Retirement Heist

by Ellen E. Schultz

  Fruehauf Trailer Corp. used a trickier maneuver to deliver departure bonuses to its human resources executives. The truck manufacturer was going over a cliff in 1996, and about three weeks before it filed for bankruptcy protection, the company transferred $2.4 million in surplus assets from the union side of Fruehauf’s pension plan into the frozen plan for salaried employees. It then awarded large pension increases to a select few. The most substantial increases went to members of the Pension Administration Committee, including a 200 percent increase to the vice president of human resources and a 470 percent increase to the controller.[3]

  AT&T used pension assets in a variety of ways. In 1997, AT&T offered 15,300 older managers the equivalent of a half-year’s pay, in the form of a cash payout from the pension plan as severance if they voluntarily agreed to retire. The move consumed $2 billion in pension assets.

  Michael J. Gulotta, who led the ERISA Advisory Council task force as it explored ways to use pension assets, was also the president of Actuarial Sciences Associates, AT&T’s benefits consulting subsidiary. In 1998, he helped the company change its traditional pension to a “cash balance” pension (more on these later), which saved the company $2.2 billion by cutting the benefits of more than 46,000 long-tenured employees in their forties and fifties. Many would see their pensions frozen for the rest of their careers.

  Employers can use pension assets to pay the actuaries, lawyers, financial managers, and trustees who provide services related to the management of the pension plans, and uncounted millions have gone to pay the actuaries who craft ways to cut benefits and to lawyers who defend suits brought by pension plan participants. For its consulting and administrative services in connection with the cash balance conversion, AT&T paid ASA $8 million from the trust assets of the AT&T Management Pension Plan.

  ASA set up a separate cash-balance plan for itself, using assets from the AT&T Management Pension Plan, which provided ASA managers with 200 percent to 400 percent of the value of what they would have if they had remained under AT&T’s management plan.

  Six months later, AT&T sold the Somerset, New Jersey, unit, ASA, to the managers for $50 million, and transferred $25 million in pension assets to ASA, more than twice the amount needed to cover the pensions owed. In 2000, two years after buying ASA from AT&T, Gulotta sold it to the giant insurance and benefits consultant Aon Corp. for $125 million. He remained a principal of the firm until his retirement.

  Surplus pension assets have ended up in executives’ pockets in more creative ways. In late 2005, CenturyTel (now CenturyLink), a telecommunications firm based in Monroe, Louisiana, attached a list to its workers’ pension plan with the names of select individuals who would get an extra helping of pension benefits from the plan.

  Normally, federal law forbids employers from discriminating in favor of highly paid employees who participate in the regular pension plan; everyone in the plan is supposed to have roughly the same deal. There’s also an IRS limit on the amount a person can earn under the plans. These restrictions are why companies provide separate, supplemental pension plans open only to executives.

  But by using complex maneuvers that take advantage of loopholes in the discrimination rules, many companies do, in fact, discriminate in favor of their executives and exceed the statutory ceiling on how much they can receive from the plans.

  CenturyTel used one of these techniques in its pension plan, which covered 6,900 workers and retirees, to boost the pensions of eighteen executives in the plan. One of them was chief executive Glen Post, who before the amendment had earned a pension of only $12,000 annually in the regular pension plan. But the increase bumped it up to $110,000 a year in retirement.

  The technique doesn’t increase the executive’s retirement benefits. When the swap is made, the supplemental executive pension is reduced by an equal amount. The goal, rather, is to enable companies to tap pension assets to pay for executive pensions—and even their pay.

  Intel, the giant semiconductor chip maker based in Santa Clara, California, used this method to move more than $200 million of its deferred-compensation obligations for the top 3 percent to 5 percent of its workforce into the regular pension plan in 2005. Thanks to this, when these executives and other highly paid individuals leave, Intel won’t have to pay them out of cash; the pension plan will pay them (more on this in Chapter 8).

  Using these methods, companies have moved hundreds of millions of dollars of executive pension liabilities into the regular pension plans, and then have used pension assets originally intended to pay the benefits of rank-and-file employees to pay the additional pension benefits for executives. The practice exists across all industries: from forest products (Georgia-Pacific) to insurers (Prudential Financial) to banks (Community Bank System Inc.).

  The practice has something in common with the practice of selling pension assets: Employers prefer to keep it under wraps, lest it spark a backlash when employees find out the CEO with millions of dollars in supplemental executive pensions is also getting an extra helping from the rank-and-file pension plan.

  To “minimize this problem” of employee relations, companies should draw up a memo describing the transfer of supplemental executive benefits to the pension plan and give it “only to employees who are eligible,” wrote a consulting actuary with Milliman Inc., a global benefits consulting firm. Covington & Burling, a Washington, D.C., law firm, advised employers to attach a list to the pension plan, identifying eligible executives by name, title, or Social Security number, along with the dollar amount each will receive. CenturyTel, People’s Energy Corp., and Niagara Mohawk Power Corp., a New York utility that’s part of London-based National Grid PLC, all used methods like this.

