Private Pension Plans

Private pension plans are administered by a bank, a life insurance company, or a pension fund manager. In employer-sponsored pension plans, contributions are usually shared between employer and employee. Many companies' pension plans are underfunded because they plan to meet their pension obligations out of current earnings when the benefits come due. As long as companies have sufficient earnings, under-funding creates no problems, but if not, they may not be able to meet their pension obligations. Because of potential problems caused by corporate underfunding, mismanagement, fraudulent practices, and other abuses of private pension funds (Teamsters' pension funds are notorious in this regard), Congress enacted the Employee Retirement Income Security Act (ERISA) in 1974. This act established minimum standards for the reporting and disclosure of information, set rules for vesting and the degree of underfunding, placed restrictions on investment practices, and assigned the responsibility of regulatory oversight to the Department of Labor.

ERISA also created the Pension Benefit Guarantee Corporation (PBGC, called "Penny Benny"), which performs a role similar to that of the FDIC. It insures pension

FYI. The Perils of Penny Benny: A Repeat of the S&L Bailout?

The current woes of "Penny Benny," the government pension insurance agency, unfortunately display many of the characteristics of the savings and loan crisis discussed in Chapter 11. When an insured company with an underfunded pension plan files for bankruptcy, Penny Benny must pay the company's workers their retirement benefits up to a limit of $47,000 per year per person. Once again we see the moral hazard principle at work: A company is more likely to risk under-funding its pension plan if Penny Benny will foot the pension bill if the firm goes bankrupt.

To keep the costs of government insurance programs from getting out of hand, the insurance agency must reduce moral hazard by monitoring the firms to assess the amount of the underfunding in their pension plans and charge higher premiums based on how much more underfunded the plans are. Unfortunately, Penny Benny has not been doing this, and since 2004 the liabilities arising from the responsibility for troubled pension plans have grown at an alarming rate. In 2004, these liabilities exceeded Penny Benny's assets by $23 billion. In 2005, the United Airlines bankruptcy resulted in Penny Benny taking over United's $6.6 billion liability to pay out pension benefits to its workers, even though Penny Benny took in only $1 billion in premiums that year. Congressional estimates suggest that Penny Benny may have to pay out $120 billion over the next decade to cover the pension liabilities of bankrupt companies. Taxpayers may be hit with another massive government bailout, the size of which will keep growing unless the government makes a concerted effort to reduce the underfunding of corporate pension plans.

The George W. Bush administration has proposed several measures to deal with the moral hazard problems created by the insurance provided by Penny Benny. It has suggested that premiums paid to Penny Benny should increase by more than 50% and that there should be a substantial increase in risk-based premiums, which would rise with greater underfunding of the pension plan. In addition, it has proposed tighter rules for calculating the degree of underfunding. Only time will tell whether these measures will be adequate to forestall a huge taxpayer bailout of Penny Benny.

benefits up to a limit (currently $47,000 per year per person) if a company with an underfunded pension plan goes bankrupt or is unable to meet its pension obligations for other reasons. Penny Benny charges pension plans premiums to pay for this insurance, and it can also borrow up to $100 million from the U.S. Treasury. Unfortunately, the problem of pension plan underfunding has been growing worse in recent years. Penny Benny has estimated that underfunding has reached levels in excess of $400 billion, with one company's pension plan alone, that of General Motors, being underfunded to the tune of $100 billion. As a result, Penny Benny, which ensures the pensions of one of every five workers, is encountering severe financial difficulties that may necessitate a federal bailout (see the FYI box, "The Perils of Penny Benny").

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