The Pension Crisis You May Not Know about Yet
Charles Blahous Answers Pressing Questions about Multiemployer Pensions
What is a multiemployer pension?
A multiemployer pension plan is a private sector defined benefit pension, sponsored jointly by a union and several companies, most typically within a common industry or geographic region.
For workers, especially those in industries where short-term employment is common, such pensions offer the advantage of portability; the worker continues to accrue pension benefits within the same plan even if moving to another employer. These plans are established under collective bargaining agreements between labor unions and multiple employers. They are administered and governed by a board of trustees, typically with equal representation of labor and management.
Multiemployer pensions, like other US private-sector defined benefit pensions, are insured by the federal Pension Benefit Guaranty Corporation (PBGC). The PBGC also insures single employer (SE) pension plans, which have a different set of rules, and do not currently face the same funding crisis.
What is the multiemployer pension “crisis”?
The PBGC’s multiemployer pension insurance program faces a worsening crisis in the form of a reported $65.1 billion deficit consisting of $67.3 billion in projected liabilities against only $2.3 billion in assets. The insurance program is currently projected to become insolvent in FY2025, threatening hundreds of thousands of workers with near-total loss of their pension benefits.
Has Congress done anything to address the problem?
In response to the crisis, Congress recently established a bipartisan, bicameral Joint Select Committee on Solvency of Multiemployer Pension Plans, which is charged with formulating recommendations “to significantly improve the solvency of multiemployer pension plans and the Pension Benefit Guaranty Corporation.”
The tasks before the select congressional committee are to rescue the multiemployer pension insurance system from insolvency and to shore up the finances of multiemployer plans more generally.
How did this crisis happen?
Contributing factors such as the decline in the number of workers contributing to the pension plan funds, as well as the Great Recession, are often cited as reasons for the multiemployer pension funding shortfall, but these explanations are incomplete. Multiemployer plans have been systemically underfunded for several years, with average funding percentages remaining consistently below 70 percent in every year since 2002. Funding levels plunged below 50 percent during the Great Recession and have remained there despite subsequent years of economic and financial market recovery. Multiemployer plans are also far more underfunded than their SE counterparts despite both sets of plans facing similar market conditions.
Multiemployer plans are underfunded primarily because they are governed by inadequate, lax valuation and funding rules. Potent incentives encourage even the most well-intended plan trustees and employer sponsors to underfund their multiemployer pension promises. These inadequacies are summarized below:
- Inaccurate measurement of plan assets - Multiemployer plan assets are not measured for statutory funding purposes in terms of their current market values, but are instead “smoothed” with previous market values looking back for up to five years, producing results that are permitted to deviate by as much as 20 percent from their actual current market value. This amount of leeway is not given to SE plans.
- Inaccurate measurement of plan liabilities - Multiemployer plan trustees have wide discretion to understate their plans’ liabilities by using inflated discount rates when translating them into present-value terms. Although there is wide conceptual agreement among economists on how to properly discount liabilities, most plans’ actuarial practices, as well as the statutory funding rules, simply disregard this consensus. Multiemployer plans’ prevalent use of inflated self-selected discount rates for valuation purposes has large, detrimental effects on their funded status. Inaccurate liability discounting is the biggest reason why multiemployer plans report funding percentages of nearly 80 percent on average even as their current-liability funding percentages average less than 50 percent.
- Lax funding requirements - Multiemployer plans are not required under law to be fully funded within any effectively enforceable time frame. Instead, significantly underfunded plans are required to adopt a “funding improvement plan” (FIP) or “rehabilitation plan” (RP) to improve the funding status. These plans aim at goals which fall well short of full funding. If the trustees of a critically underfunded plan determine that it is not feasible to emerge from critical status within ten years, their RP need only attempt to “forestall possible insolvency.” Worst of all, a critical plan that has adopted an RP is “not liable for contributions otherwise required under the general funding rules,” and the “excise tax for failure to meet the funding requirements. . . does not apply.” These provisions effectively waive funding requirements for the very plans most in need of increased funding.
- Digging the underfunding hole deeper - Multiemployer plans are also permitted to dig their financial holes deeper in other ways SE plans are not. For example, an SE plan that fails to or cannot meet its funding obligations is subject to involuntary termination by PBGC, reducing its benefit obligations to the levels PBGC guarantees. By contrast, critically underfunded multiemployer plans are permitted to continue paying full benefits without making even minimally adequate contributions, and their benefits are not cut to PBGC guarantee levels until the plan runs out of funds.
- Inadequate premiums - Premiums paid by multiemployer plans are on average less than one-sixth as large as those paid by SE plans, despite the fact that the financial pressures on PBGC’s multiemployer plan insurance system are projected to be nearly six times greater.
- Inadequate withdrawal payments - An employer withdrawing from a multiemployer pension plan is theoretically obligated to make a withdrawal liability payment equal to that employer’s share of unfunded vested benefits, but various limitations and exceptions often cause actual withdrawal payments to fall well short of this amount.
What are orphan liabilities?