  Initially, employers used these executive pension transfers as a way to use surplus pension assets, and some companies with overfunded pensions still do. To “take advantage of the Surplus Funds in the Pension Plan,” Florida real estate developer St. Joe Co. amended its employee pension plan in February 2011 to increase benefits for “certain designated executives.” These included departing president and CEO William Britton Greene, who was pushed out by a large shareholder. The amendment more than doubled the pension he’ll receive from the employee pension plan, boosting the lump sum amount from $365,722 to $797,349. Greene also received an exit package worth $7.8 million.

  But moving executive pension obligations into the regular pension plans can not only use up the surplus assets, it can put a dent in the rest of the pension assets as well. Today, many pension plans with special executive carve-outs are underfunded, including Carpenter Technology Corp., Parker Hannifin, Illinois Tool Works (which manufactures industrial machinery), PMI Group (a mortgage insurer), ITC Holdings, and Johnson Controls.

  TERMINATORS

  When it comes to siphoning pension assets, nothing beats terminating the piggy bank and grabbing the entire surplus at once.

  This maneuver was common. In the 1980s, employers terminated more than two thousand overfunded pension plans covering over two million participants and snatched surplus assets in excess of $20 billion. Some were inside jobs. Occidental Petroleum terminated its pension in 1983 and paid no income tax on the $400 million in surplus it captured because the company had net losses that year.

  Other pension plans fell victim to pension raiders like financier Ronald Perelman, who took over Revlon in 1985, killed the pension plan, and nabbed more than $100 million in surplus pension assets, and Charles Hurwitz, who took over Pacific Lumber, closed down its pension and used $55 million in surplus pension assets to help pay off the debt he took on with the leveraged buyout. To stop these abuses, Congress slapped a 50 percent excise tax on “reversions” in 1990, and pension terminations at large companies slowed almost to a halt. But there was a huge loophole (there always is): A company that terminated its pension could avoid the onerous 50 percent excise tax—and pay only 20 percent—if it put one-quarter of the plan’s surplus into a “replacement plan.” A replacement plan could be another pension.
Or it could be a 401(k). The only restriction was that companies allocate the surplus into employee accounts within seven years.

  Montgomery Ward was a big beneficiary of this loophole. The stodgy retailer, struggling to compete with low-cost giants like Kmart and Wal-Mart, filed for bankruptcy protection in 1997. Its $1.1 billion pension plan was especially fat, because two years before its bankruptcy filing, Montgomery Ward cut the pension benefits by changing to a less generous plan. This reduced the obligations, and thus increased the surplus.

  The company then terminated the pension plan and put 25 percent of the $270 million surplus into a replacement 401(k) plan. It paid the 20 percent excise tax, and the remaining $173 million of the surplus went to Ward income-tax-free, because the company had net operating losses. Ward used the money to pay creditors—the largest of which was the GE Capital unit of General Electric. It emerged from bankruptcy in 1999 as a wholly owned subsidiary of GE Capital, its largest shareholder.

  The employees didn’t have much time to build up their 401(k) savings: The company went out of business in early 2001, closed its 250 stores, and laid off 37,000 employees. What about the 20 percent of surplus assets set aside to contribute to employee accounts? The $60 million or so that hadn’t yet been allocated to employee accounts went to creditors, not employees. Creditors have often ended up with the pension surplus. Around the time Montgomery Ward was fattening its plan for slaughter, Edison Brothers Stores, a St. Louis retailer whose chains included Harry’s Big & Tall Stores, entered Chapter 11. It killed the overfunded pension plan in 1997 and set up a 401(k). After paying the 20 percent excise tax, Edison Brothers forked more than $41 million in pension money over to creditors and emerged from bankruptcy. Its employees had even less time to build a nest egg in their new 401(k): The company liquidated in 1998.

  These strategies ought to make it clear that many companies were terminating pension plans not because the pensions were underfunded or a costly burden, but because the pension plans were fat and the companies themselves were in financial trouble. The icing on the cake was that a company with losses would pay no income tax on the surplus assets.

  It also puts a less savory spin on the origin story of the 401(k): Companies like Enron, Occidental Petroleum, Mercantile Stores, and Montgomery Ward didn’t adopt 401(k)s because they were modern savings plans employees were supposedly lusting after; their 401(k)s were merely the bastard stepchildren of dead pensions.

  BLACK BOX

  Lack of a pension surplus hasn’t stopped employers from raiding their pensions. Even if a plan has no fat, companies have been able to indirectly monetize the assets using the bankruptcy courts. Struggling in the wake of September 11, US Airways filed for Chapter 11 in 2003 and asked the bankruptcy court to let it terminate the pension plan covering seven thousand active and retired pilots. The airline estimated it would have to put $1.7 billion into the plan over the coming seven years, a burden that it said would force it to liquidate. David Siegel, US Airways’ chief executive, told employees in a telephone recording that the termination of the pilots’ plan was “the single most important hurdle for emerging from Chapter 11.” He said the move was regrettable but maintained that “the future of the airline is at stake.”

