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borrow as much as $65 million from
$314 million of assets in its pension
plans; in return, the company agreed
not to terminate its two pension plans.'
Although the law clearly states that
a corporation rightfully owns the surplus assets of terminated pension plans,
the issue of "who ought to own the surplus assets" is rapidly becoming controversial. Pension holders are increasingly protesting and questioning whether
a corporation has the exclusive right to
tap a pension fund's surplus assets.
Pension holders contend that the surplus pension assets are theirs and are,
in effect, deferred wages.
If we focus on the long-term viability
of defined-benefit pension plans, the
prospects of adequate pension funding
through the next decade depend critically on the long-term financial health
of the sponsoring corporations. Almost
half of both the total number and total
assets of defined-benefit pension plans
are held by plans covering workers in
manufacturing industries." Thus, the
viability of a large percentage of
defined-benefit pension plans during
the next decade is strongly linked to
the long-term outlook of this industry
group in particular. Due to poor performance, however, it is not unreasonable to predict future bankruptcy filings and pension fund problems in the
manufacturing sector."

9. A financially distressed corporation may seek
a funding waiver (subject to IRS approval) to
defer all or part of an annual payment into the
pension fund. The IRS grants a waiver if it
determines an employer cannot meet the minimum funding standards without incurring substantial financial hardship. The PBGC plays no
formal role in the waiver process.

Federal Reserve Bank of Cleveland
Research Department
P.O. Box 6387
Cleveland, OH 44101

Material may be reprinted provided that the
source is credited. Please send copies of reprinted
materials to the editor.

Federal Reserve Bank of Cleveland
Legislative Band-Aid
In 1986, Congress enacted the first
major piece of legislation to shore up
the finances of the single-employer
PBGC fund since passage of ERISA.!O
This legislation, the Single Employer
Pension Plan Amendments Act of 1986
(SEPPAA), contains several provisions
to improve the viability of the singleemployer insurance fund, including: (1)
a tripling of the annual insurance premium; (2) more restrictive termination
rules; and (3) additional liability for
corporations choosing to terminate a
single-employer pension plan.'!
SEPPAA's most sweeping provision
is the $8.50 annual premium per
employee. The PBGC had requested a
premium increase to $7.50 based on a
projected fund deficit in 1985 of less
than $600 million, but that low estimate excluded the unusually large
claims that were later filed by AllisChalmers, Wheeling-Pittsburgh, and
LTV Corporation.
The other SEPPAA provisions make
it more difficult to terminate an underfunded plan and require sponsoring
companies that terminate an underfunded plan to assume more liability to
cover the underfunding. It is unclear at
this time, however, whether SEPPAA
makes any major change in bankruptcy
law or in the liability of zero-net-worth
corporations that terminate their
underfunded pension plans.

10. Congress also enacted the Multi-employer
Pension Plan Amendments Act of 1980 (MPPAA).
MPPAA raised the annual per capita premium
rate from 50 cents to $1.40, imposed increased
funding requirements on employers in multiemployer funds, and made employers (subject to
certain relief provisions) liable for unfunded
benefits when a company withdraws from a
multi-employer fund.

Concluding Remarks
The PBGC clearly is in a dangerous
financial condition. It is currently
insolvent and may be unable to pay its
legally required pension claims in as
little as 10 years. Its current difficulties
are primarily the result of a poorly
designed pension insurance system and
are not the consequence of an underfunded private pension system.
To survive, however, it is clear that
the PBGC must be recapitalized. The
Reagan administration and Congress
are well aware that sweeping changes
are necessary in our private pension
insurance system. The recapitalization
of the PBGC fund could conceivably
utilize many elements, including
enlarging the agency's credit line with
the Treasury; setting more stringent
standards for minimum funding and
higher maximums on yearly funding;
establishing risk-adjusted insurance
premiums; reducing PBGC's guarantee;
allowing private insurers to insure
more pension dollars; setting stiffer
waiver standards; or, mounting a bailout using taxpayer's money.
How long before the PBGC runs out
of cash? The exact timing will depend
on future plan terminations, on interest
rates, and on related factors. The result
ultimately will depend on the political
process. If Congress waits too long
before providing a solution, however, it
could find itself faced with some very
unpleasant and very expensive choices.
11. See "New Act Muddies Single- Employer Pension Water," Legal Times, Washington, D.C.,
June 16, 1986, pp. 15-17.

