Pension Fund Buyouts

I've been sitting on this for several days trying to find time to think it through, but that hasn't happened, so let me toss it out to all of you. What do you think of this plan for financial firms to buy out frozen pension funds? Is this a positive development or something to worry about? I don't find myself particularly concerned, but like PBGC interim director Charles Millard, I believe the "regulatory issues and hidden risks are very complex," and that makes me wary of taking a position on the proposal before having a more complete understanding of the consequences:

On and Off The Hook, by Tomoeh Murakami Tse, Washington Post: Some financial services firms are trying to clear a regulatory path that would let them buy out pension plans, freeing employers from pension obligations while potentially giving profit-driven financiers direct control over the retirement savings of millions of Americans.

The interested players range from venerable Wall Street banks such as J.P. Morgan Chase and Citigroup to start-ups, including one co-founded five months ago by Bradley D. Belt, the former executive director of the federal Pension Benefit Guaranty Corp. These groups say the buyouts would not only benefit companies that want to get off the hook of pension responsibilities, but also help workers by putting their retirement assets in the hands of shrewd money managers. And if those assets are profitably invested, the groups say, it would reduce pressure on the PBGC, which insures the pensions of nearly 44 million Americans but has a deficit of $18 billion. ...

Opposition groups mistrust the motives of the financial firms seeking a piece of the $2.3 trillion in assets in corporate pension plans around the country.

"My initial take on all of this is: This has a lot more to do with taking care of CEOs than taking care of workers," said Rep. Earl Pomeroy (D-N.D.)... "CEOs could look at this as a very useful way to get the uncertainties of pension funding and liability off their books." ...

The buyout proposals vary, but generally, they call for financial firms taking over pension plans that have been frozen by their original sponsors. ...

In "frozen" pension plans, employers no longer pay into the fund and workers do not accrue new benefits, though employers continue to carry the assets and liabilities on their books. That means the companies would be on the hook for additional funds if, for example, the stock market plunges...

Most employers seeking to end pension plans or get rid of frozen plans issue a lump-sum payment to employees and retirees, or they buy annuities from insurance companies, which take over management of the assets. The assets then fall under state insurance regulations, which require that the companies maintain certain reserves to balance risks...

The buyout proposals suggest a different scenario: Financial firms would take control of the assets and liabilities of a pension plan, and continue to operate it under the Employee Retirement Income Security Act of 1974. ERISA, which governs company-run pension plans and establishes minimum standards, requires that the assets be invested with "care, skill, prudence and diligence." The PBGC is the final backstop for failed pensions.

The financial services firms are in discussions with the federal agencies that interpret and enforce pension laws, including the PBGC, the Labor Department and the Internal Revenue Service... The firms are seeking a ruling on whether a buyout firm would be a legitimate sponsor of a pension plan and, if so, whether it could continue to receive tax breaks on contributions to the pension plan.

Advocates say there is nothing in the law that prevents financial firms from buying out and maintaining pension plans, as long as the transactions are properly structured to protect employees and retirees. Before proceeding, however, some firms would like to receive assurances from the regulatory agencies...

"These are very interesting proposals," said Charles E.F. Millard, interim director at the PBGC. "They make claims concerning improvement in the health of the pension-insurance system that might make them attractive. However, regulatory issues and hidden risks are very complex. And so these proposals need significant study." ...

Depending on which financial firms take over the pension plans and how they do it, some analysts said, it is far from certain whether it would alleviate the burden on the PBGC. ... Some critics fear that a financial entity might buy out a pension fund and gamble with its assets, knowing that if the investments made money, the firm would reap the excess profits, and if it lost money, the PBGC, which is funded by insurance premiums paid by pension funds, would be the backup.

"This is like the latest wonderful product from the people who brought you the subprime disaster," said Damon A. Silvers, associate general counsel of the AFL-CIO. "When you have a situation in which a risk is being laid off, and none of the participants in the transaction have that much of an interest in seeing that the benefits are being paid . . . the likelihood that there are going to be inadequate assets is pretty high." ...

Some analysts are predicting that a series of changes to accounting rules would increase the cost and risk of maintaining such plans, possibly pushing employers to find a way out of them.

The consulting firm McKinsey & Co., in an internal report earlier this year, said that 50 to 75 percent of traditional pension plans in the private sector would be terminated or frozen over the next five years.

"The two-and-a-quarter-trillion-dollar question, though, is, once they freeze it, what do they do next?" said David Oaten, head of J.P. Morgan Chase's U.S. pension advisory group. ...

