Retirement Heist Read online

  One might expect that such lush asset balances would be something to celebrate.

  Pension assets had been building for years, the result of downsizings, a robust stock market, laws enacted in 1974 that required employers to adequately fund pensions, and a 1990 law that made it harder for them to raid the surplus by terminating their pensions.

  Thanks to this, many employers hadn’t contributed a cent to their plans since the 1980s, yet they still had enough money to cover the pensions of all current and future retirees even if they lived to be one hundred. With so much money, the plans would cost the companies nothing for years to come.

  But employers weren’t celebrating. The money was burning a hole in their pockets. In theory, surplus pension assets are supposed to remain in the pension plans, to provide cushion for the inevitable times when investment returns are weak and interest rates fall. But employers felt that requiring companies to use pension money only to pay pensions made no sense.

  “Rigid and irrational legal restrictions trap these surplus assets in the pension plans and prevent them from being used productively,” maintained Mark Ugoretz, the head of ERIC, a group that lobbies for employers on benefits matters.

  Complaining that the pension assets were “locked up,” employers had asked the ERISA Advisory Council to study the issue. Employers had good reason to believe that the council would recommend changes they wanted. The council consists of fifteen members, appointed by the secretary of labor, to advise the department on benefits matters.

  The revolving cast includes representatives from think tanks, academia, unions, and pension administrators. But the council has often been dominated by corporate representatives, who influence the choice of topics and suggest which expert witnesses should testify. Nine of the fifteen appointed members of the council at the time were representatives of employers and financial firms, and many of the experts they invited to testify not surprisingly shared employers’ views.

  At the 1999 hearings, executives from DuPont, Northrop Grumman, and Marathon Oil strongly advocated allowing employers to withdraw pension money to pay for their retiree health benefits. This would not only be good for retirees, they said, but good for retirement security overall.

  John Vine, a lawyer from Covington & Burling, a Washington law firm that had advised clients on myriad methods to monetize their pension surplus, discussed ways employers could extract the assets in mergers or use them to pay severance costs or even to “provide enhanced pension benefits to a subclass of the plan’s current participants” (e.g., the employer’s executives).

  Michael J. Harrison, human resources vice president at Lucent Technologies, the giant AT&T spin-off, liked the idea of using surplus assets to pay executive benefits. (The language was less blunt; he and others advised using surplus assets to pay for pension benefits “in excess of qualified plan limits (such as 415 and 401[a][17] limits).”)

  Like other witnesses, he maintained that allowing employers to drain the surplus assets from pension plans would actually enhance retirement security. “We believe making excess pension assets more freely available for other constructive purposes would encourage more companies to voluntarily sponsor defined benefit pension plans and encourage companies to enhance participants’ security by funding these plans at a higher level,” he testified.

  DuPont’s chief actuary, Ken Porter, minced no words regarding on whose behalf the company managed the pension plans: “As a publicly traded company, DuPont has a fiduciary responsibility to its owners. We have been entrusted with the owners’ assets with the expectation that we will allocate our resources efficiently and appropriately to provide for all of our corporate obligations,” he said.

  A witness from the AFL-CIO had the temerity to suggest that employers use the surplus to increase benefits or provide cost-of-living increases for retirees. Porter dismissed this notion, saying that using the surplus to pay benefits would dilute reported earnings. “Accordingly, business competitiveness issues, not pension asset values, dictate when and whether benefits levels are changed.”

  Ron Gebhardtsbauer, senior pension fellow of the American Academy of Actuaries, echoed this trickle-down concept, testifying that if employers could use pension assets for their own benefit, it would actually help the employees and retirees. “Strengthening employer solvency can create more security for the pension plan… surplus assets could be helpful to strengthen a company at an important time… the best insurance is a strong employer.”

