Pension Plight

Just when you thought the future of Social Security was the biggest problem facing American retirees.

When United Airlines received permission from bankruptcy court in May to terminate $9.8 billion in pension obligations, the American public got a peek at a problem that has the potential to affect a vast segment of the population. The airline’s decision to default on four of its pension plans is seen as a bellwether by some experts.

It’s no secret that pension plans are becoming as rare as a $2 bill. There are roughly 30,000 defined benefit pension plans still in existence, compared with more than 112,000 two decades ago.¹ But it would be a mistake to believe that the problem is limited to people working for companies that offer a traditional pension.

Guaranty Not Guaranteed

In 1974, Congress created the Pension Benefit Guaranty Corporation to protect workers from pension failures. The PBGC collects premiums from U.S. pension plans and uses the money to pay partial retirement benefits if a plan cannot meet its pension obligations to workers.

In 2001, the PBGC had a $7.7 billion surplus. By the end of 2004, the corporation’s financial position had swung to a $23.4 billion deficit.² As bad as that sounds, it’s just the beginning. Total underfunding in the corporate U.S. pension system is estimated at $450 billion, indicating that more failures may be in the offing.³

There are a number of causes for pension underfunding:

• Longer life expectancies, causing greater-than-anticipated obligations.

• Companies that made reduced contributions during a tough year with the hope of making up the
shortfall when business improves.

• Poor stock market performance that may have resulted in lower-than-expected returns on pension plan investments.

• Over-promising benefits.

Why Pension Failures Affect You

The condition of a company’s pension plan affects not just the workers — who can expect a fraction of the retirement benefits that they were promised if the plan fails — but it can also affect its stockholders, many of whom may be holding the stock in their own retirement portfolios. For example, 362 companies in the S&P 500 have pension plans, but only 54 had surplus pension assets at the end of 2004.⁴

When pension obligations become a strain to meet, they can sap revenues that might otherwise have been reinvested in the business, potentially cutting into the company’s ability to remain competitive.

Perhaps even more onerous is the possibility that taxpayers will be called upon to help bail out the PBGC as it is forced to assume the obligations of more pension plan failures. Congress is expected to raise the PBGC’s premiums by about $7 billion per year to help avoid a collapse — a potentially catastrophic event — but legislators are already warning to expect the worst.⁵

“Taxpayers had better buckle up because we will be in for a bumpy ride as more and more corporations dump their pension obligations on PBGC,” said Representative Jan Schakowsky, a Democrat from Illinois.⁶

What Can You Do?

It’s important not to overreact to the pension problem. A review of your holdings might reveal companies that have pension troubles. Likewise, you may also find companies that are not at the mercy of a pension plan, giving them an advantage over competitors. If you are concerned about how problems in the U.S. pension system could affect your portfolio, please call. There are strategies that may help position your portfolio to take advantage of these risks.

1) Journal of Financial Planning, April 2005
2, 3, 5) Barron’s Online, May 2, 2005
4) The San Diego Union-Tribune, May 14, 2005
6) The Associated Press, May 11, 2005

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