Adam E. Cearley, the Pbgc: Why the Retiree's Traditional Life Raft Is Sinking and How to Bail it Out

• Jurisdiction: United States,Federal
• Publication year: 2011
• Citation: Vol. 23 No. 1

COMMENTS

THE PBGC: WHY THE RETIREE'S TRADITIONAL LIFE RAFT IS SINKING AND HOW TO BAIL IT OUT^*

INTRODUCTION: THE PROBLEM FACING THE PENSION BENEFIT GUARANTY

CORPORATION

On September 14, 2005, both Delta Airlines and Northwest Airlines filed for chapter 11 bankruptcy protection, following in the footsteps of other high- profile airlines seeking to shed ponderous pension obligations to stay competitive.¹Although many analysts construed Northwest's timing as a strategic move to deflect negative attention onto the larger Delta Airlines, the more likely motivation was financial.²By filing for bankruptcy on the day before a mandatory payment of sixty-five million dollars to the Pension Benefit Guaranty Corporation ("PBGC") was due, Northwest Airlines effectively made the PBGC an unsecured creditor for the entire amount it was owed.³Far from being a singular occurrence, Northwest's timing is emblematic of the strategy taken by financially-troubled companies to shed pension costs.⁴By taking advantage of the deficiencies in the bankruptcy statutes ("Bankruptcy Code") and the Employee Retirement Income Security Act ("ERISA"), companies entering bankruptcy are able to shed significant pension obligations that were never intended to be borne by the PBGC.⁵This type of maneuvering has left the PBGC with record deficits and unsustainable long-term losses.⁶

Established in 1974 under ERISA,⁷the PBGC is a nonprofit government corporation whose mission is to insure that participants of defined benefit plans are not left empty-handed when an employer becomes insolvent and unable to pay its pension obligations.⁸Prior to the passage of ERISA, retired and retiring employees relied solely on their employers' ability to continue funding their vested retirement benefits after leaving the work force. However, when the Studebaker Company bankruptcy in 1964 left its employees with only fifteen cents for each pension dollar promised, legislators began working on a solution that became the PBGC.⁹Congress established the PBGC with three distinct goals: "(1) to encourage the continuation and maintenance of voluntary private pension plans for the benefit of their participants, (2) to provide for the timely and uninterrupted payment of pension benefits to participants and beneficiaries under [pension] plans . . ., and (3) to maintain premiums established by the corporation . . . ."¹⁰

To give numbers to the enormous size of the PBGC, forty-four million employees and retirees rely on the PBGC to insure approximately $1.5 trillion of covered pension plans.¹¹Employees receive pension payments out of PBGC assets only after an employer that sponsored the pension plan can no longer afford the plan and the assets within the employer's pension trust are insufficient to cover vested obligations.¹²For single-employer plans terminating in 2006,¹³the PBGC insures premiums up to $47,659.08 a year to participants.¹⁴To date, the PBGC has assumed the pension obligations for over 3500 pension plans and is making pension payments to approximately one million participants.¹⁵In September 2005, the Congressional Budget Office ("CBO") released its ten-year estimate of the present value of net costs to the PBGC without reform.¹⁶The CBO estimated that the loss, net of premiums charged by the PBGC to employers, was approximately $86.7 billion.¹⁷

Without substantial structural changes to the system, losses of this magnitude will likely require a substantial reduction in the benefits for each employee insured by the PBGC, or even a taxpayer-funded bailout similar to the savings and loan crises in the early 1990s.¹⁸

This Comment is organized into four substantive Parts. Part I provides a brief overview of the PBGC that is focused on the agency's structure and funding rules. Part II looks at the intersection of the Bankruptcy Code and ERISA and discusses the PBGC's claims against an estate or debtor in possession ("DIP") with unfunded liabilities. Part III focuses on the parallels between the structural weaknesses of the defined benefit pension system and those of savings and loan institutions; followed by an analysis of the lessons that can be applied from the collapse of the savings and loan industry. Part IV discusses six possible solutions to the PBGC's problems in light of the savings and loan collapse and evaluates their likely effectiveness.