Comments

[Bruce Webb]

At first glance I like the idea. American corporations have a very mixed record on pensions and particularly on using the bankruptcy courts to scrape those responsibilities off. I have a friend who is a very bitter old man indeed. He had a few decades in at the door manufacturing company and a nice pension lined up then boom, overnight and right before his retirement they closed the doors and that pension vanished, leaving him reliant on Social Security.

A model where health plans are managed by the union and pension plans by people whose fiduciary responsibility is to retirees rather than shareholders would seem to establish the right buffer between employers and labor. Moreover you can see ways that it could be extended, once the plans are established it should be possible to offer health and pension plans to smaller employers, perhaps on the AFLAC model. And over time perhaps they could add portability.

[anne]

Oh dear; I have to think a while how to show just how absurd the idea is. As absurd as the idea which is welcome to all other than actual labor economists of General Motors selling the workers health insurance program that is worth $50 billion to the United Auto Workers for $30 billion.

Think first of the logic. Pension funds that are already managed by professionals are to be sold to the same professionals, so there is no company liability. Presto-chango investment returns go to the moon and beyond because the same managers who are already managing the funds are still managing the funds. Huh?

At the least, the very least, any cost control for managing the assets will go poof (I know investing magic). When David Swensen invests Yale's endowment with professionals, Swensen gains the sort of cost advantages of Berkshire Hathaway or Vanguard. While managers of company pension plans seldom or rarely have the incentive for cost control of Swenson, there is some control invcentive.

What is being called for in loosing Goldman Sachs professionals on pensions beyond investing cost control.

[anne]

Goldman Sachs buys a pension fund which it may alreafy manage at an elevated cost, and having bought the fund Goldman for a premium Goldman manages the fund at a high enough cost to cover the premium. Besides, Goldman likes to charge for management and charges lots, while taken as a whole investors can only match a market in returns minus the cost of investing.

Vanguard will not be able to bid for management along with Goldman, since Vanguard does not charge enough to cover a competitive purchase premium. So, at the least, investment costs become a really scary issue. Looked at Goldman costs lately?

Berkshire Hathaway investment management costs are even less than Vanguard's. Looked at Goldman?

Presto-chango every pension fund yields higher returns by being owned by Goldman at higher costs than just being managed by Goldman, and all are above average always.

[Meh]

I'd add to anne's objections that the risk issue is a real one. If you have a fund that you can send the tab to the government for, why wouldn't you use it to make some gambles to pull another division out of trouble?

That is the pattern of the S&L and a lot of these other issues. People get into trouble and then throw more money at risky investments in order to try and balance the books. Since we know some of these companies already have question marks lurking, should we be letting them buy into this situation at this time?

[Meh]

Finally, of course, from a narrowly political point of view, the purpose of this is to prove that you can privatise pension holdings and put them in the hands of these financial companies. Thus establishing a baseline for yet another Social Security privatisation proposal. For some, that may be grounds enough to oppose it.

[bakho]

"March 2002

PBGC Protects Benefits of 82,000 LTV Workers In Largest-Ever Federal Pension Takeover
The Pension Benefit Guaranty Corporation (PBGC) today announced it is taking over three underfunded pension plans covering some 82,000 workers and retirees of bankrupt steel maker LTV Corp., based in Cleveland. The move comes because no purchaser of LTV assets has agreed to assume any pension liabilities and, as LTV's liquidation progresses, no one will remain at the company to manage the plans' assets and pay benefits. With combined assets of almost $2.2 billion and benefit liabilities of $4.4 billion, the plans are underfunded by about $2.2 billion, PBGC estimates."

Financial Corporations are already running "portable" retirement programs. There are thousands of workers that can explain the downside of tying their pension to the fortunes of the company they used to work for.

[taq]

Much like Bruce Webb, I am acquainted with a number of individuals who have been short-changed by there company in bankrupcy court. I am not aware of any living on only SS, most receive a reduced pension through pbgc. I think that forcing companies to keep pensions out of reach of creditors is important, but i would agree with ann that the firms mentioned have a record of profiting more from than for investors.

Any time that a former government employee is getting into a similar business as his former dept., it is suspicious. Could not the PBGC or a related government organization perform a similar function without the conflict of interest. I am not aware of any federal government employee retirement program ever being underfunded (there are several examples of local and state - orange county 457 plans being the greatest default i know of, but that was due to gambling of assets, rather than poor planning?)

[anne]

What I do not understand, and stopped asking about a couple of years ago, is when the last 30 years have been astonishingly profitable times to invest whether in stocks, bonds or commercial real estate, how have there been starkly poor returns in a significant number of pension funds?

