March 30, 2011

Taxpayers Could Be on the Hook for a Private Pension Bailout

Charles Blahous

J. Fish and Lillian F. Smith Chair

Protests in Wisconsin and Ohio have stimulated debate on the controversial topic of public pension funding.  However, what no one seems to be talking about is a very similar crisis facing employer-backed pensions in the private sector. In new research published by the Mercatus Center, Charles Blahous highlights a serious problem threatening employer-backed pensions and explains what can be done to avoid a taxpayer bailout of this faltering system.

Employer-sponsored pensions are backed by the Pension Benefit Guaranty Corporation (PBGC), a government-chartered corporation established in 1974. The PBGC is financed with employer premiums, but according to its latest annual report its pension insurance programs protecting more than 44 million workers are currently facing a $23 billion deficit.

When an underfunded pension plan is terminated, its benefit obligations are assumed by the PBGC.  This insulation from risk creates a problematic incentive to shift the costs of pension underfunding to responsible sponsors of well-funded plans – and potentially, to taxpayers.”

“Prior to the establishment of PBGC pension insurance, workers lacked important protections, but those protections have come at a cost in moral hazard,” said Blahous.  “Employers and worker representatives now both face distorted incentives.  Even the best-intended actors are affected by the reality that the downside risk of pension underfunding is passed to third parties.  

“It’s natural for both employers and union representatives to want more funds kept available to the firm for job creation or wage compensation,” said Blahous.  “This has created persistent pressure upon Congress to relax pension funding requirements.”

To deal with the current hole, the PBGC should be given tools such as strengthened federal funding rules, flexibility to assess adequate risk-based premiums, and enhanced legal tools, said Blahous. Otherwise the PBGC should be eliminated and replaced with a compulsory private insurance that charges market rates.  Regardless of which of these options is chosen, asset/liability “smoothing” should be limited to the extent practicable, special preferences for politically-favored industries eliminated, unfunded benefit increases prevented within underfunded plans, and funding status disclosure significantly enhanced.

Failing to take either of these approaches, the PBGC’s shortfall should be viewed as a potential taxpayer liability, which would be grossly inequitable given that only approximately 21 percent of American workers have been promised this type of pension.

“A taxpayer bailout of the PBGC should be regarded as a ‘doomsday scenario,’” said Blahous.  “To require these taxpayers to bail out pension promises made by others’ employers is to require the vast majority of taxpayers to subsidize a benefit that only a minority is eligible to receive.”

 If policy makers don’t allow the PBGC pension insurance system to be self-financing, they are creating a risk that this bailout will come to pass, he said. In that worst-case scenario, the best policy option is to disclose the full amount of this risk to taxpayers for as long as the underfunding persists.