[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]
RETIREMENT SECURITY AND DEFINED BENEFIT
PENSION PLANS
=======================================================================
HEARING
before the
SUBCOMMITTEE ON OVERSIGHT
of the
COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTH CONGRESS
SECOND SESSION
__________
JUNE 20, 2002
__________
Serial No. 107-94
__________
Printed for the use of the Committee on Ways and Means
U. S. GOVERNMENT PRINTING OFFICE
86-581 WASHINGTON : 2003
____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; (202) 512-1800
Fax: (202) 512-2250 Mail: Stop SSOP, Washington, DC 20402-0001
COMMITTEE ON WAYS AND MEANS
BILL THOMAS, California, Chairman
PHILIP M. CRANE, Illinois CHARLES B. RANGEL, New York
E. CLAY SHAW, Jr., Florida FORTNEY PETE STARK, California
NANCY L. JOHNSON, Connecticut ROBERT T. MATSUI, California
AMO HOUGHTON, New York WILLIAM J. COYNE, Pennsylvania
WALLY HERGER, California SANDER M. LEVIN, Michigan
JIM MCCRERY, Louisiana BENJAMIN L. CARDIN, Maryland
DAVE CAMP, Michigan JIM MCDERMOTT, Washington
JIM RAMSTAD, Minnesota GERALD D. KLECZKA, Wisconsin
JIM NUSSLE, Iowa JOHN LEWIS, Georgia
SAM JOHNSON, Texas RICHARD E. NEAL, Massachusetts
JENNIFER DUNN, Washington MICHAEL R. MCNULTY, New York
MAC COLLINS, Georgia WILLIAM J. JEFFERSON, Louisiana
ROB PORTMAN, Ohio JOHN S. TANNER, Tennessee
PHIL ENGLISH, Pennsylvania XAVIER BECERRA, California
WES WATKINS, Oklahoma KAREN L. THURMAN, Florida
J.D. HAYWORTH, Arizona LLOYD DOGGETT, Texas
JERRY WELLER, Illinois EARL POMEROY, North Dakota
KENNY C. HULSHOF, Missouri
SCOTT MCINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
KEVIN BRADY, Texas
PAUL RYAN, Wisconsin
Allison Giles, Chief of Staff
Janice Mays, Minority Chief Counsel
______
Subcommittee on Oversight
AMO HOUGHTON, New York, Chairman
ROB PORTMAN, Ohio WILLIAM J. COYNE, Pennsylvania
JERRY WELLER, Illinois MICHAEL R. MCNULTY, New York
KENNY C. HULSHOF, Missouri JOHN LEWIS, Georgia
SCOTT MCIINNIS, Colorado KAREN L. THURMAN, Florida
MARK FOLEY, Florida EARL POMEROY, North Dakota
SAM JOHNSON, Texas
JENNIFER DUNN, Washington
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
hearing records of the Committee on Ways and Means are also published
in electronic form. The printed hearing record remains the official
version. Because electronic submissions are used to prepare both
printed and electronic versions of the hearing record, the process of
converting between various electronic formats may introduce
unintentional errors or omissions. Such occurrences are inherent in the
current publication process and should diminish as the process is
further refined.
.................................................................
C O N T E N T S
__________
Page
Advisories announcing the hearing................................ 2
WITNESSES
Pension Benefit Guaranty Corporation, Steven A. Kandarian........ 18
______
American Academy of Actuaries, Ron Gebhardtsbauer................ 44
American Benefits Council, and Milliman USA, Mark Beilke......... 78
American Society of Pension Actuaries, and Actuarial Consulting
Group, Inc., Scott D. Miller................................... 72
Employee Benefit Research Institute, Dallas L. Salisbury, as
presented by Jack VanDerhei.................................... 36
ERISA Industry Committee, and AT&T Corporation, Christopher W.
O'Flinn........................................................ 86
Gutknecht, Hon. Gil, a Representative in Congress from the State
of Minnesota................................................... 12
Pension Rights Center, Karen D. Friedman......................... 59
Skinner, Jonathan, Dartmouth College, and Dartmouth Medical
School......................................................... 65
SUBMISSIONS FOR THE RECORD
Munzenmaier, Fred, Duluth, GA, letter............................ 113
Women's Institute for a Secure Retirement, Cindy Housell,
statement and attachments...................................... 7
RETIREMENT SECURITY AND DEFINED
BENEFIT PENSION PLANS
----------
THURSDAY, JUNE 20, 2002
House of Representatives,
Committee on Ways and Means,
Subcommittee on Oversight,
Washington, DC.
The Subcommittee met, pursuant to notice, at 2:05 p.m., in
room 1100 Longworth House Office Building, Hon. Amo Houghton
(Chairman of the Subcommittee) presiding.
[The advisory and revised advisory announcing the hearing
follow:]
ADVISORY
FROM THE
COMMITTEE
ON WAYS
AND
MEANS
SUBCOMMITTEE ON OVERSIGHT
Contact: (202) 225-7601
FOR IMMEDIATE RELEASE
June 11, 2002
No. OV-14
Houghton Announces Hearing on
Retirement Security and Defined Benefit
Pension Plans
Congressman Amo Houghton (R-NY), Chairman, Subcommittee on
Oversight of the Committee on Ways and Means, today announced that the
Subcommittee will hold a hearing to explore retirement security issues
relating to defined benefit (DB) pension plans. The hearing will take
place on Tuesday, June 18, 2002, in the main Committee hearing room,
1100 Longworth House Office building, beginning at 11:00 a.m.
In view of the limited time available to hear witnesses, oral
testimony at this hearing will be from invited witnesses only.
Witnesses will include a representative from the Pension Benefit
Guarantee Corporation and other defined benefit pension experts.
However, any individual or organization not scheduled for an oral
appearance may submit a written statement for consideration by the
Committee and for inclusion in the printed record of the hearing.
BACKGROUND:
This hearing will examine issues related to and recommendations for
improving DB pension plans. This will be the third hearing the
Committee on Ways and Means will hold this year on retirement security.
On February 26, 2002, the full Committee held a hearing on retirement
security and defined contribution plans, and on March 5, 2002, the
Oversight Subcommittee held a hearing on employee and employer views on
retirement security, focusing on defined contribution plans.
In announcing the hearing Chairman Houghton stated, ``In our
continuing review of employee retirement security, the Oversight
Subcommittee will hear about the strengths and weaknesses of defined
benefit pension plans. Recently, there has been an increase in the
number of employers offering defined contribution plans. It is
important for Congress to learn why employers have shifted away from
defined benefit pension plans and the effect of this shift on
retirement security.''
FOCUS OF THE HEARING:
The hearing will focus on retirement security issues specifically
related to DB pension plans. Specifically, the hearing will examine the
role of DB pension plans in retirement security, rules and regulations
governing DB pension plans, the advantages and disadvantages of
offering and participating in such plans, and recommendations for
improving DB plan participation.
DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:
Please Note: Due to the change in House mail policy, any person or
organization wishing to submit a written statement for the printed
record of the hearing should send it electronically to
[email protected], along with a fax copy to
(202) 225-2610, by the close of business, Tuesday, July 2, 2002. Those
filing written statements who wish to have their statements distributed
to the press and interested public at the hearing should deliver their
200 copies to the Subcommittee on Oversight in room 1136 Longworth
House Office Building, in an open and searchable package 48 hours
before the hearing. The U.S. Capitol Police will refuse sealed-packaged
deliveries to all House Office Buildings.
FORMATTING REQUIREMENTS:
Each statement presented for printing to the Committee by a
witness, any written statement or exhibit submitted for the printed
record or any written comments in response to a request for written
comments must conform to the guidelines listed below. Any statement or
exhibit not in compliance with these guidelines will not be printed,
but will be maintained in the Committee files for review and use by the
Committee.
1. Due to the change in House mail policy, all statements and any
accompanying exhibits for printing must be submitted electronically to
[email protected], along with a fax copy to
(202) 225-2610, in Word Perfect or MS Word format and MUST NOT exceed a
total of 10 pages including attachments. Witnesses are advised that the
Committee will rely on electronic submissions for printing the official
hearing record.
2. Copies of whole documents submitted as exhibit material will not
be accepted for printing. Instead, exhibit material should be
referenced and quoted or paraphrased. All exhibit material not meeting
these specifications will be maintained in the Committee files for
review and use by the Committee.
3. Any statements must include a list of all clients, persons, or
organizations on whose behalf the witness appears. A supplemental sheet
must accompany each statement listing the name, company, address,
telephone and fax numbers of each witness.
Note: All Committee advisories and news releases are available on
the World Wide Web at http://waysandmeans.house.gov.
The Committee seeks to make its facilities accessible to persons
with disabilities. If you are in need of special accommodations, please
call (202) 225-1721 or (202) 226-3411 TTD/TTY in advance of the event
(four business days notice is requested). Questions with regard to
special accommodation needs in general (including availability of
Committee materials in alternative formats) may be directed to the
Committee as noted above.
*** NOTICE--CHANGE IN DATE AND TIME ***
ADVISORY
FROM THE
COMMITTEE
ON WAYS
AND
MEANS
SUBCOMMITTEE ON OVERSIGHT
Contact: (202) 225-7601
FOR IMMEDIATE RELEASE
June 14, 2002
No. OV-14-Revised
Change in Date and Time for Subcommittee
Hearing Retirement Security and Defined
Benefit Pension Plans
Congressman Amo Houghton, (R-NY), Chairman, Subcommittee on
Oversight of the Committee on Ways and Means, today announced that the
Subcommittee hearing on retirement security and defined benefit pension
plans, previously scheduled for Tuesday, June 18, 2002, at 11:00 a.m.,
in the main Committee hearing room, 1100 Longworth House Office
Building, will be held instead on Thursday, June 20, 2002, at 2:00 p.m.
DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:
Please Note: Due to the change in House mail policy, any person or
organization wishing to submit a written statement for the printed
record of the hearing should send it electronically to
[email protected], along with a fax copy to
(202) 225-2610, by the close of business, Friday, July 5, 2002. Those
filing written statements who wish to have their statements distributed
to the press and interested public at the hearing should deliver their
200 copies to the Subcommittee on Oversight in room 1136 Longworth
House Office Building, in an open and searchable package 48 hours
before the hearing. The U.S. Capitol Police will refuse sealed-packaged
deliveries to all House Office Buildings.
All other details for the hearing remain the same. (See
Subcommittee Advisory No. OV-14 dated June 11, 2002.)
FORMATTING REQUIREMENTS:
Each statement presented for printing to the Committee by a
witness, any written statement or exhibit submitted for the printed
record or any written comments in response to a request for written
comments must conform to the guidelines listed below. Any statement or
exhibit not in compliance with these guidelines will not be printed,
but will be maintained in the Committee files for review and use by the
Committee.
1. Due to the change in House mail policy, all statements and any
accompanying exhibits for printing must be submitted electronically to
[email protected], along with a fax copy to
(202) 225-2610, in Word Perfect or MS Word format and MUST NOT exceed a
total of 10 pages including attachments. Witnesses are advised that the
Committee will rely on electronic submissions for printing the official
hearing record.
2. Copies of whole documents submitted as exhibit material will not
be accepted for printing. Instead, exhibit material should be
referenced and quoted or paraphrased. All exhibit material not meeting
these specifications will be maintained in the Committee files for
review and use by the Committee.
3. Any statements must include a list of all clients, persons, or
organizations on whose behalf the witness appears. A supplemental sheet
must accompany each statement listing the name, company, address,
telephone and fax numbers of each witness.
Note: All Committee advisories and news releases are available on
the World Wide Web at http://waysandmeans.house.gov.
Chairman HOUGHTON. Good afternoon, ladies and gentlemen.
The Committee proceedings will start now. I will make a few
comments and my associate, Mr. Coyne will, and then we will
turn this over to you, Mr. Gutknecht.
To put a little background on this, in March the
Subcommittee on Oversight held a hearing on defined
contribution pension plans (DC plan). At this hearing, we heard
from small and large businesses, the American Federation of
Labor-Congress of Industrial Organizations, and also pension
experts. They discussed the opportunities, problem areas, and
suggestions for improvement of defined contribution plans.
Now, 9 days after his hearing, this Committee took action
and passed some of the recommendations discussed at the hearing
as part of the ``Employee Retirement Savings Bill of Rights.''
These provisions went on to be passed by the House in April,
and it was a great culmination of effort led by my good
friends, Mr. Portman and Mr. Johnson, who serve on this
Subcommittee, and Mr. Cardin. We thank all of them for their
leadership and now, of course, await Senate action.
Today, what we want to do is continue this retirement
security discussion by reviewing another type of retirement
savings vehicle--defined benefit pension plans (DB plan). While
defined contribution plans have increased in recent years, the
number of defined benefit plans continues to fall.
So, the question is, what is causing it? We will hear from
the insurer of these plans, the Pension Benefit Guaranty
Corporation (PBGC), and they will tell us a little bit about
the trend. We also will hear from pension experts on the
positive, and also the negative aspects of defined benefit
pension plans, as well as their risks and suggestions for
improvement.
First of all we are going to hear from Congressman Gil
Gutknecht of Minnesota. Mr. Gutknecht will talk to us from
personal knowledge of an experience in his district and about
the impact on workers when the employer converts a traditional
defined benefit pension plans into a hybrid defined benefit
plan called a cash-balance plan.
A retirement plan is an essential employee benefit. Yet,
companies are not required to offer, as you know, retirement
plans and can modify, convert, or eliminate these at their
will.
So, what is the right balance and what can be done to
encourage pension plan participation and also better the future
of our retirement security? As with our pension hearing in
March, I hope that this discussion will yield some fruitful
results.
I am pleased to yield to my colleague, Mr. Coyne.
[The opening statement of Chairman Houghton follows:]
Opening Statement of the Hon. Amo Houghton, Chairman, and a
Representative in Congress from the State of New York
Good morning. In March, the Oversight Subcommittee held a hearing
on defined contribution pension plans. At this hearing, we heard from
small and large businesses and their employees, the AFL-CIO, and
pension experts. They discussed the opportunities, problem areas, and
suggestions for improvement of defined contribution plans.
Nine days after this hearing, this Committee took action and passed
some of the recommendations discussed at the hearing as part of the
``Employee Retirement Savings Bill of Rights.'' These provisions went
on to be passed by the House in April. It was a great culmination of
effort led by my good friends Mr. Portman and Mr. Johnson--who both
serve on this Subcommittee--and Mr. Cardin. We thank all of them for
their leadership and now await Senate action.
Today, we want to continue this retirement security discussion by
reviewing another type of retirement savings vehicle--defined benefit
pension plans. While defined contribution plans have increased in
recent years, the number of defined benefit plans continues to fall.
What is causing this decline? We will hear from the insurer of these
plans, the Pension Benefit Guarantee Corporation, about this trend. We
also will hear from pension experts on the positive and negative
aspects of defined benefit pension plans, as well as their risks, and
suggestions for improvement.
But first, we will hear from Congressman Gil Gutknecht of
Minnesota. Mr. Gutknecht will talk to us--from personal knowledge of an
experience in his district--about some of the ramifications on workers
when an employer converts a traditional defined benefit pension plan
into a hybrid defined benefit plan called a cash-balance plan.
A retirement plan is an essential employee benefit. Yet, companies
are not required to offer retirement plans and can modify, convert, or
eliminate their retirement plans. What is the right balance and what
can be done to encourage pension plan participation and better the
future of our retirement security? As with our pension hearing in
March, I hope that this discussion will yield some fruitful results.
Mr. COYNE. Thank you, Mr. Chairman. I want to thank
Chairman Houghton for scheduling today's hearing on issues
related to defined benefit plans issues.
Retirement security in America is one of the most important
issues under the Committee's jurisdiction. This issue has
become more important as we confront the problem of an aging
population.
Americans are living longer than ever before. As more
people live into old age with longer life expectancies, the
adequacy of the financial resources available to them during
their retirement becomes a very crucial issue. Defined benefit
pension plans provide workers with a specific pension benefit
upon retirement. This benefit is guaranteed by the Pension
Benefit Guaranty Corporation.
Today more than 44 million workers participate in a defined
benefit pension plan and rely on this important source of
income during their retirement. Unfortunately, the number of
defined benefit plans has decreased in recent years,
particularly plans having less than 100 participants.
This downward trend in defined benefit plans puts the
retirement security of American workers at risk. This risk has
been widely recognized in the pension community. A working
group organized by the Pension and Welfare Benefits
Administration (PWBA) recommended that the Secretary of the
U.S. Department of Labor support legislation and regulatory
changes as well that will restore the viability of defined
benefit plans.
On March 5, 2002, when the Subcommittee on Oversight held
its hearing, as the Chairman referred to on defined
contribution plans, we agreed that there should be a similar
hearing on defined benefit plans. Thus, it is appropriate that
the Subcommittee, through this hearing, review, number one, the
role of defined benefit pension plans in providing retirement
security for all American workers.
The advantages to employers of offering defined benefit
plans, and the advantages to the workers who receive benefits
under this type of plan.
The role of the Pension Benefit Guaranty Corporation in
achieving retirement security for all our workers, and the
financial status of the Agency, including the impact of pending
cases.
As well, any recommendations the pension experts can share
with us on how to improve the viability of defined benefit
pension plans.
I would like to personally welcome Karen Friedman of the
Pension Rights Center to today's hearing. The Pension Rights
Center, along the Women's Institute for a Secure Retirement
(WISER) were very helpful to me in preparing H.R. 3488, the
Retirement Opportunity Expansion Act of 2001.
At this point, Mr. Chairman, I would ask unanimous consent
to include a written statement from Cindy Housell, Executive
Director of WISER, in the record.
Also, I would like to thank all other pension experts
appearing with us as witnesses today for their participation. I
look forward to their testimony. Thank you.
[The opening statement of Mr. Coyne follows:]
Opening Statement of the Hon. William J. Coyne, a Representative in
Congress from the State of Pennsylvania
I want to thank Subcommittee Chairman Houghton for scheduling
today's hearing on issues related to defined-benefit plan issues.
Retirement security in America is one of the most important issues
under the Ways and Means Committee's jurisdiction. This issue has
become more important as we prepare for our aging workers.
Americans are living longer than ever before. The average life
expectancy of Americans born in 2000 has been estimated to be 76.4
years, compared to 69.7 for those born in 1960. As more people live
into old age with a longer life expectancy, the adequacy of financial
resources available to them during their retirement becomes a crucial
issue.
Retirement savings, including savings under employer-sponsored
pension plans, will be stretched over longer retirement periods. Thus,
every step must be taken to ensure that all workers have a secure
retirement. Defined benefit plans should play a major role is
accomplishing this goal.
Defined-benefit pension plans provide workers with a specific
pension benefit upon retirement. This benefit is guaranteed by the
Pension Benefit Guarantee Corporation (PBGC). Today, more than 44
million workers participate in defined-benefit pension plans and rely
on this important source of income during their retirement.
Unfortunately, the number of defined-benefit plans has decreased in
recent years, particularly with plans having less than 100
participants.
According to the Pension and Welfare Benefits Administration (PWBA)
of the U.S. Department of Labor, the number of defined benefit plans
declined from 175,000 to 59,500 between 1983 and 1997. Although the
greatest drop in the number of plans was among plans with fewer than
100 participants, the decline in the greatest number of plan
participants was among larger plans.
This downward trend in defined benefit plans puts the retirement
security of American workers at risk. This risk has been widely
recognized in the pension community. A working group organized by the
PWBA recommended that the Secretary of Labor support legislative and
regulatory changes that will restore the viability of defined benefit
plans.
On March 5, 2002, when the Oversight Subcommittee held its hearing
on defined-contribution pension plans, we agreed that there should be a
similar hearing on defined-benefit plans. Thus, it is appropriate that
the Oversight Subcommittee, through this hearing, review:
Lthe role of defined-benefit pension plans in
providing retirement security for all workers;
Lthe advantages to employers of offering defined-
benefit plans, and the advantages to the workers who receive
benefits under this type of plan
Lthe role of the PBGC in achieving retirement security
for all workers, and the financial status of the agency
(including the impact of pending cases); and
Lany recommendations the pension experts can share
with us on how to improve the viability of defined-benefit
pension plans.
I would like to personally welcome Karen Friedman of the Pension
Rights Center to today's hearing. The Pension Rights Center, along with
The Women's Institute For A Secure Retirement (WISER), were very
helpful to me in preparing H.R. 3488, the Retirement Opportunity
Expansion Act of 2001. If the Chairman is agreeable, I would like to
include the written statement of Cindy Housell, Executive Director of
WISER, into the hearing record.
Also, I would like to thank all the other pension experts for
appearing as witnesses at today's hearing. I look forward to their
testimony.
Thank you.
Chairman HOUGHTON. Thanks very much. Without objection,
that will be so ordered.
[The statement of Ms. Housell follows:]
Statement of Cindy Housell, Women's Institute for a Secure Retirement
On behalf of the Women's Institute for a Secure Retirement (WISER)
we appreciate the opportunity to submit comments to the members of the
Committee on Ways and Means' Subcommittee on Oversight, on the Hearing
on Retirement Security and Defined Benefit Pension Plans.
WISER is a nonprofit organization, launched in 1996 by the Teresa &
H. John Heinz III Foundation. WISER's primary mission is education--
providing women with information and retirement planning skills so that
they can surmount the overwhelming challenges to securing retirement
income. Our goals include increasing awareness among the general
public, policymakers, and the business community of the structural
barriers that prevent women's adequate participation in the nation's
retirement systems.
Attached is an executive summary of our new report, Your Future
Paycheck, What Women Need to Know About Pay, Social Security, Pensions,
Savings and Investment. This report looks at the particular conditions
that have prevented women from planning a secure retirement. Drawing
upon a variety of sources, Your Future Paycheck shows why older women
today are almost twice as likely as men to be poor, and examines why
this trend is likely to continue for younger women.
We applaud this committee for focusing on the status of our
nation's pension system, and for allowing us to bring to your attention
the ways in which the system's current inadequacies affect women.
Reasons Why Women Need More Retirement Income:
LWomen live longer than men.
LWomen earn less than men so their Social Security and
pension benefits are smaller.
LWomen are likely to be single--and not remarry. Non-
married women are more likely to be poor.
LWomen are more likely to need long-term institutional
care.
Retirement Challenges for Women Workers:
LTwo out of three working women earn less than $30,000
per year.
LHalf of all women work in traditionally female,
relatively low paid jobs--without pensions.
LWomen are more likely to work in part-time and
minimum wage jobs without pensions
LWomen's earnings average $.73 for every $1 earned by
men.
LWomen retirees receive only half the average pension
benefits that men receive.
LWomen as the primary family caregiverss experience
long-term financial consequences by losing out on opportunities
for compounded interest on 401(k) matching contributions, as
well as a reduction in savings and investments along with the
loss of pay increases, promotions, and training opportunities.
Women as low-wage earners saving for retirement
Over the past two decades there's been a shifting of the burden of
retirement from the employer to the employee--a trend that will almost
certainly have a disproportionate effect on all low wage workers but
particularly women for the following reasons.
First, it is important to realize that the majority of women today,
are clustered in low and middle income households. The median income
for all working women in 2000 was $20,311 and for full time women it
was $27,355. (See attached income chart) The fact that women earn 73
cents for every dollar earned by men creates less of an opportunity for
retirement savings and means that women's pension benefits will be
lower than those of men. It also means they have substantially less
income available to put in an IRA or a 401(k) savings plan.
Because two out of three working women earn less than $30,000
annually, even a disciplined saver will have trouble accumulating much
in savings at that level. Second, studies have shown that women's
savings priorities are often focused on their children's education and
not on retirement. Third, with women moving in and out of the workforce
and from one job to another more frequently than their male
counterparts, the problems associated with lack of portability become
particularly acute for them. And again, because of priorities such as
their children's education and medical emergencies, women often opt to
cash out their 401(k) accumulations when they leave a job rather than
keep the funds for retirement.
Finally, given the fact that women generally have smaller amounts
saved in their 401(k) accounts and have less to fall back on from other
sources, it is not surprising that they are often more averse to
riskier investments that may provide a higher yield. It is not simply a
lack of financial sophistication, it is actually a pretty rational
behavior. Consider the startling disparity in the median amounts that
women and men have saved in retirement accounts like 401(k)s and
Individual Retirement Accounts--women have only $10,000 and men have
$18,000.
The importance of pensions in providing a secure retirement
Pension income during retirement can be the key income source that
provides a truly secure retirement. The prevailing trend over the past
two decades has been for employers to discontinue offering traditional
defined benefit plans in favor of the more portable defined
contribution plans and, the most popular plan of all time, the 401(k).
The trend toward defined contribution plans shifts the risk and the
return on the investment to the employee and often participation is
contingent on the employee making a contribution.
Defined benefit pensions, in particular, provide guaranteed monthly
payments for the rest of the worker's life and offer a survivor benefit
for his or her spouse. This feature is important for all retirees, but,
for all of the reasons discussed above, it is especially important for
women. In addition, the employer has the investment and management
responsibility. Low-income workers do not face the challenge of taking
money out of their paychecks or deciding how to invest it.
We have heard from many women and men who do not participate in
their defined contribution plans because they either do not feel they
can spare any money from their paychecks or do not understand the
investment choices--they do not face these hurdles in a defined benefit
plan.
Defined contribution plans have certain advantages for some workers.
WISER is a strong advocate of measures that increase meaningful
pension coverage for women, the majority of whom are lagging behind in
retirement benefits. Fewer than one in five women age 65 and over
received pension benefits in 2000. Without changes in the current
system, young women will face similar risks of poverty in retirement.
H.R. 3488, the Retirement Opportunity Expansion Act of 2001 will
help women gain pension benefits by increasing pension coverage and
participation and by improving the opportunities for saving by:
Lhelping to expand pension coverage by providing a
refundable tax credit to low income individuals;
Ltreating family and medical leave as hours of
service;
Lproviding credit for qualified pension plan
contributions of small employers and,
Lincluding a provision allowing payroll deduction
contributions to individual accounts with an immediate tax
benefit that would provide a needed incentive to help more
employees begin to save for their retirement.
The revolution in women's roles in society over the last generation
has not relieved them of their responsibilities as family caregivers.
Women are still more likely to leave the workforce or to work part-time
to accommodate care-giving responsibilities. In addition to maternity
leave, they also bear the primary responsibility for an ill child or a
sick relative--resulting in shorter job tenures. For example, women
stay in jobs an average of only 4.4 years, whereas pension vesting
rules generally require 5 years on the job.
The effect of low wages on pension benefits
We all know that access to a 401(k) plan is certainly better than
no retirement savings vehicle at all--but only if you can afford to
contribute to it. One survey of the nation's largest employers found
that the worst plans are offered in the retail and service industries,
where the workers are less likely to have pensions, the pay is low and
the jobs are dominated by women. The survey's result indicated that the
workers least able to save have the lowest matching contributions.
But most women aren't lucky enough even to have a pension,
regardless of its size. The recent corporate legacy of downsizing and
economic restructuring has had a disproportionate impact on women.
Currently, 40 percent of all women's jobs are now non-standard. These
non-standard jobs are part-time, contract, freelance, and often in
combination to create one full-time job. But more importantly, these
jobs mean low wages, fewer employee benefits and most often no company
pension plan.
Women's jobs are low-wage, service, part-time jobs and/in small
businesses--where pension coverage is the most sparse. Although full
time working women have made great strides in nearly reaching parity
with men, it is partly due to the declining pension coverage for men.
When all working women are compared to all working men there's a 7
percent gender gap
The effect of women's longer lives
Financial experts tell Americans generally to plan to replace 70 or
80 percent of their income at retirement. Unfortunately, this advice
doesn't work for women, who are likely to need more than 100 percent of
their pre-retirement income in order to remain secure throughout their
longer lives.
The higher life expectancy of women necessarily means that at some
point during their retirement, the vast majority will find themselves
alone. In fact, about 80 percent of men die married and 80 percent of
women die single.
Divorced older women
As a group, separated and divorced older women have the most
serious economic problems. When couples divorce, the wife typically
experiences a 26-percent decline in her standard of living compared to
a 34-percent increase for their ex-husbands. This translated into women
having less money to spend on essentials and even less to save for
retirement. Also, many women overlook the fact that they can claim a
share of their husband's pension as part of the divorce settlement.
It is also important to note that our nation's poverty rate for
single elderly women, which stands at about 18 percent, is by far the
highest percentage in the industrialized world. And the breakdown of
poverty rates among minority groups is even more stark.
For all of the reasons outlined above, defined contribution plans
may not always be the best option for women, who might in fact be
better served by the features available in a defined benefit plan--a
defined benefit plan has a lot going for it as far as women are
concerned, including a guaranteed pay out in monthly installments over
the remainder of one's life.
Finally, we commend this Subcommittee for focusing attention on
this critically important issue. The implications of inadequate pension
income are far-reaching and directly related to income. We need to
address these issues now and take steps that will narrow the gap
between those retirees who are financially able to save adequately and
those who are poor.
Thank you.
________________
WOMEN'S INSTITUTE FOR A SECURE RETIREMENT
[GRAPHIC] [TIFF OMITTED] 86581A.001
YOUR FUTURE PAYCHECK
EXECUTIVE SUMMARY
Your Future Paycheck: What Women Need to Know About Pay, Social
Security, Pensions, Savings and Investments looks at the conditions
that have prevented women from planning a secure retirement. Drawing
upon a variety of sources, Your Future Paycheck shows why older women
today are almost twice as likely as men to be poor, and examines why
this trend is likely to continue for younger women.
The choices women face now regarding their current paycheck can
have grave implications for their future paycheck. Factors such as
caregiving, pay inequities, lack of pension coverage, marital status
and employment patterns are more likely to affect women adversely.
Women live longer, but often end up with less income in retirement--in
2000, the median personal income for women age 65 and older was
$10,899, compared to $19,168 for men.
This report provides a clear picture of the status of women and
retirement today:
LPay Issues: More women are now in the workforce, but
women still earn less than men in almost every occupational
classification. On average, women earn 73 cents for every
dollar men earn. A typical 25-year-old woman with a college
degree will earn about $523,000 less over her lifetime.
LOlder Women and Poverty: Despite the overall decline
in poverty rates among older Americans during the last several
decades, many older women remain poor--in 2000, 12.2 percent of
women over 65 were poor, with older unmarried women and
minority women facing the highest rates of poverty. Today,
nearly 60 percent of older American women are either widowed,
divorced, separated, or never married.
LWomen and Social Security: Women depend more on
Social Security than men, and lag behind men in the amount of
Social Security income they receive. Ninety percent of older
women receive Social Security. Of this, one in four women rely
on Social Security as their only source of income, and over
half (52.5 percent) would be in poverty were it not for their
benefits. While the average benefit for men is $951 a month,
for women, the average benefit is $730, or roughly 23 percent
less than a man's.
LPension Income Differences Between Men and Women:
Because women switch jobs more often, they have a greater
chance of forfeiting their pension benefits. In 2000, less than
one in five retired women received income from private pensions
(18 percent). However, almost one in three men received income
from private pensions (31 percent). Of those who received such
income, the median benefit for women was $4,164--or 46 percent
of the median benefit for men ($7,768).
LYoung Women and Saving: While retirement planners all
agree that starting young can give you maximum retirement
earnings, women do not save enough. School loans, car payments,
rent and mortgages can all take precedence over securing a
retirement income. Indeed, many women ages 21-34 were more
likely to carry credit card debt than men (47 percent to 35
percent, respectively), and more single women than men live
paycheck-to-paycheck (53 percent to 42 percent).
LSaving and Investing: Women's lower earnings often
leave them with fewer resources to invest. The current
generation of unmarried elderly women has less than $1,278 in
asset income. The demographic trends are mixed--while married
midlife women are increasing their net worth, unmarried and
divorced women are lagging behind. While younger women are more
aware of the importance of saving for retirement, they also
report carrying more debt than young men, and continue to work
in professions that pay less.
LDifferences of Race in Retirement Income: Many
minority women face great challenges when saving for
retirement. The poverty rate among single elderly minority
women. For black women, the rate is 43.1 percent. For Hispanic
women, it is 37.7 percent. For all single elderly women, it is
approximately 20 percent.
In response to these trends, the report discusses a number of
proposals to better the status of women during retirement, with a focus
on improving Social Security and pension benefits.
LReform proposals for Social Security need to focus on
improving benefits for caregiverss, widowed or divorced women,
and low-wage workers.
LPension reform proposals, such as tax credits
encouraging employers to extend pension coverage to part-time
and temporary workers, could greatly benefit women who do not
have pension coverage. Educating women about pension
participation in 401(k)'s, pension coverage in small firms, and
pension integration could increase their benefits.
LEnacting pay equity legislation would increase Social
Security and pension benefits, as well as increase the money
women could save and invest.
LFinally, because women face immense challenges in
planning for a secure retirement, it is vital that women become
better educated about what they have now, what they need to
save, and how to invest.
With current debates over Social Security privatization and worker
participation in company 401(k) plans, there has been growing emphasis
on placing the burden of investing onto the individual. Because of
this, all individuals, especially women, need to know how precarious
retirement security has been in the past, in order to make informed
decisions about their financial futures.
__________
WISER Fact Sheet
Men's & Women's Income in 2000
LOver 2 out of 3 working women earn less than $30,000
a year.
LNearly 9 out of 10 working women earn less than
$45,000.
All Working Women All Working Men
Income Earned (percent) (percent)
Under $10,000 26.1% 15.4%
$10,000 to 12.1% 7.6%
$14,999
$15,000 to 30.9% 24.4%
$29,999
$30,000 to 20.6% 25.5%
$49,999
$50,000 to 7.6% 15.3%
$74,999
Over $75,000 2.8% 11.7%
Under $30,000 69.0% 47.4%
Under $35,000 76.7% 55.6%
Under $40,000 82.3% 62.4%
Under $45,000 86.8% 68.4%
Median Earnings $20,311 Median Earnings $31,040
Median Full-time Earnings $27,355 Median Full-time Earnings $37,339
Source: Money Income in the United States, US Census Bureau, 2001
Chairman HOUGHTON. So, now we turn to Mr. Gutknecht, a
distinguished, knowledgeable, and caring Member of the U.S.
House of Representatives from Minnesota. Gil?
STATEMENT OF THE HON. GIL GUTKNECHT, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF MINNESOTA
Mr. GUTKNECHT. Thank you very much, Mr. Chairman and
Ranking Member Coyne. I want to thank you for holding this
hearing. I don't come here today as a pension expert, but I
will by way of disclaimer at least, say that I was privileged
during my time in the State legislature to have served on the
Legislative Commission on Pensions and Retirement, which
usually in Minnesota is referred to as the Pension Commission.
I am familiar with the difference between defined benefit
and defined contribution plans. I understand some of the long-
term ramifications in the rules and that employers do have the
right to change or amend their pension plans at any time.
I appear today on behalf of roughly 7,000 IBM employees in
my district and I will share that story with you later.
I would like to focus our conversations today on defined
benefit retirement plans and those conversions to what are
referred to as cash balance plans. Over the past several years
our country has witnessed the unfortunate spectacle of major
corporations converting defined benefit plans to what are
called cash balance plans in order to recapture billions of
dollars from supposedly over-funded pension plans.
Hundreds of thousands of employees, many of whom are older
and vested, and I want to come back to that term, ``vested,''
in their plans saw the value of their retirement benefits drop
precipitously. In my dictionary and in virtually every
dictionary, if you look up the term ``vested,'' you will get
this definition. It is an adjective. It means settled, fixed or
absolute, without contingency, a vested right.
Despite this definition, being vested in a pension plan
does not mean what most American workers think it means.
Companies can at any time and for any reason, change a vested
employee's pension plan. Such conversions often result in
anywhere from a 20- to 50-percent reduction in final total
benefits, with long wear-away periods during which employees do
not accrue any new benefits.
Mr. Chairman and Members, this is simply wrong. When
companies change their retirement plans in a way that may
reduce employee's benefits, vested employees should be allowed
to stay in the original pension plan that they were promised.
As Mr. Coyne mentioned, Bureau of Labor and Statistics
indicate that more than 48 million American workers are age 45
or older. Over 40 million workers or their spouses participate
or receive benefits from defined benefit plans.
Several years ago, as I mentioned earlier, thousands of IBM
workers in my district came to work one morning to find that
the defined benefit pension plan that they had been enrolled in
had been changed to a cash-balance plan without warning, and
more importantly, without any consultation.
For years, these employees had been able to calculate their
future benefits with a pension calculator which was located on
their computer on their desks, compliments of IBM. When the
plan changed, a few days later the calculator disappeared. So
did the employees promised benefits.
Congress needs to take action that simultaneously gives all
employees fair warning of pension plan changes and gives vested
employees protection from company actions that rewrite the
pension rules in the middle of the game.
That is why I have introduced H.R. 4181, the Vested Worker
Protection Act of 2002. This bill would simply require that
healthy companies would be required to give, number one, 90
days notice of a defined benefit pension plan change to all
workers.
Number two; give fully vested employees the choice of
staying with their current plan or switching to the new plan
that has been amended. This bill exempts companies that are in
financial distress from any penalties, while otherwise healthy
companies would be subject to an excise tax, should they
violate the provisions of this bill.
Most Americans take protection of their pension plan for
granted. I think the Enron situation has demonstrated the need
for employees to carefully monitor how their employer handles
their retirement benefits.
As many major companies change their pension plans and
reduce future benefits, planning for retirement based on
promises made by their employees becomes extremely difficult.
Providing employee choice in the event of a planned conversion
would go a long way to reestablishing balance and fairness for
workers with respect to their pensions. With that, Mr.
Chairman, I will be happy to yield and take some questions.
[The prepared statement of Mr. Gutknecht follows:]
Statement of the Hon. Gil Gutknecht, a Representative in Congress from
the State of Minnesota
Chairman Houghton, Ranking Member Coyne, and Members of the
Subcommittee:
Thank you for allowing me to testify at this very important hearing
on retirement security and defined benefit pension plans. I would like
to focus on conversions from defined-benefit retirement plans to
``cash-balance'' plans.
Over the past several years, our country has witnessed the
unfortunate spectacle of major corporations converting defined-benefit
plans to cash-balance plans in order to recapture billions from
supposedly ``over-funded'' pension plans. Hundreds of thousands of
employees, many of whom were older and ``vested'' in their plans saw
the value of their retirement benefits drop precipitously.
In my dictionary, ``vested'' is defined as follows:
Vested. adj. 1. Settle, fixed, or absolute; being without
contingency: a vested right.
Despite this definition, being ``vested'' in a pension plan does
not mean what most Americans think it means. Companies can, at any time
and for any reason, change a vested employee's pension plan. Such
conversions often result in anywhere from a 20-50% reduction in final
benefits, with long ``wear-away'' periods during which employees do not
accrue any new benefits.
This is wrong. When companies change their retirement plans in a
way that may reduce employee benefits, vested employees should be
allowed to stay in the original pension plan that they were promised.
Bureau of Labor statistics indicate there are more than 48 million
American workers over the age of 45. The latest Bureau of Labor
statistics also show that more than 40 million workers or their spouses
participate or receive benefits from defined benefit plans. Many of
these 40 million workers fall into the over-45 age category.
Several years ago, thousands of IBM workers in my district came
into work one morning to find that the defined benefit pension plan
they had been promised had been changed to a cash-balance plan without
warning. For years these employees had been able to calculate their
future benefits with a pension calculator located on their computer,
compliments of IBM. When the plan changed, the calculator disappeared.
So did the employees' promised benefits.
Congress needs to take action that simultaneously gives all
employees fair warning of pension plan changes and gives vested
employees protection from company actions that rewrite the pension
rules in the middle of the game. That is why I introduced H.R. 4181,
the Vested Worker Protection Act of 2002. This bill would require
healthy companies to:
1. Lprovide 90 days notice of a defined-benefit pension plan
change to all workers
2. Lgive fully vested employees the choice of staying in their
current plan or switching to the new, amended plan
This bill exempts companies in financial distress from penalties,
while otherwise healthy companies will be subject to an excise tax
should they violate the provisions of this bill.
Most Americans take protection of their pension plan for granted.
The Enron situation has demonstrated the need for employees to
carefully monitor how their employer handles their retirement benefits.
As more companies change their pension plans and reduce future benefits
for employees, Congress must provide, at a minimum, protection for
vested workers who are planning for retirement based on promises made
by their employers. Providing employee choice in the event of a plan
conversion will go a long way toward re-establishing balance and
fairness for workers with respect to pensions.
Thank you.
Chairman HOUGHTON. Thank you very much. Let me just ask a
question and then I will turn it over to you. If I understand
it, really, you can have a cash-balance program without some of
the pitfalls, which you have indicated. What happened with IBM?
Mr. GUTKNECHT. I hate to speak too specifically about what
happened in IBM. The real issue, I think, Mr. Chairman, is the
term ``vested.'' Almost every American believes that once they
are vested for a pension plan, and especially based on what
are, at least expected promises that that pension plan will go
on forever.
Most people believe that they are not going to change their
pension plan. The issue here was that it was changed overnight,
without any notice. As an example, on the plane back last week,
I got off the plane and was walking with an IBMer and he said,
``I hope you will continue to fight on that pension issue. That
cost me $150,000.''
As I said, in their case, IBM had literally put, as part of
the software tools on their computers, a calculator where they
could calculate, if they stayed with the company until they
were 65, how much their pension benefit would be worth.
Chairman HOUGHTON. Gil, talk about the Employee Retirement
Income Security Act 1974, (ERISA) issue.
Mr. GUTKNECHT. Again, I hate to hold myself out as an
expert on ERISA, but here is what I understand and it was
always my understanding, the reason that the Congress passed
ERISA preemption in the first place. Major employers back in
the sixties and seventies were doing a fabulous job, IBM
included. Many major employers were doing a wonderful job of
taking care of their employees with health insurance benefits,
with life insurance benefits, some with dental insurance and
generous pension plans.
Essentially, major employers came to Washington and said,
``Listen, we don't want to have to deal with regulation in 50
different States. As long as we continue to take good care of
our employees with these generous pension plans and life
insurance plans and so forth, we would like to be preempted
from State regulation.''
