News Release

August 24, 2004

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Pension underfunding leaves taxpayers vulnerable to major bailout
Without changes to funding, premium rules, crisis on par with S&Ls a real possibility

WASHINGTON—Underfunding of private-sector pension plans is rampant—currently more than $350 billion—and has led the Pension Benefit Guaranty Corporation (PBGC) to go from a $9.7 billion surplus in 2000 to an $11.2 billion deficit in 2003. This situation increases the likelihood that more pension funds will go under and leaves the PBGC poised for a taxpayer bailout similar to the 1980s savings and loan crisis, according to a new Cato Institute study.

"As long as sponsors of underfunded pension plans are not held responsible for the exposure they impose on the PBGC, ultimately either the premium level must increase, in which case some of the cost will be shifted to well-funded pensions in the short run, or, if exposures create claims that reach catastrophic levels, taxpayers will be called upon to provide a bailout through the PBGC," writes Richard A. Ippolito in "How to Reduce the Cost of Federal Pension Insurance."

Despite the dire warning, Ippolito, a former chief economist at the PBGC, suggests that to avert an impending crisis, pension plan underfunding can be controlled by transforming the PBGC into a private insurance program that sets premiums according to the amount of risk plan sponsors add to the program.

He adds that without changes to funding and premium rules, the PBGC's deficit is likely to increase to $18 billion over the next ten years, and may swell to $50 billion or more.

"Eliminate the loopholes that permit sponsors of underfunded plans to evade the variable rate premium and require sponsors to calculate market value underfunding," Ippolito recommends. "That change would dramatically increase revenues to the PBGC, reducing the need for a bailout and greatly reducing the level of underfunding."

Further, defined-benefit pension plans would pose no risks to the PBGC (or to a private pension insurance program) if they were fully funded and with assets that matched their liabilities.

"Once taxpayers were removed as ultimate guarantors of the insurance, the plans themselves (and most notably the better funded plans) would have an incentive to align premiums with exposure, and plan sponsors would have to face up to the problems that their own underfunding creates," Ippolito writes.

Policy Analysis no. 523