“Communism,” comedian Lenny Bruce once quipped, “is like one big phone company.” This dated joke refers to the monolithic phone company known as “Ma Bell,” which enjoyed a government-granted monopoly over America’s communications sector until being broken up in 1984. But while Ma Bell is long dead, its legacy of unsustainable pensions remains alive and well.
Now, one of Ma Bell’s successors, AT&T, is seeking to renegotiate its pension plan with the Communications Workers of America (CWA), the union representing a large segment of its workforce.
Why now? Because the Pension Benefit Guaranty Corporation (PBGC), a federal agency tasked with insuring private pension plans, has long encouraged large companies to delay needed changes to their retirement plans in order to bring labor costs under control.
For decades, AT&T has offered its unionized employees defined benefit pensions, which guarantee a fixed payout to retirees. As a result, payout obligations invariably grow—even when a pension plan’s funding declines.
Why would any company agree to such a scheme? For years, it was the least costly option. Before today’s competitive and vibrant communications market, Ma Bell and unions thrived in an environment of regulated monopoly. When CWA first signed contracts with AT&T’s predecessor over 60 years ago, it was the phone company. For Ma Bell, acceding to union demands was less costly than enduring crippling strikes. Higher labor costs could simply be passed on to consumers, who lacked the ability to go elsewhere.
Ma Bell is long gone, and so are most oligopolies with high barriers to entry. Many of the large firms that have unloaded their pensions onto the PGBC—airlines, steelmakers, and automakers—once operated in an environment of little competition. During organized labor’s apogee, in the years following World War II, U.S. automakers and steelmakers dominated the market, as Europe and Japan worked to rebuild their industrial infrastructure. The Big Three Detroit automakers all had near-identical agreements with the United Auto Workers. And strict federal regulations determined airline routes and fares into the 1970s.
Today, defined benefit pensions rarely exist outside of government agencies. In the private sector, they have managed to survive in some large unionized industries—for now. This is in part the byproduct of unions’ aggressive efforts to preserve generous pensions. Another key factor is the PBGC, which has allowed some large firms to delay restructuring their employee retirement plans by allowing them to offload their pensions onto it.
The PBGC is funded through premiums paid by insured companies. But these premiums are set by Congress, in a highly politicized process, with insured companies lobbying to keep premiums low.
Unions also have an incentive to lobby for lower premiums. The more cash their employers have, the more money they can spend on current pay and benefits, while making defined benefit pensions more attractive for employers. For unions, the latter is crucial, since a stable and secure retirement is a major selling point to attract members.
Artificially low premiums inevitably lead to deficits. Indeed, the PBGC’s current deficit stands at $26 billion. Raising premiums is long overdue. But how high should they go? A 2005 Congressional Budget Office report concluded that, “raising rates so that … the present value of expected future losses would equal the present value of premium income would require both the fixed and variable portions of the annual premium to be increased by a factor of 6.5.”
Together, the PBGC backstop and dirt-cheap premiums are a recipe for moral hazard that can only lead to trouble, while discouraging employers from making needed changes. So can defined benefit pensions thrive in a competitive market? Their history suggests that their prospects aren’t promising, but we’ll only know if and when they are allowed to function without a huge insurance subsidy.