Pension Troubles: A New Savings & Loan Crisis In The Making?

The PBGC, created in 1974 as an insurance plan for defined-benefit retirement plans, is currently approaching a brink in which the federal government might be politically compelled to transfer large amounts of money to the PBGC to pay pension benefits of bankrupt companies. Over the past 4 years as the economy has struggled, several large firms have gone into bankruptcy and the PBGC has been forced to take over their insured pension liabilities, with some of the largest liabilities resulting from the bankruptcies of US Airways and United Air Lines. While the problems forcing these companies into bankruptcy are caused by general economic weakness, the pension liabilities of these firms and many others that are in danger of default involve both a decline in the stock market and moral hazard. Moral hazard is a situation in which being insured changes behavior to increase the expected liabilities of the insurance plan. In the case of the PBGC, the availability of insurance without a corresponding strong requirement that these plans be fully-funded has created an overhang of potential liabilities for the PBGC. Many firms, especially those most likely to default on their pension liabilities, have under-funded plans. Because they are under-funded, the PBGC will inherit greater liabilities than assets if the firms become insolvent. With the current large pension liabilities of United and U.S. Airways already the responsibility of the PBGC and the medium-term prospect of others (the worst-case, but not entirely unlikely one would be either GM or Ford declaring bankruptcy) increases the expected overhang for the PBGC. If this overhang is severe enough, no politician in their right mind would support severe cuts in millions of retirees pension benefits. Therefore, the political will would be there for a bail-out of the PBGC, and the implicit guarantee for other troubled companies’ pension funds. This would not be a small cost, nor would it be a one-off cost. There should be stiff premium increases for companies that have persistently under-funded pension funds. This would be far less costly than bailing out those companies who default on their pension liabilities and would be a more equitable solution. Every dollar that a pension fund is under-funded is another dollar the firm can count towards profits, which will likely be given to either the shareholders or the executives. The shortfall in pension benefits if the company goes bankrupt, however, will come from taxpayers.