Do you live in the United States? Do you pay federal taxes? I realize that excludes many Americans so if you don’t, you can move along, nothing to see here. If you do, you may be interested in what one particular federal government agency, Congress and private unions are planning. Spoiler alert, this one might sting a bit.
Have you ever heard of the Pension Benefit Guaranty Corporation, the PBGC? It is one of the lesser-known “independent” federal agencies but, to you and your posterity, every bit as dangerous as any non-independent federal agency of the United States government. As some background, this is from their most recent annual report:
Established by Congress in 1974, the Pension Benefit Guaranty Corporation (PBGC and the Corporation) insures the defined benefit pensions of workers and retirees in private-sector pension plans. PBGC now protects the retirement security of nearly 40 million American workers and retirees in defined benefit pension plans. PBGC is responsible for benefit payments to more than 1.5 million people in failed plans who otherwise may have lost their pensions – earned for years of work for steel mills, auto parts suppliers, trucking companies, grocery and department stores, airlines and more. In doing so, the Corporation enhances the retirement security of workers and retirees, and their families across the country. PBGC runs two programs to insure different types of defined benefit pension plans: single-employer plans and multi-employer plans. These two insurance programs are operated and financed separately. PBGC’s mission is to enhance retirement security by preserving plans and protecting pensioners’ benefits.
Enhance retirement security, huh? Exactly whose retirement security they are enhancing is not very clear at this point. Suffice it to say, the pensions they are, purportedly, supposed to be protecting, well, that’s not going so well. We will get to the details on that in a moment but first, a basic primer in risk and insurance, let’s call it Risk and Insurance 101. It is short and paramount to our understanding of what is a slow, but certain, train wreck waiting to happen, so please bear with me here.
Risk and Insurance 101
Pure risks and Speculative Risks
Risks are generally classified into two classes; pure risks and speculative risks. Pure risks involve only a chance of loss, never an opportunity for gain or profit. This would include any type of accident, death, disability, etc. Speculative risks involve a chance of gain or loss; speculating in the stock market, gambling down at the track or investing in to a business venture.
Only pure risks are insurable.
Static and Dynamic Risks
Risks can also be evaluated on an economic scale comparing static and dynamic risks. Static risks are the losses that are caused by factors other than a change in the economy (for example – hurricanes, earthquakes, other natural disasters). Dynamic risks are the result of the economy changing (examples – inflation, recession, and other business cycle changes) (Read more: Insurable Risks – CFP | Investopedia http://www.investopedia.com/exam-guide/cfp/principles-of-risk-and-insurance/cfp1.asp#ixzz4Vsi08jgu
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Only static risks are insurable.
Further, what are the additional elements of insurable risk? “Insurable risk” is risk that an insurer is willing to cover through an insurance policy. There is a set of additional criteria that a risk must meet to qualify as insurable.
- Any loss related to the risk must be due to chance. Regular recurring losses such as shoplifting in a supermarket are built into the price and would not be insurable as it is not fortuitous.
- Any loss related to the risk must be definite and measurable. This means that there must be bills to establish “proof of loss,” not just casual references.
- Any loss related to the risk must be predictable, meaning it must be of such a nature that its frequency and average severity can be readily determined to establish the required premium.
- Any loss related to the risk cannot be catastrophic. All individual losses are personal catastrophes. The reference here is to national or area disasters, such as floods, riots, wars, earthquakes, etc.
- Any loss exposures related to the risk must be large. To avoid adverse selection, there must be enough exposure to losses for the frequency to be predictable and to be grouped for the purpose of establishing rates.
- Any loss exposures related to the risk must be randomly selected. Concentration of risks by area, age groups, occupations, economic status, etc., can lead to adverse selection. A prominent example of the failure to avoid concentrations of risks is demonstrated by the efforts of numerous home insurers to reduce their risks, after Hurricane Andrew and several other smaller hurricanes.
So, to summarize, for a risk to be insurable, it must be:
- Due to chance
- Definite and measurable
- Cannot be catastrophic
- Of large frequency
Now, when I say, “for a risk to be insurable”, what I really mean is, “for a risk to be insurable at a profit“. We are getting to the heart of the matter. Let’s go back to 1974 when the PBGC was first legislated in to existence.
Employee Retirement Income Security Act of 1974 (ERISA)
One reason Congress enacted ERISA was, “to prevent the great personal tragedy suffered by employees whose vested benefits are not paid when pension plans are terminated”. The stated purpose of the PBGC, an outgrowth of the ERISA legislation, specifically, was to encourage the continuation and maintenance of voluntary and private defined benefit pension plans, to provide timely and uninterrupted payment of pension benefits, and to keep pension insurance premiums at the lowest level necessary to carry out its operations. I do not want to minimize the tragic consequences of losing a pension, but there was a reason no insurance company was willing to insure private defined benefit pension plan benefit payments, not to mention with “premiums at the lowest level necessary to carry out its operations”. The federal government had no business, under any circumstance, insuring voluntary and private defined benefit pension plans that, and here it is, were not insurable in the first place!