BULK RATE
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Cleveland,OH
Permit No.,385

Address Correction Requested:
Please send
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January 15, 1987
ISSN 0428~1276

ECONOMIC
COMMENTARY
Forty million Americans-about
onethird of the work force-have private,
employer-sponsored pensions that are
insured by the Pension Benefit Guaranty Corporation (PBGC).
The PBGC is a federally chartered
agency that is required by law to pay
guaranteed retirement benefits to
insured workers who would normally
lose their pensions as a result of the
failure or inability of an employer to
meet its pension-fund obligations.
As of 1985, the PBGC's safety net
protected private pension assets reaching $1.3 trillion. Recent developments,
however, centering on corporate bankruptcy actions, have raised storm
clouds over the PBGC, resulting in
questions about its ability to continue
to meet its pension-fund obligations.
In this Economic Commentary, we
examine the present and prospective
financial condition of the PBGC fund.
The fund is on thin ice. As of the end of
1986, the PBGC's accumulated deficit,
plus impending terminations, approached $4 billion.
The critical public policy issue
resulting from the fund's worsening
financial condition centers on how
Congress will choose to fix the problem. For example, will the ultimate
burden to make pension payments for
defunct plans be shifted from private
companies to the taxpayer? Will the
PBGC system continue to be selffunded by increasing the pension-fund
premium paid by participating employers? Or will new legislation reform the
entire pension-insurance process?
Thomas M. Buynak is an economist at the Federal
Reserve Bank of Cleveland. The author would like
to thank Mark Sniderman, Walker Todd, John B.
Carlson, and James B, Thomson for helpful
comments,
The views stated herein are those of the author
and not necessarily those of the Federal Reserve
Bank of Cleveland or of the Board of Governors of
the Federal Reserve System.

Providing a Safety Net
The PBGC was established in 1974
under the Employee Retirement Income
Security Act (ERISA) to guarantee the
benefits of employees who participate
in certain types of pension plans.
The idea was to design a governmentsponsored insurance system in which
employees of defined-benefit plans
would be assured that they would receive their promised benefits. A definedbenefit plan requires a corporation to
contribute to a pension fund on the
basis of the benefits that eventually are
scheduled to be paid to pension holders.' Almost three-fourths of private
pension assets today are held by
defined-benefit plans.
ERISA establishes, among other
things, minimum funding and fiduciary
standards for defined-benefit pension
plans. These plans must operate on a
"funded" basis, which means that a
corporation must fund its defined
benefit plan at the same time that it
promises the benefits.
Under PBGC rules, if a firm terminates a defined-benefit pension plan
that has insufficient assets, the agency
becomes the trustee of the plan, assuming its assets and liabilities.
Under ERISA, the PBGC must insure
all defined-benefit pension plans,
regardless of how poorly they are
funded or how weak the financial condition of the pension plan sponsor
might be. The PBGC levies a flat-rate
premium per participant and cannot

Is the U.S.
Pension-Insurance
System Going
Broke?
by Thomas M. Buynak

charge higher premiums for underfunded plans. Congressional approval is
required to raise PBGC's premium.
The agency's one-premium pricing
mechanism, coupled with the legal proviso that it must insure all definedbenefit plans, is one reason why it
differs from other types of private insurance companies.
Although the PBGC is a wholly
owned, independent government agency,
it also differs in important ways from
other federal regulatory agencies, like
the Federal Deposit Insurance Corporation (FDIC). The FDIC, for example,
has the power to regulate FDIC-insured
banks. The PBGC, in contrast, has no
regulatory powers; it passively insures
all defined-benefit plans.
The current maximum level for individual PBGC-guaranteed payments is
$1,857.95 per month. The PBGC guarantee, which was originally set at $750
in 1974, is adjusted each year in accordance with increases in the Social Security wage base. The guaranteed ceiling affects very few participants, however. In
fact, the average monthly benefit check
issued by the PBGC today is less than
$250. The guarantee covers only "basic"
benefits that, by PBGC regulation, include vested retirement benefits, plus
any cost-of-living adjustments, and any
death, survivor, or disability benefits if
a participant is on payroll status on the
date of the plan termination. Although
authorized to insure non basic benefits,
such as special supplementary benefits
that are offered to encourage early retirement, the agency has opted not to do so.
1. For a thorough discussion of the basics of pension plans, see James F, Siekmeier, "Can We
Count on Private Pensions?," Economic Commentary, Federal Reserve Bank of Cleveland, February 15, 1986.

Chart IB PBGC's
Financial Operations,
Multi-Employer Fund

Chart lA PBGC's
Financial Operations,
Single-Employer Fund
$ millions
1,200 ------------,

$ millions
30~----------~

1,000

25

800

20

600

15

Expenses

400

10

200

Expenses

5

1975

1977

1979 1981
Fiscal year

1983

1985

1977

1979

1981
1983
Fiscal Year

1985

SOURCE: 1975-1985 PBGC Annual Reports.