When a multiemployer plan sponsor goes out of business or otherwise withdraws from sponsoring the pension, the responsibility for paying the withdrawing sponsor’s former workers’ benefits is shifted to other sponsoring employers in the same plan. The obligations assumed by other employers for paying the benefit obligations of their erstwhile business competitors who have withdrawn from a plan are often referred to as “orphan liabilities.”
This phenomenon adversely affects multiemployer pension funding in a distinct way, because the companies in the plan have to pay benefits to former employees of other employers who have not necessarily paid withdrawal liabilities sufficient to finance those benefits. An SE plan will generally only require employers to finance benefits on behalf of workers employed by that sponsor, but sponsors of multiemployer plans may find themselves responsible for financing benefits of workers their own companies never employed.
What are the most important principles for reform?
Certain policy principles, many of them followed in the 2006 PPA’s SE pension reforms, may be useful when considering reforms to the multiemployer pension system. Specifically, reforms should adhere to the following principles: accuracy, transparency, damage control, incentives, practicality and equity.
How do we fix the problem?
1. Accuracy - Plan assets should be measured as closely as practicable to their current market values. Any “smoothing” of asset values should only be permitted to correct for the extent to which values on a particular reporting date may be unrepresentative of ongoing values, and there should be no blending with valuations that are significantly out of date. Further, benefit obligations should be discounted into present value terms according to their risk level: Treasury bond rates are appropriate for discounting wherever the aim is for benefits to be guaranteed and risk-free; alternatively, corporate bond rates are appropriate to the extent benefits are subject to some risk of nonpayment.
2. Transparency - Plans’ funding status should be disclosed using the aforementioned methods for accurately valuing assets and liabilities. Aspects of law that interfere with transparency, such as the multiple amortization schedules and loopholes under current law, should be repealed and replaced. A single, clear and transparent amortization schedule for addressing all sources of underfunding is optimal.
3. Damage Control - Similar to SE plans, underfunded plans should not be permitted to dig their funding holes deeper, shifting mounting costs to the PBGC insurance system and risking workers’ benefits. In such instances, freezes of benefit increases and lump sum payments, or constraints on accruals, should take effect to the extent necessary to prevent funding percentage declines.
Underfunded plans should not be permitted to draw upon previous “credit balances” to avoid making the minimum contributions necessary to stabilize funding percentages. In general, funding rules should require that sponsors adequately fund their plans, or terminate them if they cannot. In a worst-case scenario in which an underfunded plan simply cannot maintain its funded percentage during its worst years, or cannot realistically progress toward full funding pursuant to a statutory amortization schedule, PBGC should have additional authority to initiate an involuntary termination of the plan as it does with SE plans, as well as a statutory obligation to employ it as necessary to protect the insurance fund.
4.Incentives - Withdrawal liability penalties must be strong enough to deter sponsors from withdrawing and shedding their benefit funding obligations. Variable rate premiums should be assessed on sponsors of badly underfunded multiemployer plans, as recently proposed by the Trump and Obama administrations and as is done in the SE insurance program. Trustees should be held fully accountable for funding shortfalls, to constrain their latitude and mitigate their incentives to precipitate underfunding by adopting unrealistic actuarial assumptions. Federal policy should not penalize responsible sponsors who have adequately funded their plans by subsidizing the pension benefits of business competitors who have not. Importantly, the federal government should signal that no taxpayer dollars will be used to bail out underfunded pensions, because of the incentive a prospective bailout would create for all sponsors to reduce their pension contributions, potentially triggering a catastrophic surge in systemic underfunding.
5. Practicality - It will likely be beyond the capabilities of the select committee to fully repair the problem of multiemployer pension underfunding in the near term. This suggests pursuing more modest goals of gradually improving pension funding for the long term, while reducing near-term claims on the PBGC and strengthening its capacity to withstand them, thereby maintaining the insurance program’s solvency for the foreseeable future.
6. Equity - Perhaps most importantly, any policy solution will only last if it is tolerably equitable. It is unfair to workers if pension plan trustees do not adequately fund their promised benefits. It is unfair to both workers and plan sponsors if the federal government fails to ensure the solvency of the insurance system undergirding those pension benefits. It is unfair to responsible sponsors who have funded their own compensation promises if their competitors are allowed to deliver pension benefits to their own workers without paying for them. It is unfair to federal taxpayers if general government revenues are used to subsidize pension benefits that only a small minority of them are eligible to receive. Federal policy can only remain equitable if it prevents these outcomes.
What Can Lawmakers Do about the Orphan Liability Problem?
A responsible solution to the multiemployer pension crisis would require plan trustees to adopt accurate measures for valuing their plans’ assets and liabilities, while moving toward fully funding their pension promises to their own workers. If and only if such broader reforms are enacted, PBGC could also be authorized to deploy insurance program assets to relieve petitioning pension plans of their orphan liabilities, contingent upon those plans making offsetting changes to reduce their potential claims upon the insurance system.
Read more: Avoiding the Multiemployer Pension Solvency Crisis
Photo credit: Timothy D. Easley/AP/Shutterstock
A previous version of this article used "MEP" to abbreviate "multiemployer pension." 'MEP' has been removed to avoid confusion with "Open Multiple Employer Plans," sometimes referred to as "Open MEPs."