This should be good news: At a time when worry about the retirement security of American workers is rising, traditional pension plans finished 2013 in their best shape last year since the financial crisis of 2008. Yet that may only be setting the table for more corporations to stop offering them.
The funding deficit of the 100 largest pension plans sponsored by publicly traded U.S. corporations plunged 57 percent in 2013, to $125.9 billion in the year-ago period, according to Towers Watson, the benefits consulting firm. (Funding is a measure of the assets that plans have on hand to pay projected obligations to beneficiaries.) The improvement resulted from solid investment returns and higher interest rates. A Mercer analysis of pension funds sponsored by S&P 1500 companies showed similar gains.
But that may just spur a new round of corporate pension “de-risking” – industry jargon for decisions by plan sponsors to terminate or freeze plans, or transfer the obligations to insurance companies, which replace pensions with commercial annuities. De-risking becomes less costly as plan health improves.
My Reuters column explains why de-risking may accelerate this year and in 2015. In this earlier column, I explain how workers should evaluate lump sum offers. Also see this interview with annuitization expert Moshe A. Milevsky. He’s a finance professor at the Schulich School of Business at York University in Toronto.
PBGC director sounds off
For today’s column, I interviewed Josh Gotbaum, director of the Pension Benefit Guarantee Corp. (PBGC). the federally-sponsored agency that provides back-up insurance when corporate pension plans fail. PBGC doesn’t receive federal dollars – instead, it is funded from the insurance premiums paid by plan sponsors. Those sponsors and the benefit consulting firms that work with them often point to the rising cost of PBGC premiums. PBGC is chronically underfunded, and ran a $35 billion deficit last year.
In December, Congress agreed to gradually raise premiums over two years. Plan sponsors will pay a flat per-employee annual premium of $64 in 2016, up from $49 this year; sponsors also pay an additional variable rate on any unfunded liabilities in their plans. According to Gotbaum, the average combined per-person premium will be $90 within the next two years.
Josh offered some expansive and provocative points about the decline of corporate-sector pensions that wound up on the cutting room floor at Reuters due to length constraints, and these points need to be aired. Here’s an edited transcript of part of our conversation.
Q: What are your thoughts about the current pension landscape – but the improved funding status, and the likelihood that we’ll see an acceleration of de-risking in the next couple years?
A: It’s very clear that some portion of sponsors of traditional defined benefit (DB) plans would like to stop offering them, and that they will not get out of the system until their plans are fully funded. So for those folks, as market returns go up and interest rates rise, they are getting closer to full funding and they are able to make a decision.
Some of them won’t get out of the DB system entirely – they will partially de-risk. Unfortunately, we’ve created a situation [through features of the Pension Protection Act of 2006] where the preferred way to de-risk is to dump a lump sum on employees rather than buy an annuity from an insurance company. When a chief financial officer comes to me and says ‘We’re not getting out entirely, but we are de-risking and we’re doing it via a lump sum, and we’ll buy annuity contracts to cover the rest, I ask, why don’t you do the annuity for everyone? The answer is that it will save money – everyone who takes the lump sum saves me ten or 15 percent. That means the individual loses about the same amount.
In my view, its tragic we have created economic incentives for them to leave by dumping lump sums on people who aren’t investment experts or actuaries, and will never get the equivalent lifetime income that they would have received in their money stayed in the plan.
Q: I’ve heard you and others argue that much of the de-risking phenomenon is driven by the benefit consulting firms that work with corporations. Is that really the case?
A: This is a bit like asking whether financial shenanigans have been caused or facilitated by Wall Street. Of course, de-risking is driven by CFOs. But it’s a fact that this is a complex area, and the consultants are coming in and telling CFOs, ‘You can do this – you can save 10 or 15 percent on your pension costs. They’re also talking about the fact that mortality assumptions will be rising in a couple years, and that will make lump sum offers more expensive for them.
Q: Why are PBGC premiums jumping so sharply, and are you worried that the trend will drive out more plan sponsors?
A: It’s clear that now a greater argument can be made that premiums are affecting fundamental business decision-making. In the de-risking area, we now have the double whammy of underpriced lump sums – and that dumping a plan through a lump sum gets rid of a much higher premium than used to exist.
The [Obama] Administration, and the Bush Administration before it, has asked Congress to change the basic nature of premium pricing to better take risk and obligation into account.
But Congress has not seen fit to let us do that in a business-like way. Instead, it has chosen to stay with an across-the-board, one-size-fits-all approach to premiums.
I’d like to be able to set very different premiums that take into account the amount of the obligation – that would remove the incentive to do lump sum offers for small, terminated vested plans. Second, the sponsors of plans that are unlikely ever to go bankrupt shouldn’t have to subsidize sponsors that will.
Q: What are your thoughts about what’s evolving in corporate pensions in the broader context of retirement security?
A: The focus on decisions by employers to abandon traditional pensions misses the larger crisis. The bigger picture is that most employers offer no retirement plan at all. And those those who do offer [defined contribution/401k plans] have plans that result in less saving, lower returns and result in less lifetime income. So we’re talking about whether companies will decide to keep offering traditional pensions or not – that is an issue, but most are offering nothing and those that are are offering something that is worse for ret security.
We are facing a broader question as a nation, which is: How do we provide adequate retirement income? It’s clear that employers will not, or cannot shoulder the entire burden, but it’s also clear that employers are the best people to get employees to save. So if we can square that circle and improve all retirement plans, we might actually have the retirement security that our parents had.