Your pension is safe on Wall Street

Defined-benefit pension plans are famously a headache for the many firms that, once upon a time, offered them. Managing far-future liabilities related to employee career choices and life spans is far outside the core competence of nonfinancial firms. Pensions accounting is its own little universe, just like nightmares are. So doesn’t it make sense to outsource the management of those plans to financial firms, whose bread and butter is managing assets to fund liabilities? And wouldn’t it cut down on “moral hazard” if the firms managing the plans owned them, and were actually liable for any shortfalls?

A BusinessWeek article by Matthew Goldstein (hat tip to Calculated Risk commenter “synthetic-guarantee groupie“) describes a proposal to do just that, transfer ownership of closed pension plans from Main Street firms that find them burdensome to Wall Street firms that see an opportunity. Why am I (along with the article’s author) not entirely enthused?

The folks who brought you the mortgage mess and the ensuing hedge fund blowups, busted buyouts, and credit market gridlock have another bold idea: buying up and running troubled corporate pension plans. And despite the subprime fiasco, some regulators may soon embrace Wall Street’s latest scheme…

[T]he world’s biggest big investment banks, insurers, hedge funds, and private equity shops have been quietly laying the groundwork for such deals over the past year. They would be a big prize for Wall Street. The $2.3 trillion pension honey pot has $500 billion in “frozen plans” that are closed to new employees and whose benefits are capped… By managing those troubled plans, Wall Street also gains entrée to an appealing set of customers to whom it can sell a broad array of fee-generating products…

The concept of off-loading pension funds sounds great. For businesses it’s a chance to rid themselves of struggling plans, which can weigh down a balance sheet. It’s especially good timing now. New accounting rules take effect in the next year or so that will require companies to mark their pension assets to prevailing market prices each quarter—a change that could devastate some companies’ profits…

Critics, including some on Capitol Hill, worry that financial firms don’t have workers’ best interest at heart, which would put some 44 million current and future retirees at risk… The biggest fear is that Wall Street could use retirement portfolios as a dumping ground for its most toxic and troublesome investments. It’s not unlike what regulators allege UBS officials did with its stockpile of risky auction-rate securities by trying to off-load them to wealthy clients.

If Wall Street gambles with those pension assets and loses, U.S. taxpayers would probably foot the bill. When a company with a pension goes belly up today, the PBGC, under federal law, has to take on the fund’s obligations and dole out money to its beneficiaries. It’s a costly burden: The PBGC currently runs a $14.1 billion deficit.

Former PBGC director Bradley Belt argues that pension buyouts could actually strengthen the agency. If financially strapped companies could dump the plans rather than ponying up money for them, they might stay out of bankruptcy. That would mean the PBGC wouldn’t have to step in and pick up the pieces of the pension… [According to Belt,] “This is really in the public interest if it’s done correctly.”

The federal agencies that oversee the nation’s pension system are expected to weigh in on the issue—potentially paving the way for big firms that have been pursuing it, such as Aon, Cerberus Capital Management, Citigroup, JPMorganChase, Morgan Stanley, and Prudential… Regulators are almost certain to put the kibosh on buyouts by free-standing, independent firms that aren’t tied to the books of any big firm. The worry is that such a weakly capitalized company wouldn’t have the balance sheet heft to deal with the pensions if their assets soured. After all, even big Wall Street firms have been crippled by the $400 billion in subprime related losses.

In theory, this is a win-win proposal. So why, in practice, does it leave me cold? Since these are defined benefit plans, the plan owners take the loss if they mismanage pension money, so retirees should be indifferent to the transfer unless they believe that a potential sponsor will go belly up. Similarly, taxpayers are only on the hook when plan sponsors go bankrupt. If transfers are restricted to firms with strong balance sheets, the likelihood of sponsors collapsing might diminish, leaving both taxpayers and retirees better off. Financial firms could benefit from economies of scale in managing the plans, invest in expertise, and profit by increasing efficiency while totally delivering on plan promises.