We are passing through what may be the broadest and deepest international investment bull market since 1945. Why should there be more than minimal pension funds difficulties, or a selling of funds?

Would Yale sell the endowment? Would the Gates Foundation sell the endowment? Why or why not? I am missing something.

[anne]

Also, what of private pension funds in selected developed countries?

[Noni Mausa]

I think it would stabilize businesses and communities a great deal if a centralized national pension plan was available to all employees in the nation. This would be tied to the person (via Social Security number I suppose) and follow him all the days of his life, no matter whether businesses soared or crashed or weasled their way out of their obligations.

In addition, I'd like this plan paid into for every single hour worked-- even one hour a year would pay into it.

It's disgraceful that the system rewards the cheapskate employers for jerking their staff (our fellow citizens) around, keeping them on part-time hours just to avoid the cost of benefits which includes pension coverage. The lack of benefits for part-timers tempts business to operate much less efficiently, (40 p.t. versus 25 full time staff, for instance) but the inefficiency is shoved off onto the employees. A Every Hour benefit and pension structure would stabilize this, while still leaving business free to hire part-timers if they chose to. And the pension wouldn't be vulnerable to high-powered con artists.

What would buisinesses get out of this? A flat fee structure and a pool of money which would be Not Their Problem -- the same way that health care could be Not Their Problem if single-payer took over.

The feds have taken over ... how many?...orphaned pensions. That's our tax dollars paid out (for all practical purposes) to cover the broken promises of bad businesses. Never again!, say I.

Noni

[Michael Cain]

anne says: "What I do not understand, and stopped asking about a couple of years ago, is when the last 30 years have been astonishingly profitable times to invest whether in stocks, bonds or commercial real estate, how have there been starkly poor returns in a significant number of pension funds?"

In at least some cases, it is not the overall returns, but the timing of other allowed "withdrawals" of various sorts from the fund. Depending on the detailed terms of the fund itself, the company may have been allowed to pull money out if the fund contains more than the forecasts say is required to meet their obligations, and to defer the obligation to make additions if the fund comes up short. In other cases, the company may be allowed to borrow from the fund, with the fund getting no better treatment than any other unsecured creditor in the case of bankruptcy. In still other cases, the company may be allowed to draw on the fund to meet certain types of non-pension obligations, such as separation packages. In yet another "scam", the company may reorganize the pension, moving the minimum necessary to meet federal requirements into the new fund while pocketing the current excess (note that the federal requirements are substantially lower than unbiased actuaries would require). Or Halliburton's handling of the Dresser-Rand pension, in which employees in the acquired company were turned into involuntary early retirees required to take a lump-sum settlement with very substantial early-retirement penalties; Halliburton pocketed, IIRC, several hundred million dollars that remained in the fund after the employees had all been pushed out.

[save_the_rustbelt]

I don't have much time to think on this (the NASCAR race is finishing and the Steelers are playing tonight), but it seems like a very, very bad idea.

More later.

[anne]

Michael Cain, thank you.

The argument on looseness in allocation of funds to pensions is obviously correct, but I will ask for a legal summary of care-taker responsibilities to further explain what has been possible. Though investment costs must have been a factor, there had to have been a looseness in legal responsibility for funding that allowed for deep problems to selectively develop.

I may be wrong, but I thought Warren Buffett explained to us several years ago that a company could estimate investment returns in determining how much funding would be added to pension investments each year. Companies then would rountinely over-estimate returns and underfund pensions. Buffett, if I remember the context correctly, read us a series of anticipated returns by companies and showed the portfolio mixes and laughed.

[anne]

There might be a portfolio mix of 50% stock and 50% bonds, with an anticipated return of 10%. This sounds moderate, but with bond yields at 7%, stocks would have to return 13% after costs or at least 14%. A 12% return estimate would take a 16% stock return, and would just not be met other than in a chance year.

[anne]

"A 12% return estimate would take an 18% stock return after costs, and would just not be met other than in a chance year."

[Bruce Webb]

Legally there would seem to be a lot of difference between a pension fund managed by Bear Sterns on behalf of the company and an arm's length fund where the fiduciary responsibility is to the worker.

A good part of the sub-prime debacle was customers (not surprisingly) not being aware of even the existence of concepts of 'agency' and 'fiduciary'. The legal responsibilities were not where those customers thought they were. It makes a great deal of difference where 'your' pension fund manager or 'your' mortgage broker is legally obligated.

[ilsm]

When the dogs of war need food the pensioners will feed them.

