Monday, September 21, 2009

The Pension Benefits Guarantee Corporation

The US Government runs a number of insurance plans. As we debate the issue of adding another, the so called “government option” for health care reform, it is instructive to look at the existing programs. These include FHA, Ginnie Mae, Fannie Mae, Freddie Mac and a number of student loan programs (which incidentally may disappear under legislation that has passed the House and is on its way to the Senate which eliminates all federal aid to students who don’t qualify under a needs based system). Today we will look at the Pension Benefits Guarantee Corporation.

PBGC is a federal agency created by the Employee Retirement Income Security Act of 1974 (ERISA) to protect pension benefits in private-sector traditional pension plans known as defined benefit plans. If a participating plan terminates, usually through the sponsor’s bankruptcy, without sufficient money to pay all benefits PBGC's insurance program will pay the benefits provided by that plan up to the limits set by law. PBGC financing comes from insurance premiums paid by participating companies which are invested, from the assets taken from defunct pension plans, and from recoveries from the companies formerly responsible for the plans. The PBGC was presumably never supposed to be funded by the American public.

In hearings in 2005 Jim Nussle, Chairman of the House Budget Committee said, “Now in theory, the PBGC was supposed to be completely self-financing…But as we are discovering, and as most of us here know, that is not what is happening.” That year there was a $23 billion shortfall. Later in the hearing Chairman Nussle said, “To make matters worse, the Center on Federal Financial Institutions, which tracks pensions, tells us that on the current path, all PBGC assets will be exhausted, completely gone, by 2021, just 15 years from now.” We appear to be ahead of schedule. As it turns out, the PBGC has continuously operated in deficit every year since 2002. Through the second quarter of 2009 the unaudited deficit is $33.5 billion.(2) PBGC estimates that in just the auto sector alone underfunding of defined benefit plans is $77 billion. At the end of fiscal year 2008 audited financial statements showed total assets of $61,648,000,000. If we combine the $33.5 billion loss and just the unfunded auto liabilities the liabilities total over $95 billion. So the PBGC, a self funding government provided and managed insurance plan has a net deficit of over $30 billion, in other words it is bankrupt. Again from Chairman Nussle’s opening remarks in 2005, “So where does that leave us? Well, under the current scenario, if and when PBGC’s assets fall short, the choice is really one of two right now. Either for pension holders to lose the promised retirement benefits or for the taxpayers to get slapped with the bill for failed private pension plans.” So once again American taxpayers, many of whom have limited entitlements and no defined benefits, will be asked to pay the bill. The PBGC was in theory going to pay for itself, just as in theory the public option for health care will “pay for itself in future savings.”

And by the way, the PBGC was recently given wider investment authority and made its first investments in the stock market in the second quarter of last year setting up a Federal Government agency making investments in private sector companies. As a result of those investments PBGC experienced a 23% loss in its assets for the fiscal year ending September 30, 2008.(3) It is also interesting to note that the former head of PBGC, Charles Millard, is currently under investigation for improprieties for directing funds for favors involving, among others, Goldman Sachs.(4) This happened as a result of the fund’s recently granted ability to invest in publicly traded equities.

So here we have another unfunded liability, created by an entitlement in the form of a guaranteed benefits plan, under-insured by a government-run insurance program placing the responsibility for payment squarely on the shoulders of the American taxpayer.

Next issue: the housing insurance programs, all bankrupt or tottering on the edge, which the government has started since FDR created the Federal Housing Administration during the Depression.


Monday, September 14, 2009

General Motors

For many years I have watched compliant politicians bow to the unions, often in collusion with business, and the result is a bigger and bigger pile of unfunded liabilities. The most notorious side-effect of that deference is the failure of General Motors.

Like many of the current Federal benefit programs the United Auto Workers used a young workforce to fund ever increasing benefits. But as the work force aged and more and more retirees began to draw on the promised benefits, General Motors found itself in trouble. Its pension fund failed to earn enough to balance what the company was paying out in benefits while the ratio of workers paying in to retirees taking out got smaller. Whether it was poor money management, over-exuberant forecasting of returns, or endless faith in the generosity of a government hungry for union votes, GM repeatedly came off the tracks, only to be reset by bailouts.

A recent history of quick-fix GM bailouts begins in 2001. Just as consumers peeked out their heads from the detritus of the imploded bubble the far more terrible collapse of the world trade center froze consumer spending. With car sales stalled completely General Motors found itself in dire straits. Unfunded pension fund liabilities threatened to topple the automotive giant. But as usual the government stepped up with tax incentives on big cars and trucks while GM unveiled its patriot-themed campaign to “keep America rolling” with 0% financing for 5 years on all new vehicle purchases. Hummer sales soared but the underlying problems at GM continued, ignored for the time being as the new SUVs’ revving engines drowned out any cries for real financial repairs.

One of those necessary repairs was a revamping of unrealistic assumptions on the rate of return earned in the pension fund itself. A New York Times article published August 25, 2002 said in part, (1)

“Lately, the focus is on GM’s pension fund, which totaled $80 billion two years ago but has dropped to $67 billion. Although the company's current pension payouts are not exceeding pension fund earnings, the market's volatility has destroyed GM’s assumption that it would earn a net return of 10 percent a year on the fund assets. Mr. Devine said GM was ready to transfer cash to fund some of the future liability at year-end, but he contends that cannot be done all at once without endangering GM’s product spending. Yet until the shortfall for future liability is funded, he acknowledged, the issue will not go away.

