In May, Congress held a hearing titled, "No Guarantees: As Pension Plans Crumble, Can PBGC Deliver?" At the session, the head of the Pension Benefit Guaranty Corp. informed lawmakers that the agency's underfunded liabilities for its single-employer insurance program hit a record high of $33.5 billion, surpassing the old record of $24 billion in 2004.

PBGC insures the pensions of about 33.8 million workers and retirees in about 28,000 private-sector defined benefit pension plans under its single-employer insurance program, and 10.1 million participants under its multiemployer program in about 1,500 plans, according to the Employee Benefit Research Institute.

Deficit swells

Vincent Snowbarger, PBGC acting director, told members of the Senate's Special Committee on Aging that each month the agency pays over $350 million in benefits to individuals already in pay status.

By the end of fiscal year 2008, PBGC became responsible for 67 plans with 19,000 participants and $250 million in unfunded liabilities, Snowbarger said. "During the first six months of 2009, a time when the economy was weakening, PBGC took in about the same number of plans as in all of 2008 and nearly four times the number of participants - 62 pension plans with more than 75,000 participants and $480 million in unfunded liabilities."

While Snowbarger was testifying on the Hill, Constance Markakis, a senior attorney advisor in the legislative and regulatory department at PBGC, spoke at the Washington Legislative Update conference sponsored by the International Foundation of Employee Benefit Plans.

Markakis said that by the end of September 2008, PBGC's unfunded liabilities for its single-employer insurance program hit $11 billion. But by March 2009, the number had tripled to $33.5 billion.

"Our deficit grew not because of investment losses, rather because of more plan terminations coming through the agency since the last fiscal year. We had a $3 billion investment loss on our $63 billion assets portfolio. Also, 70% of our assets are invested in fixed-income," she added. "The $33.5 billion includes both actual terminations and probable terminations, which are terminations that we predict will occur within the next year."

Still, the recession and the stock market decline means more DB plans are substantially underfunded, thus the agency is seeing an uptick in applications requesting distressed termination of the plan. In addition, the down economy has triggered more corporate bankruptcy filings, which means PBGG has to step in as the pension insurer.

Increasing premiums

In the short term, PBGC will not have any issues, as they have enough assets on hand to pay for many years of benefits prior to running out of cash, says Jack Abraham, head of the retirement practice in Pricewaterhouse-Coopers' human resource services group.

"Even for plans being assumed by PBGC, the assets on hand often are enough to cover 10 to 15 years of participant payments, even if the plan is only 50% funded. Still, a prolonged downturn will force more companies into bankruptcy, which often leads to underfunded plans being assumed by the PBGC," Abraham explains.

If PBGC's financial statement continues to deteriorate because of a growing deficit, that raises the likelihood that the agency will need a federal bailout in the future, although many years down the road.

Abraham explains that before PBGC actually becomes insolvent, "Congress could take steps to try to shore up the PBGC, such as raising the premiums that continuing plans are required to pay or raising funding standards for plans in the future."

An increase in premiums and funding levels, however, may lead financially healthy employers to move away from their DB plan, resulting in less premium income for the PBGC, and even worse, may force more employers into reorganization or liquidation, further hurting the PBGC's position, Abraham asserts.

Dallas Salisbury, president of EBRI, agrees with Abraham that PBGC has enough funds to meet its benefit obligations. Salisbury also testified at the hearing with Snowbarger.

"As long as an employer or group of employers maintains the plan until it pays its last benefit, PBGC is fine. The risk is underfunded terminations due to business failures or reorganizations," Salisbury explained to the committee members.

The 33.5 billion deficit, however, suggests "a major challenge should the current economic crisis continue for some time, including [the agency's] estimate of potential auto industry net exposure of $42 billion were all plans to end up with the PBGC," he added.

Inching toward termination

To complicate matters within the DB space, businesses with frozen pension plans are more likely to consider investment strategies that will eventually allow them to terminate the plans, rather than continue them, Aon Consulting reports in a recent brief, "Ready 2012: Pension Pulse Survey."