The PBGC is self-financed; it does not
receive any regular government funding. The pension-guarantee fund is
financed from several sources: (1) from
annual premiums per participant from
insured pension plans; (2) from assets
acquired from terminated plans; (3)
from investment income, including
appreciation of investment assets; and
(4) from employer-liability payments.
The flat-rate premium charged by the
PBGC is its primary source of revenue.
Under the employer-liability provisions of ERISA and recent legislation,
the PBGC has a legal claim of 100 percent of its insurance loss, up to 30 percent of the sponsor's net worth and its
controlled group. The PBGC also can
claim the difference between 75 percent
of the insurance loss and the recoverable proceeds under its first claim.
To illustrate: assume that company
A, which has net worth of $500 million,
terminates a PBGC-insured pension
plan that is underfunded by $1 billion.
The PGBC has a claim against 30 percent of the $500 million net worth, or
$150 million. The PBGC also has a
claim of 75 percent of $1 billion minus
the recovered proceeds of $150 million,
or $600 million.

2. See Walker Todd, "Aggressive Uses of Chapter 11 of the Federal Bankruptcy Code," Economic Review, 1986 Quarter 3, Federal Reserve
Bank of Cleveland, pp. 20-26.

In our example, the PBGC thus has
total legal claims of $750 million
against the underfunding of $1 billion.
The agency's first claim has priority
status in bankruptcy, and thus may
have some value if the reorganization
value is considered as net worth of the
bankrupt company. The PBGC's
second claim has lower status in bankruptcy than its net-worth claim, and is
subject to various limitations that
further reduce its value.
Finally, PBGC's assets include a $100million line of credit with the U.S. Treasury, which is small compared to the
FDIC's $3 billion credit line. Moreover,
unlike the FDIC, the PBGC does not
have the full faith and credit of the federal government behind its obligations.
PBGC's Financial Condition: Pre-LTV
Since its beginning in 1974, the PBGC
has had negative net worth; its actuarialliabilities exceed its assets. This
accumulating deficit was largely inconsequential until 1982, when it began to
escalate, except for brief pauses in fiscal year (FY) 1980 and FY1984, when
PBGC posted positive net operating

3. LTV was precluded under the terms of its collective bargaining agreements from initiating the
termination of the two plans covering hourly
workers. Thus, the PBGC legally had to seek a
court ruling to terminate LTV's hourly plans. See
Cathy Trost and Cynthia F. Mitchell, "U.S. Pension Unit Set to Take Over Three LTV Plans,"
Wall Street Journal, January 13, 1987, p. 20.

results-which
slightly reduced its
deficit. Despite having negative net
worth since its inception, however, the
PBGC generally has had a positive cash
flow; current income has been sufficient to meet current expenses.
Most of the agency's cumulative deficit is attributed to rising liabilities incurred in its single-employer fund,
which represents 95 percent of its total
assets (see chart 1A). In contrast,
PBGC's multi-employer fund, which insures private pension plans covering
employees of more than one employer,
usually has reported surpluses, which
have mitigated what otherwise would
have been an even larger deficit (see
chart 1B).
In 1985, PBGC's cumulative deficit
nearly tripled. According to its 1985
financial statements (the latest available), the corporation had total assets of
$1.44 billion and had $2.74 billion in
total liabilities, leaving it with an accumulated deficit of approximately $1.3
billion as of the September end of its
fiscal year. This unprecedented escalation of accumulated deficit is attributed
primarily to very large claims by two
companies: the Allis-Chalmers Corporation and the Wheeling-Pittsburgh Corporation, which together saddled the
PBGC with claims of approximately
$600 million. Although the agency's
negative net worth soared in 1985, it
still had a positive cash flow.
The decision of Allis-Chalmers Corporation to terminate 11 of its pension
plans in a non-bankruptcy action, the
bankruptcy of Wheeling-Pittsburgh
Corporation, and the recent bankruptcy
petition by LTV Corporation could be
justified on the basis that those companies had no other financial choice.
However, it is equally plausible for
companies such as LTV and WheelingPittsburgh to choose bankruptcy because a court may permit a restructuring of collective bargaining agreements
and a reduction of long-term pension
and insurance liabilities.! To the
extent that the courts confirm reorganization plans based on limiting longterm exposures to such outlays, bankruptcy will be an attractive alternative
for debt-burdened corporations and a
threat to the PBGC.
The PBGC realized that it was
exposed to substantial risk of future
insolvency much earlier than 1985. As
early as 1982, it began to ask Congress
for a premium increase for its single-

employer fund. Congress last granted a
premium increase for the singleemployer fund, from $1.00 to $2.60, in
1978_The PBGC's repeated requests
for a premium increase since then were
fruitless until April 1986, when Congress finally raised the premium to
$8.50. The $8.50 premium was enacted
without consideration of the LTV
situation, which developed in July 1986.

