Letter of the Law | Published in April 1999

The Trouble with PBGC's "Government Guarantee"

To prevent government meddling and the risk of moral hazard, private-sector pension promises should rest with the private sector, the author urges

By PS | April 1999

To prevent government meddling and the risk of moral hazard, private-sector pension promises should rest with the private sector, the author urges

James B Lockhart
Former PBGC director

It is a government retirement insurance program investing billions of dollars in the stock market. Yet, despite being a government agency with premiums arbitrarily set by Congress, it has no government backing except a minuscule committed loan facility. Apparently, it still is unable to adequately forecast its future after working on a model for seven years. All its premium income is required to be invested in US government securities so that the government can maintain the fiction that the premiums are government income. Is it the Social Security program of the future? Maybe.

The Pension Benefit Guaranty Corporation's current condition is a much happier one than the state in which I found it when I arrived there almost 10 years ago. Although I was greeted with a rather na•ve editorial cartoon of my predecessor putting up a sign in front of the agency's headquarters--"Renovations Completed"--in reality, it would have been in Chapter 11 if it were a private sector company. Back then, PBGC had:

  • A $2 billion net worth deficit,
  • Many billions of claims and potential claims from terminated pension plans,
  • Unaudited and unauditable accounts,
  • A premium billing system that had been shut down for a year,
  • A total mismatch of assets and liabilities, and
  • A dizzyingly complex insurance policy and program misunderstood by participants and the courts.

Over the last decade, the PBGC has made giant strides. Its surplus now exceeds $5 billion and assets have grown from $3 billion to more than $18 billion even though the number of plans it insures continues to decline, as it has for several decades. Markets, management, and legislative reform have all been helpful. Indeed, PBGC has now been depicted in editorial cartoons as a glutton, in contrast to the image of my day as a small boy accepting a coin from a bankrupt company. Now that PBGC's renovations are finally nearing completion, it is time to reassess its future. Although some people would say why argue with success, I believe that PBGC's future should be outside the government sector. PBGC still has basic flaws, including the moral hazards of a government insurance program, the potential to cause market distortions, and the tendency to provide a tempting pot of money for politicians.

Specifically, these flaws are:
1. The moral hazard that almost brought PBGC down is still here, albeit somewhat reduced by legislation. Unions ask for benefit increases knowing a "government guarantee" is there and companies agree because they will have years to pay.

2. Companies are arguing again that PBGC's premiums are too high, and that certainly is true in some cases. The problem is that there appears to be no demand to underwrite and price the insurance based on the risk of the sponsors and their pension plans.

3. With the growing pot of money, the political temptation to meddle is increasing. The meddling might take the form of new, poorly funded defined benefit plans for small businesses or, as in my day, the pressure from liberal senators to guarantee the annuities of failed companies like Executive Life.

4. There is always the political pressure to interfere with collective bargaining or to intervene on behalf of a specific company or union.

5. Alternatively, PBGC's policies and practices have it interfering with many mergers, acquisitions and divestitures.

6. The cumbersome and inefficient government accounting, procurement, and budgeting systems, combined with the inability to pay employees what they are worth, also could lead to future problems.

7. Lastly, as the debate over Social Security investing passively in equities rages on, the ability of a government agency to invest actively in equities is questionable.

Take responsibility
We are rightly asking welfare recipients, parents, students and teachers to be more responsible. Perhaps, it is time to ask corporations and unions to be more responsible also. Privatization would do that.

Privatization could come in many forms. It could be a demutualization, a rights offering to PBGC's premium payers (corporations and/or pensions). It might come in the form of an initial public offering of stock. Possibly, PBGC's obligations to its 500,000 beneficiaries could be annuitized, coupled with the authorization of AAA private-sector companies to write the insurance.

The key result should be to put the private sector pension promise back in the private sector. Underwriting, premium setting, pension risk management, decisions about corporate restructuring, and investing of premiums and recoveries should all be in the private sector.

James B Lockhart III is senior partner of NetRisk, a risk management and software advisory firm based in Greenwich, Connecticut. He was executive director of Pension Benefit Guaranty Corporation during the Bush Administration.