Re: “PBGC says goodbye to LDI” (Pensions & Investments, page 1, Feb. 18) and related letters to the editor by Daniel P. Cassidy (March 3), Richard A. Manka and Todd Gardenhire (March 17).
The Pension Benefit Guaranty Corp.'s problem is not its asset allocation but an impossible business model. It writes (“short”) exotic options which are neither insurable nor hedgeable.
Plan sponsors are long a put option on a 60/40 stock/bond investment portfolio, for example, leveraged by writing annuities, their defined benefit obligations. The PBGC, in turn, writes contingent credit default swaps on each ERISA plan sponsor with the leveraged portfolios as the deliverable. The contingency is that only underfunded plans are delivered. No long-only securities portfolio can fund, or hedge, writing a put on a put, nor is option risk reservable (insurable).
Mr. Cassidy astutely suggests the PBGC should hedge. While Mr. Gardenhire's objection has some merit, the real problem is the PBGC's risk is unhedgeable — for example its loss on United Air Lines.
United Airlines $9.8 billion pension shortfall cost the PBGC $6.6 billion and United's 120,000 employees the $3.2 billion uninsured portion of their pensions. Even if the PBGC could have borrowed 100% of UAL's outstanding shares, selling short at UAL's 25-year-high share price, their hedge would have offset only $5.8 billion of the $6.6 billion loss. So the perfectly timed perfect hedge fails by nearly $800 million — $4 billion if you include pensioners' losses.
In the 34 years since ERISA was enacted, the S&P 500 has produced a 6,505% total return. So why are private and public sector pensions underfunded by $2 trillion? Thirty-four more years of the same “sound, mainstream financial approach” is unlikely to produce a different result for retirees, plan sponsors, or the PBGC — or eventually, taxpayers.
Jack R. Buchmiller
Stamford, Conn.
