Are Pension Plans in America the next Enron?

As the trial of Ken Lay and Jeffrey Skilling of Enron draws to a close, most hope this will bring an end to one of the worst chapters of corporate greed and investor fraud in American business history. Enron's collapse in late 2001 wiped out $60 billion of capital from investors, employees, institutions, and public municipalities. However, Enron's demise could pale in comparison to the financial crisis that lies ahead if something isn't done about the under-funding of private and public pension plans.

Recently, the New York Times Magazine and Time Magazine published articles that addressed the issue of the potential failure of thousands of private and public pension plans and the impact this could have on taxpayers. Both estimated that both private (corporations) and public (state and local governments) pension plans nationwide are currently underfunded by at least $450 billion each and could go as high as $700 billion each!

To understand this potential catastrophe better, let's first review private pension plans. These are plans set-up by corporations both large, such as General Motors, and small, such as your local private hospital, that promise to pay a fixed monthly income to their employees at retirement for the rest of their lives. Federal law requires that, in addition to the money corporations must save to provide these fixed monthly pension plans, they must also pay insurance premiums annually, based on the size of their plan, to the Pension Benefit Guaranty Corporation (PBGC). The premiums collected by the PBGC are used as insurance to pay benefits to workers whose employers close or file for bankruptcy.

Bankruptcy is becoming the major problem for private pension plans today. More and more corporations are filing for bankruptcy for the sole purpose of shedding their pension plans and letting the PBGC take them over. If you don't believe us, just ask pilots from Delta and United Airlines and employees of Delphi Corporation, whose companies just dumped their pension plans on the PBGC.

The two major concerns here are: (1) anyone who is receiving or expecting an annual benefit greater than $45,000 will be in trouble, because the PBGC only pays out a maximum annual benefit of $45,000 per employee and, (2) the insurance premiums that the PBGC is collecting do not even cover 50% of the benefits that they are currently paying out! It doesn't take a math genius to figure out that there is a major problem.

So what can be done to protect employees? pension benefits? The answer is, unfortunately, not a lot. Thanks to the way Congress has written the laws for private pension plans, corporations are encouraged to underfund their plans, workers are denied the right to sue corporations for failure to pay benefits, and arcane formulas are used to calculate pension assets and obligations. Many have compared Congress's private pension accounting laws to Enron's accounting methods with one exception: it's all perfectly legal.

Barring a reversal in government policies, the PBGC, which is currently $23 billion in the red, will require over a $100 billion taxpayer bailout in the next 20 years according to the Congressional Budget Office. Many equate the potential PBGC problem to that of the Federal Savings and Loan Insurance Corporation (FSLIC) in the 80s. The one big difference is that the U.S. government by law had to bail out the FSLIC. However the government doesn't have to bail out the PBGC, because the PBGC is a private corporation. That means Congress, if it so chooses, can legally turn its back on the PBGC. If it does, the PBGC estimates it will have to reduce the benefits it currently pays by 90%!

Our recommendation is that if you are receiving or are expecting to receive a fixed monthly pension from your employer, you should check with your Human Resources department and find out about the health of your plan.

As bad as the situation is for private pension plans, public pension plans for state and local governments are in worse shape. As of today, there are no 'safety nets' or accounting laws governing public plans. However, all that will change at the end of 2007 when new accounting rules go into effect requiring all public agencies to itemize both healthcare costs and forecast retirement benefits for all their employees. This change will either set off a wave of tax increases, reductions in government services, or both. And, if you think that state and local governments can do the same as corporations or Congress and walk away from promised retirement benefits because they don't have the money, think again. In recent cases, the courts have ruled that benefits promised to government workers (judges and legislators included) must be honored.

So what happens if any state or local government cannot pay its benefits? The municipality must raise taxes. And if the tax burden becomes too great for those local taxpayers, the federal government legally must step in. So, if the State of Louisiana can't raise enough taxes to pay their retirement benefits, guess whose taxes will be raised to foot the bill? That's right, yours!

If a recent study of 64 state and local government's pension plans by Wilshire Associates, an investment advisory company, is any indication of what the future holds for public pension plans, the news is not good. Wilshire Associates found 54 of the 64 plans (or 85%) were underfunded by a total of $175.4 billion! You may ask, 'How could this happen'? Easy. Politicians, to appease their workers and avoid strikes, just keep granting sweeter and sweeter pension deals to local unions, such as teachers, police, and firefighters, regardless of the longterm impact. In addition, they fail to put money into their pension plans, make poor investment decisions, or both. And finally, to add insult to injury, local politicians often grant other politicians and themselves generous pension benefits when they retire.

A quick peak at some of the plans in the above study shows, for example, that the West Virginia Teachers Retirement System has only 22% of the assets needed to meet its expected liabilities, and that the pension plans of the State of Illinois, a low-tax state, are underfunded by almost $38 billion!

Let's look at an actual example of a public plan that went from the black to the red. The case is Contra Costa County located in Northern California. Contra Costa is part of the California Public Employees Retirement System (Calpers), which is the largest public retirement system in the country. Calpers, which boasted some of the highest returns in the stock market for any pension plan in the country in the 80s and 90s, allowed its state and local (Contra Costa included) governments to reduce their contributions in 1999. Contra Costa got by with contributing only $55 million to its retirement costs in 1999, when the market was at an all-time high. When the market tanked in 2001-2002, the county found itself with lower assets and greater obligations (as it added employees). At the end of 2005, the county's retirement bill from Calpers had more than tripled to $180 million. The county said it had no money to pay the bill, because it had spent all its excess earnings from the bull market on 'projects' and granting higher benefits to its employees. To make matters worse, the county plans on passing on the losses to its taxpayers.

If you think a solution might be to cut pension benefits and/or make the employees pay more into the system, like private plans do, this is simply not an option. Most state constitutions forbid public entities, even prospectively, from reducing the rate at which employees accrue benefits. Remember who writes the laws: the same people who will soon be collecting retirement benefits from their public pension plans. The only option is to reduce or abolish, such as the State of Alaska did, benefits for future employees. Benefits for current public workers are sacrosanct and cannot be touched. The New York Times article said it best, 'These benefits are like headless nails; once driven in, they can never be removed.'

With all the recent negative articles about companies freezing their plans (IBM, HP, Verizon) or dumping them onto the PBGC (Delta, United, Delphi), you would think Washington would want to get involved, but that isn't the case. The Bush administration would sooner be done with pension plans altogether. Secretary of Labor Elaine Chao was quoted in the New York Times as saying, 'Traditional pensions are losing their relevance. Defined benefit plans have their advantages, but in an increasingly mobile 21st century work force, the lack of flexibility of defined benefit plans is yielding to greater usage of defined contribution plans (401ks).'

If the government is not going to support monthly fixed pension plans, don't expect corporations to continue to do so. Robert 'Steve' Miller, head of Delphi, recently said, 'A pension plan makes no sense in today's world. It's not wise for a company to make financial promises over 40 or 50 years down the road.' This coming from a man who 20 years ago dumped Bethlehem Steel's pension plan on the PBGC and plans on doing the same with Delphi's.

So what's the ultimate solution or answer to fixing pension plans? Make sure you plan for yourself and your family, because the government and your employer are not going to. We emphasize in all our financial plans that the one sure way to beat any tax law change or employee crisis is to continue to develop your own retirement savings program. By doing this you control your retirement, not the Government or your employer.