Commentary: Teamwork needed to solve PBGC's multiemployer puzzle

The United States Pension Benefit Guaranty Corp. faces a quandary. In turn, that quandary is faced by the sponsors of some of the struggling plans that the PBGC insures. As a consequence, that challenge is also affecting the investment managers who seek to manage pension fund assets.

In short, that quandary is how to make 2% equal 5.5%.

The American Rescue Plan Act tried to address the issue of chronic underfunding in the most-at-risk (“critical and declining”) multiemployer pension plans. It directed the Department of the Treasury to provide enough funding to the PBGC (creatively named “Special Financial Assistance”) to keep all such plans solvent through 2051. The PBGC estimates there will be about $90 billion of SFA, but there is no cap, so the total could well be even higher.

That might sound simple enough, but here is where the quandary begins. The legislation directs the PBGC to measure plans’ liabilities using a discount rate of approximately 5.5%, but it requires that the special financial assistance be “invested by plans in investment-grade bonds... .” In its interim final rule, issued July 9, the PBGC restricted investments to investment-grade bonds. The problem is that investment-grade bonds today yield about 2%. So how can the PBGC make a plan solvent until 2051 if the liabilities to be met are net-present valued at 5.5%, but the funds to cover those liabilities must be invested in assets that only yield 2%?

This creates a quandary for the multiemployer plans as well. Can they use their non-SFA funds to take a bit more risk, and hope to achieve a higher total return? Yes, but many of these plans are so poorly funded today that only 20% or 25% of their funds would be in already existing, non-SFA assets. Even if they could combine these two sources of funds to achieve a 5.5% return (unlikely) they would still be certain to be insolvent in 30 years. Try persuading a 25-year-old union member to keep contributing to that plan.

This also creates a puzzle for the investment managers who seek to manage some portion of this enormous inflow of funds. So far, the PBGC’s interim regulation limits SFA to “investment-grade bonds.” Is an investment manager really being a good partner if it simply proposes an allocation to investment-grade bonds — an allocation that will nearly guarantee that the plan will be insolvent before 2051?

Fortunately, there are potential solutions to each of these quandaries.

First, the careful reader of the investment guidelines cited above from the ARPA (“invested by plans in investment-grade bonds...”) will note the use of an ellipsis to indicate that the statute’s sentence does not end there. The full sentence states: “(SFA) shall be invested by plans in investment-grade bonds or other investments as permitted by the (PBGC).” The PBGC has expressed reluctance to go beyond the specific category of investment-grade bonds without first receiving input from the public. However, the time for public comment closed recently, and the PBGC has certainly heard from the public that many constituents believe the PBGC should not only allow “other investments” but even change the 5.5% interest rate for measuring liabilities.

Second, plan sponsors and their advisers can address their quandary as well. It is important to note that “critical and declining” plans were already slated to become insolvent in the next 20 years or less (and the PBGC’s multiemployer system was projected to be insolvent in five years!). Thus, those plans have (at least a 30-year) new lease on life. This gives them time to find ways to make additional contributions to their plans to increase the likelihood that they can stay solvent past 2051 and thereby attract and retain members.

As for investment managers who think they should simply suggest vanilla investment-grade bond strategies: that will not be a quandary-solving proposal. Investment managers will need to have solutions that focus on helping plans maintain their solvency for as long as possible. Under the current draft of the rule, that would require creative use of investment-grade criteria and durations. More likely, as the PBGC considers the numerous public comments, it will decide that other categories of investment are “permitted” after all. Investment managers will need to pull together all their resources to help plan sponsors and their consultants analyze liabilities, (potentially bifurcated) discount rates, limited allocation to “other” assets, the possible use of “fixed income-like” investments with an eye towards maintaining and potentially extending plans’ solvency and viability.

Working together, the PBGC, the multiemployer plans and their investment partners can meet this challenge.

Charles E.F. Millard is the former director of the U.S. Pension Benefit Guaranty Corp. and now serves as a senior adviser for Amundi U.S., based in New York. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I’s editorial team.