Aside from Bankruptcy Of A Sponsor, The Benefits Of Someone Being Paid Their Pension Can’t Be cut. Right?

Aside from the bankruptcy of a plan sponsor, the benefits of someone being paid their pension can’t be cut.  Right?

Well, mostly true.  With governments in trouble, benefits have been cut, as in Rhode Island, Detroit, and a variety of other places with badly managed finances.  Usually that’s a big political fight.  Concessions come partly as a result that you could end up with less if you fight it, and don’t take the deal.

With corporations, the protection of the Pension Benefits Guarantee Corporation [PBGC] has kept pensions safe up to a limit — as of 2016, up to roughly $60K/year for those retiring at age 65 (less for younger retirees) from single-employer plans, and $12,870/year at most for those in multiemployer plans.  (For some complexities, read more here.  Also note that the PBGC itself is underfunded and faces antiselection problems as well.)

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Multiemployer plans are an inherently weak structure, because insolvent employers can’t contribute to fund plan deficits, and typically, multiemployer plans arise from collective bargaining arrangements, so that the firms employing the laborers are all in the same industry.  Insolvency in industries, particularly where there is collective bargaining pushing up costs and limiting work process flexibility, tends to be correlated across firms.  My poster child for that was the steel industry in 2002, where 20+ firms went insolvent.  Employer insolvencies in an underfunded multiemployer plan affect all participants, including those working for solvent firms.  (Note that solvent employers have to pay their pro-rata share of underfunding in order to exit a multiemployer plan, as I noted for UPS in this article.)

Now in 2014, Congress passed a law called the Kline-Miller Multiemployer Pension Reform Act of 2014.  That allowed the PBGC, together with the Departments of Treasury and Labor, to negotiate benefit cuts to the pension plans in order to avoid the plans going insolvent — at which point, all pensioners would be limited to the PBGC limits for their payments.  Workers in the plan — active, vested, and retired, would have to vote on any deal.  Majority of those voting wins, so to speak.

The first plan to successfully go through this procedure and cut benefits to participants happened a few weeks ago, in the Iron Workers Local 17 Pension fund.  Average benefits were cut 20%, with some cut as much as 60%, and some not cut at all.  The plan was funded to a 24% level, and there are only 632 active employed workers to cover the benefits of 2,042 participants.  The fund would likely run out of money in 2024.  Note that only 900+ voted on the cuts, with the cuts passing at roughly 2-1.

There are at least four other multiemployer plans with similar applications to cut benefit payments.  Prior to this four other multiemployer plans had such applications denied — there were a variety of reasons for the denials: the cuts were done in an inequitable way in some cases, return assumptions were unreasonably high, etc.

My original source for this piece is note by David Gonzales of Moody’s.  They rate these actions as credit positive because it potentially ends the process where an underfunded multiemployer plan would encourage an employer to default because it can’t afford the liability.  Somewhat perverse in a way, because the pain has to go somewhere on an underfunded plan — it’s all a question of who gets tapped.  Note that it also protects the PBGC Multiemployer Trust, which itself is likely to run out of money by 2025.  After that, those relying on the PBGC for multiemployer pension payments get zero, unless something changes.

For those wanting 30 pages of informative data on scope of the matter, here is a useful piece from the Congressional Research Service.

Final Note

You might think this is an extreme situation, and yes, it is extreme.  It’s not so extreme that there aren’t other underfunded plans as bad off as this multiemployer plan.  I would encourage everyone who has a defined benefit plan to take a close look at their funded status.  I don’t care about what your state constitution says on protecting your pension benefits.  If the cash gets close to running out, “the powers that be” will find a way around that.  After all, what happened with the Iron Workers Local 17 Pension Fund was illegal prior to 2014.  Now it is 2017, and benefits were cut.

Because of underfunding, there will be more cuts.  Depend on that happening for the worst funds, and at least run through the risk analysis of what you would do if your pension benefit were cut by 20% for a municipal plan, or to the PBGC limit for a corporate plan.  Why?  Because it could happen.

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.