  The experts who testified also included consultants from Watson Wyatt Worldwide and Mercer, two of the largest global benefits-consulting firms, which for years had helped large employers use all these strategies to tap their pension plans like piggy banks. They felt that these were all great ideas, as did the chairman of the working group, Michael J. Gulotta. As chief of AT&T’s actuarial consulting unit, he had helped the company and many others convert billions of dollars in its pension assets into company assets. They all had much to gain by helping employers further unlock the riches in their pension assets, and they already had plenty of experience doing so.

  Not surprisingly, their final report concluded that “for the good of America,” the government ought to loosen the withdrawal rules. The irony is that all these employers, and many others, had already been quietly siphoning billions from their pension plans for years. They were merely seeking “reforms” that would open the spigots even further.

  The arguments sounded plausible: Pension plans already had too much money and would only become even more overstuffed. After all, the stock market, like real estate, would only go up: The economy was buzzing, the government had a massive budget surplus, and interest rates were low.

  One of the few dissenting voices was David Certner’s. AARP’s legislative affairs watchdog, Certner was adamant that pension assets be used for no purpose other than providing pension benefits. “The funds are put into the pension trust for the exclusive benefit of the participants,” he said at one of the council’s meetings.

  Allowing employers to use the money for anything else would put the plans at risk, Certner warned, because employers would be tempted to skim off excess funds in good times and then face shortfalls when the markets declined. He warned that the recent bull market would end and that changes in the economy, interest rates, or market returns could quickly erase the surplus, putting individuals at risk. If the plans failed, participants could see a big chunk of their benefits wiped out.

  If his warnings sound familiar, it’s because every single one of Certner’s predictions came true. But nobody was listening. And nothing has changed. These are the strategies employers were using—and have continued to use—to drain their pensions.

  PARTING GIFTS

  One common use of pension assets has been to finance restructurings. In 1994, Bell Atlantic, formed after the breakup of the Baby Bells in the early 1980s, was transforming not only its technology but also its workforce. In 1994, it had 100,000 employees, many of whom had been on the job for decades. This was exactly the cohort that many industries, including the fast-changing telecom sector, were eager to whittle down. Workers were in their peak earnings years, and the value of their pensions, which was based on tenure, was about to spike. Severance is typically paid for with cash, so shedding this large cohort would be costly.

  Fortuitously, Bell Atlantic had a lushly overfunded pension plan and, like many companies, it offered to sweeten the pensions of those it was letting go. Over the next six years the company used $3 billion in pension assets to finance early-retirement incentives for 25,000 managers. Using pension surplus not only saved the company cash but saved payroll taxes, because, unlike severance pay, money paid from a pension in lieu of severance isn’t subject to the 7.65 percent Social Security (FICA) taxes.

  Pension law doesn’t allow companies to use pension assets to pay severance, so companies characterized the payments as “termination benefits,” “shutdown benefits,” or “additional pension credits” that might pro
vide people additional years of service or the equivalent of, say, an additional year of an employee’s pay.

  Bell Atlantic merged with GTE (formerly known as General Telephone & Electronics Corp.) in 2000 and changed its name to Verizon Communications, but the pension withdrawals continued. Over the next five years, Verizon continued to pay for retirement incentives using pension assets, even though the surplus, which had peaked at $24 billion in 2000, had shrunk to only $1.7 billion by the beginning of 2005, thanks to market losses and company withdrawals.

  Verizon then had to make a critical decision: It could stop withdrawing assets to finance layoffs, and let the pension plan rebuild its cushion of assets to provide employees and retirees with greater retirement security. Or it could cut pensions, which would lop off some of the liability, making the plan better funded.

  The company chose the latter strategy, and froze the pensions of its fifty thousand management employees. The move eliminated $3 billion in liabilities from the books and replenished the surplus. Of course, Verizon didn’t describe the transaction that way. “This restructuring reflects the realities of our changing world,” Verizon chairman and CEO Ivan Seidenberg said in a statement announcing the change. “Companies today, including many we compete with, are not adopting defined benefit pension plans.” Verizon subsequently withdrew $5 billion from the surplus, and the 2008 market crisis wiped out the rest. By early 2011, the plan had a deficit of $3.4 billion.

