Even someone with a foot fetish would find little gratification in the shoe stories of the past month. First it was the indignity of our President having to dodge shoes in Iraq, and now it turns out that yet another shoe has dropped on the American automobile industry.
Auto dealers across the country with union mechanics are learning that the annual contribution to the union retirement plans has increased almost ten-fold over a three year period. Suddenly, the annual pension cost amounts to almost as much as the annual payroll itself. Peering forward into the coming years, the demands will be even higher thanks to the downdraft in both the stock and bond markets of 2008.
A short lesson in so-called "Defined Benefit" retirement plans will remind us that these plans guarantee a specific retirement benefit based on average salary and number of years worked. It is the obligation of the employer to make sure that there will be enough money in the plan to support the payout for retirees. These plans are like hand grenades with the pins pulled out. Their costs are impossible to control because they invite too much wishful thinking and future promises that bear no relationship to reality.
In the auto mechanics case, a typical dealer might have contributed about $200,000-$300,000 per year a few years ago. Then it was $700,000. For last year, the same dealer would have been advised to pony up $2,000,000 or more. Dealers who stay in business will be paying much more in future years to make up for stock market losses. It is hard to imagine how small regional dealers will ever be able to meet their growing obligation. Moreover, they are personally liable, so their only option is to go out of business while they still have enough business and personal assets to cover the immediate cost.
So, where does that leave the auto industry? With fewer local dealers across the nation, who will be conveniently located to sell automobiles and create the rebound we hope to see? Speaking as an automobile fanatic who once rebuilt a Corvair engine on my kitchen table, this is all too painful to watch.
Government, unfortunately, has been part of the problem. When pension funds were over-funded years ago after a string of great investment years, the government dictated that retirement plans had to increase benefits to pick up the slack or pay a penalty tax on the amount of over funding. Increasing the benefit formula was admittedly better than paying a penalty, but now we are confronted with, as one union leader put it, "the greatest enemy of the labor movement --- a company that goes out of business.
There is a simple solution: Freeze accruals in these retirement plans. This means that the plan continues, but that no future increased benefits are earned for subsequent years of work. That freeze doesn't have to continue forever --- only until plan earnings and benefits align to bring the annual contribution requirement back to some reasonable level. The average employee may wind up with only 80-90 percent of what was originally promised, but this will be far better than the $35,000 maximum annual benefit that the Pension Benefit Guarantee Corporation will pay when the entire plan is bankrupt. If you don't believe me, talk to a retired pilot from bankrupt United Airlines who once thought they would be retiring with six figure incomes. For their part, government employees are really out to lunch with no federal guarantee backing their unsustainable retirement benefits. What's going to happen to them?
All defined benefit retirement plans in jeopardy should adopt the frozen accrual alternative and adopt it now. Very few plans resisted the urge to increase benefits back when the economy was booming, because it was too tempting to make promises that didn't cost a dime at the time. Now, the auto dealers' dilemma illustrates how the bills can start to arrive. Whether you're an auto dealer, the City of Vallejo, or the State of California, the amount of the bill is so off the charts it's just laughable.
Elected officials, both politicians and union leadership, have a huge problem saying "no" to pension increases, because generosity, however misplaced, buys votes. At some point, however, leadership has to recognize the moment when, like Wiley Coyote, we have run off the cliff with our feet churning in mid-air. With the nation's auto dealers serving as canaries in the mineshaft, I think we are at that moment right now.