The April 17 editorial on the Pension Benefit Guaranty Corp. hit some good points, but missed the major one. The PBGC is an insurance company and should be run like one. That is the "substantive change" that is needed.
Yes, providing service to clients and beneficiaries is very important. Also, premiums should be set based on risks and not the need for tax dollars. Likewise, investments should be made based on the present liabilities and risks of future losses.
The PBGC should not be asking Congress to cut premium rates, but rather to be delegated the authority to set premiums within agreed parameters based on the risks they are underwriting. In some cases that would mean lower rates, but it also could mean higher rates for some underfunded plans with shaky sponsors. It is my understanding the PBGC has completed its pension model and it should be modified for setting premiums.
The problem of delegating authority is that PBGC premiums, due to the magic of government accounting, are also treated as tax revenue. Congress may be reluctant to give up the power, but setting premiums based on risk levels has to be the right solution for the PBGC and the 40 million participants it protects.
This same government accounting causes the investment constraints you mentioned. If a premium dollar was taken out of the required Treasury investments and, say, invested in a corporate bond, it would be a tax expenditure. Moving from cash to accrual accounting as proposed in the Bush administration would help, but the real answer is to remove the PBGC from the U.S. government through partial or total privatization.
That being said, it does not mean the corporation's investment mix is wrong or that its benchmarks are wrong. The PBGC attempts to match its liabilities (future payments to former participants in terminated plans) with assets per a policy that was first established when I was there. The point of matching is that the PBGC's fixed-income losses will be offset with gains on their liabilities, as in 1999 when the present value of future payments went down in value with the assets. Asset/liability matching is standard practice and appropriate risk management for any insurance company, especially one like the PBGC with a known, fixed stream of future payments. The key difference is most insurance companies would be doing some of this matching with higher yielding securities than U.S. Treasuries.
Once the matching is done, the issues of how much of the surplus should be invested in equities can be debated. The PBGC's present percent is very high in comparison to many other insurance companies. It also has contingent liabilities (corporate bankruptcies and the equity investments in their pension plans) that are highly correlated with equity performance. I would be more comfortable with their present mix, or even your suggested higher equity levels, if risk management studies, including value at risk, were being performed.
As to the equity performance, the PBGC did underperform its benchmark in 1999 (Wilshire 5000), but it seems to be tracking relatively well over a five-year period. However, it would be nice to know why they selected that benchmark and if they are incurring more or less risk than the benchmark. Although we exceeded our benchmarks in most years during my tenure, I can be very sympathetic as investment manager selection within the government can be very cumbersome. It was frustrating that the tight procurement rules did not allow input from the presidentially appointed advisory board (including the CEO of General Motors Investment Management Co.) or even myself, who previously had chaired a corporate pension committee. It was one of the reasons we had a strong bias toward indexing. To be fair, the constraints of Washington sometimes worked to the better. We successfully avoided the underperformance of international stocks during the period partially because of potential political hassle.
As for your third point, PBGC actuarial assumptions are supposed to be designed to equal private sector annuity rates. That puts a distress termination on equal footing with a standard termination and also gives the PBGC the option to annuitize its liabilities. I would agree, if the PBGC rate methodology no longer reflects the market, it should be changed.
It is time for substantive changes, but maybe not exactly as Pensions & Investment suggested. PBGC premiums are just one part of the many government rules and regulations that have kept small and medium size firms from starting or retaining defined benefit pension plans. After all, tens of thousands of defined benefit plans were terminated when premiums were much lower. A cross-subsidy from well-funded plans to underfunded plans and new plans is not the answer. It is just an incentive for the well-funded plans to leave the system. If there are going to be subsidies, they should be made explicit and be paid by all taxpayers.
The substantive changes should take the form of government initiatives to promote retirement savings in all their forms -- defined benefit pensions, defined contribution, individual retirement accounts and other private savings. Those changes should include deregulation, the privatization of the PBGC's insurance function with risk-based premiums, and reversing the anti-pension bias of our present tax policy.
James B. Lockhart III is managing director of NetRisk Inc., Greenwich, Conn., and a former executive director of the PBGC.