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Tuesday June 01, 09:23
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Pension Under-funding Is the Emerging Global Dragon
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Pension plan funding across the world is much like a dragon that has just begun to emerge from its cave.
Spurred by stock market declines, poor investment decisions,aging populations and underfunding of defined-benefit pension plans, the beast is beginning to inflame the political process.
Politicians who admitted skipping pension payments are at the center of a major political scandal in Japan, for example. In the U.K., the government is considering a new pension insurance program called the Pension Protection Fund.
In the U.S., intense political pressure created an opposite result: companies in financial distress were allowed an $80 billion break from plan funding over the next two years.
More transparency on pension accounting will certainly help both private and public pensions across the world. Yet the sword of Damocles may hang over thousands of pension plans simply because of the way private plans are funded.
Wrong Approach
Many critics of current pension-funding laws and investment policies say they are grossly inadequate to meet the needs of aging societies.
Don’t look to the U.S., though, as a good example of how to strengthen pension funding. Congress recently shifted more of the burden of insuring private pensions to the Pension Benefit Guaranty Corporation (PBGC), a quasi-governmental agency charged with bailing out private plans. It’s funded by insurance premiums paid by companies and is required to back a system in which 90 percent of U.S. private defined-benefits are underfunded.
Zvi Bodie, author of ``Worry-Free Investing’’ (Prentice- Hall, 2003) and a finance professor at Boston University who has been a long-time opponent of the U.S. approach to pension funding, disparaged the recent ``Pension Funding Equity Act’’ that permits pension payment delays for financially ailing companies.
``This legislation will weaken the pension insurance system,’’ says Bodie, referring to the U.S. law, which he says may require a PBGC rescue similar to the $200 billion U.S. savings and loan bailout in the early 1980s. ``I believe that companies should perhaps promise less (in pension benefits), but deliver what they promise.’’
Hurting Retirees
The PBGC is on a record pace to take over pension plans from failing companies. It posted an $11.2 billion deficit at fiscal year-end 2003 and a $9.7 billion gap at fiscal mid-year.
While politically popular, pension insurance has limited benefits for retirees, who receive diminished benefits when the PBGC takes over their plan.
The most retirees will receive if the agency takes over a pension plan is $44,386.32 annually in 2004 or $3,698.86 per month for those who retired at age 65. The benefit drops for younger retirees. The PBGC doesn’t cover severance, vacation or health benefits.
Ask former Pan Am Airlines employee Leonard Beaumont of Bethpage, New York, about the PGBC’s protection. Beaumont worked as a mechanic for the airline for 30 years and was looking forward to a $70,000 annual pension. When Pan Am went bankrupt and liquidated in 1992, the airline’s pension plan was taken over by the PBGC. Then Beaumont was told he would only receive the PBGC-guaranteed amount of $43,000 for that year.
At 67, Beaumont says he was forced to take a job as a vocational director in a drug-treatment center to pay his bills. He has since joined a group of other Pan Am employees in a suit against the PBGC to regain lost benefits. The PBGC won’t comment on the suit.
The Funding
Pension insurance, though, will never be able to stem the fundamental crisis behind the funding gap. Benefits can only be paid when combined investment returns and contributions cover future payments.
Bodie blames some of the funding shortfalls on fund managers and companies taking too much risk in stocks in recent years and coming up short during a bear market.
``I’m in favor of matching (pension) assets to liabilities,’’ says Bodie. ``I’m not against stocks per se, I’m against saying that investing in stocks is safe in the long run.’’
Steve Kandarian, the former PBGC executive director who successfully shifted most of the agency’s trust fund to fixed income vehicles before he left earlier this year, observed that ``weaker companies continue to get further into the hole (with increased pension under-funding), hoping that the stock market will bail them out.’’
Hurting Investors
When companies rack up huge debts to their pension plans, it also hurts corporations and investors directly.
Credit ratings of 34 non-financial companies have been downgraded since 1999 because of large pension under-funding problems, according to Gregg Stein, a spokesman for Standard and Poor’s Corp., the rating service.
When corporations’ debt securities are downgraded, that means those companies have to pay bondholders a higher yield on their debt to compensate for the higher risk of default. In turn, these increased debt costs often divert cash away from investors’ dividends or company operating funds.
For example, a company rated ``BB’’ (AAA is the highest S&P rating) will pay investors a 1.9 percentage-point premium over a comparable Treasury security, Stein says.
All told, S&P estimates that only 19 percent of the 331 companies in its S&P 500 index of the largest industrial companies with defined benefit plans ``matched or exceeded (pension fund) liabilities in 2003.’’
Fixing the System
Increased disclosure through pending International Accounting Standards Board pension rules will help unmask the costs of pension funds in the private sector.
By January 2005, all European Union-listed companies must follow the same international pension accounting standards. The U.S., which enhanced its pension accounting rules late last year, may follow suit.
Accounting transparency may also have the unfortunate consequence of compelling more employers to curtail or shut down their costly defined benefit plans. A survey by Deloitte Consulting LLP in April found that 52 percent of companies surveyed ``are opting to move away from defined benefit plans.’’
Global pension challenges will not be solved easily. Solutions won’t be forthcoming, though, until all parties agree that the restive beast is more than a myth that’s hidden in some dark, cavernous financial statement. Global disclosure is the first step in this epic battle.
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