Pg 1 of 250 JONES DAY 222 East 41st Street New York, New York 10017 Telephone: (212) 326-3939 Facsimile: (212) 755-7306 Corinne Ball Heather Lennox Lisa Laukitis Steven Bennett Michael D. Silberfarb - and - JONES DAY 325 John H. McConnell Boulevard Suite 600 Columbus, Ohio 43215 Telephone: (614) 469-3939 Facsimile: (614) 461-4198 Todd S. Swatsler Robert W. Hamilton Attorneys for Debtors and Debtors in Possession UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK --------------------------------------------------------------- x : In re : : Hostess Brands, Inc., et al., 1 : : Debtors. : : --------------------------------------------------------------- x Chapter 11 Case No. 12-22052 (RDD) (Jointly Administered) DEBTORS OMNIBUS REPLY MEMORANDUM IN SUPPORT OF MOTION OF DEBTORS AND DEBTORS IN POSSESSION TO (A) REJECT CERTAIN COLLECTIVE BARGAINING AGREEMENTS AND (B) MODIFY CERTAIN RETIREE BENEFIT OBLIGATIONS, PURSUANT TO SECTIONS 1113 (C) AND 1114 (G) OF THE BANKRUPTCY CODE 1 The Debtors are the following six entities (the last four digits of their respective taxpayer identification numbers follow in parentheses): Hostess Brands, Inc. (0322), IBC Sales Corporation (3634), IBC Services, LLC (3639), IBC Trucking, LLC (8328), Interstate Brands Corporation (6705) and MCF Legacy, Inc. (0599).
TABLE Pg OF 2 CONTENTS of 250 Page Preliminary Statement... 1 Introduction... 2 Argument... 4 A. The Debtors Have Met The Standards For Relief Under Sections 1113 And 1114... 4 (1) The Section 1113/1114 Proposals Were Based on the Most Complete and Reliable Information Available, and the Debtors Have Negotiated in Good Faith... 4 (2) The Debtors Proposals Are Necessary to Hostess Reorganization... 6 (a) Viewed as a Whole, the Debtors Section 1113/1114 Proposals Are Necessary... 6 (b) The IBT Proposes a Necessity Standard That Has No Legal Basis... 9 (c) Exiting the MEPPs Is Essential to Attracting the Capital Hostess Needs to Succeed... 11 i) MEPP overview... 11 ii) There are enormous liabilities and uncertainties associated with Hostess participation in the MEPPs... 12 iii) Participation in the MEPPs is a huge obstacle for potential investors... 15 iv) The IBT has offered no specific proposals regarding the MEPPs... 17 (3) The Debtors Proposals Are Fair and Equitable... 18 (a) The Fair and Equitable Standard... 18 (b) Hostess Employees Are Being Treated Fairly and Equitably... 19 (c) Other Employers Participating in the MEPPs and the MEPPs Themselves Have No Right to Have Their Individual Interests Taken into Account in Connection with the Motion... 23 (4) The IBT Does Not Have Good Cause To Reject the Proposals... 29 (5) The Balance of Equities Favors Implementation of the Proposals... 31 B. The Debtors Decision To Temporarily Cease Making Some MEPP Contributions Does Not Preclude Section 1113/1114 Relief... 32 Conclusion... 35 - i -
TABLE OF Pg AUTHORITIES 3 of 250 Page FEDERAL CASES In re Adelphia Business Solutions, Inc., 341 B.R. 415 (Bankr. S.D.N.Y. 2003)... 21 In re Alabama Symphony Ass n, 211 B.R. 65 (N.D. Ala. 1996)... 33 Ass n of Flight Attendants-CWA, AFL-CIO v. Mesaba Aviation, Inc., 350 B.R. 435 (D. Minn. 2006)... 6, 8, 31 In re Blue Diamond Coal Co., 131 B.R. 633 (Bankr. E.D. Tenn. 1991)... 5, 20 Borman s Inc. v. Allied Supermarkets, Inc., 706 F.2d 187 (6th Cir. 1983)... 27 In re Bowen Enterprises, Inc., 196 B.R. 734 (Bankr. W.D. Pa. 1996)... 6 In re Carey Transp., Inc., 50 B.R. 203 (Bankr. S.D.N.Y. 1985)... 29 In re Century Brass Prods., Inc., 795 F.2d 265 (2d Cir. 1986)... 18 Chaterlain v. Lloyd, No. 08-400-C, 2009 WL 3672888 (M.D. La. Nov. 3, 2009)... 25 In re Chrysler LLC, 405 B.R. 79 (Bankr. S.D.N.Y. 2009)... 24 In re Comcoach Corp., 698 F.2d 571 (2d Cir. 1983)... 27 In re Delphi Corp., No. 05-44481 (Bankr. S.D.N.Y. May 26, 2006)... 23, 24, 26 In re Delta Air Lines, 351 B.R. 67 (Bankr. S.D.N.Y. 2006)... 8 In re Elec. Contracting Servs. Co., 305 B.R. 22 (Bankr. D. Co. 2003)... 28, 30, 34 In re Frontier Airlines Holdings, Inc., No. 08-11298 (RDD), 2008 WL 5110927 (Bankr. S.D.N.Y. Nov. 14, 2008 (Drain, J.)... 7 In the Matter of GCI, Inc., 131 B.R. 685 (Bankr. N.D. Ind. 1991)... 20 Gerhardson v. Gopher News Co., Civ. No. 08-537 (JRT/JJG), 2009 WL 3242024 (D. Minn. Sept. 30, 2009)... 26 In re Horsehead Indus., Inc., 300 B.R. 573 (Bankr. S.D.N.Y. 2003)... 6, 31
TABLE OF Pg AUTHORITIES 4 of 250 In re Indiana Grocery Co., Inc., 138 B.R. 40 (Bankr. S.D. Ind. 1990)... 32 In re Ionosphere Clubs, Inc., 101 B.R. 844 (Bankr. S.D.N.Y. 1989)... 24 In re Ionosphere Clubs, Inc., 922 F.2d 984 (2d Cir. 1990)... 23 In re Ionosphere Clubs, Inc., 22 F.3d 403 (2d Cir. 1994)... 33, 34 In re Jones Truck Lines, Inc., 130 F.3d 323 (8th Cir. 1997)... 32 In re Kaiser Aluminum Corp., 456 F.3d 328 (3d Cir. 2006)... 26 In re Kentucky Truck Sales, Inc., 52 B.R. 797 (Bankr. W.D. Ky. 1985)... 18, 21, 30, 34 In re Liberty Cab & Limousine Co., 194 B.R. 770 (Bankr. E.D. Pa. 1996)... 4 In re Martin Paint Stores, 207 B.R. 57 (S.D.N.Y. 1997)... 27 In re Maxwell Newspapers, Inc., 981 F.2d 85 (2d Cir. 1992)... 23, 30 In re Moline Corp., 144 B.R. 75 (Bankr. N.D. Ill. 1992)... 33, 34 NLRB v. AMAX Coal Co., 453 U.S. 322 (1981)... 25 In re Northwest Airlines, 346 B.R. 307 (Bankr. S.D.N.Y. 2006)... 9, 20 In re Old Carco LLC, 406 B.R. 180 (Bankr. S.D.N.Y. 2009)... 25 In re Oneida Ltd., 351 B.R. 79 (Bankr. S.D.N.Y. 2006)... 21 Professional Adm rs Ltd. v. Kopper-Glo Fuel, 819 F.2d 639 (6th Cir. 1987)... 25 In re Quigley Co., Inc., 391 B.R. 695 (Bankr. S.D.N.Y. 2008)... 24 In re Refco, Inc., 505 F.3d 109 (2d Cir. 2007)... 24, 26 In re Royal Composing Room, Inc., 848 F.2d 345 (2d Cir. 1998)... 6 In re Saint Vincents Catholic Medical Centers of New York, 429 B.R. 139 (Bankr. S.D.N.Y. 2010)... 27 In re Salt Creek Freightways, 47 B.R. 835, 839-40 (Bankr. Wyo. 1985)... 6, 29-2 -
TABLE OF Pg AUTHORITIES 5 of 250 In re Smith Mechanical Contractors, Inc., No. 95-60030-S-11, 1995 WL 864676 (Bankr. W.D. Mo. June 26, 1995)... 27 In re Sol-Sieff Produce Co., 82 B.R. 787 (Bankr. W.D. Pa. 1988)... 5 Teamsters Airline Division v. Frontier Airlines, Inc., No. 09 Civ. 343 (PKC), 2009 WL 2168851 (S.D.N.Y. July 20, 2009)... 7 In re Tower Automotive, Inc., 342 B.R. 158 (Bankr. S.D.N.Y. 2006)... 24 Truck Drivers Local 807 v. Carey Transp. Inc., 816 F.2d 82 (2d Cir. 1987)... 9, 18, 20, 29, 30, 32 In re UAL Corp., 408 F.3d 847 (7th Cir. 2005)... 24-27 In re UAL Corp., 443 F.3d 565 (7th Cir. 2006)... 24, 25 STATUTES 11 U.S.C. 1113... 1-3, 6, 9, 10, 18-21, 23-27, 29, 30-35 11 U.S.C. 1114... 1-3, 6, 18, 20, 21, 24, 29, 31, 35 29 C.F.R. 4219... 12 29 U.S.C. 1322... 12 29 U.S.C. 1341... 26 29 U.S.C. 1382... 11 29 U.S.C. 1383... 11 29 U.S.C. 1399... 12 I.R.C. 432... 11 I.R.C. 4971... 11-3 -
Pg 6 of 250 TO THE HONORABLE ROBERT D. DRAIN UNITED STATES BANKRUPTCY JUDGE: Hostess Brands, Inc. and the other above-captioned debtors and debtors in possession (collectively, Hostess or the Debtors ) respectfully submit this omnibus reply memorandum in support of their motion (the Motion ) to (a) reject certain collective bargaining agreements and (b) modify certain obligations to provide retiree benefits, pursuant to sections 1113(c) and 1114(g) of the Bankruptcy Code. 2 PRELIMINARY STATEMENT The Debtors request for relief under sections 1113 and 1114 is not about trying to fix blame for Hostess current financial distress. Nor is it about belittling past sacrifices or accusations that the unions are the cause of all of Hostess difficulties. The Debtors have no interest in finger-pointing or name-calling. They have no interest in an acrimonious re-telling of history. Rather, the Debtors sole focus is on creating a company that, in a still-struggling economy, can emerge as a viable, long-term competitor in the country s fresh baking industry. Anything less will cost thousands of dedicated, hard-working Hostess employees their jobs. To that end, Hostess is seeking to implement a Turnaround Plan that will allow it to return to profitability. The Turnaround Plan calls for far-reaching changes across a number of areas some involving labor issues, some not. Without question, however, a key element of the Turnaround Plan requires that the Debtors address the enormous pension and healthcare commitments (and uncertainties relating to potential future obligations) associated with their 296 separate collective bargaining agreements, as well as a number of work rules contained in 2 Capitalized terms not defined herein shall have the meanings given to them in the Motion.
Pg 7 of 250 the CBAs. As Hostess Motion and accompanying Memorandum of Law (the Memorandum of Law ) made clear, Hostess cannot succeed unless these burdens are addressed. Discussions with the Debtors two biggest unions, the IBT and the BCT, are ongoing. Hostess is committed to making every effort to reach an agreement with the Unions. While much progress has been made, to date the parties have been unable to do so. In the absence of an agreement, implementation of the Debtors Section 1113/1114 Proposals pursuant to sections 1113(c) and 1114(g) of the Bankruptcy Code is critical to a successful reorganization. The objections that have been filed in opposition to the Motion do not, and the evidence that will be presented to the Court will not, undermine the conclusion that the Debtors have met the substantive and procedural requirements for relief under sections 1113 and 1114. 3 Accordingly, that relief should be granted. INTRODUCTION In this brief, the Debtors will address the substantive points raised in the objections. Clearly, however, the disagreement before the Court focuses on two central issues. The first is whether Hostess should be allowed to reject its CBAs with the BCT and the IBT insofar as they mandate the Debtors participation in 24 multiemployer pension plans ( MEPPs ). The IBT, other employers that participate in and contribute to the MEPPs, and the MEPPs themselves argue that Hostess MEPP obligations are not really a problem, and that allowing Hostess to exit the MEPPs would be unfair. As Hostess has already explained, 3 The principal objections to the Motion were filed by the IBT (Dkt. No. 408) (the IBT Obj. ), by Hostess competitor BBU, Inc. (Dkt. No. 282) (the BBU Obj. ), and by various multiemployer pension plans in which Hostess is a participant (Dkt. Nos. 356, 357) (the MEPP Objs. ). A number of other companies that participate in MEPPs in which Hostess is also a participant have joined in the BBU objection or filed similar objections. (Dkt. Nos. 309, 311, 320, 321, 335, 336, 349, 354, 358, 359, 360) (collectively, the Competitors Objs. ). In addition, the Independent Bakers Association and the National Coordinating Committee for MultiEmployer Plans have sought leave to present their views as amici. (Dkt. Nos. 348, 350.) Hostess has not objected to those requests. Finally, the BCT has advised the Court that it is not opposing the Motion. (Dkt. No. 298). - 2 -
Pg 8 of 250 however, the current and potential future liabilities associated with its participation in the MEPPs are a huge obstacle to its efforts to attract the capital it needs to succeed. Any argument to the contrary is wishful thinking. And there is nothing unfair about Hostess converting to an alternative retirement arrangement that will afford its union employees as much or more retirement security than they have today. Indeed, there should be no misunderstanding that, whether or not the Motion is granted, Hostess will cease participating in the MEPPs. If the Court grants section 1113 relief, Hostess will withdraw from the MEPPs. In the absence of such relief, Hostess only alternative will be a brand sale liquidation that would put an end to Hostess altogether. So Hostess can either exit the MEPPs as a viable going concern, or it can exit the MEPPs through a liquidation sales process. But continued participation in the MEPPs is not going to happen. The second principal area of disagreement is whether Hostess can obtain relief under sections 1113 and 1114 of the Bankruptcy Code even though a final capital structure for the reorganized debtors is not yet in place. The IBT argues the Motion should be denied because Hostess has not finalized a capital structure with which the IBT agrees and that gives the union equity in the new company. IBT Obj. at 15-16. As further explained below, however, nothing in the Bankruptcy Code dictates that section 1113/1114 relief be granted only if the union has blessed a specific capital structure for the reorganized company that the union deems workable. A finalized, definitive capital structure is by no means a prerequisite to demonstrating that section 1113/1114 proposals are fair and equitable or otherwise meet the 1113/1114 standards. And plan feasibility is properly addressed only when a debtor seeks confirmation of a particular chapter 11 plan of reorganization. - 3 -
Pg 9 of 250 ARGUMENT A. The Debtors Have Met The Standards For Relief Under Sections 1113 And 1114 (1) The Section 1113/1114 Proposals Were Based on the Most Complete and Reliable Information Available, and the Debtors Have Negotiated in Good Faith As noted in the Motion and explained further in the Declarations, the Debtors Section 1113/1114 Proposals are based on the most complete and reliable information available to the Debtors, including the Debtors most recent Turnaround Plan and cost projections, all of which have been made available to the Unions. See Brown Decl. at 9, 13. The Debtors have thus satisfied their obligation to base the Section 1113/1114 Proposals on the most meaningful financial and statistical information available. See In re Liberty Cab & Limousine Co., 194 B.R. 770, 776 (Bankr. E.D. Pa. 1996) No one has asserted otherwise. 4 In addition, the Debtors have engaged in extensive discussions with the Unions regarding the Proposals. As set forth in the Motion and supporting Declarations, prior to filing their chapter 11 petitions, the Debtors made themselves available for numerous meetings with the IBT and the BCT in their attempt to reach mutually satisfactory modifications. Beginning in mid-2011, the Debtors formally met with the IBT at least nine separate times and with the BCT at least 10 separate times, and had many other email and telephone conversations with the Unions. Driscoll Decl. at 11; Loeser Decl. at 6; Deposition of IBT Vice President and Secretary-Treasurer-elect Ken Hall (the Hall Dep. ) at 52 (Hostess has not failed to meet with IBT at reasonable times to negotiate CBA proposals). Since the Petition Date, negotiations with the IBT and the BCT have continued. See, e.g., Deposition of IBT Director of Research and Strategic Campaigns Iain Gold (the Gold 4 The Debtors anticipate submitting revised proposals on or before March 2, 2012, as provided in the Amended Pre-Trial Scheduling Order (Dkt. No. 275). Information relating to those proposals will be made available to the Unions. - 4 -
Pg 10 of 250 Dep. ) at 91-92. Those efforts will be further detailed in supplemental declarations that will be filed with the Court in accordance with the Amended Pre-Trial Scheduling Order. Moreover, throughout the course of these negotiations, the Debtors have acted in good faith. Indeed, to facilitate negotiations prepetition, the Debtors funded the Unions retention of their financial advisors and attorneys and they have filed a motion to continue doing so postpetition. In addition, as part of the negotiation process, the Debtors have significantly amended their proposals to incorporate Union-proposed changes. Gold Dep. at 72. By any measure, the Debtors have demonstrated good faith. See, e.g., In re Blue Diamond Coal Co., 131 B.R. 633, 646 (Bankr. E.D. Tenn. 1991); In re Sol-Sieff Produce Co., 82 B.R. 787, 795 (Bankr. W.D. Pa. 1988). The IBT claims that, because it is not satisfied with Hostess response to several of the IBT s demands, Hostess has not negotiated in good faith. For example, the IBT claims that Hostess failure to capitulate to the IBT s insistence that Hostess remain in the MEPPs demonstrates a lack of good faith. IBT Obj. at 45. To be sure, Hostess has stood firm in its intention to exit the MEPPs. That position is based on the well-founded proposition that remaining in the MEPPs is a major barrier to attracting new capital. But Hostess has been more than willing to discuss reasonable alternatives, and has proposed a retirement arrangement that it believes could afford greater retirement security to its union employees. In essence, the IBT is arguing that, because the parties have been unable to reach agreement on every issue that has been raised, Hostess has not acted in good faith. Never mind that the parties have been meeting regularly for months and in fact have been able to reach an agreement on a number of key points. Never mind that, in order to do that, Hostess has repeatedly demonstrated a willingness to compromise. Never mind that Hostess has paid for the - 5 -
Pg 11 of 250 IBT s professional advisors. And never mind that, according to one of the IBT s principal negotiators, Hostess has never refused to discuss any issue that has been put on the table. See Hall Dep. at 16-17. By any standard, this is not evidence of lack of good faith. See, e.g., In re Salt Creek Freightways, 47 B.R. 835, 839-40 (Bankr. Wyo. 1985) (finding no bad faith where parties failed to reach agreement on pension trust obligations, stating that failure to reach agreement appears to be the result of the difficultness of the task, rather than the lack of good faith of either party. ); see also Ass n of Flight Attendants-CWA, AFL-CIO v. Mesaba Aviation, Inc., 350 B.R. 435, 457-58 (D. Minn. 2006) (not bad faith for debtor to adhere to 1113 proposal that is essential to reorganization where cost saving target is necessary); In re Bowen Enterprises, Inc., 196 B.R. 734, 744 (Bankr. W.D. Pa. 1996 (good faith requirement satisfied if debtor seriously attempts to negotiate a reasonable modifications of an existing collective bargaining agreement prior to its motion to reject it ). (2) The Debtors Proposals Are Necessary to Hostess Reorganization (a) Viewed as a Whole, the Debtors Section 1113/1114 Proposals Are Necessary As set forth in the Debtors Memorandum of Law (at 8-9), in assessing the section 1113 necessity requirement, a debtor s proposal must be viewed as a whole, and not by its specific elements. See, e.g., In re Horsehead Indus., Inc., 300 B.R. 573, 584 (Bankr. S.D.N.Y. 2003. Thus, a request for relief under sections 1113 or 1114 cannot be defeated by challenging the necessity of particular parts of the proposal if, taken as a whole, the proposal generates the total amount of savings necessary for a successful reorganization. In re Royal Composing Room, Inc., 848 F.2d 345, 349 (2d Cir. 1998) (In re Royal Composing Room II). See also In re Frontier Airlines Holdings, Inc., No. 08-11298 (RDD), 2008 WL 5110927, at *14 (Bankr. - 6 -
Pg 12 of 250 S.D.N.Y. Nov. 14, 2008 (Drain, J.) ( [P]roposal must be viewed as a whole and not piecemeal.... ), vacated on other grounds sub nom. Teamsters Airline Division v. Frontier Airlines, Inc., No. 09 Civ. 343 (PKC), 2009 WL 2168851, at *16 (S.D.N.Y. July 20, 2009). Taken as a whole, the Debtors Section 1113/1114 Proposals are clearly necessary to a successful reorganization. The IBT s lead financial expert largely acknowledges that fact, freely conceding that, in order to succeed, Hostess must address collective bargaining issues, including a number of the work rules and wage and benefit issues. Declaration and Expert Report of Harry J. Wilson (the Wilson Decl. ) at 16(a). Mr. Wilson admits that Hostess must find a way to make past-due investments in its facilities, equipment, marketing and research and development so that it can effectively compete in the marketplace. Wilson Decl. at 16(c). And he recognizes the imperative that Hostess be able to attract[] a high-quality investor or investors to provide the necessary capital the Company needs to exit [bankruptcy]. Wilson Decl. at 16(f). Of course, these objectives lie at the very heart of the Turnaround Plan. And the Debtors Sections 1113/1114 Proposals are the most critical step in attaining them. As Mr. Wilson admits, in order to emerge from chapter 11 as a competitive enterprise with long-term viability Hostess must be able to attract the capital it needs to exit bankruptcy, modernize its facilities and market its products. Without question, that capital will have to include new equity investors. The Debtors advisors have determined that, in order to obtain that capital, the Debtors must be able to assure potential investors that the Debtors may reasonably be expected to eventually achieve EBITDA margins of 11%. Kramer Decl. at 22; Driscoll Decl. at 15. 5 5 Mr. Wilson asserts that targeting an 11% EBITDA margin is unnecessary because EBITDA margins are largely irrelevant to investors. Wilson Decl. at 36(d). To the contrary, however, EBITDA margins are important to investors because they speak to whether a business is being managed sustainably. A low EBITDA margin relative to a company s competition suggests that the company has insufficient - 7 -
Pg 13 of 250 Reducing labor and pension costs is a key component of the Debtors plan to achieve EBITDA margins at the targeted level. The Debtors analyses have revealed that their union employees are receiving total compensation well in excess of the market. Johnson Decl. at 8, 31. In addition, Hostess is confronting MEPP liabilities in the billions of dollars exacerbated by profound uncertainties as to what its future MEPP exposure might be. See Rebuttal Expert Report of Mitchell Hofing attached hereto as Exhibit B (the Hofing Rebuttal Report ) at 19-24; Kramer Decl. at 13-15. At the same time, Hostess is operating under antiquated work rules that severely hinder its ability to grow revenues. Parlato Decl. at 24; Driscoll Decl. at 6. The Section 1113/1114 Proposals seek to address these critical issues so that Hostess can attract the capital it needs to succeed. See In re Delta Air Lines, 351 B.R. 67, 74-76 (Bankr. S.D.N.Y. 2006) (debtors proved necessity with evidence that pay rates, work rules and benefits dramatically exceeded those of their competitors). If the Debtors are unable to implement the Section 1113/1114 Proposals, on the other hand, they almost certainly will be forced to liquidate through a sale of individual brands and assets, resulting in significantly lower returns for all constituents. Kramer Decl. at 27. A (continued ) profitability to remain competitive in the long run and generate appropriate returns. Moreover, until Hostess can achieve EBITDA margins in line with its peers, no reasonable investor would conclude that Hostess has successfully addressed the problems that have lead to two bankruptcies. See Rebuttal Expert Report of Michael A. Kramer attached hereto as Exhibit A (the Kramer Rebuttal Report ) at 8. It is thus not surprising that courts have repeatedly recognized the relevance of EBITDA margins to a restructuring company. See Ass n of Flight Attendants-CWA, AFL-CIO v. Mesaba Aviation, Inc., 350 B.R. at 451 (record supported bankruptcy court s finding that investors would give operating margin significant consideration and that specific EBIT margin was necessary for [debtor] to attract investment to exit bankruptcy and to be competitive with other regional airlines with high EBIT margins ); In re Northwest Airlines Corp., 346 B.R. 307, 323 (Bankr. S.D.N.Y. 2006) (finding debtor s cost savings ask to unions was integral part of business plan, where business plan projected EBITDA margins that were reasonable in the industry and necessary in order to attract new investors and allow the Debtors to exit Chapter 11. ) - 8 -
Pg 14 of 250 liquidation would also likely result in a loss of jobs for most or all of the Debtors 19,000 employees. Kramer Decl. at 27. Implementation of the Section 1113/1114 Proposals is thus necessary to a successful reorganization. See, e.g., In re Northwest Airlines, 346 B.R. 307, 322-24 (Bankr. S.D.N.Y. 2006) (debtors proved necessity under Second Circuit s standard by demonstrating that $195 million ask in section 1113 proposal was necessary, along with savings from other unions and from other initiatives, to obtain 6.5% pre-tax profit margin, which margin was reasonable within the industry and necessary to attract new investors). (b) The IBT Proposes a Necessity Standard That Has No Legal Basis Notwithstanding the frequently-articulated principle that section 1113 proposals are to be assessed as a whole under the necessity standard, the IBT argues that to the extent a union has offered counterproposals to specific elements of a debtor s 1113 proposal, the Court must determine whether each such element is necessary. See IBT Obj. at 32. In addition, the IBT asserts that, under Truck Drivers Local 807 v. Carey Transp. Inc., 816 F.2d 82 (2d Cir. 1987) (Carey Transp. II), a debtor is required to satisfy some heightened necessity standard with respect to proposals made after submission of its initial proposal. IBT Obj. at 31. Lastly, the IBT claims the Court should accord extra weight to the Union s views in analyzing whether Hostess 1113(c) demands are necessary for it to reorganize because workers economic interests are uniquely tied to the economic health of the business. IBT Obj. at 34. None of these arguments is well-founded. As the cases Hostess has cited demonstrate, a number of courts, including this one, have recognized the principle that section 1113 proposals should be assessed as a package, not piecemeal. The IBT has cited no authority to the contrary. - 9 -
Pg 15 of 250 Nor is there anything in Carey Transp. II to support the notion that the necessity requirement becomes more onerous for a debtor as negotiations proceed. Indeed, that view would strongly discourage any negotiation after an initial proposal had been made and thus violate the fundamental purpose of section 1113 encouraging negotiation and consensual agreement. Finally, no court has held that a union s (self-interested) view of what is necessary should control the section 1113 analysis. While, to be sure, there is some alignment between the interests of unions and employers, over a hundred years of labor strife (and the IBT s threat to strike if section 1113 relief is granted in this case) suggests that the alignment is less than perfect. In the end, what is before the Court are the Debtors Section 1113/1114 Proposals. The Court is obliged to determine whether those proposals are necessary to a successful reorganization. And while the IBT is certainly entitled to offer its views on that question, there is no authority for the proposition that those views should be accorded extra weight. Hostess thus fundamentally disagrees with the suggestion that the Court should review the individual components of the Section 1113/1114 Proposals for necessity and apply some heightened standard that attaches extra weight to the IBT s position. But the discussion is largely academic inasmuch as the particular proposal the IBT has focused on withdrawal from the MEPPs is not only necessary, it is perhaps the single most critical element of the Turnaround Plan. And it is an element regarding which the IBT has, in fact, offered no specific counterproposal. - 10 -
Pg 16 of 250 (c) Exiting the MEPPs Is Essential to Attracting the Capital Hostess Needs to Succeed i) MEPP overview MEPPs are collectively-bargained pension plans that provide defined pension benefits to employees or retirees of more than one unrelated employer. Under applicable law, MEPPs that fail to meet statutorily-defined funding targets are characterized as either in endangered status, seriously endangered status or, if worse, critical status. I.R.C. 432. When a MEPP is in critical status, its trustees must develop a rehabilitation plan to improve the funding sufficiently to allow it to exit critical status within a rehabilitation period (typically 10 years). I.R.C. 432(e). In most instances, rehabilitation plans seek to address the MEPP s underfunding by imposing a mix of contribution rate increases on participating employers and pension benefit changes on active participants. Hofing Rebuttal Report at 10, 11. The law recognizes that some critical status MEPPs have such severe funding problems that they cannot be solved within the mandated rehabilitation period. In those cases, the rehabilitation plan must include all reasonable measures to emerge from critical status at a later time or to forestall possible insolvency. 6 See I.R.C. 432(e)(3)(A)(ii); see also Hofing Rebuttal Report at 12. Under ERISA, if a contributing employer permanently ceases to have an obligation to contribute, or permanently ceases all... operations, such employer is deemed to have effected a complete withdrawal from the MEPP. 29 U.S.C. 1383(a). An employer who 6 Each year, the actuary for a MEPP in critical status must certify whether the MEPP is making scheduled progress in meeting the requirements of its rehabilitation plan. See I.R.C. 432(b)(3)(A)(ii). If a MEPP is falling behind on progress under its rehabilitation plan, or fails to satisfy the requirements of its rehabilitation plan at the end of the rehabilitation period (normally 10 years), the trustees will likely be forced to raise employer contributions to attain the projected funding improvement. If no action is taken, the Internal Revenue Code authorizes the imposition of excise taxes on contributing employers in the amount necessary to establish the requisite progress. I.R.C. 4971(g)(3) (excise tax is equal to the amount of the contributions necessary to meet the benchmarks ); Hofing Rebuttal Report at 5 n.6. - 11 -
Pg 17 of 250 withdraws from a MEPP shall be assessed withdrawal liability that reflects the employer s allocable share of the MEPPs unfunded vested benefits. 29 U.S.C. 1382. When several large employers withdraw from a MEPP and fail to pay their withdrawal liability, or when a MEPP is approaching insolvency, the trustees can terminate the plan and force the involuntary withdrawal of all remaining contributing employers effecting a so-called mass withdrawal. 29 C.F.R. 4219. When that occurs, plan liabilities are revalued using PBGC-mandated assumptions (typically increasing the total liability), the withdrawal liability of solvent employers is redetermined, 7 and the withdrawal liability of insolvent employers is reallocated to solvent employers. As a MEPP approaches insolvency, the plan trustees may determine that they have a fiduciary obligation to force a mass withdrawal in order to increase through the mass withdrawal liability payments the amount of funds available to pay accrued pensions under the plan. 8 Hofing Rebuttal Report at 14. ii) There are enormous liabilities and uncertainties associated with Hostess participation in the MEPPs Hostess participates in 40 separate MEPPs, 22 of which provide benefits to IBTrepresented Hostess employees (the IBT MEPPs ). At least 13 of the 22 IBT MEPPs are in critical status, including four out of the five IBT MEPPs with the greatest number of active Hostess employees. These four MEPPs constitute approximately 58% of the IBT-represented employees who receive IBT MEPP benefits. Hofing Rebuttal Report at 15. 7 8 Ordinarily, the amortization term for paying off initial withdrawal liability is capped at 20 years. 29 U.S.C. 1399(c)(1)(B). But when calculating a withdrawn employer s redetermination liability for mass withdrawal purposes, the 20-year cap on payments is lifted, and the mass withdrawal liability amount can potentially become a payment in perpetuity. 29 U.S.C. 1399(c)(1)(D). MEPP pensions are guaranteed by the Pension Benefit Guarantee Corporation (the PBGC ), but the guarantee is modest. 29 U.S.C. 1322a(c)(1). MEPP trustees thus have an incentive to force termination and trigger mass withdrawal payments in order to postpone insolvency. Hofing Rebuttal Report at 6 n.7. - 12 -
Pg 18 of 250 Even more troubling, the Central States, Southeast and Southwest Areas Pension Plan ( Central States ), the IBT MEPP with the greatest number of active Hostess employees, has adopted a rehabilitation plan that concedes that no reasonable measures will allow it to emerge from critical status during the rehabilitation period. The terms of the Central States rehabilitation plans provide for annual increases in contribution rates by all contributing employers upon the expiration of their respective collective bargaining agreements. Hofing Rebuttal Report at 16. Indeed, the Central States fund, which covers nearly 2,500 Hostess employees, is in such distress that its Executive Director and General Counsel has publicly stated it is projected to be insolvent in the next 10-15 years. See Future for Multi-Employer Pension Plans: Hearing before the Comm. on Senate Health, Education Labor and Pensions, 111th Cong. 1, 4 (2010) (statement of Thomas C. Nyhan, Executive Director and General Counsel, Central States, Southeast and Southwest Areas Pension Fund) attached hereto as Exhibit D-1. During the course of labor negotiations with certain other employer contributors, Mr. Nyhan has been more specific, noting that the fund s actuaries are currently projecting that Central States will be insolvent by 2024 (assuming its actuarial assumptions are met). Hofing Rebuttal Report at 17. Numerous risk factors suggest that the MEPPs underfunding problems will get worse in the coming years. As a result, if Hostess remains in the MEPPs, its contribution obligations and contingent withdrawal liability will likely increase substantially. For example, a company that permanently withdraws from a MEPP is liable for its share of the underfunded liability at the time of withdrawal. In many cases, however, withdrawing companies are unable to satisfy that liability. Given the state of the U.S. economy, there is a legitimate risk that other employers will withdraw from the MEPPs and fail to satisfy their withdrawal liability. If that - 13 -
Pg 19 of 250 occurs, those MEPPs will lose important revenue streams, which could substantially increase their underfunding problems. Hofing Rebuttal Report at 20. In addition, many MEPPs are currently understating their liabilities (and therefore their level of underfunding). In order to calculate a MEPP s liabilities, actuaries make assumptions regarding the expected rate of return on the fund s investments. If the actuaries assume higher rates of return, the plans projected liabilities will be lower. Under federal law, investment return assumptions made by a single employer pension plan must equal a certain indexed rate (currently approximately 5%). MEPPs, however, are not subject to investment return assumption limits. And many of them have been making unrealistically optimistic assumptions. Hofing Rebuttal Report at 21. For example, four of the five IBT MEPPs with the most active Hostess employees (covering approximately 58% of all IBT-represented employees) assume investment returns of between 7.5% and 8.5%. As a result, they are likely understating their reported liabilities. 9 The continued use of high return rate assumptions will further increase the underfunding liability associated with these funds. If that occurs, the MEPPs may have to further increase contribution obligations. 10 Hofing Rebuttal Report at 21. And MEPP funding is also subject to demographic risk. As the workforce has aged and industries like trucking and baking contracted, the proportion of retirees to current 9 10 In 2010, IBT s expert, Mr. Wilson, was a candidate for the position of New York state comptroller. In support of his candidacy, Mr. Wilson s campaign released a white paper in which Mr. Wilson called the use of an 8% investment return assumption by pension funds, whether public or corporate, irresponsibly fanciful. Public Pensions: Averting New York s Looming Catastrophe, Taxpayers for Wilson, 31 (Sept. 2, 2010) attached hereto as Exhibit D-2. Mr. Wilson called the state pension fund s use of a higher investment return assumption... to reduce its stated liabilities [a]... twisted practice [that] has no grounding in basic economics or finance or even common sense.... Id. at 22. Some MEPPs in critical status also increase their funding risk by continuing to maintain extremely generous pension accrual rates. For example, Hostess contributes to NETTI on behalf of approximately 700 employees who can earn annual lifetime pensions of between $64,224 and $84,240 after 30 years of service. But the average annual compensation of these employees ranges from $37,000 (at age 25) to $44,000 (at age 55). Hofing Rebuttal Report at 8 n.9. - 14 -
Pg 20 of 250 workers has increased significantly. As this ratio increases, and unless the contribution amounts that participating employers make for active employees increases, underfunding will become more severe. Hofing Rebuttal Report at 23. These risk factors are expected to result in increased underfunding of MEPPs in coming years. As a result, many critical status MEPPs will be forced to increase their rehabilitation efforts. If that occurs, there is a strong likelihood that Hostess future contribution rates will increase. See, e.g., Moody s 2009 Report at 5 ( As rehabilitation plans become evidenced in either current or future labor contracts, we expect that companies operating cost structures will be affected by requirements to increase contributions. ) And if critical status MEPPs facing increased underfunding do not increase contribution obligations, the participating employers could be faced with excise tax liability. If underfunding reaches too high a level, the trustees of a MEPP may choose to terminate the plan, thus causing a mass withdrawal and assessment of mass withdrawal redetermination and reallocation liability, as noted above. Hofing Rebuttal Report at 24. iii) Participation in the MEPPs is a huge obstacle for potential investors In light of the potentially crippling liability exposure posed by the MEPPs, in its Memorandum of Law (at 10) Hostess made the rather unremarkable assertion that the Debtors would likely be unable to attract the capital they need to succeed unless they could cease their participation in the MEPPs. See Kramer Decl. at 23-24. In his declaration, Mr. Wilson largely cedes the point, acknowledging that there are issues with MEPPs, that they are potentially a meaningful deterrent, and that some aspects of MEPPs do discourage investors. Wilson Decl. at 77(c)(i), 78. Nonetheless, he seeks to downplay the MEPP issues, first by noting that multiemployer pension plans are not uncommon (covering about 7% of the U.S. - 15 -
Pg 21 of 250 workforce), and then by identifying a number of seemingly successful S&P companies that participate in MEPPs. Wilson Decl. at 73, 74. 11 Neither point is in issue. But neither responds to the fact that financial experts are growing more and more concerned about the emerging threat of widespread insolvencies among MEPPs. See, e.g., Moody s 2009 Report at 5; George M. Kraw, Four Reforms to Save Multiemployer Plans, BNA Pens. & Ben. Daily, Nov. 17, 2010, at 1-3 ( [W]ithdrawal liability... is a significant financial disincentive for new employers.... Absent a politically unlikely government bailout or significant inflation that washes away the debts of private parties and government alike, there is no scenario in which these plans will be able to pay their full promised pensions under current rules. ) (emphasis added); U.S. Gov t Accountability Office, GAO-11-79, Changes Needed to Better Protect Multiemployer Pension Benefits at 1 (2010) ( Most multiemployer plans report large funding shortfalls and face an uncertain future. ); Paul Secunda, The Forgotten Employee Benefit Crisis: Multiemployer Benefit Plans on the Brink, 21 Cornell J. L. & Pub. Pol y 77, 86 (2011) (describing MEPPs as precarious because contributing employers increasingly are defaulting on their required contributions ); Christine Williamson, Multiemployer Plan Sponsors May Face Peril, Moody's Says, Pensions & Investments, Sept. 29, 2009 (after liquidity shock recently experienced by contributing employers, Standard & Poor s also started to include multiemployer plan implied obligations in 11 One of the companies Mr. Wilson points to in support of the proposition that many successful firms participate in MEPPs is UPS. See Wilson Decl. at 74. Interestingly, however, one cause of the Central States fund s current distress is the decision by UPS in 2007 to voluntarily withdraw from it effectively buying its way out (at a cost of $6.1 billion). See Wesley Smyth, Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern, Moody s Global Corporate Finance, Special Comment (Moody s Investors Serv.), Sept. 2009 at 4 and attached hereto as Exhibit D-3 ( Moody s 2009 Report ). At least as to Central States then, UPS chose to cut its losses by exiting the plan. - 16 -
Pg 22 of 250 corporate credit ratings ). 12 Should such MEPP insolvencies occur, seemingly successful companies participating in those MEPPs might soon find themselves fighting for their survival. Finally, that some other MEPPs may currently be in stable condition is of little consequence; the fact is that, as described above, many of the MEPPs Hostess participates in are most definitely not. Indeed, it is telling that Mr. Wilson says nothing about the current condition of any of the MEPPs in issue. iv) The IBT has offered no specific proposals regarding the MEPPs With respect to the MEPP issue, a final point is critical. Despite the IBT s many allusions to its counterproposals, the fact is it has not offered any proposal that would allow Hostess to reduce significantly and to tolerable levels its liabilities while remaining in the MEPPs. To the contrary, while the IBT has floated the idea of Hostess trying to devise a way to withdraw from, and then re-enter, the MEPPs, with some sort of limitations on liability, the IBT has itself offered nothing by way of a concrete, detailed proposal. 13 Moreover, Hostess has been unable to devise a re-entry alternative, and even if it could, such re-entry would be fraught with risk. Any agreement by the IBT (or any of the other unions) to reduce Hostess MEPP contribution levels would be subject to renegotiation upon expiration of the governing collective bargaining agreements. Because the underfunding of critical status MEPPs is likely to have increased by the time these collective bargaining agreements expire, the IBT will likely pressure Hostess to increase contribution levels at that time, and the critical status MEPP trustees may demand it. Thus, the risk of increases in 12 13 These articles are attached hereto as Exhibits D-3 through D-7. In his declaration, Mr. Wilson states that the IBT has had some discussions about potentially creative structures to assist [Hostess] with [its] cash flow constraints while continuing participation in the MEPPs. Wilson Dec. at 48. While Hostess does not necessarily agree with Mr. Wilson characterization, even he does not suggest that the IBT has offered any concrete re-entry proposal. - 17 -
Pg 23 of 250 Hostess contribution level would not be eliminated, but rather merely deferred. Hofing Rebuttal Report at 26. In addition, if Hostess were to re-enter the MEPPs, it risks re-acquiring a withdrawal liability obligation for any new underfunding in such MEPP. That risk cannot be eliminated. Furthermore, it is highly unlikely that mass withdrawal risk could be eliminated or capped. Hofing Rebuttal Report at 27. In the end, the need for Hostess to extricate itself from the MEPPs could not be clearer. There is simply no viable path to success that includes Hostess remaining in the MEPPs. (3) The Debtors Proposals Are Fair and Equitable (a) The Fair and Equitable Standard Sections 1113(b)(l)(A) and 1114(g)(3) require that a debtor s proposals treat all affected parties fairly and equitably. The purpose of this requirement is to spread the burden of saving the company to every constituency while ensuring that all sacrifice to a similar degree. Carey Transp. II, 816 F.2d at 90 (quoting In re Century Brass Prods., Inc., 795 F.2d 265, 273 (2d Cir. 1986)). Because section 1113 and 1114 motions are frequently made long before a plan of reorganization is proposed, the debtor cannot at the time of the hearing on the motion be expected to guarantee the ultimate treatment of all constituents. See Carey Transp. II, 816 F.2d at 91; In re Kentucky Truck Sales, Inc., 52 B.R. 797, 802 (Bankr. W.D. Ky. 1985). Instead, courts look to changes proposed, as well as concessions already made and likely to be made by creditors, stockholders or owners of the debtor, and other non-union employees. Id. The IBT argues that Hostess employees are not being treated fairly because Hostess will not agree to a final capital structure that gives the employees equity in the reorganized company. IBT Obj. at 15-16, 41-45. Other companies participating in the MEPPs, - 18 -
Pg 24 of 250 along with the MEPPs themselves, claim that they are not being treated fairly because if Hostess is allowed to exit the MEPPs, their MEPP liability will be borne by other plan participants. See generally MEPP Objs. and Competitors Objs. But the IBT s argument is easily rebutted, and neither the MEPPs nor other companies participating in them have standing to have their individual interests considered in connection with a section 1113/1114 motion. (b) Hostess Employees Are Being Treated Fairly and Equitably As set forth in Hostess Motion and Memorandum of Law, the Section 1113/1114 Proposals treat the Unions fairly when compared with the burdens that have been and will be imposed on the Debtors other constituencies. In recent years, the Debtors have imposed significant cutbacks on its management and non-union employees. In fiscal year 2010, for example, the Debtors eliminated more than 10% of their management and non-union jobs. Management and non-union workers have sacrificed retirement benefits and 401(k) match programs, have seen their health care payments increased, and have had other benefits reduced or taken away altogether. As a result, they are now generally compensated at or below market rates when compared with similarly skilled workers in the open market. See Loeser Decl. at 7; see also Rebuttal Expert Report of Dr. John H. Johnson IV attached hereto as Exhibit C (the Johnson Rebuttal Report ) at 21-33 (concluding that Hostess management compensation is below comparable market benchmarks even taking into account the recently proposed incentive plan). The Debtors Union Employees, on the other hand, receive core compensation packages that are well above market. 14 Even if the Section 1113/1114 Proposals are 14 Seeking to rebut this fact, the IBT has submitted the Declaration and Expert Report of Dr. Michael H. Belzer (the Belzer Decl. ). Dr. Belzer claims that, when analyzed regionally rather than nationally, Hostess IBT-represented employees are actually under-compensated compared to the market. Belzer - 19 -
Pg 25 of 250 implemented, the Union Employees would receive compensation packages that are equal to or superior to those of similarly skilled workers in comparable positions. Johnson Decl. at 35. With respect to other stakeholders, the Debtors anticipate that lenders who are fully secured will receive the full amount of their claims. Lenders and other creditors who are undersecured or unsecured will receive less than a full recovery. Current equity holders are likely to suffer a complete loss. In short, any creditors that are advantaged by a successful reorganization in these cases will make fair and equitable sacrifices. The IBT challenges none of this, but claims that the Section 1113/1114 Proposals should not be approved because Hostess has not been willing to reach agreement with the IBT as to a final capital structure for the reorganized company. IBT Obj. at 43. The IBT claims that (1) it should be allowed to assure itself that the capital structure will support long-term success and (2) the union employees are entitled to equity in the reorganized company. IBT Obj. at 17-18, 41-45. On the first point, courts have long recognized that requests for relief under sections 1113 and 1114 on the one hand, and plan confirmation on the other, are separate and distinct procedures that nearly always occur at very different times in a bankruptcy case. Thus, [b]ecause a section 1113 application will almost always be filed before an overall reorganization plan can be prepared, the debtor cannot be expected to identify future alterations in its debt structure. Carey Transp. II, 816 F.2d at 91; In re Northwest Airlines Corp., 346 B.R. at 326; In re Blue Diamond Coal Co., 131 B.R. at 645 ( Congress obviously could not have (continued ) Decl. at 5. As set forth in Dr. Johnson s Rebuttal, however, Dr. Belzer s analysis is fundamentally flawed for a number of reasons, and does little to call into question Dr. Johnson s conclusion that Hostess union employees are receiving substantially above-market compensation. See Johnson Rebuttal Report at 4-5, 9-20. - 20 -
Pg 26 of 250 intended that the court make findings with respect to the likely treatment of creditors and equity security holders under a plan of reorganization.... Since the court may not be able to determine precisely what the relative sacrifices of creditors, equity security holders, and employees will be under a plan... section 1113(c) should not be read to require the court to do the impossible. ) (quoting 5 Collier on Bankruptcy 1113.01[4][d][ii][C] (15th ed. 1990) (citations omitted)); In the Matter of GCI, Inc., 131 B.R. 685, 692 (Bankr. N.D. Ind. 1991) ( the fact that the requested [CBA] modification may... come early in the proceeding and before the precise details of any proposed plan can be known should not be fatal to the motion or preclude a finding that all affected parties will be treated fairly and equitably ); cf. In re Kentucky Truck Sales, 52 B.R. at 802 ( This requirement of equivalent sacrifice does not mean that the debtor must formally propose his plan of reorganization prior to seeking rejection of the collective bargaining agreement. ). Moreover, to the extent the IBT is concerned about whether the Debtors final capital structure will allow Hostess to succeed, that is a judgment solely within the province of the Court. The Debtors will have to make a feasibility showing in order obtain plan confirmation. 11 U.S.C. 1129(a)(11); see, e.g., In re Oneida Ltd., 351 B.R. 79 (Bankr. S.D.N.Y. 2006) (determining feasibility in conjunction with confirmation of plan of reorganization); In re Adelphia Business Solutions, Inc., 341 B.R. 415 (Bankr. S.D.N.Y. 2003) (same). If the IBT has issues with capital structure, it can raise them with the Court in connection with the plan confirmation process. But nothing in the Bankruptcy Code gives the IBT the right to approve a final capital structure at this stage of the case. With respect to the IBT s second point that it is entitled to equity in the reorganized company nothing in sections 1113 or 1114 suggests that union employees who - 21 -
Pg 27 of 250 are otherwise sharing sacrifice in an equitable manner in support of a reorganization have some right to equity participation. As described above, any stakeholder who stands to gain if Hostess is able to successfully reorganize is making (or has made or will make) a material sacrifice. To be sure, if granted, the Section 1113/1114 Proposals will yield millions of dollars in cost savings for Hostess. But cuts that have already yielded substantial savings have been directed at others who were in no position to demand equity in exchange for their sacrifice. Moreover, as to the central focus of the IBT s objection pension benefits Hostess has a particularly strong argument that the union is being treated fairly and equitably. To replace the MEPP pensions, Hostess has proposed implementing two separate single employer retirement arrangements: a single employer defined benefit plan and a single employer defined contribution plan. Employees will participate in both. These plans will provide good benefits and eliminate the risks and uncertainties associated with relying on the MEPPs for a secure retirement. Employees will retain all vested normal retirement rights earned with the MEPPs, but will begin accruing future benefits under the new defined benefit/defined contribution plans. For a variety of reasons, assuming similar contribution levels, many IBTrepresented employees will actually be better off accruing benefits under Hostess new retirement plans than they would be if they remained in the MEPPs. See Hofing Rebuttal at 28 ( I also have concluded that a good portion of Hostess current IBT-represented employees will likely earn greater pensions from single-employer pension arrangements sponsored exclusively by Hostess than they would if Hostess continues to contribute to the MEPPs on their behalf, assuming the same annual contribution levels. ). Lastly, the IBT s claim that the Section 1113/1114 Proposals are not fair and equitable because Hostess is seeking outsized compensation for management (IBT Obj. at 42), - 22 -
Pg 28 of 250 is belied by the facts. The IBT is referring to Hostess current efforts to obtain approval for an incentive plan for certain of its managers. A study completed by Dr. Johnson, however, reveals that, taking into account the incentive plan, Hostess management employees will still be receiving compensation that is below comparable market benchmarks. See Johnson Rebuttal Report at 32-33. (c) Other Employers Participating in the MEPPs and the MEPPs Themselves Have No Right to Have Their Individual Interests Taken into Account in Connection with the Motion BBU and other companies participating in the MEPPs in which Hostess is a participant, along with some of the MEPPs themselves, argue that their individual interests will be unfairly harmed if the Motion is granted. Clearly, however, while the MEPPs (as contrasted with the companies contributing to them) may have a right to be heard on whether the relief requested is in the best interest of the Debtors estates, they have no standing to assert that the Court should take their individual interests into account in passing upon the section 1113/1114 standards. Prior to the enactment of section 1113, the U.S. Supreme Court had recognized that a collective bargaining agreement was an executory contract subject to rejection under section 365(a) the Bankruptcy Code. In response, Congress enacted section 1113 to ensure[] that the debtor attempt to negotiate with the union prior to seeking to terminate a collective bargaining agreement. In re Ionosphere Clubs, Inc., 922 F.2d 984, 989 (2d Cir. 1990). To do this, Congress decided to vary the normal rules for rejecting executory contracts under Section 365... [by] set[ting] up a dynamic where the debtor and its unions are directed to negotiate or act at their peril.... Amended Order Granting in Part and Denying in Part Motion of UAW to Limit Participation in the Hearing on Delphi s Section 1113 and Section 1114 Motion, In re - 23 -
Pg 29 of 250 Delphi Corp., No. 05-44481, at 11 (Bankr. S.D.N.Y. May 26, 2006) (Docket No. 3917) (Drain, J.) ( Delphi ); In re Maxwell Newspapers, Inc., 981 F.2d 85, 90 (2d Cir. 1992) ( the entire thrust of 1113 is to ensure that well-informed and good faith negotiations occur in the market place, not as part of the judicial process ). Accordingly, only the parties who have a right to participate in the CBA negotiations should participate in the hearing on whether the debtor s proposal during negotiations was necessary and fair and whether the union lacked good cause. Delphi at 11; In re UAL Corp., 408 F.3d 847, 851 (7th Cir. 2005). Both BBU and the MEPPs cite section 1109(b) of the Bankruptcy Code as a basis for their claim of standing. BBU Obj. 14; BCT MEPP Obj. at 6 n.4; IBT MEPPs Obj. 13. Setting aside the question of whether employers participating in the MEPPs (as opposed to the MEPPs themselves) are parties in interest under section 1109(b) in the first instance, the fact is section 1109(b) is irrelevant. Specific creditors have no individual interests that are protected by section 1113, and thus they have no right to be heard in connection with the specific requirements of section 1113. Delphi at 13; accord In re UAL Corp., 443 F.3d 565 (7th Cir. 2006) (section 1113 does not create negotiating rights for creditors); cf. In re Tower Automotive, Inc., 342 B.R. 158, 162 (Bankr. S.D.N.Y. 2006) (while necessity and fairness language in section 1114 protect retirees, [g]eneral unsecured creditors have no such specific protection in Chapter 11, either with respect to the process of bargaining or the substantive provisions of a plan ). 15 15 Section 1109(b) does not trump section 1113 s specific purpose. In re Chrysler LLC, 405 B.R. 79, 81 (Bankr. S.D.N.Y. 2009) ( standing to be heard under 1109(b) does not automatically impart upon the Court the ability to adjudicate all issues raised by parties in interest ). Nor does it override the practical concern raised by the Seventh Circuit in In re UAL Corp., 408 F.3d at 851, that the section 1113 process would become unmanageable if any party in interest were allowed an absolute right to appear. See In re Refco, Inc., 505 F.3d 109, 118-19 (2d Cir. 2007) ( [I]t is important that a bankruptcy court is not too facile in granting applications for standing. Overly lenient standards may potentially over-burden the reorganization process by allowing numerous parties to interject themselves into the case on every issue, thereby thwarting the goal of a speedy and efficient reorganization. ) (quoting In re Ionosphere Clubs, Inc., 101 B.R. 844, 850-51 (Bankr. S.D.N.Y. 1989)); In re Quigley Co., Inc., 391 B.R. 695, 702-3 (Bankr. - 24 -