The Chicago-based HR consulting firm surveyed about 70 U.S. employers with more than 100 frozen defined benefit plans, totaling plan assets of over $50 billion.

Among DB plans in which benefits accruals are frozen for all participants or eligibility is limited, about 81% of respondents are considering termination strategies that include hedging significant risks (35%), changing investments to reflect the shorter investment horizon to termination (27%), or moving to a more liability-driven investment approach (19%).

"The majority of plan sponsors wants to terminate their frozen plans quickly, but doesn't have sufficient assets to do so," says Cecil Hemingway, U.S. retirement practice leader at Aon Consulting. "Survey participants told us they made the design changes associated with closing their pension plans (soft freeze) or ending future benefit accruals (hard freeze). However, without addressing the investment paradigm, they are leaving themselves open to significant future risk," he adds.

The data also shows that 68% of employers with frozen DB plans thought that funding challenges will lead to cutbacks in hiring and training to make up for the shortfall in plan funding, that is needed to terminate the plan.

Amid a recession, "coming up with the cash requirement to get the plan fully funded so that you can terminate it is going to be a challenge," says Jon Waite, chief actuary of SEI's institutional group. On a termination basis, plan sponsors were typically used to getting up to a 100% funding level. "But right now, they will probably need to reach maybe 110% or 115% funding levels. Those numbers represent big dollars," Waite explains.

Additionally, interest rates tend to be low during a recession, resulting in a higher cost of settling the obligations of the plan with an insurer or paying out a larger single sum to the participants, compared to periods of higher interest rates, says PwC's Abraham.

According to the Aon Consulting report, 75% of respondents who are considering a plan termination within the next five years plan to hire multiple vendors. Despite the cost- savings and efficiencies associated with using one vendor, many employers believe terminating a plan requires expertise, specialization and prudent fiduciary behavior - objectives that are more easily achieved by using multiple vendors.

"Ultimately, plan sponsors of frozen pension plans have to decide whether they want to terminate their plan, start it up again, eliminate or mitigate accompanying risk, or change the benefits provided under the program," Hemingway says. "Without [an investment] plan, it's highly unlikely that companies will be happy with their pension plans five years from today and will instead be thinking about what they need to do in order to address the funding shortfalls and economic drain of the plan, since it still exists and still has not been addressed."

Insights and key findings from Aon's report, "Ready 2012: Pension Pulse Survey"

Companies with multiple plans tend to freeze them all in a similar manner the majority of the time. When they don't, the less-affected plans tend to be union-negotiated plans.

>> Once a plan has been frozen, it loses its HR value - the attraction and retention of the workforce and the ability to effectively manage the workforce. The plan now becomes a debt of the organization that can bring substantial risk (asset as well as compliance risk) to the organization. This risk needs to be understood and addressed.

>> For many organizations, the plan should be derisked over time and potentially terminated at an appropriate time. Review of the risk will typically generate very different approaches to asset allocation and plan management than had been in use prior to the review.

>> Plan sponsors should make certain that their goals and desires are understood by their consultants and that any potential conflicts of interest are addressed before termination strategies are set. A preliminary review of the potential vendors available to assist with a termination and a clear discussion of the goals of the plan sponsor will benefit everyone involved in the process.

>> Companies considering the freezing or termination of their DB pension plans should consider appropriate communications to control the message and reaction of the employees. Additionally, consideration of changes to other plans as a result of a plan freeze or termination (potentially including DC plans, severance plans and retention plans) may be appropriate as well.

>> While it is true that a significant number of companies have frozen their DB plans within the past three years, the majority of plan sponsors retained their plans without a freeze.

>> DB plans still provide real value to many employers, and the choice of whether or not to retain or freeze the plan should be based on whether or not the plan meets sponsor and employee needs, and whether or not its risks can be acceptably addressed.

Source: Aon Consulting