[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]





                 CHALLENGES FACING PENSION PLAN FUNDING

=======================================================================

                                HEARING

                               before the

                SUBCOMMITTEE ON SELECT REVENUE MEASURES

                                 of the

                      COMMITTEE ON WAYS AND MEANS
                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                               __________

                             APRIL 30, 2003

                               __________

                           Serial No. 108-10

                               __________

         Printed for the use of the Committee on Ways and Means



88-996              U.S. GOVERNMENT PRINTING OFFICE
                            WASHINGTON : 2003
____________________________________________________________________________
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Internet: bookstore.gpr.gov  Phone: toll free (866) 512-1800; (202) 512ï¿½091800  
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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               SANDER M. LEVIN, Michigan
WALLY HERGER, California             BENJAMIN L. CARDIN, Maryland
JIM MCCRERY, Louisiana               JIM MCDERMOTT, Washington
DAVE CAMP, Michigan                  GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota               JOHN LEWIS, Georgia
JIM NUSSLE, Iowa                     RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas                   MICHAEL R. MCNULTY, New York
JENNIFER DUNN, Washington            WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia                 JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio                    XAVIER BECERRA, California
PHIL ENGLISH, Pennsylvania           LLOYD DOGGETT, Texas
J.D. HAYWORTH, Arizona               EARL POMEROY, North Dakota
JERRY WELLER, Illinois               MAX SANDLIN, Texas
KENNY C. HULSHOF, Missouri           STEPHANIE TUBBS JONES, Ohio
SCOTT MCINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
KEVIN BRADY, Texas
PAUL RYAN, Wisconsin
ERIC CANTOR, Virginia

                    Allison H. Giles, Chief of Staff

                  Janice Mays, Minority Chief Counsel

                                 ______

                Subcommittee on Select Revenue Measures

                    JIM MCCRERY, Louisiana, Chairman

J.D. HAYWORTH, Arizona               MICHAEL R. MCNULTY, New York
JERRY WELLER, Illinois               WILLIAM J. JEFFERSON, Louisiana
RON LEWIS, Kentucky                  MAX SANDLIN, Texas
MARK FOLEY, Florida                  LLOYD DOGGETT, Texas
KEVIN BRADY, Texas                   STEPHANIE TUBBS JONES, Ohio
PAUL RYAN, Wisconsin
MAC COLLINS, Georgia


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
Advisory of April 23, 2003, announcing the hearing...............     2

                               WITNESSES

U.S. Department of the Treasury, Hon. Peter R. Fisher, Under 
  Secretary for Domestic Finance.................................     7

                                 ______

American Academy of Actuaries, Ron Gebhardtsbauer................    50
American Benefits Council, and DuPont Co., Kenneth Porter........    42
Pension Benefit Guaranty Corp., Hon. Steven A. Kandarian.........    14
Pension Rights Center, Norman P. Stein...........................    38

                                 ______

                       SUBMISSIONS FOR THE RECORD

AARP, statement..................................................    75
American Medical Group Association, Alexandria, VA, Donald W. 
  Fisher, statement..............................................    80
Connecticut Hospital Association, Wallingford, CT, statement.....    81
ERISA Industry Committee, statement..............................    82
Gold, Jeremy, New York, NY, statement and attachment.............    87
March of Dimes, statement........................................    92
Mayo Clinic, Bruce M. Kelly, letter..............................    93

 
                 CHALLENGES FACING PENSION PLAN FUNDING

                              ----------                              


                       WEDNESDAY, APRIL 30, 2003

             U.S. House of Representatives,
                       Committee on Ways and Means,
                   Subcommittee on Select Revenue Measures,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 2:36 p.m., in 
room 1100, Longworth House Office Building, Hon. Jim McCrery 
(Chairman of the Subcommittee) presiding.
    [The advisory announcing the hearing follows:]

ADVISORY FROM THE COMMITTEE ON WAYS AND MEANS

                SUBCOMMITTEE ON SELECT REVENUE MEASURES

                                                CONTACT: (202) 226-5911
FOR IMMEDIATE RELEASE

April 23, 2003

No. SRM-1

                McCrery Announces Hearing on Challenges

                      Facing Pension Plan Funding

    Congressman Jim McCrery (R-LA), Chairman, Subcommittee on Select 
Revenue Measures of the Committee on Ways and Means, today announced 
that the Subcommittee will hold a hearing on challenges facing pension 
plan funding. The hearing will take place on Wednesday, April 30, 2003, 
in the main Committee hearing room, 1100 Longworth House Office 
Building, beginning at 2:30 p.m.

    In view of the limited time available to hear witnesses, oral 
testimony at this hearing will be heard from invited witnesses only. 
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:

    Under present law, pension plans are required to use the 30-year 
Treasury bond rate for a variety of defined benefit pension 
calculations. For example, the 30-year Treasury rate is used to 
calculate funding requirements, certain premium payments to the Pension 
Benefit Guaranty Corporation (PBGC), and lump sum distributions.

    As a result of the U.S. Department of the Treasury's debt buyback 
program and the subsequent discontinuation of the 30-year Treasury 
bond, the interest rate on outstanding 30-year bonds has fallen 
significantly. Businesses have expressed concerns that this very low 
rate results in an overstatement of their actual liabilities, thus 
forcing them to make artificially inflated payments to their pension 
plans and to the PBGC.

    In 2002, the Congress enacted temporary relief in the Job Creation 
and Worker Assistance Act (P.L. 107-147). The new law temporarily 
raises the permissible interest rate which may be used to calculate a 
plan's current liability and variable rate PBGC premiums. The provision 
applies to plan years 2002 and 2003. This hearing will explore options 
for a permanent and comprehensive replacement solution. The hearing 
will also explore other pension plan funding issues that have been 
raised.

    In announcing the hearing, Chairman McCrery stated, ``The issue of 
pension funding is a perilous one. Funding requirements which are too 
low will leave plans drowning in liability and unable to pay promised 
benefits. Funding requirements which are too high will burden companies 
by forcing them to shore up a plan by devoting resources which are more 
urgently needed for current expenses, such as new employees or buying 
new equipment. The challenge for Congress is both clear and daunting.''

FOCUS OF THE HEARING:

    The focus of the hearing is to discuss the funding rules related to 
defined benefit pension plans and evaluate proposals for replacing the 
30-year Treasury rate that is used in pension plans calculations.

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, Wednesday, May 14, 2003. 
Those filing written statements that wish to have their statements 
distributed to the press and interested public at the hearing should 
deliver their 200 copies to the Subcommittee on Select Revenue Measures 
in room 1135 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 
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materials in alternative formats) may be directed to the Committee as 
noted above.

                                 

    Chairman MCCRERY. The hearing will come to order. Good 
afternoon, everyone. As you are now hearing, we have votes on 
the House floor, a series of votes. What we will do is, I and 
my Ranking Member, Mr. McNulty, will deliver our opening 
statements and then probably recess to go vote and come back.
    Today the Subcommittee will examine issues regarding the 
funding of defined benefit (DB) pension plans. In particular we 
will focus on proposals to replace the 30-year Treasury bond 
rate which is used by plan sponsors to calculate how much cash 
they must contribute to their pension plans and the size of 
lump sum distributions paid to retirees from those plans.
    Pension plans must use specific interest rate assumptions 
in calculating whether the plan meets various funding 
requirements. In 1987, the Congress chose a 4-year weighted 
average of the 30-year Treasury rate as a benchmark. Until 
recently, plans could use any interest rate between 90 percent 
and 105 percent of that weighted average.
    The Treasury rate was chosen because it was deemed to be 
transparent, difficult to manipulate, and a fair proxy for the 
price an insurer would charge for a group annuity which would 
cover accrued benefits if the plan would be terminated.
    Artificially high interest rates may lead companies to 
underfund a pension plan today, possibly leading to future 
shortfalls. Likewise, artificially low interest rates may force 
companies to overfund a DB plan relative to its future needs. 
In an economic slowdown, this can further weaken cash-strapped 
companies, forcing them to make required contributions instead 
of using the money to retain current employees, hire new ones, 
or invest in new equipment.
    In 2001, the U.S. Department of Treasury discontinued 
issuing 30-year bonds. Combined with other market forces, the 
interest rate on the outstanding bonds has fallen 
significantly. According to a recent report by the U.S. General 
Accounting Office the rate has diverged from other long-term 
interest rates, an indication that it also may have diverged 
from group annuity rates.
    Responding to this situation in 2002, the U.S. Congress 
included a provision in the Job Creation and Worker Assistance 
Act which temporarily allowed plans to use an interest rate as 
high as 120 percent of the 30-year Treasury rate to determine 
plan funding requirements. Not only does the provision expire 
at the end of this year, it also avoided one of the most vexing 
issues which Congress must face in considering a replacement 
rate. That is, the subject of lump sum distributions. When an 
individual becomes eligible for benefits from a DB plan, he may 
have the choice to take those benefits on a monthly basis over 
his lifetime or to receive them as a lump sum. The lump sum 
should equal the present value of the lifetime annuity. The 30-
year Treasury rate is used to make this calculation.
    If the 30-year Treasury rate is much lower than the rate 
earned on an actual annuity, then the lump sum payment will be 
artificially high. By contrast, if the 30-year Treasury is much 
higher than the rate earned on an actual annuity, then the lump 
sum payment will be artificially low. As a result, using an 
inaccurate rate to calculate lump sums could create significant 
distortions in a retiree's choice between annuities and lump 
sum distributions.
    The temporary relief passed in 2002 did not address this 
issue, leaving unchanged the range of interest rates which can 
be used in calculating lump sum distributions. I look forward 
to hearing testimony today about this issue.
    We may also hear today about current rules which limit 
contributions by employers when a plan is overfunded. Designed 
to prevent companies from taking excessive deductions, these 
rules could have the perverse effect of discouraging companies 
from setting aside money for a DB plan when times are good, 
expecting them instead to be able to free up the necessary cash 
when times are bad. I am interested in considering whether the 
well-intended deduction limits in current law are really 
serving the best interests of employees and retirees.
    I am also interested in hearing about the effect of the 
funding rules on the current financial status of the Pension 
Benefit Guaranty Corp. (PBGC), which steps in and assumes the 
liabilities for plans no longer able to meet their DB 
commitments.
    Increasing the interest rate used in calculating future 
liabilities would have cross-cutting effects on the PBGC. On 
one hand, such a move would reduce the number of employers 
paying variable rate premiums to the PBGC and might give a 
clean bill of health to some financially troubled plans. On the 
other hand, ensuring funding requirements are consistent with 
real-world interest rates would reduce the financial stress on 
employers and could keep some of them from having to turn over 
their plans to the PBGC.
    With the economy still sputtering and the prospect of PBGC 
having to assume the liabilities of additional pension plans 
still looming, this is an important issue which merits 
consideration today.
    Before we get to those discussions, we will hear from Peter 
Fisher from the Department of Treasury to give the 
administration's perspective. Before we can hear from him, I 
want to yield to my friend and colleague from New York, Mr. 
McNulty, for any opening comments he would like to make.
    [The opening statement of Chairman McCrery follows:]

    Opening Statement of The Honorable Jim McCrery, Chairman, and a 
         Representative in Congress from the State of Louisiana

    The hearing will come to order. I ask our guests to please take 
their seats.
    Good afternoon.
    As this is our first hearing of the year, let me again welcome to 
the Subcommittee on Select Revenue Measures our newest Members, Mac 
Collins, Max Sandlin, Lloyd Doggett, and Stephanie Tubbs-Jones. I am 
sure they will each add their own unique perspectives to our work.
    Today, the Subcommittee will examine issues regarding the funding 
of defined benefit pension plans. In particular, we will focus on 
proposals to replace the 30-year Treasury bond rate, which is used by 
plan sponsors to calculate how much cash they must contribute to their 
pension plans and the size of lump sum distributions paid to retirees 
from those plans.
    Pension plans must use specific interest rate assumptions in 
calculating whether the plan meets various funding requirements. In 
1987, the Congress chose a four-year weighted average of the 30-year 
Treasury rate as a benchmark. Until recently, plans could use any 
interest rate between 90% and 105% of that weighted average.
    The Treasury rate was chosen because it was deemed to be 
transparent, difficult to manipulate, and a fair proxy for the price an 
insurer would charge for a group annuity which would cover accrued 
benefits if the plan is terminated.
    Artificially high interest rates may lead companies to under-fund a 
pension plan today, possibly leading to future shortfalls. Likewise, 
artificially low interest rates may force companies to over-fund a 
defined benefit plan relative to its future needs. In an economic 
slowdown, this can further weaken cash-strapped companies, forcing them 
to make required contributions instead of using the money to retain 
current employees, hire new ones, or invest in new equipment.
    In 2001, the Treasury Department discontinued issuing 30-year 
bonds. Combined with other market forces, the interest rate on the 
outstanding bonds has fallen significantly. According to a recent 
report by the General Accounting Office, the rate has ``diverged from 
other long-term interest rates, an indication that it also may have 
diverged from group annuity rates.''
    Responding to this situation, in 2002, the U.S. Congress included a 
provision in the Job Creation and Worker Assistance Act which 
temporarily allowed plans to use an interest rate as high as 120% of 
the 30-year Treasury rate to determine plan funding requirements
    Not only does the provision expire at the end of this year, it also 
avoided one of the most vexing issues which Congress must face in 
considering a replacement rate. That is the subject of lump sum 
distributions.
    When an individual becomes eligible for benefits from a defined 
benefit plan, they may have the choice to take those benefits on a 
monthly basis over their lifetimes or to receive them as a lump sum. 
The lump sum should equal the present value of the lifetime annuity. 
The 30-year Treasury rate is used to make this calculation.
    If the 30-year Treasury rate is much lower than the rate earned on 
an actual annuity, then the lump sum payment will be artificially high. 
By contrast, if the 30-year Treasury is much higher than the rate 
earned on an actual annuity, then the lump sum payment will be 
artificially low. As a result, using an inaccurate rate to calculate 
lump sums could create significant distortions in a retiree's choice 
between annuities and lump sums.
    The temporary relief passed in 2002 did not address this issue, 
leaving unchanged the range of interest rates which can be used in 
calculating lump sum distributions. I look forward to testimony today 
about this issue.
    We may also hear today about current rules which limit 
contributions by employers when a plan is ``over-funded.'' Designed to 
prevent companies from taking excessive deductions, these rules could 
have the perverse effect of discouraging companies from setting aside 
money for a defined benefit plan when times are good, expecting them 
instead to be able to free up the necessary cash when times are bad. I 
am interested in considering whether the well-intentioned deduction 
limits in current law are really serving the best interests of 
employees and retirees.
    I am also interested in hearing about the effect of the funding 
rules on the current financial status of the Pension Benefit Guaranty 
Corporation, which steps in and assumes the liabilities for plans no 
longer able to meet their defined benefit commitments.
    Increasing the interest rate used in calculating future liabilities 
would have cross-cutting effects on the PBGC. On one hand, such a move 
would reduce the number of employers paying variable rate premiums to 
the PBGC and might give a clean bill of health to some financially 
troubled plans. On the other hand, ensuring funding requirements are 
consistent with ``real world'' interest rates will reduce the financial 
stress on employers and could keep some of them from having to turn 
over their plans to the PBGC.
    With the economy still sputtering and the prospect of PBGC having 
to assume the liabilities of additional pension plans still looming, 
this is an important issue which merits consideration today.
    Before we get to those discussions, we will hear from Peter Fisher 
from the Treasury Department to give the Administration's perspective.
    And before we can hear from him, I yield to my friend and colleague 
from New York, Mr. McNulty, for any opening comments he would like to 
make.

                                 

    Mr. MCNULTY. Thank you very much, Mr. Chairman. In the 
interest of time I will just submit my written statement for 
the record, because you have adequately outlined the issues at 
hand. I will just say two things. Number one, thank you for 
accommodating my schedule, because this hearing was originally 
scheduled at a time I would not be able to make it, and I thank 
you for changing that so that I could be here today. Number 
two, thank you for scheduling the hearing, because these issues 
are of critical importance to the future retirement security of 
millions of American workers.
    [The opening statement of Mr. McNulty follows:]

Opening Statement of The Honorable Michael R. McNulty, a Representative 
                 in Congress from the State of New York

    I am pleased to join Chairman McCrery and the Select Revenue 
Measures Subcommittee for this hearing today to consider issues which 
are crucial to the continued retirement security for millions of our 
workers.
    An important aspect of the current pension system is our defined 
benefit (or DB) plans. These plans provide a secured source of 
retirement income for those workers who are eligible to participate.
    In recent years we have seen some of the major weaknesses of our 
defined contribution (or DC) plan system. The failure of major 
corporations such as Enron and Worldcom has had a devastating impact on 
workers' retirement whose assets were held in a 401(k) plan. In 
addition, we have witnessed the impact of the weak stock market on the 
money available to workers under their retirement plans. These account 
balances have decreased substantially over the past two years.
    Under DB plans, workers do not bear these risks. These investment 
risks remain with the plan and the employer. The worker is guaranteed 
the promised pension benefit under the plan.
    This hearing today gives us the opportunity to examine the impact 
of the 30-year treasury bond rate on the funding of DB plans.
    The Department of Treasury's debt buyback program, and its 
subsequent announcement to discontinue issuing 30-year Treasury bonds, 
have impacted the interest rate of the outstanding bonds as the rate 
steadily declines. Sponsors of DB plans have expressed concerns 
regarding the increased funding obligations for these plans because of 
the declining 30-year interest rate.
    As the baby-boom generation prepares to retire, beginning as early 
as 2008, every aspect of retirement becomes important, including the 
issue before us today.
    I thank Chairman McCrery for scheduling this important hearing, and 
I thank our guests for appearing before us to testify. We look forward 
to working together with the Administration and all interested parties 
to resolve this issue.

                                 

    Chairman MCCRERY. Thank you, Mr. McNulty. I was more than 
happy to accommodate your request because this is a problem 
that is going to require joint effort to solve, I think. So, we 
were pleased to be able to do that so you could be here and 
contribute to our attempts to understand this problem and I 
hope, solve it.
    With that, I will call the first panel, the Honorable Peter 
Fisher, Under Secretary for Domestic Finance, Department of 
Treasury; and Steven A. Kandarian, Executive Director of the 
PBGC. Gentlemen, welcome. Rather than have you begin and have 
to be interrupted, I am going to ask you to withhold and then 
we will recess until right after the final vote. It is a series 
of votes, I don't know if it is two or three. Series of four 
votes. So, it will probably be, unfortunately, about one-half 
hour before we get back. We will get back as soon as we can. 
The hearing is in recess.
    [Recess.]
    Chairman MCCRERY. The hearing will come to order. 
Gentlemen, we apologize for the delay. Now we will be pleased 
to hear your oral testimony. I know that your written testimony 
will be entered into the record in its entirety. Now, Mr. 
Fisher, if you would summarize your testimony in about 5 
minutes, and we would appreciate that.

STATEMENT OF THE HONORABLE PETER R. FISHER, UNDER SECRETARY FOR 
       DOMESTIC FINANCE, U.S. DEPARTMENT OF THE TREASURY

    Mr. FISHER. Thank you, Mr. Chairman, Ranking Member 
McNulty, other Members of the Committee, thank you for this 
opportunity to discuss the need to strengthen Americans' 
retirement security by measuring pension liabilities 
accurately.
    There is a pension funding problem in America today. 
Pension plan participants are uncertain about their plans' 
funding levels. Equity markets are unsure of the demands that 
minimum pension funding may impose on sponsors' cash flows. 
Without an accurate measure of liabilities, the minimum funding 
rules could lead to insufficient or excessive funding of 
pension promises, as you, Mr. Chairman, pointed out in your 
opening remarks.
    We must remember that behind all the technical details is 
the retirement security of hardworking Americans. Our ultimate 
goal must be to improve pension security for workers and 
retirees by strengthening the financial health of the voluntary 
DB pension system. Pensions must be well funded for the benefit 
of workers and retirees. Plan sponsors must be able and willing 
to support the DB system. The PBGC's financial integrity must 
be assured. All three groups have an interest in a sustainable 
program and in the right solution, and any changes we undertake 
must promote the resiliency of our financial system.
    H.R. 1776, the Pension Preservation and Savings Expansion 
Act of 2003, recognizes the urgency of pension reform and 
promoting retirement security. Its chief sponsors, Congressmen 
Portman and Cardin, are to be commended for their leadership.
    H.R. 1000, the Pension Security Act of 2003 introduced by 
Representative Boehner, advances principles for improving the 
DB contribution system that the President set forth last year. 
My testimony today will focus only on measuring pension 
liabilities.
    In our view, overall pension reform requires three steps: 
first, develop a more accurate, reliable and timely measure of 
pension liabilities; second, fix the pension funding rules; and 
third, establish transition rules so as to avoid an abrupt 
change in firms' funding plans.
    Current law uses the 30-year Treasury rate for measuring 
pension liabilities. Because of our discontinuation of the 30-
year bond and the shortened time structure of payments in many 
pension plans and other changes in financial markets, the 
Department of Treasury does not believe that the 30-year 
Treasury rate produces an accurate measure of pension 
liabilities.
    As you pointed out, Mr. Chairman, last year Congress 
responded to Federal employees' concerns with a temporary 
extension and expansion of the upper range of the allowable 
corridor surrounding the 30-year Treasury rate for calculating 
current liability. This expansion expires at the end of this 
year. Without further action, the upper end of the corridor 
will snap back to 105 percent, distorting both the measurement 
of current liabilities and funding requirements.
    Ideally, Congress would develop an appropriate permanent 
replacement for the 30-year Treasury rate. H.R. 1776 offers a 
permanent replacement based upon long-term, high-quality 
corporate bond rates. We believe that moving from a Treasury 
full faith and credit discount rate to one based on rates on 
high-quality, long-term corporate bonds could improve the 
measurement accuracy.
    Before Congress selects any permanent replacement for the 
30-year, it will be necessary to consider at least three key 
issues. First, different pension plans have different benefit 
payment schedules, some with quite immediate payment 
requirements and others whose expected payments are in the 
distant future. In principle, pension liabilities could be more 
accurately measured if the discount rates were related to the 
time structure of benefit payments. We suggest that it is 
important to consider whether and how to reflect the time 
structure of a pension plan's future benefit payments in the 
discount methodology.
    Second, under current law, the measurement of both assets 
and liabilities involve ``smoothing'' techniques, as do the 
funding requirements. While there may be sound reasons to 
measure current interest rates using something other than the 
spot rates on a particular trading day, the current practice of 
using a 4-year average raises important questions as to the 
accuracy of the resulting measure. We need to review carefully 
whether this practice continues to make sense.
    Third, under current law, as you again described, Mr. 
Chairman, pension liabilities are calculated using one discount 
rate but lump sum payments are calculated using a different 
discount rate. We suggest considering whether and how a 
permanent replacement for the 30-year Treasury rate should 
affect the discount rate for lump sum payments. The consequence 
of failing to settle on an appropriate discount rate 
methodology will be an inaccurate measurement of pension 
liabilities. That means under- or over-funding of pension 
plans, either less secure pensions for workers and retirees or 
undue burdens on plan sponsors. Further work is needed to 
define an accurate measurement before we settle on a permanent 
solution.
    So, what should we do now? We recommend that Congress enact 
legislation before the end of June to extend the corridor 
relief that Congress provided in 2002. We propose that for plan 
years beginning in 2004 and 2005, the upper bound of the 
interest rate corridor continue to be 120 percent of the 4-year 
weighted average of the yield on the 30-year Treasury security. 
Quick action on this temporary extension is critical.
    At the same time, we need to act swiftly to devise a 
permanent solution, not just for the liability measurement, but 
funding and transition rules too. The PBGC's Executive 
Director, Steve Kandarian, will illustrate the urgency of the 
work before us. We look forward to working with you on both an 
interim and then a permanent solution. Thank you.
    [The prepared statement of Mr. Fisher follows:]

