WurfWhile

It’s immoral.

U.S. Bankruptcy Judge Eugene Wedoff ruled yesterday that United Airlines can terminate its four major pension plans with $6.6 billion in liabilities, sending them to the Pension Benefit Guaranty Corporation (PBGC), the federal agency that insures defined-benefit (fixed payments for life) pensions. PBGC will pay only some of United Airlines’ pension obligations - with pension cuts to employees of as much as 60% or more representing the rest of the obligation.

Adding insult to injury, United Airlines will ask Judge Wedoff to null current contracts for over $3 billion in annual labor savings beyond the pension savings. Further, United maintains an extravagant $4.5 million pension for its CEO Glenn Tilton and has said that workers cannot legally strike (and will be fired if they try). So much for the friendly skies.

With great justification, even further justified by the earlier exchanged ownership for wages in an Employee Stock Option Plan (ESOP), unions are seeking to replace United Airlines management. They are also threatening CHAOS to bring management down.

United terminating its pension is likely to start a financial run on PBGC. Already American Airlines is citing United’s dropping of pensions as a competitive disadvantage for American. This view of competitive advantage in dumping defined-benefit pension obligations is not, and will not be limited to the airline industry.

PBGC seems to suffer from a number of structural problems, including the fact that it is a government corporation that receives no funding from general tax dollars, nor does it enjoy the backing of the full faith and credit of the United States for its obligations. Instead, according to its Executive Director Bradley D. Belt, operating costs rely on “insurance premiums, assets from pension plans trusteed by PBGC, investment income, and recoveries from the companies formerly responsible for the trusteed plans (generally only pennies on the dollar).” Insurance premiums consist of a $19 per participant charge and a premium based on the amount of a plan’s current unfunded vested benefits that is limited by law, and currently insufficient. Even with PBGC capping retirement payments (some United workers, for example, will lose over 60% of their retirement based on the judge’s ruling and PBGC payment formulas), the government agency still is running a deficit and has roughly three dollars in liabilities for every two in assets (a shortfall of $23 billion for fiscal year 2004).

From the recent congressional testimony of Executive Director Bradley Belt:

“The current insurance program is replete with moral hazards. Benefits can be increased as long as [a company’s retirement] plan is at least 60 percent funded, regardless of the financial capacity of the company. Management and workers in financially troubled companies may agree to increase pensions in lieu of wage increases.

For a company, the cost of wage increases is immediate, while the cost of new pension benefits is spread out over 30 years. In addition, labor may choose to bargain for wages or other benefits rather than for full funding of a plan because of the federal backstop. If the company recovers, it may be able to afford the increased benefits. If not, the costs of the insured portion of the increased benefits are shifted to other companies through the insurance fund [PBGC].

Similarly, a company with an underfunded plan may increase asset risk to try to make up the gap, with much of the upside gain benefiting shareholders (but not necessarily participants) and much of the downside risk being shifted to other premium payers.

The standard insurance industry safeguards against moral hazard are risk-based underwriting and risk-based premiums. These safeguards are absent from the pension insurance program. Unlike most private insurers, the PBGC cannot apply traditional risk-based insurance underwriting methods. It cannot turn away bad risks and it cannot charge more for them. As a result, there has been a tremendous amount of cost shifting from financially troubled companies with underfunded plans to healthy companies with well-funded plans.

Consider: …[W]hile United Air Line’s credit rating has been junk bond status and its pensions underfunded by more than $5 billion on a termination basis since at least 2000, it has paid just $75 million in premiums to the insurance program over the 10-year period 1995 to 2004. Yet the termination of United’s plans will result in a claim on the fund of roughly $6.6 billion.”

In other words, defined-benefit pensions are part of the retirement crisis in America. The system does not work for working Americans when the retire because it provides little security. Company pension obligations aren’t accompanied by serious attempts to make sure companies meet their obligations. Americans need secure retirement - and we need it now. With Baby Boomers retiring, look for this to be a major issue in upcoming elections. Since Republicans don’t seem too terribly interested in retirement security, it could be the basis of a new Democratic majority if Democrats are smart - or the basis of a permanent minority if they aren’t.