All of a sudden, it seems to me that it is not the workers
that are breaking their end of that bargain. It is not Congress
that has changed the bargain. It is the major employers.
Now, as I say, it is one thing if those employers are
facing a very difficult financial situation. I think we all
recognize that when the ship is sinking we have to do some
things to change. In many cases we are talking about major
employers that are extremely profitable and otherwise have no
problem meeting their obligations in these programs, which in
most cases are over-funded now.
Chairman HOUGHTON. We have a vote and we probably have 10
minutes for questioning. So, let us go right at it. Bill, have
you got questions?
Mr. COYNE. Thank you, Mr. Chairman. I just want to thank
the gentleman for bringing to the Congress a real, live example
from his district of the shortcomings in the laws that exist
today relative to the pension relationships between employer
and employee. Thank you.
Mr. GUTKNECHT. Well, thank you, Mr. Coyne. If I could just
respond, you know, as I say, many of us were surprised when
this happened. Many of my constituents said, ``Well, I thought
this was illegal.''
The more they studied it, they found, no it isn't
technically illegal and that is when people started saying
there ought to be a law and that is what we do.
Mr. COYNE. IBM later agreed to make some changes regarding
who can opt into the old defined benefit plan or go to the new
cash-balance plan. Do you know how such a decision impacted
your constituents that were adversely affected by the
conversion?
Mr. GUTKNECHT. Well, under enormous pressure, both from the
employees and from people like me and other Members of Congress
from other districts that represented IBMers, they did reduce
the age and people, I think, above the age of 40 were allowed
to stay in their defined benefit plan.
Now, if I could say this, Mr. Chairman, you know, some
people say, well, this is a lot of bureaucracy and red tape
that employers have to go through. All of these employers are
going to continue to have a defined benefit plan for many years
to come anyway, for the employees who are already in the system
that were vested for the benefits that they were already vested
for, this program will go on.
So, in many cases, it is really a matter of whether they
are going to continue their defined benefit plan for 30 years
or 40 years. It is not a question whether or not they will have
to continue participating in a defined benefit plan, it is just
a matter of how long.
Mr. COYNE. Thank you.
Chairman HOUGHTON. Please, Mr. Weller.
Mr. WELLER. Thank you, Mr. Chairman. First, let me begin by
thanking you for conducting this hearing, but also commending
my colleague from Minnesota for his leadership in drawing
attention to the important of retirement security issues.
You have worked on this issue for a long time and I
appreciate your perseverance and your persistence on behalf of
your constituents.
Let me just ask one question since I recognize we are
limited here on time. On the issue of pensions and the
conversion issue from a defined benefit, many have said that
those who are impacted the most are long-time workers and that
those who relatively new employees actually may find it more
attractive.
I was just wondering, from your perspective in working with
your constituents, have you seen that and can you give an
example or two?
Mr. GUTKNECHT. Well, let me say, Mr. Chairman, I am not
adverse to defined contribution plans. I think you would find,
if you gave employees the choice, many of the younger workers
would go to the defined contribution plan. It is those workers
who are between the ages of, say, 40 and 45 or 40 and 50 that
are long-term employees that really get hurt when there is this
conversion that happens because if you look at what happens
with a defined benefit plan, you accrue most of your benefits
during the last 5 years of your employment.
So, that is where this wear-away factor happens, where
employees lose hundreds of thousands of dollars. Literally, I
have talked to IBM employees who have told me they have lost
hundreds and hundreds of thousands of dollars in total
benefits. So, it really does affect those people who have been
with the company 20 years, who are, what some would describe as
approaching middle age, and there are a lot of those baby
boomers out there and this could have a profound impact on
them.
The real concern I have, and I still consider IBM to be a
wonderful employer. They are a good company, a solid company,
but you have to ask yourself, if it could happen at IBM, it
could happen anywhere.
Mr. WELLER. Just a quick follow up on that. From the
relatively new employees, have you seen just from your
examination that when there is conversion over the cash balance
and for a relatively new employee who may stay with the company
for a long period of time, did you see an advantage to a cash
balance over a defined benefit?
Mr. GUTKNECHT. Well, that is a hard one to answer. It would
vary by program. I am not an expert. You would have to get an
actuary in here to explain that. In a mobile workforce
environment defined contribution plans are the answer,
depending on how the pension plan is structured.
If somebody is going to stay with the company for a long
period of time, 30, 40 years, in almost every case they would
be better with a defined benefit plan as they are currently
structured. That is the minority of employees entering the
workforce today.
The problem is that you have some of these older companies
like IBM, like General Electric, big companies where
historically there are a lot of people who started with the
company when they got out of school and they stayed with the
company until they retired. Those people are dramatically
affected when you have these conversions.
Of course, that is the reason the companies do that,
because they realize they can save billions of dollars. My
estimate is that IBM probably is saving somewhere around $5
billion over the next 6 years by making this conversion.
Mr. WELLER. Thank you.
Chairman HOUGHTON. Mr. Pomeroy.
Mr. POMEROY. Gil, I think you have done a great job on this
issue. You have absolutely been a bulldog on it and really
helped elevate national attention about troubling issues
presented in these conversions where there are not particularly
hold harmless protections made so that people don't find
dramatic benefit reduction.
There are 56 percent, about half the people in the
workforce, have at work retirement savings options of some
kind. About 56 percent of those have DC plans. About 30 percent
have a defined benefit and a defined contribution plan
available. About 14 percent, defined benefit only.
Now, the position that I take on the questions that my
friend, Congressman Weller was asking is that the defined
benefit plan has an awful lot going for it in terms of being
able to provide annuity protection to workers in their
retirement years for as long as they live.
My goal is to take another look at what we can do to
reinvigorate market interest in defined benefit plans. One of
the things that caused me some concern about over-responding,
about laying in a whole host of guarantees to address the
circumstance that we saw with the IBM case is that you would
never have a new defined benefit plan offered anywhere because
no one is going to buy that forever liability.
You offer a defined benefit 1 year and you are going to
have to keep it in place as an option at least until the worker
retires. Would you respond to that concern relative to your
legislation?
Mr. GUTKNECHT. Mr. Pomeroy, you know, I have to agree. I
think that is one of the concerns. That is when it comes back
to the whole ERISA bargaining. If they are not offering a
pension plan now, then Congress really doesn't have much to say
about it. The real concern I have is there is no one out there
protecting the middle-aged worker who is currently in a defined
benefit plan. I don't know that there is much we can do to
encourage more employers to offer defined benefit plans.
I do know that if we don't discourage the kind of thing
that we saw happen with IBM, we are going to see a whole lot
more of it. That number of people in defined benefit plans is
going to go down. You have consultants working for what used to
be the major accounting firms that are out there telling people
how they can make these conversions and ultimately shift money
from over-funded pension plans to their bottom line.
Mr. POMEROY. Well, the shift in defined benefit to defined
contribution which, in my opinion, raises even more questions
than moving to the hybrid hasn't run its course, but we have
had a heck of a lot of it really fundamental reshaping the
market. Part of your bill involves notice. I don't think we
should under-appreciate what very clear advance notice does in
the workforce.
For example, if I am intending a plan that does not deal
adequately with the wear-away factor, that does not treat the
more tenured employees fairly, and I give them very clear
notice of that in advance. As an employer HR department, I am
buying a host of trouble. All my most senior operatives, I am
about to tell them, ``I am going to rip you off on your
retirement benefit conversion.''
There is an awful lot that will spring automatically from
that. They are going to take things into their own hands. They
don't need a new statute, necessarily to do that, provided we
provide the statutory requirement on notice. So, I think that
that part of your bill gets a lot done right there, even
without the guaranteed continuation of the option.
Chairman HOUGHTON. Thank you.
Mr. POMEROY. Thanks, Mr. Chairman. I yield back.
Chairman HOUGHTON. Well, thanks very much. I appreciate
this. We have a vote on. We will come back and we will take the
next panel after this.
Mr. GUTKNECHT. Well, again, on behalf of IBM employees,
thank you very much for having this hearing.
Chairman HOUGHTON. Thank you.
[Recess.]
Chairman HOUGHTON. All right, ladies and gentlemen, we are
going to continue. There will be no more votes in the House for
the day, so therefore we will have an uninterrupted session
here. I would like to introduce Mr. Steven A. Kandarian,
Executive Director of the Pension Benefit Guaranty Corp.
Welcome, Mr. Kandarian. You can begin your testimony at any
time.
STATEMENT OF STEVEN A. KANDARIAN, EXECUTIVE DIRECTOR, PENSION
BENEFIT GUARANTY CORPORATION
Mr. KANDARIAN. Thank you. Mr. Chairman, Mr. Coyne and
Members of the Subcommittee, thank you for inviting me to
appear today to talk about defined benefit plans. The PBGC is a
government corporation that ensures the pensions of about 44
million participants and beneficiaries in approximately 35,000
ongoing defined benefit plans.
Our Board of Directors is comprised of the Secretary of
Labor who is Chair, and the Secretaries of the U.S. Department
of Commerce and the U.S. Department of the Treasury. We receive
no funds from general tax revenues. Operations are financed by
premiums from plan sponsors, assets from plans we trustee,
recoveries in bankruptcy, and investment income.
In its single-employer program, PBGC operated in a deficit
position during its first 21 years. In 1996 we recorded our
first surplus which grew to over $10 billion in the year 2000,
but has rapidly declined since.
Today, less than 2 years later, our unaudited surplus has
been cut by more than half and is now under $5 billion.
Moreover, I expect this number to decline further.
We also face over $9 billion in underfunding in the steel
industry. About half of that is in steel companies that are
currently in bankruptcy. In addition, we face large
underfunding in troubled companies in the airline and retail
sectors.
Terminating large pension plans creates an administrative
challenge as well. Last year we became responsible for paying
the benefits of 89,000 participants, the largest number of new
participants in a single year in our 27-year history. We
project taking in about 200,000 new participants this fiscal
year. The number could be even higher next year.
In addition, we are closely monitoring troubled companies
with under-funded plans. The ERISA authorizes PBGC to act to
avoid an unreasonable increase in long-run loss to the
insurance system. We are examining each situation to determine
whether we need to terminate plans now to avoid an even greater
loss in the future.
Last week we moved to terminate the highly underfunded
pension plans of Republic Technologies International to avoid
an additional loss of approximately $100 million to the
insurance system.
From an administrative viewpoint, we continue to focus on
accelerating our use of technology in providing the best
customer service possible. For example, in LTV for the first
time, we sent out letters to participants before we took over
the plans so workers would know what to expect.
I will now talk about the decline of defined benefit plans.
The number of plans we insure peaked in 1985 at about 114,000.
Since then, there has been a sharp decline to approximately
35,000 plans. Plans with fewer than 100 participants have
declined most rapidly. The percentage of the private sector
workforce that has a defined benefit plan declined from 38
percent in 1980 to 22 percent in 1998.
The total number of participants has actually grown
slightly, but this masks a troubling decline in the number of
active workers in defined benefit plans. We project that by
next year there will be more retired and separated participants
than active workers in the defined benefit system.
A number of factors have led to the decline of defined
benefit plans. Employment has shifted away from large,
unionized industrial companies that have traditionally offered
these plans. Employer attitudes toward retirement security have
become less paternalistic.
Younger, more mobile workers prefer the portability and
investment control of 401(k) plans, and companies seek pension
cost that they can control, as they increasingly compete with
domestic and foreign businesses that do not offer defined
benefit plans.
The only type of defined benefit plan that has increased in
popularity in recent years is the cash balance plan. Over 30
percent of the Fortune 100 companies have adopted cash balance
plans. Cash balance plans provide an account balance and
greater portability than traditional plans, which makes them
attractive to mobile workers.
We view cash balance plans as the most viable avenue to
reverse the decline of the defined benefit system.
Mr. Chairman, today PBGC faces its greatest challenge in a
decade. I can assure this Subcommittee that we are working hard
to protect the health of the defined benefits system. I would
be happy to answer any questions from the Subcommittee.
[The prepared statement of Mr. Kandarian follows:]
Statement of Steven A. Kandarian, Executive Director, Pension Benefit
Guaranty Corporation
Mr. Chairman, Mr. Coyne, and Members of the Subcommittee:
It is a pleasure to appear before this Subcommittee today. I became
Executive Director of the PBGC on December 3, 2001, a little over six
months ago. You have asked me to provide you with information on the
status of defined benefit plans.
Defined benefit plans have historically played an essential role in
the three-legged stool of retirement income. The hearings you are
holding today provide a welcome focus on the future role of defined
benefit plans.
Overview of PBGC
I would like to take a few minutes to give you some background on
the PBGC and its role in the pension system. PBGC was created by ERISA,
the Employee Retirement Income Security Act of 1974, to guarantee
private defined benefit pension plans that terminate without sufficient
assets. Defined benefit plans provide a monthly retirement benefit,
usually based on salary and years of service. The benefit amount does
not depend on investment performance.
PBGC is one of the three so-called ``ERISA agencies'' with
jurisdiction over private pension plans. The other two agencies are the
Department of the Treasury (including the Internal Revenue Service) and
the Department of Labor's Pension and Welfare Benefits Administration
(PWBA). Treasury and PWBA deal with both defined benefit plans and
defined contribution plans, including 401(k) plans. PBGC deals only
with defined benefit plans, and only to a limited extent, as guarantor
of benefits in underfunded plans that terminate. PBGC has very limited
regulatory or enforcement authority over ongoing plans; the authority
PBGC does have relates to certain employer reporting requirements and
to determining whether a plan should be terminated to protect the
insurance program.
PBGC protects the benefits of about 44 million participants and
beneficiaries in slightly more than 35,000 ongoing defined benefit
pension plans. When a plan insured by PBGC terminates without
sufficient assets, PBGC becomes trustee of the plan and pays plan
benefits, subject to statutory limits. For the vast majority of
participants in PBGC-trusteed plans, plan benefits are paid in full. On
average, participants receive over 94 percent of the benefits they had
earned at termination. However, some participants receive a
considerably smaller portion of their earned benefit. In addition, the
94 percent figure does not take into consideration benefits for which
the participant had not yet satisfied all conditions at the time of
termination, such as 30-and-out benefits.
At the end of FY 2001, PBGC was responsible for paying current or
future pension benefits to about 624,000 people in terminated plans,
and payments, for the first time, exceeded $1 billion. PBGC has added
over 140,000 new participants already in this fiscal year.
PBGC is a wholly-owned federal government corporation. It operates
under the guidance of a three-member Board of Directors--the Secretary
of Labor, who is the Chair, and the Secretaries of Commerce and the
Treasury.
[GRAPHIC] [TIFF OMITTED] 86581A.002
PBGC receives no funds from general tax revenues. Operations are
financed by insurance premiums set by Congress and paid by sponsors of
defined benefit plans, assets from pension plans trusteed by PBGC,
investment income, and recoveries from the companies formerly
responsible for the trusteed plans. There is a two-part annual premium
for single-employer plans--a flat-rate premium of $19 per plan
participant plus a variable-rate premium of $9 per $1,000 of the plan's
unfunded vested benefits. PBGC has a separate, smaller insurance
program for multiemployer plans, which are collectively bargained plans
maintained by two or more unrelated employers.
PBGC's statutory mandate is: (1) To encourage the continuation and
maintenance of voluntary private pension plans for the benefit of their
participants, (2) to provide for the timely and uninterrupted payment
of pension benefits to participants and beneficiaries under PBGC-
insured plans, and (3) to maintain premiums at the lowest level
consistent with carrying out the agency's statutory obligations.
Financial Condition of the PBGC
For its first 21 years, PBGC operated at a deficit. Beginning in
1996, PBGC has gradually built up a surplus as a result of legislative
reforms, a strong economy, good returns on investments, and no major
terminations from 1996-2000. PBGC had a surplus of $9.7 billion in its
single-employer program at the end of fiscal 2000 (September 30, 2000).
At the end of fiscal 2001 (September 30, 2001), the surplus had dropped
to approximately $7.7 billion. As of April 30, our unaudited surplus
had fallen to under $5 billion.
Net Position FY 1990--2002
Unaudited Projection
[GRAPHIC] [TIFF OMITTED] 86581A.003
NOTE: PBGC was in deficit for all years prior to 1990
----------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------
SOURCE: PBGC Annual Reports (1990--2001), 2002 projection
----------------------------------------------------------------------------------------------------------------
I'm concerned that our surplus may decline even further. Including
the approximately $1.6 billion in claims from the LTV plans, the steel
industry now accounts for about 38% of all claims against PBGC.
And we still face over another $9 billion in underfunding in the
steel industry, nearly half of which is in steel companies that are in
bankruptcy proceedings. We also face large amounts of underfunding in
troubled companies in the airline and retail sectors.
PBGC Claims
1975--2002
[GRAPHIC] [TIFF OMITTED] 86581A.004
----------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------
SOURCE: PBGC Annual Reports (1990--2001), 2002 projection
----------------------------------------------------------------------------------------------------------------
Integrated Steel Plan Underfunding
[GRAPHIC] [TIFF OMITTED] 86581A.005
Pension Shutdown Benefits
Underfunding (potential additional underfunding)
----------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------
SOURCE: PBGC Analysis of Actuarial Valuation Reports
----------------------------------------------------------------------------------------------------------------
Administrative Workload
Not only does the PBGC face a challenge financially, we face a
challenge administratively. Large plan terminations have always been,
and continue to be, the single most important factor determining PBGC's
workload as well as its financial condition. PBGC became responsible
for 104 plans with 89,000 participants last year, the largest number of
new participants in PBGC's 27-year history. This year, we already have
become responsible for over 140,000 new participants, and the end-of-
year figure could be as high as 200,000. Little relief is in sight. If
the plans of some of the troubled steel companies, airlines and others
are terminated, new participants coming to PBGC in fiscal year 2003
could exceed this year's 200,000 new participant figure.
New Participants in Trusteed Plans
Fiscal Year 1988--2003 (projected)
[GRAPHIC] [TIFF OMITTED] 86581A.006
----------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------
SOURCE: PBGC Insurance Operations Department Reports
----------------------------------------------------------------------------------------------------------------
PBGC Actions to Address these Problems
We are taking steps to deal with this financial and administrative
challenge. From a financial perspective, PBGC is closely monitoring
troubled companies with underfunded plans. And PBGC is carefully
examining each situation to determine if PBGC must terminate plans now
in order to avoid even greater losses to the PBGC insurance program in
the future. PBGC is totally financed by our premium payers--the
sponsors of defined benefit plans. We have an obligation to those
premium payers to be fiscally responsible and take the necessary
difficult actions to keep PBGC financially sound.
From an administrative viewpoint, we continue to accelerate our use
of computer technology, contractors, and other measures to get
participants into pay status as soon as they are eligible, to reduce
waiting times for final benefit determinations, and to provide superior
customer service. Participants feel a great deal of stress when their
pension plan terminates, frequently at the same time they lose their
jobs. PBGC should be a source of reassurance, not another source of
stress. To this end, we are both continually learning from what
participants and plan sponsors tell us and proactively designing new
ways of providing better information. For example, in LTV, for the
first time, we sent out letters to participants before we took over the
plan so they would know what to expect.
Trends in Defined Benefit Plans
I would now like to turn to what is happening to defined benefits
plans.
Number of Defined Benefit Plans
The percentage of private-sector workers with pension coverage in
their current jobs has remained constant at just under 50 percent since
the mid-1970s. But there has been a large and continuing shift away
from defined benefit plans to defined contribution plans. The number of
PBGC-insured defined benefit plans peaked in 1985 at about 114,000.
Since then there has been a sharp decline to slightly more than 35,000
plans in 2001, a decline of almost 70 percent.
[GRAPHIC] [TIFF OMITTED] 86581A.007
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SOURCE: PBGC Premium Filings
----------------------------------------------------------------------------------------------------------------
This reduction in the number of plans has not been proportional
across all plan sizes. Plans with fewer than 100 participants have
shown the most marked decline, from about 90,000 in 1985 to 20,500 in
2001. There also has been a sharp decline for plans with between 100
and 999 participants, from more than 19,000 in 1985 to less than 10,000
in 2001.
In marked contrast to the trends for plans with fewer than 1,000
participants, the number of plans with more than 1,000 participants has
shown modest growth. Since 1980, the number of PBGC-insured plans with
between 1,000 and 9,999 participants has grown by about 1 percent, from
4,017 to 4,070 in 2001. The number of plans with at least 10,000
participants has grown from 469 in 1980 to 809 in 2001, an increase of
72 percent.
The growth in the number of large plans is attributable to two
factors. First, the rapid increase in inactive participants (retirees
and separated vested participants) has pushed some plans into higher
size categories. Second, in instances where one employer maintained
more than one plan, frequently as a result of corporate mergers and
acquisitions, the employer has merged those plans.
Number of Participants
In contrast to the dramatic reduction in the total number of plans,
the total number of participants in PBGC-insured defined benefit plans
has shown modest growth. In 1980, there were 35.5 million participants.
By 2001, this number had increased to about 44 million.
These numbers, however, mask the downward trend in the defined
benefit system because total participants include not only active
workers but also retirees (or their surviving spouses) and separated
vested participants. The latter two categories of participants reflect
past coverage patterns in defined benefit plans. A better forward-
looking measure is the trend in the number of active participants,
workers currently earning pension accruals. Here, the numbers continue
to decline.
In 1985, there were 29.0 million active participants in defined
benefit plans; by 1998, this number had fallen to an estimated 23.0
million, a decrease of 21 percent. At the same time, the number of
inactive participants has been growing. In 1985, inactive participants
accounted for only 27 percent of total participants in defined benefit
plans. This number has increased to 45 percent by 1998. If this trend
continues, by the year 2003 the number of inactive participants will
exceed the number of active workers.
Ratio of Participants in Defined Benefit Pension Plans
1985-2006 (estimated)
[GRAPHIC] [TIFF OMITTED] 86581A.008
----------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------
SOURCE: U.S. Department of Labor, Pension Welfare & Benefits Administration, Abstract of 1998 Form 5500 Annual
Reports, Winter 2001-2002
----------------------------------------------------------------------------------------------------------------
Decline of Defined Benefit Plans
The percentage of the workforce participating in either a defined
benefit or defined contribution pension plan has not changed
appreciably in the last 20 years. But the mix has changed. The
percentage of the private sector workforce that has a defined benefit
plan declined from 38 percent in 1980 to 22 percent in 1998. In 1980,
over 80 percent of workers with a pension plan had a defined benefit
plan. By 1998, that percentage had dropped to less than 50 percent. In
1980, about two-thirds of workers who had a defined benefit plan had no
other employer-sponsored plan; by 1998, that ratio had reversed with
only about one-third having no other plan. As defined benefit plans
declined, 401(k) plans, a type of defined contribution plan, grew.
Introduced in the early 1980s, the number of 401(k) plans grew from
17,000 in 1984 to over 300,000 in 1998.
Private Workforce Participation in Defined Benefit Plans
1975-1998
[GRAPHIC] [TIFF OMITTED] 86581A.009
----------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------
SOURCE: U.S. Department of Labor, Pension Welfare & Benefits Administration, Abstract of 1998 Form 5500 Annual
Reports, Winter 2001-2002
----------------------------------------------------------------------------------------------------------------
Pension Participation Rates
1979-1998
[GRAPHIC] [TIFF OMITTED] 86581A.010
----------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------
SOURCE: U.S. Department of Labor, Pension Welfare & Benefits Administration, Abstract of 1998 Form 5500 Annual
Reports, Winter 2001-2002
----------------------------------------------------------------------------------------------------------------
Reasons for the Decline of Defined Benefit Plans
A number of factors have caused the shift away from defined benefit
plans since the mid-1980s. Employment has shifted from the unionized,
large manufacturing sector companies where defined benefit plans were
common to the non-manufacturing sector with smaller employers where
defined contribution plans predominate. Workers placed less value on
defined benefit plans, and employer attitudes towards pensions changed
from one of paternalism to one of worker self-reliance.
A new type of plan, the 401(k) plan, became available in the mid-
1980s, and employers now had another option. Younger, more mobile
workers preferred the portability and investment control offered by
these 401(k) plans.
Changes to pension and tax laws have increased the complexity and
costs of administering defined benefit plans. Companies with defined
benefit plans found themselves increasingly competing, domestically and
globally, with companies that did not offer any plan or offered only a
defined contribution plan. Funding of defined contribution plans,
unlike funding of defined benefit plans, is more predictable and easier
to control.
The only type of defined benefit plan that is increasing in number
is the cash balance plan. Cash balance plans typically credit a
percentage of a worker's salary plus interest each year to a
participant's cash balance account. At retirement, the participant
generally has a choice between taking a lump sum or an annuity. Because
there is a nominal account with a growing balance, the plan looks like
a 401(k) account. A growing number of employers with defined benefit
plans are shifting to cash balance plans rather than abandoning defined
benefit plans altogether.
Conclusion
Mr. Chairman, I appreciate the opportunity to address the
Subcommittee. Your consideration of the future of defined benefit plans
is important to this Nation's long-term retirement outlook. Defined
benefit plans remain a vital component of our retirement system.
My staff and I would be happy to provide any information that the
Subcommittee might need in the future as you study defined benefit
plans. I'd be happy to answer any questions from the Subcommittee.
Chairman HOUGHTON. Thanks very much. Mr. Coyne.
Mr. COYNE. Thank you, Mr. Chairman. Thank you for your
testimony. I appreciate it. Given the diminishing role that
defined benefit plans will play in workers' lives and the
importance of a predictable and guaranteed base of income in
retirement, how important do you believe it is to ensure that
Social Security, which is a defined benefit system, remain that
rather than being partially privatized.
Mr. KANDARIAN. It is a three-legged stool of Social
Security, a private pension of some sort, and personal savings.
Each is critical for everyone's retirement. Social Security is
the first leg on that stool.
I certainly support the President's view on Social Security
reform. I think the long-term gains people can realize if
properly investing a portion of their monies makes a lot of
sense. It is a voluntary system that he is proposing. I
certainly think it is a wise idea.
Mr. COYNE. So, you don't think that is putting in jeopardy
any kind of stability as a defined benefit plan if Social
Security is partially privatized?
Mr. KANDARIAN. Social Security is not my area of
responsibility or expertise. Certainly from what I have read
and studied to date, the demographics are such that there will
be fewer and fewer active workers compared to the number of
retirees and something has to be done in the long term to make
the system viable.
Certainly the kinds of returns that have been realized
within the system to date are problematic for the long-term
health of the system. So, again, I do support strongly the
President's view of allowing people to voluntarily invest part
of their monies in specified accounts.
Mr. COYNE. In your testimony you pointed out about the
steady decline in the number of defined benefit plans. I wonder
if you would elaborate further on what you think the reason for
these declines have been.
Mr. KANDARIAN. For the overall system?
Mr. COYNE. Yes.
Mr. KANDARIAN. Well, the biggest decline in terms of the
numbers, again, are the smaller companies, the smaller plans,
under 100 participants. In terms of what we can do about that,
there is legislation that has actually passed the House, it is
H.R. 3762, the Pension Security Act, which contains helpful
provisions was originally voted on last year but was dropped
for reasons of germaneness.
These non-controversial provisions which reduce premiums
for smaller firms and especially for first time employers in
the system, would go a long way, we believe, toward making
these kinds of plans more attractive and palatable. So, that is
one way we can perhaps turn around that piece of the system.
In terms of the larger companies, it is a difficult
question. You take a look at companies like Microsoft or Wal-
Mart and other very large employers that do not have defined
benefit plans. You have to ask yourself why does that segment
of the economy choose not to enter the system.
I have not talked to them directly and I don't know first
hand specifically as to those companies I mentioned, but
overall, there are issues, I think, in terms of where our
economy has gone, the level of competition businesses face
today, the interest and, in fact, I would say the need for
businesses to remain as flexible as possible financially. For
some large companies that are not in the system, their concern
is that if they come into the system, if it is too difficult in
terms of how much they have to put into the plan at any one
point, especially during a recession or a down year with very
aggressive both domestic and foreign competition that may not
have a defined benefit plan, they are at a competitive
disadvantage. So, I think that is a factor that I am not
certain that can be totally addressed legislatively. I think
that is an issue of competition in the business world.
Mr. COYNE. In your testimony you pointed out that the PBGC
is financially secure at this time. What do you see as the
biggest threat to the security of the PBGC in the short and the
long term?
Mr. KANDARIAN. In the short run there are a couple of
industries in particular that have highly underfunded plans.
They have some troubled companies in those industries.
Specifically, the steel industry has about $9 billion in
underfunding. About half of that underfunding is in companies
that are currently in chapter 11. Now being in chapter 11 alone
doesn't mean that we take over the plan, but certainly it
raises the probability that some of those plans may come into
us.
The airline industry has gone from being about $3 billion
underfunded in the year 2000 to $11 billion in the year 2001.
Certainly just reading the business press, there are a number
of companies there that are seeking loan guarantees and have
expressed concern about their current financial status.
So, those are the kinds of things we are looking at in the
short run. The impact in terms of what that does to our current
surplus is difficult to know and certainly I don't want to
speculate about specific companies not remaining in business.
It wouldn't be a wise thing for me to be doing as a Federal
government official.
Overall, these industries are troubled, have large
underfunding, and depending upon what happens to these
businesses, our surplus could diminish greatly and could
actually turn into a deficit.
Mr. COYNE. Do you have any additional measures that you
think ought to be taken to minimize any further financial
threat to PBGC? Do you have additional recommendations?
Mr. KANDARIAN. In the case of Republic Steel, as I
mentioned, we moved to terminate that plan prior to the point
in time when the company would have terminated that plan. That
avoided taking in what is called shutdown types of benefits.
That reduced the liability to PBGC.
There is about $2.7 billion in shutdown liabilities in the
steel system today. Over $1 billion of that is in bankrupt
companies. So, that would be one aspect of the liabilities we
face that we have some control over and which on a case-by-case
basis we have to consider under the existing law.
Mr. COYNE. Thank you very much.
Chairman HOUGHTON. Let me just ask you a quick question
before I turn it over to Ms. Dunn. This is all opinion, but if
you take a look at the trends here, you are going to be under
water.
Mr. KANDARIAN. Mr. Chairman, I'm sorry. I don't hear very
well. Could you speak a little closer to the microphone?
Chairman HOUGHTON. Yes. You are going to be under water if
these trends continue. Also, when you talk about the steel
industry, if I understand it, half of the steel companies are
now in or near bankruptcy. So, what happens at that point?
Mr. KANDARIAN. To the Agency?
Chairman HOUGHTON. Yes. I mean this thing turned in 1995
for a variety of different reasons. One was the increase in the
premium. What happens here?
Mr. KANDARIAN. Historically, from inception to today, 38
percent of the claims against our system have come from the
steel industry. The workers in the steel industry represent
about 2 percent of the participants in our insurance system.
So, you see the problem right there.
Chairman HOUGHTON. Right.
Mr. KANDARIAN. Airlines represent over 20 percent of the
whole, of the 100 percent. So, those two alone--only
Chairman HOUGHTON. How about the retail? You said the
retail was in trouble, too.
Mr. KANDARIAN. Retail, I wouldn't say as an industry, but
as is public knowledge, K-Mart is in chapter 11 and they are a
very large company. So, that is of concern to us. Steel and the
airlines are the two big ones in the near term that could be
very troublesome in terms of our financial health.
Now, we have very little control other than on issues such
as shutdown costs and on things called follow-on plans, which
means the company goes into chapter 11, tries to reorganize,
terminates their pension plan because they can't support it,
and then they want to have a new plan on the way back out of
bankruptcy.
We have some say on whether or not they can have another
defined benefit plan immediately. Those are the only real
substantive issues that we can get into in terms of limiting
the liability side of our balance sheet.
Other signs in terms of our financial health are assets. A
question there might be how might you better invest your
monies. There are current constraints in the law and current
constraints in terms of Board policy, I think, in many cases
for many good reasons. We are conservatively invested, so I
think we are fine in that sense. We certainly don't get very
high returns, let us say, compared to some pension funds
because we must be conservative.
Chairman HOUGHTON. Well, thank you very much. Ms. Dunn.
Ms. DUNN. Thank you very much, Mr. Chairman. I was glad to
hear your comments on the ideas that came out of the Joint
Committee on Social Security. I simply want to add a couple of
points to that because I know that you work in this area. My
particular interest is in making sure that women moving into
retirement are able to have some sense of peace of mind that
their pension is going to be there when they get there.
Therefore, Social Security becomes hugely important to them
as one of those three legs you talked about. In 75 percent of
the cases, women live longer than men. Currently, Social
Security is paying about 2 percent in my district, under a 2-
percent return on the dollars that are put in on their behalf
through their working lives.
I think we have an opportunity, if we do it right, to make
sure that women are even more secure moving into retirement. I
see, for example, one of the pieces of legislation out there
that we used to call Archer-Schotts, now the Shaw bill, that
creates the benefit coming from Social Security as a floor to
what women will collect once they go into retirement.
So, I was really happy for you to mention that. I simply
want to urge you to look at all the possibilities that would
come from this because many of us are going to begin
formulating ideas next year to put into legislation that will
help women out.
You talked about a premium increase. Tell me how this all
works. If you do slide down, down, down, go into deficit, can
you continue to operate in a deficit position?
Mr. KANDARIAN. Actually, we can operate in a deficit
position and did from 1974 to 1995. The reason we are able to
do that is that our assets are liquid securities, meaning
public stocks, and U.S. Treasury bonds, which represent about
60 percent of our assets. So, we have money today.
When you look at our position in terms of why we are in
deficits--because obviously, our liabilities are greater than
our assets. Our assets are on hand today, while our liabilities
are over the lives of all these retirees who are now in our
system. So, we don't run out of money when we go into deficit.
It simply means, on an actuarial basis, if nothing else
changed, we would eventually in the out-years run out of money.
So, how do you get out of deficit? Well, the first thing
you hope happens is that current premiums eventually outpace
any new failures that come into the system; the economy turns
around, fewer failures.
You hope that the asset side of our balance sheet grows,
especially the stock portfolio that we own, which is about 35
to 40 percent of our assets. There are other actuarial
assumptions that can impact our responsibilities which might
make them actually decline.
So, I would say the last thing I would like to do in the
whole spectrum of things to do is raise premiums. The reason I
feel that way is that from inception in 1974 to today premiums
have gone up 19-fold. If you adjust for inflation, they have
gone up 5.4 times the rate of inflation.
If we are trying to encourage defined benefit plans, I
think it would be counterproductive to talk, at least
initially, in terms of a premium increase when premiums have
already been increased significantly from the start of PBGC's
history.
Ms. DUNN. Is there any further answer that we need to be
paying attention to now considering what is happening in the
steel industry and other industries to deplete your funds?
Mr. KANDARIAN. I don't think there is much we can do other
than wait and see how it shakes out. When we get to that point,
if we slide into a deficit position, we will have to see where
we stand and see what kinds of responses make sense.
Ms. DUNN. Do you have the ability to do this is through
regulations or must there be some sort of legislation that
helps you out?
Mr. KANDARIAN. On the premium side, we actually have
regulatory authority but it has never been exercised, and I
wouldn't propose exercising it. It has always been done by
Congress.
Ms. DUNN. Thank you. Thank you, Mr. Chairman.
Chairman HOUGHTON. Thank you, Ms. Dunn. Mr. Pomeroy.
Mr. POMEROY. Thank you, Mr. Chairman. This is a great
hearing. I have known the preceding two administrators of PBGC
and I don't know, this is the first opportunity I have had to
have the testimony and the presentation and Congressional focus
on what you do and to how pensions work. I think this is a very
important undertaking.
For example, I don't think we understand defined benefit
plans very well. To suggest that you could do better for women
who outlive men on average by 7 years and assure them a
guaranteed annuity payment, payable every month for as long as
they live, you can't do better than that.
That is why Social Security works so well and that is why
defined benefit plans work so well. We need to make certain
that we certainly guarantee the pension benefits already out
there and try and create a market where we might elicit new
interest. That is why I appreciate your observation on premium
increases. I think we don't want to go there unless we
absolutely have to.
The time we passed the reforms in 1995 or whenever it was,
we figured we fixed the solvency thing once and for all,
especially with the market run up. Although things have leveled
out a bit since then.
Your predecessor, David Strauss, gleaned from his statutory
authority the responsibility to be the advocate in the
Administration for defined benefit plans. How do you view your
responsibilities in this way?
Mr. KANDARIAN. I view my responsibilities as the protector
of the defined benefit plan system. In terms of advocacy, to a
degree I want to be an advocate of retirement security, which
includes defined benefit plans, but certainly coming from the
business community, I realize that for some companies it is the
most appropriate and best vehicle and for some other companies
it may not be the most appropriate and best vehicle.
Congress, in its wisdom, passed legislation that enables
companies to choose among different kinds of voluntary private
pensions. Certainly, I am very supportive of defined benefit
plans, but I wouldn't suppose to tell all companies that it is
the appropriate vehicle for all of them.
Mr. POMEROY. I understand. That isn't what I was meaning in
indicating that the PBGC position should be the champion of
pensions. I think what I mean is making certain the fund is
solvent, making certain that the concerns about business
relative to premium and regulation are listened closely to and
responded to, if at all possible, without jeopardizing the
guarantees.
Mr. KANDARIAN. Absolutely. When I came to Washington I took
it upon myself to introduce myself, because I am new to town,
to many of the stakeholders and constituent groups, including
those representing labor, representing business interests,
people on the Hill, including yourself.
Mr. POMEROY. I appreciate that.
Mr. KANDARIAN. My interest was to just say, here I am, I am
now the Executive Director. Any concerns, please feel free to
pick up the phone and call me. That is an open invitation to
anyone in the system.
Mr. POMEROY. Well, I think you have demonstrated in your
testimony today that you have really ramped up very, very
quickly in terms of getting a grasp of the responsibilities of
your office.
I also would like to note that the activities of your staff
are really quite phenomenal. The number of plans that they are
administering, the sheer volume of checks they are cutting
every month, the retirement security of citizens, there is a
very strong record of productivity in their performance.
Mr. KANDARIAN. I can't say enough about the staff and their
professionalism at PBGC. It has been very welcome for me to
come into an organization as well run as it is. We are trying
to even go further in the future on customer service. We are
trying to introduce a lot of new technology to make things much
more interactive with workers who have pensions from us, so
they can see things online, just like you would, maybe, with
the Fidelitys on the world where you get on-line and do things
yourself and not have to wait for someone to pick up the phone.
So, one of my initiatives on the administrative side is to
create a new position at PBGC called Chief Technology Officer
that reports directly to me so that over the next few years we
will be in a position to have the most current technology
available in the marketplace for all the stakeholders, whether
it be workers or companies, to interact with us.
Mr. POMEROY. That is excellent. A final point, I think we
have a lot to learn about the role of annuities in retirement
securities. This is not at all in reference to the Social
Security debate. We will have plenty of that another time. I
mean people retiring, even from, for example, a hybrid plan, a
cash balance plan, and not exercising the annuity option and
instead taking a lump sum determination.
I think as you evaluate the studies of the performance of
the plans and information that you might derive relative to how
the annuity income stream matches the retirement income needs
of the pensioners, it would be helpful information. Maybe we
will have some cross transference in terms of Congress
understanding that we need to do more to incent the American
public to move toward an annuity option and they look at
management of their own retirement assets.
Mr. KANDARIAN. We would be happy to work with you on that.
One observation on our side is that putting aside plans that
come into us, just plans in the marketplace, most people, when
they leave, do take lump sums if they have that option. About
25 percent of participants have that option and a lot of them
take that option. It is hard for me to be too judgmental about
their lives and their needs, but in terms of retirement
security it is problematic.
Mr. POMEROY. A final point, just an observation on that
point. You know, you have asked them, as we have converted to
other types of plans, the American worker to take an awful lot
of responsibility, savings at adequate rates, investing in
appropriate ways. The one we are really just starting to
understand, the issue we have to deal with, the level of
information people have to match their finite assets with their
unknown life expectancy.
Mr. KANDARIAN. Right.
Mr. POMEROY. I think that people are making decisions, but
that doesn't mean they have been given any information about
how best to make those decisions. I believe annuities have a
much greater role to play in the future. I want to work with
you as we learn about marketplace activity that might shed
light on these issues.
Mr. KANDARIAN. We would be happy to do so.
Mr. POMEROY. Thank you very much, Director.
Chairman HOUGHTON. Thank you. Mr. Johnson.
Mr. JOHNSON. Thank you, Mr. Chairman. Thank you for being
here. It is good to see you. Tell me, do you support the PBGC
related small business changes included in the Pension Security
Act that passed the House and is waiting action in the Senate
today?
Mr. KANDARIAN. H.R. 3762, the Pension Security Act that
passed in April?
Mr. JOHNSON. Yes.
Mr. KANDARIAN. Yes, we do.
Mr. JOHNSON. You do?
Mr. KANDARIAN. Yes.
Mr. JOHNSON. How is that going to affect you one way or the
other?
Mr. KANDARIAN. We think it would enable some of the smaller
employers to find our system more attractive than they do today
by lowering the initial amounts of the premiums they pay and
just making it less costly as they first get introduced into
the system. Now they may find some of those barriers just too
great in terms of entering the system.
Mr. JOHNSON. So, you think that some of the small
businesses might invoke a pension plan that would come under
your purview?
Mr. KANDARIAN. We hope so. We wouldn't know until,
obviously, the legislation passes and we see how the
marketplace reacts. It is the part of the system that has seen
the greatest decline in numbers of plans and participants, well
plans certainly. So, we would like to try to offer something to
attract them into the system and make it more palatable at the
start.
Mr. JOHNSON. I agree with you, but how do we get people to
participate in those kind of plans and companies to offer them
more effectively?
Mr. KANDARIAN. I think your question almost answers itself
in the sense that the workers have to really value this benefit
for the employer to say, ``I will take this obligation, this
liability.'' It is a different kind of obligation or liability
than the 401(k) plan which is much more flexible for an
employer who in a bad year doesn't have to fund it.
That same kind of flexibility doesn't exist necessarily in
a defined benefit plan. There could be minimum funding
requirements. So, for an employer to say, ``I will trade off
that risk for some reward,'' the question is what is the
reward? Presumably, the reward is to have a better, more loyal
workforce. That means the workers have to understand and
appreciate that pension. If they don't, then it is less likely
the employer will take on such a plan.
