The $800 Billion Question

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The New York Sun

Today experts gathered in Washington will discuss the $800 billion question facing America: What will we do about our old-fashioned defined-benefit pension liabilities? Speakers in the panels convened by AARP and the Employee Benefits Research Institute will consider topics such as “the current state of employer-based pensions” and “how much and what risk should individuals bear?” They’d save some time if they just read a report, also released today, by a senior fellow at the Free Enterprise Fund, Peter Ferrara. In respect of the current state of employer-based pensions, Mr. Ferrara notes that employers are shifting en masse to defined contribution plans like 401(k)s. As to how much risk individuals should bear, Mr. Ferrara points out that it’s a moot point. Individuals, both as workers and as taxpayers, are already bearing more risk than they think.

If Americans think of nothing else when they think about pensions, they should think of $800 billion. That’s the total unfunded liability of defined-benefit pensions plans in the public and private sectors. In other words, millions of American workers are counting on receiving $800 billion in pension benefits that no one knows how to pay for. The amount state and local governments set aside for their pension programs is estimated to be $350 billion short of what they will eventually need to pay out, while private-sector employers with defined benefit plans are staring at a $450 billion shortfall. That $800 billion, incidentally, is entirely separate from the catastrophe looming over Social Security if the retirement system isn’t reformed.

Defenders of traditional defined-benefit plans like to argue that the competing defined contribution alternative is too risky, but the $800 billion deficit in defined benefit plans makes risk a moot point. If anything, defined-benefit plans are even riskier. Just look at General Motors. Mr. Ferrara notes that GM now spends $6 billion a year for employee health costs, more than it pays for steel. GM posted a loss of $10.6 billion last year, and its debt has a junk rating. It also runs the largest pension plan of its type in the world, with 600,000 employees, retirees, and surviving spouses counting on the system.

Were GM to go bankrupt – not inevitable, but a danger – it would pass that burden to the Pension Benefit Guaranty Corporation. Employees and retirees would most likely see their benefits dramatically reduced, the fate that has befallen thousands of steel workers and airline employees in recent years. Taxpayers would faced an unfunded liability of $31 billion if the PBGC, a quasi-governmental entity similar to an insurance agency that has its own multi-billion-dollar shortfall, couldn’t pay those reduced benefits from its own pockets.

If this is retirement “security,” we’d prefer the “insecurity” of a defined-contribution plan. Although “insecurity” is the wrong word, as Mr. Ferrara notes, considering the risks a 401(k) eliminates, particularly inflation risk. Defined benefit plans force workers and retirees to worry about inflation because they depend on their employers to control the risk. Once the pension vests, the only way a pensioner can ensure a benefit that will keep pace with inflation is by lobbying the employer for cost-of-living adjustments, and pensioners are largely at the mercy of their employers and their unions. In 401(k) plans, in contrast, the markets have historically provided real asset growth after inflation.

Mr. Ferrara is preaching to the choir as far as corporate America is concerned. In 2005, 37% of Fortune 100 companies offered defined-benefit pensions, compared to 89% in 1985; 36% of the Fortune 100 list now offer defined-contribution plans where only 10% did two decades ago. Others, however, are dragging their feet along the path to sustainable pensions.

Governments are big offenders, offering some of the most generous defined benefit plans around. Defying all logic and self-interest, the United Auto Workers union is threatening to cripple a major GM supplier, Delphi, with a strike if Delphi tries to rationalize its defined benefit pension in bankruptcy court. Meantime, as a growing number of healthy companies shift to defined-contribution plans leaving ailing old-economy titans as the last bastions of defined benefits, the shortfalls threaten to grow. Today’s AARP seminar, and any other talk about American pensions, will be in vain if it fails to address the $800 billion question.

The New York Sun

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