Pg 30 of 250 To the contrary, debtors seeking relief under sections 1113 and 1114 need only protect the interests of the estate and parties in interest generally, on a business judgment standard under the Second Circuit s Orion Pictures and Lionel cases. Delphi at 12 (emphasis added). Application of the business judgment standard does not require a debtor to give special consideration to the interests of any individual creditor so long as the section 1113 motion would benefit the estate as a whole. See In re UAL Corp., 443 F.3d at 571-72 ( whether the [CBA modification] makes good business sense and does not disturb the creditors rights inter se [] do not... requir[e] the debtor to negotiate with creditors seeking special consideration just because they may be in a position to throw a monkey wrench into a transaction otherwise highly advantageous to the debtor and the creditors as a whole ); cf. In re Old Carco LLC, 406 B.R. 180, 192 (Bankr. S.D.N.Y. 2009) (when applying business judgment rule, court may not disapprove debtor s decision to reject executory contract even if rejection could ruin the counterparty, so long as estate as a whole would benefit), reh g denied, 423 B.R. 40 (Bankr. S.D.N.Y. 2010). Perhaps mindful of these principles, some of the MEPPs also argue that they are interested parties under section 1113(d)(1) because they will be directly affected by the withdrawal of the Debtors. IBT MEPPs Obj. 17. But just like the pension fiduciary in In re UAL, 408 F.3d at 851, the MEPPs are not in a position to participate in the collective bargaining process. Professional Adm rs Ltd. v. Kopper-Glo Fuel, 819 F.2d 639, 643-44 (6th Cir. 1987) ( federal labor policy demand[s] that the trustees operate independently of the collective bargaining process ); Chaterlain v. Lloyd, No. 08-400-C, 2009 WL 3672888, at *3 (continued ) S.D.N.Y. 2008) ( Prudential limitations on standing play an especially important role in bankruptcy [which]... is often a zero-sum game in which every creditor may be affected by a dispute. ). - 25 -
Pg 31 of 250 (M.D. La. Nov. 3, 2009) (MEPP trustees have a role only in matters of fund administration, not issues that are properly the subject of collective bargaining ). Rather, their job is to wait for the employer and its unions to decide on the terms of the CBAs, and only then to collect required employer contributions and make distributions to beneficiaries in accordance with the plan documents. It is not the MEPPs role to interfere with the bargaining process by cheerleading for one side or the other. See NLRB v. AMAX Coal Co., 453 U.S. 322, 336-37 (1981) (management and union-appointed trustees do not bargain to set terms of CBA; they enforce obligations, once decided upon, without regard to interests of either union or employer). Nor do they have authority to require any contributions not required by the CBAs. Id. Since the MEPPs have no role in the collective bargaining process, they have no basis for being heard on a Section 1113 motion on the merits. Delphi at 10-11. BBU likewise claims standing as an interested party under section 1113(d)(1), analogizing its role to that of a guarantor. BBU Obj. 19. The analogy fails. To be sure, in In re UAL Corp., the Seventh Circuit held that the debtor could not terminate its pension obligations pursuant to section 1113 without the involvement of the guarantor, the PBGC. 408 F.3d at 851. But that decision was based on unique statutory requirements expressly afforded to the PBGC with respect to attempts to terminate ERISA pension plans. Cf. In re Kaiser Aluminum Corp., 456 F.3d 328 (3d Cir. 2006) (debtor cannot terminate insolvent single employer pension plan until separate proceeding involving PBGC is initiated under 29 U.S.C. 1341, even if section 1113 relief has already been granted). Unlike the PBGC, BBU has no say at all with respect to any voluntary modification of the Debtors CBAs. Under ERISA, the Debtor is liable to the plan alone for withdrawal, and BBU has no power to enforce that payment. Gerhardson v. Gopher News Co., - 26 -
Pg 32 of 250 Civ. No. 08-537 (JRT/JJG), 2009 WL 3242024, at *3 (D. Minn. Sept. 30, 2009) (emphasis in original). Because BBU s consent would be unnecessary to a voluntary change in the agreement, there is no reason to include [it] in the 1113 proceeding.... In re UAL, 408 F.3d at 851. Ultimately, BBU stakes its guarantor analogy on the fact that it would be adversely affected if the MEPPs do not recover in full on their withdrawal liability claims. But the Second Circuit has held that a derivative interest in another creditor s recovery does not give rise to standing to be heard in bankruptcy proceedings. In re Refco, Inc., 505 F.3d at 117 (no right to be heard based on assertion of right that is purely derivative of another party s rights in the bankruptcy proceeding ); In re Saint Vincents Catholic Medical Centers of New York, 429 B.R. 139, 148 (Bankr. S.D.N.Y. 2010) ( [t]he real party in interest is the one who, under the applicable substantive law, has the legal right which is sought to be enforced or is the party entitled to bring suit ) (quoting In re Comcoach Corp., 698 F.2d 571, 573 (2d Cir. 1983)); Southern Blvd., Inc. v. Martin Paint Stores (In re Martin Paint Stores), 207 B.R. 57, 61 (S.D.N.Y. 1997) ( deep[] concern[] about the bankruptcy proceeding, such as interest in seeing another creditor recover in full, does not confer standing). BBU s interest as a competitor is likewise unprotected by section 1113. See In re Smith Mechanical Contractors, Inc., No. 95-60030-S-11, 1995 WL 864676, at *6 (Bankr. W.D. Mo. June 26, 1995) ( The Bankruptcy Code focuses only on the Debtor before it, and not the industry or the competitors of the Debtor.... It does not make sense to turn over the fate of a bankruptcy debtor to a multiemployer bargaining unit which consists of a group of the Debtor s competitors. ); cf. Borman s Inc. v. Allied Supermarkets, Inc., 706 F.2d 187 (6th Cir. 1983) (competitor s interest in holding debtor to terms of CBA negotiated by multiemployer bargaining - 27 -
Pg 33 of 250 unit does not outweigh interests of debtor and its union in maximizing likelihood of successful reorganization), cert. denied, 464 U.S. 908 (1983). Thus, neither the MEPPs status as unsecured creditors, nor BBU s competitive interest in limiting the cost of its own union contracts and minimizing the Debtors comparative advantage upon emergence from bankruptcy, is relevant to the section 1113 analysis. Even if the interests of the other MEPP employers, and of the MEPPs, were taken into account, section 1113 relief here would be fair and equitable. First, all employer participants entered the MEPPs with their eyes open. The potential for shared liability lies at the foundation of multiemployer pension plans. Participating employers and the MEPPs to which they contribute have always understood that, if one of the participating employers fails, the others are liable for that employer s MEPP contributions. Indeed, that shared liability is one of the reasons why Hostess finds itself in bankruptcy. A number of the MEPPs in which Hostess has been a participant have lost contributing employers and foisted upon the other members (including Hostess) increased contributions to shoulder that loss. If anything, the objections filed by the other employers and the MEPPs prove the breadth and depth of the predicament confronting Hostess. Whether Hostess is permitted to exit the MEPPs or not, other employers will. And even were that not the case, there is still the very real possibility that, because of unrealistically optimistic actuarial and investment assumptions, future participants are going to see enormous increases in their MEPP liability. Hostess can successfully reorganize or it can liquidate. But it cannot remain in the MEPPs with the attendant looming liabilities. At bottom, the other employers and the MEPPs are simply voicing their displeasure with fundamental principles of the Bankruptcy Code. As unsecured creditors, the - 28 -
Pg 34 of 250 MEPPs will have sizeable claims against the Debtors for their withdrawal liability. Those claims will, under the Bankruptcy Code s priority rules, be in line behind the secured claims. The MEPPs will get all they are entitled to: the opportunity to share whatever assets are made available to the unsecured creditors, which will certainly be no worse than would be the case were Hostess forced to liquidate. See In re Elec. Contracting Servs. Co., 305 B.R. 22, 33 (Bankr. D. Co. 2003) (multiemployer fund s withdrawal liability claim would be no better off if debtor is not allowed to reject its CBA and forced instead to liquidate). As for the other MEPP employers, they are not the first to question the fairness of the bankruptcy process. To be sure, the Bankruptcy Code permits debtors to discharge liabilities, reject bad contracts, and otherwise reorder their affairs in ways that are not available to competitors operating outside of bankruptcy. Thus, the operation of the Bankruptcy Code does have competitive implications. To the extent parties may find that objectionable, the appropriate forum is Congress, not this Court. (4) The IBT Does Not Have Good Cause To Reject the Proposals To reject a collective bargaining agreement or modify retiree benefits, the debtor must demonstrate that the union refused to accept the debtor s proposals without good cause. 11 U.S.C. 1113(c)(2) and 1114(g)(2). The burden lies with the union to articulate in detail its reasons for declining to accept the debtor s proposals. See Carey Transp. II, 816 F.2d at 92. In doing so, the union cannot base its rejection from the viewpoint of [its] self-interest. Rather, everyone s focus must instead be placed on what is necessary to permit reorganization under chapter 11. See, e.g., In re Carey Transp., Inc., 50 B.R. 203, 211 (Bankr. S.D.N.Y. 1985) (Carey Transp. I) (quoting In re Salt Creek Freightways, 47 B.R. at 840), aff d, Carey Transp. II, 816 F.2d 82. - 29 -
Pg 35 of 250 In claiming that it has good cause to reject the Section 1113/1114 Proposals, the IBT largely rehashes its arguments regarding the MEPPs and the need for a final, agreed-upon debt structure. See IBT Obj. at 35-40. It claims that it has good cause to reject because Hostess has not proven that it needs to exit the MEPPs, and because the IBT is entitled to assess whether the reorganized company s final debt structure is sound. IBT Obj. at 38, 39. With respect to the MEPPs, Hostess has made a compelling showing that a successful reorganization very much depends on its leaving those plans. Moreover, as noted above, the IBT has not offered any specific alternative proposal with respect to the MEPPs. Offering to discuss any proposal Hostess might devise to withdraw from and then re-enter the MEPPs, with some non-specific agreement as to limitations on liability, is a far cry from the sort of specific proposal that might give the IBT a good faith basis for rejection. See In re Maxwell Newspapers, Inc., 981 F.2d at 90 (to support good cause, union alternative must focus[] on the needs of its employer s reorganization ); cf. In re Kentucky Truck Sales, Inc., 52 B.R. at 805 (no good cause to reject debtor s proposal to cease contributions to Teamsters multiemployer health and pension plan; union made no concrete counter-offer showing debtor s proposal was unnecessary); see also In re Elec. Contracting Servs. Co., 305 B.R. at 32 (no good cause to reject proposal out of concern for impact on contracts with other employers). Indeed, the very case the IBT relies upon, Carey Transp. II., focused on whether the union s counterproposal offered an equally effective set of modifications. 816 F.2d at 91-92. Here, the IBT has made no counterproposal pertaining to the MEPPs at all. It has not identified any lenders or investors who are willing to make a proposal that is not premised on Hostess leaving the MEPPs. 16 Rather, it has offered its unsubstantiated conjecture that there may 16 The IBT s vague reference to unidentified credible investors who are willing to evaluate an investment that is not conditioned upon Hostess withdrawal from the MEPPs (see IBT Obj. at 38) is by no measure a - 30 -
Pg 36 of 250 be a way to successfully reorganize without getting out of the MEPPs. The IBT s wishful speculation cannot be good cause for rejecting the Section 1113/1114 Proposals. Nor can good cause for rejection be found in the IBT s insistence that Hostess come to an agreement on capital structure. See IBT Obj. at 39. As noted above, the Debtors will be required to demonstrate feasibility in order to confirm any plan of reorganization. Thus, they will emerge from these cases only upon a demonstration that they are not taking on excessive debt, and otherwise are in a position to succeed. Particularly in light of the practical difficulties associated with attempting to finalize a definitive capital structure at this stage of the case, the IBT s insistence that Hostess do so is likewise not good cause for rejection. (5) The Balance of Equities Favors Implementation of the Proposals With respect to balancing the equities, the IBT has focused primarily on the third prong of the six-part test, which is the likelihood and consequences of a strike if the bargaining agreement is avoided. IBT Obj. at 46-48. The IBT points out that its members could strike if its CBAs were rejected, and that an affirmative strike vote has been taken. But it says nothing about the actual likelihood of a strike should the Motion be granted. Surely, merely alluding to a right to strike is not enough to tip the equities against section 1113 relief. If it were, such relief would never be granted. Moreover, as Hostess has repeatedly emphasized, in the absence of section 1113/1114 relief here, it will be forced to liquidate. Thus, the consequences of a strike will not be materially different than the consequences of an order denying the Motion. See Ass n of Flight Attendants-CWA, AFL-CIO (continued ) specific proposal that would allow Hostess to remain in the MEPPs. Moreover, it now appears that there was only one such investor, KPS, and Mr. Hall understood that in fact KPS was not interested in making any investment unless something could be done about Hostess $2 billion of MEPP withdrawal liability. Hall Dep. at 91. - 31 -
Pg 37 of 250 v. Mesaba Aviation, Inc., 350 B.R. at 463 (upholding bankruptcy court finding that while potential strike would be devastating, debtor would be liquidated in absence of labor cuts, so threat of strike did not justify denying 1113 motion); In re Horsehead Indus., Inc., 300 B.R. at 587 ( A strike is an inherent risk in every 1113 motion, and in the end, it makes little difference if the Debtors are forced out of business because of a union strike or the continuing obligation to pay union benefits to avoid one. The unions may have the legal right to strike, but that does not mean that they must exercise that right. The union s right to strike carries with it the burden of holding the fate of the rank and file in its hands. Little purpose would be served by a strike if a strike results in the termination of operations and the loss of jobs by the strikers. ). The IBT mentions only one other prong of the balancing equities test, arguing that its employees do not have the same cost-sharing abilities as Hostess other creditors. IBT Obj. at 49-50. But that same prong requires a consideration of how various employees wages and benefits compare to those of others in the industry. Carey Transp. II, 816 F.2d at 93. Here, Dr. Johnson s study reveals that the compensation of Hostess union employees is well above market undermining the IBT s cost-sharing point. The other four prongs of the applicable standard all weigh in Hostess favor. See discussion in Debtors Memorandum of Law at 19-21. B. The Debtors Decision To Temporarily Cease Making Some MEPP Contributions Does Not Preclude Section 1113/1114 Relief Lastly, the IBT argues that Hostess is barred from the relief it seeks under section 1113(f) (IBT Obj. at 25-26), which provides that [n]o provision of this title shall be construed to permit a trustee to unilaterally terminate or alter any provisions of a collective bargaining agreement prior to compliance with the provisions of this section. (Emphasis added.) This subsection makes it clear that once a bankruptcy petition has been filed, section 1113 affords - 32 -
Pg 38 of 250 the only basis for rejecting or amending a CBA. That is, section 1113(f) is not implicated where the conduct at issue occurs prepetition. In In re Indiana Grocery Co., Inc., 138 B.R. 40 (Bankr. S.D. Ind. 1990), for example, the court rejected the argument that the debtor s allegedly illegal prepetition modification of its CBAs precluded it from seeking postpetition relief from the CBAs under section 1113. The court held that prepetition conduct may be found to have been an unfair labor practice, but [it] cannot be violations of section 1113, since prior to filing for relief in bankruptcy, that section had no application. Id. at 46-47; accord, In re Jones Truck Lines, Inc., 130 F.3d 323, 330 (8th Cir. 1997) ( Section 1113(f)... refers to post-petition conduct ) (emphasis added). Nevertheless, the IBT notes that the Debtors unilaterally terminated their MEPP contribution obligations months before the bankruptcy filing by temporarily suspending payments due to some of its MEPPs, arguing that the failure to make these payments estops Hostess from rejecting the CBAs now. IBT Obj. at 25-26. Clearly, however, the Debtors decision to suspend temporarily making certain payments prepetition was not a rejection of the CBAs at all, but rather a simple breach. As the IBT admits, at the time, Hostess clearly stated that it was a temporary suspension and that the failure to make the payments created a deferred obligation. IBT Obj. at 13. Indeed, Hostess never denied the existence of its obligations and has continued to operate under the CBAs. Thus, while Hostess may have breached certain contractual obligations, it has neither terminated, nor altered any provision of, the CBAs. See In re Moline Corp., 144 B.R. 75, 79 (Bankr. N.D. Ill. 1992) ( [W]hile the debtor in possession..., by failing to make payments when due may have breached the collective bargaining agreement, the debtor - 33 -
Pg 39 of 250 has neither altered nor terminated the collective bargaining agreement.... No rights under the contract have been terminated. The contract is exactly the same collective bargaining agreement the parties entered into before the Chapter 11 case. Therefore, the debtor has not violated 1113(f). ). Simply stated, a debtor who fails to meet a payment obligation under its collective bargaining agreement and then treats the unpaid obligation as a claim does not violate section 1113(f). See In re Ionosphere Clubs, Inc., 22 F.3d 403, 407 (2d Cir. 1994) ( [A]pplication of the priority scheme of section 507 will not allow [the debtor] unilaterally to modify or terminate its obligations under the CBAs. ). The IBT cites In re Alabama Symphony Ass n, 211 B.R. 65, 69 (N.D. Ala. 1996) for the surprising proposition that Hostess prepetition breach of some its CBAs precludes postpetition rejection of those CBAs under section 1113. In Alabama Symphony, the district court did indeed reverse the bankruptcy court and rule that the prepetition breach of a collective bargaining agreement precluded postpetiton rejection of that CBA under section 1113. But the court s analysis is fundamentally flawed. First, it disregarded the plain terms of the statute in failing to recognize that section 1113(f) limits only the postpetition conduct of a trustee and has no application to conduct occurring prepetition. Second, the court failed to grasp the plain distinction between the outright repudiation or termination of a contract and a simple breach. If Alabama Symphony is correct, then a debtor can never seek under section 1113 to reject a CBA that the debtor had breached in any way. That is a draconian limitation that section 1113(f) was never intended to impose. In re Kentucky Truck Sales, Inc., 52 B.R. at 799 n.5 (failure to make contributions to multiemployer health and welfare fund is technical breach with no bearing on motion to reject CBA); In re Elec. Contracting Servs. Co., 305 B.R. at 30-31 (denial of rejection motion for 1113(f) violation imposes death penalty on - 34 -
Pg 40 of 250 reorganization contrary to chapter 11 purpose). It would mean that debtors would have to cure any prepetition CBA defaults in order either to reject or to assume the CBA. However, the Second Circuit has held that the section 1113(f) cannot be construed to modify the normal chapter 11 claims priority scheme. In re Ionosphere, 22 F.3d at 407; see also In re Moline, 144 B.R. at 79 ( There is simply no indication that Congress intended 1113(f) to be a superpriority provision for prepetition claims.). Hostess prepetition breach of its obligations to make payments to the MEPPs was in no way a repudiation or termination of the underlying CBAs. Section 1113(f) has no application here. CONCLUSION For the reasons set forth above and in the Debtors Motion and Memorandum of Law, the Section 1113/1114 Proposals set forth modifications to the Debtors Collective Bargaining Agreements and Benefit Obligations that are critical to a successful reorganization. The Debtors have met the standards for relief under sections 1113 and 1114. The Debtors ask the Court to grant that relief so that they have the opportunity to emerge from these chapter 11 cases as a competitive and sustainable enterprise. - 35 -
Pg 41 of 250 Dated: February 29, 2012 New York, New York Respectfully submitted /s/ Corinne Ball Corinne Ball Heather Lennox Lisa Laukitis Steven Bennett Michael D. Silberfarb JONES DAY 222 East 41st Street New York, New York 10017 Telephone: (212) 326-3939 Facsimile: (212) 755-7306 - and - Todd S. Swatsler Robert W. Hamilton JONES DAY 325 John H. McConnell Boulevard Suite 600 Columbus, Ohio 43215 Telephone: (614) 469-3939 Facsimile: (614) 461-4198 ATTORNEYS FOR DEBTORS AND DEBTORS IN POSSESSION - 36 -
Pg 42 of 250 Exhibit A Kramer Rebuttal Report
Pg 43 of 250 JONES DAY 222 East 41st Street New York, New York 10017 Telephone: (212) 326-3939 Facsimile: (212) 755-7306 Corinne Ball Heather Lennox Lisa Laukitis Steven C. Bennett Michael D. Silberfarb - and - JONES DAY 325 John H. McConnell Boulevard Suite 600 Columbus, Ohio 43215 Telephone: (614) 469-3939 Facsimile: (614) 461-4198 Todd S. Swatsler Robert W. Hamilton Attorneys for Debtors and Debtors in Possession UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK ---------------------------------------------------------------x : In re : : Hostess Brands, Inc., et al., 1 : : Debtors. : : ---------------------------------------------------------------x Chapter 11 Case No. 12-22052 (RDD) (Jointly Administered) REBUTTAL EXPERT REPORT OF MICHAEL A. KRAMER IN FURTHER SUPPORT OF MOTION OF DEBTORS AND DEBTORS IN POSSESSION TO (A) REJECT CERTAIN COLLECTIVE BARGAINING AGREEMENTS AND (B) MODIFY CERTAIN RETIREE BENEFIT OBLIGATIONS, PURSUANT TO SECTIONS 1113(C) AND 1114(G) OF THE BANKRUPTCY CODE 1 The Debtors are the following six entities (the last four digits of their respective taxpayer identification numbers follow in parentheses): Hostess Brands, Inc. (0322), IBC Sales Corporation (3634), IBC Services, LLC (3639), IBC Trucking, LLC (8328), Interstate Brands Corporation (6705) and MCF Legacy, Inc. (0599). NYI-4432994v2
Pg 44 of 250 I, Michael A. Kramer, declare under penalty of perjury as follows, pursuant to the provisions of 28 U.S.C. 1746: 1. I submit this Rebuttal Expert Report in further support of the Motion of Debtors and Debtors in Possession to (a) Reject Certain Collective Bargaining Agreements and (b) Modify Certain Retiree Benefit Obligations, Pursuant to Sections 1113(c) and 1114(g) of the Bankruptcy Code (the Motion ). Except as otherwise indicated, all facts set forth herein are based upon my personal knowledge, my review of relevant documents, my opinion, my experience as a financial professional and with the Debtors businesses or my conversations with the Debtors employees. If called on to testify, I could and would testify to the facts and opinions set forth herein. I. THE DEBTORS INABILITY TO ATTRACT CAPITAL 2. As detailed in my expert report, to have any chance of restructuring as a stand-alone entity with long-term viability, Hostess must raise substantial capital (likely in the form of equity) to fund its exit from bankruptcy and to make the expenditures necessary to compete in the national baked goods industry. In addition, Hostess cannot restructure without the support of its secured lenders. 3. In his expert report, the IBT s lead financial advisor, Harry Wilson, acknowledges that the IBT MEPPs are potentially a meaningful deterrent to prospective equity investors; however, Mr. Wilson suggests that because some successful companies participate in multiemployer pension plans, Hostess MEPP liability will not be a significant deterrent to investors. 2 I disagree. 4. The majority of the MEPPs in which Hostess currently participates are 2 Declaration and Expert Report of Harry J. Wilson at 77. NYI-4432994v2-2-
Pg 45 of 250 significantly underfunded. Indeed, it is my understanding that the MEPPs covering a considerable portion of Hostess IBT employees suffer from so much underfunding that they have been statutorily deemed to be in critical status. To my knowledge, the trustees of these MEPPs have instituted rehabilitation plans. These rehabilitation plans require the MEPPs to improve their funding status, which is often accomplished through increases in contribution levels of participating employers. 5. As a result, if Hostess continues to participate in the MEPPs, it will be exposed to exogenous factors (not related to its baking operations) that could dramatically increase its contribution obligations and/or withdrawal liability. Increases in the contribution obligations will divert Hostess cash flow from Hostess operations and investor returns to the MEPPs. Because the ratio of Hostess cash flow to MEPP contribution obligations is significant, Hostess is particularly vulnerable to increases in contribution obligations. If Hostess remains in the MEPPs and contribution levels continue to rise, Hostess likely will be unable to make necessary expenditures to improve its operations, develop new products or adequately market its existing products. Nor will Hostess have the cash to attract and retain talented employees or the profitability to attract capital. This would significantly reduce the value of any equity investment in Hostess. 6. Moreover, if, in the future, Hostess were facing financial distress, or even if it was forced into bankruptcy, any new equity investor claims would be subordinated to MEPP withdrawal liability claims. This would reduce the likelihood that an investor would put new capital into Hostess today. Similarly, to the extent that this liability continues to exist it will limit potential investors ability to exit and monetize their investment. 7. Given the risks described above, I find it unlikely that any investor would NYI-4432994v2-3-
Pg 46 of 250 provide capital to Hostess in the form of equity were Hostess to remain in the MEPPs. Moreover, even if an investor were found, the secured lenders have indicated that they would prefer a liquidation over continuing to lend capital to a company with MEPP participation and attendant liability risk. I find this to be a reasonable position. II. RELEVANCE OF EBITDA TARGETS 8. Mr. Wilson argues that investors will be relatively indifferent to Hostess EBITDA margin so long as Hostess generates sufficient cash flow to manage the business in a sustainable way. 3 I disagree. EBITDA margin is a useful measure of whether a business is being managed sustainably. A low EBITDA margin relative to a company s competition suggests to an investor that the company has insufficient profitability to stay competitive in the long run and to generate appropriate returns. Moreover, until Hostess is capable of achieving EBITDA margins in line with its peers, no reasonable investor would conclude that Hostess has successfully addressed the underlying problems that have caused its continual financial distress, including its two bankruptcies. I declare under penalty of perjury, pursuant to 28 U.S.C. 1746, that the foregoing declaration is true and correct. Dated: February 25, 2012 /s/ Michael A. Kramer Michael A. Kramer 3 Declaration and Expert Report of Harry J. Wilson at 36. NYI-4432994v2-4-
Pg 47 of 250 Exhibit B Hofing Rebuttal Report
Pg 48 of 250 JONES DAY 222 East 41st Street New York, New York 10017 Telephone: (212) 326-3939 Facsimile: (212) 755-7306 Corinne Ball Heather Lennox Lisa Laukitis Steven C. Bennett Michael D. Silberfarb - and - JONES DAY 325 John H. McConnell Boulevard Suite 600 Columbus, Ohio 43215 Telephone: (614) 469-3939 Facsimile: (614) 461-4198 Todd S. Swatsler Robert W. Hamilton Attorneys for Debtors and Debtors in Possession UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK ---------------------------------------------------------------x : In re : : Hostess Brands, Inc., et al., 1 : : Debtors. : : ---------------------------------------------------------------x Chapter 11 Case No. 12-22052 (RDD) (Jointly Administered) REBUTTAL EXPERT REPORT OF MITCHELL HOFING IN SUPPORT OF MOTION OF DEBTORS AND DEBTORS IN POSSESSION TO (A) REJECT CERTAIN COLLECTIVE BARGAINING AGREEMENTS AND (B) MODIFY CERTAIN RETIREE BENEFIT OBLIGATIONS, PURSUANT TO SECTIONS 1113(C) AND 1114(G) OF THE BANKRUPTCY CODE 1 The Debtors are the following six entities (the last four digits of their respective taxpayer identification numbers follow in parentheses): Hostess Brands, Inc. (0322), IBC Sales Corporation (3634), IBC Services, LLC (3639), IBC Trucking, LLC (8328), Interstate Brands Corporation (6705) and MCF Legacy, Inc. (0599). NYI-4432515v7
Pg 49 of 250 I, Mitchell Hofing, declare under penalty of perjury as follows, pursuant to the provisions of 28 U.S.C. 1746: 1. I am a co-founder of Dexter Hofing, LLC ( Dexter Hofing ), an actuarial consulting firm located at 1221 Avenue of the Americas, Suite 4200, New York, New York 10020. Dexter Hofing has served as a consultant to Hostess Brands, Inc. and the other abovecaptioned debtors and debtors-in-possession (collectively, the Debtors or Hostess ) since it was founded on April 8, 2011. I submit this Rebuttal Expert Report in support of the Motion of Debtors and Debtors in Possession to (a) Reject Certain Collective Bargaining Agreements and (b) Modify Certain Retiree Benefit Obligations, Pursuant to Sections 1113(c) and 1114(g) of the Bankruptcy Code (the Motion ). Except as otherwise indicated, all facts set forth in this Rebuttal Expert Report are based upon my personal knowledge, my review of relevant documents, my opinion, my experience as an actuarial consultant specializing in consulting with respect to multiemployer pension plans, or my conversations with Hostess representatives, representatives of various multiemployer pension plans covering employees represented by local unions affiliated with the International Brotherhood of Teamsters (the IBT ), industry experts and other consultants. If called on to testify, I could and would testify to the facts and opinions set forth herein. I. BACKGROUND AND QUALIFICATIONS 2. Dexter Hofing is an actuarial consulting firm specializing in advising employers with respect to multiemployer pension plan issues. Dexter Hofing advises its clients on identifying and managing the risks in connection with participation in, and exit from, multiemployer pension plans. NYI-4432515v7-2-
Pg 50 of 250 3. I formed Dexter Hofing in 2011. Prior to 2011, I worked for 13 years at Mercer LLC ( Mercer ), where I concentrated on providing consulting advice to employers on pension plans. Since 2007, the primary focus of my work has been on multiemployer pension plan issues, including advising multiemployer pension plans themselves. I am familiar with the funding status of many multiemployer pension plans, including several plans covering current and past employees represented by the IBT. Although I do not practice law, I am generally familiar with the legal rules governing the funding of multiemployer plans. 4. I am an Enrolled Actuary, a Fellow of the Society of Actuaries, a Fellow of the Conference of Consulting Actuaries and a Member of the American Academy of Actuaries. I received my undergraduate degree in 1983 from Yale University, with a B.S. in mathematics, and a J.D. from New York University in 1993. 5. I initially was engaged by Hostess in June 2009, when I was still employed at Mercer. I was originally engaged by Hostess to estimate Hostess potential withdrawal liability from specific multiemployer pension plans. My more recent work with Hostess has also included modeling pension proposals. 6. My CV is attached hereto as Exhibit A. I have not authored any publications in the past 10 years. I have not testified as an expert in the previous four years. In connection with my work performed for Hostess, I am charging my hourly rate of $500. I am not being separately compensated for expert service and testimony in this case. My compensation, and Dexter Hofing s remuneration, does not depend upon the outcome of the Motion. II. SUMMARY OF CONCLUSIONS 7. Pursuant to numerous collective bargaining agreements, Hostess is required to contribute to 24 separate Taft-Hartley multiemployer pension plans (collectively, NYI-4432515v7-3-
Pg 51 of 250 such multiemployer plans, the MEPPs ) for the benefit of employees represented by the IBT and/or the Bakery, Confectionary, Tobacco and Grain Workers International Union (the international union, together with its 35 local affiliates, the BCT ). 2 8. In his expert witness report, Harry Wilson argues that Hostess participation in the MEPPs will not be a significant deterrent to potential investors or purchasers. 3 Although I cannot opine on what the risk tolerance may be of an investor, I have concluded that employer contributors to the MEPPs, including Hostess, face risks of unpredictable contribution increases and significant withdrawal liability obligations. 9. In addition, I have concluded that a good portion of Hostess current IBTrepresented employees will likely earn greater pensions from single-employer pension arrangements sponsored exclusively by Hostess than they would if Hostess continues to contribute to the MEPPs on their behalf, assuming the same annual contribution levels. III. MULTIEMPLOYER PENSION PLANS 10. The MEPPs are collectively-bargained pension plans that provide defined pension benefits to employees or retirees of more than one unrelated employer. Federal labor law requires such pension plans to be managed and operated by a board of trustees jointly consisting of union and management representatives. All employers participating in a MEPP have an obligation to make ongoing contributions to the MEPP to fund the vested benefits. 11. Under applicable law, MEPPs that fail to meet statutorily defined funding targets are characterized as either in endangered status, seriously endangered status or, if 2 3 In addition to the 24 MEPPs with the IBT and the BCT, Hostess also participates in 16 multiemployer pension plans pursuant to its collective bargaining agreements with unions other than the IBT or BCT. Declaration and Expert Report of Harry J. Wilson (the Wilson Declaration ) at 68 & 72. NYI-4432515v7-4-
Pg 52 of 250 worse, critical status. 4 When a MEPP is in critical status, its trustees must develop a program to improve the funding sufficiently to exit from such status within the rehabilitation period (normally 10 years). Such a program is known as a rehabilitation plan. Rehabilitation plans typically impose a mix of contribution rate increases on contributing employers and pension benefit changes on active participants that are designed to improve the MEPP s underfunding. 5 12. Federal law recognizes that some MEPPs in critical status have such significant underfunding that no set of reasonable measures can be implemented as part of a rehabilitation plan that will allow the MEPP to exit critical status within the rehabilitation period. In such cases, the law allows the MEPP trustees to design a rehabilitation plan to allow the MEPP to emerge from critical status at a later time or merely to forestall insolvency. 6 13. Under federal law, if a contributing employer permanently ceases to have an obligation to contribute or permanently ceases all... operations, such employer is deemed to have effected a complete withdrawal from the MEPP. If an employer withdraws from a MEPP, it may be assessed withdrawal liability. Withdrawal liability is calculated based on an employer s allocable share of the MEPP's unfunded vested benefits. 14. When several large employers withdraw from a MEPP and fail to pay their withdrawal liability, or where the MEPP is approaching insolvency, the trustees of the MEPP can 4 5 6 See I.R.C. 432. See I.R.C. 432(e)(3)(A). For seriously endangered and endangered MEPPs, there is an analogous requirement to implement a funding improvement plan. In addition, under federal law, a MEPP must annually benchmark funding progress against the terms of its rehabilitation plan and may modify the rehabilitation plan as necessary. If a MEPP is unable to reach its targeted benchmark for three consecutive years, the Internal Revenue Code authorizes the imposition of excise taxes on all contributing employers in the amount necessary to establish the requisite progress. I.R.C. 4971(g)(3). Given this specter of excise taxes, the trustees would likely increase the employer contributions (or modify benefits) if there are consecutive years of insufficient progress. NYI-4432515v7-5-
Pg 53 of 250 terminate the plan and involuntarily force the withdrawal of all contributing employers. Such termination would cause a mass withdrawal, under which plan liabilities are revalued using PBGC-mandated assumptions (typically increasing the total liability). When a mass withdrawal occurs, withdrawal liability of solvent employers is redetermined, and in addition, the withdrawal liability of insolvent employers is reallocated to solvent employers. As a MEPP approaches insolvency, the plan trustees may determine that they have a fiduciary obligation to force a mass withdrawal in order to increase the amount of funds available to pay accrued pensions under the plan. 7 A. Hostess Multiemployer Pension Plans 15. Of the 24 MEPPs to which Hostess contributes, twenty-two provide benefits to IBT-represented Hostess employees (the IBT MEPPs ). At least 13 of the 22 IBT MEPPs are in critical status, including four out of the five IBT MEPPs with the greatest number of active Hostess employees. These four MEPPs constitute approximately 58% of IBTrepresented employees who receive IBT MEPP benefits. 16. In addition, the trustees of the Central States, Southeast and Southwest Areas Pension Plan ( Central States ) and the New England Teamsters & Trucking Industry Pension Fund ( NETTI ), which cover approximately 49% of Hostess IBT-represented employees, have adopted rehabilitation plans that concede that no reasonable measures will allow them to emerge from critical status during the rehabilitation period. The terms of these rehabilitation plans provide for annual increases in contribution rates by all contributing employers upon the expiration of such employers respective collective bargaining agreements. 7 Upon insolvency, pensions of a MEPP are guaranteed by the Pension Benefit Guarantee Corporation (the PBGC ), but the guarantee is modest, so trustees have an incentive to force a termination and trigger mass withdrawal payments so as to postpone the insolvency. NYI-4432515v7-6-
Pg 54 of 250 17. The Central States fund a MEPP covering nearly 2,500 Hostess employees and the IBT MEPP with the greatest number of active Hostess employees (to which Hostess contributes approximately $16.6 million annually) has such significant underfunding that Thomas Nyhan, its Executive Director and General Counsel, has publicly stated that it is projected to be insolvent in the next 10-15 years. 8 During the course of labor negotiations, Mr. Nyhan stated to me that the fund s actuaries are currently projecting that Central States will be insolvent by 2024 (assuming its actuarial assumptions are met). 18. Although Hostess total annual contribution obligation has decreased slightly in recent years, its contribution obligations have increased on a per employee basis. In fiscal year 2010, Hostess contributed over $90 million to the MEPPs. Hostess estimates that its current withdrawal liability for the MEPPs is nearly $2 billion. B. Risk of Increased Contribution Obligations and Withdrawal Liability 19. There are numerous risk factors that indicate that the underfunding in the MEPPs could become more severe in coming years. As a result, if Hostess remains a contributor in the MEPPs, its total contribution obligations and contingent withdrawal liability probably will increase significantly. (1) Risk Related to Other Participating Employers 20. Under federal law, a company that permanently withdraws from a MEPP is liable for its share of the underfunded liability at the time of withdrawal; however, in many cases, companies that withdraw from MEPPs are unable to satisfy such liability. Given the state of the U.S. economy, there is a legitimate risk that other employer contributors will withdraw 8 Future for Multi-Employer Pension Plans: Hearing before the Comm. on Senate Health, Education Labor and Pensions, 111th Cong. 1, 4 (2010) (statement of Thomas C. Nyhan, Executive Director and General Counsel, Central States, Southeast and Southwest Areas Pension Fund). NYI-4432515v7-7-
Pg 55 of 250 from the MEPPs and fail to satisfy their withdrawal liability. If this occurs, such MEPPs will be without important revenue streams in coming years, which could substantially increase underfunding of the MEPPs. If a particularly large contributor withdraws from a MEPP and fails to satisfy its withdrawal liability, contribution obligations for other employer contributors could rise substantially. (2) Risks Related To Assumptions of Aggressive Investment Returns 21. In addition, many MEPPs currently may understate their liabilities (and therefore their level of underfunding). When calculating liabilities, pension plan actuaries make assumptions regarding the expected rate of return on the fund's investments. If the actuaries assume higher rates of return on investment, the plans projected liabilities will be lower. Under federal law, investment return assumptions made by a single employer pension plan must equal a certain indexed rate (currently approximately 5%). MEPPs, however, are not required to abide by similar investment return assumption limits. Instead of using investment return assumptions that approximate those of single employer plans, a number of MEPPs use aggressive investment return assumptions. For example, four out of the five IBT MEPPs with the greatest number of active Hostess employees covering approximately 58% of all IBT-represented employees assume investment returns of between 7.5% to 8.5%. Because of these high rate of return assumptions, many of these MEPPs probably understate their reported liabilities and already bear more underfunding than they publicly report. In addition, there is a risk that the continued use of high rate of return assumptions will further increase the underfunding liability associated with these funds and these MEPPs will be required to increase contribution obligations in order to improve their funded status. 9 9 Some MEPPs in critical status also increase their funding risk by continuing to maintain extremely NYI-4432515v7-8-
Pg 56 of 250 (3) Investment Return Risk 22. Moreover, the MEPPs are particularly vulnerable to large-scale market downturns. For example, in 2008, most MEPPs suffered substantial losses on their investments, which significantly decreased their funding levels. If the MEPPs suffer similar losses in future years, the level of underfunding could increase significantly. (4) Demographic Risk 23. The funding of the MEPPs also is subject to demographic risk. As the United States workforce has aged and industries such as the trucking and baked goods industries have contracted, the proportion of inactive participants (retirees and persons with deferred pensions) to active participants (those currently employed) has increased significantly. For example, the ratio of inactive participants to active employee participants in the Central States fund is currently 4.6:1. The ratio of inactive employees to active employees is expected to grow due to industry contraction, an aging of the workforce and fewer employers willing to participate in the transportation industry and baking industry MEPPs. As this ratio increases, unless the contribution amounts that participating employees make for active IBT- and BCT-represented employees increases, underfunding will become more severe. 24. It is expected that the risk factors described in paragraphs 20 23 will result in increased underfunding of MEPPs in coming years. As a result, many critical status MEPPs probably will be forced to increase their rehabilitation efforts. If this occurs, there is a strong prospect that Hostess future contribution rates will increase. And if critical status MEPPs (continued ) generous pension accrual rates. For example, Hostess contributes to NETTI on behalf of approximately 700 employees who can earn an annual pension for life of between $64,224 and $84,240 after 30 years of service. But the average annual compensation of such employees runs from $37,000 (at age 25) to $44,000 (at age 55). NYI-4432515v7-9-
Pg 57 of 250 facing increased underfunding do not increase contribution obligations, the participating employers face the prospect of excise taxes under the Internal Revenue Code. Moreover, if underfunding reaches too high a level, the trustees of a MEPP may choose to terminate the plan, thus causing a mass withdrawal and assessment of mass withdrawal redetermination and reallocation liability, as noted above in paragraph 14. C. Risks Associated with Reentering IBT MEPPs as a New Employer 25. In his expert report in support of the IBT s objection to the Motion, Harry Wilson argues that the IBT has had some discussions about potentially creative structures to assist [Hostess] with [its] cash flow constraints while continuing participation in the MEPPs. 10 I have been advised by counsel for Hostess that, during negotiations with the IBT, the IBT suggested to Hostess that a number of the MEPPs might consent to allow Hostess to withdraw from and reenter the IBT MEPPs as a new employer with reduced contribution levels. 26. These new contribution levels, however, would be subject to renegotiation upon expiration of the respective governing collective bargaining agreements. Because the underfunding of many of the IBT MEPPs probably will increase by the time these collective bargaining agreements expire, the IBT probably will pressure Hostess in the subsequent bargaining to increase contribution levels at that time. Risk of increases to Hostess contribution level, therefore, would not be eliminated they merely would be deferred to the expiration of a new collective bargaining agreement. 27. In addition, it is highly unlikely that mass withdrawal risk could be eliminated or capped. The law requires that the PBGC consent to any such cap. Such approval 10 Declaration and Expert Report of Harry J. Wilson at 48. NYI-4432515v7-10-
Pg 58 of 250 is counter to the interests of the PBGC (mass withdrawal payments can postpone insolvency, thus forestalling payments under the PBGC guaranty). IV. COMPARISON OF BENEFITS RECEIVED UNDER MEPPS VERSUS SINGLE-EMPLOYER PENSION PLANS 28. I also have concluded that a good portion of Hostess current IBTrepresented employees will likely earn greater pensions from single-employer pension arrangements sponsored exclusively by Hostess than they would if Hostess continues to contribute to the MEPPs on their behalf, assuming the same annual contribution levels. This is due to several factors. In a new single-employer defined benefit plan, each contributed dollar is dedicated to the accrual of new pension benefits. In contrast, in underfunded MEPPs, a good portion of each dollar of contributions must be applied to pay down the existing underfunding on pensions already earned by inactive employees. Consequently, new single-employer defined benefit plans often can deliver a higher level of benefit accruals for the same contribution amounts (notwithstanding that single-employer plans are required to use conservative investment assumptions). Critically underfunded MEPPs that do not re-direct a good portion of Hostess contributions to pay down underfunding, and instead continue to use contributions to support overly generous pension accrual rates, are increasing the risk of insolvency. I declare under penalty of perjury, pursuant to 28 U.S.C. 1746, that the foregoing declaration is true and correct. Dated: February 25, 2012 /s/ Mitchell Hofing Mitchell Hofing NYI-4432515v7-11-
Pg 59 of 250 Exhibit A NYI-4432515v7-12-
Pg 60 of 250 Professional Designations: Mitchell Hofing Fellow of the Society of Actuaries (2006) Fellow of the Conference of Consulting Actuaries (2010) Member of the American Academy of Actuaries (2008) Enrolled Actuary (2003) Education: Juris Doctor from New York University School of Law Bachelor of Science in Mathematics from Yale University - Benjamin Runk Prize for Excellence in Mathematics Work Experience: Dexter Hofing LLC April 2011 present Principal and co-owner New York, NY Particular expertise in: Multiemployer pension plans (including funding issues) Multiemployer issues as they affect corporate transactions such as mergers, acquisitions, spinoffs, closures of facilities, etc. Collective bargaining issues related to multiemployer plans Withdrawal liability issues Mercer 1998 April 2011 Principal in the Retirement Risk and Finance business New York, NY Expertise in multiemployer plans for employers participating in such plans Plan design, discrimination testing, benefit calculations for single employer plans Coffee Sugar Cocoa Exchange 1996 1998 Member of the Exchange New York, NY Traded commodities futures options on floor of the Exchange Union Bank of Switzerland 1995-1996 Vice President New York, NY Traded energy products derivatives (oil, natural gas, heating oil, unleaded gasoline, jet fuel) American International Group Trading Group 1992-1995 Vice President Greenwich, CT Traded energy products derivatives (oil, natural gas, heating oil, unleaded gasoline, jet fuel) American Stock Exchange 1988-1991 Member of the Exchange New York, NY Traded equity options on floor of the Exchange Dewey Ballantine Bushby Palmer & Wood 1986-1987 Legal Clerk in the tax department New York, NY
Pg 61 of 250 Exhibit C Johnson Rebuttal Report
Pg 62 of 250 UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK --------------------------------------------------------------- x : In re : : Hostess Brands, Inc., et al., 1 : : Debtors. : : --------------------------------------------------------------- x Chapter 11 Case No. 12-22052 (RDD) (Jointly Administered) TO BE FILED UNDER SEAL 1 The Debtors are the following six entities (the last four digits of their respective taxpayer identification numbers follow in parentheses): Hostess Brands, Inc. (0322), IBC Sales Corporation (3634), IBC Services, LLC (3639), IBC Trucking, LLC (8328), Interstate Brands Corporation (6705) and MCF Legacy, Inc. (0599).
Pg 63 of 250 EXHIBIT D Miscellaneous Sources D-1 Future for Multi-Employer Pension Plans: Hearing before the Comm. on Senate Health, Education Labor and Pensions, 111th Cong. (2010) (statement of Thomas C. Nyhan, Executive Director and General Counsel, Central States, Southeast and Southwest Areas Pension Fund). D-2 Public Pensions: Averting New York s Looming Catastrophe, Taxpayers for Wilson (Sept. 2, 2010). D-3 Wesley Smyth, Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern, Moody s Global Corporate Finance, Special Comment (Moody s Investors Serv.), Sept. 2009. D-4 George M. Kraw, Four Reforms to Save Multiemployer Plans, BNA Pens. & Ben. Daily, Nov. 17, 2010. D-5 U.S. Gov t Accountability Office, GAO-11-79, Changes Needed to Better Protect Multiemployer Pension Benefits (2010). D-6 Paul Secunda, The Forgotten Employee Benefit Crisis: Multiemployer Benefit Plans on the Brink, 21 Cornell J. L. & Pub. Pol y 77, 86 (2011). D-7 Christine Williamson, Multiemployer Plan Sponsors May Face Peril, Moody s Says, Pensions & Investments, Sept. 29, 2009.
Pg 64 of 250 Exhibit D-1
Pg 65 of 250 Statement of Thomas C. Nyhan Executive Director and General Counsel Central States Southeast and Southwest Areas Pension Fund Before the Committee on Health, Education, Labor and Pensions United States Senate May 27, 2010 Chairman Harkin, Senator Enzi and the other members of this Committee, I would like to thank you for this opportunity to testify at this hearing on Building a Secure Future for Multiemployer Plans. My name is Tom Nyhan and I am the Executive Director and General Counsel of the Central States, Southeast and Southwest Areas Pension Fund (the "Fund"). I will talk to you today about how the deregulation of the trucking industry and the recession that began in 2008 has affected the Fund. I will also address how the "qualified partition" provisions in the Create Jobs and Save Benefits Act of 2010 (S. 3157), introduced by Senators Casey, Brown, Stabenow and Burris, will provide essential relief to the Fund, thereby protecting the pensions of hundreds of thousands of participants in the Fund, as well as the tens of thousands of jobs of those Americans employed by businesses that contribute to the Fund. My message today is simple. I urge Congress to enact the "qualified partition" proposal this year. Because of a confluence of forces, most notably the dramatic consolidation in the trucking industry and the most significant recession in decades, the Central States Fund faces an unprecedented financial crisis. If no action is taken, the Fund is projected to be insolvent in the next 10-15 years. And long before the date of insolvency, the remaining contributing employers will either be forced out of business (causing catastrophic job losses) or, fearful of the ramifications of insolvency, will adopt measures that would accelerate the insolvency date. Indeed, at present, many employers are already facing such financial distress. The "qualified partition" proposal will stabilize the Fund and prevent this crisis. While many factors have contributed to the Fund's problems, the single largest factor relates to the pension benefits that are paid to retirees of employers no longer in business (and thus not contributing to the Fund). Over 40% of the annual pension benefits are paid to such retirees commonly referred to as "orphan retirees." When an employer with an underfunded corporate plan goes out of business, the PBGC assumes the obligations. When a company in a multiemployer plan goes out of business without paying its share of the liabilities, it is the surviving employers in the multiemployer plan that assume the liabilities. But they can't continue in this role, as the increased contributions are forcing more and more of these employers out of business.
