$8 Billion Surplus Withers at Agency Insuring Pensions

he federal agency that insures the pensions of some 44 million Americans has been pounded by a succession of big corporate bankruptcies and has burned through its entire $8 billion surplus in one year.

The agency, the Pension Benefit Guaranty Corporation, provides protection to retirees in case of a failure, much as the Federal Deposit Insurance Corporation protects depositors when a bank fails. Though it can continue to make its current payments, the agency is expected to disclose a deficit of $1 billion to $2 billion at the end of this month.

Its soundness is likely to deteriorate further in the coming months, as more bankrupt companies find themselves unable to fulfill their promises to tens of thousands of present and future retirees. US Airways, United Airlines and Kmart are among the companies struggling to emerge from bankruptcy protection under the weight of large underfunded pension plans.

An awareness of the pension agency's rapidly diminishing strength is already fueling a debate in Washington about whether the guaranteed retirement benefits of millions of Americans are at risk and, if so, who should pay to make them airtight.

Businesses support the agency's operations by paying premiums for each person covered by the insurance, and they are sure to resist any increase. The decisions are difficult. Postpone the increase and the pension system could be imperiled, but increase it too sharply and companies might decide to stop offering pensions altogether.

"You can get this wrong in both directions," said Damon A. Silvers, associate general counsel at the A.F.L.-C.I.O.

Among the remedies being discussed are charging all companies with pension plans higher premiums, requiring them to fund their plans more fully, making the companies with the shakiest plans pay the most and changing the way the agency invests its money.

Traditional company pension plans became commonplace after World War II and are estimated to be the second-largest source of income today for elderly Americans, after Social Security. But employers offer them voluntarily, and over the last decade many have been switching to 401(k) plans, which are simpler and generally cheaper to administer because employees set aside the money and decide how to invest it themselves.

For workers, traditional pensions are considered more reliable than 401(k) plans, because pensions provide a predetermined monthly check from retirement to death and are guaranteed by the government.

The Pension Benefit Guaranty Corporation was created in 1974 to take over insolvent pension plans and keep paying benefits when a company could not. A retiree whose plan is taken over keeps getting monthly checks, but the amount may be smaller, because the government limits the amount it insures. The current maximum is about $3,600 a month for those older than 65 at the time of the takeover, and less for those who are younger. As of 2001, the agency had $22 billion in assets and was responsible for paying the pensions of 624,000 current and future retirees. It paid more than $1 billion in stipends that year.

The agency has weathered deficits in the past, its finances worsening when stock prices have fallen or when very large corporations have collapsed. In 1992, after it shouldered $1.4 billion in unfunded claims from Pan American World Airways and Eastern Air Lines, there were warnings that the agency itself might go broke, much as the Federal Savings and Loan Insurance Corporation had done a few years earlier.

Steps were taken to strengthen the agency and make it harder for companies to run their pension plans into the ground. Rising stock prices further bolstered the agency in the latter half of the 1990's, and the warnings of a disastrous S.& L.-style collapse died away.

Now, those warnings have returned, as the gap has soared between what companies have promised to pay in pensions and the funds they have set aside to do so. At the end of last year, the gap was estimated to be $300 billion. During the agency's previous crisis, in 1993, the funding gap peaked at $109 billion.

Stock prices are down again, and interest rates are unusually low. Normally, stock prices and interest rates move in opposite directions. When they both go down at the same time, it is particularly painful.

In pension accounting, the lower the interest rate, the greater the future obligations. That is because of the difficulty of setting aside enough money to cover future payments, which loom large if interest is accruing at only a few percent a year, and has nothing to do with any increase in the number of retirees or their benefits.

"This is really the first time the P.B.G.C. has been faced with this confluence of events," said Mark A. Oline, a managing director of Fitch Ratings. Mr. Oline monitors airlines, which make up a large part of the pension agency's workload. The last time a three-year bear market coincided with low interest rates was 1939 to 1941, he said, and the agency did not exist then.

"The big question is, if all of a sudden these liabilities have become so enormous, how is this situation addressed?" Mr. Oline said.

Although the Pension Benefit Guaranty Corporation is a government agency, its work is financed entirely by companies, not general tax revenues. Companies pay $19 per person covered each year, or more if a pension fund is underfunded. The basic rate has not changed since 1991.

That means that if the agency's troubles worsen, businesses will be asked to pay higher premiums, put more cash into their own pension plans or both. The agency is also considering a new way of assessing premiums, making the companies with the weakest pension funds pay the most.

Any of those changes would require Congressional action and would be controversial. Already companies are struggling with their own pension deficits, and are finding they must pay millions of dollars to keep their plans compliant with the current rules.

