Defined Benefit Pension Fund explained:
A company contributes a set dollar amount every year for every employee to a pension fund. The bylaws of the pension fund set the amount of interest that must be earned on the balance each year along with the contribution amount.
If the corporation does not earn the required amount of interest on their pension fund they must contribute some of their operating earns to make up the shortfall. Most pension funds are cash account funds and work this way.
When an employee retires the pension fund determines how much was contributed to the pension fund for the employee and the total interest earned on those contributions. Then this amount is anuitized and the retiree receives a monthly amount based on this annuity. The old style pension fund system paid a set amount to the retiree based on how long they worked for the company.
That's basically how a pension fund operates. Now on to how things went so wrong for the pension funds on the flip.
Historically pension funds were conservative investors. They only needed to return say 5.25% per year on their money in the case of a typical pension fund so they didn't take a whole lot of chances. But then in the late ninties the corporations realized they had a gold mine on their hands. And here's why.
Corporations were looking for ways to increase the bottomline. Corporations had tens of billions in these pension funds. The corporations only had to earn 5.25% return on their pension funds. The corporations realized if they could make a higher return on their pension funds then they could skim the money off above and beyond the 5.25%. Example: Corporate pension fund invests $10 Billion in something that returns 10.25%. They skim $500,000 off the top and add it to their bottomline.
In the late ninties with the stock market returning double digit gains year over year the temptation became too great for the corporations. And they started investing in the stock market with their pension funds. Everything was going swimmingly until 2000 when the stock market started it's decline. The pension funds had such huge positions it would have taken literially months to unwind these positions. In addition, unwinding these positions would have caused massive chaos and contributed to greater losses in the stock market.
The pension funds for the most part held on to their stock market positions and lost as a whole 100's of billions of dollars. These losses need to be made up because by law the pension funds must adhere to their bylaws and earn a set amount of interest on their principle each year and if they do not then the corporations must make up the difference.
Why has it taken so long for this crisis to develop? Shouldn't this have been an issue back in 2003 after 2 years of losses for the pension funds? Well it has taken this long because the regulating agencies gave the corporations time in hopes the stock market would go like gang busters again and the short fall would be recovered through stock market gains. Time has run out and the corporations are lining up at the court house steps to unload their pension funds on the Pension Benefit Guaranty Corp. Which will itself be bankrupt in a short while unless taxes are raised or the Government borrows more money to pay for the pensions being unloaded on them. The Pension Benefit Guaranty Corp. is funded by the US taxpayers.
The cause of this crisis is directly attributed to corporate greed and malfeasance. Is it criminal? If it isn't it should be.