Easy Street Investing

Pension Plan Shocker Dead Ahead!

Nilus Mattive

I’ve talked about corporate pension plans before, but in a few short weeks I think we’re going to get some shocking news. Namely, that the government backup for failed pension plans is more underfunded than it has ever been before.

Back in April, I told you a bit about the Pension Benefit Guaranty Corporation and its decade of running in the red.

But just to recap: The PBGC is there for workers when their companies break retirement promises, and yet ironically, the PBGC itself has been underfunded every year since 2002!

To its credit, the organization was doing a decent job of getting back toward the black lately. It cut its deficit slightly in 2005, then made major strides in 2006 … 2007 … and 2008.

Now that streak looks ready to end — in a BIG way — when the PBGC reports its full-year financial results at the end of this month.

I’m basing that on what the group’s acting director Vince Snowbarger told a Senate Special Committee on Aging back in May. At that point, he said the PBGC was running a $33.5 billion deficit in 2009.

That’s THREE TIMES the size of the group’s deficit last year, and the largest shortfall in its 35-year operating history!

As Snowbarger stated in his written testimony:

“The increase in the PBGC’s deficit is driven primarily by a drop in interest rates and by plan terminations, not by investment losses. The PBGC has sufficient funds to meet its benefit obligations for many years because benefits are paid monthly over the lifetimes of beneficiaries, not as lump sums. Nevertheless, over the long term, the deficit must be addressed.”

PBGC Acting Director Vince Snowbarger and former director, Charles Millard, testify before the Senate.
PBGC Acting Director Vince Snowbarger and former director, Charles Millard, testify before the Senate.

I’m willing to bet that the PBGC’s official release at the end of this month is going to show a rather dire situation, possibly worse than the mid-year deficit.

And the most important part of Snowbarger’s statement is that this deficit WILL need to be addressed.

That raises a few important questions …

First, Where Does the PBGC Get Its Funding?

The PBGC is a federal corporation created under the Employee Retirement Income Security Act of 1974. That basically means it’s a quasi-governmental agency, much like Fannie Mae and Freddie Mac were. (Yes, feel free to either shudder or snicker at this point.)

Essentially, the PBGC builds up a kitty by collecting premiums from working pension plans, and then uses that money to dole out benefits when companies go bankrupt or otherwise abandon their plans.

The PBGC currently guarantees basic pension benefits for about 44 million U.S. workers and retirees taking part in nearly 30,000 defined benefit pension plans.

Before I go any further, here’s a quick refresher on defined benefit pension plans: They’re the dying breed of retirement plans that guarantee participants a set amount of money — paid monthly for life — generally based on the number of years of service performed at a company.

To operate these plans, companies have to sock away money for each covered worker. More importantly, they have to hope their investment assumptions work out well enough to produce enough in future returns to cover promised payouts.

When their investment portfolios don’t perform as planned — and that has been happening across the board lately given a rather tumultuous decade for stocks — companies must either dig deep into their corporate coffers or discontinue their plans.

You can see why very few old-line companies are offering defined benefit pension plans to their new crop of workers. And why they’re having a hard time keeping their existing plans solvent.

More importantly, we should all remember that the PBGC basically faces the same challenges … plus a couple of additional hurdles.

Like private companies, it has a set amount of money in its kitty. And like private companies, it has to hope future investment returns allow that money to grow fast enough to cover future outlays.

But it CANNOT borrow from its regular operations to cover its deficit. After all, it doesn’t have a regular business to fall back on …

It CANNOT discontinue its operations, obviously …

And given the fact that fewer companies are choosing to continue offering defined benefit plans, it has fewer and fewer healthy plans to collect premiums from!

So Where Will the PBGC Get the Money
to Correct Its Massive Deficit?

Here’s the thing … the PBGC does have a lot of money in its plan. And it’s unlikely that anyone currently receiving benefits is going to suffer in the short-term.

As Snowbarger noted in his testimony, because benefits are paid out monthly, the PBGC has some leeway. Plus, a greater number of failed plans means more immediate funding for PBGC because most companies leave behind some money when they close shop.

chart

However, none of that makes the long-term health of the PBGC any better. It really only has a few ways to solve its systemic underfunding.

Obviously, if its investment portfolio has a rip-roaring rally, everything will be just peachy. But the idea of investment gains making up much ground is a long shot. Especially once you realize that the PBGC’s portfolio is about 30 percent in stocks and 70 percent in bonds!

That kind of an asset allocation certainly helped the PBGC avoid an even bigger catastrophe during the recent meltdown. However, based on historical returns, we should hardly expect it to post massive gains going forward.

The second option is for the PBGC to cut the amount of benefits it pays out to current recipients or to reduce the amount it offers to future workers covered in the event of plan failures. Remember that the PBGC already imposes a cap on how much it pays out workers — currently $54,000 a year to anyone 65 years or older.

Still, I don’t see it being able to reduce payments to anyone already covered. Only the idea of a smaller guarantee to future recipients is a possibility. They could simply maintain current payout levels and let long-term inflation work its magic.

But really … the PBGC simply needs to get more money into its coffers.

A lot of experts are calling for higher premiums being charged to member pension plans. And that may certainly happen. Yet there are two big drawbacks to this approach, as I see it:

First, as previously noted, there are already fewer and fewer companies offering defined benefit pension plans.

Second, charging the good plans higher premiums will only give companies one more reason to STOP providing defined benefit pension plans, which would exacerbate the existing problem.

That leaves just one place for the PBGC to get its money … you and me!

The PBGC’s Ongoing Deficit Will Likely Be
One More Bailout for Uncle Sam to Deal With

The story is just like all the others — whether it’s Fannie, Freddie, Social Security, the FDIC, or some other program.

They start with great intentions. They run fine when things are going well. But when things go bad, they become taxpayer money pits. They’re beasts that need constant feeding, growing hungrier and hungrier with time.

In the case of the PBGC, things have been running surprisingly well up until this point. And the organization has never taken a dime of taxpayer money yet.

I should also note that interest rate changes greatly affect the organization’s balance sheet … with higher rates making future obligations less of a problem.

Still, what are the odds that we’ll see a couple more major plan failures before the economy finds its footing? And what are the odds that taxpayers will ultimately be on the hook for at least some money five or ten years from now?

You know which way I’d be betting.

Best wishes,

Nilus

P.S. The real lesson in all this is that we cannot rely on anyone or anything for our individual retirement security. In fact, those of us who act responsibly may very well end up shelling out MORE money to fund ailing systems and failing government backstops.

I suggest you keep saving aggressively … use available tax shelters … and invest in a handful of wealth-building companies to secure your own financial well being.

If you want to get the short list of dividend stocks that I recommend for maximum long-term wealth, plus all my insights on retirement matters and other personal finance topics, subscribe to my monthly newsletter, Dividend Superstars, today.



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Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Nilus Mattive, Claus Vogt, Ron Rowland, Michael Larson and Bryan Rich. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual prices investors pay or receive. Regular contributors and staff include Kristen Adams, Andrea Baumwald, John Burke, Amy Carlino, Selene Ceballo, Amber Dakar, Dinesh Kalera, Red Morgan, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau, Jill Umiker, Leslie Underwood and Michelle Zausnig.

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