The PBGC: A broke insurance company sponsored by your government

Published in Real Clear Markets.

Imagine an insurance company with assets of $88 billion, but liabilities of $164 billion. It has a huge deficit: a net worth of a negative $76 billion, and a capital-to-asset ratio of minus 87 percent.

Would any insurance commissioner anywhere allow it to remain open and to keep taking premiums from the public to “insure” losses it manifestly cannot pay?  Of course not. Would any rational customer buy an insurance policy from it, when the company cannot even hope to honor its commitments?  Nope.

But there is such an insurance company, open and in business and taking in new premiums for obligations it will not be able to pay. Needless to say, it is a government insurance company, since no private entity could continue in business in such pathetic financial shape. It is the Pension Benefit Guaranty Corp. (PBGC), a corporation wholly owned by the U.S. government, operating on an obviously failed model. Its board of directors comprises the secretaries of the departments of Labor, Commerce and the Treasury; quite a distinguished board for such egregious results.

There are two financially separate parts of the PBGC: the Single-Employer Program, which insures the defined-benefit pension plans of individual companies; and the Multiemployer Program, which insures union-sponsored plans with multiple companies making pension contributions. The Single-Employer Program has a large deficit, with assets of $86 billion, liabilities of $110 billion and a negative net worth of $24 billion. That is bad enough.

But now imagine an insurance company with assets of $2 billion and liabilities of $54 billion. That is a truly remarkable relationship. Its net worth is negative $52 billion, or 26 times its assets. That is the PBGC’s Multiemployer Program – which, as no one can doubt, is well on the way to hitting the wall.

The PBGC can continue to exist for only two reasons: because the government forces pension plans to buy insurance from it and because its political supporters entertain the abiding hope that Congress will somehow or another give it a lot of other people’s money to cover its unpayable obligations.

Congress should not do this, and so far, it has shown no inclination to announce a taxpayer bailout. But the real simultaneous financial and political crunch will occur when the disastrous Multiemployer Program runs out of cash while still being oversupplied with obligations. This moment is readily foreseeable, but has not yet arrived and is estimated to be a number of years off.

The PBGC was created by the Employment Retirement Income Security Act of 1974 (ERISA). This put into statue an idea created by the research department of the United Auto Workers union in 1961: let’s get the government to guarantee our pensions. The idea was politically brilliant but, financially, less brilliant.

According to the law, the PBGC was not supposed to be able to get itself into the insolvent status in which it not finds itself. As each PBGC Annual Report always informs us, “ERISA requires that PBGC programs be self-financing.” But they aren’t—not by a long shot, where the value of that long shot is at least $76 billion. What does the “requirement by law” to be self-financing mean when you aren’t and have no hopes to be so?

One thing originally intended to be quite clear we find in the next Annual Report sentence: “ERISA provides that the U.S. Government is not liable for any obligation or liability incurred by PBGC.” To repeat: Not liable. But of course, they said the same thing in statute about Fannie Mae and Freddie Mac. They made Fannie and Freddie put that in bold face type on every memorandum offering their debt for sale. But they bailed out Fannie and Freddie anyway.

As it has turned out, the Fannie and Freddie bailout has proved to provide a positive investment return to the taxpayers: an internal rate of return of about 7 percent so far. But any bailout money put into the PBGC will be simply gone. It would not be an investment, but purely a transfer payment.

That reflects the fact that Fannie and Freddie, when their operations were not perverted by politically mandated excess risk, had a fundamental model capable of making profits, as they did before the housing bubble and now are again. This profit potential is not shared by the PBGC. Its fundamental model is to take politically mandated excess risk in order to promote unaffordable pensions, not to insure them according to rational actuarial principles.

Defined-benefit pension plans have proved beyond doubt to be an extremely risky financial construction. The idea that the government is guaranteeing them encouraged the negotiation of pensions unaffordable to the sponsors in the first place, and the underfunding of pension obligations later. These are the kinds of very costly moral hazards entailed in the very existence of the PBGC. Of course, the PBGC might have, had Congress allowed it to, charged vastly higher premiums. But this would be against the other of its assigned missions: to encourage and promote defined-benefit pensions.

You can understand how this was felt to be a nice idea, but it creates an irresolvable conflict for the PBGC. The corporation is simultaneously supposed to promote the use and survival of defined-benefit pension programs, while it is also supposed to run a sound, self-financing insurance company. Obviously, it has utterly failed at being a sound insurer. Arguably, by creating incentives to design unaffordable pensions, it also failed at promoting defined-benefit pension plans, and has rather accelerated their ongoing demise.

There is no easy answer to the PBGC problem as a whole, but Congress took a sensible and meaningful step with the Kline-Miller Multiemployer Pension Reform Act of 2014. We will devote the next essay to examining the implications of this act and the reasonable attempt to use it recently thwarted by the U.S. Treasury Department.