Op-Ed ¦ September 14, 1992
Protector becomes the threat to pensions

By David Langer

First of two parts
The purpose of enacting the Employee Retirement Income Security Act of 1974 was to protect plan participants. While ERISA has afforded a measure of protection, the damage wreaked by it and successive laws and regulations requires a thorough re-evaluation now be made and corrective measures taken. Otherwise, the private defined benefit pension system faces continued decimation.

The harm federal protection has done to participants of single employer defined benefit plans is suggested in the accompanying graph. In the pre-ERISA period of 1959-'74, an average of 15 new plans were established for each plan that was terminated. In the post-ERISA years of 1975-'91, the ratio has plummeted to 2-to-1. Notably, the number of plans terminated over the two periods soared from 15,000 to 144,000.

ERISA lies at the heart of these disturbing statistics. It principally was designed to safeguard the participants of single-employer defined benefit plans, generally regarded as the most effective way of providing pension benefits to retiring employees.

Such plans pinpoint a desired benefit level and allow an employer to fund the benefits on a regular basis. While these plans enjoyed considerable popularity and success beginning in the 1940s, the federal government intervened in 1974 with one of the most voluminous laws ever passed in this country, ERISA.

A significant part of this federal protective apparatus -- the Pension Benefit Guaranty Corp. -- has become the object of a good deal of concern.

We all read about the PBGC frequently in the news and learn to our growing dismay that its liabilities are increasing because of new and projected corporate failures, that it is in the courts contesting with normal creditors for the assets of corporations in financial trouble, and that its executive director has proposed reforms to strengthen the financial position of the PBGC that, if not adopted, he warns will result in the tripling of the premiums plan sponsors have to pay.

Moreover, Congress' investigative arm, the General Accounting Office, declared it is unable to satisfy itself as to the fairness of the PBGC's liability estimates; also, because of weaknesses in the PBGC's premium and accounting operations, the GAO will not express an opinion on the pension insurance agency's financial statements for fiscal years 1990 and 1991. In sum, the GAO cautioned the financial statements have "limited reliability." Imagine the outcry if International Business Machines Corp. or any other corporation routinely issued financial statements of questionable reliability.

The PBGC now has come to be seen by many as the bane of the defined benefit plan. The PBGC is not, of course, the only problem these plans have.

There is also the debilitating complexity established initially by ERISA's some 300 original pages, vastly expanded and made more complicated since 1974 by an untold number of new laws and regulations containing restrictions, limitations and penalties; these additional rules require a good deal of rethinking as well.

Democracy in action?
The PBGC was the product of a variety of forces shaping ERISA in 1974.
A need had developed to protect pension promises. In particular, two large unions, the United Steelworkers of America and United Auto Workers, had many members working for employers in weak industries and covered by negotiated pension plans that were poorly funded. A number of the employers already had terminated their plans, and retirees and employees lost a substantial portion, if not all, of their benefits.

As a result, the heads of these two unions and their actuaries lobbied heavily for federal pension insurance. Bills were introduced regularly in Congress starting in 1964 to establish such protection.

Congressional and federal agency staffers, ever on the alert for issues to serve their employers, saw great political potential and staged a series of well-publicized public hearings at which they presented persons who had been harmed by the private pension system. A major television network picked up on it and aired "Pensions: The Broken Promise," which created a furor and further encouraged Congress to enact pension legislation.

Pension insurance, to be administered by a new agency, the PBGC, was proposed to restore lost benefits. But not everyone was enthralled by the prospect. Opponents included unions afraid the additional cost would cause small employers who hired their members to curtail pension benefits. Employers with well-funded plans felt no need for it.

Objections were raised regarding the actuarial soundness of insuring a risk that was subject to serious "anti-selection," that is, gaming to take advantage of the new federal protection. By this gaming, for instance, an employer could set up a defined benefit plan knowing it was too financially weak to maintain funding and then use the PBGC to provide the unfunded but guaranteed pensions.

One congressman who consistently opposed the PBGC, John Erlenborn, predicted many employers would turn away from defined benefit plans because of the potential new liability of 30% of their net worth upon plan termination. As a result of the opposition, it was believed the PBGC was going to be dropped. However, Congress passed the inclusion of the PBGC suddenly to the surprise of observers, which suggested a political deal had been struck between the unions and a number of major corporations.

One possible quid pro quo received by employers in return for their support was ERISA's pre-emption of state pension and welfare laws, which relieved multistate corporations of major headaches that could arise if individual states were to establish their own laws governing pension and welfare benefits.

Most plan sponsors, with a majority of covered plan participants, apparently had little or no say in the final decision to establish the PBGC. Further, a variety of safeguards urged by Dan McGill of the Pension Research Council and others were disregarded in the drafting of the legislation. These safeguards included the guarantee of pension benefits only when the plan sponsor went out of business (it was believed an ongoing employer would not terminate a plan, which later proved not to be the case), risk-related premiums and more rapid funding of past service liabilities.

It was perhaps inevitable that well over one-half of the benefits paid by the PBGC since 1974 have gone to members of the Steelworkers and Auto Workers unions. The unions were, of course, doing their job of protecting their members. Unfortunately, there were too few other interested parties with enough understanding and influence to either lobby against the pension insurance program or insist on a more financially viable one.

Pension promise not for all
Prior to ERISA, most defined benefit plans made no greater promise than did defined contribution plans, promising only what existing assets would provide. Politically, all defined benefit plans came to be seen as making pension promises, although it was mainly union plans that were based on a legally binding commitment by the employer.

It should be noted that during the entire legislative process leading up to ERISA, a subtle discrimination was practiced against the millions of defined contribution plan participants. Their benefits also were limited to available assets, but they were completely omitted from any pension insurance scheme, undoubtedly because their plans' benefits bore no resemblance to those of defined benefit plans. There were no horror stories told before congressional committees or on TV by the 60-year-olds with long years of service who were covered by profit-sharing plans for a few years and whose employer went out of business, leaving them, too, with wholly inadequate retirement funds.

A profound change wrought by ERISA was that the largely voluntary nature of past service funding by employers was stripped away, replaced with one based on compulsion. It created considerable resentment among employers.

Employers had been assuming the liability for past service benefits and had good reason to do so: They needed plans to attract and retain employees and to retire them in an orderly fashion. Employers generally accepted their pension obligation as a regular business expense and were concerned about the harm inadequate funding could have on employee morale.

Executives were also participants with benefits related to their salaries without limitations; they thus had a meaningful personal stake in a well-funded plan.

Voluntarism was working reasonably well prior to ERISA.
Even in its more circumscribed role of insuring only defined benefit plans, the PBGC undoubtedly has saved pensions of many participants in insolvent plans. However, the absence of careful thought and planning in the PBGC's design has proved highly damaging to the defined benefit system. This is painfully ironic since most such pension plans were operating successfully before the 1974 law was enacted.

- David Langer is president and consulting actuary of David Langer Co. New York,
and chairman of the employee benefits committee of the Actuarial Society of
Greater New York.

Copyright 1992 Crain Communications, Inc., Pensions & Investments, September 14, 1992
Reproduced with permission.