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Wednesday, June 8, 2005

Too many books

The New York Times had a good story yesterday on the collapse of the United Airlines pension plan. At the root of the problem was the weakness of the federal pension law known as ERISA (named after the ancient Greek goddess of actuaries). ERISA, which tells companies how much they have to contribute to employees' pensions, is scandalously lax in its accounting standards. Under the ERISA accounting rules, everything in the United pension world looked peachy -- so much so that the company was allowed to skip a year's worh of contributions a few years back. In contrast, if you looked at the books that United showed its investors and filed with the Securities and Exchange Commission (SEC), the fact that the pension plan was doomed would have been apparent much earlier.

It may have been perfectly legal, but the United pension failure shows that whenever someone keeps two sets of books, one is closer to telling the truth than the other. The tax laws are another area in which the multiple-books practice leads to endless hanky-panky. When corporations fill out their income tax returns, they make themselves look as poor as possible -- the lower the taxable income, the lower the tax. But on the financial statements they show their investors and bankers, and file with the SEC, they paint the rosiest possible picture -- as much profit as possible, to boost stock prices and executive compensation.

Here's a revolutionary idea: Why not require just one set of books? Why don't we get the accounting rules as fair and accurate as possible, and then every year, require presentation of one conclusive set of numbers that are the company's income (profit) for all purposes? Corporations would pay taxes based on the profits that are driving their stock prices and their CEOs' scandalous bonuses. Pension contributions would be gauged to the more realistic accounting rules that the SEC requires, rather than the goofball pretend games that ERISA has evolved to allow.

Just one bottom line for all purposes. What a crazy concept.

Comments (6)

The great accomplishment of ERISA was to require full funding for all defined contribution pension plans (where the company puts in a specific amount on behalf of each employee and the particpants get whatever those contributions plus earnings add up to when he or she retires). That is, private companies could no longer just make an unsecured promise to pay a certain pension when an employee retires; the money actually had to be placed in a separate account, safe from creditors or corporate raiders.

Unfortunately, defined benefit plans (the ones that promise a specific pension payment upon retirement) have never been as secure because the amount you need to pay into the plan today to secure a specic benefit in twenty, ten or five years is always a matter of some speculation. I agree the PGBC could do a better job of requiring honest bookkeeping and goodfaith efforts on the part of companies to fully and accurately fund define benefit plans, but I'm not sure you can ever fully protect against things like the stock market collapse of a few years back.

That just one more reason defined contribution plans are the wave of the future. I may be the only person who remembers that Denny Smith proposed switching PERS to a defined contribution system when he ran for governor in 1994.

Jack R., you may be the only person who remembers Denny Smith. And I grew up in Salem!

Pension Actuaries Are The Phone Answer Guys For Fly-By-Night Roofers Who Have Been Paid In Advance

Extended Comment On Jack Bog's Blog Pertaining To One Pension Plan For All Oregonians

Why not have one pension plan open to ALL Oregonians? It will be a bank but we will call it a pension instead so that it is not, well . . . called a bank.

The savings and loan buyout hurt our economy and now between borrowing for the war in Iraq and pension bailouts, our economy will suffer again.

This to me is the tip of the iceburg.

The great accomplishment of ERISA was to provide safeguards so that workers' defined benefit pension benefits don't just vanish along with their employer. That safeguard has held up over the nearly 32 years that ERISA's been around. But for ERISA, UAL's participants would have far less than they have now.

Defined benefit pension plans actually are more secure than defined contribution plans. Under a defined benefit plan, the employer bears all risks of poor investment performance and plan benefits are guaranteed (up to statutory maximums) by the PBGC. Under a defined contribution plan, all investment performance risk is borne by participants and your benefit equals whatever your account balance is at the time you retire. If the markets drop by 50% just before you retire, hey, that's your problem buddy.

Granted, there are some significant problems facing private pension plans. There's nothing the PBGC can do to fix the existing problems. It's up to Congress. Certainly a state-sponsored , "one pension plan" for everyone isn't the answer. Just take a look at the Oregon Section 529 plan to see how well that thing has performed (net of the exceedingly large management fees paid to the fund provider).

The problems of private defined benefit plans can be solved by making three rather simple changes to the existing rules: (1) require pension plans to be funded on a "termination" basis,(2) get rid of the onerous full funding limitations Congress added in the mid 1980s, and (3) amend the bankruptcy code to give a company's pension plans/PBGC secured creditor status.

Currently, plans are funded on a going concern basis. However, when an employer gets into trouble and has to terminate the plan, even if it's fully funded on a going concern basis it can be woefully underfunded on a termination basis. All too often, it's the PBGC that makes up the difference (witness UAL's pension plans).

Additionally, Congress imposed "full funding limitations" in the 1980s (TEFRA, DEFRA, REA, TRA) that limited companies' abilities to make extra contributions during good years as a hedge against bad years. This was done to increase tax revenues -- and we're paying for it now (and will continue to pay more and more if changes aren't made -- and soon). Of course, even if these changes are rolled back, they won't help until we return to a more healthy economy.

Finally, under existing bankruptcy law, a pension plan (or, in an involuntary termination, the PBGC) is treated as a general unsecured creditor when the plan sponsor declares bankruptcy. This permits companies to simply walk away from their unfunded liabilities. If Congress were to give plans/the PBGC secured creditor status, this would go a long way towards ensuring promised benefits aren't cut back in the event the company tries to walk away from its pension plans.

"That just one more reason defined contribution plans are the wave of the future. I may be the only person who remembers that Denny Smith proposed switching PERS to a defined contribution system when he ran for governor in 1994.

Dang. I take back a quarter of the rotten things I ever said about him.

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