"The well-funded employers don't want to pay a lot of money to bail out the employers whose pension plans have fallen," said Judith F. Mazo, director of research at the Segal Company, a benefits consulting firm, and a member of the pension agency's advisory committee.

At the same time, Ms. Mazo said, the companies with the shakiest pension plans will protest if their premiums go up, saying they obviously do not have the cash. If they did, they would have put it into their pension plans.

For now, most big companies with pension plans are taking the position that the current troubles will pass on their own.

"There is no crisis whatsoever," said Janice M. Gregory, vice president of the Erisa Industry Committee, a group that lobbies on behalf of the largest corporations on pensions and other issues regarding employee benefits.

As members of the Erisa Industry Committee see it, interest rates are sure to rise again. Then the balance-sheet values of future liabilities will shrink, and much of the pension agency's deficit will disappear.

In addition, Ms. Gregory said, businesses anticipate further relief through an initiative by the Treasury Department to change the interest rate that companies use for their pension calculations. In the past, they used the 30-year Treasury bond as a benchmark, but the government announced in early 2000 that it would stop issuing those bonds. Businesses want to switch to a high-quality corporate bond as the benchmark. That rate would be higher, shrinking future pension liabilities.

In the meantime, Ms. Gregory noted, the pension agency has more than enough cash on hand to make its current payments. It takes in some $800 million each year in premiums.

"That gives them a cushion to cover any additional new claims that come in," Ms. Gregory said. "The P.B.G.C. is in good shape."

That view is firmly countered by some financial analysts. Zvi Bodie, a professor of finance at the Boston University School of Management who was invited to present his position to the pension agency, wrote an academic paper in 1996 laying out a "possible doomsday scenario" ending with an enormous taxpayer bailout.

Ominously, some of what he foreshadowed has already happened: a sharp and prolonged drop in stock prices, a proliferation of pension-plan underfunding and several large pension defaults.

Professor Bodie says the agency should begin charging premiums based on the riskiness of a company's pension portfolio. He has also spoken to the agency's advisory committee about the merits of investing the agency's own trust fund in fixed-income securities. The agency's board voted in 1994 to permit its trust fund of seized plan assets to be invested up to 100 percent in stocks, but the agency is considering scaling back. The money from premiums is invested in government securities.

Much of the agency's surplus disappeared early last year when it assumed the pension plans of the LTV Corporation, the large steel company. LTV had already been through one bankruptcy and pension trusteeship, in 1986. After LTV reorganized, the pension agency forced it to take back its pension obligations — only to watch the company file for Chapter 11 protection again in 2000.

In March 2002, the pension agency assumed LTV's pension payments for a second time, wiping out $1.6 billion of its surplus. In December, the agency assumed $1.1 billion in unfunded pension claims from National Steel, and later that month, it took over Bethlehem Steel's pension plans, for an estimated $3.7 billion.

Until last year, the agency's largest case was the 1991 takeover of Pan Am's pensions, for $841 million.

The big pension plan failures show no sign of stopping this year. US Airways' reorganization plans depend heavily on the airline's ability to cope with some $3.1 billion in pension contributions due over the next seven years. The airline has been seeking government permission to stretch the payments out over 30 years.

"The minute you grant that, you'd have all the other airlines lining right up," Mr. Oline of Fitch Ratings said, "and some other industries after that, asking for the same thing."

By David Henry in New York, with
David Welch in Detroit,
Michael Arndt in Chicago, and
Amy Barrett in Philadelphia
NEWS: ANALYSIS & COMMENTARY
August 5, 2002
Source

Amid the wreckage of the worst bear market in at least three decades, hemorrhaging corporate pension plans are rapidly becoming Wall Street's biggest new worry. They have lost hundreds of billions of dollars, and now companies face the end of their long-running holiday from writing checks to the plans. Over the next 18 months or so, companies ranging from General Motors to United Technologies face having to pump billions into their plans to comply with federal laws to protect pensioners.

Even if plan investments somehow manage to eke out 5% returns this year, companies in Standard & Poor's 500-stock index will be $40 billion short of their projected pension obligations, according to Morgan Stanley estimates. If plans lose 5%, they'll be $150 billion in the hole. Either way, it is a world away from 1999 when the plans had a $292 billion surplus and a 30% cushion over their commitments. "The squeeze on U.S. pension funds has the potential to be the defining U.S. financial crisis of the 2000s, like the savings and loan squeeze of the 1980s," says Bob Prince, director of research and trading at money manager Bridgewater Associates.