Defined benefit pension plans are subject to inflation, interest rates, stock and bond markets, the Federal Reserve, multiple assumptions and enormous political, economic and business risks. In no way are the potential losses pure, static, due to chance, definite and measurable, predictable, not potentially catastrophic, of large frequency and always random. This was a complete failure from the beginning. The only reason it took this long to get to the circumstances this agency finds itself now, is that the vast majority of those covered under these plans had yet to retire. As soon as baby boomers began to retire, defined benefit pension plans ran in to trouble and the PBGC ran in to problems.
How big are those problems? W. Thomas Reeder, Director of the PBGC, opined in the most recent, 2016, PBGC Annual Report as follows:
While I am pleased that given the recent trends in claims and premiums, the single-employer program is likely to continue to improve over the next decade, I remain concerned that the multi-employer plan program faces a growing deficit. The FY 2016 Annual Report shows that the multi-employer plan program deficit is at an all-time high and needs significant reform in order to remain viable. Multi-employer defined benefit plans provide retirement security to more than 10 million participants and their beneficiaries. But PBGC estimates that plans covering about 10% to 15% of the 10 million multi-employer participants are at risk of running out of money over the next 20 years and that PBGC’s multi-employer insurance program is likely to run out of money by the end of 2025. Insolvency of PBGC’s multi-employer insurance program would devastate not only the retirement benefits of the 1 million to 1.5 million participants and their families in these at-risk plans but all the participants in multi-employer plans that are currently receiving financial assistance from PBGC as well.
What is not reported here and what must be placed in to context? First, every organization, private, government agency, what have you, tends to be overly optimistic when forecasting the future. That is how many defined pension plans ran in to problems in the first place. Plans were overly optimistic and, thus, were underfunded. PBGC was overly optimistic and, thus, their premiums were far lower than what would have been prudent (not that there would be, or will ever be, any way to predict claims and, thus, price premiums). Second, the United States, while growth has been sluggish, has experienced since 2009, the second longest economic expansion in the last 100 years. Profit margins have been at record highs, the Federal Reserve has maintained very favorable monetary policies and interest rates have declined (the fiscal year-end for the PBGC is September 30 which ended prior to the recent run-up it rates following the November, 2016, elections) and, consequently, has driven most major stock and bond market indexes to all-time highs. What are the chances these highly favorable conditions continue?
There is some good news. The PBGC, and the plans they insure are, under current law, self-funding. Plan assets and insurance premiums are to be the sole source of retirement plan payments to beneficiaries. However, given current shortfalls, given the nature of politics and given the current precedent, in fact standing policy, the bailout regime, of the federal government apparatus, taxpayers are being considered for contribution to these private bankrupt, primarily union, pension plans. Proposals are making their way to Congress but before we review those, the government is in damage control mode.
The President’s 2017 Budget proposed a structure for increased premiums under the multi-employer program at a level that would help alleviate some of the risk of the multi-employer program becoming insolvent within 20 years. Changes to the multi-employer insurance program such as this restructuring are urgently needed to protect the lifetime pensions of millions of America’s workers and retirees.
W. Thomas Reeder, Director of the PBGC, 2016 Annual Report
Note in the chart below that for 2017, premium rates on the varying plans have increased from double to four-fold their levels in 2012.
Rates will continue to rise from there as shown in the next chart.
If we take at face value the rosy projections offered by the PBGC, assume markets continue climbing to new highs, the new premiums are adequate to cover future losses and assume that the now higher cost of funding and insuring these antiquated and unpredictable fossils of the union-dominated 20th century don’t implode even more plans, it is still, most likely, too late. The combined shortfall of the two primary plan types as of September 30, 2016, is nearly $80 billion, up approximately $3 billion from the prior fiscal year. (The following chart is in $ millions.)
But, that’s not the worst of it. These results represent only the bankrupt plans currently under receivership with the PBGC. There are more coming down the line that could be bailed out by the taxpayers directly or indirectly through the the same PBGC that has already presided over huge losses in the plans they currently administer.
According to the PBGC, a whopping 96 percent of all multi-employer plans have funding ratios of less than 60 percent—meaning they have less than 60 percent of the funds necessary to pay promised benefits. In total, multi-employer plans have promised over $600 billion more than they are estimated to be able to pay.
If multi-employer, read union, plans get their way, $600 billion in taxpayer money, unfunded private non-union and public pension liabilities totaling over $5 trillion would be the probable last shoe to drop.
If Congress passes legislation to bail out the UMWA pension plan with nearly a half a billion dollars a year, what will stop it from passing legislation to bail out the other 1,200 plans that have more than $600 billion in unfunded promises? If Congress forces taxpayers to bail out private union plans, why not also private non-union plans that have $760 billion in unfunded liabilities, and public plans that have as much as $4 trillion to $5 trillion in unfunded liabilities?
As I have stated, this was a predictable outcome and one many saw coming over 40 years ago. Companies realized that defined benefit plans, and guaranteeing retirement benefits, was simply not a risk worth taking. That is why the defined contribution plan, where the contributions are known and the benefits are in no way guaranteed, replaced the defined benefit plan as the go-to retirement solution at nearly all private companies, save closely held ones. It was, primarily, private and public unions, that foolishly stuck with these plans in a short-sighted effort to placate their membership, who obviously wanted a guaranteed retirement. Who doesn’t? Now, those that have no pension, who pay the bills, the taxpayers, are going to be asked to kick in? I don’t think so. The losses need to be absorbed by the PBGC, the unions and their employers, period.