Guest Post: Pensions’ Death Spiral?

Submitted by Leo Kolivakis, publisher of Pension Pulse.

The New York Times reports that the plight of carmakers could upset all pensions:

Decisions that the government will make soon on the future of General Motors and Chrysler could accelerate the decline of traditional pension plans, which have sheltered generations of workers from an impoverished old age.

Pension experts predict that a government takeover of the two giant plans would spur other auto companies and all types of manufacturers to abandon such benefits for competitive reasons.

For hundreds of thousands of retired auto workers, a federal pension takeover would mean sharply reduced benefits. For the federal agency that insures pensions, it would mean a logistical nightmare in the short term — and most likely a slow demise eventually as fewer and fewer small plans remain in the system and pay premiums.

So far, the prospect of a grueling grind through bankruptcy court has been a major deterrent to companies that might want to rid themselves of pension obligations. But retirement and labor specialists are watching closely to see whether the administration’s auto task force will give either of the auto companies an easier way to shed their huge pension funds, blazing a simplified trail for others to follow.

With or without a bankruptcy filing, the government is quietly making the preparations that would be needed to take over Chrysler’s pension plan, with its 255,000 participants, according to government officials.

Even if Chrysler manages to strike a deal to sell many of its assets to Fiat, perhaps in conjunction with a bankruptcy filing, experts doubt Fiat will agree to take on its pension plan without extraordinary assistance. One possibility being considered is a cash infusion of $1 billion from Daimler, which previously owned Chrysler and had agreed to backstop a pension failure for several years.

The future of General Motors’ pension plan is also unclear. G.M. has until June 1 to come up with an acceptable business plan. If it declares bankruptcy, it still may try to keep its pension plan afloat. G.M.’s plan for hourly workers, which covers 485,000 people, was in reasonably good shape until last fall’s market turmoil, and would not require cash contributions until 2013.

If one or both of these plans collapse, the federal agency that insures pension benefits, the Pension Benefit Guaranty Corporation, will lose a big source of the premium revenue it collects from companies with pension funds. But more important, the demise of the bellwether auto plans might set a template for other companies seeking to cut costs and stay competitive.

“If one of these companies solves its pension problem by shunting it off to the federal government, then for competitive reasons the others have to do the same thing,” said Zvi Bodie, a professor of finance at the Boston University School of Management and longtime observer of the government’s pension insurance system. “That is the death spiral.”

Though the automakers’ plans each have a gap between what they have on hand and what they owe their retirees over the years, if they failed, most of that shortfall would be made up by workers in the form of smaller benefits — not by the companies or the government.

The government estimated that Chrysler’s plan was $9.3 billion short as of last November — but said it would be responsible for only about $2 billion of that. Most of the shortfall would be sliced from workers’ benefits. At G.M., the estimated shortfall was $20 billion as of last November, but the government would assume $4 billion of obligations and G.M.’s workers would lose the rest.

When Daimler sold a majority stake in Chrysler in 2007 to a private equity firm, Cerberus, it promised to pay $1 billion into the government’s pension insurance program if the pension plan failed within five years. The Treasury could try to persuade Daimler to put some of that money into the plan to avoid a failure.

For years, traditional pensions — those that shield workers from market risk — have been in a slow decline, with troubled sectors like aviation and steel shedding their plans in bankruptcy court as new types of individually managed benefits like 401(k) plans have taken hold.

But big sectors, particularly manufacturing and financial services, have clung to the old plans. The Pension Rights Center, a consumer group in Washington, estimates that 18 million Americans are still building up such benefits every year, and millions more retirees are receiving guaranteed payments from their former employers.

“Those that are fortunate enough to have those plans are sleeping soundly,” said Karen Ferguson, director of the center.

The loss of the auto pensions would be devastating partly because Detroit sustains many other businesses and partly because of their history. It was the United Automobile Workers union, more than any other force, that pushed Congress to enact laws forcing companies to put money behind their pension promises and creating the federal guarantor. The failure of a major auto workers plan would be a blow to the whole system.

Not only would Ford have reason to opt out of the expense of maintaining a pension plan, but so would Toyota and Honda, which also have pension plans at their American plants, said Teresa Ghilarducci, a professor of economics at the New School for Social Research and former member of the P.B.G.C.’s advisory board.

Professor Ghilarducci said she believed the Obama White House had selected people for its auto task force who understood these stakes, and would strive to find some middle ground.

The pension insurance agency, currently operating with an $11 billion deficit, has long viewed the automakers’ plans with anxiety, though its officials declined to discuss the situation. G.M.’s plan alone is bigger than the guarantor. The agency has roughly $67 billion in assets to cover the benefits of nearly 4,000 failed pension plans; G.M. has $84 billion in trust just to cover promises to its own workers.

