[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









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86-581                         WASHINGTON : 2003
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                      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


 
----------------------------------------------------------------------------------------------------------------
 
-----------------------------------------------------------------------------------------------------------------
                                          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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
         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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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).
---------------------------------------------------------------------------
    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
---------------------------------------------------------------------------
    \iv\ Jerry S. Rosenbloom and G. Victor Hallman, Employee Benefit 
Planning, third edition, Prentice-Hall, 1991.
---------------------------------------------------------------------------
         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
---------------------------------------------------------------------------
    \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:
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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
---------------------------------------------------------------------------
    \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
---------------------------------------------------------------------------
    \ix\ See Charles G. Tharp, ``Yes,'' in Dallas L. Salisbury, ed, Do 
Employers/Employees Still Need Employee Benefits?, EBRI-ERF, 1998, pp 
11--13.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \x\ Steven G. Vernon,  Employee Benefits: Valuation, Analysis and 
Strategies, John Wiley & Sons, Inc., 1993.
---------------------------------------------------------------------------
    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 
---------------------------------------------------------------------------
        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.
---------------------------------------------------------------------------
    \1\ Pension laws restrict some of this flexibility for taxable 
employers, but they are less strict for churches and government plans.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \6\ EGTRRA, the Economic Growth, Tax Relief and Reconciliation Act 
of 2001.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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.)
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
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:
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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!
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
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    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.

---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
    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 
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
         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\
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \10\ See Watson Wyatt, supra, at 14-20, 48-53.
---------------------------------------------------------------------------
         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\
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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

                                
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