Currently, around 130 multiemployer pension plans are projected to become insolvent in the next 20 years. Some of these plans are projected to run out of money within the next 10 years.
As these plans become insolvent and are taken over by the Pension Benefit Guaranty Corporation (PBGC); the PBGC, in turn, is then projected to become insolvent around 2025, after which it will not be able to pay guaranteed benefits for insolvent multiemployer plans. If these events occur, more than one million workers, retirees and beneficiaries will see their hard-earned pension benefits drop to nearly zero.
Despite these disquieting statistics, it’s important to keep in mind that, under current law, the majority of multiemployer plans are on target to fully satisfy their benefit obligations. (For the latest data on the financial status of Segal’s clients, see an infographic of key findings.)
What Congress Is Doing to Help Troubled Plans
Earlier this year, Congress formed the Joint Select Committee for the Solvency of Multiemployer Pension Plans and charged it with recommending a legislative solution to this pressing issue. The Joint Select Committee is weighing options for strengthening the multiemployer pension system and making it more sustainable for the future.
In the first two public hearings held by the Joint Select Committee, some members raised questions suggesting that one way to reduce the risk associated with multiemployer plans would be to force them to use more conservative actuarial assumptions and to adhere to stricter funding standards — in other words, follow funding rules similar to those in place for single-employer plans.
When considering possible solution to the Multiemployer Pension Plan Crisis, it is important for the Joint Select Committee to understand the nature of multiemployer pension plans, and how they are fundamentally different from single-employer plans.
Unreasonable Funding Requirements for Multiemployer Pension Plans Could Destabilize the System.
Applying single-employer funding rules to multiemployer plans would be unreasonable and inappropriate. Moreover, it could significantly increase, rather than decrease, the risk facing the multiemployer system. Here’s why:
- Both the amount and volatility of contribution requirements for multiemployer plans would drastically increase.
- Many participating employers would not be able to afford significantly higher contributions, which would drive them to withdraw from the plans in which they participate.
- In some cases, financially weak employers may be forced into bankruptcy.
- If new, unreasonable funding standards precipitate employer withdrawals, contribution bases will be significantly weakened.
- Many otherwise-healthy plans could be pushed toward insolvency.
In the first two public hearings held by the Joint Select Committee, some members raised questions suggesting that one way to reduce the risk associated with multiemployer plans would be to force them to use and adhere to more conservative and stricter funding standards — in other words, follow funding rules similar to those in place for single-employer plans. However, that suggestion ignores one key piece of information about these stricter single-employer rules – as we discuss below these stricter rules have neither preserved or stabilized the single-employer defined benefit plans:
- As a result of these rules the number of active single employer defined benefit plans has declined because of increased cost and significantly increased variability in annual contribution requirements.
- Since implementing the rules, relief measures have had to be adopted to restore stability to the single-employer system, with minimal positive impact.
In a letter to the Joint Select Committee, we shared our concerns about the possibility of requiring multiemployer plans to use actuarial assumptions that currently only apply to single-employer plans.
To quantify the impact of a change in the funding rules relating to multiemployer interest rate assumptions used to discount liabilities, Segal Consulting performed a detailed analysis of two national multiemployer plans. We found the increase in the necessary contributions to meet current funding standards would not be sustainable for either of the plans, both of which are currently considered healthy or on the road to good health. In fact, a change to a considerably lower discount rate would create a much greater pension crisis than the one that already exists.
Multiemployer Interest-Rate Assumptions Are Not the Problem.
For multiemployer plans, the Pension Protection Act of 2016 (PPA’06) reduced the period over which shortfalls must be funded, but it kept the interest-rate assumption used to measure plan liabilities as the expected investment return on plan assets. Today, most multiemployer plans have interest-rate assumptions in the range of 7.0 to 7.5 percent. In recent years, there has been increased scrutiny of those assumptions. Some even believe the assumptions contributed to the current multiemployer solvency crisis. That belief is not supported by data. Even taking into account the investment losses from the 2000s, actual historical returns for multiemployer plans have consistently exceeded 7.5 percent on a rolling 30-year basis.*
Because investment returns are, by nature, volatile, pension plans must be permitted to build surpluses following periods of strong investment returns, so they have a cushion against the periods of investment losses that will likely follow. Unfortunately, pension funding and tax laws prevented plans from building up surpluses following the strong investment returns of the 1990s. As a result, multiemployer plans were less able to withstand the investment losses that came in the 2000s.
Employer Withdrawals and Bankruptcies Are a Major Concern.
Many multiemployer plans strike a delicate balance in keeping employers participating in the plan. Employers often consider the cost of paying ongoing contributions to remain in the plan versus the cost of exiting and paying withdrawal liability. Given the significant increases in contribution rates in recent decades, withdrawal has become a more attractive option for many employers.
If multiemployer contribution requirements were significantly increased, many more financially healthy employers would come to the conclusion that it no longer makes financial sense to continue participating in the plan, and they would decide to withdraw. Less healthy employers may find they cannot afford the higher contributions needed to remain in the plan, nor can they afford to pay their withdrawal liability. This could drive some employers into bankruptcy.
The compounding effect of employers withdrawing from the plan or being driven into bankruptcy is a major concern. As more employers withdraw from the plan, the burden on the remaining employers will continue to increase, motivating them to withdraw as well. A significant number of plans could be pushed into mass withdrawal, insolvency, or both. In the end, this could significantly increase the projected liability for PBGC’s multiemployer program.
A Destabilized Multiemployer Pension Plans System Would Have Significant Collateral Damage.