The economic consequences of the squeeze could extend far and wide. Cash that companies earmarked for buying new equipment, expanding markets, hiring employees, buying back stock, or repaying debt will have to be used to shore up pension plans. The shift will be another downer for stock prices, cutting out spending that used to boost growth in earnings per share. And the impact will soon be felt.

Under government rules, some companies must start making up for 2001 shortfalls by the end of this year. For others, the bites will start in 2003 or 2004. "Some companies are going to be contributing for the first time in 10 years," says John Ehrhardt, a principal and consulting actuary at Milliman USA Inc. "In thinking about capital expenditures, there is a new party at the table, the pension plan."

Old-line companies or those with large unionized workforces will be particularly hard hit because they have large defined-benefit plans--ones offering guaranteed payouts to pensioners. The biggest obligations are among auto, telephone, airline, steel, chemical, and pharmaceutical companies. For example, if plans lose 5%, United Technologies (UTX ) could have to cough up $1.4 billion in 2003, Delphi (DPH ) $1 billion, and AMR (AMR ) $415 million, according to the Morgan Stanley estimates. The companies say they're stepping up infusions sharply, but doubt they'll need to put in as much as quickly as some estimates. United Technologies Corp. says it recently contributed $247 million worth of its own stock to its plans. Delphi Corp. says it is putting in at least $200 million a year for the next five years, but concedes that won't be enough if its investments don't appreciate 10% a year. AMR Corp., parent of American Airlines, says it intends to make larger contributions than in the past, but won't say how much. General Motors Corp. (GM ), which has the biggest pension plan of all, with $80 billion in obligations, disclosed July 16 that it expects to put $9 billion into its plans by 2007.

How did companies paint themselves into such a corner? It was more than bad luck. They made a bold bet during the 1990s that stock prices and interest rates would move in opposite directions, as they have nearly every year since the Great Depression. The relationship is crucial to pension funds because when interest rates go down, government rules require the plans to have bigger pools of investments to meet future obligations. That can only happen if stocks rise or companies put more money into the funds.

For years, the tactic worked like a charm as fund assets went up while their liabilities increased. Companies became confident about putting more of their pension assets into stocks than before. The resulting investment gains during the bull market more than covered most of the payouts they made to current retirees, averaging about 7% of the funds' total values. Better yet, accounting rules allowed companies, quite legally, to boost their reported earnings by billions with higher projected investment gains because they were holding more stocks. Some, again quite legally, were able to actually tap the surpluses to help pay retiree medical expenses and even merger consolidation costs.

Lately, however, the bet has turned sour. Stocks--in which a record 60% of fund assets were invested in early 2000--have gone down in the bear market, as have interest rates. The result: Funds' assets have plunged at the same time that their liabilities have soared. The pincer movement has wiped out surpluses racked up during the long-running bull market, and then some.

The reversal has been fast and furious. As recently as 1999, nearly 78% of the plans at S&P 500 companies had surpluses. But by the end of this year, less than 26% will have one. And workplace demographics are making matters worse. With average lifespans lengthening, more plan beneficiaries are retiring than dying. So cash to pay benefits is draining out of the weakened funds as never before. Besides, the funds are dwindling as new workers are put into defined-contribution plans such as 401(k)s, in which employees, not the company, take all the investment risks.

With impending cash calls, the stock market is getting a double whammy from corporate pension plans. The first battering came late last year when investors realized companies had inflated their reported earnings by exploiting loopholes in accounting rules. By making overly optimistic assumptions about future investment returns, companies were able to puff up earnings by some 10% even though the maneuver generated no new cash. Now, investors are being side-swiped again. This time, reported earnings aren't affected even though real cash exits to the pension plans.

The fear is that nobody but the companies knows exactly how big the cash calls will be. Companies hardly ever disclose anything in their Securities & Exchange Commission filings about the impact of the government pension rules on them. "The specific calculations are impossible to get right with publicly available data," says Trevor S. Harris, accounting analyst at Morgan Stanley. That is important because it means investors can't accurately predict corporate cash flows. Milliman's Ehrhardt, who helps companies navigate funding rules, says many companies know more about the coming cash calls than they have been telling. For investors' sake, "opening up the book on funding strategy is where companies should be going," he says.

Some companies may have reasons for not showing their cards. Ehrhardt says many that have cash on hand are putting more money into their plans even when the government rules don't require it. One big appeal: Executives get to figure the additional assets into their estimated investment returns in their reported earnings. If they are estimating 10% investment returns, a $100 million contribution will boost operating income by $10 million, which is more than many believe they can earn elsewhere right now. Also, they can often get tax deductions for the payments. And thanks to a recent change in tax law, they can sometimes contribute to overfunded plans without suffering penalties.