In a failure of that size, the agency’s immediate challenge would be logistical, not financial. Its insurance covers a simple benefit, not the much richer pensions negotiated over the years by the U.A.W. It would have to process applications from thousands and thousands of workers, most of whom would get the bad news that they were going to get less than promised.

The government’s maximum benefit is $54,000, but coverage falls off rapidly for workers who are younger when their plan fails. For a 62-year-old the maximum is $42,660, and for a 55-year-old, it is only $24,300.

Calculating which workers would bear how much of the losses would be fiendishly complex. The government’s rules favor older participants and contain tripwires and arbitrary cutoffs that can leave similar workers with sharply different benefits.

None of this can be sorted out in advance, because the calculations also depend on the amount of money in a pension fund on the day it terminates — something the pension benefits corporation does not yet know.

Some pension specialists, aware of these difficulties, are hoping the Obama administration’s auto task force will spare at least the G.M. pension fund. Not only would that let laid off workers keep receiving full benefits, but it could also break the death spiral among other plans.

For traditional pension plans, “maybe this is their last stand,” said Jeffrey B. Cohen, a partner with the law firm Ivins, Phillips & Barker in Washington who was chief counsel for the Pension Benefit Guaranty Corporation from 2005 to 2007. If the automakers’ plans fail, he added, “the biggest domino will have fallen for the P.B.G.C.”

This article has been revised to reflect the following correction:

Correction: April 25, 2009
An article on Friday about the implications of possible pension plan failures at General Motors and Chrysler misstated the maximum benefit guarantee under the federal government’s pension insurance program. The maximum is $54,000, for a person who is 65 or older when a company pension plan fails — not $42,660, which is the maximum for a person who is 62.

Late Monday night, Reuters reports that Daimler reaches deal to offload Chrysler:

Daimler AG on Monday reached an agreement with Chrysler, the U.S. automaker’s owner Cerberus Capital Management, and the U.S. Pension Benefit Guaranty Corp to exit its 19.9 percent stake in the company.

Daimler had sold an 80.1 percent stake in the U.S. automaker to private equity firm Cerberus in 2007, ending a stormy decade long relationship with the struggling U.S. carmaker that is operating under U.S. government aid.

In Canada, auto workers made a historic concession to pay into their own pensions:

Newly hired Canadian workers will contribute $1 for every hour worked or about $1,700 a year, a change that comes after the subject of pensions for members of the Canadian Auto Workers, and who pays for them, became a hot-button topic among Canadians and a toxic issue for politicians during the debate about whether taxpayers’ money should be used to keep Chrysler and General Motors of Canada Ltd. from collapsing.

Angry constituents complained to politicians in Ottawa and Toronto after GM said in a restructuring plan submitted to the federal and Ontario governments in February that it was being crippled by pension payments.

“We heard what people said, but I don’t go by that,” CAW president Ken Lewenza said in an interview yesterday after ratification meetings with workers from Chrysler’s Brampton, Ont., and Windsor, Ont., assembly plants. “It’s really how do we send a message to the companies that we recognize the [pension] challenges going forward?”

He noted that newly hired members of the United Auto Workers at Detroit Three plants in the United States will have no pensions, so the CAW needed to act to maintain Canada’s competitive position.

The direct costs of pensions for existing employees will still be carried by the companies and the union argues that in previous rounds of bargaining, workers could have won higher wage increases or improvements in benefits but agreed instead to pension payments by the companies.

All three companies are retrenching in Canada, so they’re not likely to be hiring new employees for some time. But the principle of auto workers paying directly for their own pensions is now established.

The pension move is just one of several major concessions the CAW made in the first agreement to take away hard-won benefits since the union agreed in the early 1980s to cut wages by about $1.15 an hour to help keep Chrysler from plunging into bankruptcy.

“Sacrifices have to be made because we have a cannon at our head,” Mr. Lewenza told Brampton plant workers and retirees.

Other changes – which will apply to all three companies in Canada – include a freeze on wages and cost-of-living pension increases until 2012; an end to company coverage of semi-private hospital rooms; increases in health-care co-payments; and an increase in the amount of time it takes newly hired workers to reach full wages.

The concessions will cut Chrysler’s labour costs by about $240-million annually.

That meets the demand set by Ottawa and Ontario that the company cut its labour costs to $57 an hour from $76 to match those of Toyota Motor Manufacturing Canada.

Chrysler has received $750-million of a planned $1-billion loan from the two governments and its parent company is in negotiations with Italian auto maker Fiat SpA on a strategic alliance. The Canadian and U.S. governments require the company to have a Fiat deal in place by Thursday.

