The time has come for Congress to make hard decisions concerning the Pension Benefit Guaranty Corp.
The best decision for taxpayers, and, ultimately all employers and employees, would be to freeze the PBGC's obligations at their present level. That is, Congress should say the PBGC will guarantee only the pension benefits of pension plans it has already taken over. When the last beneficiary of those plans dies, the PBGC will cease to exist.
This would get the government out from under a burden it should never have accepted to begin with — providing insurance that no private insurance company would touch.
Congress should not have touched it either. That's because insuring pension liabilities exposes the government to "moral hazard" risk. Moral hazard refers to the possibility that the fact the government is providing insurance will adversely change the behavior of those who benefit from the insurance.
For example, unions might demand, and companies could agree to, large pension benefits knowing that if something went wrong, the pension insurer would pick up the obligation. Absent that insurance, unions and companies might negotiate less expensive pension benefits, and the unions might press employers to better fund the plans to protect against the possibility the company might some day fail.
In fact, as James A. Wooten points out in his recent book, "The Employee Retirement Income Security Act of 1974 — a Political History," unions consciously chose to push for plan termination insurance and resisted tighter funding rules when ERISA was being debated.
That's because they realized tighter funding meant higher costs for employers, making it harder to negotiate generous pension benefits. They also realized the higher benefits and looser funding standards could expose employees to a higher risk the company might default on its promises, and termination insurance would ameliorate that risk.
When the PBGC was established, a number of commentators — including Pensions & Investments — warned that termination insurance would be unsustainable in the long run. And the current PBGC deficit has proven them right. As predicted, the PBGC's existence has encouraged unions to negotiate higher benefits, and it is one factor that has subtly encouraged employers to underfund those promises.
United Airlines, which now will drop almost $10 billion in unfunded liabilities on to the PBGC, is but the latest example of the moral hazard coming home to roost. The action is likely to force other struggling airlines to terminate their plans as well and drop large unfunded liabilities on to the PBGC.
If they don't, they will be at a competitive disadvantage not only to the discount airlines that never offered defined benefit plans, but also to United and US Air.
In a real sense, the existence of the PBGC is distorting competition in the airline industry, as it has previously distorted competition in other industries, such as the steel industry.
Congress must address the problem now, and it has few realistic options. If it attempts to raise the PBGC insurance premiums aggressively, and set them based on the risk of default, it may well trigger more plan terminations by struggling companies, worsening the PBGC's deficits. This could trigger more premium increases and more terminations.
Likewise, if it moves aggressively to force companies to fund their pension liabilities over shorter periods, it again may trigger a cascade of more pension terminations.
If Congress decides to provide more capital to the PBGC out of general revenue to help it weather the current crisis, it will merely postpone the reckoning, because the moral hazard will still exist.
If Congress freezes the PBGC's obligations and undertakes modest, gradual improvements in funding requirements, it may well force companies and unions to negotiate more realistically about both current and future benefits.
If it fails to freeze the PBGC liabilities soon, the agency's unfunded liability will continue to grow, and eventually taxpayers will have to pick up the tab — another example of the dangers of moral hazard.
Defined benefit plans existed before the PBGC, they can live without it.