Pg 66 of 250 The law currently provides a mechanism to address such a situation by "partitioning" the plan into two separate plans. S. 3157 updates the existing partition rules by allowing certain qualifying funds to elect partition, but with a price the electing fund must transfer sufficient assets to the PBGC such that the PBGC will not have to use any of its funds to pay the benefits of participants transferred in the partition for a period of five years from the date the partition was elected. Given the current budgetary situation, the transfer of assets strikes an appropriate balance of significantly reducing the financial exposure of the PBGC while simultaneously allowing the fund to retain sufficient assets to keep it solvent. The following provides more detail regarding the Fund, its status, and the partition proposal. Overview of the Central States Fund Multiemployer pension plans are collectively bargained, jointly administered pension plans funded by a number of contributing employers that are often in the same industry. The Fund is one of the largest multiemployer plans in the country, providing (as of December 31, 2009) coverage to nearly 423,000 participants across the country, including 81,000 active employees and 342,000 retirees, survivors and deferred vested participants. 1 The Fund is projected to pay approximately $2.9 billion in benefits in 2011. Since it began, the Fund has paid nearly $48 billion in benefits to working families. 2 I have attached a slide presentation to my testimony that outlines the financial issues that the Central States Fund currently faces and I ask that this presentation be entered into the record. Approximately 2000 employers contribute to the Fund. Nine out of 10 of these employers are small businesses, with fewer than 50 employees. Although these employers are in a variety of industries, including trucking/freight; car haul; tank haul; warehouse; food processing distribution (including grocery, dairy, bakery, brewery and soft drinks) and building and construction, historically there has been a heavy concentration of employers in the trucking industry. 1 As of July 8, 2009 the IBT and YRCW, the Central States Fund s largest remaining employer entered into a Memorandum of Understanding ( MOU ) whereby the company was allowed to terminate its participation in the Fund as of July 1, 2009, which further reduced the number of actives by approximately 24,000. The MOU is intended to relieve the company of the pension funding obligation in an effort to allow it to weather the recession. The MOU provides that the termination will be temporary and that YRCW intends to resume participation in the pension plan on January 1, 2011. 2 Nearly 30 years ago, the management of the Central States Fund was reformed as a result of a consent decree entered into with the United States Department of Labor ( DOL ). Since then, the Central States Fund has operated under judicial and DOL oversight. The investments of the Fund are managed by major financial institutions initially screened by the DOL and approved by a federal judge. These financial institutions have exclusive management and control of the Fund s investment function. 2
Pg 67 of 250 Changes in the Fund since 1980. In 1980, there was one retiree/inactive employee for every four active employees in the Fund. Today, that ratio has flipped there are 4.2 retirees/inactive employees for each active employee. A major reason for this dramatic shift has been the increased competition and reduced margins in the trucking industry that followed on the heels of trucking deregulation in 1980. Of the 50 largest employers that participated in the Central States Fund in 1980, only four remain in business today. More than 600 trucking companies that contributed to the Fund have gone bankrupt since 1980 and many thousands of others have gone out of business without filing formal bankruptcy. Also in 1980, Congress passed the Multiemployer Pension Plan Amendments Act of 1980, adding withdrawal liability obligations to employers that stop making contributions to an underfunded multiemployer pension plan. Because employers are fearful of incurring withdrawal liability, the Fund has not been able to attract new employers. As a result of these trends, over 40 cents of every dollar the Fund now pays in benefits goes to retirees who were employed by an employer that went out of business without paying its proportionate share of the Fund's unfunded pension liability ("orphan employees"). This means the Fund is acting as the primary insurer of the unfunded pensions of employers that have gone out of business. It also means that the remaining employers in the Fund are responsible for funding the pensions of their defunct competitors' employees or the pensions of retirees from a completely different industry. The cost of funding these orphan benefits has grown to unaffordable levels. As an example, trucking industry employer contribution rates under the National Master Freight Agreement have doubled since 2003. The rates have increased from $140 per week in 2000 to $380 per week (nearly $9.50 per hour in a 40 hour week) per active participant at the end of the current collective bargaining agreement in 2013. Approximately $150 of that weekly contribution will be required to fund orphan participants benefits. Other contributing employers have been subjected to similar contribution increases. Because of the increasing number of retirees and decreasing number of active employees, the Central States Fund's benefit payments to retirees have exceeded employer contributions in every year since 1984. In 2009 the Central States Fund paid approximately $2.74 billion in benefits while receiving employer contributions of approximately $675 million. This left an operating deficit of $2.1 billion that must be funded by investment returns. Prior to 2001, investment returns were sufficient to allow the Central States Fund's asset base to grow despite paying annual benefits to retirees that exceeded annual contributions. But, during 2001-2003, the Fund investments lost money, and asset values declined. The investment losses experienced during 2001-2003 were compounded by a significant decrease in covered employees due to employers going out of business. With the bankruptcy of Consolidated Freightways and Fleming Foods in 2003 and their failure 3
Pg 68 of 250 to pay more than $403 million in withdrawal liability, the unfunded liabilities of the Fund increased. These bankruptcies illustrate the role the Fund has played as insurer of pensions owed to the employees of defunct employers. For example, at the time of its bankruptcy, Consolidated Freightways maintained a "single employer" pension plan and was also a contributing employer to the Central States Fund. When it went out of business in 2002, the Pension Benefit Guaranty Corporation (the "PBGC") assumed responsibility for Consolidated Freightways' single employer plan for salaried employees, which was underfunded by $276 million. By contrast, the Central States Fund and its remaining employers assumed responsibility for $319 million in unfunded vested benefits owed to Consolidated Freightways's rank and file employees. The Central States Fund took aggressive action to deal with underfunding after asset values declined during 2001-2003 including freezing "early out" benefits and cutting the rate of future pension accruals in half. Moreover, the bargaining parties significantly increased contribution rates and reallocated money originally earmarked for other purposes to the Central States Fund. Effect of the 2008 Financial Crisis on the Pension Fund. The steep decline experienced by the financial markets in 2008 compounded the Fund's problems. Not only did the Fund experience an investment loss of $7.7 billion in 2008, but benefit payments exceeded contributions by $1.75 billion, leaving the Fund with assets of $17.4 billion and a funded ratio of 48.5 percent. Given its annual operating deficit ($1.785 billion), the Fund would have to earn over 10% on its investments each and every year and maintain its employer base just to keep the asset base from deteriorating. Unless the Central States Fund reduces the liability associated with orphan participants, it will become insolvent within the next 10-15 years - the actual date of which will depend upon the Fund's investment experience and the rate at which contributing employers continue to go out of business. Partition of Multiemployer Plans Current Partition Authority. Congress anticipated the problem facing funds like the Central States Fund. Since 1980, the law has provided a way to address the funding problems that occur when there are an excessive number of orphan employees in a multiemployer plan. The PBGC may order the "partition" of a multiemployer plan, which in effect removes from the plan pension liabilities that were earned with failed employers that have gone through formal bankruptcy proceedings. The PBGC transfers plan benefits attributable to the orphan employees of the failed employers to a separate plan, and then guarantees the benefits of the orphan employees in that separate plan at the PBGC benefit guaranty level for multiemployer plans. The remaining portion of the plan covering employees of ongoing employers continues, but without the burden of the orphan liabilities. In effect, PBGC's partition authority enables the agency to surgically 4
Pg 69 of 250 remove liabilities from a multiemployer plan to enable the plan to survive. Since 1980, only two multiemployer plan partitions have been allowed. Qualified Partition Proposal. Under S. 3157, the PBGC's current partition authority will be updated to provide that a "Qualified Partition" of a multiemployer pension plan could be elected by multiemployer plans that meet certain, strict requirements. The Central States Fund would be eligible to elect a Qualified Partition, as well as the Western Pennsylvania Teamsters Pension Fund and a limited number of other smaller multiemployer plans. A Qualified Partition would transfer to a separate plan backed by the PBGC the responsibility for the vested benefits of participants earned with employers that filed for bankruptcy or otherwise went out of business. Along with the transfer of liabilities, the multiemployer plan would transfer to the PBGC assets so that the PBGC will have no obligation to pay the benefits of participants transferred in the partition for a period of five years from the date the partition was elected. The PBGC's benefit guaranty for participants whose benefits are transferred to the PBGC in a Qualified Partition would be increased to fully protect the benefits transferred. During that same five-year period, the trustees of the multiemployer plan may stop further escalation of the contribution rate of contributing employers if the trustees determine that such action is necessary and appropriate to preserve covered employment under the plan. Qualified Partition Would Strengthen the Central States Fund and Protect the Participants and Beneficiaries of the Fund. Partition will prevent the Fund from becoming insolvent by removing liabilities for orphan employees. In the year after partition, the ratio of inactive to active participants in the Fund will improve from 4.2 to 1, to 2.2 to 1. The Fund's annual benefit payments will decline from $2.9 billion to $1.8 billion, assuming YRC resumes contributions as planned. Also, the gap between annual benefit payments and annual contributions that must be filled by investment earnings will be cut from $2.0 billion today to $.9 billion. With fewer unfunded liabilities, the Central States Fund would be projected to remain solvent through the 30-year projection period. As a result, the pensions of the participants remaining in the Fund would be protected. Moreover, orphan employees will not be adversely affected if a Qualified Partition is elected. They will continue to receive their promised benefits, which will not be reduced due to the partition. Qualified Partition Would Protect Thousands of Employers Most of Them Small Employers and Preserve Tens of Thousands of Jobs. If the Fund's financial challenges are not addressed, contributing employers face escalating liabilities and cash contribution requirements as more employers fail. A contributing employer can stay in the plan, and risk being driven out of business. Or, if the contributing employer is unusually financially strong, it can withdraw as soon as possible and start paying off a portion of the plan's liabilities (which are capped in various ways) over 20 years as allowed by statute leaving fewer employers to fund the plan and an even greater burden on the dwindling number of remaining employers. By stabilizing the Fund and enabling trustees to mitigate contribution requirements, partition would enable companies contributing to the Fund both to remain in the Fund and to remain financially viable, preserving thousands of jobs. 5
Pg 70 of 250 Qualified Partition Would Protect Other Multiemployer Plans. Importantly, the benefits of providing for a Qualified Partition are not confined to the jobs and retirement benefits of Central States' own population of participating employees. Many, if not most, of the employers that currently contribute to Central States Fund also do business outside the geographic regions served by the Central States Fund. Many of these companies contribute to multiemployer pension plans other than the Central States Fund. For example, a significant number of the contributing employers to the Central States Fund also contribute to the Western Conference of Teamsters Pension Fund a multiemployer plan that is even larger than Central States and that offers coverage for workers in most of California and the Pacific Northwest. Without a Qualified Partition, the projected insolvency of the Central States Fund would have had a serious impact on the ability of these contributing employers to maintain their contributions to the other multiemployer plans they contributed to, thereby endangering these other multiemployer plans. Qualified Partition Would Protect the PBGC. Because the Central States Fund will become insolvent, the PBGC will ultimately have to fund the benefits of participants in the Fund. By strengthening the Central States Fund and preventing its insolvency, a Qualified Partition of the Fund would prevent the PBGC from eventually having to assume the liabilities of the remaining participants in the Fund. This would save the PBGC billions of dollars with regard to the Central States Fund alone. Conclusion The partition proposal will stabilize the Fund and a limited number of other small multiemployer plans facing a similar financial crisis by allowing these multiemployer plans to elect to separate off the liabilities attributable to the orphan employees of bankrupt employers, together with a share of assets, from the liabilities and assets related to current contributing employers. It will greatly improve the actuarial soundness and long term prospects of the plans covered by the proposal. Thus, the partition proposal will reverse the forces that are driving employers out of business and costing jobs with each passing day. Congress is deeply concerned about job losses in the Country. The partition proposal will preserve tens of thousands of jobs that otherwise will be lost in the immediate future. With a financially sound multiemployer plan, contributing employers will be able to meet their obligations to the Central States Fund while competing successfully in the marketplace. We urge Congress to address this issue as soon as it can. Thank you for this opportunity to address the Committee. I will be happy to answer any questions the Committee may have. 6
Pg 71 of 250 Exhibit D-2
Pg 72 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com Public Pensions: Averting New York s Looming Tax Catastrophe I have a special word for my fellow Democrats: one cannot both be a progressive and be opposed to pension reform. The math is irrefutable that the losers from excessive and unfunded pensions are precisely the programs progressive Democrats tend to applaud. - David Crane, California pension advisor There are lots of people who would like to think that because times have changed someone else will be paying for this problem. There is no one left to pay for this problem. We have got to fix it ourselves, and everyone has to make a contribution to it. - Chris Christie, Governor of New Jersey Why use an 8% assumption? Because if you used more conservative numbers, as the academic studies suggest, you would have to make larger current contributions to the pensions, when state and local governments and schools are already in fiscal trouble This is going to end in tears for many states and municipalities. I mean real tears. Pension funding in some states will be required by law to consume 25-30% or more of tax revenues. That is going to mean much higher taxes or reduced services. - John Mauldin, president of the investment advisory firm Millennium Wave Advisors, LLC. 1
Pg 73 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com Table of Contents Public Pensions: Averting New York s Looming Tax Catastrophe... 1 I. Executive Summary... 3 II. Introduction: Why Is This A Critically Important Issue Facing Our State And Our Nation?... 5 III. How Bad Can It Be, And How Did We Get Here?... 7 IV. Brief Primer On the New York State Pension System... 12 V. Rules Matter: Politicians Take Advantage of Public Pension Accounting Rules To Hide Deficits... 22 VI. Private Sector Standards: Not Perfect, But More Honest And Realistic... 25 VII. What Does It All Mean? How Big is Our Problem?... 35 VIII. The Right Way to Manage the CRF... 37 IX. Anticipating the Critiques... 43 X. Key Takeaways... 47 XI. Conclusion... 52 2
Pg 74 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com I. Executive Summary This paper examines the looming public pension catastrophe approaching our nation generally and New York State specifically. There are several key points we will consider in detail: The coming public pension crisis is the largest financial problem our nation faces at the state level, and the cost to taxpayers will dwarf that from TARP, the Fannie Mae/Freddie Mac bailout, the S&L bailout or any other recent American financial crisis. The magnitude and nature of the pension crisis is disguised by the application of lax government accounting standards that allow for accounting deceptions and do not stand up to private sector scrutiny. An honest accounting of pension assets and liabilities would reveal a substantial underfunding in New York State s Common Retirement Fund of anywhere from $30 billion to $80 billion. The current New York State Comptroller s pension borrowing legislation will further increase the level of underfunding. Under the current Comptroller, the Fund s investment returns have been significantly below the median of other comparable public pension funds for the last year, the last two years and the last three years and have thus further exacerbated New York s pension shortfall. The Fund s cumulative underperformance, relative to its 8% target investment return over the past 3 years, totals nearly $50 billion. Pension promises to state and local government workers and retirees are guaranteed by law, legal precedent or, in some cases like New York, state constitutions. 1 Ultimately, these shortfalls are borne by unsuspecting taxpayers who are on the hook for higher taxes. In dealing with New York s pension underfunding, the State and its leadership must adhere to three bedrock principles: The true extent of our shortfall must be made clear through an honest accounting. New Yorkers are already the most heavily taxed people in the nation and cannot afford additional taxes, so increased taxes cannot be a part of any solution The benefits of New York s government workers, retirees and their beneficiaries are to be provided for in full. They have earned these benefits as part of their negotiated compensation on the basis of a contract that must be honored. 1 For details by state, see Morrison and Foerster LLP and Greenebaum Doll and McDonald PLLC, "Index by States: Extent of Protection of Pension Interests." 25 Sept. 2007. Available at <http://finance.ky.gov/nr/rdonlyres/275a2978-5dde-4138-a7f5-af02d17d7f97/0/statebystatememo10.pdf> 3
Pg 75 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com While the pension crisis is national in scope, it affects each public fund individually, and we New Yorkers need to fix our own Pension Fund in order to save New York members, retirees, beneficiaries and taxpayers from this looming tax crisis. The New York State Comptroller, as the sole trustee of the State s Fund, should work with the Governor, the Legislature and all stakeholders within the framework of the principles above to develop long-term reforms that ease our Pension System back to solvency. But we cannot determine the full set of solutions that are available to New York until we first uncover the true magnitude of our own crisis. This white paper aims to uncover as much as can be determined through publicly-available sources the Comptroller must release more data on his assumptions to allow for more fulsome analysis and, more importantly, solutions. 4
Pg 76 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com II. Introduction: Why Is This A Critically Important Issue Facing Our State And Our Nation? By any reasonable metric, the underfunding of public pension plans is the greatest state-level financial crisis facing our nation. Yet, despite its size, it remains an arcane subject, shrouded in accounting considerations that lead to misunderstandings and neglect. When faced with a potentially overwhelming subject that poses significant danger, however, the correct response should not be to bury our heads in the sand, but rather to work hard to articulate the core issues clearly and develop public support for good and lasting reform. As the nation s financial capital, New York should be a natural leader in this cause. Unfortunately, the damage done by years of neglect has left an enormous hole in our State s Pension Fund that will take years to repair. By some estimates, State and local government contributions to New York s Pension System (which are funded through state and local taxes) will triple in the next three years; 2 and given the reported assumptions, there is cause to believe that amount will prove, in time, to be understated. For this reason, among others, we often argue that New York is in the early stages of a massive fiscal crisis. As bad as our current circumstances are, they will get worse in the coming years. Yet, this crisis remains largely invisible, due to the cloaking effect of single-year budgeting and politicians who refuse to address the crisis they created, especially in an election year. We must not let career politicians drive the State into fiscal insolvency. Historically, New York was the economic engine of America, a beacon of opportunity to millions of immigrants, and it can be again, if we confront our fiscal problems forthrightly and work hard to fix them before they drown us in an ocean of debt and taxes. This report builds on our last white paper, which discussed a sweeping set of ethics reforms that we would introduce early next year. 3 Those ethics reforms would clean up our Pension Fund s management and are both necessary and interconnected to the changes we propose here. Our larger aim, through the ideas encapsulated in both papers, is to professionalize the management of the Pension Fund and break the link between our retirement system and politicians who betray the public trust, either ethically or in their failure to fulfill their fiduciary responsibilities. 2 Gershman, Jacob. Cuomo, Lazio Spar Over Pensions. The Wall Street Journal. 7 Jul. 2010. 6 Aug. 2010. http://online.wsj.com/article/na_wsj_pub:sb10001424052748704862404575351420074469874.html 3 Our ethics reform white paper can be accessed on our website. Taxpayers for Wilson. The Office of the State Comptroller It s a Question of Ethics. 7 July 2010. 24 Aug. 2010. <http://wilsonfornewyork.com/images/uploads/ethics_white_paper_final.pdf> 5
Pg 77 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com We welcome a dialogue on these issues with political leaders, union leaders, government employees and beneficiaries, the media and certainly the taxpayers, who are being handed the bill. It is not too late to fix our Pension System and avert the fate of other failed states, but it soon will be, and the sooner we work to address our broken retirement system, the less painful it will be. One final but important note: sadly, the whole pension debate has devolved into a food fight between fiscally responsible individuals and organizations, on the one hand, and public employees and their union leadership on the other. In our view, that is not the right fight. We do not blame public employees or their union leadership for wanting better compensation and benefits. Benefits, including future pension payments, are a negotiated part of overall compensation that have been promised under a contract and earned. Enhanced compensation and benefits are a natural goal for any employee or any organization advocating on behalf of employees. Rather, we believe the blame lies squarely at the feet of career politicians who use taxpayer dollars to make promises we can t afford to secure campaign donations, votes and support. Our elected officials are the ones charged with watching out for the taxpayers, and they have let their own narrow self-interest trump their broader fiduciary duties. As Arthur Levitt, Jr., argued in 2007, If politicians aren t willing to pay for their promises, then they shouldn t make these hollow promises in the first place. 4 The State Comptroller is the elected official with the clear fiduciary responsibility to address New York s pension problems. That is why one of our goals in transforming this office is to help reestablish a healthy, sustainable balance that provides fairly for public employees at a cost that is manageable for taxpayers. This dynamic is in the best long-term interests of taxpayers AND public employees. The crisis we would otherwise suffer could only end badly for both. 4 Levitt Jr., Arthur. Remarks. New York Private Equity Conference. New York, NY. 30 Oct. 2007. 24 Aug. 2010. 2 <www.pebc.ca.gov/images/files/071113_pension.pdf> 6
Pg 78 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com III. How Bad Can It Be, And How Did We Get Here? The value of pension promises already made by U.S. state governments will grow to $7.9 trillion by 2023. 5 A series of studies suggest that the underfunding of these promises could total $3 trillion or more. 6 For most states, pension promises are guaranteed to their beneficiaries by law, legal precedent or the state constitution and are effectively the equivalent of debt that is at least pari passu with, and arguably senior to, every other State obligation. 7 No matter what, taxpayers are on the hook for them. In the event of defaults, pension underfundings would require extraordinary action in the form of large tax increases, significant debt offerings (if they could even be completed), a federal bailout or a full-blown restructuring on an unprecedented scale. To put the $3 trillion underfunding in perspective, the cost to taxpayers for the savings and loan crisis was $124.6 billion. 8 The estimated cost to taxpayers for the Troubled Asset Relief Program (TARP) ranges from $109 to $127 billion, according to the Congressional Budget Office and the Office of Management and Budget, respectively. 9 The bailouts of Fannie Mae and Freddie Mac are projected to be $389 billion over the life of the program. 10 Those figures, as large as they are, pale next to the gathering storm of America s underfunded public pensions. And, as with previous crises, the writing is on the wall. Yet, virtually all policymakers either choose to passively ignore the underlying reality, since the crisis is not immediate, or actively obscure it, taking advantage of lax government accounting standards to hide the truth from view. 5 Novy-Marx, Robert and Joshua Rauh. The Intergenerational Transfer of Public Pension Promises, National Bureau of Economic Research, Working Paper 14343 (September 2008): 7. 6 See the following: Aubry, Jean-Pierre, Munnell, Alicia H. and Quinby, Laura, The Funding of State and Local Pensions: 2009-2013, Center for Retirement Research at Boston College, April 2010; Novy-Marx, Robert and Rauh. Joshua, Public Pension Promises: How Big are They and What are They Worth?, Center for Retirement Research at Boston College, July 2010; Biggs, Andrew. An Options Pricing Method for Calculating the Market Value of Public Sector Liabilities, American Enterprise Institute, Working Paper #164, March 2010; Novy-Marx, Robert and Rauh, Joshua, The Intergenerational Transfer of Public Pension Promises, National Bureau of Economic Research, Cambridge, September 2008; Barro, Josh and Buck, Stuart, Underfunded Teacher Pension Plans: It s Worse Than You Think, Manhattan Institute Civic Report No. 61, April 2010; and Novy-Marx, Robert and Rauh. Joshua, The Liabilities and Risks of State-Sponsored Pension Plans, Journal of Economic Perspectives, Vol. 23, No. 4, Fall 2009, p. 191-210. 7 For details by state, see Morrison and Foerster LLP and Greenebaum Doll and McDonald PLLC, "Index by States: Extent of Protection of Pension Interests." September 25, 2007, available at <http://finance.ky.gov/nr/rdonlyres/275a2978-5dde-4138-a7f5-af02d17d7f97/0/statebystatememo10.pdf> 8 United States General Accounting Office. Financial Audit: Resolution Trust Corporation s 1995 and 1994 Financial Statements. Washington: GPO, 1996. Print. 13. <http://www.gao.gov/archive/1996/ai96123.pdf> 9 ---. Congressional Budget Office. Report on the Troubled Asset Program. Washington: GPO, 2010. Print. 10 ---. Budget Office. CBO s Budgetary Treatment of Fannie Mae and Freddie Mac Background Paper. Washington: GPO, 2010. 9 <http://www.cbo.gov/ftpdocs/108xx/doc10878/01-13-fanniefreddie.pdf> 7
Pg 79 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com Unfortunately, willful ignorance and deception serve only to make the issue even more pernicious and all the more important to examine in the open. New York is by no means alone. On the contrary, New York s practice of passing fund underperformance through to taxpayers (while helping create the nation s highest state and local tax burden) has led to a smaller hole than in many states. Here, however, we are reminded of the story of a shipwreck. In the accident, 50 passengers are left treading water in the open sea while vainly waiting for help. These passengers have familiar names: California, Illinois, New Jersey and, of course, New York. It doesn t matter whether one of these passengers is a stronger swimmer than a handful of the others; if help doesn t arrive soon, they all drown, some sooner than others. The lesson here is that we should not take solace in the travails of other states we have to right our own ship before we drown in an ocean of taxes and debt. Root Causes The root cause of the crisis rests with the elected officials who overpromised public benefits in order to secure political support from public employee unions. These benefits come due in the future, and the next election is always imminent; it is no wonder, then, why politicians often ignore the consequences of these promises. In this way, politicians are to public pensions as lax underwriting standards were to the mortgage crisis the great enablers, pursuing short-term gain at a huge long-term cost. Had intervention in the mortgage sector occurred earlier, the ultimate fallout and cost would have been mitigated, perhaps even avoided. Unfortunately, no one wanted to pull away that punch bowl until it was too late. Similarly, very few of our elected leaders want to admit to our public pension crisis. We could extend the analogy: the Greek sovereign debt crisis was caused by politicians who hid the size of deficits in order to muddle through what they thought were short-term troubles; the 2008-2009 banking crisis was caused by banking leaders who took on excessive leverage to magnify near-term profits with insufficient regard for the risks and attendant long-term costs. And so on. Have we not learned anything from these mistakes? Are our public leaders so blind to these examples as to let them be repeated over and over? Without immediate action, the answer appears to be yes. This is all the more reason to bring fresh perspectives into the public sector, from individuals with the skill set and determination to identify, describe and avert financial crises before they occur. 8
Pg 80 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com There s Plenty Of Blame To Go Around: There are several groups that have aided and abetted politicians in Albany, Sacramento, Trenton and elsewhere in creating this crisis. First and foremost on the list is the Governmental Accounting Standards Board (GASB), the agency that sets accounting standards for public pension funds. Their guidelines, so different from the policies that govern the private sector, have allowed politicians to claim for their states and municipalities far better fiscal health than would otherwise be the case under any reasonable standards. Meanwhile, GASB is funded in large part by the very public pension funds it is supposed to police. Further, GASB has roughly one-quarter the staffing of its corporate cousin, FASB, increasing its challenges. Finally, a majority of its board consists of sitting public officeholders and public financial officials, again raising concerns about potential conflicts of interest. The actuaries who support aggressive accounting policies also bear their share of the blame. Recall that Arthur Anderson was a major accounting firm until it was revealed that their lax oversight enabled Enron s fraudulent accounting, ultimately leading to the indictment of Arthur Anderson and its dissolution. In an apt public sector example of similarly inept accounting work, a New York State actuary report in 2008 held that an early retirement bill carried no additional costs for municipalities. New York City protested the bill would cost $200 million each year, and it later came to light that the State actuary was paid for the report by public sector unions. 11 On top of that, a later report found this same actuary had vetted more than 50 bills, and a survey of just 11 of them that passed showed they would result in $500 million in eventual costs. 12 Today s pension actuaries would do well to heed the lessons of Arthur Anderson. Various independent groups, including the Pew Center for the States, have also unwittingly served to enable select politicians. The Pew Center issued a widely disseminated report on the health of public pension funds, and New York State officials cite Pew s rankings as definitive evidence of our pensions health. Yet, the report indicates the rankings are based on states selfreported financial statements. 13 Pew is explicitly saying that, in the end, it has compiled information reported to it, rather than validating all of the underlying assumptions. However, 11 Hakim, Danny. Unions Bankrolled Analyst Vetting Pension Bill. The New York Times. 16 May 2008. 24 Aug. 2010. <http://www.nytimes.com/2008/05/16/nyregion/16actuary.html> 12 Hakim, Danny. Pension Costs Off by $500 Million, City Finds. The New York Times. 3 June 2008. 31 Aug. 2010. <http://www.nytimes.com/2008/06/03/nyregion/03actuary.html> 13 The Pew Center on the States. The Trillion Dollar Gap. February 2010, pp. 52-54 <http://downloads.pewcenteronthestates.org/the_trillion_dollar_gap_final.pdf> 9
Pg 81 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com because of how it is being used by certain politicians, the Pew Report is unintentionally validating the very practices at the core of our pension problems. Finally, national politicians have enabled their counterparts at the state level. The Tower Amendment, a 1975 amendment to the Securities Exchange Act of 1934 that creates a carveout from the disclosure requirement for municipal issuers, removed an important enforcement mechanism. With only the later creation of an insufficiently vigilant GASB, there is a void in oversight of public pension funds financial practices that leave taxpayers unacceptably exposed. A National and Nonpartisan Issue That Requires Local Solutions Leading members of both parties (at least outside of Albany) recognize the size and immediacy of the pension crisis. It affects every state and public pension plan to one degree or another. The resulting costs are increasingly eating up larger percentages of annual municipal budgets nationwide at the expense of all other government services and the resulting tax burden crowds out opportunity and jobs. In San Diego, thanks to a history of unfunded pension deals, the City has been forced to allocate 8% of its budget to its Employees Retirement System. 14 In Los Angeles, pension costs are expected to consume 19% of their general fund budget in the coming fiscal year. 15 California pension advisor David Crane made the following point in a hearing on May 10, 2010: I have a special word for my fellow Democrats: one cannot both be a progressive and be opposed to pension reform. The math is irrefutable that the losers from excessive and unfunded pensions are precisely the programs progressive Democrats tend to applaud. Those programs are being driven out of existence by rising pension costs. 16 This bipartisan problem is a zero sum game, as Democratic San Francisco Mayor Gavin Newsom also pointed out: 14 Lowenstein, Roger. The End of Pensions. The New York Times. 30 Oct. 2005. 24 Aug. 2010. <http://www.nytimes.com/2005/10/30/magazine/30pensions.html?pagewanted=print> 15 Halper Evan and Lifsher Marc. Public Employee Pensions Under Pressure. Los Angeles Times. 23 Apr. 2010. 24 Aug. 2010. <http://articles.latimes.com/2010/apr/23/business/la-fi-pension-reform-20100423/2> 16 David Crane s testimony before the Senate Public Employees and Retirement Committee on pension reform, SB 919 on May 12, 2010. Available at <http://www.foxandhoundsdaily.com/blog/david-crane/6918-cranes-testimonypension-reform>. 10
Pg 82 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com I don't know about a more important progressive issue than pension reform. There is no discretion left in our budgets to advance our progressive values of investing in people if that discretion is taken up to meet our (pension) obligations 17 State or local governments in Illinois, Ohio, West Virginia and elsewhere face similar budget strains aggravated by pension promises. In Maine, there is not enough money to do much of anything else if the State adheres to its rule requiring full funding of its ballooning pension costs. 18 In New Jersey, the State opted not to contribute anything to the Police and Firemen's Retirement System in 2001 through 2003 after their pension assets plummeted in the dot-com bust. That bill is coming due; as of June 2009, New Jersey s pension systems faced unfunded liabilities of $46 billion, 19 and New Jersey became the first state to be charged by the SEC with securities fraud for its inadequate disclosure of these problems. 20 In short, this is a national problem of towering proportions that must be addressed on a state by state basis. For every year where we refuse to acknowledge economic realities, they grow worse. 17 Borenstein, Daniel. Bipartisan Pandering on Pensions. Contra Costa Times 22 May 2010. 18 Walsh, Mary Williams. Facing Pension woes, Maine Looks to Social Security. The New York Times, 20 Jul. 2010. 24 Aug. 2010. <http://www.nytimes.com/2010/07/21/business/economy/21states.html?_r=1&pagewanted=2>. Referring to the rule, Maine State Senator Peter Mills put the matter delicately: It s going to rip the guts out of our budget. 19 Dopp, Terrence. N.J. May Forgo 2012 Pension Payment, Christie Says. Bloomberg Businessweek. 30 Jul. 2010. 24 Aug. 2010. <http://www.businessweek.com/news/2010-07-30/n-j-may-forgo-2012-pension-payment-christiesays.html> (Note: this assumes an annual 8.25% return on investments, an actuarial assumption that understates the magnitude of the shortfall.) 20 United States of America Before the Securities and Exchange Commission. Securities Act of 1933, Release No. 9135, August 18, 2010, Administrative Proceeding, File No. 3-14009, In the Matter of: State of New Jersey, Respondent. 11
Pg 83 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com IV. Brief Primer On the New York State Pension System The objective of New York State s Pension System is to deliver on its constitutional commitments to pensioners at a predictable and affordable cost to taxpayers. 21 It is formally named the Common Retirement Fund and interchangeably referred to as the Fund, the System or the Retirement System. It is made up of two different systems: the Police and Fire Retirement System (PFRS) with 65,585 members, retirees and beneficiaries and the much larger Employees' Retirement System (ERS) with 969,845 members, retirees and beneficiaries. Together, they comprise the Common Retirement Fund (CRF) and hold assets for more than one million employees and retirees from the State government and participating local governments. 22 CRF is the nation s third largest public pension in assets. Like all public plans, its funding sources are annual earnings on its assets (invested in a portfolio of stocks, bonds and other investments), as well as annual government employee and employer contributions. Defined Benefit Plans And Its Implications: New York State offers government employees a defined benefit plan, wherein the State guarantees workers annual payments for life upon retirement irrespective of how the plan s investments have performed. 23 From the beneficiaries' standpoint, this offers security: workers receive a guaranteed income as long as they live. 24 Promises of future payment are, by definition, fixed obligations, so anytime New York contracts with employees, the resulting future pension payments become liabilities of the State. There is nothing inherently wrong with defined benefit plans. However, they pose two central challenges that, in the hands of profligate politicians, have proved extraordinarily costly: By design, defined benefit plans place market risk in the hands of the plan sponsor in this case, New York State and its taxpayers. This stands in contrast to a defined contribution plan, where market risk (and also opportunity) resides with the individual. This, also, is not necessarily problematic except politicians play the game of heads I win, tails the taxpayers lose. When times are flush, politicians have routinely sweetened 21 From the standpoint of beneficiaries, this means annual annuity payments upon their retirement. 22 Office of the State Comptroller, New York State and Local Retirement System. Snapshot of the New York State Common Retirement Fund. 4 Aug. 2010. <www.osc.state.ny.us/pension/snapshot.htm> 23 Novy-Marx, Robert and Rauh, Joshua D. The Liabilities and Risks of State-Sponsored Pension Plans. Journal of Economic Perspectives, Vol. 23, No. 4, (2009): 191. 24 Because the employer is committed to paying and maintaining a certain level of benefits, this arrangement is called a defined benefit" plan. 12
Pg 84 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com benefits; however, when times are challenging, promised benefits cannot be taken back. Taxpayers are stuck with the obligations. That dynamic brings us to the second challenge. Politicians are generally ill-equipped to assess the true costs of these programs long-term liabilities, market risk, etc. and thus tend to underestimate them, since it is in their interest to do so. By underestimating these costs, they can promise more; when the bill comes due, they likely won t be around to worry about it. Here is a simple example to illustrate the importance of estimating future costs properly. Say you need to pay someone $10,000 in ten years, and you want to set aside enough cash today to make good on your promise. How much should you set aside? Well, you have to convert that future obligation (in ten years) to a present value how much it is worth today. The rate at which you discount, or reduce, that future obligation each year is the discount rate. If you use an 8% discount rate, that $10,000 future value is only $4,632 in today s dollars. However, if you instead use a 5% discount rate, you would have to set aside $6,139 today. The importance of this assumption can t be overstated. What if you set aside $4,632 and only achieve 5%? You end up with $7,545, a shortfall of nearly 25%. The bottom line is clear: when estimating long-term financial costs, the assumptions are critical. Virtually all financial practitioners and economists argue that the chosen discount rate should be a function of the risk of the underlying obligation: if you have to pay the obligation, no matter what, you should use a lower discount rate to reflect the incontrovertibility of the obligation. The alternative is what New Yorkers have witnessed in this decade applying a discount rate of 8%, achieving 5% returns and creating a significant shortfall that triggers huge tax increases. Unfortunately, these points are lost on the vast majority of our elected leaders, most of whom lack the training or experience to adequately consider the hugely consequential impact of discount rates on public policy. For evidence, one needs to look no further than New York State s Pension Fund, which uses an outsized 8% discount rate (although in the face of increasing criticism from us and others, the Comptroller is said to be considering a marginal reduction). 25 To apply the analogy used above, since the Pension Fund has been using an 8% discount rate but has achieved returns of less than 5% over the last decade, there is currently an enormous shortfall which is triggering large increases in employer contributions and thus taxes this year and over the next several years. 25 Scott, Brendan. "Low pension return may $oak taxpayers." New York Post. 21 Aug, 2010. 25 Aug. 2010. <http://www.nypost.com/p/news/local/low_pension_return_may_oak_taxpayers_sf9ojenk8yspdjwm6fpqwl> 13
Pg 85 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com Unsustainable Promises The New York State Constitution prevents the termination, diminishment or impairment of any plan benefit once it is granted to government employees. 26 Nevertheless, the State Legislature has acted to amend benefits through the years. The amendments had the effect of instituting a tiered system whereby employees, depending on when they were hired, are eligible for different benefit levels: 27 Tier 1 Before July 1, 1973 Tier 2 July 1, 1973 through July 26, 1976 Tier 3 July 27, 1976 through August 31, 1983 Tier 4 September 1, 1983 through December 31, 2009 Tier 5 January 1, 2010 to present Pension benefits for all New York participants are based on years of credited service and the final average salary (FAS). FAS is calculated as the average of the wages earned during any 36 consecutive months of service when employee earnings were at their highest. 28 Annual annuity payments are also subject to cost of living adjustments (COLA), which are generally 50% of an annual inflation rate, but never less than 1% or more than 3%, and applied only to the first $18,000 of the annuity. 29 These benefits are not subject to state and local income taxes true in only ten states. 30 New York is one of only three states that include overtime pay in calculating employees FAS. 31 Let s examine the State s pension obligations for a Tier 4 employee who works for 30 years (the old "30 and out"), retires at age 55 and in the last years of service earns an 26 Office of the State Comptroller, New York State and Local Retirement System, Retiree Annual Statement FAQ, 5 Aug. 2010. <www.osc.state.ny.us/retire/retirees/ras_frequently_asked_questions.htm#faq1> 27 Office of the State Comptroller, New York State and Local Retirement System, What Tier Are You In?, 24 Aug. 2010. <http://www.osc.state.ny.us/retire/members/find_your_tier.htm> 28 Office of the State Comptroller, New York State and Local Retirement System, Noncontributory Plan for Tier I Members (Section 75-d and 75-e), 4 Aug. 2010, www.osc.state.ny.us/retire/publications/zo1502.htm 29 Office of the State Comptroller, New York State and Local Retirement System, An explanation of Cost-of-Living Adjustments for retirees of the New York State and Local Retirement System, 23 Aug. 2010, http://www.osc.state.ny.us/retire/word_and_pdf_documents/publications/1800s/1863-colabrch.pdf 30 Snell, Ronald and Waisanen, Bert. State Personal Income Taxes on Pensions and Retirement Income: Tax Year 2009. September 2009. 24 Aug. 2010. <http://www.ncsl.org/default.aspx?tabid=12657> <http://www.ncsl.org/default.aspx?tabid=12657> 31 Goldberg, Delen. New York s Public Pensions are Socking Taxpayers. The Post-Standard. 15 Feb. 2009. 24 Aug. 2010. <http://www.syracuse.com/news/index.ssf/2009/02/new_yorks_public_pensions_are.html> 14
Pg 86 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com average salary of $70,000. 32 Each of these employees will have contributed to their own pensions just over $8,000. 33 In return, they will have accrued over $1,000,000 in pension annuity payments after 25 years of retirement. 34 This amounts to a return of nearly 130 to 1. Stunningly, benefits were even more generous under Tiers 1 and 2, where no employee contributions were ever required. Tier 5 was a step in the right direction, with the math changing to a 28 to 1 return for the same employee, although Tier 5 employees cannot retire until they are 62 years old. Historically, it was the case that states had to offer public workers plusher pensions because they earned lower salaries than their private-sector counterparts. In most cases today, however, government workers earn significantly more than their private sector counterparts. According to the U.S. Department of Labor s Bureau of Labor Statistics, public employee compensation (wages and benefits) is nearly 44% higher than private-sector compensation, though these comparisons vary meaningfully for different job classifications. 35 Yet in New York, the benefits keep on coming. During the 2005 legislative session, the New York Senate and Assembly passed at least 46 bills increasing pension benefits for public employees, at an estimated cost of more than $100 million. 36 In 2007, the New York State Legislature passed 21 pension-boosting bills. 37 Most stunningly, in the middle of a fierce battle to close a gaping deficit that delayed passage of a New York State budget for over four months, there were 50 bills before New York s Legislature, as of June 2010, that would add to pension benefits. 38 The costs to the State for maintaining this whole system are skyrocketing. In fiscal year 1998, New York spent almost $3.5 billion on member benefits. By fiscal year 2008, the last year for which these data are available, New York spent over $7 billion, an increase of over 100% in ten 32 Final Average Salary (FAS) is calculated by the highest average wages earned during any three consecutive years. 33 Assumes 3.9% salary growth per year, in accordance with actuarial assumptions listed in the New York State Complete Annual Financial Report (NYSCAFR FY2009). 34 They receive 60% of their FAS annually plus COLA once they turn 62 (assumes 2.0% annual inflation for the purpose of estimating the COLA at 1%, or half the assumed inflation rate). 35 ---. Bureau of Labor Statistics. Employer Costs for Employee Compensation. Washington, 2010, News release. <www.bls.gov/news.release/ecec.nr0.htm>. Note that this compensation gap essentially disappears in the case of jobs in the management, professional and related category, with all-in compensation for the public sector and the private sector virtually identical. However, large gaps exist within other job categories, creating the overall 44% disparity. 36 McMahon, EJ. Blame Albany, New York Post. 22 Dec. 2005. 5 Aug. 2010. Note that the article was found through The Empire Center for New York State Policy website: <http://www.manhattan-institute.org/html/_nypost_blame_albany.htm> 37 Goldberg, Delen. New York s Public Pensions are Socking Taxpayers. The Post-Standard. 15 Feb. 2009. 24 Aug. 2010. <http://www.syracuse.com/news/index.ssf/2009/02/new_yorks_public_pensions_are.html> 38 Confessore, Nicholas. Varied Bills for Special Interests Move Quietly Through Albany. The New York Times. 30 June 2010. 24 Aug. 2010. <http://www.nytimes.com/2010/07/01/nyregion/01handouts.html> 15
Pg 87 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com years. 39 The financial impact on everyday New Yorkers is similarly meteoric. Over the last decade, taxpayers annual pension contributions increased from $245 million in 2000 to $1.7 billion in 2010. 40 This whole unsustainable proposition is why private sector employers have been moving to defined contribution, or 401(k), plans. From 1980 through 2008, the proportion of private sector employees enrolled in defined benefit plans fell from 38% to 20%. 41 For states and municipalities, it, unfortunately, is not possible to guarantee benefits that so thoroughly outpace a reasonable rate of return for pension funds without dramatically increasing taxpayer subsidies. As a result, New York taxpayers contributions toward pension benefits in the last decade have grown to roughly $10 for every $1 that public employees contribute to their own pensions. Pension Contributions Fiscal Year ($ in millions) 2009 2008 2007 2006 2005 2004 2003 2002 2001 Employee contributions (ERS & PFRS): $ 273.3 $ 265.7 $ 250.2 $ 241.2 $ 227.3 $ 221.9 $ 219.2 $ 210.2 $ 319.1 Taxpayer contributions: $ 2,456.2 $ 2,648.4 $ 2,718.6 $ 2,782.2 $ 2,964.8 $ 1,286.5 $ 651.9 $ 263.8 $ 214.8 Ratio of taxpayer contributions to employee contributions: 9.0 10.0 10.9 11.5 13.0 5.8 3.0 1.3 0.7 Recent Underperformance Has Exacerbated This Dangerous Imbalance New York State s Pension System faces significant challenges that have been made worse by dramatic underperformance of the Fund in recent years under the current Comptroller. Note the summary of performance for a broad universe of 57 public pension funds over the last three fiscal years. In each case, New York s Pension Fund returns are substantially below the median. 42 Even in fiscal year 2010, when the State Comptroller s office announced with much 39 Office of the State Comptroller, New York State and Local Retirement System. 2009 Comprehensive Annual Report. Albany, NY, 2010. 21. <http://osc.state.ny.us/retire/word_and_pdf_documents/publications/cafr/cafr_09.pdf> 40 Gershman, Jacob. Cuomo, Lazio Spar Over Pensions. The Wall Street Journal. 7 Jul. 2010. 6 Aug. 2010. http://online.wsj.com/article/na_wsj_pub:sb10001424052748704862404575351420074469874.html 41 Butrica, Barbara A., Iams, Howard M., Smith, Karen E., and Toder, Eric J., The Disappearing Defined Benefit Pension and Its Potential Impact on the Retirement Incomes of Baby Boomers, Social Security Bulletin, Vol. 69, No. 3, 2009. 24 Aug. 2010. <http://www.ssa.gov/policy/docs/ssb/v69n3/v69n3p1.html> 42 R.V. Kuhns & Associates Public Pension Performance (> $2bn) Report for the Fiscal Quarter Ending March 31, 2010, p.17. This perfectly overlaps with New York State s fiscal year and is a direct data match. The R.V. Kuhns data are available online at: http://www.pera.state.nm.us/pdf/perafinancialarticles/fy10q3performanceanalysis.pdf (accessed August 2010). 16
Pg 88 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com fanfare that New York s Pension Fund had achieved returns of 25.90%, the Comptroller underperformed the median by almost 7 full percentage points, an enormous amount. 35% 30% 25% 20% 15% New York State Performance vs. Public Pension Median For the Past Three Fiscal Years 32.86% 25.90% Median Public Pension Performance New York State Pension Performance New York State s Compounded Annual Growth Rate for the past year, past two years and past three years is well below the median among comparable public pension funds. 10% 5% 0% -5% Fiscal Year 2010 Returns CAGR* FY09-10 -1.25% -3.73% CAGR* FY08-10 -0.54% -1.67% -10% *Note: Compounded Annual Growth Rate Source: These data are taken from R.V.Kuhns & Associates and are for fiscal years ending on 3/31 Of course, the most appropriate benchmark for a public pension fund is not a blend of the overall equity and fixed income markets, or even an index of public pension funds; the right benchmark is the investment return assumption stipulated by the Fund. The reason for this is because, as previously stated, the Fund must deliver on its investment return assumption, or any shortfall is passed on to the taxpayer. In other words, even if the Fund outperformed other public pension funds (which the R.V. Kuhns data show it definitively did not over the last three years), it would still have lost ground relative to its benchmark and thus triggered tax increases. In fact, the Fund s cumulative underperformance, relative to its 8% target investment return, over the past 3 years, totals nearly $50 billion. If all the Fund had done was keep pace with the median returns for public pension funds in the past year, it could have reduced this cumulative underperformance by $7 or $8 billion a material improvement for New York State taxpayers. It has been rumored, though neither refuted nor corroborated by the Comptroller, that a significant portion of this underperformance stems from the Comptroller s decision to suspend customary rebalancing at the trough of the equity market. 17
Pg 89 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com With the revelation of these aggregated data as compared to New York State s Fund performance, there should be little debate going forward from this point: our Fund has performed significantly worse than the median performance of other comparable public pensions over the years that overlap with the current Comptroller s tenure. Looking back further, R.V. Kuhns & Associates compiled aggregate returns for a broad universe of 89 representative public funds over the ten fiscal years between 2000 and 2009. The median compounded annual growth rate in that decade for a group of 89 public pensions that included New York State s was 3.04%. New York State s Fund, individually, returned 3.06% in that period, just above the median, which means our better relative performance in the earlier part of this decade has been weighed down substantially by poor recent performance. 43 Why Does All Of This Matter To New Yorkers? Most New Yorkers are not aware that whether the Pension Fund meets its obligations or not directly influences our State s highest-in-the-nation tax burden. The overall management of the Fund is akin to a pay-as-you-go scheme, with annual tax collections that plug shortfalls for any year there are shortfalls (based on a five-year smoothing mechanism). It is the great shell game the State Comptroller plays with New York s Pension System assume any shortfall is covered by future tax increases without laying out a multi-year forecast on what that means for taxpayers. As losses are realized and factor into the Fund s assessment through a five-year smoothing mechanism, they trigger increases in contributions by the State and local governments. These governments pay a certain percentage of their total payroll costs into the Pension Fund. As this percentage rises, the costs of State and local government rise, triggering either tax increases or cuts in other government services. Since our elected officials have proven highly reluctant to administer spending cuts, for all practical purposes pension underperformance means tax increases for all New Yorkers. The problem is especially significant for New Yorkers outside of the five boroughs of New York City, since New York City has a separate pension system. (New York City residents still bear some of the cost of the State Fund through their state tax burden.) So, while many New Yorkers consider the Fund to be an abstract matter that only affects the roughly 1 million retirees, beneficiaries and members, the harsh reality is that it has a significant impact on all of us. 43 Note: New York State s fiscal year ends on March 31 and R.V. Kuhns data from 2000 to 2009 are for fiscal years ending June 30, 2009. 18
Pg 90 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com In fact, this significant impact is about to grow much larger in the next few years. In just the last three years under the current Comptroller s tenure, the Fund underperformed its 8% target by nearly $50 billion in other words, if the Fund had actually achieved its 8% target, it would be nearly $50 billion larger. Since the Fund s performance, in fact, was negative, this gigantic shortfall will be passed on, over time, to taxpayers. Hiding the Impact: A Raid By Any Other Name Most observers recognize (and we certainly strongly agree) that New Yorkers cannot afford higher taxes. So, with the coming tax increases triggered by the Fund s underperformance, what s a politician to do? Simple: cover it up. Specifically, in this case, create a scheme to limit near-term contributions without being honest about the problem, and kick the can down the road past the election so voters won t see the problem for years. Here is how it all started back in 2009:.Comptroller DiNapoli has proposed legislation to ease the impact of the required contributions on tax rates. This legislation, which has been introduced in the Senate (S5826) and in the Assembly (A8899) would permit employers to amortize the increase in the required contribution rate over a ten year period. In the future the legislation would permit a gradual decline in the required contribution rate. The portion of the payment that exceeds the actuarial contribution rate would be used to further reduce previously amortized amounts. When all amortizations are exhausted any additional contributions will fund contribution stabilization accounts, which would be used to offset the impact of any future increases in the employer contribution rate. Enactment of this proposal would benefit employers by providing them with an option which would lessen the budgetary volatility of funding required pension contributions. 44 After initially supporting the borrowing plan he created, 45 then taking pains to deny knowledge about the borrowing plan 46 and then finally assailing the borrowing plan, 47 the current 44 Murray, Kevin. Letter to employers regarding final contribution rates for February 1, 2011 payment. September 2009, 24 Aug. 2010, 2. <www.osc.state.ny.us/retire/word_and_pdf_documents/employers_files/2011_final_rates/ers_final_rates_letter- 2011.pdf> 45 Hakim, Danny. State Plan Makes Fund Both Borrower and Lender. The New York Times. 11 June 2010. 24 Aug. 2010. <http://www.nytimes.com/2010/06/12/nyregion/12pension.html> 46 Benjamin, Elizabeth. Controversial pension plan could sink Tom DiNapoli. New York Daily News. 14 June 2010. 31 Aug. 2010. <http://www.nydailynews.com/news/2010/06/14/2010-06- 14_controversial_pension_plan_could_sink_state_controller_tom_dinapoli_.html> 19
Pg 91 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com Comptroller supported the borrowing plan, even going to great lengths to characterize this scheme as a smoothing, forcing municipalities to establish reserve accounts in good times that will offset the increasing contribution levels in bad times, like today. 48 However, the Comptroller won t release a long-term forecast and his underlying assumptions so taxpayers can assess the borrowing plan. Based on New York State Division of the Budget forecasts, it is unlikely that these reserve accounts will be utilized in the next 15 years, perhaps even longer, due to the depths of our pension problems. The reduced contributions will have to be paid back in the future with interest. This is a textbook definition of a borrowing which is why virtually every major publication covering this scheme has characterized it as such. 49 In fact, it s worse than that. The Comptroller s borrowing plan, passed as part of this year s budget, is nothing more than a disguised raid of the Pension Fund. For decades, the Comptroller has served as the last line of defense against politicians seeking to borrow from the Pension Fund to balance the State budget, or defer contributions to the Pension Fund for the same purpose. But the Comptroller s borrowing plan does exactly that; by reducing the State s contribution to the Pension Fund by just over $200 million, it helped the State close its budget gap. By deferring payments due today and paying them in the future with interest, it borrows from the Pension System on an unprecedented scale. In just the first six years, the plan would allow the State and local governments to borrow approximately $10 billion, with future interest costs in excess of $3 billion. 50 As stunning as this act of fiscal gimmickry may be, the approach was tried once before and it failed. Comptroller DiNapoli s predecessor, Alan Hevesi, authored a similar plan several years ago. Of the $655 million he borrowed (a tiny fraction of what Comptroller DiNapoli now proposes to borrow), approximately $400 million remains outstanding, and to this day annual 47 Office of the New York State Comptroller. DiNapoli: Pension Fund Will Not Be Raided. Press release, 14 June 2010. <http://www.osc.state.ny.us/press/releases/june10/061410.htm> 48 Budget Bill No. A09710 & S6610-C, Part TT, Section 103 (lines 33-35): if the amortizing employer s annual bill for the fiscal year does not include an amount attributable to a prior amortization, then the employer s graded payment shall be paid into the employer contribution reserve fund. 49 Hakim, Danny. Comptroller Backflips on Pension Borrowing. The New York Times, 15 June 2010; Gershman, Jacob. Shutdown Fears Wane in Albany, Wall Street Journal, 14 June 2010; Editorial, Double Talk: After Swearing Off Borrowing, the Governor is Trying to Take Out a Loan, New York Daily News, 19 June, 2010; Madore, James T. Will Albany Borrow from Pension Fund, In Order to Pay Into It? Newsday, 12 June, 2010; DiNapoli to NY Legislature: Hands Off Pension Fund, New York Post, 14 June, 2010. 50 According to calculations based on the New York State Division of the Budget projections and the Spring 2010 Market Recast, Pension Amortization Proposal General State Charges. The Division of the Budget s previous projection indicated over $11 billion in borrowing. 20
Pg 92 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com repayment costs exceed $75 million. It remains an open question as to how anyone looking out for the public welfare could seek to replicate and dramatically expand on such a failed program. For the average New Yorker this year the 2010 election year rates will stay the same as in 2009, when total employer contributions were $2.5 billion or so. That comes to just over $500 for every household outside of New York City (the City has its own separate pension system but bears some of the state cost through state taxes). Due to the underperformance of the Fund, government employer contributions are expected to increase dramatically and, when combined with interest costs, will cause total contributions to increase by 2017 to over $1,800 per household. The net effect of the underperformance and borrowing costs is a $1,300 per household increase in pension costs. 51 Unfortunately for New York taxpayers, the actual costs of this new scheme could be even more devastating, as the borrowing plan that ultimately passed the State Legislature on August 3, 2010 allows for this to go on each and every year forever. So these significant increases would not come in 2017, as called for under the original plan incorporated in the proposed budget, but the borrowings would be much larger over time, the interest costs would grow accordingly, and the bill would not come due for even longer. It is a Ponzi scheme that, like Bernie Madoff s, would eventually collapse on itself. Indeed, the plan s true costs depend upon the performance of the State s Pension Fund. And according to previous reports the Comptroller has not disputed, his office is assuming fantastically a repeat of market conditions after the 1987 crash, including the halcyon years between 1988 and 1998 when returns averaged nearly 14%. 52 If the market underperforms that rate what amounts to the best ten-year span in the Fund s history then this borrowing plan s reported costs could be even higher. To put this expectation into perspective, assuming the same asset mix as the current Pension Fund portfolio while making reasonable predictions for returns on fixed income and alternative investments, equities would have to skyrocket, with the Dow needing to reach 80,000 (versus a current level slightly above 10,000) by 2022 for the Comptroller s market assumptions to hold up. Should the Fund return anywhere less than an astounding 14% average over the next ten years, it would mean even greater financial pressure on the State and municipalities and a mountain of new debt both of which could lead to substantial underfunding. 51 About $1,000 of that hidden tax is due to the Fund s underperformance under DiNapoli and $300 is due to interest on his borrowing scheme. 52 Hakim, Danny. Pension Costs for Local Governments May Triple. The New York Times. 7 Jul 2009. 31 Aug. 2010. <http://www.nytimes.com/2009/07/08/nyregion/08pension.html> 21
Pg 93 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com The most remarkable aspect of this plan is that it passed at all. It is unambiguously bad for both taxpayers, who will be footing a rapidly increasing pension bill for years despite oft-repeated claims that it is fully funded, and for public employees, who will see the funding status of their Retirement System decline precipitously as a result of this borrowing plan. V. Rules Matter: Politicians Take Advantage of Public Pension Accounting Rules To Hide Deficits The Governmental Accounting Standards Board, or GASB, is the rulemaking body for state and local government accounting practices, which includes policies surrounding public pension funds. While GASB establishes a long series of rules and practices that affect public pension funds, we focus on four of the most important practices for the purposes of this white paper: 1) Discount rate The proper discount rate is a critical assumption that can create swings for the Fund in the tens of billions of dollars. GASB advises that a discount rate be based on an estimated long-term investment yield for the plan, with consideration given to the nature and mix of current and expected plan investments. 53 This approach of basing the discount rate on an assumption of long-term investment returns is dramatically different from the standard followed by all corporations and nonprofits and every financial practitioner and economist of good standing. Here is one example of the pernicious effect of GASB s rule: let s say a public pension fund manager decides to substantially increase the risk profile of his investments. Normally this would lead to the assumption of higher returns (even though it also substantially increases the risk of loss). The use of a higher investment return assumption would then translate into the use of a higher discount rate, which reduces the present value of future liabilities. By taking on substantially more risk (and substantially increasing the risk of loss), then, the pension fund would actually be able to reduce its stated liabilities. This twisted practice has no grounding in basic economics or finance or even common sense, yet it is a fundamental foundation of public pension accounting. In a 2007 speech, former SEC Chair Arthur Levitt Jr. (whose father, Arthur Levitt Sr., was widely admired for his stewardship of the New York State Pension Fund during its fiscal crisis in the 1970s), blamed these accounting rules for the major pension problems in our country, making the point in no uncertain terms that they fail to reflect accurately both the cost of the benefits 53 GASB Statement 25 22
