Messed Up Pensions

Recently, the government announced that it would take over the United Airlines pilots pensions in the government-funded Pension Benefit Guaranty Corp.  This move is irritating pilots, because their pensions get reduced, and it is annoying to me as a taxpayer, that I have to bail out a company that was too screwed-up to fully fund its pension obligations. 

This points up the biggest danger of government guarantees -- it causes companies to be more reckless.  Back in the 80's, banks and S&L's made insanely risky investments with bank deposits.  The people who should have been most interested in this problem - bank depositors - ignored it because they felt safe that the government had guaranteed their deposits.  In the same way, airlines and other ailing businesses with defined benefit pensions cut back on pension funding when times were bad, and the very group that should have been crying foul - the company unions - did not, because they again counted on a bail-out.

I put the blame squarely on the company's management, who made a commitment to employees and then failed to keep it, and now are using government pension gaurantees as a subsidy to close their cash flow gap.  However, it is interesting to look at the role of unions too.  For decades, unions have demanded defined benefit pensions (ones that promise a fixed amount per month at retirement) and have opposed defined-contribution pensions (ones where the company promised to contribute a fixed amount today into an investment fund).  I assume the main reason for this is that unions do not want workers to bear the market risks on investments.

Over time, though, defined benefit plans have, despite this opposition, gone the way of the dinosaur (at least in private companies - most government jobs still have them).  This is for a number of reasons:

  • 401-K accounts now offer much of the same tax-deferral benefits for defined contribution programs that defined-benefit plans had
  • Defined-benefit plans turn out to have market risk too.  One is inflation - benefits levels may be guaranteed, but unexpectedly high inflation can effectively reduce them, while defined contribution plans, if invested correctly, will likely produce returns to offset these inflation losses.  In addition, during go-go stock markets, holders of defined-benefit plans found out that they did not enjoy the benefits of higher investment returns - their employers pocketed them (by the way, may Americans are discovering the same about their Social Security benefits).
  • As employees move around more, workers have found that defined benefit plans are not very portable, and tend to punish workers who do not stay for decades.  401-K plans are much more beneficial to workers who do not stay their whole career, or at least 20 years, in one place.
  • As United pilots have found, defined benefit pension plans are hard to police by current employees- there are just too many variables that allow companies to argue that the pensions are OK.  On the other hand, defined contribution plans are very easy to police- one can check the amount of contribution each month against the amount promised.
  • Finally, defined benefit plans rely on their company staying in business and fiscally sound for decades into the future.  This may have seemed a good bet at US Steel or United Airlines in 1950, but would anyone make that bet today?  For any company?