'Multiemployer' Pension Hole Keeps Getting Deeper
The first rule of holes, say the people who set such rules, is to stop digging. But when it comes to so-called “multiemployer pensions,” which face $600 billion in funding shortfalls, 168 bipartisan members of Congress have shovel in hand, ready to gamble tens of billions of taxpayer money to keep these plans afloat. Multiemployer pensions need help, but first they need a hard look at how they got where they are.
Most pensions are “single-employer” plans, meaning that a single company sponsors a pension for its own employees. By contrast, a multiemployer pension is a joint enterprise between a labor union and multiple employers within the same industry. For instance, the Central States Plan covers 400,000 workers and retirees from 1,400 different employers in the trucking industry and is jointly administered by those employers and the Teamsters union.
Some large but deeply underfunded plans like Central States could run out of money within a decade. The Pension Benefit Guaranty Corporation would protect retirees’ benefits only up to $12,870 per year. Worse, the PBGC is itself underfunded, such that even a single large insolvency could bankrupt the agency. In response, Congress has set up a Joint Select Committee tasked with crafting a solution by November 30.
How did things get so bad? The story usually involves so-called “orphaned liabilities.” These are benefits owed to participants whose employers either went bankrupt or withdrew from the plan. Multiemployer pensions require that remaining employers take responsibility for these orphaned liabilities, a requirement that has overwhelmed the plans. In this view, the insolvency of multiemployer pensions is something the pension administrators could neither have foreseen nor prevented.
But the true story is that, due to lax federal funding rules, multiemployer pensions never fully funded their benefits in the first place. Instead, multiemployer pensions operated under funding rules that allowed plans to credit themselves with risky investment returns before those returns materialized. Multiemployer plans set their contribution rates on the assumption that plan investments would earn roughly 7.5 percent annual returns, forever. That kept contributions low, but it also meant that if one participating employer went bankrupt or withdrew, the remaining employers were on the hook for guaranteeing 7.5 percent investments returns on the plan’s assets in all future years. No Wall Street firm would provide that kind of guarantee absent a hefty fee. As it happens, from 1996 through 2016 multiemployer pensions received investment returns roughly one percentage point below their assumed rates, according to Stanford economist Joshua Rauh. The results have been disastrous.
Make no mistake: These were the funding rules that multiemployer pensions lobbied Congress for and want maintained in the future. But they are rules that, with the exception of U.S. state and local government employee pensions — themselves underfunded by multiple trillions of dollar — are very uncommon in the pension world. Almost all other pensions must fund themselves using conservative assumptions of investment returns. Single-employer pensions in the U.S., for example, assume a corporate bond yield of about 4.0 percent.
In addition, in most other contexts pensions are required to address any unfunded liabilities quickly. Single-employer plans must generally move back to full funding in seven years, while multiemployer plans are allowed 30 years to pay off any unfunded liabilities. Stricter pension funding requirements mean higher upfront contributions. Unions didn’t want this, since the money might come out of employees’ pay raises, and employers themselves wanted to keep contributions low. But true full funding comes with an important advantage: Employees’ benefits are safe even if the sponsoring employer goes bankrupt.
The Butch Lewis Act, the proposed legislation to rescue multiemployer plans, adopts what state and local government call a “pension obligation bond.” The pension sponsor borrows at a low rate, then invests in risky assets in hopes of receiving higher returns. Chicago is currently considering a $10 billion bond offering, which has been greeted with a mixture of derision and alarm. The Butch Lewis Act would go further: Since no private entity would lend to underfunded multiemployer plans, the federal government does the lending. If the plans can’t repay, the federal government eats the loss. The Butch Lewis Act’s sponsors the are touting an unreleased Congressional Budget Office estimate that the Act would cost “only” $34billion over the first decade.
The retirees threatened by multiemployer pension insolvency are themselves blameless. They’re also members of a powerful Democratic Party constituency primarily located in Midwest swing states. Add it all together and a bailout may be inevitable. But that bailout should at least nod in the direction of good public policy. While other reforms to the PBGC are needed, I have four ideas with regard to how multiemployer pensions requesting federal assistance should be treated.
First, any multiemployer plan seeking federal help should be taken over by the PBGC. The managers and trustees of these plans — some of whom are highly-paid — were tasked with looking out for pension participants and could have done more to address underfunding. It should be clear to everyone — pension participants, employers, unions, and Congress — that this is a pension disaster, not business as usual. Putting failing plans in receivership helps convey that message.
Second, multiemployer plans should no longer be exempted from the more stringent funding standards required for single-employer plans, which include lower discount rates and less tolerance for long-term unfunded liabilities. It is clear that the original justification for looser funding standards — that multiple employers banding together could effectively self-insure pension liabilities — was mistaken. If plans cannot survive on those terms, they should be frozen before inflicting greater losses on retirees and taxpayers.
Third, any multiemployer plan seeking federal assistance should immediately freeze the accrual of new benefits and switch employees to 401(k)s to which both employees and employers contribute. That’s standard practice when a single-employer pension turns to the PBGC for help. According to PGBG data, the Central States plan continues to promise new benefits equal to 20 percent of workers’ wages, over six times more generous than the typical employer contribution to 401(k)s. Currently, nearly two-thirds of contributions made by deeply underfunded multiemployer plans simply cover newly earned benefits, which is crazy for plans on the brink of insolvency.
Freezing accruals would free up money to pay current benefits. The Butch Lewis Act allows insolvent multiemployer pensions to continue promising those generous new benefits, even as plans rely on federal aid to pay benefits to current retirees. Since employees do not themselves contribute to multiemployer plans, there is no reason even from a cash-flow basis to continue promising new benefits.
Fourth, after these preceding steps, retirees should have their benefits protected, but not without limit. Retirees in single-employer pensions, which operate under much stricter funding rules, do not receive unlimited PBGC protection. And 401(k) holders certainly don’t get a bailout if their accounts crash. Yes, promises were made to multiemployer plan participants, but by employers and unions, not the federal government. Lower-income retirees should receive most of their benefits, but there must be real cuts as benefits rise.
Multiemployer pensions could have been more prudent by contributing more and taking less investment risk; they chose not to be. Multiemployer pensions weren’t struck by lightning, but by a lack of preparation enabled by lax federal regulation. The Butch Lewis Act proposes to respond with a bailout that adopts one of the worst financing practices of state and local government. Retirees deserve protection, but surely we can do better than this.
Andrew G. Biggs is a resident scholar at the American Enterprise Institute.