The Pension Mess: How Washington Can Start Cleaning Up

There's a time bomb ticking in America's private pension system. Although the airline industry's hefty $32 billion in unfunded pensions has captured headlines in recent months, the problem extends much further. Automotive companies, for instance, have about $60 billion in pension shortfalls. The Pension Benefit Guaranty Corp. says U.S. pension underfunding at large companies grew 27% last year, to $354 billion. The deficit for all companies was a staggering $450 billion. Compare that with a total shortfall of less than $50 billion in 2000, and it's clear that this fast-growing crisis must be addressed while the PBGC -- already facing a $23 billion deficit after taking over terminated plans from the likes of Bethlehem Steel (MT ) and United Airlines (UALAQ ) -- can still shoulder the burden.

DEJA VU. If this all sounds a bit familiar, it should. In the 1980s, the Federal Savings & Loan Insurance Corp., the government-sponsored insurance fund for the thrift industry, watched as the nation's S&Ls fell victim to a toxic brew of skyrocketing interest rates, lax oversight, imprudent lending, and outright fraud. The feds stepped in and the government eventually led a $223 billion (in today's dollars) bailout of the industry. One reason the taxpayer tab was so high was that the government was slow to react. That's why Washington should get serious about a pension fix now.

First, Congress must bring some sanity to the bedlam of pension contribution rules. Now, companies can be technically current in funding while owing billions in shortfalls, and they can increase benefits even when they haven't funded existing promises. For example, Bethlehem Steel's pension plan was 84% funded on a current-liability basis, but only 45% funded when all termination costs were tallied -- with a shortfall of $4.3 billion when the company finally handed its plan over to the PBGC in 2002. Yet because of various loopholes, Bethlehem wasn't required to make any catch-up contributions for years prior to its plan termination and even avoided making any cash contributions in the three years before it ditched the plan.

United Airlines' record was even worse: It wasn't required to make cash contributions to its pilot pension plan from 2000 to 2004, even though that plan was $3 billion in arrears. United's employee plans were technically fully funded on a current account basis, but only 41% funded at termination. United dumped all its plans on the PBGC earlier this spring for a total shortfall of $9.8 billion -- of which the PBGC is on the hook to pay $6.6 billion. To prevent similar abuse of the system, rules are needed that extend tax incentives to companies that prefund pensions when they are financially flush but set tougher timetables for making up shortfalls later.

Second, Congress needs to sharply increase the premiums the PBGC can charge underfunded plans. Today there is little difference between what is paid by companies that have adequately funded their plans and those that haven't. Instead, the PBGC should be allowed to charge higher premiums to companies with shaky finances or large unfunded liabilities.

TIME TO PRIORITIZE. Risk-adjusted pricing is already commonplace in financial products such as mortgages, where buyers who put up higher downpayments on their homes get cheaper rates, and car insurance, where bad drivers pay more. It's also used by federal bank insurers for setting deposit insurance rates. So applying risk-based pricing to pension insurance premiums isn't exactly revolutionary. But it's unpopular with many weak companies and with labor groups that fear employers will simply stop offering defined-benefit pensions if premiums get higher.

Yet that argument may already be academic. The number of workers covered by such pensions has been dropping for at least 20 years as employers have shifted toward often cheaper 401(k)-type plans. Thus, Congress' first priority should be to force companies to fully fund their pensions over the next few years -- lessening the hit taxpayers could shoulder if the PBGC becomes overwhelmed with underfunded plans later.

Finally, Congress must act to ensure that all workers receive timely, understandable information detailing whether their pension plans are adequately funded. Under current law, the PBGC receives financial information on the most risky underfunded plans fairly early, but cannot disclose it. Instead, companies can take up to 30 months to report plan finances publicly -- often too late for workers to press for more responsible pension management. Greater transparency will also give employees a reality check when companies offer meaningless benefits that they can't realistically afford. Indeed, the sooner more light is cast on the festering pension mess, the better for workers -- and taxpayers.

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