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PBGC Director Joshua Gotbaum; Illustration by Arthur Mount

A YEAR AGO, IN THE WEEK AFTER THANKSGIVING, AMR Corp., parent of American Airlines, gave its 130,000 employees and retirees something to be less than grateful for: The third-largest U.S. airline filed a Chapter 11 petition to restructure the company via bankruptcy court. Like Delta Air Lines, Northwest Airlines Corp. and United Airlines parent UAL Corp. before it, American contended it would need to unload its four defined benefit pension plans to return to profitability. If the company succeeded, a total of about $8.3 billion in assets to help cover $18.5 billion in promised benefits could have vanished from its books. No company had ever tried to escape pension obligations as large.

The ink on the AMR filing was barely dry when the Pension Benefit Guaranty Corp., the federal pension insurance agency, swung into action. Leading the charge: PBGC director Joshua Gotbaum.

The prospect of giant American Airlines leaving taxpayers with the bill for its pension promises gave Gotbaum a high-profile perch from which to begin the job of remaking the federal pension insurance corporation, which now oversees $107 billion in obligations. Appointed by President Barack Obama in July 2010, the 61-year-old Gotbaum soon found himself on a mission to repair an agency damaged by annual threats of looming insolvency, constant turnover at the top, years of poor oversight by long-entrenched staff in key roles, questionable governance practices and a truckload of scathingly critical reports by its inspector general and the Government Accountability Office.

But fixing the PBGC’s problems is not Gotbaum’s primary goal. As the head of what is fast becoming the defined benefit pension provider of last resort, he has joined the ranks of industry leaders out to remake the U.S. retirement system. “As a first principle, we need to find a way to make it easier and less expensive for employers and enable employees to achieve secure retirements,” says Gotbaum. If done correctly, that would ultimately put the agency out of business.

Established under the Employee Retirement Income Security Act of 1974, the PBGC is charged above all with saving pensions. According to the omnibus pension law, a company in bankruptcy must show proof in court that it cannot honor its pension promises to its employees and retirees before it is allowed to terminate its plan. Nonbankruptcy pension terminations are permitted only after a thorough accounting. PBGC staff have long endeavored to carry out this charge, often working through the courts, but highly publicized bankruptcies and pension fund terminations by major U.S. corporations in the first decade of this century have cast doubt on the agency’s ability to do so. As one former PBGC director confided to Institutional Investor, “The bankruptcy industry sees the PBGC as rolling over in a bankruptcy.”

To build bargaining muscle in the AMR case, the PBGC director and his staff contacted the airline’s creditors to determine whether they too would be served by avoiding the termination of American’s pension plans. They also worked the press and Congress.

“If American Airlines terminated its pension plan, the PBGC would’ve been the largest creditor, at $9 billion,” Gotbaum explains. “So we went to the other creditors and said, ‘Folks, we think American Airlines can afford not to terminate its pensions.’ ” By January the agency had filed 76 liens against AMR  assets that were not part of the bankruptcy. Next, while preparing for the possible assumption of billions in new obligations, Gotbaum approached news outlets to build a public case against the terminations. “One of the issues with the PBGC is that no one knows what it does,” he complains.

By early March of this year, American had backed down and agreed to freeze three of its plans. The fate of the fourth — the pilots’ plan — is currently being worked out.

In the wake of two major financial downturns in this new century, two rounds of pension funding relief from Congress and a massive inflow of terminated pensions, the PBGC has reached a unique position as the largest public trustee of private pension assets. In addition to its $107 billion in liabilities, the agency manages $81 billion in assets, for a net deficit, or underfunding, of $26 billion — numbers that have swelled tenfold over the past decade. The PBGC now pays out $6 billion a year in pension benefits to 900,000 retirees in 4,300 failed plans; they range from airline baggage handlers and supermarket employees to steelworkers in a Taft-Hartley plan. If you add in all the active workers in the PBGC system, there are a total of 1.5 million people whose benefits will be paid by the agency.

