The temptation to abuse pension funds is nothing new. In cartoonist Garry Trudeau’s collection titled “But the Pension Fund Was Just Sitting There!” con man Duke uses pension money to hire a football star. Jimmy Hoffa allegedly looted Teamsters union funds for years before he disappeared in 1975. Nothing is new under the sun.
The phenomenon recently became local with news of a U.S. Labor Department investigation into whether Eagan-based Northwest Airlines systematically shortchanged its employee pension fund. Northwest issued a vigorous denial.
Regardless of specifics about Northwest, pension fund problems are always in the news. Numerous studies of late estimate that pension plans are under-funded in the hundreds of billions of dollars.
Nonetheless, pension plans are inherently problematic. Incentives for mismanagement are bountiful as employers try to meet earnings projections. But such problems are not limited to for-profit corporations. The deficiencies in many government pension funds are at least as serious as any in the private sector.
Except for military retirees and veterans, few people benefited from pension plans before the 1940s. To skirt wage ceilings imposed during World War II, employers desperate for workers offered fringe benefits like pensions and health insurance.
After the Great Depression, people welcomed promises of economic security in old age. Another incentive for offering pensions was a federal law that treated contributions to funds as tax-deductible business expenses.
Employees trusted they would receive promised benefits. Companies like General Motors, U.S. Steel and IBM were comfortable quasi-monopolies that had been around for a long time. Everyone expected them to be around forever.
When plans are initially introduced, the number of retirees relative to workers remains low for a long time. Each year, thousands of workers see hundreds of colleagues retire on pensions. Over time, most become sure the money will be there when they retire too. It is inherently easier to manage a plan when there are five workers for every retiree than when the ratio is one-to-one or even less.
The fact that increased outlays will be deferred for years frequently motivates employers to offer higher pensions rather than higher wages. It is human nature to push a problem off to a later date, particularly when solving it now requires making hard choices.
While early pensions were simply paid as current business expenses, regulations soon required ongoing employer payments to dedicated pension funds. Deciding exactly how large such funds must be is not an exact science.
One uncertainty is how long people live. Over the past 60 years, life expectancies have grown. Retirees enjoy pension benefits for more years than preceding generations.
The value of assets in funds also fluctuates. When stock markets boom, portfolio values grow effortlessly. Meeting future obligations seems easy. When stock prices fall, however, meeting future obligations is tougher.
Annual earnings on investments also are key. A portfolio that earns returns of 12 percent can fund more pensions than one earning 8 percent. When annual returns from investments fall, a greater principal amount is needed to fund the same prospective outlays.
Unfortunately, stock prices and returns on investments often move together. When the economy booms, stock prices rise and rates of return on investments are high. Meeting pension obligations is a slam-dunk.
When the economy slows, however, stock prices and portfolio returns fall. Plans no longer can meet projected outlays. If regulations require actuarial solvency, employers must pony up additional funds just when corporate earnings or tax receipts are depressed.
Rules that allow use of long-term average asset values or rates of return smooth out the effects of economic fluctuations. Determining long-run stock values or average rates of return is not easy, however. There always is an element of subjectivity.
Subjectivity inherently introduces opportunities for abuse. Corporate financial officers striving to meet earnings projections and elected officials trying to balance budgets are tempted to fudge some pension assumption to solve their problem.
The fact that rules cannot be cut-and-dried means that allegations like those involving Northwest must be investigated. Businesses facing financial problems always push accounting choices in their own favor. The question of when they cross the line into illegality is not obvious.
What is clear is that many pension funds, both private and public, are seriously under-funded. We are going to be dealing with these messes for a long time.
© 2006 Edward Lotterman
Chanarambie Consulting, Inc.