  Seidenberg wasn’t affected by the pension freeze. His supplemental executive pensions and deferred-compensation plans had grown to $96 million by the beginning of 2011.

  In the 1990s, dozens of companies, including utilities, defense contractors, and manufacturers, began relying on their pension funds to finance restructuring. Unfortunately, the companies with the biggest incentive to do this were companies in a downward financial spiral. Delta and United, struggling in the travel slump after the September 11 terrorist attacks, each used roughly half a billion dollars to fund buyouts and pay termination benefits to employees they laid off. Each subsequently declared bankruptcy, and the pension plans they handed over to the Pension Benefit Guaranty Corp. (PBGC), the federal pension insurer, were so underfunded that employees lost billions in pensions they were entitled to.

  The Big Three automakers took this route, too. General Motors, the poster child for chronic underfunding, used $2.9 billion in pension assets to pay for lump-sum severance benefits in 2008. In 2007, Ford Motor Co. used $2.4 billion, a move that left it with no cushion when the market cratered in 2008. By 2011, the pension had a $6.7 billion shortfall. Delphi, the eternally troubled auto parts spin-off of GM, entered bankruptcy in 2005, yet the following year used $1.9 billion in pension assets to pay for its “special attrition program,” which is what it called its buyout program. The pension never recovered, and Delphi dumped the plans for seventy thousand workers and retirees on the PBGC in 2009. Delphi employees were devastated. Mark Zellers, a Delphi retiree in Columbus, Ohio, lost a third of his pension and took a $9-per-hour job at Home Depot to help make up for the difference and pay for his health care, which was also eliminated in the bankruptcy.

  ROBBING PETER TO PAY PAUL

  Companies giving their workforces makeovers tapped the pension plans to pay for another essential benefit: retiree health benefits. These health plans continue a retiree’s health coverage until age sixty-five, when Medicare kicks in. Employers don’t usually fund the plans, instead paying the cost of the coverage each year, the same pay-as-you-go arrangement used for medical plans for current employees. Thus, pulling cash from pension plans to pay for these costs enables companies to avoid using cash to pay the benefits. Over the past two decades, companies have also siphoned billions of dollars from their pension plans to pay for retiree health benefits.

  DuPont pioneered the practice. It dipped into its pension assets on more than seven different occasions during the 1990s, drawing out $1.7 billion to pay for retiree health benefits. It also used “a significant amount” of surplus pension assets to finance a number of voluntary retirement programs. The market decline in the early 2000s erased what was left of the pension surplus. DuPont froze its pension starting in 2007, but that wasn’t enough to restore it to health, and by early 2011 the plan was $5.5 billion in the hole.

  Employers had lobbied aggressively for the right to use pension assets for retiree medical benefits, which are called “420 transfers,” after the section of the tax code they fall under. They argued that if a plan had a surplus, why not use it to benefit the retirees? Congress agreed in 1990, but included some limits. To protect the pension plan, employers could withdraw the assets only if the plan had a surplus. But that didn’t stop employers from pulling money from their deteriorating pension plans anyway. Despite the market decline between 2000 and 2002, Allegheny Technologies, Qwest, and U.S. Steel continued to transfer millions of dollars from their pension plans to pay for retiree health benefits, moves that contributed to their subsequent deficits.

  The practice continues. Prudential Financial transferred $1 billion from its pension plan in 2007 to pay for several years’ worth of retiree health benefits, and Florida Power & Light transferred more than $180 million from its pension plan between 2005 and 2010. Their pension plans remain well funded, but so, initially, did the pensions of the companies above.

  SELLING SURPLUS ASSETS

  Mergers, acquisitions, and spin-offs have also enabled companies to convert their surplus pension assets into cash. The strategy might be as simple as merging an underfunded pension plan with an overfunded one. But there are were less obvious ways to monetize the assets.

