The Hostess Bankruptcy And The Threat Of A PBGC Bailout

by Ivan Osorio on November 20, 2012 · 2 comments

in Bailout Watch, Economy, Employment, Insurance, Labor

On Friday, November 16, Hostess Brands announced it was shutting down operations after the Bakers, Confectionery, Tobacco Workers and Grain Millers International Union (BCTGM), which rejected the company’s last contract offer in September, announced it would go on strike. (Today, the two parties entered into a last-ditch negotiation effort today to avoid liquidation.)

The same day, the Pension Benefit Guaranty Corporation (PBGC), the federally created agency that insures private sector pensions, announced that its deficit had increased from $26 billion to $34 billion over the past year.

Then yesterday, Hostess announced that  it would pass off its pension liabilities to the PBGC.

If this looks like an oncoming slow-motion train wreck, that’s because it is — and taxpayers are standing on the tracks.

Hostess has about $2 billion in unfunded pension liabilities, which would add even more red ink to the PBGC’s already strained books. If a growing number of companies shed their pension liabilities on to the PBGC — a possibility given the American economy’s continuing weakness — the threat of a taxpayer bailout will only grow. AP’s Marcy Gordon notes, “If the trend continues, the agency could struggle to pay benefits without an infusion of taxpayer funds.”

How did we get into this mess?

The PBGC, created by Congress in 1974 as part of the Employee Retirement Income and Security Act, was designed to fund itself through premiums charged to insured companies. The problem was the design. PBGC premiums are set by Congress, which has no obligation to take risks into account when setting those premiums. In fact, the beneficiaries of those low premiums — unions and large unionized firms — have an incentive to lobby to keep those premiums low.

To his credit, the PBGC’s current head, Joshua Gotbaum, has asked Congress to allow the agency to raise premiums to reflect risk, and the Government Accountability Office has endorsed the proposal. The sooner this is done the better. Congress shouldn’t be in the business of setting prices, and there is no reason to make an exception for pensions, especially since the insurer is supposed to be able to fund itself through premiums.

Of course, any policy change that would raise premiums is likely to be opposed by the unions and unionized firms that benefit from artificially low premiums — especially if they have to rise substantially, as seems likely. For private sector unions, this is a particularly troubling prospect, since it takes away a major selling point for union membership: a guaranteed secure retirement. Yet there is nothing secure in pension plans for which the numbers don’t add up.

To make matters worse, many of Hostess’ pension troubles extend beyond the company itself, because it is a participant in several multiemployer pension plans. These plans make each participant responsible for the liabilities of every other participant because of a phenomenon known as the “last man standing” rule. Fortune‘s David Kaplan explains:

In trying to shed costs, Hostess is gunning for what are known as MEPPs — multi-employer pension plans — which it is required to participate in under its labor agreements with the unions.

MEPPs, which grew in popularity back in the union glory days of the 1950s and ’60s, were designed for companies within an industry to share pension burdens. There are nearly 1,500 MEPPs in the country, covering more than 10 million workers. These mammoth defined-benefit plans — employers, not workers, make the contributions — were especially attractive to unions, as they allowed workers to move easily between companies.

Trouble with MEPPs is, if some employers go out of business, the remaining companies have to pick up the shortfall in funding benefits. When there are too few employers left standing, the fund is in trouble. According to a March research report by Credit Suisse, MEPPs are now underfunded by $369 billion. A third of the 40 MEPPs to which Hostess contributes are among the most underfunded plans in the country.

Thus, multiemployer plans exacerbate the moral hazard of subsidized public pension insurance by spreading the liabilities around to other plan participants, who are left holding the tab in case of another participant’s bankruptcy. Until this problem is addressed, situations like the one at Hostess are likely to be repeated.

Will multiemployer pensions survive a change to risk-based premiums? Unlikely, given that they carry strong moral hazard on their own due to the “last man standing” rule. And doing away with the rule would make single-employer plans relatively more attractive.

Will single-employer defined benefit plans survive such a change? We’ll only know when they’re allowed to operate without a huge insurance subsidy.

Who knows? If the market were finally allowed to set pension insurance premiums to reflect risk, pension insurance may well become a competitive field.

For more on the PBGC, see here.

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