Statement of The Honorable Peter R. Fisher, Undersecretary for Domestic 
                Finance, U.S. Department of the Treasury

    Chairman MCCRERY., Ranking Member McNulty, and members of the 
Committee, I appreciate this opportunity to discuss with you the need 
to strengthen Americans' retirement security by measuring accurately 
pension liabilities.
    There is a pension funding problem in America today. Wall Street 
firms estimate that current pension underfunding runs to hundreds of 
billions of dollars. Pension plan participants are uncertain about 
their plans' funding levels and equity markets are unsure of the 
demands that minimum pension funding may impose on sponsors' cash 
flows. The absence of a clear picture of the extent of defined benefit 
pension underfunding creates a cloud of uncertainty in equity markets. 
Moreover, without an accurate measure of liabilities, the minimum 
funding rules, which rely upon an accurate measurement of pension 
liabilities, could lead to insufficient (or excessive) funding of 
pension promises.
    To deal with this challenge, an important step is to develop a more 
accurate, reliable, and timely measure of pension liabilities.
    As we go about this task, we must remember that behind all the 
technical details we will discuss is the retirement security of 
hardworking Americans. Our ultimate goal must be to improve pension 
security for workers and retirees by strengthening the financial health 
of the voluntary defined benefit pension system that they rely upon. 
That system is complex, with many interdependent parts. Achieving our 
objective of secure pensions requires that those pensions be well-
funded, that plan sponsors be able and willing to support the defined 
benefit system, and that the Pension Benefit Guaranty Corporation's 
financial integrity be assured. All three of these groups have an 
interest in a sustainable program, so all have an interest in getting 
to the right solution. In addition, any changes we undertake need to be 
implemented in a manner that promotes the stability and resiliency of 
our financial system and financial markets.
    Before proceeding, let me first note that H.R. 1776, the Pension 
Preservation and Savings Expansion Act of 2003, recognizes the urgency 
of pension reform and of promoting retirement security. Its chief 
sponsors, Congressmen Portman and Cardin, are to be commended for their 
leadership in this complex, but critical area of public policy. I would 
also note that H.R. 1000, the Pension Security Act of 2003, introduced 
by Rep. Boehner advances principles for improving the defined 
contribution system that the President set forth last year. My 
testimony, however, will focus just on the issue of measuring pension 
liabilities.
    In our view, overall pension reform that will lead to more secure 
pensions for American workers and retirees requires three steps: first, 
develop a more accurate, reliable, and timely measure of pension 
liabilities; second, fix the pension funding rules; and third, 
establish transition rules so as to avoid an abrupt change in firms' 
funding plans.
    The predicate step to making pensions more secure is to develop a 
more precise measurement of pension liabilities. My testimony today 
will focus on this critical step and, in particular, on the issue of 
replacing the 30-year Treasury rate as the discount rate used in 
measuring pension liabilities. As I will explain, it is critical that 
Congress develop an appropriate, permanent replacement for the 30-year 
Treasury rate in measuring pension liabilities. However, there are many 
critical questions that need to be answered before settling upon that 
replacement. Thus, to give firms the certainty they need to plan for 
their short-term pension funding obligations, we recommend extending 
the current temporary corridor for two more years. At the same time, we 
need to begin work immediately on getting to that permanent replacement 
and to dealing with other problems with the current system.

Discounting Future Pension Benefit Payments to Today's Dollars
    Making pensions more secure requires a more precise measurement of 
pension liabilities. The amount of pension liabilities determines a 
plan sponsor's annual funding obligation. Without a reliable measure of 
pension liabilities, plan sponsors may not contribute sufficient funds 
to their pension plan--or may contribute more than they need to for the 
obligations undertaken.
    In addition, without accurate, reliable measures neither plan 
beneficiaries, investors, nor the Pension Benefit Guaranty Corporation 
know how big the pension obligation may be for a given firm. Investors 
that do not have a clear picture of a company's pension liabilities 
factor that uncertainty into their credit evaluation of the firm, 
raising its borrowing costs and lowering its stock price.
    In order to get to a more accurate measure of pension liabilities, 
we need to agree on how to discount future benefit payments to today's 
dollars. After describing why this is so, I will then describe why we 
believe that we should be working towards a permanent replacement for 
the 30-year Treasury rate in measuring pension liabilities.

Using a Discount Rate to Measure Pension Liabilities
    Pension liabilities are measured as the discounted present value of 
the future benefit payments to be made to a pension plan's 
participants. These future benefit payments depend upon numerous 
factors, including the terms of the particular plan and actuarial and 
mortality assumptions about plan participants.
    To get the present value--that is, the cost in today's dollars of 
these future payments--these future payments must be ``discounted'' by 
some interest rate to show how many dollars today are equivalent to 
those payments in the future. As the interest rate that is used to 
discount future benefit payments declines, the value of those 
liabilities increases.
    A simple example explains this concept. Suppose someone was offered 
the choice between $100 today and $110 a year from now. If that person 
could invest $100 today at a 10 percent annual return, the two offers 
would have the same economic value. If however, interest rates were 
lower and the person could only earn 5 percent annually, the offers 
would not have the same economic value. Instead, the person would need 
to be offered $104.76 today for the offers to be economically 
equivalent. Thus as interest rates decline, the amount of money a 
pension plan needs today (to have in discounted present value terms the 
amount of money needed to make future benefit payments) increases.

Background on the Use of the 30-Year Treasury Rate
    Federal law sets minimum funding rules for private pension plans. 
These rules reflect the complex actuarial work needed to determine the 
amount of assets that a plan should hold to meet its benefit 
obligations many years into the future. One of the most important of 
these rules is the interest rate for discounting pension liabilities. 
Since 1987, the law has used the yield on 30-year Treasury bonds as the 
basis for this interest rate. The measurement of a pension plan's 
liabilities calculated using this rate is the basis for the federal 
``backstop'' funding rules applied to underfunded pension plans.
    Congress chose the 30-year Treasury rate as an approximation of 
interest rates used in the group annuity market. In other words, 
Congress wanted a discount rate that would reflect how much an 
insurance company would charge a pension plan to assume responsibility 
for the plan's benefit obligations.
    Although additional refinements have occurred since 1987, the rate 
on the 30-year Treasury bond continues to play a prominent role in 
determining pension liabilities for funding purposes. Until recently, 
pension plans could determine the value of their pension liabilities 
using any rate between 90 percent and 105 percent of the four-year 
moving average of the yield on 30-year Treasury bonds. As I will 
explain shortly, last year, Congress temporarily increased the upper 
end of this corridor to 120 percent. Note that the upper end of the 
corridor produces a larger discount rate and hence a smaller measured 
liability and a smaller funding requirement. The lower end of the 
corridor produces the reverse--a larger measured liability and hence 
greater required funding.
    However, the Treasury Department does not believe that using the 
30-year Treasury bond rate produces an accurate measurement of pension 
liabilities.

Why We Need to Replace the 30-Year Rate in Measuring Pension 
        Liabilities
    The discontinuation of the issuance of the 30-Year bond--which was 
part of much needed changes in Treasury financing of government debt--
makes replacement of the 30-year rate in pension law necessary. 
However, we believe that regardless of whether the discontinuation had 
occurred or not, there was already growing evidence and concern that 
the 30-year Treasury was becoming less relevant as a benchmark for use 
in pension calculations.
    One reason the 30-year Treasury has become less relevant is because 
of changes in pensions themselves. The lengthy time structure of the 
30-year bond makes it less and less relevant when compared to the 
shortening time structure of the payments of many defined benefit 
pension plans. This shortened time structure is the consequence of the 
increasing average age of active and terminated deferred participants 
and the increased proportion of participants represented by retirees. 
Using a long-term rate to discount all pension obligations understates 
the true cost of obligations that will be paid sooner whenever the 
yield curve is upward sloping (as is true now and is generally the 
case).
    In addition, changes in the Treasury bond market and in financial 
markets more broadly have made the 30-year Treasury rate less 
reflective of the cost of group annuities and less accurate as a 
benchmark for pension liabilities. The difference between the Treasury 
yield curve and a high-grade corporate bond curve is not fixed, and 
that spread is wider today than it was in 1987.
    In response to these concerns, last year Congress provided for a 
temporary expansion of the upper range of the allowable corridor 
surrounding the 30-year Treasury for calculating the interest rate used 
to determine current liability. This temporary change expires at the 
end of this year. In the absence of a permanent replacement or an 
extension of last year's expansion of the upper range, the law will 
``snap back'' to 105 percent as the upper end of the corridor.
    Such an outcome would, in our view, increase the discrepancy 
between the discount rate mandated in the law and that used to price 
group annuities. And since minimum funding rules are based upon 
measured (current) liabilities, a discount rate that further distorts 
that measurement will also distort the funding requirements.
    Consequently, we believe that Congress should take action this year 
to avoid this ``snap back.'' And, since firms need to make plans now 
for the funding contributions they will make next year, we believe that 
Congress needs to act quickly on this matter.

Finding a Permanent Replacement for the 30-year Treasury Rate
    We need to get to a permanent replacement for the 30-year Treasury 
rate in computing pension liabilities.
    H.R. 1776 offers a permanent replacement for the 30-year Treasury 
with a measure based upon long-term high-quality corporate bond rates. 
We believe that moving from a Treasury full faith and credit discount 
rate to one based on rates on high-quality long-term corporate bonds 
could improve the accuracy of measuring pension liabilities. Pension 
benefit promises made by private sponsors are not without risk since 
pension sponsors can and do go out of business. We think that this risk 
should be reflected in the computation of pension liabilities. We also 
understand that high-grade corporate bond rates are used in group 
annuity pricing.
    Before Congress selects any permanent replacement for the 30-year 
Treasury rate, however, it will be necessary to consider several key 
issues, including the following.
    First, different pension plans have different benefit payment 
schedules, some with quite immediate payment requirements and others 
whose expected payments are distant in the future. We know that the 
yields available on financial instruments are different for these 
different maturities; typically yields relevant to closer maturities 
are lower. Thus the question arises whether an accurate present value 
measurement of these different benefit payments--some made in the near-
term and some in the distant future--should be discounted at rates 
appropriate to their respective timing.
    Both economic theory and current practice in fixed-income markets 
suggest that the most accurate way to measure the present value of a 
stream of future cash flows is to match the cash flows occurring at a 
particular time with a discount rate that reflects the interest rate on 
a portfolio of financial instruments with the same maturity date. In 
this way, the discount rates used would be reflecting the time 
structure of the cash flows. In principle, an accurate measurement of 
pension liabilities, which is the present value of a series of benefit 
payments to be made over time, could be more accurately measured if the 
discount rate used was related to the time structure of those benefit 
payments.
    Thus, we suggest it would be important to consider whether and how 
to reflect the time structure of a pension plan's future benefit 
payments in determining the appropriate discount rate to use. At the 
same time, we recognize that reflecting the time structure of future 
benefit payments could introduce some added complexity, which would 
also need to be considered.
    Second, under current law, the measurement of both assets and 
liabilities involves ``smoothing'' techniques, as do the funding 
requirements. Properly measured, pension liabilities are the cost in 
today's prices of meeting a pension plan's future obligations. If a 
pension plan's obligations were to be settled today in the group 
annuity market, their value would be determined using today's interest 
rates rather than an average of rates over the past several years, 
which is the current practice in measuring current liabilities for 
minimum funding purposes.
    Using current, unsmoothed interest rates would promote 
transparency. An accountant or analyst evaluating a pension plan can 
readily determine the funded status of the plan if asset values are 
expressed at current market prices and liabilities are computed using 
current unsmoothed discount rates. When either or both of these 
measures are smoothed, however, it is very difficult to determine the 
plan's funded status with any degree of certainty. While there may be 
sound reasons to measure current interest rates for discounting 
purposes using something other than the spot rates on a particular 
trading day, the current practice of using a four-year average of 
interest rates raises important questions as to the accuracy of the 
resulting liability measurement.
    Thus, we suggest that consideration be given to whether continuing 
this practice advances the ultimate objective. It may be that there are 
compelling arguments to allow for some smoothing with respect to the 
funding contributions that plan sponsors make to their pension plans. 
We need to carefully review whether four-year smoothing of the discount 
rate used for purposes of measuring a pension plan's liabilities 
continues to make sense. We also need to consider how eliminating this 
smoothing could affect the variability of liability measurement, 
recognizing that under current law the existing use of smoothing still 
produces volatility in funding requirements.
    Third, under current law, pension liabilities are calculated using 
one discount rate but lump sum payments made by pension plans are 
calculated using a different discount rate. The pension liability 
measurement we are discussing is the basis for funding contributions to 
be made by plan sponsors--some of which will ultimately fund workers' 
annuity pension payments but some of which will be paid to workers in 
the form of a lump sum. Thus, we suggest that it would be worth 
considering whether and how a permanent replacement for the 30-year 
Treasury rate in measuring pension liabilities should relate to any 
possible changes in the discount rate used to calculate lump sum 
payments.
    To this point, my remarks have focused on issues to consider in 
selecting a permanent replacement discount rate for measuring pension 
liabilities. While these issues are critical to the goal of achieving 
an accurate measurement of those liabilities, there are additional 
issues unrelated to the discount rate replacement that should also be 
considered.
    Thus, we suggest that, in the process of working towards a more 
accurate measurement of pension liabilities, the mortality table and 
the retirement assumptions that underlie the computation of current 
liability also be evaluated. There is also the question of whether a 
sponsor in computing current liability should be allowed to recognize 
that some retirees opt for lump sums rather than annuities at 
retirement. Under current law current liability assumes that all 
retirees take their retirement in the form of an annuity. These 
questions require further study.
    I believe that we all need to consider the issues that I have just 
described to ensure that any permanent replacement to the 30-year 
Treasury rate results in an accurate measurement of pension 
liabilities. The consequence of failing to replace the 30-year Treasury 
rate with an appropriate discount rate methodology will lead to 
inaccurate measurement of pension liabilities. Such an outcome, in 
turn, will lead to under- or over-funding of pension plans. The former 
outcome would make pensions less secure for workers and retirees. The 
latter outcome could place an undue burden on plan sponsors by shifting 
more corporate funds to the pension plan than are necessary to fund the 
company's pension obligations.

Interim Steps
    Companies have told us that they need to know what their cash 
requirements are for funding next year's funding obligation by the end 
of the second quarter of this year, but further work is needed to 
define an accurate measurement of pension liability. While we have 
considered alternatives to the discount rate methodology proposed in 
H.R. 1776, we are not yet to the point of offering a specific 
replacement. Yet we agree with those who say that quick congressional 
action on modifying current law is essential, both because in the 
absence of such action the law reverts to a discount rate methodology 
that would be even more distorting than the current rate and because 
plan sponsors need certainty soon in order to plan for next year's 
funding requirements.
    To that end, we recommend that Congress enact legislation before 
the end of this June to extend the short-term interest rate corridor 
relief that Congress provided in 2002. We would propose that, for plan 
years beginning in 2004 and 2005, the upper bound of the interest rate 
corridor for the deficit reduction contribution continue to be 120 
percent of the 4-year weighted average of the yield on 30-year Treasury 
securities.
    During the time offered by the two year extension, we would look 
forward to working with Congress and pension stakeholders to work 
through the complex but critical issues I have described that must be 
addressed to ensure accurate pension liability measurement and, more 
importantly, advance our ultimate objective of making pensions more 
secure.
    The change in the method of determining pension liabilities may 
result in changes in the annual contribution amounts, so transition 
relief will be required. In addition, these changes should lead us to 
consider changes in the current funding rules which would increase the 
security of the pension promises made to America's workers and their 
families.
    I would like to stress the need for quick action on this temporary 
extension of the corridor. This action is needed to give companies time 
to budget for next year's funding obligation. At the same time, 
however, we must also move quickly to deal with the complex questions I 
have outlined in my testimony. We need to work expeditiously to come up 
with a permanent solution, not just for how best to measure liabilities 
but also for the funding rule changes that are needed. The testimony 
you are about to receive from PBGC's Executive Director Steve Kandarian 
illustrates the urgency of the work before us. We look forward to 
working with you to advance this interim solution and to satisfy the 
long-term need for accuracy in the measurement of pension liabilities.

Conclusion
    Defined benefit pensions are a valuable benefit and the cornerstone 
of many workers' retirement security. Recent financial market trends 
have exposed underlying weaknesses in the system, weaknesses that must 
be corrected if that system is to remain viable in the long run. It 
will take considerable time and effort to fix the system. Developing 
acceptable solutions will also require the cooperation and flexibility 
of all interested parties.
    While we must avoid unnecessary delay, the seriousness of current 
pension problems and the complexity of the defined benefit system 
suggest that repairing the system will require time for study and for 
consensus building. That is why we recommend that Congress, rather than 
making a permanent replacement for the 30-year Treasury rate this year, 
extend for an additional two-year period the temporary increase of the 
pension discount rate used to compute current liability.
    During this two-year period government, industry, and participants 
will have adequate time to develop a set of consistent coherent 
proposals that will insure that pension funding is adequate, that 
pension demands on firm finances are reasonable and that the financial 
integrity of the pension insurance system will be maintained for the 
workers and retirees that are counting on it for their retirement 
security.

                                 

    Chairman MCCRERY. Thank you, Mr. Fisher. Mr. Kandarian.

   STATEMENT OF THE HONORABLE STEVEN A. KANDARIAN, EXECUTIVE 
         DIRECTOR, PENSION BENEFIT GUARANTY CORPORATION

    Mr. KANDARIAN. Chairman McCrery., Ranking Member McNulty, 
and Members of the Subcommittee, I want to thank you for 
holding this hearing today on pension plan funding and for your 
interest in the retirement security of America's workers.
    My testimony will focus on the state of the PBGC and the DB 
pension system and on pension funding issues. Last year, PBGC's 
single-employer insurance program went from a surplus of $7.7 
billion to a deficit of $3.6 billion, a net loss of $11.3 
billion in just 1year. This loss is more than five times larger 
than any previous 1-year loss in the Agency's 28-year history. 
Moreover, based on our midyear report, the deficit has now 
grown to about $5.4 billion. Because PBGC receives no Federal 
tax dollars, it is premium payers, employers that sponsor DB 
plans, who bear the cost when the Agency takes over underfunded 
pension plans.
    During the last 2 years, PBGC has become responsible for 
plans with billions of dollars in underfunding; $1.3 billion 
for National Steel, $1.9 billion for LTV steel, and $3.9 
billion for Bethlehem Steel. Just last month the U.S. Airways 
pilot plan presented a claim against the insurance system of 
$600 million.
    The worst may not be over. In plans sponsored by companies 
with below investment grade credit ratings, our exposure to 
pension underfunding has more than tripled, from $11 billion to 
$35 billion, and that number will be higher in fiscal year 
2003. Even though our current $5.4 billion deficit is the 
largest in the Agency's history, it does not create an 
immediate liquidity problem for PBGC. We will be able to 
continue paying benefits for a number of years, but putting the 
insurance program on a sound financial basis is critical.
    Some have argued that because PBGC is not in any immediate 
danger of running out of cash, there is no need for Congress to 
address the issue of pension underfunding. We believe this view 
is misguided. We should not pass off the cost of today's 
problems to future generations. Data now available to PBGC 
confirms the total underfunding in the single-employer DB 
system exceeds $300 billion, the largest number ever recorded 
in the system.
    The airline industry alone now has $26 billion in 
underfunding and the automotive sector more than $60 billion. 
In light of the staggering amounts of underfunding, we are 
concerned that a number of proposals now under consideration 
would weaken existing pension funding rules by granting 
permanent funding relief.
    Mr. Chairman, there are a number of challenges facing the 
DB system. First, the current rules are inadequate to ensure 
sufficient pension contributions for chronically underfunded 
plans. The funding targets are simply not high enough for 
companies at the greatest risk of termination. Another defect 
is allowing plan assets and liabilities to be ``smoothed,'' 
which can reduce contributions. Finally, nothing in the funding 
rules requires companies with underfunded plans to make cash 
contributions to their plans every year.
    In an effort to strengthen the DB system, PBGC and the U.S. 
Department of Labor, Department of Treasury, and U.S. 
Department of Commerce are currently examining a number of 
long-term reforms in four areas. First, as Secretary Fisher has 
discussed, we must accurately measure pension assets and 
liabilities. Some groups want to substitute a single, smooth, 
long-term corporate bond rate for the 30-year Treasury rate as 
a means of providing permanent funding relief. The PBGC's 
calculations indicate that this proposal would allow plan 
funding to fall below the already low levels permitted under 
current law.
    Second, plan sponsors should not make pension promises that 
they cannot keep. Under current law, benefits can be increased 
even if a plan is only 60 percent funded. In addition, many 
companies with underfunded plans are not required to make 
annual pension contributions. These and other weaknesses in the 
current rules underscore the importance of getting pension 
plans funded to an appropriate target in a reasonable period of 
time.
    Third, pension plan information must be transparent. The 
current value of plan assets and liabilities is not available 
to workers, retirees, investors, or creditors. Moreover, the 
most current information regarding the funded status of plans 
is provided to PBGC but is not provided to the public. Timely, 
accurate data would enable the capital markets to inject 
further discipline into the system and allow all stakeholders 
to better protect their interests.
    Finally, we must ensure the long-term stability of the 
pension insurance system. Under current law, PBGC is exposed to 
losses from shutdown benefits, benefits triggered by plant 
shutdowns or permanent layoffs that companies typically do not 
fund and for which no specific premium is paid. In addition, 
the present premium structure does not reflect the risk of a 
claim from a given plan. While we believe that well-funded 
plans represent a better solution to any premium changes, we 
should not rule out premium increases as an option at a time 
when the Agency has a large and growing deficit.
    Mr. Chairman, the existence of the pension insurance 
program creates moral hazard, tempting management and labor and 
financially troubled companies to create pension promises that 
the companies are unable to keep. These unfunded promises 
increase the cost that chronically underfunded pension plans 
impose on the DB system.
    Financially strong companies at some point may exit the DB 
system, leaving only those that pose the greatest risk of 
claims. This potential for adverse selection could pose a 
serious problem for the insurance program. The funding rules 
must be carefully examined and strengthened to ensure the long-
term viability of the pension system. Better-funded pension 
plans are critical to the retirement security of American 
workers.
    Again, I thank you for inviting me to testify this 
afternoon.
    [The prepared statement of Mr. Kandarian follows:]

  Statement of The Honorable Steven A. Kandarian, Executive Director, 
                  Pension Benefit Guaranty Corporation

     Chairman McCrery, Ranking Member McNulty, and Members of the 
Subcommittee:
    Good afternoon. I am Steven A. Kandarian, Executive Director of the 
Pension Benefit Guaranty Corporation (PBGC). I want to thank you for 
holding this hearing on pension plan funding and for your interest in 
the retirement security of America's workers. The way we address these 
complex issues is critically important to the financial well being of 
America's workers and retirees and to the financial health of plan 
sponsors.
    I am going to focus on the state of the PBGC and the defined 
benefit pension system, as well as funding issues that directly impact 
PBGC. During FY 2002, PBGC's single-employer insurance program went 
from a surplus of $7.7 billion to a deficit of $3.6 billion--a loss of 
$11.3 billion in just one year. This loss is more than five times 
larger than any previous one-year loss in the agency's 28-year history. 
Moreover, based on our midyear unaudited financial report, the deficit 
has grown to about $5.4 billion. Furthermore, data now coming in to 
PBGC confirm that the total underfunding in the single-employer defined 
benefit system exceeds $300 billion, the largest number ever recorded.
    In light of these record deficits and staggering amounts of pension 
underfunding, we are concerned that a number of proposals now under 
consideration would weaken existing funding rules and grant permanent 
funding relief.