The PBGC’s multiemployer system would be further strained, as more plans would require financial assistance. More workers, retiree, and beneficiaries would be at risk of losing their pensions, increasing their dependency on social programs.
Furthermore, the distress placed on participating employers could have negative effects on the broader economy.
Multiemployer plans are the single most effective tool available to workers seeking a lifetime income stream in retirement. More than 10 million workers and their families rely on this system to contribute towards their financial security in retirement. Ninety percent of those workers are participants in plans fully capable of meeting the promise of a secure retirement.
Correcting Common Misperceptions About the Funding Rules for Single-Employer Plans
Single-employer funding rules have not strengthened retirement security. When Congress passed the Pension Protection Act of 2006 (PPA’06), it made stark changes to funding standards for single-employer pension plans. Notably, PPA’06 required plan liabilities to be measured using more conservative actuarial assumptions, and it shortened the period over which plan sponsors must fund any shortfalls. Some may say these changes improved funding levels security for single-employer plans, but they also contributed to the continued decline of participation in defined benefit (DB) plans.
Increasingly, corporate sponsors are freezing their DB plans. Many are considering termination once interest rates rise. Instead, employees participate in defined contribution (DC) plans, which are inefficient at providing lifetime retirement income. It is too early to measure the societal effects of the shift in employer-provided retirement plans from DB plan to DC plans. Some experts, however, believe we will begin to see increasing numbers of employees working longer than they are able due to inadequate retirement savings, and increasing numbers of retirees outliving their savings. Both of these factors could increase dependency on social programs.
Single-employer plan funding requirements are not based on market rates. PPA’06 intended to apply the principles of financial economics to single-employer plan funding standards, requiring plan liabilities to be measured based on current market interest rates rather than expected returns on plan assets. Specifically, PPA’06 mandated a three-segment yield curve of corporate bond rates to measure single-employer plan liabilities, representing a risk free (or at least low-risk) discount rate.
PPA’06 took effect in 2008, and it was almost immediately followed by the Global Financial Crisis. To stimulate the economy, the Federal Reserve began to cut interest rates, which soon reached historic lows. Suddenly, corporate bond yields were producing unreasonably low interest rates for measuring single-employer plan liabilities — and, therefore, unreasonably high contribution requirements on employers that cannot afford them.
Congress passed a series of relief measures allowing “interest-rate smoothing” for single-employer plan sponsors, including a provision in 2012 that allows the use of a 25-year average of market interest rates.† The funding relief provided by Congress to single-employer plans was well-placed, and it highlights how the theoretical principles of financial economics often have practical shortcomings with pension funding.
Multiemployer Plans Are Fundamentally Different from Single-Employer Plans.
There are certain fundamental differences between multiemployer plans and single-employer plans. For this reason, many of the funding rules that have been implemented for single-employer plans are inappropriate for multiemployer plans.
For one, contributions to single-employer plans are made at the discretion of the sponsoring employer. The rate of contributions to multiemployer plans, on the other hand, is established through collective bargaining and is locked in through the duration of the contract. For this reason, multiemployer plans cannot easily adapt to the volatility of contribution requirements that would result from market-based measurements, shortened funding periods, or both.
Additionally, multiemployer plans by definition have more than one participating employer. Having many participating employers provides advantages such as pooling of risk. Conversely, when employers withdraw from a multiemployer plan — whether voluntarily or due to a bankruptcy — they leave “orphan” liabilities that become the responsibility of the remaining employers. If multiemployer funding requirements were to be increased, the greater burden on participating employers would not be isolated to the benefits of their own employees, but it would include a portion of orphan liabilities as well. For many plans, the increased burden associated with orphan liabilities would be too much for the remaining employers to bear.
Most Multiemployer Plans Have Already Taken Significant Corrective Actions.
Over the past two decades, most multiemployer plans have taken significant corrective actions to improve funding levels following the investment losses of the 2000s. These corrective actions most often include reductions in the rate of future benefit accruals for active plan participants and increases in contribution rates for participating employers.
Several plans in critical status have already declared they have exhausted all reasonable measures, meaning that they cannot reasonably emerge from critical status within the statutory timeframe (usually 10 years). Even plans currently in the “green zone” (neither endangered nor critical) have had to more than double contribution rates over the last dozen years or so, while slashing the rates of future benefit accruals to a fraction of what they once were.
If multiemployer funding requirements were substantially increased, it would require plans to take additional corrective action to meet the higher funding targets. Depending on the magnitude of the change in funding requirements, some multiemployer plans may be able to make further changes to contributions and benefits to adhere to the new standards. Many (if not most) plans, however, would find further significant increases to contributions or reductions in benefit levels to be unsustainable.
Meeting the Challenge
It is in everyone’s interest — workers, retirees, beneficiaries, employers and taxpayers — to find a solution to the multiemployer pension solvency crisis that strengthens the system for future generations. The components of a comprehensive solution exist already:
- Establish a federally guaranteed loan program to provide financial assistance to troubled plans. The loan program should be designed to allow troubled plans time to resolve their problems.
- Avoid undue cost and financial burdens to healthy plans by keeping PBGC premiums at a reasonable level.
- Develop an understanding of the multiple factors that have contributed to the financial solvency crisis of some plans. Recognize the solution is complex and do not be lulled into a false comfort level with simplistic ideas, such as solely focusing on funding rules.
- Adopt legislation, such as the GROW Act, which would give healthy plans more flexibility and tools to remain healthy plans. Do not require plans to become insolvent before making plan redesign tools or composite plans available.
Source: The Segal Company