Chart 2

The PBGC's Potential
Future Liabilities
Alicia H. Munnell investigated the prospective financial condition of the
PBGC in 1982, and she observed that
the business of guaranteeing private
pension plans was potentially quite
expensive." Munnell's investigation
found that the PBGC was financially
vulnerable in 1982 to the termination of

4. See Laurent Belsie, "U.S. pension-insurance
agency awash in steel-industry red ink," The
Christian Science Monitor, December 15,1986, p. 3.

Deficit

I------------------:==~-,

$ millions
4,000
3,000
2,000

LTV Spins Off Unfunded Pension
Liabilities Onto the PBGC
LTV Corporation's pension plans are
underfunded by $2.3 billion. Its hourly
pension plans are more severely underfunded than its salaried plans (see chart
2). In September 1986, the Dallas-based
corporation transferred one of its two
salaried plans to the PBGC and, on Ianuary 13, 1987, a federal court allowed the
agency to terminate LTV's three other
pension plans.' Assumption of the four
LTV plans will triple the agency's
already burgeoning cumulative deficit.
While it is clear that the agency is
already insolvent, the assumption of
LTV's unfunded liabilities is pushing
the cash outflows of the PBGC above
its cash inflows.' As a consequence,
the agency is now forced to reduce its
reserves by selling investment assets so
that it can pay its legally mandated
claims. This is a no-other-choice, shortrun solution that undermines the
PBGC's long-term viability because, in
effect, it forces the agency to accelerate
recognition of future earnings in order
to strengthen current earnings. The
process of selling assets eventually will
exhaust the PBGC's reserves.

PBGC's Accumulated

D
D

Unfunded terminational liability of LTV's salaried pension plans
Unfunded termination liability of LTV's hourly
pension plans

Actual accumulated deficit

1,000

1980

1981

1982
1983
Fiscal year

SOURCE: 1980-1985 PBGC Annual Reports.

1984

1985

Combined Employer Fund.

major pension plans, despite the apparent financial soundness of the overall
pension system.
Munnell's study revealed that the
majority of terminated plans with
insufficient assets were terminated
because of adverse business conditions,
such as poor economic conditions, business liquidations, or plant closings.
Almost three-fourths of the plans with
insufficient assets were terminated as
a result of bankruptcy-an
unpredictable event. Although most plan terminations were relatively small, she found
that the worst underfunded plans are
typically the larger plans. Thus, it is
not surprising that the PBGC today is
facing insolvency and liquidity problems in the wake of the pension-plan
terminations of Allis-Chalmers, and the
bankruptcy of Wheeling-Pittsburgh and
of LTV, all of which Munnell identified
in 1982 as companies with a high likelihood of pension-plan termination.
A second, but minor, phenomenon affecting the solvency of the PBGC is the
growing number of corporations that are
voluntarily terminating their overfunded
plans. When a pension fund is over-

funded, a corporation's management has
an incentive to voluntarily terminate a
defined-benefit plan and to strip the
corporation's fund of surplus assets, a
procedure called a reversion. 6 In a reversion, the pension-sponsoring corporation claims the surplus pension assets.
According to PBGC data, pension
plan reversions have removed approximately $11 billion in excess assets
from the private pension system since
1980. Pension-asset reversions have not
yet contributed to any significant
degree to the PBGC's financial plight.
However, if the recapitalization of the
PBGC fund imposes a disproportionate
burden on overfunded pension plans,
then pension-asset reversions might
rise rapidly. This, in turn, would
aggravate PBGC's financial troubles.
The Tax Reform Act of 1986 will
partially undercut the incentive to terminate overfunded pension plans because it requires corporations to pay an
additional tax of 10 percent on asset reversions. However, there are other ways
in which corporations can obtain access
to surplus pension assets without terminating their pension funds. For example, Cleveland-based Sherwin-Williams
Company recently received approval
from the U.S. Department of Labor to

5. See Alicia H. Munnell, "Guaranteeing Private
Pension Benefits: A Potentially Expensive Business," New England Economic Review, Federal Reserve Bank of Boston, March/April1982, pp. 33-44.

7. See "Pension loan cleared for SherwinWilliams," Crain's Cleveland Business, November
3-9, 1986, page 1.

6. See Arturo Estrella, "Corporate Use of Pension
Overfunding," Quarterly Review, Federal Reserve
Bank of New York, Spring 1984, pp. 17-25.

