Would surging equity markets save multiemployer pension plans?

The multiemployer pension plans projected to be insolvent by 2038 could benefit from sustained returns in equity markets – but even under unusually optimistic projections, most plans expected to run out of cash would still do so.

A recent analysis by the Society of Actuaries breaks down the impact investment returns have on the pending insolvency of more than 100 multiemployer plans.

Actuaries at SOA identified 115 plans in so-called critical and declining status, a classification established by Congress for plans expected to be insolvent within two decades.

According to SOA, 107 of those plans will be insolvent by 2038, as some critical and declining plans will be able to delay insolvency, largely because of the robust returns in equity markets in 2016 and 2017, when the typical multiemployer plan returned 8 percent and 14 percent on investment portfolios, respectively.

The projected 107 insolvencies assumes an annual return of 6 percent of assets, which Lisa Schilling, retirement research actuary with SOA, calls a “middle of the road” assumption.

“We didn’t choose the 6 percent investment return assumption because we see it as the most likely—it is less than some and more than others. We use 6 percent because it’s a round number that represents the middle,” Schilling explained.

To account for the inherent uncertainty in forecasting economic growth, equity market returns, and interest rate volatility, SOA modeled five annual average return scenarios on projected multiemployer plan insolvencies.

Under the most bearish assumption, SOA calculated 0 percent returns for two years, then subsequent average returns of 6 percent over 20 years. Under that scenario, 110 plans will be insolvent by 2038.

Under the most bullish assumption, SOA calculates 10 percent average returns over the next two decades. That assumption, which Schilling characterized as exceedingly hopeful, would still have 68 plans reaching insolvency by 2038.

“No matter what one’s feelings are about the country’s economic future, 10 percent average annual returns is beyond optimistic,” she said.

Investment returns on plan assets can heavily influence the timing of insolvency, according to SOA’s report, which Schilling coauthored.

For plans expected to be insolvent in the near term, returns are less impacting, as those plans are too small, and their liabilities too significant, for variations in returns to materially impact the timing of insolvency.

Under the 6 percent return baseline model, SOA projects five plans will be insolvent by 2021. And 21 plans that provide pensions for about 95,000 retirees and workers will be insolvent by 2023.

After 2023, more plans will reach insolvency each year through 2038. Insolvencies will hit 33 plans by 2025, the year Central States Pension plan, which covers more than 400,000 participants, is projected to be insolvent.

By 2030, 70 plans will be insolvent; by 2038, 107 plans, covering 875,000 participants, will be insolvent.

Same story as PBGC

The Pension Benefits Guaranty Corp., the federal corporation charged with insuring private sector pension benefits, typically puts the number of projected insolvencies at 130 plans.

That number accounts for plans that have already become insolvent, and also includes plans that have been approved to suspend some benefits by the Treasury Department under the Multiemployer Pension Reform Act of 2014. SOA’s analysis does not include plans in either status.

“PBGC’s analysis focuses primarily on the impact of insolvencies to them, as they should,” said Schilling. PBGC says the $2 billion in reserves in its multiemployer insurance program will be exhausted sometime in 2025, after the Central States plan becomes insolvent.

“We’re looking at the total amount of benefits impacted by insolvencies, not just what PBGC would pay,” said Schilling. “But the basic story we are telling is the same as PBGC.”

The 21 plans SOA projects to be insolvent by 2023 represent $427 million in annual benefit payments to retirees, with an average annual per-retiree benefit of $8,600.

The 91 plans projected to be insolvent by 2033 represent $7.1 billion in annual payments to retirees, with an average annual per-retiree benefit of $13,000.

Under PBGC’s insurance program for multiemployer plans, the maximum guaranteed benefit for a retiree with 30 years of service is $12,870. For a worker with 20 years of service, the maximum guaranty is $8,580 annually.

Burn rate

All of the plans analyzed by SOA have negative cash flow positions, meaning their benefit obligations are more than revenue from plan contributions and withdrawal liability payments.

One way to understand why even exceedingly optimistic investment returns won’t save most plans is through understanding a plan’s “burn rate,” said Ms. Schilling.

A plan’s burn rate represents its cash flow relative to the value of its assets. A plan with negative cash flow of 10 percent of the value of its assets has a 10 percent burn rate.

With a 10 percent burn rate in one year, a plan would need to actualize a 10 percent return on assets the following year to keep its funded liability neutral.

SOA estimates that 81 of the 115 plans in critical and declining status have a burn rate over 10 percent this year, and 27 of those plans have a burn rate over 20 percent.

What’s worse, as plan assets decline, burn rates increase, meaning plans will need even larger investment returns to stave insolvency.

Expecting markets to provide the necessary returns would be imprudent, suggested Schilling.

“These plans are going to need a huge infusion of cash,” she said.

Schilling said the prospect of freezing plans, which some stakeholders have suggested as an option, could ultimately accelerate insolvency, not stave it.

Freezing a plan, and reducing new benefit obligations, would limit the growth of unfunded liabilities. But it would also lower the number of active employees on whose behalf employers make annual contributions to plans. Less contribution revenue could hasten insolvency for some plans.

Freezing plans would have little effect on the timing of insolvency for plans expected to run out of cash in the next decade, SOA says.

“You freeze a plan and you cut off its income stream,” Schilling said. “No matter how meager it might be, it is still an income stream. In a weird way, it makes the unfunded liability situation even worse.”

Structure of collective bargaining has hamstrung plans

Critical and declining multiemployer plans have been victim to a perfect storm of demographic shifts, the Great Recession, lower union membership, and poorly crafted trade agreements, according to analysis commonly offered by stakeholders and policy makers.

But the structure of collective bargaining agreements has also hamstrung some plans.

Employer contributions are negotiated by labor and employer representatives. Both sides are advised by their own actuaries. Once negotiations close, contributions are set for the life of a collective bargaining agreement—typically three to five years.

“Whatever happens to the funded status of a plan after negotiations take place has not been taken into account during the negotiations,” explained Schilling. “ What was agreed on won’t change even if underlying condition of plans change.”

Some plans have been unable to recover the withdrawal liabilities employers are required to pay when they leave a multiemployer plan. Various legal and practical reasons—such as bankruptcy—have prevented some employers from paying full withdrawal liabilities.

Exactly how much is a mystery, even to unbiased actuaries.

“The withdrawal liability is supposed to be set at a high level, but for different reasons, it often ends up not being enough,” said Schilling. “The uncollectible amount is big, but no one really knows how big.”