Pg 94 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com owed to public workers and the value of the assets set aside to pay them. 54 (We will address his latter claim soon enough.) 2) Investment return assumption Unlike in the private sector, GASB suggests that the investment return and the discount rate are identical. We ll discuss in the next section why that should not be the case, and in fact is not for any entities other than the public pension funds governed by GASB. Just as importantly, GASB provides very limited prescriptions around what might constitute an acceptable estimated longterm investment yield for [pension plans] and, as discussed above, does not offer any consideration for the appropriate risk profile and what that might mean for investment returns. But given the nature of the underlying liabilities, it is critical that GASB formulates investment return guidelines that take risk into account, lest it continue to push public pensions into increasingly risky investments (as has been very much the case in recent years). In fact, the current Comptroller has sought to increase the Fund s exposure to alternative assets such as private equity firms and hedge funds 55 while blaming those same firms for contributing to our nation s recent economic collapse. 56 3) Asset valuation To measure against the present value of a pension fund s discounted liabilities, one must tally up its current assets. This would seem straightforward enough presumably, one could just take the market value of the underlying assets. Unfortunately, that s not how public pension accounting generally works. Public pension funds are allowed to use a variety of accounting gimmicks to restate their asset values. New York s Pension Fund uses an actuarial asset value that incorporates two accounting devices that have little relation to the market value of assets. First, asset values are smoothed out over a five year horizon. In other words, if the Fund owns stock in Microsoft, and Microsoft trades on the stock exchange at $25.00 per share, the actuarial value of Microsoft at that time could be $20, $30 or some other number that reflects a five-year smoothing. 54 Levitt Jr., Arthur. Remarks. New York Private Equity Conference. New York, NY. 30 Oct. 2007, p. 3 (http://www.pebc.ca.gov/images/files/071113_pension.pdf) 55 Hakim, Danny. DiNapoli Reports Plunge in the State Pension Fund. The New York Times. 29 May 2009. 31 Aug. 2010. <http://cityroom.blogs.nytimes.com/2009/05/29/dinapoli-reports-plunge-in-state-pension-fund/> 56 Interview with Thomas P. DiNapoli, NYS Comptroller. The Empire Page. 26 Aug. 2010. 31 Aug. 2010. <http://www.empirepage.com/2010/8/26/interview-with-thomas-p-dinapoli-nys-comptroller> 23
Pg 95 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com Second, a component of the actuarial asset value allowable by GASB includes the present value of future State and local government contributions (paid for through state and local taxes) and contributions by employees. These assets are not really there, but rather represent the expectation of future payments. To make matters worse, given limited disclosure, the employers are generally not aware of the magnitude of their future obligations. But here s the even greater problem. Because of this provision, as long as a state is willing to stipulate that it will ALWAYS pass through pension fund shortfalls to the taxpayers and has a robust mechanism to do so, IT WILL ALWAYS BE FULLY FUNDED. 57 This present value tax account will increase to reflect higher future taxes. For example, in New York s 2004 Complete Annual Financial Report (CAFR), these present values were negligible, less than $2 billion in aggregate, 58 but in the most recent 2009 CAFR, the total exceeded $20 billion. 59 This amounts to a more than ten-fold increase in the present value of future employer contributions (derived from state and local taxes) in order to fill the hole created over that period of time. 4) Amortization Currently, GASB allows public funds to amortize changes in policies or even benefits over a period of up to 30 years, dramatically reducing the impact on any one year, though there is an effort to change this standard to 15 years. A move to 15 years would double the annual impact of losses (and gains), further draining cash flows in bad environments yet it would likely still be more generous and less rigorous than current private sector standards. 57 Office of the State Comptroller, New York State and Local Retirement System. 2009 Comprehensive Annual Report. Albany, NY, 2010. 96. <http://osc.state.ny.us/retire/word_and_pdf_documents/publications/cafr/cafr_09.pdf>: Under the aggregate funding method, the difference between the actuarial liabilities above and the actuarial value of present assets is funded as a level percentage of salary over the future working lifetimes of current members. 58 Office of the State Comptroller, New York State and Local Retirement System. 2009 Comprehensive Annual Report. Albany, NY, 2010. 76. <http://osc.state.ny.us/retire/word_and_pdf_documents/publications/cafr/cafr_09.pdf> 59 Office of the State Comptroller, New York State and Local Retirement System. 2009 Comprehensive Annual Report. Albany, NY, 2010. 100. <http://osc.state.ny.us/retire/word_and_pdf_documents/publications/cafr/cafr_09.pdf> 24
Pg 96 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com VI. Private Sector Standards: Not Perfect, But More Honest And Realistic Much like GASB oversees public pension plans, the Financial Accounting Standards Board (FASB) oversees private ones. Despite the interrelationships between FASB and GASB (they are both part of the Financial Accounting Foundation), on the critical assumptions outlined above, they could not be more different: 1) Discount rate FASB follows the same basic principles suggested by modern economics and finance: it directs private pensions to discount their obligations at a rate consistent with the yields of high quality (AA rated or better) corporate bonds: [A]n employer may look to rates of return on high-quality fixed-income investments in determining assumed discount rates. The objective of selecting assumed discount rates using that method is to measure the single amount that, if invested at the measurement date in a portfolio of high-quality debt instruments, would provide the necessary future cash flows to pay the pension benefits when due. Notionally, that single amount, the projected benefit obligation, would equal the current market value of a portfolio of highquality zero coupon bonds whose maturity dates and amounts would be the same as the timing and amount of the expected future benefit payments. 60 This would mean applying different discount rates to obligations in different years. For example, pension payments due in 2011 would be discounted at the 1-year AA bond rate, while pension payments due in 2040 would be discounted at the 30-year AA bond rate. The average discount rate will depend on the average age, retirement age and life expectancy of public employees, but, for the Fund, in the current interest rate environment, would almost certainly be less than 6% under the FASB standard, as it is applied to corporations and nonprofits. 61 So, if New York s Pension Fund were managed by a corporation, say IBM or GE, then it would be expected to use a discount rate of less than 6%. But New York State is not a corporation. State pension benefits are constitutionally protected, and thus are substantially less risky than corporate pension benefits, which are considered unsecured obligations and are often compromised, unfortunately, in a corporate bankruptcy. Basic principles of economics would dictate a lower discount rate for the Pension Fund than for a corporation. 60 Financial Accounting Standards Board, Statement of Financial Accounting Standards No. 87 Employers Accounting for Pensions, 2008. 61 As of July 2010, the IRS lists the 1 year AA bond rate as 1.13%, the 15 year AA bond rate as 5.53% and the 30 year AA bond rate as 6.02%. 25
Pg 97 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com How low might the proper rate be? Since public pension benefits are virtually risk-free, many commentators have argued that the discount rate should be equal to the risk-free rate, or U.S. government treasuries. 62 With the 30-year Treasury bond currently yielding less than 4%, this would suggest a discount rate of less than 4%. Other commentators argue that New York State s municipal bond rates are better indicators of the proper discount rate. In fact, GASB is already considering supplementing the practice of using the rate of return on public pension fund investments as the discount rate with a proposal to use a high-quality municipal bond index rate for a portion of future benefit payments. 63 The result, according to Moody s, is that discount rates will almost certainly be lower with large increases in the reported deficits. 64 We re left, then, with a range of possible outcomes that demands serious debate and review: an upper range of just below 6%, consistent with the actual practices of the private sector, and a lower range of closer to 4% or less, consistent with the standards set by the private sector when applied to public sector obligations that carry important differences. 2) Investment return assumption What is a sustainable long-term rate of return for a pool of assets as large as the State Pension Fund? There is no simple answer, since no one has a crystal ball. However, there are some important guidelines to consider: i) When in doubt, it is better to err on the side of caution, as taxpayers will bear the cost if you are wrong. ii) Past returns are not necessarily a good indication of future returns. As Warren Buffet often warns, investors of all stripes should not make the mistake of looking in the rearview mirror. 62 Novy-Marx, Robert and Rauh, Joshua. The Intergenerational Transfer of Public Pension Promises, National Bureau of Economic Research, Working Paper 14343 (September 2008): 7 63 States May Face Pension Pressure as New GASB Rules Widen Funding Deficits. Bloomberg News. 7 July 2010. 26 Aug. 2010. <http://www.bloomberg.com/news/2010-07-09/states-may-face-pension-pressure-as-new-gasb-rules-widenfunding-deficit.html> 64 States May Face Pension Pressure as New GASB Rules Widen Funding Deficits. Bloomberg News. 7 July 2010. 26 Aug. 2010. <http://www.bloomberg.com/news/2010-07-09/states-may-face-pension-pressure-as-new-gasb-rules-widenfunding-deficit.html>. 26
Pg 98 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com For example, it is often argued by advocates of higher investment return assumptions at public pension funds that long-term rates of return are around 8%. The primary driver of these historical rates is equity returns that have approached 10% over a long period of time. Notably, the very folks who benefited enormously from that rate of appreciation in the 20 th Century are among the first to understand and argue that those returns cannot be expected in the future. Here is Warren Buffett again: Let me summarize what I've been saying about the stock market: I think it's very hard to come up with a persuasive case that equities will over the next 17 years perform anything like anything like they've performed in the past 17. If I had to pick the most probable return, from appreciation and dividends combined, that investors in aggregate repeat, aggregate would earn in a world of constant interest rates, 2% inflation, and those ever hurtful frictional costs, it would be 6%. 65 Why would this be the case, considering historical returns have been higher? To oversimplify matters a bit, there are three primary components to equity appreciation in the long-term: real GDP growth (as earnings growth cannot outpace GDP growth in the long-term), inflation (the first two, taken together, would be nominal GDP) and dividends. For much of the 20 th century, real growth averaged 3.3%, inflation averaged 3.1% and dividends amounted to approximately 4% of the underlying equity value, leading to a cumulative long-term equity return of approximately 10%. 66 More recently, since 2000, annual inflation has averaged only 2.5%, dividend yields 1.8% and GDP growth 1.9%. 67 That comes closer to 6% than 8%. Looking ahead, the long-term view is much more consistent with recent history. The 20 th Century witnessed America s transformation from a largely agrarian economy to the world s largest industrial power a level of growth that cannot be replicated over the long-term by an economy as mature as America s. While there is some disagreement about this (generally, those who disagree favor a lower expected growth rate), most prognosticators expect real GDP growth to be close to 2% in the long run. 65 Buffett, Warren and Loomis, Carol. Warren Buffett on the Stock Market, Fortune Magazine, 22 Nov. 1999. 25 Aug. 2010. <http://money.cnn.com/magazines/fortune/fortune_archive/1999/11/22/269071/index.htm> 66 See Alpha and Vega (both anonymous), Are Stocks Overvalued?. Risk Over Reward. Oct. 25, 2009. Aug. 23, 2010; http://www.riskoverreward.com/2009/10/are-stocks-overvalued.html Dudley and others 1999; Wadhwani 1998; http://www.multpl.com/inflation/table; http://www.multpl.com/s-p-500-dividend-yield/table; and Officer, "Lawrence H. What Was the U.S. GDP Then?" MeasuringWorth. 2010. 31 Aug. 2010. <http://www.measuringworth.org/usgdp/> 67 Ibid. 27
Pg 99 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com After the efforts of the Volcker Fed in the early 1980s, inflation has generally been much lower. The deflationary impact of the growth of the Chinese and Indian labor markets has further depressed inflation over the past decade. Current long-term market forecasts (as supported by spreads relative to Treasuries in the TIPS market) suggest long-run inflation rates closer to 2%. 68 Finally, dividends, once a large component of equity returns, have declined dramatically in recent decades. Currently, the dividend yield on the S&P 500 is approximately 1.9%. 69 In other words, both long-run expectations and (the post-dot com bubble) recent history suggest long-term equity returns of 6%, not the 10% we experienced during America s transformation into an industrial power. The experts uniformly agree: There is a near certain probability that the financially based global economy of the past halfcentury will not return, nor will we experience the steroid driven growth excesses that it facilitated. 70 --Bill Gross, CEO of PIMCO it will be interesting to see whether companies have reduced their assumptions about future pension returns. Considering how poor returns have been recently and the reprises that probably lie ahead, I think that anyone choosing not to lower assumptions CEOs, auditors, and actuaries all is risking litigation for misleading investors. And directors who don't question the optimism thus displayed simply won't be doing their job. 71 --Warren Buffett Why use an 8% assumption? Because if you used more conservative numbers, as the academic studies suggest, you would have to make larger current contributions to the pensions, when state and local governments and schools are already in fiscal trouble This is going to end in tears for many states and municipalities. I mean real tears. Pension funding in some states will be required by law to consume 25-30% or more of tax revenues. That is going to mean much higher 68 As of August 27, 2010, the spread between 10 year TIPS and 10 year Treasuries was 1.61%, and the spread between 30 year TIPS and 30 year Treasuries was 2.02%. 69 Dividend Yield for Stocks in the S&P 500, indexarb. Aug. 27, 2010: http://indexarb.com/dividendyieldsortedsp.html 70 The Future of Investing: Evolution or Revolution? Investment Outlook April 2009. 11 Aug. 2010 <http://media.pimco-global.com/pdfs/pdf_uk/io%20april%2009%20uk.pdf?wt.cg_n=pimco- EUROPE&WT.ti=IO%20April%2009%20UK.pdf> 71 Buffett, Warren and Loomis, Carol. Warren Buffett on the Stock Market, Fortune Magazine, 10 Dec. 2001. 11 Aug. 2010. <http://money.cnn.com/magazines/fortune/fortune_archive/2001/12/10/314691/> 28
Pg 100 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com taxes or reduced services. 72 --John Mauldin, president of the investment advisory firm Millennium Wave Advisors, LLC Of course, the Fund does not consist of 100% U.S. stocks; it has meaningful allocations to international stocks, fixed income, real estate, private equity and hedge funds managing various strategies. But the widely-held diminished expectations for equities over the long run are instructive and the right argument why historically high returns are not likely to be replicated in the coming decades certainly not likely enough to bet on with taxpayer money. For example, let s take a look at the international stock portfolio. Much of what has been argued here about U.S. equities could be applied to international stocks as well equity appreciation is a function of underlying economic growth and dividends. Economic growth for markets outside the U.S. has been remarkably similar to U.S. economic growth for the past four decades in fact, the U.S. share of global GDP in 2009 (approximately 27%) was virtually identical to its share in the early 1970s, as faster growth in Asia was offset by slower growth in Europe, leading the US share to remain constant. 73 The dividend yield on international stocks is slightly higher today than for U.S. stocks, 74 but this slight advantage can be more than offset by currency risks embedded in international stocks. Unfortunately, there s no lifeline in international stocks; over the last 10 years, the equity returns of the MSCI EAFE index have been virtually identical to (actually, slightly less than) the returns of U.S. stocks. 75 What about fixed income? Long-term return data for fixed income is less frequently cited, but the best available data suggest a diversified bond portfolio would have generated a 5.5% return over most of the past century. 76 Unlike equities and their greater volatility, this performance has been more consistent, as various bond indices suggest more recent fixed income returns (in the midst of the longest and strongest bull market for fixed income in decades) of between 5% and 6.5%. 77 Given current yields, there is a compelling argument that fixed income in the next few years will underperform its historical averages, but our arguments center, appropriately for the Fund, on a long-term analysis. So, unfortunately, there is no salvation here, either. 72 Mauldin, John. The Problem with Pensions. Seeking Alpha. 8 Aug. 2010, 11 Aug. 2010. <http://seekingalpha.com/article/219420-the-problem-with-pensions> 73 Perry, Mark J. U.S. Share of World GDP Remarkably Constant. Carpe Diem. 19 Nov. 2009, 31 Aug. 2010. <http://www.mjperry.blogspot.com/2009/11/us-share-of-world-gdp-remarkably.html> 74 Current dividend yield of MSCI EAFE index is 2.62%. 75 According to the MSCI Barra website (www.mscibarra.com), through August 30, 2010, the trailing 10 year return for the EAFE index was -1.23%, vs. -1.07% for MSCI s Investable Market 2500 Index. 76 www.personal.vanguard.com/us/insights/saving-investing/model-portfolio-allocations.com 77 www.us.ishares.com/product_info/fund/performance/agg.htm 29
Pg 101 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com Finally, what about alternatives real estate, private equity and hedge funds? Recall that the current Comptroller has been seeking to increase the 25% cap on alternatives imposed by the Legislature, 78 even while arguing that such firms knowingly made risky bets in search of quick profits at any cost... truly the worst of Wall Street. 79 This glaring inconsistency aside, even the actuaries believe that there is relatively little outperformance to be gained from a diversified portfolio of alternatives. For example, the Pension Consulting Alliance s (PCA) 2010 10-year capital market projections are based on the view that real estate will underperform equities by about 2%, hedge funds will perform in line with equities and private equity will outperform equities by about 3%, 80 leading to an alternatives portfolio that would outperform equities by 1% at most. However, these different asset classes do provide some diversification and thus help mitigate volatility. The reality is that, given the correlations between private equity, in particular, and some hedge funds to U.S. equities, it is unrealistic to expect meaningful outperformance to be driven by the alternatives portfolio, particularly net of fees. At roughly 20% of the current Fund, this part of the portfolio also does not change the ultimate conclusion that long-term returns, if managed well with a prudent risk profile, are likely to be within the range of 5% to 6% and certainly not 8%. Not coincidentally, Buffett assumes an expected long-term rate of return for his Berkshire Hathaway plan assets, across all asset classes, of 6.9%. 81 Buffett is considered by many to be one of the all-time great investors and has grown the market value of his holding company at a compound annual rate of 22% over the last 45 years. 82 Yet, he is the first to acknowledge that he established his formidable track record over a unique period in American history that won t be replicated in this century. In addition, the 2010 Wilshire Report, based upon data from the most recent financial and actuarial reports provided by 125 pension funds including New York s, 78 Cataldo, Adam and McDonald, Michael. States Double Down on Hedge Funds as Returns Slide. Bloomberg. 14 Aug, 2008. 10 Aug. 2010. <http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ami_ufrp4xb4> 79 Interview with Thomas P. DiNapoli, NYS Comptroller. The Empire Page. 26 Aug. 2010. 31 Aug. 2010. <http://www.empirepage.com/2010/8/26/interview-with-thomas-p-dinapoli-nys-comptroller> 80 Pension Consulting Alliance. "2010 Ten-Year Return, Risk, and Correlation Assumptions." January 2010. 2. <http://www.pensionconsulting.com/pdfdocs/nominal%202010%20assumptions%20short%20form%20final_1-10.pdf> 81 Berkshire Hathaway, Inc. 2009 Annual Report. 25 Aug. 2010. 53. <http://www.berkshirehathaway.com/2009ar/2009ar.pdf> 82 Berkshire Hathaway, Inc. 2009 Annual Report. 25 Aug. 2010. 4. <http://www.berkshirehathaway.com/2009ar/2009ar.pdf> 30
Pg 102 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com forecasts that none of them can be expected to earn long-term asset returns that equal or exceed 8%. 83 It is for these reasons that we believe a far more realistic investment return assumption is in the range of 5% to 6% and that 8% is irresponsibly fanciful. This logic reflects the recommendation to the board of The California Public Employees' Retirement System (CalPERS) by its advisor, Blackrock: You're not going to get a 7.6% return when the U.S. is seeing a subpar (economic) growth rate of 2% to 3%...You'll be lucky to get 6%... maybe 5%. 84 --Laurence Fink, chairman and CEO of BlackRock Inc. Given the weight of the evidence, logic and of expert opinion, only one question remains: What does Tom DiNapoli know that Warren Buffett doesn t? How can any public pension realistically expect to outperform the great investors? No public pension should, 85 and there is a growing realization of this view creeping into the thinking of public pension trustees as evidenced by rumors that CalPERS is considering reducing its investment return assumption to 6% as soon as this December conveniently after the next election. 86 3) Asset valuation For the purposes of calculating funding levels, FASB mandates that pension assets are marked to market, 87 a stark contrast to the actuarial asset value approach adopted by New York. By not marking assets to market, New York further obscures the truth about its pension funding. Even so, were New York to mark its pension assets to market, it may not necessarily translate into lower values. In 2008, for example, the market value of New York s Pension assets was very 83 Wilshire Consulting. 2010 Wilshire Report on State Retirement Systems: Funding Levels and Asset Allocation. March 2010. 13. <http://www.wilshire.com/businessunits/consulting/investment/2010_state_retirement_funding_report.pdf> 84 Fink gives CalPERS a reality check. Pensions & Investments. 10 Aug. 2009. 11 Aug. 2010. <http://www.pionline.com/article/20090810/printsub/308109987> 85 The same applies to corporate pension funds, even though there are some corporate pension funds that also maintain higher, and equally unrealistic, long-term investment return assumptions. 86 Chon, Gina. Calpers Confronts Cuts to Return Rate. Wall Street Journal. 1 March 2010. 25 August 2010. <http://online.wsj.com/article/na_wsj_pub:sb10001424052748703316904575092362999067810.html> 87 FASB allows for exceptions when calculating the income statement impact and future contributions, but not for calculating funding ratios. 31
Pg 103 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com close to the actuarial value, largely by coincidence. 88 In 2009, however, as the market sell-off decimated the asset base, the actuarial value of Fund assets would have smoothed the decline. Our ability to assess the impact of mark-to-market asset valuation is hamstrung by the limited transparency provided by New York s Comptroller. A recent example of another public pension system performing a mark-to-market valuation, however, is hardly encouraging. For 2008, New York City s chief actuary, Robert C. North, calculated the mark-to-market value of assets in the five funds that make up New York City s Pension System, using the same discount rate for liabilities as New York State, and revealed a $45 billion funding deficit compared to the fully 89, 90 funded status that the more misleading, GASB-approved accounting method reported. But the larger problem arises from the practice of using the present value of future tax payments to calculate the funding ratio. This is one of the great fictions of New York State: as long as the Comptroller is willing to raise contribution rates (and thus taxes) as high as is necessary in the future, then the Pension Fund will always seem fully funded. 4) Amortization FASB s policy on assessing the impact of benefit changes is to amortize them over the average remaining service lives of the employees. 91 Since this would surely translate into a shorter amortization period, it would also increase the amount to be expensed each year. Regrettably, given the limited transparency provided by the New York State Comptroller s office, it is impossible to predict the impact of a change to conform to private sector practice. 92 88 Office of the State Comptroller, New York State and Local Retirement System. 2008 Comprehensive Annual Report. Albany, NY, 2010. 63. <http://www.osc.state.ny.us/retire/word_and_pdf_documents/publications/cafr/cafr_08.pdf>: The market value of assets in FY 2008 was $153.9 billion. Office of the State Comptroller, New York State and Local Retirement System. 2009 Comprehensive Annual Report. Albany, NY, 2010. 48. <http://osc.state.ny.us/retire/word_and_pdf_documents/publications/cafr/cafr_09.pdf>: The actuarial value was $151.7 billion. 89 Cooper, Michael and Walsh, Mary Williams. Pension Fund Short or Full? Depends on the Evaluator. The New York Times. 27 Aug. 2006. 25 Aug. 2010. <http://query.nytimes.com/gst/fullpage.html?res=9a04efd8103ef934a1575bc0a9609c8b63&scp=1&sq=pension %20Fund%20Short%20or%20Full?%20Depends%20on%20the%20Evaluator&st=cse> 90 According to the most recent Complete Annual Financial Reports from the five public pension funds that make up New York City s pension system. 91 Financial Accounting Standards Board, Statement of Financial Accounting Standards No. 87 Employers Accounting for Pensions, 2008. 92 See Girard Miller, New Proposal for Pension Books. Governing. (20 May 2010), available at: http://www.governing.com/columns/public-money/new-gasb-proposals-pension-bookkeeping.html. 32
Pg 104 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com In short, private sector standards would drive substantial revisions in the Fund s stated assets and liabilities and paint a very different, but more accurate, picture of its financial health. Fortunately, change is coming. GASB is currently conducting an extensive review of its policies, including a number of the key issues raised here. Some of the considered changes can be previewed in a GASB document entitled Preliminary Views of the Governmental Accounting Standards Board on major issues related to Pension Accounting and Financial Reporting by Employers, No. 34P (June 16, 2010). 93 For these changes to take effect, GASB must first consider public comment on the proposals, in accordance with Federal Administrative Law. If GASB does the right thing and adopts the fairer standards of its FASB cousin (though the Preliminary Views statement suggests they will only partially do so), we will have truth in public pension accounting for the first time, and our public officials will no longer be able to hide our pension crisis from wider view. Not surprisingly, but embarrassingly nevertheless, many state pension fund officials, including the New York State Comptroller, have taken this opportunity to write to GASB officials and urge them not to make any material changes in its oversight practices and are opposing alterations to its rules. 94 This is the equivalent of Enron writing to the FASB and requesting that they not change the accounting rules governing the special purpose entities that were a factor in its ultimate demise. Meanwhile, The Wall Street Journal reports that the proposed GASB reforms are popular among government bond buyers, civic groups and others who use the financial information presented by local governments and others who may be harmed by misleading representations of state financial obligations. 95 Evidently, public pension officials fear truth in accounting and accepting the standards under which corporations must operate. Anticipated changes go beyond those of GASB. In January 2010, the SEC announced that it had a special unit investigating public pension disclosures. The first public action of this initiative resulted recently in an accusation of securities fraud against New Jersey, the first ever against a state, and a settlement. Further SEC action is anticipated. 96 93 Available at: www.gasb.org/cs/contentserver?c=document_c&pagename=gasb%2fdocument_c%2fgasbdocumentpage&cid =1176156938122 ( Jun. 16 Preliminary Views ) 94 Chon, Gina. Gurus Urge Bigger Pension Cushion. The Wall Street Journal. 29 Mar. 2010. 25 Aug. 2010. <http://online.wsj.com/article/na_wsj_pub:sb10001424052748703416204575146213238489720.html> 95 Ibid. 96 Walsh, Mary Williams. Pension Fraud by New Jersey is Cited By S.E.C. The New York Times. 18 Aug. 2010. 31 Aug. 2010. <http://www.nytimes.com/2010/08/19/business/19muni.html> 33
Pg 105 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com While our nation s pension underfunding crisis may be massive, regulatory changes and public pressure will bring the game to an end soon, and New York must begin to prepare for these changes today. 34
Pg 106 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com VII. What Does It All Mean? How Big is Our Problem? To summarize the impact of private sector standards, consider the following: There is a reasonable range of appropriate discount rates for public pension funds, though New York s chosen rate is far outside this range. There is a reasonable range of investment return expectations for public pension funds, though New York s current return assumption is also outside this range. The Comptroller does not provide enough transparency for outsiders to calculate the impact of valuing assets at their current market values (only historical values) or to calculate the impact of revised amortization standards, though we know the latter would certainly exacerbate the underfunding by increasing liabilities, and the former likely would as well. Even before factoring in the affects of mark-to-market valuation and shorter amortization schedules, private sector standards (i.e., a discount range of around 4% to 6%) would reveal a pension deficit for New York State ranging from about $30 billion to $80 billion. 97 This analysis should make clear that public pension funds are the next great Ponzi scheme likely to blow a hole through the American economy, and the politicians in charge of them are covering it up through lax accounting standards that hide the size of the crisis. The enormity of this calls to mind the structured investment vehicles (SIVs) that helped nearly sink some Wall Street banks, most notably Citibank. These SIVs allowed investment banks to take advantage of current accounting rules and keep certain assets and debts off-balance sheet, to the point where even highly sophisticated senior executives and board members misunderstood the risks. 98 However, once investors learned of the size of the problems, they created havoc, prompting action. Similarly, Greece s financial position was not understood until a new regime came into power and revealed what had been previously hidden by questionable accounting. The above are just two of the many financial calamities that were a part of the great credit bubble we lived through in recent years. The credit bubble enabled excess consumption and borrowing by every segment of society from Wall Street to federal and state governments to consumers. 97 This analysis relies on the assumption of a 15 year average life for employees. 98 Dash, Eric. Big Rescue of Funds by Citigroup. The New York Times. 14 Dec. 2007. 31 Aug. 2010. <http://www.nytimes.com/2007/12/14/business/14citi.html?scp=1&sq=big%20rescue%20of%20funds%20by%20c itigroup&st=cse> 35
Pg 107 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com It will take years of sacrifice under a long-term plan to repair the damage, but the only alternative is to follow the course of Japan, which refused to deal with the fallout from its own credit bubble in the 1980s and stagnated for decades as a result. For states, the biggest bubble hangover is the coming pension crisis, and we need to be honest about the size of it before it overwhelms us. If we act soon enough, we can still avoid the horrific cataclysms that engulfed those other two segments but only if we act soon enough. 36
Pg 108 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com VIII. The Right Way to Manage the CRF Many of our pension issues are rooted in the political considerations that seep into the management of the Fund. To prevent political influence where it is unhelpful, damaging and too often scandalous, New York s pension management is in need of several immediate professional reforms. At the core of these reforms are changes in the decision-making process of the Fund s trustee. Sole Trustee: Pros and Cons New York State s Pension System is one of only three states that employ a sole pension trustee. Much has been said, and for good reason, about the shortcomings of this management structure, including: 1) No one person has a monopoly on wisdom and should not be entrusted with that much authority. 2) The sheer size and breadth of our Pension Fund leads to substantial opportunities for corruption, as evidenced in recent years. Even with an honest Comptroller and senior staff of integrity, the potential appearance of impropriety is significant enough that the appropriateness of a sole trustee must be questioned. 3) The political process does not typically lead to identifying the best stewards of the Pension Fund. Combining an inherently professional role with the electoral process leads to poor results and unqualified Comptrollers. There are other concerns, but these are the chief arguments for reforming the sole trustee, and why the vast majority of states prefer a fiduciary board. There are also significant advantages to the sole trustee system, seen most clearly through the failures of public pension systems managed by a board: 1) The sole trustee maintains ultimate accountability. When the Fund performs poorly, the voters know whom to blame, rather than diffusing responsibility among appointed board members. 2) The sole trustee can be an effective bulwark against politically motivated raids on the Pension Fund by profligate politicians who can t balance the State budget. Unfortunately, this longstanding virtue and its tradition in New York has been undermined by the current and most recent Comptrollers, who both proposed, and ultimately got passed, pension raids in the form of borrowing plans. 37
Pg 109 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com 3) The sole trustee can bring about effective reform of Fund management more quickly and more professionally than a board. At a time when reform is badly needed, this becomes especially important. So how does one address the major shortcomings of the sole trustee system while retaining its virtues? Mend it, Don t End it A thoughtful reform approach would preserve the strengths of the sole trustee and correct its major shortcomings. To do this, the entire approach to investing the Fund should be changed. Most significantly, the Comptroller should create a true investment committee of 7 to 9 retired, world-class investors. New York State has more investment talent than any other state or even any country in the world, yet we barely utilize it. The current Investment Advisory Committee is hardly utilized for key investment decisions and has suffered a number of defections. A proper investment process would create a world-class investment committee and also utilize it far more extensively, as described below. This is not a novel concept it is, in fact, the way the vast majority of successful investment organizations are managed, and the Fund would do well to adopt the same common-sense approach. It is important to note the distinctions between this Investment Committee and the boards that are found at the vast majority of public pension funds. First, none of the appointees would be politically motivated or based on politics; they would be purely merit-driven considerations based on investment talent. By design and execution then, each appointee would possess an extraordinary amount of financial experience. Second, the Investment Committee would be utilized differently than a typical board and as outlined below: 1) Establish asset allocation. a. The Comptroller will work with the Investment Committee to revise the asset allocation, within the boundaries established by the Legislature but with dramatically less risk in the portfolio. The Comptroller will retain the ultimate authority on the final asset allocation, but it will be developed through extensive discussions with and review by the Investment Committee. b. Recent stewardship of the State Pension Fund is a lesson on the perils of an overly aggressive return assumption: by shooting too high, the Fund took on too much risk, which led to more volatility and underperformance. Here, it s interesting to 38
Pg 110 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com note that in the 1980s, before inflation and market bubbles enticed public pension funds into equities in far greater proportions, most were invested primarily in treasuries, corporate bonds and other less risky assets and had a correspondingly lower investment return assumption, generally around 4% to 5%. 99 One way to think about that history is that public pension funds for decades were invested conservatively, had little volatility and delivered on their promises, even in adverse market environments. The long bull market from 1982 to 2000 allowed for pension funds to take on more risk, make richer promises and get away with it. It has taken the better part of a decade of mediocre market returns for the sins of the bull market period to catch up with us, but the overall trend among public pension fund returns has been clear enough. The corresponding costs have proven to be massive. Interestingly, over the last three years, the most conservative part of the portfolio, the fixed income portfolio, was far and away the best performing portion of the Fund (a 6.8% compound annual return over the past three years, when overall performance was negative). Had the current Comptroller established a 6% investment return assumption at the beginning of his tenure and shifted more assets into fixed income, the Fund would have performed much better, with less risk, than it actually did, and taxpayers would be much better off. 2) Equities and Fixed Income Investments a. The asset allocation process will likely result in a meaningful shift from equities to fixed income. Still, within each asset class, there is a second layer of decisions to be made: what is the appropriate mix of active vs. passive (index fund) management? b. The vast majority of active managers underperform the index after fees over time. i. For example, the below chart illustrates the net rate of return over the last 1, 3, 5 and 10 years, for actively managed funds in New York s pension portfolio and the net rate of return for the S&P (passively managed funds would do approximately 0.20% worse than the S&P due to fees). As these results consistently show, active managers selected for the Pension Fund perform materially worse, on average, after fees than a passively managed index. 99 National Association of State Retirement Administrators. Public Pension Plan Investment Return Assumptions. NASRA Issue Brief March 2010. 25 Aug. 2010. 3. <http://www.calpersresponds.com/downloads/nasra_invreturnassumption%20acrobat5compatible.pdf> 39
Pg 111 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com Returns for Actively and Passively Managed Funds in the CRF Portfolio* ^ S&P 500 Historical Returns (-15 bps) -3.15% -2.14% Last 10 Years (FY 2000-09) CRF Actively Managed Fund Returns (-50 bps) -4.91% -5.93% Last 5 Years (FY 2005-09) -15.82% -13.21% Last 3 Years (FY 2007-09) -38.24% -39.37% Last Year^ (FY 2009) ^Last year for which data are available -50% -40% -30% -20% -10% 0% ^We assume gross returns are reported in the NYS CAFR and calculate fees of 50 basis points for actively managed funds and 15 basis points for passively managed funds. *Source: 2009 NYS CAFR ii. This is not to say that active management should be abandoned rather, that the Comptroller should select active managers in a manner different from current practice, namely: 1. Only select managers who can generate true alpha, or outperformance relative to the market, net of fees. This is highly likely to lead to a reduced number of active managers in the portfolio, increasing the percentage of equities currently under passive management (78%) 100 while reducing the overall fees currently paid to equity fund managers ($98.8 million). 101 2. Utilize the Investment Committee s expertise to do so. iii. In fact, it is with the selection of active managers that most of the opportunity for ethical impropriety, or at least the appearance of impropriety, develops. To eliminate this problem, the Comptroller and the Investment Committee should operate as a double veto system for the 100 Office of the State Comptroller, New York State and Local Retirement System. 2008 Comprehensive Annual Report. Albany, NY, 2010. 58 <http://www.osc.state.ny.us/retire/word_and_pdf_documents/publications/cafr/cafr_08.pdf> 101 Office of the State Comptroller, New York State and Local Retirement System. 2008 Comprehensive Annual Report. Albany, NY, 2010. 51. <http://www.osc.state.ny.us/retire/word_and_pdf_documents/publications/cafr/cafr_08.pdf> 40
Pg 112 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com selection of any active manager. When the staff makes a recommendation to hire an active manager, that recommendation must first be presented to the Investment Committee. Only if the recommendation is approved by the Investment Committee can it be reviewed by the Comptroller, who also has the ability to approve or decline. For an active manager to be selected, then, the manager must first be approved by the Investment Committee, then the Comptroller a double veto system. 3) Alternatives (Private Equity and Hedge Funds): a. Just as in the case of more traditional equity and fixed income active money managers, most private equity funds and hedge funds do not outperform the market, net of fees and particularly on a risk-adjusted basis (i.e., adjusting for the fact that certain, but not all, firms employ leverage and thus have greater risk associated with their strategies and their returns). Similarly, then, the Comptroller must only invest in alternative managers who can generate true alpha and who pass through the double veto system. This approach is highly likely to lead to a reduced number of active managers in the portfolio, as well as reduced fees paid by the Fund. Presently, the New York State Pension System pays over $175 million annually in management fees to private equity and hedge funds. 102 4) Direct Investments, including Real Estate: a. Direct investments and real estate pose special challenges they present all of the conflicts inherent in active manager selection but also require greater in-house expertise in order to properly diligence the opportunity, assess the risks, etc. i. In one of the better practices of the current Comptroller, he utilizes a more active advisory committee for real estate investments as a partial recognition of this special case b. However, in a much more professionalized investment process, there is an opportunity for a modest amount of direct investment in partnership with private investment funds that bear the same risk that the Fund would bear. c. These investments should be subject to strict limits and in all cases will constitute a small proportion of the portfolio. d. All such investments would have to go through the same double veto system, with a separate Investment Committee for real estate investments. 5) Staff. a. Under a substantially more professional operation, the investment staff of the Fund will follow a more clearly defined investment process, complete with robust 102 Ibid. 41
Pg 113 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com investment memoranda laying out the rationale for an investment and periodic portfolio reviews to test whether the investment case has borne out or must be revisited. Well-managed investment organizations consistently and universally follow such disciplines, and professionalizing the management of the Fund will lead to greater accountability, greater results and an improved investment culture that will benefit Fund members, retirees, beneficiaries and employees. The above structure blends the benefits of the sole trustee system (principally, creating a bulwark against the politicization of the Fund while preserving accountability to the electorate) with the intended benefits of a board (principally, broader decision-making and input, greater transparency to guard against mistakes of judgment and ethical breaches) that are too often not realized in practice (witness the many abuses at CalPERS, the City of San Diego, Ohio and Illinois). 103 The institutionalized dynamic also ensures that the Comptroller receives and deliberatively considers the best investment guidance available, while maintaining political independence. This arrangement can help ensure strong risk-adjusted returns as well as protections from ethical lapses and raids from politicians who scheme to use the State s Pension Fund to make up for the consequences of their own profligate spending. This improved process of enhanced due diligence and analysis should also lead to a reduction in the almost $350 million that the current Comptroller s office spends on management fees to Wall Street and other outside investment firms. 104 103 Walsh, Mary Williams. Ex-Chief of S.E.C. Says Pension Funds in Danger. The New York Times. 31 Oct. 2007. 25 Aug. 2010. <http://www.nytimes.com/2007/10/31/business/31sec.html> 104 Office of the State Comptroller, New York State and Local Retirement System. 2008 Comprehensive Annual Report. Albany, NY, 2010. 51. <http://www.osc.state.ny.us/retire/word_and_pdf_documents/publications/cafr/cafr_08.pdf> 42
Pg 114 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com IX. Anticipating the Critiques Critique #1: The Pew Center on the States and Governing Magazine say that New York has the best-managed public pension fund in the nation. This is categorically false. Both the Pew Center 105 and Governing Magazine 106 say that New York State is the best funded (but stay tuned) public pension plan in the country, not the best managed. In fact, the New York State Pension Fund is neither well-funded nor well-managed: 1) In the case of both the Pew Center and Governing Magazine, neither makes an independent judgment on funding levels. Both take New York s own reported ratios at face value. 107 They don t prepare a robust comparison of the accounting practices among states, don t question whether those accounting practices are appropriate or reveal much else that shows significant independent analysis. In effect, Pew and Governing Magazine are merely repeating the New York State Comptroller s own problematic claims built on accounting gimmicks. a. Pew and Governing Magazine risk being accomplices to the great public pension Ponzi scheme. To avoid that ignominy, they should highlight the issues described herein and use them to compare fund practices so that investors and taxpayers know the truth about our country s public pensions. 2) Well-managed could mean a range of different things, but, for an investment fund, most fundamentally it comes down to performance. Interestingly, the Comptroller has cited relative performance for the Fund as recently as May 2009, 108 but, to the best of our knowledge, that disclosure mysteriously ended as the Fund s performance fell below the median for the Comptroller s tenure. In short, the Fund s performance over the last year, last two years and last three years has lagged the median performance of public pension funds tracked by R.V. Kuhns & Associates. 105 The Pew Center on the States. The Trillion Dollar Gap. February 2010, pp. 56. <http://downloads.pewcenteronthestates.org/the_trillion_dollar_gap_final.pdf> 106 Kim, Andy and Kerrigan, Heather. Pension Preparedness. Governing Magazine. August 2010. 23 Aug. 2010. <http://www.governing.com/topics/public-workforce/pensions/pension-preparedness.html> 107 Pew Center on the States. The Trillion Dollar Gap, February 2010. 23 Aug. 2010. 53. <http://downloads.pewcenteronthestates.org/the_trillion_dollar_gap_final.pdf> Kim, Andy and Kerrigan, Heather. Pension Preparedness. Governing Magazine. August 2010. 23 Aug. 2010. <http://www.governing.com/topics/public-workforce/pensions/pension-preparedness.html> 108 Office of the New York State Comptroller. New York State Pension Fund Declines 26 Percent. Press release, 30 May 2009. <http://www.osc.state.ny.us/press/releases/may09/052909.htm> 43
Pg 115 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com Of course, as stated earlier, the real benchmark for a public pension fund is its investment return assumption, as performance short of that goal triggers tax increases, and, in the last three years, the Pension Fund has underperformed that benchmark by nearly $50 billion. Critique #2: Reducing the investment return assumption will trigger tax increases. This argument is the height of hypocrisy: The current Comptroller enables a colossal pension problem, we blow the whistle on it, and he blames the whistleblower. The underlying economics make clear that our State Pension Fund is substantially underfunded. Dealing with that will force some very hard choices. But the first step to dealing with a problem is being honest about the size of it, which the current Comptroller refuses to do. Ironically, recent press reports suggest that the Comptroller is actually considering some changes to his current practices. After months of defending the current 8% return assumption in the face of pressure from us and others, the Comptroller is reportedly planning to reduce the investment return assumption to 7.5% or 7.75%. 109 While our proposals and policies highlight the true magnitude of our pension deficit, it is our firm view that New Yorkers cannot afford higher taxes. On the contrary, the entire reason we are waging this campaign is to use the full powers of the Comptroller s office to cut spending and force fiscal discipline, including tax cuts, to benefit New Yorkers from all walks of life. A lower overall tax burden, particularly for working class and middle class New Yorkers, is the only way in which New York can attract businesses and jobs and grow its economy. Having identified the true extent of our pension deficit, our prescribed course of action is to work with the Governor and the Legislature on a long-term plan to bring our Fund back to solvency at an acceptable cost to taxpayers and without any increase in taxes. We must honor our obligations to government workers, but we must not increase New Yorkers tax burden. The way to achieve this is through meaningful pension reform over a long period of time. Critique #3: The Pension Fund is not a hedge fund; it is invested for the long-term. Markets rebound over time, and we shouldn t change policy simply because we went through a tough period in the equity markets. 109 Scott, Brendan. "Low pension return may $oak taxpayers." New York Post. 21 Aug, 2010. 25 Aug. 2010. <http://www.nypost.com/p/news/local/low_pension_return_may_oak_taxpayers_sf9ojenk8yspdjwm6fpqwl> 44
Pg 116 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com When the Comptroller and his staff make this argument, it reveals an unsettling ignorance about investment management and calls to mind the former Governor s characterization of Mr. DiNapoli as thoroughly and totally unqualified. Our argument for reducing the risk in the portfolio has nothing to do with recent equity market underperformance and everything to do with this simple question: given the nature of the Fund s liabilities (i.e., constitutionally protected), what is the appropriate long-term risk profile for the assets? If the liabilities (benefit payments) are guaranteed, then the investments must be managed in a low-risk way. Otherwise, we develop the financial difficulties that continue to mushroom and threaten public pensions nationwide. Critique #4: Now is not the time to switch policies. We need to maintain the policies of Mr. DiNapoli, who is tested and trusted, rather than switch to a risky new approach. The Pension Fund is woefully underfunded and has achieved investment returns below the median for public pension funds for the last year, last two years and last three years all of Mr. DiNapoli s tenure. The Fund s underperformance relative to its unrealistic benchmark, which could have and should have been revised downward, has cost New York taxpayers nearly $50 billion. By contrast, our approach dramatically reduces the risk in the Pension Fund. In effect, it makes it a boring asset which, considering it provides constitutionally protected benefits to retirees, is exactly what members, retirees, beneficiaries and taxpayers should want it to be. Pensioners, current members and taxpayers deserve a boring asset that doesn t impose higher taxes on them because a politician thought he could make up for shortfalls with risky investment strategies. Critique #5: The last several Comptrollers have been politicians, not professionals. Why isn t Mr. DiNapoli s background appropriate, given that history? We live in far more financially perilous times now than we have at any point in the last 30 years, and this turmoil argues for a professional financial steward. A key driver of rising pension costs is their arcane, complex nature and the consequent timidity or even ignorance with which traditional politicians address them. We believe that the Comptroller must have the requisite experience to understand, address and be able to reform these issues in the most effective way. 45
Pg 117 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com We also believe that the members of the Investment Committee should be world-class investment professionals possessing at least one of the following: a) A CPA from an accredited university; b) An MBA from an accredited business school; and c) At least 10 years of finance or accounting experience. There is precedent for this approach. The Mississippi Public Employee Retirement System conducted a survey of other state systems on behalf of the National Association of State Retirement Administrators and found that about 36% had a formal education policy for its pension board members, 24% had mandatory educational requirements and at least one other had a mandatory certification program. 110 Similarly, the Sarbanes-Oxley Act of 2003 strongly urges that the audit committee of a public company contain at least one financial expert, or disclose the fact that it does not. Just as Sarbanes-Oxley sought to deal with Enron-type abuses by ensuring that corporate audit committees contained financial expertise, the Fund should have the same requirement. Of course, if those are the requirements for a position on the Investment Committee, one may wonder whether they should also be requirements, either in law or in practice, for the Comptroller as well. No reasonable New Yorker would hire a politician to manage his or her own retirement account. Why would we elect someone with no financial background to be New York s chief fiscal officer? Critique #6: Over the last twenty years, the Fund has returned in excess of 8%, so an investment return assumption of 7.5% to 8% is achievable, even conservative. We examine this at length in our discussion of investment return assumptions, but the best critique rests on two factors: 1) Outside of pension funds, which have an incentive to inflate return expectations to grant greater benefits today at the expense of future taxpayers and aren t hemmed in by more prudent accounting standards, few responsible investors assume an 8% long-term rate of return, or, more importantly for the purposes of calculating funding ratios, would apply an 8% discount rate to liabilities that are constitutionally protected. 110 National Association of State Retirement Administrators. Board Education Survey. November 2005. 25 Aug. 2010. <http://www.nasra.org/resources/board%20education%20and%20travel%20policy.pdf> 46
Pg 118 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com 2) The performance over the last twenty-plus years is a tale of two cities the great bull market of the late 1980s and 1990s, including the impact of the dot-com bubble, and the more challenged markets of this decade, with Fund returns to date below 5%. Virtually all experts believe that the anomaly in this history is not the past decade, but the long bull market of the late 1980s and 1990s, leaving a period that incorporates that history a poor gauge for future results. X. Key Takeaways Note: footnotes for these summary points appear previously in this document. A series of recent studies reveal that a proper accounting of our nation s public pension funds reveals an underfunding of approximately $3 trillion. The cost to taxpayers for the savings and loan crisis was $124.6 billion. The estimated cost to taxpayers for the Troubled Asset Relief Program (TARP) ranges from $109 to $127 billion. The bailouts of Fannie Mae and Freddie Mac are projected to be $389 billion. These figures, massive as they are, pale next to the gathering storm of America s underfunded public pensions. A similarly honest accounting of New York State s pension assets and liabilities would reveal a substantial underfunding of between $30 billion to $80 billion. The costs to New York State of its Pension System are skyrocketing. In fiscal year 1998, New York spent almost $3.5 billion on member benefits. By fiscal year 2008, New York spent over $7 billion, an increase of over 100%. The rise in the financial cost for everyday New Yorkers has been similarly meteoric. Over the last decade, taxpayers annual pension contributions increased from $245 million to $1.7 billion, and the ratio of taxpayers contributions to employee contributions has grown to roughly $10 to $1. Under the current Comptroller, the Fund s investment returns have been significantly below the median of other comparable public pensions for the last year, the last two years and the last three years and have further exacerbated New York s pension shortfall. In fiscal year 2010, for example, when the State Comptroller s office announced with fanfare that the Fund achieved returns of 25.90%, the Comptroller 47
Pg 119 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com dramatically underperformed the median return of 32.86% a miss of nearly $8 billion that is being passed on to taxpayers. In the prior fiscal year, the Comptroller lost 26.38% of the Fund s value and has had negative overall performance over the past three years. The Fund s cumulative underperformance, relative to its 8% target investment return, over the past 3 years totals nearly $50 billion. To cover up the tax increases triggered by the Fund s underperformance, the current Comptroller devised a scheme to limit near-term pension contributions and kick the can down the road past the election. The plan has been labeled a borrowing plan by every major news organization to cover it, despite the Comptroller s transparent protests to the contrary. In just the first six years, the plan would allow the State and local governments to borrow up to $10 billion, which would carry future interest costs in excess of $3 billion. The overall cost of this scheme is devastating as the bill that ultimately passed the Legislature allows for this foolhardy borrowing to go on indefinitely, without a proper accounting of its costs. The costs to New York s overtaxed families will be overwhelming. Under an earlier version of the plan that limited borrowing to six years, pensionrelated costs for New York households outside of New York City would have increased by $1,300/year by 2017. Instead, the plan that was approved increases the costs by delaying the day of reckoning. In short, it is a Ponzi scheme that will eventually collapse. To illustrate just one of the incredible risks of this plan, it reportedly relies on fanciful market assumptions that repeat the market conditions after 1987, including the halcyon years between 1988 and 1998 when returns averaged nearly 14%. o If the unrefuted reports are true, for the Comptroller s market assumptions to hold up, the Dow would need to reach 80,000 by 2022. Lax government accounting standards set by GASB allow politicians to hide public pension deficits. 48
Pg 120 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com GASB allows public pensions to choose a target return rate on fund investments and a corresponding discount rate without consideration of market risk. As a result, riskier investments translate into higher return expectations and higher discount rates, perversely reducing the present value of pension liabilities. This has no grounding in basic economics, finance or common sense and is not allowed for any private sector entities or nonprofits, but it is a fundamental foundation of public pension accounting. The New York State Comptroller has taken advantage of GASB s twisted logic and increased the State Fund s exposure to alternative assets, such as private equity firms and hedge funds, resulting in fees to alternative asset funds of approximately $200 million, while he simultaneously blames them for contributing to our nation s economic collapse in a cynical election year ploy. Over the last three years, the most conservative part of the Fund s portfolio fixed income was far and away the best performing asset (a 6.8% compound annual return over the past three years, when overall performance was negative). o Had the Comptroller established a lower, more realistic investment return assumption at the beginning of his tenure and accordingly shifted more assets into lower-risk assets, the Fund would have performed much better, with less risk, and taxpayers would be much better off today. o Instead, he defended his 8% return assumption for months, after being criticized by us and others, and then recently reversed himself to indicate he is considering a modest, but insufficient, move downward. GASB also allows public pensions to use a variety of accounting gimmicks to restate their asset values, and New York s Pension Fund uses an actuarial asset value that incorporates two devices that have little relation to the market value of assets. First, asset values are smoothed out over a five year horizon. So, if the Fund owns stock in Microsoft, and Microsoft trades on the stock exchange at $25.00 per share, the actuarial value of Microsoft at that time could be $20, $30 or some other number that reflects a five-year smoothing. Second, a component of the actuarial asset value allowable by GASB includes the present value of future State and local government contributions (paid for through state and local taxes) and contributions by employees. 49
Pg 121 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com Due to this provision, as long as the Fund is willing to stipulate that it will always pass through pension fund shortfalls to the taxpayers and has a robust mechanism to do so, it will always appear fully funded. In other words, the Comptroller s contention that the Fund is fully funded is nothing more than a combination of accounting gimmicks and a rock-solid assurance that he will pass through underperformance to the taxpayers claiming credit for fully-funded status on the backs of New York s beleaguered taxpayers. Our ability to assess the impact of mark-to-market asset valuation is hamstrung by the limited transparency provided by New York s Comptroller. But a recent example of a public pension system performing such a valuation is telling. o For 2008, New York City s chief actuary calculated the mark-tomarket value of assets in the five funds that make up the City s Pension System and revealed a $45 billion funding deficit compared to the fully funded status that the more misleading, GASB-approved accounting method reported The New York State Comptroller also assumes a fanciful 8% rate of return on Fund investments. A sustainable long-term rate of return for a pool of assets as large as the State Pension Fund is likely closer to 6%, perhaps less. Further, since taxpayers are on the hook for shortfalls, a proper fiscal watchdog would err on the side of caution. Historical returns that include the great bull market of the late 1980s and 1990s are a poor guide, as the conditions that led to that anomalous performance are unlikely to be repeated. Further, the vast majority of professional investors believe that the longer-term view of market performance needs to be adjusted downward to account for the U.S. s more mature economy and long-term structural challenges. Warren Buffet, among the most successful investors in the world, assumes a longterm rate of return for his Berkshire Hathaway pension assets of 6.9% and has argued that equity returns of 6% are a more reasonable long-term assumption. What does Tom DiNapoli know that Warren Buffett doesn t? 50
Pg 122 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com This analysis should make clear that public pension funds are likely to blow a hole through the American economy, and the politicians in charge of them are covering it up through lax accounting standards that hide the size of the crisis. GASB is currently conducting an extensive review of its policies, including a number of the issues raised here. Rather than leading the charge on reform, as the Comptroller of New York State should be, the current Comptroller has instead taken this opportunity to write to GASB officials and urge them not to make any material changes in its oversight practices and is opposing alterations to its rules. o This is the equivalent of Enron writing to the SEC and requesting that they not change the rules governing the special purpose entities that were a factor in its ultimate demise. In dealing with New York s pension underfunding, the State and its leadership must adhere to three bedrock principles: 1. The true extent of our shortfall must be made clear through honest accounting. 2. New Yorkers cannot afford additional taxes, so increased taxes cannot be a part of any solution. 3. The promises already made of New York s government workers, retirees and their beneficiaries are to be provided for in full. Given the limited levers left, the reality is that the Comptroller will need to work with policymakers to develop a long-term restructuring plan that is consistent with these principles, yet brings the Fund back to fully funded status over time. Such a plan will by necessity require a Tier VI for new employees. 51