                           State of the PBGC

    PBGC was created as a federal corporation by the Employee 
Retirement Income Security Act of 1974 (ERISA). PBGC protects the 
pensions of nearly 44 million workers and retirees in more than 32,000 
private defined benefit pension plans. PBGC's Board of Directors 
consists of the Secretary of Labor, who is the chair, and the 
Secretaries of the Treasury and Commerce.
    PBGC insures pension benefits worth $1.5 trillion. In addition, 
PBGC is responsible for paying current and future benefits to 783,000 
people in over 3,000 terminated defined benefit plans. As a result of 
the recent terminations of several very large plans, PBGC will be 
responsible for paying nearly $2.5 billion in benefits to nearly 1 
million people in FY 2003, up from $1.5 billion in FY 2002.

            No Full Faith and Credit; No Federal Tax Dollars

    While PBGC is a government corporation created under ERISA, it is 
not backed by the full faith and credit of the United States 
government. Moreover, PBGC receives no federal tax dollars. Instead, 
PBGC is funded by four sources: insurance premiums paid to PBGC by 
defined benefit pension sponsors; assets of pension plans that PBGC has 
trusteed; recoveries in bankruptcy from former plan sponsors (generally 
only cents on the dollar); and earnings on invested assets.
    When PBGC takes over pension plans that are underfunded by billions 
of dollars, it is the premium payers--employers that sponsor defined 
benefit plans--who bear the cost. Financially healthy companies with 
well-funded pension plans end up subsidizing financially weak companies 
with chronically underfunded pension plans. As a result, over time, 
strong companies with well-funded plans may elect to leave the system. 
This potential for ``Adverse selection'' could pose a serious problem 
for the insurance program.

                       Health of PBGC's Programs

    PBGC operates two financially independent insurance programs, the 
larger single-employer program and a smaller program for multiemployer 
plans (i.e., plans set up between a union and two or more employers). 
The multiemployer program has been in surplus since 1980. The single-
employer program, however, was in deficit for 21 years from 1974 until 
1995.
    For six years, from 1996 until 2001, the single-employer program 
was in surplus, reaching a surplus of nearly $10 billion in FY 2000. 
The surplus grew substantially during these years because of PBGC's 
investment gains during the stock market boom and because PBGC did not 
have to trustee any plans with large amounts of underfunding. During FY 
2001 and FY 2002, however, PBGC's surplus rapidly deteriorated. At the 
end of fiscal 2002 (September 30, 2002), the surplus had disappeared 
altogether, leaving PBGC with a deficit of $3.6 billion. As of March 
31, 2003, our unaudited deficit has grown to about $5.4 billion.

PBGC Net Position, Single-Employer Program, FY 1980-FY 2002

[GRAPHIC] [TIFF OMITTED] T8996A.001

    Our deficit has been caused by the failure of a significant number 
of large companies with highly underfunded plans. These include the 
plans of Trans World Airlines; retailers including Bradlees, Caldor, 
Grand Union, and Payless Cashways; steel makers including LTV, Acme, 
Empire, Geneva, and RTI; other manufacturers such as Singer, Polaroid, 
Harvard Industries, and Durango. Mr. Chairman, pension claims for 2002 
alone were greater than the total claims for all previous years 
combined. At current premium levels, it would take about 12 years of 
premiums to cover just the claims from 2002.
    There are significantly underfunded plans in a number of 
industries, including steel, airlines, and the automotive sector. Two 
of these industries, steel and airlines, have accounted for 73 percent 
of the claims against PBGC, yet represent fewer than 5 percent of 
insured participants. Steel, with less than 3 percent of participants, 
has accounted for 56 percent of PBGC's claims, and airlines, with about 
2 percent of participants, have constituted 17 percent of claims.
    In December 2002, the plans of two major steel companies, Bethlehem 
and National Steel, terminated with combined underfunding of over $5 
billion. And just last month, the US Airways pension plan for pilots 
terminated with underfunding of $2 billion.
    That is what's in the door. Still looming is $35 billion in vested 
underfunded claims in ``reasonably possible'' plans sponsored by 
financially weak companies, according to PBGC's FY 2002 estimates. When 
this number is updated for FY 2003, the reasonably possible figure will 
be much higher. Because PBGC has now absorbed most of the steel plans, 
the airline and automotive sectors represent our biggest exposure. The 
airline industry now has $26 billion of total pension underfunding. In 
the automotive sector--comprised of auto, auto parts, and tire and 
rubber companies--total pension underfunding exceeds $60 billion.

[GRAPHIC] [TIFF OMITTED] T8996B.001

    The termination of large plans with low funding levels drove PBGC 
into deficit, and additional large claims may increase that deficit. 
Even though the current $5.4 billion dollar deficit is the largest in 
the Agency's history, it does not create an immediate liquidity problem 
for PBGC--we will be able to continue paying benefits for a number of 
years. But, putting the insurance program on a sound financial basis is 
critical. We should not pass off the cost of today's problems to future 
generations.
    Recently, some have argued that, because PBGC is not in any 
immediate danger of running out of cash, there is no need to address 
the issue of pension underfunding. We believe this view is misguided.
    Mr. Chairman, Congress heard the same argument in 1987 and again in 
1994 when Congress strengthened pension security for workers. Without 
those reforms, workers and the PBGC would be in even worse shape today 
and plan sponsors would be digging themselves out of an even larger 
underfunding hole.

              State of the Defined Benefit Pension System

    Defined benefit plans are an important source of retirement income 
security for rank-and-file American workers. The defined benefit 
system, however, has serious structural problems that need to be 
addressed.
    As you know, Mr. Chairman, our pension system is voluntary. In 
recent years, many employers have chosen not to adopt defined benefit 
plans, and other employers have chosen to terminate their existing 
defined benefit plans. Since 1986, 97,000 plans with 7 million 
participants have terminated. In 95,000 of these terminations the plans 
had enough assets to purchase annuities in the private sector to cover 
all benefits earned by workers and retirees. The remaining 1,800 were 
PBGC terminations where companies with underfunded plans shifted their 
unfunded pension liabilities to the insurance program, resulting in 
benefit reductions for some participants and premium increases for 
other pension plan sponsors.
    Of the 32,000 defined benefit plans that remain ongoing, many are 
in our most mature industries. These industries face growing benefit 
costs due to an increasing number of retired workers.
    At the same time, plan assets, which typically are invested over 50 
percent in equities, have suffered a large decline and pension 
liabilities have ballooned due to falling interest rates. Last year 
over 270 corporations reported to PBGC that they had pension plan 
underfunding greater than $50 million. This is more than three times 
the number of corporations that have reported to PBGC in any year in 
the past, and we expect the number to be higher still this year.

Total Underfunding Insured Single-Employer

[GRAPHIC] [TIFF OMITTED] T8996C.001

         PBGC estimates from Form 5500 and Section 4010 Filings


----------------------------------------------------------------------------------------------------------------
                                 Top 10 Firms Presenting Claims FY 1975--Present
-----------------------------------------------------------------------------------------------------------------
                                 Fiscal Year of Plan   Claims (Billions         Covered
                                     Termination              $)             Participants        Funded Ratio*
----------------------------------------------------------------------------------------------------------------
Bethlehem Steel                  2003                  $3.9               95,000              45%
LTV Steel                        2002                 1.9                 79,600              50%
National Steel                   2003                 1.3                 35,400              47%
Pan American Air                 1991, 1992           0.8                 37,500              31%
Trans World Airlines             2001                 0.7                 34,300              47%
US Airways Pilots                2003                 0.6                 7,200               64%
Eastern Air Lines                1991                 0.6                 51,200              65%
Wheeling Pitt Steel              1986                 0.5                 22,100              27%
Polaroid                         2002                 0.4                 11,400              67%
Sharon Steel                     1994                 0.3                 6,900               21%
----------------------------------------------------------------------------------------------------------------
* Funded ratio at termination for PBGC benefits; participants lose additional benefits not covered by PBGC
----------------------------------------------------------------------------------------------------------------

    During the last economic downturn in the early 1990s, the pension 
insurance program absorbed what were then the largest claims in its 
history--$600 million in underfunding for the Eastern Airlines plans 
and $800 million for the Pan American Airlines plans. Those claims seem 
modest in comparison to the plans we have taken in lately: $1.3 billion 
for National Steel, $1.9 billion for LTV Steel, and $3.9 billion for 
Bethlehem Steel. Underfunding in some troubled airlines is even larger.
    With pension promises growing and plan funding levels at their 
lowest point in more than a decade, the dollar amount of pension 
underfunding has skyrocketed. Meanwhile, PBGC's premium collections 
over the past decade have remained flat at roughly $800 million a year. 
In fact, premium revenue for FY 2002 was at its lowest level since 
1991.

              Challenges Facing the Defined Benefit System

    Mr. Chairman, there are a number of challenges facing the defined 
benefit system. One of the most fundamental challenges is that the 
current funding rules are inadequate to ensure sufficient pension 
contributions for those plans that are chronically underfunded. To our 
knowledge, none of the defined benefit pension plans responsible for 
the $300 billion in underfunding is in violation of law. Companies with 
hugely underfunded plans have followed the funding requirements of 
ERISA and the Internal Revenue Code.
    When PBGC trustees these underfunded plans, participants often 
complain that ``there ought to be a law'' requiring companies to fund 
their plans. Mr. Chairman, there is a law, but it is inadequate to 
fully protect the pensions of America's workers when their plans 
terminate. The funding targets are simply not high enough for the plans 
of companies at the greatest risk of termination. Another defect in the 
funding rules is permitting plan assets and liabilities to be smoothed, 
which can reduce contributions. Finally, nothing in the funding rules 
requires companies with underfunded pensions to make annual cash 
contributions to their plans.
    Another trend impacting the defined benefit system is increased 
competitive pressures that have led companies to reexamine their entire 
cost structure. In the 1990s, companies noticed that many workers did 
not place a high value on their defined benefit plans, compared to the 
value they placed on their 401(k) plans. Furthermore, companies became 
concerned that their financial obligations to defined benefit plans 
were highly volatile, in part because of fluctuations in interest rates 
and a dependence on equity investment gains. This volatility can make 
business planning difficult. As a result, many companies have been 
increasingly unable to afford, or unwilling to maintain, defined 
benefit plans.
    In addition, companies found that demographic trends have made 
defined benefit plans more expensive. With workers retiring earlier and 
living longer, plans must pay annuities for far longer. Today, an 
average male worker spends 18.1 years in retirement compared 11.5 years 
in 1950, an additional seven years of retirement that must be funded.

Pension Participation Rates 1979--1998

[GRAPHIC] [TIFF OMITTED] T8996D.001

Source: U.S. Department of Labor
Pension and Welfare Benefits Administration
Abstract of 1998 Form 5500 Annual Reports Winter 2001--2002

                      Changing World--Demographics
          Average Number of Years Spent in Retirement (Males)

[GRAPHIC] [TIFF OMITTED] T8996E.001

                     Problematic Pension Proposals

    Mr. Chairman, we have seen or heard of a number of proposals for 
changes in ERISA that would allow companies to reduce their pension 
contributions. There are proposals to lengthen the amortization periods 
for funding; to allow the use of weaker mortality tables; to reduce 
variable rate premiums paid to PBGC by seriously underfunded plans; to 
weaken pension contributions for certain companies and industries; and 
to allow benefit increases even when a pension plan is less than 60% 
funded.
    These proposals all have the same impact of reducing contributions 
to seriously underfunded plans. To grant temporary relief to pension 
sponsors in financial difficulty is one thing. But to change ERISA in 
the ways being proposed would institutionalize greater long-term 
underfunding with potentially grave consequences for the defined 
benefit system.

                           Reform Principles

    In an effort to improve pension security for workers and retirees 
by strengthening the financial health of the defined benefit system, 
PBGC and the Departments of Labor, Treasury, and Commerce are currently 
examining a number of long-term reforms. These ideas are still being 
refined, but I would like to share with you some of our thoughts.
Correct Measurement of Assets and Liabilities
    Secretary Fisher has discussed some of the issues that would need 
to be addressed before settling upon a permanent replacement for the 
30-year Treasury rate. As he said, the Administration believes that 
Congress should provide a temporary solution for two more years. The 
Administration also recognizes the importance of accuracy, 
transparency, and the time structure of these liabilities. I would like 
to emphasize the importance we place on strengthening the funding rules 
at the same time that a permanent replacement is adopted for 30-year 
Treasuries.
    Some groups want to substitute a single, smoothed long-term 
corporate bond rate for the 30-year Treasury rate as a means of 
providing permanent funding relief. But as PBGC's calculations 
indicate, this proposal would allow plan funding to fall below the 
already low levels permitted under current law.

Proposal Illustration (effective 01/01/2004)

Mature Manufacturing Company

[GRAPHIC] [TIFF OMITTED] T8996F.001

Proposal Illustration (effective 01/01/2004)

Airline Company

[GRAPHIC] [TIFF OMITTED] T8996G.001

  Composite Rate consists of Moody's Aa Long Term Corporate Bond Index, 
    Merrill Lynch 10+ High Quality Index, Salomon Smith Barney High 
    Grade Credit Index, and Lehman Brothers Aa Long Credit Index.

    Mr. Chairman, we are concerned about the financial integrity of the 
defined benefit system. While we support extending the current 
temporary solution for another two years, we believe that this time 
should be used to carefully examine the current funding rules and 
strengthen them so as to put the system on a sound financial footing 
over the long run.
Funding
    Plan sponsors must not make pension promises that they cannot or 
will not keep. For example, under current law benefits can be increased 
as long as the plan is at least 60% funded. In too many cases, 
management and workers in financially troubled companies may agree to 
increase pensions, in lieu of larger wage increases. The cost of wage 
increases is immediate, while the cost of pension increases can be 
deferred for up to 30 years and may ultimately be passed on to PBGC's 
premium payers if the company fails.
    Under current law, many companies with underfunded plans are not 
required to make annual pension contributions. A significant number of 
highly underfunded pension plans recently trusteed by PBGC were not 
required to make contributions for a number of years prior to 
termination. Moreover, in several cases, these companies paid little or 
no variable rate premiums to PBGC in the years leading up to 
termination. These and other weaknesses in the current rules underscore 
the importance of getting pension plans funded to an appropriate target 
level over a reasonable period of time without putting a company in 
financial distress.
Transparency/Disclosure
    Mr. Chairman, pension plan information must also be transparent. 
Pension plans must be required to provide understandable information 
that best reflects the current state of plan assets and liabilities. 
The current value of plan assets and liabilities is not transparent to 
workers, retirees, investors, or creditors, and the current disclosure 
rules do not require timely data that would help participants and 
shareholders understand the funding status of plans and the 
consequences of pension underfunding. Timely, accurate data would 
enable the capital markets to inject further discipline into the system 
and allow all stakeholders to better protect their interests.
    Congress added new requirements in 1994 providing more timely data 
to PBGC and expanding disclosure to participants in certain limited 
circumstances, but our experience tells us these disclosures are not 
adequate. The information provided to PBGC is confidential, so its 
impact is limited. And the notices to participants do not provide 
sufficient funding information to inform workers of the consequences of 
plan termination. Currently, only participants in plans below a certain 
funding threshold receive annual notices of the funding status of their 
plans, and the information provided does not reflect what the 
underfunding likely would be if the plan terminated. Workers in many of 
the plans we trustee are surprised when they learn that their plans are 
underfunded. They are also surprised to find that PBGC's guarantee does 
not cover certain benefits, including certain early retirement 
benefits.
Long-term Stability of the Pension Insurance Program
    Mr. Chairman, we believe changes should be made to strengthen the 
long-term stability of the defined benefit insurance system. For 
example, in many cases current law requires that PBGC pay shutdown 
benefits--early retirement benefits triggered by plant shutdowns or 
permanent layoffs--that companies typically do not fund and for which 
no specific premium is paid to PBGC. These shutdown benefits--which are 
similar to severance benefits not guaranteed by PBGC--account for 
billions of dollars of PBGC's unfunded liability exposure. We are 
considering whether plan sponsors should be allowed to offer shutdown 
benefits as part of an insured pension plan.
    PBGC is also examining its premium structure in light of the 
massive increase in claims. Under the current structure, premiums are 
computed based solely on the number of plan participants and the dollar 
amount of pension underfunding. The formula does not attempt to reflect 
the risk of a claim from a given plan. While we continue to believe 
that well-funded plans represent a better solution for participants and 
the pension insurance program than any changes on the premium side, we 
should not rule out premium increases as an option at a time when PBGC 
has a large and growing deficit.

                               Conclusion

    In closing, I would like to cite the remarks of the former chairman 
of the Ways and Means Oversight Subcommittee the last time ERISA 
funding was considered. Representative J.J. [Jake] Pickle was one of 
the chief advocates of the 1987 and 1994 reforms. His comments on the 
floor at the time the 1994 pension reforms were enacted are worth 
remembering:

          L``I note that I would have personally preferred to make 
        these reforms much stronger, and I caution my colleagues that 
        they should not expect these reforms to immediately solve all 
        the problems caused by underfunded pension plans. In order to 
        overcome strenuous objections by certain automobile, steel, and 
        airline companies we have included very generous transition 
        rules for companies which have maintained chronically 
        underfunded pension plans. . . . I deeply regret that we have 
        given another reprieve to companies who have shirked their 
        pension obligations for the 20 years since the passage of 
        [ERISA].''

          Congressional Record, 103rd Cong., 2nd Sess., 
        H11477, Nov. 29, 1994.

    Mr. Chairman, the existence of the pension insurance program 
creates moral hazard, tempting management and labor at financially 
troubled companies to make pension promises the companies later find 
they are unable to keep. These unfunded promises increase the cost that 
chronically underfunded pension plans at weak companies impose on the 
defined benefit system. Over time, this leads to higher premiums for 
all plan sponsors. Financially strong companies at some point will have 
had enough, and will exit the defined benefit system, leaving only 
those which pose the greatest risk of claims. We need to make sure that 
the incentives in the system are changed so this doesn't happen.
    The funding rules need to be carefully examined and then 
strengthened to ensure the long-term viability of the pension system. 
The funding rules should encourage companies to make regular 
contributions to reach an appropriate funding target. Making defined 
benefit plans better funded is important to providing retirement 
security to American workers.
    Again, I thank the Chairman for inviting me to testify this 
afternoon. I will be happy to answer any questions.

                                 