Meantime, by making estimates based on the numbers companies do report, Harris and other analysts are scoping out the ailment and the most seriously diseased companies. For example, Harris figures that if the Delphi plan's investments end this year with even a 5% loss, its remaining assets will be enough to fund just 65% of its $8.4 billion in obligations. Besides the $600 million Delphi should put in this year, government rules suggest it would need to put in an additional $1 billion next year.

John G. Blahnik, treasurer at Delphi, says the company is being "open and frank" in earnings conference calls about the cash needs of its pension plans. But like most companies, Delphi is presenting its assessments on its own terms, without regularly reporting all the assumptions that go into its estimates. Blahnik says Delphi recently doubled its contributions to the plans, to $400 million this year, to try to get it back on track. Assuming the plan's assets earn 10% a year, he intends to put in at least $200 million, taking advantage of some extra time Delphi earned under government rules for contributions made in the past.

Worries about pension plans sucking cash out of companies are increasingly catching Wall Street's attention. They were a factor in the downgrade of GM's credit rating last fall by Standard & Poor's, and they are in part to blame for its stock falling 34% since mid-May. GM's forecasted $9 billion in makeup payments through 2007 compare with $3.6 billion in cash flow the company is expected to generate this year after dividends, interest, and capital expenditures. To help fund a $2.2 billion payment this year, the company sold convertible debt in April. GM may have to repeat that operation in the future. "We're going to have to put in more cash than we planned," says Vice-Chairman and Chief Financial Officer John M. Devine.

"All companies are going to have to look at their pension plans," warns Patrick D. Campbell, CFO of 3M. His company hasn't decided yet how much cash to pony up, but he doesn't quarrel with Harris' estimates that $378 million will be needed in 2003 if investments lose 5% this year. The company's U.S. and foreign plan assets were 11% short of projected obligations at the end of 2001, according to the company's annual report. And since then, U.S. stocks have fallen another 27%. "Obviously, we're going to have to think this through," says Campbell.

At Raytheon Co. (RTN ), CFO Franklyn A. Caine says he is preparing contingency plans for its funds. He had expected pension assets to earn 9.5% this year. Now, he figures that even if the fund suffers no losses, Raytheon will have to pump in an extra $85 million in 2004. If the fund loses 9.5%, he will have to find an extra $189 million in 2004.

Last year, Maytag Corp. (MYG ) made its first payment in years to its plans, some $65 million, says CFO Steven H. Wood. This year and again next, it will put in $115 million as it tries to make up for the poor markets and for an increase in benefits won by its labor unions. "We think it is prudent to contribute to the plan," says Wood. But he concedes the money would be well spent paying down debt, Maytag's other priority. During the bull market, available money went toward stock buybacks even though the plans were slightly underfunded.

Investors will probably wish for a long time that Maytag and other companies still had the luxury of not tending to their pension plans. The complexity of funding rules, filled with various triggers, allowances, and accelerated payment requirements, will add uncertainty to corporate cash flows for years to come. More complexity and greater uncertainty are the last things that battered investors want.

We are witnessing truly historical times...stay tuned...as those pensions investments also wither on weaker and weaker equity markets...falling dollar...massive credit bubble maintenance...raw goods inflation ..nagging trade defecits...global instability...social unrest

The Nazis are out early today. How about the billions the US gives to Egypt? How about the billions the US spends each year defending Europe? South Korea? Why do you always whine about the Jews?

NAFTA, eliminating american jobs and businesses, and starting a war in the middle east, what else would you expect?

How many Americans do you think even know about this agency?
Altho it has been the subject of concern before, todays headlines make it seem "just another Federal agency running
over its budget."

DAVID M. WALKER - Comptroller General of the United States
"Immediately prior to his appointment as Comptroller General, Mr. Walker was a partner and global managing director of Arthur Andersen LLP's human capital services practice and a member of the board of Arthur Andersen Financial Advisors, a registered investment advisor. He also served as a Public Trustee for Social Security and Medicare from 1990 to 1995 while he was a partner with Arthur Andersen. Prior to joining Arthur Andersen, Mr. Walker was Assistant Secretary of Labor for Pension and Welfare Benefit Programs and Acting Executive Director for the Pension Benefit Guaranty Corporation. His earlier technical, professional and business experience was gained with Price Waterhouse, Coopers & Lybrand, and Source Services Corporation."

$3,400,000,000,000 (TRILLION) OF TAXPAYERS' MONEY IS MISSING

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