Mr. JOHNSON. Well, 401(k)s are kind of questionable at the
end of your employment period. I think maybe people are finally
realizing defined benefit or defined payment plans are
something they need.
Do you have any suggestions for an appropriate replacement
for the 30-year Treasury bond as the interest rate for pension
calculations and do you think there should be one number used
for all purposes or should there be different numbers for
different fund planning?
Mr. KANDARIAN. We are actually in discussions right now
with our colleagues at the Treasury Department and Labor
Department on this issue and haven't yet come up with a
position. It is certainly an issue that needs to be addressed.
I hope the issue is addressed this year.
Mr. JOHNSON. Do you think we need legislation to implement
whatever your decision turns out to be?
Mr. KANDARIAN. My understanding is that it would require
legislation, yes.
Mr. JOHNSON. Thank you. Thank you, Mr. Chairman.
Chairman HOUGHTON. Thank you very much. Mrs. Thurman, you
are all set? Okay. Let me ask you a question. Mr. Gutknecht was
here before and he talked about the vagaries and the downsides
of the cash balance program. You have said that you think that
maybe the cash balance program is something which is going to
be the savior of the system. Also, I have a question. So that
is really one question.
The other is that the Pension Guaranty Benefit Corp. was
established in 1974 to protect defined benefit, but not defined
contribution plans. So, how does the cash balance fit into
that? Maybe you can handle both of those questions.
Mr. KANDARIAN. A cash balance plan is a form of a defined
benefit plan. It is just one design of a defined benefit plan,
therefore, it is covered by ERISA guarantees. Of course,
defined contribution plans are not. Did you want me to comment
further about cash balance plans?
Chairman HOUGHTON. Yes, go on. Please elaborate on this.
Mr. KANDARIAN. As to cash balance plans, I think the
Congressman correctly pointed out some problems associated with
conversions which is different from a new cash balance plan
where there is no defined benefit plan to begin with. I think
the latter, that is a new cash balance plan, is less
controversial and I am not sure I have heard very much
disagreement in the community about the desirability of those
plans.
Certainly the conversions have some issues that are
difficult and thorny and must be looked at. I know that the
Treasury Department has some regulations that they are looking
at and proposing soon and actually have, I think, a draft reg
out right now on some notice provisions. So, again, under
ERISA, this whole area is divided up among the three different
places in the Administration, Labor Department, PWBA, Treasury
Department, and the PBGC. The element that the Congressman was
referring to is really being addressed by the Treasury
Department today.
Mr. JOHNSON. My impression was that he was a little
concerned about the long term of the cash balance programs
because there wasn't enough time. He suggested a 90-day period
where people could turn around and also he was worried about
the vesting provisions. Do you worry about those things also in
the cash balance plans?
Mr. KANDARIAN. Again, those are regulations that the
Treasury Department is looking at. I think I would rather, at
this point, pass on giving a specific viewpoint until I have
more time to see what they are proposing and work with them.
Chairman HOUGHTON. I have only one final question and that
is always looking over the next hill and taking a look at what
PBGC might be in 20 or 30 years. We are going to have big
changes in our economy, particularly from abroad. Do you see
any fundamental changes in the charter or the approach that you
have to the plans which you are now backing up?
Mr. KANDARIAN. I think my biggest long-term concern, and I
am talking about 20 or 30 years out, would be maybe the
corollary to Social Security, which is the demographics. So, if
for example the strongest companies eventually drop out of the
system for whatever reason, and if they are fully funded they
can terminate their plans by buying an annuity in the private
markets and simply not have a defined benefit plan going
forward and therefore not be paying premiums to PBGC.
So, if that were to occur by the strong companies that
could buy those annuities in the marketplace because they are
fully funded and what you had left over were the companies that
had highly underfunded plans, and perhaps the correlation there
is that they be weaker companies, then you would have a much
smaller base upon which to, if necessary, raise premiums or
somehow tap into to support the insurance system.
So, I guess the upshot of that is that we want to make this
system, which is a voluntary system, as palatable, as
attractive, and as good as possible for those strong companies
to stay in the system. If they don't, long term, I think we
have a big problem.
Chairman HOUGHTON. Well, I certainly agree with you. Thank
you very much for your testimony and for your willingness to
share your knowledge with us. We hope to get you back again.
Thank you so much.
Mr. KANDARIAN. Thank you, Mr. Chairman.
Chairman HOUGHTON. We are going to call our third panel.
Sorry to be so long here, but we have Jack VanDerhei, who is an
Employee Benefit Research Institute (EBRI) Fellow. We have Ron
Gebhardtsbauer, Senior Pension Fellow of the American Academy
of Actuaries; Karen Friedman, Director of Policy Strategies,
Pension Rights Center; Dr. Jonathan Skinner who is a Professor
in the Department of Economics at Dartmouth; Scott Miller,
President-elect of the American Society of Pension Actuaries
(ASPA); and Mark Beilke who is the Director of Employee
Benefits Research at Milliman USA in Wisconsin, he is working
on behalf of the American Benefits Council (ABC); and also
Christopher W. O'Flinn, Chairman of the ERISA Industry
Committee (ERIC), and Vice President of the Corporate Human
Resources of AT&T.
Now, if this panel can't answer our questions, no panel
can. So, we are honored to have this lineup of distinguished
people, with your basic knowledge. I would ask Mr. VanDerhei to
begin his testimony.
STATEMENT OF JACK VANDERHEI, FACULTY MEMBER, SCHOOL OF BUSINESS
MANAGEMENT, TEMPLE UNIVERSITY, PHILADELPHIA, PENNSYLVANIA, AND
DIRECTOR, FELLOWS PROGRAM, EMPLOYEE BENEFIT RESEARCH INSTITUTE,
PRESENTING STATEMENT OF DALLAS L. SALISBURY, PRESIDENT AND
CHIEF EXECUTIVE OFFICER
Dr. VANDERHEI. Mr. Chairman and Members of the
Subcommittee, I am Jack VanDerhei, a Faculty Member at Temple
University's Fox School of Business Management in Philadelphia
and Research Director of the EBRI Fellows Program. I am here to
submit the testimony of Dallas Salisbury, President and chief
executive officer of the Employee Benefit Research Institute.
Unfortunately, he could not be here today due to scheduling
conflict after the hearing was rescheduled. Accordingly, I ask
that his testimony be submitted for the record.
In the few minutes I have here I would like to highlight
part of Mr. Salisbury's testimony and draw attention to some of
EBRI's research on retirement security. As I am sure others
have mentioned, and I will not belabor the point, the trend in
U.S. retirement plans has moved away from the so-called
traditional defined benefit pension plans and toward defined
contribution retirement plans such as the 401(k).
Mr. Salisbury makes the point that this ignores how defined
benefit plans have also changed. Evidence shows that
increasingly they pay individuals lump sum distributions rather
than annuities. Estimates suggest that the vast majority of
defined benefit plan participants who leave an employer with
less than 10 years of service take a lump sum distribution;
That a significant percentage of defined benefit plans now
offer lump sum distributions on retirement and that nearly all
the cash balance plans offer lump sum distributions. This
fundamentally affects the way in which a defined benefit plan
contributes to retirement security.
By way of example, Mr. Salisbury likes to cite his father's
defined benefit pension plan which began paying him a monthly
annuity in 1978. Today, that check represents a very important
contribution to his parents' retirement security, largely
because they have lived years longer than they had expected to
live and have spent all the money they saved.
The greatest virtue of an annuity is this protection
against unexpected longevity. That is the only true form of
retirement income security in Mr. Salisbury's opinion, a check
that does not stop until one dies.
Our research underscores the point of this personal
anecdote. According to projections I have simulated with Craig
Copeland of EBRI, there will be a definite decrease in
traditional defined benefit income and a corresponding increase
in retirement income that will need to be managed by
individuals themselves.
Our model is based on timed series of pension plan
provisions including those changes necessitated by the Tax
Reform Act 1986, as well as employee behavior observed for more
than 11 million participants for more than 30,000 401(k) plans.
We modeled expected future retirement income from private
retirement plans for males and females born between 1936 and
1964, in other words, for those who would be between the ages
of 38 and 66, and then determined how much of each groups
retirement income is likely to be attributed to each of three
components: First, defined benefit plans; second, individual
account employer-sponsored plans. These include both defined
contribution and cash balance plans. Thirdly is rollover to
IRAs.
We found that for males the percentage of private
retirement plan wealth provided by defined benefit plans will
decrease from 39 percent for today's retirees to 26 percent for
the 38 year olds. While for females in those age cohorts, they
are expected to undergo a similar decrease from 50 percent to
37 percent.
The combination of defined contribution plans and cash
balance plans perhaps surprisingly is expected to remain
relatively constant, between 32 and 34 percent of private
retirement plan wealth for both genders.
The component that is assumed to grow substantially is made
up of rollover to IRAs. Under our baseline assumptions, males
are expected to increase the percentage of retirement wealth
attributable to this component from 28 percent for today's
retirees to 40 percent for 38 year olds when they retire.
Females are expected to have a similar increase from 18
percent to 31 percent. It should be noted that these
projections are based on the assumption that the current
scenario does not change. For example, defined benefit plans do
not continue to decline in prominence. If the trends we have
seen in the last two decades continue, however, the shifts will
be even more in favor of individual account plans that are
unlikely to result in annuitization.
The simulator results have very important implications for
future retirees. First, individuals, rather than plan sponsors,
will have to shoulder the risk of investment losses while they
manage their retirement assets.
Second, retirees increasingly will need to decide what to
do with their lump sum distributions from all sources. This
applies not just to 401(k)s or IRAs, but also to the non-Social
Security income they are receiving from a defined benefit plan
in the form of a lump sum.
For many retirees, their financial security will depend on
buying an annuity from an insurance company or exceedingly
careful money management to avoid outliving their assets. The
point here is that the percentage of private retirement income
paid in the form of annuity is likely to decrease
substantially.
Public policy with respect to future retirement security
should not be based exclusively on a debate about defined
benefit or defined contribution plan type. The future debate
must also include worker education on savings, investing,
longevity, retiree health, long-term care and what choices
individuals can make to avoid running out of money before they
die.
That concludes my statement. I will be happy to answer
questions at your convenience. Thank you, Mr. Chairman.
[The prepared statement of Mr. Salisbury follows:]
Statement of Dallas L. Salisbury, President and Chief Executive
Officer, Employee Benefit Research Institute*
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* EBRI is a private, nonprofit, nonpartisan public policy research
organization based in Washington, DC. Founded in 1978, its mission is
to contribute to, to encourage, and to enhance the development of sound
employee benefit programs and sound public policy through objective
research and education. EBRI does not lobby and does not take positions
on legislative proposals.
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Mr. Chairman and members of the Committee, it is a pleasure to
appear before you today to discuss retirement security and defined
benefit pension plans. I am Dallas Salisbury, President and CEO of the
Employee Benefit Research Institute. EBRI [1] has been undertaking
research and education on employee benefit issues since its founding in
1978. EBRI does not lobby for or against specific proposals, instead
our mission is to provide data that will assist others in assessing
trends and in making policy decisions.
Since my full submission will be included in the hearing record, I
will provide a brief summary of points for your consideration:
1. LSince I joined the U.S. Department of Labor in 1975 to
assist in the implementation of the Employee Retirement Income
Security Act of 1974 (ERISA), defined benefit pension plans
have changed a great deal.
2. LThen, nearly all paid benefits in the form of annuities
for most individuals when they reached normal retirement age.
Essentially all of the nation's largest employers had a defined
benefit plan and a thrift-saving or profit-sharing plan, and
multi-employer trusts and public employers had defined benefit
plans.
3. LToday, largely as a result of decisions made by
government, defined benefit pension plans pay more individuals
lump-sum distributions than annuities, supplemented by defined
contribution plans to which the employer contributes. Many of
the largest new-economy employers that never had a defined
benefit plan, and are now among our largest employers, rely
exclusively on defined contribution plans. Most multi-employer
trusts and public employers sponsor both defined benefit and
defined contribution plans.
4. LData from the Federal Reserve Survey of Consumer Finance
documents the trend toward plan change.i Of all
families reporting at least one worker with some type of
pension coverage, the portion of those families with at least
one worker participating in a defined contribution plan only
was 57% in 1998, compared with 38% in 1992, while families with
at least one worker participating declined from 40% to 21%
between 1992 and 1998, while workers with both stayed steady at
22% in both 1992 and 1998. The best available estimates suggest
that the vast majority of defined benefit plan participants who
leave an employer with less than 10 years of service take a
lump-sum distribution; that over half of all defined benefit
plans now offer a lump-sum distribution at retirement; and that
nearly all of the over 500 individual account defined benefit
plans (``cash-balance'' plans) offer lump-sum distributions.
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\i\ See Craig Copeland and Jack VanDerhei, Personal Account
Retirement Plans: An Analysis of the Survey of Consumer Finances, EBRI
Issue Brief No. 223 (July 2000).
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5. LI note this trend toward defined benefit plans paying
lump-sum distributions because it fundamentally affects the way
in which a defined benefit plan contributes to retirement
security, yet too many articles and analyses still assume/
suggest that all defined benefit plans pay annuities upon
retirement, thus shielding retirees from the need to make
investment, longevity, rate of spending, and other decisions
required of those who are paid lump-sum distributions. The year
2002 finds far less difference between the amount of retirement
security provided by the defined benefit and defined
contribution plan systems than existed in 1974.
6. LPublic policy change joined with demographics and
economics to bring these two plan types closer together. The
primary difference between defined benefit and defined
contribution plans to this day is the fact that private
employers make the funding contributions to defined benefit
plans, and in the event of adverse investment performance must
contribute more in order to pay the promised accrued benefit,
while both employers and workers generally contribute to
private defined contribution plans, and the worker alone bears
the burden, or gains the fruits, of bad or good investment
performance.
7. LThe federal government was one of the first major
employers to drastically reduce the generosity of its defined
benefit pension plan, while adding a defined contribution plan
(1984), but many others in both the public and private sectors
have followed suit. The primary reasons it was done: a desire
to reduce cost and future funding liabilities; a desire to
reduce the golden handcuffs that make it difficult for a worker
to change jobs; a desire to allow greater fund accumulation for
shorter service workers; a desire to provide a program that
workers would better understand and be more likely to
appreciate.
8. LRules and regulations related to defined benefit plans are
extensive and complex, as is the administration of the plans,
as indicated by the recent Department of Labor report. That
report underlined the shift of plans to the payment of lump-sum
distributions, and the complexity of making the benefit payment
calculations. The worker tradeoff for this complexity, and the
potential for errors, is that the employer typically makes all
contributions to the plan and the participant is protected (up
to the PBGC guaranty limit) against investment ``losses'' as
well as an entire array of potential deviations from actuarial
assumptions.
9. LDefined benefit plans (with the exception of a few
contributory plans) are full participation plans, as workers do
not make a choice on whether or not to participate. For workers
that may not be inclined to contribute to a 401(k) plan
(particularly the lowest paid workers), this may make a defined
benefit plan preferable to a 401(k) plan (although some 401(k)
plans may provide nonelective contributions whether or not the
employee contributes). Were that worker to stay for a full
career (a low probability), the benefit value/account balance
would grow to a level amounting to a meaningful contribution to
retirement security. Were the worker to leave after a few years
of employment, either a defined benefit plan or a defined
contribution plan would provide a small lump-sum distribution
that likely would be spent.
10. LLarge employers that had defined benefit plans in 1974,
and are still in business, in most cases still have them. The
design changes to lump sums and cash balance have allowed them
to compete with defined contribution plans for worker
understanding and appreciation. Proposals such as allowing pre-
tax worker contributions to defined benefit plans would further
erase the differences between the plan types, and might lead to
an increase in the sponsorship of defined benefit plans. Were
benefits paid in lump-sum form, however, this would likely have
no favorable impact on retirement security (once the worker
retires) relative to a defined contribution plan.
11. LMy father's defined benefit pension plan began paying him
a monthly annuity in 1978. Today, that check represents a very
important contribution to my parents' retirement security. Why?
Largely because he and my mother have lived years longer than
they planned or expected to, and they have spent all the money
they saved. The greatest virtue of an annuity is this
protection against unexpected longevity. That is the only true
form of retirement income security: a check that does not stop
until one dies. It is no longer the case that all defined
benefit plan retirees choose to be paid in annuity form, and
few defined contribution participants do so. Future retirement
security should no longer be based on a debate about defined
benefit or defined contribution, as that is no longer the
central issue when both plan types paying lump-sum
distributions at job change and retirement. The future debate
must be about worker education on savings, investing,
longevity, retiree health, long-term care, and what choices
individuals can make to avoid running out of money before they
die.
Introduction
A review of the state of defined benefit pensions must begin with a
clear understanding of what a ``pension plan'' is. While this sounds
simple, it is done because the ``legal'' meaning has clearly changed
over the past 28 years.ii Today, the term is used to
describe any employer or government-sponsored capital accumulation
program that has a stated purpose of providing funds for retirement.
Defined benefit, defined contribution, annuity payment or lump-sum
distribution form, all are within the new definition.
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\ii\ The Employee Retirement Income Security Act of 1974 (ERISA)
states: ``any plan, fund, or program which was heretofore or is
hereafter established or maintained by an employer or by an employee
organization, or by both, to the extent that by its express terms or as
a result of surrounding circumstances, such plan, fund, or program--
`(A) provides retirement income to employees, or results in a deferral
of income by employees for periods extending to the termination of
covered employment or beyond, regardless of the method of calculating
the contributions made to the plan, the method of calculating the
benefits under the plan or the method of distributing benefits from the
plan' (emphasis added). This represented an expansion in concept from
the first full version of the legislative proposal, H.R. 2, which
limited plans to those which ``for the purpose of providing for its
participants or their beneficiaries, by the purchase of insurance or
annuity contracts or otherwise, retirement benefits, and includes any
deferred profit-sharing plan which provides benefits at or near
retirement.''[ii] (emphasis added) H.R. 2 was closer to the traditional
dictionary definition of a pension: ``a retirement or disability
allowance'' (emphasis added).
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ERISA expansion of the definition of pension plan to include
capital accumulation plans with lump-sum distributions at ``termination
of covered employment,'' as opposed to ``at or near retirement,''
actually serves to clearly highlight the ``State of Pensions'' in the
United States. Both the public and private sector have moved in the
direction of sponsoring fewer plans that only pay benefits ``at or near
retirement'', and have created more and more plans which pay at
``termination of covered employment''. The result has been dramatic
changes in defined benefit pension plans--those that promise a fixed
accrual and a determinable benefit without worker investment risk--
including the development of defined benefit individual account plans
(``cash-balance'' plans) and growth in the number of defined
contribution plans--those that promise payment of funds contributed
(once the employee is vested), adjusted for investment earnings, but
promise no fixed benefit, as the worker holds investment risk.
I do not provide a normative assessment of whether these trends are
good or bad for employers, unions, individuals, or public policy. They
are what they are.
1996 data from the U.S. Bureau of the Census combined all plan
types under the single heading of ``pension,'' as do the data from the
Federal Reserve. The data show the impact of a maturing pension system,
with the divergence of net flows and net contributions. Net flows are a
measure of new contributions, plus all investment earnings, less
benefit payments. Net contributions are a measure of benefit payments
less new contributions. The fact that net contributions are negative,
while net flows are positive, underlines the primary virtue of advance
funding, compound interest, and investment earnings.
For the individual worker, the move to more lump-sum distributions
from defined benefit and defined contribution plans suggests a number
of needs:
LA need for basic financial literacy education.
LA need for understanding saving represents a tradeoff
in lifestyle today in order to have money to live on tomorrow.
LA need for understanding investing, fees, returns net
of fees, etc.
LA need for evaluation of how important the job-
related benefits are, and the degree to which they may
determine happiness for a lifetime.
What is the Pension Landscape Today?
Congress acted in 1983 to change the pension system for federal
civilian employees. Prior to 1984, the only federal retirement plan was
a final pay defined benefit plan. For those hired after the 1983 act, a
new reduced defined benefit plan was accompanied by a generous 401(k)-
type plan. Those already working had the option of remaining in the old
plan or shifting to the new plans. Congress had also acted in 1978 to
add two new sections to the Internal Revenue Code, 125 and 401(k).
Proposed regulations in 1981 eventually led to a massive transition of
traditional profit-sharing plans into 401(k) plans, which meant that
the employee could contribute pre-tax dollars assuming the employer
incorporated a 401(k) feature in their profit sharing plan. State and
local governments, and non-profit organizations, had this type of
opportunity in 457 and 403(b) plans. Legislation since 1986 has moved
all these so-called ``salary-reduction'' plans closer together in
design and rules, with nearly all employers now able to establish
401(k) plans. Recent years have seen debates in a number of states over
proposals to either introduce expanded supplemental ``salary
reduction'' plans, or to replace defined benefit plans with defined
contribution plans. Demographic change, and economic competition, makes
it likely that these debates, and trends, will continue.
The following table presents data from the U.S. Department of Labor
on private employer pension plans in terms of number of plans. The
trend lines are clear: defined benefit plans are on the decline and
salary reduction plans are becoming the primary ``pension'' plans in
the nation. The numbers on multi-employer plans reinforce the trend
line of increasing use of supplemental and primary defined contribution
programs. iii,}iv Finally, the data hide the use of lump-sum
distributions in defined benefit plans.
Number of Qualified Private Pension Plans 1975-2002
----------------------------------------------------------------------------------------------------------------
Single- Employer Single- Employer Multi-employer Defined Multi-employer Defined
Year Defined Benefit Defined Contribution Benefit Contribution
----------------------------------------------------------------------------------------------------------------
1975 101,214 207,437 2,132 311
1985 167,911 461,158 2,261 805
1998 54,699 672,297 1,706 1,329
2002 est. 36,000 700,000 1,800 1,500
----------------------------------------------------------------------------------------------------------------
Sources: U.S. Department of Labor and author estimates.
As the number of plans has changed, so have the numbers of
participants. Data from the Federal Reserve Survey of Consumer Finance
document this trend through 1998.iii Considering all
families reporting at least one worker with some type of pension
coverage, the number of those families with at least one worker
participating in a defined contribution plan only was 57% in 1998,
compared with 38% in 1992, while the portion of families with at least
one worker participating in defined benefit plans declined from 40% to
21%, while workers with both stayed steady at 22%.
---------------------------------------------------------------------------
\iii\ See Craig Copeland and Jack VanDerhei, ``Personal Account
Retirement Plans: An Analysis of the Survey of Consumer Finances,''
EBRI Issue Brief no. 223 (July 2000).
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Employer preferences for pensions now focus more on economic
performance than retirement income security. Pensions are viewed
favorably if they serve to:
LImprove corporate efficiency.iv
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\iv\ Jerry S. Rosenbloom and G. Victor Hallman, Employee Benefit
Planning, third edition, Prentice-Hall, 1991.
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LEnhance morale.
LKeep channels for promotion open.
LFacilitate work-force reduction.
LEnhance employee identification with profit.
LOffer a most cost-effective and least
administratively intense form of capital accumulation.
LAttract and hold capable employees.v
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\v\ See Emily S. Andrews, Pension Policy and Small Employers: At
What Price Coverage?, EBRI-ERF, 1989, chapter IV for a summary of
research; Richard A. Ippolito, Pensions, Economics and Public Policy,
Pension Research Council, 1986; and Richard A. Ippolito, Pension Plans
and Employee Performance Evidence, Analysis, and Policy, The University
of Chicago Press, 1997.
A senior corporate executive noted in 1998 that ``not having
benefits at some threshold level will repulse employees, but the mere
presence of a more generous benefits package will not attract and
retain employees.'' vi This view is explanatory of the
movement in recent years to flexibility, and an effort to respond to
environmental factors with program design. This includes:
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\vi\ See Charles G. Tharp, ``Yes,'' in Dallas L. Salisbury, ed, Do
Employers/Employees Still Need Employee Benefits?, EBRI-ERF, 1998, pp
11--13.
LRespond to favorable tax laws that provide an
incentive to provide a pension program.
LRespond to demands in labor negotiations.
LRespond to social and indirect government pressures.
LRespond to inherent advantages of group purchase/
provision.
LRespond to shareholder desires and competition.
Developments in the retirement plan market represent a response to
work-force patterns. There is now a large body of literature that uses
government data to show that the workforce has always had high turnover
and that few have spent 25 years or more with one employer. Not only is
this true of the private sector, but it has been so for the public
sector as well. Defined contribution plans and individual account
defined benefit plans provide a career-average benefit, as noted above,
which may serve to deliver more to most workers (due to relatively
short service), than traditional defined benefit plans. For the
employer, they provide a more certain cost, which can be more easily
budgeted. A growing number of all plans provide lump-sum distributions,
which are more popular with workers. They are portable, and once a
lump-sum distribution is taken upon job termination they eliminate any
employer-specific risks. Data from the Pension Benefit Guaranty
Corporation underline the number of workers for whom this is a
consideration.
Can We Return to `The Way We Were'?
Writing prior to the enactment of ERISA, one leading actuary noted:
``A defined benefit final-pay pension plan may be selected precisely
because it is the only type of plan which permits the employer to
design a pension formula that takes both sources of retirement income--
Social Security and company benefits--into account. By doing so, a firm
can provide higher paid employees a proportionately greater company
pension. This compensates for the fact that these individuals receive a
lower percentage of final earnings from Social Security.''
vii ERISA and subsequent legislation has limited the degree
to which a plan sponsor can integrate a pension plan with Social
Security (how much defined benefit can be offset), and funding and
benefit limits have shifted much of what is done for high-income
workers outside the qualified plan.
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\vii\ Robert B. Peters, Defined Benefit and Defined Contribution
Plans: A Corporate Perspective, in Dallas L. Salisbury, ed., Economic
Survival in Retirement: Which Pension is for You?, EBRI-ERF, 1982, pp
81--86.
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He continued: ``Such a plan may also be necessary to reward an
employee whose salary has increased rapidly or whose service was
relatively short. Additionally, only a pension can reward past as well
as future service and base the total benefit on final average pay.
Finally, some companies believe that they are better able to assume
investment risk . . .'' Taking these in order, new funding and
liability rules tied to plan termination insurance have all but ended
the consideration of past service due to the liabilities it creates,
and the difficulties the new funding limits place of setting aside
funding. Employers and unions that believe they can better absorb risk
have continued defined benefit plans, or moved to hybrid plans like the
cash balance plan, rather than moving totally to defined contribution.
The combination of the PBGC and tax-funding limits, however, make it
unlikely that new defined benefit pension plans will be formed by
either single employers or multi-employer groups. Whether this is good
or bad, right or wrong, matters little in light of the overwhelming
public policies that make it so.
The actuary concluded: ``The corporate viewpoint on the defined
benefit versus defined contribution issue is formed by various
competing factors: (1) whether its financial position can sustain the
economic uncertainties posed by a defined benefit plan; (2) the extent
to which competitive factors determine benefit levels and types; and
(3) the corporation's perception of its responsibility to provide for
employees' retirement and other financial needs.'' Fewer employers are
willing to assume that they can financially sustain a plan as they may
well be taken over or spun off tomorrow; the new economy employer
creates constant pressure to change benefit programs by turning new
hire and retention competition to current cash and short-term
incentives, not a great pension 25 years hence; and increasingly
employers view their primary obligation to be survival so that they can
provide work, leaving post-work planning to the individual. Many
employers and unions will view this last statement as overly harsh, but
I view it increasingly as the reality. Because of these factors,
defined benefit pensions are inherently problematic in this new world,
as the sponsor issues relate to regulation, funding and liability, not
to the simpler issue of portability.
What have changed are the regulatory environment, the workforce,
world economics, technology, and feelings of employer and worker
security. Taken together, they suggest that we will not return to the
defined benefit design dominance of yesterday, regardless of the
consequences for individual retiree economic security, and not even to
the dominance of annuity payouts.
How 25 Years Has Changed Demands/Motivations viii
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\viii\ See Daniel M. Holland, Private Pension Funds: Projected
Growth, National Bureau of Economic Research, 1966; Private Pensions
and the Public Interest, American Enterprise Institute, 1970; and
Norman B. Ture with Barbara A. Fields, The Future of Private Pension
Plans, American Enterprise Institute, 1976, and Dallas L. Salisbury and
Nora Super Jones, eds, Pension Funding and Taxation: Implications for
Tomorrow, EBRI-ERF, 1994: and Dallas L. Salisbury, ed, When Workers
Call the Shots: Can They Achieve Retirement Security, EBRI-ERF, 1995.
The government does influence action, and ERISA changed design
drivers. The law went from no vesting minimum standard to immediate
vesting in some cases; from asset use in a plan for building the firm
to arms-length transactions; from clear ``capital accumulation'' versus
``retirement plan'' distinctions, to limited distinctions; from
selective provision of lump-sums allowed to the `all or none'
requirement; from less government tax revenue from lump sums to greater
government tax revenue from lump sums; from a retirement income focus
to a cash portability focus; from a regulatory and tax incentive bias
toward defined benefit plans to a strong regulatory and tax incentive
bias toward defined contribution plans; from a clear emphasis on
employer/union provision advantages to an increased focus on individual
self determination and ``retail delivery''; from a paternalistic
assessment basis of social obligation and corporate identification to
one of maximum satisfaction of the largest number of workers.
As one expert has put it, movement from ``golden handcuffs'' to an
employee/employer contract of partnership, personal accountability, and
self reliance moved the nation away from traditional defined benefit,
employer-pay-all plans with their focus on encouraging an employee to
remain with a single employer until ``normal retirement age,'' and
toward greater financial and psychological independence, and
identification with the service firm versus the employer.ix
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\ix\ See Charles G. Tharp, ``Yes,'' in Dallas L. Salisbury, ed, Do
Employers/Employees Still Need Employee Benefits?, EBRI-ERF, 1998, pp
11--13.
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Plan design and recruitment action has moved from broad-based
attraction to key employee attraction; from delivery of fast vested
matches in short-term savings programs to vested matches for long-term
savings programs; from delivery of final pay annuities to long-term
workers to smaller accumulations for all workers and a focus on lump-
sum distributions,x, and from employers, unions and plans
dealing with long-term risks, to avoiding long term risks (investment,
inflation, mortality) and placing their burden on individuals and
families.
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\x\ Steven G. Vernon, Employee Benefits: Valuation, Analysis and
Strategies, John Wiley & Sons, Inc., 1993.
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Major employers and unions have always provided the pension
coverage available today. Over 95 percent of participants are in large
employer settings. Most large employers with 401(k) plans now use
employer stock in the plans; some of the largest unions have negotiated
stock ownership, or outright employee ownership. As one senior
executive put it in 1998: ``employee ownership allows the corporation
to build partnership and a high performance work culture.''
xi As one executive notes:
---------------------------------------------------------------------------
\xi\ See Charles G. Tharp, ``Yes'', in Dallas L. Salisbury, ed, Do
Employers/Employees Still Need Employee Benefits?, EBRI-ERF, 1998, pp
11--13.
L``While income security is an issue, it is increasingly
being recognized that long-term security can best be achieved
through personal development and professional growth.
Ironically, the presence of high-cost `1950's, one size-fits-
all benefits' may, in fact, be a precursor to job insecurity as
cost-cutting measures may be necessary for an organization to
carry this heavy burden.'' And, he continues: ``There is a
general question of whose responsibility it is to provide
retirement income. There is increasing emphasis today on the
notion that it is up to individuals to provide a greater
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portion of their own retirement security.''
For the decades ahead such views are likely to dominate pension
decision-making. Many of these views are now entering the debate over
the future of Social Security--proposals by both the 2000 Republican
and Democrat candidates for President for voluntary government
sponsored individual accounts to supplement today's Social Security--
and many of the same pressures and attitudes reviewed here can be found
in that debate. In short, whatever one would like the pension world to
be from a normative perspective, this descriptive review suggests that
it will look more like the pension world of the 1990s than that of the
1950s. The individual will be king, and economic well being once one is
no longer working will increasingly rest on what saving and consumption
choices the individual made throughout his or her life. ``Choose to
Save'' is taking on new meaning, as it will determine whether
individuals can retire, or must work forever.
Once a worker retires, a retirement security debate over defined
benefit versus defined contribution plans would only be relevant today
if one plan type paid only annuities and the other only lump-sum
distributions. As long as both plan types pay lump-sum distributions to
all who have achieved small accruals, and as long as both plan types
increasingly pay lump-sum distributions at retirement (retirees
generally select a lump-sum when given a choice), the argument that one
provides a greater promise of retirement security than the other, when
both pay lump-sums, cannot be sustained.
My father's defined benefit pension plan began paying him a monthly
annuity in 1978. Today, that check represents a very important
contribution to my parents' retirement security. Why? Largely because
he and my mother have lived years longer than they planned or expected
to, and they have spent all the money they saved. The greatest virtue
of an annuity is this protection against unexpected longevity. That is
the only true form of retirement income security: a check that does not
stop until one dies. It is no longer the case that all defined benefit
plan retirees choose to be paid in annuity form, and few defined
contribution participants do so. Future retirement security should no
longer be a debate about defined benefit or defined contribution, as
that is no longer the central issue in an age when both plan types
paying lump-sum distributions at job change and retirement. The future
debate must be about worker education on savings, investing, longevity,
retiree health, long-term care, and what choices individuals can make
to avoid running out of money before they die.
Chairman HOUGHTON. Okay. Please proceed.
STATEMENT OF RON GEBHARDTSBAUER, SENIOR PENSION FELLOW,
AMERICAN ACADEMY OF ACTUARIES
Mr. GEBHARDTSBAUER. Chairman Houghton, Ranking Member
Coyne, and distinguished Members of the Committee, thank you
for inviting me here today to speak on this very important
topic of defined benefit pension plans and retirement security.
As Chairman Houghton said, my name is Ron Gebhardtsbauer,
and I am with the American Academy of Actuaries. We are the
nonpartisan professional organization for actuaries of all
practices in the United States.
Defined benefit plans are an essential component of
retirement security in the United States along with defined
contribution plans. While younger employees understand and
value and appreciate the cash nature of a defined contribution
plans, older employees and retirees will tell you that cash
does not equal retirement security. A stable income for life
does.
Thus, there are many advantages to having both types of
plans and many large employers do just that. They will have a
defined benefit plan and a 401(k).
In my written testimony I list many advantages that defined
benefit plans over 401(k)s so I will just give a few here. For
employees, defined benefit plans are more likely to provide a
secure stable income for life. Employees won't have to worry
about a bear market happening when they want to retire or after
they retire.
For employers, defined benefit plans provide contribution
flexibility. They can contribute more in good years and less in
difficult years. For the Nation, defined benefit plans help
reduce poverty better at older ages.
Unfortunately, the legal playing field is not level and as
a consequence you will see from the chart that was just put up,
that as Jack just mentioned, there has been a dramatic trend
away from defined benefit plans toward 401(k)s.
You can think of the retirement system as a three-legged
stool where one is Social Security, another is personal savings
and another is employer pensions.
In the mid-1970s when ERISA was enacted, the employer leg
was predominately defined benefit plans. Forty percent of the
workforce was covered by defined benefit plans, the blue line.
Now it is only half that and 401(k)s predominate, the green
line.
Other defined contribution plans besides the 401(k)s are
far below at only 12 percent. So, it is really not defined
contributions that people like, it is 401(k)s. We knew that.
The battle really was never between defined benefit and defined
contribution. The battle was between defined benefit and
401(k)s and 401(k)s are winning for sure. For example, two-
thirds of the money now going into retirement plans is going
into 401(k)s.
That means that this three-legged stool is starting to look
like just a two-legged stool because the employer leg and the
personal savings leg are becoming very similar.
Having both defined benefit and defined contribution
elements is good. Having only one is not good. It doesn't have
to be this way. As I said, both defined benefit and defined
contribution plans are essential to retirement security and
both have their advantages, so it is important that the laws
are structured so that defined benefit plans also have equal
standing with 401(k)s so that employers and employees can have
the best of both worlds.
As I just mentioned, the playingfield is not level for
private sector companies. However, in the government or church
sectors where these rules are not there, the playingfield is
more level and in fact, guess what, there are more defined
benefit plans in the church and government sectors.
So, how can we level this playingfield? The answer is not
to hurt 401(k)s but to build on their successes. Why are they
successful? Well, 401(k)s can have pre-tax employee
contributions. In fact, government defined benefit plans can
also have pre-tax contributions. Private sector companies
cannot have them. So, that is one idea. You could let private
sector DB Plans have pre-tax employee contributions.
Another is 401(k) plans can have employer matching
contributions. In fact, in the nonprofit world you can have
defined benefit plans with matches, but again, in the for-
profit world you can't do it.
So, here are two ideas in the 401(k) area that would be
great if we could give it to the defined benefit area and level
the playingfield. Thus, the answer is obvious. Include 401(k)s
in the defined benefit area. You could call it a defined
benefit 401(k) plan.
In my written testimony I suggest applying other 401(k)
rules to the defined benefit world, such as phased requirement.
A 401(k) can have phased retirement at age 59 and a half, but a
defined benefit plan cannot.
Some of these ideas will create a more level playingfield.
It is important that we act soon, because the earliest baby
boomers are now at retirement age. Let us create laws so that
they can have a more secure retirement. Thank you for the
opportunity to speak. I look forward to your questions.
[The prepared statement of Mr. Gebhardtsbauer follows:]
Statement of Ron Gebhardtsbauer, Senior Pension Fellow, American
Academy of Actuaries
The American Academy of Actuaries is the public policy organization
for actuaries practicing in all specialties within the United States. A
major purpose of the Academy is to act as the public information
organization for the profession. The Academy is non-partisan and
assists the public policy process through the presentation of clear and
objective actuarial analysis. The Academy regularly prepares testimony
for Congress, provides information to federal elected officials,
comments on proposed federal regulations, and works closely with state
officials on issues related to insurance. The Academy also develops and
upholds actuarial standards of conduct, qualification and practice, and
the Code of Professional Conduct for all actuaries practicing in the
United States.
Chairman Houghton, Ranking Member Coyne, and distinguished
committee members, thank you for inviting me to testify on retirement
security and defined benefit pension plans. My name is Ron
Gebhardtsbauer, and I am the Senior Pension Fellow at the American
Academy of Actuaries. The Academy is the public policy organization for
actuaries of all specialties within the United States. A major purpose
of the Academy is to act as the public information organization for the
profession. The Academy is non-partisan and assists the public policy
process through the presentation of clear and objective actuarial
analysis.
My written statement will focus on the three important issues for
this hearing, namely:
1. LThe advantages and disadvantages of defined benefit (DB)
pension plans;
2. LReasons for the decline in DB plans and implications; and
3. LRemedies that will strengthen the DB system and retirement
security.
In particular, I suggest that since DB and DC plans are both
valuable for retirement security, the law provide a level playing field
for both of them, so that one is not advantaged over another, and so
that employers can choose the one that is right for them and their
employees.
Definitions
Defined benefit (DB) plans specify the benefit employees will
receive whenever they retire from employment (or quit or die). Thus, DB
benefits can be any amount, calculated according to a formula and
defined in a legal document.\1\ For example, a traditional DB formula
might be 1% of average compensation for every year worked. Thus,
someone who worked 30 years would get 30% of his average compensation
when he or she retired (on top of Social Security). Because the benefit
is defined, employees know what benefit to expect when they retire,
thus enabling them to plan ahead for retirement.
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\1\ Pension laws restrict some of this flexibility for taxable
employers, but they are less strict for churches and government plans.
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DB plans can also require contributions from employees, but they
would be after-tax and thus less attractive to employees. Very few DB
plans have employee contributions now.
Defined contribution (DC) plans specify the contribution the
employer pays into the plan each year for the employee. The amount that
employees get at retirement depends on how well the assets are invested
in the meantime.
In 1978, Congress enacted section 401(k) of the Internal Revenue
Code (IRC) to allow employees to make pre-tax employee contributions to
certain DC plans and allow employers to match them. In a typical
private sector 401(k) arrangement, an employee might contribute 6% of
wages (pre-tax), and the employer might match it 50 cents on the
dollar, for a total employer contribution of 3% of that employee's
wages. Thus, private sector employees often contribute more than the
employer.
The Federal Employees Retirement Savings program acts something
like a 401(k). If employees contribute 5% of wages (pre-tax), the
federal government will match the employee contribution with another 5%
of wages into the account. Unlike most private-sector 401(k)
arrangements, however, the federal government contributes 1% of an
employee's wages into his or her account, even if the employee
contributes nothing.
Hybrid DB Plans that look like DC plans. DB plans can, if desired,
mimic the benefits of DC plans, while providing flexibility in how much
is contributed each year and where the funds are actually invested.
They also have much more flexibility in design and can improve benefits
quickly when needed (but are still funded gradually or in advance).
Examples of hybrids can be found in church-wide plans in the U.S., and
the Social Security system of Sweden. The U.S. rules for private-sector
plans are unclear and thus make it difficult for companies to sponsor
these plans, but many of them do exist and they are sometimes called
cash balance plans.
Coverage History
Just after ERISA was signed into law in 1975, 40% of the labor
force participated in a DB plan, and 16% participated in a DC plan (see
Chart I). Today, however, the reverse is true: only 21% participate in
a DB plan, while 46% participate in a DC plan.\2\ As Chart I shows,
almost anyone who participates in a pension plan is in a DC plan, and
sometimes it is in addition to a DB plan.
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\2\ The 2000 Form 5500 data is not available yet, because pension
plans file about 9 months after the end of the plan year, which could
be September 2002 for plans with plan years starting in December of
2000.
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Analysts have attributed the movement from DB to DC plans to: (1)
larger DC plan benefits for young, mobile employees; (2) Employers
attracting young employees with larger DC benefits upfront; and (3) DB
benefits being more difficult to understand than DC benefits.
But I do not think that they have pinpointed the reason correctly,
because, as I mentioned above, DB plans can look exactly like a DC plan
to the participants. If the employer and employees wanted a DC plan,
with employees being able to allocate their funds, they could simply
change the DB plan formula to match the DC plan they wanted. There are
plans in the U.S. that already do this. This approach would be much
easier than having to terminate the DB plan and start up a DC plan from
scratch. In addition, with the DB plan, the employer would keep the
investment and contribution flexibility. So, there must be another
reason.