    Chairman MCCRERY. Thank you, Mr. Kandarian. Mr. Fisher, is 
there a general consensus that the 30-year Treasury rate should 
be replaced as the benchmark for pension plan calculations?
    Mr. FISHER. Well, I am certainly of that opinion. I know 
there are some academics who continue to think that the 30-year 
Treasury rate provides a good measure. That is not my opinion 
and it is not our opinion.
    I think that the difficulties with the 30-year Treasury 
rate were actually evident prior to our discontinuation of the 
use of the instrument for Federal borrowing. As the Federal 
Reserve squeezed inflation out of our economy over the last 
part of the decade of the nineties, the relationship that 
markets had become used to as to how high a yield curve we had, 
how steep a yield curve we had, began to change. I think even 
so, in the middle- and late-nineties, the pension industry 
began to reflect on the changing structure of the yield curve 
and began to see the Treasury rate as not being an appropriate 
reflection of the private annuity costs which Congress had been 
looking at as a good measure in 1987.
    Chairman MCCRERY. Do you think there is any consensus, or 
to what extent is there a consensus, in your opinion, that we 
should move away from a government rate and move toward some 
corporate bond rate?
    Mr. FISHER. We are of that opinion and I am of that 
opinion. As I say, the academic community I would say is still 
divided. I think that my own view is that the accuracy of the 
measurement will be enhanced if we reflect the nature of the 
liabilities we are looking at, that these are private claims, 
pensions do not get a full faith and credit guaranty, and they 
are riskier than that. Even with the system managed by Steve, 
we see that individuals don't receive everything that they 
originally bargained for. That is less than full faith and 
credit. It seems to me the private credit curve is the right 
place to look.
    Chairman MCCRERY. So, although you hold these opinions, and 
your Department of Treasury does, and yet your recommendation 
is that for the next 2 years anyway, we stick to the current 
fix which depends on the 30-year Treasury rate.
    Mr. FISHER. That is exactly right, because of the three 
issues identified in my testimony: the problems with lump sums, 
the problem with the time structure--and I am forgetting my 
third issue.
    Chairman MCCRERY. What is the problem with those? Is it a 
substantive problem or is it a political problem?
    Mr. FISHER. There is both the political, frankly, and a 
substantive problem on the lump sums in which it is very 
difficult to figure out how to get the right set of transition 
rules for individuals, as you were describing, and for plan 
funding. So, that is both the technical and, frankly, looking 
at the three interests that I described, the need to ensure the 
integrity of the PBGC, the need to get adequate funding, and 
the need to be reasonable, have reasonable burden for plan 
sponsors--trying to find your way through that is actually both 
the technical issue that I have not been able to solve yet on 
the lump sums and I think a very difficult political issue, 
because getting it wrong will exacerbate the problems we have 
now with the system.
    Chairman MCCRERY. Well, the problem we have right now with 
the system is that the interest rate we are using to calculate 
the lump sum distribution is too low. Therefore the lump sum 
distribution is too high. Isn't that correct?
    Mr. FISHER. In terms of the accuracy, I couldn't agree with 
you more. Now, how we get to a world of getting to--removing 
the arbitrage that has been introduced by the temporary 
extension that was provided last year is a challenge for us all 
to figure out how to get the right transition rules both for 
companies and individuals.
    Chairman MCCRERY. You haven't figured that out yet.
    Mr. FISHER. I have not. I am all ears.
    Chairman MCCRERY. So are we.
    Mr. Kandarian, in your testimony you noted that between 
1980 and 1985, PBGC was in deficit and then ran a surplus from 
1996 to 2001. The deficit that we are experiencing now, though, 
in 2002, 2003, is larger than those that you experienced in the 
nineties. Restate, if you would, how serious a problem it is 
today, given that it is higher than the levels we have 
experienced in the past levels of deficit.
    Mr. KANDARIAN. I think it is a very serious problem, 
especially if you take into account the level of underfunding 
in the entire system, the $300 billion number that I mentioned. 
The Agency takes in about $800 million a year in premiums for 
its single-employer program. We have hanging out there in the 
private sector currently $300 billion in underfunding. Now, we 
don't guarantee 100 percent of that, as Secretary Fisher has 
mentioned, but we guarantee most of it, the large share of it, 
the vast majority. The question is how many of these 
financially troubled companies will end up ultimately 
terminating their pension plan and coming into this Agency 
highly underfunded. So, given the size of this insurance 
system, given the size of the DB system, I find that troubling.
    Chairman MCCRERY. If the economy were to improve, wouldn't 
that bring us somewhat back into a brighter picture in terms of 
the deficit of the PBGC?
    Mr. KANDARIAN. It would. An improving economy should result 
in fewer companies going out of business and therefore having 
their pension plans come into us. In addition, presumably the 
stock market would do better in that situation and assets in 
plans would grow in value, since most companies have over half 
their assets in pension plans in the equity markets. So, that 
would reduce the level of exposure.
    Chairman MCCRERY. So, at least one thing that the Congress 
should maybe focus on is getting the economy growing again.
    Mr. KANDARIAN. That is right.
    Chairman MCCRERY. You caution against increasing the 
interest rate benchmark because of the PBGC's financial status. 
While the financial status of the PBGC is a concern, we know 
that using an artificially low interest rate has detrimental 
effects on the companies that are providing these benefits. It 
increases their liabilities to the PBGC, which take cash out of 
their hands which they wish they could use to hire more 
employees, to pay their employees more, to invest in plant and 
equipment or whatever. So, how do we strike a balance between 
your need for better funding and companies' needs to keep as 
much cash as possible to do their business?
    Mr. KANDARIAN. I think there are really two separate issues 
here. One is accurately measuring pension liabilities. That is 
what Secretary Fisher has been talking about. Once you know 
what the accurate measure of those liabilities is, you then 
have to have good funding rules, strong funding rules to get 
these plans to fund up to some reasonable level over some 
period of time.
    Let me give you an example. We ran some computer models 
using different interest rates and we picked the 10 largest 
companies in the DB system that have underfunded pensions 
today. Five years from now, if you simply kept the 120 percent 
measure of measuring liabilities that you have today, and then 
compare that to a composite bond rate, you would see a 4-
percent further drop in funding. It would actually go from 77 
percent at 105 percent Treasuries, to 70 percent at 120 percent 
Treasuries, down to 66 percent using a composite bond rate. 
What is important to note in all those cases, the plans may be 
underfunded across the board regardless of which interest rate 
you choose.
    Chairman MCCRERY. Well, let's look at some specific 
examples. You note that several of the airlines have declared 
bankruptcy and they were in full compliance with the funding 
rules. Many did not have to make additional contributions to 
their plans, pay additional PBGC premiums, or provide notices 
to workers that their plan was underfunded. Yet now we know 
that they are plans were somewhat underfunded. What happened?
    Mr. KANDARIAN. Well, there is a great deal of averaging and 
smoothing, as we discussed earlier. You can smooth out your 
assets, for example over a 4-year period of time or even 
longer. So, if you assume you still have in your asset pool the 
year 2000 stock market values, to some degree, that misstates 
the current status of your plan. The same thing occurs on the 
interest rate side. Interest rates have been coming down 
dramatically in the last 3 years. That increases liabilities on 
a termination basis, or on a current basis, but those numbers 
are all smoothed and you end up with liabilities that are 
reflecting, really, past economic circumstances, not the 
current circumstance.
    So, for example, even outside the airline industry we had 
Bethlehem Steel come in with over $4 billion in underfunding, 
and they weren't required to make a payment until July of 2003 
and hadn't made one for years. So, those are some of the 
weaknesses that you are correctly pointing out in the current 
funding rules.
    Chairman MCCRERY. Do you have any recommendations for 
fixing those problems?
    Mr. KANDARIAN. Well, we do have the task force I mentioned 
of the Department of Treasury, Department of Labor, Department 
of Commerce, and PBGC. We are deeply involved in these issues. 
I think we are coming pretty close to putting together a 
package of funding rule proposed changes. One concept we are 
certainly looking at very closely is trying to make sure that 
companies don't go through long funding holidays where no 
monies are going in for years. Oftentimes during the boom 
times, when they actually have the ability to put monies into 
their plans, and then when things turn around in an economic 
slowdown, the rules kick in eventually, and the size of the 
funding becomes extremely burdensome to these companies. So, 
finding some way to smooth out the contribution side of the 
system I think would be a big plus.
    Chairman MCCRERY. Thank you very much. Mr. McNulty.
    Mr. MCNULTY. Thank you, Mr. Chairman. I thank both of the 
witnesses. The Chairman covered the question I had for Mr. 
Kandarian. I would just like to ask Secretary Fisher the 
general question, if we adopt the standard that adds more 
complexity to the DB plan system, what long-term impact do you 
anticipate those measures would have on the viability of 
employer-sponsored pension plans?
    Mr. FISHER. Well, the cash flow and time-value of money 
issue identified, and in my written testimony I also identified 
that there is a concern that it could add some complexity, is, 
I think, an important issue to identify, to think about the 
long-term viability of the DB system. On one level you can 
think of this as adding complexity, but on the other it gets to 
an accuracy issue will mean that plans that don't need to have 
as much funding don't have that burden.
    I think most Americans understand that if you go to the 
bank, you get a different rate on a certificate of deposit for 
1 year than you do for 10 years. So, that the time-value of 
money matters.
    Now, most of the big plans, I am confident, are fully aware 
of the time-value of the payments--that is, the payment flows 
that are expected next year versus 5 years from now--with some 
accuracy, because indeed I think they have to have those for 
financial accounting purposes. So, I don't think it is that 
complex for them to come up with an understanding of their cash 
flows. One of the difficulties we have here is there is one set 
of rules for accounting purposes and the Securities and 
Exchange Commission (SEC) disclosure; then over here we have 
got a different set of rules. There is a lot of confusion and 
uncertainty out among investors as to what is the right 
measure. I think that is adding to the difficulties companies 
are facing now.
    I want to be clear, we think that transition rules to help 
companies along deal with these burdens may be necessary, and 
we want to get to talking about that, but we don't think the 
measurement of the liability is the right place to put that. 
Let's get to an accurate measure before we get to the 
transition rule issue.
    Let me finally say I think that for a lot of DB plans, this 
is not a burden for them; most of them go and buy private 
annuities when someone takes out a lump sum or to sustain their 
operations, and they have these--cash flows are priced in when 
the insurance company prices them the annuity.
    Mr. MCNULTY. Thank you. Mr. Chairman, since she has a 4:00 
p.m. commitment elsewhere, I would like to yield the balance of 
my time to Ms. Tubbs Jones.
    Ms. TUBBS JONES. Thank you, Mr. Chairman, Ranking Member.
    Mr. Fisher, let me pick up right where you were just 
talking about private annuities to fund pension plans. You are 
familiar I am sure with the proposed dividends tax cut.
    Mr. FISHER. Yes, I am, ma'am.
    Ms. TUBBS JONES. We had testimony previously from some the 
insurance companies that the dividends tax cut would in fact 
impact annuities. If that is true, it is possible that they may 
well impact some of the private pension plans that are funded 
by annuities.
    Mr. FISHER. It is possible. I am not familiar with the 
details. I know that there are people trying to work on the 
technical issues there, and I have not been a part of that. You 
are right; you are identifying an issue that we have been 
addressing at the Department of Treasury.
    Ms. TUBBS JONES. Would you please do some work and get back 
with me on the impact it might have on the DB plans? We had a 
whole host of people from the insurance industry here 
discussing that very issue with us. It seems to me as we go 
down this road to decide how we are going to fund pension 
plans, this is a logical area that we might focus.
    Mr. FISHER. Absolutely. We would be very happy to do that.
    Ms. TUBBS JONES. Thank you. One short question. I don't 
know how much time I have left. You use the term, Mr. 
Kandarian, ``smoothing.'' For the record, would you define 
smoothing for me, please?
    Mr. KANDARIAN. Yes. Smoothing is used throughout the system 
in a couple of different ways. One, the assets of a pension 
plan where a company can smooth for 3, 4, or 5 years the value 
of those assets; an average actually.
    Ms. TUBBS JONES. Define ``smooth'' for me.
    Mr. KANDARIAN. They average the value of those assets over 
a period of time looking backward. So, today, for example, if a 
company were to sell its portfolio of securities, let's say it 
was worth $100; on a smooth basis, that number might be $130, 
especially if they held a lot of equities in their plan, which 
most do, and the equity markets are down on a broad basis.
    Ms. TUBBS JONES. Who defines what a smooth basis is?
    Mr. KANDARIAN. It is in the Tax Code, the Department of 
Treasury rules.
    Ms. TUBBS JONES. Thanks. I yield back. Thanks a whole lot 
for the time.
    Chairman MCCRERY. Mr. Collins, would you like to inquire?
    Mr. JOHNSON. Thank you, Mr. Chairman, I appreciate that.
    Chairman MCCRERY. Or Mr. Johnson, would you like to 
inquire?
    Mr. JOHNSON. Who did you talk to?
    Chairman MCCRERY. Mr. Collins, but he declined. So, I will 
go to you, Mr. Johnson.
    Mr. COLLINS. I yield to the man with the power.
    Mr. JOHNSON. All right. Thank you, Mr. Collins. I am 
wondering why the Department of Treasury doesn't want to come 
up with a fixed rate, because we have been temporary for some 
time. As I recall, I think it was Mr. Portman along with a 
couple of others and myself--Cardin was one of them--that sent 
you a letter back in November 2001--that is almost 2-years-
ago--asking you to fix this rate. We never got a response. 
Today you are saying you don't want to fix the rate today, but 
that you want to do another temporary for a couple of years. I 
don't understand that. Could you explain it, please?
    Mr. FISHER. Sir, I am very sorry if the Department of 
Treasury did not respond to you.
    Mr. JOHNSON. I understand you got a new guy in there now. 
John Snow is a good one. That is beside the fact. Tell me why 
you want a temporary rate.
    Mr. FISHER. We have not been able to come to a conclusion, 
we are working very hard with the Department of Commerce and 
the Department of Labor and the PBGC, as to how to deal with 
the three issues identified in my testimony. The issue that 
slipped my mind was the smoothing. I think that on the cash 
flows and having a proper--having it reflect it properly, those 
pension plans that have a lot of near-term payments, this is a 
very challenging issue, as is the lump sum. If I had a 
technical answer I would share it with you.
    Mr. JOHNSON. Mr. Portman and Cardin have suggested using a 
basket of corporate bond indexes as a solution. Have you all 
considered that?
    Mr. FISHER. Yes, we have. As far as that goes, I am very 
attracted to the idea of using a private credit curve, that is, 
corporate rates. If we are doing that in the name of accuracy 
to try to get a better, more accurate measure, we think it 
matters to look at the cash flows.
    Let me try to use a simple example. If a company is going 
to have more than half its workers retire within the next 5 
years, simply put, the better measure would be a 5-year rate. 
Some other company, half their workers might not be retiring 
for 30 years. In that case, it, roughly speaking, would be 
appropriate to use a 30-year rate. Those will be very different 
and we will get to different conclusions about the adequacy of 
their funding if we recognize the time-value of money.
    Mr. JOHNSON. Okay. Well, I wish you would look at figuring 
out something permanent and try to get a response to this.
    Mr. FISHER. I am eager to do the same, sir.
    Mr. JOHNSON. Thank you. Mr. Kandarian, in Texas, as you 
know, we are dealing with the saga of American Airlines, and 
their pension funding is way under. In fact to come up to 
speed, it is going to cost them close to $3 billion in the next 
year, they say, which could force them into bankruptcy. In 
other parts of the country we have got auto and steel that have 
some of the same problems.
    Can you tell me generally how underfunded some of the big 
plans are and what your responsibility is?
    Mr. KANDARIAN. Congressman, one of the things that I 
mentioned in my testimony was that we would like to have the 
system be more transparent in terms of information. 
Unfortunately, under the law I can't disclose information about 
specific companies. That is the current state of the law.
    Mr. JOHNSON. How many? You can give me a number. Is it 5, 
10, 20, 100 companies?
    Mr. KANDARIAN. Number of companies?
    Mr. JOHNSON. Yes.
    Mr. KANDARIAN. That are--I am sorry?
    Mr. JOHNSON. Underfunded.
    Mr. KANDARIAN. In the entire system?
    Mr. JOHNSON. Yes, sure. Well, and you know the unions are 
underfunded as well, some of the union plans, so it wouldn't 
hurt if you made that a public issue as well.
    Mr. KANDARIAN. Over half the plans are underfunded. There 
are about 32,000 plans.
    Mr. JOHNSON. When you say underfunded, what do you mean; 
less than 90 percent?
    Mr. KANDARIAN. It is really less than 100, but some can be 
dramatically underfunded. For example, the steel companies 
whose plans we took recently were, generally speaking, 30 to 50 
percent funded when they came into us. We didn't guarantee all 
those benefits, but to a participant, to a worker, those plans 
were between 30 and 50 percent funded. I will tell you that the 
major network airlines as a group are approximately 50 percent 
funded on a termination basis.
    Mr. JOHNSON. That is all the airlines.
    Mr. KANDARIAN. All the network airlines, the major ones.
    Mr. JOHNSON. Okay. In the case of United, for example, 
which is bankrupted, have you had to guarantee any of those 
pension plans yet?
    Mr. KANDARIAN. We have not had to guarantee them yet. The 
question will end up being whether the company can emerge from 
Chapter 11 bankruptcy with the plans intact. The test basically 
is will the plans preclude United from emerging from 
bankruptcy. If the answer is yes, that they cannot get out of 
bankruptcy, then they could qualify under what is called a 
``disasters determination'' and essentially put the plans to 
PBGC, one or more of their plans. That is what happened with 
U.S. Airways.
    Mr. JOHNSON. Yes, sir. Thank you, Mr. Chairman. Thank you 
for your responses.
    Chairman MCCRERY. Mr. Cardin.
    Mr. CARDIN. Thank you, Mr. Chairman.
    Mr. Fisher, I certainly appreciate your testimony. I look 
forward to working with you. I am somewhat disappointed that 
you are not prepared to make a more definitive judgment as to 
what we should be doing on the replacement rates. We know that 
a temporary fix is not the right answer. We know we have to do 
something. We know that there are problems with good benefit 
plans that are adequately funded with the current interest 
assumptions, and that if it favors the--could have some major 
impact on lump sums that need to be dealt with. The longer we 
wait, the more we jeopardize good plans.
    So, I am somewhat surprised--it seems like the 
administration is prepared to work out all the problems on the 
dividend exclusion issue, which has many more complications 
than this issue, and are ready to make immediate judgments. On 
this issue which has been around for a long time, you are not 
prepared today to give us your definitive judgment. I find that 
somewhat disappointing because I know this Committee would like 
to act this year on the issue.
    So, I just really would hope that we could--you raise good 
points. There is no question that there are different types of 
plans out there. We want to make sure they are adequately 
funded. We don't want to add to the problems of underfunded 
plans. I would hope that you would focus on it now so that we 
can get this issue resolved in this Congress and not have to 
wait any longer. Any help in that regard we would certainly 
appreciate.
    Mr. FISHER. Well, if I could, I share your frustration, Mr. 
Cardin, and we look forward to working energetically. I want to 
be very clear the administration is not suggesting we need a 2-
year extension of the current corridor, and will wait until the 
end of that to work on these issues. We need that extension to 
give plan sponsors certainty. The Department of Treasury staff 
will be at work tomorrow morning, if you would like, with the 
joint working group on tax staff level here on Capitol Hill. We 
have been working hard on these issues. I share your--and I 
applaud you and Mr. Portman for getting the bill forward.
    I do believe, as--I don't know if you were in the room--how 
many times I have said that a private credit curve we think is 
the right starting point. I am very pleased to move the ball 
along there. We do think, though, that the cash flows, the lump 
sum and the smoothing, if we don't get the right answer there, 
we run the risk of doing more harm than good for the system as 
a whole.
    Mr. CARDIN. We will look forward to your recommendations in 
that regard. Thank you, Mr. Chairman.
    Chairman MCCRERY. Mr. Portman.
    Mr. PORTMAN. Thank you, Mr. Chairman. So many questions, so 
little time. Now we have a vote called. I really appreciate you 
having this hearing and being able to vet some of these issues.
    Some of these questions may have been answered earlier. One 
just general question, maybe to sort of lay the bigger picture 
here and maybe--Mr. Kandarian, you and I have talked about this 
generally--but if we could just lay this out, how many DB plans 
were there, say, in the mid-eighties and how many are there 
today?
    Mr. KANDARIAN. There were approximately 114,000 DB plans in 
the mid-eighties, and today about 32,000.
    Mr. PORTMAN. That is roughly the numbers that we have been 
working with. I think we need to think about this in the 
context of what we are talking about today. To those who would 
say that somehow by establishing this composite of long-term 
corporate bonds is going to hurt the DB plans; the DB plans are 
being hurt already. The number of plans that have been frozen 
in the last couple of quarters, to new participants, are a big 
concern.
    For those of us who believe in DB plans and want to see 
them continue and strengthen, I think we need more than just, 
with all due respect, another 2-year extension of what is truly 
uncertainty. I understand, Mr. Fisher, you say the plans need 
certainty, so you are giving them certainty of another 2 years. 
It is just another 2 years. It is 2 years of what I believe to 
be an inaccurate measure still, and one that causes some of 
these good plans to look at their options, like freezing or 
like getting out of the business altogether and offering new 
entrants a defined contribution (DC) 401(k) or something like 
that. Sometimes we get away from that. We are looking at plans 
quickly leaving many midsize corporations, and they have 
already left the smaller companies.
    The Employee Retirement Income Security Act (ERISA) section 
4002, Mr. Kandarian, requires PBGC to encourage the 
continuation of maintenance of voluntary pension plans to 
benefit participants. We have received consistent reports that 
DB plans are being frozen, sometimes to all participants, 
sometimes to new participants. I just wonder what you are 
recommending to provide stability and encouragement to plan 
sponsors that are already in the system so that they will 
continue to have their DB plans.
    Mr. KANDARIAN. I think one of the best things we can do is 
devise a funding structure that allows companies to put in 
moneys during good years and not have to wait until bad years 
to make up the difference. These plans are volatile from the 
point of view of the level of funding. It changes pretty 
dramatically because of the way they invest their assets.
    As I mentioned before, the assets are typically over 50 
percent equities. Those markets can move up and down with a 
fair amount of volatility. So, during good years, when 
oftentimes they are flush with capital and profits, they either 
have a funding holiday--there is no requirement to put money 
in--or in some cases they butt up against the maximum funding 
rules and they cannot put money in. To allow them to put moneys 
in during these good years I think would help take some of the 
volatility out of the system.
    Mr. PORTMAN. That is something that I think probably our 
panelists coming up would embrace. I think they are, though, 
very concerned about some of the proposals that are out there 
with PBGC and possibly with the Department of Treasury to look 
at the cash flow, because it is complicated and because it 
doesn't provide them the certainty that they are looking for.
    One just general question I have, looking at the big 
picture here--and maybe Mr. Fisher can reply to this. Do you 
think the 30-year Treasury rate was a good measure back when 
the 30-year Treasury rate was being issued? Do you think it was 
the right liability measure to have?
    Mr. FISHER. I think we observed over the course of the 
nineties, even before we discontinued issuance, that it 
probably was losing whatever accuracy it might have had in the 
late eighties. As the inflation premium, frankly, was squeezed 
out of the economy, it became a less and less accurate measure. 
It may have been more of an anomaly in the eighties that it 
looked like a good proxy for private annuity rates.
    Mr. PORTMAN. Back in the eighties when it was considered a 
good proxy for private annuity rates and therefore considered a 
good measurement tool, it didn't take into account cash flow, 
did it?
    Mr. FISHER. No, it hasn't, but I think it should.
    Mr. PORTMAN. Okay. I know we have got a lot of things to go 
over, but on the lump sum side--which is your second issue you 
raise in addition to smoothing--your testimony says here, it is 
worth considering whether a permanent replacement of a 30-year 
Treasury rate is needed for the purpose of calculating lump 
sums. Are you implying that the 30-year Treasury rate might be 
used, an obsolete measure like that, for lump sums?
    Mr. FISHER. No, I am not. I think, though, that we have to 
look very carefully at making sure we don't accelerate the 
arbitrage now that has opened up under the current statute.
    Mr. PORTMAN. What is your recommendation on lump sums in 
general? What is the administration's position on lump sums?
    Mr. FISHER. We don't have a recommendation at this time. We 
would be eager to work with you and others to try to resolve 
what we see as the very difficult both technical and political, 
frankly, transition issues; how to get reasonable payment 
schedules for plan sponsors and how to be fair to plan 
beneficiaries.
    Mr. PORTMAN. My time is up, but Mr. Johnson talked about 
the letter back in 2001. This is an issue we have all been 
looking at for some time and knowing that it was, I would say, 
even a crisis in some companies at a time when the economy is 
down, when companies are looking for ways to be able to help 
the bottom line and keep their employees, I know these are 
complicated issues, I know they are tough political issues.
    Mr. Cardin and I have borne the brunt of that over the last 
couple of weeks with some articles that I think were inaccurate 
because they weren't based on all the information, which is 
very complicated. It sure would help--when you say it is 
complicated and political--politically if you would take a 
position. I know you have to work with PBGC but it is not much 
help to just offer a 2-year extension and say the 
administration doesn't have a position, when it has really been 
3 years we have been struggling with these issues and we could 
use a little leadership.
    Thank you, Mr. Chairman.
    Mr. WELLER. [Presiding.] We have a vote under way right 
now. There are some Members that would like to ask questions, I 
know Mr. Pomeroy, and there may be others who hope to return in 
time to ask questions. I have a few I would like to share with 
the panel.
    Mr. Fisher and Mr. Kandarian, thank you for participating 
and appearing before the Committee today. Pension calculations 
are pretty important to a lot of people. So, this is a 
significant issue that is before us today. Of course, what has 
driven us, that Department of Treasury-made decision this past 
couple of years to suspend the 30-year bond. Mr. Fisher, I was 
wondering from your perspective and given your expertise, and 
perhaps Mr. Kandarian you can address this as well, but if the 
Department of Treasury had not suspended issuance of the 30-
year bond, would it today still be a viable rate for pension 
calculations?
    Mr. FISHER. No, I don't think it would. I think there was 
actually a fair bit of literature in the actuarial community 
and in the pension-sponsor community in the late nineties 
addressing the inadequacy of the 30-year, before any decision 
was made to suspend it. That was because the structure of 
interest rates, the relationship between Treasury and corporate 
spreads was changing, and the overall slope of the yield curve 
was also changing as the Federal Reserve succeeded in squeezing 
inflation out of our economy. So, I think that the pressure on 
DB liability measurement was already there before we suspended 
the 30-year.
    Mr. WELLER. Okay. Mr. Kandarian, do you have a perspective 
or do you agree?
    Mr. KANDARIAN. I defer to the Department of Treasury's 
position on this.
    Mr. WELLER. Mr. Fisher, if the Department of Treasury were 
to decide to reissue the 30-year bond at some point in the 
future, do you see it ever again being considered for this 
purpose; or, based on what you just stated, do you think that 
will be consistent?
    Mr. FISHER. At least on our current understanding of 
interest rates in the hypothetical you are offering, I don't 
think I would be recommending that it be considered here for 
these purposes. I also think it a sufficiently remote 
possibility, approaching zero, that it will be brought back. I 
also think that would be a reason not to wait and hold your 
breath for whether the Department of Treasury was going to 
reissue 30-year bonds.
    Mr. WELLER. Mr. Fisher, do you think there is a benefit to 
using a Department of Treasury-issued instrument for pension 
calculations in terms of the openness and transparency of those 
markets?
    Mr. FISHER. I think there certainly is a benefit and there 
was at the time that it was adopted in 1987. I think that 
overall, the transparency of our capital markets in this 
country has advanced tremendously over the last 15 years. I 
think that whereas in 1987 the use of private credit curves or 
corporate credit curves did not seem adequately transparent in 
the late eighties, I think that today with the information 
technology and all of the instantaneous information available 
to us, it is much more credible that we will get to a 
sufficiently transparent rate. Those are other issues. In my 
testimony today I only addressed the three major issues. There 
are a number of other technical issues that would need to be 
addressed to come to the right setting of how to use a private 
credit curve.
    Mr. WELLER. Mr. Fisher, thinking in terms what the risks 
are in choosing an inaccurate rate, what are the risks involved 
with choosing the interest rate that is too high or one that is 
too low?
    Mr. FISHER. An interest rate which is--well, in each 
direction we can get to overfunding or underfunding. If we 
underfund pensions, then we put at risk the beneficiaries, the 
workers, and retirees. If we overfund, we put too great a 
burden on the plan sponsors and run the risk of a declining 
population of sponsors willing to be in the DB universe. So, 
this is precisely why one of the things I always remind the 
Department of Treasury staff is the risks are more symmetric 
than we think. That is why we are so convinced we have to be 
very careful to get to accuracy; then, I want to be clear, 
consider changes to the funding rules and transition rules so 
that we are not too burdensome on companies if getting to a 
more accurate measure ends up raising the measured burden. So, 
I think that is a big reason to be very cautious before we risk 
doing some harm here.
    Mr. WELLER. Okay, thank you, Mr. Fisher.
    Just one last question for Mr. Kandarian. Several proposals 
have been discussed, such as a corporate bond index, a yield 
curve, and 2-year extension of last year's relief. How would 
those options affect plan funding and the financial status of 
the PBGC?
    Mr. KANDARIAN. We have an illustration to the right there, 
which demonstrates what the funding levels would be based upon 
different interest rates. I mentioned, I think, earlier in my 
testimony, in response to one of the questions, we looked at 
the plans of the 10 sponsors with the largest underfunding. In 
5 years from now, if we went back to the 105 percent of 
Treasury rate, those plans would be 77 percent funded. If you 
stayed at the 120 percent of Treasury rate that we have today 
and extended that for 5 years, the number would be 70 percent, 
again compared to 77 percent. If you dropped it to a composite 
bond rate it would drop from 77 percent to 66 percent funded. 
So, it would reduce fairly dramatically the level of funding of 
a system that already is underfunded today if that were the 
only change we were making. Which is why we are talking about 
the funding rules as well.
    Mr. WELLER. All right. Thank you very much. Mr. Pomeroy.
    Mr. POMEROY. Thank you, Mr. Chairman. I want to begin by 
just expressing my disappointment with the recommendation the 
administration is bringing forward today. This is a thorny 
problem but it is not a new one. On November 28, 2001, 
Representatives Cardin, Portman, Johnson, and myself sent a 
letter to the administration asking for your guidance. I 
believe that we are doing great disservice to employers that 
are trying to keep the security of DB pension coverage 
available for their workers, especially in the face of this 
recession. So, to not have a more advanced plan, something with 
certainty, really tells me that--I will be blunt about it--
someone has dropped the ball within this administration, 
probably at the Department of Treasury, to have the testimony 
today being we want a 2-year extension of the jury-rigged 
proposal we now have in place while we look at this some more.
    It is bipartisan concern around here on retirement income 
security for workers. I think there is some agreement that the 
pension plan of the DB character has an enduring value to the 
marketplace. We want to find ways to expand it, not be 
inattentive to the problems that are forcing its diminishment.
    I am very concerned, while the financial press has talked 
so much about cash balance conversions, one thing we don't seem 
to be talking about is activity relative to freezing DB plans. 
I would just throw open to either of you, probably PBGC in 
particular, do we have a data capture mechanism knowing when a 
plan has been frozen?
    Mr. KANDARIAN. We know when a plan terminates, Mr. Pomeroy, 
but we don't know when a plan is frozen because the plan is 
still outstanding.
    Mr. POMEROY. If I was an employer, terminate a plan, you 
arrive at a termination liability, and there are obviously cost 
consequences relative to that. Freezing it abates some of that 
reconciliation of account owed. So, actually there is a 
financial incentive perhaps to freezing as opposed to 
terminating.
    Mr. KANDARIAN. Right. Since the eighties, 97,000 plans have 
actually terminated. About 95,000 went to the group annuity 
market and bought annuities to take care of those obligations.
    About 1,800 of those plans came into us because they were 
underfunded and the plan sponsor couldn't----
    Mr. POMEROY. Those are the terminated ones?
    Mr. KANDARIAN. Yes.
    Mr. POMEROY. My point is I am afraid there is an even 
greater number being frozen, and my concern is that in this 
atmosphere of uncertainty, with very considerable potential 
exposure to the employers, we are driving that number even 
higher. It would seem to me we ought to find a way to capture 
data on the plans that are being frozen because that clearly 
has a significant impact in terms of the retirement savings 
future of this country. Any ideas within the administration 
relative to that idea?
    Mr. KANDARIAN. We have no mechanism today to gather that 
information, to require that information to come to us, but we 
can certainly take a look and see if there is something we 
could propose.
    Mr. POMEROY. I certainly don't want to burden employers. It 
would seem to me it is pretty important information, especially 
for those of us attempting to sort out public policy 
consequences. If they are freezing and we don't know about it, 
we ought to know about it.
    Mr. KANDARIAN. Typically, the plans that are frozen are 
plans covering salaried workers, because the union plans 
require a collective bargaining agreement to freeze the plan, 
and that typically is not provided in those bargaining plans.
    Mr. POMEROY. Well, in other words, it looks like--I see 
that they will quickly--only in organized union collective 
bargaining agreements will be the last place you have pensions 
anymore, and I find that terribly regrettable.
    It seems to me the approach you indicate a preference for 
Mr. Secretary, on the yield curve as the basis for how we are 
going to calculate this would fall disproportionately heavily 
on struggling industries, steel, airline industries. They are 
in some of the worst financial shape and creating a lot of 
concern to their future viability in the marketplace. Do you 
find critical flaws in the 30-year--I don't propose that 
Portman-Cardin got it just right, but do you really find it 
fatally flawed? Isn't it beneficial to the yield curve plan in 
that it does not fall quite as hard on these industries that 
are already in wobbly condition?
    Mr. FISHER. Let me first try to address the first component 
there of these hard-hit industries. I think that one of the 
difficulties I would like to focus on is the fact that the 
capital markets through their regular accounting are aware of 
some of the big liability holes where they have the 
underfunding. Then we end up with a lot of confusion, because 
over here in this world, as opposed to the SEC accounting 
world, we have a different measure of the liability, and so I 
don't think--I think the full weight of that measure of the 
liability, the one that comes from the cash flow analysis, is 
already burdening these companies in the sense that its 
investors are aware of it.
    I think we can actually do a great service to those 
companies that are struggling by coming to an agreement on 
accurate measures and not confusing the capital market with 
different measures. If we come to an agreement on accurate 
measures, then I want to repeat what I have said before and how 
important it will be to think hard about funding rules and 
transition rules. I think the companies that are hard hit today 
need transition rule relief. I don't think we should use the 
measurement of the liability as a vehicle for what should be 
transition relief.
    Mr. POMEROY. Now, do you anticipate transition relief as an 
accounting and measurement issue or transition relief in terms 
of changing the format of the retirement?
    Mr. FISHER. As part of the funding rules to work our way 
out of this, we look at funding rules and transition rules as 
part of the reform. We have to begin with accurate measures, 
and I actually think that if we get to, in this world, as 
accurate a measure as we can over here, that it comports with 
what the financial markets are looking at, and then we work as 
hard as we can on the funding and the transition rules 
together, we will reduce the burden on those companies by 
removing the uncertainty that overhangs their share price of 
not knowing what the funding path is going to be.
    The current rules create great volatility in the funding 
requirements of companies. That is the existing regime, and 
that is part of what I would like us to ultimately be getting 
at.
    Mr. POMEROY. What you say there makes sense to me. I just 
wish we were further along in terms of having a product. I 
really do believe it is imperative we do.
    Mr. FISHER. Sir, I want to assure you I am also frustrated 
by how far along we are, and I want to assure you we will work 
expeditiously with staff here on the Hill in this matter. The 
2-year extension is not for us, it is for the industry and the 
plan sponsors. We are ready to go to work tomorrow and next 
week immediately on these issues, as we have for many months, 
and I apologize that you were frustrated by our lack of 
response. Please let me just ask for your forgiveness.
    Chairman MCCRERY. [Presiding.] Thank you, gentlemen, for 
your testimony.
    I would like to call the second panel now. Norman P. Stein, 
on behalf of the Pension Rights Center, Douglas Arant Professor 
of Law, University of Alabama; Mr. Kenneth Porter, on behalf of 
the American Benefits Council--Mr. Porter is Director of the 
Corporate Insurance and Global Benefits Financial Planning, the 
DuPont Co.; and Ron Gebhardtsbauer, Senior Pension Fellow at 
the American Academy of Actuaries.
    While they are taking their seats, I would like to 
recognize Mr. Weller.
    Mr. WELLER. Thank you, Mr. Chairman. I would just like to 
ask unanimous consent to insert into the record a column on--
regarding liquidity of the long-term bond by Nicholas Neubauer, 
if I may.
    [The information follows:]

