March 03, 2006
Remarks at The University of Texas School of Law VALCON
Conference
by Bradley D. Belt
Executive Director, Pension
Benefit Guaranty Corporation
Thank you for the invitation to speak to you today about the PBGCfs role
in corporate restructurings and bankruptcies. Unfortunately, it is an
increasingly visible and important role, for two main reasons: the growing
number of companies struggling to meet the costs of the promises they have made
to their workers and retirees, and the growing incidence of companies seeking to
renege on such promises.
As you are aware, PBGC has been a key player in some of the largest and most
complex bankruptcy reorganizations in the nationfs history. United
Airlines is the biggest and most visible. Ultimately, we had an allowed
claim against the estate for the full amount of underfunding in the pension
plans?more than $10 billion. Given the extraordinary strain that case put
on the Corporationfs resources, particularly our corporate finance and legal
staff, I had hoped we would be able to take a brief respite.
Alas, we are now actively involved in some other bankruptcies you might have
heard of?Northwest Airlines, Delphi Automotive and Delta Airlines, to name just
a few. All told, the PBGC is currently dealing with more than 300 open
bankruptcy cases of all sizes and types. In addition to bankruptcies, we
must also monitor the status of on-going plans where the underfunding or default
risk has risen.
In past years, the role of the federal pension insurance program was more
limited. However, pension plans have grown dramatically in size.
With more than $2 trillion in obligations, defined benefit pension plans
represent one of the largest liabilities underwritten by corporate
America?off-balance sheet, but a liability nonetheless. If there were
sufficient assets set aside to cover these liabilities, there wouldnft be much
of an issue for the pension insurance program?and, more important, for
beneficiaries.
Unfortunately, that is not the case. As a result of falling assets value in
the earlier part of the decade, sustained low interest rates, new benefit
promises, and inadequate cash contributions, the number of pension plans that
are underfunded and the amount of underfunding has skyrocketed over the past
five years. Estimates vary, but there is well north of $200 billion in
underfunding measured on an gon-goingh or GAAP basis, and more than $400 billion
on a settlement cost basis. As the cash flows necessary to support these
funding gaps have risen, so-called legacy costs have become a front and center
issue in some companiesf economic survival.
All too many of them have sought to terminate their pension plans, most of
them through the gdistressh termination process. In 2005 alone, there were
120 corporate pension defaults affecting almost 270,000 participants. As I
will discuss in more detail in a moment, there is a rigorous legal process that
must be followed before a plan can be terminated. Based on the public
comments of some company executives, however, one might conclude that
terminating pension plans and shifting those costs to the federal insurance
program is a perfectly acceptable business stratagem to enable them to become
more competitive. I want to disabuse them of that notion. Let me be
clear: As long as a company maintains a pension plan, there is a legal
obligation to fund the plan, comply with ERISA, and fulfill the fiduciary
obligation to act in the best interests of plan participants.
Bear in mind that the PBGC wears two hats when dealing with companies in
bankruptcy?one as a contingent creditor, and the other as a regulator. It
is our regulatory status that is often overlooked. As the agency
responsible for administering and enforcing Title IV of ERISA, PBGC has a
statutory responsibility to protect the interests of the federal pension
insurance program and its stakeholders, which include participants in pension
plans at risk of termination, all insured participants, premium payers and,
ultimately, taxpayers. As such, the PBGC strives to prevent avoidable losses,
mitigate risks, maximize recoveries, and enforce compliance with Title IV.
As a creditor, we use our status as appropriate. While the PBGC has
some priority claims, we typically are a general unsecured creditor with respect
to the full amount of the unfunded benefit liability. Even so, that
unsecured claim in many cases makes us the largest creditor of the company, by
far. In addition, we will occasionally have a security interest as a
result of a settlement agreement or a funding waiver, and we typically (but not
always) serve on creditorsf committees.
As a regulator, our authorities are more limited than those of other
financial regulators and federal insurers. The FDIC, for example, has
several enforcement arrows in its regulatory quiver that better enable it to
protect against bank failures, including the authority to issue cease and desist
orders. While PBGCfs tools are more limited in scope, the agency uses them
as proactively and aggressively as appropriate to protect the insurance
program. Among other things, we have the authority to:
- conduct examinations, audits, and investigations
- issue subpoenas
- act to prevent long-run losses and evasion of
liability
- bring actions in federal court for legal or equitable
relief
- bring actions for breach of fiduciary duties (if we have
become plan trustee).
PBGC also coordinates with other regulators on pension funding and related
matters, including the SEC and ERISA agencies, and will make enforcement
referrals in appropriate circumstances.
It is important to understand PBGCfs interest and role in out-of-court
restructuring as well as in the bankruptcy context. As a guarantor of
financial and credit risk, PBGC closely monitors developments in on-going plans
as part of its Early Warning Program. As an insurer, PBGC is concerned
with both the potential incidence of claims as well as the potential magnitude
of claims. We will take action as necessary and appropriate to reduce the
risk of a claim or lessen the magnitude of the loss if a claim is ultimately
presented. PBGC is particularly interested in actions or transactions that
pose a risk of loss to the insurance program, such as a material increase in the
amount of underfunding or decrease in the ability of the plan sponsor to support
one or more pension plans. The types of transactions that PBGC has
identified in previously issued guidance as relevant in this regard include:
- the breakup of a controlled group
- the transfer of significantly underfunded pension
liabilities
- the payment of extraordinary dividends
- the substitution of secured debt for unsecured debt.