I’m nervous not because this is a bad idea in theory, but because I no longer have confidence in the firms that would run these plans. Large financial firms have proven too adept at circumventing prudential regulations until a crisis erupts, and then compelling rule-changes that offload the cost of errors to third parties, which would be taxpayers and retirees in this case. In theory, taxpayers shouldn’t be on the hook for whatever happened at Bear (and every other bank the Fed is lending to), but look where we are.

Supporters of these transfers are right that not permitting the proposal to go forward has real costs. Potentially salvageable, productive firms may buckle under the weight of legacy pension guarantees that expert financials could successfully bear, harming both the private economy and the public purse.

There are costs to not having a financial system worthy of confidence.

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  1. Richard Kline

    Somebody tell me, please, how it is that pension beneficiaries _gain something_ by having a profit-expectant firm inserted between the beneficiary and the stake? That's the present health insurance model, no?—and exactly what is WRONG with the health insurance model, wide boys expecting a meal wedged in the middle of a system in no way funded or expecting to feed them. If we were talking about strapped companies pooling their pensions in tightly mandated non-profit pension firms whose brief both began and ended with capital preservation, I might take an interest. Turning these accounts over to finanicial boys already used to getting their steak dinners bought by the rubes pipelined into their brokerages, I'm dead against it. We need new and different thinking about funding and managing pensions in the US as a social expectation—but that would explicitly include provisions to keep Wall Street AWAY from the dough.

    Oh and BTW that PBGC is just a shaky half-sister to the old, dead FSLIC under the scenario outlined in this proposal. That is, the finance boys get Mom & Pop's pensions pipelined to them to play with for personal profit, but if they bust out said finance whizzes get to point claimants down the turnpike to Washington (at beneficiary expense, of course). That's just a license to speculate, and an incentive to steal.

    And I never had any confidence in the financial whizzers anyway to do anything but line their own pockets. This proposal shouldn't just be dead on arrival, it should be hunted down and killed in its lair.

  2. Anonymous

    No comment, but read this:




    The Wall Street Journal

    At a time when scores of companies are freezing pensions for their workers, some are quietly converting their pension plans into resources to finance their executives’ retirement benefits and pay.
    In recent years, companies from Intel Corp. to CenturyTel Inc. collectively have moved hundreds of millions of dollars of obligations for executive benefits into rank-and-file pension plans. This lets companies capture tax breaks intended for pensions of regular workers and use them to pay for executives’ supplemental benefits and compensation.
    The practice has drawn scant notice. A close examination by The Wall Street Journal shows how it works and reveals that the maneuver, besides being a dubious use of tax law, risks harming regular workers. It can drain assets from pension plans and make them more likely to fail. Now, with the current bear market in stocks weakening many pension plans, this practice could put more in jeopardy.
    How many is impossible to tell. Neither the Internal Revenue Service nor other agencies track this maneuver. Employers generally reveal little about it. Some benefits consultants have warned them not to, in order to forestall a backlash by regulators and lower-level workers.
    The background: Federal law encourages employers to offer pensions by giving companies a tax deduction when they contribute cash to a pension plan, and by letting the money in the plan grow tax free. Executives, like anyone else, can participate in these plans.
    But their benefits can’t be disproportionately large. IRS rules say pension plans must not “discriminate in favor of highly compensated employees.” If a company wants to give its executives larger pensions — as most do — it must provide “supplemental” executive pensions, which don’t carry any tax advantages.
    The trick is to find a way to move some of the obligations for supplemental pensions into the plan that qualifies for tax breaks. Benefits consultants market sophisticated techniques to help companies do just that, without running afoul of IRS rules against favoring the highly paid.
    Intel’s case shows how lucrative such a move can be. It involves Intel’s obligation to pay deferred compensation to executives when they retire or leave. In 2005, the chip maker moved more than $200 million of its deferred-comp IOUs into its pension plan. Then it contributed at least $187 million of cash to the plan.
    Now, when the executives get ready to collect their deferred salaries, Intel won’t have to pay them out of cash; the pension plan will pay them.
    Normally, companies can deduct the cost of deferred comp only when they actually pay it, often many years after the obligation is incurred. But Intel’s contribution to the pension plan was deductible immediately. Its tax saving: $65 million in the first year. In other words, taxpayers helped finance Intel’s executive compensation.
    Meanwhile, the move is enabling Intel to book as much as an extra $136 million of profit over the 10 years that began in 2005. That reflects the investment return Intel assumes on the $187 million.
    Fred Thiele, Intel’s global retirement manager, said the benefit was probably somewhat lower, because if Intel hadn’t contributed this $187 million to the pension plan, it would have invested the cash or used it in some other productive way.
    The company said the move aided shareholders and didn’t hurt lower-paid employees because most don’t benefit from Intel’s pension plan. Instead, they receive their retirement benefits mainly from a profit-sharing plan, with the pension plan serving as a backup in case profit-sharing falls short.
    The result, though, is that a majority of the tax-advantaged assets in Intel’s pension plan are dedicated not to providing pensions for the rank and file but to paying deferred compensation of the company’s most highly paid employees, roughly 4 percent of the work force.
    And taxpayers are on the hook in other ways. When deferred executive salaries and bonuses are part of a pension plan, they can be rolled over into an Individual Retirement Account — another tax-advantaged vehicle.
    Intel believes that its practices “feel consistent” with both the spirit and letter of the law that gives tax benefits for providing pensions.
    Intel may be a model for what’s to come. Many companies are phasing out their pension plans, typically by “freezing” them, i.e., ending workers’ buildup of new benefits. This leaves more pension assets available to cover executives’ compensation and supplemental benefits. A number of companies have shifted executive benefits into frozen pension plans.
    Technically, a company makes this move by increasing an executive’s benefit in the regular pension plan by X dollars and canceling X dollars of the executive’s deferred comp or supplemental pension.
    CenturyTel, for instance, in 2005 moved its IOU for the supplemental pensions of 18 top employees into its regular pension plan. Chief Executive Glen Post’s benefits in the regular pension plan jumped to $110,000 a year from $12,000. A spokesman for the Monroe, La., company, which made more such transfers in 2006, was frank about its motive: to take advantage of tax breaks by paying executive benefits out of a tax-advantaged pension plan.
    So how can companies boost regular pension benefits for select executives while still passing the IRS’s nondiscrimination tests? Benefits consultants help them figure out how.
    To prove they don’t discriminate, companies are supposed to compare what low-paid and high-paid employees receive from the pension plan. They don’t have to compare actual individuals; they can compare ratios of the benefits received by groups of highly paid vs. groups of lower-paid employees.
    Such a measure creates the potential for gerrymandering — carefully moving employees about, in various theoretical groupings, to achieve a desired outcome.
    Another technique: Count Social Security as part of the pension. This effectively raises low-paid employees’ overall retirement benefits by a greater percentage than it raises those of the highly paid — enabling companies to then increase the pensions of higher-paid people.
    Indeed, “it is actually these discrimination tests that give rise to Qserp in the first place!” said materials from one consulting firm, Watson Wyatt Worldwide. “Qserp” means “qualified supplemental executive retirement plan” — an industry term for a supplemental executive pension that “qualifies” for tax breaks.
    Watson Wyatt senior consultant Alan Glickstein said the firm’s calculations tell employers exactly how much disparity they can achieve between the pensions of highly paid people and others. “At the end, when the game is over, when the computer is cooling off, you know whether you passed (the IRS nondiscrimination tests) or not,” he said. At that point, companies can retrofit the benefits of select executives, feeding some into the pension plan.