  One strategy involves selling a unit to another company, then handing over more pension money than is needed to pay the benefits of the transferred workers and retirees, in exchange for a higher sale price. General Electric is a master of the practice. In 1993 it sold an aerospace unit to fellow defense contractor Martin Marietta. In the deal, it transferred thirty thousand employees and $1.2 billion in pension assets to Martin Marietta to cover the liabilities for their pensions. That was $531 million more than was needed to fulfill the pension obligations. By getting a better price for the unit because it came with the surplus, GE effectively got to put half a billion dollars from its pension plan into its pocket.

  GE did dozens of such deals over the years, monetizing billions of dollars of pension assets. Thanks to this and other practices, the $24 billion in surplus in its plan in 1999 evaporated in the following years, and at the beginning of 2011 the plan was short $6 billion.

  The Defense Department wasn’t asleep at the wheel during these deals. It sued GE to recover the surplus, because when the government provides money in its contracts to fund pension and retiree medical benefits, the company is supposed to return the money if it is not subsequently used for benefits. The money isn’t supposed to vanish into company coffers.

  Contractors get around this by restructuring. If a contractor closes a segment, it has to hand the pension surplus to the government; but if the contractor sells the unit, it can turn the pension over to the acquirer and get some cash for the surplus out of the deal. The new owner can then close the segment, which is what Martin Marietta did to the GE unit it acquired. Government lawyers consider these to be sham transactions intended to help the contractor raid the pension, and the legal tugs-of-war between defense contractors and the government over the scalping of retiree assets have kept a generation of Justice Department lawyers busy for years.

  GE countersued the U.S. government in the U.S. Court of Federal Claims in Washington,[1] saying not only was it entitled to keep the entire surplus, but the government actually owed GE hundreds of millions of dollars. The company’s reasoning? Because GE transferred so much pension money to Martin Marietta, the pensions of the aerospace workers it didn’t transfer were now less well funded. GE wanted the government to pony up the shortfall. This was just one of roughly twenty lawsuits between GE and the federal government regarding retiree assets t
hat have slogged through the courts in the past two decades.

  There’s no way to know how many billions of dollars in pension assets vanished into the coffers of dealmakers in the frenzy of acquisitions, mergers, spin-offs, and the like, because the details are concealed in non-public-disclosure documents.

  Generally, lawsuits are the only way these transactions are flushed into the open. Employees have sued when they learned that the surplus in their pension plans was being used to top up the pension of a newly acquired company, or for some other corporate purpose. But the courts have essentially green-lighted these indirect pension raids.[2]

  Companies keep these arrangements out of the limelight because employers are fiduciaries, meaning they’re supposed to manage the plans solely for the benefit of participants and beneficiaries. Actuaries and lawyers discussed this dilemma at a session on “Consulting in Mergers & Acquisitions” at a professional conference in 1996. Their solution? Don’t put it in writing. “The parties need to cut a purchase price and that’s it,” said a partner with the New York corporate law firm Sullivan & Cromwell. “That way nobody can pinpoint what portion of the purchase price, if any, was attributable to the pension surplus.”

  A principal at Mercer, the human resources and benefits consulting firm, explained that some of the companies he worked with “believe that none of this should be documented, so they don’t leave a nice paper trail. You need to decide what situation you find yourself in.” The panelists noted that buyers typically pay fifty to eighty cents on the dollar for surplus assets.

  PENSION PARACHUTES

  Conveniently, when key managers lose their jobs in connection with mergers, spin-offs, and other restructurings, the pension plan can help finance their departure payments. These arrangements also remain off the radar screen of regulators, employees, and the IRS. In 1999, Royal & Sun Alliance, a global London-based insurer, closed a Midwest division and laid off all 228 of its employees. Just before the shutdown, the insurer, commonly known as RSA, amended the division’s employee pension plan to award larger benefits to eight departing officers and directors. One human resources executive, for example, got an additional $5,270 a month for life, paid out in a lump sum of $792,963.