These or similar actions or transactions may not have an adverse impact on a
pension plan. To the extent that the impact may be adverse, however, PBGC
will discuss with the sponsor ways in which the adverse impact can be eliminated
or the interests of plan participants and the federal insurance program can
otherwise be protected. Typical protections that PBGC will seek from plan
sponsors include:
- making additional contributions to the plan
- posting collateral or another security interest
- providing letters of credit or guarantees
- escrowing funds that would be available to the plan upon
certain triggering events.
PBGC routinely will retain a financial advisor to assist in the analysis of a
transaction and the structuring of appropriate protections for the insurance
program.
The key message I want to deliver is that companies with large pension
liabilities, significantly underfunded pension plans, or sub-investment grade
credit ratings should contact PBGC in advance of taking any action or engaging
in any transaction that may impact the pension liability. It would be best
for all concerned to resolve issues in advance than get into the position of
trying to unscramble eggs.
Let me now turn to bankruptcy context, and more specifically, the process for
gdistressh terminations under Title IV of ERISA. PBGC has a statutory
responsibility to ensure that companies seeking to terminate underfunded pension
plans strictly adhere to the legal and regulatory requirements before they may
shift their liabilities onto the pension insurance program. Time does not
permit me to go into great detail about the distress procedures and
requirements, but suffice it to say that a desire to be more competitive is not
a relevant consideration under the statute. Rather, the plan sponsor has
the burden to prove it meets the distress criteria. This is true for all
members of the sponsorfs controlled group as well. In addition, mere assertions
that a plan is not affordable or that the company canft otherwise
continue in business while maintaining a plan are insufficient. I
emphasize the singular because the showing must be made on a plan-by-plan basis.
Moreover, a distress termination is intended to be used only after other
remedies or less drastic measures have been exhausted. This includes
reducing non-pension costs or freezing existing plans to reduce future liability
growth. Sponsors also should have exhausted other statutory remedies
intended to deal with business hardships or cash flow problems, such as funding
waivers under section 412(d) of the Internal Revenue Code, amortization
extensions under 412(e), or Prohibited Transaction Exemptions from DOL under
Title I of ERISA. Distress is a last resort, not the path of least
resistance.
I would also note that while a bankruptcy court determines whether a company
would be able to emerge from bankruptcy while maintaining a plan, PBGC will not
process a termination if it determines that the statutory procedures have not
been fully satisfied. In addition, PBGC has the authority and discretion
under ERISA to restore plans during the process or after plans have been
terminated and trusteed?for example, if business conditions have changed or
there has been an abuse of the insurance program.
In this latter regard, we will closely scrutinize transactions or
arrangements that are, or appear to be, related to plan terminations.
Financial arrangements or transactions that are structured to inappropriately
shift liabilities onto the pension insurance program, or to use the federal
guarantee as a subsidy in conjunction with new benefits or other financial
consideration, frustrate the purposes of ERISA and are prohibited. PBGC
will assess whether the purpose or effect of transactions or financial
arrangements is to avoid the strict criteria and procedures for a distress
termination; to avoid or evade the maximum guarantee limits established by
Congress; to avoid the termination liability of a sponsor or controlled group
member; to induce employees to agree to termination of a plan; to transfer or
allocate assets in a manner inconsistent with the provisions of Title IV; to
threaten the integrity of the pension insurance program in any other manner.
The factors that PBGC will consider in determining whether a transaction or
arrangement is abusive include the timing of the arrangement or transaction
(i.e., is it temporally related to plan termination); the structural
relationship of the arrangement or transaction to plan termination (e.g., is
there a linkage with benefits promised under the terminated plan); and financial
considerations (e.g., whether follow-on pension benefits or other financial
considerations provided could otherwise support one or more of the existing
plans).
A couple of examples may be illustrative. This audience is undoubtedly
familiar with the agencyfs authority to address abusive gfollow-onh plans, which
was upheld by the Supreme Court in the LTV case. That case dealt with a
fairly flagrant example of evading the maximum guarantee limits and inducing
employees to agree to a plan termination. We have subsequently seen
instances of more creative approaches that nonetheless have the same purpose or
effect. This includes providing cash or other securities to employees to
compensate for the loss of non-guaranteed benefits, whether or not they are
provided in a deferred compensation structure. Other transactions that may
constitute an impermissible abuse of the insurance program include control group
breakups or asset sales that result in the sponsor being unable to support a
plan.
The key point is that the substance and effect of the arrangement or
transaction will dictate whether it is abusive, not the form. If an
arrangement or transaction is determined to be abusive, PBGC will take action to
protect the interests of the pension insurance program. In addition to
declining to process a proposed termination or restoring a plan to its
pre-termination status as noted above, PBGC may also pursue claims against
former contributing sponsors or controlled group members or seek to obtain
injunctive or other equitable relief in federal court.
The bottom line is that the federal pension insurance program is not intended
to subsidize a companyfs on-going labor costs. This adversely impacts plan
participants, industry competitors, other plan sponsors that have responsibly
funded their pension promises, and it puts American taxpayers at risk of having
to bailout the insurance program. The company that makes promises to its
employees should keep them and not shift its obligations to third-parties.