I suggest that the biggest reason is that the playing field is not
level for DB plans in the private sector. DC plans can have certain
provisions, like pre-tax employee contributions, that DB plans cannot
have. As evidence, I note that Canadian employers and state and local
governments in the U.S. have a much more level playing field for DB
plans (for example, they have pre-tax contributions), and all three
have a much higher percentage of DB plans than in the U.S. private
sector.\3\
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\3\ See Professor Robert Brown's paper discussing why it did not
happen in Canada in the July 2001 issue of the North American Actuarial
Journal (NAAJ), and discussions in the April 2002 NAAJ.
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The other primary reason is that pension law for private sector
employers in the U.S. is much more onerous for DB plans. In fact, some
pension professionals consider the regulations draconian. A study by
the American Academy of Actuaries in 1993\4\ showed that increased
government regulation was the major factor in 44% of DB plan
terminations in the late 1980s. Another study by Edwin Hustead of the
Hay Group\5\ noted that the administrative costs of a 10,000 person DB
plan were less than the costs of a similar-sized DC plan in 1980, but
by 1996, the DB costs had grown dramatically to almost 50% more than
the DC plan's administrative costs. The important point here is that
employers would like the flexibility to pick the plan that is right for
both them and their employees. Because current law makes it difficult
and expensive to maintain a DB plan, it creates a bias towards 401(k)
arrangements. The law should let employers and employees make the right
choice for their particular situations, not steer them to a particular
option.
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\4\ The Impact of Government Regulation on Defined Benefit Pension
Plan Terminations, a Special Report by the American Academy of
Actuaries (March 1993).
\5\ Retirement Income Plan Administrative Expenses 1981 through
1996, presented by Edwin C. Hustead of the Hay Group to the Pension
Research Council conference (May 1996).
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As further evidence, I note that there has also been a very large
decline in DC plans that do not have a 401(k) arrangement. Chart II
shows that of the 46% of the labor force participating in DC plans, 3/
4ths of that number are in 401(k) arrangements. When you subtract out
the 401(k) arrangements, you find that the remaining DC plans trail
behind even DB plans. In fact, due to EGTRRA,\6\ this 12% participating
in ``other DC plans'' may practically disappear.
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\6\ EGTRRA, the Economic Growth, Tax Relief and Reconciliation Act
of 2001.
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In fact, the ``battle'' has never been between DB and DC plans. It
has been between 401(k) arrangements and all other plans. And 401(k)s
are winning.
The third chart shows that two-thirds of all retirement
contributions go to 401(k) arrangements, only 16% to other DCs and 17%
to DBs.\7\ This is a dramatic change during the past two decades. The
elimination of so many DB plans represents an alarming reduction in
retirement security, especially when the leading edge of the baby boom
has reached age 55, a typical age for early retirement. The retirement
dates of workers are now subject to the ups and downs of the markets,
how well their funds are invested, and how much employees have
contributed. And it could dramatically increase our nation's government
assistance payments in 20 years for retirees who spend down their
savings too fast.
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\7\ The DB percentage may increase over the next few years because
of the recent poor investment returns.
---------------------------------------------------------------------------
I will discuss these concerns next in the section on the advantages
and disadvantages of DB plans over 401(k) arrangements.
Advantages of DB Plans Versus 401(k)s to Employees
1. LRetirement Security. DB plans provide employees with
predictable incomes for life, no matter how long they live.
That can help employees improve their retirement planning,
because they have a better idea of what their pension will be.
2. LRisks. DB plans can more effectively reduce the risks for
employees than DC plans. Those risks include:
a. LInvestment risk. In a DB plan, the employer
generally assumes the investment risk, so employees
will not suffer if they retire in a ``bear'' market. In
a 401(k), older employees experiencing a bear market
might have to delay retirement. For example, Chart IV
shows that in 1973-74, stocks fell about 40%, while
inflation went up more than 20%. Under this scenario,
retirement income from a 401(k) would have been cut in
half. While today's economic circumstances may not be
as severe as they were in 1973-74, the current bear
market may make individuals reluctant to retire at this
time.\8\
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\8\ Current workers could mitigate the effects of a bear market if
they invest in GICs (Guaranteed Investment Contracts). But many people
do not do so because GICs have lower average returns than stocks.
---------------------------------------------------------------------------
On the other hand, DB pension plans invested
in stocks can smooth investment risk because:
(1) Lthe large size and long-term nature of a
pension fund; and
(2) Lthe rules for funding and expensing allow
employers flexibility in making contributions
to the pension fund over time (although these
are not as flexible as they used to be).\9\
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\9\ The ability to smooth investment risk and manage contributions
to the pension fund can increase the risk of insolvency, i.e., the
employer could go under when the plan is not fully funded. However, the
Pension Benefit Guaranty Corporation (PBGC) would take over the plan in
this case and make sure the benefits are paid.
---------------------------------------------------------------------------
b. LLongevity risk. The DB plan assumes the employee's
longevity risk by paying a pension for the life of the
worker (and the spouse, unless waived), no matter how
long they live. Employees in a 401(k) arrangement can
do this by buying an annuity after they retire, but not
many do. Chart V shows various ways of taking out one's
retirement money. A lifetime annuity guarantees that
your money will not run out, no matter how long you
live. In fact, the data in Chart V show that the
annuity can provide the retiree with a larger income
than if they manage their investments themselves. Some
investment advisors suggest waiting until one's late
70s before buying an annuity. However, Chart IV reminds
us that one keeps the investment risk until one buys
the annuity. On the other hand, a DB plan provides the
same benefit no matter what the condition of the stock
market when one retires. The DB pension is predictable,
so the employee does not need to worry about investment
or longevity risks.
c. LInflation risk. The employer generally assumes the
inflation risk until the employee quits or retires.
Some DB plans (such as Social Security) also take on
the inflation risk after separation from employment by
indexing benefits up to and after retirement. These
plans are not common in the private sector, however,
due to the volatile nature of inflation risk, and the
complexities they bring to a pension plan. And since
this benefits employees who no longer work for the
employer, the employer has less incentive to assume
this risk.
Many traditional DB plans provide ``ad hoc'' cost-of-
living adjustment (COLAs) to retirees if inflation has
been high, and assets have done well, but these are not
a guarantee. Some analysts suggest that a 401(k)
investing in stock can compensate for this risk, but as
with variable annuities and stock indexes, stock
returns do not correlate well with inflation over the
short run. As mentioned before, in 1973 and 1974 stocks
fell about 40%, while inflation went up more than 20%
(see Chart IV). In difficult economic times, the best
inflation hedge is staying in a DB plan or investing in
inflation-indexed Treasury bonds, which a 401(k) or
cash balance DB plan could do.
d. LContribution risk. DB plans generally cover almost
all employees. However, in a 401(k) arrangement, even
with tax advantages and employer matches, many workers
will not or cannot contribute, and they will not have a
benefit when they retire.
e. LLeakage risk. This is a very important retirement
security issue. Many DB plans still pay only annuities.
However, in all 401(k) arrangements, employees can
easily withdraw their money and spend it before
retirement. Recent studies show that leakage occurs
less often now for workers getting large lump sums, but
it still happens often, especially with small lump
sums. This means many employees will not have enough
money to retire and may fall on government or family
assistance in their old age. In addition, many
employees will take their lump sum at retirement. They
may think it is so large that they can retire early
and/or spend some of it right away, assuming not all of
it will be needed for retirement. Unfortunately, many
people do not know how much money they will need to
last the rest of their life, so they take too much out,
too soon.
On the other hand, DB plans generally pay retirement
benefits in the form of an annuity, not a lump sum.
This is changing, but is still much less likely than in
DC plans. In fact, some hybrid plans that look like DC
plans are different in one respect--they do not pay
lump sums. Employees may not appreciate this, but
surveys of retirees suggest that they will appreciate
it more after they retire. Cash is not the same thing
as retirement security. For retirees, retirement
security means a stable, lifetime income for life that
is not affected by a bear market.
f. LDisability risk. Many DB plans pay pensions upon
disablement. DC plans are not as good at providing
disability benefits as DB plans. For example, if
disability occurs at a young age, a DC account will not
be large enough to pay a disability pension. Thus, an
employer that sponsors a DC plan often obtains
disability coverage from an insurance company. However,
that can be expensive or very difficult to find,
especially for a small employer. With a DB plan, the
employer self-insures this risk and does not have to
pay for the insurer's loading charges and profits.
g. LDeath risk. DB pension plans pay pensions to
spouses upon death of the employee, and the employer
self-insures this risk. In a DC plan, the pension would
be quite small for a young employee if it has to come
from his or her account. Thus, many employers with only
DC plans buy life insurance for the employees, for an
extra charge.
h. LEarly retirement risk. In some DB plans, employees
that are retired early can receive a subsidized early
retirement benefit in order to manage the transition
into retirement. In a 401(k), there will not be enough
funds to provide a pension at an early age.
3. LHigher Returns. DB plans have been more efficient at
investing one large pot of funds, which means they can fund
larger benefits with the same contribution, or the same benefit
with a smaller contribution.
Recent figures from the DOL Abstract of Form 5500
data show that employees in 401(k) arrangements have
been allocating just as much to stocks as the typical
DB plan, so their average returns have been similar.
However, much of this is due to their high
concentration in employer stock. DOL data also show
much higher levels of risk for employees in their
401(k) arrangements. The standard deviation of their
returns is 2 to 3 times higher than in DB plans, per
Table E24 of the DOL Abstract.
Advantages of DB Plans Versus 401(k)s to Employers
1. LWorkforce Management. DB plans help employers better manage
their workforce. For example:
a. LRetirement windows. Companies can use early
retirement windows in DB plans to downsize in less
painful ways than laying off employees, which can
dispirit the workforce, the community, and customers. A
401(k) arrangement cannot provide early retirement
windows.
b. LRetire older employees with dignity. It is easier
to retire older employees when one can give them a
pension from a DB plan. If the employer had only a
401(k), the older employee may not have enough funds to
retire due to a number of reasons: recent drops in the
stock market, recent jumps in inflation, poor
investing, low contribution levels, having borrowed
against and spent his or her retirement funds. (This
last situation can occur at employers with DB plans,
but it is far less likely.)
c. LCreate promotion potential for younger employees.
DB plans can help employers encourage workers to
retire, allowing employers to promote and keep younger
employees. As noted above, a 401(k) cannot be used this
way.
d. LRetain employees. DB plans can be somewhat ``back-
loaded'' to provide incentives for employees to
continue with the company. DC plans cannot be as back
loaded as a final-pay DB plan.
e. LRecruit employees. DB plans, like 401(k)s, can be
more ``front-loaded'' if the employer wants to provide
larger contributions upfront to attract employees.
f. LSatisfy union demands. Unions are more likely to
bargain for DB plans.
2. LFlexibility of DB plans. As mentioned earlier, the DB plan
is as flexible and creative as the ideas of its designer.
a. LContribution flexibility. Employers have some
flexibility in the amount of contributions they make to
DB plans each year. In good years, they can put in
more, so that in tough years, they can afford to put in
less. Employees do not need to worry about this because
pension law has:
(1) Lminimum contribution requirements to keep
DB plans well funded; and
(2) Lthe PBGC protects employees in case the
contribution requirements fail and lead to
insolvency.
A 401(k) does not have this
flexibility. If an employer commits to
a 50% match, the employer must pay it,
no matter how much the employees
contribute that year. The employer can
reduce the contribution the next year.
b. LInvestment flexibility. Employers with DB plans can
invest more in experimental assets classes, hard-to-
value assets, and non-liquid assets. Since many other
investors (including DC plans) will not or cannot do
this, DB plans may earn a premium from these
investments.
c. LDesign flexibility. DB benefit formulas can be
amended easily. For example, an employer can:
(i) Lopen a retirement window to encourage
some quick retirements
and pay for it gradually;
(ii) Lincrease benefits to younger employees
when the labor market is
tight; and
(iii) Lprovide an ad hoc COLA to retirees if
inflation has been high and/or the pension
plan's investments have done well.
A 401(k) could not make these design
changes.
3. LTax Advantages. All retirement plans get tax advantages,
but DB plans can get larger ones, because employers can put
more into a DB plan for older workers than into their 401(k).
That result is possible because Congress at one time wanted to
encourage DBs over 401(k)s, since DB plans were more likely to
cover most employees than a 401(k). This particular DB
advantage has been greatly reduced in the recent past, as the
maximum allowable contributions to 401(k)s have been increased.
4. LIncreased Productivity. Like 401(k)s and other DC plans, DB
plans can improve employee morale and reduce employee fears
about retirement, which can increase employee productivity. DB
plans are more effective in reducing employee fear among older
employees because DB pension benefits are more predictable.
Advantages of DB Plans Versus 401(k)s to the Nation
1. LDB pension plans are broader based. Generally, a higher
percentage of an employer's workforce is covered in a DB plan
than in a 401(k), where the employee's contribution is
voluntary. Thus, low-income workers are more likely to get a
benefit from a DB plan and not depend on government assistance
programs in retirement.
2. LDB surpluses helped the nation become competitive again. In
the 1980s and early 1990s, pension plan surpluses helped U.S.
employers become competitive in world markets again. Early
retirement windows helped companies become lean and pension
funds made American markets among the most efficient in the
world. 401(k)s cannot provide early retirement windows and may
not be as good as DB plans at making our markets efficient.
3. LThe trillions in DB assets promote national saving,
investing, and certain markets that 401(k)s cannot, such as
real estate. DB plans provide huge sources of funds that reduce
interest rates (and hence, borrowing costs) and provide start-
up funds for IPOs, etc. In addition, DB plans can provide these
funds to the real estate sector, and other less-liquid and
hard-to-value assets. These sectors are already hurting due to
the movement to 401(k)s and other DC plans that generally do
not or cannot invest in these areas. In addition, the average
amount of money per person is larger in DB plans than in DC
plans.
4. LReduces the nation's dependence on Social Security and
government assistance programs. Both DB and DC plans reduce the
nation's dependence on government programs, but DB plans are
better at it because DB participants are more likely to get a
stable, predictable benefit for the rest of their lives.
5. LDB plans reduce poverty rates for the elderly. Lifetime
pension benefits from DB plans are more likely to help reduce
poverty rates where they are the highest (very elderly single
women), because they are level incomes payable for life.
6. LDefer tax revenues for a time when the country needs them.
The pension tax deferral moves tax revenues from the current
year to a time when the country will most need them. In a
decade or so, the nation will probably need more income taxes
to pay for the bonds that Social Security will redeem to pay
benefits. However, future income taxes may decrease as retirees
pull money out of their Roth 401(k)s and IRAs free of taxation.
Thus, the taxes on DB benefits will be needed more then than
they are now.
Furthermore, it should be noted that pensions should
not be seen as a tax expenditure over the long run:
they are tax-deferred, not tax-exempt. Over time, the
tax revenues on pension income received in the future
will likely exceed the tax revenues lost today (because
pension plans earn higher returns than the additional
borrowing required by the Treasury Department today
when it gets less in taxes). A Cleveland Federal
Reserve\10\ report bolsters this point. It reported
that tax rates in retirement are higher for many people
because of the complex way in which Social Security is
taxed above certain thresholds. Ultimately, the
government may get more tax revenues from retirees than
it lost by giving pension plans the benefit of tax
deferral. (This quirk in Social Security taxation could
be fixed by taxing it like pensions.)
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\10\ Does Participating in a 401(k) Raise Your Lifetime Taxes?,
Working Paper 0108, by Jagadeesh Gokhale, Laurence J. Kotlikoff and
Todd Neumann, Federal Reserve Bank of Cleveland (June 2001).
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Disadvantages and Challenges of DB Plans
The primary disadvantage of DB plans is that they do not provide
much benefit to mobile employees. That may be true of traditional DB
plans, but it does not have to be that way. DB plans can mimic DC
plans. Front-loaded DB plans, for example, can pay just as much to
mobile employees as DC plans.
Some analysts also point out that DC plans are more popular because
they are easier to understand. There are two responses to that:
1. Lcash may be more transparent to young employees, but when
one is closer to retirement, a level pension is more
transparent. Cash does not equal retirement security--a stable
lifetime income does; and
2. Lyoung employees could convince the employer to sponsor a
hybrid DB plan, which is just as transparent as a DC plan to
younger employees. If given clear flexibility in pension law,
private sector employers could make the monthly income from a
hybrid plan more stable and transparent for older employees.
Since employees have the option of choosing their employer (and
retirement benefits are part of that decision), federal policy has
generally allowed employers flexibility to structure their compensation
packages. Some employers and some employees will prefer more wages,
some will prefer more benefits. The marketplace can sort out who works
with whom.
Since DB plans can mimic DC plans, they have few disadvantages in
comparison with DC plans, except that this flexibility itself can make
DB plans more complex.
Finally and most importantly, the biggest disadvantage facing DB
plans is that the law is more difficult on DB plans than DC plans. For
example, DB plans cannot have pre-tax employee contributions and
employer matches, and it is difficult to implement hybrid plans. More
will be provided on this later.
Why the Move Away from DB Plans to 401(k)?
If DB plans have all these advantages and there are remedies for
the disadvantages, why are so many employers moving to 401(k)
arrangements (especially if a DB plan can mimic a DC plan)?
As suggested in the coverage section, the reason is that pension
laws and regulations do not provide a level playing field for DB plans.
Other DC plans (the ones without 401(k) features) are in decline too,
so it is not the DC nature of the plan that is making employers switch.
It is the advantages found in IRC Section 401(k). Thus, the first step
might be to modify IRC Section 401(k) to include DB plans.
Furthermore, pension law is much more complex for a DB plan than
for a DC plan. For example, we can create a DB plan to pay exactly the
same benefits as a DC plan, but the law will not allow it. What is the
policy reason for that? We need to level the playing field, so
employers can choose the type of plan that works best for them and
their employees.
Ways to Level the Playing Field
One quick way to level the playing field would be to include DB
plans in IRC Section 401(k)\11\--in essence, creating a ``DB 401(k).''
It would be difficult to comply with all of the DB and 401(k) rules at
the same time, some of which would contradict others. Thus, it will be
preferable for the ``DB 401(k)'' plan generally to follow DB rules,
with the following modifications:
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\11\ Congress could make a few changes to IRC 401(k) to allow
401(k) features in DB plans. For example, add the words ``defined
benefit plan'' to the first sentences of IRC Sec. 401(k)(1),
Sec. 401(k)(2), Sec. Sec. 401(k)(2)(B)(i)(III) and (IV), and
Sec. 401(m)(1), and add a sentence to Sec. 401(k) that Treasury will
specify in regulations how the words ``contributions'' and
``deferrals'' can include pay credits to DB plans, as long as they have
a market-related rate of return. Other sections of the law may need
revisions, as well.
---------------------------------------------------------------------------
1. LAllow voluntary pre-tax employee contributions in DB plans.
This is similar to what employers can do in 401(k)s
now (and government employers can do in DB plans using
the Section 414(h) pick-up rules). Employee deferrals
could be tested using the 401(k) non-discrimination
tests or the DB non-discrimination tests (but not
both). These employee deferrals should be exempt from
the 411(c)(2)(C) requirement to accumulate at 120% of
the federal mid-term rate, as long as all participants
can choose a market-related rate.
2. LAllow employer matches in DB plans.
Currently, many hospitals and other non-profits match
employee 403(b) deferrals and put the match into the DB
plan. However, for-profits cannot do that.
Allowing the match in the DB plan under IRC
Sec. 401(k)(4)(A) could benefit employees by reducing
investment and longevity risks on the match portion.
Employers could benefit because they could pay for it
out of surpluses in the DB plan. This would also raise
revenue for the government.
Note: Non-profits test these matches under the DB
general test non-discrimination rules. Matches could be
tested under either the 401(m) or the DB non-
discrimination rules, but it does not make sense to
force it to comply with both sets of non-discrimination
rules.
3. LConcerns on contingent accruals.
Some people may be concerned about allowing
contingent accruals in DB plans. Non-profits, however,
can already do it in DB plans, and for-profits can do
it in profit-sharing plans. Banning the practice in DB
plans simply encourages more profit-sharing and ESOP
plans, where the risks for employees are higher.
Currently, DB plans generally provide benefits for
most employees. Contingent accruals would mean that
some employees (more likely lower-paid ones) might not
make a contribution, and therefore would not get an
accrual. Some possible remedies are:
a. LNon-elective employer contributions. Some employers
provide non-elective employer contributions to everyone
in order to meet the 401(k)(3) nondiscrimination tests.
Pay credits that already exist in a cash balance plan
could also help satisfy these rules.
When the 401(k) merges into a cash balance
plan, the 401(k) accruals could be on top of
the non-elective cash balance accruals.
(Employee advocates will be interested in
surveys showing that pay credits in cash
balance plans and other hybrid plans are less
likely to be integrated than traditional DB
plans.)
b. LSafe harbor rules. IRC Section 401(k)(12)(C) allows
employers to avoid the non-discrimination tests in
their 401(k) if they promise a 100% match on the first
3% of pay, and a 50% match on the next 2% of pay.
Allowing that on the DB side might raise concerns for
employees.
Past remedies for this concern have been to
require the employer to make the first
contribution. For example, in the federal
employee Thrift Savings Plan, the employer
makes an automatic contribution equal to 1% of
pay to everyone first, and then contributes the
match on top.
Policymakers need to be careful about placing
more requirements (like an automatic or minimum
contribution) on the ``DB 401(k)'' than they
have for the DC 401(k). If they do, the playing
field will not be level, and the law will bias
employers to 401(k)s, even if they and their
employees would prefer a DB plan.
One remedy would be to also require the
automatic contribution for the DC 401(k), but
that would probably result in some employers
dropping their DC 401(k). Another possible
remedy would be to give the DB 401(k) an
offsetting advantage over the DC 401(k), such
as allowing employers to use the DB plan's
surplus to pay for the match. This might be
enough to motivate some employers (those with
over-funded DB plans) to move their 401(k) to
the DB side.
c. LAllow the IRC Section 25B tax credit match in the
DB 401(k). Low-income employees should be able to get
the tax credit match in a DB plan, just as they can now
have in a DC plan (due to EGTRRA\12\). This will help
encourage more low-income employees to participate.
---------------------------------------------------------------------------
\12\ In EGTRRA, the current tax credit rule has cliffs. The tax
credit match drops from 50% to 20% when adjusted gross income (AGI)
goes over $15,000. Thus, someone earning one more dollar means they
could lose 30% of $2,000 or $600 in taxes. This could be fixed by
making the tax credit match equal to 50% of the contribution minus, for
example, 3% of their AGI.
---------------------------------------------------------------------------
d. LBetter returns than Treasury rates: This is a very
important change in the law. In order to encourage
employees to make contributions, it will help greatly
if the law made it easier for DB plans to provide
higher rates of return on employee contributions
(deferrals, matches, and non-elective contributions).
Some people in the IRS use section 417(e) to make it
difficult to provide a rate of return higher than the
Treasury rate. Since employees can get a higher return
in their DC 401(k), why would they voluntarily
contribute into their DB 401(k) if the return were
less?
Lawmakers could clarify that the IRC handles
this well in section 411(a)(7)(A)(i) already.
That would ensure that DB accounts could
provide a market-related rate without causing
myriad problems for the DB plan.\13\ The 417(e)
rule was created for traditional DB plans that
promise a pension at retirement. It was enacted
in the early 1980s when discount rates were
very high and lump sums were very small.
Employees then sued for larger lump sums.
---------------------------------------------------------------------------
\13\ Alternatively, the accrued benefit could be defined to be the
account balance in hybrid plans.
---------------------------------------------------------------------------
This is not a problem for account balances.
For example, one would never have thought to
apply this rule to a 401(k), and similarly, it
does not make sense to apply it to this DB
401(k). Doing so would not level the playing
field.
It would make more sense for the law to have
a minimum rate of return based on market rates
(not a maximum rate). That would especially
help older employees who are more likely to
have large accounts due to their longer periods
of service.
Other ideas are suggested by Pension Equity
Plans (PEPs), which are similar to cash balance
plans except that they effectively increase the
account by the increase in the employee's
wages. Other plans might want to increase
accounts by a productivity index or the GDP
(like Sweden).
If IRC Section 417(e) is fixed for account-
based plans, it should include these
possibilities too. For example, it could allow
interest credits equal to any market-related
return or any wage index.
e. LAllow the special rule 401(k)s have for early
participation. Policymakers could encourage employers
to provide DB plans with automatic deferral elections
at hire. This can be done by opening up IRC Section
401(k)(3)(F) to deferrals in DB plans, and as in
401(k), exempting people who have not met the age and
service rules in ERISA from the non-discrimination
tests.
f. LEncourage default automatic elections. Pension law
could encourage employers to have automatic deferral
elections at hire and at each pay anniversary. The law
could give specific approval to have a default amount
placed in a default fund. (It could increase an
employee's deferrals by 1% or 2% of pay, up to a total
of 6% of pay unless the employee affirmatively requests
otherwise.) A DB fund with a default return equal to a
long-term Treasury rate, plus 1% or 2%, or a corporate
bond rate, could make this default more appealing.
g. LPhased retirement. Employees over age 59= who are
phasing into retirement and taking distributions from
their 401(k) will not want to lose this ability if it
is merged into their DB plan. Employees in DB plans
should be able to get distributions at age 59= just as
in their DC 401(k) plan, as permitted under IRC
Sec. 401(k)(2)(B). Otherwise, employees might
contribute less to the DB 401(k).
The law might also allow phased retirement
after 30 years of service, if the employee is
at least age 55. This would help employees who
want to go part-time to get some of the early
retirement subsidy in the plan, if applicable.
h. LMaximums applied separately: The maximum benefit,
contribution, and deferral rules should be applied
separately to the DB and 401(k) parts. Otherwise, if an
employer folds its 401(k) into a generous DB plan, some
contributions/deferrals might have to be reduced.
4. LAllow employers to change asset choices.
Employers should still be able to change asset
options, just as in a 401(k), without worrying about
any requirements in Section 411(d)(6). The plan could
be required to continue having at least a couple
market-related returns, a bond rate, and a money market
rate available.
For example, if an index or mutual fund disappeared,
the plan would need to change it to some other market-
related return.
5. LAccrual rules.
It might be preferable to have the DB 401(k) accounts
follow the DC accrual rules, not the DB accrual rules
(or at the very least, allow the plan to have ``greater
of'' formulas and allow them to test using the DB
accrual rules on each formula separately). This would
also ensure that increases (and decreases) in an
employee's contribution (and therefore their match in
the DB plan) would not cause any violation of the
accrual rules.
This might also give policymakers a chance to clarify
and simplify accrual rules for hybrid plans. It would
make sense to test pay credits by using an age-weighted
formula with a maximum discount rate of 8%, for
example. It would still produce accruals that were much
less age-weighted than a traditional DB plan because DB
plans are also age-weighted through the increase in the
final pay average. If less age weighting is desired,
the rule could limit the discount rate to, for example,
6% or 5%.
6. LSwitching between DB and account.
As long as the account earns a market rate, employees
could be allowed to switch the lump sum value of their
DB benefit to the account side when they leave the
employer--instead of taking the lump sum--and move it
back at old age in order to convert to an annuity,
perhaps at the date minimum distributions are required.
Some pension plans do this already, but one has to move
between plans in order to do it.
7. LNew funding rule for ``DB 401(k)s.''
In addition, the minimum funding rules will need to
be modified to accommodate the ``DB 401(k).'' A
simplified funding rule might work, such as 90% of the
current pay credits to the account or, if greater, 20%
of the amount by which the account balances (with
minimum) exceed the plan assets.
8. LOther uses of 410(k) funds in DBs.
In addition, this new feature could be added to an
already existing DB plan. It would create a plan that
has significant accounts for young employees and old-
style annuity guarantees for older employees. Other
uses for this idea would be as follows:
a. LThe extra assets in the accounts could be used to
provide COLAs to traditional DB pensions or past
service credits for prior service or prior jobs (which
would help make DB plans more portable).
b. LThe ``DB 401(k)'' idea could allow floor-offset
plans to be aggregated into one DB plan, so the
employee would get the greater of an account and a
traditional DB benefit. It would make more sense to the
employee (since it will get rid of the offset) and
entail less risk to the employer, since the assets
would all be in one plan. Currently, the assets needed
in the DB component of a floor-offset arrangement can
be very unpredictable. It could be large, if the DC
plan has poor investment returns, or it could be zero,
if the DC plan has great investment returns (in which
case, the employer will have a difficult time trying to
get the assets back).
9. LConversions from 401(k) to ``DB 401(k).''
This idea should not be limited only to new plans.
Allowing conversions would mean the 401(k) would not
have to be terminated in order to convert it. To
encourage employers to convert their current 401(k)s to
this plan, it will be important to enact the
suggestions in the above section. Whenever a new
advantage is provided to the current DC 401(k)s rules,
it would need to be provided on the DB side too,\14\ or
employers might convert back to the original 401(k).
---------------------------------------------------------------------------
\14\ And similarly, if the ``DB 401(k)'' has a restriction placed
on it, it should also be placed on the 401(k), too. That is why it
makes sense to have the rules in the same place in IRC Sec. 401(k) for
both DB and DC plans.
---------------------------------------------------------------------------
10. LOther ideas for leveling the playing field that do not
involve Sec. 401(k) include:
a. LSimplify minimum funding rules for DB plans. The
current rules are incredibly complex and the Academy
has assigned a task force to make suggestions in this
area.
b. LFix the discount rate for funding liabilities. Due
to the current abnormally low Treasury rates, the IRC
was going to force employers to contribute too much to
their pension plans. Congress resolved this concern by
passing a temporary rule that allows employers to use a
higher discount rate, but it is in effect only through
2003. A permanent fix is needed, and policymakers
should consider using annuity prices or corporate bond
rates (which is what annuity pricing is based on) for
setting the discount rates. Some have suggested using
government rates, but they are not capable of
estimating annuity prices and can create problems. If
Treasury rates went back to having the same margins
with corporate bond rates, a fix based on a government
rate would not encourage adequate funding which would
cause problems for the PBGC.
c. LClarify the laws for hybrid plans. Hybrid, cash
balance, and pension equity plans have been around for
about two decades, but the laws have not been modified
to handle these new kinds of retirement plans.
Consequently, new rules are being created through court
decisions, which try to adapt the old rules to the new
plans. Since there has been no clear guidance from
Congress to the courts, some employers are falling into
traps that they did not know existed.
d. LAllow employers to raise the pension plan's normal
retirement age. Currently a pension plan cannot raise
its normal retirement age above 65. Congress has
already raised the retirement age for Social Security.
It is inconsistent with Congress' pro-work policy for
older Americans for the retirement age for pension
plans to be kept at age 65. Allowing pension plans to
use the same normal retirement age as Social Security
would make sense.
e. LRevise Congressional budget rules to reflect future
tax revenue received on pensions. Whenever Congress
tries to improve retirement security by increasing
pension coverage to the part of the working force
without pensions, current budget rules show the loss in
revenue today. But this misses the fact that tax
revenue in the out years will increase and pay back the
loss in revenue today (as discussed on page 9).
If the budget rules could reflect these
pension tax deferrals as budget neutral, it
would be easier to pass solutions to the
pension coverage problem.
The budget rules already allow this under the
Credit Reform Act of 1990 for government loans
by offsetting the payments received in the out
years for housing loans, school loans, rural
electrification loans, the Disaster Loan fund,
loans for rural development, the Business Loan
Investment Fund, mortgage guarantees,
international aid, the Export-Import Bank,
foreign military sales, and the Overseas
Private Investment Corporation. The reason
behind passing the Credit Reform Act was
similar: it helped Congress make the best
financial decision when deciding whether to
provide loans or loan guarantees. This law
could also be used to handle the pension tax
deferral, showing that it is clearly a tax
deferral, not a tax exemption.
Conclusion
DB plans were once the most common way of providing retirement
security to America's workers. However, due to the non-level playing
field created by pension laws, many employers have switched to 401(k)
plans, which do not provide the same level of retirement security as
traditional DB plans. One way to level the playing field is to allow DB
plans the same flexibility as 401(k)s. Other ideas (such as fixing the
discount rates and simplifying the minimum funding rules\15\) are
discussed in my testimony, and I would be glad to analyze the effects
of any proposals you wish to consider. Thank you for the opportunity to
share my views today.
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\15\ Also, see the suggestions in my testimony before the U.S.
Department of Labor's ERISA Advisory Board (available on the Academy's
web site at http://www.actuary.org/pdf/pension/ERISA--071701.pdf).
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Chairman HOUGHTON. Thank you very much, Mr. Gebhardtsbauer.
Now, Ms. Friedman.
STATEMENT OF KAREN D. FRIEDMAN, DIRECTOR, POLICY STRATEGIES,
AND COORDINATOR, CONVERSATION ON COVERAGE, PENSION RIGHTS
CENTER
Ms. FRIEDMAN. Mr. Chairman, with your permission I would
like to summarize our prepared statement and submit the longer
statement into the record.
Chairman HOUGHTON. Without objection.
Ms. FRIEDMAN. Mr. Chairman, Mr. Coyne, Members of the
Subcommittee, I am Karen Friedman. I am the Director of the
Pension Rights Center's Conversation on Coverage, a new project
funded by the Ford Foundation to launch a national dialog on
ways of increasing pensions and savings for America workers.
Thank you so much for inviting us today to talk about the
critical role that defined benefit plans play in retirement
security in this country.
If there is a silver lining in the Enron crisis, it is the
recognition of the importance of pensions. Up until recently,
most experts contended that traditional employer-paid pensions
had lost their luster, overshadowed by popular 401(k) plans. In
the wake of Enron, there has been a resurgence of interest
among experts on all sides of the issue in finding new ways of
encouraging defined benefit plans.
Two decades ago, most large companies routinely offered
traditional pensions to their workers, recognizing that these
retirement benefits were a critical component of a larger
compensation package. The deal was that if employees remain
loyal to companies, worked hard and met certain requirements,
they would be rewarded with a monthly benefit for life backed
by a Federal guarantee. In recent years that trend has been
reversed.
The Center has long been troubled that companies have been
dropping good, solid employer-paid pension plans and replacing
them with do-it-yourself savings plans that put the risk and
responsibility of investing on the shoulders of individuals. A
recent study by NYU economist, Edward Wolfe shows that despite
stock market gains and the rapid growth of 401(k) plans, the
typical American facing retirement today has had a decline in
retirement wealth relative to other generations of near
retirees.
The reasons for this decline are not hard to find. Unlike
defined benefit plans where employers put money in for
employees at all income levels, 401(k)s only benefit those
employees who can afford to put money into the plans, keep it
in the plans until retirement age, and who have the luck to get
good investment returns.
Employers point to over regulation as the cause for the
decline of DB plans. We think that reduced regulation may have
a role to play. Relaxation of rules by administrative agencies
not only invited the growth of 401(k) plans, but also permitted
the expansion of top hat plans which allowed all executives to
provide extremely generous retirement packages for themselves
outside of the defined benefit plans that are covering their
employees.
Whatever the reason for the decline in traditional plans,
there is a growing consensus that something has to be done to
try to encourage these plans. What incentives are there to
provide defined benefit plans? The principal incentive has
generally been considered to be the tax breaks offered to
employers to set up and contribute to plans. For smaller
businesses, the carrot has often been the ability to provide
large retirement benefits for the company owners.
There is no question, retirement income must be enhanced
for working Americans. Half of all private sector workers have
no retirement plan other than Social Security and there is no
question that people need both pensions and Social Security to
make ends meet.
Last July, the Pension Rights Center convened the
Conversation on Coverage to bring together experts from a wide
variety of perspectives to examine new ways of expanding
retirement income for working Americans.
We thought we would share with you today a few of the
proposals that address either the expansion of defined benefit
coverage or proposals that included key elements of defined
benefit plans, sort of what Ron has been talking about.
As an incentive for small companies to adopt defined
benefit plans, one proposal increases the amount small business
owners could set aside for their own retirement on a tax-
favored basis. In exchange for this carrot, the company would
have to cover all workers and provide fair benefits across the
board.
A variation of this proposal was introduced by Congressman
Coyne in a Smart Plan as part of his larger bill which we
strongly support, and in 1997 by Congressman Pomeroy, and also
Nancy Johnson.
One proposal created the benefit concepts with newer cash
balance ideas. Another proposal created the concept for a
hybrid plan in which older employees would receive lifetime
pensions based on their final pay while younger employees would
receive portable benefits based on contributions made for them.
There were other proposals that would take key elements of
defined benefit plans and export them into defined contribution
structures.
For instance, one proposal called for the creation of
financial institutions similar to TI and Cref to relieve small
employers of administrative burdens and fiduciary
responsibilities while offering employees pooled professional
investment management and insured lifetime annuities. There was
a variety of other creative proposals presented in the
Conversation, including the development of new kinds of multi-
employer plans for unrelated employers, as well as a number of
proposals that built on the low income tax credit included in
last year's tax bill.
Some Conversation participants also suggested the need for
developing insurance for 401(k) plans. There are no easy
solutions when it comes to retirement security. It will take
all of us working together to find approaches that will do the
job effectively by striking a balance between burdens and costs
to employers and fairness and adequacy for employees.
The Pension Rights Center looks forward to working with the
Members of this Subcommittee as we move into the second stage
of the Conversation on Coverage. Thank you for inviting me to
appear today. I would be happy to answer your questions.
[The prepared statement of Ms. Friedman follows:]
Statement of Karen D. Friedman, Director, Policy Strategies, and
Coordinator, Conversation on Coverage, Pension Rights Center
Mr. Chairman, Members of the Subcommittee, I am Karen Friedman,
Director of Policy Strategies for the Pension Rights Center, a 26-year-
old consumer rights organization dedicated to promoting the retirement
security of workers, retirees and their families. I am also coordinator
of the Center's Conversation on Coverage, a new initiative funded by
the Ford Foundation to launch a national dialogue on ways of increasing
pensions and savings for American workers.
The Pension Rights Center welcomes the opportunity to testify today
about defined benefit plans and their important role in providing
adequate, guaranteed retirement income to millions of Americans. If
there is a silver lining in the Enron crisis, it is the recognition of
the importance of pensions. Retirement income issues have surfaced as a
critical concern in the public consciousness, and are rising to a
priority issue on the national political agenda.
Up until recently, most experts in the field contended that
traditional employer-paid defined benefit plans had lost their luster,
overshadowed by popular 401(k) plans. No wonder. Throughout the past
decade financial columnists and CEOs alike had preached that everyone
could become millionaires through their 401(k) plans. Traditional
defined benefit plans seemed to be going the way of the dinosaur--
heading for extinction.
But seemingly overnight attitudes have changed. In the wake of the
collapse of 401(k) plans at Enron and Global Crossing, and losses at
Lucent, Kmart and Polaroid, there has been a resurgence of interest on
the part of experts on all sides of the issue in finding new ways of
encouraging defined benefit plans. Although there may not be a
unanimous vision of how to go about doing this, representatives of both
business and labor appear to be genuinely committed to finding ways of
maintaining and expanding these plans.
Two decades ago, most large companies routinely offered traditional
employer-paid defined benefit pensions to their workers, recognizing
that these retirement benefits were a critical component of a larger
compensation package. The deal was that if employees remained loyal to
companies, worked hard and met certain requirements, they would be
rewarded with a specific monthly amount for life that was backed by a
federal private pension insurance program. Employees and employers both
understood the nature of the bargain: employees would get a lower
salary in exchange for getting the good pension they needed to
supplement their Social Security payments.
But in recent years that trend that has been reversed. While the
percentage of the private sector workforce participating in employer-
sponsored retirement plans has remained fairly constant,\1\ the
percentage of the workforce in old-style pension and profit sharing
plans is shrinking rapidly as more and more companies are replacing
them with savings plans. Looking just at defined benefit plans, the
percentage of the private workforce covered has declined by 40
percent.\2\ The switch to savings plans is most noticeable in small
businesses, which have dropped their plans entirely. But there has also
been a disturbing shift in large companies, which have effectively
frozen their traditional plans and told their employees to save for
themselves through their 401(k)s. Only among union members in these
companies are defined benefit plans still strong.\3\
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\1\ Alicia H. Munnell and Annika Sunden, ``Private Pensions:
Coverage and Benefit Trends,'' Center for Retirement Research, 2001, p.
6.
\2\ U.S. Department of Labor Pension and Welfare Benefits
Administration, Private Pension Plan Bulletin: Abstract of 1998 Form
5500 Annual Reports, Number 11, Winter 2001-2002, p. 68, Table E4b.
\3\ 70 percent of union workers have defined benefit retirement
coverage, compared with 16 percent of nonunion workers. ``The
Retirement Double Standard,'' from the AFL-CIO web site, www.AFLCIO.org
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In fact, this type of cutback is exactly what happened at Enron. As
described in the Wall Street Journal, Enron, like so many other
companies, had taken advantage of the leeway provided by accounting
practices and lax federal regulation to cut back on the employees'
underlying pension plan. In 1987, Enron froze its traditional plan that
offered lifetime insured benefits and used the plan's ``surplus''
assets to create a ``floor offset'' plan that primarily relied on
company stock to provide benefits. Nine years later, that plan, in
turn, was replaced by a barebones new type of pension plan (that
significantly reduced the expected benefits of older employees),
supplemented by the 401(k). All of these changes were highly technical
moves that effectively allowed the company to cut future benefits,
increase the pension ``surplus'' and, by dint of an accounting
maneuver, use pension earnings to artificially inflate corporate
earnings on the company's balance sheet. Of course, when the company's
paper profits went up, so did the compensation packages of corporate
officials like CEO Kenneth Lay.\4\
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\4\ Ellen E. Schultz and Theo Francis, ``Enron Pensions Had More
Room at the Top,'' Wall Street Journal, January 23, 2002. Ken Lay will
receive a lifetime pension of $475,042 a year, plus a company-paid $12
million insurance policy. In contrast, long-service Enron employees
have been left with almost nothing. One 25-year employee told USA Today
that he would receive a $221 per month benefit from the original
defined benefit pension plan, nothing from the ``floor offset plan,''
and a total of $15,000 from the new cash balance pension plan.