Pg 123 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com XI. Conclusion In this white paper we have examined the nature of New York s own pension crisis in order to expose its magnitude. The first step must be to acknowledge we have a significant problem and to try to determine the size of it. The next step is an open dialogue among pension stakeholders on how to address our crisis. New or higher taxes in any form should be ruled out. Since New Yorkers already bear the highest state and local tax burden in the nation, and this burden continues to drive out businesses, jobs and people that are vital to the State s tax base, additional or increased taxes are simply unaffordable. The coming tax hikes created by the Fund s underperformance under the current Comptroller must be mitigated or avoided to the fullest extent possible. It is also fundamentally unfair to ask overtaxed citizens to rectify the mistakes of imprudent politicians who did not properly consider the costs of their campaign promises or execute their responsibilities effectively. As for solutions, the opacity of information makes it difficult to articulate the full set of options that remain. The only proper way to solve this problem is to conduct a full-blown analysis of future liabilities, apply appropriate valuation and accounting standards and then create a longterm plan by working with elected leaders and stakeholders to bring the Fund back to the fully funded status that members, retirees, beneficiaries and taxpayers all deserve. There are some areas which we can identify now, however, and we would pursue the following plan of action in order to help save New York taxpayers from the coming economic and tax disaster: a) Apply private sector accounting standards to uncover the true size of our problems. The shortfalls, created by years of mismanagement, cannot be fixed overnight. The Comptroller must work with the Governor and the Legislature to address its problems over time. This begins with the creation of a Tier VI benefit plan that curbs abuses like pension padding and double dipping and reflects financial realities. Tax increases to support pension problems are unacceptable. We will do whatever possible to curb or eliminate the current tax increases projected by the State Comptroller today. b) Establish target returns and asset allocations that will incorporate less risk, less active management, reduced fees and less volatility. Our members, retirees and beneficiaries deserve a well-managed Pension Fund that will be able to honor all of our obligations. c) Fight, with every power at our disposal, any efforts to borrow from the Pension Fund, and do everything possible to mitigate the tax impact from recent mismanagement. 52
Pg 124 of 250 PUBLIC PENSIONS: AVERTING NEW YORK S LOOMING TAX CATASTROPHE September 2, 2010 Taxpayers for Wilson 19. W. 44th Street, 1401 New York, NY 10036 (212) 221-7809 www.wilsonfornewyork.com d) Immediately bring in outside expertise to improve the current investment decision-making but preserve the sole trustee s accountability and independent powers to protect the Fund from raids. e) Combine these efforts to professionalize the Pension Fund with our earlier ethics reform proposals to create the most effective and transparent public fund in the nation. 53
Pg 125 of 250 Exhibit D-3
Pg 126 of 250 www.moodys.com Special Comment Moody s Global Corporate Finance September 2009 Table of Contents: Introduction 1 Nature and Operation of Multiemployer Plans 2 Last Man Standing 4 Appendix I 7 Appendix II 9 Appendix III 11 Appendix IV 18 Moody s Related Research 19 Analyst Contacts: New York 1.212.553.1653 Wesley Smyth Vice President - Senior Accounting Analyst David Berge Vice President-Senior Credit Officer Marie Menendez Senior Vice President Jason Cuomo Vice President-Senior Accounting Analyst Mark Lamonte Senior Vice President Daniel Gates Team Managing Director Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern An update of Moody s funding deficiency estimates reveals a widening gap Introduction Moody s has updated its estimates for the funding shortfall for 44 rated companies that participate in Multiemployer Pension Plans ( MEPP s ) in the U.S. The precariously weak funding levels in most MEPPs are resulting in an increase in imputed debt for participating companies. In a few cases, the magnitude of future MEPP funding obligations is placing downward pressure on ratings. The funded status of MEPP s fell precipitously during 2008. We examined 126 plans that include some of some of largest MEPP plans in the country. We estimate that these plans are collectively underfunded by upwards of $165 billion. The ballooning of the under funded status of these funds has substantially increased the implied liability for contributing companies in the industries affected. In summary, we expect to see the following developments over the near term with respect to companies involved with multiemployer plans: The funding requirements of the Pension Protection Act of 2006 ( PPA ) will result in larger contributions for many sponsoring companies, in some cases extremely large increases. On top of these increased payments companies may face contentious labor relations due to retiree benefits being cut. While underfunding will not result in downgrades for most companies that are affected by multiemployer plans, the financial stress created by the potential for increased calls on cash could have a material impact on the ratings of certain companies that may not have the size, scope, or financial wherewithal to withstand such additional burdens on their cost structure. We believe that speculative grade companies that have weak flexibility to meet an increased pension funding need will be at the greatest risk for downgrades. Electronic copy available at: http://ssrn.com/abstract=1471963
Special Comment Pg 127 of 250 Moody s Global Corporate Finance Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern Table 1 If smaller and/or weaker companies are unable to handle increased contributions, or possibly exit the plans due to bankruptcy, this will further increase the funding burden placed on otherwise stronger companies contributing to an underfunded plan. This last man standing scenario suggests that certain investment grade companies could eventually face substantial rating pressure. Nature and Operation of Multiemployer Plans Multiemployer pension plans are defined under U.S. federal law by the Taft-Hartley Act of 1947. They cover workers from more than one employer. These plans are funded by employer contributions that are determined by collective bargaining with one or more labor unions. These plans exist to provide benefits to unionized workers in businesses characterized by frequent job switching, such as construction, entertainment, printing, food/supermarkets, hotels/casinos, and transportation businesses. They do so by considering service with multiple employers under the same plan as if the worker had worked for the same employer the entire time. The employers participating in a multiemployer plan often share a common industry bond. Multiemployer plans that provide defined pension benefits cover about 10 million active and retired workers in the US, or about 20 percent of workers with defined benefit plans. A simplified way to understand multiemployer plans is to contrast them to the more common single employer plans: Feature Multiemployer Single-employer Plan control Trustees, consisting of an equal number of The company controls all aspects of the plan management and union representatives Contributions As negotiated between the company and the union; little ability to deviate from the contract As required or permitted by pension and tax law; considerable flexibility in funding, for well funded plans Accounting Pay as you go with minimal disclosure Accrual accounting with substantial smoothing of income; extensive disclosures Company liability at withdrawal or termination Benefit reductions Company liability for underfunding Pro-rata share of plan under-funding Can reduce accruals of future benefits for active employees; can't reduce benefits earned to date for active or retired employees; except in certain circumstances for "critical status" plan The amount of liability is a complex function of actions by other employers, trustees and the union; company could be liable for more than its share if other employers are insolvent Amount of plan under-funding Same, except that vested benefits cannot be cut Fully liable for under-funding Appendix I shows a list of companies that disclosed contributions to multiemployer pension plans. We located these companies by searching public disclosures for references to multiemployer plans and we reviewed pension disclosures in the financial statements of companies in industries where multiemployer plans are common. Our most recent assessment identified 44 companies whose debt we rate. This is a decline from the 62 companies which were noted in our August 2006 rating methodology Multiemployer Pension Plans: Moody s Analytical Approach. There were several reasons for this decline; bankruptcies, mergers, plan withdrawals and discontinued business lines account for the majority of the decrease. Funding requirements Pension Protection Act 2006 Funding requirements for multiemployer plans are a lot less complicated when compared to single employer plans. This is because contributions to multiemployer plans are set through negotiations between unions and company sponsors. However, to ensure retiree benefits are protected, when a multiemployer plan falls below certain funding levels, stronger funding requirements become effective under provisions of the Pension Protection Act of 2006. Plans whose funding levels are below 80% are referred to as endangered, while 2 September 2009 Special Comment Moody s Global Corporate Finance - Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern Electronic copy available at: http://ssrn.com/abstract=1471963
Special Comment Pg 128 of 250 Moody s Global Corporate Finance Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern those below 65% are referred to as critical. The more common terms for these funding levels are yellow zone and red zone. When a plan is endangered, the plan administrators must devise a rehabilitation plan to return to an 80% funded status within the next 10 years through either increased contributions or decreased benefits or a combination of both. Plans which are classified as critical must also devise a 10 year rehabilitation plan but the PPA also mandates an immediate cut in certain vested benefits. However, the time frame a plan has to return to an 80% funded status was extended by an extra three years when the Worker, Retiree, and Employer Recovery Act of 2008 (WRERA)was passed into law at the end of 2008. The WRERA also allows plan sponsors to elect to temporarily freeze the status of certain multiemployer plans at the funding status held during the previous plan year. This covers plan years beginning on or after Oct. 1, 2008, and before Oct. 1, 2009. Also, if the plan was "endangered" or in "critical status" the preceding plan year, it isn't required to revise its funding improvement plan or schedules until the following plan year. A number of underfunded plans have taken advantage of the freeze in the hopes of some recovery to asset values, rather than negotiating funding increases while at a temporary market bottom Funded Status Appendix III lists 126 multiemployer plans. We estimate that these plans represent the majority of assets and obligations for all multiemployer plans. These plans represent 115 of the largest plans (as measured by assets) and 11 other plans that we selected to supplement the list in certain industries with few large plans. We obtained plan data from Form 5500 pension disclosure documents that plans must file annually with the US Department of Labor. Unfortunately, the data disclosed in Form 5500s is not up-to-date. The most recent Form 5500s include plan years ended in 2007. Complete information for 2008 year end will not be available until October 2009 at the very earliest. Despite the limitations in the data a very stark picture emerges. Collectively, the multiemployer plans were in weak shape in 2007. When data for year end 2008 is finally released, it is sure to show substantial deterioration in asset values during 2008, when almost all broad investment indices experienced sharp declines. At the end of 2007, the plans that we examined had a 77% funded ratio and total underfunding of $87 billion. By contrast a similar universe of single employer plans indicated a funded status of 101% entering into 2008 s maelstrom and ended the year with a funding level of only 75%. Using 2007 numbers as a starting point we estimate that underfundings for our universe of MEPP s ballooned to approximately $165 billion or a 56% funded level. In other words for every dollar that these funds owe, they hold only 56 cents of invested assets. Funded status of plans by industry sector $ millions Funded status 2007 Funded status 2008 Industry $ % $ % Construction (39,156) 75% (72,484) 54% Entertainment/Printing (1,213) 93% (4,946) 72% Food/Supermarket (7,692) 79% (15,358) 58% Hotels/Casino (690) 83% (1,556) 63% Transportation (34,828) 72% (58,071) 53% Other (3,771) 91% (12,295) 68% Total (87,350) 77% (164,710) 56% The severity of the shortfall suggests that the vast majority of multiemployer plans are in the yellow or red zone. These funding levels will no doubt result in remediation plans which will cut benefits and/or increase contributions. While these plans are being formulated, companies which participate in MEPP s have the specter of increased contributions and/or contentious labor relations looming over their heads. 3 September 2009 Special Comment Moody s Global Corporate Finance - Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern
Special Comment Pg 129 of 250 Moody s Global Corporate Finance Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern Last Man Standing The driving force behind the creation of MEPP s was the transient work force that is inherent in such industries as trucking, retail, and construction, among others. With individual employees likely to have worked for a number of companies over the person s working life, combined with the entrance and exit of many employer companies over that span, it is impractical for any one company to provide pension (and other retirement) benefits to members of this work force. This led to the creation of a risk-pooling system amongst the sponsor companies which resulted in multiemployer plans. Under such a plan, if a participating sponsor ceases to make contributions (for example, through voluntary exit or bankruptcy), the remaining sponsors will share the responsibility to make up for such a shortfall in funding on a joint and several basis. Throughout normal business cycles in the past, this arrangement has worked relatively well, as long as the pension funds themselves are adequately funded and if companies depart from the plan in an orderly fashion, alleviating any shock to the plan from a mass exodus. However, while the risk sharing characteristics of MEPP s make them attractive to beneficiaries, the pooling arrangement doesn t necessarily immunize the sponsor companies from risk during a deep and prolonged economic downturn, as we are currently experiencing. In fact, the joint and several responsibility among sponsors can exacerbate the risk that the obligation borne by a contributing company becomes more onerous. Because of the highly cyclical nature of industries participating in multiemployer plans, a situation can arise where many contributors, or possibly a particularly large but vulnerable employer may exit the plan as the result of bankruptcy. This problem would be particularly acute if it occurs at a time when a plan s status becomes critically under-funded, requiring increased contributions from a shrinking sponsor pool. As a result, an otherwise healthy sponsor could face daunting levels of additional contributions to MEPP s in which it participates. The remaining companies are effectively paying for the retirement benefits of employees that never worked for them commonly referred to as orphans - but who instead were employed by companies that no longer participate in the plan. This problem is exacerbated by declining union membership often fueled by the growth of non-union players (e.g., FedEx in transportation, Wal-Mart in the supermarket space) and longer life expectancies which drives a growing imbalance between the number of retirees to active workers. In this financial crisis scenario, the MEPP scheme has essentially created a negative feedback loop: an everdecreasing number of companies financing an ever-increasing liability. A theoretical outcome from this feedback loop is that there are eventually few, or ultimately only one company left sponsoring the entire retirement benefits of every retiree in the plan, hence the term last man standing is used to describe this phenomenon. The risk for remaining sponsors becomes more acute if withdrawing sponsors are unable to pay their termination liability at the time of withdrawal because of financial distress. This concept is very clearly demonstrated by the condition of the Central States Southeast and Southwest area pension plan (Central States) and its impact on sponsors in the trucking industry. In December of 2007, UPS (senior unsecured rating of Aa3) - voluntarily withdrew from Central States plan, at a cost of $6.1 billion. Before its withdrawal, UPS was one of the largest contributors to Central States. In 2008 UPS reported $51 billion in revenue and $32 billion in assets. At the end of 2007, which takes into account the UPS exit contribution, Central States was 67% funded, with a total underfunding of $18 billion. The broad market declines in asset values experienced since then suggests that Central States under-funding levels have increased substantially. We estimate that Central States 2008 funded ratio could be as low as only 44% which would equate to underfunding of $25 billion. Absent a mass withdrawal of the remaining sponsors before December 1, 2009 1, it is believed that UPS will have no further obligation to contribute anything to help reduce this deficit. Making matters worse, the second largest contributor, YRC Worldwide Inc. (corporate family rating Caa3; 2008 revenues of $9 billion and $4 billion in assets) is facing significant financial stress, and has arranged an 18-month cessation of union pension fund contributions which will not require repayment. This means that the cost to remediate the under-funding of the Central States plan will fall on a pool of much smaller companies at a time of considerable weakness in the trucking sector, which could place stress on the financial condition of those companies. With UPS and YRC no longer contributing, one of the largest remaining employers currently making contributions to the Central States plan is Arkansas Best (senior 1 A mass withdrawal is when substantially all the employers withdraw from the plan within a year. If this occurs, ERISA regulations allow the fund to recalculate the withdrawal liability of companies that withdrew within the prior two years. 4 September 2009 Special Comment Moody s Global Corporate Finance - Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern
Special Comment Pg 130 of 250 Moody s Global Corporate Finance Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern unsecured rating of Baa2), which is only a fraction of the size of either UPS or YRC. In 2008, Arkansas Best reported $1.8 billion in revenues and $972 million in assets. Moody s Multiemployer Pensions Plan Methodology As previously noted, we published a rating methodology that explains our analytical approach to MEPPs in August 2006. Our methodology for evaluating the credit impact of funding shortfalls under MEPPs is consistent with our approach for single employer pension plans. This involves (1) adjusting a company s financial statements to reflect the company s share of the multiemployer plan s under-funding as a debt-like liability and recognize related interest expense, and (2) inquiring into the likely pattern of future cash contributions to the plans, including the possibility that the company could trigger a withdrawal liability. Moody s adjusts the company s financial statements to reflect our belief that a company s share of plan underfunding represents a long-term debt-like liability, because: The economics of under-funding in multiemployer plans are similar to single-employer defined-benefit plans where Moody s has long viewed the amount of under-funding as a debt-like liability of the sponsors. If under-funding is left unresolved, ultimately, provisions in tax and pension law will compel plan administrators to seek increased contributions from sponsor companies to cover a major part of the deficiency. Our ability to precisely estimate a company s share of MEPP under-funding is limited by sparse public disclosure; few companies disclose their share of any under-funding or even the identity of the plans in which a company participates. So, our rating methodology employs a computation based on limited publicly available data to roughly estimate a company s share of any under-funding. See Appendix IV for an explanation of our calculations and related assumptions. Using this methodology our updated multiples for 2008 are as follows: Average Under Funding Multiple by Industry Group* Updated Multiple Previous Multiple Construction 5.2 2.7 Entertainment/Printing 2.8 1.8 Food/Supermarket 7.4 2.6 Hotels/Casino 3 1.5 Transportation 5.6 3.1 Other 4 0.7 *Multiples based on 2008 estimated underfundings-see Appendix III See Appendix II for the companies updated imputed debt numbers. Ratings Impact With the underfunded status of so many plans growing to critical levels, combined with considerable stress experienced in the mostly-cyclical industries involved, we will make adjustments to financial data, as outlined above, which will imply a much higher liability inherent in the capital structure and risk profile of many companies. Consequently, the condition of the multiemployer plans will likely (a) negatively impact the cash flow generating capability of a contributing company and/or (b) meaningfully increase debt. The application of higher multiples to growing contributions figures will result in substantial weakening of key credit ratios such as leverage. The higher Debt/EBITDA multiples that ensue will reflect Moody s current assessment of the company s debt-like MEPP termination liability. Some ratings could face downward consideration as the result of these adjustments. As rehabilitation plans become evidenced in either current or future labor contracts, we expect that companies operating cost structures will be affected by requirements to increase contributions. The degree to which this 5 September 2009 Special Comment Moody s Global Corporate Finance - Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern
Special Comment Pg 131 of 250 Moody s Global Corporate Finance Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern occurs will not only be a function of the amount of underfunding, but also the state of the participating industry i.e. if important participants exit due to bankruptcy and leave more obligation to be borne by the surviving companies ( last man standing ). In the short term we believe that increased demands on liquidity could have the largest ratings impact for speculative grade companies. Companies at this rating level typically do not have large amounts of liquidity and little flexibility in cost structure. An important determinant in the rating impact on affected issuers will be the magnitude of cash required to meet increased funding obligations relative to the company s liquid resources, (those that can be internally generated and assurance of external funding availability) and other cash requirements, such as its debt maturity profile, capital spending requirements to maintain its competitive position and efficiency of operations, dividend payments and working capital requirements. The timing of inflows versus outflows will also be a consideration. The overall flexibility that a company exhibits in its ability to manage cash requirements, and its willingness to make trade-offs in order to maintain financial integrity and a strong financial profile will be key factors in the rating analysis. Ironically distressed companies ratings may not be immediately impacted by MEPP underfundings. Unions will not want to deal a deathblow to these companies so they should be able to negotiate payment modifications to their contribution levels. For example YRC Worldwide Inc, currently rated Caa3, arranged an 18-month cessation of union pension fund contributions which will not require repayment. This does not solve the problem or eliminate a company s obligation, but can potentially delay the impact until a firm s financial health improves. We expect that investment grade companies will be hardest hit in absolute dollar terms because they are typically the largest companies in their industries and the likeliest last men standing. However, due to their current financial strength and flexibility these increased contributions may not lead to liquidity problems, and near term financial distress is not as much of a risk as for speculative grade rated entities. However, in the longer term, the systemic risk may weigh more heavily on investment grade companies. As weaker companies fail, the remaining companies will be required to increase their contributions. This in turm could lead to weaker margins, which would have a concomitant impact on their ability to generate robust levels of operating cash flows. Reduced cash flows may result in lower levels of capital investment necessary to sustain or grow market share during the cyclical recovery, or an increasing reliance on debt to fund the required capital spending. All this may negatively impact these companies competitive position, especially vis-à-vis non-union, non-mepp participants, suggesting stress on certain companies ratings. 6 September 2009 Special Comment Moody s Global Corporate Finance - Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern
Special Comment Pg 132 of 250 Moody s Global Corporate Finance Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern Appendix I Companies Participating in Multiemployer Pension Plans Contribution to Multiemployer Pension Plans ($'000s) 2008 Contribution as % of Company Name Rating 2008 2007 2006 2005 CAGR Debt CFO Industry: Construction EMCOR Group, Inc. Ba1 221,100 187,000 150,100 133,500 18% 110.49% 65.99% U.S. Concrete, Inc. B2 15,300 13,700 15,100 13,900 3% 5.00% 51.55% Vulcan Materials Company Baa2 8,008 8,368 7,352 5,825 11% 0.23% 1.84% Industry: Entertainment/Printing CBS Corporation Baa3 43,100 34,600 31,200 37,400 5% 0.62% 2.01% News Corporation Baa1 116,000 114,000 88,000 75,000 16% 0.81% 5.16% New York Times Company (The) B1 15,000 15,000 16,000 16,000-2% 1.42% 6.06% Time Warner Inc. Baa2 66,000 75,000 75,000 58,000 4% 0.17% 0.64% Viacom Inc. Baa3 3,000 4,900 3,800 12,900-39% 0.04% 0.15% Walt Disney Company (The) A2 56,000 54,000 51,000 37,000 15% 0.38% 1.03% Washington Post Company (The) A1 1,300 1,500 1,600 2,600-21% 0.23% 0.24% Industry: Food/Supermarket Anheuser-Busch Companies, Inc. Baa2 17,200 16,700 16,200 16,200 2% 0.04% 0.41% B&G Foods, Inc. B2 1,100 900 800 700 16% 0.21% 2.72% Coca-Cola Enterprises Inc. A3 48,000 37,000 37,000 36,000 10% 0.53% 2.97% ConAgra Foods, Inc. Baa2 8,500 7,700 10,500 8,000 2% 0.24% 6.85% Dean Foods Company B1 28,295 27,164 27,231 57,664-21% 0.63% 3.94% Del Monte Foods Company Ba3 7,800 6,500 5,500 5,500 12% 0.50% 3.88% Dole Food Company, Inc. B2 1,600 2,800 3,700 3,600-24% 0.07% 3.59% Flowers Foods, Inc. Baa2 900 500 500 500 22% 0.27% 0.95% Great Atlantic & Pacific Tea Co., Inc.(The) B3 48,200 34,400 32,100 378,800-50% 4.35% NM Kellogg Company A3 64,000 108,000 137,000 120,000-19% 1.55% 5.05% Kroger Co. (The) Baa2 219,000 207,000 204,000 196,000 4% 2.32% 7.56% Rite Aid Corporation Caa2 10,924 13,341 13,326 11,642-2% 0.18% 3.04% Safeway Inc. Baa2 286,900 270,100 253,800 234,500 7% 5.22% 12.75% Sara Lee Corporation Baa1 48,000 47,000 45,000 46,000 1% 1.51% 7.92% Stater Bros. Holdings, Inc. B2 40,508 38,548 38,022 38,548 2% 4.96% 69.06% Supervalu, INC. Ba3 142,000 122,000 37,000 37,000 57% 1.67% 9.26% Sysco Corporation A1 35,040 37,296 29,796 28,822 7% 1.41% 2.21% Industry: Hotel/Casinos Boyd Gaming Corporation B1 1,000 1,100 2,200 2,500-26% 0.04% 0.45% Harrah's Entertainment, Inc. Caa3 37,700 35,900 34,600 21,500 21% 0.16% 7.13% MGM MIRAGE Caa2 192,000 194,000 189,000 161,000 6% 1.43% 25.50% Riviera Holdings Corporation Ca 2,020 1,989 1,952 1,760 5% 0.82% 47.00% Starwood Hotels & Resorts Worldwide Inc. Ba1 9,000 9,000 8,000 11,000-6% 0.22% 1.39% 7 September 2009 Special Comment Moody s Global Corporate Finance - Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern
Special Comment Pg 133 of 250 Moody s Global Corporate Finance Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern Companies Participating in Multiemployer Pension Plans Contribution to Multiemployer Pension Plans ($'000s) 2008 Contribution as % of Company Name Rating 2008 2007 2006 2005 CAGR Debt CFO Industry: Transportation Arkansas Best Corporation Baa2 111,064 109,559 104,076 91,981 6% 660.9% 105.44% Quality Distributions LLC Caa1 2,300 2,200 2,200 1,600 13% 0.63% 11.74% Ryder System, Inc. Baa1 4,886 4,843 4,879 4,700 1% 0.17% 0.39% United Parcel Service, Inc. Aa3 1,069,000 7,642,000 1,405,000 1,234,000-5% 10.83% 12.69% YRC Worldwide Inc. Caa3 554,100 578,000 542,000 472,700 5% 40.72% 252.07% Industry: Other Allegheny Technologies Incorporated Baa3 1,500 1,300 1,100 800 23% 0.29% 0.20% Alpha Natural Resources Inc. Ba2 191 84 28 32 81% 0.04% 0.04% ARAMARK Corporation B1 34,000 34,000 22,200 9,400 54% 0.58% 6.85% MDU Resources Group, Inc. Baa1 73,100 51,500 57,600 39,600 23% 4.17% 9.30% Sealy Mattress Company B2 4,700 5,300 4,700 4,500 1% 0.60% 8.75% United States Steel Corporation Ba2 42,000 30,000 29,000 28,000 14% 1.33% 2.53% United Technologies Corporation A2 163,000 145,000 132,000 126,000 9% 1.42% 2.65% NM: Not meaningful, cash from operations are negative 8 September 2009 Special Comment Moody s Global Corporate Finance - Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern
Special Comment Pg 134 of 250 Moody s Global Corporate Finance Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern Appendix II Imputed debt for Companies Participating in Multiemployer Pension Plans All figures in $'000s unless otherwise noted 2008 Company Name Rating Contributions Multiple Industry: Construction Imputed Debt 2008 Reported Debt Imputed debt As % of Reported debt EMCOR Group, Inc. Ba1 221,100 5.2 1,149,720 200,104 574.56% U.S. Concrete, Inc. B2 15,300 5.2 79,560 305,988 26.00% Vulcan Materials Company Baa2 8,008 5.2 41,642 3,547,773 1.17% Industry: Entertainment/Printing CBS Corporation Baa3 43,100 2.8 120,680 6,996,100 1.72% News Corporation Baa1 116,000 2.8 324,800 14,289,000 2.27% New York Times Company (The) B1 15,000 2.8 42,000 1,059,375 3.96% Time Warner Inc. Baa2 66,000 2.8 184,800 39,983,000 0.46% Viacom Inc. Baa3 3,000 2.8 8,400 8,002,000 0.10% Walt Disney Company (The) A2 56,000 2.8 156,800 14,639,000 1.07% Washington Post Company (The) A1 1,300 2.8 3,640 553,825 0.66% Industry: Food/Supermarket Anheuser-Busch Companies, Inc. Baa2 17,200 7.4 127,280 43,178,000 0.29% B&G Foods, Inc. B2 1,100 7.4 8,140 535,800 1.52% Coca-Cola Enterprises Inc. A3 48,000 7.4 355,200 9,029,000 3.93% ConAgra Foods, Inc. Baa2 8,500 7.4 62,900 3,490,000 1.80% Dean Foods Company B1 28,295 7.4 209,383 4,489,251 4.66% Del Monte Foods Company Ba3 7,800 7.4 57,720 1,560,000 3.70% Dole Food Company, Inc. B2 1,600 7.4 11,840 2,155,304 0.55% Flowers Foods, Inc. Baa2 900 7.4 6,660 335,206 1.99% Great Atlantic & Pacific Tea Co., Inc.(The) B3 48,200 7.4 356,680 1,108,008 32.2% Kellogg Company A3 64,000 7.4 473,600 4,129,835 11.47% Kroger Co. (The) Baa2 219,000 7.4 1,620,600 9,420,000 17.20% Rite Aid Corporation Caa2 10,924 7.4 80,838 6,011,709 1.34% Safeway Inc. Baa2 286,900 7.4 2,123,060 5,499,800 38.60% Sara Lee Corporation Baa1 48,000 7.4 355,200 3,188,000 11.14% Stater Bros. Holdings, Inc. B2 40,508 7.4 299,759 816,286 36.72% Supervalu, INC. Ba3 142,000 7.4 1,050,800 8,484,000 12.39% Sysco A1 35,040 7.4 259,296 2,477,000 10.47% Industry: Hotel/Casinos Boyd Gaming Corporation B1 1,000 3.0 3,000 2,647,674 0.11% Harrah's Entertainment, Inc. Caa3 37,700 3.0 113,100 23,209,000 0.49% MGM MIRAGE Caa2 192,000 3.0 576,000 13,464,166 4.28% Riviera Holdings Corporation Ca 2,020 3.0 6,060 245,703 2.47% Starwood Hotels & Resorts Worldwide Inc. Ba1 9,000 3.0 27,000 4,008,000 0.67% 9 September 2009 Special Comment Moody s Global Corporate Finance - Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern
Special Comment Pg 135 of 250 Moody s Global Corporate Finance Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern Imputed debt for Companies Participating in Multiemployer Pension Plans All figures in $'000s unless otherwise noted 2008 Company Name Rating Contributions Multiple Imputed Debt 2008 Reported Debt Imputed debt As % of Reported debt Industry: Transportation Arkansas Best Corporation Baa2 111,064 5.6 621,958 16,805 3701% Quality Distributions LLC Caa1 2,300 5.6 12,880 362,586 3.55% Ryder System, Inc. Baa1 4,886 5.6 27,362 2,862,799 0.96% United Parcel Service, Inc. Aa3 1,069,000 5.6 5,986,400 9,871,000 60.65% YRC Worldwide Inc. Caa3 554,100 5.6 3,102,960 1,360,752 228.03% Industry: Other Allegheny Technologies Incorporated Baa3 1,500 4.0 6,000 509,800 1.18% Alpha Natural Resources Inc. Ba2 191 4.0 764 520,857 0.15% ARAMARK Corporation B1 34,000 4.0 136,000 5,859,557 2.32% MDU Resources Group, Inc. Baa1 73,100 4.0 292,400 1,752,402 16.69% Sealy Mattress Company B2 4,700 4.0 18,800 783,405 2.40% United States Steel Corporation Ba2 42,000 4.0 168,000 3,156,000 5.32% United Technologies Corporation A2 163,000 4.0 652,000 11,476,000 5.68% 10 September 2009 Special Comment Moody s Global Corporate Finance - Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern
Special Comment Pg 136 of 250 Moody's Global Corporate Finance Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern Appendix III Major Multiemployer Plans ($ millions) Estimated Net Estimated RPA 94 Moody's Adjusted Estimated Under funding Plan Name Plan Assets* Current Liability** Funded Status Contributions*** Multiple (D)=(B)/ (F)=[(C*90% - (A) (B) (C) (C*90%) (E) (B)*50%]/E Industry: Construction Alaska Electrical Pension Plan 1,230.9 1,840.1 74.3% 42.2 5.0 Alaska Laborers - Employers Retirement Fund 472.9 712.6 73.7% 17.1 4.9 Boilermaker Blacksmith National Pension 5,678.5 10,880.8 58% 278.4 7.4 Bricklayers & Trowel Trades International Pension Fund 1,149.9 2,382.6 53.6% 92.3 5.4 Building Service 32B-J Pension Fund 1,174.9 3,086.8 42.3% 120.2 6.7 Building Trades United Pension Trust Fund MIL and Vicinity 1,100.2 1,814.2 67.4% 88.1 3.0 California Ironworkers Field Pension Trust 1,280.6 2,206.2 64.5% 91.3 3.9 Carpenter Pension Trust for Southern California 2,089.6 3,844.6 60.4% 101.2 6.8 Carpenters Pension Fund of Illinois 1,178.4 2,039.1 64.2% 57.4 5.7 Carpenters Pension Fund of Philadelphia and Vicinity 1,102 1,844.7 66.4% 90.7 3.1 Carpenters Pension fund of Western Pennsylvania 514 939.9 60.8% 23.7 7.0 Carpenters Pension Trust Fund Detroit & Vicinity 855.6 2,297.2 41.4% 41.8 14.5 Carpenters Pension Trust Fund for Northern California 1,608.5 3,152.5 53.7% 140.6 4.4 Carpenters Pension Trust Fund of St Louis 1,253.9 2,031.5 68.6% 70.8 4.1 Carpenters Retirement Plan of Western Washington 835.1 1,269.9 73.1% 42.5 3.6 Central Laborers Pension Fund 730.6 1,496.8 54.2% 47.2 6.5 Central Pension Fund of the IUOE and Participating Employers 7,869.8 12,627.6 69.2% 514.5 3.4 Chicago District Council of Carpenters Pension Fund 1,923.9 3,051.2 70.1% 190.5 2.2 Electrical Contractors Assoc. of City of Chicago Union 134, IBEW Jt. Pension 2 779.9 1,176.3 73.7% 58.3 2.4 Electrical Workers Pension Fund, Local 103, IBEW 548.8 903.0 67.5% 41.5 3.2 Electrical Workers Pension Trust Fund of Local Union 58 458.1 911.5 55.8% 31.1 5.8 Indiana State District Council of Laborers & Hod Carriers Pension Fund 635 1,365.4 51.7% 32.0 9.3 Iron Workers District Council of Southern Ohio & Vicinity Pension Trust 519.6 1,071.3 53.9% 39.4 5.6 11 September 2009 Special Comment Moody s Global Corporate Finance - Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern
Special Comment Pg 137 of 250 Moody's Global Corporate Finance Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern Major Multiemployer Plans ($ millions) Estimated Net Estimated RPA 94 Moody's Adjusted Estimated Under funding Plan Name Plan Assets* Current Liability** Funded Status Contributions*** Multiple (D)=(B)/ (F)=[(C*90% - (A) (B) (C) (C*90%) (E) (B)*50%]/E Iron Workers Local No. 25 Pension Trust Fund 512.9 1,227.5 46.4% 40.5 7.3 Laborers District Council and Contractors Pension Fund of Ohio 1,288.1 1,898.6 75.4% 35.8 5.9 Laborers District Council of W. PA Pension Fund 514.3 1,222.3 46.8% 28.9 10.1 Laborers National Pension Fund 1,293.5 2,314.7 62.1% 47.8 8.3 Laborers Pension Fund 1,568.1 2,613.9 66.7% 125.1 3.1 Washington State Plumbing & Pipefitting Industry Pension Fund 481.1 590.1 90.6% 16.8 1.5 Laborers Pension Trust Fund for Northern California 1,115.7 2,477.0 50.0% 98.0 5.7 LIUNA National Industrial Pension Fund 638.4 1,410.5 50.3% 53.0 6.0 MA State Carpenters Guaranteed Annuity Fund 1,104.0 1,194.0 102.7% 93.9-0.2 MA State Carpenters Pension Fund 966.2 1,564.6 68.6% 59.9 3.7 Massachusetts Laborers Pension Fund 838.4 1,440.1 64.7% 54.4 4.2 Michigan Carpenters Pension Fund 429.4 949.9 50.2% 21.0 10.1 Michigan Laborers Pension Fund 518.9 1,042.6 55.3% 33.9 6.2 Midwest Operating Engineers Pension 2,320.7 3,805.4 67.8% 137.2 4.0 Minnesota Laborers Pension Fund 874.8 1,556.9 62.4% 51.6 5.1 National Automatic Sprinkler Industry Pension 2,206.5 3,616.7 67.8% 90.3 5.8 National Electrical Benefit Fund 8,580.3 16,390.1 58.2% 433.0 7.1 National Elevator Industry Pension 3,659.7 5,730.5 71.0% 204.0 3.7 NECA-IBEW Pension Trust Fund 611.7 982.7 69.2% 31.7 4.3 NJ Carpenters Pension Fund 841.1 1,468.6 63.6% 60.8 4.0 NY District Council of Carpenters Pension Plan 1,338.8 2,510.4 59.3% 195.7 2.4 OE Pension Trust Fund 2,793.2 5,922.6 52.4% 180.5 7.0 Ohio Operating Engineers Pension Plan 1,377.4 2,022.7 75.7% 42.1 5.3 IUOE Stationary Engineers Local 39 Pension Plan 515.8 878.6 65.2% 40.9 3.4 Operating Engineers Local 324 Pension Fund 983.4 2,310.0 47.3% 57.7 9.5 Operating Engineers Pension Trust 1,645.5 2,962.5 61.7% 112.3 4.5 12 September 2009 Special Comment Moody s Global Corporate Finance - Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern
Special Comment Pg 138 of 250 Moody's Global Corporate Finance Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern Major Multiemployer Plans ($ millions) Estimated Net Estimated RPA 94 Moody's Adjusted Estimated Under funding Plan Name Plan Assets* Current Liability** Funded Status Contributions*** Multiple (D)=(B)/ (F)=[(C*90% - (A) (B) (C) (C*90%) (E) (B)*50%]/E Plumbers & Pipefitters National Pension 4,004.1 8,158.1 54.5% 323.3 5.2 Pipe Fitters Retirement Fund Local 597 776.6 1,564.0 55.2% 73.0 4.3 Sheet Metal Workers National Pension Fund 2,550.4 7,454.5 38.0% 316.0 6.6 Sheet Metal Workers Pension Plan of Northern Calif 845.9 1,707.3 55.1% 43.1 8.0 Sheet Metal Workers Pension Plan of S. CA, Arizona and Nevada 739 1,379.4 59.5% 28.4 8.8 Twin City Carpenters Pension Fund 983.2 2,174.1 50.2% 60.0 8.1 Western Metal Industry Pension Plan 984.3 1,270.0 86.1% 11.6 6.9 Wisconsin Carpenters Pension Fund 640.7 1,259.9 56.5% 46.6 5.3 Construction - Summary 85,532.6 158,016.8 60.1% 5,501.70 5.2 Construction Regulatory Funded Status 54% Industry: Entertainment/Printing AFTRA Retirement Plan 1,509.2 2,434.7 68.9% 44.2 7.7 American Federation of Musicians & Employers Pension 1,549.1 2,180.6 78.9% 53.2 3.9 BERT Bell Pete Rozelle NFL Player Retirement Plan 835.4 1,546.4 60.0% 125.9 2.2 Chicago Newspaper Publishers Drivers Union Pension Trust 73.3 153.9 52.9% 4.1 7.9 Directors GUILD of America - Producer Pension Plan 1,649.6 1,165.2 157.3% 103.2-2.9 GCIU Local 119B NY Printers League Pension Fund 85.7 133.4 71.4% 1.1 NM GCIU-Employer Retirement Fund 1,065.4 2,053.4 57.6% 23 NM Newspaper and Mail Delivers - Publishers Pension Fund 118.2 216.9 60.5% 5.6 6.8 Newspaper GUILD of NY the New York Times Pension Plan 175.2 276.3 70.5% 12.4 3 Producer-Writers Guild of America Pension Plan 1,572.2 2,300.9 75.9% 53.1 4.7 The Newspaper Guild International Pension Plan 68.2 120.7 62.8% 2.4 8.3 Equity League Pension Plan 946.7 983.2 107.0% 31-1 Screen Actors Guild- Producers Pension 2,894.2 3,922.7 82.0% 119.6 2.7 13 September 2009 Special Comment Moody s Global Corporate Finance - Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern
Special Comment Pg 139 of 250 Moody's Global Corporate Finance Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern Major Multiemployer Plans ($ millions) Estimated Net Estimated RPA 94 Moody's Adjusted Estimated Under funding Plan Name Plan Assets* Current Liability** Funded Status Contributions*** Multiple (D)=(B)/ (F)=[(C*90% - (A) (B) (C) (C*90%) (E) (B)*50%]/E Entertainment/Printing - Summary 12,542.4 17,488.3 79.7% 578.8 2.8 Entertainment/Printing - Regulatory Funded Status 72% Industry: Food/Supermarket Bakery & Confectionery Union & Industry International Pension 4,667.2 8,325.5 62.3% 186.3 7.6 UFCW Unions and Food Employers Pension Plan of Central Ohio 412.6 747.4 61.3% 11.7 11.1 National Shopmen Pension Fund 388.1 533.4 80.9% 8.6 5.3 FELRA and UFCW Pension Fund 742.3 2,073.4 39.8% 40.9 13.7 Oregon Retail Employees Pension Plan 699.6 968.2 80.3% 14.4 6 Rocky Mt. UFCW Unions & Employers Pension Plan 656.6 1,050.3 69.5% 25.4 5.7 Retail Clerks Pension Plan 1,340.9 2,201.9 67.7% 27.5 11.7 SO CA UFCW Union Joint Pension 3,548.6 6,749.4 58.4% 158.7 8 UFCW International Union Industry Pension 3,681.1 5,018.1 81.5% 78.4 5.3 UFCW International Union Pension Plan for Employees 776.6 1,298.9 66.4% 79.8 2.5 UFCW Nothern California Joint Pension 3,203.3 5,836.5 61.0% 145.2 7.1 UFCW Unions & Employers Midwest Pension Fund 1,008.1 1,680.2 66.7% 11.1 NM Food/Supermarket - Summary 21,124.90 36,483.3 64.3% 788 7.4 Food/Supermarket - Regulatory Funded Status 58% Industry: Hotel/Casino Alaska Hotel & Restaurant Employees Pension Plan 136 189.6 79.7% 0.9 NM HERE Local 25 and Hotel Association of Washington, DC Pension 62.3 140.3 49.3% 7.6 4.2 Hotel Employees Restaurant Employees Pension Plan 78 98.7 87.8% 2.1 2.6 Hotel Industry-ILWU Pension Plan 148.5 251.2 65.7% 4.1 9.5 Hotel Union and Hotel Industry of Hawaii Pension Plan 260.2 335.7 86.1% 13.8 1.5 14 September 2009 Special Comment Moody s Global Corporate Finance - Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern
Special Comment Pg 140 of 250 Moody's Global Corporate Finance Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern Major Multiemployer Plans ($ millions) Estimated Net Estimated RPA 94 Moody's Adjusted Estimated Under funding Plan Name Plan Assets* Current Liability** Funded Status Contributions*** Multiple (D)=(B)/ (F)=[(C*90% - (A) (B) (C) (C*90%) (E) (B)*50%]/E LA Hotel-Restaurant Employer-Union Retirement Fund 104 135.9 85.0% 5.2 1.8 NY Hotel Trades Council and Hotel Association of NYC Pension Fund 617.2 1,245.1 55.1% 97 2.6 Southern Nevada Culinary & Bartenders Pension Trust 1,196.5 1,762.2 75.4% 58.6 3.3 Hotel/Casino - Summary 2,602.8 4,158.8 69.5% 189.3 3.0 Hotel/Casino - Regulatory Funded Status 63% Industry: Transportation Automotive Mechanics Local No. 701 Union Pension Fund 542.7 1,084.4 55.6% 21.3 10.2 Alaska Teamster-Employer Pension Plan 638.9 1,070.7 66.3% 27.2 6 Automotive Industries Pension Plan 1,152 1,768.1 72.4% 25.1 8.7 Automotive Machinists Pension Plan 693.8 1,207.8 63.8% 21.7 9.1 Central Pennsylvania Teamsters Defined Benefit Plan 662.4 1,336.1 55.1% 75.2 3.6 Central States SE&SW 19,397 44,414.2 48.5% 1,440.3 7.1 District No. 9, IAM and Aerospace Workers Pension 482.7 769.3 69.7% 18.6 5.6 IAM National Pension Plan 6,623.7 8,852.4 83.1% 269.2 2.5 IB of T Union Local 710 Pension 1,416.8 2,833 55.6% 107.5 5.3 Local 705 IB of T Pension Trust Fund 852.8 2,045.3 46.3% 79.1 6.2 Local 804 I.B.T. and Local 447 IAM UPS Multi-employer Retirement Plan 546.1 1,529.1 39.7% 61.6 6.7 Masters, Mates & Pilots Pension Plan 413.1 811 56.6% 16.6 9.5 New England Teamsters & Trucking Industry Pension 2,723.9 7,466.6 40.5% 229.2 8.7 NYS Teamsters Conference Pension & Retirement Fund 1,809.3 3,914.7 51.4% 102.3 8.4 Teamsters Joint Council No. 83 of Verginia Pension Fund 402.6 814.3 54.9% 30.5 5.4 Teamsters Local 639 Employers Pension Trust 656.7 959.4 76.1% 37 2.8 Teamsters Pension Trust of Philadelphia and Vicinity 1,166.8 2,673.1 48.5% 91.4 6.8 Trucking Employees of North Jersey Welfare Fund Inc. Pension Fund 409.2 699.4 65.0% 43.4 2.5 15 September 2009 Special Comment Moody s Global Corporate Finance - Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern
Special Comment Pg 141 of 250 Moody's Global Corporate Finance Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern Major Multiemployer Plans ($ millions) Estimated Net Estimated RPA 94 Moody's Adjusted Estimated Under funding Plan Name Plan Assets* Current Liability** Funded Status Contributions*** Multiple (D)=(B)/ (F)=[(C*90% - (A) (B) (C) (C*90%) (E) (B)*50%]/E Western Conference of Teamsters 23,382.8 36,820.3 70.6% 1,320.4 3.7 Western Pennsylvania Teamsters and Employers Pension Plan 891.4 1,866.7 53.1% 43.9 9 Transportation - Summary 64,864.6 122,935.9 58.6% 4061.7 5.6 Transportation - Regulatory Funded Status 53% Industry: Other 1199 Health Care Employees Pension 7,035.0 7,979.7 98.0% 265.7 0.3 American Maritime Officers Pension Plan (2005) 428.4 657.3 72.4% 45.8 1.8 CWA/ITU Negotiated Pension Plan 779.6 1,295.9 66.8% 16.5 11.7 ILWU-PMA Pension Plan 1,906.4 3,724.1 56.9% 146.5 4.9 Major League Baseball Players Pension Plan 1,375.2 2,563.8 59.6% 128.9 3.6 MEBA Pension Trust 945.7 1,136.1 92.5% 3.1 12.4 National Asbestos Workers Pension Fund 412.4 703.2 65.2% 12.5 8.8 National Integrated Group Pension Plan 680.5 1,387.5 54.5% 17.8 NM NYS Nurses Association Pension Plan 1,597.6 1,976.7 89.8% 100.9 0.9 PACE Industry Union-Management Pension Fund 1,416.7 2,851.7 55.2% 58.6 9.8 Seafarers Pension Trust 544.1 646 93.6% 4.8 3.9 SEIU National Industry Pension Fund 934.6 1,598.1 65.0% 39.1 6.4 Steamship Trade Assn of Baltimore - Intl Longshoremans Assn AFL-CIO Pension Fund 620.2 647.2 106.5% 8.0-2.4 Steelworkers Pension Trust (2007) 1,487.6 2,497.2 66.2% 164.6 2.3 The Cultural Institutions Pension Plan 822.4 888.4 102.9% 26.7-0.4 United Mine Workers of America 1974 Pension Plan 5,076.8 7,804.9 72.3% 21.9 44.5 Other - Summary 26,062.9 38,358 75.5% 1061.4 4 Other - Regulatory Funded Status 68% 16 September 2009 Special Comment Moody s Global Corporate Finance - Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern
Special Comment Pg 142 of 250 Moody's Global Corporate Finance Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern * Asset values for end of year 2008 were estimated by applying the following assumptions to EOY 2007 fair market values Equity Debt Other Asset mix 65% 25% 10% Gains / (Losses) (38.50%) 1% (30%) ** 2008 RPA current liability assumed unchanged from 2007 *** 2008 Contributions assumed unchanged from 2007 Notes All the data is collected from Form 5500s filed with the Department of Labor. The most recent 5500s include plan years ended in 2007. In case 2007 data was not available, we used 5500s for plan years ended in 2006. (B) Plan Assets are recorded at fair market value at the end of the year and are obtained from Schedule H (Form 5500) (C)RPA 94 Current Liability related to retired participants is obtained from Schedule B (Form 5500). It is recorded as of the valuation date, which is typically the beginning of the year. The interest rate used to compute the RPA 94 Current Liability is per the guidelines issued by the IRS (section 412). (D) Moody's Adjusted Funded Status uses the RPA 94 amount (expected future benefit payments discounted at the risk free rate of interest) multiplied by a factor of 90% We believe this approach best simulates a benefit obligation measured using generally accepted accounting principles. (E)Funded Status is the weighted average funded status of all plans in an industry. (F)Total Contribution includes contributions made by all participating employers to the plan during the year. (G)The Under-Funding Multiple compares the relationship between a plan's funded status and annual contributions the plan receives from participating companies. Under funding multiple for the industry is computed using total plan assets, total average liability and total contributions (i.e. weighted average multiple) NM: Not meaningful (Under funding multiples in excess of 15x are labeled NM) 17 September 2009 Special Comment Moody s Global Corporate Finance - Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern
Special Comment Pg 143 of 250 Moody's Global Corporate Finance Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern Appendix IV Moodys Calculation of Imputed Debt for Multiemployer Pension Plan Obligations We calculate imputed debt for companies contributing to MEPP s using the following steps 2 : 1. Compute an under-funding multiple for individual major multiemployer plans based on the relationship between a plan s funded status and total annual contributions to the plan from all participating companies 2. Group major multiemployer plans into broad industry categories and compute an industry under-funding multiple as the weighted average of the under-funding multiples for the plans in that industry 3. Roughly estimate a company s share of under-funding by multiplying the company s most recent annual contribution to its plans by the applicable under-funding multiple We calculate the under-funding multiple for each plan in three steps: 1. Measure the plans funded status. We subtract net plan assets from 90 percent of the RPA 94 liability ( the adjusted liability ) 2. Calculate the gross multiple. We divide the funded status in (1) by total contributions to the plan from all participating companies 3. Determine the under-funding multiple. We take 50 percent of the gross multiple in (2). This haircut reflects our view that in contract negotiations with unions, companies will ultimately fund about 50 percent of the underfunding and union employees will fund the remaining 50 percent by foregoing current wages, benefits or work rules Our methodology attempts to adjust a company s financial statements to reflect the company s share of the MEPP underfunding, which in theory should create comparability to SEPP s. That being said, one major difference between our methodologies for MEPP s and SEPP s is that we reduce the underfunded levels for MEPP s by 50% when imputing debt. The rationale for this apparent contradiction is that in recent years many companies have held all-in compensation increases for union employees to modest levels. In effect, a portion of the increase in multiemployer funding has resulted from union requests to direct much of the increase in the total compensation package to multiemployer plans, thereby forgoing a portion of current wage increases. As neither unions nor management are dominant in negotiations, absent more specific information, we expect that union employees will share about 50 percent of the burden to address under-funding of multiemployer plans, while companies will fund the remaining 50 percent. This differs from SEPP s in that the sponsoring company is legally obligated to fund vested benefits. These assumptions will only work when companies intend to continually contribute to their respective MEPP s. This was clearly demonstrated when UPS withdrew from Central States in December of 2007. When UPS withdrew, it was required to contribute $6.1 billion in cash to the fund. For year ended December 2006 we imputed $4.4 billion of debt for UPS contributions to all its multiemployer plans, which includes Central States. The exact amount of debt associated with Central States is unknown but it would be certainly a lot less than the $4.4 billion in total imputed debt and in turn a lot less than the $6.1 billion paid. The explanation for this large difference between our imputed debt and UPS payment is two fold; 1. A withdrawal liability is calculated in a much different way than an ongoing liability. Without delving into technical details a withdrawal liability will nearly always be higher than a company s current share of the unfunded liability. This is one of the reasons many company s either cannot afford to withdraw from a plan or simply do not want to. 2 See rating methodology Multiemployer Pension Plans: Moody s Analytical Approach for a more detailed description of the calculations. 18 September 2009 Special Comment Moody s Global Corporate Finance - Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern
Special Comment Pg 144 of 250 Moody's Global Corporate Finance Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern 2. When UPS withdrew, the employees and retires did not shoulder any of the burden of underfunding, which is clearly different from our 50% assumption. Once again this is a major reason why companies do not want to withdraw from plans after withdrawal they are less able to push some of the funding burden onto plan participants. The 50 percent haircut would be revisited if it appears that a company may withdraw from its plans. Moody s Related Research Rating Methodology Multiemployer Pension Plans: Moody s Analytical Approach, August 2006 (98445) Analytical Observations Related To U.S. Pension Obligations, January 2003 (77242) Special Comment Managing Ratings With Increased Pension Liability, Special Comment, March 2003 (115011) To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this report and that more recent reports may be available. All research may not be available to all clients. 19 September 2009 Special Comment Moody s Global Corporate Finance - Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern
Special Comment Pg 145 of 250 Moody's Global Corporate Finance Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern Report Number: 119880 Authors Wesley Smyth David Berge Marie Menendez Senior Production Associates Shubhra Bhatnagar Cassina Brooks CREDIT RATINGS ARE MOODY'S INVESTORS SERVICE, INC.'S (MIS) CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MIS DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. CREDIT RATINGS DO NOT CONSTITUTE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS ARE NOT RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. 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Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually on Moody s website at www.moodys.com under the heading Shareholder Relations Corporate Governance Director and Shareholder Affiliation Policy. 20 September 2009 Special Comment Moody s Global Corporate Finance - Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern
Pg 146 of 250 Exhibit D-4
A BNA, INC. Pg 147 of 250 PENSION & BENEFITS! DAILY Reproduced with permission from Pension & Benefits Daily, 220 PBD, 11/17/10, 11/17/2010. Copyright 2010 by The Bureau of National Affairs, Inc. (800-372- 1033) http://www.bna.com Multiemployer Plans Four Reforms to Save Multiemployer Plans BY GEORGE M. KRAW George M. Kraw (gkraw@kraw.com) is an attorney with Kraw & Kraw Law Group, with offices in Mountain View and Newport Beach, Calif. Kraw is a member of the California and District of Columbia Bar and a former member of the Pension Benefit Guaranty Corporation s Advisory Committee. He specializes in the representation of multiemployer benefit plans. M ultiemployer pension plans are one of the great triumphs of labor relations of the past century. Sponsored by unions and employers, multiemployer plans have helped provide dignity to workers in retirement and stable workforces for employers in construction, trucking, entertainment, coal, retail, food, and other industries. There are more than 10 million participants nationwide in nearly 1,500 multiemployer plans. However, the future of those plans is bleak unless reforms are made now to change the governance rules and financial obligations of multiemployer plans. The Pension Protection Act of 2006 (Pub. L. No. 109-280) and more recent legislative efforts have been insufficient to repair the plans deteriorating financial conditions. Some large multiemployer plans are teetering on the brink of collapse. There are many causes for the underfunding, and every underfunded plan is unhappy in its own way. But most frontline pension fund trustees would point to investments that have failed to meet expected returns during the past decade, fewer new participants in plans, and aging workforces as major causes. In some cases, policies designed to safeguard workers pensions and improve benefits have had the unintended effect of making bad situations worse and have left many pension plans under crushing debt that will be impossible to pay off. Some plans felt pressure to increase benefits COPYRIGHT 2010 BY THE BUREAU OF NATIONAL AFFAIRS, INC. ISSN
2 Pg 148 of 250 in better economic times, leaving them with no reserves for getting through the current economic crisis. Bankruptcy proceedings, rooted in equitable concepts of the law, are the best way to handle multiemployer plans whose financial obligations greatly exceed their assets but that still have significant financial holdings. Moody s Investors Service estimated the total unfunded liability of 126 of the nation s largest multiemployer pension plans exceeded $165 billion in 2008. A 2009 survey by the National Coordinating Committee for Multiemployer Plans found that 80 percent of the plans reviewed were in endangered or critical underfunded status, which put those plans under increased regulatory constraints. Meanwhile, the Pension Benefit Guaranty Corporation s insurance program for multiemployer plans has insufficient funds to cover insured benefits, even though the PBGC-guaranteed maximum monthly benefit of $1,320 per participant and median monthly benefit of $820 are relatively low. PBGC s multiemployer plan program has reported a deficit every year since 2003. At the end of fiscal year 2009, the program had assets of $1.46 billion and total liabilities of $2.33 billion. A reported $2.30 billion of those liabilities represented nonrecoverable future financial assistance to distressed plans. A May 2010 report to Congress from the Government Accountability Office summed up the situation by saying that multiemployer plans face ongoing funding and demographic challenges that have the potential to place an additional financial burden on the PBGC. Suggested Reforms Several changes in the rules governing multiemployer pension plans could help save those plans, whose distress has been well-documented. Four reforms are necessary: s Cutting vested benefits if plan trustees deem it necessary and plan sponsors agree; s Capping or eliminating withdrawal liability to bring more employers into multiemployer plans; s Allowing plans greater flexibility to reduce investment assumption rates below current levels and to immunize or hedge part or all of their assets and liabilities; and s Creating a Chapter 11-type bankruptcy procedure for severely distressed plans. The common element in all of these reforms is that of giving plans and participating employers and unions greater flexibility to address their specific needs. None of the reforms would be mandatory. The principle underlying each of the proposed reforms is that troubled pension plans should balance the interests of active and retired participants by preserving pension plans while preserving jobs and industries. Allow Plans to Cut Vested Benefits The PPA created new funding requirements for plans just as the nation was entering the most severe economic crisis since the depression of the 1930s. The law allowed multiemployer plans whose underfunded status was deemed critical to cut some vested benefits for plan participants. That authority to cut vested benefits should be expanded and extended to all multiemployer plans. The plans should have the means to revise and restructure vested benefits in ways that ensure the survivability of individual multiemployer plans and the industries that sponsor them. It is best to allow plans to act sooner rather than later when they are on the brink of insolvency. The guiding principle here should be that plans must not be forced to adopt contribution rates from active participants that result in uncompetitive and unsustainable labor costs and loss of jobs. Plans should be allowed to ask what actions will provide the greatest good for the greatest number of participants and act accordingly. As a safeguard for participants, sponsoring unions and employer groups should be given the right to veto any cutbacks greater than those currently allowed under the PPA. Allow Plans to Waive or Cap Withdrawal Liability Withdrawal liability for employers has crimped the ability of multiemployer plans to attract new employers more than any other provision of the Employee Retirement Income Security Act. Withdrawal liability requires an employer that withdraws from a multiemployer plan to pay a share of the plan s unfunded liability. In its 2010 report to Congress, GAO said the PBGC views withdrawal liability as an incentive for employers, participants, and their collective bargaining representatives to avoid insolvency and to collaborate in trying to find solutions to a plan s funding problems. In reality, however, withdrawal liability has interfered with collective bargaining and exacerbated the difficulties that unionized industries have had in maintaining industry market share because the liability is a significant financial disincentive for new employers to join multiemployer plans. In the worst cases, rather than strengthening multiemployer plans, withdrawal liability has led to a death spiral in which market share and competitive wages have been traded for increased contributions to pension plans. As a plan s finances weaken, the plan s withdrawal liability increases. New proposals from the Financial Accounting Standards Board would require employers that participate in multiemployer plans to list their withdrawal liability on their audited financial statements even if they have no intention of withdrawing. The new requirements would further weaken the market competitiveness of large multiemployer plan employers by adding those contingent liabilities to their balance sheets. Given the difficult financial circumstances of many multiemployer plans and the financial relief that expanded employer participation would bring, it would be reasonable in the future to let each multiemployer plan establish its own rules for withdrawal liability. Some plans and sponsors might decide to keep withdrawal li- 11-17-10 COPYRIGHT 2010 BY THE BUREAU OF NATIONAL AFFAIRS, INC. ISSN
Pg 149 of 250 3 ability. Others might waive it completely. Some might require it only for employers that already participate in a multiemployer plan. All options should be on the table. The important point is that the survivability of multiemployer plans that are not fully funded depends on the survivability of the industries that pay into those plans. Withdrawal liability provides little protection for plans if participating employers are forced out of business and jobs are lost. Provide Special Rules for Plans That Want to Reduce Their Investment Assumption Rates or Immunize Their Portfolios Most multiemployer plans assume between 6 percent and 8 percent rates of return on their investments. Those rates are based on past history and are not realistic for the future. Many plans are reluctant to lower their assumed rates of return because doing so would increase the plans liabilities. The lower the investment rate of return, the more assets plans must have on hand today to pay for future obligations. Believers in the socalled new normal expect institutional investors to garner returns of 5 percent or less, and yet many multiemployer plans are expected to continue trying to achieve 6 percent to 8 percent returns. Sophisticated investors like Bill Gross, cofounder of Pacific Investment Management Co. (PIMCO) and manager of PIMCO s Total Return fund, are telling plan trustees that they are unlikely to come close to such results. Compounding the problem are lower returns from traditional fixed-income investments such as corporate and government bonds. One unfortunate response to this trend has been for multiemployer plans to invest in risky assets such as private equity, hedge funds, and the like in an effort to achieve their assumed rates of return. Multiemployer plans should be permitted to assess whether their assumed rates of return are too high and to lower them without running into regulatory problems. Providing that flexibility also would require changing some portion of a plan s vested benefits into contingent benefits, which would be paid only upon improvements in the plan s finances and returns in excess of the new assumption rates. Plans also should be able to immunize portions of their portfolio. The aim of such liability-driven investment strategies is to invest pension funds in assets that will increase or decrease in direct correlation with an increase or decrease in a pension plan s liabilities. Immunization strategies can be paired with investments in inflation-protected, fixed-income securities to provide protection against inflation. Critics of immunization strategies argue that they result in lower investment earnings. However, a welldesigned immunization strategy provides the best guaranty that pension promises can be fulfilled. When combined with inflation-protected securities, immunization also ensures that a pension s real value will be maintained throughout a pensioner s retirement. Provide Chapter 11-Type Bankruptcy Procedures Multiemployer plans that have suffered severe investment losses or that represent declining industries risk a gradual slide into insolvency. Under current law, a multiemployer plan s eventual collapse may be both inevitable and foreseeable. Recent legislative proposals to expand PBGC s partition authority so that multiemployer plans can apply triage strategies and save viable portions of multiemployer plans have been mischaracterized by some as taxpayer-financed union bailouts (101 PBD, 5/27/10; 37 BPR 1271, 6/8/10) and (102 PBD, 5/28/10; 37 BPR 1270, 6/8/10). Those proposals face significant political opposition because they are seen as a potential threat PBGC s solvency and ultimately a threat to taxpayers, notwithstanding the fact that PB- GC s multiemployer insurance program is ultimately funded by sponsoring employers and unions through insurance premiums, not by the federal government. Outlook for the Future Clearly some multiemployer plans will not survive their current financial and economic problems without restructuring. A Chapter 11-type bankruptcy procedure would provide a more orderly and fairer approach to dealing with the problems on a case-by-case basis. It would allow courts to allocate losses by taking into account the interests of all stakeholders. The current statutory regime places heavy burdens on employers that remain in troubled plans and in some cases threatens loss of jobs and industry survival. Bankruptcy proceedings, rooted in equitable concepts of the law, are the best way to handle multiemployer plans whose financial obligations greatly exceed their assets but that still have significant financial holdings. Reforms such as those suggested here would significantly affect the PBGC and might require that participants in plans adopting these changes receive lower levels of insurance coverage for their pensions. Any change in the level of benefit guaranteed by PBGC would require a cost-benefit analysis that would weigh the specific concerns of PBGC against the interests of all multiemployer pension plans. There is no scenario in which these plans will be able to pay their full promised pensions under current rules. The challenges facing some multiemployer plans require more aggressive action than a gradualist approach can provide. Substantial government financial aid for multiemployer plans is unlikely in the current economic and political environment. Future inflation could reduce plan debt, but it also would decrease the value of pensions. Multiemployer plans are at a point where everyone involved must recognize that some troubled plans will be unable to meet all their promises to participants and that their collapse threatens to take jobs, employers, and whole industries out with them. Absent a politically unlikely government bailout or significant inflation that washes away the debts of private parties and government alike, there is no scenario in which these plans will be able to pay their full promised pensions under current rules. ISSN BNA 11-17-10
4 Pg 150 of 250 If troubled multiemployer pension plans are to be left to their own devices to solve their funding problems, they must be given the means to do so. 11-17-10 COPYRIGHT 2010 BY THE BUREAU OF NATIONAL AFFAIRS, INC. ISSN
Pg 151 of 250 Exhibit D-5
Pg 152 of 250 GAO United States Government Accountability Office Report to the Chairman, Committee on Education and Labor, House of Representatives October 2010 PRIVATE PENSIONS Changes Needed to Better Protect Multiemployer Pension Benefits GAO-11-79