8. See The Handbook of Pension Statistics 1985,
Commerce Clearinghouse, Inc., Chicago, Illinois,
pp.28-29.

Chart IB PBGC's
Financial Operations,
Multi-Employer Fund

Chart lA PBGC's
Financial Operations,
Single-Employer Fund
$ millions
1,200 ------------,

$ millions
30~----------~

1,000

25

800

20

600

15

Expenses

400

10

200

Expenses

5

1975

1977

1979 1981
Fiscal year

1983

1985

1977

1979

1981
1983
Fiscal Year

1985

SOURCE: 1975-1985 PBGC Annual Reports.

The PBGC is self-financed; it does not
receive any regular government funding. The pension-guarantee fund is
financed from several sources: (1) from
annual premiums per participant from
insured pension plans; (2) from assets
acquired from terminated plans; (3)
from investment income, including
appreciation of investment assets; and
(4) from employer-liability payments.
The flat-rate premium charged by the
PBGC is its primary source of revenue.
Under the employer-liability provisions of ERISA and recent legislation,
the PBGC has a legal claim of 100 percent of its insurance loss, up to 30 percent of the sponsor's net worth and its
controlled group. The PBGC also can
claim the difference between 75 percent
of the insurance loss and the recoverable proceeds under its first claim.
To illustrate: assume that company
A, which has net worth of $500 million,
terminates a PBGC-insured pension
plan that is underfunded by $1 billion.
The PGBC has a claim against 30 percent of the $500 million net worth, or
$150 million. The PBGC also has a
claim of 75 percent of $1 billion minus
the recovered proceeds of $150 million,
or $600 million.

2. See Walker Todd, "Aggressive Uses of Chapter 11 of the Federal Bankruptcy Code," Economic Review, 1986 Quarter 3, Federal Reserve
Bank of Cleveland, pp. 20-26.

In our example, the PBGC thus has
total legal claims of $750 million
against the underfunding of $1 billion.
The agency's first claim has priority
status in bankruptcy, and thus may
have some value if the reorganization
value is considered as net worth of the
bankrupt company. The PBGC's
second claim has lower status in bankruptcy than its net-worth claim, and is
subject to various limitations that
further reduce its value.
Finally, PBGC's assets include a $100million line of credit with the U.S. Treasury, which is small compared to the
FDIC's $3 billion credit line. Moreover,
unlike the FDIC, the PBGC does not
have the full faith and credit of the federal government behind its obligations.
PBGC's Financial Condition: Pre-LTV
Since its beginning in 1974, the PBGC
has had negative net worth; its actuarialliabilities exceed its assets. This
accumulating deficit was largely inconsequential until 1982, when it began to
escalate, except for brief pauses in fiscal year (FY) 1980 and FY1984, when
PBGC posted positive net operating

3. LTV was precluded under the terms of its collective bargaining agreements from initiating the
termination of the two plans covering hourly
workers. Thus, the PBGC legally had to seek a
court ruling to terminate LTV's hourly plans. See
Cathy Trost and Cynthia F. Mitchell, "U.S. Pension Unit Set to Take Over Three LTV Plans,"
Wall Street Journal, January 13, 1987, p. 20.

results-which
slightly reduced its
deficit. Despite having negative net
worth since its inception, however, the
PBGC generally has had a positive cash
flow; current income has been sufficient to meet current expenses.
Most of the agency's cumulative deficit is attributed to rising liabilities incurred in its single-employer fund,
which represents 95 percent of its total
assets (see chart 1A). In contrast,
PBGC's multi-employer fund, which insures private pension plans covering
employees of more than one employer,
usually has reported surpluses, which
have mitigated what otherwise would
have been an even larger deficit (see
chart 1B).
In 1985, PBGC's cumulative deficit
nearly tripled. According to its 1985
financial statements (the latest available), the corporation had total assets of
$1.44 billion and had $2.74 billion in
total liabilities, leaving it with an accumulated deficit of approximately $1.3
billion as of the September end of its
fiscal year. This unprecedented escalation of accumulated deficit is attributed
primarily to very large claims by two
companies: the Allis-Chalmers Corporation and the Wheeling-Pittsburgh Corporation, which together saddled the
PBGC with claims of approximately
$600 million. Although the agency's
negative net worth soared in 1985, it
still had a positive cash flow.
The decision of Allis-Chalmers Corporation to terminate 11 of its pension
plans in a non-bankruptcy action, the
bankruptcy of Wheeling-Pittsburgh
Corporation, and the recent bankruptcy
petition by LTV Corporation could be
justified on the basis that those companies had no other financial choice.
However, it is equally plausible for
companies such as LTV and WheelingPittsburgh to choose bankruptcy because a court may permit a restructuring of collective bargaining agreements
and a reduction of long-term pension
and insurance liabilities.! To the
extent that the courts confirm reorganization plans based on limiting longterm exposures to such outlays, bankruptcy will be an attractive alternative
for debt-burdened corporations and a
threat to the PBGC.
The PBGC realized that it was
exposed to substantial risk of future
insolvency much earlier than 1985. As
early as 1982, it began to ask Congress
for a premium increase for its single-