  Few challenged the “terminate or liquidate” statement. Cheering the move were US Airways’ creditors, lenders, and shareholders with a stake in the reorganized company, because removing the pension plan would wipe out a liability and make the company more likely to emerge from Chapter 11 in a position to pay its debts and provide a return to its shareholders. Other cheerleaders were the Air Transportation Stabilization Board, which was poised to guarantee loans to the carrier, and the airline’s lead bankruptcy lender, Retirement Systems of Alabama, which stood to gain a large equity stake in US Airways when it emerged from Chapter 11. They accepted, without question or independent confirmation or research, the airline’s analysis and backed its request to kill the plan.

  The pilots suspected that the airline was exaggerating the ill health of their pension to convince the court to let it pull the plug. Why the pilots’ plan, they wondered, and not the flight attendants’ plan or the mechanics’ plan? Had the airline deliberately starved their pension plan while funding the others? There was no way to tell, because the company didn’t turn over pension filings that included the critical liability and asset figures—not until the night before the bankruptcy hearing that would decide the pension’s fate. Without the information, the pilots couldn’t make their case that the liabilities were inflated.

  In court, US Airways’ team of lawyers and consultants presented reams of actuarial calculations and colorful charts and tables demonstrating the pension plan’s deficit and the perils of preserving it. The frustrated pilots, with their lone actuary, couldn’t put on as good a show. The bankruptcy judge relied on US Airways’ figures and allowed the termination to proceed. In his decision, Judge Stephen Mitchell said that the pilots were less credible, because they had “based their calculation on rules of thumb and rough estimates while [US Airways’] actuary based his on the actual computer model used for administration of the plan.”

  Bankruptcy raids like this are made possible by a loophole in the bankruptcy code, which coincidentally was enacted at about the same time as federal pension law, in the late 1970s. The law says that when companies go into Chapter 11, banks and creditors take priority over employees and retirees, who have to get in line with the other unsecured creditors, like the suppliers of peanuts and cocktail napkins.

  Delta Air Lines filed for bankruptcy in 2005 and terminated the pension plan covering 5,500 pilots. Denis Waldron, a retired pilot from Waleska, Georgia, had been receiving a monthly pension of $1,939 until the pension plan was taken over by the Pension Benefit Guaranty Corp. But the PBGC guarantees only a certain amount. The maximum in 2011: $54,000 a year ($4,500 a month) for retirees who begin taking their pensions at sixty-five. The maximum is lower at younger ages, and for those with spouses as beneficiaries. The PBGC doesn’t guarantee early-retirement subsides, which are enhancements that make pensions more valuable. The payout is further limited for the pilots because they are required to retire at age sixty. After myriad calculations, including various look-back penalties, Waldron’s pension fell to just $95 a month.

  Pilots were slammed in another way as well: Their supplemental pensions weren’t guaranteed at all. Don Tibbs, of Gainesville, Georgia, had put in more than thirty years as a pilot and was receiving $7,000 a month from his supplemental pilots’ plan and $1,197 a month from the regular pension plan. The supplemental plan was canceled when the airline filed for bankruptcy, and a year later, when Delta turned the pilots’ pension plan over to the PBGC, Tibbs lost that pension, too, thanks to quirks in the insurer’s rules.

  Though creditors, shareholders, and executives all profited, Tibbs now has only his Social Security and a small military reserve income. “They were able to use the bankruptcy court to walk away from their obligation,” Tibbs recalled bitterly. “What happened to me and a lot of my friends was and is criminal.”

  United Airlines was next in line on the bankruptcy tarmac, and it spread the pain even more widely. In 2006 it terminated all its pension plans—for flight attendants, mechanics, and pilots.

  Today the giant surpluses are gone: sold, traded, siphoned, diverted to creditors, used to finance executive pay, parachutes, and pensions. But you’d think the employers had nothing to do with it. Companies blame investment losses for their plight, as well as their aging workforces, union contracts, regulation, and global competition. But their funding problems were largely self-inflicted. Had they not siphoned off the assets, they would have had a cushion that could have withstood even the market crash that troughed in March 2009. Nonetheless, employers continue to lobby for more liberal rules that would enable them to shift hundreds of millions of dollars of additional executive obligations into the pension plans and to withdraw more of the assets to pay other benefits. Meanwhile, their solution wh
en funds run low remains the same: Cut pensions.

  Chapter 2

  HEIST

  Replenishing Pension Assets by Cutting Benefits

  IN 1997, Cigna executives held a number of meetings to discuss their pension problem. At the time, the plan was overfunded, but executives weren’t satisfied and suggested cutting the pensions of 27,000 employees in an effort to boost the earnings they could report on their bottom line. The only hitch? How to cut people’s pensions—especially those for long-tenured employees over forty—by 30 percent or more, without anyone noticing?

  Cigna was just the latest of hundreds of large companies, including Boeing, Xerox, Georgia-Pacific, and Polaroid, that had already gone through this charade in the 1990s. These companies had something in common: They all had large aging workforces—with tens of thousands of employees who had been on the job for twenty to thirty years. These workers were entering their peak earning years, and with traditional pensions that are calculated by multiplying years of service by one’s annual salary, their pensions were about to spike. With the leverage of traditional pension formulas, as much as half an employee’s pension could be earned in his final five years. In short, millions of workers were about to step onto the pension escalator.