    They can do this even if they freeze the pension plan, because executives’ supplemental benefits and deferred comp aren’t based on the frozen pension formula.
    Generally, only the executives are aware this is being done. Benefits consultants have advised companies to keep quiet to avoid an employee backlash. In material prepared for employers, Robert Schmidt, a consulting actuary with Milliman Inc., said that to “minimize this problem” of employee relations, companies should draw up a memo describing the transfer of supplemental executive benefits to the pension plan and give it “only to employees who are eligible.”
    The IRS was also a concern for Mr. Schmidt. He advised employers that in “dealing with the IRS,” they should ask it for an approval letter, because if the agency later cracks down, its restrictions probably won’t be retroactive.
    “At some point in the future, the IRS may well take the position” that supplemental executive pensions moved into a regular pension plan “violate the ’spirit’ of the nondiscrimination rules,” Mr. Schmidt wrote. In an interview, he confirmed his written comments.
    Companies don’t explicitly tell the IRS that an amendment is intended to shift supplements executive benefits obligations into the regular pension plan. “They hide it,” a Treasury official said. “They include the amendment with other amendments, and don’t make it obvious.”
    With too little staffing to check the dozens of pages of actuaries’ calculations, the IRS generally accepts the companies’ assurances that their pension plans pass the discrimination tests, the official said.
    “Under existing rules, there’s little we can do anyway. If Congress doesn’t like it, it can change the rules.” To halt the practice, Congress would have to end the flexibility that companies now have in meeting the IRS nondiscrimination tests.
    A spokesman for the IRS said it has no idea how many such pension amendments it has approved or how much money is involved.
    Sometimes, the only tipoff that a firm is moving executive benefits into the regular pension is that it provides small increases to some lower-paid groups in the plan, in order to pass the nondiscrimination tests.
    Royal & SunAlliance, an insurer, sold a division and laid off its 228 employees in 1999. Just before doing so, it amended the division’s pension plan to award larger benefits to eight departing officers and directors. One human-resources executive got an additional $5,270 a month for life.
    But to do this and still pass the IRS’s nondiscrimination tests, the company needed to give tiny pension increases to 100 lower-level workers, said the company’s benefits consultant, PricewaterhouseCoopers. One got an increase of $1.92 a month.
    Joseph Gromala, a middle manager who stood to get $8.87 more a month at age 65, wrote to the company seeking details about higher sums other people were receiving. A lawyer wrote back saying the company didn’t have to show him the relevant pension-plan amendment.
    Mr. Gromala then sued in federal court, claiming that administrators of the pension plan were breaching their duty to operate it in participants’ best interests. The company replied that its move was a business decision, not a pension decision, so the fiduciary issue was moot. The Sixth U.S. Circuit Court of Appeals agreed.
    PricewaterhouseCoopers declined to comment. A spokesman for Royal & SunAlliance’s former U.S. operation, now called Arrowpoint Capital, said the pension plan “wasn’t discriminatory.” Royal & SunAlliance recently changed its name to RSA Insurance Group.
    Pension-plan amendments like the documents Mr. Gromala sought must be filed with the IRS, but the agency normally won’t disclose specifics such as who benefits. The IRS says it can’t release details of the amendments because they reflect individuals’ benefits.
    Employers sometimes tell executives that moving their supplemental pensions or deferred comp into the company pension plan will make them more secure. Normally, supplemental pensions or deferred comp are just unsecured promises; companies don’t set aside cash for supplemental executive pensions and deferred comp because there’s no tax break for doing so. But the promises will be backed by assets if the company can squeeze them into a tax-advantaged pension plan.
    This supposed security can prove illusory, as executives at Consolidated Freightways found out.
    The trucking firm moved most of its retirement IOUs for eight top officers into its pension plan in late 2001. It said this would protect most or all of their promised benefits, which ranged up to $139,000 a year.
    This came as relief to Tom Paulsen, then chief operating officer, who says he knew the Vancouver, Wash., trucking company was on “thin ice.”
    But the pension plan was underfunded. And Consolidated didn’t add more assets to it when the company gave the plan new obligations. Adding the executive IOUs thus made the plan weaker. It went from having about 96% of the assets needed to pay promised benefits to having just 79%.
    Consolidated later filed for bankruptcy and handed its pension plan over to a government insurer, the Pension Benefit Guaranty Corp. The PBGC commits to paying pensions only up to certain limits. Mr. Paulsen said he and other executives have been told they won’t get their supplemental pensions.
    Some lower-level people will lose benefits, too. Chester Madison, a middle manager who retired in 2002 after 33 years, saw his pension fall to $20,400 a year from $49,200. Mr. Madison, 62, has taken a job selling flooring in Sacramento, Calif.
    He faults those who made the pension decisions. “I look at it as greed and taking care of the top echelons,” he says.
    It’s impossible to know how much the addition of executive pensions to the pension plan contributed to the plan’s failure. But in this as in similar companies where a plan saddled with executive benefits failed — such as at kitchenware maker Oneida Ltd. in upstate New York — it’s clear the move weakened the plans by adding liabilities but no assets.
    A trustee for Consolidated’s bankruptcy liquidation declined to discuss details of the company’s pension plan.
    Mr. Madison and five other ex-employees sued Towers Perrin, a consulting firm that had advised Consolidated on structuring its benefits. The suit, alleging professional negligence over this and other issues, was dismissed in late 2006 by a federal court in the Northern District of California. Towers Perrin declined to comment.
    Some companies, after moving executives’ supplemental benefits into a pension plan, now take steps to protect them. When Hartmarx Corp. added executive obligations to its pension plan last year, it set up a trust that automatically would be funded if the plan failed.
    Glenn Morgan, the clothier’s chief financial officer, said the trust benefits nine or 10 people. “The purpose is to pay them the benefit they’ve earned,” he said.

