[New York times] July 28, 2003 New Rules Urged to Avert Looming Pension Crisis By MARY WILLIAMS WALSH
Top government officials have begun a calibrated campaign to bring attention to corporate pension plans, which they say may be on a road to collapse. But underneath their measured words are proposals that could fundamentally change the $1.6 trillion industry, altering the way pension money is set aside and invested. On Wednesday, the comptroller general placed the Pension Benefit Guaranty Corporation, the agency that guarantees pensions, on a list of "high risk" government operations. Elaine L. Chao, the secretary of labor, issued a statement on the same day warning that the decades-old system in which workers earn government-guaranteed pensions "is, unfortunately, at risk." Treasury Secretary John W. Snow, a former railroad chief executive who had responsibility for a $1.3 billion pension fund, warned recently that a financial meltdown similar to the savings-and-loan collapse of 1989 might be brewing. Steven Kandarian, the executive director of the Pension Benefit Guaranty Corporation, gave a speech earlier this month in which he foresaw a possible "general revenue transfer" - polite words for a bailout of the agency. Before being named to head the agency, Mr. Kandarian was a founding partner and managing director of the private equities firm of Orion Partners. While officials want to underscore the dangers to retirement benefits that millions of Americans count on, they do not want to frighten consumers, roil financial markets or anger the companies that already put billions of dollars into the system. But some pension analysts, reading between the lines, say they think that officials are not only looking at calling upon companies to put more money into their ailing pension plans - a painful prospect at a time when cash is tight - but also at the more radical remedy of encouraging funds to reduce their heavy reliance on the stock market. At issue are defined-benefit pensions, the type in which employers set aside money years in advance to pay workers a predetermined monthly stipend from retirement until death. Today, about 44 million private-sector workers and retirees are covered by such plans. Three years of negative market forces have wiped away billions of dollars from the funds, triggering the defaults of some pension plans and leaving the rest an estimated $350 billion short of what they need to fulfill their promises. Until recently, the idea that America's pension edifice was built on a flawed foundation was preached by a tiny number of financial specialists and considered heresy by almost everyone else. But after several years of declines in the stock market, there is a growing argument that pension managers, who have been investing most of their money in stocks for years, should be in predictable bond investments that would mature when the money will be needed, matching the retirement ages of their workers. Now the view is gaining ground in academia, and getting a fair-minded hearing by well-placed financial officials, who are incorporating some of its reasoning in their pension proposals. The measures they have put forward bear little resemblance to those considered earlier this month in a rancorous House Ways and Means Committee session. The House pension bill is more generous to business. If enacted, it would lop tens of billions of dollars off the amounts companies would pay into their pension funds in each of the next three years. Businesses favor the bill's approach, but hoped to make its changes permanent. Treasury officials say they think that this approach would put benefits at risk, particularly at companies with older workers who will be claiming their pensions soon. "The fact of the matter is that more money is needed in those plans, to ensure that older workers receive the benefits they have earned through decades of hard work," said Peter R. Fisher, under secretary for domestic finance, in testimony to a House subcommittee panel earlier this month. The high number of pension funds that have defaulted has already severely weakened the pension insurance agency, raising fears of a bailout. The agency finances its operations by charging companies premiums, and it still has enough cash flow to make all of its payments to retirees for now. But its deficit has grown to record size, and it cannot keep absorbing insolvent pension plans indefinitely. It could raise premiums, an unpopular idea with companies, or in dire straights it could turn to the taxpayers for more money. Permitting companies to pay less into their pension plans would only increase the risk of such a bailout. Thus, the Treasury's calls for what Mr. Fisher called a "comprehensive reform." Unknown to most Americans, a small group of finance specialists has been making the case for a number of years that pension funds are in danger because their managers invest heavily in stocks. These analysts were hooted at during the stock boom years of the 1990's, but in the aftermath of a three-year bear market, their arguments are being