Spotting Financial Risks

he Pension Benefit Guaranty Corp. has had the unenviable distinction of making regular appearances on the government's annual listings of programs posing a "high risk" for America's taxpayers. And small wonder, for this tiny agency has responsibility for overseeing 58,000 defined benefit pension plans covering 41 million American workers-which are underfunded by $71 billion, according to the latest count.

When any of these plans goes belly up, the PBGC steps in to cover workers' pensions; today, it pays benefits to 372,000 people whose pension plans were terminated, at an annual cost exceeding $700 million. The outlays are covered by premiums the corporation collects from corporate pension plans, but at the moment, the PBGC has a projected long-term deficit of $1.2 billion.

It's obviously in the interests of the government and the taxpayers to see to it that the problem doesn't get out of hand. Risks lie around many a corner in the modern era of complex mergers, acquisitions and other corporate transactions. Pensions are often an afterthought in such deals, although well-funded ones have been used to finance corporate raiders' ambitions.

The goal of the PBGC's award-winning Early Warning Program is to anticipate threats to big pension plans in time to act to protect them. The program is on the cutting edge of enforcement innovation, combining an anticipatory posture aimed at preventing future loss, careful targeting of the most significant potential problems and methods that encourage compliance and voluntary disclosure. Other enforcement programs have employed some of these elements, says Linda Kaboolian, who evaluated the project on behalf of the John F. Kennedy School of Government, where she is an assistant professor of sociology, but it's rare to seem them all deployed effectively.

Close monitoring of 58,000 pension plans is obviously impossible for the PBGC, which has a budget of only $4 million and a staff that includes just 14 financial analysts. But the corporation narrowed its focus recently after its analysis showed that only 400 corporations account for 85 percent of its exposure. The principal problem, PBGC analysts concluded, lay in five industries: steel, tires, machinery, automobile and airlines. To protect pension funding in the problem cases, PBGC so far has negotiated settlements with 27 corporations, adding $13.4 billion to the nation's pool of pension funding and protecting one million participants.

Facing a Deficit

The PBGC was born in 1974, when the government discovered that pensions were underfunded by more than $100 billion. That year, Congress passed the Employee Retirement Income Security Act (ERISA), requiring annual pension funding and establishing the PBGC to guarantee pensions.

The new law succeeded in reducing underfunding to the $20 billion range during the first half of the 1980s. But the wave of corporate restructuring in the second half of the decade, followed by the recession early in the 1990s, steadily worsened the problem.

The PBGC conceived the idea for the Early Warning Program in 1990, at a time when the agency was confronting the largest bankruptcies and losses in its history. The failure of Eastern Airlines and Pan American World Airways convinced PBGC leaders that they couldn't maximize recoveries for pensioners if they waited until companies' financial conditions had deteriorated to the point where pension plans had to be terminated.

Explains Martin Slate, longtime civil servant, financial expert and the presidentially appointed executive director of PBGC since 1993, "Our problem was that our activity was on the back end. We were getting into cases when companies were going bankrupt and pension funds were in extremis, and there were few assets around."

With the agency climbing toward the top of government's high-risk lists, the Early Warning Program started up in 1991, targeting the most pressing hazards as determined from financial and actuarial information gathered by other agencies, including the Internal Revenue Service and other Treasury sources, the Securities and Exchange Commission and the Labor Department.

Staff and Strategy

From the start, the agency has strived to bring as much expertise as possible to its activities.

Slate is himself a pension expert, having worked on ERISA matters at the IRS for years. Working for him in key positions are people who boast extensive private-sector experience and an understanding of corporate finance practices. Ellen Hennessy, deputy executive director and chief negotiator at PBGC, was a corporate pension lawyer for 15 years before coming to the agency in 1993. Andrea Schneider, director of corporate finance and head of the negotiations department at PBGC, was vice president of investment banking at Merrill Lynch & Co. before joining PBGC in 1991. "They're incredible," says Kaboolian of the top PBGC staff.