“'It doesn't get off the table until it gets off the table,' he said.”

At the end of 2002 GM’s unfunded pension obligations stood at $19.3 billion. In an attempt to fix the shortfall GM issued $13.2 billion of a new type of bond complete with Government subsidy (2). The proceeds were contributed to the fund along with a $4.26 billion “tax shield” created by that bond issuance. In theory GM should have been close to fully funded. Yet when it collapsed (again, and this time for real) in 2009, the unfunded pension liabilities were $13.5 billion. So from the time the quick-fix financing scheme was cooked up in 2002 to the final GM collapse in 2009, the unfunded liability in the pension fund grew by 50%. And GM became, as one commentator put it, “a benefits company funded by an auto company.”

The taxpayer is now invested in GM to the tune of $80 billion and growing. And the history of government bailouts to GM continues: we just added $3 billion more in taxpayer money to bribe individuals to buy cars through the “cash for clunkers” program!

But who is now responsible for the UAW pension fund? Normally the Pension Benefit Guaranty Corporation, an insurance company run by the U. S. Government similar to the FDIC, would step in and assume those liabilities. So the theory is by bankrupting GM and letting the emergent company continue to operate the pension fund the PBGC would avoid taking that loss. What happens if the new GM fails? It turns out that the PBGC and the American Taxpayer are on the hook, once again, for the benefits of the UAW. But the PBGC itself is just one more, all together now, “unfunded liability” of the US Treasury. The PBGC was formed to insure the pension funds of participating corporations. In concept it was supposed to be self-funding. In reality it has been in deficit every year since 2002. As Mr. Devine said earlier, “It doesn’t get off the table until it gets off the table.”

My next article will start to look at all the various insurance companies run by the Federal Government beginning with the Pension Benefits Guarantee Corporation.

Photo from:

Thursday, September 10, 2009

Beware the Public Option

I originally anticipated discussing the collapse of GM in this blog, however given the debate currently raging over health care reform this is where I will focus today because, guess what, the hidden cost of health care overhaul is… another Unfunded Liability!

Last night the President laid out a plan for health care overhaul. The plan contains numerous necessary reforms, others are not. Here I will only take issue with one: the Public Option. Why? Because the Public Option is a prime example of an unfunded liability.

Here is what he said, “But an additional step we can take to keep insurance companies honest is by making a not-for-profit public option available in the insurance exchange.” And how does that get paid for? “... not a dollar of the Medicare trust fund will be used to pay for this plan… Reducing the waste and inefficiency in Medicare and Medicaid will pay for most of this plan.” Isn’t this contradictory? In other words, if Medicare and Medicaid savings are going to pay for this isn’t the payment by definition going to come out of money that would otherwise be available to the Trust Fund?

This provides us with an easy segue into a discussion of the financial health of Medicare. If we are relying on savings in one entitlement to pay for another the former had better be financially sound. It is not.

Each year the Social Security and Medicare Boards of Trustees publish an annual report along with “A Message to the Public”.(1) In this year’s report signed by the Secretary of the Treasury as Managing Trustee it states, “As was true in 2008, Medicare's Hospital Insurance (HI) Trust Fund is expected to pay out more in hospital benefits and other expenditures this year than it receives in taxes and other dedicated revenues. The difference will be made up by redeeming trust fund assets. Growing annual deficits are projected to exhaust HI reserves in 2017, after which the percentage of scheduled benefits payable from tax income would decline from 81 percent in 2017 to about 50 percent in 2035 and 30 percent in 2080. In addition, the Medicare Supplementary Medical Insurance (SMI) Trust Fund that pays for physician services and the prescription drug benefit will continue to require general revenue financing and charges on beneficiaries that grow substantially faster than the economy and beneficiary incomes over time.”

The consequence of this statement is profound. The current Medicare system will need substantial savings and additional revenue just to keep its own head above water. The problem once again is the unfunded liability that arises from guarantees of benefits without a dedicated payment plan. Simply reducing the deficit of an unfunded liability doesn’t create funding available for another. Today the unfunded liability in Medicare alone is $85.9 trillion or six times the total annual production of our economy. The report goes on, “The projected exhaustion of the HI Trust Fund within the next eight years is an urgent concern. Congressional action will be necessary to ensure uninterrupted provision of HI services to beneficiaries. Correcting the financial imbalance for the HI Trust Fund—even in the short range alone—will require substantial changes to program income and/or expenditures.” And this is how we are going to fund the new Public Option?

Tuesday, September 8, 2009

Unfunded Liabilities 101

Unfunded liabilities are insidious critters. Say for example you buy a ten year old house. When you buy it the roof is fine. But it has a fifteen year roof which, after five years, starts leaking. Time for the roofer but you didn’t include the cost of a new roof in your budget. Congratulations, you’ve just experienced your first unfunded liability. Now you must take away from other spending, draw on savings or get a loan.

Let's play a game. Make a list of all your future liabilities: a college education, retirement or simply the replacement of your car? How many of these have a funding plan? Those that don't are unfunded liabilities. Now think about the government. If you are a taxpayer, every future commitment the government makes becomes your obligation...

Next week the low hanging fruit, the auto industry.