Christine Dugas, ``Enron's Dive Destroys Workers' Pensions'', USA
Today, February 6, 2002.
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Long before Enron collapsed, the Center issued strong warnings
about the trend away from traditional pensions to less secure 401(k)
plans.\5\ We have been troubled that companies have been dropping good,
solid, employer-paid pension plans and replacing them with do-it-
yourself savings plans that put the risk and responsibility of
investing on the shoulders of individuals. Employees have not
complained about these ``pension paycuts'' because they have not
understood what was happening, and have been led to believe that they
could become millionaires in the stock market through their 401(k)
investments. But now we see that for most employees the promises of
401(k) riches were largely an illusion. The sad truth is that even
before Enron and the recent stock market downturn, half of all
employees contributing to 401(k) plans had less than $12,000 in their
accounts.\6\
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\5\ Karen W. Ferguson, ``How 401(k)s Hurt Lower-Paid Workers, The
New York Times, April 17, 1986, p.F2
\6\ Patrick J. Purcell, Retirement Savings and Household Wealth in
1998: Analysis of Census Bureau Data, Congressional Research Service,
2002, p. 13.
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Rather than increasing the retirement wealth of rank and file
workers, the advent of 401(k)s appears to have actually reduced it. A
recent study by New York University economist Edward N. Wolff,
published by the Economic Policy Institute, shows that despite stock
market gains and the rapid proliferation of 401(k) plans, the typical
American facing retirement has had a decline in retirement wealth
relative to other generations of near-retirees.\7\ According to
Professor Wolff, every group of near-retirees except those at the very
top lost ground compared to their counterparts in 1983. He cites the
contraction of defined benefit plans as a core reason for this decline
in household wealth particularly among low-and moderate-income
households.
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\7\ For the typical (median) household headed by a person age 47-64
retirement wealth declined by 11 percent between 1983 and 1998. Edward
N. Wolff, Retirement Insecurity: The Income Shortfalls Awaiting the
Soon-to-Retire, Economic Policy Institute, 2002, p.25, pp. 22-23, Table
8.
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The reasons for this decline are not hard to find. Unlike defined
benefit plans, where employers put money in for employees at all income
levels, 401(k)s only benefit those employees who can afford to put
money into the plans, keep it in the plans until retirement age, and
take the risks needed to get good investment returns. As Enron has
shown, in many cases, these plans also offer employees an often-
irresistible opportunity to gamble on a ``sure thing''--their
companies' stock.
Employer organizations contend that their members have dropped or
cut back on defined benefit plans because increases in government
regulation over the years have made the plans too costly to maintain.
But it is equally plausible that these plans have declined because of
reductions in government regulation. Relaxation of rules by
administrative agencies not only invited the adoption of 401(k) plans,
which gave company officials an easy way to divert attention from cost-
saving cutbacks in their defined benefit plans, but also permitted the
expansion of ``top hat'' plans, which allowed these executives to
provide extremely generous retirement packages for themselves outside
of the defined benefit plans covering their employees.
Whatever the reasons for the decline in traditional pensions, there
is a growing consensus that something should be done to try to
encourage the defined benefit plans, or at least plans that incorporate
certain key elements of defined benefit plans.
From an employees' perspective, the most important features of
defined benefit plans are that these plans are insured, professionally
managed, employer-paid, and that they provide lifetime benefits to
workers at all income levels--not just those who can afford to save for
themselves.
At the same time, there are shortcomings in the defined benefit
system that also need to be acknowledged and addressed. For instance,
traditional plans often use complicated formulas that
disproportionately favor certain groups of employees over others--most
commonly, higher-paid and older employees--and for that reason can be
perceived as unduly complex and unfair. Also, unlike 401(k)s their
benefits are not portable. If employees leave defined benefit plans
early in their work lives, they usually have to wait until retirement
age to collect their benefits--when the value of the benefits will have
been eroded by inflation. And retirees' fixed benefits are rarely
adjusted for increases in the cost of living. Although these issues can
be addressed within the current defined benefit structure, this would
add costs which, up until now, employers have been unwilling to assume.
What incentives are there for employers to provide defined benefit
plans when they can simply offer cheaper 401(k) plans? Why should they
assume the risk and responsibility--not to mention the cost--of
providing these plans, when it is much easier and cheaper simply to
tell employees to save for themselves, and provide for their own
retirement through ``nonqualified plans''?
The principal incentive has generally been considered to be the tax
breaks offered to employers to set up and contribute to plans--which,
when federal, military and state government plans are added, constitute
the largest of all of the nation's federal tax subsidies.\8\ For
smaller businesses, the ``carrot'' has often been the ability to
provide large retirement benefits for themselves. To a lesser extent
now than in the past, another inducement to set up defined benefit
plans has been that they can reward loyal, longer-service employees,
and help ``manage'' the workforce (for example, by encouraging older
employees to leave the workforce at early retirement age). Where
employees are represented by a union, collective bargaining can also
provide an effective incentive for setting up a plan.
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\8\ The Joint Committee on Taxation estimates the revenue loss for
employer contributions to retirement plans to be $84 billion this year,
Joint Committee on Taxation, Estimates of Federal Tax Expenditures for
Fiscal Years 2001-2002, p.22, Table 1.
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The question is whether these incentives are sufficient to
encourage employers to set up (and continue) plans that will provide
meaningful benefits for American workers. Last year's tax law, the
Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) was
premised on the notion that increased tax incentives would encourage
the formation of private retirement plans. The problem is that tax
relief was provided not just to employers to encourage them to maintain
defined benefit plans, but also to employees and employers to increase
contributions to 401(k)s. Once the law is phased in, older higher-
income employees will be able to reduce their taxable income by $20,000
a year (and their employers will be able to contribute an additional
$20,000 as a match to the employees' contributions).\9\ The danger is
that EGTRRA may have made 401(k)s so attractive to better-off employees
that it will be even easier for employers to reduce costs by cutting
back on defined benefit plans in favor of do-it-yourself arrangements.
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\9\ The President's Budget for fiscal year 2003 estimates that the
revenue loss from 401(k)s will be $60 billion next year. ``Analytical
Perspective Fiscal Year 2003'', U.S. Budget for Fiscal Year 2003, Vol.
4, p. 107, Table 6-3.
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The events of the last eight months and public focus on this issue
have given us a unique opportunity to reexamine the nation's private
retirement income policies. What can be done to enhance retirement
income for working Americans? There is an urgent need to answer this
question. Half of all private sector workers have no retirement plan
other than Social Security, and of the 51 million workers with plans,
19 million, or roughly 37 percent, have 401(k)s as their only plan.\10\
The typical American retiree without an adequate private retirement
plan, will have little more than Social Security, which will provide
only half of what he or she will need to maintain his or her standard
of living in retirement--less than the minimum wage!
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\10\ Private Pension Plan Bulletin: Abstract of 1998 Form 5500
Annual Reports, U.S. Department of Labor Pension and Welfare Benefits
Administration, Number 11, Winter 2001-2002, p. 68, Table E4b.
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To begin the process of addressing this critical issue, last July
the Pension Rights Center convened the Conversation on Coverage. With
primary funding from the Ford Foundation and the W.K. Kellogg
Foundation, we brought together 75 experts from business, labor,
academia, financial, consumer and retiree organizations to look at new
ways to deliver benefits to working Americans. The focus of the
Conversation was on developing new ways of delivering benefits to
employees who have no plans at all, particularly low- and moderate-
income wage earners. Our goal was to spark a national dialogue by
inviting representatives of all points of view to develop workable
solutions in a consensus setting.
The Conversation participants reviewed an array of proposals that
sought to expand coverage either through the existing employer-based
system or by creating new institutions and structures. In coming
months, we will be releasing a white paper, to be published by the
Century Foundation, which will expand on these ideas and start the next
stage of the Conversation. We thought it might be helpful to share with
you a few of the proposals that were presented at the Conversation that
addressed the expansion of defined benefit coverage or that included
key elements of defined benefits plans. These are just a few of the
many creative suggestions offered at the Conversation on Coverage.
One proposal was aimed at increasing incentives for small business
owners to set up defined benefit plans by increasing the amounts they
could set aside for their own retirement on a tax favored basis. This
proposal provides an explicit trade off: In exchange for the ``carrot''
for business owners, the plan would be barred from taking advantage of
current rules that allow employers to exclude workers from their plans,
and pay proportionately larger benefits to higher-paid employees than
rank and file workers. Also, benefits would be portable and, in one
version of this proposal, insured by the Pension Benefit Guaranty
Corporation. Two variations of this proposal have already been
introduced into Congress. Most recently, Congressman William Coyne
included the ``SMART'' plan (Secure Money Annuity or Retirement Trusts)
as Section 402 of his Retirement Opportunities Expansion Act of 2001
(H.R. 3488). Previously, in 1997, Congresswoman Nancy Johnson and
Congressman Early Pomeroy had introduced ``SAFE'', The Secure Assets
for Employees Plan Act (H.R. 1656).
A proposal designed to appeal to larger employers was presented by
Jim Davis, Principal and Consulting Actuary for Milliman USA. The
``Individual Advantage Plan'' would merge traditional defined benefit
concepts with newer ``cash balance'' ideas. Older employees would
receive the insured lifetime pensions based on their final pay that
they had counted on receiving, while younger employees would receive
portable benefits based on contributions that would accumulate as if
they had been put into individual accounts. Since neither group would
get as much as under a traditional defined benefit plan or a cash
balance plan, the overall cost to the employer (and the revenue loss to
the Treasury) would be the same. The incentive for the employer would
be that dollars would be allocated in ways that would help companies
attract younger workers, and retain older employees.
A very different proposal, that would take key elements of defined
benefit plans and place them into a defined contribution structure, was
presented by Professor Norman Stein of the University of Alabama School
of Law. His approach, which had been developed by a nonpartisan group
of twenty pension experts, was designed to encourage smaller employers
to contribute to plans by relieving them of administrative burdens and
fiduciary responsibilities, and giving them the flexibility of deciding
each year whether to contribute. Like defined benefit plans, this
approach, called the ``Pensions 2000'' proposal, would offer pooled,
professional investment management, and lifetime annuities, that would
be insured when employees retired. Also, like defined benefit plans,
the money would be locked in until retirement age.
Unlike defined benefit plans, and unlike the SAFE/SMART and
Individual Advantage Plan approaches, the Pension 2000 design envisions
that employees, as well as employers, would be able to make tax
deferred contributions to the plans, which would be administered by
financial institutions. These contributions would be structured as a
``reverse 401(k)'': The employees' contributions would ``match'' the
employer contributions. Those employees who could afford to put money
in the plan would be able contribute up to $2 for each $1 contributed
by their employer. The others, who could not afford to contribute,
would at least be assured of getting the employers' contributions.
There were a variety of other proposals presented at the
Conversation, including the development of new kinds of multiemployer
plans for unrelated employers as well a number of proposals that built
on the low-income tax credit included in last year's tax bill. A one-
page summary of each of these proposals can be found on the
Conversation's website www.pensioncoverage.net. In addition,
participants at the Conversation suggested the need to develop new
concepts, such as insurance for 401(k) plans--an idea that has
generated particular interest since Enron's collapse.
To say the obvious, there are no easy solutions when it comes to
retirement security. At this point in our political history, we as a
nation are unwilling either to increase the government's role in
providing retirement security, or to set individuals completely adrift
on their own individual savings ``ice floes''. That means that we will
have to work extremely hard to figure out how to achieve the right mix
of incentives and regulation within our voluntary employer-sponsored
private retirement system. The challenge will be to find approaches
that will ``do the job'' efficiently and effectively by striking a
balance between burdens and costs to employers and fairness and
adequacy for employees. The Pension Rights Center looks forward to
working with the Members of this Subcommittee as we move into the
second stage of the Conversation on Coverage.
Thank you for inviting us to appear here today. I would be happy to
answer any questions you may have.
Chairman HOUGHTON. Thanks very much, Ms. Friedman. Dr.
Skinner.
STATEMENT OF JONATHAN SKINNER, PH.D., JOHN FRENCH PROFESSOR OF
ECONOMICS, DARTMOUTH COLLEGE, AND PROFESSOR OF COMMUNITY AND
FAMILY MEDICINE, DARTMOUTH MEDICAL SCHOOL, HANOVER, NEW
HAMPSHIRE
Dr. SKINNER. Thank you, Mr. Chairman and Members of the
Subcommittee. My name is Jonathan Skinner. I am a Professor of
Economics at Dartmouth College.
Some years back, my colleague, Andrew Samwick and I became
concerned that 401(k) plans could be exposing workers to risk
and potentially lower pension benefits in comparison to what
was then the status quo defined benefit plans.
At the time no one had figured out how to compare DB plans
with DC plans because of the complexity in different types of
both DB and DC plans. In research sponsored by the National
Institute on Aging, we set out to answer this question. We used
the Federal Reserve's Survey of Customer Finances from 1983
through 1998 with detailed information on hundreds of actual
pension plans.
We have used these data to compare benefits for workers
covered by typical DB plans in 1983, back when they were still
the norm, with the benefits those same workers with the same
earnings would have received under typical 401(k) plans from
the later 1990s. To my surprise, we found the reverse of what I
expected.
The 401(k) plans seemed to provide higher returns with less
risk than comparable DB plans. To make sure this finding was
robust, we cooked the books in favor of defined benefit plans
whenever possible. For example, when we simulated stock and
bond returns for the 401(k) accounts, we included the dismal
returns from the 1930s, but excluded the go-go years after
1990, a year when the Dow never closed above 3,000. Based on
this research, we make four basic points.
First, not only do 401(k) plans from the 1990s do better
than DB plans for the median worker, they also do better for
the worker with minimal pension benefits. In other words,
401(k)s don't always do a great job of providing pension
benefits for lower income or unlucky workers. But, DB plans, in
1983 and in 1989 were doing even worse.
Second, we were concerned about workers who neglected to
contribute to 401(k)s or who spent their 401(k) balances when
they changed jobs. Typically, what we found is that people who
don't contribute often have an alternative DB plan. So, while
they are not contributing to the 401(k), they still have some
supplemental coverage. In fact, we found fewer than 4 percent
of the workforce had the option of contributing to a 401(k) and
didn't, and did not also have some other kind of plan.
Now, it is true that when they changed jobs, some workers
spend their 401(k) balances on houses, cars and vacation
travel. However, Samwick and I showed that even when workers
spend a large fraction of their DC plans when they change jobs,
they still do better than DB plans.
The reason is that DB plans are often not vested or eroded
by inflation, meaning they are of little value to workers who
change jobs. At least under 401(k) plans workers get to spend
their money on things they want, like boats and houses. A third
concern is that 401(k)s pay large lump sums at retirement to
unsophisticated investors who may spend their money too
quickly. Most retirees move their assets into IRAs, but I would
like to see more default options or even requirements available
for retirees such as annuities to ensure pension payments for
the widows 30 years out.
Fourth, the Enron debacle has focused attention on what is
the most serious charge against 401(k) plans, that they are
just too risky for use in retirement planning.
Our simulations did not consider risks from employee stock
ownership plans directly. I will return to this issue below.
What we did consider was risks from stock market fluctuations,
extreme portfolio choices and low rates of contributions. As
mentioned above, even with all of these risks, the 401(k) plan
still largely dominated DB plans.
The intuition is straightforward. Promotions, bonuses or
poor health for the worker or her family can have profound
effects on earnings in the last 5 years of service, the years
that often weigh most heavily in many DB benefit formulas.
For a worker at age 35, that is one roll of the dice. By
contrast, the typical 401(k) plan collects a percentage of
salary over the worker's entire career. While the stock market
often does take one step back, as it has in recent years, it
also tends to take two steps forward. So, on average, stocks
through 2002 are still doing pretty well.
While a portfolio of stocks is a good investment, a
portfolio of 95 percent Enron stocks is not. It is critical to
develop stricter rules to regulation investment in company
stock. It is important not to throw out the proverbial baby
with the bath water. A well-designed 401(k) plan with
appropriate restrictions on company stock ownership and
provisions for rolling assets into annuities at retirement can
and should play an important role in improving workers'
financial security.
[The prepared statement of Dr. Skinner follows:]
Statement of Jonathan Skinner, Ph.D., John French Professor of
Economics, Dartmouth College, and Professor of Community and Family
Medicine, Dartmouth Medical School, Hanover, New Hampshire
My name is Jonathan Skinner, and I am the John French Professor of
Economics at Dartmouth College in Hanover, NH. As is well understood,
there has been a dramatic shift during the last several decades away
from defined benefit (DB) towards defined contribution (DC) pension
plan, most notably 401(k) plans. Has the shift toward 401(k) plans
enhanced or detracted from American workers' financial security at
retirement? In my comments below, I will focus on four major criticisms
of DC and 401(k) plans that seem to suggest that future retirement
security of current American workers could be jeopardized by this
trend:
LCompared to DB plans, 401(k) plans cannot provide a
comfortable pension at retirement, even when workers are
contributing the recommended fraction of their salary.
LMany workers do not contribute even the recommended
amounts, or eschew contributing altogether. When they switch
jobs, they spend their 401(k) assets on houses, boats, or
travel.
LDefined contribution plans paying out lump sums at
retirement can be spent down quickly by unsophisticated
retirees, rather than providing a fixed annual income (or
annuity), as in defined benefit plans.
LThe Enron debacle has focused attention on what is
perhaps the most serious charge against 401(k) plans--that they
are just too risky for use in retirement planning. The risks
come not simply from Employee Stock Ownership Plans (ESOPs),
but also from uniformed or overly aggressive investment
choices, or just weak overall stock market and bond returns.
In a research project, funded in part by the National Institute on
Aging, Andrew Samwick of Dartmouth College and I have considered each
of these four concerns.\1\ A systematic analysis of DB and DC plans has
proven difficult in the past because of the varying characteristics of
DB plans across firms, and varying contribution rates, matching plans,
and investment decisions for workers in DC plans, again across the
universe of firms offering such plans. This variability has made it
difficult to generalize about ``typical'' DC or DB plans. Comparisons
are further complicated by the continued evolution of both DB and DC
plans during the past several decades.
---------------------------------------------------------------------------
\1\ ``How Will Defined Contribution Pension Plans Affect Retirement
Income?'', Dartmouth College (September 2001). http://
www.dartmouth.edu/samwick/dbdc200110.pdf. Also see our paper
``Abandoning the Nest Egg? 401(k) Plans and Inadequate Pension
Saving.'' in Sylvester J. Schieber and John B. Shoven (eds.) Public
Policy Toward Pensions. Cambridge: MIT Press, 1997, 197-217.
---------------------------------------------------------------------------
We addressed this shortcoming by using data from the Federal
Reserve Board of Governors' Surveys of Consumer Finances (SCF) from
1983 to 1998, and, in particular, the Pension Provider Surveys (PPS)
that accompanied the 1983 and 1989 SCFs. The Surveys asked detailed
information about family assets, income, 401(k) contributions, and
demographic information, while the pension supplements provided
information about nearly one thousand pension plans in 1983, and about
half that number in 1989. For each survey respondent who was covered by
a pension, an attempt was made to obtain the summary plan descriptions
from the employer or union. These descriptions were then coded into
computer software by the Survey Research Center at the University of
Michigan. We used a substantially enhanced version of this software to
compute pension entitlements. The detailed information has been merged
with more recent data from the SCF on characteristics of 401(k) through
1998.
Briefly, Samwick and I found that 401(k) plans are not the ticking
time bomb that many fear. If some 401(k) plans do not provide
adequately for retirement, then neither did many DB plans. These
findings do not depend on the extraordinary gains in equity markets
during the 1990s because in our analysis, we excluded all equity
returns after 1990, a year in which the Dow Jones Industrial Average
never closed above 3000. The result is robust to lower simulated equity
rates of return, to job mobility where workers ``spend down'' some part
of their balances, and to the presence of workers contributing little
or nothing to their accounts.
To provide a flavor for the findings of our research, I consider
each of the four criticisms of DC plans in more detail.
1. Compared to DB plans, DC plans cannot provide for a comfortable
retirement pension
There are a number of reasons why similar workers may receive
different pension benefits at retirement beyond the simple reason that
one worker has a DB plan and the other a DC plan. Individual workers
may get different pension benefits from the same pension plan because
of different earnings, asset allocation, or investment returns over
their lifetime. Within DB plans, there is remarkable variability in the
nature of plans across firms, in particular with regard to how benefits
are ``backloaded'' with respect to earnings in the final 3 or 5 years
of service. To capture this variability, we simulated a wide variety of
different worker earning ``histories'' through age 62. In other words,
we created a group of nearly 40,000 synthetic ``workers'' with complete
earnings histories, and asked how this group of workers would have
fared over their lifetime with the set of defined benefit plans
available in 1983. Then we took the same synthetic ``workers'' with the
same earning histories and provided for them randomly chosen 401(k)
plans from the universe of plans offered in 1995 as well as in other
years. These 401(k) plans are also subject to risk from stock and bond
returns; this was done by randomly assigning historical rates of return
from stocks and bonds during the 1900-1990 period. Thus it was possible
for some 401(k) enrollees to experience the dismal stock rates of
return from 1932 and 1933 multiple times during their employment.
Summary information about our results is presented in Table 1, with all
values expressed in $1995 dollars, and time trends are shown
graphically for 401(k) plans in other years (1992, 1998) for the median
worker in Figure 1.
In the first column of Table 1, mean 1983 DB pension benefits are
$13,917, in contrast to the mean expected annuitized annual benefits of
$30,880 for typical 1995 401(k) plans in Column 2. Recall that these
expected DB and 401(k) pension benefits are for workers with identical
earnings histories, and do not reflect the fact that earnings were
higher in 1995 than in 1983. Median pension benefits for DB plans are
$9,227 while median pension benefits for 401(k) plans are $12,694. Even
among those with the very worst pension benefits--at the
10th percentile--401(k) benefits, $1,890, are higher than
those for the DB plans, $1,638. In short, while 401(k) plans do not
provide large pension benefits for the bottom 10th
percentile of the working population because of low earnings, poor
stock returns, or low contribution rates, so also does the bottom
10th percentile of DB pensions provide minimal benefits.\2\
By contrast, 401(k) plans provided far more generous retirement
benefits for the vast majority of workers. The 1989 DB pension benefits
are on average more generous, perhaps because of the attrition of
weaker DB plans during this period, but even with these more generous
benefits, the universe of 1995 401(k) plans still dominates (see
Samwick and Skinner, 2001, op. cit., Table 4B).
---------------------------------------------------------------------------
\2\ These very low DB benefits may reflect Social Security
``offsets'' in which the DB payment is reduced dollar-for-dollar as
Social Security monthly benefits rise.
---------------------------------------------------------------------------
In many respects, the most generous plans are those that combine
both DB and DC plans, as shown in Columns 3 and 4. Replacing combined
DB and DC plans with just 401(k) plans results (not surprisingly) in a
small average decline, and a larger median decline, in overall
benefits. For these workers, 401(k) plans were used to supplement
existing DB plans.
Figure 1 shows the secular change in the generosity for the median
worker in both DB, DC, and 401(k) plans. (Non-401(k) DC plans tended to
be more generous than just 401(k) plans.) Median expected payments from
DB plans rose between 1983 and 1989, as noted above. Other researchers
have not found increased generosity in DB plans since 1989, however.\3\
At the same time, the average expected generosity of 401(k) plans has
been increasing through the 1990s, because of both higher contribution
rates by participants and a larger share of investments in equity
rather than in bonds.
---------------------------------------------------------------------------
\3\ Gustman, Alan L., Isha Archer, Mariam Malik, and Toinu Reeves.
``Pension Changes from 1990 to 1995 Based on Data from Watson Wyatt
Reports on Pensions for the Largest Fifty Firms,'' mimeo, Dartmouth
College (1998).
---------------------------------------------------------------------------
To return to the first criticism of DC plans: we cannot say whether
they will provide an ``adequate'' level of retirement security for
workers in the future. But as Table 1 shows, the typical DC plan is
expected to yield a higher return than the typical DB plan for a broad
range of earnings and investment experiences.
2. Workers are not even contributing the recommended amounts to their
DC plans, and when they change jobs, they spend down the accumulated
401(k) assets on houses, boats, or vacations.
This combination of low contribution rates and spent pension
balances when workers change jobs would appear to predict serious
problems for the future of American Workers. In 1993, Myron Mintz,
chair of the Pension Benefit Guaranty Corporation (PBGC) stated ``A
whole generation of people are going to wake up years from now and say,
`God, I wish I had known when I was 32 that I should have been putting
this money in.'' \4\
---------------------------------------------------------------------------
\4\ Vise, David A. ``A Pensionless Future? Workers at Risk as Firms
Abandon Plans.'' The Washington Post. May 13, 1993, Section A, p. 1.
---------------------------------------------------------------------------
It's true that some workers do not roll over their DC plan balances
when they move, but instead spend them on houses, cars, or vacation
travel, particularly when the balances are small. However, rollover
rates are considerably higher when the amount of the balance is large.
Furthermore, Andrew Samwick and I show that even when workers spend a
large fraction of their DC plans when they change jobs, they still do
as well or better than DB plans. The reason is that DB plans often have
vesting provisions, are not adjusted for inflation, or are tied to the
last few years of work, meaning that they are worth little or nothing
to workers who change jobs. At least under DC plans, workers get to
spend their money on things they want to, rather than having it revert
back to the employer entirely.
What about workers who neglect to contribute to 401(k)s altogether?
It is true that a large number of workers fail to contribute to their
401(k) plans. However, the ones who fail to contribute typically have
an alternative plan, such as a DB pension; the 401(k) is simply a
supplemental plan. In a related study, we estimated that between 2-4%
of all workers are offered 401(k) plans to which they fail to
contribute, and have no alternative pension plan. By contrast, nearly
half of all workers during the period of analysis did not even have the
option of a pension, since their employers offer no pension
coverage.\5\
---------------------------------------------------------------------------
\5\ Samwick and Skinner, 1997, op. cit. Of course, this does not
mean that only half of workers will ever have pensions; indeed by the
time they are close to retiring, nearly two-thirds of households have
some accumulated pension wealth (Gustman, Alan L., Olivia S. Mitchell,
Andrew A. Samwick, and Thomas L. Steinmeier, ``Pension and Social
Security Wealth in the Health and Retirement Study,'' in J.P. Smith and
R.J. Willis, eds., Wealth, Work, and Health: Innovations in Measurement
in the Social Sciences. University of Michigan Press, 1999.)
---------------------------------------------------------------------------
To sum up, it may be true that some employees with the option to
save through defined contribution plans may not be saving enough for
retirement; pension benefits in the bottom two deciles are very low.
But as we have shown, defined benefit plans also fell short at
providing enough for retirement; on net, it appears that DC plans may
do a better job particularly with regard to workers who switch from job
to job.
3. Defined Contribution plans typically pay benefits as lump sum
disbursements at retirement rather than providing annuitization.
One concern with lump sum disbursements is that they may be
invested poorly by the recipient, or spent too quickly particularly if
the recipient (or spouse) lives for an unusually long time. By
contrast, DB plans typically pay benefits as an annuity that insures
the recipient against variation in longevity and prevent the recipients
from spending their wealth ``too'' quickly. One option for retirees
with large lump-sum payments is to roll them into Individual Retirement
Accounts (IRAs). This approach continues to defer tax payments and
allows the individual to continue to accumulate (if they wish) until
age 70 \1/2\, at which point beneficiaries must withdraw according to
an actuarial schedule. While such an approach does not provide an
annuity in the way that DB pensions do (it is still possible to run
down one's IRA account), it allows for smoothing out the 401(k) assets
over time. Alternatively, retirees could put the (after-tax) 401(k)
dollars directly into a private annuity. I am somewhat concerned about
the lack of annuitization for households with large DC pension
balances, particularly with regard to benefits for widows who may
outlive the household's assets. Annuitization could therefore be
encouraged through the use of default provisions to roll a fraction of
DC balances into annuities.
4. Defined contribution and 401(k) plans force workers to face too much
uncertainty regarding their pension benefits
There are a variety of risks facing workers with 401(k) pension
plans. In Samwick and Skinner (2001, op. cit.) we considered several
sources of risk: low overall stock and bond returns, inadequate
contribution rates, and portfolios that were 100% in stocks or 100% in
bonds. That study did not consider the problem of employee stock option
plans, or ESOPs, an issue to which we return below. As shown in the
simulation model reported in Table 1, we found that even with this
investment risk, 401(k) plans in 1995 were no more risky than DB plans
in 1983, and in fact provided greater pension security for nearly every
retiree.
The result may appear surprising, but the intuition is
straightforward. There are two sources of uncertainty; stock market
returns, and the worker's future earnings. It turns out there is
considerable variation in earnings, even among mature men. Promotions,
bonuses, or ill health can have profound effects on earnings in the
last 5 or 3 years of service, the years upon which DB plan benefits are
often based. As well, for workers in their 50s, particularly for women,
the burden of caring for aging parents may cause withdrawal from the
labor market at a time when there is the greatest pension return to
continued work experience. By contrast, the typical 401(k) plan entails
annual contributions over one's entire work history, so the resulting
balance reflects an average of earnings instead of the final few years.
And while some years in the stock market may cause the DC balances to
jump or fall by 20 percent or more, what is important is the
(geometric) average of all the stock market returns over a lengthy
period. Thus the risk faced by 401(k) enrollees appears to be no
greater than that faced by DB enrollees.
Of course, recent history tells us that there are many other
reasons why 401(k) pension plans can yield very poor returns. Even
before Enron, 10,000 employees of Carter-Hawley-Hale were required to
put their 401(k) money into company stock; the company later declared
bankruptcy.\6\ Similarly, when Color Tile declared bankruptcy in the
mid-1990s, workers found themselves out of a job and without pension
benefits; one disgruntled Color Tile worker commented ``I would never
join a 401(k) plan again. ''\7\ As well, unethical or uninformed
employers may create ``malformed'' 401(k) plans with ``too few choices,
arbitrarily set contribution limits, hidden fees, and other traits that
can, . . . at worst, seriously hobble workers' efforts to prepare for
retirement.''\8\ Finally, there is a vast reservoir of employee
ignorance about how to direct their self-directed pension funds. Based
on a survey conducted by Towers Perrin, one third of respondents
thought there was no risk in investing in bonds, (despite the
sensitivity of bond prices to nominal interest rate changes), while 40
percent of those in a self-directed saving plan did not know how their
pension assets were invested. These shortcomings are not intrinsic to
401(k) plans themselves, however. They are the consequence of
imprudently administered 401(k) plans that leave the worker uneducated
and with poor options.
---------------------------------------------------------------------------
\6\ Kahn, Virginia Munger, ``The Perils of Company Stock for
Retirement,'' The New York Times (March 16, 1997): Section 3, page 6.
\7\ Schultz, Ellen E., ``Color Tile's 401(k) Plan Runs Aground,''
The Wall Street Journal June 5, 1996, Section C, p. 1.
\8\ Johnston, David Cay, ``Investing it: Building a Better
401(k),'' The New York Times (October 22, 1995): Section 3, page 1.
---------------------------------------------------------------------------
Policy Implications and Conclusions
I have drawn on recent research with Andrew Samwick to address
criticisms of emerging defined contribution plans such as 401(k)s.\9\
We found that DC plans certainly have their faults, but their faults
are probably less severe than those found in existing DB plans. For
example, we found that DC plans are expected to entail less risk and
provide generally better pension benefits compared to DB plans. And
while workers may spend some of their lump-sum 401(k) disbursements
when they leave their jobs, at least they get to spend it on something
they like. By contrast, when workers leave firms with DB plans, they
either get nothing, or their pension payments beginning at age 65 will
be seriously eroded by inflation.
---------------------------------------------------------------------------
\9\ Samwick and Skinner, 2001, op. cit.
---------------------------------------------------------------------------
Nonetheless, it is clear that there is a great deal of room for
improvement in the design of DC pension plans, for example by improving
the rollover rates for DC plans when workers switch jobs. The Economic
Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) mandated that
rolling the 401(k) to an IRA should be the default for balances of
between $1,000 and $5,000, for example. While changing defaults have
been shown to have important effects on individual behavior, one could
strengthen this policy further by requiring workers to roll over at
least 50 percent of their 401(k) balances in excess of $1,000 into a
qualified IRA account. This compromise allows access to funds during a
potentially difficult time such as unemployment, but still preserves at
least half of the retirement nest egg. Another option is to encourage
rolling some fraction of the 401(k) balance at retirement into a
qualified annuity fund. And it goes without saying that the lack of
legal enforcement leading to ``malformed'' pension plans with
inappropriate investment choices and restrictions, and the lack of
worker financial education, are the real time bombs threatening public
(and legislative) perception of DC plans.
Finally, I return to a major shortcoming of the pension system more
generally; namely, that even by the time workers reach their 50s, one-
third of households do not have any pension wealth at all (Gustman et
al, 1999, op. cit.). Thus, a real concern with pension plans is how to
make it easier for firms to offer pensions to workers currently not
covered by any plan. In this arena, 401(k) plans offer clear advantages
over DB plans with their greater portability and fewer administrative
burdens. Defined contribution pension plans may not provide the
solution to the problem of low retirement saving among many workers.
But we have argued they have the potential to play an important role to
improve workers' financial security at retirement.
__________
Table 1: Counterfactual Pension Income Distributions, 1983 Pension
Provider Survey
------------------------------------------------------------------------
DB Only DB and DC Any DB
---------------------------------------------------------
1983 1995 1983 1995 1983 1995
PPS 401(k) PPS 401(k) PPS 401(k)
------------------------------------------------------------------------
Mean 13,917 30,880 38,135 36,905 21,412 32,745
------------------------------------------------------------------------
Median 9,227 12,694 22,970 17,086 11,874 14,061
------------------------------------------------------------------------
10th 1,638 1,890 4,929 3,102 2,103 2,160
Percentile
------------------------------------------------------------------------
90th 30,301 69,864 80,152 77,267 46,862 72,488
Percentile
------------------------------------------------------------------------
Standard 15,951 65,068 87,993 77,767 51,933 69,303
Deviation
------------------------------------------------------------------------
Obs. 22,999 ......... 10,308 ......... 33,307 ........
------------------------------------------------------------------------
Source: Samwick and Skinner, 2001 (op. cit.)
__________
Figure 1: Median Pension Benefits, by Type of Plan and Year
[GRAPHIC] [TIFF OMITTED] 866581A.016
Chairman HOUGHTON. Thanks very much, Dr. Skinner. Mr.
Miller.
STATEMENT OF SCOTT D. MILLER, PRINCIPAL, ACTUARIAL CONSULTING
GROUP, INC., SOUTH SALEM, NEW YORK, AND PRESIDENT-ELECT,
AMERICAN SOCIETY OF PENSION ACTUARIES, ARLINGTON, VIRGINIA
Mr. MILLER. Thank you, Mr. Chairman and Members of the
Subcommittee. My name is Scott Miller. I am a Principal with
Actuarial Consulting Group (ACG) with offices in New York and
Illinois. The ACG provides actuarial, consulting and planned
administrative services for retirement plans covering thousands
of participants throughout the country.
I am here today to present the view of ASPA, for whom I
currently serve as President-elect. The ASPA is a national
organization with over 5,000 retirement plan professionals who
provide consulting and administrative services for qualified
retirement plans covering millions of American workers.
The ASPA applauds this Subcommittee's leadership in
examining the need to expand and reform the private retirement
pension system. This need is critical with respect to
encouraging plan sponsors to adopt defined benefit plans.
Unlike 401(k) plans, defined benefit plans provide a
monthly annuity retirement benefit for employees. This annuity
benefit is guaranteed to continue for the life of the worker
and cannot be exhausted.
By contrast, benefits provided under a 401(k) plan are not
guaranteed and are directly dependent on actual investment
experience. This uncertainty of benefit amount is increasingly
a concern as Americans live longer than ever before. Without
defined benefit plans, there is a great risk that many
Americans will outlive their retirement savings.
While interest in defined benefit plan coverage among
employees has increased, restrictive rules have seriously
impeded the ability of large and small businesses alike to
maintain defined benefit plans for their employees.
The complex rules applicable to defined benefit plans are
particularly challenging to small businesses that lack the in-
house expertise to manage them. We need to reform these rules
so that defined benefit plans become more attractive to small
businesses.
If we can revitalize defined benefit plans, both small
businesses and their employees will benefit from the enhanced
retirement security.
The remainder of my testimony will focus on some proposals
that will help remove some of the major roadblocks faced by
small businesses that want to establish defined benefit plans
for their employees.
A defined benefit plan provides guaranteed benefits that
are not susceptible to the whims of the stock market. Thus, it
would be ideal if workers were covered by both, defined benefit
plans and 401(k) plans to ensure that at least some level of
retirement benefits are always protected.
Unfortunately, present law discourages the formation of
defined benefit plans in combination with 401(k) plans,
particularly for small businesses. For example, a defined
benefit plan and a 401(k) plan cannot be maintained in a single
plan. This requires two separate plans, adding thousands of
dollars of unnecessary annual administrative costs.
Further, present law includes nondiscrimination, testing
safe harbors. That makes it easier for employers to maintain
401(k) plans. For instance, an employer that offers a 3 percent
profit-sharing contribution on behalf of employees is deemed to
satisfy the complicated, nondiscrimination testing requirements
applicable to 401(k) plans.
However, there is no analogous 401(k) plan safe harbor for
employers who maintain a defined benefit plan, thus
discouraging this combination.
The ASPA supports a proposal called the DB-K which would
address these roadblocks making it easier for small businesses
to offer both 401(k) and defined benefit plans to their
employees. Employees are sometimes less enthusiastic about
defined benefit plans because the benefits are admittedly
harder to understand than 401(k) account balances.
In a traditional defined benefit plan, the benefit is
typically based on final average pay and is expressed in the
form of a monthly annuity that commences at retirement age.
Younger workers often find this hard to comprehend.
Employees find account based plans easier to understand and
thus more attractive. In response, new kinds of hybrid or cash
balance plans have been developed. A cash balance plan is a
defined benefit plan under which the guaranteed defined benefit
is expressed as an account balance.
I want to emphasize that with small businesses, cash
balance plans generally do not involve conversions since there
is usually no existing defined benefit plan.
There are a number of significant legal uncertainties
associated with cash balance plans because of the way benefits
are accrued and distributed as compared to traditional defined
benefit plans.
In general, these legal issues involve application of the
accrual and benefit back loading rules, application of the age
discrimination and employment act and distribution of benefits,
sometimes called the ``whipsaw problem.''
Small businesses wanting to provide a defined benefit plan
for their employees are attracted to cash balance plans since
they are easier to explain to employees and the benefits tend
to be more portable.
However, unlike their larger firm counterparts, small
businesses cannot afford high-priced lawyers to provide legal
options allowing them to sort through the various unanswered
legal questions.
These legal issues need to be quickly resolved through
Treasury Department regulations and through corrective
legislation to the extent the Treasury Department lacks the
legal authority to do so.
The ASPA greatly appreciates the Subcommittee's interest in
revitalizing defined benefit plans. In addition to the
proposals discussed in my testimony, ASPA is developing other
proposals to promote defined benefit plan coverage and we would
welcome the opportunity to discuss them with you.
The retirement security of American workers will certainly
be enhanced if we can revitalize defined benefit plans and once
again make them attractive to small business employers. Thank
you and I would be pleased to answer any of your questions.
[The prepared statement of Mr. Miller follows:]
Statement of Scott D. Miller, Principal, Actuarial Consulting Group,
Inc., South Salem, New York, and President-Elect, American Society of
Pension Actuaries, Arlington, Virginia
Introduction
Thank you, Mr. Chairman and members of the subcommittee. My name is
Scott Miller. I am a Principal of Actuarial Consulting Group, Inc.,
with offices in New York and Illinois. Actuarial Consulting Group, Inc.
provides actuarial, consulting, and plan administrative services for
retirement plans covering thousands of participants throughout the
country. Although, many of the firm's clients are small businesses with
less than 100 employees, the firm also provides retirement plan
services to larger firms, including Fortune 100 companies.
I am here today to present the views of ASPA, for whom I currently
serve as President-Elect. ASPA is a national organization of over 5,000
retirement plan professionals who provide consulting and administrative
services for qualified retirement plans covering millions of American
workers. The vast majority of these plans are maintained by small
businesses. ASPA members are retirement plan professionals of all
types, including consultants, administrators, actuaries, and attorneys.
ASPA's membership is diverse, but united by a common dedication to the
private pension system.
ASPA shares the concerns of this subcommittee, of Congress, and of
America about the tragic consequences arising from the bankruptcy of
Enron Corp. We applaud this subcommittee's leadership in exploring
whether, and where, our nation's pension laws may need strengthening.
We also commend the subcommittee for its stated commitment to
maintaining the framework of laws upon which is built a strong,
employer-based system of providing retirement income benefits to our
nation's workers.
The current plight of the Enron 401(k) plan participants highlights
the need to expand and reform the private pension system. The need for
reform is especially acute with respect to encouraging plan sponsors to
adopt and provide defined benefit pension plans. Unlike 401(k) and
other defined contribution plans, defined benefit pension plans provide
a defined monthly annuity retirement benefit for employees. This
annuity benefit is guaranteed to continue for the life of the worker
and cannot be exhausted. On the other hand, benefits provided under a
401(k) or other defined contribution plan are not guaranteed and are
directly dependent on actual investment experience. Therefore, the
level of benefits and how long they can continue to be paid is unknown
to the retiree. As Americans live longer then ever before, this
uncertainty regarding the actual amount of retirement benefits is
increasingly a concern.\1\ Without defined benefit pension plans, there
is a great risk that many Americans will outlive their retirement
savings.
---------------------------------------------------------------------------
\1\ The average life expectancy of Americans born in 1960 was 69.7
years. It has been estimated that those born in 2000 will live for an
average of 76.4 years. U.S. National Center for Health Statistics,
Vital Statistics of the United States.
---------------------------------------------------------------------------
Further, and very importantly, in a defined benefit pension plan,
it is the employer, and not the employee, that bears the risk of
investing the plan assets. This means that the employer has an
obligation to make sure the defined benefit pension plan is properly
funded to provide the promised benefits, regardless of investment
experience. Therefore, the lower the investment returns, the higher the
required employer contribution. Additionally, the Pension Benefit
Guaranty Corporation insures the payment of a minimum level of
retirement benefits under a defined benefit pension plan should the
plan sponsor's financial stability falter and they are not able to
properly fund the plan.