employer fund. Congress last granted a
premium increase for the singleemployer fund, from $1.00 to $2.60, in
1978_The PBGC's repeated requests
for a premium increase since then were
fruitless until April 1986, when Congress finally raised the premium to
$8.50. The $8.50 premium was enacted
without consideration of the LTV
situation, which developed in July 1986.

Chart 2

The PBGC's Potential
Future Liabilities
Alicia H. Munnell investigated the prospective financial condition of the
PBGC in 1982, and she observed that
the business of guaranteeing private
pension plans was potentially quite
expensive." Munnell's investigation
found that the PBGC was financially
vulnerable in 1982 to the termination of

4. See Laurent Belsie, "U.S. pension-insurance
agency awash in steel-industry red ink," The
Christian Science Monitor, December 15,1986, p. 3.

Deficit

I------------------:==~-,

$ millions
4,000
3,000
2,000

LTV Spins Off Unfunded Pension
Liabilities Onto the PBGC
LTV Corporation's pension plans are
underfunded by $2.3 billion. Its hourly
pension plans are more severely underfunded than its salaried plans (see chart
2). In September 1986, the Dallas-based
corporation transferred one of its two
salaried plans to the PBGC and, on Ianuary 13, 1987, a federal court allowed the
agency to terminate LTV's three other
pension plans.' Assumption of the four
LTV plans will triple the agency's
already burgeoning cumulative deficit.
While it is clear that the agency is
already insolvent, the assumption of
LTV's unfunded liabilities is pushing
the cash outflows of the PBGC above
its cash inflows.' As a consequence,
the agency is now forced to reduce its
reserves by selling investment assets so
that it can pay its legally mandated
claims. This is a no-other-choice, shortrun solution that undermines the
PBGC's long-term viability because, in
effect, it forces the agency to accelerate
recognition of future earnings in order
to strengthen current earnings. The
process of selling assets eventually will
exhaust the PBGC's reserves.

PBGC's Accumulated

D
D

Unfunded terminational liability of LTV's salaried pension plans
Unfunded termination liability of LTV's hourly
pension plans

Actual accumulated deficit

1,000

1980

1981

1982
1983
Fiscal year

SOURCE: 1980-1985 PBGC Annual Reports.

1984

1985

Combined Employer Fund.

major pension plans, despite the apparent financial soundness of the overall
pension system.
Munnell's study revealed that the
majority of terminated plans with
insufficient assets were terminated
because of adverse business conditions,
such as poor economic conditions, business liquidations, or plant closings.
Almost three-fourths of the plans with
insufficient assets were terminated as
a result of bankruptcy-an
unpredictable event. Although most plan terminations were relatively small, she found
that the worst underfunded plans are
typically the larger plans. Thus, it is
not surprising that the PBGC today is
facing insolvency and liquidity problems in the wake of the pension-plan
terminations of Allis-Chalmers, and the
bankruptcy of Wheeling-Pittsburgh and
of LTV, all of which Munnell identified
in 1982 as companies with a high likelihood of pension-plan termination.
A second, but minor, phenomenon affecting the solvency of the PBGC is the
growing number of corporations that are
voluntarily terminating their overfunded
plans. When a pension fund is over-

funded, a corporation's management has
an incentive to voluntarily terminate a
defined-benefit plan and to strip the
corporation's fund of surplus assets, a
procedure called a reversion. 6 In a reversion, the pension-sponsoring corporation claims the surplus pension assets.
According to PBGC data, pension
plan reversions have removed approximately $11 billion in excess assets
from the private pension system since
1980. Pension-asset reversions have not
yet contributed to any significant
degree to the PBGC's financial plight.
However, if the recapitalization of the
PBGC fund imposes a disproportionate
burden on overfunded pension plans,
then pension-asset reversions might
rise rapidly. This, in turn, would
aggravate PBGC's financial troubles.
The Tax Reform Act of 1986 will
partially undercut the incentive to terminate overfunded pension plans because it requires corporations to pay an
additional tax of 10 percent on asset reversions. However, there are other ways
in which corporations can obtain access
to surplus pension assets without terminating their pension funds. For example, Cleveland-based Sherwin-Williams
Company recently received approval
from the U.S. Department of Labor to

5. See Alicia H. Munnell, "Guaranteeing Private
Pension Benefits: A Potentially Expensive Business," New England Economic Review, Federal Reserve Bank of Boston, March/April1982, pp. 33-44.