I. THE PBGC STRUCTURE

The PBGC was created under ERISA¹⁹to provide a safety net to workers with defined benefit pension plans.²⁰A defined benefit plan provides enrolled retirees a guaranteed monthly income that is usually determined by the tenure of an employee with a company and the salary that the employee earned.²¹

The PBGC is responsible for insuring almost every type of defined benefit plan.²²In comparison, defined contribution plans such as 401(k) accounts provide employees with an individual retirement account, of which the employee takes the balance at retirement.²³Unlike defined benefit plans, defined contribution plans do not oblige employers to any future financial obligation to an employee following separation. Because there is no risk of nonperformance to the retiree, these plans are not insured by the PBGC and fall outside the scope of this Comment.²⁴Instead, the solvency concerns facing the PBGC all stem from the consequences surrounding the termination of defined benefit plans.

A. Terminating Pension Plans

Under ERISA, there are three ways in which a pension plan can be terminated by an employer.²⁵The first method is through a voluntary standard termination.²⁶Standard terminations pose no risk to the PBGC because they can only take place when the assets within a pension trust are sufficient to cover the present value of all currently vested obligations.²⁷When an employer voluntarily terminates a fully funded pension plan, the PBGC's balance sheet is not affected, other than the loss of normal insurance premiums that the PBGC charges companies with defined benefit plans.²⁸Consequently, this Comment focuses on the two remaining methods of plan termination.

The second way an employer may terminate its plan is through a voluntary distressed termination.²⁹Voluntary distressed terminations are limited because they can only occur at the request of the employer and by permission of the

PBGC.³⁰Before allowing a company to terminate its plan, the PBGC must first determine whether the company has met the statutory requirements for a distressed termination.³¹To qualify, the company must be undergoing insolvency proceedings such as reorganization or liquidation;³²or the PBGC concludes either that it is likely the company will become insolvent without termination³³or that pension costs have become "unreasonably burdensome" because of a declining workforce.³⁴When a company successfully terminates an under-funded pension plan, the PBGC takes over the management of the plan and makes guaranteed payments to employees first from the pension trust's remaining assets and then from the assets of the PBGC.³⁵

To mitigate the massive unfunded obligations the PBGC can incur during a distressed termination, ERISA authorizes a third termination method enabling the PBGC to institute an involuntary distressed termination of a plan when certain criteria are met.³⁶To exercise this right, the PBGC must demonstrate that the plan does not meet the minimum funding standard,³⁷that there is a tax deficiency,³⁸that the plan will be unable to pay its benefits,³⁹or that a long-run loss to the PBGC can be reasonably expected.⁴⁰At the outset of an involuntary termination proceeding, the PBGC seeks the appointment of a trustee and a judgment that termination is necessary to protect the interests of either the plan participants or the PBGC.⁴¹PBGC-initiated terminations usually occur in situations where companies have negotiated labor agreements with employee unions.⁴²This occurrence is a result of ERISA's prohibition against voluntarily standard or distressed terminations by companies with pension plans negotiated in collective bargaining agreements.⁴³Hence, because the

PBGC is not a party to a collective bargaining agreement it can violate such agreements and terminate potentially costly pension plans on behalf of the employer through involuntary terminations.⁴⁴

B. Pension Plan Funding

To help protect the interests of both plan participants and the PBGC, ERISA sets out requirements for the minimum funding levels of pensions.⁴⁵

The funding standards are intended to guarantee that in the event that a company can no longer pay future pension benefits, it will be able to voluntarily terminate the plan and pay off all its outstanding obligations.⁴⁶

Theoretically, all plans should have a fully funded balance. Exceptions added to the minimum funding standards, however, have eroded the stability that these provisions were intended to provide.

Among ERISA's funding requirements are mandatory premiums that the PBGC charges companies on a per-participant basis,⁴⁷a variable premium charged to companies with plans that are under-funded,⁴⁸and rules that limit the amount a plan can be under-funded.⁴⁹Working against these provisions, however, is the Tax Code which imposes a maximum funding limit for how much a company can contribute to the plan in a given year.⁵⁰The contribution ceiling is intended to prevent companies from exploiting the tax-deductible status of pension contributions and disrupting a company's regular contribution to the tax revenue stream. Though the limit may be effective in reducing the on-book deficit of the federal budget, the funding limit is shortsighted. As the

CBO concluded, "[T]he net result of current funding rules is that many plans have become badly under-funded . . . thus exposing the PBGC to substantial potential losses."⁵¹

Despite rules in place that discourage chronic under-funding, between 59% and 84% of companies with large covered plans report funding gaps greater than 10%.⁵²To counteract this pattern, companies with under-funded...