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Growing danger to pension plans has government officials worried
Mary Williams Walsh
New York Times
Jul. 28, 2003 12:00 AM
Top government officials have begun a campaign to bring attention to corporate pension plans that, they say, may be on a road to collapse. Underneath their careful words are proposals that could change the $1.6 trillion industry, altering the way pension funds are set aside and invested.
Last Wednesday, the comptroller general placed the Pension Benefit Guaranty Corp., the agency that guarantees pensions, on a list of "high risk" government operations. Labor Secretary Elaine Chao issued a statement the same day warning that the decades-old system in which workers earn government-guaranteed pensions "is, unfortunately, at risk."
Treasury Secretary John Snow, a former railroad chief executive with responsibility for a $1.3 billion pension fund, warned recently that a financial meltdown similar to the savings-and-loan collapse of 1989 was brewing.
Steven Kandarian, executive director of the Pension Benefit Guaranty Corp., gave a speech this month in which he foresaw a possible "general revenue transfer," polite words for a bailout of the agency. Before being named to head the agency, Kandarian was a founding partner and managing director of the private equities firm of Orion Partners.
While officials want to underscore the danger to the retirement benefits that millions of Americans count on, they do not want to frighten consumers, roil financial markets or anger the companies that put billions of dollars into the system.
Billions wiped away
But some pension fund analysts, reading between the lines, say they believe that officials are looking not only at calling upon companies to put more money into their ailing pension plans, a painful prospect when cash is tight, but also at the more radical remedy of encouraging funds to reduce their heavy reliance on the stock market.
At issue are defined-benefit pensions, the type in which employers set aside money years in advance to pay workers a predetermined monthly amount from retirement until death. Today, about 44 million private-sector workers and retirees are covered by such plans.
Three years of negative market forces have wiped billions of dollars from the funds, triggering the defaults of some pension plans and leaving the rest an estimated $350 billion short of what they need to fulfill their promises.
Until recently, the idea that the nation's pension system was built on a flawed foundation was preached by a few financial specialists but considered heresy by almost everyone else. But after several years of declines in the stock market, there is a growing argument that pension managers, who have been investing most of their money in stocks for years, should in fact be in predictable bond investments that would mature when the money was needed, matching the retirement ages of the workers.
Now that view is gaining ground in academia, and getting a fair-minded hearing by central financial officials, who are incorporating some of its reasoning in their pension proposals.
The measures they have put forward bear little resemblance to those considered this month in a rancorous House Ways and Means Committee session. The House pension bill is more generous to business. If enacted, it would lop tens of billions of dollars off the amounts companies would pay into their pension funds in each of the next three years. Businesses favor the bill's approach but had hoped to make its changes permanent.
'More money needed'
Treasury officials say they believe this approach would put benefits at risk, particularly at companies with older workers who will be claiming their pensions soon.
"More money is needed in those plans to ensure that older workers receive the benefits they have earned through decades of hard work," Peter Fisher, undersecretary for domestic finance, said in testimony to a House subcommittee this month.
The high number of pension funds that have defaulted has severely weakened the pension insurance agency, raising fears of a bailout. The agency finances its operations by charging companies premiums, and it still has enough cash flow to make all of its payments to retirees for now. But its deficit has grown to record size, and it cannot keep absorbing insolvent pension plans indefinitely.
Premiums could rise
It could raise premiums, an unpopular idea with companies, or in a dire situation it could turn to the taxpayers for more money. Letting companies pay less into their pension plans would only increase the risk of such a bailout.
That is why the Treasury has called for what Fisher described as a comprehensive reform.
Unknown to most Americans, a small group of finance specialists has for a number of years been making the case that pension funds are in danger because their managers invest heavily in stocks. These analysts were hooted at in the stock boom of the 1990s, but in the aftermath of a three-year bear market, their arguments are being considered more carefully.
Money managers of all sorts invest in stocks, of course, and no one is questioning stocks for mutual funds, foundations or university endowments. But pension funds are different, the argument goes, and they require a different strategy: stocks when workers are young, perhaps, but later on, as workers age, an ultraconservative portfolio of bonds, with the duration shortening as the workers approach retirement.
Bonds are safer
This type of pension investment strategy went out of style in the 1960s and is little used today. Life insurers make a notable exception, using duration-matched bonds when they issue annuities.
Stocks are widely assumed to return more over time than bonds that are held to maturity, and therefore have seemed a cheaper investment vehicle.
The implications of a revival of the old strategies would be profound. Pension funds, with assets worth roughly $1.6 trillion at the end of 2002, make up a significant share of the stock market and help to drive its movements. Suggestions that pensions might be safer if this money were placed elsewhere are not warmly received on Wall Street.
If anything, corporate pension managers appear to be moving toward more risk, not less. The composition of pension portfolios is not generally disclosed, so trends are hard to track. But anecdotal evidence suggests that pension managers are turning to hedge funds, real estate investment trusts, "emerging" markets, and other riskier, unconventional investments in an effort to recoup the losses of the past three years.
Companies appear to be "making the smallest contributions allowed, while taking investment risk in the hope that their gamble will pay off," said Jeremy Gold, an advocate of duration-matched bonds for pension funds.
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