What type of accounting math is your pension using?  Is it valid assumptions about future returns or fuzzy math that allows underfunding and puts the fund at risk?

What type of accounting math is your pension using? Is it valid assumptions about future returns or fuzzy math that allows underfunding and puts the fund at risk?

Underfunding Pensions Through Accounting Manipulation

There is a significant amount of misinformation in the public about pension plans.  Since the great recession began in 2008, there has been a high level of concern about the ability of state and local governments to fully meet their pension obligations.  With private company pensions, the Bernie Madoff ponzi scandal significantly harmed numerous pension funds, and combined with the stock market crash has resulted in some pension funds defaulting, and others becoming significantly underfunded.

For private company pension funds, the employer controls the fund, and while the company is responsible for the benefits that it promises to pay employees, it is also able to invest the pension funds in any manner it deems most appropriate.  When the pension fund is well capitalized, employees tend not to be concerned how the pension funds are utilized; however, when the company is in distress or the fund is under-capitalized, the use of pension funds can become a significant issue.  There have been multiple motions by the Department of Labor in recent years to recover pension funds from private companies that have improperly utilized pension accounts.  These improper uses generally include taking money from the pension account to support the business, or investing the money in unethical ways that place the business or private interests above those of fund itself.

Make sure that those who are running your pension plan play by the right set of rules.  Not just the rules that they make up.

Make sure that those who are running your pension plan play by the right set of rules. Not just the rules that they make up.

Who’s watching the hen house?

Controversy can arise even when a pension is being administered legally.  The amount that a company must contribute to a pension fund is dictated from year to year based on various actuarial estimates including the lifespan of pension recipients, the expected investment return on the fund, and projections about how long employees will remain with a company, how many will become vested, company payroll growth or decline over time, etc.  The company which is responsible to make contributions into this pension fund, is also largely responsible for establishing these estimates that determine the level of required pension contribution.  At times, a company may have a distinct incentive to manipulate these estimates in order to  reduce the amount that they have to contribute.  In fact, some companies have withdrawn money from pension funds at various points because they claim that based on actuarial estimates the fund is over capitalized.

This is an especially acute problem among companies that are struggling, because when a company goes bankrupt and a pension is placed at risk, there is a federal entity known as the Pension Benefits Guarantee Corporation which backstops private pension funds, and ensures that the benefits of individual employees are secure.  A private company knowing this has an incentive to attempt to access pension funds, even if it puts the long term health of the fund at risk, because if the company fails and the pension becomes insolvent, the government becomes responsible for the fund, and if the company fails with a healthy pension fund, there is no benefit to the failed company.  If a company fails and the government takes over the pension plan, the benefit is not fully guaranteed.  The amount of the guarantee is set from year to year based on the health of the guarantee fund.  For 2013, the guarantee level is $57,477 per year of retirement benefits.

2 Responses to Is Your Pension at Risk? Underfunded Pensions

  1. Troy says:

    Great post. I recently wrote a post about pension funds too and how they’re practically just ponzi schemes. Many of the public pension funds haven’t a hope of fulfilling their liabilities.

    • pradmin says:

      You’re right in that many pensions have an implicit rate of return that they need to make in order to pay their future liabilities. They are considered fully funded if they have a stack of cash now such that if it grows at 8% (or whatever the assumed RoR) from now until the end of time, then they can pay the bills as they come due.