The single biggest problem for multiemployer pension plans

The current landscape

In 2016, there were 1,296 multiemployer plans covering approximately 10.3 million participants. Of these participants, 3.8 million were active participants, 3.7 million were retirees and beneficiaries, and 2.8 million were former employees who worked long enough to earn vested benefits in a pension plan but left the company sponsoring the plan and are not yet receiving retirement benefits. Many of these participants are employed by small companies in the building and construction industries, but these plans also cover employees in retail trade, manufacturing, mining, trucking and transportation, and entertainment industries (Exhibit 1).

Exhibit 1: Multiemployer defined benefit plans by industry

Percentage of total multiemployer defined benefit plans

Source: Pension Benefit Guaranty Corporation data tables, J.P. Morgan Asset Management. Based on Form 5500 filings for plan year ending 2015. Chart is based on the number of insured participants. Industry classifications are based on principal business activity codes used in the North American Industry Classification System. Numbers may not sum to 100 due to rounding. Data are as of November 12, 2018.

In 2015, nearly 65% of plans were in the Green Zone, meaning that they would most likely be able to pay all of the participants’ benefits without changes to employer contributions or participant benefits. However, 12.5% of plans were classified as endangered, meaning that their funded status was less than 80% and they were projected to have a funding deficiency in one of the next six years. The remaining nearly 24% of plans were classified as “critical or declining,” as their funded status was less than 65% and the plan was expected to be insolvent within five years. These “critical or declining” plans are required to adopt a rehabilitation program to improve funded status over a 10-year window, and simultaneously provide notice to all plan participants, beneficiaries, the collective bargaining parties, Pension Benefit Guaranty Corporation (PBGC) and the Department of Labor (DOL) ² .

These solvency problems stem from a number of areas. To start, using a discount rate based on expected plan returns has created problems for multiemployer plans, as return assumptions have been too high and plans are only able to adjust the rate used every few years. Furthermore, the multiemployer system has not enjoyed the same benefits from rising rates as has been the case with single-employer plans, which have seen the value of future liabilities come down as interest rates have risen.

Additionally, the ERISA anti-cutback rule has prevented plan administrators from amending plans in a way that decreases accrued benefits, and excise taxes on contributions to overfunded pensions have incentivized some trustees to increase benefits during good times in order to avoid paying this tax. Furthermore, the decline of the U.S. manufacturing sector and union membership more broadly, coupled with demographic headwinds, have led this situation to become increasingly unsustainable given the reliance on employer contributions to fund these plans.

² Topoleski, John J. “Multiemployer Defined Benefit (DB) Pension Plans: A Primer.” Congressional Research Service. September 2018.

Exhibit 2: Total number of participants and beneficiaries in defined benefit plans

Millions of participants and beneficiaries

Source: Department of Labor, J.P. Morgan Asset Management. Based on Form 5500 filings for plan year ending 2015. Single employer plans include single employer plans, plans of controlled groups of corporations, and multiple-employer noncollectively bargained plans. All defined benefit plans paying premiums to PBGC's single employer program are included. Multiemployer plans include multiemployer plans and multiple-employer collectively bargained plans. All defined benefit plans paying premiums to PBGC's multiemployer program are included. Data are as of November 12, 2018.

Broad economic impact

Unfortunately, prospects for improvement seem limited at the current juncture. Potential solutions, such as decreasing the discount rate used to determine the value of future liabilities, would exacerbate an already problematic situation, while increasing contributions would increase the financial burden on employers, dragging on profitability and potentially putting these companies out of business. The best solution seems to be one based on federal loans; while our read of the situation is that this outcome is somewhat inevitable, it seems unlikely to sit well with fiscal conservatives given growing concerns about the U.S. debt and deficit.

While few of the proposed resolutions are palatable to all those involved, the collapse of the multiemployer pension system would create notable headwinds for the U.S. economy. With some of the largest multiemployer plans at risk of insolvency if restructuring does not occur, there is the potential for the PBGC – which insures benefits promised by defined benefit private pension plans – to become insolvent as well. In fact, a recent report from the PBGC suggested that it would be insolvent by 2025 if some sort of corrective action is not taken (Exhibit 3).
The collapse of the multiemployer system would lead participants and retirees to receive only 50% of what they had expected, and the subsequent collapse in the PBGC would leave them only receiving about 2% of t average worker expected to collect $20,000 per year in retirement, failure of the multiemployer system hose expected benefits. Put another way, if the would lead this amount to fall to $10,000, followed by a mere $400 if the PBGC were to fail as well ³ .

Exhibit 3: Expected insolvency for multiemployer pension plans in critical and declining status

Cumulative number of participants, thousands, cumulative benefits paid, millions of U.S. dollars

Source: Congressional Research Service, J.P. Morgan Asset Management. Based on 2015 Form 5500 data. Plans in critical and declining status must indicate the year in which they expect to become insolvent. This chart is for illustrative purposes only. Data are as of November 12, 2018.

The failure of these institutions and sharp drawdown in benefits received would have a significant impact on the economy through a number of channels. First, employers would struggle, as increased contribution requirements, coupled with increasing unfunded liabilities, would make it difficult for these firms to compete. In many cases this could drive these employers into bankruptcy, hitting small employers hardest, but also would impact large multinational employers who contribute to multiemployer plans.

