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Uncle Sam's Little Nephew May Need A Big Bailout

 December 26, 2012 10:16 AM


(By Mani) The Pension Benefit Guarantee Corp.'s (PBGC) 2012 Annual Report reveals significant deterioration in its finances as the present value of accumulated future benefits jumped due to large declines in interest rates while losses from newly insolvent pensions and probable future insolvencies continued to grow.

PBGC protects the retirement incomes of more than 44 million American workers. It is an independent agency of the United States government. PBGC was created by the Employee Retirement Income Security Act of 1974 (ERISA) to encourage the continuation and maintenance of voluntary private defined benefit pension plans.

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Now, the PBGC 34.4 billion deficit is the highest ever, and remained cash flow negative. Payouts to current pension recipients have outstripped the premium income collected from solvent pensions by $2.75 billion

In addition, the 70 percent funded ratio is the lowest since 2004 and is down from 75 percent a year ago PBGC's own estimate of exposure to "reasonably possible terminations" is $322 billion, i.e., about 2 percent of the current U.S. GDP.

The only major piece of good news was the 12.6 percent return on PBGC's investment portfolio.

"The PBGC might become one of the first public entities to receive a bailout," UBS strategist Boris Rjavinski wrote in a note to clients.

When the government bailed out Fannie and Freddie, it was not legally obligated to keep them afloat as they were owned by private shareholders. Nonetheless, virtually all investors thought the government would stand behind Fannie and Freddie, and were proven correct in 2008.

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PBGC is a part of the government. However, in the big picture sense, there is little difference. PBGC, like Fannie and Freddie, is on sound financial footing as long as the US government backs it.

"The advantage of injecting capital into PBGC is that it becomes more obviously solvent, instead of counting on government support in a crisis. Just like its distant cousin the FDIC, PBGC's liabilities are contingent," Rjavinski said.

However, taxpayers and legislators probably will not care about PBGC's or FDIC's obligations while they are "deep out of the money". Unfortunately, with the $34 billion deficit that continues to grow, policy makers will have to start thinking about how to foot the pension protection agency bill, when it comes due.

The 12.6 percent return in the PBGC investment portfolio in fiscal 2012 was undoubtedly very strong. The resulting $9.8 billion net balance sheet contribution from investments was very significant. Which begs the question: why did the funded gap still worsen by $8 billion?

The answer lies a little over one mile away from the PBGC headquarters, at the Federal Reserve. As the 2012 annual report indicates, the "actuarial charges due to changes in interest rates" increased $10.8 billion, as "interest factors" decreased by 103 basis points.

"We estimate that PBGC's liabilities have an average duration of roughly 10.9 years," Rjavinski wrote.

There have been many complaints from private investors, including pensions, about the Fed lowering their liability discounting rates. Operation Twist was joined by QE3 and soon to be followed by QE4.

Chairman Bernanke has indicated several times that he is well aware of the pain caused by low yields, but feels convinced that the net benefit from economic recovery will outweigh the potentially short-term problems for pensions. Perhaps PBGC Director Josh Gotbaum will soon take a short walk along the red line in to plead his case with Chairman Bernanke.

Meanwhile, the market impact from developments at PBGC may be muted in the near-term, but grow in the future. It runs a very conservative investment portfolio with about two thirds allocated to fixed income.

"Future increases in busted pensions may make PBGC net seller of stocks, buyer of bonds," Rjavinski noted.

When the agency takes over assets of a busted pension, it is very likely to bring them in line quickly with PBGC's own portfolio mix.

In 2012, PBGC realized roughly $1 billion in losses from taking over 155 terminated pensions with an average funded ratio of 50 percent. However, that number could have been easily over $10 billion had the one single large airline bankruptcy restructuring in 2012 led to termination of its pension plans.

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