And it’s not just car companies. Royal Dutch Shell PLC said Monday that the ratio of assets to liabilities in its pension fund is now only 80% following the slump in global equities, and it has increased contributions to fill the gap:

Shell’s contribution to the fund has risen from 5% to 23.6% and the employee contribution has risen from 2% to 8% of salaries, the company said in an update posted on its Web site Saturday. The increased payments should bring the pension’s funding ratio to 105% within three years and 127% by 2023, the company said.

The pension fund is also reducing its exposure to investments in equities, which it considers to be higher risk. The fund will now comprise 30% shares, 50% fixed interest and 20% alternatives, compared with the previous 55-30-15 mix, the statement said. Exposure to emerging market shares has been cut by five percentage points to 20% of shares.

Public plans are not faring better. John Bury writes that on an actuarial basis the New Jersey state pension plan is a funding disaster. In the U.K., public sector pensions are in disarray:

As many across the UK take time out to consider their own pension arrangements it has been revealed that the UK taxpayer will be taking on a significantly increased burden in the medium to longer term. Figures buried in the back of this week’s budget showed a £2.3 billion shortfall in public sector pension payments which was covered by the Treasury using taxpayer’s money. This was for the year 2007/08 with the figure set to rise to a staggering £4.1 billion this year.

All in all, the cost of maintaining gold plated pension schemes, alternatively known as defined benefit schemes, will rise to a staggering £4.6 billion a year in 2010/11 and is set to increase year-on-year for the foreseeable future. All in all the UK taxpayer will have pumped in an extra £14.1 billion between 2006 and 2011 in order to maintain defined benefit pension payments for those working in the public sector.

As more and more non-public sector workers in the UK struggled to maintain their pension fund contributions it appears that the fat cats of the public sector are licking their lips. How ironic that we saw Gordon Brown introduced new pension regulations which will see billions of pounds a year taken from taxpayers pension schemes while public sector arrangements maintain their status quo.

In Ireland, government plans to deal with insolvent pension funds have received a muted response from interest groups. In Canada, the wolves are at the pension door:

Dalton McGuinty says Ontario doesn’t have the resources to put more money into its pension safety net (Save Our Pensions, Auto Workers Urge McGuinty – April 24).

Yet, we have all the resources necessary for public service (and MPP) pension plans: They are funded from tax revenue. But apparently the Ontario Pension Guarantee Fund cannot fulfill even the meagre guarantee that was made for private defined-benefit pension plans – support to the $1,000 per month level.

The fact that members of defined-benefit plans have been restricted in their allowable contributions to RRSPs throughout their working lives makes it all the more invidious.

It seems a double standard, whereby public sector pensions are 100 per cent protected, while private-sector pensioners can be thrown to the wolves.

These same wolves are the so-called experts that have wreaked havoc on our global financial system. [Note: You should read the Barricade’s latest comment on the tyranny of experts.]

In New York, Comptroller William Thomson released a list last Friday of “placement agents” — middlemen who collect fees from private firms investing pension funds. Attorney General Andrew Cuomo is looking into whether these agents took fees as illegal kickbacks:

On the list were firms either owned by or employing three former city pension fund managers. A New York Post report questioned Thompson’s role as their former boss. Jeff Simmons, a Thompson spokesman, said yesterday, “Any suggestion of improper actions is simply untrue.” The former workers, two of whom also made contributions to Thompson’s mayoral campaign, followed city rules by waiting more than a year before taking business with the pension funds, he said.

Last week Thompson called for a ban on placement agents, but that requires approval by the boards of each of five city pension funds, all “chaired by City Hall representatives,” Simmons said.

The New York Post reported on Friday that the investigation into the New York State pension fund has spread to Israel.

With few exceptions, all around the world, pension plans are in poor health. As fears of globally spreading swine flu cases spurred the World Health Organization to raise its pandemic alert to an unprecedented level, maybe it’s time we also sound the alarm on the pension pandemic which is leaving global pensions in a death spiral.

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  1. Will

    The best thing that could happen to labor is for the pension system to fail. Short term this may seem scary, but long term it will remove from the system one of the greatest ruses of all time. Pensions are simply not guaranteed, they are pay on tuesday for a cheeseburger today. Workers have deluded themselves accepting these deals; the companies entered into them deferring payment to a later time when they can default or renegotiate the payments away. Labor leaders have poorly represented their workers by pushing these deals and the rank and file have acted selfishly voting for payouts for themselves knowingly or ignorantly ignoring that such plans were a pyramid scheme that was not sustainable.

