One of organized labor’s strongest calling cards, politically if not economically, is that unions protect the long-term interests of employees. If workers join, the argument goes, they will be far better off. Yet rhetoric too often hasn’t matched reality, and perhaps nowhere more so than in the area of retirement plans. That’s the conclusion of a recent study by Diana Furchtgott-Roth, senior fellow with the Hudson Institute in Washington, D.C. Furchtgott-Roth, chief economist for the U.S. Department of Labor (DOL) during 2003-05, authored a report released this month by the institute titled, “Unions vs. Private Pension Plans: How Secure Are Union Members’ Retirements?” Employer-sponsored pensions, she concludes, deliver more security for nonunion employees than union-managed funds do for their own members.
A great many American workers are enrolled in some form of retirement plan. It’s a virtual necessity given that Social Security payments on average provide roughly only 40 percent of the income necessary for a comfortable retirement. Employees have to be able to count on sound and prudent management of their pension funds, whether of the “defined-benefit” (fiduciary-managed) or “defined-contribution” (employee-managed) variety. Of the roughly 700,000 active retirement programs, the vast majority are now of the latter variety, the most familiar of which is the 401(k) plan. Charged with enforcing the Employee Retirement Income Security Act (ERISA), the Labor Department in almost all cases require private-sector plan sponsors to submit annual “Form 5500” financial disclosure forms. An underfunded plan – that is, one whose liabilities exceed assets – inevitably raises red flags if the condition is severe and longstanding. Even in mild cases, the DOL, along with the ERISA-created Pension Benefit Guaranty Corporation (PBGC), may notify sponsors of the need for better capitalization.
Funding shortfalls, unfortunately, are more endemic to union than to nonunion plans. Analyzing data from the DOL’s Employee Benefit Security Administration for the year 2005, Furchgott-Roth calculated that large-scale nonunion pension plans had an overall asset-to-liability ratio of 98 percent. The figure for collectively-bargained union plans of similar size was 88 percent. Breaking the data down further, 37 percent of large nonunion retirement funds were fully funded, compared to only 19 percent of large union funds. And while a mere two percent of large-scale nonunion plans are in “critical” condition, 11 percent of the union plans of equivalent size are.
Rank-and-file members may find it more than a little galling that the pensions of union bosses and their office employees are better funded than their own. For the year 2005, the author discovered, the 21 largest union pension plans on average had less than 70 percent of the funds necessary to cover liabilities. In other words, these plans are flirting with bankruptcy. Yet officer and staff funds from the same unions had a combined funding level of 88.2 percent, while the figure for officer pension funds alone was 98.4 percent. The Service Employees International Union (SEIU) provides a good example of union leaders’ “Do as I say, not as I do” approach to investing. In 2006, the SEIU National Industry Pension Plan, which covered slightly over 100,000 members, was only 75 percent-funded. Yet a separate fund for the union’s own employees was 91 percent. And for another fund, for SEIU officers and employees, the figure was 103 percent.
Equally distressing, pension underfunding has worsened over time. The SEIU National Industry Pension Plan, for instance, had been close to 110 percent-funded in 1996 before plummeting to 75 percent-funded a decade later. Leaders of the 1.9 million-member Service Employees, beginning with President Andrew Stern, lay much of the problem at the doorstep of private-equity funds, especially Kohlberg Kravis Roberts & Co., with whom the union has a large portfolio. KKR and The Carlyle Group, as Union Corruption Update recently described at length, have been targets of SEIU activism. The union since then has kicked up the action. On July 17, the Service Employees sponsored a “global day of action,” replete with rallies in dozens of cities the world over. The intent was to pressure KKR into divesting from companies that resist unionization and investing in those that promote environmental protection, human rights, fair taxation and other progressive causes.
Such advocacy might be part of the problem. Asset portfolios of union-managed plans tend to reflect the political beliefs of union leaders and their allies. But causes that seem appealing in the abstract aren’t so attractive in practice. Very often, “social investing” means routing funds to organizations with a strong union presence. And studies purporting to show that such investing produces a bonanza, note Alicia Munnell (Boston College) and Annika Sunden (Social Insurance Agency, Stockholm), often confuse cause and effect, while downplaying the fact that their favored funds often charge unusually high fees, which reduces annual returns. Requiring funds to pass ideological screen tests may backfire, notes Jon Entine, editor of the book, Pension Fund Politics: The Dangers of Socially Responsible Investing (AEI Press, 2005). In 1999, for example, California State Treasurer Phil Angelides helped persuade officials at CalPERS and CalSTRS, two giant public-employee pension funds on whose boards he sat, to sell more than $800 million in tobacco shares. “I feel strongly that we wouldn’t be living up to our fiduciary responsibility if we didn’t look at these broader social issues,” he said at the time. Yet in the several years following the divestiture, the American Stock Exchange Tobacco Index outperformed the Standard & Poor’s 500 Index by more than 250 percent and the NASDAQ by more than 500 percent. Emotion, not reason, typically rules the day.
There are some additional reasons behind the financial instability of union-backed pension funds, argues Furchtgott-Roth. For one thing, such plans typically are written to cover a long duration, and are not modified annually. As such, employers lack the flexibility to correct for market downturns, actuarial changes and other unplanned occurrences. Another explanation is that union leaders lack a strong interest in maintaining full funding. For them, what matters most is reporting victory to members following negotiations. Employers likewise have been myopic. For them, it’s cheaper to promise extra future benefits than it is to pay extra current wages in the same amount. The looming collapse of the Big Three automakers is largely the result of decades of delaying the day of reckoning in pension funding.
Playing Russian roulette with union pension funds is more than poor investment strategy; it’s also illegal. ERISA statutes specify that pension fiduciaries must base investment decisions solely on the basis of minimizing risk and maximizing returns. Putting funds in certain investments because they seem “moral” or “socially beneficial” is contrary to the spirit and letter of the law. Congress took a major step in the right direction two years ago by passing the Pension Protection Act of 2006. The measure, signed into law by President Bush, requires that troubled pension plans pay higher premiums to PBGC. In addition, it mandates greater disclosure by sponsors, something likely to lead to better management of dangerously undercapitalized plans such as the Sheet Metal Workers National Pension Fund, with 43 percent of the assets needed to cover liabilities. The law, notes Furchtgott-Roth, also limits increases in plan benefits and enables employees to become more active in decision-making. At the same time, since many key provisions are set to expire in 2014, the law will have only a limited effect.
The best reform of all therefore may be more employee autonomy – the kind found in defined-contribution retirement plans. These financial instruments, by their very design, protect participants from fiduciary mismanagement, since there are no fiduciaries. Organized labor long has spurned this arrangement, arguing it produces lower returns and higher failure rates. But these claims are dubious, if not outright false. Expanding the range of opportunities for individual workers may be the most “progressive” investment strategy. (Hudson Institute, 7/08; American Enterprise Institute, 2005).