Pg 153 of 250 Accountability Integrity Reliability Highlights of GAO-11-79, a report to the Chairman, Committee on Education and Labor, House of Representatives October 2010 PRIVATE PENSIONS Changes Needed to Better Protect Multiemployer Pension Benefits Why GAO Did This Study Thirty years ago Congress enacted protections to ensure that participants in multiemployer pension plans received their promised benefits. These defined benefit plans are created by collective bargaining agreements covering more than one employer. Today, these plans provide pension coverage to over 10.4 million participants in approximately 1,500 multiemployer plans insured by the Pension Benefit Guaranty Corporation (PBGC). In this report, GAO examines (1) the current status of nation s multiemployer plans; (2) steps PBGC takes to monitor the health of these plans; (3) the structure of multiemployer plans in other countries; and (4) statutory and regulatory changes that could help plans provide participants with the benefits they are due. To address these questions, GAO analyzed government and industry data and interviewed government officials, pension experts and plan practitioners in the United States, the Netherlands, Denmark, United Kingdom, and Canada. What GAO Recommends GAO is asking Congress to consider ways to eliminate duplicative reporting requirements and establish a shared database. GAO is also recommending that PBGC, IRS, and Labor work together to improve data collection and monitoring efforts. In commenting on a draft of this report, the agencies generally agreed to improve their coordination efforts. View GAO-11-79 or key components. For more information, contact Barbara D. Bovbjerg at (202) 512-7215 or bovbjergb@gao.gov. What GAO Found Most multiemployer plans report large funding shortfalls and face an uncertain future. U.S. multiemployer plans have not been fully funded in aggregate since 2000 and the recent economic recession had a severely negative impact on the funded status of multiemployer plans. Annual data from the Internal Revenue Service (IRS) show that the proportion of multiemployer plans less than 80 percent funded rose from 23 percent of plans in 2008 to 68 percent of plans in 2009. While some plans may be able to improve their funded status as the economy improves, many plans will continue to face demographic challenges that threaten their long-term financial outlook including an aging workforce and few opportunities to attract new employers and workers into plans. PBGC monitors the health of multiemployer plans, but can provide little assistance to troubled plans until they become insolvent, at which point PBGC provides loans to allow insolvent plans to continue paying participant benefits at the guaranteed level (currently $12,870 per year for 30 years of employment). PBGC receives more current information on plan status, but uses older plan data to determine which plans are at the greatest risk of insolvency, because these data are audited, comprehensive, and PBGC s monitoring system was designed for them. The private pension systems in the countries GAO studied face short-term and long-term challenges similar to those that U.S. multiemployer plans currently face, including plan funding deficiencies and an aging workforce. The plans in these countries are subject to a range of funding, reporting, and regulatory requirements that require plans to interact frequently with pension regulators. Multiemployer plans in these countries have a number of tools available to improve and maintain their funded status, such as increasing contributions and reducing the rate of benefit accruals. The statutory and regulatory framework for multiemployer plans is not structured to assist plans on an ongoing basis and promotes little interaction among the federal agencies responsible for monitoring and assisting plans and safeguarding participant benefits. The lack of timely and accurate information and interagency collaboration hampers efforts to monitor and assist plans, and to enforce plan requirements. The recent economic downturn revealed that these plans, like most pension plans, are vulnerable to rapid changes in their funded status. Plans in the worst condition may find that the options of increasing employer contributions or reducing benefits are insufficient to address their underfunding and demographic challenges. For these plans, the effects of the economic downturn, declines in collective bargaining, the withdrawal of contributing employers, and an aging workforce will likely increase their risk of insolvency. Without additional options to address plan underfunding or to attract new employers to contribute to plans, plans may be more likely to require financial assistance from PBGC. Additional claims would further strain PBGC s insurance program that, already in deficit, it can ill afford. United States Government Accountability Office
Pg 154 of 250 Contents Letter 1 Background 3 Multiemployer Plans Reported Large Funding Shortfalls and Face an Uncertain Future 11 PBGC Monitors the Health of Multiemployer Plans, but Does Not Assist Troubled Plans on an Ongoing Basis 19 Pension Structures in Other Countries Provide Multiemployer Plans with Options to Improve Funding 27 Changes to U.S. Multiemployer Plan Framework Could Help to Protect Pension Benefits 34 Conclusions 43 Matters for Congressional Consideration 44 Recommendations for Executive Action 44 Agency Comments and Our Evaluation 45 Appendix I Objectives, Scope, and Methodology 47 Appendix II Comments from the Department of Labor 50 Appendix III Comments from the Department of the Treasury 53 Appendix IV Comments from the Pension Benefit Guaranty Corporation 56 Appendix V GAO Contact and Staff Acknowledgments 59 Tables Table 1: PPA Funding Zone Status and Reporting Requirements 5 Table 2: Selected Differences between Single-employer Plans and Multiemployer Plans 7 Table 3: Funding Zone Status of Multiemployer Plans, as Certified with IRS, Tax Years 2008 and 2009 14 Table 4: Classification of Plans on PBGC s Contingency List 19 Page i GAO-11-79 Multiemployer Pensions
Pg 155 of 250 Table 5: Multiemployer Plan Information Filed with PBGC 24 Table 6: Comparison of Select Economic and Demographic Characteristics in the Studied Countries and the United States (2008) 28 Table 7: Comparison of Multiemployer Plan Structures in the Studied Countries and the United States 29 Table 8: Reporting Requirements for Multiemployer Plans in the Studied Countries 31 Table 9: Monitoring of Multiemployer Plans in the Studied Countries 32 Table 10: Recovery Periods and Tools Available to Improve Plan Funded Status in the Studied Countries 33 Table 11: Comparison of Multiemployer Plan Status Information Received by Federal Agencies, 2008 and 2009 35 Table 12: Experts Suggestions to Improve PBGC s Assistance to Plans 38 Table 13: Experts Suggestions to Improve the Multiemployer Framework 41 Figures Figure 1: PBGC-Insured Multiemployer Plans and Participants, 1980 through 2009 9 Figure 2: PBGC-Insured Multiemployer Plan Participants, by Industry, 2000 through 2008 10 Figure 3: Aggregate Funded Status and Funding Level of PBGC- Insured Multiemployer Plans, 1980 through 2007 11 Figure 4: Funded Status of PBGC-Insured Multiemployer Plans, by Industry, 2000 through 2007 13 Figure 5: PBGC-Insured Multiemployer Plan Participation, by Participant Status, 1980 through 2007 16 Figure 6: Private Sector Union Affiliation, by Industry, 2000 through 2009 17 Figure 7: PBGC Multiemployer Insurance Program Assets, Liabilities, and Net Position, Fiscal Years 1980 through 2009 18 Figure 8: PBGC-Insured Multiemployer Plans on PBGC s Contingency List, Fiscal Years 2000 through 2009 21 Figure 9: Multiemployer Plans Receiving PBGC s Financial Assistance and Amounts Received, 1981 through 2009 22 Page ii GAO-11-79 Multiemployer Pensions
Pg 156 of 250 Abbreviations AFN Annual Funding Notice BLS Bureau of Labor Statistics DB defined benefit EBSA Employee Benefits Security Administration EPCU Employee Plans Compliance Unit ERISA Employee Retirement Income Security Act of 1974 IRS Internal Revenue Service ME-PIMS Multiemployer Pension Insurance Modeling System MPPAA Multiemployer Pension Plan Amendments Act of 1980 NLRA National Labor Relations Act of 1935 OECD Organisation of Economic Co-operation and Development PBGC Pension Benefit Guaranty Corporation PIMS Pension Insurance Modeling System PPA Pension Protection Act of 2006 WRERA Worker, Retiree, and Employer Recovery Act of 2008 This is a work of the U.S. government and is not subject to copyright protection in the United States. The published product may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately. Page iii GAO-11-79 Multiemployer Pensions
Pg 157 of 250 United States Government Accountability Office Washington, DC 20548 October 18, 2010 The Honorable George Miller Chairman Committee on Education and Labor House of Representatives Dear Mr. Chairman: Thirty years ago Congress enacted new protections for multiemployer pension plans to better ensure that they could fulfill their promise to pay benefits to plan participants in retirement. Today, these plans continue to constitute an important part of the nation s private employer pension system. For the purposes of this report, multiemployer plans are defined benefit (DB) plans established through collectively bargained pension agreements between labor unions and two or more employers. 1 In 2009, there were about 1,500 multiemployer plans covering more than 10.4 million workers and retirees approximately 1 of every 4 workers and retirees in the United States covered by a private-sector DB plan. Multiemployer plans are distinct from single-employer plans, which are established and maintained by one employer, and multiple-employer plans, many of which maintain separate funding accounts for each employer. Multiemployer plans cover unionized workers in many industries, including trucking, retail food, construction, mining, and garment, and provide some portability of benefits. Workers in multiemployer plans can continue accruing pension benefits when they change jobs if their new employer is a contributing employer in the same plan. Such arrangements are particularly suited to workers in these industries, who change jobs frequently over the course of a career. The Employee Retirement Income Security Act of 1974 (ERISA) created the Pension Benefit Guaranty Corporation (PBGC) as a U. S. government corporation to provide plan termination insurance for certain single- and multiemployer pension plans that become unable to provide pension benefits. For multiemployer plans, PBGC guarantees, within prescribed 1 Collective bargaining has been the primary means by which workers can negotiate, through unions, the terms of their pension plan. The National Labor Relations Act (NLRA) required employers to bargain with union representatives over wages and other conditions of employment, and subsequent court decisions established that employee benefit plans can be among those conditions. Page 1 GAO-11-79 Multiemployer Pensions
Pg 158 of 250 limits, participant benefits when a covered plan becomes insolvent and cannot pay such benefits when due for a plan year. PBGC provides loans to insolvent multiemployer plans to allow them to continue paying benefits at the PBGC guarantee level, which in 2010, was $12,870 per year, based on 30 years of employment. In 2004, we reported that the multiemployer system, in contrast with private single-employer plans, operates in a framework that redistributes risk toward employers and participants and away from the government and potentially the taxpayer. 2 This framework, we noted, can create important incentives for interested parties to resolve financial difficulties, such as plan underfunding. However, we also found that weak economic conditions in the early 2000s and declines in interest rates and equity markets had increased the financial stress on the overall multiemployer plan framework and each of its key stakeholders. We identified several challenges to the long-term health of these plans, including a lack of employer funding flexibility compared with single-employer plans and the national decline of collective bargaining. Earlier this year we testified that deterioration in economic conditions had increased stress on multiemployer plans, which continue to face funding shortages and other challenges. 3 Given these ongoing concerns about multiemployer plans, this report addresses the following questions: (1) What is the current status of the nation s multiemployer pension plans? (2) What steps does PBGC take to monitor the health of these plans? (3) What is the structure of multiemployer plans in other countries? (4) What statutory and regulatory changes, if any, could help plans to continue to provide participants with the benefits due to them? 2 GAO, Private Pensions: Multiemployer Plans Face Short- and Long-Term Challenges, GAO-04-423 (Washington, D.C.: Mar. 26, 2004), and GAO, Private Pensions: Multiemployer Pensions Face Key Challenges to Their Long-Term Prospects, GAO-04-542T, (Washington, D.C.: Mar. 18, 2004). 3 GAO, Private Pensions: Long-standing Challenges Remain for Multiemployer Pension Plans GAO-10-708T, (Washington, D.C.: May 27, 2010). Page 2 GAO-11-79 Multiemployer Pensions
Pg 159 of 250 To identify the current status of the nation s multiemployer pension plans, we analyzed data from PBGC, the Department of Labor s Employee Benefits Security Administration (EBSA), and the Department of the Treasury s Internal Revenue Service (IRS) and reviewed relevant industry studies. To determine the steps PBGC takes to monitor the health of these plans, we interviewed PBGC officials and reviewed PBGC s multiemployer policies and procedures. We also reviewed relevant federal laws and regulations. To understand the structure of multiemployer plans in other countries, we conducted site visits to four countries the Netherlands, Denmark, United Kingdom, and Canada and we worked with U.S. State Department officials to identify and interview government officials and various pension experts in these countries. We did not conduct an independent legal analysis of foreign laws. To identify what changes, if any, are needed to help plans continue to provide participants with the benefits due them, we interviewed a diverse range of multiemployer plan experts and practitioners in the United States and abroad. We assessed the reliability of the data used in this report and determined that they were reliable for our purposes. We conducted this performance audit from September 2009 through October 2010, in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Appendix I provides more detail on the scope and methodology used in developing this report. Background The Taft Hartley Act of 1947 established terms for negotiating employee benefits in collectively bargained multiemployer plans and placed certain restrictions on the operation of these plans, including the placement of plan assets in a trust. 4 For example, the law required a collectively bargained plan and its assets to be managed by a joint board of trustees equally representative of management and labor. It further required plan assets to be placed in a trust fund, legally distinct from the union and the employers, for the sole and exclusive benefit of the plan beneficiaries. In 1974, Congress passed ERISA to protect the interests of participants and 4 Pub. L. No. 80-101. Page 3 GAO-11-79 Multiemployer Pensions
Pg 160 of 250 beneficiaries covered by private sector employee benefit plans. 5 Title IV of ERISA created PBGC as a U. S. government corporation to provide plan termination insurance for certain defined benefit pension plans that are unable to pay promised benefits. PBGC operates two distinct pension insurance programs, one for multiemployer plans and one for singleemployer plans. These programs have separate insurance funds as well as different insurance coverage rules and benefit guarantees. The multiemployer insurance program and PBGC s day-to-day operations are financed by annual premiums paid by the plans and by investment returns on PBGC s assets. 6 In turn, PBGC guarantees benefits, within prescribed limits, when a multiemployer plan is insolvent and unable to pay the basic PBGC-guaranteed benefits when due for the plan year. In 1980, Congress sought to protect worker pensions in multiemployer plans by enacting the Multiemployer Pension Plan Amendments Act (MPPAA). 7 Among other things, MPPAA (1) strengthened funding requirements to help ensure plans accumulate enough assets to pay for promised benefits, and (2) made employers, unless relieved by special provisions, liable for their share of unfunded plan benefits when they withdraw from a multiemployer plan. The amount owed by a withdrawing employer is based upon a proportional share of a plan s unfunded vested benefits. 8 Liabilities that cannot be collected from a withdrawing employer, for example, one in bankruptcy, are to be rolled over and eventually funded by the plan s remaining employers. 9 These changes were made to discourage employer withdrawals from a plan. 5 29 U.S.C. 1001 nt. 6 The single-employer insurance program receives additional financing from assets acquired from terminated single-employer plans and by recoveries from employers responsible for underfunded terminated single-employer plans. PBGC receives no funds from federal tax revenues, but it is authorized under ERISA to borrow up to $100 million from the federal treasury if it has inadequate resources to meet its responsibilities. 7 Pub. L. No. 96-364. 8 Vested benefits are benefits that are no longer subject to risk of forfeiture. Unfunded vested benefits are the difference between the present value of a plan s vested benefits and the value of plan assets as determined in accordance with Title IV of ERISA. 9 These liabilities are frequently referred to as orphaned liabilities. Page 4 GAO-11-79 Multiemployer Pensions
Pg 161 of 250 The Pension Protection Act of 2006 (PPA) established new funding and disclosure requirements for multiemployer plans. 10 (See table 1.) Table 1: PPA Funding Zone Status and Reporting Requirements Funding zone status Funded percentage Annual Funding Notice (AFN) Plan reporting requirements Annual actuarial certification of funded status Notice of endangered or critical status Funding improvement plan or rehabilitation plan Safe 80 Endangered 65-80 Funding improvement plan Critical <65 Rehabilitation plan Filing requirements Recipients Within 120 days after the close of the plan year PBGC, participants, beneficiaries, participating unions and contributing employers Within 90 days after the start of the plan year Secretary of the Treasury and trustees Source: GAO analysis of the Pension Protection Act of 2006. Within 30 days after actuarial certification PBGC, Department of Labor, participants, beneficiaries, participating unions and contributing employers Adopted within 240 days after the deadline for actuarial certification Participating unions and contributing employers must receive schedules within 30 days of adoption PPA requires trustees of plans certified in endangered or critical status to take specific actions to improve the plans financial status, such as developing schedules to increase contributions or reduce benefits. 11 Plans certified as endangered must adopt a funding improvement plan, which 10 Pub. L. No. 109-280. 11 Under PPA, a plan is considered to be in endangered status if it is less than 80 percent funded or if the plan is projected to have a funding deficiency within 7 years. A plan that is less than 80 percent funded and is projected to have a funding deficiency within 7 years is considered to be seriously endangered. A multiemployer plan is considered to be in critical status if (1) it is less than 65 percent funded and has a projected funding deficiency within 5 years or will be unable to pay benefits within 7 years; (2) it has a projected funding deficiency within 4 years or will be unable to pay benefits within 5 years (regardless of its funded percentage); or (3) its liabilities for inactive participants are greater than its liabilities for active participants, its contributions are less than carrying costs, and a funding deficiency is projected within 5 years. Page 5 GAO-11-79 Multiemployer Pensions
Pg 162 of 250 outlines steps the plan will take to increase the plan s funded status over a 10-year period or, in some cases, longer. Plans certified as critical must adopt a rehabilitation plan, which outlines actions, to enable the plan to cease to be in critical status by the end of a 10-year rehabilitation period and may include reductions in plan expenditures (including plan mergers and consolidations), reductions in future benefit accruals or increases in contributions, if agreed to by the bargaining parties, or any combination of such actions. 12 To assist plans in critical status, PPA amended ERISA to allow these plans to reduce or eliminate adjustable benefits, such as early retirement benefits, post-retirement death benefits, and disability benefits. In addition, critical status plans are generally exempt from the excise taxes that IRS can assess on plans with funding deficiencies. 13 The funding requirements of PPA took effect just as the nation entered a severe economic recession in December 2007. As a result, Congress enacted the Worker, Retiree, and Employer Recovery Act of 2008 (WRERA) to provide multiemployer plans with temporary relief from some PPA requirements by allowing multiemployer plans to temporarily freeze their funded status at the previous year s level. 14 The freeze allows plans to delay creation of, or updates to, an existing funding improvement plan or rehabilitation plan, or postpone other steps required under PPA. 15 WRERA also requires plans to send a notice to all participants and beneficiaries, bargaining parties, PBGC, and the Department of Labor indicating that the election to freeze the status of a plan does not mean that the funded status of the plan has improved. WRERA also provided for a 3-year extension of a plan s funding improvement or rehabilitation period. 12 26 U.S.C. 432(e). 13 PPA specified that plans in critical status may include in their rehabilitation plans reductions in plan expenditures (including plan mergers and consolidations), reductions in future benefit accruals, or increases in contributions. 14 Pub. L. No. 110-458. 15 Section 204(b) of WRERA provides a special rule for multiemployer plans that would be in critical status for the election year if they had not elected to freeze the plan s funded status. In particular, if the plan has been certified by the plan actuary to be in critical status for the election year, then the plan is treated as being in critical status for that year for purposes of applying the excise tax exception under section 4971(g)(1)(A) of the Internal Revenue Code. Page 6 GAO-11-79 Multiemployer Pensions
Pg 163 of 250 Although both single-employer and multiemployer plans are subject to the rules outlined in Title IV of ERISA, there are several important differences between the plan types that affect the structure and stability of each type of plan. (See table 2.) Table 2: Selected Differences between Single-employer Plans and Multiemployer Plans Plan characteristic Single-employer plans Multiemployer plans PBGC benefit guarantee levels PBGC s guarantees benefits up to $54,000 per year for a retiree at age 65. Benefit amounts are indexed for inflation. PBGC premium structure In 2010, plans pay PBGC a flat rate premium of $35 per participant that is indexed for inflation. Plans are also subject to a variable rate premium based on underfunding and termination premiums. Insurable events The insurable event is generally termination of an underfunded plan, after which PBGC assumes responsibility and pays benefits directly to participants. Provision of financial assistance PBGC provides no financial assistance to plans but instead takes over terminated underfunded plans as trustee. Fiduciary and settlor function Risk distribution Portability of benefits Ability to adjust contribution and benefit levels Employer sponsor generally assumes fiduciary role in addition to its settlor role. Plans generally do not share the risk with other employers. Plans are established and maintained by only one employer and their benefits are not normally portable. Employer sponsors, depending on their employees bargaining rights, may make adjustments to future contributions and benefits according to the company s fiscal condition provided that minimum funding requirements are met. PBGC guarantees benefits of $12,870 per year, based on 30 years of employment. Benefit amounts are not indexed for inflation. In 2010, plans pay PBGC an annual flat rate premium of $9 per participant. The premium is indexed for inflation. The insurable event is plan insolvency. PBGC provides loans to plans when they become insolvent, and a multiemployer plan need not be terminated to qualify for financial assistance. Insolvent multiemployer plans also are required to reduce or suspend payment of any portion of benefits to beneficiaries that exceeds PBGC s guarantee level. If a plan recovers from insolvency, it must begin repaying the PBGC loan. Individual employers do not assume a fiduciary role in plan management, which is instead handled by a board of trustees. Plans typically continue to operate after an individual employer, or sponsor, goes out of business because the plan s remaining employers are jointly liable for funding benefits for all vested participants. Plans provide participants some benefit portability because they allow workers to continue to accrue pension benefits when they change jobs as long as their new employer also participates in the same plan. Individual employers cannot adjust their plan contributions at will and may be restricted in making changes until the collective bargaining agreement comes up for renegotiation, typically once every 2 or 3 years. Page 7 GAO-11-79 Multiemployer Pensions
Pg 164 of 250 Plan characteristic Single-employer plans Multiemployer plans Plan terminations PBGC assumes trusteeship and If an employer withdraws from a plan, the accrued administers payment of participant benefits benefits for its workers stay in and are when an underfunded plan terminates. administered by the plan. The plan terminates by mass withdrawal of all contributing employers. When a plan becomes insolvent, PBGC does not take over trusteeship but instead provides financial assistance to its trustees, who continue to administer the plan until all guaranteed benefits are paid out. Employer withdrawal There is no withdrawal liability for plan sponsors. However, plan sponsors are liable for benefits of its employees and to PBGC for any underfunding. Source: GAO analysis of ERISA, PBGC documents, and prior GAO reports. An employer seeking to withdraw from a plan is liable for its allocable share of the plan s unfunded vested benefits for all employees covered by the plan. In cases of bankruptcy, the remaining employers in the plan assume responsibility for funding benefits to the bankrupt employer s participants. a a PBGC officials said that this greater financial risk for employers and lower guaranteed benefit level for participants in multiemployer plans, in practice, creates incentives for employers, workers, and their collective bargaining representatives to avoid insolvency and find solutions to a plan s financial difficulties. The overall number of multiemployer plans insured by PBGC has decreased steadily since the 1980s as a result of plan mergers and terminations. At the same time, the aggregate number of participants including active and inactive has continued to rise. (See fig. 1.) Page 8 GAO-11-79 Multiemployer Pensions
Pg 165 of 250 Figure 1: PBGC-Insured Multiemployer Plans and Participants, 1980 through 2009 Participants (in millions) 12 Plans 2,500 10 2,000 8 1,500 6 4 1,000 2 500 0 0 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Year Participants Plans Source: PBGC annual Pension Insurance Data Books. The number of participants in multiemployer plans also varies by industry. While PBGC covers workers in all major industrial sectors, the construction trades consistently account for over one-third of all covered multiemployer plan participants, totaling 36 percent in 2008. Other industries, including transportation and manufacturing, account for a smaller portion of participants, roughly 15 percent in 2007. (See fig. 2.) Page 9 GAO-11-79 Multiemployer Pensions
Pg 166 of 250 Figure 2: PBGC-Insured Multiemployer Plan Participants, by Industry, 2000 through 2008 Participants (in millions) 4 3 2 1 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 Year Construction Manufacturing Transportation Retail trade Services Other industries Source: GAO analysis of PBGC annual Pension Insurance Data Books. Note: PBGC draws these data from annual premium filings in which plans self-report their industry classification based on the predominant business activity of all employers in the plan. The industry classification categories are based on principal business activity codes used in the North American Industry Classification System. Additionally, the Other Industries category is made up of industries that individually account for less than 3 percent of all PBGC-insured multiemployer plan participants, including Agriculture, Mining, Information, Wholesale Trade, Finance, Insurance, and Real Estate. The 2001 participant data presented here are from PBGC s Pension Insurance Data Book 2002. PBGC published different 2001 participant data in its Pension Insurance Data Book 2001. Page 10 GAO-11-79 Multiemployer Pensions
Pg 167 of 250 Multiemployer Plans Reported Large Funding Shortfalls and Face an Uncertain Future Multiemployer Plans Have Experienced General Funding Declines Since 2000 Multiple data sources that we examined indicate that most multiemployer plans experienced steep declines in their funded status in recent years. According to PBGC, multiemployer plans in aggregate have not been fully funded at 100 percent or above level since 2000 and their net funded status has declined significantly through 2007, the last date for which PBGC data are available. While plans are considered safe if their funded status is at least 80 percent, the aggregate funded status the percentage of benefits covered by plan assets of multiemployer plans insured by PBGC declined from 105 percent in 2000 to 69 percent in 2007. (See fig. 3.) Figure 3: Aggregate Funded Status and Funding Level of PBGC-Insured Multiemployer Plans, 1980 through 2007 Percentage 120 Dollars (in billions) 50 100 0 80-50 60-100 40-150 20-200 0-250 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Year Funded status Funding level Source: GAO analysis of PBGC annual Pension Insurance Data Books. Page 11 GAO-11-79 Multiemployer Pensions
Pg 168 of 250 The funded status of multiemployer plans insured by PBGC varies significantly by industry sector within which the plan operates. According to PBGC data, while all industries generally follow the same trend in funded status, plans in the transportation industry have since 2000 reported a consistently lower funded status than other industries. For example, in 2007, the aggregate funded status for plans in the transportation industry was 63 percent in contrast to the overall average of 69 percent. Furthermore, in 2000, the last year that the aggregate funded status of all multiemployer plans was over 100 percent, the funded status of multiemployer plans in the retail trade and services industries was about 30 percent higher than the funded status of plans in the transportation industry. (See fig. 4.) The extent of underfunding in multiemployer plans also varies by industry with the construction and transportation industries accounting for 71 percent of the underfunding of all PBGC-insured multiemployer plans in 2007. Page 12 GAO-11-79 Multiemployer Pensions
Pg 169 of 250 Figure 4: Funded Status of PBGC-Insured Multiemployer Plans, by Industry, 2000 through 2007 Funded percentage 120 110 100 90 80 70 60 50 10 0 2000 2001 2002 2003 2004 2005 2006 2007 Year Construction Manufacturing Transportation Retail Trade Services Other Industries Total Source: GAO analysis of PBGC annual Pension Insurance Data Books. Note: PBGC draws these data from annual Form 5500 filings in which plans self-report their industry classification based on the predominant business activity of all employers in the plan. The industry classification categories are based on principal business activity codes used in the North American Industry Classification System. Additionally, the Other Industries category is made up of industries that individually account for less than 3 percent of all PBGC-insured multiemployer plan participants, including Agriculture, Mining, Information, and Wholesale Trade. Since 2007, the last year for which data are available, aggregate plan funded status has declined further as a result of investment market declines. While the rapid drop in funded status, like the economic conditions that caused it, was severe, experts said that its effect on plans was similar to what happened to plans during the market correction of 2000 to 2002. For example, experts said that some plans, learning from the downturn from 2000 to 2002, took remedial steps in the following years, Page 13 GAO-11-79 Multiemployer Pensions
Pg 170 of 250 such as increasing contributions, and likely fared better in the recent recession. In contrast, other plans did not change course after the 2000 to 2002 downturn in the hope that market returns would erase their deficits and are now the plans in the most critical financial condition. Many Multiemployer Plans Reported Large Funding Shortfalls during the Recent Economic Downturn Although funded status was in a general decline since 2000, the economic recession that began in December 2007 had a negative impact on the funded status of multiemployer plans, according to a number of data sources. Annual actuarial certification data from IRS show that the proportion of multiemployer plans reporting in endangered or critical zone status rose significantly, from 23 percent of plans in 2008 to 68 percent of plans in 2009. (See table 3.) Table 3: Funding Zone Status of Multiemployer Plans, as Certified with IRS, Tax Years 2008 and 2009 2008 2009 Funding zone status Plans % Plans % Critical status 138 10 461 35 Endangered status 175 13 444 33 Subtotal 313 23 905 68 Safe status 1,034 77 426 32 Total 1,347 100 1,331 100 Source: GAO analysis of Internal Revenue Service annual actuarial certification data. Note: The endangered status category includes plans certifying as endangered or seriously endangered. Data from PBGC, although incomplete, show a similar downward trend in plan funded status. According to the annual funding notices that PBGC received in the 2009 plan year, nearly all of the 484 plans that filed reported a decrease in funded status from 2008 to 2009. Similarly, PBGC received more notices of critical or endangered status from plans, from 266 plans in 2008 to 624 plans in 2009. Recent industry surveys of multiemployer plans found similar declines in funded status. For example, two industry groups surveying their multiemployer plan membership in 2009 found the same result: 80 percent of plans reported being in critical or endangered zone status, a reversal Page 14 GAO-11-79 Multiemployer Pensions
Pg 171 of 250 from 2008 when 80 percent of plans reported being in safe status. 16 Similarly, another industry survey of nearly 400 plans found that the proportion of plans in the endangered or critical zone status increased from 24 percent in 2008 to 80 percent in 2009. 17 While these surveys are not comprehensive, they provide further evidence of the negative impact that the economic downturn had on multiemployer plans. Although it did not affect their underlying funded status, many plans took advantage of the one-time freeze allowed under WRERA. According to IRS data, 745 plans elected to freeze their funded status in either 2008 or 2009, including 373 plans in critical status, 351 in endangered status, and 21 plans in safe status. According to experts, some plans took advantage of the freeze option for a variety of reasons. Plans wanted to give the markets a chance to rebound in order to recoup plan assets lost in the downturn. Others may have chosen the freeze due to timing of collective bargaining agreements, not wanting to take steps to address funding deficiencies until a new agreement was reached. Still other plans elected the freeze to avoid having to revisit or revise ongoing rehabilitation plans. However, experts also noted that the WRERA freeze option was not helpful for all plans. Specifically, some plans chose not to freeze in endangered status, preferring to go straight to critical status to give them more options to address their funding deficiencies. Plans Face Long-standing Demographic Challenges and an Uncertain Future Multiemployer plans continue to face demographic challenges that threaten their long-term financial outlook including an aging workforce and few opportunities to attract new employers and workers into plans. While the number of total participants in multiemployer plans has slowly increased, the proportion of active participants to retirees and separated vested participants has decreased. 18 (See fig. 5.) For example, multiemployer plans had about 1.6 million fewer active participants in 2007 than in 1980, according to PBGC. With fewer active participants, 16 See the Segal Company, Winter 2010 Survey of Plans 2009 Zone Status and, the International Foundation of Employee Benefit Plans, Multiemployer Pension Funding Status and Freeze Decisions. 17 See National Coordinating Committee for Multiemployer Plans, Multiemployer Pension Plans, Main Street s Invisible Victims of the Great Recession of 2008 (Washington, D.C.: April 2010). 18 A separated vested participant is one who has earned a nonforfeitable pension benefit but is no longer accruing benefits under the plan and has not yet started receiving benefits. Page 15 GAO-11-79 Multiemployer Pensions
Pg 172 of 250 plans have more difficulty making up funding deficiencies by increasing employers funding contributions. Moreover, increases in life expectancy also put pressure on plans, increasing the amount of benefits that the plan will have to pay as retirees live longer. Figure 5: PBGC-Insured Multiemployer Plan Participation, by Participant Status, 1980 through 2007 Percentage of participants 100 90 80 70 60 50 40 30 20 10 0 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Year Separated vested Retired Active Source: PBGC annual Pension Insurance Data Books. The future growth of multiemployer plans is largely predicated on growth of collective bargaining. Yet collective bargaining has declined in the United States since the early 1950s. According to recent data from the Bureau of Labor Statistics (BLS), union membership a proxy for collective bargaining coverage accounted for 7.2 percent of the U.S. private-sector labor force in 2009. In contrast, in 1990, union membership in the private sector accounted for about 12 percent, and in 1980, about 20 percent. While union membership has trended downward in most industries, it has remained relatively high in the transportation sector. (See fig. 6.) Page 16 GAO-11-79 Multiemployer Pensions
Pg 173 of 250 Figure 6: Private Sector Union Affiliation, by Industry, 2000 through 2009 Percentage of workforce 30 25 20 15 10 5 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Year Construction Manufacturing Transportation Retail trade Other industries Private sector total Source: GAO analysis of BLS data. Note: The Other industries category includes the following industries: Agriculture, Mining, Information, and Wholesale Trade. Some experts told us that some industries within which multiemployer plans operate were already in decline such as the printing and trucking industries and that their situation was likely exacerbated by the economic downturn. They also noted that other plans, while facing shortterm funding deficiencies, belonged to industries that remained strong such as the construction and entertainment industries and were likely to improve their funded status as the economy improved. 19 19 Although the construction industry has the highest liabilities, plans in this industry, one expert said, were more likely to attract active participants and improve their funded status in periods of economic growth. Page 17 GAO-11-79 Multiemployer Pensions
Pg 174 of 250 PBGC s ability to assist multiemployer plans is contingent upon its insurance program having sufficient funds to do so. The net position of PBGC s multiemployer pension insurance program has steadily declined since its highest point in 1998 as program liabilities outpaced asset growth. (See fig. 7.) The program s net position went negative in 2003 and by 2009 the multiemployer program reported an accumulated deficit of $869 million. Figure 7: PBGC Multiemployer Insurance Program Assets, Liabilities, and Net Position, Fiscal Years 1980 through 2009 Dollars (in millions) 2,500 2,000 1,500 1,000 500 0-500 -1,000-1,500 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Year Liabilities Assets Net position Source: PBGC annual Pension Insurance Data Books. The demographic challenges that multiemployer plans face also affect PBGC s ability to assist them. Plans pay PBGC an annual flat rate premium per participant. Similarly, contributions by employers in a multiemployer plan are generally paid on a per work-hour basis. Consequently, declines in the number of plan participants during periods of high unemployment and long-standing reductions in collective bargaining can result in less premium income to PBGC and an increased probability of PBGC-insured multiemployer plans requiring financial assistance. Page 18 GAO-11-79 Multiemployer Pensions
Pg 175 of 250 PBGC Monitors the Health of Multiemployer Plans, but Does Not Assist Troubled Plans on an Ongoing Basis Monitoring Plan Insolvency Risk PBGC monitors the financial condition of its insured multiemployer plans to identify plans that are more likely to become insolvent and require financial assistance from the multiemployer insurance program. To identify the universe of multiemployer plans, PBGC maintains a database that matches a plan s annual premium filings with its financial information reported on its annual Form 5500 filings. 20 PBGC then uses multiemployer plans annual Form 5500 filings, critical and endangered status notices, and other information to generate a contingency list of plans that have an increased risk of insolvency and making a claim to the PBGC s multiemployer insurance program or terminating altogether. PBGC classifies plans into several categories on this contingency list, depending on the plan s likelihood of a PBGC claim. (See table 4.) Table 4: Classification of Plans on PBGC s Contingency List Classification Current probable Terminated future probable Ongoing future probable Reasonably possible Remote watch list Definition A plan that is known to be insolvent and has received or will begin receiving financial assistance from PBGC. A plan that may still have assets but the combination of plan assets and collectible payments of withdrawal liability are projected to be insufficient to cover plan benefits plus expenses. An ongoing plan with a projected date of insolvency within 10 years. An ongoing plan with a projected insolvency date between 10 and 20 years away. Any plan that is not classified as probable or reasonably possible, but has a smaller probability of future liability to PBGC. Source: PBGC. 20 Each year, qualified DB pension plans are required to file a Form 5500 disclosure of financial information with IRS, EBSA, and PBGC. Beginning with the 2009 reporting year, Form 5500 filing and processing became wholly electronic. Filers are able to complete Form 5500 online or with third-party software using a new Web-based interface called ERISA Filing Acceptance System 2 (EFAST2) that EBSA officials say has greater data capture accuracy than its paper-based predecessor. Page 19 GAO-11-79 Multiemployer Pensions
Pg 176 of 250 To determine which multiemployer plans belong in each of these categories, PBGC uses an automated screening process that measures the financial health of plans. The variables that PBGC reviews are: ratio of active participants (those for whom employers are continuing to make contributions) to other participants (those for whom plans are making benefit payments); ratio of assets to the present value of vested benefits accrued by participants; ratio of plan assets to annual benefit payments to retirees; ratio of annual contributions to carrying costs (i.e., normal cost and interest on unfunded liability); ratio of annual contributions from employers to the benefit distributions to retirees; and ratio of plan assets to the present value of retired participants accrued benefits. PBGC also monitors plans to assess their risk of insolvency and the effect of insolvency on PBGC s multiemployer program. PBGC determines expected claims on the multiemployer insurance program based on two factors, the amount of underfunding in the plans and the likelihood that the plans will become insolvent or face a mass withdrawal of contributing employers from a plan. PBGC also analyzes ongoing multiemployer plans (i.e., plans that continue to have employers making regular contributions for covered work) to determine whether they pose probable or possible claims on the insurance program. In conducting this periodic analysis, PBGC examines plans that are chronically underfunded, have poor cash flow, have a falling contribution base, or lack an asset cushion to temporarily weather income losses. A combination of any one of these factors may prompt PBGC to conduct a more detailed analysis of the plan s funding and the likelihood that the contributing employers will be able to maintain the plan. Since 2002, the number of plans classified as probable or placed on the watch list has steadily increased while the number of plans classified as reasonably possible has remained about the same. (See fig. 8.) Page 20 GAO-11-79 Multiemployer Pensions
Pg 177 of 250 Figure 8: PBGC-Insured Multiemployer Plans on PBGC s Contingency List, Fiscal Years 2000 through 2009 Number of Plans 160 140 120 100 80 60 40 20 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Year Watch list Reasonably possible Probable Source: GAO analysis of PBGC data. Providing Financial Assistance to Plans PBGC provides insolvent multiemployer plans with financial assistance in the form of loans to provide beneficiaries with the PBGC-guaranteed benefit and for reasonable administrative expenses. PBGC considers a plan insolvent if it does not have enough assets to pay the PBGC guaranteed benefits for a full plan year. 21 An insolvent plan can obtain the loan by filing a claim with PBGC s multiemployer insurance program. PBGC can set the conditions under which it provides plans with this financial assistance. For example, PBGC can require that: a loan be repaid if the recipient plan s financial condition improves, a loan be collateralized by employer contributions, withdrawal liability payments, and other plan assets, and 21 An insolvent plan continues operations and PBGC provides necessary financial assistance for payment of benefits at guaranteed level and for reasonable administrative expenses. Page 21 GAO-11-79 Multiemployer Pensions
Pg 178 of 250 PBGC be given broad audit authority over the plan. In addition, PBGC must require payment of benefits at the guaranteed benefit level. PBGC provides financial assistance to plans that can no longer make benefit payments. Once begun, these loans generally continue year after year until the plan no longer needs assistance or has paid all promised benefits at the guaranteed level. Although called loans in statute, these funds are provided to plans that have a declining asset base, making them unlikely to be repaid. To date, only 1 of the 62 plans that received PBGC financial assistance between 1981 and 2009 has ever repaid its loan. While the number of plans receiving financial assistance has risen steadily since 1981, the amount paid has peaked twice in the past decade. In fiscal year 2009, PBGC paid $85.6 million in financial assistance to 43 insolvent plans. (See fig. 9.) Figure 9: Multiemployer Plans Receiving PBGC s Financial Assistance and Amounts Received, 1981 through 2009 Dollars (in millions) 100 90 80 70 60 50 40 30 20 10 0 Plans 50 45 40 35 30 25 20 15 10 5 0 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Year Total amount of financial assistance Plans Source: PBGC annual Pension Insurance Data Books. Page 22 GAO-11-79 Multiemployer Pensions
Pg 179 of 250 Projecting Future Claims to PBGC Since 1998, PBGC has assessed the long-term risk to the single-employer insurance program using its Pension Insurance Modeling System (PIMS), a stochastic simulation model designed to quantify the amount of risk facing the programs. According to PBGC, the model helps PBGC assess its financial vulnerability from future events that may be significantly different from past events. Over time PBGC realized that a separate multiemployer plan model was needed to account for the unique factors that make up multiemployer plans, such as the role and number of unions and the role of negotiations in developing collective bargaining agreements. Following the enactment of PPA in 2006, PBGC developed a specific multiemployer PIMS model (ME-PIMS) that used data from a stratified sample of 132 plans that included the top 20 in terms of total underfunding. For these selected plans, PBGC uses data from the Form 5500 Schedule MB (and formerly Schedule B) and other sources to look at benefit levels, how benefits were accrued, and how fast they accrued. PBGC then estimated compensation levels and funding targets. According to PBGC officials, the model is weighted toward the bigger plans because that is where most of PBGC s risks lie. The model can project up to 20 years in the future, but the typical simulation is no longer than 10 years. As the projection period is extended, the simulation becomes less reliable. ME-PIMS takes into account the different funding rules, nature of exposure, and possible future outcomes of multiemployer plans. The model anticipates that individual plans have various probabilities of positive and negative experiences, and that these probabilities can change significantly over time. Using the ME-PIMS model, PBGC projects interest rates, stock returns, and related variables; asset returns; plan demographics; plan size; plan benefit level and employer contribution increases; and a plan s probability of mass withdrawal. PBGC stresses that ME-PIMS is not a predictive model but instead simulates the flow of claims that could develop under hundreds of combinations of economic parameters and extrapolations of plans respective historical patterns. ME- PIMS cannot model for the financial condition of individual employers or industries in part because, until recently, PBGC has not had access to information at the contributing employer level. PBGC uses ME-PIMS to report the agency s liabilities and exposure to losses under the multiemployer program in its annual reports. According to PBGC s 2009 annual report, ME-PIMS showed the median amount of claims over the next 10 years to be about $5.5 billion and a median net position outcome of $2.4 billion. Page 23 GAO-11-79 Multiemployer Pensions
Pg 180 of 250 Data That PBGC Uses Are Outdated While PBGC officials told us that they could benefit from having more current data than are available on the Form 5500, they prefer using Form 5500 data on multiemployer plans because these older data are the most comprehensive, the agency s monitoring system is designed for it, the data are audited, and most private plans are required by law to file the form on an annual basis. Officials told us that, given the current Form 5500 reporting schedule, even with the data capture capabilities of the new EFAST2 system, they cannot make up for the time lag in plan filing and, as a result, its monitoring suffers. 22 Officials told us that the time lag made it difficult to detect when a plan was in trouble and what steps could be taken to avert greater problems. PPA generally requires multiemployer plans to provide more timely financial information to PBGC. (See table 5.) Table 5: Multiemployer Plan Information Filed with PBGC Notice, report, or filing item Time frame Plans required to file Form 5500 (including Schedules MB By the last day of the 7th calendar month All multiemployer plans. and R) for annual certification by plan actuary following the end of a plan year. Plans may also apply for a one-time filing extension of up to 2½ months. Annual funding notice 120 days from end of plan-year for large plans. Small plans with 100 or fewer participants must file either with their annual report or before the annual report filing deadline. All PBGC-insured plans. Notices of critical or endangered status 30 days after the date of certification. All plans that certified with IRS that they are in critical or endangered zone status. Plan actuarial valuations Upon request. PBGC asks for but cannot compel plans on its contingency list to provide. PBGC premium filings By last day of the 16th full calendar month following end of the preceding premium payment year (e.g., April 30, 2009, for 2008 calendar-year plans) for plans with fewer than 100 participants. By 15th day of the 10th full calendar month following end of prior plan year (e.g., October 15, 2008, for 2008 calendar-year plans) for plan with 100 or more participants. All PBGC-insured plans. Source: GAO analysis of certain reporting requirements for multiemployer plans under ERISA and the Internal Revenue Code of 1986 (the Code). 22 For 2008 and later plan years, plans are required to identify whether they are making scheduled progress on their funding improvement or rehabilitation plan on the Form 5500 Schedule MB. In addition, plans are required to provide a summary of their funding improvement or rehabilitation plan. PPA also requires multiemployer plans to report the names of contributing employers that contribute 5 percent or greater of the total plan contributions for a plan year on Form 5500-Schedule R. Page 24 GAO-11-79 Multiemployer Pensions
Pg 181 of 250 In addition to Form 5500 data, PBGC-insured multiemployer plans are required to submit annual funding notices (AFN) to PBGC. The AFN must include, among other things, the plans identifying information and funded percentage for the plan year, a statement of the market value of the plan s assets as of the end of the year, a statement of the number of retired, separated vested, and active participants under the plan, and whether any plan amendment, or scheduled benefit increase or reduction has a material effect on plan liabilities. PBGC officials told us they do not use the AFNs they receive to determine the overall health of the universe of multiemployer plans, but may look at the market valuation of assets on the AFN of a specific plan once it has been identified through Form 5500 data as a potential candidate for the watch list. PBGC officials also told us they do not use the AFN in developing data for model simulation, annual reports, or data books. PBGC also receives annual notices of critical or endangered status from plans within 30 days of plans certifying their funding zone status with IRS, as required by PPA. PBGC officials said they compare the information in the notices which alert recipients of the plan s funding zone status and the reasons for it with the plan s Form 5500 filings to determine whether to place a plan on its contingency list. Plans on the list are asked to provide their current actuarial valuations so PBGC can monitor plans going forward. PBGC officials stated that, while plans are not required to provide this information, they are typically willing to cooperate with the requests. PBGC Provides Non- Financial Assistance to Troubled Plans on an Ad Hoc Basis In addition to providing financial assistance, PBGC can assist troubled plans with technical assistance, facilitate mergers, and partition the benefits of participants orphaned by employers who filed for bankruptcy. Generally, it is up to plans to request these kinds of assistance. Occasionally, PBGC is asked to serve as a facilitator and work with all the parties to a troubled plan to improve a plan s financial status. Plan administrators can request PBGC s help to improve funding status of plans or provide assistance on other issues. They may contact PBGC s customer service representatives to obtain assistance on premiums, plan terminations, and general legal questions related to PBGC programs. PBGC has also assisted in the orderly shutdown of plans. The plans involved in these actions either merged with other multiemployer plans or purchased annuities from private-sector insurers for their beneficiaries. For example, PBGC facilitated the closeout of seven small multiemployer plans in 2010 that were receiving or expected to receive future financial assistance payments from PBGC and identified two additional plans for closeout in the future. According to PBGC, these small plan closeouts are Page 25 GAO-11-79 Multiemployer Pensions
Pg 182 of 250 part of an ongoing effort to reduce plan administrative costs borne by PBGC s multiemployer program. PBGC can also facilitate mergers between two or more multiemployer plans. According to PBGC officials, PBGC has received notice of 303 mergers since 2000, 5 of which PBGC facilitated by paying $8.5 million from the multiemployer insurance program to the merged plans. Plans considering a merger must request approval from PBGC and typically involve merging a plan with a low funding level with a plan having a more favorable asset-to-liability ratio. PBGC officials told us that they carefully consider each merger request to ensure that the merger creates a stronger plan that will sustain operations indefinitely. They further noted that PBGC wanted to be sure that plans that received funds in a facilitated merger did not end up accepting the money only to become a liability to PBGC in the near future, in effect causing PBGC to make loans twice to poorly managed plans. PBGC can also partition the benefits of certain participants from a financially weak multiemployer plan under certain circumstances. Partition is a statutory mechanism that permits financially healthy employers to maintain a plan by carving out the plan liabilities attributable to participants orphaned by employers who filed for bankruptcy. 23 Under ERISA, PBGC has the authority to order the partition of a plan s orphaned participants either upon its own motion or upon application by the plan sponsor. Once a plan is partitioned, PBGC assumes the liability for paying benefits to the orphaned participants. ERISA specifies four criteria that dictate when PBGC can utilize its partitioning authority. 24 PBGC may order a partition if: the plan experiences a substantial reduction in the amount of contributions that has resulted or will result from a case or proceeding under Chapter 11 bankruptcy with respect to an employer; the plan is likely to become insolvent; 23 According to PBGC, orphaned participants may also include participants whose employers withdrew from a plan without filing bankruptcy. However, this group of participants would not be eligible for partitioning. 24 29 U.S.C. 1413. Page 26 GAO-11-79 Multiemployer Pensions
Pg 183 of 250 contributions will have to be increased significantly in reorganization to meet the minimum contribution requirement and prevent insolvency; and partition would significantly reduce the likelihood that the partitioned plan will become insolvent. Like all multiemployer plans, the partitioned participants are subjected to ERISA s multiemployer guaranteed benefit limits. PBGC may order the partition of a plan after notifying plan sponsors and participants, whose vested benefits will be affected by the partition. Since the implementation of MPPAA in 1980, PBGC has partitioned two plans. 25 In the most recent partition in July 2010, PBGC said it approved the move because, by removing 1,500 orphaned participants from the plan, PBGC was able to delay plan insolvency for at least 6 additional years and preserve full benefits for the approximately 3,700 workers and retirees of firms still contributing to the plan. Without partition, the plan would have become insolvent sooner and the federal benefit limits would have applied to all its retirees. Pension Structures in Other Countries Provide Multiemployer Plans with Options to Improve Funding The private pension systems in the countries we studied the Netherlands, Denmark, the United Kingdom, and Canada support industrywide, employer-based pension plans that share some common attributes with U.S. multiemployer plan structure. Each of the countries is a member of the Organisation of Economic Co-operation and Development (OECD) and supports a three-pillar pension system that consists of a basic state pension (e.g., similar to Social Security), private employer-based pensions (e.g., single- or multiemployer), and individual retirement savings (e.g., independent retirement accounts). While each of the countries we studied had a pension system with some unique characteristics, pension officials in some countries told us they faced common short-term and long-term challenges in securing pension benefits for participants, including plan underfunding and an aging workforce. 26 25 PBGC partitioned the pension plan of Council 30 of the Retail, Wholesale and Department Stores Union and the Chicago Truck Drivers, Helpers & Warehouse Workers Union Pension Plan. 26 We did not review or attempt to verify the information or legal requirements pertaining to plans maintained in these countries. We relied upon the representations and materials furnished by government officials in these countries and other experts. Page 27 GAO-11-79 Multiemployer Pensions
Pg 184 of 250 Multiemployer Plan Structures The scope and coverage of the studied countries multiemployer pension structures varied depending on a country s circumstances and plan design. While none of the countries had as much invested in its private pension systems as the United States, pension assets in the Netherlands exceeded the country s gross domestic product in 2010, according to OECD. Moreover, some countries with older workforces had a higher density of active trade union workers to help pay for the pensioner benefits. (See table 6.) Table 6: Comparison of Select Economic and Demographic Characteristics in the Studied Countries and the United States (2008) The Netherlands Denmark United Kingdom Canada United States Gross domestic product $675.1 billion $202.2 billion $2.2 trillion $1.3 trillion $14.4 trillion GDP per capita $41,063 $36,808 $35,631 $38,975 $47,186 Total population (in millions) 16.4 5.5 61.4 33.1 304.2 Size of labor force (ages 25-64) (in millions) 7.2 2.4 25.6 14.9 126.0 Trade union density Includes public (%) 18.9 67.6 27.1 27.1 11.9 Effective retirement age (men/women) a 62/61 64/61 63/62 63/62 65/64 Population over age 65 (%) 14.9 15.9 16.2 13.6 12.7 Population over age 65 (as % of labor force) 27.4 25.3 26.8 21.1 20.8 Average overall life expectancy at age 65 83.4 82.7 83.3 84.5 83.6 Source: OECD. a Data on effective retirement age, which is the real age that people retire, are reported from 2007. Multiemployer plan structures in these countries did differ from those in the United States in several important ways. (See table 7.) First, like the United States, the United Kingdom provides some form of governmentsponsored pension insurance, but while the level of compensation guaranteed is upwards of 90 percent, payouts only occur when the last remaining employer becomes insolvent. Second, while the United Kingdom and the Canadian province of Quebec assess withdrawal liability to employers leaving a multiemployer plan in ways similar to the United States, officials in the Netherlands, Denmark, and the Canadian province of Ontario did not and several experts told us that such assessments would discourage employers from remaining in multiemployer plans. In the Page 28 GAO-11-79 Multiemployer Pensions
Pg 185 of 250 Netherlands and Denmark, collective bargaining agreements apply to both union and nonunion workers in an industry. Table 7: Comparison of Multiemployer Plan Structures in the Studied Countries and the United States Plan type The Netherlands Denmark United Kingdom Canada United States Collectively bargained, defined benefit plans Collectively bargained, defined contribution plans Affinity groups Industry Profession or trade group Application of collective bargaining agreement Plan governance Pension guarantees for employees Withdrawal liability for employers Applies to union and nonunion employees in an industry. Boards of trustees comprising equal representation of employers and employees None Applies to union and nonunion employees in a profession or trade group. Boards of trustees comprising equal representation of employers and employees Pension contributions are guaranteed against any loss that would result in the value of the benefits falling below the value of the contribution. Collectively bargained, defined benefit plans Collectively bargained, defined benefit plans Collectively bargained, defined benefit plans Labor union Labor union Labor union Applies to union employees. Boards of trustees comprising representation of employers and employees The Pension Protection Fund generally pays 100% of compensation to retirees and up to 90% of compensation to participants who have not yet reached retirement age. None None Withdrawing employers must pay proportionate share of plan s unfunded liabilities. Source: GAO analysis. Applies to union employees. Boards of trustees typically comprising representation of employers and employees; some plans are union run. None None imposed on plans under federal jurisdiction; in province of Quebec, withdrawing employers must pay proportionate share of plan s unfunded liabilities. In province of Ontario, employers may withdraw only with consent of the union(s). Applies to union employees. Boards of trustees comprising equal representation of employers and employees PBGC provides a guaranteed benefit of $12,870 per year for 30 years of service. Withdrawing employers must pay allocable share of plan s unfunded vested benefits. Page 29 GAO-11-79 Multiemployer Pensions
Pg 186 of 250 But, as in the United States, the recent economic downturn had a negative impact on defined benefit plans, including multiemployer plans, in three of the four countries we studied. The four countries experienced double-digit declines in their pension investment returns in 2008, according to OECD data, 27 and all but one experienced steep declines in the funded status of their multiemployer plans. For example, in the Netherlands, the aggregate funded status dropped below 100 percent for the first time, from 149 percent in 2007 to 89 percent in 2009. 28 Similarly, the United Kingdom reported that funded status for all DB plans fell from 102 percent in 2008 to 80 percent in 2009. Unlike the others, Denmark s plans survived the crisis with little decline in overall funding, which several plan officials attributed to changes that the pension regulator made prior to the crisis, such as moving from actuarial to market valuations of plan assets and liabilities. According to officials that we spoke with, the Netherlands and Canada also implemented funding relief measures to help plans address their funding deficiencies, such as extending the length of plan recovery periods. Officials at the Dutch Central Bank told us they hired additional staff to handle the workload of increasing numbers of recovery plans. Other Countries Plans Are Subject to a Range of Funding, Reporting, and Regulatory Requirements Minimum Funding Requirements Three of the four countries that we studied reported they had recently implemented some form of minimum funding requirements for multiemployer plans, but the levels varied by country. Officials we spoke with told us that plans that fell below these funding thresholds were 27 OECD reports the following returns on pension investments in 2008: The Netherlands (-16.9%); Denmark (-16.8%); United Kingdom (-17.4%); Canada (-21.4%); and the United States (-26.2%). 28 In the Netherlands, multiemployer plans share investment gains by periodically adjusting the value of workers benefits, known as indexation. According to officials, pension boards usually adjust workers and also retirees benefits conditional on the pension fund s overall funding level. If a plan s funding ratio is above the established benchmark, benefits are indexed to reflect the growth in wages or prices. However, if a plan s funding ratio is below the established benchmark benefits may be only partially indexed or not indexed at all. By law, employers are not allowed to provide full indexation if the funded ratio is below 130 percent. According to officials, most plans either paid partial indexation or none at all in 2009. Page 30 GAO-11-79 Multiemployer Pensions
Pg 187 of 250 required to submit recovery plans to bring the funding levels back above the minimum level. Canada, Denmark, and the Netherlands required plans to be funded at a level of 100 percent or above. The United Kingdom recently suspended its minimum funding requirements in favor of planspecific funding levels, and officials told us regulators still sought to maintain an aggregate funding level of 110 percent. Also, plans in the Netherlands are required to build funding reserves, or buffers, commensurate to the risk associated with their investment policies. Officials at the Dutch Central Bank told us plans must develop buffers for interest rate risk, private equity exposure, and hedge fund exposure. Reporting Requirements While the reporting requirements in these countries are not so different from those in the United States, multiemployer plans in some countries submit more frequent plan funding and actuarial reports to regulators. For example, in the Netherlands and Denmark, all plans are required to submit data on a quarterly and annual basis and plans in recovery status had, in some countries, additional reporting requirements. (See table 8.) Table 8: Reporting Requirements for Multiemployer Plans in the Studied Countries General reporting requirements for all plans Additional requirements for plans in recovery status The Netherlands Denmark United Kingdom Canada a Annual financial reports Quarterly financial reports A 15-year continuity analysis every 3 years Recovery plan Annual progress report on recovery plan Annual financial and audit reports Quarterly financial reports, solvency assessments, and register of assets report Recovery plan Daily market valuation reports Monthly progress reports on recovery plan Actuarial valuation reports every 3 years Recovery plan Actuarial valuation reports every 3 years Actuarial valuations at least every year. Source: GAO analysis. a This column summarizes only those multiemployer plans under federal jurisdiction. Some countries require plans to submit plan data electronically, which officials said allowed for real-time monitoring and transparency. For example, Danish plans are required to report market valuations of their assets and liabilities, which regulators said allowed them to identify plans at risk through market surveillance with minimal up-to-date information. The regulators told us they can take action as soon as a plan is in trouble and proactively notify plans of impending financial problems. In the United Kingdom, plan trustees are required to update their financial information electronically and can do so in real-time on the regulator s Page 31 GAO-11-79 Multiemployer Pensions