According to a recent survey, interest in defined benefit pension
plan coverage among employees has increased by 20 percent as employees
find it difficult to manage their 401(k) plan accounts.\2\ However,
since the passage of ERISA, many restrictive and complex laws have been
enacted, and complicated regulations issued, which have seriously
impeded the ability of large and small businesses alike to maintain
defined benefit pension plans for their employees.
---------------------------------------------------------------------------
\2\ PlanSponsor.com (June 5, 2002).
---------------------------------------------------------------------------
The consequences of this have been dramatic, particular for small
businesses. According to the Department of Labor, since 1983 the number
of small business defined benefit pension plans has dropped over 70
percent. The termination of these defined benefit pension plans has
occurred during a period of time when small businesses are employing an
ever-increasing percentage of the U.S. workforce. Today, small
businesses employ half of the nation's workers, and have created more
than half of the new jobs in recent years. However, according to the
Bureau of Labor Statistics, small business employees are only half as
likely to be covered by any retirement plan, and only one-fifth as
likely to be covered by a defined benefit pension plan, than their
counterparts working at larger firms.
This disparity between small and large business employees is
clearly unacceptable. Some of the most burdensome and complex rules in
pension law apply to defined benefit pension plans. These rules are
particularly challenging to small businesses that lack the in-house
expertise to manage them. We need to reevaluate and modernize these
rules so that defined benefit pension plans become more attractive to
small businesses. This can be done while still protecting the interests
of employees. If we can revitalize defined benefit pension plans, both
small businesses and their employees will benefit from the enhanced
retirement security.
The remainder of my testimony will focus on proposals that will
help remove the major roadblocks faced by small businesses that want to
establish and maintain defined benefit pension plans for their
employees.
Proposals to Promote Small Business Defined Benefit Pension Plan
Coverage
Facilitate Combination Defined Benefit/401(k) Plans (the ``DB-K'')
A defined benefit pension plan provides a guaranteed level of
benefits to workers (insured by the federal government) that are not
susceptible to the whims of the stock market. By contrast, benefits
under a defined contribution plan, like a 401(k) plan, are dependent on
investment returns--if the stock market goes down, benefits are
reduced. Consequently, it would be ideal if workers were covered by
both a defined benefit pension plan and a 401(k) plan to ensure that at
least some retirement benefits are always protected.
Unfortunately, present law discourages the formation of defined
benefit pension plans in combination with 401(k) plans, particularly
for small businesses. For example, a defined benefit pension plan and a
401(k) plan cannot be maintained as a single plan with a single trust.
Requiring two separate plans adds thousands of dollars of unnecessary
annual administrative costs. Further, present law includes
nondiscrimination testing safe harbors that make it easier for
employers to maintain 401(k) plans. For instance, an employer that
offers a 3 percent profit-sharing contribution on behalf of employees
automatically satisfies complicated nondiscrimination testing
requirement applicable to 401(k) plans. However, there is no analogous
401(k) plan safe harbor for employers who maintain a defined benefit
pension plan, thus discouraging employers from offering both 401(k) and
defined benefit plans.
In addition, special corporate deduction limits are triggered when
an employer funds both a defined benefit pension plan and a 401(k)
plan. These deduction limits are often problematic for small businesses
since they are based on a percentage of aggregate employee compensation
and small businesses naturally have fewer employees and therefore a
limited contribution level. If the small business is offering a 401(k)
plan with matching contributions, a fairly typical scenario, these
deduction limits greatly inhibit the ability of the small business to
offer an additional defined benefit pension plan.
Finally, present law also does not permit employees to earn higher
defined benefit accruals in the form of matching contributions, that
relate to the amount an employee contributes to a 401(k) plan. If it
did, this would allow employers to reward employees who save for
retirement on their own behalf, with greater employer guaranteed
defined benefits.
ASPA supports a proposal, called the ``DB-K'', which would address
these roadblocks making it easier for small businesses to offer both
401(k) and defined benefit pension plans to their employees. Although
there are several technical details which we would be happy to outline
for you, in summary the DB-K proposal would accomplish four objectives:
LFirst, a 401(k) plan and a defined benefit pension
plan could be maintained as a single plan with a single trust
with reduced administrative costs.
LSecond, under a new 401(k) plan safe harbor, the
nondiscrimination test applicable to 401(k) plans will be
satisfied if a defined benefit pension plan maintains a
sufficient level of benefit (e.g., 1 percent per year final
average pay plan accumulated over 20 years) that is always
fully vested.
LThird, certain matching and/or profit sharing
contributions under a 401(k) plan (including a 401(k)
arrangement that is maintained as part of a defined benefit
pension plan) would be disregarded in determining whether the
special deduction limits for combined plan funding are
exceeded.
LFourth, the law would be modified to allow for
defined benefit pension plans to provide higher benefit
accruals for employees who take the responsibility to save,
through matching benefit accruals based on the level that
employees defer from their compensation.
Clarify Rules Governing Hybrid or ``Cash-Balance'' Plans
Employees are sometimes less enthusiastic about defined benefit
pension plans because the benefits are admittedly harder to understand
than 401(k) account balances. In a traditional defined benefit pension
plan, the benefit is typically based on final average pay and is
expressed in the form of a monthly annuity that commences at retirement
age, which is often far off into the future. Employees find account-
based plans, that track current account values, easier to understand
and thus more attractive.
In response, new kinds of hybrid or ``cash balance'' plans have
been developed. A cash balance plan is a defined benefit pension plan
under which the promised benefit is expressed as a hypothetical account
balance. The account is ``hypothetical'' because there is no actual
account established on behalf of the participant. Nonetheless, the
participant is entitled to the benefit provided in the account. This
account is really just a bookkeeping notion. An eligible employee
accrues a benefit by earning a right to a hypothetical contribution
(usually a percentage of compensation) for each year of participation,
which is credited to the employee's account. The hypothetical account
balance is also increased each year by a guaranteed interest rate. When
benefits are distributed from a cash balance plan, the hypothetical
account balance is converted into the actuarial equivalent of the form
of annuity or installment benefit payable under the plan (or chosen by
the participant, if the plan provides multiple payment options). These
options could include a single lump sum distribution.
There are a number of significant legal uncertainties associated
with cash balance plans because of the way benefits are accrued and
distributed as compared to traditional defined benefit pension plans.
Although these issues are technical in nature, they are critical to the
legal operation of the plan. In general, these legal issues involve
application of the accrual and benefit backloading rules to cash
balance plans, application of the Age Discrimination and Employment Act
to cash balance plans, and distribution of the benefit under a cash
balance plan (the so-called ``whipsaw'' problem).
There has also been some controversy when employers, generally
larger employers, have converted traditional defined benefit pension
plans to cash balance plans. However, conversions are generally not an
issue for small businesses considering a cash balance plan, since there
is often no preexisting defined benefit pension plan.
Small businesses wanting to provide a defined benefit pension plan
for their employees are attracted to cash balance plans since they are
easier to explain to employees and the benefits tend to be more
portable. Unfortunately, most small businesses are reluctant to
establish these defined benefit pension plans because of the legal
uncertainties. Unlike their larger firm counterparts, small businesses
cannot afford high-priced lawyers to provide legal opinions allowing
them to sort through the various unanswered questions. Small businesses
will not provide these valuable defined benefits for their employees
unless these legal uncertainties are resolved in a clear and
unambiguous way. It is critical that these issues are quickly resolved
through Treasury regulations, or through corrective legislation to the
extent Treasury lacks the legal authority to do so.
Modernize Actuarial Assumptions
Current laws with regard to actuarial assumptions required for
defined benefit funding and benefit calculations are outdated. For
example, current rules require the use of 30-year Treasury bond
interest rates when calculating the current liability of the plan. Last
October the Department of Treasury announced that it was no longer
issuing 30-year Treasury bonds. However, defined benefit pension plan
funding calculations are still based on these rates, which is now
artificially low since no new bonds are being issued. Use of this
artificially low 30-year Treasury bond rate has contributed to the
unnecessary overfunding of many larger defined benefit pension plans,
making them less attractive to these employers. Fortunately, this year
Congress enacted a temporary solution that will last through 2003.
However, a permanent replacement interest rate benchmark must be found
soon to address employer's uncertainties about future funding
obligations.
The fluctuations in the 30-year Treasury bond rate have also had a
negative impact on small business defined benefit pension plans. Under
current law, the 30-year Treasury bond rate is also used for
calculating the defined benefit pension plan limit under IRC Section
415(b) for lump sum distributions. A reduction in the rate yields a
higher limit, putting added funding pressure on plans, especially
smaller plans that suddenly are required to make higher than
anticipated lump sum payments to participants. This unanticipated
increase can amount to tens of thousands of dollars, simply due to a
minor change in the monthly interest rate \1/4\ of a percent). A small
business may not be able to afford such uncertainty. These consistently
changing interest rates cause required funding levels to often
fluctuate significantly making financial planning for small businesses
difficult.
Prior to 1994, this problem did not exist. A fixed 5 percent
interest rate was used for calculating the defined benefit pension plan
limit under IRC Section 415(b) for lump sum distributions. ASPA
believes that we should return to this benchmark to give small
businesses more stability with respect to plan funding requirements.
This would also give small business owners, who are often subject to
the 415 limit, a precise measure of what their benefit will be at
retirement. Because of present law, you cannot tell many small business
owners exactly what their benefit will be at retirement, because an
interest rate fluctuation at the time of retirement could significantly
affect their benefit amount. This uncertainty makes the defined benefit
pension plan less attractive to the small business owner when deciding
whether or not to adopt a plan for herself and her employees.
Allow for Flexible Funding of Defined Benefit Pension Plans
Employers, particularly small employers, are also often reluctant
to adopt defined benefit pension plans because of mandatory funding
requirements. These mandatory funding requirements are designed to
ensure that defined benefit pension plans are adequately funded. They
require that employers contribute at least a minimum amount to the plan
each year--a minimum funding requirement. Employers, particularly small
businesses, are often worried that they may not be able to afford the
minimum funding requirements if there is a business downturn.
Unfortunately, present law also limits the maximum amount employers can
contribute to the plan in any year, and thus prevents prospering
employers from contributing an additional amount when the business is
doing well, and can afford it, to cover a potential future business
downturn. This presents an unacceptable risk to many small businesses
whose revenue can be dramatically affected by an economic recession in
a manner disproportionately greater than larger firms. Ironically, the
operation of current law funding requirements generally require higher
minimum funding requirements during an economic downturn and restrict
funding during a stronger economy.
ASPA believes that an employer maintaining a defined benefit
pension plan should be permitted to contribute an additional amount
(within reasonable limits) during an economic upswing to prepare for
the potential of a future economic downturn. This could be allowed, for
example, once every five years. Under such a proposal, the total amount
contributed to the plan over the given period would not change. It
would simply allow the small business to make larger contributions in
the years the additional financial resources are available.
Conclusion
ASPA greatly appreciates this subcommittee's interest in
revitalizing defined benefit pension plans. In addition to the
proposals discussed in my testimony, ASPA is developing other proposals
to promote defined benefit pension plan coverage and we would welcome
the opportunity to discuss them with you. The retirement security of
American workers will certainly be enhanced if we can revitalize
defined benefit pension plans and once again make them attractive to
small business employers.
Thank you, Mr. Chairman and members of the subcommittee, for this
opportunity to make our views known. I would be pleased to answer any
questions you may have.
Chairman HOUGHTON. Well, thanks very much, Mr. Miller.
Mr. Beilke.
STATEMENT OF MARK BEILKE, DIRECTOR, EMPLOYEE BENEFITS RESEARCH,
MILLIMAN USA, VIENNA, VIRGINIA, ON BEHALF OF THE AMERICAN
BENEFITS COUNCIL
Mr. BEILKE. Mr. Chairman, thank you very much for the
opportunity to appear today. Milliman USA is a consulting and
actuarial firm with more than 5,000 employee benefit clients of
all sizes, most of which sponsor defined benefit plans. I am
appearing today on behalf of the American Benefits Council
where Milliman serves on the Board of Directors.
Mr. Chairman, other witnesses today have detailed the poor
health of our defined benefit system. A key factor is that
throughout the 1980s and early 1990s frequent changes were made
to the statutes governing defined benefit plans. The result was
that administration of these plans has become increasingly
expensive and complicated.
During the same period, Congress repeatedly reduced the
benefits that could be earned through defined benefit plans,
undermining the commitment to these voluntary plans by key
decision makers.
Representatives Portman and Cardin have led the effort to
establish a more supportive environment for defined benefit
plans. Their work culminated in the landmark reforms enacted in
the 2001 tax law.
In the Council's view, making these pension changes
permanent, something the House may consider as soon as
tomorrow, is one of the most important steps Congress can take
to encourage defined benefit plans.
To stem defined benefit plan terminations, Congress needs
to correct the artificially inflated liabilities that employers
face as a result of the demise of the 30-year Treasury bond.
Under current law, defined benefit plan sponsors are required
to use 30-year Treasury bond rates for a variety of
calculations under the plan. Yet the Treasury Department's buy
back and discontinued issuance of 30-year Treasury bonds has
driven these rates to a level significantly below other
conservative long-term bond rates.
The result has been an artificial inflation in pension
liabilities. This produces a very substantial increase in the
pension contributions and PBGC premiums employers must pay.
These unreasonably inflated liabilities play an increasing role
in employers' decisions to abandoned defined benefit pensions.
Led by Representatives Johnson of Texas, Portman, Cardin,
and Pomeroy, Congress has already moved to address these very
serious problems by enacting short-term pension funding and
premium relief and additional short-term relief is contained in
the House-passed Pension Security Act.
Next, it will be imperative for Congress to enact permanent
pension interest rate reform. This will involve selection of a
new long-term interest rate, not only for pension funding and
premium purposes, but for all pension calculations currently
dependent on the 30-year rate, including the valuation of
maximum benefits and lump sums payable from defined benefit
plans.
Any change affecting lump sums will, of course, need to
include significant transition relief for employees nearing
retirement age.
The Council is committed to working with Congress and with
groups from across the ideological spectrum to craft a
permanent pension interest rate reform so necessary for defined
benefit plans to remain viable.
One bright spot in the defined benefit landscape has been
the development of cash balance and other hybrid defined
benefit plans. While these plans offer traditional defined
benefit advantages such as employer funding and risk bearing,
plus Federal guarantees, they do so in an individual account
form, which enhances portability and understandability.
Their benefit accrual pattern is not as backloaded as
traditional plans, producing higher pension benefits for
employees who switch jobs several times during their careers.
As a result, cash balance plans are often a better fit for
the retirement needs of today's mobile workforce.
Unfortunately, the laws and regulations applicable to
defined benefit plans have not been updated to reflect the
development of cash balance plans. The relevant Federal
agencies have been engaged for several years in an effort to
resolve the uncertainties caused by the awkward application of
the traditional rules to these plans.
This effort is apparently nearing fruition and proposed
guidance on some of these questions is eagerly awaited by the
benefits community. The Council believes that whether through
regulatory guidance or statutory clarification, it is
imperative that we resolve the remaining uncertainties
surrounding cash balance plans. These plans are the only source
of vitality in our defined benefit system today and are the
most effective way to preserve defined benefit plan advantages
in a manner that meets the needs of a mobile workforce.
Our policy framework should encourage these plans through
clear rules that acknowledge their unique design features and
we hope to work with Congress to achieve this result.
Mr. Chairman, the Council feels strongly that we must
ensure that both traditional and cash balance defined benefit
plans remain viable choices for employers so the companies can
select the pension design most suited to the needs and wishes
of their workforce.
Defined benefit plans offer unique advantages for
employees, but without prompt action by Congress we fear these
plans will increasingly disappear from the American pension
landscape. Thank you, Mr. Chairman.
[The prepared statement of Mr. Beilke follows:]
Statement of Mark Beilke, Director, Employee Benefits Research,
Milliman USA, Vienna, Virginia, on behalf of the American Benefits
Council
Chairman Houghton, Ranking Member Coyne, thank you very much for
the opportunity to appear before you today on this critically important
topic. I am Mark Beilke, Director of Employee Benefits Research for
Milliman USA. Milliman USA is a firm of consultants and actuaries with
more than 30 offices in the U.S., more than 1,600 employees, and over
5,000 employee benefits clients, most of which sponsor defined benefit
pension plans. I am appearing today on behalf of the American Benefits
Council, where Milliman serves on the board of directors. The American
Benefits Council (Council) is a public policy organization representing
principally Fortune 500 companies and other organizations that assist
employers of all sizes in providing benefits to employees.
Collectively, the Council's members either sponsor directly or provide
services to retirement and health plans covering more than 100 million
Americans.
Background on Defined Benefit Plans
Mr. Chairman, I want to thank you for calling this hearing to
examine the state of our nation's defined benefit pension system. Such
an examination is urgently needed. While the private-sector defined
benefit system helps millions of Americans achieve retirement income
security, it is not a system in good health. The total number of
defined benefit plans has decreased from a high of 170,000 in 1985 to
59,000 in 1997 (the most recent year for which official Department of
Labor statistics exist), and most analysts believe there are fewer than
50,000 plans in the U.S. today.\1\ There has been a corresponding
decline in the percentage of American workers with a defined benefit
plan as their primary retirement plan from 38% in 1980 to 21% in 1997.
Looking at the decline in defined benefit plans from one year to the
next makes this unfortunate downward trend all the more stark. The
Pension Benefit Guaranty Corporation (PBGC) reports that it insured
39,882 defined benefit plans in 1999 but only 38,082 plans just one
year later in 2000. This is a decrease of almost two thousand defined
benefit plans in a single year. Furthermore, based on what we are
seeing throughout my firm, there is more plan termination activity in
2002 that we have seen in recent years.
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\1\ The decline in sponsorship of defined benefit plans is in stark
contrast to the increase in sponsorship of defined contribution plans,
such as 401(k)s. According to the same official Department of Labor
statistics, the number of defined contribution plans has increased from
462,000 in 1985 to 661,000 in 1997.
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These numbers are particularly sobering because defined benefit
plans offer a number of features that are effective in meeting employee
needs--benefits are funded by the employer (and do not typically depend
upon employees making their own contributions to the plan), employers
bear the investment risk in ensuring that earned benefits are paid,
benefits are guaranteed by the federal government through the PBGC, and
benefits are offered in annuity form. The stock market conditions of
recent years (and the corresponding decline in many individuals' 401(k)
balances), as well as the national retirement policy discussions
spurred by the bankruptcy of the Enron Corporation, have once again
demonstrated to many the important role that defined benefit plans can
play in an overall retirement strategy.
So, with these advantages for employees, what has led to the ill-
health of the defined benefit system? Several factors have played a
role. First, the statutory and regulatory landscape has not been
friendly to defined benefit plans and the companies that sponsor them.
Throughout the 1980's and early 1990's, frequent changes were made to
the statutes and regulations governing defined benefit pensions, often
in the name of promoting pension ``fairness.'' Yet the result was that
these plans became increasingly expensive and complicated to administer
and the plan design flexibility so important to employers was impaired.
During the same period, and motivated by a desire to raise federal
revenue, Congress repeatedly reduced the benefits that could be earned
and paid from defined benefit plans, undermining the personal
commitment to these voluntary plans by senior management and other key
decision-makers.
Defined benefit plans also require very significant--and often
unpredictable--financial commitments from employers, something that
many companies found more difficult to maintain in light of intense
business competition from domestic and international competitors, many
of which did not offer defined benefit plans and so did not have the
corresponding pension expense. In addition, employees have not tended
to place great value on defined benefit pension benefits offered by
employers, preferring ``shorter-horizon'' and more visible benefits
such as 401(k) and other defined contribution plans, stock option or
stock purchase programs, health insurance and cafeteria plans. So
ironically, while defined benefit plans have been complicated for
employers to administer and expensive for them to maintain, they have
not resulted in a significant increase in employee satisfaction, which
is one of the core reasons for an employer to offer a benefit program
in the first place.\2\
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\2\ Employee preference for account-based and more portable
benefits has been a prime factor in the development of hybrid defined
benefit plans, which are discussed below.
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The Pension Achievements Contained in the 2001 Tax Law
The Council is very gratified that in recent years Congress has
recognized these disturbing trends and has begun to establish a more
supportive policy environment for defined benefit pensions. This change
of direction was initiated by Representatives Rob Portman and Ben
Cardin and began in earnest with passage of the Portman/Cardin pension
reforms contained in the Small Business Job Protection Act of 1996 and
the Taxpayer Relief Act of 1997.
Representatives Portman and Cardin continued their efforts with the
Comprehensive Retirement Security and Pension Reform Act (H.R. 1102 in
the 106th Congress; H.R. 10 in the 107th
Congress), which was ultimately enacted as part of the 2001 tax law.
This legislation contained a number of very positive changes to the
rules governing defined benefit plans. Correcting a series of past
revenue-driven restrictions enacted by Congress, the Portman/Cardin
legislation repealed an artificially low cap on pension funding that
had complicated pension budgeting and financing. It also increased the
benefits that can be earned under--and paid from--qualified defined
benefit pension plans so that these plans remain an attractive vehicle
for employers to sponsor in our voluntary pension system. The Portman/
Cardin legislation also simplified a number of the most complex rules
applicable to defined benefit plans, making these plans somewhat easier
to administer, particularly in the context of mergers and acquisitions.
Mr. Chairman, you played a leading role in advancing these pension
reforms through the Ways & Means Committee and many members of this
Subcommittee worked to see these reforms enacted as part of the
Economic Growth and Tax Relief Reconciliation Act of 2001. Thank you
for these efforts, and thank you, of course, to Representatives Portman
and Cardin for their leadership in drafting and advancing a series of
reforms that have put our nation's defined benefit pension policy on a
new and more productive course.
Making the 2001 Pension Reforms Permanent
We understand that this week the House of Representatives will
consider legislation introduced by Representatives Portman and Cardin--
H.R. 4931, the Retirement Savings Security Act of 2002--which will make
the pension changes of the 2001 tax law permanent. In the Council's
view, this is one of the most important steps Congress can take to
continue to encourage and support defined benefit pension plans. Sound
pension policy depends upon truly long-range planning and budgeting,
for both employees and employers, and this is difficult to achieve
given that all of last year's positive reforms are scheduled to
evaporate come 2011. Consistency and supportiveness have too often been
lacking in our nation's policy toward defined benefit pension plans,
but by making the 2001 pension changes permanent Congress can realize
these goals and help to restore the health of our nation's defined
benefit system.
Unfinished Pension Reforms from the Portman/Cardin Legislation
Additional changes to our pension laws that would aid defined
benefit pensions were contained in the Portman/Cardin pension
legislation approved by the House (H.R. 10) but were not enacted as
part of the final 2001 tax law due to anticipated application of the
Byrd Rule in the Senate. Representatives Portman and Cardin have
gathered these reforms in H.R. 3918, the Pension Improvement Act of
2002 and nearly all of these reforms were included in the Pension
Security Act (H.R. 3762) passed by the House of Representatives on
April 11, 2002.
These reforms would make defined benefit plans a more attractive
vehicle for small employers through pension insurance premium relief
and simplified reporting. They would create fairness for defined
benefit plan sponsors by allowing the PBGC to pay interest on premium
overpayments. Finally, they would help to simplify and rationalize
defined benefit plan administration through a number of regulatory
reforms, such as providing a limited safety valve from mechanical
testing rules, encouraging electronic dissemination of plan documents,
and modernizing plan notice regimes.
The provision providing for a limited safety valve from the
mechanical pension testing rules has come under criticism from some
quarters. The Council believes that this criticism is unfounded and
that the safety valve provision is needed to ensure the rationality of
the rules governing our pension system. The provision has been
thoroughly vetted and debated and has been approved by the House of
Representatives five times, often by overwhelming margins. The
provision merely provides a limited safety valve so that fair pension
plans that may be tripped up by mechanical testing rules can, under
limited circumstances, demonstrate the equity of their plan to Treasury
Department officials.
We encourage you to enact these important remaining items from the
Portman/Cardin pension legislation this year in order to take another
important step to support and encourage defined benefit pensions.
Pension Interest Rate Reform
Another area in which Congress has been tremendously helpful in
recent months is in addressing the very serious repercussions for
defined benefit pension plans of the decline in 30-year Treasury bond
rates.\3\ If one puts aside the necessary follow-up work to enact the
unfinished Portman/Cardin pension changes and to make the 2001 pension
reforms permanent, clearly the action most urgently needed to stem the
increasing number of defined benefit plan terminations is for Congress
to enact permanent and comprehensive reform of the interest rates used
for pension calculations. To highlight the urgency of this task, the
Council has recently learned of several large employers that have
concluded they must freeze their defined benefit plans. In each
instance, the financial ramifications stemming from the low 30-year
Treasury bond rates has been a primary factor.
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\3\ The decline in these rates is attributable to the Treasury
Department program of the last four years to buy back 30-year bonds
from the public and was capped off by the outright discontinuation of
the 30-year bond on October 31, 2001.
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Under current law, employers that sponsor defined benefit pension
plans are required to use 30-year Treasury bond rates for a wide
variety of pension calculations. Yet the Treasury Department's buyback
program and subsequent discontinuation of the 30-year bond has driven
rates on these bonds to a level significantly below other conservative
long-term bond rates. The result has been an artificial inflation in
pension liabilities, often by more than 20 percent. As a result of
these inflated liabilities, employers confronted inflated required
pension contributions and inflated variable premium payments to the
PBGC. Due to the nature of the pension funding rules, a number of
employers faced dramatic increases in their pension funding
obligations. I personally saw plans that had been overfunded for
several years, requiring no cash contributions, which required
substantial funding. Others that had modest and predictable
contribution levels in the past saw funding requirements at multiples
of what had been required in recent years.
Congress recognized that these unwarranted funding and premium
obligations could not have come at a worse time. Such requirements
would drain away hundreds of millions of dollars at a time when
employers needed all the resources they could muster to keep workers on
the payroll and to make the purchases and investments necessary to
return the nation to economic growth. Congress also recognized that
unreasonably inflated liabilities discourage employers from maintaining
strong pension programs for their employees.
To correct for these inflated liabilities, Congress included short-
term pension interest rate relief in the Job Creation and Worker
Assistance Act of 2002, which President Bush signed into law on March
9, 2002. This short-term relief helped to remedy the artificially
inflated funding and premium obligations faced by employers for the
2002 and 2003 plan years. It did so by allowing employers to use a
higher interest rate for pension purposes (120 percent of the 30-year
bond rate for funding purposes and 100 percent of the 30-year bond rate
for premium purposes). This relief has made a meaningful difference to
employers around the nation who have seen artificial liabilities
corrected and precious resources freed up for maintaining payrolls and
keeping businesses strong. This helped salvage employer commitment to
these plans so as to ensure that employees will continue to build
defined benefit pension benefits.
Four members of the Ways & Means Committee--Representatives Sam
Johnson, Rob Portman, Ben Cardin and Earl Pomeroy--led the effort to
secure this relief, and the Council wishes to extend its sincere
appreciation for their leadership on this issue. These same Members are
now working hard to apply the relief to the final 2001 payment that
defined benefit plan sponsors must make by September 15, 2002 and to
make a number of technical corrections to the relief provided in the
stimulus legislation. These additional reforms were included in the
House-passed Pension Security Act (H.R. 3762) and the Council looks
forward to working with the Ways & Means Committee to identify an
appropriate legislative vehicle that can carry these additional reforms
to the President's desk in a timely fashion.
Once short-term relief has been achieved, the Council believes it
will be imperative for Congress to turn its attention to developing and
enacting permanent and comprehensive pension interest rate reform. This
effort must involve selection of a substitute long-term interest rate
for use by pension plans in lieu of the 30-year Treasury bond rate. The
effort must also involve correction of the rate not only for pension
funding and premium purposes (the areas addressed by the short-term
relief) but for all pension purposes currently dependent on the 30-year
rate, such as the valuation of maximum benefits and lump sums payable
from defined benefit pensions.
The low 30-year Treasury bond rates have had the same inflationary
effect on lump sum payments from defined benefit plans that they have
had on the funding and premium obligations of these plans. In other
words, the low rates have produced artificially inflated lump-sum
payments to departing employees. While these inflated lump sums may
appear to redound to the benefit of the affected employees, the reality
is that the drain of cash from plans as a result of these artificially
inflated payments has led a number of plan sponsors to freeze or
terminate their defined benefit plans. This is clearly a very
unfortunate result for the employees at these firms. Artificially
inflated lump sums also deter employees from taking their benefit in an
annuity form of payment, which would often be the preferable choice
from a retirement income security and retirement policy perspective.
Clearly, any change to the interest rate used for lump-sum valuation
purposes will need to include significant transition relief for
participants nearing retirement age, but making this change is critical
to the future of defined benefit plans.
We cannot over emphasize the urgency of developing this permanent,
comprehensive reform nor the degree to which achieving this reform is
related to stemming the decline in defined benefit plans. The Council
is committed to working with Congress and with groups from across the
ideological spectrum to craft the permanent, comprehensive pension
interest rate reform so necessary for defined benefit plans to remain
viable.\4\
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\4\ The Council is currently developing our recommendations
regarding the appropriate permanent, comprehensive solution to the
pension interest rate problem and will be pleased to share our thoughts
with Congress when we complete this process.
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Hybrid Plan Clarification
One notable bright spot in the defined benefit plan landscape in
recent years has been the development of what are known as hybrid
defined benefit plans, the most common variety of which is the cash
balance plan.\5\ These plans have proven popular with employees and
employers alike. While they offer the benefits of a traditional defined
benefit plan (employer funding and risk-bearing, federal guarantees,
the option of annuity benefits), they do so in an individual account
form that is more easily understood and therefore more easily
integrated into the employee's overall retirement planning. Cash
balance plans also offer the benefit of portability since benefits can
be rolled over to an employee's next workplace retirement plan or to an
Individual Retirement Account. In addition, they offer a more even
accrual pattern than traditional defined benefit plans (where
significant benefit accruals are dependent on long service, producing
disappointing results for employees who switch jobs several times
during their careers). The bottom line is that the individual accounts,
portability and level accruals of cash balance plans often make these
hybrid defined benefit plans a better fit for the retirement needs of
today's mobile workforce than the traditional defined benefit
pension.\6\
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\5\ The cash balance design combines features of a traditional
defined benefit pension with those of a defined contribution plan such
as a 401(k), hence the term ``hybrid.'' In a traditional defined
benefit plan, an individual's pension is generally determined by a
formula incorporating the employee's years of service and pay near
retirement. The benefit in this traditional pension is expressed in the
form of a lifetime annuity (stream of income) beginning at normal
retirement age, which is typically 65. In a cash balance plan, an
individual's pension is generally determined by an annual benefit
credit (typically a percentage of pay) and an annual interest credit
(an annual rate of interest that is specified by the plan). These
benefit and interest credits are expressed as additions to an
individual's cash balance account. These accounts grow over time as the
benefit and interest credits accumulate and compound. Benefits in a
cash balance plan are ultimately paid out in the form of a lifetime
annuity or a lump sum.
\6\ Congress devoted significant attention to conversions from
traditional defined benefit plans to cash balance plans during the
106th Congress. It was understandably concerned about the
information employees received regarding these conversions and how
certain, discrete groups of workers were affected by the change in plan
design. These concerns led to enactment of an expanded notice
requirement as part of the 2001 tax law, which will ensure that all
employees receive the information they need to understand these
conversions and the effect on their pension benefits.
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Unfortunately, the laws and regulations applicable to defined
benefit plans have not been updated to reflect the development and
adoption of cash balance plans over the last 15 years. These defined
benefit rules were constructed entirely around the model of a
traditional defined benefit plan, where the typical formula is tied to
years of service and final pay and the benefit is paid in an annuity
form at age 65. As a result, the rules are ill-suited to account-based
cash balance plans, which have more level accruals and typically pay
lump sums at whatever age employees depart. The awkward application of
the traditional defined benefit rules to cash balance plans has left a
number of pressing legal and compliance issues regarding these hybrid
plans unresolved.
To give one example, some uncertainty exists regarding whether the
value of the cash balance account constitutes the employee's accrued
benefit in a cash balance plan. This is clearly what is intended under
a cash balance plan such that when an employee departs they are paid
the balance in their account. Yet some have argued that application of
the traditional defined benefit rules yields a different result. This
theory holds that, in determining an employee's lump sum distribution
from a cash balance plan, the plan must project the cash balance
account value forward to normal retirement age using the plan's
interest crediting rate and then discount the resulting figure to a
present value using the statutorily prescribed 30-year Treasury bond
rate. When the plan's interest crediting rate is higher than the 30-
year bond rate, this process produces an amount higher than the value
of the cash balance account. This has been dubbed the ``whipsaw''
theory. While such a theory might appear to benefit the affected
employee, the result is that employers must lower the cash balance
plan's interest crediting rate for all employees to the low 30-year
Treasury bond rate in order to avoid whipsaw, substantially impairing
the growth in cash balance accounts that would result from payment and
compounding at a higher interest rate.
The federal agencies with jurisdiction over defined benefit plans--
led by the Treasury Department--have been engaged for several years in
an effort to resolve some of these legal and compliance uncertainties.
The Council understands that this effort is nearing fruition and that
proposed guidance on some of these questions may be issued later this
summer. Yet it appears that the regulatory guidance will not address
all of the outstanding issues, and the agencies may well conclude that
they do not have statutory authority to reach all of the open
questions. The Council believes that, whether through regulatory
guidance or statutory change, it is imperative that we resolve the
remaining uncertainties surrounding cash balance plans. These plans are
the only real source of vitality in our defined benefit system today
and have proven themselves to be the most effective way to deliver
defined benefit plan advantages and protections in a way that meets the
needs of today's mobile employees. The statutory and regulatory climate
should encourage these plans through clear rules that acknowledge their
unique design features. Thus, we hope to work with Congress in the wake
of the issuance of regulatory guidance later this year to complete the
task of establishing a stable and supportive legal environment for cash
balance plans.
The Next Generation of Pension Reform
With the enactment of the many positive Portman/Cardin pension
reforms as part of the 2001 tax law, the Council has spent a good deal
of time over the past year developing additional recommendations to
further strengthen and expand the employer-sponsored retirement system.
A number of these recommendations focus on ways to revitalize our
defined benefit system and many of the defined benefit reforms I have
already discussed today top our list of recommendations. Thus, we
believe making the 2001 pension reforms permanent, enacting the
unfinished Portman/Cardin pension changes, achieving permanent and
comprehensive pension interest rate reform, and clarifying the rules
applicable to cash balance plans are the most important steps Congress
can take to improve the health of our defined benefit system.
Yet there are other reforms that the Council believes would help
strengthen defined benefit pensions, and let me share a few with you
today.
LFirst, the Council believes it is appropriate to
consider reducing the per participant pension insurance
premiums that employer sponsors of defined benefit plans pay to
the PBGC. The premium discounts contained in the original
Portman/Cardin bill and included in recent House-passed pension
legislation (H.R. 3762) benefit only small employers or those
firms that have never had a defined benefit plan. We believe
modest premium relief would also be appropriate for employers
to help restrain this significant cost that accompanies
sponsorship of a defined benefit pension.
LSecond, the Council believes Congress should help to
make defined benefit pension benefits a more useful mechanism
for the financing of retiree medical coverage. Pension benefits
are often used to meet health costs in retirement and we
believe certain tax changes would help employees do this more
efficiently. At many companies today, employees are asked to
bear a share of the cost of retiree medical coverage. Yet if
these employees are receiving a pension benefit and wish to pay
their retiree medical premium with these funds, the position of
the Internal Revenue Service appears to be that these workers
must pay tax on the pension benefit and then pay the premium
with after-tax dollars. We recommend that Congress allow
employees to direct the appropriate portion of these pension
payments to pay retiree medical premiums on a pre-tax basis (as
active employees may do with salary to pay health premiums).
This will allow employees to pay these premiums with pre-tax
dollars, helping to alleviate one of the primary financial
pressures faced by many older Americans.
LThird, the Council recommends adoption of legislation
introduced by Representatives Roy Blunt and Earl Pomeroy (H.R.
3012), which allows employers to ``pick up'' employee
contributions to a contributory defined benefit plan so that
these employee contributions may be treated as pre-tax
contributions. This ``pick-up'' pre-tax treatment is permitted
for contributory defined benefit plans of state or local
governments but not for the contributory defined benefit plans
maintained by some private-sector firms. Allowing this pre-tax
treatment will encourage employers and employees alike to
remain committed to these contributory defined benefit plans
rather than abandoning them for exclusively defined
contribution arrangements (where employee contributions are
typically pre-tax).
LFourth, the Council believes that a legislative
solution is necessary to address the growing administrative
burdens attributable to ``lost participants'', i.e.,
participants with relatively small benefits who cannot be
located by plans. The cost for plans of maintaining records of
these benefits and searching for the participants is
significant, and a solution needs to be found. The Council
believes that one option to explore is a material expansion of
PBGC's missing participant program to apply to plans that have
not terminated.
LFifth, the Council recommends further simplification
of the many complex rules governing defined benefit plans, many
of which achieve little from a policy perspective but can make
pension plan administration both more complicated and more
costly.\7\
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\7\ What follows are several examples of defined benefit plan
complexity in need of reform and simplification. Today when a defined
benefit plan obtains from a participant a waiver of the qualified pre-
retirement survivor annuity (QPSA) (with spousal consent) and the
participant is younger than 35 years old, the plan must seek another
waiver from the same participant (again with spousal consent) after he
or she has attained age 35. Another example of needed reform is
legislation to further facilitate the use of new technology in plan
administration. This use reduces costs and improves accuracy, thereby
clearly improving administrative efficiency. A final example is
legislation that reduces unnecessary burdens on the many defined
benefit plans that use base pay (or rate of pay) in their benefit
formula. Current law requires such plans to perform complex testing not
otherwise necessary. The Council would be pleased to share with
interested Members of the Subcommittee our other recommended regulatory
simplifications in the defined benefit area.
The Council hopes to work with Representatives Portman and Cardin,
with you Chairman Houghton and Ranking Member Coyne, and with other
leaders in Congress to see these additional defined benefit reforms
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included in the next generation of pension reform legislation.
Conclusion
Mr. Chairman, I want to thank you once again for calling this
hearing on what the Council believes to be one of the most important
components of our nation's retirement system and for examining some of
the most important retirement policy questions we as a nation face
today. The Council feels strongly that we must ensure that both
traditional and hybrid defined benefit plans remain viable choices for
employers so that companies can select the pension plan design most
suited to the needs and wishes of their workforce. Defined benefit
plans offer unique advantages for employees, but without prompt action
by Congress we fear these plans will increasingly disappear from the
American pension landscape.
Thank you very much for the opportunity to appear today and I would
be pleased to answer whatever questions you and the members of the
Subcommittee may have.
Chairman HOUGHTON. Thank you very much. Mr. O'Flinn?
STATEMENT OF CHRISTOPHER W. O'FLINN, VICE PRESIDENT, CORPORATE
HUMAN RESOURCES, AT&T CORPORATION, BASKING RIDGE, NEW JERSEY,
AND CHAIRMAN, ERISA INDUSTRY COMMITTEE
Mr. O'FLINN. Mr. Chairman and Members of the Subcommittee,
I appreciate the invitation to come here and present ERIC's
views on what can be done to restore vitality to the defined
benefit plan system.
We think it is imperative for Congress to make a
fundamental change in the way it thinks about defined benefit
plans and the laws that govern them. We would hope you would
think of these plans as essential tools for providing
retirement income to our citizens and not regard them as a
source of revenue to achieve Congressional budgetary targets.
With this in mind, we hope that Congress would apply a
tripartite evaluation to proposed legislation: first, from the
employee's point of view, then the employer, plan sponsor,
point of view, and lastly, the national interest. In other
words, simply ask if the bill is going to provide additional
security to employees, if it is going to encourage employers to
sponsor defined benefit plans, and last, if it is going to
strengthen the defined benefit plan system.
This is a simple criteria, but as some of the previous
speakers have indicated, it was not followed in the 1980s and
the early 1990s when Congress passed nine major pieces of
legislation essentially designed to meet Congressional
budgetary targets.
Through these laws and the regulations that followed,
defined benefit plans were subjected to a bewildering array of
complex, rigid, inconsistent, and unnecessarily burdensome
legal requirements. The result, I think, is a part of the
answer to a question Congressman Coyne asked earlier. The
result is a complexity the level of which accounted for a part
of the decline that previous speakers have testified to in the
number of defined benefit plans.
Only recently, through the legislation sponsored by
Representatives Portman and Cardin and other Members of this
Committee, has Congress begun to move in a different direction
and the Committee deserves the congratulations of those
interested in retirement security for passing this legislation.
In other words, our answer to what is killing defined
benefit plans is that in part the complexity of the regulatory
environment is killing defined benefit plans. We would also
point to another trend in the workplace. There is a trend that
is characterized as additional mobility in the workforce.
Over the past 20 years, looking at folks today compared to
say, 1983, there is a marked decline in the years spent with
the current employer. This is tremendously significant to
defined benefit plans participants. A traditional defined
benefit plan rewards long service employees and they typically
have about 15 years of service at age 55.
If you will look at some of the charts in the back of my
testimony, you will see that, for example, for a male age 55,
current employer tenure in 1983 was 15 years on average, which
meant that individual met the requirements for significant
benefits in a traditional defined benefit plan.
In other words, the typical person was on time to receive
significant benefits. Today that figure is down to 10 years. In
other words, the median employee is not on time to receive
significant benefits under a traditional defined benefit plan.
That means the plan is less significant to employees today, the
traditional defined benefit plan, than it was in 1983.
If it is less significant to the employees, it is of less
interest to the employer to sponsor it. We don't want to spend
money sponsoring a plan that employees don't appreciate. Today,
there is no question that employees appreciate traditional
defined benefit plans much less than they did when they were on
time to qualify for those significant benefits.
In terms of what can be done, we think, the cash balance
plan, which as previous speakers have indicated, does not
require long service and accrues benefits gradually over a
period of time, is the answer for revitalizing the defined
benefit area, keeping the risk of investments with the employer
and providing a PBGC guarantee.