[save_the_rustbelt]

Even though a pension fund is frozen the company has fiduciary and compliance duties, so in effect the company would be selling itself out of those duties.

The company should already have the funds in the hands of shrewd managers, so there is no gain there. The financial firms are already getting management fees, so just do they have to gain by owning the plan??????????????????

If the plan is underfunded when frozen selling it won't fix the problem.

The company could close the plan and buy annuities for the benefits (I think this is still legal) which is somewhat safe assuming they use a highly rated insurance/annuity company.

This smells of fraud in the making - bad idea.

[Bruce Webb]

taq,

I suspect a lot of the difference is between reorganizing through bankruptcy (in which case you would probably retain some pension liability) and simply closing the doors forever.

[Bruce Webb]

STR can you show me where a company actually has a fiduciary interest towards employees for any given level of benefits. I see companies reopening benefit packages for retirees all the time. Ask United Airlines pilots.

[evagrius]

It's thsame idea as privatizing Social Security.

Just another attempt to gain money to keep the economic pump primed.

[anne]

Remembering, Warren Buffett spoke to the faulty legal framework problem protecting pension balances and rights while echoing a fierce critique by Charles Munger on pension investment costs which were estimated at a terrible 2 percentage points. I was too conservative in the example I used from Buffett, but let me repeat using half the cost used by Buffett.

There might be a portfolio mix of 50% stock and 50% bonds, with an anticipated return of 10%. This sounds moderate, but with bond yields at 7%, stocks would have to return 13% after costs or at least 14%.

An 11% return estimate would take a 15% stock return or 16% after costs, and would just not be met other than in a chance year.

A 12% return estimate would take a 17% stock return or 18% after costs, and would just not be met other than in a chance year.

Notice the investment assumption absurdity.

[anne]

Corporate responsibility must be determined by legislative framework, not manager good will. that however means regulation in a time when regulation was routinely rejected.

[dd]

Well at least know we know how the IB's plan to fund the super-conduit.

[anne]

Think then, if we can assume a 2 percentage point cost for professional pension fund management, as customary, then even when a 10% combined stock and bond return is gained, the realized return for workers will be 8%. Buffett suggested however that 8% is all that should be expected before costs. I cannot imagine professional bidding for pension funds without the strictest cost controls, but that will be fiercely fought by financial companies.

This is a terribly dangerous sort of step at a time when regulation is considered all but beyond thought.

[James Killus]

I want some way to tie the corporate managers' fortunes to the fate of the pension funds. If the managers are getting stock options, I want the options to be held in trust by the pension fund. If the fund springs a lead, the managers' money would be the first to plug the hole.

I think everyone here has the same suspicion: the way the game is played right now, the proposal being floated is the shuffle just before substituting the cold deck. Somebody wants to carve another piece out of workers' retirements.

[anne]

No; the need is regulation, we really have to move to using regulation properly again. We have been deregulating for 30 years, and the results are ever more plainly problematic and balance is needed. Not a change in control, not increased cost but regulatory efficiency and balance.

[save_the_rustbelt]

Bruce:

Companies may have no fiduciary "interest" unless labor forces it upon them.

A company has all sorts of fiduciary and compliance duties to a defined benefit pension plan, the one thing the government has not been able to force is full funding, because a) the accounting rules** make it very difficult to figure out where the plan is at and b) the company may not have the cash flow to fund the plan.

(The company almost always have enough cash flow to fund the qualified and non-qualified goodies for the execs.)

When the company is in the Chapter 11 dumper (either for real or by design) it is almost always too late to get the cash flow in order.

Other benefits, especially retiree health benefits, are not guaranteed and famous for being "adjusted" when the company gets in trouble. A defined benefit plan can also be renegotiated with a union, always to the detriment of the workers, in a save the company manuever.

IF I were a beneficiary in a frozen DB pension plan, I would rather have the money annuitized than given to a Wall Street firm.

** My profession, the accounting profession, has not done a good job with this and deserves some heat. And too many lawyers are helping management screw workers.

PS: I would like to see a few prosecutions of plan trustees, might bring a little integrity into play.

[save_the_rustbelt]

Anne:

Good questions.

First, the problem is not poor pension returns. The problem is that if enough cash is never put into the plan there won't be adequate returns regardless of the market.

Second, there is plenty of regulation on the books, but the regulations cannot force current funding (see my post above).