7. See "Pension loan cleared for SherwinWilliams," Crain's Cleveland Business, November
3-9, 1986, page 1.

6. See Arturo Estrella, "Corporate Use of Pension
Overfunding," Quarterly Review, Federal Reserve
Bank of New York, Spring 1984, pp. 17-25.

8. See The Handbook of Pension Statistics 1985,
Commerce Clearinghouse, Inc., Chicago, Illinois,
pp.28-29.

borrow as much as $65 million from
$314 million of assets in its pension
plans; in return, the company agreed
not to terminate its two pension plans.'
Although the law clearly states that
a corporation rightfully owns the surplus assets of terminated pension plans,
the issue of "who ought to own the surplus assets" is rapidly becoming controversial. Pension holders are increasingly protesting and questioning whether
a corporation has the exclusive right to
tap a pension fund's surplus assets.
Pension holders contend that the surplus pension assets are theirs and are,
in effect, deferred wages.
If we focus on the long-term viability
of defined-benefit pension plans, the
prospects of adequate pension funding
through the next decade depend critically on the long-term financial health
of the sponsoring corporations. Almost
half of both the total number and total
assets of defined-benefit pension plans
are held by plans covering workers in
manufacturing industries." Thus, the
viability of a large percentage of
defined-benefit pension plans during
the next decade is strongly linked to
the long-term outlook of this industry
group in particular. Due to poor performance, however, it is not unreasonable to predict future bankruptcy filings and pension fund problems in the
manufacturing sector."

9. A financially distressed corporation may seek
a funding waiver (subject to IRS approval) to
defer all or part of an annual payment into the
pension fund. The IRS grants a waiver if it
determines an employer cannot meet the minimum funding standards without incurring substantial financial hardship. The PBGC plays no
formal role in the waiver process.

Federal Reserve Bank of Cleveland
Research Department
P.O. Box 6387
Cleveland, OH 44101

Material may be reprinted provided that the
source is credited. Please send copies of reprinted
materials to the editor.

Federal Reserve Bank of Cleveland
Legislative Band-Aid
In 1986, Congress enacted the first
major piece of legislation to shore up
the finances of the single-employer
PBGC fund since passage of ERISA.!O
This legislation, the Single Employer
Pension Plan Amendments Act of 1986
(SEPPAA), contains several provisions
to improve the viability of the singleemployer insurance fund, including: (1)
a tripling of the annual insurance premium; (2) more restrictive termination
rules; and (3) additional liability for
corporations choosing to terminate a
single-employer pension plan.'!
SEPPAA's most sweeping provision
is the $8.50 annual premium per
employee. The PBGC had requested a
premium increase to $7.50 based on a
projected fund deficit in 1985 of less
than $600 million, but that low estimate excluded the unusually large
claims that were later filed by AllisChalmers, Wheeling-Pittsburgh, and
LTV Corporation.
The other SEPPAA provisions make
it more difficult to terminate an underfunded plan and require sponsoring
companies that terminate an underfunded plan to assume more liability to
cover the underfunding. It is unclear at
this time, however, whether SEPPAA
makes any major change in bankruptcy
law or in the liability of zero-net-worth
corporations that terminate their
underfunded pension plans.

10. Congress also enacted the Multi-employer
Pension Plan Amendments Act of 1980 (MPPAA).
MPPAA raised the annual per capita premium
rate from 50 cents to $1.40, imposed increased
funding requirements on employers in multiemployer funds, and made employers (subject to
certain relief provisions) liable for unfunded
benefits when a company withdraws from a
multi-employer fund.

Concluding Remarks
The PBGC clearly is in a dangerous
financial condition. It is currently
insolvent and may be unable to pay its
legally required pension claims in as
little as 10 years. Its current difficulties
are primarily the result of a poorly
designed pension insurance system and
are not the consequence of an underfunded private pension system.
To survive, however, it is clear that
the PBGC must be recapitalized. The
Reagan administration and Congress
are well aware that sweeping changes
are necessary in our private pension
insurance system. The recapitalization
of the PBGC fund could conceivably
utilize many elements, including
enlarging the agency's credit line with
the Treasury; setting more stringent
standards for minimum funding and
higher maximums on yearly funding;
establishing risk-adjusted insurance
premiums; reducing PBGC's guarantee;
allowing private insurers to insure
more pension dollars; setting stiffer
waiver standards; or, mounting a bailout using taxpayer's money.
How long before the PBGC runs out
of cash? The exact timing will depend
on future plan terminations, on interest
rates, and on related factors. The result
ultimately will depend on the political
process. If Congress waits too long
before providing a solution, however, it
could find itself faced with some very
unpleasant and very expensive choices.
11. See "New Act Muddies Single- Employer Pension Water," Legal Times, Washington, D.C.,
June 16, 1986, pp. 15-17.

