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PBGC's Perverse Incentives Undermine Multiemployer Pensions

For years, the Pension Benefit Guaranty Corporation (PBGC), the federal agency that insures private sector defined benefit (DB) pension plans, has been severely underfunded below what it needs to cover its payout obligations to retirees, especially for multiemployer pensions. Closing this funding gap is urgent. Yet despite greater attention to the problem by lawmakers, the media, and the public, the problem persists.

A major reason for that is the perverse incentives built into the very workings of the PBGC. And it’s even worse for its multiemployer pension program.

First, PBGC premiums are set by Congress—a sure way to politicize the process and end up with premiums that don’t reflect actual funding risks.

Second is the “last man standing” rule, under which all participants in a multiemployer pension plan are responsible for the pension obligations of every other company in the plan. That means if one company goes bankrupt, its pension obligations are taken on by the other plan’s member companies.

Add to that federal pension insurance with too-low premiums and you’ve got a recipe for disaster. Indeed, the PBGC’s multiemployer insurance program is now a slow-moving disaster that threatens to undermine the PBGC’s very viability.

The Economist’s Buttonwood columnist highlights the problem, comparing the PBGC unfavorably with its British counterpart, the Pension Protection Fund (PPF), which “is pretty well-funded, thanks to a policy of buying inflation-linked government bonds to match its liabilities closely.” While a well-functioning private market for pension insurance would be preferable, the PPF model is still an improvement over the PBGC’s centrally controlled premium setting regime.

Things don’t look quite as healthy over at the PBGC, which has been around for much longer. As of its 2015 report it had total assets of $87.7 billion and liabilities of $164 billion—a deficit of $76.3 billion, a record (see chart). The big problem is the multi-employer bit of the PBGC’s responsibilities, where the deficit is $52.3 billion.

Multi-employer schemes cover industries such as mining and trucking, in which a number of companies contribute to a collective pot. As the industry shrinks and individual employers go bust, the financial position of such schemes deteriorates. They end up in the arms of the PBGC when they run out of money to pay benefits (normally, when a single company goes out of business, there are enough assets to cover most of the liabilities). So when a multi-employer failure occurs, the PBGC’s liability is accordingly huge. It makes provision on its balance-sheet for funds that it expects to run dry over the next decade. But Congress has provided for the PBGC to get a levy of only $27 per employee per year. That adds up to an annual payment of around $270m, woefully inadequate to cover a $52 billion liability.

Any policy solution that could do any good should include closing off multiemployer plans for new employees and increasing premiums and allowing premiums to reflect actual funding risk—which would inevitably mean higher premiums. “If Congress doesn’t want to charge employers more, it should fund the PBGC directly,” warns Buttonwood. While that would entail an honest recognition of the PBGC’s crisis, it would amount to an enormous subsidy to companies that already enjoy absurdly low premiums.