Pg 188 of 250 information system. In the Netherlands, the Dutch Central Bank updates the aggregate funded status of plans on a quarterly basis and makes this information available on its public Web site. Monitoring These countries all monitored multiemployer plans for compliance and to determine plan funding and solvency risk. While the Netherlands and Denmark monitored the solvency risks of all plans, officials in both countries told us they also plan to develop a risk-based monitoring strategy, such as that used in the United Kingdom and Canada, which would target monitoring to plans that represented the greatest risk. Officials in these countries also had varying degrees of authority to intervene in the operations of multiemployer plans. (See table 9.) Table 9: Monitoring of Multiemployer Plans in the Studied Countries Regulatory authorities Monitoring activities The Netherlands Denmark United Kingdom Canada a Dutch Central Bank The Netherlands Authority for the Financial Markets Risk-based monitoring approach that includes review of all plans rules to see if they comply with legislation. Financial Supervisory Authority Risk-based monitoring approach that includes review of all plans and conducts formal periodic on-site audits to verify information submitted by all plans. Employs a traffic light system that determines the risks associated with each plan. Conducts stress tests for specific market risks that have certain triggers a 12% decline in equities, 0.7% interest rate change; 8% decline in real estate values that alert it to plans that need to take further action. Tracks whether employers made their required contributions to the plans and assesses the quality of the board of trustees. Pensions Regulator Pension Protection Fund Department of Works and Pensions Risk-based, plan-specific monitoring approach that focuses on education and enablement, with enforcement where appropriate. Reviews annual report and meets with plan sponsor to discuss the information provided. Assigns permanent case managers to the largest plans. Office of the Superintendent of Financial Institutions (federal) Risk-based supervisory framework that identifies plans at high risk. Reviews plans for key plan risks, including investment portfolio, actuarial assumptions, plan administration, and the likelihood of continued sponsor funding. Conducts on-site visits to a number of plans usually in response to a complaint. Page 32 GAO-11-79 Multiemployer Pensions
Pg 189 of 250 Intervention authorities The Netherlands Denmark United Kingdom Canada a Can prescribe actions that plans must take and demand plan disclosures to participants. Can appoint individuals to a plan s board. Can suspend board. Can require plans to maintain financial reserves commensurate with their investment risk. Can close down company. Can put company on administration. Can remove board members. Can compel contributions, remove plan trustees, require a recovery plan, terminate a plan, and force debt onto an employer. Can force disclosure of information from plans if solvency ratio falls below certain thresholds. Can terminate plans. Must approve any plan terminations, reductions in accrued benefits, distributions of surplus, and transfers of assets between plans. Source: GAO analysis. a This column summarizes only those multiemployer plans under federal jurisdiction. Plans in Other Countries Have Options to Improve Funded Status Multiemployer plans in the countries we studied have a number of options to improve and maintain their funded status, and a specific length of time allotted to recovery. (See table 10.) Some of the countries allow plans to increase contributions and reduce the rate of benefit accruals. In Denmark, regulators told us that plans that fail stress tests must adjust investments to resolve funding deficiencies within 6 months. The Netherlands, United Kingdom, and Canada have longer recovery periods and the Netherlands and Canada allow plans to reduce accrued benefits, including the benefits of retirees, although this step is seen as a measure of last resort. Table 10: Recovery Periods and Tools Available to Improve Plan Funded Status in the Studied Countries Length of recovery period Tools available to assist recovery The Netherlands Denmark United Kingdom Canada a Plans must return to minimum funding level (105%) in 5 years and 125% funded in 15 years. Increase contributions, reduce or suspend indexation, reduce benefit accrual rate and accrued benefits. Plans expected to resolve funding deficit within 6 months. Increase contributions and adjust plan s risk exposure. There is no formula for recovery; it is a planspecific approach. Recovery period varies by plan, generally within 10 years. Increase contributions and reduce benefit accrual rate. Plans must resolve solvency deficits within 5 years. Increase contributions, reduce benefit accrual rate and accrued benefits. Source: GAO analysis. a This column summarizes only those multiemployer plans under federal jurisdiction. Plans may also seek out mergers to reduce administrative costs and indirectly help preserve their funded status. Most of the countries we Page 33 GAO-11-79 Multiemployer Pensions
Pg 190 of 250 studied allow plan mergers, but some officials told us that they were infrequent. Canadian officials told us mergers of multiemployer plans would be difficult because plan membership is based on profession and multiemployer plans do not want to lose control of plan policy and governance, even if the plan would be financially better off after a merger. In Canada, when full mergers do occur, they said, they tend to result from a merger of unions. In the Netherlands, mergers occur, but the industry identification of multiemployer plans limits merger activity to plans in the same industry. In Denmark, single-employer plans can choose to merge with multiemployer plans even if the participants are not affiliated with the plan s employer organization to take advantage of lower administrative fees. In the United Kingdom, there is a large trust that combines many single-employer and several multiemployer plans, benefiting all participating plans with lower costs and better investment opportunities. Changes to U.S. Multiemployer Plan Framework Could Help to Protect Pension Benefits Lack of Timely, Complete, and Accurate Information Hinders Ongoing Assessments of Multiemployer Plans PPA requires multiemployer plans to file numerous notices with EBSA, IRS, and PBGC regarding their funded status. Our review of filings received by the three agencies found that plans are not all complying with these requirements. Moreover, we found that plans that did comply filed notices that varied in form and content. While current reporting requirements, if followed, would provide federal agencies with the data needed to monitor plan health, the current multiemployer plan framework requires plans to submit these data in a fractured format to three different agencies that do not share the information they receive. As a result, federal officials told us that their agencies are limited in their ability to assess the current and recent health of multiemployer plans. Plans are required to certify their funding zone status each year with IRS, but they are not required to include their current funded percentage in this report, which would be helpful to officials determining the gravity of plans funding deficiencies. Also, IRS officials told us that some plans provided a brief letter identifying the zone status, while other plan s submitted lengthy reports that detailed the assumptions and calculations Page 34 GAO-11-79 Multiemployer Pensions
Pg 191 of 250 used to determine the plan s zone status. IRS officials told us that, while some plans provided their funded percentage in the certification notice, the agency did not track this information nor share the list of certifying plans with any other federal agency. Within 30 days of certifying their funding zone status with IRS, PPA requires plans in critical or endangered status to submit a notice of their status to PBGC and EBSA, among others. 29 In our review of data from 2008 and 2009 obtained from the three agencies, we found large discrepancies in the number of plans certifying with IRS and the number of plans submitting notices of critical or endangered status to PBGC and EBSA. For example, IRS data show that 461 of the 1,331 plans certified in critical status in 2009, but only 132 plans provided notices of their certified status to EBSA. Similarly, some plans that elected to freeze their current funding status did not file notices of this election with PBGC and EBSA, as required. (See table 11.) Table 11: Comparison of Multiemployer Plan Status Information Received by Federal Agencies, 2008 and 2009 2008 2009 Number of plans certifying zone status with IRS 1,347 1,331 Number of plans indicating critical status Agency notified IRS 138 461 PBGC 111 296 a EBSA 100 b 132 c Number of plans indicating endangered status IRS 175 444 PBGC 155 317 d EBSA 128 e 83 f Number of plans indicating their election to freeze funding status in 2008 or 2009 IRS 745 PBGC 408 EBSA 309 g 29 This notification is filed with the EBSA, IRS, and PBGC and furnished to plan participants, beneficiaries, and the bargaining parties. 26 U.S.C. 432(b)(3)(D)(i) and 29 U.S.C. 1021(f)(3)(A). Page 35 GAO-11-79 Multiemployer Pensions
Pg 192 of 250 Source: GAO analysis of EBSA, IRS, and PBGC data. Note: EBSA data analyzed by GAO was taken from the EBSA Web site on August 19, 2010. Also, the endangered status category includes Endangered Status Notices and Seriously Endangered Status Notices. a PBGC received 304 Critical Status Notices for 2009, which included 2 duplicate notices and 6 other notices. b EBSA posted 102 Critical Status Notices for 2008, which included 2 duplicate notices. c EBSA posted 140 Critical Status Notices for 2009, which included 7 duplicate notices and 1 other notice. d PBGC received 323 Endangered Status Notices for 2009, which included 6 duplicate notices. e EBSA posted 133 Endangered Status Notices for 2008, which included 4 duplicate notices and 1 other notice. f EBSA posted 102 Endangered Status Notices for 2009, which included 8 duplicate notices and 11 other notices. g EBSA posted 323 WRERA Notices for 2009, which included 14 duplicate notices. In addition, for plan years beginning after December 31, 2007, all defined benefit plans are required to provide an additional notice an annual funding notice to PBGC, plan participants and beneficiaries, labor organizations, and, in the case of multiemployer plans, also to each participating employer. Like the notice of critical or endangered status, this notice must be provided within 120 days following the end of each plan year. EBSA can assess a civil penalty of $110 per day per participant against the plan administrator for failure to submit the plan s annual funding notice to participants and beneficiaries. Among other things, the AFN provides recent information on a plan s funded status, actuarial valuations of assets and liabilities, market valuations of assets, and a plan s asset allocation. According to PBGC officials, only half of multiemployer plans filed these notices in the 2008 plan year and many plans had failed to file notices for the 2009 plan year within the 120-day statutory timeline. PBGC officials could not explain why plans failed to file the notices with PBGC. But while EBSA can assess a civil penalty for failure to submit an annual funding notice, PBGC officials did not share any information on plans annual funding notices with EBSA, making it unlikely that EBSA would have the information necessary to assess such a penalty. Industry experts told us that the reporting requirements for multiemployer plans are confusing and duplicative, and that further consolidation of notices is needed. They noted that plan reporting requirements have increased significantly and become burdensome for plans to administer with each notice having a different recipient and due date. Even if participant notices were more clearly written, one expert said, there is nothing that an individual can do to address the critical or endangered status because benefits are collectively bargained. Moreover, participants Page 36 GAO-11-79 Multiemployer Pensions
Pg 193 of 250 do not need multiple notices each time an event occurs to change the longterm projections of their plan s standing. Current Multiemployer Framework Faces Challenges in Assisting Plans in Need The statutory and regulatory framework guiding multiemployer plans is not structured to assist troubled plans, limits the actions agencies can take, and promotes little interaction among federal agencies that bear joint responsibility for monitoring and assisting these plans and their participants. We found that EBSA, IRS, and PBGC do not work together to share information received from plans and cannot determine whether all multiemployer plans are meeting applicable legal requirements. First, PBGC s involvement with multiemployer plans is mostly limited to the plans on its contingency list that are already insolvent and receiving financial assistance or pose a potential risk for future claims against PBGC. PBGC has authority to interact with plans on an ongoing basis, but has done so infrequently to date. For example, at a recent testimony before Congress, an EBSA official stated that one large multiemployer plan, the Central States Southeast and Southwest Pension Fund, did not meet the criteria for partition, despite having $2.1 billion in unfunded liabilities in 2009 and reportedly paying over 40 cents on every dollar to beneficiaries whose employers left the plan without covering their obligations. In fact, PBGC has only used its partition authority twice in its history and facilitated five plan mergers since 2000. Experts told us that plans could benefit from a greater level of PBGC interaction and a more flexible application of the tools available to PBGC. (See table 12.) 30 30 The suggestions in this table do not reflect GAO s views or the views of other federal officials that we interviewed. We collected this information interviewing a variety of experts. See appendix I for more information about how we conducted this work. Page 37 GAO-11-79 Multiemployer Pensions
Pg 194 of 250 Table 12: Experts Suggestions to Improve PBGC s Assistance to Plans Issue Experts description of the problem Options suggested by experts Level of PBGC involvement While the multiemployer structure was designed to Through more aggressive plan monitoring, PBGC limit PBGC s exposure and let the employers serve could intervene as soon as a plan is in trouble, as principal guarantors, PBGC is typically viewed rather than waiting for a plan to become insolvent. as the guarantor of last resort for multiemployer PBGC could step in before plans reach the point of plans. In the current system, PBGC provides little having to assess mass withdrawal liability, at which assistance to multiemployer plans prior to point all employers are committed to insolvency and focuses on limiting the simultaneously withdrawing from a plan. government s exposure instead of ensuring that participants receive the benefits they deserve. PBGC could benefit from a continuous dialogue with pension plans a case worker model in PBGC waits too long to intervene and provide which PBGC staff provide actuarial or technical assistance to troubled plans. Plans on the path to assistance to plans on an ongoing basis instead of insolvency can only watch and wait until PBGC waiting until the plans are unsalvageable. finally gets involved. Plan partitioning In some mature plans, benefit payments to orphaned participants make up the majority of plan liabilities. PBGC has the authority to partition plan liabilities, but it is limited to orphaned pensioners coming from bankrupt companies and PBGC has been hesitant to use it. PBGC s partition authority could be expanded to preserve the healthy part of a plan. Partition should apply to situations other than bankruptcy, but the agency should exercise caution and use partitioning as a tool of last resort. A high qualification threshold needs to be set for such intervention to ensure it was reserved for plans in the worst condition. Expansion of this authority would benefit about a dozen plans, most of them in the mining and trucking industries. Giving PBGC the ability to take over the sick part of a troubled plan so the healthy part could remain viable would benefit taxpayers in the long term because, if the plan became insolvent, PBGC would be responsible for paying benefits to all beneficiaries and not just the orphaned participants. Partition should be coupled with a requirement that the healthy part of a partitioned plan de-risk its investment strategies to prevent a repeat of financial trouble. Page 38 GAO-11-79 Multiemployer Pensions
Pg 195 of 250 Issue Experts description of the problem Options suggested by experts Plan mergers The current economic climate has made mergers more difficult because all plans are on unsure footing caused by the market collapse. Under the standard fiduciary rules, trustees of healthy plans may be less willing to merge with unhealthy plans for fear that they could be challenged for breach of fiduciary trust for assuming the liabilities of the weaker plan. PBGC could be more active in facilitating mergers between healthy plans and unhealthy plans to maintain solvency and protect the agency from payouts. PBGC could alleviate the healthier plans concerns by stepping in to provide incentives and financial assistance to allow these plans to make wise fiduciary decisions and support the smaller plans. PBGC could seek opportunities to promote mergers among different affinity groups because multiemployer plans are willing to consider branching out to find ways to preserve the plan and secure their participants retirement future. PBGC would need a funding stream in addition to premiums to be able to support merger activity. Source: GAO analysis of information collected from pension experts and plan practitioners. Second, the Employee Plans Compliance Unit (EPCU) at IRS, which is responsible for verifying that all multiemployer plans file annual actuarial certifications of funded status and confirming that the certifications are filed in a complete and timely manner, 31 does not have the capacity to identify plans that fail to file or verify that all plans submitting certifications are indeed multiemployer plans. IRS officials told us they could not determine whether all multiemployer plans filed their actuarial certifications because they did not know the universe of multiemployer plans. Specifically, they said they did not have a complete list of all multiemployer plans in part because the data they use is taken from the plans Form 5500 filings, which included plans that had identified themselves as multiemployer plans but, judging from the plan name, were not (e.g., dental offices or 401(k) plans). Officials told us they hoped to get 31 According to IRS, Section 432(b)(3) of the Code requires an actuarial certification of whether or not a multiemployer plan is in endangered status, and whether or not a multiemployer plan is or will be in critical status, for each plan year. This certification must be completed by the 90th day of the plan year and provided to the Secretary of the Treasury and to the plan sponsor. Failure of the plan s actuary to timely certify the plan s status is treated for purposes of section 502(c)(2) of ERISA as a failure or refusal by the plan administrator to file the annual report required to be filed under section 101(b)(1) of ERISA. A penalty of up to $1,100 per day may be assessed by the Secretary of Labor. Plans certified to be in endangered status must adopt a funding improvement plan that is reasonably expected to enable the multiemployer plan to achieve certain funding improvements by the end of its funding improvement period. Plans certified to be in critical status must adopt a rehabilitation plan that is reasonably expected to enable the multiemployer plan to emerge from critical status by the end of its rehabilitation period. A funding improvement plan or rehabilitation plan must be updated each year after the initial endangered or critical year. Page 39 GAO-11-79 Multiemployer Pensions
Pg 196 of 250 a more accurate data set in the future, but it would take several years before this would happen. EPCU officials told us plan filings vary widely in scope and length. For example, some plans send a brief memo indicating their funding zone status; others send a long report detailing each of the actuarial assumptions used to determine the zone status. IRS officials told us some plans provided funded status as a percentage while others reported only zone status. IRS currently collects paper copies of the annual certifications. Officials said the annual certification notices required the same kind of information as the WRERA notices, which can be filled out and filed electronically on the IRS Web site. In March 2008, IRS proposed guidance to plans on the preferred format or content for the annual certification notices, but this guidance has not been finalized. EPCU officials told us that they did not interact with either EBSA or PBGC with regard to the filing of certification notices. They said in the past they sent a few short summaries about the funding zone status certifications to IRS headquarters, but did not interact directly with EBSA or PBGC officials regarding the annual certifications. Moreover, IRS did not make certification data available to either EBSA or PBGC so they could reconcile the critical or endangered status notices with the number of certifications to determine if plans were complying with the law. EPCU officials said it would be beneficial for them to have direct contact with other federal agencies to share information on multiemployer plans. Third, EBSA, which is responsible for assessing civil penalties for reporting violations against plans that do not file annual actuarial certifications of funded zone status, does not receive or actively seek out information from PBGC and IRS to enforce this penalty. PPA also requires plans that certify their funding zone status as either critical or endangered to send notices of endangered and critical funding status to EBSA, among others, but, unlike the annual certification of a plan s status, there are no penalties associated with the failure to furnish endangered or critical status notices. EBSA s Office of Participant Assistance scans the notices it receives and posts them on its Web site. Officials from EBSA s Office of Regulations and Interpretation and the Office of Enforcement said they make no attempt to reconcile the status notices with the certifications filed with IRS. They said they had no interaction with IRS officials on Page 40 GAO-11-79 Multiemployer Pensions
Pg 197 of 250 these matters and noted some utility if IRS were to share certification data with EBSA. 32 Elements of Multiemployer Framework May Limit Protection of Benefits The pension experts and plan practitioners that we interviewed identified several elements of the multiemployer framework that were restrictive and had the potential to affect plans ability to keep the pension promise to beneficiaries. These experts noted that each of these elements had unintended consequences made evident by the recent economic downturn. (See table 13.) 33 Table 13: Experts Suggestions to Improve the Multiemployer Framework Issue Experts description of the problem Options suggested by experts Modifying accrued benefits Under current law, trustees cannot adjust retirement age or accrued benefits, even if the plan is in critical status. If plans in endangered or Benefits need to be aligned with plan funding so incremental benefit cuts can be made, if necessary, to preserve plan assets longer. critical status could make such adjustments, they Plans need to strike a compromise between would have more tools at their disposal to close active workers and retired beneficiaries to their funding gaps. Mature plans with high retiree spread the risk. liability cannot make any further benefit cuts. PBGC may need to look into whether it can Much of a plan s liabilities lie in accrued benefits, reduce benefits for retirees to help plans spread plans need to be able to cut both future and the risk evenly among all participants active accrued benefits, as well as increase and inactive. contributions. Decreasing accrued benefits would require Most plans with a small active participant base legislative changes. have no tools to address asset losses. They need a way to reduce accrued benefits to retirees. As it now stands, the inability for multiemployer plans to adjust accrued benefits creates intergenerational inequity and leaves plans with few options to address funding deficiencies. 32 PPA also gave Labor the authority to assess civil monetary penalties of up to $1,100 per day against plan sponsors that fail to timely adopt funding improvement or rehabilitation plans. However, EBSA has not exercised this authority to date because IRS has yet to finalize regulations regarding what the content of these plans should be. As a result, EBSA has relied on plans to act in a good faith compliance basis. According to EBSA, EBSA s Office of the Chief Accountant is currently constructing a program to enforce the PPA civil penalty provisions. 33 The suggestions in this table do not reflect GAO s views or the views of other federal officials that we interviewed. We collected this information interviewing a variety of experts. See appendix I for more information about how we conducted this work. Page 41 GAO-11-79 Multiemployer Pensions
Pg 198 of 250 Issue Experts description of the problem Options suggested by experts Withdrawal liability Withdrawal liability discourages employers from leaving a plan; it also discourages new employers A plan s current unfunded liability should stay with the plan s current employers. from joining a plan, especially one with unfunded A withdrawing employer should pay his share of liabilities, because they assume partial the unfunded liability when withdrawing so as to responsibility for the unfunded liability of all not unfairly pass it onto employers who were employers in the plan. not in the plan when those debts were incurred. New employers are afraid to join a multiemployer plan due to the burden of the withdrawal liability that would befall them after they joined. Without new participants, however, there will be no growth in multiemployer plans. Endangered status designation PBGC guarantee level Plans in endangered status have insufficient tools to address their funding deficiencies. The endangered status designation had been a mistake in that it set plans up for failure. Plans in endangered status find themselves in a purgatory forced to face many challenges with limited tools. Some plans must wait and watch as their funding status deteriorates to the critical level, at which time they can choose from myriad tools to address their funding deficiency. The PBGC guaranty level is low and many participants would lose a considerable amount in unguaranteed benefits if their plans were to become insolvent. Trustees are aware that the best way to insure benefits is to avoid insolvency, thereby reducing the liabilities for PBGC. The significant increase in premiums since 2005 did not coincide with a comparable rise in the benefit guaranty. There is no need for the endangered status and it would be best if plans were considered to be either safe or critical. Most plans would prefer the safety valves built into critical status. Some plans are certifying in critical status bypassing endangered status to take advantage of the additional tools. Eliminating the endangered status would require legislative changes. Raising the guarantee would give participants more insurance against underfunding because PBGC s guaranty would cover more of their benefits if their plan became insolvent. The benefit guarantee needs to be indexed to inflation. Establishing a benefits-related premium so plans that provided participants with larger benefits would pay higher premiums. Establishing a risk-based premium structure would be a good idea in the future if it were applied to plans with only active employers and workers. However, under current conditions, such a structure is not feasible as it would require underfunded plans to pay additional premiums at a time when they could least afford it. Increasing the PBGC guarantee level indexing it to inflation, and adding a risk-based guarantee would require legislative changes. Source: GAO analysis of information collected from pension experts and plan practitioners. Page 42 GAO-11-79 Multiemployer Pensions
Pg 199 of 250 Conclusions For decades, multiemployer plans have secured and provided an uninterrupted stream of pension benefits to millions of U.S. workers and retirees. Through collective bargaining, employers and employees worked to maintain their pension benefits despite changing economic climates and financial challenges. As a result, the vast majority of plans have remained solvent and relatively few plans have made claims for financial assistance from PBGC s insurance program since its inception in 1980. However, the recent economic downturn revealed that multiemployer plans, like most pension plans, were vulnerable to sudden economic changes and had few options to respond to the funding challenges highlighted by these economic conditions. The result was a steep decline in the funded status of most multiemployer plans now below 70 percent in aggregate. In the short term, the majority of plans will have to make difficult decisions to improve their funding and protect against future declines. The multiemployer plan universe represents diverse groups of employers, participants and industries some of which may be better prepared to meet their future funding obligations. While some plans may be able to improve their funded status as the economy improves, plans in the worst condition may find that the current options of increasing employer contributions or reducing benefit accruals are insufficient to overcome the funding and demographic challenges they face. For these plans, the combination of the effects of the economic downturn, the decline in collective bargaining, the withdrawal of contributing employers, and an aging workforce has likely accelerated their path to insolvency. Without additional options to address their underfunding, or new employers joining the plans to replenish the contributions, many plans may find themselves at greater risk of insolvency and more likely to need PBGC financial assistance sooner rather than later. Such a situation would put additional stress on PBGC s insurance program that, already in deficit, it can ill afford. The current statutory and regulatory framework for multiemployer plans is not structured to assist troubled plans on an ongoing basis. PBGC, Labor and IRS are all required by law to collect various funding data from plans, and these data are often duplicative. Moreover, these agencies are not making full use of these data to mitigate the risks to participants or to enforce plan discipline. While PBGC monitors plans on an ongoing basis, it focuses on the short-term risks to the trust funds rather than outward on the long-term risks to participants or the impact on their benefits if their plans cannot pay the benefits they promised. Page 43 GAO-11-79 Multiemployer Pensions
Pg 200 of 250 There are other approaches to consider. While some practices in the countries we studied, such as mandatory employer participation, would not be feasible in the U.S. context; others may have more ready application for addressing some challenges that U.S. multiemployer plans face. For example, the countries that we studied had pension regulators that interacted with plans on a frequent basis, collected timely and detailed plan information, provided a range of tools to plans to address plan underfunding and made information on the funded status of plans available to the public. Yet, there is no one-size-fits-all solution. For example, some plans greatest challenges may be their aging workforce or vulnerability to economic volatility, while others may face challenges inherent to the industries and geographical regions they serve. Without more timely and accurate information on plan health, PBGC and other federal agencies can do little to help plans to respond to circumstances like the ones they experienced in the recent economic downturn. But collecting this information is not enough. The agencies must also incorporate this information into their monitoring and oversight efforts and use the most current data to inform their policies and risk assessments. To do this, the agencies responsible for multiemployer plans must work together to provide greater security for multiemployer plans, which for decades have limited the exposure to PBGC and the taxpayer. Matters for Congressional Consideration To provide greater transparency of the current status of multiemployer plans, assist federal monitoring efforts, and help plans address their funding deficiencies, Congress should consider: consolidating the annual funding notices and the PPA notices of critical or endangered status to eliminate duplicative reporting requirements; and requiring IRS, EBSA, and PBGC to establish a shared database containing all information received from multiemployer plans. Recommendations for Executive Action 1. To improve the quality of information and oversight of multiemployer plans, we recommend that EBSA, IRS, and PBGC amend existing interagency memoranda of understanding to address, among other things, the agencies plans for sharing information they collect on multiemployer plans on an ongoing basis. Specifically, the agencies should address how they will share data: Page 44 GAO-11-79 Multiemployer Pensions
Pg 201 of 250 To identify the universe of multiemployer plans. To reconcile similar information received by each agency. To identify possible reporting compliance issues and take appropriate enforcement action. The agencies should revisit this agreement periodically to determine whether modifications are required to ensure that each agency is able to carry out its responsibilities. 2. To collect more useful information from plans, the Secretary of the Treasury should direct the IRS to develop a standardized electronic form for annual certifications that requires plans to submit their funded percentage. 3. To implement better and more effective oversight practices, the Director of the PBGC should develop a more proactive approach to monitoring multiemployer plans, such as assigning case managers to work with the plans that pose the greatest risk to the agency and provide non-financial assistance to troubled plans on an ongoing basis. Agency Comments and Our Evaluation We provided a draft of this report to the Secretary of Labor, the Secretary of the Treasury, and the Director of PBGC for review and comment. Each agency provided us with written comments, which we reprinted in appendixes II, III, and IV of this report. In responding to the draft report, the agencies acknowledged the vital role of these plans in providing retirement security to millions of U.S. workers and retirees. PBGC further noted that the agency has limited information to analyze the health of multiemployer plans, and that additional information is needed to monitor plan health. The three agencies also generally agreed with our recommendations to improve interagency information sharing and to take steps to acquire more current and accurate data on the status of multiemployer plans. The agencies noted, however, that in their view a new interagency MOU was unnecessary. The Department of the Treasury highlighted actions that the agency currently takes to coordinate with the other agencies. The Department of Labor provided an updated status of the actions that the agency has taken with regard to multiemployer plans. For example, EBSA said it recently initiated contact with IRS to begin work on reconciling Page 45 GAO-11-79 Multiemployer Pensions
Pg 202 of 250 certain multiemployer data. IRS and PBGC further stated that memoranda were already in place that could be amended to allow for better information sharing. While we are encouraged by these developments, we do not believe that separate arrangements among agencies will produce the kind of interagency cooperation needed to facilitate information sharing and effective ongoing monitoring of the health of multiemployer plans. Therefore, we continue to believe that, in order to foster meaningful interagency coordination, the agencies should either amend existing agreements or enter into new ones, as we are recommending. EBSA and PBGC also provided technical comments, which we incorporated in this report, as appropriate. As agreed with your office, unless you publicly announce its contents earlier, we plan no further distribution of this report until 30 days from its issue date. At that time, we will send copies of this report to relevant congressional committees, PBGC, the Secretary of Labor, the Secretary of the Treasury, and other interested parties. In addition, the report will be made available at no charge on the GAO Web site at http://www.gao.gov. If you or your staff have any questions about this report, please contact me at (202) 512-7215 or bovbjergb@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made contributions to this report are listed in appendix V. Sincerely yours, Barbara D. Bovbjerg Managing Director, Education, Workforce, and Income Security Issues Page 46 GAO-11-79 Multiemployer Pensions
Pg 203 of 250 Appendix I: and Appendix I: Objectives, Scope, and Methodology Methodology We were asked to answer the following research questions: (1) What is the current status of the nation s multiemployer pension plans? (2) What steps does PBGC take to monitor the health of these plans? (3) What is the structure of multiemployer plans in other countries? (4) What statutory and regulatory changes, if any, are needed to help plans to continue to provide participants with the benefits due to them? To identify the current status of the nation s multiemployer pension plans, we interviewed officials and analyzed data and documents from PBGC, the Department of Labor s Employee Benefits Security Administration (EBSA) and the Department of the Treasury s Internal Revenue Service (IRS), and reviewed relevant industry studies and literature on multiemployer plans. To determine the recent funding status of multiemployer plans, we analyzed historical summary data published in PBGC s annual data books and summary data from IRS on the annual notices of funding status certification submitted in 2008 and 2009. To corroborate these data, we analyzed notices of critical and endangered status and WRERA notices sent to PBGC and EBSA and published on EBSA s Web site. To identify the demographics of multiemployer plans, including the number of plans, number of participants, and industry concentration of plans, we analyzed data published in PBGC s annual reports and data books. To determine private-sector union affiliation, we analyzed data from the Bureau of Labor Statistics. We assessed the reliability of the selected data that we used from these sources by comparing the number of plans filing reports to federal agencies. We determined that, although the data were incomplete and had certain limitations, which we present in our report, they were sufficiently reliable for the purpose of making clear which federal agencies collect data and showing how these data are similar and how they differ. To supplement this quantitative analysis, we interviewed EBSA, IRS, and PBGC officials; and a diverse range of pension experts and multiemployer plan practitioners. We selected experts based on those who had published on multiemployer plans or whose names were referred to us by other interviewees, and we spoke to 48 experts. We analyzed their responses on the current status of plans, the impact of the recent recession, and the future outlook of multiemployer plans. As appropriate, we reviewed relevant federal laws and regulations that pertain to multiemployer plans. To determine the steps PBGC takes to monitor the health of multiemployer plans, we interviewed PBGC officials and reviewed documentation on PBGC s multiemployer plan monitoring, modeling, and assistance policies and procedures. We also reviewed relevant statutory and PBGC regulatory requirements with regard to multiemployer plans. Page 47 GAO-11-79 Multiemployer Pensions
Pg 204 of 250 Appendix I: Objectives, Scope, and Methodology To understand the structure of multiemployer plans in other countries, we reviewed four countries selected because of their comparable multiemployer plan frameworks the Netherlands, Denmark, United Kingdom, and Canada and interviewed government officials, plan administrators and trustees, employer and union representatives, and other pension experts. We selected these countries after completing an initial review of employer-sponsored pension plan designs in Organisation for Economic Co-operation and Development (OECD) countries. We focused on OECD countries in order to increase our opportunity to identify practices used in countries with well-developed capital markets and regulatory regimes comparable, if not always similar, to the United States. We acknowledge that there may be relevant plan design features from a non-oecd country that we did not address in this report. Although we did not independently analyze each country s laws and regulations, we collected information about each country s multiemployer plan structure and interviewed government officials and pension experts and in each country. We relied on the expertise of staff in the U.S. State Department to identify potential interviewees in these countries and to schedule the interviews. We did not review the laws or requirements of those foreign countries mentioned in this report. Rather, we relied upon the descriptions and materials furnished by officials and experts of these countries. To identify what statutory and regulatory changes, if any, are needed to help plans continue to provide participants with the benefits due to them, we reviewed pension literature and interviewed a variety of experts on multiemployer plans, including officials from EBSA, IRS, and PBGC; pension experts; and practitioners representing a range of industries and plan sizes. We selected experts based on those who had published on multiemployer plans or whose names were referred to us by other interviewees, and we spoke to 48 experts. We conducted this performance audit from September 2009 through October 2010, 1 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe 1 Subsequent to sending a draft of this report to the agencies for comment, the report s date of issuance was changed from fiscal year 2010 to fiscal year 2011. As a result, the number of the report was changed from GAO-10-926 to GAO-11-79. Page 48 GAO-11-79 Multiemployer Pensions
Pg 205 of 250 Appendix I: Objectives, Scope, and Methodology that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Page 49 GAO-11-79 Multiemployer Pensions
Pg 206 of 250 Appendix II: from the Department of Labor Appendix II: Comments from the Department of Labor Page 50 GAO-11-79 Multiemployer Pensions
Pg 207 of 250 Appendix II: Comments from the Department of Labor Page 51 GAO-11-79 Multiemployer Pensions
Pg 208 of 250 Appendix II: Comments from the Department of Labor Page 52 GAO-11-79 Multiemployer Pensions
Pg 209 of 250 Appendix III: from the Department of the Treasury Appendix III: Comments from the Department of the Treasury Page 53 GAO-11-79 Multiemployer Pensions
Pg 210 of 250 Appendix III: Comments from the Department of the Treasury Page 54 GAO-11-79 Multiemployer Pensions
Pg 211 of 250 Appendix III: Comments from the Department of the Treasury Page 55 GAO-11-79 Multiemployer Pensions
Pg 212 of 250 Appendix IV: from the Pension Benefit Guaranty Corporation Appendix IV: Comments from the Pension Benefit Guaranty Corporation Page 56 GAO-11-79 Multiemployer Pensions
Pg 213 of 250 Appendix IV: Comments from the Pension Benefit Guaranty Corporation Page 57 GAO-11-79 Multiemployer Pensions
Pg 214 of 250 Appendix IV: Comments from the Pension Benefit Guaranty Corporation Page 58 GAO-11-79 Multiemployer Pensions
Pg 215 of 250 Appendix V: GAO and Staff A Appendix V: GAO Contact and Staff cknowledgments Acknowledgments GAO Contact Staff Acknowledgments Barbara Bovbjerg (202) 512-7215 or bovbjergb@gao.gov Individuals making key contributions to this report include David R. Lehrer, Assistant Director; Jonathan S. McMurray, Analyst-in-Charge; Robert Campbell; and Thanh Lu. Joseph Applebaum, Susan Aschoff, and Roger J. Thomas also provided valuable assistance. (130957) Page 59 GAO-11-79 Multiemployer Pensions
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Pg 217 of 250 Exhibit D-6
THE FORGOTTEN EMPLOYEE BENEFIT CRISIS: MULTIEMPLOYER BENEFIT PLANS ON THE BRINK Paul M. Secunda* This Article provides a first time look at the numerous challenges facing multiemployer or Taft Hartley benefit plans in the post-global recession and health care reform world. These plans have provided pension, health, and welfare benefits to union members of smaller employers in itinerant industries for over sixty years and even today these plans collectively have over 10 million participants in over 1,500 plans. Multiemployer plans are increasingly mired in financial trouble and are finding it more difficult to continue providing adequate retirement and health benefits to their members. Although they once represented one of the great triumphs in American labor relations, these plans are now becoming just another part of the growing employee benefits crisis confronting the United States. The purpose of this Article is to consider, and respond to, the various financial, healthcare, and judicial challenges that threaten the ongoing viability of these plans. By addressing these challenges in a systematic manner, this Article seeks to provide a more sustainable path forward so that multiemployer benefit plans can continue to provide crucial employee benefits to the next generation of union workers. INTRODUCTION... 78 I. MULTIEMPLOYER BENEFIT PLAN PRIMER... 82 II. THE FINANCIAL CHALLENGE TO MULTIEMPLOYER PENSION PLANS... 88 A. Permit Cutting of Vested Benefits... 90 B. Cap or Eliminate Withdrawal Liability... 91 C. Chapter 11-Type Bankruptcy Procedure As Alternative to Plan Partitioning... 92 * Associate Professor of Law, Marquette University Law School. This article grew out of a shorter trade publication piece for a non-legal audience of multiemployer plan trustees, which will appear in the TRUSTEES HANDBOOK: A BASIC TEXT ON LABOR-MANAGEMENT EM- PLOYEE BENEFIT PLANS, Chapter 3 (Kordus 7th ed. forthcoming 2011). Many thanks to Marcia McCormick, Colleen Medill, and David Pratt for their insightful comments on this complex topic. I would also like to thank Elisabeth Derango, Marquette University Law School Class of 2012, for her excellent research assistance on this paper. 77
78 CORNELL JOURNAL OF LAW AND PUBLIC POLICY [Vol. 21:77 III. D. Reduce Investment Assumption Rates and Permit Plans to Hedge... 94 THE LEGISLATIVE CHALLENGE TO MULTIEMPLOYER HEALTH PLANS... 95 A. Grandfathered Plans... 96 B. Minimum Essential Coverage... 98 C. Health Benefit Exchanges... 99 IV. THE JUDICIAL CHALLENGE TO MULTIEMPLOYER PENSION AND HEALTH PLANS... 101 A. Denial of Benefit Claims Under ERISA... 102 B. Inherently Conflicted Multiemployer Plans... 103 CONCLUSION... 106 INTRODUCTION The benefits world was abuzz in 2007 when the big three Detroit automakers General Motors, Chrysler, and Ford established voluntary employees beneficiary associations (VEBAs) 1 to deal with the growing amount of debt related to their legacy costs. 2 VEBAs provide payments of life, health, accident, or other similar benefits to members or their beneficiaries. 3 These tax-exempt trusts are able to remove immense healthcare obligations from company balance sheets, while at the same time ensuring retirees some level of benefit that might otherwise be lost should the employer file for bankruptcy or renege on previous lifetime 1 VEBA[s] allow[ ] an employer to reach an agreement with the applicable union to fund a stand-alone, tax-exempt trust that assumes full responsibility for all future retiree health benefits. See Susan E. Cancelosi, VEBAs to the Rescue: Evaluating One Alternative for Public Sector Retiree Health Benefits, 42 J. MARSHALL L. REV. 879, 899 (2009) (citing Aaron Bernstein, Can VEBAs Alleviate Retiree Health Care Problems?, 1 CAPITAL MATTERS: OCCA- SIONAL PAPER SERIES 7 (Apr. 2008), http://www.law.harvard.edu/programs/lwp/pensions/publications/occpapers/occasionalpapers_ap9_fin2.pdf). 2 See Sholnn Freeman & Frank Ahrens, GM, Union Agree on Contract to End Strike; Deal Seen as Model Across Industries, WASH. POST, Sept. 27, 2007, at A1 ( Under the new contract, UAW retiree benefits will be paid out by a voluntary employees beneficiary association (VEBA). ). Legacy costs are: [t]he costs involved with a company paying increased healthcare fees and other benefit-related costs for its current employees and retired pensioners. See Legacy Costs, INVESTOPEDIA, http://www.investopedia.com/terms/l/legacycosts.asp (last visited Mar. 4, 2011). 3 I.R.C. 501(c)(9) (2006).
2011] THE FORGOTTEN EMPLOYEE 79 healthcare promises. 4 The hope was that these VEBAs would cap legacy costs, especially employer liability for retiree medical benefits. 5 But the need for VEBAs in the first place to help contain legacy costs also sheds needed light on a related and much more troubling employee benefits issue that has been neglected for far too long. The employee benefit plans that provide retiree, health, and other welfare benefits to unionized workers and retirees are generally struggling to survive the current economic and regulatory environment in the United States. These multiemployer plans, also referred to as Taft Hartley plans, are collectively bargained 6 and maintained by one or more employers, usually within the same or related industries. 7 Although multiemployer plans may seem less relevant today, given lower union density levels in America, there are in fact more than 10 million participants nationwide in over 1,500 multiemployer plans. 8 Part of the problem is that these plans are increasingly mired in financial trouble and are finding it more difficult to successfully negotiate new legislative and navigate judicially-imposed obstacles. Although these plans once represented one of the great triumphs in American labor relations in providing employee benefits to workers of small employers in itinerant industries like building and construction, trucking, retail, and the entertainment industry 9 such plans are quickly becoming 4 See Daniel Keating, Automobile Bankruptcies, Retiree Benefits, and the Futility of Springing Priorities in Chapter 11 Reorganizations, 96 IOWA L. REV. 261, 267 (2010) (citing in part Steven J. Sacher, Issueman Tackles the New VEBAs, 35 PENS. & BEN. REP. (BNA) 820 (Apr. 8, 2008)) ( Typically, an employer will seriously consider a VEBA trust for retiree medical benefits when certain conditions are present. The employer must be a company that is financially precarious enough that the possibility of bankruptcy legitimately threatens its employees. ). 5 See id. at 265 67. 6 See Introduction to Multiemployer Plans, PENS. BEN. GUAR. CORP., http:// www.pbgc.gov/prac/multiemployer/introduction-to-multiemployer-plans.html (last visited Mar. 4, 2011). See also Concrete Pipe & Prod. of Cal., Inc. v. Constr. Laborers Pens. Trust for S. Cal., 508 U.S. 602, 637 38 (1993) ( [T]he nature of multiemployer plans... [is to] operate by pooling contributions and liabilities. ). 7 See Concrete Pipe, 508 U.S. at 605 06. 8 See George M. Kraw, Four Reforms to Save Multiemployer Plans, BNA PENS. & BEN. DAILY, Nov. 17, 2010, at 1, http://www.kraw.com/pdf/kraw-pension-benefits.pdf; U.S. GOV T ACCOUNTABILITY OFFICE, GAO-11-79, CHANGES NEEDED TO BETTER PROTECT MULTIEM- PLOYER PENSION BENEFITS 1 (2010), available at http://www.gao.gov/highlights/ d1179high.pdf [hereinafter GAO]. There are also roughly sixteen million retired workers and their families who receive health and other benefits from these plans. See DEPARTMENT OF LABOR, Comment Letter from the Nat l Coord. Comm. for Multiemployer Plans to the Emp. Ben. Sec. Admin 1 (Apr. 29, 2008), available at http://www.dol.gov/ebsa/pdf/nccmp042908. pdf [hereinafter National Coordinating Committee for Multiemployer Plans]. 9 See Kraw, supra note 8.
80 CORNELL JOURNAL OF LAW AND PUBLIC POLICY [Vol. 21:77 just another part of the growing employee benefits crisis confronting the United States. 10 Three principal challenges face multiemployer plans in the coming years. First, a significant number of benefit plans are increasingly underfunded and in danger of becoming insolvent. 11 This state of affairs is due in no small part to both decreasing union membership 12 and more retirees. 13 Recent legislation in the form of the Pension Protection Act of 2006 (PPA) 14 did not appear to go far enough in addressing the financial woes of multiemployer plans. 15 Although the Pension Relief Act of 2010 (PRA) 16 does provide some funding relief for multiemployer pension plans in response to the current unstable economic environment, it is 10 See, e.g., Keating, supra note 4, at 294 ( Today, the folly of creating new legacy costs is nothing short of obvious to employers as they watch both the defined-benefit pension crisis and the retiree-medical-benefit crisis play themselves out on Wall Street and on Main Street. ); David Cho, Growing Deficits Threaten Pensions: Accounting Tactics Conceal a Crisis for Public Workers, WASH. POST, May 11, 2008, at A1 (discussing state pension crises). 11 See GAO, supra note 8 ( Most multiemployer plans report large funding shortfalls and face an uncertain future. ). 12 See News Release, BUREAU OF LABOR STATISTICS, Union Members 2010, at 1 (Jan. 21, 2011), www.bls.gov/news.release/pdf/union2.pdf (explaining that union membership decreased in 2010 by 612,000 workers). The number of Taft Hartley plans is at a low point, and private-sector unions in the United States are currently struggling to keep their density rate over 7% of the workforce. See Charles A. Jeszeck, Private Pensions: Long-standing Challenges Remain for Multiemployer Pension Plans, Testimony Before the Committee on Health, Education, Labor and Pensions, U.S. Senate, (May 27, 2010), in GAO Highlights, Report on GAO-10-708T, May 27, 2010, at 9, 11, http://help.senate.gov/imo/media/doc/jeszeck.pdf (discussing how the number of multiemployer plans has decreased steadily since the 1980s). 13 The Future of Retirement in the United States: Hearing before the S. Sp. Comm. On Aging, 108th Cong. 1 (2004) (statement of, Jagadeesh Gokhale), available at http:// www.cato.org/testimony/ct-jg040122.html [hereinafter Future of Retirement] ( Population projections by the Social Security Administration indicate that between the year 2003 and 2030, the number of working-aged individuals (those aged 20 64) will increase by just 13.3 percent. The number of those aged 65 and older, however, will increase by 93.1 percent. (These rates of population increase were 51.6 percent and 71.1 percent respectively during the previous 30 years.) ). 14 Pension Protection Act (PPA) of 2006, Pub. L. No. 109-280, 120 Stat. 780. PPA establishes for multiemployer pension plans new funding requirements, additional funding rules for plans that are in endangered or critical status, enhanced disclosure requirements to participants regarding a plan s funding status, and a requirement that defined benefit plans offer a joint and 75% survivor annuity option. PENS. ANALYST, Pension Protection Act of 2006 Requires Major Changes to Multiemployer Defined Benefit Plans in 2008 and Beyond, PRUDENTIAL FINANCIAL, Jun. 2007, at 1, http://www.prudential.com/media/managed/pensanalyst.ppa06.multiemployerdb.2008.pdf [hereinafter PENSION ANALYST]. 15 For instance, among other provisions, it merely gives incentives to Taft Hartley plans that find themselves in endangered, seriously endangered or critical status to ensure that these underfunded plans address their funding issues. PENSION ANALYST, supra note 14, at 3. Yet these notice and reporting requirements have not stopped the hemorrhaging, as more Taft Hartley plans are in danger now than in 2006. See infra note 67 and accompanying text. 16 Pension Relief Act (PRA) of 2010, Pub. L. No. 111-192, 124 Stat. 1280.
2011] THE FORGOTTEN EMPLOYEE 81 still unclear what long-term impact it will have. 17 Finally, more recent legislation to provide multiemployer plans with some financial help, such as The Create Jobs and Save Benefits Act of 2010, 18 have died in the Senate committee this past year. 19 In addition to these financial woes facing multiemployer pension plans, a second major issue facing multiemployer plans involves new healthcare regulations. Multiemployer health benefits are perceived as too generous, 20 and starting in 2018, they may face a new 40% excise tax under the federal Patient Protection and Affordable Care Act of 2010 (PPACA). 21 Multiemployer health plans also must consider the impact of new PPACA provisions involving grandfathered plans, minimum essential benefits, and health benefit exchanges. Only by negotiating this new regulatory terrain can these plans hope to continue providing cost-effective health benefits to their members. Third, and finally, there are significant judicial challenges to both multiemployer pension and health plans. Recent decisions made by courts in the multiemployer plan context have made governance of such plans, by plan administrators and other fiduciaries, even more difficult. This is problematic because multiemployer plan administrators need to know the scope of their fiduciary obligations when dealing with claim issues, so as not to inadvertently breach their fiduciary duties to plan participants and beneficiaries while making claim determinations. 22 To illustrate typical interpretation issues in this environment, this Article considers recent developments in how reviewing courts handle benefit denials. Consideration of these issues will give some indication of the 17 The PRA specifically includes provisions that will reduce required employer contributions and will extend the amortization period for investment losses for multiemployer plans. Id. 211. 18 S. 3157, 111th Congress (2010), available at http://thomas.loc.gov/cgi-bin/query/ z?c111:s.3157: [hereinafter Bill Text] (permitting multiemployer pension plans to merge or form alliances with other plans, as well as to increase PBGC guarantees for insolvent plans to increase participant benefits). 19 See THE LIBRARY OF CONGRESS, Bill Summary & Status, 111th Congress (2009-2010), S. 3157, http://thomas.loc.gov/cgi-bin/bdquery/z?d111:s.03157: (last visited Apr. 4, 2011) (noting that last major action was referral of bill to Senate Committee on March 23, 2010). 20 See Editorial, Cadillac Plans, N.Y. TIMES, Jan. 16, 2010, http://www.nytimes.com/ 2010/01/16/opinion/16sat1.html?pagewanted=1&_r=1 (defining employer-sponsored as highpriced health insurance policies). 21 Patient Protection and Affordable Care Act of 2010, Pub. L. No. 111-148, 124 Stat. 119. Although PPACA faces numerous constitutional challenges in the courts, which means that the 2018 Cadillac tax and other provisions could be struck down. Patricia Donovan, Tis the Season for Constitutional Challenges to PPACA, HEALTHCARE INTELLIGENCE NETWORK (Dec. 22, 2010), http://hin.com/blog/2010/12/22/tis-the-season-for-constitutional-challengesto-ppaca. This Article proceeds under the assumption that PPACA will eventually be found to be constitutional. 22 See infra note 33 and accompanying text.
82 CORNELL JOURNAL OF LAW AND PUBLIC POLICY [Vol. 21:77 complexity of the questions that the Judiciary continues to wrestle with in the multiemployer plan context. This Article proceeds in four Parts to describe the significant challenges facing multiemployer plans in the current political and legal environment. Part I introduces the basics of multiemployer benefit plans. Part II considers the financial challenges to multiemployer pension plans and possible solutions. Part III explores the potential impact that PPACA may have on the ability of multiemployer health plans to continue providing health benefits to their members on a cost-effective basis. Lastly, Part IV concludes by looking at a typical issue of judicial interpretation that threatens to make multiemployer pension and healthcare plan administration even more complicated. The hope is that by addressing financial, healthcare, and judicial challenges, a more sustainable way forward can be plotted so that multiemployer benefit plans can continue to provide crucial employee benefits to the next generation of union workers. I. MULTIEMPLOYER BENEFIT PLAN PRIMER Employees receive many different types of compensation for their work. An increasingly large portion of this compensation, as much as 40% in some cases, is in the form of employee benefits. 23 Employee benefits come in two generic flavors: deferred compensation and in-kind benefits. The primary examples of deferred compensation plans are pensions and retirement plans. Employees earn this type of compensation in the present, but it is not available to the employee until later generally after reaching normal retirement age. On the other hand, compensation that is usable in the short-term, such as health, disability, or life insurance benefits, constitutes in-kind payments. The Employee Retirement Income Security Act of 1974 (ERISA) 24 is the comprehensive federal law that regulates the provision of employer-provided pension benefit and welfare plans: ERISA protects employee pensions and other benefits by providing insurance[,]... specifying certain plan characteristics in detail[,]... and by setting forth certain general fiduciary duties applicable to the management of both pension and nonpension benefit plans. 25 Although employers are not required to offer employee benefit plans to their employees, once such plans are adopted, ERISA provides the applicable legal framework. 23 See STEVEN L. WILLBORN, STEWART J. SCHWAB, JOHN F. BURTON, JR. & GILLIAN LESTER, EMPLOYMENT LAW: CASES AND MATERIALS 665 (4th ed. 2007). 24 29 U.S.C. 1001 1461 (Supp. 2010). Following the practice of other ERISA articles, this Article hereinafter refers to the original section numbers as enacted by ERISA in the ERISA format, rather than to the United States Code section numbers. 25 Varity Corp. v. Howe, 516 U.S. 489, 496 (1996).
2011] THE FORGOTTEN EMPLOYEE 83 Rather than relying on the distinction between deferred compensation and in-kind benefits, ERISA divides the universe of covered employee benefit plans into employee pension benefit plans and employee welfare-benefit plans. 26 ERISA plans can also be categorized by the type and number of employers engaged in their provision. Most employer plans are single employer plans run by individual employers. 27 On the other hand, multiemployer plans are sponsored by more than one employer under provisions of a collective bargaining agreement for the benefit of union members, 28 while multiple employer plans are sponsored by unrelated employers, outside of a collective bargaining agreement. Different provisions apply to these benefit plan arrangements under ERISA. 29 In addition to ERISA, multiemployer plans are also regulated by Section 302(c)(5) of the Taft Hartley Amendments of 1947. 30 Under Section 302(c)(5), multiemployer benefit plans must be established in trust to provide employee benefits to union employees. 31 The union and management must each appoint half of the plan s trustees. 32 Regardless of who appointed them, trustees have a fiduciary duty to act in the sole and exclusive interest of the plan and its participants. 33 Because a multiemployer plan involves more than one employer, it is not uncommon for large plans to have hundreds, or even thousands of contributing employers. 34 Employer contributions are usually made on a per-hour basis, but may also be measured by some other unit of production. Service with all of the employers contributing to the plan is added together to compute a participant s vesting and benefit-accrual credit. 35 These features allow an employee to accrue pension and health benefits seamlessly, despite transfers from one contributing employer to another. 36 26 See ERISA 3(3), 3(4). 27 See generally JOHN H. LANGBEIN, SUSAN J. STABILE & BRUCE A. WOLK, PENSION AND EMPLOYEE BENEFIT LAW 64 71 (4th ed. 2006). 28 See ERISA 3(37). 29 See generally COLLEEN E. MEDILL, INTRODUCTION TO EMPLOYEE BENEFITS LAW: POL- ICY AND PRACTICE 240 (3d ed. 2011). 30 Labor Management Relations Act of 1947, Pub. L. 80-101, 61 Stat. 136 (codified as amended at 29 U.S.C. 186(c)(5) (2006)). 31 Id. 32 Id. (requiring a multiemployer plan to be maintained as a trust fund sponsored by a joint board of trustees, and that employees and employers are equally represented in the administration of [the] fund ). 33 Introduction to Multiemployer Plans, supra note 6. 34 See National Coordinating Committee for Multiemployer Plans, supra note 8. 35 See Introduction to Multiemployer Plans, supra note 6 ( The bargaining parties negotiate a contribution rate and the trustees translate that rate into a benefit. Decisions to increase benefits or change the plan are also typically made by the board of trustees. ). 36 Indeed, portability of plan benefits between employers is one of the primary advantages of the multiemployer plan framework. See Newsletters/Alerts, Executive Alert: Multiem-
84 CORNELL JOURNAL OF LAW AND PUBLIC POLICY [Vol. 21:77 Although individual employers make contributions measured by the work performed by their workers, those contributions, once received, are not specifically earmarked for the employees of the employers who make them. 37 Rather, all contributions, and the earnings thereon, are available to pay the benefits of each participant, based on that participant s service record. Thus, multiemployer plans operate by pooling contributions and liabilities. 38 Furthermore, [a]n employer s contributions are not solely for the benefit of its employees or employees who have worked for it alone. 39 With regard to pension benefits, most multiemployer pension plans are established and maintained as defined benefit plans (DBPs). 40 Employee pension benefit plans under ERISA generally come in two distinct types: DBPs and defined contribution plans (DCPs). 41 Because employers are responsible for providing a defined benefit amount to employees at retirement under DBP arrangements, there is more regulation of these plans so that the promised benefits are available upon retirement and plans do not default on their pension promises. For instance, ERISA provides minimum vesting, benefit accrual, and funding standards for DBPs and sets up an insurance scheme, operated by the Pension Benefit Guaranty Corporation (PBGC), to address cases of employer terminations. 42 On the other hand, employers are only responsible to contribute money to employee s individual plan accounts under the DCP model and that is where their responsibility ends. In DBPs, which are the focus of this Article, the burden is placed on the employer to contribute funds to the pension plan on an actuariallysound basis so that sufficient funds exist to pay the worker when she retires. 43 Under this arrangement, the risk is placed on the employer to invest sufficiently to fund the ongoing pension expenses. The required ployer Pension Funding Reform: Helpful, but Systemic Problems Persist, Baker & Hostetler LLP, (May 28, 2010), http://www.bakerlaw.com/alerts/multiemployer-pension-funding-reform-helpful-but-systemic-problems-persist-05-28-2010/ [hereinafter Executive Alert] ( [A]n employee who moves amongst several employers in the same industry will accrue an aggregate... benefit which will reflect all of the work performed by that employee in that industry. ). 37 See Concrete Pipe & Prod. of Cal., Inc. v. Constr. Laborers Pens. Trust for S. Cal., 508 U.S. 602, 637 38 (1993). 38 Id. 39 Id. 40 See Cent. States, Se. & Sw. Areas Pens. Fund v. Schilli Corp., 420 F.3d 663, 667 (7th Cir. 2005). 41 See ERISA 3(4). 42 See Introduction to Multiemployer Plans, supra note 6 ( Multiemployer plans are subject to many of the vesting, accrual, and minimum participation rules that apply to singleemployer plans. ). 43 See id. ( Most multiemployer plans are unit benefit plans that offer a specified dollar-amount benefit per month multiplied by years of credited service. ).
2011] THE FORGOTTEN EMPLOYEE 85 minimum funding of DBPs is calculated based on a complex actuarial analysis revolving around factors such as age, length of service, projected future salary increases, and rate of return on plan investments. 44 The current low level of union density in the private sector of the United States has been especially problematic in multiemployer defined benefit plans because such plans operate on the assumption that current workers contributions to the plan will support older workers in their retirement. 45 With multiemployer plans, [t]he general principle at work is that each employer must make regular contributions to the plan to fund the... benefits of those employees who perform services for that employer. 46 Benefits from a defined benefit plan are primarily paid in the form of an annuity, which comes in many forms, but generally provides a stream of payments to the employee for the rest of their life. 47 As a result of the annuity form of payment, not only is the risk of investment return placed on the employer, but so is the risk of employee longevity. 48 ERISA also requires that DBPs contain payment features that permit a spouse to continue to receive some benefit from the plan after the death of the covered employee. 49 Because of the risks associated with employers maintaining defined benefit plans, ERISA establishes a scheme of plan termination insurance. 50 Congress created the PBGC to administer this insurance program and provide some level of retirement income for employees under DBPs, 44 Funding of defined benefit plans is highly regulated by ERISA under the complex minimum funding standards of ERISA 301 305. 45 See Jeszeck, supra note 12, at 10 (explaining that for multiemployer plans the proportion of active participants paying into the fund[s] to others who are no longer paying into the fund[s] has decreased, thereby increasing plan liabilities. ). 46 Executive Alert, supra note 36. 47 See David Pratt, Retirement in a Defined Contribution Era: Making the Money Last, 41 J. MARSHALL L. REV. 1091, 1139 (2008). 48 See id. at 1139 41; Marion Crain, Afterword: The American Romance with Autonomy, 10 EMP. RTS. & EMP. POL Y J. 187, 201 n.33 (2006) ( Most of these employers were planning to shift [from defined benefit plans] to expanded 401(k) plans in which employees rather than employers will bear the risks of inflation, market volatility, and longevity (outliving one s savings). ); Edward A. Zelinsky, The Defined Contribution Paradigm, 114 YALE L.J. 451, 477 (2004) ( [T]o the extent the employer maintaining a defined benefit plan attracts employees who value defined benefit coverage, the employer is likely to lure older employees and the longevity risks associated with a self-selected workforce attracted to a classic defined benefit annuity by the expectation of long life spans. ). 49 The qualified joint survivor annuity (QJSA) and qualified preretirement survivor annuity (QPSA) for surviving spouses are the default forms of distribution provided for under defined benefit plans. See ERISA 205. For a case concerning the annuity options for surviving spouses and the gender equity issues implicated thereby, see Lorenzen v. Emp. Ret. Plan of the Sperry & Hutchinson Co., 896 F.2d 228 (7th Cir. 1990). 50 ERISA 4022.
