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To Fix The PBGC, Free Its Premiums

Setting the heavily underfunded Pension Benefit Guaranty Corporation (PBGC) on a sound financial footing has got to be one of the toughest jobs anywhere. The PBGC, the federally chartered agency that insures private sector pensions, is currently $26 billion in the hole. It could face increasing stress as more large firms seek to offload their pensions. Therefore, current PBGC head Joshua Gotbaum faces a daunting task. He has proposed some good ideas, but it's doubtful they will be enough.

The PBGC is funded by premiums paid the insured parties, not directly by taxpayers, but that doesn't mean that taxpayers are not exposed to its liabilities. As AEI's Alex Pollock noted in The American recently, the PBGC enjoys an "implicit" federal guarantee, similar to that of Fannie Mae and Fredde Mac. This creates a moral hazard by providing an incentive to companies (who run single-employer

plans) and unions (who run multiemployer plans) to make lower contributions into their funds, in the knowledge that someone else can always pick up the tab.

Despite the PBGC’s and Fannie’s statements, all market participants and politicians know that the Treasury will always bail out such government-sponsored adventures in financial risk-taking. It is simply too politically useful to the government to be able to claim it is not obligated, although in fact it is. Then Congress can continue to set up such off-balance sheet, off-budget risk vehicles to satisfy various political desires. If the government ever did let even one such vehicle fail, their political usefulness would end—so none will ever be allowed to fail. But of course, like Fannie Mae, they are not guaranteed! This situation requires a nuanced, Washington appreciation of the answer to the question, “What is truth?”

To test the government’s purposeful ambiguity on this point, think about whether one could amend the PBGC chartering act to replace the flexible notion that “the U.S. government is not liable for any obligation of the PBGC,” with this: “The U.S. government is prohibited from providing any funds, directly or indirectly, to protect the creditors or beneficiaries of the PBGC.” The latter would be clear and would definitively take the taxpayers off the hook. It would therefore be very unpopular with all those who wish to rely on the taxpayers while claiming they are not, considering they are in a hole $26 billion deep.

Furthermore, PBGC premiums are set not through any market-based mechanism, but by Congress, which has set them too low for years. Companies and unions with large pension costs have strong incentives to lobby Congress to keep premiums too low, as that provides them an insurance subsidy that lets them keep their underfunded pensions going. And those pensions are risky. Most pensions insured by the PBGC are defined benefit plans, which, unlike defined contribution plans, pay out a set amount independently of the plans' funding level.

Last week, the PBGC's Gotbaum responded to Pollock:

A taxpayer bailout is not our agenda. PBGC has never taken a dime from taxpayers and we want to keep it that way.

PBGC funds come from premiums paid by the pension plans we insure (and from recoveries from the plans we take over). However, Congress sets those premiums, not PBGC—and it has set them too low. From time to time, Congress raises the premiums—it did so again last month—but always bows to pressure to keep them low. If Congress keeps this up, Mr. Pollock will be right: PBGC eventually will either get a taxpayer bailout or, if not, go bankrupt.

But that’s a path we can avoid. There is a way out, and the administration proposed it over a year ago: Let PBGC, not Congress, set premiums. Let PBGC do it on a businesslike basis—based on each company’s actual risk. That's the way it’s done by the FDIC, by other government insurance programs, and by virtually every private insurance company on the planet.

Gotbaum is right. Moving the setting of PBGC premiums away from Capitol Hill is absolutely necessary to bring some fiscal sanity to the agency's structure. However, reform should go further. The PBGC may be better equipped to set premiums than Congress, but it is still likely to be susceptible to political pressure. And face pressure it will.

A 2005 Congressional Budget Office (CBO) study estimated that PBGC premiums would need to increase more than sixfold to better reflect risk. The PBGC's situation hasn't changed much since the CBO did its study. It is highly unlikely that the current beneficiaries of the PBGC's huge pension insurance subsidy will let it go without a fight.

For more on pensions, see here.