              Treasury Should Resume Issuing 30-year Bonds

    In October 2001, the U.S. Treasury Department announced a surprise 
decision to stop issuing 30-year Treasury bonds. Since that time, long-
term markets have suffered from a sense of limbo. Investors have been 
without an alternative risk-free, long-term investment option. 
Corporations have been without a government-backed benchmark to price 
their long-term debt. The market-making infrastructure in long-term 
debt markets has struggled to maintain its vibrancy. Reversing the 
decision and resuming issuance of 30-year bonds would stimulate the 
economy and have many other positive benefits. A return of the 30-year 
bond would:

Benefit Taxpayers through prudent debt management
    Putting away 30-year money at today's all-time low rates is common 
sense debt management. Both corporations and individuals are taking 
advantage of the current low rates; companies such as Citigroup, 
Goldman Sachs, Boeing and S.C. Johnson recently issued 30-year bonds, 
and individuals are refinancing 30-year mortgages at record rates. As 
Business Week quotes Standard & Poors' Chief Economist in the attached 
commentary: ``The U.S. Treasury should be at least as smart as 
homeowners.'' At the time the Treasury announced the elimination of the 
long bond, it optimistically predicted that the Federal government 
would see a relatively quick return to surpluses. Unfortunately, 
today's estimates show that will not be the case for some time. While 
shorter term issues may cost the government slightly less in interest, 
they will have to be refinanced upon their expiration, quite likely at 
higher rates. By issuing debt across the entire yield curve, Treasury 
would best hedge its exposure to whatever kind of interest rate 
environment the future might bring. With the uncertainty facing our 
Nation right now, having at least some of the Treasury's debt financed 
for 30 years at record low rates just makes sense.

Benefit Investors and Corporations
    Reissuance would lower risk profiles for long-term investors of all 
types. Skittish investors looking for secure instruments would have 
long-term government bonds restored to them as an investment option. 
Portfolio managers would again have a long-term, risk-free investment 
vehicle, instead of trying to substitute alternatives issued by 
concerns less creditworthy than the U.S. Government. Corporations would 
again have this valuable benchmark to assess the value of long-dated 
assets and liabilities.

Benefit the U.S. Government by maintaining the vibrancy of long-term 
        markets
    Long-term markets are currently operating in a state of limbo, 
beset by expectations and rumors that the Treasury will ultimately 
reissue the 30-year bond. With the return of long-term budget deficits, 
it seems the likely course of action. In the meantime, anecdotal 
evidence suggests the long-term market is already suffering from 
reduced liquidity, with market participants complaining of higher costs 
and erratic price behavior. Unfortunately, the longer the U.S. Treasury 
goes without issuing the long bond, the more difficult and costly it 
will be to rebuild the eroding market-making infrastructure to support 
it.

                                *  *  *

    In sum, reissuing the 30-year bond would benefit taxpayers, the 
full range of investors and the U.S. Government by reinstating a long-
term, risk-free investment and pricing benchmark, returning to a 
common-sense debt management policy that issues debt over the entire 
yield curve, and preserving fully functioning long-term debt and 
capital markets for the future of U.S. Government debt management.

                                 

    Chairman MCCRERY. Without objection. Welcome, gentlemen. 
Your written testimony will be inserted in the record in its 
entirety, and we invite you now to summarize your testimony in 
about 5 minutes, and we will begin with Mr. Stein.

    STATEMENT OF NORMAN P. STEIN, DOUGLAS ARANT PROFESSOR, 
 UNIVERSITY OF ALABAMA SCHOOL OF LAW, TUSCALOOSA, ALABAMA, ON 
              BEHALF OF THE PENSION RIGHTS CENTER

    Mr. STEIN. We would like to be able to substitute a longer 
document.
    Chairman MCCRERY. That is perfectly acceptable. Thank you.
    Mr. STEIN. Mr. Chairman, Members of the Subcommittee, I am 
Norman Stein, a law professor at the University of Alabama, 
where I am privileged to hold the Douglas Arant professorship 
and to direct the law school's pension counseling program.
    It is also my privilege to appear here today on behalf of 
the Pension Rights Center, the Nation's only consumer 
organization dedicated solely to protecting and promoting the 
pension rights of workers and retirees.
    The pension funding issues you are considering today appear 
to many as hyper-technical matters, primarily of interest to 
actuaries and accountants and academics and, I guess, 
Congressmen.
    The Subcommittee decision to hold today's hearing, however, 
underscores the critical relationship between such seemingly 
technical issues as a 30-year Treasury rate on the one hand and 
the retirement security of millions of American workers on the 
other.
    My testimony today will focus on two discount rate issues: 
the proper interest rate for determining plan liabilities for 
certain statutory funding purposes; and the proper rate for 
determining lump sum benefit values.
    Turning to plan funding, the business community and labor 
organizations have argued that the use of 30-year Treasury 
rates currently overstates pension liabilities, artificially 
causing some plans to appear underfunded, and thus be required 
to satisfy unnecessarily high minimum funding obligations; but 
for participants, the key concern in DB plans is benefit 
security.
    Adequate funding levels are a necessary bulwark against 
underfunded plan terminations and sharp reductions in the 
benefits and benefit rights of participants in DB plans. In 
addition, a well-funded pension plan is in a much better 
position to enhance benefits and provide cost-of-living 
adjustments to retirees. The 30-year Treasury rate provides a 
conservative benchmark for plan funding purposes and several 
actuaries have privately suggested to us that the current 30-
year Treasury rate does not greatly overstate pension 
liabilities.
    Nevertheless, we are not unsympathetic to the arguments of 
the business community that the 30-year Treasury rates may be 
too low for valuing liabilities in many plans. We thus urge 
this Congress to proceed conservatively, lest we find as the 
baby boomers begin retiring in substantial numbers a decade 
from now that the private pension system is asset short because 
of decisions about funding standards made precipitously this 
year.
    Some in the business community have advocated a replacement 
rate as high as 105 percent of the long-term corporate bond 
rate. The choice of such a benchmark, however, would to a large 
extent be arbitrary and arguably would have no sounder 
theoretical grounding than the 30-year Treasury rate in use 
today. If the latter overstates liabilities in a manner 
detrimental to plan sponsor flexibility, the former may well 
understate liabilities and result in an era of plans unable to 
satisfy benefit commitments.
    We do not come here today with a recommendation for a 
specific replacement rate but believe that an index that tracks 
annuity purchase rates should be the Committee's target. The 
corporate bond rate, we believe, is not the best surrogate for 
this target.
    Turning to lump sums, the 30-year Treasury rate is also 
used for determining lump sum values for annuity benefits. Two 
related arguments are made for changing the rate here. First, 
that the required lump sum values are higher than the actual 
annuity values and thus bleed plans of resources; and second, 
that the higher lump sum values discourage participants from 
taking annuities, which subjects them to challenging money 
management problems in retirement.
    The Pension Rights Center has never been an advocate of 
lump sum payment options, but the reality is that once plans do 
offer such options, employees rely on the availability of lump 
sums. Moreover, lump sums are not always an option. Plans are 
permitted to cash out on a mandatory basis participants whose 
benefits have a present value of $5,000 or less.
    It does not logically follow that the same rate that is 
used for certain plan funding purposes should also be used to 
value lump sums. Participants cannot be expected to achieve the 
same rates of return that are reflected in annuity purchase 
rates, assuming an equivalent level of risk. This is especially 
true for employees who receive small lump sum values in 
mandatory cash-out situations.
    We are also skeptical that the 30-year Treasury rate is the 
primary reason employees who have a choice of benefit form 
elect to take lump sums. In our experience, employees elect 
lump sums because they do not wish to leave a former employer 
in control of their retirement wealth. If Congress wishes to 
discourage the practice of lump sums, there are far more 
effective ways of doing so than altering the interest rate used 
to value them, which in our view would be akin to trying to 
melt a glacier with a bic lighter.
    Thus, in general, we favor a more conservative interest 
rate for valuation of lump sums than for plan funding purposes, 
and especially so with respect to employees who are mandatorily 
cashed out by a plan.
    We are also concerned that any change in the interest rates 
used to determine lump sum values not affect the benefit 
expectations of current participations. At a minimum, any 
change should apply only to benefit accruals occurring after 
the effective date of the change in the section 417(e) interest 
rate. In addition, there should be a lengthy grandfathering 
provision period so as not to defeat the reasonable 
expectations of those close to retirement.
    Finally, we would also like to suggest the Committee 
consider the desirability of some sort of smoothing of whatever 
rate is elected for valuing benefit options. At present, a 
sudden change in interest rate immediately before a 
participant's retirement or earlier separation from service can 
have a dramatic effect on the value of the participant's lump 
sum. Smoothing would cushion the participant from the effects 
of rate volatility and facilitate more effective planning for 
retirement.
    Thank you.
    [The prepared statement of Mr. Stein follows:]

 Statement of Norman P. Stein, Douglas Arant Professor, University of 
 Alabama School of Law, Tuscaloosa, Alabama, on behalf of the Pension 
                             Rights Center

    Mr. Chairman, Members of the Subcommittee, I am Norman Stein, a 
professor at the University of Alabama School of Law, where I am 
privileged to hold the Douglas Arant Professorship and to direct the 
law school's pension counseling program, which has helped hundreds of 
individuals with their pension problems.
    It is also my privilege to appear here today on behalf of the 
Pension Rights Center, the nation's only consumer organization 
dedicated solely to protecting and promoting the pension rights of 
workers, retirees and their families.
    The issues you are to discuss today, pension funding and 
particularly the continued appropriateness of the 30-year Treasury rate 
for various statutory purposes appear to many as hyper-technical 
matters, primarily of interest to actuaries and accountants and 
academics. The Subcommittee's decision to hold a hearing on this issue 
alone, however, underscores the critical relationship between such 
seemingly technical issues, on the one hand, and the retirement 
security of millions of American workers, on the other. As you have 
heard from representatives of the business community, these technical 
issues also bear heavily on the financial health of many industries and 
individual companies.
    My testimony today will focus separately on two issues: the proper 
discount rate for determining plan liabilities for certain statutory 
funding and PBGC purposes; and the commutation of annuity benefits into 
lump sum benefit amounts. In my comments, I will allude to some other 
funding issues, but will concentrate on alternatives to the 30-year 
Treasury rates for these two purposes.

Plan Funding. The business community and labor organizations have 
argued that the use of 30-year Treasury rates currently overstates 
pension liabilities, artificially causing some plans to appear 
underfunded and to satisfy unnecessarily high minimum funding 
obligations.
    Benefit security is a key concern for participants in defined 
benefit plans. Adequate funding levels are a necessary bulwark against 
unfunded plan terminations and sharp reductions in the benefits and 
benefit rights of participants in defined benefit plans. At the Alabama 
Pension Clinic we counsel clients who know first-hand the devastating 
consequences of underfunding. They, like the USAirways pilots and 
Bethlehem Steel retirees who recently made headlines, lost thousands of 
critical pension dollars because their benefits were only partly 
guaranteed when their plans terminated. In addition, a well-funded 
pension plan is in a much better position to enhance benefits and 
provide COLAs for retirees. The 30-year Treasury rate provides a 
conservative benchmark for plan funding purposes and at least some 
actuaries have privately suggested to us that the current 30-year 
Treasury rate does not greatly overstate pension liabilities, at least 
for determining whether a plan is underfunded for certain statutory 
purposes. (This is particularly true given that some funding rules, 
viewed in isolation, can be seen as permitting a firm to underfund a 
plan in certain situations.)
    We are, however, sympathetic to the arguments of the business 
community that the 30-year Treasury rate is somewhat too low for 
valuing liabilities in most plans. In determining a replacement rate, 
however, we urge that this Congress proceed conservatively, lest we 
find as the baby boomers begin retiring in substantial numbers a decade 
from now, that the private pension system is asset-short because of 
decisions about funding standards made precipitously years earlier.
    The business community has advocated a replacement rate equal to as 
much as 105% of a composite high-quality, long-term corporate bond 
rate. The choice of such a rate is, however, to a large extent 
arbitrary and arguably has no sounder theoretical grounding than the 
30-year Treasury rate. If the latter overstates liabilities in a manner 
detrimental to plan sponsor flexibility, the former may well understate 
liabilities and may result in an era of plans unable to satisfy benefit 
commitments.
    We do not come here with a recommendation for a replacement rate, 
but believe that an index that more closely tracks annuity purchase 
rates should be the committee's target. The corporate bond rate misses 
this target.

Determining Lump Sum Values. The 30-year Treasury rate is also used for 
determining lump sum values for annuity benefits in defined benefit 
plans that provide for a lump sum distribution option. Two related 
arguments are made for changing this rate: first, that the lump sum 
values are higher than the annuity values and thus bleed plans of 
resources; and second, that the higher lump sum values encourage 
participants to take annuities, which subjects them to challenging 
money management problems in retirement.
    The Pension Rights Center has never been an advocate of lump sum 
payment options--annuity payouts provide far greater security for both 
retirees and their spouses. But the reality is that once plans do offer 
such options, employees rely on the availability of lump sums. 
Moreover, lump sums are not always an option. Plans are permitted to 
cash out, on a mandatory basis, participants whose annuity benefits 
have a present value of $5,000 or less.
    It does not logically follow that the same rate that is used for 
certain plan funding purposes should also be used to value lump sums. 
Participants cannot be expected to achieve the same rates of return 
that are reflected in annuity purchase rates or a composite bond rate. 
This is especially true for employees who receive small lump sum values 
in mandatory cashout situations. Moreover, reduction of lump sum values 
in this situation will make it less likely that a former employee will 
rollover their lump sum into an individual retirement account and thus 
preserve the benefits for retirement.
    We are also skeptical that the 30-year Treasury rate is the primary 
reason employees who have a choice of benefit form elect to take lump 
sums. In general, they elect lump sums because they do not wish to 
leave a former employer in control of their retirement wealth. If 
Congress wishes to discourage the practice of lump sums, there are far 
more effective means of doing so then altering the interest rate used 
to value them. This is akin to trying to melt a glacier with a bic 
lighter.
    Thus, in general, we would favor a much more conservative interest 
rate for valuation of lump sums than for plan funding and other 
statutory purposes, and especially so with respect to employees who are 
mandatorily cashed out by a plan.
    We are also concerned that any change in the interest rates used to 
determine lump sum values not effect the benefit expectations of 
current participants. At a minimum, any change should apply only to 
benefit accruals occurring after the effective date of a change in the 
section 417(e) interest rates. In addition, there should be a 
grandfathering provision for those within five years of retirement, so 
as not to defeat their reasonable expectations.
    We also would like to suggest that the Committee consider the 
desirability of some sort of smoothing of whatever rate is used for 
valuing benefit options. At present, a sudden change in interest rate 
immediately before a participant's retirement or earlier separation 
from service can have a dramatic effect on the value of a participant's 
lump sum. Smoothing would cushion the participant from the effects of 
rate volatility and facilitate more effective planning for retirement.
    Thank you. I would be happy to take any questions.