    The only true compensation is the money i put in my pocket today. Let workers fund their own retirements, then they know how much they are earning for their work, how much they will have in the future (roughly), won’t be scammed out of false promises to pay later, and other workers who are not in the unions won’t be double screwed by paying for their own retirements AND backing these scams with their taxes. Nothing could be more unfair to labor than tax payer backed pensions.

    instead of backing any of these pensions the govt should just extend unemployment benefits to ALL workers, and make some provisions to temporarily boost Soc Sec to help those entering retirement immediately. And that should have something like a 10yr phase out. Then we can be done with this nonsense.

    Next we should get rid of FDIC which allows everyone to live in a fantasy world of comfort and ignore the risks their deposits are exposed to.

  2. anita

    i agree with your comments regarding pensions. The reasons you state are quite valid. I would go one step further and get rid of employer provided health insurance as well. This will allow corporations to focus their energies on things they understand (or should) rather than pension and health benefits. It will also make for a more mobile labor force and allow small businesses to compete more effectively with the behemoths.

    Not sure about the FDIC thing- most folks who keep their money in the bank lack the sophistication to figure which banks are sound and which are not. I think it would make more sense to get rid of the “too big to fail” that way the large depositors -the ones who can influence bank behavior know that they will be on their own.

  3. Brick

    The most scary thing I read from your article was the details from shell. Employees will have to stump up an extra 6 percent of there salaries which means 6 percent less money spent in the economy. If every pension scheme did this we would very quickly be in a technical depression.

    Shell propose to increase their contribution by 23 percent and forget to mention the number of jobs they will need to shed to be able to afford this. The alternatives are that we forget saving and spend all our money like we used to and just rely on the government being well funded enough to provide a social safety net when the time comes.

    I just feel sorry for shell employees in the UK who thanks to the government will soon be paying tax on the 23 percent shell pays into the pension. In total that is probably a 15 percent pay cut for them, which is money which would have gone to help the economy recover.

    As for GM and Chrysler pensions then the problem is that the firms never paid enough into the pension schemes. They had a choice and they chose to keep kicking the can down the road. The end of the road is now here for all these schemes and its going to cost the individual in taxes soon or later or in wages to make up for the lost savings.

  4. Neal

    From March 30, 2009


    WASHINGTON – Just months before the start of last year’s stock market collapse, the federal agency that insures the retirement funds of 44 million Americans departed from its conservative investment strategy and decided to put much of its $64 billion insurance fund into stocks.

    Switching from a heavy reliance on bonds, the Pension Benefit Guaranty Corporation decided to pour billions of dollars into speculative investments such as stocks in emerging foreign markets, real estate, and private equity funds.

    The agency refused to say how much of the new investment strategy has been implemented or how the fund has fared during the downturn. The agency would only say that its fund was down 6.5 percent – and all of its stock-related investments were down 23 percent – as of last Sept. 30, the end of its fiscal year. But that was before most of the recent stock market decline and just before the investment switch was scheduled to begin in earnest.

    No statistics on the fund’s subsequent performance were released.

    (end quote)

    Feel better now?

  5. asphaltjesus

    Will’s comments have some ethical problems.

    First and foremost was the employment deal was made with the employee relying on the pension being funded. The fallout from this is the employee is relying/making plans based on the existence of a pension. Do you see the political/social implications?

    The business consequence of that is that it is completely okay to make contracts then break them later because the other party changed their mind. Do you see how that sets up a very hostile business climate.

    Leo, I really do appreciate your tireless work on the topic but younger workers (Will) have been conditioned to accept theft as entrepreneurial activity and have been convinced that all social programs are bad. (Anita)

    When the truth is closer to neither one being aware of what conditions were like without both things.

  6. Pete

    What is different about the auto pension/healthcare scenario that the airlines besides scale? Hasn’t the path already been paved? Won’t Ford be looking like something between American Airlines and Southwest Air – lonely soldier – better firms get worse treatment? How do shareholder reconcile this scenario, your competitor manages themselves into bankruptcy then returns with lower cost basis to cut your profit margins. I know there are no free markets – but at least – how about efficient markets and some semblance of creative destruction and evolution as opposed to devolution. Thoughts?

  7. Pete

    let me add – can you name anyone that travels today – that can honestly say United Airlines has a better product today? What does that tell you about the likely outcome of bailout of GM. How about you ask the shareholder of American Airlines and Southwest, if their better business planning and execution was rewarded? How would that play our for say, Ford??

  8. Shanky

    WOW – Kamban’s link is a goodie!

    As for the pensions – the destruction of the wealth/income of the baby boomers is possibly the worst thing that could happen. They are supporting so many of the younger generation. Thus, it’s a double whammy.

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