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January 15, 1987
ISSN 0428~1276

ECONOMIC
COMMENTARY
Forty million Americans-about
onethird of the work force-have private,
employer-sponsored pensions that are
insured by the Pension Benefit Guaranty Corporation (PBGC).
The PBGC is a federally chartered
agency that is required by law to pay
guaranteed retirement benefits to
insured workers who would normally
lose their pensions as a result of the
failure or inability of an employer to
meet its pension-fund obligations.
As of 1985, the PBGC's safety net
protected private pension assets reaching $1.3 trillion. Recent developments,
however, centering on corporate bankruptcy actions, have raised storm
clouds over the PBGC, resulting in
questions about its ability to continue
to meet its pension-fund obligations.
In this Economic Commentary, we
examine the present and prospective
financial condition of the PBGC fund.
The fund is on thin ice. As of the end of
1986, the PBGC's accumulated deficit,
plus impending terminations, approached $4 billion.
The critical public policy issue
resulting from the fund's worsening
financial condition centers on how
Congress will choose to fix the problem. For example, will the ultimate
burden to make pension payments for
defunct plans be shifted from private
companies to the taxpayer? Will the
PBGC system continue to be selffunded by increasing the pension-fund
premium paid by participating employers? Or will new legislation reform the
entire pension-insurance process?
Thomas M. Buynak is an economist at the Federal
Reserve Bank of Cleveland. The author would like
to thank Mark Sniderman, Walker Todd, John B.
Carlson, and James B, Thomson for helpful
comments,
The views stated herein are those of the author
and not necessarily those of the Federal Reserve
Bank of Cleveland or of the Board of Governors of
the Federal Reserve System.

Providing a Safety Net
The PBGC was established in 1974
under the Employee Retirement Income
Security Act (ERISA) to guarantee the
benefits of employees who participate
in certain types of pension plans.
The idea was to design a governmentsponsored insurance system in which
employees of defined-benefit plans
would be assured that they would receive their promised benefits. A definedbenefit plan requires a corporation to
contribute to a pension fund on the
basis of the benefits that eventually are
scheduled to be paid to pension holders.' Almost three-fourths of private
pension assets today are held by
defined-benefit plans.
ERISA establishes, among other
things, minimum funding and fiduciary
standards for defined-benefit pension
plans. These plans must operate on a
"funded" basis, which means that a
corporation must fund its defined
benefit plan at the same time that it
promises the benefits.
Under PBGC rules, if a firm terminates a defined-benefit pension plan
that has insufficient assets, the agency
becomes the trustee of the plan, assuming its assets and liabilities.
Under ERISA, the PBGC must insure
all defined-benefit pension plans,
regardless of how poorly they are
funded or how weak the financial condition of the pension plan sponsor
might be. The PBGC levies a flat-rate
premium per participant and cannot

Is the U.S.
Pension-Insurance
System Going
Broke?
by Thomas M. Buynak

charge higher premiums for underfunded plans. Congressional approval is
required to raise PBGC's premium.
The agency's one-premium pricing
mechanism, coupled with the legal proviso that it must insure all definedbenefit plans, is one reason why it
differs from other types of private insurance companies.
Although the PBGC is a wholly
owned, independent government agency,
it also differs in important ways from
other federal regulatory agencies, like
the Federal Deposit Insurance Corporation (FDIC). The FDIC, for example,
has the power to regulate FDIC-insured
banks. The PBGC, in contrast, has no
regulatory powers; it passively insures
all defined-benefit plans.
The current maximum level for individual PBGC-guaranteed payments is
$1,857.95 per month. The PBGC guarantee, which was originally set at $750
in 1974, is adjusted each year in accordance with increases in the Social Security wage base. The guaranteed ceiling affects very few participants, however. In
fact, the average monthly benefit check
issued by the PBGC today is less than
$250. The guarantee covers only "basic"
benefits that, by PBGC regulation, include vested retirement benefits, plus
any cost-of-living adjustments, and any
death, survivor, or disability benefits if
a participant is on payroll status on the
date of the plan termination. Although
authorized to insure non basic benefits,
such as special supplementary benefits
that are offered to encourage early retirement, the agency has opted not to do so.
1. For a thorough discussion of the basics of pension plans, see James F, Siekmeier, "Can We
Count on Private Pensions?," Economic Commentary, Federal Reserve Bank of Cleveland, February 15, 1986.