As these firms come under pressure, they would likely take action in an effort to get things back on track. These actions would likely be characterized by cost cutting and layoffs, leading the unemployment rate to rise and economic growth to slow. This environment of softer economic growth would lead to a more challenging return environment for a plan’s investments, thereby creating a negative feedback loop, which further exacerbates the underfunded status of the multiemployer system.

³ Scott, Michael D. “Multiemployer Pension Crisis: Causes, Impact, Federal workout Options and Solutions.” National Coordinating Committee for Multiemployer Plans (NCCMP) Presentation to the Staff of the Joint Select Committee on Solvency of Multiemployer Pension Plans. July 19, 2018.

Diving in deeper, 3.7 million retirees and beneficiaries received about $41 billion in benefits in 2016, which is estimated to have generated around $83.5 billion of economic output ⁵ . This suggests that the economic multiplier on multiemployer pension benefits is greater than 2x, far larger than that of the recent corporate tax cut. In other words, every dollar of benefits that a participant receives has historically generated just over two dollars of economic output.

With the number of retirees expected to increase over time, and nearly 70% of nominal GDP coming from consumption, multiemployer pension plans will remain as an important support for economic growth in the years to come. However, with nearly $560 billion in unfunded liabilities6 (as of 2015) and 13.6 million total jobs related to the multiemployer system7, failure to pay these benefits could result in a significant drag on consumption and a notable reduction in federal, state and local taxes (Exhibit 4).

So what can we do?

There have been a number of suggestions as to how to fix this problem; the issue is, very few of them will actually work. A common proposal involves reducing the discount rate that these plans use to calculate their future liabilities.

Exhibit 4: Economic impact of multiemployer pension system

Based on 2016 plan year

Source: National Institute for Retirement Security, J.P. Morgan Asset Management. Based on Form 5500 filings for plan year ending 2016. *Total taxes include federal, state and local taxes. Data based in IMPLAM analysis. Data are as of November 12, 2018.

While discount rates in the multiemployer system are meant to measure the expected return on a pool of assets – and given our expectation for more muted returns going forward, a lower discount rate may be appropriate in certain situations – substantially reducing the discount rate would dramatically increase the funding required to keep these plans solvent (Exhibit 5).For example, with 64% of plans currently sporting a funded status of greater than 80% (putting them in the Green Zone), a shift to either a corporate bond or 30-year U.S. Treasury yield would reduce the share of plans in the Green Zone to 7% and 2%, respectively ⁷ .

Furthermore, the impact of higher discount rates on required contributions would be severe. Required contributions are a function of the value of the benefits accrued during the year, the operating expenses of the plan, and a payment to help reduce any unfunded liabilities. The use of a higher discount rate would not only create a headwind to reducing unfunded liabilities, it would simultaneously increase the value of accrued liabilities and likely result in higher operating costs as well. It is also important to note that the use of market rates would increase the volatility of plan funded status, a potential issue when contribution rates are often times determined for three years or more through the collective bargaining process.

Exhibit 5: Plan attributes under different discount rates  

$bn

This chart is for illustrative purposes only.

Source: Department of Labor, J.P. Morgan Asset Management. Based on Form 5500 filings for plan year ending 2015. Corporate bond rate and 30-yr. U.S. Treasury rate are based on average bond yield during October 2018. Data are as of November 12, 2018.

⁴ Scott, Michael D. “Multiemployer Pension Facts and the National Economic Impact.” National Coordinating Committee for Multiemployer Plans. January 2018.
⁵ Topoleski, John J. “Data on Multiemployer Defined Benefit (DB) Pension Plans.” Congressional Research Service. August 2018. The unfunded liability calculation is based on the current liability value (RPA ‘94 value) using a discount rate tied to the 30-year U.S. Treasury yield.
⁶ Scott, Michael D. “Multiemployer Pension Facts and the National Economic Impact.” National Coordinating Committee for Multiemployer Plans. January 2018.
⁷ Ablin, Ben and Pazamickas, David. “The Impact of Alternative Discount Rates on Multiemployer Pension Plan Funding.” Horizon Actuarial Services. June 2018.

As a result, it seems that there are three things that could be done to address this issue: increase contributions, decrease benefits or obtain a loan to improve the funded status of these plans. The first option is relatively challenging to implement, as few employers would be able to sustain the financial burden of the contributions required to remedy the problem. The second option – decreasing benefits – is equally challenging, as the ERISA anti-cutback rule prevents this from occurring. While the Multiemployer Pension Reform Act (MPRA) of 2014 did provide one channel through which struggling pensions can reduce benefits, there have only been seven instances since 2016 where reductions were approved8. The third route – some sort of loan – seems like the best and only option, but may be challenged by fiscal conservatives given significant growth in the debt and deficit this year. As such, the road to any resolution looks set to be a rocky one.

The broader issue here is that increasing contributions, decreasing benefits or providing a federally backed loan all call the viability of the broader defined benefit system into question. If confidence in the system is eroded, the potential economic drags described above may become even more severe as participation decreases and employers see profitability come under pressure. In other words, if employers do not believe that their employees will receive their promised benefits, there will be a race for the exit and only an empty bag left behind. As a result, while the road to resolution will be challenging, it is one that must be taken. In the end, policymakers and stakeholders will need to work together in order to come up with a viable solution that is acceptable to all parties, as failing to do so could have significant implications for the broader U.S. economy.

⁸ The Multiemployer Pension Reform Act of 2014. https://www.treasury.gov/services/Pages/Benefit-Suspensions.aspx .

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