There are also more than 33 million actively employed participants in close to 26,000 insurance-paying single-employer plans. A separate multiemployer program for Taft-Hartley union plans covers more than 10 million plan participants in about 1,500 active plans. The single-employer program has a higher premium and distributes a higher benefit to participants than the Taft-Hartley program. Retirees whose pensions are trusteed in the single-employer program receive a maximum guaranteed payment of about $56,000 at age 65, while those in the multiemployer program can receive only a paltry $12,870 for 30 years of service.

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“The PBGC is a reflection of the economic challenges that face the country,” observes Phyllis Borzi, assistant secretary for employee benefits security at the Department of Labor and director of its Employee Benefit Security Administration in Washington.

Borzi oversees pension and PBGC issues for her boss, Labor Secretary Hilda Solis, who is the ERISA-designated chairman of the PBGC board, which also includes Treasury Secretary Timothy Geithner and Acting Commerce Secretary Rebecca Blank and now meets once every quarter. Their staffs oversee the day-to-day functioning of the agency and generally fill in for the secretaries at the board meetings. “I spend an extraordinary amount of time on the PBGC,” says Borzi. That degree of attention is a relatively recent phenomenon.

Until Congress in July passed MAP-21, or the Moving Ahead for Progress in the 21st Century Act, also known as the highway bill, 16 years could elapse without a single meeting. For 13 years, from 1990 through 2003, the board held a total of six. To bring the PBGC’s governance in line with that of other public institutions that oversee more than $80 billion in fiduciary assets and liabilities, Congress recommended, at the close of its 2012 session, expanding the board to include both audit and investment committees.

The pension insurance program itself has suffered criticism for years over the moral hazards created by the agency’s original structure. Because the PBGC protects both employers and employees when a pension is shed, employers have less motivation to retain their commitments to these benefits. Unlike those of public insurance corporations like the Federal Deposit Insurance Corp. or most private insurance companies, PBGC’s premiums are set by Congress without regard to plan sponsor risk. The agency cannot set its own underwriting standards and has to provide coverage whether or not premiums are paid or contributions made to a plan.

“The design of the PBGC and many of the underpinnings of ERISA are inherently flawed,” says former PBGC director Bradley Belt, who is now head of the Washington office of the Milken Institute, a Santa Monica, California–based think tank.

It does not help that the PBGC operates at a competitive disadvantage in recruiting and retaining personnel relative to agencies like the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission, which unlike the PBGC have been given pay flexibility. Today its salaries average $60,000 less than the SEC’s and the CFTC’s for top executive and certain professional positions, and $13,000 less for other senior positions. “We lose people every year because salaries go up 5 percent at other agencies,” explains PBGC general counsel Judith Starr, who adds that the agency’s private sector peers earn between 40 and 80 percent more, depending on seniority. She believes that dedication to the mission keeps people at the PBGC.

The agency’s own inspector general, Rebecca Anne Batts, has been publishing volumes of negative reports since her arrival in 2008. During Gotbaum’s first week on the job, in July 2010, Batts briefed him on what she saw as the most egregious problems at the agency. “An audit services contractor had done horrifically substandard work,” Batts explains. The contractor, Integrated Management Resources Group, based in Lanham, Maryland, had been entrenched for a decade but not professionally qualified to audit plan assets, she says. The firm was terminated after Gotbaum took over.

Moreover, PBGC staff were not trained to oversee the contract work, nor was audit management aware of a problem. “They have a whole department that doesn’t know what it’s doing,” Batts continues, and “an absence of basic knowledge and skills.” According to the inspector general, there are still 195 recommendations to PBGC management by her office, with an average age of 27 months.

To deal with this overload, Gotbaum has targeted three areas for urgent remediation: putting a consensus investment policy in place; improving the agency’s connection with its constituencies, including pension recipients, plan sponsors, business and labor, Congress and the public; and admitting and correcting errors, then making changes to ensure they don’t recur. “The mistakes the IG found are real and embarrassing,” says Gotbaum. “The PBGC hasn’t spent a lot of time trying to explain that.”

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