We also hope the Congress would address these critical
questions that previous speakers have spoken about regarding
the replacement for the 30-year Treasury bond rate and also
address the funding issues applicable to defined benefit plans
to permit us to reduce the volatility that characterizes
current defined benefit plan funding. Thank you for this
opportunity to address you.
[The prepared statement of Mr. O'Flinn follows:]
Statement of Christopher W. O'Flinn, Vice President, Corporate Human
Resources, AT&T Corporation, Basking Ridge, New Jersey, and Chairman,
ERISA Industry Committee
Chairman Houghton, Ranking Member Coyne, and members of the
Subcommittee, good morning. I am Christopher O'Flinn. I am Vice
President, Corporate Human Resources, at AT&T Corporation. I also serve
as Chairman of The ERISA Industry Committee, commonly known as
``ERIC.'' I appear before the Subcommittee today on ERIC's behalf.
ERIC is a nonprofit association committed to the advancement of the
employee retirement, incentive, health, and welfare benefit plans of
America's largest employers. ERIC's members provide comprehensive
retirement, incentive, health care coverage, and other economic
security benefits directly to some 25 million active and retired
workers and their families. ERIC has a strong interest in proposals
affecting its members' ability to deliver those benefits, their costs
and effectiveness, and the role of those benefits in the American
economy.
At the outset, ERIC wishes to express its deep appreciation for
Chairman Houghton's introduction and sponsorship of H.R. 2695, which
clarifies the employment tax treatment of statutory stock options to
reflect Congress's intent and the IRS's long-standing administrative
practice. We are gratified that the provisions of H.R. 2695 were also
included in H.R. 3762, which was passed by the House earlier this year.
ERIC strongly supports this clarification of existing law and is
committed to working with Chairman Houghton to secure its prompt
enactment.
ERIC is also gratified that Congressman Portman has introduced H.R.
4931, which would make permanent the ground-breaking employee benefit
provisions that were included in the Economic Growth and Tax Relief
Reconciliation Act of 2001. ERIC was a strong supporter of those
provisions, and we look forward to working closely with Congressman
Portman and the members of this Subcommittee to obtain enactment of
H.R. 4931.
ERIC also commends Chairman Houghton and the members of the
Subcommittee for holding this hearing on retirement security and
defined benefit plans. The hearing will help to focus Congressional and
public attention both on the importance of the voluntary defined
benefit system in providing retirement security and on the improvements
that need to be made in the system.
I am pleased to present ERIC's views both on the role and
importance of voluntary defined benefit plans and on the improvements
that need to be made in the defined benefit system.
A Fundamental Change in Thinking. We think that it is imperative
for Congress to make a fundamental change in its way of thinking about
defined benefit pension plans and the laws that govern them in order to
encourage rather than discourage the formation and maintenance of such
plans. Instead of thinking of defined benefit plans and the governing
laws as a source of revenue to be used to achieve Congressional
budgetary targets, Congress should think of them as essential tools for
providing critically needed retirement benefits to millions of workers
and their families. With this objective in mind, Congress should
evaluate current or proposed legislation governing defined benefit
plans in light of three basic questions:
1. LEmployers' interests: Does the legislation facilitate the
ability and willingness of employers to establish and continue
voluntary defined benefit plans that meet employers' business
needs?
2. LEmployees' interests: Does the legislation enhance the
abilityof employees to obtain retirement security?
3. LNational interest: Does the legislation strengthen the
voluntary retirement system by encouraging employers to
establish and maintain voluntary defined benefit plans?
Unless there are affirmative answers to all of these questions, the
legislation is likely to undermine, rather than advance, the objective
of providing retirement benefits to employees and their families in the
context of a voluntary employer-sponsored system.
The pension reform provisions that were included in last year's
Economic Growth and Tax Relief Reconciliation Act were a good step in
this direction, and we are very appreciative of the efforts of the
Chairman, Congressman Portman, and the other members of the
Subcommittee in seeing to it that these provisions were enacted. But
more--much more--needs to be done.
Because ERIC's members believe in the mission and ability of
defined benefit plans to provide retirement security, ERIC's members
have retained their defined benefit plans. It has not been easy for
them to do so, however. The hostile regulatory environment for defined
benefit plans requires even ERIC members to reassess their commitment
to these plans.
For example, the Labor Department's Office of Inspector General
(the ``OIG'') recently issued a critical report regarding lump-sum
distributions from cash balance pension plans.\1\ The OIG Report is
based on a controversial legal theory that is contrary to both the law
and sound retirement security policy.\2\ Both the OIG Report itself and
the OIG's release of related confidential information reflect such a
lack of understanding and such a level of hostility toward cash balance
plans that the Report could inflict irreparable damage on the nation's
defined benefit system. Attached to this statement are copies of two
ERIC submissions setting forth in detail ERIC's objections to the
Report and the OIG's unwarranted release of confidential information.
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\1\ U.S. Dep't of Labor, Office of Inspector General, PWBA Needs to
Improve Oversight of Cash Balance Plan Lump Sum Distributions (Report
No. 09-02-001-12-121) (March 29, 2002).
\2\ The General Accounting Office found that there was
``uncertainty'' whether plan sponsors must adhere to this controversial
legal theory. See General Accounting Office, Private Pensions:
Implications of Conversions to Cash Balance Plans 21 (GAO/HEHS-00-185)
(Sept. 2000).
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The Need for Flexibility, Creativity, and Diversity. Congress needs
to foster an environment that favors the creation and continuation of
retirement plans and that permits employers to adopt a variety of
approaches to providing retirement security. Congress must reform the
rules governing defined benefit plans to reverse the dramatic decline
in defined benefit plan coverage that has occurred over the past two
decades. Congress also must make the law more hospitable to defined
contribution plans and to new types of plans, such as ``hybrid'' plans
that seek to combine the best features of defined benefit and defined
contribution plans in a single plan.
The same type of retirement plan is not suitable for all employers
or for all workforces. Congress should seek to create a regulatory
environment that--
Lallows employers to create plans that work best for
them and their employees,
Ldoes not unnecessarily restrict employer flexibility
with rigid, cumbersome rules, and
Lallows employers to create new types of plans that do
not necessarily fall within the rigid ``defined benefit'' and
``defined contribution'' categories.
The Decline in Defined Benefit Plan Coverage. Defined benefit plans
provide valuable retirement benefits that typically are (1) not subject
to investment risk, (2) guaranteed by the Pension Benefit Guaranty
Corporation, (3) payable as an annuity, (4) are provided automatically
to employees without any decision to participate on their part, and (5)
are not contingent on employee contributions. However, although defined
benefit plans provide valuable retirement security benefits to the
millions of employees who participate in them, the coverage of these
plans is declining, and the pace of decline accelerating. Statistics
from a variety of sources point unequivocally to these conclusions:
LSince the enactment of ERISA in 1974, the percentage
of private sector U.S. workers covered by defined benefit
pension plan has dropped from 39% in 1975 to 23% in 1995.\3\
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\3\ Watson Wyatt Worldwide, The Unfolding of a Predictable Surprise
at iii (2000).
---------------------------------------------------------------------------
LThe percentage of workers participating in defined
benefit plans shrank by 0.8% per year from 1980 to 1985, by 2%
from 1985 to 1990, and by 2.3 % from 1990 to 1995.\4\
---------------------------------------------------------------------------
\4\ Id. at 2.
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LThe number of active participants in defined benefit
plans has fallen since 1984 by an average of about 2% per
year.\5\ Between 1979 and 1998, the number of defined benefit
plan participants fell by over 22%, from 29.4 million to 22.9
million. During the same period, the number of defined
contribution plan participants nearly tripled, from 17.4
million to 50.3 million.\6\
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\5\ U.S. Dep't of Labor, Pension & Welfare Benefits Administration,
Private Pension Plan Bulletin: Abstract of 1998 Form 5500 Annual
Reports No. 11 (Winter 2001--2002); Joint Committee on Taxation,
Background Information Relating to the Investment of Retirement Plan
Assets in Employer Stock 16 (JCX-1-02) (Feb. 11, 2002). Although the
Private Pension Plan Bulletin shows a slight increase in the number of
active participants in defined benefit plan participants between 1997
and 1998, the increase consists of fewer than 250,000 individuals, and
was accompanied by a 5% decline in the number of defined benefit plans
between 1997 and 1998. See Private Pension Plan Bulletin at 2, Tables
E1 & E8.
\6\ Private Pension Plan Bulletin, supra, Table E8.
---------------------------------------------------------------------------
LBetween 1988 and 1999, the number of active
participants in PBGC-insured defined benefit plans fell by 18%,
from 27.3 million to 22.4 million--notwithstanding the
expansion of the total workforce during this period.\7\
---------------------------------------------------------------------------
\7\ Pension Benefit Guaranty Corporation, 2001 Annual Report 14.
---------------------------------------------------------------------------
LVirtually all of the growth in pension plan
participation since the mid-1970s is attributable to the growth
of Sec. 401(k) defined contribution plans. Defined contribution
plans covered 42% of the full-time employees in the private
sector in 1999.\8\
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\8\ U.S. General Accounting Office, Private Pensions: Improving
Worker Coverage and Benefits 7-8 (GAO-02-225) (April 2002); JCX-1-02,
supra, at 13, 16-17.
Why has this happened? From the early 1980s until 1994, Congress
piled law on top of law in an effort to meet Congressional budgetary
targets by squeezing as much ``tax revenue'' out of defined benefit
plans as it could. Through these laws, Congress created a regulatory
climate that micro-managed these plans. The result was to subject
defined benefit plans to a bewildering array of complex, rigid,
inconsistent, and unnecessarily burdensome legal requirements.
The resulting legal regime has been excessive, oppressive, and
convoluted. Its primary effect has been a decline in retirement
security. It has discouraged many employers from adopting new plans and
encouraged many others to terminate their existing plans. For example:
LNew short-sighted funding rules have subjected
employers to unrealistic funding assumptions and have limited
employers' ability to fund their defined benefit plans until
late in their employees' careers.
LRigid restrictions on the use of pension assets have
converted a defined benefit plan into a ``black hole'' from
which contributions cannot emerge--even if the plan's assets
vastly exceed the amount required to fund the plan's benefits.
LComplex, and frequently amended, legal requirements,
including compensation and benefit limits and distribution
rules have required plans to invest a substantial portion of
their resources in legal compliance and plan administration,
rather than in providing benefits to participants and
beneficiaries.
This regime has weakened retirement security by delaying funding,
by subjecting employers to highly volatile funding requirements that
are difficult, if not impossible, for employers to predict, by
subjecting plans to excessive administrative costs, and, in the
aggregate, by making it less attractive for employers to maintain and
contribute to defined benefit plans.
The decline in defined benefit plan coverage has substantially
weakened the retirement security of our nation's workforce.
The Development of Cash Balance and Other ``Hybrid'' Plans. The one
exception to the dramatic decline in defined benefit plan coverage has
been the emergence of cash balance and other ``hybrid'' defined benefit
plans. Although these plans are defined benefit plans, they combine
many of the most attractive features of both defined benefit and
defined contribution plans.
Traditional defined benefit pension plans typically provide
benefits pursuant to a formula that expresses an employee's benefit as
a deferred annuity, commencing at the plan's normal retirement age
(generally, age 65).
A cash balance pension plan is a defined benefit plan that defines
an employee's benefit as the balance in his or her cash balance
account. The account receives periodic credits, usually a percentage of
the employee's pay, while the employee works. In addition, the account
is credited with interest until the account balance is distributed.\9\
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\9\ Another form of ``hybrid'' plan--a pension equity plan--works
differently. Like a cash balance plan, a pension equity plan defines
the participant's benefit in terms of a lump sum--but without relying
on an account or interest credits. For example, a pension equity plan
might define a participant's lump-sum benefit as a specified percentage
of final average pay multiplied by the participant's years of service
with the employer. For example, if the specified percentage were 8%,
and the participant completed 10 years of service, the participant's
lump-sum benefit would be 80% of his or her final average pay.
---------------------------------------------------------------------------
Traditional defined benefit plans provide extremely valuable
benefits to broad groups of employees in many segments of our economy,
especially those where long-term employment is prevalent and where many
employees remain with their employers for most or all of their careers.
In other segments of the economy, however, most of the benefits
provided by a traditional defined benefit plan are allocated to a
relatively small group of long-service employees, and the vast majority
of plan participants receive little or no benefits. Traditional defined
benefit plans often penalize older employees who want to work beyond
early retirement age. Traditional plans also can restrict the mobility
of younger employees who risk losing a substantial portion of their
retirement benefits if they leave the employer before reaching early
retirement age.
Since 1983, there has been a marked drop-off in the median job
tenure for the average employee, reflecting the fact that employees now
spend shorter periods of time with a single employer. This phenomenon
is documented by the three tables at the end of this statement.
Because cash balance and other ``hybrid'' plans allocate benefits
more evenly over an employee's career, these plans correct many of the
shortcomings of traditional defined benefit plans and are particularly
well-suited to an employee who does not spend his or her entire career
with a single employer.
Advantages to Employees:
LUnderstandable Benefits: Unlike traditional defined
benefit plans, cash balance plans provide an easily understood
account balance for each participant. Employees--who are
accustomed to dealing with bank account balances, Sec. 401(k)
account balances, and IRA balances--are comfortable with a
retirement plan that provides a benefit in the form of an
account balance.
LAutomatic Savings: Unlike Sec. 401(k) plans,
additions are made automatically to the accounts of all
participants in a cash balance plan. An employee does not have
to choose to participate or decide how much to contribute.
LEmployees Do Not Bear Investment Risk: Unlike
Sec. 401(k) plans and other defined contribution plans, cash
balance plans do not require employees to bear the risk of
adverse investment experience. As under a traditional defined
benefit plan, the employer bears the risk that the plan's
investments will perform poorly. Sudden or even prolonged
downturns in the plan's investment performance do not affect
participants' benefits under the plan. Because they are defined
benefit plans, cash balance plans are insured by the Pension
Benefit Guaranty Corporation (the ``PBGC'') and are subject to
the stringent limits on investments in employer stock that
apply to defined benefit plans.
LGreater Benefits for More Employees: Under a
traditional pension plan, an employee typically earns most of
his or her benefits in the last few years before retirement. By
contrast, a cash balance plan allocates benefits more evenly
over an employee's career, regardless of whether the employee
remains with the employer until retirement. Because most
employees do not remain with the same employer until
retirement, the vast majority of workers earn greater benefits
under cash balance plans than under traditional pension plans.
LWomen Benefit: Cash balance plans offer significant
advantages to women and others who tend to move in and out of
the workforce. Mobile workers--not just women--are more likely
to accrue a significant and secure retirement benefit under a
cash balance plan than under many other plan designs.
LRelease from ``Pension Jail'': Because the benefits
under cash balance plans tend to accrue more evenly over an
employee's career than do the benefits under a traditional
defined benefit plan, and do not suddenly ``spike'' when an
employee becomes eligible for early retirement, cash balance
plans release many employees from what is often referred to as
``pension jail''--the need to remain employed with the same
employer until early retirement age in order to qualify for a
major portion of the benefit that their retirement plan
provides.
LOlder Workers Benefit: The value of the benefit
earned by an older worker increases at the same rate both
before and after normal retirement age. By contrast, under many
traditional pension plans, the value of the benefits accrued
each year actually often declines when an employee works beyond
a certain age (normal retirement age or early retirement age in
the case of a plan providing subsidized early retirement
benefits).
LPortable Benefits: Cash balance benefits are
portable. An employee who leaves before retirement can roll
over his or her cash balance account to an IRA or a new
employer's plan.
LAnnuities Available: Since cash balance plans must
offer annuities, a participant who wants to receive retirement
benefits as a stream of income for life can receive a life
annuity without incurring the cost and inconvenience of
shopping for an annuity in the individual annuity market.
Annuity benefits are also available to the surviving spouses of
deceased plan participants.
Advantages to Employers. Cash balance plans offer the following
important advantages to employers:
LAppropriate Employment Incentives: Because cash
balance benefits are easy to communicate, because employees
understand and value cash balance benefits, and because cash
balance benefits accrue much earlier in a participant's career
than do the benefits under most traditional defined benefit
plans, cash balance plans strengthen employer efforts to
recruit and retain productive employees.
LAppropriate Retirement Incentives: Because cash
balance plans do not provide sudden ``spikes'' in benefits when
an employee reaches early retirement age, they do not encourage
productive workers to retire (and perhaps go to work for a
competitor) as soon as they reach retirement age.
LBenefit Funding: Under a cash balance plan, benefits
accrue much earlier in a participant's career, and the value of
current accrued benefits does not depend on an employee's
future earnings. This enables the employer to fund a much
larger portion of the plan's projected benefit obligations--the
value of the benefits that employers are required to use as a
funding target for accounting purposes--than under a
traditional defined benefit plan.\10\ This increases employees'
retirement security.
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\10\ See Watson Wyatt, supra, at 14-20, 48-53.
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LBenefit Communication and Coordination: Because the
benefits under a cash balance plan are expressed as a lump sum,
they can be more easily communicated and coordinated with other
employer-provided benefits (e.g., Sec. 401(k) plan benefits)
that are also expressed as lump sums.
Advantages to the Nation
LIncreased Coverage: Because cash balance and other
``hybrid'' plans are the only defined benefit plans currently
attracting the interest of employers and employees, they
currently offer the greatest hope for maintaining and actually
increasing defined benefit plan coverage in the United States.
LIncreased Retirement Security: Because cash balance
and other ``hybrid'' plans are defined benefit plans, they
provide a reliable source of retirement security.
LIncreased Labor Mobility: Because cash balance plans
do not encourage employees to remain employed until they
qualify for early retirement, they increase labor mobility.
LGreater Independence for Women: Because cash balance
plans offer significant advantages to women and others who tend
to move in and out of the workforce, cash balance plans provide
greater financial independence for women and other mobile
workers.
LLess Pressure on Government Programs: The success of
defined benefit plans, and cash balance plans in particular,
will relieve pressure on federal and state governments to
provide retirement and other financial assistance to elderly
citizens.
Congress Should Act. Congress must act promptly if it wishes to
reverse the decline of the defined benefit plan. Although there are
many steps that can and should be taken, we suggest the following as a
start:
Encourage Hybrid and Other Innovative Plan Designs: Congress should
enact legislation directing the Treasury Department and other federal
agencies to create an environment that encourages the development and
maintenance of hybrid and other innovative plan designs.
Reform the Funding Standards: Congress should reform the current
funding rules to make the funding of defined benefit plans more sound,
less volatile, more flexible, and more consistent with sound funding
principles. The funding standards should be designed to meet retirement
security needs, not short-term Congressional budget targets.
Replace the 30-Year Treasury Bond Rate: Congress should establish a
permanent replacement for the 30-year Treasury bond standard used to
set the interest rate for purposes of pension funding, the variable
rate PBGC premium, and lump-sum benefits under defined benefit plans.
We suggest that the yield on the 30-year Treasury bond be replaced by
the composite yield on high quality, long-duration corporate bonds,
based on the average yield reported by a number of independent indices.
The composite yield would be representative of rates of return that
underlie the price of annuities sold by insurers active in the group
annuity marketplace.
ERIC expects to present specific proposals on improvements in the
funding standards and on a permanent replacement for the 30-year
Treasury bond standard to Congress for consideration in the near
future.
Permit Excess Pension Assets to be Used to Fund Defined
Contribution Plans: Congress should enact legislation that permits the
excess assets of defined benefit plans to be used to enhance the
retirement security of plan participants by transferring them to a
defined contribution plan for the benefit of participants in the
defined benefit plan. The legislation should be modeled on the current
provisions of Sec. 420 of the Internal Revenue Code, which permits
excess pension assets to be transferred to an account to provide
retiree health benefits. Section 420 has worked well for many year, and
has been extended by Congress on two separate occasions. The favorable
experience under Sec. 420 argues strongly in favor of this proposal.
As I explained at the beginning of my statement, Congress should
evaluate these and other proposals in light of the following questions:
1. LEmployers' interests: Does the legislation facilitate the
ability and willingness of employers to establish and continue
voluntary defined benefit plans that meet employers' business
needs?
2. LEmployees' interests: Does the legislation enhance the
ability of employees to obtain retirement security?
3. LNational interest: Does the legislation strengthen the
voluntary retirement system by encouraging employers to
establish and maintain voluntary defined benefit plans?
With respect to the proposals we have made, the answer to each of
these questions is an unequivocal ``Yes,'' and we urge the Subcommittee
to act on our proposals promptly.
In its deliberations, the Subcommittee should continue to be
mindful of the critical role that a diverse array of voluntary
employer-sponsored plans play in providing retirement security to
millions of American workers and their families. Although defined
benefit plans are the focus of this hearing, defined contribution plans
also play a critical role in providing retirement security.
Improvements in the law governing defined benefit plans should not be
made at the expense of defined contribution plans.
Finally, with the reemergence of federal budget deficits, we urge
the Subcommittee not to repeat the disastrous experience of the period
from 1982 through 1994. Retirement plans should now be viewed as a
critical vehicle for providing retirement security to workers and their
families, not as a source of revenue to be used to achieve
Congressional budgetary targets.
We very much appreciate the opportunity to present our views today
to the Subcommittee. We look forward to working with Chairman Houghton,
Ranking Member Coyne, and the other members of the Subcommittee and
their staffs on the important issues that the Subcommittee has raised.
__________
Attachment 1:
May 21, 2002
The Honorable Elaine L. Chao
Secretary of Labor
U.S. Department of Labor
200 Constitution Avenue, N.W.
Washington. DC 20210
Dear Secretary Chao:
On March 29, 2002 the Department of Labor Office of Inspector
General (OIG) released a report regarding lump-sum distributions from
cash balance pension plans (Report).\11\ Based on information collected
from a ``judgmental sample'' of 60 companies, the Report propounds that
13 of the sampled companies failed to properly calculate the lump-sum
benefit.\12\ For the reasons described below, we are writing to
strongly object to and request an investigation of the violation of a
promise of confidentiality by the OIG intended to induce cooperation by
the companies in the sample.
---------------------------------------------------------------------------
\11\ U.S. Department of Labor, Office of Inspector General, ``PWBA
Needs to Improve Oversight of Cash Balance Plan Lump Sum
Distributions'' (Report No. 09-02-001-12-121).
\12\ For reasons explained in our May 16, 2001 letter to you and to
Secretary of the Treasury Paul O'Neill, we contend that the OIG Report
is based on an illegitimate and ill-conceived legal theory, an
uncritical and unsupported acceptance of that theory, and a
misapplication of the Department of Labor's authority over cash balance
plans.
---------------------------------------------------------------------------
On May 20, 2002 Representative Bernie Sanders (I-VT) released
information to the press and media and published on his Web site the
names of the 13 companies alleged by the OIG to have underpaid
participants.\13\ Representative Sanders specifically cites the
Department of Labor Office of Inspector General as the source of his
information.
---------------------------------------------------------------------------
\13\ http://bernie.house.gov/documents/releases/20020520161735.asp
---------------------------------------------------------------------------
We strongly believe that the release of the information by the DoL
OIG was improper and requires an investigation and appropriate action
against those responsible for leaking information that was confidential
and therefore protected.
In its effort to collect information from the 60 companies in its
``judgmental sample,'' including the 13 companies cited by
Representative Sanders, the OIG specifically stated that they were
conducting ``an audit of the Department's oversight of defined benefit
plans that have converted to a cash balance formula.''
As an inducement for cooperation in obtaining information about
benefit calculations and other data necessary for their audit of the
Department's oversight responsibilities, the OIG specifically promised
the companies that:
``. . . the information you will provide is considered
confidential. The results of our review of your information will be
combined with reviews of other plans and will be used to develop a
report to Department of Labor management officials. The report will not
identify any plans or plan sponsors by name or other identifying
means.'' (See attachment 2.)
The release of the information to Representative Sanders is a clear
and egregious violation of the confidentiality promise made by the OIG
to each company from which it requested information. While the report
itself did not identify the companies, the release of the information
to Representative Sanders nevertheless constitutes a breach of the
confidentiality promised by the OIG. Moreover, Representative Sanders
is well known to be strongly opposed to cash balance plans. Thus, the
release of the information to Representative Sanders, particularly in
light of the specific promise of confidentiality, conflicts with an
objective that is consistent with the requirements of objectivity and
independence of the Department's Inspector General.
The OIG's apparent release of confidential information will have a
significant chilling effect on the willingness of employers and plan
sponsors to cooperate with the Department of Labor in the future. It
casts a shadow over the objectivity of the Office of Inspector General
and raises significant questions with regard to controls within that
office.
For the reasons indicated, we respectfully urge that the Department
initiate an investigation of the OIG and, if the OIG is in fact the
source of the breach of confidentiality, take corrective steps to
ensure the integrity of the Department and the Office of Inspector
General.
Very truly yours,
Mark J. Ugoretz
President
cc: LHon. Ann Combs, Assistant Secretary for Pensions and Welfare
Benefits Administration
LElliott P. Lewis (Acting Deputy Inspector General for Audit, USDoL)
__________
Attachment 2:
May 16, 2002
BY HAND DELIVERY
The Honorable Elaine L. Chao
Secretary of Labor
U.S. Department of Labor
200 Constitution Avenue, NW.,
Washington, DC 20210
The Honorable Paul H. O'Neill
Secretary of the Treasury
U.S. Treasury Department
1500 Pennsylvania Avenue, NW.,
Washington, DC 20220
Re: Lump-Sum Distributions from Cash Balance Pension Plans
Dear Secretary Chao and Secretary O'Neill:
We are writing to express our strong concerns about the report
recently issued by the Office of Inspector General of the Department of
Labor regarding lump-sum distributions from cash balance pension plans
(the ``OIG Report'').\14\
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\14\ U.S. Dep't of Labor, Office of Inspector General, ``PWBA Needs
to Improve Oversight of Cash Balance Plan Lump Sum Distributions''
(Report No. 09-02-001-12-121) (March 29, 2002).
---------------------------------------------------------------------------
The OIG Report threatens to damage our Nation's private pension
system by creating the impression that many pension plans are
underpaying plan participants. We urge you to act promptly to dispel
this erroneous impression.
The OIG Report is based on an invalid legal theory that is contrary
to both the law and sound retirement security policy. Moreover, the
Treasury Department, not the Department of Labor, is responsible for
interpreting the statutory provisions on which this legal theory is
based.
At a time when some employers are shifting away from defined
benefit pension plans, and when many employees are seeking the
retirement security that defined benefit plans provide, it is
imperative for the Administration to support the development of defined
benefit plans that meet employee needs. Because they are defined
benefit plans, cash balance plans provide benefits that employees can
rely on, without the risk of adverse investment experience. Because of
their design, cash balance plans provide portable retirement benefits
that are allocated equitably over an employee's career.
Cash balance plans address the needs of millions of employees,
including women, who do not spend their entire career with a single
employer. Cash balance plans provide benefits that grow steadily over
time in a fair and equitable manner. The Administration should create
an environment that fosters the creation and continuation of such
plans, not an environment that is hostile to them.
The OIG Report is based on a ``whipsaw'' theory that undermines
many cash balance plans. The OIG Report uncritically propounds the
whipsaw theory as established law even though the whipsaw theory
violates established law and fundamentally alters the benefit promised
by a cash balance plan. The whipsaw theory requires cash balance plans
to violate federal law and undermines important federal policies. By
altering the plan's benefit promise, the whipsaw theory improperly
restricts the freedom that employers have under existing law to
determine the benefits that their plans provide.\15\
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\15\ We focus on cash balance plans because the OIG Report focused
on such plans. However, the concerns that we voice in this letter would
also apply to any attempt to apply the whipsaw theory to other types of
``hybrid'' plans (defined benefit plans that express their benefits as
something other than an annuity beginning at normal retirement age).
---------------------------------------------------------------------------
Cash Balance Plans
Traditional defined benefit pension plans typically provide
benefits pursuant to a formula that expresses an employee's benefit as
a deferred annuity, commencing at the plan's normal retirement age
(generally, age 65). A cash balance pension plan is a defined benefit
plan that defines an employee's benefit as the balance in his or her
cash balance account. The account receives periodic credits, usually a
percentage of the employee's pay, while the employee works. In
addition, the account is credited with interest until the account
balance is distributed. Because the interest credits typically are
based on a variable index, it is impossible to know in advance the rate
at which a participant's cash balance account will grow.
Cash balance plans offer the following important advantages:
LUnderstandable Benefits: Unlike traditional defined
benefit plans, cash balance plans provide an easily understood
account balance for each participant. Employees--who are
accustomed to dealing with bank account balances, Sec. 401(k)
account balances, and IRA balances--are comfortable with a
retirement plan that provides a benefit in the form of an
account balance.
LAutomatic Savings: Unlike Sec. 401(k) plans,
additions are made automatically to the accounts of all
participants in a cash balance plan. An employee does not have
to choose to participate or decide how much to contribute.
LEmployees Do Not Bear Investment Risk: Unlike
Sec. 401(k) plans and other defined contribution plans, cash
balance plans do not require employees to bear the risk of
adverse investment experience. As under a traditional defined
benefit plan, the employer bears the risk that the plan's
investments will perform poorly. Sudden or even prolonged
downturns in the plan's investment performance do not affect
participants' benefits under the plan. Because they are defined
benefit plans, cash balance plans are insured by the Pension
Benefit Guaranty Corporation (the ``PBGC'') and are subject to
the stringent limits on investments in employer stock that
apply to defined benefit plans.
LGreater Benefits for More Employees: Under a
traditional pension plan, an employee typically earns most of
his or her benefit in the last few years before retirement. By
contrast, a cash balance plan allocates benefits more evenly
over an employee's career, regardless of whether the employee
remains with the employer until retirement. Because most
employees do not remain with the same employer until
retirement, the vast majority of workers earn greater benefits
under cash balance plans than under traditional pension plans.
LWomen Benefit: Cash balance plans offer significant
advantages to women and others who tend to move in and out of
the workforce. Mobile workers--not just women--are more likely
to accrue a significant and secure retirement benefit under a
cash balance plan than under many other plan designs.
LOlder Workers Benefit: The value of the benefit
earned by an older worker increases at the same rate both
before and after normal retirement age. By contrast, under many
traditional pension plans, the value of the benefits accrued
each year actually often declines when an employee works beyond
a certain age (normal retirement age or early retirement age in
the case of a plan providing subsidized early retirement
benefits).
LPortable Benefits: Cash balance benefits are
portable. An employee who leaves before retirement can roll
over his or her cash balance account to an IRA or a new
employer's plan.
LAnnuities Available: Since cash balance plans must
offer annuities, a participant who wants to receive retirement
benefits as a stream of income for life can receive a life
annuity without incurring the cost and inconvenience of
shopping for an annuity in the individual annuity market.
Annuity benefits are also available to the surviving spouses of
deceased plan participants.
As the preceding discussion demonstrates, an essential feature of a
cash balance plan is its ability to express an employee's benefit as a
current lump-sum value and to pay out that benefit in a lump sum equal
to the current balance in the employee's cash balance account. Without
this feature, a cash balance plan cannot (1) provide readily understood
benefits to employees, (2) distribute benefits equitably among
employees, and (3) provide lump-sum benefits that are not subject to
erratic interest-rate swings. The whipsaw theory would prevent many
cash balance plans from achieving these objectives. As we explain in
detail below, the whipsaw theory--
LHas no statutory support;
LConflicts with the statute and the regulations;
LConflicts with other statutory and regulatory
provisions;
LDiscourages the deferral of benefits until
retirement;
LDiscourages participants from electing to receive
annuities;
LWeakens spousal protections;
LHurts employees by limiting plans' interest crediting
rates;
LFavors younger employees over older employees;
LProvides erratic benefits;
LProvides windfall benefits;
LInterferes with employer-employee relationships;
LWeakens pension funding;
LRisks weakening the PBGC; and
LDiscourages employers from adopting defined benefit
plans.
The Whipsaw Theory
Under the whipsaw theory, an employee's cash balance account must
be projected forward to normal retirement age at the interest rate set
forth in the plan (which is typically based on a variable index) and
then discounted back to an actuarial present value using the 30-year
Treasury interest rate--the rate specified by Code Sec. Sec. 411(a)(11)
and 417(e) and ERISA Sec. Sec. 203(e) and 205(g).\16\ If the resulting
amount exceeds the balance in the employee's current cash balance
account, the lump-sum distribution payable to the employee must be
increased to the amount determined under the whipsaw calculation,
producing a windfall benefit to the employee-a benefit that the plan
was not designed to provide and a benefit that the employee had no
reason to anticipate.
---------------------------------------------------------------------------
\16\ References in this letter to ``ERISA'' are to the Employee
Retirement Income Security Act of 1974, as amended, and references to
the ``Code'' are to the Internal Revenue Code of 1986, as amended.
---------------------------------------------------------------------------
The windfall benefit mandated by the whipsaw theory is payable
whenever the plan's current interest rate exceeds the statutory
interest rate (the 30-year Treasury rate). Projecting out an employee's
cash balance account at the plan's interest rate and then discounting
it back at a lower statutory interest rate will always yield an amount
larger than the balance in the employee's cash balance account.
The amount of the windfall benefit mandated by the whipsaw theory
will increase the younger an employee is at the time he or she receives
a lump-sum distribution. The age-based difference in amount is
attributable to the fact that the interest rate differential that
produces the windfall benefit will apply over a longer period for a
younger employee and therefore will produce a larger windfall benefit
for a younger employee than for a similarly-situated older employee. In
most cases, the windfall benefit will disappear entirely for any
employee at or over normal retirement age (typically, age 65) at the
time of the distribution.
The windfall benefit mandated by the whipsaw theory also disappears
for any employee who receives his or her benefit under the cash balance
plan as a nondecreasing annuity, rather than as a lump sum. This is
because the statutory interest rate does not apply to such annuities,
while it does apply to lump sums.
The OIG Report
The OIG Report is seriously flawed, both procedurally and
substantively.
First, the validity of the whipsaw theory is within the
jurisdiction of the Treasury Department, not the Labor Department. This
is because the whipsaw theory purports to be based on the vesting and
benefit accrual provisions of the Code and ERISA. The Treasury
Department, not the Labor Department, is responsible for interpreting
and applying the vesting and benefit accrual provisions.\17\
---------------------------------------------------------------------------
\17\ See ERISA Sec. 3002(c); Presidential Reorganization Plan No. 4
of 1978, Sec. 101, 5 U.S.C. App. (2000), 43 Fed. Reg. 47713 (Oct. 17,
1978); see also 29 C.F.R. Sec. 2530.200a-2.
---------------------------------------------------------------------------
Second, although the Treasury has indicated that it is developing
regulations that will address the whipsaw issue,\18\ the Treasury has
not issued even proposed regulations. Under the circumstances, it is
inappropriate for the Department of Labor's OIG to apply the theory.
---------------------------------------------------------------------------
\18\ IRS Notice 96-8, 1996-1 C.B. 359.
---------------------------------------------------------------------------
Third, the OIG appears to have misapplied the whipsaw theory in at
least some cases. Our understanding is that the OIG concluded that at
least one of the plans that it criticized failed to comply with IRS
Notice 96-8 because the lump-sum distributions under the plan were not
actuarially equivalent to the plan's qualified joint and survivor
annuity. This conclusion is completely at odds with the view of the
Internal Revenue Service that a lump-sum distribution need only be
actuarially equivalent to the plan's single life annuity.\19\
---------------------------------------------------------------------------
\19\ See T.D. 8219, 53 Fed. Reg. 31837, 31840 (Aug. 22, 1988)
(``There is no requirement that each form of benefit be the actuarial
equivalent of all other benefit forms. Thus, a plan could have a
[qualified joint and survivor annuity] benefit form that has a larger
actuarial value than a benefit payable as a single life annuity and the
amount of a single sum optional form could be determined based on the
single life annuity.... Thus, a plan may satisfy [the] requirements [of
Code Sec. Sec. 411(a)(11) and 417(e)] even though it has a subsidized
joint and survivor annuity and determines a single sum distribution
based on an unsubsidized single life annuity.'').
---------------------------------------------------------------------------
Fourth, the whipsaw theory is highly controversial.\20\ Although
the Internal Revenue Service endorsed the whipsaw theory in Notice 96-
8, the Service's failure to issue proposed regulations has thus far
shielded the theory from the scrutiny of a formal rulemaking. An OIG
Report is not a substitute for a rulemaking proceeding nor is it an
appropriate vehicle for addressing or resolving an important and
controversial policy issue.
---------------------------------------------------------------------------
\20\ See, e.g., Sennott, Finding the Balance in Cash Balance
Pension Plans, 2001 U. Ill. L. Rev. 1059 (2001); Lurie, Caught in the
Jaw of the Saw: A Bum Rap for Cash Balance Plans, 89 Tax Notes 549
(Oct. 23, 2000).
---------------------------------------------------------------------------
Fifth, notwithstanding the controversial nature of the whipsaw
theory, the OIG Report accepts it as a ``given.'' The Report utterly
fails to consider whether the whipsaw theory is consistent with
applicable statutory and regulatory provisions and does not address the
very powerful arguments that the whipsaw theory is simply wrong.\21\
---------------------------------------------------------------------------
\21\ Courts of appeal in two of the 13 federal circuits have
applied the whipsaw theory. See Esden v. Bank of Boston, 229 F.3d 154
(2d Cir. 2000); Lyons v. Georgia-Pacific Corp. Salaried Employees
Retirement Plan, 221 F.3d 1235 (11th Cir. 2000). Those courts applied
the whipsaw theory under the pre-1995 version of the statute, however;
they did not apply it under current law. See Lyons v. Georgia-Pacific
Corp. Salaried Employees Retirement Plan, No. 97-CV-980, 2002 WL 415393
(N.D. Ga. March 12, 2002). Moreover, the Esden and Lyons courts did not
have the benefit of the arguments made in this letter, and their
decisions are not binding in the remaining 11 circuits in any event. At
least one court has expressed serious reservations regarding the
reasonableness of projecting variable-rate interest credits forward to
normal retirement age (as the whipsaw theory requires). See Eaton v.
Onan Corp., 117 F. Supp.2d 812, 833 (S.D. Ind. 2000).
---------------------------------------------------------------------------
As we explain below, the whipsaw theory--the Report's lynchpin--is
inconsistent with applicable statutory and regulatory provisions and
with important federal policies.
The Whipsaw Theory Is Invalid
The Whipsaw Theory Has No Statutory Support. The whipsaw theory
appears nowhere in the Code, ERISA, or the regulations. Where the
plan's interest credit rate is based on a variable index, projecting
the current rate forward to normal retirement age (perhaps 30 or 40
years into the future) is inherently nonsensical. There is no reason to
believe that current interest rates are predictive of future rates, and
there is no reason to believe that Congress intended them to be used to
predict the annuity benefit a participant would be entitled to receive
many years in the future.
The Whipsaw Theory Conflicts with the Statute and the Regulations.
The whipsaw theory conflicts with the statutory and regulatory
provisions that govern how an accrued benefit expressed in the form of
an annuity beginning at normal retirement age is to be derived in the
case of a plan that does not define its benefits in that way.
Under both the Code and ERISA, if a plan (such as a cash balance
plan) does not provide an accrued benefit in the form of an annuity
beginning at normal retirement age, the statutory ``accrued benefit''--
which must be used to determine the minimum amount of a lump-sum
distribution--is an annuity beginning at normal retirement age that is
the actuarial equivalent (determined under Code Sec. 411(c)(3) and
ERISA Sec. 204(c)(3)) of the accrued benefit under the plan.\22\
---------------------------------------------------------------------------
\22\ Code Sec. 411(a)(7)(A)(i); ERISA Sec. 3(23); Treas. Reg.
Sec. 1.411(a)-7(a)(1)(ii).
---------------------------------------------------------------------------
Actuarial equivalence under Code Sec. 411(c)(3) is determined using
the assumptions specified by Code Sec. 417(e). This is made clear both
by the statute and the regulations. Code Sec. 411(c)(3) refers to Code
Sec. 411(c)(1) & (2). Under Code Sec. 411(c)(2)(B), an account balance
is converted to an annuity beginning at normal retirement age based on
the assumptions specified by Code Sec. 417(e). The corresponding ERISA
provisions say the same thing.\23\
---------------------------------------------------------------------------
\23\ See ERISA Sec. 204(c)(2)(B), (c)(3).
---------------------------------------------------------------------------
Similarly, the implementing regulation, Treas. Reg. Sec. 1.411(a)-
7(a)(1)(ii), provides that where a defined benefit plan does not
provide an accrued benefit in the form of an annuity beginning at
normal retirement age, ``accrued benefit'' means an annuity beginning
at normal retirement age that is ``the actuarial equivalent (determined
under Sec. 411(c)(3) and Sec. 1.411(c)-5 of the accrued benefit
determined under the plan.''\24\ The IRS guidance under Code
Sec. 411(c) provides that actuarial equivalence is to be determined
using the interest rate assumptions of Code Sec. 417(e), not the
interest credit rate set forth in the plan.\25\
---------------------------------------------------------------------------
\24\ The reference to 1Sec. 1.411(c)-5 appears to be a
typographical error; there has never been a Sec. 1.411(c)-5. We suspect
that the reference was intended to be to Sec. 1.411(c)-1, the only
regulation ever issued under Code Sec. 411(c).
\25\ See Treas. Reg. Sec. 1.411(c)-1(e)(1); IRS Employee Plans
Examination Guidelines [7.7.1] 10.3.1.A (03-11-1998); IRS Announcement
95-33, para.362.1(1)(a), 1995-19 I.R.B. 14 (April 17, 1995).
---------------------------------------------------------------------------
The Whipsaw Theory Conflicts with Other Statutory and Regulatory
Provisions. A statute must be interpreted in a manner that harmonizes
all of its provisions.\26\ As we explain in the following paragraphs,
the whipsaw theory produces results that conflict with the objectives
of other statutory and regulatory provisions.
