Home > Economics - General > The great risk shift, yet again

The great risk shift, yet again

August 5th, 2008

The Wall Street Journal has a fascinating article about how corporations like Intel are loading up their general pension funds with obligations to pay massive “supplemental” benefits to senior executives. It’s partly a tax dodge, and partly an example of what Jacob Hacker has called the great risk shift. The extra liabilities increase the risk that the fund will fail, but the top brass can be protected against this eventuality with a trust fund, while the rank and file get to take their chances.

Update To clarify, in response to comments here and at Crooked Timber, the pension entitlements of ordinary workers are supposed to be protected by the government through Pension Benefit Guaranty Corporation, and to the extent that this works as expected, risk is shifted to the PBGC rather than to workers. But as both the WSJ story and the discussion at CT make clear, things don’t always work as planned. Some benefits paid to ordinary workers turn out to be classed as supplemental and therefore lost when the scheme fails.

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  1. huh?
    August 6th, 2008 at 00:44 | #1

    the top brass can be protected against this eventuality with a trust fund, while the rank and file get to take their chances.

    Wrong. Google “Pension Benefit Guaranty Corp”.

    The rank-and-file are protected up to a limit of about $40,000 a year by the US taxpayer. The trust fund is there to protect the employees’ pension amounts over the PBGC limits. It is private, so what is the issue?

    (oh, I get it – evil executives. yawn).

  2. jquiggin
    August 6th, 2008 at 06:42 | #2

    Next time, read the article before commenting, Huh? It contradicts all the claims you make.

  3. huh?
    August 6th, 2008 at 09:09 | #3

    I read the article. It contradicts you, which is no doubt why you made the update. The rank-and-file are protected by PBGC, up to $4,380 per month in 2008, which is $52,560 per year. So yeah, I was wrong about the “about $40,000″ – an old figure I quoted from memory but you’re not complaining about my estimates being too low now, are you?

    The trust fund is just a private mechanism for insuring the benefits of execs who cannot have their retirement income guaranteed by PBGC because they earn too much.

    So please do tell, where is the great “risk shift” you speak of?

  4. Ian Gould
    August 6th, 2008 at 10:32 | #4

    There is one possible benefit to big retirement benefits for executives – it keeps their interests allied with those of shareholders even after they retire.

    How often have we seen CEOs depart in a blaze of glory only to see massive write-downs with 2-3 years? (Some of which is of course down to their successor painting the situation in the worst possible light so their own perfroamnce looks better.)

    Executive incentives tend to reward them for maximising profits on an annual basis or over a few years, even if by doing so they sacrifice the long term interests of the shareholders (i.e. by underinvesting or by undertaking impressive but overly expensive takeovers).

    So I’d be happy to see executives getting big retirement payments – provided they had to sacrifice 50% or mroe of their current compensation in contributions and a large minority, at least, of their pension fund was mandatorily invested into the company.

  5. smiths
    August 6th, 2008 at 11:08 | #5

    “Intel believes that its practices “feel consistent” with both the spirit and letter of the law”

    honestly you couldnt make this stuff up,

    also in response to huh? how much has the PBGC got to cover these problems, a nano fraction i would suggest,

    like the American banks,

    The FDIC has about $53 billion in funds to handle future bank failures.
    The FDIC says that they have 90 banks on their “watch list�. (note IndyMac was not on the list)
    There are 8,500 banks in the U.S. Based on an independent analysis by Chris Whalen from Institutional Risk Analytics, they have identified 8% of all banks, or around 700 banks as troubled.
    The implications of 700 institutions failing are huge.
    There is roughly $6.84 trillion in bank deposits.
    It is almost beyond belief that $2.6 trillion of these deposits are uninsured.
    There is only $274 billion of the $6.84 trillion as cash on hand at banks.
    This means that $6.5 trillion has been loaned to consumers, businesses, developers, etc.
    The FDIC has $53 billion to cover $6.84 trillion of deposits.
    http://preview.tinyurl.com/57ffe2

  6. jquiggin
    August 6th, 2008 at 11:46 | #6

    #3 This time read right to the end of the article and you get

    Some lower-level people will lose benefits, too. Chester Madison, a middle manager who retired in 2002 after 33 years, saw his pension fall to $20,400 a year from $49,200. Mr. Madison, 62, has taken a job selling flooring in Sacramento, Calif.