considered more carefully. Money managers of all sorts invest in stocks, of course, and no one is questioning stocks for mutual funds, foundations or university endowments. But pension funds are different, the argument goes, and they require a different strategy: stocks when workers are young, perhaps, but later on, as workers age, an ultraconservative portfolio of bonds, with durations shortening as they approach retirement. This type of pension investment strategy went out of style in the 1960's and is little used today. (Life insurers make a notable exception, using what they call duration-matched bonds when they issue annuities.) Stocks are widely assumed to return more over time than bonds held to maturity, and have therefore seemed a cheaper investment vehicle. And the implications of a revival of the old strategies would be profound. Pension funds, with assets worth roughly $1.6 trillion at the end of 2002, make up a significant share of the stock market and help to drive its movements. Suggestions that pensions might be safer if this money were placed elsewhere are not warmly received on Wall Street. If anything, corporate pension managers appear to be moving toward more risk, not less. The composition of pension portfolios is not generally disclosed, so trends are hard to track. But anecdotal evidence suggests that pension managers are turning to hedge funds, real estate investment trusts, emerging markets and other riskier investments, in an effort to recoup the stock losses of the past three years. Companies appear to be "making the smallest contributions allowed, while taking investment risk in the hope that their gamble will pay off," said Jeremy Gold, an outspoken advocate of duration-matched bonds for pensions funds. The notion that low-risk bonds might be the solution to the pension problems, which sounds so radical to companies, is not being uttered by cabinet members. Ms. Chao and Mr. Snow have drawn attention to the pension problems, but have not put forward specific remedies. When he mentioned the savings and loan crisis, in a meeting with reporters and editors of The Wall Street Journal, Mr. Snow cautioned that he did not want to overstate its similarities to today's pension difficulties. Mr. Snow did go on to say, though, that the same ailment that felled the savings and loan institutions in 1989 is now eating away at pension funds: a mismatching of assets and liabilities. And he noted that, like the savings and loan institutions, pensions are covered by a federal insurance agency. The presence of a federal insurer in such cases is sometimes said to promote riskier behavior. The job of developing and putting forward a specific response to the pension danger has been left to officials below cabinet rank, close to the pension insurance agency. The Treasury's Mr. Fisher outlined the administration's ideas in some detail in his Congressional testimony. He recommended, foremost, a new way of calculating pension obligations, which would take employee demographics into account. This method would recognize that pension payments owed to workers retiring soonest need to be funded more securely than those for much younger workers. Mr. Fisher also called for less reliance on "smoothing," the practice of averaging factors over several years when pension values are calculated. Pension calculations involve the use of interest rates, but since real-world interest rates zig-zag up and down, they are smoothed in an effort to keep the pension numbers stable. Currently, the smoothed rate used by actuaries is an average of historic rates from the past four years. Mr. Fisher testified that four years was too long, and that this excessive smoothing was causing the very volatility it was intended to reduce. This happens, he said, because the smoothing blurs the true state of a pension fund, masking deterioration for months at a stretch, until companies find their plans are noncompliant and have to start pouring in money. Reducing the excess smoothing would help companies avoid such unpleasant surprises, Mr. Fisher said. He recommended moving gradually from the four-year average to a 90-day average. Pension specialists who have considered these remarks carefully say they think that what Mr. Fisher is really describing is a way to shift pensions into conservative bond investments. Mr. Fisher said nothing of this in his testimony, but actuaries said the message was implicit: If smoothing is phased out, pension values would start zig-zagging with interest rates, unless managers moved into bonds. Mr. Fisher declined to elaborate on his testimony. Separately, Mr. Gold has testified that the administration proposals would help to relieve the pressure on pensions. But he urged the administration to go further "to encourage prudent behavior by plan managers." Ron Gebhardtsbauer, senior pension fellow for the American Academy of Actuaries, said the problem is that such prudent behavior would cost companies more. "Employers kind of like having stocks in there," Mr. Gebhardtsbauer said. "It makes the pension plan cheaper."