                                 

    Mr. MCCRERY. Thank you, Mr. Stein. Mr. Porter.

 STATEMENT OF KENNETH PORTER, DIRECTOR, CORPORATE INSURANCE & 
GLOBAL BENEFITS FINANCIAL PLANNING, DUPONT COMPANY, WILMINGTON, 
      DELAWARE, ON BEHALF OF THE AMERICAN BENEFITS COUNCIL

    Mr. PORTER. Chairman McCrery and Congressman McNulty, thank 
you very much for the opportunity to appear today. I am Ken 
Porter, director of Corporate Insurance and Global Benefits 
Financial Planning for the DuPont Company. DuPont has 79,000 
employees worldwide and delivers science-based solutions to 
such areas as food and nutrition, health care, construction, 
and transportation.
    I appear today on behalf of the American Benefits Council 
where DuPont and I personally serve on the board of directors. 
The American Benefits Council is a public policy organization 
principally representing Fortune 500 companies and other 
organizations that either sponsor directly or provide services 
to retirement and health plans that cover more than 100 million 
Americans.
    Like you, the Council Members are concerned about the 
health of the voluntary DB employer-sponsored plans in the 
United States. We have heard about the numbers and the decline 
of the number of plans in recent years and the freezing of 
plans. We are very troubled by this. Companies that sponsor 
these plans need stability.
    I personally in my company have a plan that has been 
overfunded for 18 years, been over the full funding limit. We 
have not been permitted to make tax-deductible contributions. 
This year for the first time that has changed.
    Our rating agencies that set our credit ratings are 
demanding 4-year or 5-year cash flow analyses now that we might 
have funding opportunities, and I can't tell them what that is 
because I don't know what the law is going to be. I can deal 
with the uncertainty of the investment markets better than I 
can the uncertainty of the law. Rating agencies don't 
understand why I can't tell them what a 5-year forecast of cash 
flow is. I am in an urgent need for a permanent solution.
    In this regard, the Council is extremely pleased that a 
permanent reform has now been introduced by Representatives 
Portman and Cardin as part of H.R. 1776. We wish to sincerely 
thank them for the many months of hard work and deliberation 
that has led to the introduction of this bipartisan proposal. 
They have once again forward with a balanced solution to a 
complex and pressing pension problem.
    The Portman-Cardin proposal permanently replaces the 30-
year Treasury bond rate with a rate of interest earned on 
conservative long-term corporate bonds. It directs the 
Department of Treasury to produce this rate based on one or 
more corporate bond indices. On balance, it is just a 
conservative middle-road rate that is somewhere between what 
corporations can actually earn on their investments in an 
ongoing pension plan and what insurance companies charge 
companies for then terminating pension plans.
    The Council is gratified that the Portman-Cardin proposal 
embraces a number of the principles of reform that the Council 
has developed. First, the proposal is both permanent and 
comprehensive covering funding premiums and lump sum 
calculations. Second, it applies a consistent rate for the 
various pension calculations. Third, it is a blend of stable 
long-term corporate bond rates that is new and more rational 
benchmarking for measuring liabilities. Fourth, it provides a 
strong existing set of rules that provide the stability that 
employers need in order to be able to get the credit ratings 
and the debt support that they need in this economy.
    So, in concluding, as you have heard, the Department of 
Treasury is advocating an alternative approach. This approach 
is not analyzed. It hasn't been developed. We don't know 
exactly what it is. What we do know is it provides a level of 
uncertainty, and we need some stability. It uses an interest 
rate to measure liability associated with the duration of time 
till benefits are paid out.
    We have serious concerns with this approach. First, a yield 
curve will significantly increase the volatility and complexity 
of pension funding as we understand it. More importantly, 
because it hasn't been tested and hasn't been vetted, we don't 
know what it is. It is unclear how the concept would apply to 
issues as it relates to calculation of lump sums. It is unclear 
how it would apply to employees' contributions to pension plans 
and the payment of credits under hybrid pension plans. It is 
likewise unclear what sort of transition approach would be 
adopted from the current system.
    Accordingly, if we look at the experience of the United 
Kingdom as an example, where an accounting standard was adopted 
that required this kind of an analysis, we have concern that 
there could be unintended negative impacts on the investment 
markets, the economy, and the Federal deficit. Some may wish to 
debate the theoretical merits of the yield curve concept, and 
if in fact that is the decision to debate that, we would love 
as a Council to participate in that debate, but there is an 
urgent need for us to permanently replace the 30-year Treasury 
rate, and it can't wait for an academic discussion. It needs to 
move now.
    Mr. Chairman, DB plans offer many unique retirement 
advantages. The employer community and the sponsors of these 
programs are very interested in their continuation. They are 
very concerned in perpetuating plans, to provide security to 
our employees, but without prompt action by Congress to replace 
the obsolete 30-year Treasury rate, we fear that these plans 
will increasingly disappear from the American landscape.
    Thank you.
    [The prepared statement of Mr. Porter follows:]

  Statement of Kenneth Porter, Director, Corporate Insurance & Global 
 Benefits Financial Planning, DuPont Company, Wilmington, Delaware, on 
                behalf of the American Benefits Council

    Chairman MCCRERY., Ranking Member McNulty, I thank you for the 
opportunity to appear today on this critically important topic. I am 
Ken Porter, Director of Corporate Insurance & Global Benefits Financial 
Planning for the DuPont Company. DuPont is a company with 79,000 
employees worldwide that delivers science-based solutions in such areas 
as food and nutrition, health care, apparel, safety and security, 
construction, electronics and transportation.
    I am appearing today on behalf of the American Benefits Council, 
where DuPont 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.
    Like you, Mr. Chairman, the Council and its member companies are 
very concerned about the health of the voluntary, employer-sponsored 
defined benefit pension system. The largest problem today for defined 
benefit plans is the required use of an obsolete interest rate for 
pension funding, pension premium and lump sum distribution 
calculations. Use of this obsolete benchmark--the rate on 30-year 
Treasury bonds--artificially inflates a plan's liabilities and required 
contributions that competes for limited cash the sponsoring employers 
need for capital improvements that create jobs, and threatens 
employers' ability to continue their commitment to defined benefit 
programs for their employees. The effects of this interest rate anomaly 
are exacerbated by the current economic and stock market downturn, 
which have dramatically reduced plan asset levels.
    Fortunately, Congress can address many of these challenges in a 
positive manner that will enable employers to provide financially sound 
pension programs. Our testimony today details the current threats and 
opportunities. After providing some background on the defined benefit 
system and the current state of pension funding, we discuss the urgent 
need to replace the 30-year Treasury bond rate through prompt enactment 
of the provision included in the Pension Preservation and Savings 
Expansion Act (H.R. 1776), which was recently introduced by 
Representatives Portman and Cardin. We then discuss several other 
policy priorities for the defined benefit system and conclude by 
providing our perspective on the current financial position of the 
Pension Benefit Guaranty Corporation (PBGC).

Background on Defined Benefit Plans

    While the defined benefit system helps millions of Americans 
achieve retirement income security, it is a system in which fewer and 
fewer employers participate. The total number of defined benefit plans 
has decreased from a high of 170,000 in 1985 to 56,405 in 1998 (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 
this decline over just the past several years makes this unfortunate 
downward trend all the more stark. The PBGC reports that it insured 
39,882 defined benefit plans in 1999 but only 32,321 plans in 2002. 
This is a decrease of over seven thousand, five hundred defined benefit 
plans in just three 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 reflect the unfortunate reality that today's 
environment is so challenging that more and more employers are 
concluding that they must terminate their pension programs. Even more 
disheartening, the statistics quoted above do not even take into 
account pension plans that have been frozen by employers (rather than 
terminated), an event that, like termination, results in no additional 
accruals for existing employees and no pension benefits whatsoever for 
new hires. If frozen plans were tracked, the tragic decline of our 
nation's defined benefit pension system would be even more apparent.
    These numbers are sobering from a human and policy perspective 
because defined benefit plans offer a number of security features 
critical for employees' retirement security--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 the 
form of a life annuity assuring that participants and their spouses 
will not outlive their retirement income. The stock market conditions 
of recent years (and the corresponding decline in many individuals' 
401(k) balances) 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 
decline of the defined benefit system? We see several factors that have 
played a role. First, we see a less than friendly statutory and 
regulatory environment for 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.'' The 
primary driver behind these changes was a desire to eliminate potential 
abuses attributed to small employer pension plans. And yet, these rules 
were applied across the board to employers of every size. The result 
was that defined benefit pension plans became increasingly expensive 
and complicated to administer and plan funding and design flexibility 
was impaired. During this same period, Congress repeatedly reduced the 
benefits that could be earned and paid from defined benefit plans in 
order to increase federal tax revenues, thus significantly reducing the 
utility of these voluntary plans to senior management and other key 
decision-makers. Moreover, many companies have found the cost of 
maintaining a defined benefit plan more difficult in light of intense 
business competition from domestic and international competitors, many 
of which do not offer defined benefit plans to their employees and so 
do not have the corresponding pension expense.

Perspective on Pension Plan Funding

    The deterioration in the funding status of many defined benefit 
plans is, as has been discussed today, attributable in large measure to 
the unique combination of historically depressed asset values and 
historically low interest rates. And indeed, the statistics on plan 
funding levels can appear bleak.\2\ Yet we must maintain the proper 
perspective in evaluating the significance of today's numbers. First, 
we must recognize that many current measures of funded status use the 
obsolete 30-year Treasury bond rate to value liabilities. This low and 
discontinued rate makes plan liabilities seem larger than they really 
are and consequently makes a plan's funding level seem more dire than 
it really is. When coupled with the current abnormally low interest 
rate environment, use of an obsolete Treasury bond rate is punitive to 
America's retirement system. Second, we must remember that looking at a 
pension plan's funding level at a specific point in time is a very 
misleading indicator of the plan's ultimate ability to pay out 
participant benefits.
---------------------------------------------------------------------------
    \2\ A January 2003 report from a national consulting firm found 
that the pension benefit obligation funded ratio--the ratio of market 
value of assets to pension benefit obligations for a benchmark plan--is 
near its lowest point in 13 years. Capital Market Update, Towers 
Perrin, January 2003.
---------------------------------------------------------------------------
    Finally, it is important to note that the swing from the abundant 
pension funding levels of the 1990s to the present state of increasing 
deficits for many plans is due in significant measure to the 
counterproductive pension funding rules adopted by Congress. Over the 
nearly 30 years since the enactment of the Employee Retirement Income 
Security Act (ERISA), Congress has alternated between strengthening the 
pension plan system and limiting the revenue loss from tax-deductible 
pension contributions. Beginning in 1986, Congress limited the ability 
of companies to contribute to their plans by lowering the maximum 
deductible contribution and imposing a heavy excise tax on 
nondeductible contributions. In 1997 and after, some relief was 
provided, but the overall result is that our laws and regulations 
strongly encourage employers to keep their plans as near as possible to 
the minimum funding level instead of providing a healthy financial 
cushion above that level.\3\ By 1995, only 18 percent of plans had a 
funded ratio of assets over accrued liabilities of 150 percent or more 
as compared with 45 percent in 1990.\4\
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    \3\ The Council strongly supports review and re-evaluation of the 
basic funding rules that prevent employers from funding their plans 
generously when economic times are good and then impose draconian 
funding obligations when economic times are bad.
    \4\ Table 11.2, EBRI Databook on Employee Benefits, 1997, 
4th Edition, The Employee Benefits Research Institute, 
Washington, D.C.

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Pension Interest Rate Reform

    Clearly the action most urgently needed to improve the health of 
the defined benefit system and stem the increasing number of defined 
benefit plan freezes and terminations is for Congress to enact a 
permanent replacement for the 30-year Treasury bond rate currently used 
for pension calculations.
    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 confront inflated required 
pension contributions and inflated variable premium payments to the 
PBGC. Due to the nature of the pension funding rules--where required 
contributions do not increase proportionally with increases in 
liabilities and decreases in funded levels--a number of employers have 
been confronting dramatic increases in their pension funding 
obligations. These inflated required contributions divert corporate 
assets urgently needed to grow companies and payrolls and return the 
nation to robust economic growth.\5\
---------------------------------------------------------------------------
    \5\ Concurrently, these inflated contributions may contribute 
significantly to the growing federal budget deficit. Plan contributions 
are deductible under the Internal Revenue Code, and to the extent that 
funds used for contributions are not available for other, nondeductible 
investments or do not represent income to the corporation, they would 
be lost as revenue for federal budget purposes.
---------------------------------------------------------------------------
    Even historically robustly funded pension plans may now be faced 
with voluntary or mandatory contributions. Under current law, when a 
plan comes out of full funding, voluntary actions taken in 2003 may 
affect mandatory contributions in 2004 and 2005. The uncertainty in 
provisions of law related to pension funding rules can be more daunting 
than the uncertainty of future investment markets. Without immediate 
change in the law, it is impossible for even these historically well-
funded plans to estimate the appropriate 2003 voluntary actions that 
may be appropriate for longer-term cash flow management.
    The low 30-year Treasury bond rates have the same inflationary 
effect on lump sum payments from defined benefit plans. In other words, 
the low 30-year bond rates have produced artificially inflated lump sum 
payments to departing employees. While these inflated lump sums may 
appear to redound to the benefit of workers, the reality is that the 
drain of cash from plans as a result of these artificially inflated 
payments jeopardizes the financial position of the plan and undermines 
the ability of the employer to continue providing benefits to current 
and future employees. Artificially inflated lump sums also deter 
employees from taking benefits in an annuity form of payment, with the 
protections such form offers against spousal poverty and outliving 
one's financial resources. Plans with lump sum payouts as an option 
report nearly 100 percent of retiring participants elect the lump sum 
option because they perceive lump sums as extremely favorable when 
compared to the promise of a lifetime income guarantee. The cold 
reality is that departing employees are taking a benefit payment that 
is far greater than what the plan had been expected to pay. The 
resulting unexpected costs increase the visibility of pension expense 
within corporate budgets and contribute to the determination by many 
that defined benefit pension programs are unsupportable.
    The various financial ramifications of the low 30-year bond rate--
funding, premiums, lump sums--have been a key factor underlying the 
recent increase in the number of employers freezing their defined 
benefit plans. Across a range of industries--from health care to 
manufacturing to transportation--we at the Council have seen a marked 
increase in freezes over the past 12 months with many more employers 
currently considering taking this step. This has disastrous results for 
employees. Those working for the employer receive no newdefined benefit 
pension benefits for the remainder of their service. And those not yet 
hired will have no opportunity to build a defined benefit pension 
benefit. In a world where employees already shoulder significant 
exposure to stock market volatility and retirement income risk through 
defined contribution plans and personal savings vehicles, these pension 
freezes and the corresponding loss of retirement security are a dire 
development for American workers and their families.
    Recognizing the importance of stemming this tide, Congress enacted 
short-term interest rate relief for funding and premium purposes in the 
Job Creation and Worker Assistance Act of 2002. The Council wishes to 
thank the members of this Subcommittee for providing this short-term 
but quite meaningful relief. This relief, however, was not 
comprehensive in nature and expires at the end of this year. It is 
therefore imperative for Congress to enact permanent and comprehensive 
pension interest rate reform as soon as possible.
    The Council is extremely pleased that a proposal for such reform 
has now been introduced by Representatives Portman and Cardin as part 
of their Pension Preservation and Savings Expansion Act of 2003 (H.R. 
1776). We wish to sincerely thank Representatives Portman and Cardin 
for the many months of hard work and careful deliberation that led to 
introduction of this bipartisan proposal. They have once again come 
forward with a balanced and critically needed solution to a complex and 
pressing pension problem.
    The Portman/Cardin proposal permanently replaces the 30-year 
Treasury bond rate with the rate of interest earned on conservative 
long-term corporate bonds, directing the Treasury Department to produce 
this rate based on one or more corporate bond indices. This use of a 
corporate bond rate blend steers a conservative middle course between 
the rates of return actually earned by pension plans and the annuity 
rates charged by insurers to terminating plans. This new rate would 
apply for all pension calculation purposes, including funding, PBGC 
premiums and lump sums.
    The Council has been advocating permanent replacement of the 30-
year bond rate for several years and we are gratified that the Portman/
Cardin proposal embraces a number of the principles for reform that we 
have set forth. First, their proposal is both permanent and 
comprehensive.\6\ Second, their proposal uses a consistent rate for 
pension calculations rather than using differing rates for funding and 
lump sums (which could create severe financial instability in plans). 
Third, the proposal looks to a blend of stable, long-term corporate 
bond indices as the basis for the new interest rate benchmark. Fourth, 
the proposal maintains existing interest rate averaging mechanisms and 
corridors, recognizing that the rate replacement task is too important 
to be held up by debates over the possible wisdom of structural reform.
---------------------------------------------------------------------------
    \6\ While the Council is pleased that as part of this comprehensive 
approach H.R. 1776 applies the new interest rate to lump sum 
calculations, we are concerned about the significant delay before 
application of the corporate bond rate to lump sums takes effect. We 
understand the need to provide a transition period to address the 
concerns of workers on the verge of retiring and taking lump sums, but 
we are concerned that the two-year delay in application of the lump sum 
rate change followed by the 5-year transition from the 30-year rate to 
the corporate bond rate simply postpones the necessary shift for too 
long. With the full change in interest rate for lump sums not taking 
effect until 2010, employers will continue to see employees taking 
inflated lump sums for many years, with the corresponding harmful 
effect on plan funding and employers' ability to maintain benefit 
levels and potentially the plan itself.
---------------------------------------------------------------------------
    We cannot over-emphasize the urgency of enacting the permanent, 
comprehensive reform contained in H.R. 1776 nor the degree to which 
achieving this reform is related to stemming the decline in defined 
benefit plans. Action is needed by late spring in order to convince 
employers currently struggling with the difficult decision of whether 
to freeze or terminate their plans that help is on the way. Uncertainty 
about the future interest rate is also contributing to stock price 
instability as companies cannot accurately predict their future pension 
liabilities and costs. Stock market analysts have even begun to 
downgrade the stocks of firms with significant defined benefit plans in 
light of this uncertainty while credit rating agencies have recently 
been citing the size of retiree benefits obligations as grounds to 
change plan sponsors' credit ratings, place them on credit watch, or 
issue statements of negative outlook. Finally, the correction of 
inflated pension financing obligations will allow companies to devote 
resources to growing their businesses and the economy.
    To address these uncertainties and the truly negative ramifications 
for pension plan participants, employer sponsors, equity markets and 
indeed our economy as a whole, we urge Congress to enact the Portman/
Cardin proposal in H.R. 1776 as part of the first possible legislative 
vehicle being sent to the President. In this regard, we urge the 
inclusion of the proposal in the economic growth legislation that the 
Ways & Means Committee will soon craft.\7\ Without enactment of 
permanent and comprehensive reform this spring, the harm to our 
nation's defined benefit pension system--and the millions of American 
families that depend on this system for retirement income--will be 
irreparable.
---------------------------------------------------------------------------
    \7\ It is anticipated that the interest rate reform proposal 
contained in H.R. 1776 may actually generate tax revenue and so would 
not divert resources from other elements of the economic growth 
package.
---------------------------------------------------------------------------
    Before leaving the issue of pension interest rate reform, let me 
briefly discuss an alternative approach to replacing the 30-year rate 
that has been discussed by some and is currently under review by the 
Treasury Department. This approach would be to use a corporate bond 
yield curve as the new interest rate benchmark for valuing pension plan 
liabilities. Under this yield curve concept, the interest rate used for 
measuring the liability associated with a particular pension plan 
participant would be the interest rate on a bond with a duration equal 
to the period prior to the retirement date of that participant.
    The Council has a number of very significant concerns about a yield 
curve approach.\8\ But perhaps the most serious threshold problem is 
that a yield curve concept is just that--a concept, an idea--and one 
that is highly controversial at that. It is not a formulated proposal 
for replacing the 30-year Treasury bond rate. For example, it is 
unclear how such a concept would apply to issues such as the 
calculation of lump sums, the valuation of contingent forms of 
distribution, the payment of interest and conversion to annuities of 
employee contributions to defined benefit plans, and the payment of 
interest credits under hybrid pension plans. It is likewise unclear 
what sort of transition approach would be adopted to move from the 
current system of reliance on a single duration rate to a much more 
complex system that relies on a multiplicity of instruments with 
differing durations and rates. Some may wish to debate the theoretical 
merits of the yield curve concept and/or explore the many unanswered 
questions such a concept presents--indeed the Council would be happy to 
be a part of such discussions. But the urgent need to replace the 30-
year rate cannot await such academic deliberations. Plans and benefits 
are being frozen today and a replacement for the obsolete 30-year rate 
must likewise be enacted today.
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    \8\ First, a yield curve approach to measuring pension plan 
liabilities would increase the volatility of these liabilities. 
Liabilities would become dependent not only on fluctuations in interest 
rates but also on changes in the shape of the yield curve (which occur 
when the rates on bonds of different durations move independent of one 
another) and on changes in the duration of plan liabilities (which can 
occur as a result of layoffs, acquisitions, divestitures, etc.). In 
addition, proponents of a yield curve concept have generally frowned on 
the so-called smoothing techniques embodied in present law, which allow 
employers to use the average of the relevant interest rate over several 
years in valuing liabilities. Reduction or elimination of smoothing 
would further increase volatility. Yet volatility in pension 
obligations undermines employers' ability to predict and budget their 
costs and has already been one significant deterrent under current law 
to remaining in the defined benefit system. Clearly it would be 
counterproductive to aggravate this deterrent in a proposal designed to 
improve the health of the defined benefit system. Second, the markets 
for bonds of certain durations that would be utilized under a yield 
curve concept are very thin, with few such bonds being issued. As a 
result, single events--the bankruptcy of a single company unrelated to 
the plan sponsor, for example--can affect the rate of a given bond 
index dramatically and further aggravate the volatility of pension 
liability measurements. Third, a yield curve approach would be 
significantly more complex than the current system. As a result, it 
will be much more difficult to explain to employer sponsors of plans, 
many of which already see the complexity of the system as a reason to 
abandon their defined benefit programs. For large employers with 
multiple defined benefit plans, complexity will be further increased 
since each plan will be required to use a different rate for 
measurement of its liabilities (since the duration of liabilities in 
each plan will differ). The complexity of the approach will also mean 
that employers must rely more heavily on sophisticated actuarial and 
software services, driving up the costs in an already expensive pension 
system. Such increased costs are detrimental to all employers but can 
be particularly daunting to small and mid-size employers where pension 
coverage rates are the lowest.