    It’s impossible to know how much the addition of executive pensions to the pension plan contributed to the plan’s failure. But in this as in similar companies where a plan saddled with executive benefits failed — such as at kitchenware maker Oneida Ltd. in upstate New York — it’s clear the move weakened the plans by adding liabilities but no assets.

    As regards your continued insistence on the claim that the trust fund is “just a private mechanism”, what is this supposed to mean? As the article makes clear, the whole setup is designed to secure tax benefits from the government, while shifting risk to the PBGC.

    But even if the arrangements were “private” in the sense of being internal to the firm, how would that change the fact that they favor top management at the expense of ordinary workers?

  7. huh?
    August 6th, 2008 at 14:18 | #7

    smiths: the PBGC is fully funded. Employers with defined benefit pension plans pay insurance premiums into it to cover any shortfalls.

    jquiggin: if Mr. Madison is now 62 and retired in 2002 then he retired at 56. The PBGC guarantee for 56yo retirees is $2,113.13 per month. Mr Madison presumably knew that when he chose to retire early – i.e. he knew (or should have known) that if the company pension plan became administered by the PBGC, his pension would be reduced. I guess he figured it was a risk worth taking for the extra retirement years.

    As for whether executive pensions in the plan caused it to fail: the article freely admits: “It’s impossible to know how much the addition of executive pensions to the pension plan contributed to the plan’s failure.”

    The real problem is the PBGC caps: there’s no tax effective way for higher paid employees to be paid a defined benefit retirement salary commensurate with their income without resorting to creative accounting practices.

    Why shouldn’t a company get the same tax break on pension contributions for executives that they get for lower-paid workers?

    Are you volunteering to pay a higher tax rate on your superannuation contributions because you earn well above the median salary?

    As for the trust fund favoring top management over “ordinary” workers : it doesn’t. Top management are not protected at all without some such arrangement, whereas the ordinary workers have the PBGC.

  8. jquiggin
    August 7th, 2008 at 11:12 | #8

    #6 At least you now admit the risk was shifted though as WSJ notes, we can’t say exactly how much, and of course it’s the worker’s fault for not anticipating this.

  9. huh?
    August 7th, 2008 at 11:29 | #9

    At least you now admit the risk was shifted

    I never denied it. But it is hardly a “*great* risk shift”. In the case of intel, they both shifted the risk *and* the assets to pay for execs’ retirement, so it simply amounts to a scheme for reducing tax.

    Again, do you think it is reasonable that companies pay a vastly higher higher tax rate on their pension contributions for executives? Do you pay a vastly higher tax rate on your superannuation contributions? Are you perpetuating a great evil by being a member of the same superannuation fund as your departmental secretary?

    As for poor Mr Madison: come on, he retired at 56. Given that life expectancy for his demographic is probably close to 30 years from age 56, he took a huge risk reducing his guaranteed pension by that much (the probability that his employer’s fund would fail in 30 years must be reasonably high, with or without executive obligations).

    Admit it, this is a complete beat-up.

  10. Socrates
    August 8th, 2008 at 09:22 | #10

    I’m neither an economist nor a lawyer, but I can’t help thinking this is not just unfair but could be some form of breach of contract. Following the article and JQ’s line of thought, employees chose a job based on their assessment of the wage and benefits. This “risk shift” seems really to be an asset transfer, in that executives then get a share of the fund set up for paying the employees benefits. Employees presumably have no control mover the shift, but suffer a loss of benefits. If the management knowingly makes a change that precludes the promised benefit flowing to the employee, isn’t that a breach of contract? The benefit has been earnt through the labor of the employee. If it is money owing and the means of payment are deliberately (partially) removed, that seems to me to breach the original employment contract.

    Am I missing something here? I can’t help thinking that in this and a lot of the more dubious financial scandals, the behavious is often just plain old fraud, but the mechanisms are so complex that its very hard to track down exactly where the offence occured.

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