WHAT IS Pension Shortfall
A pension shortfall is a situation where a company offering employees a defined benefit plan does not have enough money to meet the obligations of the pension fund. A pension shortfall typically occurs because the investments selected by the pension manager did not live up to expectations.
BREAKING DOWN Pension Shortfall
A pension shortfall is a significant event that requires the company offering a defined benefit plan to take steps to rectify the situation. A company that starts the pension is responsible for paying its employees the money that they were guaranteed. In such a plan, the employee takes on none of the investment risk. Essentially, the company guaranteed eligible employees who worked for them for a set period of time that they would receive a specific amount of money upon retirement. If the money is not there when people are ready to retire, it can imperil both the company and employees alike.
Fund managers and companies can forecast whether there will be an issue with meeting their obligations well before retirees receive their allotted payments. Upon discovery of a shortfall, one option would be to increase the contributions they make to the plan. A well-known example of this course of action was automobile company General Motors, which discovered that they faced a pension shortfall in 2016 and subsequently allocated a significant portion of the company’s profits to ensure that the company’s obligations were met. While a reliable option, this course of action would dent the company’s net income.
Another option for a company to make up a shortfall would be to simply improve their investment performance; however, that strategy is fraught with risk as greater returns are not guaranteed.
The Role of Pension Insurance
In some cases, a company that is unable to make up for its pension shortfall with its own money may be able to seek relief from pension insurance. A U.S. government-sponsored enterprise known as the Pension Benefit Guaranty Corporation (PBCG) exists to encourage the continuation and maintenance of private defined benefit plans, ensure payment of pension benefits, and keep pension insurance premiums in check. Created by the Employee Retirement Income Security Act of 1974 (ERISA), the PBCG may be able to step in and make sure that pension payments are made in full when a company faces a shortfall. In exchange for this protection, the company has to pay a premium for each worker that is included in the plan.