Slate and his staff have augmented their internal capabilities by developing a network of consultants and advisers among Wall street equity and credit analysts and industry sources. Slate has made sure that the staff has access to all the tools used by sophisticated Wall Street firms, including on-line access to breaking financial news.

The experts then put it all together with a three-step strategy to define how and when the agency would intercede:

• Targeting: The program's experts evaluate data and establish prudent levels of monitoring, based on potential liability, possible risk and number of people affected.
• Early Action: If a plan is at risk, PBGC negotiators open a dialogue while there is still time to shore it up.
• Tailoring: At the bargaining table, PBGC negotiators consider the interests of employees, retirees, the corporation and the government to tailor a settlement with which the corporation can and will comply. For instance, if a company wants to sell a cash-rich subsidiary, that is fine, Slate says, as long as some cash gets left behind for the pension plan.

In the negotiations, PBGC carries a big stick--the threat to involuntarily terminate a pension plan. That action requires immediate transfer of plan assets to the PBGC; it has never yet been employed since it can drive a company to bankruptcy.

Success Stories

Most companies consequently come to the bargaining table willing to hash out a settlement. Ed Bramson, general counsel for Ampex Corp., a data-storage manufacturer that agreed to add $80 million to its pension fund in 1994, says he appreciated the savvy displayed by the program's staff. "They seem to have a fair number of people there with commercial experience, who realize [pension funding] is not a black or white issue," he says.

The Early Warning Program's greatest success involved negotiations over the huge General Motors Corp. pension plan, which was underfunded by $20 billion. Slate made it his business to call GM executives during his first days on the job because he knew the company's already-mammoth funding shortfall could be aggravated by GM's plans to sell its Electronic Data Systems (EDS) subsidiary. The relatively healthy EDS should not be allowed to walk away without contributing to the pension plan, PBGC leaders believed.

In October 1993, GM executives offered to add $6 billion of EDS stock to the pension fund, an amount PBGC officials deemed insufficient. After arduous negotiations ended almost a year later, GM agreed to add $4 billion in cash and $6 billion of EDS stock to the pension, while continuing to contribute $2 billion to the fund annually. In return, PBGC allowed GM to release EDS.

One of the agency's accomplishments in the past three years has been to cut its long-term accumulated deficit from $2.9 billion to $1.2 billion. Another has been to inspire an attitudinal change in the pension-benefit community, evidenced in part by the willingness of many companies to take the initiative in approaching the PBGC to solve underfunding problems.

One thing that inspires companies to do this is PBGC's annual distribution of a list of the top 50 underfunded pension plans. Says Slate: "We've gotten nine companies to make major contributions totaling $2 billion just by telling them that they're going to be on the Top-50 list. We told one company that they were going to be number 46. And they said, 'How much to be 51? How much to be 52? How much to be 53?' Finally, they gave $200 million to be 54"-and thus off the published list.

Slate has had regular dealings with Congress, especially last year as he was seeking changes in law that would add reporting requirements to enhance the agency's ability to identify and respond to corporate transactions. The changes were incorporated in the Retirement Protection Act, enacted as a rider on a big trade bill. "For the Democrats, it was helping people," Slate says. "For the Republicans, it was deficit consciousness."

The PBGC's innovation could be replicated in other agencies at the federal, state and local level. Early-warning programs could help manage risk in banking, farm credit and state insurance regulatory programs, Slate observes. Kaboolian says: "Any compliance organization could learn from them. They increased voluntary compliance, maximized scarce resources and worked with reluctant compliers." More importantly, though, she sees the PBGC as a leader in a government compliance revolution. "The new ethos in compliance organizations is moving towards the idea that maybe we should be spending money on helping people comply. A large number of non-compliers don't have the resources to figure out how to meet compliance regulations or can't figure out how to comply because of the complex requirements."

Slate sees the Early Warning Program only as a promising beginning. "We have a way to go," he says. "Socially, our challenge is to institutionalize our program. We haven't taken this thing through a full financial cycle, and pension situations can become much more difficult when there's a scarcity of resources. So it's important for us to make sure that pension matters are part of the culture. That's our biggest challenge."