86 CORNELL JOURNAL OF LAW AND PUBLIC POLICY [Vol. 21:77 if the employer should default on their pension promises. 51 The cost of the PBGC is borne primarily by employers that maintain pension plans through monthly employer contributions. 52 Contribution amounts are calculated both by participant and based on the amount of unvested vested benefits the plan maintains. 53 Unfortunately, the PBGC currently has insufficient funds to cover many insured benefits and its multiemployer plan program has run a deficit every year since 2003. 54 Even when the PBGC has a surplus, it only provides a percentage of the normal retirement benefit below a limit set by statute. 55 Matters are made even more precarious because many employers of multiemployer plans are facing significant financial difficulties and increasingly are defaulting on their required contributions to these plans. 56 Although the trustees of these plans have the statutory authority to collect delinquent contributions under ERISA 515, 57 this is a time-consuming process and may require expensive litigation. 58 Terminations of defined benefit plans can be divided into two categories: mass withdrawals or plan amendments. 59 With a mass withdrawal, employers withdraw or cease to be obligated to contribute to the plan, while [a] plan amendment termination occurs when the plan adopts an amendment that provides that participants will receive no credit for service with any employer after a specified date, or an amend- 51 Id. See also About PBGC, PENS. BEN. GUAR. CORP., http://www.pbgc.gov/about/whowe-are.html (last visited Feb. 13, 2010). 52 See Introduction to Multiemployer Plans, supra note 6 ( In multiemployer plans, the amount of the employer s contribution is set by a collective bargaining agreement that specifies a contribution formula (such as $3 per hour worked by each employee covered by the agreement) and further provides that contributions must be paid to the plan on a monthly basis. ). 53 The Pension Protection Act of 2006 has recently increased the annual premium amount that employers must contribute to the PBGC, while at the same time increasing minimum funding requirements for such plans. See Pension Protection Act of 2006, H.R. 4, 109th Cong. 101 16, 401 12 (2006). 54 See Kraw, supra note 8, at 2 (By the beginning of fiscal year 2010, the deficit in PBGC funding for these plans was almost $1 billion.). 55 In 2009 the maximum protected pension was $54,000 for an employee who retired at age 65. Press Release, PENSION BENEFIT GUARANTY CORPORATION, PBGC Announces Maximum Insurance Benefit for 2009 (Nov. 3, 2008), available at http://www.pbgc.gov/news/press/ releases/pr09-03.html. The amount is higher for those who retire at a later age and less for those who retire when younger. Id. 56 See J. Mark Poerio et al., Pension Plan Funding Notices and Delinquent Plan Contributions 1, STAYCURRENT, Paul, Hastings, Janofsky & Walker LLP (May 2008), available at http://www.paulhastings.com/assets/publications/917.pdf ( The current economic downturn is likely to expand the ranks of underfunded multiemployer (union) pension plans, and cause more employers to fall behind in making required contributions to their pension and welfare plans. ). 57 ERISA 515. See also ERISA 502(g). 58 See Poerio et al., supra note 56. 59 ERISA 4041A.
2011] THE FORGOTTEN EMPLOYEE 87 ment that makes it no longer a covered plan. 60 Currently, the PBGC is responsible for $2.3 billion in future assistance to terminated multiemployer plans and it is unlikely that these funds will be recovered in the future. 61 Employers in underfunded multiemployer plans find it difficult to leave such plans because of the threat of withdrawal liability. 62 Congress enacted the Multiemployer Pension Plan Amendments of 1980 (MP- PAA) 63 in an effort to protect the financial stability of multiemployer pension plans, 64 and withdrawal liability is triggered when an employer partially or completely withdraws from such a plan. 65 The goal of withdrawal liability is to keep employers in the multiemployer arrangement by basing their liability on the employer s share of the plan s unfunded vested benefits. 66 Yet, as current PBGC funding deficits make clear, 67 this provision alone has not kept multiemployer pension plans from terminating, especially given current economic and demographic realities. 68 Nor has the MPPAA led to better funding of multiemployer plans. 69 This underfunded status has placed additional regulatory constraints on many plans under the Pension Protection Act and other pension laws. 70 60 Introduction to Multiemployer Plans, supra note 6 ( Unlike single-employer plans, multiemployer plans continue to pay all vested benefits out of existing plan assets and withdrawal liability payments. PBGC s guarantee of the benefits in a terminated, multiemployer plan payable as financial assistance to the plan only starts if and when the plan is unable to make payments at the statutorily guaranteed level. ). 61 Kraw, supra note 8, at 2. 62 See Jeszeck, supra note 12, at 7. 63 Multiemployer Pension Plan Amendments Act of 1980, Pub. L. No. 96-364, 94 Stat. 1208. 64 Multiemployer health plans, as discussed below, are not automatically subject to withdrawal liability. See infra notes 147 49 and accompanying text. 65 See Jeszeck, supra note 12, at 7 (explaining how plan withdrawal liability works). 66 See id. at 8 (explaining how this greater financial risk on employers and lower guaranteed benefit level for participants in multiemployer plans, [is supposed to] create incentives for employers, participants, and their collective bargaining representatives to avoid insolvency and to collaborate in trying to find solutions to the plan s financial difficulties. ). 67 For instance, Moody s Investor Service estimated the total unfunded liability of 126 of the nation s largest multiemployer pension plans at over $165 billion in 2008. See GAO Report, supra note 8. The National Coordinating Committee for Multiemployer Plans found in a 2009 survey that four out of every five of the plans reviewed were endangered or in critical condition as far as their funding levels. See id. Perhaps most significantly, the GAO reported in 2010 that the proportion of multiemployer plans that are less than 80 percent funded rose from 23 percent of plans in 2008 to 68 percent of plans in 2009. See id. 68 See Kraw, supra note 8, at 2 (discussing the how the financial reality of withdrawal liability is a disincentive for new employers to join multiemployer plans since withdrawal liability must be put on audited financial statements). 69 See Jeszeck, supra note 12, at 12 (discussing how the intent of MPPA to limit PBGC s exposure to future losses from underfunded plans has not yet been realized). 70 PENSION ANALYST, supra note 14, at 3 4 (noting additional funding and notice requirements for underfunded plans).
88 CORNELL JOURNAL OF LAW AND PUBLIC POLICY [Vol. 21:77 Having reviewed the necessary multiemployer plan framework and terminology, the next section considers proposals for overcoming the financial challenges to multiemployer pension plans. II. THE FINANCIAL CHALLENGE TO MULTIEMPLOYER PENSION PLANS Not surprisingly, the reason why many multiemployer pension plans are underfunded is the current global recession that began in 2007. 71 Many investments made by multiemployer trustees during this time period turned out disastrously. 72 Of course, multiemployer plans are not alone in this regard for instance, public pension plans also have endured significant losses in value during the recent global recession. 73 Yet, there is now new evidence that with the recovery of global and domestic markets, a good number of multiemployer pension plans are starting to recover financially. For instance, The Segal Company, in its Winter 2011 Survey of its 370 client plans, found that more than half of the surveyed plans (53%) were now in good financial health, a significant increase from 2009 (38%). 74 Of course, there are important structural issues as well. There are fewer new employee participants in these plans, while at the same time there is a larger aging workforce that needs to be paid out of these funds. 75 This means that the growth of multiemployer plans has been stalled by the lack of growth in union representation and the resultant lack of union economic power to bargain pension benefits for their members. Finally, the PGBC has been unable to keep up with the rate of newly-terminated multiemployer pension plans. 76 Multiemployer pension plan underfunding, however, is not a new issue or challenge. As explained in the previous section, Congress amended ERISA in 1980 to try to address the problem of significant underfunding of Taft Hartley plans. The MPPAA attempted to protect the financial stability of these plans through the introduction of withdrawal liability but problems with plan funding persist for many 71 Jeszeck, supra note 12, at 8. 72 See id. at 13 (discussing the serious short-term financial stresses experienced by multiemployer plans). 73 See William T. Payne & Stephen M. Pincus, The Constitutional Limitations of Public Employee Pension Reform Legislation, 19 THE PUBLIC LAWYER 12, 12 (2011) ( The recent recession has refocused attention on the issue of underfunded government pensions in the United States. ). 74 See Survey of Plans 2010 Zone Status, SEGAL SURVEY 1 (Winter 2011), http://www. segalco.com/publications/surveysandstudies/winter2011zonestatus2010.pdf. 75 Id. at 10 (commenting on the decrease in the proportion of active participants to retirees due to an aging workforce). 76 See id. at 11 12 (discussing how PBGC s liabilities have outpaced asset growth since 1998).
2011] THE FORGOTTEN EMPLOYEE 89 Taft Hartley funds. 77 There are, however, many reforms that could potentially cure some of these funding issues. For instance, current employees do not directly contribute to their pension plans, unlike their public pension plan counterparts. 78 Additionally, most multiemployer pension plans are defined benefit plans, which put the risk of funding these plans squarely on employers. 79 Such defined benefit plans also require compliance with complicated and time-consuming benefit vesting schedules. 80 Like in the single employer plan context, multiemployer pension plans could consider adopting a defined contribution plan paradigm, which would mean that once the employers contributed to the multiemployer pension plan, their funding responsibilities would end. Not surprisingly, however, both increased employee contributions and shifting to the defined contribution model would likely lead to strong union and employee objections. This is because there is a belief among unions and their members that pensions are a form of deferred compensation and they take lower salaries now, in order to have retirement benefits later. 81 The argument continues that they should not have to forego even more of their salary in the short-term due to increased contributions. Additionally, unions and their members maintain that they should not have all the responsibility of investing their retirement monies so that they have enough to retire on in the future. Indeed, recent experience in the single employer plan environment with 401K plans suggest that employees are far less ready for retirement under the defined contribution plan model and generally do not have enough money saved to retire successfully. 82 This state of affairs may be due to most U.S. employees the lack of financial sophistication. George Kraw, an attorney who specializes in the representation of multiemployer plans in California, and is a former member of the PBGC s Advisory committee, has put forth some other alternatives. 83 The rest of this Part considers four proposals advanced by Kraw, including: (1) more readily permitting plans to cut vested benefits; (2) allowing 77 Multiemployer Pension Plan Amendments Act of 1980, Pub. L. 96-364, 94 Stat. 1208. 78 See Paul M. Secunda, Constitutional Contracts Clause Challenges in Public Pension Litigation, 28 HOFSTRA LAB. & EMP. L.J. 263 (2011) (detailing how recent legislation would have Wisconsin public employees contribute funds to their public pension plans). 79 See supra note 48 and accompanying text. 80 See, e.g., ERISA 203(a) (29 U.S.C. 1053(a)). 81 See Lorraine A. Schmall, Keeping Employer Promises When Relational Incentives No Longer Pertain: Right Sizing and Employee Benefits, 68 GEO. WASH. L. REV. 276, 279 (2000) ( [E]mployees own their pension expectancies what they thought they were promised in exchange for working at a rate of pay that reflects contributions to their deferred benefits. ). 82 See Paul M. Secunda, 401K Follies: A Proposal to Reinvigorate the United States Annuity Market, ABA SECTION ON TAXATION NEWS QUARTERLY 13, 14 (Fall 2010) (arguing that reliance on defined contribution pension plans in the private-sector is likely to going to lead to a massive retirement income security problem in the United States). 83 See Kraw, supra note 8.
90 CORNELL JOURNAL OF LAW AND PUBLIC POLICY [Vol. 21:77 voluntary caps or elimination of withdrawal liability; (3) setting up a Chapter 11-type procedure for permitting multiemployer pension to equitably address financial difficulties; and (4) promoting a new fund investment strategy based on the new normal of investment return. 84 Although none of these proposals might be considered ideal from a worker perspective, unions and their members may be willing to buy into some of these proposals if like with the institution of VEBAs in 2007 in the retiree healthcare context little other choice exists in saving their pension benefits. A. Permit Cutting of Vested Benefits The first suggested reform is to allow plans to cut vested benefits if plan trustees deem it necessary and plan sponsors, like the employer and union, agree. 85 Currently, the Pension Protection Act of 2006 allows multiemployer plans to cut some vested benefits for plan participants if the plan s underfunded status becomes endangered or critical. 86 Kraw s proposal would extend this power to plans that are not yet critically underfunded, but are headed in that general direction. 87 The argument goes that it would be generally easier for Taft Hartley plans to act, without having to battle insolvency at the same time. 88 In this vein, Kraw comments that [t]he guiding principle here should be that plans must not be forced to adopt contribution rates from active participants that result in uncompetitive and unsustainable labor costs and loss of jobs. 89 Vested benefits are sacrosanct under ERISA. Indeed, there is a broad anti-alienation provision that prohibits accrued benefits from being used in most situations for anything but the benefit of the participants and beneficiaries of the plan. 90 Because of the sanctity of such vested benefits under employee benefits law, the promulgation of such a radical measure would have to be accompanied by the ability of the participating unions to veto any such measure. Of course, that might make the cutting of vested benefits less likely to happen, but it appears to be a step that 84 Id. at 2. 85 Id. 86 See PENSION ANALYST, supra note 14, at 3 4. Endangered status means that the fund is less than 80 percent funded, while critical status means that the fund is less than 65 percent funded. See Jeszeck, supra note 12, at 4. 87 Kraw, supra note 8, at 2. 88 Id. 89 Id. 90 Normally, the anti-alienation rules operate to prevent an employer from assigning or alienating plan benefits. See ERISA 206(d). In-service distributions from an individual account plan or qualified domestic relations orders (QDROs), which permit a plan administrator to pay a former spouse or other dependent from a participant s pension benefits, represent two important exceptions to the general anti-alienation provisions. Id.
2011] THE FORGOTTEN EMPLOYEE 91 should only be taken if the long-term prospects for the plan are dubious and immediate, and aggressive action is needed to keep the employers in the covered industry from shedding jobs. B. Cap or Eliminate Withdrawal Liability A second possible reform would be to cap or eliminate withdrawal liability to allow more employers to join multiemployer plans. 91 The idea here is that employers are not joining multiemployer pension plans because they are concerned about joining such a plan, and then when financial problems occur, potentially being stuck with vast withdrawal liability. 92 Kraw s suggested reform seeks to give multiemployer pension plans the ability to incentivize more employer members by either capping the possible amount of withdrawal liability or doing away with such liability altogether. 93 In this vein, Kraw argues that even though withdrawal liability is supposed to incentivize employers, unions, and participants to find solutions to their funding issues, the reality is that withdrawal liability has interfered with collective bargaining and kept new employers from joining multiemployer arrangements. 94 This proposal fails under principles of statutory preemption. 95 Multiemployer pension plans are simply not able to voluntarily agree with new employer members to cap or eliminate withdrawal liability, since such a provision would be directly inconsistent with MPPAA requirements and consequently, preempted. 96 Thus, Congress would have to amend the MPPAA in order to adopt the capping or elimination of withdrawal liability approach. Although Congress could conceivably undertake such steps to improve the solvency of multiemployer pension plans, the PBGC would likely be 91 Kraw, supra note 8, at 2. 92 Executive Alert, supra note 36 ( By participating in a multiemployer pension plan, an employer... accepts a risk of loss based on its share of the plan s unfunded pension obligations. For example, negative investment performance inevitably will require each remaining participating employer to contribute more, or face the prospect of a more significant withdrawal liability if and when it chooses (or has to) walk away. ). 93 Kraw, supra note 8, at 2. 94 Id. Indeed, Kraw s arguments ring true with many employee benefit law experts who have long believed that the MPPAA overreaches because no rational employer who has any choice would ever agree to join a multiemployer plan where withdrawal liability is completely out of its control and virtually unlimited in amount. See MEDILL, supra note 29, at 240. 95 Under a traditional statutory preemption analysis, conflict or obstacle preemption occurs where [a contractual provision] stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress. Crosby v. Nat l Foreign Trade Council, 530 U.S. 363, 373 (2000) (quoting Hines v. Davidowitz, 312 U.S. 52, 67 (1941)). 96 Waiver of withdrawal liability is only permitted to be undertaken by the PBGC; and then only where an employer has withdrawn completely from a plan and then subsequently resumes covered operations. See ERISA 4207; 29 C.F.R. 4207.1 4207.11 (2010).
92 CORNELL JOURNAL OF LAW AND PUBLIC POLICY [Vol. 21:77 against such a measure because almost all multiemployer pension plans are defined benefit plans, and the PBGC needs the withdrawal liability money for its own funding purposes. Furthermore, even if the MPPAA could be amended in this way, a cap may create a moral hazard problem and further increase the PBGC s potential liabilities. This is because PBGC premiums for insurance coverage are based on actuarial assumptions, 97 and the current ability to assess withdrawal liability is almost certainly built into these assumptions. C. Chapter 11-Type Bankruptcy Procedure As Alternative to Plan Partitioning Kraw s third proposed reform would create a Chapter 11-type bankruptcy procedure for severely distressed plans. 98 This reform would be an alternative to a proposal that has already been floated as a way to deal with some of the insolvency issues facing multiemployer pension plans. 99 Under the partition proposal, the PBGC s authority would be expanded to partition plans so that multiemployer pension plans would be able to at least save the viable parts of their plans. 100 Currently, PBGC has the authority to order the partition of a multiemployer pension plan. 101 The new proposed law, permitting qualified partitions, would permit a multiemployer plan to spin off into a new plan ( partitioned plan ) the liabilities and certain assets attributable to employees of employers who have filed for bankruptcy or who have failed to pay their withdrawal liability. 102 Additionally, this qualified partition proposal would transfer responsibility to the PBGC for payment of the full plan benefits of participants transferred to the partitioned plan, which in many cases would be well above the amount guaranteed by the PBGC under current law. 103 97 See Introduction to Multiemployer Plans, supra note 6. 98 Kraw, supra note 8, at 3. 99 Id. 100 Hearing on Multiemployer Defined Benefit Pension Plans: Before S. Comm. on Health, Education, Labor and Pensions, 111th Cong. 1 (2010) (statement of Phyllis C. Borzi, Assistant Secretary of Labor, Employee Benefit Security Administration), available at http:// www.dol.gov/ebsa/newsroom/ty052710.html. 101 Id. ( ERISA empowers the PBGC to order the partition of a multiemployer plan, either upon its own motion or upon application by the plan sponsor. Partition is a statutory mechanism that permits healthy employers to maintain a plan by carving out the plan liabilities attributable to employees of employers who have filed for Chapter 11 bankruptcy. Once partitioned, the PBGC assumes liability for paying benefits to the participants of this newly carvedout but terminated plan. ). 102 Id. 103 Id.
2011] THE FORGOTTEN EMPLOYEE 93 Interestingly, critics of the qualified partition proposal, including the Department of Labor s (DOL) Employee Benefit Security Administration (EBSA), worry that this proposal will take money away from the single-employer PBGC program and further burden the already underfunded PBGC. 104 Consequently, the Obama Administration is unlikely to support a qualified partition proposal at this time. As an alternative to qualified partitioning, Kraw suggests a Chapter 11-type bankruptcy procedure whereby the financial issues of financially-distressed plans could be handled in a more orderly manner and on a case-by-case basis. 105 These special bankruptcy rules for multiemployer plans would be particularly appropriate with plans whose financial obligations greatly exceed their assets, but who also still have significant financial holdings. 106 In such cases, a bankruptcy court could allocate losses by taking into account the interests of all stakeholders. 107 In particular, Kraw likes the fact that bankruptcy courts operate under equitable concepts of law and therefore could fashion a just outcome for all parties concerned. 108 Although it is accurate to say that bankruptcy courts have the ability to fashion equitable outcomes for distressed multiemployer pension plans, unions might not readily agree to allow the bankruptcy courts to decide the future of their benefit plans. Recent history has demonstrated that these courts have treated workers rights shoddily, including rights to retirement health benefits, all in the name of the allowing companies to emerge from bankruptcy. One notable example of how retiree benefits are treated in bankruptcy is provided by the case of In re Horizon Natural Resources Co. 109 This case demonstrates employers abilities to circumvent the requirements of Bankruptcy Code Section 1114, 110 even where union members have vested retirement benefits. In Horizon, ten unionized coal companies filed for bankruptcy under Chapter 11. 111 All of the companies 104 Id. ( We are concerned about the impact of the proposal on participants in singleemployer plans trusteed by the PBGC. As of the end of fiscal year 2009, the single-employer program insured about 33.6 million people covered by more than 27,600 plans, and reported a net deficit of $21.1 billion. ). 105 Kraw, supra note 8, at 3. 106 Id. 107 Id. 108 See id. 109 316 B.R. 268 (Bankr. E.D. Ky. 2004). 110 Section 1114 provides that the bankruptcy trustee shall timely pay and shall not modify any retiree benefits unless a modification is approved by the court or the retirees. See 11 U.S.C. 1114(e) (2006). The statute further limits such modifications, stating that if the employer causes a modification of retiree benefits within 180 days prior to the bankruptcy filing and at a time when the employer is insolvent, the benefits shall be reinstated unless the court finds that the balance of the equities clearly favors such modification. Id. at 1114(l). 111 Horizon Natural Resources, 316 B.R. at 270 71.
94 CORNELL JOURNAL OF LAW AND PUBLIC POLICY [Vol. 21:77 collective bargaining agreements (CBAs) contained successorship clauses that required new owners of the companies to assume the responsibilities of the previous collective bargaining agreement. 112 During the bankruptcy proceedings, however, the debtors decided to liquidate their companies. 113 Citing an inability to find buyers willing to assume the retiree health obligations of the prior collective bargaining agreement, the court allowed the sales to proceed free of the successorship clauses, essentially terminating all retiree health benefits. 114 Consequently, unions would most likely only consider a Chapter 11-type bankruptcy procedure if there were no other alternatives, and the very survival of the employer or industry was at stake. It thus seems unlikely that such a strategy would provide the necessary means to overcome the financial problems besieging these pension plans in the current environment. D. Reduce Investment Assumption Rates and Permit Plans to Hedge Kraw s final reform suggestion, and perhaps the one with the most potential to help turn the financial tide, would give multiemployer pension plans greater flexibility to reduce investment assumption rates below current levels. 115 Currently, most plans assume between six- and eight-percent rates of return on their investments. 116 Plans are generally unwilling to reduce these unrealistic rates because doing so would thereby increase the plan s liabilities. 117 Moreover, the lower the assumed rate of investment return, the more assets the plan must have on hand to pay current obligations to retirees. 118 Kraw also argues that multiemployer pension plans should immunize or hedge part or all of their assets and liabilities. 119 Immuniza- 112 Id. at 271. 113 Id. 114 Id. at 282 83. Unfortunately for retirees, Horizon was not an aberration. A similar scenario unfolded in In re Ormet, 355 B.R. 37 (Bankr. S.D. Ohio 2006), where the court enforced a unilateral modification to retiree health benefits over the objection of the union. Id. at 43 44. See also In re Northwest Airlines Corp., 346 B.R. 307 (Bankr. S.D.N.Y. 2006) (finding that Section 1114 of the Bankruptcy Code permits a debtor to reject collective bargaining agreement if the rejection is, among other things, necessary to the debtor s ability to reorganize.). 115 Kraw, supra note 8, at 2. 116 Id. at 3. 117 See Gambling Our Future, THE ECONOMIST, (Mar. 10, 2010, 7:04 PM), http:// www.economist.com/blogs/freeexchange/2010/03/pension_crises ( The higher the rate they assume, the smaller the projected liability. ). 118 See id. ( A big reason why states are so keen to maintain a projected 8% return is that they use their projected returns on assets to discount their future obligations. ). See also John E. Petersen, Fairy Tale Pension Projections, GOVERNING, (Mar. 2010), available at http:// www.governing.com/columns/public-finance/fairy-tale-pension-projections.html (discussing how public pensions assumption in an 8% return rate has proven disastrous). 119 Kraw, supra note 8, at 3.
2011] THE FORGOTTEN EMPLOYEE 95 tion of portions of multiemployer pension plan s investment portfolio would be done by investing in securities that would increase or decrease in direct correlation with an increase or decrease in pension plan liabilities. 120 Such liability-aware investing (LAI) seeks to reduce a significant portion of the economic risks of a defined benefit plan, 121 and [i]n particular, the risk of significant changes in interest rates used to discount pension liabilities is addressed by LAI mandates. 122 Some critics argue that this dual-prong investment approach will lead inevitably to lower investment returns. 123 Yet, such lower investment returns may, in fact, be more consistent with the new normal. 124 Additionally, by balancing these liability-driven investments with fixedincome securities, much of the same risk-return profile on investments likely can be maintained. 125 In short, this investment strategy deserves more careful consideration and could be an important part of an overall strategy for repairing financially-battered multiemployer pension plans. III. THE LEGISLATIVE CHALLENGE TO MULTIEMPLOYER HEALTH PLANS Multiemployer pension plans are certainly facing a difficult economic and demographic environment. Yet, the storm clouds are gathering around multiemployer health plans as well. A very fluid situation exists for these plans as a result of multiemployer health plans being at the epicenter of the political storm 126 surrounding passage of the Patient Protection and Affordable Care Act of 2010. 127 In fact, it actually took a last-minute compromise not assessing taxes on expensive, Cadillac health care plans until 2018 that permitted the legislation to be enacted with the support of the labor movement. 128 Under this compromise, a 40% excise tax on excess benefits will be imposed on health care providers, starting in 2018, to the extent that 120 This type of investing is called liability-aware investing or LAI. See Armand Yambao, Liability Aware Investing For Defined Benefits Pension Funds, ENNIS, KNUPP & ASSOCIATES, INC., 1 (Feb. 2008), available at http://www.nasra.org/resources/mvl/lai.pdf. 121 Id. 122 Id. 123 Kraw, supra note 8, at 3. 124 Id. See also Ernest Werlin, The New Normal Means: Slow Growth and Low Returns, HERALD-TRIBUNE, Dec. 15, 2010, at D3, available at http://www.heraldtribune.com/ article/20101230/columnist/12301031. 125 Kraw, supra note 8, at 3. 126 Editorial, Cadillac Plans, supra note 20 (discussing how multiemployer Cadillac plan threatened to derail health care reform). 127 Pub. L. 111-148, 124 Stat. 119 (as amended by the Health Care and Education Reconciliation Act of 2010, Pub. L. 111-152, 124 Stat. 1029). 128 See Janet Hook and Noam N. Levey, Unions Agree to Compromise on Cadillac Tax for Healthcare, L.A. TIMES, Jan. 15, 2010, http://articles.latimes.com/2010/jan/15/nation/lana-health-congress15-2010jan15.
96 CORNELL JOURNAL OF LAW AND PUBLIC POLICY [Vol. 21:77 the aggregate value of the employer-sponsored health coverage for an employee exceeds a threshold amount. 129 Until now, health coverage itself has not been taxed; indeed, it has been a highly tax-favored employee benefit. 130 Under PPACA, however, the threshold dollar limitation for multiemployer health plans in 2018 will be $10,200, 131 though that is just a starting point for determining the thresholds for taxing excess benefits. 132 Because of the various ways that adjustments to this threshold will be made under PPACA, an employer or employers with a workforce that is more expensive to insure, due to age and gender characteristics, should not be put at a disadvantage. 133 Nevertheless, because multiemployer health plans tend to be some of the more expensive health care plans, many of these plans will have to modify their coverage or be forced to pay the 40% excise tax on excess benefits. In addition to the 2018 excise tax on multiemployer health plans, there are also important challenges lurking around the corner for these plans. These challenges include issues revolving three PPACA concepts: (1) grandfathered plans, (2) minimum essential coverage, and (3) health benefit exchanges. A. Grandfathered Plans Whether an employer-provided health plan is subject to all, or only some, of the new health care market reforms under PPACA depends on whether the plan is a grandfathered plan. 134 A grandfathered plan is a group health plan that was in effect upon enactment of PPACA in March 2010. 135 These grandfathered plans are exempt from many, but not all, of the individual and group healthcare market reforms that are scheduled to be implemented in 2014. 136 For instance, grandfathered plans must still comply with provisions relating to: (1) a uniform explanation of coverage; (2) loss-ratio reports and rebate premiums; (3) excessive waiting periods; (4) lifetime limits; (5) annual limits; (6) pre-existing health con- 129 I.R.C. 4980I (2006) (as added by PPACA 9001(a) (2010)). This section of the I.R.C. was held unconstitutional as not severable from PPACA in Florida v. U.S. Dept. of Health and Human Services, 2011 WL 285683 (N.D. Fla. Jan. 31, 2011). 130 MEDILL, supra note 29, at 19 ( For fiscal year 2011, the tax expenditure for health care and long term care insurance plans sponsored by employers is estimated at $115.2 billion. This amount represents the second largest tax expenditure in the federal budget. ). 131 See I.R.C. 4980I(b)(3). 132 CCH EDITORIAL STAFF, CCH S LAW, EXPLANATION, AND ANALYSIS OF THE PATIENT PROTECTION AND AFFORDABLE CARE ACT 2205, at 969 (2010) [hereinafter CCH]. 133 Id. 2205 at 970. 134 Patient Protection and Affordable Care Act (PPACA), 111-148, 1251(e), 124 Stat. 119 (2010). 135 Id. 136 Id.
2011] THE FORGOTTEN EMPLOYEE 97 dition exclusions; and (7) the extension of dependent coverage to age twenty-six. 137 As far as multiemployer health plans, group health coverage, subject to CBAs ratified before the enactment of PPACA, are not covered by all of the laws health care market reforms until that CBA terminates. 138 Moreover, if a CBA is modified to conform to the new health care requirements, it will be considered to remain in effect and will not be treated as a non-grandfathered plan. 139 One of the remaining questions is whether grandfathered status under PPACA may be lost because of a change in the employer contribution rate to the plan. 140 On this issue, EBSA has issued a frequently asked questions (FAQ) guide about PPACA implementation. 141 Because multiemployer health plans do not always know whether or when a contributing employer changes its contribution rate as a percentage of the cost of coverage, 142 many multiemployer health plans sought regulatory guidance on what steps should be taken to communicate with contributing employers. 143 EBSA indicated that, [i]f multiemployer plans and contributing employers follow steps similar to those outlined in Q&A2, above, the same relief will apply to the multiemployer plan unless or until the multiemployer plan knows that the contribution rate has changed. 144 Q&A2 in turn provides: The Departments have determined that, until the issuance of final regulations, they will not treat an insured group health plan that is a grandfathered plan as having ceased to be a grandfathered health plan immediately based on a change in the employer contribution rate if the employer plan sponsor and issuer take the following steps: Upon renewal, an issuer requires a plan sponsor to make a representation regarding its contribution rate for the plan year covered by the renewal, as well as its contribution rate on March 137 CCH, supra note 132, 185, at 120 21. 138 PPACA 1251(d). 139 CCH, supra note 132, 185 at 121. 140 See United State Department of Labor s Employee Benefit Security Administration (EBSA), FAQ About the Affordable Care Act Implementation Part I, UNITED STATE DEPART- MENT OF LABOR, http://www.dol.gov/ebsa/faqs/faq-aca.html (last visited Feb. 23, 2011). 141 Id. 142 Id. at Q&A3. 143 Id. 144 Id.
98 CORNELL JOURNAL OF LAW AND PUBLIC POLICY [Vol. 21:77 23, 2010 (if the issuer does not already have it); and The issuer s policies, certificates, or contracts of insurance disclose in a prominent and effective manner that plan sponsors are required to notify the issuer if the contribution rate changes at any point during the plan year. 145 So, in short, Taft Hartley health plans should be able to keep their grandfathered status by following these interim steps until final regulations have been issued. Nevertheless, this issue and others like it highlight the need for multiemployer health plan administrators to be vigilant about plan changes that could potentially jeopardize their grandfathered status. B. Minimum Essential Coverage The essential health benefits package offered by qualified health benefit plans under PPACA, including multiemployer health plans, must include specific categories of benefits, meet certain cost-sharing standards, and provide certain levels of coverage. 146 Beginning in 2014, minimum items and services include: (1) ambulatory patient services; (2) emergency services; (3) hospitalization; (4) maternity and newborn care; (5) mental health and substance abuse disorder services; (6) prescription drugs; (7) rehabilitative services and devices; (8) laboratory services; (9) preventive and wellness services; and (10) pediatric services (including oral and vision care). 147 Significantly, however, self-insured plans are not covered health plans for this purpose, and thus will not have to comply with the requirements of the essential health benefits package. 148 As a result, incentives exist for multiemployer health benefit plans to go the selfinsured route, rather than purchasing health insurance coverage from a third party. 149 In fact, even smaller Taft Hartley employee benefit plans may be able to self-insure with the help of stop-loss insurance and the use of 145 Id. at Q&A2. 146 CCH, supra note 132, 205, at 128. 147 PPACA 1302(a), (b)(1). These benefits are supposed to be consistent with the scope of benefits provided under a typical employer-sponsored plan. Id. 1302(b)(2). Plans may, of course, provide more than the minimum essential benefit. Id. 1302(b)(5). 148 CCH, supra note 132, 205, at 128 (citing PPACA 1301(b)(1)(B)). 149 A self-insured plan is one offered by a multiemployer plan that directly assumes the major cost of health insurance for their employees. See BUREAU OF LABOR STATISTICS, DEFI- NITIONS OF HEALTH INSURANCE TERMS 6, http://www.bls.gov/ncs/ebs/sp/healthterms.pdf (last visited on Feb. 16, 2011).
2011] THE FORGOTTEN EMPLOYEE 99 relatively low attachment points. 150 Stop-loss insurance operates by having the self-insured plan cover up to a certain amount of a claim, and then the stop-loss insurance coverage kicks in at that attachment point to pay the rest. 151 As the attachment point becomes lower and lower, the insurance scheme begins to resemble a fully insured health plan. 152 Nevertheless, the federal appellate courts that have considered this issue continue to treat these plans as self-insured plans for employeebenefit law purposes. 153 Given the availability of this strategy, even prior to the enactment of PPACA, the majority of multiemployer health plans are already either wholly or partially self-funded. 154 Consequently, the more multiemployer health plans become selfinsured plans, the less they will have to worry about providing their members statutorily-required minimum essential benefits. Although the provision of additional benefits may be deemed in the best interest of plan members, such provision may also undermine the ability of these plans to provide cost-effective health care benefits and thus, the impact of these provisions need to be monitored carefully. C. Health Benefit Exchanges A more insidious problem that might face multiemployer health plans involves the creation of health benefit exchanges. Effective in 2014, state-based American Health Benefit Exchanges and Small Business Health Options Program (SHOP) Exchanges will be established. 155 Through these programs, individuals and small businesses with up to 100 employees may purchase qualified health coverage. 156 States may also 150 Stop-loss insurance is a form of reinsurance for self-insured employers that limits the amount the employers will have to pay for each person s health care (individual limit) or for the total expenses of the employer (group limit). Id. The limit at which the stop-loss insurance kicks in is called the attachment point. See Am. Med. Servs., Inc. v. Bartlett, 111 F.3d 358, 361 (4th Cir. 1997) (involving Maryland employers purchase of stop-loss insurance to cover their plans benefit payments above an annual $25,000-per-employee level, known as the attachment point. ). 151 See Am. Med. Servs., Inc., 111 F.3d at 361. 152 See id. at 362 (quoting In re: Maryland Stop Loss Insurance Litigation, No. MIA-370-12195, at 4 (Dec. 8, 1995)) ( At very low attachment points... a stop loss policy is merely a substitution for health insurance. ). 153 Id. at 364 ( [Maryland] s regulations fail to recognize that in a self-funded plan, with or without stop-loss insurance and regardless of the attachment point, the provision of benefits depends on the plan s solvency, whereas the provision of benefits in an insured plan depends entirely on the insurer s solvency. ). 154 See James Conlon, Self-Insurance and Small Taft-Hartley Trust Funds (Part I), LA- BORERS HEALTH AND SAFETY FUND OF NORTH AMERICA (Jul. 2008), http://www.lhsfna.org/ index.cfm?objectid=ca65b475-d56f-e6fa-9f3dbeda4d41aefc ( Self-insurance is increasingly becoming the cost containment strategy of choice among Taft-Hartley Trust Funds providing health and welfare benefits to their participants and their qualified dependents. ). 155 PPACA 1311(b). 156 Id. 1311(b)(1)(C).
100 CORNELL JOURNAL OF LAW AND PUBLIC POLICY [Vol. 21:77 form regional Exchanges or allow more than one Exchange to operate in the state, as long as each Exchange serves a distinct geographic area. 157 A governmental agency or a non-profit organization will administer these exchanges. 158 Although health benefit exchanges do not directly impact multiemployer health plans, their presence might exacerbate some of the financial difficulties that these plans are already facing. For example, smaller employers might decide that instead of joining a multiemployer plan and worrying about withdrawal liability, they will just provide no health coverage, suffer an excise tax, and let their employees get their health coverage through these exchanges. 159 As pointed out in the previous discussion of the multiemployer pension plans, employers are already reluctant to join these plans because of the potential for substantial withdrawal liability if they decide to leave such a plan. 160 Yet, here, a cap or elimination of withdrawal liability may give the proper incentive for additional employers to join multiemployer health plans. 161 Unlike multiemployer pension plans, the MPPAA s withdrawal liability provisions do not apply to multiemployer health plans. 162 Rather, the current practice is to impose withdrawal liability by contractual agreement, if at all. 163 Thus, the voluntary cap-waiver idea, advanced by Kraw in the multiemployer pension context, could potentially work if a multiemployer health benefit plan currently assesses such withdrawal liability under a CBA or under a trust agreement. The elimination or capping of such liability would then simply be a matter of amending the relevant documents. Moreover, given that this is a private ordering situation, it probably would not be necessary to create a cap-waiver for existing members, though existing members might object to being subject to withdrawal 157 CCH, supra note 132, 215, at 138. 158 PPACA 1311(d). 159 See JACKSON LEWIS, HEALTH CARE REFORM: LABOR RELATIONS IMPLICATIONS FOR UNIONIZED AND UNION-FREE EMPLOYERS, 6 7 (2011), http://www.jacksonlewis.com/media/ pnc/2/media.1182.pdf ( The excise tax imposed on employers opting to end all health insurance coverage is substantially less than the cost of the typical health insurance premium for an individual. Consequently, employers may seriously consider terminating health insurance coverage. ). 160 See Kraw, supra note 8, at 2. 161 See supra notes 91 97 and accompanying text (discussing withdrawal liability cap or waiver). 162 MEDILL, supra note 29, at 264 ( ERISA Section 515 concerning delinquent employer contributions applies to multiemployer welfare benefit plans (particularly health care plans) as well as multiemployer pension plans. The employer withdrawal liability provisions of the MPPAA, however, apply only to multiemployer pension plans. ). 163 Id. ( [A] multiemployer welfare benefit plan cannot assess withdrawal liability against a participating employer unless the employer has expressly agreed to the assessment of withdrawal liability. ).
2011] THE FORGOTTEN EMPLOYEE 101 liability while other plan members are not. To assuage current members concerns, it could be pointed out that all members will likely benefit from the multiemployer health plan by attracting new employer-members and increasing contributions to the plan. In sum, PPACA will likely have many divergent effects upon multiemployer health benefit plans, both predictable and unpredictable. In addition to the excise tax for high-cost multiemployer health benefit plans starting in 2018, other significant issues that multiemployer benefit plans must consider include: how to maintain grandfathered plan status, becoming self-funded to retain discretion over health benefits offered to members, and the use of withdrawal liability agreements to lure new employers to join multiemployer health plans rather than letting these employers direct their employees to the health benefit exchanges for coverage. Assuming PPACA is constitutional, 164 multiemployer health plans will need to remain vigilant on all of these issues to ensure provision of health care benefits to union members on a cost-effective basis. IV. THE JUDICIAL CHALLENGE TO MULTIEMPLOYER PENSION AND HEALTH PLANS Nonetheless, all is not well with the judicial interpretation of ERISA provisions relating to multiemployer benefit plans. Indeed, when considering Section 302(c)(5) of the Taft Hartley Act of 1947, matters become even more convoluted and difficult for plan administrators and trustees to follow. The basic problem stems from the often vague and expansive language used in both ERISA and Section 302(c)(5). As a result, the United States Supreme Court and lower federal courts have struggled over numerous, significant issues involving multiemployer health and pension plans. 165 Although this law continues to shift as successive courts, and even different United States Supreme Courts, interpret these laws in diverse ways; a number of important insights can still be garnered by considering just one representative area: the standard of review for a multiemployer benefit plan s denial of a claim by a participant or beneficiary to certain pension or health benefits. Consideration of this issue provides another cautionary tale to multiemployer plans and their trustees on best practices 164 Currently, the district courts are divided 3 2 in favor of upholding PPACA as a constitutional exercise of Congressional authority. Compare Mead vs. Holder, 766 F. Supp. 2d 16 (D.D.C. 2011) (declaring PPACA individual mandate constitutional) with Florida ex rel. Bondi v. U.S. Dept. of Health &Human Servs., 780 F. Supp. 2d 1256 (N.D. Fla. Jan. 31, 2011) (striking down the entire PPACA as unconstitutional). 165 See, e.g., Aetna Health Inc. v. Davila, 542 U.S. 200, 223 (2004) (Ginsburg, J., concurring) (arguing that fresh consideration of the availability of consequential damages under [ERISA] 502(a)(3) is plainly in order. ).
102 CORNELL JOURNAL OF LAW AND PUBLIC POLICY [Vol. 21:77 in avoiding unnecessary litigation and the potential liability for fiduciary breaches. A. Denial of Benefit Claims Under ERISA ERISA Section 502(a)(1)(B) claims are instituted to recover benefits, to enforce rights under the plan, or to clarify rights to future benefits. 166 Claims for benefits are by far the most common legal action brought under ERISA. 167 A plan participant or beneficiary may bring such a suit, against the plan, for the value of the denied benefits or rights. 168 For instance, if a plan participant wishes to receive full hospital bedrest for a high-risk pregnancy, and the plan administrator denies the claim, the participant may file a claim against the plan for only the value of that bed-rest, not for the damages associated with loss of the baby. 169 Significantly, compensatory and punitive damages are not available under Section 502(a)(1)(B). 170 Moreover, because of the strong preemptive effect of ERISA on contrary state laws, 171 most of the time ERISA participants and beneficiaries will not receive consequential relief under state law. 172 These denials of benefit claims are also difficult to win for ERISA plaintiffs because, before bringing a Section 502(a)(1)(B) claim in state or federal court, a plan participant must exhaust her internal claim remedies. 173 Once the plan administrator has denied a claim, the plan participant must file an appeal with the administrator, wait for a further adverse 166 ERISA 502(a)(1)(B). 167 See generally, RICHARD A. BALES, JEFFREY M. HIRSCH, & PAUL M. SECUNDA, UNDER- STANDING EMPLOYMENT LAW 226 (2007). 168 See Paul M. Secunda, Sorry No Remedy: Intersectionality and the Grand Irony of ERISA, 61 HASTINGS L.J. 131, 146 (2009). 169 See Corcoran v. United Health Ins., Inc., 965 F.2d 1321 (5th Cir. 1992) (holding that the plaintiffs who lost their baby could only recover for the difference between the services actually rendered and the services that should have been received, not for the wrongful death of the child). 170 See Mass. Mut. Life Ins. Co. v. Russell, 473 U.S. 134, 144 (1985) ( Section 502(a)(1)(B)... says nothing about the recovery of extracontractual damages, or about the possible consequences of delay in the plan administrators processing of a disputed claim. ). 171 See Secunda, supra note 168, at 133 (maintaining that, [c]ourts broadly interpret the preemption provisions of ERISA under section 514 to invalidate benefits-related state laws and then force employees to depend on an inadequate, comprehensive and reticulated remedial scheme under section 502(a) ). 172 See Pilot Life Ins. Co. v. Dedeaux, 481 U.S. 41, 52 (1987) (finding that Mississippi common law claims for tort, contract, and bad faith were preempted by ERISA). See also Secunda, supra note 168, at 169 70 (recommending that Congress pass an ERISA Civil Rights Act to provide consequential relief in ERISA cases where reinstatement, back pay, and other equitable make-whole relief is insufficient to provide adequate relief caused by denials of benefits. ). 173 ERISA 503; 29 C.F.R. 2560.503-1(2010).
2011] THE FORGOTTEN EMPLOYEE 103 determination, and exhaust all internal claims procedures before bringing her benefit claim in state or federal court. 174 At that point, the issue then becomes the appropriate judicial standard of review to employ when examining the plan administrator s benefit determination. 175 In 1989, in Firestone Tire & Rubber Company v. Bruch, 176 the United States Supreme Court directed review of the benefit decision under a very deferential arbitrary and capricious standard when the plan vests the administrator with discretion to make such decisions. 177 More recently, under Metropolitan Life v. Glenn, 178 a conflict of interest may exist where the plan both determines whether a qualified benefit claim exists and is also responsible for paying that claim. 179 If such a conflict of interest exists, that conflict must have weight in deciding whether the plan administrator s determination was arbitrary or capricious. 180 The question then becomes how much weight to give such a conflict of interest. B. Inherently Conflicted Multiemployer Plans A recent case by the Second Circuit, Durakovic v. Building Services 32 BJ Pension Fund, 181 explored this exact issue in which a self-insured multiemployer plan 182 denied a claimed benefit to a participant or beneficiary of the plan. More specifically, Durakovic involved an office cleaner who suffered chronic pain and weakness following an automobile accident, and applied for, and was denied disability benefits from her union s multiemployer plan. 183 In support of her disability claim, Durakovic submitted the reports of two of her physicians, the finding of the Social Security Administra- 174 ERISA 503; 29 C.F.R. 2560.503-1 (2010). 175 See Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101, 114 16 (1989) (holding provision of plan contract is to be reviewed under de novo standard unless benefit plan gives administrator or fiduciary discretionary authority to determine eligibility for benefits or to construe terms of plan). 176 Id. 177 Id. at 115. 178 554 U.S. 105 (2008). 179 Id. at 108 ( We here decide that this dual role [of the plan insurer] creates a conflict of interest. ). 180 Id. ( [A] reviewing court should consider th[e] conflict as a factor in determining whether the plan administrator has abused its discretion in denying benefits; and... the significance of the factor will depend upon the circumstances of the particular case. ). 181 609 F.3d 133 (2d Cir. 2010). 182 Most multiemployer health plans are now self-funded. See supra note 153 and accompanying text. See also Kaiser Family Foundation, Employer Health Benefits 2010 Annual Survey, KAISER FAMILY FOUNDATION, 154, available at http://ehbs.kff.org/pdf/2010/8085.pdf (noting the percentage of workers in self-funded plans is now 59% and [e]ighty percent of covered workers in firms with 1,000 to 4,999 workers and 93% of covered workers in firms with 5,000 or more workers are in self-funded plans in 2010. ). 183 Durakovic, 609 F.3d at 135.
104 CORNELL JOURNAL OF LAW AND PUBLIC POLICY [Vol. 21:77 tion that she was disabled, and the report of a vocational expert. 184 The multiemployer plan required her to go to two different independent physicians and to their own vocational expert. 185 Significantly, in denying her claim, the plan did not mention any of the evidence submitted by Durakovic, but relied solely on their own experts. 186 After exhausting all of the necessary internal appeal procedures, she filed suit in federal court under Section 502 (a)(1)(b). 187 The court began its analysis by finding that the arbitrary and capricious standard of review under Firestone was the appropriate standard for reviewing the plan s determination. 188 Moreover, because this case involved a situation where the ERISA-fund administrator... both evaluates claims for benefits and pays benefits claims, the plan was considered conflicted, and therefore, under Metropolitan Life v. Glenn, the district court was required to weigh the conflict as a factor in its analysis. 189 The Second Circuit disagreed with the district court that the presence of the conflict was a relatively unimportant one. 190 Instead, the court emphasized the multiemployer organization of the fund, and concluded that multiemployer plans are inherently conflicted under Glenn when making benefit decisions. 191 It reasoned that because trustee boards made up of equal numbers of union and employer representatives administer Taft Hartley plans, 192 they suffer from board members with conflicting loyalties. 193 Although trustees have fiduciary interests that weigh in favor of participants and beneficiaries of the plan, they also tend to have interests that favor the employer over these employees. 194 For instance, by rejecting meritorious benefit claims, plan trustees, loyal to the company, will help reduce future employer contributions to the plan. 195 To protect against such conflicts infecting the claim determination process, the court, relying on language from Glenn, suggested that appropriate procedural safeguards could include: (1) walling off claims 184 Id. at 135 136. 185 Id. at 135 137. 186 Id. at 136 37. 187 Id. at 137. 188 Id. at 137 138. 189 Id. at 138. See also Metro. Life v. Glenn, 554 U.S. 105 (2008). 190 Durakovic, 609 F.3d at 138 40. 191 Id. at 139 40. 192 29 U.SC. 186(c)(5) (2006). 193 Durakovic, 609 F.3d at 139 ( The employer representatives have fiduciary interests that weigh in favor of the trusts beneficiaries on the one hand, but representational and other interests that weigh to the contrary.... That the board is (by requirement of statute) evenly balanced between union and employer does not negate the conflict. ) (citations omitted). 194 Id. 195 Id. ( The rejection of claims will reduce future employer contributions. ) (citing Holland v. Int l Paper Co. Ret. Plan, 576 F.3d 240, 249 (5th Cir.2009)).
2011] THE FORGOTTEN EMPLOYEE 105 administrators from those interested in firm finances; and (2) imposing management checks that penalize inaccurate decision-making irrespective of whom the inaccuracies benefit. 196 The court therefore rejected the plan s contention that it was not conflicted because it was composed of equal members from management and labor, 197 though it agreed that the presence of union representatives should be considered in deciding how severe the conflict is in any case. 198 In this vein, the court found that the weight accorded to any conflict should vary in direct proportion to the likelihood that the conflict affected the benefits decision. 199 In Durakovic, because there were no procedural safeguards in place to protect against the inherent conflict of interest, and because the plan did not consider any of the plaintiff s evidence as far as her ability to continue to work, the decision to find the plan s determination arbitrary and capricious was straightforward. 200 All of this is not to say that plan trustees may not deny a claim in good faith because a claim is simply not meritorious. But given this inherently conflicted legal standard, plan trustees and their advisors will now need to do double-diligence when denying claims and make sure substantial evidence exists for the claim decision. 201 Plans and their trustees will need to have a comprehensive paper trail, set up procedural safeguards to mitigate conflicts, and make certain to consider and mention all evidence submitted by the parties. In fact, in addition to approaching denial of benefit issues with the necessary caution, multiemployer plans and their trustees need to remain mindful of the ever-changing legal landscape in this area of the law. Judicial interpretations will also have significant impact in areas as diverse as the recovery of delinquent employer contributions, 202 standards for 196 See Metro. Life v. Glenn, 554 U.S. 105, 117 (2008). 197 Id. But see Anderson v. Suburban Teamsters of N. Ill. Pens. Fund Bd. of Trs., 588 F.3d 641, 648 (9th Cir. 2009) ( The various participating employers-not the Trustees-fund the Plan. The Trustees have no personal economic interest in the decision to grant or deny benefits. Additionally, the Board of Trustees consists of both employer and employee representatives, who determine employee eligibility under the Plan. Both sides are at the table. ). This line of reasoning in Anderson appears less persuasive than that in Durakovic because the Ninth Circuit did not consider the fact that management trustees can have conflicting loyalties to their employers, especially if denying a claim will lead to lower employer contributors from their company. See supra notes 181 83 and accompanying text. 198 Durakovic, 609 F.3d at 141. 199 Id. at 139. 200 Id. at 142 ( Giving appropriate weight to the Glenn conflict, any rational trier of fact would conclude that the Funds decision was unsupported by substantial evidence, and therefore arbitrary and capricious. ). 201 Id. at 141 ( Substantial evidence is such evidence that a reasonable mind might accept as adequate to support the conclusion reached by the administrator and requires more than a scintilla but less than a preponderance. ). 202 See, e.g., Cent. States, Se. & Sw. Areas Pens. Fund v. Gerber Truck Serv., Inc., 870 F.2d 1148 (7th Cir. 1989) (en banc) (interpreting ERISA 515 to bar employers from raising
106 CORNELL JOURNAL OF LAW AND PUBLIC POLICY [Vol. 21:77 breach of fiduciary duty, 203 and the imposition of withdrawal liability. 204 Consequently, in addition to the financial and healthcare challenges facing multiemployer benefit plans, judicial challenges will also play a substantial role in determining the viability of these plans in the future. CONCLUSION Multiemployer benefit plans remain as important today as when the Taft Hartley Amendments first created them in 1947. These plans continue to represent one of the great triumphs in American labor relations by providing pension, health, and welfare benefits to union workers in itinerant industries. Because these plans are now under siege as a result of financial, healthcare, and judicial developments, steps need to be taken immediately to secure the dignity of the 10 million workers who participate in the 1,500 multiemployer plans throughout the nation. What is at stake is not merely the ability of these employees to receive crucial employee benefits, but also the workforce stability that is engendered in these itinerant industries as a result of the existence of such multiemployer benefit plans. This Article provides a first-time look at the numerous challenges that face these multiemployer pension benefit plans in the post-global recession and health care reform world of the United States. By highlighting potential reform proposals and underscoring the dangers that continue to threaten the very existence of these plans, this Article aims to rejuvenate the discussion of how to make these benefit plans more financially sustainable in the future, and how to more effectively address the impending legal conflicts that these plans will inevitably have to confront. defenses based on the unenforceability of a contract because of oral promises made by the union). 203 See, e.g., Deak v. Masters, Mates & Pilots Pens. Plan, 821 F.2d 572, 581 (11th Cir. 1987) (treating plan amendments in multiemployer context as fiduciary functions, rather than settlor functions, and invalidating amendments not made in furtherance of the participants and beneficiaries interests); but see Walling v. Brady, 125 F.3d 114 (3d Cir. 1997) (ERISA fiduciary duties do not apply to decisions regarding plan amendments, including those decisions made by trustees of multiemployer plans). 204 See, e.g., Cent. States, Se. & Sw. Areas Pens. Fund v. Safeway, Inc., 229 F.3d 605 (7th Cir. 2000) (concluding that, although employer is generally liable for its proportionate share of unfunded vested benefits determined as of the date of withdrawal from the plan, multiple instances of withdrawal liability can occur and that a multiemployer plan can recalculate an employer s withdrawal liability every year).
Pg 248 of 250 Exhibit D-7
Pg 249 of 250 Multiemployer plan sponsors may face peril, Moody s says By Christine Williamson September 21, 2009, 12:01 AM ET If Moody s Investors Service, New York, has its way, the precariously weak funding levels of many multiemployer pension plans finally will become more critical to the way analysts evaluate the creditworthiness of U.S. corporations. Moody s estimated that U.S. multiemployer plans were collectively underfunded by at least $165 billion, putting their funded status around 56% at the end of 2008. That s a precipitous fall from 2007 when multiemployer plans were already in weak shape, with an aggregate funding status of 77% resulting from total underfunding of $87 billion, wrote Wesley Smyth, vice president and senior accounting analyst, in a Sept. 10 report, Growing Multiemployer Pension Funding Shortfall is an Increasing Credit Concern. By contrast, Mr. Smyth noted that single-employer pension plans started 2008 with a collective funding status of 101% and ended the year at 75%. Multiemployer pension plans were defined by the Taft-Hartley Act of 1947. The plans provide pension benefits to workers in a particular industry such as trucking, construction, food service/grocery, hotels/casinos or printing and are funded by employer contributions that are determined through collective bargaining with labor unions. While Moody s has long treated single-employer pension liabilities as debt because it can materially affect the company, it wasn t until 2006 that Moody s researchers woke up to the multiemployer issue, said Mark LaMonte, senior vice president and Mr. Smyth s boss. The wake-up call came when a Moody s credit analyst flagged a financial footnote in The Kroger Co. s annual Securities and Exchange Commission 10-K filing that year that said the Cincinnati grocery retailer s contribution obligation to multiemployer pension plans was $1.2 billion. Mr. LaMonte said that was eerily similar to defined benefit plan obligations that we use when we calculate leverage and other metrics in determining a company s credit rating. Corporations are not required to recognize their contribution requirement to multiemployer plans as a pension obligation on their balance sheets; they only have to record the expense annually in the 10-K filing, Mr. LaMonte said.