  3. wintermute

    defined benefit schemes are alive and well in the UK public service sector. There is now a £600 billion unfunded future liability for this largesse. That is the equivalent of a deadweight freddie/fannie bailout – on a much smaller economy. Is it going to take a depression in the UK to force the government to actually SAVE THE MONEY IN ADVANCE needed to fund their employee pensions properly. Talk of Wall Street firms not being trusted to manage pension pots properly – they can’t do worse than governments…

  4. Anonymous

    Create crisis then usurp control. The wall street gang, (protected from naked shorting by SEC), with access to the fed window, and IRS credit card activity records will simply take financial control of americans from cradle to grave. Our freedoms are being taken from us every minute of every day. Are we freer today than we were four years ago? 95 years ago?

  5. Anonymous

    Common guys just think of the managment fees wall street could use to bleed these funds dry. We have to think about the house in the Hamptons and villa in Milan that the investment VP’s need to maintain.

  6. daveNYC

    So GS (for example) grabs one of these pension funds, sticks it in the newly created GS Pension Management Company, loads the pension up with ‘dubious’ assets (which are all considered Level 3, so no worries about the pension appearing under funded), then 10-20 years down the line the GSPMC goes tits up and the tax payers get stuck bailing out the fund, and the retirees lose some bigass percentage of their pension.

    This is only a win-win for the financials and the politicians they donate to.

  7. Mara

    I have no doubt that the full intention all along was to rob the massive pensions (defined bene’s and 401k’s) from the pre-boom and baby boomers. The Wallstreeters saw companies with fat pension funds just sitting there, not giving to The Street. Geez, it’s like they were saving it for somebody! I do recall that when Social Security was created, most people didn’t live past 65 anyway. Now with people living 15-20 years past that, it’s become a bit of a problem, especially when you underfund your pension accts and the govt (or some independent auditor) doesn’t keep you honest about it. Anyway, I made a bet with a friend around 2001 that the last big stickup would be that the retirement funds of most middle-class people would be “lost”, crashed, or otherwise swindled away before the boomers could ever cash them in. Sadly, it looks like I’m going to win the bet. Of course, there are still those “dark pools” of money hanging out there (google ‘project turquoise’). We’ll see what nefariousness they provide in the coming year.

  8. Anonymous

    Oh for pity sake, when will you rubes wake up? Paulson and his covered bond derivatives need collateral (reserves) and they need that Trillion dollar slosh parked in pension funds to play the next bubble game; meanwhile Paulson, et al return back to GS and various conduits and (then as any smart insider with a blind trust fund) buys low from the retards and sells high to the other retards. This is America baby and wall street is where you play monopoly, collusion, corruption, treason, fraud, misrepresentation and all those other games that are connected to the fraud in washington…

  9. macndub

    There is no world in which this is a good idea for beneficiaries. The idea is simple: obtain billions (trillions?) more in assets, sleeve to the Fed, obtain treasuries, rebuild capital, and charge a fee. A win-win, for the bank.

    A loser for the taxpayer and beneficiary.

  10. Anonymous

    Howabout they put all that money into IRAs and get the “Professional Money Managers” out from between an employee and his/her retirement?

    The money would be much more difficult to steal (er… mismanage) that way, wouldn’t it?

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