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Additional Defined Benefit Issues of Importance

    While replacement of the 30-year Treasury rate is clearly the most 
urgent policy priority for today's defined benefit pension system, the 
Council wishes to draw the Subcommittee's attention to a number of 
additional issues of importance confronting the defined benefit system.

         Making the 2001 Pension Reforms Permanent. The 2001 
        tax act contained a number of very positive changes to the 
        rules governing defined benefit plans, which originated in 
        previous Portman/Cardin pension bills. These included repeal of 
        artificial funding caps, increases in the benefits that can be 
        paid and earned from defined benefit plans, and simplifications 
        to a number of defined benefit plan regulations. We strongly 
        urge Congress to make these and the other 2001 retirement 
        savings reforms, which are scheduled to sunset at the end of 
        2010, permanent so that employees and employers can have the 
        long-term certainty so necessary for retirement planning.

         The Next Generation of Defined Benefit Plan Reform. 
        In addition to the 30-year bond rate replacement, the latest 
        Portman/Cardin pension bill (H.R. 1776) contains a number of 
        improvements to the defined benefit system. These reforms would 
        help retirees use their pension payments to finance retiree 
        health or long-term care coverage on a pre-tax basis, would 
        address impediments in the defined benefit plan deduction and 
        funding rules, and would further streamline defined benefit 
        plan regulation. We urge Congress to enact these changes at the 
        earliest opportunity.

         Hybrid Plans. Pending at the regulatory agencies are 
        several projects to provide needed guidance regarding hybrid 
        pension plans such as cash balance. These hybrid plans maintain 
        defined benefit security guarantees while providing the 
        transparency, individual accounts and portability that 
        employees prefer. They have been a rare source of vitality 
        within our defined benefit system. We urge Congress to allow 
        the pending regulatory projects to proceed and to reject bills 
        (such as H.R. 1677) that would override these efforts and 
        impose unsupportable mandates on pension plan sponsors.

         Pension Accounting. Finally, the Council wishes to 
        alert the Subcommittee to some ominous developments concerning 
        the accounting standards for pension plans. Accounting 
        standard-setters, led by those in the United Kingdom, are 
        pushing to require companies to reflect the full fluctuation in 
        pension asset gains and losses on the firm's financial 
        statements each year, thereby prohibiting companies from 
        amortizing such results over a period of years as they do under 
        today's accounting standards. This new `mark-to-market' 
        approach is inconsistent with the long-term nature of pension 
        obligations, produces extreme volatility in annual corporate 
        income, and has prompted 75% of British pension sponsors to 
        consider terminating their plans. Given the many other 
        challenges faced by sponsors of defined benefit plans, 
        abandonment of current U.S. accounting standards for this 
        `mark-to-market' approach would be devastating.


Financial Status of the Pension Benefit Guaranty Corporation

    Given the discussion today about the financial condition of the 
PBGC, let me provide our perspective on this situation. I want to 
underscore that the Council has always predominantly represented 
companies with very well-funded plans. Indeed, the Council has been at 
the forefront of past Congressional efforts promoting strong funding 
standards to ensure that the weakest plans would not be able to 
terminate their plans and impose their liabilities on other PBGC 
premium payers. Simply stated, the Council has no incentive to 
trivialize any problems at the PBGC that will come back to haunt us if 
other companies are not able to keep their promises to retirees.
    Nonetheless, while the deficit revealed in the PBGC's 2002 annual 
report is certainly to be considered very seriously, we do not believe 
it indicates an urgent threat to the PBGC's viability. Indeed, the PBGC 
operated in a deficit position throughout much of its history. Nor does 
the shift from surplus to deficit over the course of one year suggest 
the need to change the pension funding or premium rules in order to 
safeguard the health of the PBGC. In particular, the Council is 
unlikely to support any proposal that would unwisely penalize prudent 
and proven plan asset allocation strategies or firms undergoing short-
term financial stress. We note that, as the agency stated in its 
report, the insurance program's total assets are in excess of $25 
billion and it should be able to meet current and expected obligations 
for years to come. At this point in time, we believe the best way to 
ensure the agency's financial position is to keep as many employers as 
possible committed to the defined benefit system. The urgently needed 
policy changes we are advocating today will help achieve this aim and 
ensure that the PBGC continues to receive a steady stream of premium 
income from defined benefit plan sponsors.

Conclusion

    Mr. Chairman and Ranking Member McNulty, I want to thank you once 
again for calling this hearing on what the Council believes are some of 
the most important retirement policy questions our nation faces. 
Defined benefit plans offer many unique advantages for employees and 
the employer sponsors of these programs sincerely believe in their 
value, 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 MCCRERY. Thank you, Mr. Porter. Mr. 
Gebhardtsbauer.

    STATEMENT OF RON GEBHARDTSBAUER, SENIOR PENSION FELLOW, 
                 AMERICAN ACADEMY OF ACTUARIES

    Mr. GEBHARDTSBAUER. Chairman McCrery, Ranking Member 
McNulty, and distinguished Members, my name is Ron 
Gebhardtsbauer, and I am the Senior Pension Fellow at the 
American Academy of Actuaries. The Academy is the professional 
organization for all actuaries in the United States. My written 
statement provides more details on this subject so that I can 
focus on the most important issue for this hearing: the need 
for a quick permanent fix to the pension discount rate.
    The DB plans are beneficial to employees, the Nation and 
employers. However, many employers are considering freezing or 
terminating their plans because the temporary fix to the 
discount rate expires at the end of this year. Meanwhile, major 
financial decisions are being made today which depend on what 
next year's pension contribution will be.
    Market analysts, board members, and courts are asking can 
the company afford their pension plan next year. They may 
decide that the employer cannot afford the pension plan and 
later find out that the rule was fixed and that the employer 
could have afforded it. Bad decisions can come from this 
uncertainty. Thus, a permanent fix is desperately needed and 
needed very soon.
    So, what should this rate be? The Academy's Pension 
Practice Council suggests that a high-quality corporate bond 
rate, the blue line of the chart--or annuity pricing rate which 
is the green line, which is just a little bit lower, or 
something between those two rates would be appropriate. These 
color charts are also in the back of your handouts.
    Although these rates are only 70 basis points apart, we do 
not take a position on exactly which rate is the correct one. 
Rather, Congress is the best-suited place to balance the 
competing interests of benefit security and employers' ability 
to maintain the plan. For example, a lower discount rate will 
improve benefit security and help the PBGC, while a higher 
discount rate can help benefit adequacy and improve employers' 
ability to maintain the plan.
    In addition, this chart shows a smoother line; you can see 
the smooth line that we are currently allowed to use for 
discounting. That is the brown line. You will notice that it 
has consistently been quite close to the corporate bond line, 
the blue line, so the rules for a long time have been already 
at the corporate bond line. Clearly, it has been above the 
green line, the annuity pricing line. In fact, when the highest 
permissible rate fell recently, Congress fixed it. As you see, 
it jumps up and goes back up to the blue line. Congress put it 
back up where the corporate bond line is, and there are reasons 
for using a corporate bond rate. For example, the SEC and the 
Federal Accounting Standards Board both require it for the 
financial statements.
    In addition, if a terminating pension plan is funded to the 
corporate bond amount, it generally does not need the PBGC 
because if additional amounts are needed--in other words, if it 
is slightly underfunded--the employers are more likely to pay 
that small amount back into the plan and terminate on a 
standard basis.
    Some plans use a slightly different interest rate for their 
financial statements. They will use a rate from an immunized 
bond portfolio. In this case even if the employer doesn't make 
the contribution, PBGC generally does not experience an 
economic loss even if they take over this pension plan, because 
PBGC does not guarantee the full benefits in the plan and they 
do not buy annuities.
    Third, another acceptable rate, again that green line, the 
annuity rate, is the discount rate used by insurance companies 
to price annuities. It could increase the liabilities over 
using a bond rate by, say, 6 or 7 percent so you can see where 
all these rates that we are talking about are pretty close. We 
are talking on the head of a pin here. Employers may not want 
to contribute more than they need to. For instance, if they 
self-insure, just like the PBGC, they don't buy annuities, so 
that they can avoid paying the profits and the risk margins 
that an insurance company would charge.
    There are many other ideas for keeping DB plans afloat 
described in my written testimony.
    One important idea mentioned earlier by most of the people 
has been to allow employers to contribute more in the years in 
which they are healthy. Currently some employers cannot create 
a margin in their pension plan with a deductible contribution. 
In fact, if they make that contribution they would have to pay 
an excise tax immediately and some day they might have to pay a 
huge reversion tax.
    The rule works well when interest rates are high but not 
when interest rates are low, like right now, particularly for 
plans that are retiree heavy like hourly plans, which cannot 
advance fund their benefit increases.
    In summary, being forced to contribute when you can least 
afford it and being kept from contributing when you can afford 
it is unreasonable and difficult on the PBGC, employers, and 
participants. So, raising the discount rate soon and allowing 
the contributions above 100 percent of current liability would 
resolve these two major problems.
    We at the Academy would like to work with you on this, and 
we thank you for having this hearing and inviting us to speak.
    [The prepared statement of Mr. Gebhardtsbauer follows:]

   Statement of Ron Gebhardtsbauer, Senior Pension Fellow, American 
                          Academy of Actuaries

    Chairman McCrery, Ranking Member McNulty, and distinguished 
committee members, good afternoon and thank you for inviting us to 
testify on ``The Challenges Facing Pension Plan Funding.'' My name is 
Ron Gebhardtsbauer, and I am the Senior Pension Fellow at the American 
Academy of Actuaries. The Academy is the non-partisan public policy 
organization for all actuaries in the United States.

    My written statement covers five important issues for this hearing, 
namely:

     (1) Problems of the current funding rules and the need for a 
quick permanent fix,

     (2) Alternatives for discounting liabilities,

     (3) Concerns with current lump sum rules,

     (4) Pension Benefit Guaranty Corporation (PBGC) issues, and

     (5) Allowing greater contributions when employers are able to 
make them.


Background and Problem: Defined benefit (DB) plans are beneficial to 
employees, employers, and the nation.\1\ However, as you know, a 
problem in pension funding rules arose in 1998 due to Treasury bond 
rates becoming inordinately low in comparison to corporate bond rates 
and annuity prices. As pointed out in our 2001 paper on this 
subject,\2\ the rules' use of 30-year Treasury rates has dramatically 
increased minimum pension contributions (to levels much higher than 
Congress ever intended), at a time when employers are seriously 
constrained financially.
---------------------------------------------------------------------------
    \1\ See our earlier testimony on the advantages of defined benefit 
plans at the June 20, 2002 hearing of the Ways and Means Subcommittee 
on Oversight on ``Retirement Security and Defined Benefit Pension 
Plans'' at http://www.actuary.org/pdf/pension/testimony_20june02.pdf
    \2\ See our paper, ``The Impact of Inordinately Low 30-Year 
Treasury Rates on Defined Benefit Plans,'' which can be found at http:/
/www.actuary.org/pdf/pension/treasurybonds_071101.pdf

Temporary Fix: Fortunately, Congress acted quickly in March of 2002 to 
remedy this problem by allowing employers to use a higher discount rate 
in 2002 and 2003 for determining their pension liabilities and PBGC 
premiums. However, the pension rules revert back to the low discount 
rates in 2004. Meanwhile, major financial decisions are being made 
today, which depend on what next year's pension contribution will be. 
In addition, bankruptcy judges are being forced to decide today whether 
employers can afford their pension plans in 2004 and beyond. Courts may 
decide the employer cannot afford its pension plan, and later find out 
that the rule had been corrected and the employer could have afforded 
the pension plan. Bad decisions can come from uncertainty. Thus, a 
permanent fix is desperately needed for the funding rules quickly. 
Delaying the fix will continue to allow the bad decisions being made in 
courts, in board rooms, and on trading floors today that are adverse to 
---------------------------------------------------------------------------
the future of our voluntary retirement system.

Selecting an appropriate target: The first step to resolving this issue 
(and perhaps the most challenging) is to select an appropriate target. 
Any interest rate alternative should be judged based on the results it 
produces relative to this target. An appropriate target should:

         Produce contributions that will adequately address 
        participant and PBGC security concerns without forcing ongoing 
        companies to put more assets into their pension plans than 
        needed;
         Encourage the continuation of voluntary plans for the 
        benefit of their participants--which is one of the three stated 
        purposes of ERISA's Title IV (section 4002(a)(2))--and avoid 
        discouraging the formation of defined benefit plans because of 
        overwhelming or unpredictable funding requirements;
         Avoid funding requirements that unnecessarily divert 
        funds that could otherwise go to increasing other benefits and 
        wages, retaining employees, or keeping the company from 
        financial distress; and
         Maintain PBGC premiums at the lowest level consistent 
        with carrying out their obligations per ERISA section 
        4002(a)(3).


Annuities and/or Lump Sum Values: Congress may have intended the 
interest rate used in current liability calculations to reflect a plan 
sponsor's cost of plan termination--the actual cost of annuities and 
lump sums. In the Omnibus Budget Reconciliation Act of 1987 (OBRA '87), 
Congress specified that the interest rate used should be ``consistent 
with the assumptions which reflect the purchase rates which would be 
used by insurance companies to satisfy the liabilities under the 
plan.''\3\ Note that the law uses the word ``liabilities,'' and not 
``annuities.'' Thus, we are not sure why the cost of lump sums should 
be ignored, as per IRS Notice 90-11. Currently, lump sum amounts can be 
larger than the respective annuity premiums due to interest rate 
requirements in IRC section 417(e). We recommend that Notice 90-11 be 
revised to specify that benefit liabilities equal the lump sum amounts 
for participants expected to elect lump sums. Without this 
modification, plans can be underfunded when, as now, lump sums are 
greater than the value of the annuity using the current liability 
discount rate.
---------------------------------------------------------------------------
    \3\ Internal Revenue Code (IRC) section 412(b)(5)(B)(iii)(II).
---------------------------------------------------------------------------
    It appears that, at the very least, Congress believed that interest 
rates inherent in annuity purchase prices and lump sums would be within 
the range specified by the new law for determining current liability (a 
10 percent corridor on either side of a four-year average of 30-year 
Treasury rates). In fact, we note that the highest permissible discount 
rate by law has consistently been quite close to corporate bond rates, 
and above annuity discount rates. In fact, when the highest permissible 
discount rate fell below the corporate bond rate, Congress fixed it 
temporarily by putting it back up with corporate bond rates.

Alternatives: An Academy paper in 2002 provided three alternative 
discount rates for fixing this problem,\4\ and they are set forth on 
the accompanying graph. They are:
---------------------------------------------------------------------------
    \4\ Please read ``Alternatives to the 30-Year Treasury Rate'' at 
www.actuary.org/pdf/pension/rate_17july02.pdf for more details.

         The pension plan's expected long-term rate of return 
        (orange line);
         A high-quality long-term corporate bond rate of 
        return (blue line); and
         Discount rates used in pricing annuities (green 
        line).

    The Academy's Pension Practice Council suggests that a corporate 
bond, an annuity-pricing rate, or something between the two may be 
appropriate for discounting liabilities for underfunded plans. Although 
these rates are only about 70 basis points apart, we do not take a 
position on exactly which index is the ``correct'' one, since Congress 
is the appropriate body to decide how to balance the competing 
interests of benefit security and the employers' ability to maintain 
the plan. A lower discount rate will improve benefit security (and help 
the PBGC), while a higher discount rate will help employers' ability to 
maintain the plan. The next four sections discuss these rates and the 
long-term Treasury rate (red line).

        Expected Long-Term Rate of Return (Orange Line): The Employee 
        Retirement Income Security Act (ERISA) has allowed the enrolled 
        actuary since 1974 to choose a reasonable interest rate (taking 
        into account reasonable expectations) for pension funding 
        calculations. As you can see from the first chart, actuaries 
        have chosen a long-term rate averaging around 8 percent for at 
        least the last 15 years.

        In the 1980s, the PBGC noted that the funding rules, taken as 
        a whole, were still allowing pension plans to be underfunded. 
        The biggest problem was in the amortization periods, not in the 
        interest rates for minimum funding. (In the 1980s, the average 
        interest rates used by actuaries were significantly below 
        Treasury rates.) The rules allowed pension plans to improve 
        benefits frequently and pay for them over 30 years (even though 
        the associated benefit increase could be paid out before 30 
        years). Thus, benefit improvements could defund underfunded 
        pension plans (and provide deferred compensation, possibly at 
        PBGC's expense). Consequently, OBRA'87 changed the rules not 
        only to shorten the funding periods for underfunded plans, but 
        also to require a separate discount rate for the calculation 
        based on the 30-year Treasury rate. The rules specified that 
        pension liabilities for this calculation (known as current 
        liabilities or CL) be determined using a discount rate no 
        larger than 110 percent of the 30-year Treasury rate, averaged 
        over the prior four years (the brown line in the chart). As you 
        can see, it was close to corporate bond rates and, in fact, was 
        actually higher than the average interest rates used by 
        actuaries at the time. You can also see that Treasury rates, 
        annuity pricing rates, corporate bond rates, and the maximum 
        allowable rate were closer back then.

        Treasury Rates (Red Line): Why was the 30-year Treasury rate 
        chosen? Among other reasons, the Treasury rate was easy to 
        obtain, had a duration similar to pension plans, and wasn't 
        easily subject to manipulation (or, at least, that was the 
        perception at that time). In addition, the rate could be 
        rationalized by employers for funding purposes because the law 
        allowed use of 110 percent of the Treasury rate (which allowed 
        a rate near corporate bond rates), and it was smoothed (by 
        using a four-year average of the rate) so it would not cause 
        excessively volatile contributions and was predictable in 
        advance.

        Today, the Treasury rate is used for determining pension 
        funding amounts, PBGC variable premiums, lump sum amounts, and 
        many other pension items.\5\ Unfortunately, Treasury rates have 
        fallen much more than corporate bond rates and annuity 
        rates.\6\ For example, from 1983 through 1997, Treasury rates 
        were around 100 basis points below Moody's composite corporate 
        bond rate (except for 1986), but by the year 2000 they were 200 
        basis points lower. In addition, we now know that Treasuries 
        can be manipulated by the private sector and by the government. 
        A major investment banking firm manipulated prices in August of 
        1991 and the Treasury showed it could manipulate prices in 
        November of 2001, when it said it would stop issuing 30-year 
        Treasuries. By comparison, a composite corporate bond rate 
        would be much more difficult to manipulate. Corporations would 
        be unlikely to manipulate it upwards to reduce pension costs, 
        because that would increase borrowing costs. In fact, if 
        corporate bond rates ever were manipulated up, annuity prices 
        would presumably be decreased in the same way as bond prices, 
        so the resulting liabilities would still be appropriate.
---------------------------------------------------------------------------
    \5\ See a complete list on page 13 of our paper entitled 
``Alternatives to the 30-year Treasury Rate'' at http://
www.actuary.org/pdf/pension/rate_17july02.pdf. We recommend that the 
discount rate be changed for every calculation of current liability 
(both the RPA94 version and the OBRA87 version) so that there is only 
one current liability number. There is no reason to have two versions.
    \6\ Why did Treasury rates fall so much compared to corporate bond 
rates? In August 1998, the CBO's Economic and Budget Outlook suggested 
that, for the first time in 30 years, the U.S. unified budget would 
show a surplus; and, in fact, that the surplus would pay off the U.S. 
debt by 2006 and then build up assets for the government. The 
government would need to buy back its outstanding Treasury bonds, even 
if they were non-callable. The law of supply and demand suggests that 
with reduced supply (and continued demand), prices will go up. Treasury 
bond prices did go up and their interest rates dropped. In fact, they 
dropped faster than corporate bond rates, and that has continued since 
then. (This may also be due to the market's perception of increased 
risk for corporate debt, particularly at certain firms). This has 
continued, even as budget surpluses have turned to deficits, probably 
due to increased demand caused by investors turning from stocks and 
corporate bonds to the safety of Treasury bonds, and because of 
decreased supply in the wake of the government's decision in 2001 to 
stop issuing 30-year bonds.

        As noted above, using the Treasury rate increases today's 
        contributions. If today's low Treasury rates are used to 
        determine liabilities,\7\ current costs could increase by up to 
        50 percent over those using long-term expectations.\8\ In 
        effect requiring a Treasury rate says, this is what the 
        contribution should be if the pension plan is invested solely 
        in Treasury bonds.\9\ The next section discusses the cost 
        assuming the pension plan is invested solely in corporate 
        bonds.
---------------------------------------------------------------------------
    \7\ Even though pension contributions for underfunded plans are 
determined using 105 percent of Treasury rates (except for 2002 and 
2003), lump sums are determined using 100 percent of Treasury rates, 
which also affects the cost of the plan.
    \8\ Comparing liabilities using long-term expected costs as a 
baseline is not intended to imply endorsement of that particular rate. 
It was merely used because many employers designed their pension plans 
using those returns. For purposes of these calculations, we assume that 
the plan is invested 60 percent in equities and 40 percent in bonds, 
and would yield approximately 200 basis points over corporate bond 
rates, and that the plan's duration is a typical duration of 12 (i.e., 
decreasing the interest rate by 1 percent would increase liabilities by 
1.01 raised to the twelfth power or 12 percent). The 50 percent comes 
from (1 + 8.1 percent - 4.7 percent)caret12 - 1 = 50 
percent. Plans with mostly retirees could have a duration of about 8 
(i.e., a 1 percent decrease in the interest rate would increase 
liabilities by about 8%), while a plan with mostly young employees 
could have a duration of about 25 (for an increase of about 25 percent 
for each 1 percent decrease in the discount rate).
    \9\ Of course, pension plans are not invested solely in Treasury 
bonds. They are also invested in equities and corporate bonds, with the 
expectation that they will earn a larger return over the long term. 
(Ibbotson data from the past 76 years shows that over any 20-year 
period, stocks have performed better than bonds.) Of course, that is 
not a guarantee, so employers have taken on a risk that the future may 
not be like the past.

        Long-Term High-Quality Corporate Bond Rates (Blue Line): 
        Pension liabilities for financial statements are generally 
        discounted using current long-term high-quality corporate bond 
        rates due to the requirements in Financial Accounting Standard 
---------------------------------------------------------------------------
        87 (FAS87) paragraph 44.

        In response to statements by the Securities and Exchange 
        Commission, some corporations use a discount rate that is quite 
        close to a high-quality long-term corporate bond index.\10\ In 
        fact, the highest permissible discount rate for funding has 
        also been quite close to this corporate bond index (see chart 
        of discount rates). When the permitted rate fell, Congress 
        fixed it by putting it back up near the corporate bond 
        rates.\11\ Thus, using this rate (or something close to it) 
        would be in accord with the original intent of the rule, and 
        could be considered not to increase the discount rate and lower 
        contributions. If this corporate bond index is used, 
        liabilities are estimated to be around 27 percent higher than 
        if expected returns are used.\12\ Except in the case of 
        bankruptcy, a terminating plan that is funded to this amount 
        generally does not provide a risk to the PBGC because, if 
        additional amounts are needed, they are small, and employers 
        have often made the additional contributions to avoid distress 
        terminations (which can be very complex and entail benefit cuts 
        to employees).