---------------------------------------------------------------------------
\26\ See FDA v. Brown & Williamson Tobacco Corp., 529 U.S. 120, 133
(2000) (``A court must... interpret [a] statute as a symmetrical and
coherent regulatory scheme and fit, if possible, all parts in an
harmonious whole.'') (internal quotations and citations omitted);
Richards v. United States, 369 U.S. 1, 11 (1962) (``We believe it
fundamental that a section of a statute should not be read in isolation
from the context of the whole Act.'').
---------------------------------------------------------------------------
A Plan's Use of the Whipsaw Method Would Be Unlawful Because It
Discourages the Deferral of Benefits Until Retirement Age. A plan that
used the whipsaw method would violate Code Sec. 411(a)(11) and ERISA
Sec. 203(e)--the very sections that are claimed to be the basis for the
whipsaw theory.
Under the whipsaw theory, an employee who terminates employment
before normal retirement age faces a dilemma. If the employee does not
agree to receive an immediate lump-sum distribution, and instead leaves
his or her benefit in the plan until normal retirement age, the
employee will forgo the additional benefit mandated by the whipsaw
theory. For younger employees especially, the amount at stake could be
substantial.
However, the regulations under Code Sec. 411(a)(11) forbid a plan
from putting an employee in this predicament. They specifically
prohibit a plan from imposing a substantial detriment on any employee
who does not consent to an immediate distribution.\27\ The Internal
Revenue Service has found a substantial detriment to exist as a result
of plan provisions with far less consequence than what is at stake
here.\28\ The whipsaw theory cannot be valid if it requires a plan to
violate the very statute on which the whipsaw theory is based.
---------------------------------------------------------------------------
\27\ See Treas. Reg. Sec. 1.411(a)-11(c)(2)(i).
\28\ See Rev. Rul. 96-47, 1996-2 C.B. 35 (loss of the right to
choose among a broad range of investment alternatives is a substantial
detriment to declining to consent to an immediate distribution from the
plan).
---------------------------------------------------------------------------
The Whipsaw Theory Discourages Participants From Electing to
Receive Annuities. Because the whipsaw theory rewards employees who
elect to receive their benefits as immediate lump sums, it conflicts
with the provisions of the Code and ERISA that favor the distribution
of benefits in the form of an annuity.\29\ Because benefits paid in the
form of a nondecreasing annuity are not subject to the present value
requirements of the Code and ERISA, the whipsaw theory does not apply
to them. Because annuitants do not receive whipsaw benefits, the
whipsaw theory discourages employees from electing to receive their
benefits as annuities.
---------------------------------------------------------------------------
\29\ Code Sec. Sec. 411(a)(11), 417; ERISA Sec. Sec. 203(e), 205.
---------------------------------------------------------------------------
The Whipsaw Theory Weakens Spousal Protections. Both the Code and
ERISA go to great lengths to protect employees' spouses. A defined
benefit plan is required to protect the spouse with a qualified
preretirement spouse's annuity (a ``QPSA'') before the employee retires
and with a qualified joint and survivor annuity (a ``QJSA'') after the
employee retires--unless the employee elects otherwise with his or her
spouse's consent.\30\ By providing a powerful economic incentive to
elect to receive lump-sum benefits, the whipsaw theory undermines this
important federal policy.
---------------------------------------------------------------------------
\30\ See Code Sec. 417; ERISA Sec. 205.
---------------------------------------------------------------------------
The Whipsaw Theory Hurts Employees by Limiting Plans' Interest
Crediting Rates. According to Notice 96-8, whipsaw can be avoided if
the plan's interest crediting rate does not exceed the statutory
interest rate under Code Sec. 417(e) and ERISA Sec. 203(e). This
creates incentives that are contrary to the interests of employees.
Because the whipsaw theory imposes unintended liabilities only on plans
with interest crediting rates exceeding the statutory interest rate, it
discourages employers from offering a plan with an interest rate
exceeding the statutory rate. This clearly conflicts with the
objectives of the Code and ERISA, which are designed to encourage
employers to provide benefits to their employees. Contrary to federal
policy, whipsaw punishes employers for being generous to their
employees.
The Whipsaw Theory Favors Younger Employees Over Older Employees.
The additional benefit mandated by the whipsaw theory also produces
large age-based disparities in benefits. Under the whipsaw theory,
employees of different ages who have the same pay and service history
with the employer (and therefore the same account balances) will
receive dramatically different lump-sum benefits based solely on the
difference in their ages. A younger employee will receive a larger lump
sum than a middle-aged employee, and a middle-aged employee will
receive a larger lump sum than an employee who is past normal
retirement age (who will in most cases receive no benefit from whipsaw
at all). The adverse impact on older employees can hardly be said to
promote the policy against age discrimination reflected in Code
Sec. 411(b)(1)(H), ERISA Sec. 204(b)(1)(H), and Sec. 4(i)(1) of the Age
Discrimination in Employment Act.
The Whipsaw Theory Provides Erratic Benefits. Because whipsaw
occurs only when the plan's interest crediting rate exceeds the
statutory interest rate, whipsaw causes benefits to vary erratically
from one year to the next based on fluctuations in interest rates. The
wide swings in the benefits provided by whipsaw are contrary to the
interests of employees who will not be able to predict their benefits
from one year to the next and whose lump-sum benefits in one year will
significantly erode (or increase) in the next.
The Whipsaw Theory Provides Windfall Benefits. Cash balance plans
are designed to provide a lump-sum benefit equal to the balance in an
employee's cash balance account. Because the whipsaw theory requires a
cash balance plan to provide additional benefits when the plan's
interest crediting rate exceeds the statutory rate, whipsaw causes a
cash balance plan to provide windfall benefits--benefits that the plan
was not intended to provide and that employees had no reason to
anticipate.
The Whipsaw Theory Interferes with Employer-Employee Relationships.
Whipsaw interferes with employer-employee relationships by encouraging
employees to quit rather than to work. Because whipsaw benefits vary
erratically from year to year, whipsaw encourages employees to quit,
and to take lump-sum distributions, in order to capture whipsaw
benefits before they disappear.
The Whipsaw Theory Weakens Pension Funding. The erratic swings in
benefits under the whipsaw theory will impair sound pension funding.
Unanticipated benefit increases will create or increase unfunded
pension liabilities, encourage employees to terminate employment and
withdraw their benefits in a lump sum, and jeopardize the plan's funded
status. Such unexpected increases in benefit liabilities and cash
outflows will undermine the objective of the Code and ERISA to
strengthen pension funding.\31\
---------------------------------------------------------------------------
\31\ See Code Sec. 412; ERISA Sec. Sec. 301-08.
---------------------------------------------------------------------------
The Whipsaw Theory Risks Weakening the PBGC. Whipsaw's adverse
impact on pension funding will also impose additional and unpredictable
liabilities on the PBGC, the federal agency that is required to insure
terminated defined benefit pension plans. If employers are unable to
fund the additional benefits that the whipsaw theory creates, those
benefits will eventually be shifted to the PBGC.\32\ Whipsaw could
weaken the PBGC's financial condition and undermine the soundness of
the termination insurance program.
---------------------------------------------------------------------------
\32\ Cf. Pension Benefit Guaranty Corp., Title IV Aspects of Cash
Balance Plans With Variable Indices, 65 Fed. Reg. 41610 (July 6, 2000).
---------------------------------------------------------------------------
The Whipsaw Theory Discourages Employers from Adopting Defined
Benefit Plans. For the reasons identified in the preceding paragraphs,
the OIG Report's use of the whipsaw theory may discourage employers
from adopting cash balance and other hybrid plans--plan designs that,
unlike many traditional plan designs, are currently attracting
employers to the defined benefit plan system. But beyond that, there is
the even more worrisome risk that the Report's use of the whipsaw
theory will do lasting damage to the define benefit plan system as a
whole. We are concerned that the Report reflects a level of government
hostility toward defined benefit plans, and a lack of understanding of
those plans, that will reinforce the inclination of many employers to
shy away from defined benefit plans altogether.
Conclusion
At a time when millions of employees are looking increasingly for
retirement security, it is crucial for the Administration to support
the development of secure cash balance and other defined benefit plans.
As a defined benefit plan, a cash balance plan provides benefits
that employees can rely on, without the risk of adverse investment
experience. Cash balance plans provide secure and equitable benefits
that meet the needs of millions of employees, including women, who do
not spend their entire career with a single employer. Cash balance
plans treat all workers alike, regardless of age. Cash balance benefits
provide portable benefits that grow steadily over time in a fair and
equitable manner.
We urge the Departments to act promptly to strengthen the private
pension system by dispelling the erroneous impression created by the
OIG Report and by creating a regulatory environment that fosters the
creation and continuation of cash balance and other hybrid plans that
meet employees needs. Specifically, we ask the Departments to revoke
both Notice 96-8 and the OIG Report.
If we can provide you with any additional information or analysis
that will help you and your staffs to address the issues we have
raised, please let us know.
Because of the seriousness and magnitude for the issues we have
raised, we respectfully request the opportunity to meet with each of
you in the near future to discuss the issues further.
Sincerely,
Mark J. Ugoretz
President
cc: Ann L. Combs (Assistant Secretary for PWBA--Labor Department)
Pamela F. Olson (Acting Assistant Secretary for Tax Policy--Treasury
Depart-
ment)
William Sweetnam (Benefits Tax Counsel--Treasury Department)
Elliott P. Lewis (Acting Deputy Inspector General for Audit--Labor
Department)
[GRAPHIC] [TIFF OMITTED] 866581A.017
[GRAPHIC] [TIFF OMITTED] 866581A.018
[GRAPHIC] [TIFF OMITTED] 866581A.019
Chairman HOUGHTON. Well, thank you very much. Now, Mr.
Coyne.
Mr. COYNE. Thank you, Mr. Chairman. Ms. Friedman, in your
testimony you note that the 2001 Pension Reform Bill may have
made 401(k)s so attractive to better off employees that it will
be easier for employers to reduce costs by cutting back on the
defined benefit plans in favor of the do-it-yourself
arrangement. Could you elaborate on your statement?
Ms. FRIEDMAN. Well, yes. The incentives that were put into
the Economic Growth and Tax Reconciliation Act of 2001 (EGTRA)
would essentially increase limits for 401(k) plans, yet even
before the passage of EGTRA, only 5 percent of those
participating in 401(k) plans could afford to put in the
maximum.
So, our concern is that yes, this might create some new
plans, but it is not going to trickle down to rank and file
employees. So, our concern in general with EGTRA, although I
certainly applaud Congress for taking steps to address the
coverage issue, is that we feel that a lot of the provisions in
EGTRA are going to benefit high-income employees primarily.
Since the majority of both tax preferences and also pension
benefits accrue to the highest paid workers in this country, we
would like to see incentives for rank and file workers. So, I
guess our position would be that we should hold off and we
would encourage Congress to hold off from making those
provisions permanent until we see whether or not they have
their desired effect of helping rank and file employees.
Also, just in terms that I did not answer your question
fully, that if employers are finding 401(k)s that much more
advantageous, it is a disincentive to set up defined benefit
plans.
In the wake of Enron, I would say that more and more
employees do understand the importance of security and that I
think we should come up with incentives to encourage the
establishment of new defined benefit plans, recognizing that
401(k) plans are a good supplemental plan, but they are not
necessarily the best way of providing retirement income to
millions of American workers.
Mr. COYNE. How critical do you believe it is to have Social
Security remain a defined benefit system rather than a
partially privatized system, given the decline that we are
experiencing in defined benefit plans?
Ms. FRIEDMAN. The Pension Rights Center takes a very strong
position on that, Congressman. We feel that Social Security
should remain as a guaranty defined benefit system and that the
system should not be privatized because we have already seen
what can happen in situations like Enron. I think that what we
want is to have a strong Social Security system, especially
because so many Americans depend solely on Social Security for
their retirement income.
What we need to do is strengthen the private pension
system. I also want to say, Congressman Coyne, that we do
support your Retirement Opportunity Expansion Act. We applaud
you also for putting in the refundable tax credit which will
expand coverage for those low and moderate wage earners who now
don't have pension plans.
Mr. COYNE. Thank you very much. Mr. Miller, do you think
that we should offer defined benefit plans that are especially
designed for small businesses?
Mr. MILLER. Sure. I think it is important, whatever we can
do to encourage employers to adopt defined benefit plans is the
way we should go. There have been some specialty plans such as
the simple plan that have been enacted previously. What we
found is that those plans often enticed employers that never
had retirement programs before to get involved and to start
sponsoring plans.
What we found is that those are stepping stones. That is a
place to start. What we found is important is that we also have
to have that next step for employers. So, that is where
suggestions like the DB-K program where you are encouraging
employees to save for their own retirement and take
responsibility for their own retirement by making salary
deferral contributions and also giving the ability for and the
encouragement for employers to also sponsor the defined benefit
plans where there is a guaranteed level of benefits is very
important. We need to move in that direction.
The cash balance concept is another step. So, while the
specialized plans are an important first step, I think we have
to also look at what the next steps for employers are going to
be.
Mr. COYNE. Ms. Friedman pointed out that she supported the
Smart Plan. Have you had a chance to review that and take a
position on it?
Mr. MILLER. Yes, and we believe that that type of program
does have certain limitations that discourage employers from
getting involved in those plans. The ASPA has previously been
supporting a different proposal, the safe proposal, which we
believe has more flexibility and more ability and encouragement
for employers to get involved in those types of programs.
Mr. COYNE. Thank you.
Chairman HOUGHTON. Mr. Portman.
Mr. PORTMAN. Thank you, Mr. Chairman and thank all the
witnesses for being here and for your good testimony. This is
great to get it in the record. I apologize I wasn't here
earlier. I was actually at the Committee on Rules trying to get
a rule for the possibility of bringing up the permanent
extension of the Portman-Cardin bill for tomorrow. It may or
may not happen tomorrow, but it is possible. I appreciate the
comments that were made by the witnesses that I got to here.
Maybe Ms. Friedman and others weren't as positive. I didn't
hear that.
Ms. FRIEDMAN. We applaud your efforts.
Mr. PORTMAN. Selective listening maybe, and coming late. I
really appreciate the Chairman's willingness to dig into some
of these issues and focus on them. I wish that when I was at
Dartmouth College that Dr. Skinner had been there. I would have
been an economics major instead of anthropology major. On the
other hand, here I am, getting into all of your issues.
Your data is just fascinating. I hear so much information
out there about the differences between DBs and DCs. The
approach that we have always taken in the Portman-Cardin
legislation and with Mr. Houghton's Subcommittee and Mr. Coyne
and so on, is we want to encourage both.
A lot of the changes in Portman-Cardin, I think, will help
with regard to the DB side. I don't believe there is any
inconsistency in promoting both, particularly with regard to
smaller businesses.
The date, though, that you show also reflects the fact that
we do have a more mobile workforce. I guess my general
question, and maybe I should direct this to Ms. Friedman
because I heard you say earlier that Portman-Cardin helps the
highest paid workers versus rank and file workers. I don't know
who rank and file workers are exactly.
If you are focused on low income workers, which I think you
are, then wouldn't you think that because most low income
workers tend to change jobs more, on average they change jobs
more and they have more mobility, that a pension system where
they could take the benefits with them from job to job would be
more advantageous than the traditional defined benefit plan
where they would not have the opportunity to vest, which is
really what Dr. Skinner found out in his studies and what
others have commented on.
Ms. FRIEDMAN. Congressman Portman, as I said earlier, the
Center is convening now the Conversation on Coverage. In fact,
we had the first stage last year. The Conversation on Coverage
is a national dialog where we are bringing together business,
labor, consumer groups, academics, in fact I would venture a
guess that everybody on this panel participated last year and
we are going to continue that.
We are looking at incentives. The Pension Rights Center
takes the position that we have to have a system where there is
a delicate balance between incentives for employers, fairness
and adequacy for workers and we are opportunity to lots of
different ideas.
At the Conversation last year there were proposals, and you
will see it in our written statement, there was a proposal for
new kinds of hybrid plans that jump off from the cash balance
plans that exist now.
Our issue with cash balance plans is much more in the
conversion and we are certainly open to having a dialog with
the business community on finding new ways of creating hybrid
plans. There were other proposals that were presented at the
Conversation on Coverage that also took the best parts of
defined benefit plans, which is the guaranteed payment, the
annuitization, and paired it with some of the best features of
401(k) plans like portability and simplicity. So, we would
welcome you and other Members of the Subcommittee to join us in
the Conversation on Coverage as we explore these issues.
Mr. PORTMAN. Speaking as one Member of the Subcommittee, I
would be happy to join in your conversation. Where I have found
you all have normally come out, and I am delighted to hear your
testimony today or at least your answers to the questions,
because you sound more open to it, is that you have a
fundamental disagreement with many of us who believe that so
long as there is not a mandate that businesses offer pension
plans, you do need to provide flexibility.
That sensitive or delicate balance you talk about in fact
is something very important and every time we try to create
more incentives, it seems to me you all have come in and said
that that is not appropriate.
With small businesses offering very little in terms of
pension coverage, fewer than 20 percent of businesses under 25
employees, we believe, offer any kind of coverage at all, even
a set plan or a simple plan or a 401(k). It just seems to me we
do need to focus on those employers and on those low-income
workers who tend to work there. So, I am encouraged by your
statement and would be happy to join in that Conversation.
If I could ask one question of folks in the private sector
here--my time is running out--but what has the impact been of
the reforms from last year? We have some data coming in that in
the first 6 months there was an increase in the IRA
contributions which, I guess, is good news, that in a flat
economy you have about a 25-percent increase, I am told, in
terms of IRA contributions. That is one of the few pieces of
good news in our economy in the last year.
The 401(k) and defined benefit numbers are more difficult
for us to come by. We have some anecdotal information that is
not very helpful. Can you all give us any information today as
to what the impact has been thus far of the changes that were
made last year through the tax relief legislation? Maybe ABC
could take a shot at that. Do you all have any data for us?
Okay, how about an anecdote?
Mr. MILLER. Well, I think what we have found is that with
the market going in the direction that it is going, I think
what employees have learned is that there is not the constant
increase in their account balances. I think that the economy
had people thinking that 401(k) plans were the only thing you
really needed.
A lot of people, as we heard, there was a 70-percent
decrease in small business defined benefit plans in the recent
past. That decrease is because 401(k) plans became the way to
go. While the market was doing very well, people were happy
with it and were comfortable with it.
I think what we found in the last couple of years with the
decreasing in the market is that people are less comfortable
with just a 401(k) plan. They need that security that a
qualified defined benefit plans gives them.
I think that we still have to expect that the employees
take advantage of different opportunities that are out there
for them to save. It is that three-legged stool concept. We
can't make this work unless all those legs are there.
So, I think that the changes that have been made in the
401(k) market, encouraging people to save in the 401(k) plans
to give them incentives to do that are great. What we need to
do now is that next step, again, to make sure, to give people
the comfort that a defined benefit plan is there that
guarantees that they will have a certain level of income once
they reach retirement.
We are not going to be able to get there. Right now we have
half of our workforce being employed by smaller employers, but
an employee of smaller employers are only one-fifth as likely
to have a defined benefit plan from their employer than larger
companies. I think we have to change that around. I think we
have to be able to give these employees from small employers
the opportunity to have the comfort that when they retire they
know they are going to have a certain level of income.
I think one of the ways, as a lot of people have been
saying, is the cash balance issue. I think we need
clarification on the rules. We have to have the Treasury
Department come out with regulations and where necessary have
legislative changes in order to encourage people to use those
plans because the concepts are good. That is the type of
program that employees understand and they will be more
comfortable.
The traditional defined benefit plan again is harder for
the employees and the employers to understand. I think that the
employers need to have flexibility in funding. The ironic part
of funding a defined benefit plan is that the required
contribution in a defined benefit plan is highest when the
economy is doing badly.
So, what you are saying is, when your business is doing
badly that is when we are going to require that you put in a
higher contribution, but we will not allow you when you are
prospering to put in additional contributions in order to give
you a little cushion so that if your business does go downhill-
or you start running into certain business problems or economic
problems-that you will be able to use that cushion to help
offset your contribution levels.
Mr. PORTMAN. I appreciate that, Mr. Miller. I don't
disagree with anything you said. I would love to find out if
anybody else on the panel--I've taken too much time already--
has any information on the 30-year Treasury bond issue, which
we are trying to get some much better guidance with regard to
cash balance and maybe there's some talk about a hybrid. I
agree with all that. I would love to know what the impact is of
the changes last year, if anybody has any information on that.
By the way, since my time is just about up, if you have any
information, you can provide it to Barbara or to me, I would
really appreciate it, afterwards. We are also working with Mr.
Cardin on another bill to try to simplify further and to try to
come up with some other incentives for defined benefit plans as
well as defined contribution plans. So, I would love to have
your input on that over the next couple of months.
Mr. O'FLINN. I am sorry, Mr. Chairman, this is it.
Chairman HOUGHTON. No.
Mr. O'FLINN. Although we don't have any hard data on this,
we can put some pieces together to show a major impact of the
bill. For example, the 3-year vesting requirement, the 3-year
CLIFF vesting, reducing the vesting from 5 years to 3 years.
My company and several large companies that I'm familiar
with have over 40 percent of their employees with less than 6
years of service. So, a reduction in the vesting is an
immediate benefit to many of those people and also encourages
them to think in more positive terms of the plan to make their
own contributions. I don't have data on the contributions.
Also, the catch-up contribution of $1,000; $1,000 is not
going to make or break anyone's retirement security, but it
gives us an excuse to conduct a communications campaign about
contributions to the plan to this group of people who should be
thinking very seriously about retirement.
So, what happens is the entire contribution plan gets
reviewed by the employee because of this news and the
opportunity it triggers, I think, a lot more contributions
than, you know, would be attributable to the $1,000.
Mr. PORTMAN. Sorry, Earl. Thank you, Mr. Chairman.
Chairman HOUGHTON. Mr. Pomeroy.
Mr. POMEROY. Thank you, Mr. Chairman. I was very interested
in my colleague's questions and appreciate his leadership on
these issues, so you could have gone all afternoon as far as I
was concerned, thought you were, as well.
The questions I have of this excellent panel, I really
enjoyed every presentation, as we evaluate defined benefit
versus defined contribution, Dr. Skinner you are outnumbered
today with your research, but some of the things that you said
actually do surprise me.
One, that even low income workers will achieve a higher
rate of savings under a DC arrangement than DB. Then, virtually
all of them or all but 4 percent of them not contributing have
other retirement savings options. I would like to just probe
these a little.
First, the earnings issue. It is my understanding that for
your study you used historical performance. Did you project
returns going forward?
Dr. SKINNER. Yes. What we did is, we projected forward
using actual rates of return from 1900 to 1990. So, that is
what we sampled from. Somebody could, in theory, get the Great
Depression twice. Some of the people doing badly in 401(k)
plans, that is where they ended up.
Also, there were some of the plans that were out there in
the 1980s, the DB plans were just pretty horrible. They weren't
indexed for inflation and they had the Social Security offsets.
So, these are people who had them in place and so they retired
and they just really weren't worth very much. It was
unfortunate, but that is what the numbers told us.
Mr. POMEROY. Dr. VanDerhei, would a measurement period--
does the 1900 to 1990 measurement period have recognized
analogous levels of return to what we could look forward to now
going from 2002 to 2022?
Dr. VANDERHEI. Well, the extreme difficulty with doing any
kind of simulation, and I am certainly guilty of this in
everything I have been running, is that we have only had one
snapshot of what the U.S. stock market could look like. There
are a number of different ways that one can try to add that
type of uncertainty into a simulation.
I certainly agree with what Dr. Skinner and Dr. Samwick
did. It is one approach. Other people might go back and try to
historically replicate the exact time series that has been
seen, but obviously, we have only, again, had one time series
to look at in this country. To the extent that that is not
going to necessarily capture everything that might happen in
the future, about the only way one can go around that is to
come up with one's own synthetic distribution of expected rates
of return.
I do believe they had done some sensitivity analysis on a
number of different types of financial scenarios and I think
they were rather robust.
Dr. SKINNER. If I could add to that, we also subtracted 3
percentage points, 300 basis points, from every year's stock
market return and we ran it. You know, a 3-percentage point gap
is a huge gap. We ended up with roughly similar medians for the
DB versus the 401(k)s. Still, at the bottom, the 401(k) still
did better than the DB plans.
Mr. POMEROY. You know, I'm sort of not an economist. It
strikes me that that does not capture the very significant
change in demographics that we are about to undergo in the next
30 years and the resulting impact that may have overall on
performance of growth of the economy, whether we will see that
kind of historic growth looking forward.
The other issue relative to rates of savings, I believe it
was EBRI data that showed about one third were not
participating in savings and that was even when there was an
employer match under the 401(k) opportunity.
Dr. VanDerhei, are you familiar with that point?
Dr. VANDERHEI. I don't believe that is EBRI data because
although we have 11 million individuals in our database, they
are all participants. So, we can't give you information on non-
participants hence we cannot give you the participation rate.
However, I do believe that number is fairly well in line
with industry studies that have been put out. Fidelity has put
out Building Futures. Vanguard has put out their own
publication.
There is a substantial percentage of 401(k) participants
that chose not to contribute in a specific year, the important
point is that that does not mean that they will not contribute
ever while they are with that employer who sponsors that
401(k).
Mr. POMEROY. Right. To me it is just almost--I mean it just
doesn't make sense that virtually all of the non-participants
have alternative retirement savings options at work, because
half of the people in the workforce today don't have any option
to save for retirement at work.
The number with both the defined benefit and a defined
contribution option is a third or less of those in the
workforce today. So, to think that all but 4 percent, I am just
not getting that.
Dr. SKINNER. I'm sorry. I should be clearer about the
number. It is a percentage of the workforce. It is people who
are offered 401(k)s and they don't have a DB plan or any other
401(k) or maybe their spouse has a 401(k) and they turn it
down.
So, I absolutely agree with you that if you are thinking
about the problem of people not saving enough, I tend to worry
less about the people who are offered and decide not to take it
because they may come back and contribute later. I also worry
about people who are never given the option to contribute.
Ms. FRIEDMAN. Congressman Pomeroy, may I respond to that as
well.
Mr. POMEROY. Certainly.
Ms. FRIEDMAN. The Pension Rights Center, one of the reasons
that we are all having the Conversation on Coverage and we are
looking for new designs, how do we encourage more plans, is
because there is a lot of people who don't participate simply
because they don't have the money to participate.
You will find that with a typical median worker. They are
living from day to day trying to make all their expenses. So,
retirement is a long way off. I think that is one of the
reasons that the Pension Rights Center has been critical of
401(k) plans and do-it-yourself savings plans because it
requires employees to put the money in first before getting a
match.
Some of the proposals that came out of the Conversation on
Coverage came up with ways of putting in a reverse match where
an employer would put it in first and the employee could match
if they have the money.
I also wanted to say to you that in terms of some great
coverage statistics that might be of help, I would like to be
able to submit this to the record, Dr. Alicia H. Munnell and
Dr. Annika Sund1n from the Center for Retirement Research did
this very good piece for the Conversation on Coverage called
``Private Pensions: Coverage and Benefit Trends.'' I would be
happy to give you a copy and also submit it into the record.
Mr. POMEROY. I am familiar with their work. It is
excellent. We should have that in the record.
[The information is being retained in the Committee files.]
Mr. POMEROY. Dr. VanDerhei, did you have a response on that
last point about the--you look like you were going to say
something. I just want to make that opportunity available to
you.
Dr. VANDERHEI. The only thing that I wanted to add, which I
think, may go part of the way to explain your sense of
disbelief in perhaps some of these results, is that we have
found in our simulations, and it is very critical what you
assume as far as participation in subsequent jobs.
We talked a lot about job mobility today. If you assume
that somebody who is in a 401(k) plan today always remains in a
401(k) on each subsequent job, obviously, the defined
contribution scenario looks a lot better than if you go back
and say with each additional job there is perhaps a 50-percent
chance of being employed by an employer that offers one and
then whether or not they are going to have the type of matching
formula that is going to provide incentives for them to
continue to contribute.
Mr. POMEROY. Do you have data on rollover? There was a
statistic that was really horrifying about the number of
distributions not rolled back into an IRA. Do any of you have
data on that?
Dr. VANDERHEI. Well, both Hewitt and Fidelity make that
information available. I would be glad to send it to you. It is
largely a function of account balance size, the larger the more
likely it is to be rolled over. The smaller, the more likely to
be cashed out, and also age, the older you are.
Mr. POMEROY. Dr. Skinner, I don't mean to sound like I am
picking on you. You made a very clear statement that annuities
could play a very important role in achieving long-term
retirement income security and I think advanced a very
constructive notion of default annuitization or something to
try and get those selecting that option up.
I agree with you on that. I don't mean in place of DB
plans. I don't mean in any way to condemn DC plans. I just want
us to be very clear eyed about whether we are achieving the
kind of rates of savings as well as advancing sufficiently
worker expertise in terms of matching assets to expected
longevity coming upon retirement to achieve the overall goals
of retirement income security that we need. All of you are
leaders in this area. It has just been my joy to work with you.
We have a lot of work ahead. Thank you very much.
Chairman HOUGHTON. Okay, I have one final question. Now you
are all a Board of Directors, okay? We are part of the Portman-
Pomeroy Corp. and we are deciding what sort of pension plan we
would have for our employees.
Maybe you could just sum up very briefly what your pension
plan basically would be and if there are necessary changes in
the law in order to make this thing more palatable, salable.
Let's start with you, Mr. VanDerhei.
Dr. VANDERHEI. Under the current scenario, I would
certainly go with a hybrid approach, not cash balance hybrid,
but a combination of defined benefit and defined contribution.
If you are asking what is the one recommendation I would
suggest, it is something that Ron has mentioned and several
others. It is the addition of a 401(k) salary reduction feature
for defined benefit plans.
I did a study for the Labor Department in the early
eighties as a result of the reversion phenomenon and in 80
percent of the plan sponsors that I interviewed that had
reverted their defined benefit plan, it was to go into 401(k)
plans because that is all they were hearing from their
employees is this great opportunity for salary reduction. They
could not offer it through the defined benefit vehicle, so they
decided to terminate altogether.
Chairman HOUGHTON. All right. How about you, sir?
Mr. GEBHARDTSBAUER. I am going to be like an actuary and
say I need to have more data. I would need to know what kind of
industry I was in. Is it an industry where employees are going
to be around for a long time or they are going to be more
mobile, industries where people are around for a long time like
in the government or in multi-employer organizations or big
organizations--
Chairman HOUGHTON. It is a service organization and we are
in a very mobile society.
Mr. GEBHARDTSBAUER. Okay, thank you. Well, as some people
have already talked about, I also like the hybrid or DB-K idea
which brings in the 401(k) idea into the DB world and if I
could design it without the way the laws are in the United
States, you could have pre-tax contributions and matches from
the employer, so it would look like the 401(k) to the
employees.
I can design that in a DB context so it will look exactly
like a 401(k) to the employees or a cash balance plan to the
employees, but I (the employer) also get advantages. In fact
this is in reference to Professor Skinner's point before. I can
make it look just like the DC plan and get the same kind of
returns as he is talking about.
If I have it in a DB world, then as an employer I have
funding flexibility. I have investment flexibility. I have
flexibility to design it in ways every once in a while if I
want to have an early retirement window, I can put that in.
So, in a DB world we have more flexibility. In the 401(k)
world, you just get whatever is in the assets. There can be
periods, for instance, when the assets of a 401(k) will go down
and none of your employees will want to retire. So, that can
cause difficulty in my workforce management area.
So, I like the 401(k) idea. I like the DB idea. If we can
put them both together, I can create something with enough
flexibility that not only is it good for me, by the way, but it
will also be good for the country, too, and the employees,
because benefits then can come out in the form of an annuity.
They will like it. It is also good for the country because it
reduces poverty levels for very old Americans, too.
Ms. FRIEDMAN. I guess it is my turn. I guess that we would
say taking the best of the DB world, the defined benefit
structure and the defined benefit plan. I am thinking here that
your corporation is probably on the relatively small side.
The most important thing to the Pension Rights Center would
be fairness, so the same percentage of pay contributed for all
employees. Make sure that the benefits will be annuitized, that
they would be insured so that people wouldn't lose out.
There could be some sort of a salary reduction feature. We
would also like to see a reverse match, as I said before, where
an employer put in first, and then the employee could match
that and also pooled investments to ensure that we don't end up
with another Enron, and we have secure retirement. I think that
would be my pick today.
Chairman HOUGHTON. Thank you. Doctor?
Dr. SKINNER. I think I would not surprisingly go with the--
--
Chairman HOUGHTON. Don't forget, you have a Dartmouth fan
up here.
Dr. SKINNER. I know, a very distinguished graduate.
No, I think I would go with a 401(k) plan where I would
make a strong effort to educate the workers that if they wanted
a safe investment that there was an option for inflation
adjusted Treasury bonds which would basically be as sure as
anything there is.
I think this would give firms less flexibility, but it
would also give them less flexibility to dump their pension
liabilities onto the PBGC, which would probably be a nice
thing, too. Thanks.
Chairman HOUGHTON. Thanks very much.
Mr. Miller.
Mr. MILLER. Not surprisingly, I would be in favor of a DB-K
program where you take the benefits of both a 401(k) and a
defined benefit plan. One of the important changes in the law
would be to change the law to allow you to have both those
types of programs within the same plan so that you can reduce
the administrative costs.
The second thing would be to, just like we have certain
safe harbor contributions within a 401(k) plan, within our DB-K
program you would want to have some type of comparable safe
harbors in order to let the employees know in advance what
level of contributions they will be able to make into the plan
while guaranteeing all employees a certain baseline level of
benefit.
You would need to make certain changes to the deduction
limitations. Right now the way it is is that you can, because
of the way the deduction limitations are when you have a
defined benefit and a 401(k) plan, with a defined benefit plan
you might be in a position after making that contribution to
not be able to make a contribution and take a deduction within
a 401(k) plan.
We have to change the laws so that matching contributions,
even though defined benefit plan contributions are being made,
the employee could still make and take deductions for matching
contributions and basically allow the employer to make matching
contributions by matching it through defined benefit accruals
in order to again increase the guaranteed level of benefits
that the employee could rely on.
Chairman HOUGHTON. Okay. Mr. Beilke.
Mr. BEILKE. Yes, as was said before, of course, more
information on objectives is always important. What are we
looking at with our own employees here? Are we looking at an
isolation that we have come to a conclusion that we want to
provide a certain amount of retirement income or are we
constrained by the amount of financial commitment that we can
put toward this and what kind of competitive environment are we
in?
You know, if we do something very light, is everybody going
to run to our competitor because they have something better? If
we do something good, are we putting ourselves out of business
and spending too much?
All those things have to be taken into account. Once we
have taken those into account and defined all those things, I
believe that, my personal recommendation would be two plans.
One of the defined contribution nature and one of a defined
benefit nature. The reason why is we have the older, long
service employees already who have not been in a plan until
now, if this is the first time we are putting a plan in. We
cannot expect them to buildup enough for retirement in the
short time period that they still have left. Only a defined
benefit plan can provide benefits for the service that they
have already provided to us.
On the other hand, the defined contribution plan, with this
mobile workforce that you mentioned, is very attractive to them
and very important to them.
So, you have to balance the needs of our executives,
Representatives Portman and Pomeroy, and their needs to provide
retirement income for themselves when they retire and the
younger employees that come and go.
As far as what law changes would be needed to make this go
forward easier, certainly the 30-year Treasury bond and the
amount of volatility that is going to cause us because we would
be so underfunded in that defined benefit plan in which we gave
past service.
We start right out with unfunded liabilities. As we go into
funding this, the funding rules right now could cause us to
jump all over the place in early years of how much we had to
fund that and not know what the commitment really is as we walk
into this, which we really should do in a fiduciary manner of
knowing where this is all going.
Certainly, going back to Mr. Portman's earlier question of
what did this law just do, I think it changed the attitudes out
with us in trying to put in new plans. Now that we see Congress
realizing that the laws of the eighties and nineties which
always constricted what we could do, made it more complicated,
the law last year finally is the first step in a turnaround in
that fashion of trying to simplify some things and also to
expand issues that allow more coverage.
Seeing that mindset change gives us more good feelings
about what is going to happen in the future in that we don't
jump into this and see a bunch of laws like we saw in the
eighties, that we would be much more open to putting in plans
that do require a good financial commitment in the future
without being worried about being hit with law changes that
completely change what we are doing every year down the road.
Chairman HOUGHTON. Thank you very much. Finally, Mr.
O'Flinn.
Mr. O'FLINN. Mr. Chairman, in the hypothetical you outlined
with high mobility, I think we would clearly select a cash
balance plan together with a 401(k) plan. The ERIC companies
are large companies with a heavy commitment to benefits. So,
there are many of them who, for competitive reasons, and of
course they would want to match the competition, would be
forced to put in a tradition defined benefit plan.
So, all of the problems that come with that, including the
volatility in the funding, would be a consideration and they
would need to address that.
I would add one thing that hasn't been mentioned. That is
that I would want the ability to put in a comprehensive
education program. Some of the things that Congressman Pomeroy
referred to would not happen. People would make informed and
presumably better decisions.
Although those programs are very common, they are not
without legal risk. It would be wonderful to have a clear legal
pathway to educate employees appropriately so that they could
make informed decisions that would affect their financial
security.
Chairman HOUGHTON. Well, thank you very much. That is a
fascinating idea. I wish I could be a Member of this
corporation to continue this discussion. Thank you very much
for your contributions. The hearing is adjourned.
[Whereupon, at 5:00 p.m., the hearing was adjourned.]
[Submissions for the record follow:]
Women's Institute for a Secure Retirement, Cindy Housell,
statement and attachments
Duluth, Georgia
July 5, 2002
To: Subcommittee on Oversight of the Committee on Ways and Means
From: Fred Munzenmaier
Subject: Comments to the Subcommittee on Retirement Security and
Defined
Benefit Plans
I am submitting these comments on my own behalf as a private
citizen.
My comments are as follows:
Defined benefit plans have been a cornerstone of our National
retirement income policy for the better part of the twentieth century.
The significance of these plans to the financial security of our
retired population is exceeded only by the importance of Social
Security.
As you know, in recent years there has been a trend away from
defined benefit plans in both the private and public sectors. The
smaller the employer, the more likely that a defined benefit plan has
been terminated or not considered at all.
Your Subcommittee will hear comments from commentators that 401(k)
plans and other forms of defined contribution (DC) plans are more
portable and better suited to today's mobile workforce. Defined
contribution plans no doubt play an important role in the overall
retirement scheme.
As workers with only a DC plan actually retire, however, they must
cope with fluctuations in the capital markets during their retirement
years--unfortunately there is a proclivity to focus only on managing DC
accounts before retirement. When one has to factor in the cash flow
needs in retirement, the weakness of sole reliance on DC plans is
exceedingly evident. Consider what happens when a retiree must
liquidate investments at a down point in the market just to meet
current cash flow needs. Most people are not equipped to manage these
inevitable situations.
Nowadays, capital markets are not only influenced by economic
factors (which make managing a defined contribution arrangement
difficult enough), the markets are influenced by the degree of
integrity (or lack thereof) of corporate leaders.
All things considered, those workers without a defined benefit
pension will wish they had one.
In spite of the platitudes your Subcommittee will hear about why
there has been a decline in defined benefit plans in favor of the more
trendy DC plans, the primary reason for the decline is much more
subtle. The decline is tied directly and indirectly to our system for
guaranteeing pensions, i.e., the system embodied in the Pension Benefit
Guaranty Corporation (PBGC).
Your Subcommittee and the Nation must ask a basic question as
follows:
Is our current system of guaranteeing defined benefit plan
benefits (i.e., the PBGC) synonymous with the protection of
American workers' pensions?
The PBGC reports that 644,000 people have guaranteed benefits from
plans that have actually terminated. In 2001, there were 44 million
workers in plans covered by the PBGC. Assuming there were at least that
many (DB coverage has been declining) in each of the 25+ years of the
PBGC's existence, is 644,000 out of 1.1 billion man-years (44 million
times 25 years--yielding a 6 in 10,000 chance to benefit) a sufficient
return on our investment in the plan termination system?
I submit to you that for every defined benefit plan participant who
got a PBGC guaranteed benefit, there are many more who never had a
chance for a pension because their employer is not willing to subject
company operations to the fits and starts that have been created by our
current pension funding rules that are driven by concerns about the
PBGC's financial condition.
In fact, it is against the PBGC's interests to insure terminating
plans. Each terminating plan that the PBGC must assimilate hurts its
financial position. Over the years since ERISA, I have attended pension
industry meetings where PBGC representatives were speakers, and I had a
personal interview with the first Executive Director of the PBGC. It
has always astonished me that the first concern of the PBGC officials
is for the financial status of the PBGC. The protection of workers'
pensions did not seem to be on their first priority.
The problems began with the flawed concept in ERISA but have been
multiplied many-fold by subsequent pieces of legislation designed to
protect the PBGC. Specifically, OBRA 87 and RPA 94 imposed absurd
funding requirements that must be met by private sector employers.
The system is flawed in other ways, too. Besides the ridiculous
funding requirements, the PBGC has carte blanche to meddle in the
business affairs of any corporation that sponsors a defined benefit
pension plan. The PBGC has a unilateral right to step in and terminate
any private sector retirement plan that it chooses.
The premiums that employers must pay to the PBGC started out in the
1970's at $1 per participant. The premiums are now $19 plus a
``variable premium'' based on ultra-conservative rules that actuaries
must use to measure plan's unfunded vested benefits. To many employers,
the PBGC variable premium can be hundreds of thousands or millions of
dollars even though the plans are in fact well funded according to the
calculations of the Enrolled Actuaries who serve the plans. The under-
funding exists merely because of the bizarre assumptions mandated by
the OBRA 87 and RPA 94 legislation.
As a result, too many responsible business leaders have been forced
to avoid defined benefit pension plans. Corporate governance
responsibilities dictate such decisions in spite of the good that
defined benefit plans could do to provide retirement security to their
workers.
In closing, I suggest that the Subcommittee call for a report by
the General Accounting Office on whether the current system for
guaranteeing pensions in this Country has been worthwhile or whether
the time for the PBGC has come an gone. This report might also cover
methods to protect workers covered by DC plans (401(k) plans) in the
aftermath of recent corporate accounting scandals.
Respectfully submitted:
Fred Munzenmaier