It is commonly acknowledged that an important virtue of defined benefit pension plans is the security they provide to pay promised retirement benefits regardless of market fluctuations. An integral element of this security is the Pension Benefit Guaranty Corporation, the quasi-governmental organization tasked with safeguarding these pensions in the event of company failure.
Like the plans it insures, the PBGC must invest its capital with the goal of paying out benefits for decades into the future. Most pension experts agree that pension policy should be crafted by looking at the long view rather than focusing on a snapshot point in time. Consequently, the likelihood that a plan or the PBGC itself will be able to pay benefits over a period covering decades is a far more accurate measure of a plan's health or the integrity of the PBGC than a snapshot on a specific date when equity values and interest rates can vastly overestimate or underestimate the true financial picture.
The PBGC's own strategy for investing the assets it acquires when it takes over a terminated plan is an integral component of its financial status. Over the past several years, however, the PBGC has struggled to settle on an investment policy for its millions of dollars in assets. Clouding the issue is the agency's financial position, which by its own estimates plummeted from a $9.7 billion surplus in 2000 to a record $23.3 billion deficit in 2004, before recovering somewhat to a $10.7 billion deficit at the end of 2008. Abrupt changes in the agency's investment policy at historically inopportune times have been a major contributor to the agency's financial woes.
In the early part of the 2000s, the agency shifted to a particularly conservative investment approach stressing capital preservation, with a significant percentage of assets including all employer premium dollars, per statutory requirements invested in U.S. Treasury securities. To do so, the agency effectively locked in its then-recent equity losses. And because its new investment policy was so conservative, the PBGC's trust fund failed to capitalize on the significant market gains that followed.
In 2004, the American Benefits Council commissioned a study that confirmed that the PBGC's investment policy was flawed and urged PBGC to adopt a more growth-oriented strategy by increasing its investments in higher-yielding fixed income securities and equities. The report also found that the agency relies on unrealistically low interest rate assumptions, which exaggerate the underfunding in defined benefit plans it acquires, overvalue lump-sum distributions relative to annuities and skew the agency's deficit levels. By using more market-based assumptions in the calculation of its assets and liabilities, the PBGC would have a better understanding of its current financial standing and therefore a clearer view of the future.
In February 2008, the PBGC responded with a more diversified investment policy that allocated an increased portion of assets toward equities. In a statement announcing the move, the PBGC acknowledged that because "obligations are paid over many years, the new investment policy is designed to take advantage of a long-term investment horizon. The strategy of increased diversification including use of alternative investments aims at generating returns, while providing superior protection against ultimate downside risks over time."
Less than a year later, the bottom fell out of the stock market, rendering yet another unfortunate snapshot of the agency's finances despite a positive outlook over the long time horizon. The PBGC then rescinded its 2008 policy guidelines, which had not yet been fully implemented. Now the PBGC is once again considering a revision of its investment policy, hosting a series of informational sessions with investment professionals, academicians and other stakeholders. The agency is looking to determine (1) how to balance its role as a fiduciary and an insurer, (2) the appropriate risk levels and time horizons for PBGC investments, and (3) the types of analyses necessary to assess its financial position.
If defined benefit pensions are to be viable well into the future, it is critical that PBGC's public policy including its investment policy center around the concept of long-term growth. The agency should have the courage of its convictions and be willing to abide by a well-constructed investment policy over complete business cycles, thereby avoiding the potential catastrophic consequences that may result from frequent, abrupt policy shifts. The PBGC should also use more realistic interest rate assumptions when measuring its liabilities, to prevent itself from making broad strategic choices based on an artificially inflated or deflated balance sheet. This will enable policymakers to more quickly identify challenges to the defined benefit system as well as sustain both the private sector pension system and the PBGC itself through more growth-based investment.
