would reduce its estimated deficit.

The PBGC also has exaggerated its estimated deficit in prior years. In 1990, the PBGC estimated its deficit at $1.9 billion. But included are probable net claims of $1.1 billion, more than doubling the true deficit of $802 million. For the most recent threeyear period of 1990-1992, probable net claims added a sizable average of 81% to the true deficit.

How probable are the PBGC's probable net claims? My office computed the PBGC's degree of success in predicting probable net claims that, in fact, came due. The prediction success rates were 11%, 50% and 35%, respectively, in 1990, 1991 and 1992, a batting average of about one-third.

Because PBGC was off the mark twothirds of the time, its use of the phrase "probable net claims" is therefore not justified. The PBGC's use of probable net claims clearly puts a more negative spin on the deficit than is warranted.

There is another way to look at the deficit, that is, as a percentage of the PBGC's assets. This shows a more sanguine picture of the PBGC financial outlook. As a percentage of assets, the true PBGC deficit dropped from 75% in 1985 to 27% in 1992, the 27% being more the result of lowered interest rates than losses from plan terminations. This favorable trend doesn't mean a threat to the PBGC could not materialize at a later date -- few insurance schemes are completely invulnerable -- but the PBGC has not demonstrated that the public need be fearful of the deficit.

The other issue to be examined is the $45 billion Secretary Reich holds out as a portent of long-term problems. This represents the PBGC estimate of the total underfunding of active pension plans, a large portion of which the PBGC would have to cover should the sponsoring companies of those plans fail.

This figure, however, has minimal reliability. It is but a stab in the dark, not being calculated directly from the 65,000 plans, all of which differ substantially in benefit provisions and actuarial method and assumptions. The range of error of the PBGC's estimate will thus be quite wide. The underfunding is subject to interest rate fluctuations as well, and long-term rates are currently at their lowest level since the establishment of the PBGC in 1974, leveraging the underfunding upward. Any study of the PBGC's problems should estimate this underfunding at higher interest rates as well to provide a fuller picture.

The PBGC gives the implication that the underfunding of $45 billion is a shadowy menace. It is not. For most plans, the underfunding simply represents the remaining past service obligation that an employer normally funds over a period of years. Such an obligation is a necessary accompaniment if a plan is to provide benefits for service prior to the effective date of the plan or a benefit increase, and no stigma should therefore be attached to a sound actuarial method for the budgeting of plan costs.

Can one determine which part of the $45 billion and future increases will become claims against the PBGC? The agency believes $12 billion is attributable to plans of sponsors in heavy industries in "difficult financial circumstances." This is questionable, because difficult judgments are required with respect to a multitude of complex factors, including the economy, management skill and technological change, which can vary widely over each year for a variety of reasons.

The PBGC also projects its deficits over a 10-year period. These projections depend on several factors -- each of which is subject to uncertainty -- from premium collections to legislation and court decisions. Considering the PBGC's batting average of only onethird for predicting near-term claims, it is reasonable to conclude that as it goes out from two to 10 years, its ability to predict will diminish rapidly.

For example, the PBGC estimated in 1986 a deficit of $7.4 billion to $11 billion for 1992, while the actual deficit it computed came to $2.7 billion. Further, note the estimated PBGC deficit for 2002 appearing in its 1992 annual report is in the range of $2 billion to $28 billion (or even higher -- the agency does not regard $28 billion to be the worst-case basis.) A prediction of such range is of little use.

Two other indicators also show the PBGC is in better financial condition than it admits. One is the net cash flow generated by income items (premiums and investment income) less disbursement items (benefits and expenses). From 1985 through 1988, income exceeded disbursements by a total of $435 million ($109 million per year), while in the past four years, 1989-1992, the excess was $2.5 billion ($631 million per year). The average annual amount of net income thus rose nearly 500% -- certainly a strong financial performance.

On an individual items basis, premiums rose more than tenfold to $876 million from $82 million, while benefits rose nearly fourfold to $634 million from $170 million and expenses (administration plus investment) rose threefold to $99 million from $33 million.

The second indicator of increasing financial strength is the ratio of assets to the sum of benefits and expenses. This ratio provides a rough measure of the number of years that disbursements at the current annual rate could be made from existing assets. The ratio from 1985 to 1992 has risen at an average rate of 6% per year. At the end of 1985, there were $5.69 in PBGC assets for each $1 the PBGC paid out. At the end of 1992, there were $8.59 per $1, a hefty 51% increase.

What is an adequate ratio? The goal of Social Security old age benefits is about one year of benefit payments. Secretary Reich's task force on the PBGC proposes that defined benefit plans have $3 in assets per $1 of payout. The PBGC's goal should probably be around $5 in assets per $1 of payout to allow time to spot trends and to arrive at any course of action.

Based on the above analysis, Secretary Reich and his task force have not made their case for the adoption of their proposals to raise either premiums or sponsor contributions. There is some merit, however, in those proposals aimed at minimizing additional large claims, for reasons of equity to the other sponsors. There is a need, however, to consider alternatives to the task force's proposals and to evaluate the usefulness of the PBGC in the country's efforts to provide retirement security for its citizens.

Copyright 1993 Crain Communications, Inc., Pensions & Investments, December 13, 1993
Reproduced with permission.
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© 2001 DAVID LANGER COMPANY, INC.