[Bruce Webb]

"A company has all sorts of fiduciary and compliance duties to a defined benefit pension plan"

'fiduciary' has a defined meaning in law. I am not a lawyer so I won't try to spell it out, not least for fear of getting it wrong. But that door company walked away from its defined benefit plan and from what I can see neither its legal or acccounting team had a single legal obligation vis a vis the prospective retirees. In both cases it would seem their responsibilities began and ended with duties owed to the company. The company may have had some 'fiduciary and compliance duties' but much of that seemed to have been erased through the magic of bankruptcy and dissolution of the corporation.

People who actually know stuff can steer me right here. On the other hand I spent the last fifteen years in real estate and know quite a bit about how you can hedge off risk by setting up a new LLC for each project. '"Jones Brothers VIII LLC" I hardly knew you. And of course there is no legal overlap with "Jones Brothers IX LLC". Nope totally and entirely different entities. Just ask the Washington State Secretary of State'.

Wow. Who knew that setting up an LLC (Limited Liability Company) actually limited liability? (well me, my ex boss and his attorney had a pretty good idea) (and lawyers feel free to jump in here, because I suspect you can get after the 'Managing Partner', but getting at his personal assets might be a little tough, sometimes you really can get value for money by paying for legal assistance).

[save_the_rustbelt]

BRuce Webb:

Google "Erisa 1974."

The weakness in the pension (defined benefit) regulatory scheme is that when a company gets behind on funding (for whatever reason) and then has business problems there is no mechanism for catch up other than 1) default the plan to the feds or 2) run the company through Chapter 11.

Defined contribution plans have their own weaknesses of course, but usually the funding is current, as least the withheld segment.

[anne]

STR, thank you; though assurance of contribution is critical in regulation.

[Michael Cain]

STR: "Companies may have no fiduciary "interest" unless labor forces it upon them... A company has all sorts of fiduciary and compliance duties to a defined benefit pension plan, the one thing the government has not been able to force is full funding..."

My defined-benefit pension (taken as a lump sum, a long story there) came from a fund where, many years ago, the union had bargained (a) to have it set up as a trust with terms such that the company could get money back only after all obligations of the trust had been paid, and (b) to use an expected return for investments that was tied to the 30-year Treasury rate.

It was only when I found myself in the situation where I had to make decisions about taking the pension that I started doing some research and discovered how unusual this situations was.

[BJ Feng]

I think a company should make good on their pension promises no matter how foolish those promises were to begin with. How to put that into practice is the difficult part. I was thinking about making pension obligations senior to all debt so that if a company goes bankrupt, the pension plan would be the first in line. But that has a lot of negative drawbacks. First, any company with a pension would have to pay a lot higher rate of interest on its debt because all issued debt would be subordinate. That could sink a company that otherwise could survive. There really isn't a simple solution.

Here is where the unions have to step up and show both leadership and skill. Unions have to use their power to safeguard the pensions during good times. It seems that unions only care about pension obligations when the company is in trouble and options are limited. When a company has no money, it has no money, the trick is to safeguard the pension plan when times are good and the company has money. It's a shame that the unions are so incompetent when it comes to these things. It seems all they care about in good times is getting more money from the company and restricting the company's flexibility. Unions have to reform themselves to better work with the company and they definitely have to be more forward looking. They should be willing to give up wages during lean times with the understanding and agreement that workers will be rewarded more than usual during the next upswing after management has made the necessary cuts to be productive. Entrenching into an impossible situation will only kill the company and get everyone laid off with their pensions lost. Where are the competent unions?

[Dickeylee]

The competent unions are being bled to death by the Dept of Labor under both republican and democratic administrations. LM-10's, LM-9's, LM-3's, etc...and then the NLRB under control of anti-union groups, all add up to the destruction of worker protections over the last 30 years. Right-to-work laws actually mandate unions to cover all the dead beats who don't pay dues just as if they were dues-paying members. Really, it's Alice in Wonderland fighting off all the Laws against the wage earning stiffs. And what they do to our retiree's is criminal and immoral, but that's another spiel.

[anne]

Oh dear, the pension fund issue is as applicable for corporation with as corporations without unions; and the idea of rapacious unions ruining corporations good times and bad is simply dark irony and an absence of logic. We have passed through a dream-like 30 years in corporate income and investment market returns, the idea that workers are to blame for pension fund troubles is nutty. The troubles however are real.

[Doug K]

smells like S&L to me too..
the pension funds are already professionally managed. Changing management is very unlikely to increase returns, and probably will increase costs and risk: so I don't see where the faery dust to "help workers by putting their retirement assets in the hands of shrewd money managers" will come from. Add the taxpayer-guaranteed PBGC bailout, and there's every incentive for the shrewdies to gamble with other people's money. I'd want to see a lot more liability for the "shrewd money managers" before letting them get their paws on my pension.