    \10\ As noted later, some bond indices do not include items such as 
call risk, etc.
    \11\ Graphs of these interest rates show that using a four-year 
average of this index would be quite close to the OBRA87 interest 
rates, and the two-year average (or 95 percent of the four-year average 
or 100 percent of the index minus 40 basis points) would be quite close 
to the RPA94 and JCWAA rates.
    \12\ This assumes that expected returns would be around 2 percent 
greater than corporate bond returns. The 27 percent comes from 
1.02caret12 - 1 = 27 percent. See footnote 8 for further 
details.
---------------------------------------------------------------------------
        Some corporations use (for their financial statements) a 
        discount rate based on a bond portfolio that would match plan 
        benefits with the cash flows from bond coupons and maturity 
        values of this bond portfolio. This means that an employer 
        could hedge its interest rate risk if it held the appropriate 
        bonds (i.e., if interest rates changed, the liabilities could 
        still be matched by the bond cash flows). The investment yield 
        from this bond portfolio would most likely be between the high-
        quality corporate bond index and the interest rate used by 
        insurance companies to price annuities (which has been 
        approximated by the index minus 70 basis points, as discussed 
        in the next section).\13\ Using this rate could improve benefit 
        security further for participants and means the pension plan 
        should be less likely to need trusteeship by the PBGC. If this 
        plan qualified for a distress termination, the PBGC would 
        generally not experience an economic loss (even if PBGC holds 
        those bonds) because PBGC does not guarantee the full benefit, 
        and it does not buy annuities. The PBGC, like employers, self-
        insures (i.e., does not buy annuities) in order to reap higher 
        returns and avoid the larger expenses, risk margins, and profit 
        loadings of the insurance company.
---------------------------------------------------------------------------
    \13\ This rate would be less than the corporate bond rate because 
it is reduced for default risk (the risk that the debtor will default), 
call risk (the risk that the bond will be paid off early--generally the 
last 3 years), and possibly for expenses. (As discussed later, the rate 
can also be lower if the yield curve is steep and the benefits are 
front-weighted, due to having a high proportion of retirees, or it can 
be larger if the duration is long, due to having mostly younger 
employees.) This rate would be larger than the annuity rate because it 
would not be reduced for other charges that insurance companies charge, 
such as profit loadings, risk margins, and commissions. It could be 
close to the corporate bond index if defaults are very few, the yield 
curve is flat or inverted or the duration of benefit liabilities is 
greater than the duration of the long-term bond index, or benefits are 
large (so that expenses are small as a percent of liabilities), or 
interest rates are not lower than coupon rates when the call provision 
is in effect, or lump sums are less than the current liability if/when 
smoothed interest rates are lower than the current interest rate. On 
the other hand, the rate could be closer to the annuity rates, for the 
opposite reasons.

        Discount Rates Used in Pricing Group Annuities (Green Line): 
        The discount rates used in pricing annuities are similar to the 
        corporate bond rates, because when someone buys an annuity, the 
        insurance company invests the money in corporate bonds (often 
        with lower credit ratings of A and Baa, in order to reap the 
        credit risk premium), private placements, and mortgages. A 
        study for the Society of Actuaries by Victor Modugno suggested 
        that these discount rates could be approximated by Bloomberg's 
        A3 option-adjusted corporate bond index minus 70 basis points 
        (for the insurance company expenses, risk margins, and 
        profits). The adjustment is less than 70 basis points if one 
        uses the high quality composite rate suggested by the ERISA 
        Industry Committee (ERIC). Liabilities determined using an 
        annuity discount rate could be approximately one-third higher 
        than those determined using expected returns (or about 7 
        percent higher than those determined using a high-quality 
        corporate index), assuming the appropriate mortality table is 
        used.\14\ A terminating plan with assets equal to this 
        liability amount would be able to buy annuities for everyone, 
        and thus would be less likely to require the help of the PBGC.
---------------------------------------------------------------------------
    \14\ The 7 percent comes from (1 + 60bp)caret12 - 1 = 7 
percent.


Dynamic Process for Setting Discount Assumption: Determining annuity 
prices is not an easy or exact science, and no one index will work 
forever without adjustment. Discount rates (and mortality assumptions) 
vary among insurance companies, and over time companies change their 
pricing methods, so it is difficult to fix a formula in law that is 
appropriate for all time. Our 2002 paper and a recent GAO report\15\ 
both suggest that if Congress desires such a rate, it should allow a 
dynamic process to set it. For example, if Congress carefully defines 
the rate in law to be the discount rate used in pricing the average 
annuity, a committee with annuity pricing actuaries, pension actuaries, 
investment professionals, and government actuaries could set the 
discount rate. Alternatively, our paper also suggested that Congress 
could define the discount carefully in law and allow the plan's 
enrolled actuary to determine it. Either of these methods could also be 
used to set a high-quality long-term corporate bond rate.
---------------------------------------------------------------------------
    \15\ The GAO (General Accounting Office) report, ``Process Needed 
to Monitor the Mandated Interest Rate for Pension Calculations.''

Smoothing: As in our paper, we suggest policy-makers investigate 
reducing the four-year smoothing rule for discount rates in IRC Section 
412(b)(5)(B)(ii)(I) to something less; for example, two-year smoothing 
(with greater weighting to more recent rates). Otherwise, if interest 
rates go back up quickly (as they did in the late 1970s and early 
1980s), then plans would have to use a discount rate lower than 
Treasury rates to determine their contributions (i.e., employers would 
have to increase their contributions even though the plans would have 
enough funds to buy annuities to cover all plan liabilities.) The 
Academy's Pension Practice Council believes this suggestion would 
produce funding requirements that would be reasonably predictable in 
advance and have enough smoothing to satisfy sponsor concerns. However, 
if this issue would slow down passage of legislation, it should be 
deferred for further study. For example, it could take time for 
regulations to be proposed and finalized, and employers need to know 
---------------------------------------------------------------------------
now what the discount rate will be for 2004.

Yield Curves and Hedging: Some actuaries suggest using a current yield 
curve (i.e., using different rates for different periods in the future, 
not just one average long-term rate) so that volatility can be hedged 
by investing in certain asset classes. On the other hand, many other 
actuaries are concerned about the volatility that could ensue if a plan 
sponsor did not want to change its investment philosophy and move away 
from stocks. Thus, they prefer using a smoothed average rate. 
Therefore, our paper suggested that Congress not mandate a yield curve 
for funding,\16\ but rather allow for it. The IRC could accommodate 
both if plan sponsors could elect to use the then-current corporate 
bond yield curve. The use of a yield curve (which could have 30 or more 
rates) will take time to propose in regulations and finalize, and will 
add complexity to an already very complex set of minimum funding rules 
(without necessarily changing the results appreciably, especially when 
the yield curve is flat). Clearly, it would be too complex for lump sum 
calculations,\17\ and Congress might want to exempt small plans from 
the calculations or create simplified alternatives, such as one rate 
for actives and one rate for retirees.
---------------------------------------------------------------------------
    \16\ A yield curve has the advantage of pricing liabilities more 
like the financial markets would (lower discount rates for short 
duration liabilities). When the yield curve is steep, it would increase 
the liabilities of hourly plans with large retiree populations by 
around 5 percent. However, we note that it may not increase liabilities 
as much as expected since interest rates have less effect on plans with 
shorter durations. In addition, a more precise calculation might also 
use a blue-collar mortality table for the hourly plan, which could 
decrease costs by 2 to 3 percent, and would fully offset the effects of 
using the yield curve, except when it is unusually steep (e.g., 1992, 
1993, 2002, and 2003).
    \17\ See the reasons suggested on page 12 of our paper on 
alternatives located at http://www.actuary.org/pdf/pension/
rate_17july02.pdf

Changing the Discount Rate and Mortality Table at the Same Time. It is 
widely understood that minimum funding calculations will soon be 
required to reflect an updated mortality table, which would further 
increase the required funding for pension plans. It makes sense to make 
any change in interest rates effective at the same time the mortality 
table is changed for funding, so that calculation methods only need to 
be revised once. In addition, because the change in the discount rate 
and the mortality table affect the liability calculations in the 
opposite direction, they will have offsetting effects on each 
other.\18\
---------------------------------------------------------------------------
    \18\ Changing from the 83GAM to the most recent mortality table, 
RP2000, has the same effect as lowering the discount rate by up to 0.5 
percent for males, 0 percent for females (because their mortality rates 
haven't improved much since 1983), and 0.25 percent for unisex rates 
(if 50/50). Thus, changing the mortality table also justifies 
increasing the discount rate.

Retroactivity: Permitting a change in interest rates retroactively to 
2001 could reduce the contributions for some employers immediately by 
retroactively reducing the contributions that would have been required 
in 2001 and allowing the reduction in the mandated contribution to 
increase the credit balance. This increase in the credit balance could 
then be used to reduce the current-year minimum contribution, which 
could reduce the current severity of cash flow problems affecting 
employment, compensation, and other benefit issues (and it would 
increase government tax revenues). However, the retroactivity provision 
should be optional, so that employers do not have to incur the cost of 
revising past actuarial valuations or have to change their budgeting of 
contributions--or lose the deduction for contributions made in good 
---------------------------------------------------------------------------
faith on the basis then in effect.

Pension Calculations Affected: As in our paper, we encourage Congress 
to change the interest rate for every calculation of current liability. 
Replacing the reference to the 30-year Treasury rate in all of the 
RPA94 and OBRA87 calculations listed on page 13 of our ``Alternatives'' 
paper would increase consistency and simplicity. The use of multiple 
interest rates and multiple liability numbers is confusing to 
actuaries, employers, participants, and other interested parties in the 
general public, such as investors.

    Changing the current liability interest rate would not affect 
certain other calculations, which policy-makers may wish to also 
consider, including:

         Lump sums under IRC section 417(e), maximum lump sums 
        under section 415, and automatic lump sums under $5,000 under 
        section 411(a)(11), which all use the 30-year Treasury rate.
         The projection of employee contributions under IRC 
        section 411(c), which uses 120 percent of the federal mid-term 
        applicable rate and the 30-year Treasury rate.


Lump Sums: There are reasons for using one corporate bond rate or 
annuity price (not a complex yield curve) in every place where the 30-
year Treasury rate is currently used. For example:

         Simplicity--Only one rate is used, instead of the 
        multitude of rates now used.
         Spousal benefits--The use of Treasury rates for 
        determining lump sums makes the lump sum option more valuable 
        than the qualified joint and survivor annuity. This conflicts 
        with the original intent of ERISA--to encourage pensions to 
        surviving spouses.
         Public policy--The current rules mandating the 
        Treasury rate make it impossible for plans to provide an 
        actuarially equivalent lump sum. Thus, the economic decision to 
        take a lump sum is not a neutral one. Workers can take the lump 
        sum and buy a larger annuity with it (which they rarely do). 
        Thus, the rules encourage workers to take lump sums, which may 
        be viewed negatively from a public policy perspective because 
        more retirees will spend down their lump sum too quickly and 
        end up falling on government assistance (Supplemental Security 
        Income and Medicaid).
         Plan funding--The payment of a lump sum in an 
        underfunded plan decreases the funding ratio, particularly if 
        the lump sum is subsidized by the unusually low Treasury rate. 
        In addition, plans will tend to be less well funded, because 
        Notice 90-11 prohibits the subsidy from being included in the 
        current liability calculation. This is not only a concern for 
        participants,\19\ but also for the PBGC.
---------------------------------------------------------------------------
    \19\ For example, retirees of Polaroid are suing their former 
employer for paying the mandated, subsidized lump sums to recent 
retirees, because they are defunding the plan. This means the retirees 
will have their benefits cut down to the guaranteed benefit by PBGC.
---------------------------------------------------------------------------
         Increased costs beyond amounts intended--Plan 
        sponsors have to contribute more funds to the plan because the 
        low Treasury rate made lump sums larger (not because the 
        employer decided to increase lump sums). Thus, the plan is more 
        expensive than the employer originally intended.
         Obstruction of bargaining process--Due to the expense 
        of paying larger lump sums, plan sponsors are less likely to 
        make plan improvements suggested by workers at the next 
        bargaining period. Thus, requiring the Treasury rate ignores 
        the collective bargaining process and discriminates against 
        participants that don't take lump sums. If employees were 
        permitted to decide where the funds should go, staff in labor 
        organizations have told us that bargainers would probably use 
        the funds to improve the benefit formula for all workers, 
        instead of just for those workers who take lump sums.

    Changing to a higher interest rate can reduce a worker's lump sum, 
so a transition rule may be helpful. For example, ERIC and ABC suggest 
phasing in the interest rate change over three years. Their phase-in 
could limit the increase in the interest rate to about 0.5 percent per 
year.\20\ We note that Treasury rates have increased in the past, so 
this would not be the first time that lump sum interest rates have 
increased. The Treasury rate went up in the 1990's by more than 1 
percent three times (i.e., 1994, 1996, and 1999). Furthermore, with 
this transition, a worker's lump sum may not go down. It may still grow 
because each year a worker gets additional service and pay increases, 
and their age gets closer to the normal retirement age (NRA).\21\ \22\
---------------------------------------------------------------------------
    \20\ Unless all interest rates go up dramatically in the next three 
years.
    \21\ Each year, participants get one year closer to their normal 
retirement date (NRD), which means their lump sum increases by one 
year's interest rate (unless they are already beyond their NRD, in 
which case the lump sum can decrease).
    \22\ Another idea might be to freeze the lump sum dollar amount on 
the amendment date (using the accrued benefit on that date), so that 
the lump sum amount would not decrease unless the old rules would have 
reduced it (e.g., due to the Treasury rate going up or due to the 
participant being beyond the NRA, or due to a case where a large early 
retirement subsidy is in the lump sum). However, this would require two 
lump sum calculations and thus could be a little more complex to 
calculate than the 3-year phase-in idea.

    In addition, we suggest Congress simplify the very complex 
calculations caused by Sec. 415(b)(2)(E) for maximum lump sums. One 
simple alternative suggested by ASPA (the American Society of Pension 
Actuaries) would be to use just one interest rate. Our paper, 
``Alternatives to the 30-Year Treasury Rate,'' suggested that it could 
be somewhere in the 5 percent to 8 percent range. The Academy has also 
suggested to the Treasury Department in the past that the rules could 
be greatly simplified by deleting the words ``or the rate specified in 
the plan'' in Section 415(b)(2)(E), so that the maximum lump sum would 
be the same in all plans (and the discount rate used above and below 
---------------------------------------------------------------------------
the Normal Retirement Age would be the same).

PBGC's Financial Status: Another issue that policy-makers need to 
consider whenever the funding rules are modified is the effect of the 
changes on the PBGC. Increasing the discount rate in accordance with 
earlier intentions (which is close to a corporate bond rate or annuity-
pricing rate) may help the PBGC indirectly if it means that employers 
are more likely to be able to afford their pension plans for a few more 
years (hopefully, until the economy recovers). This could mean that 
fewer plans will need to be trusteed by the PBGC and more defined 
benefit plans will be around to pay premiums to the PBGC. By fixing the 
discount rate, Congress signals to employers its intention to keep 
defined benefit plans as a viable option for employer retirement 
programs. However, that statement comes with a caveat. Since increasing 
the interest rate reduces minimum contributions, there may be a need to 
review the funding and premium rules in the near future, particularly 
if PBGC has more major losses over the next couple of years in this 
current economic downturn.

    Due to the triple whammy of plummeting stock prices, lower interest 
rates, and more bankruptcies, the PBGC has gone from a surplus of $10 
billion just two years ago to a $3.6 billion deficit. However, the 
dollar amount of the deficit may not be as relevant as the funding 
ratio, which is 90 percent. Each time the PBGC takes over a pension 
plan, it also takes over the plan assets. PBGC's assets are now over 
$31.5 billion\23\ while its annual outgo is expected be around $3 
billion. Thus, the PBGC will not have problems fulfilling its primary 
mission for a number of years--to pay guaranteed benefits on time. This 
is not to say that we do not need a change in the funding rules. On the 
contrary, the Academy has already met with the PBGC to discuss ways to 
fix them. We are just saying that PBGC's large asset base allows time 
to thoroughly discuss how to fix the funding rules before enacting 
them.
---------------------------------------------------------------------------
    \23\ This $31.5 billion amount includes the $6 billion in assets 
from probable plans in PBGC's FY 2002 annual report (such as Bethlehem 
Steel), because PBGC includes such liabilities in the report.

    This discussion so far has only taken into account PBGC's past 
terminations. However, PBGC's financial status is also intimately 
linked with how industries (like the airline industry) fare over the 
next several years. The pension underfunding at several weak airlines 
exceeds $10 billion. In fact, PBGC's 2002 Annual Report forecasts that 
future claims could be twice the average of past claims--a clear signal 
---------------------------------------------------------------------------
it may want to double premiums and/or tighten funding rules.

Risk-Related PBGC Premiums and Funding Rules: Recently, the PBGC 
floated the idea of charging higher premiums (or strengthening the 
funding rules) for plans that present more risk to them (e.g., plans 
with high levels of equities and plans sponsored by weak companies). 
These rules might be helpful to strong employers so that they would not 
have to subsidize weak employers. However, employer groups\24\ say 
their members have not asked for these fixes, possibly because almost 
all plans have over 50 percent of their assets in equities. And many 
employers are wary of basing these calculations on credit ratings 
because they could someday have lower credit ratings themselves\25\--
and because this approach may result in significant cost increases for 
companies that can least afford them. In addition, implementing these 
risk-related premiums and funding rules would raise many complex issues 
(in an area that is already overly complex). For example, credit 
ratings might be needed for non-rated private employers, subsidiaries 
of foreign owners, and individual controlled group members. Risk levels 
would be needed for stocks and bonds (and some bonds present more 
volatility and/or mismatch risk than certain stocks). Plan sponsors 
might seek ways to temporarily avoid the riskier investments on the 
measurement date, and if those rules were tightened it could hurt the 
markets when pension plans started selling equities. However, if PBGC 
needs to substantially increase its premiums because of large increases 
in claims, some strong employers might be willing to discuss risk 
related premium and funding ideas. Maybe there are ways to help make 
them more palatable such as:
---------------------------------------------------------------------------
    \24\ For example, the Committee on Investment of Employee Benefit 
Assets (CIEBA), the ERISA Industry Committee (ERIC), and the American 
Benefits Council (ABC).
    \25\ In addition, reflecting credit rating changes would make 
contributions and premiums more volatile.

         transition rules;
         delayed implementation;
         exemptions for current benefit levels, while 
        assessing for benefit increases; or
         caps on the increase in the premium or the 0.9% 
        multiplier (similar to the $34 per participant cap that was 
        placed on the initial variable premium legislation).


Other Reforms: There are many other ideas that could be considered, 
such as:

         To make it more difficult for weak companies and 
        underfunded plans to increase benefits.\26\
---------------------------------------------------------------------------
    \26\ For example, charge a larger premium rate (on just the benefit 
increase) that is risk related, require faster funding (fund benefit 
increases faster than 30 years; FAS already requires employers to 
expense benefit increases over a much shorter period, and the deficit 
reduction contribution rules already do that when the funding ratio is 
under 80 percent or 90 percent continually), or prohibit the benefit 
increases unless liens are provided as in Section 401(a)(29)--and just 
increase the 60 percent threshold to 70 percent or 80 percent.
---------------------------------------------------------------------------
         To address the cost of shutdown benefits (or not to 
        guarantee them).
         To get contributions into the plans earlier. The PBGC 
        tells us that pension plans frequently do not contribute in 
        their last year when the PBGC takes over the plan. Thus, 
        requiring sponsors of underfunded plans to make contributions 
        by year end (or very soon thereafter) could help the PBGC. 
        Employers might be amenable to this rule if quarterlies were 
        eliminated. This could also enable quicker reporting of pension 
        plan financial information, which would also be valuable to the 
        PBGC and the markets, and be a positive step in the direction 
        of greater clarity and transparency.
         To suspend the use of the credit balance when plans 
        are very underfunded. (PBGC notes that some companies don't 
        have to pay their deficit reduction contributions because they 
        have a large credit balance.) Another way to reduce that 
        concern in the future would be to reduce the 30-year 
        amortization period for plan amendments.
         To improve PBGC's standing in bankruptcy courts, and 
        give presumption to PBGC assumptions for determining their 
        claim in bankruptcy.
         To increase disclosure.

    In addition, we have been asked what reforms would be helpful for 
hourly and bargained plans\27\ because they are more likely to be 
underfunded than salaried plans. Reasons for this are:
---------------------------------------------------------------------------
    \27\ Some of these ideas might apply to both single and multi-
employer plans, so the suggestions may also be applicable to both. In 
fact, having different rules for these hourly plans can set up 
arbitrage opportunities that some plan sponsors have tried to exploit. 
(Multi-employer plans need not pay variable premiums or deficit 
reduction contributions.) Some of the reasons for the difference in the 
rules may be that the multiemployer guarantees are smaller than those 
for single employer plans, the PBGC multiemployer fund has a surplus, 
and it is more difficult for multi-employer plans to change their 
contributions in the middle of a bargaining period.

         They are amended frequently to update benefit levels 
        for inflation. These amendments can be funded over 30 years 
        (even though the increased retiree benefits can be paid out 
        much faster). If plans are very underfunded, they have to 
        amortize benefit increases over 3 to 7 years by means of the 
        deficit reduction contribution. One compromise might be to 
        smooth out these rules so that there is not such a large cliff 
        between them. Congress might consider reducing the 30-year 
        period (FAS already requires companies to expense benefit 
        increases over a much shorter period).
         When assets exceed current liability, the plan 
        sponsor can't make a deductible contribution. If funding rules 
        allowed hourly plans to deduct contributions even if assets 
        exceeded current liability, then hourly plans could advance-
        fund their future benefit increases.
         They are more likely to be in industries that have 
        large legacy costs payable to large retiree populations (in 
        comparison to smaller workforces). Shorter amortization periods 
        and allowing margins would help this too.
         They can experience large asset losses, and may find 
        it difficult to amortize them over a small workforce, even if 
        assets cover their retiree liability. Immunization of the 
        retiree liability in underfunded plans could be discussed, but 
        Congress would need to be careful about removing the 
        flexibility plan sponsors currently have to invest pension 
        assets in the way that best fits their plan and the ever-
        changing economic conditions.

    These are all very complex ideas and have far-reaching implications 
for the pension world, so they should not be implemented until after 
major discussion and analysis.

Allowing Contributions in Good Years: We recommend that employers be 
allowed to make a deductible contribution to their pension plans in 
years when they are healthy and can afford it, even if assets are above 
100 percent of current liability. Currently, contributions in this 
situation may not be deductible and may also be subject to an excise 
tax. When interest rates were higher, the full funding limit allowed a 
pension plan to have a margin above current liability (see second 
chart). That margin is also needed when interest rates are low, 
particularly for plans that are retiree-heavy and for hourly plans, 
which cannot easily advance fund their benefit increases. Congress 
could allow a contribution up to (for example) 130 percent of current 
liability minus assets. Alternatively, the definition of the full 
funding limit could have (for example) 130 percent of current liability 
as a minimum. At the very least, the excise tax on nondeductible 
contributions could be eliminated in this situation.

    We also note that there are strong incentives for companies to 
contribute more, and companies have learned a lot lately about the 
risks inherent in pension plan funding. Recent drops in the market have 
provided a good reason for employers to increase their funding margins 
and build a cushion to protect against adverse experience. Thus, 
companies may be more willing to contribute more than necessary in the 
future to avoid falling below certain key thresholds, if the law allows 
them a deduction (or at least doesn't penalize them with an excise tax 
for making nondeductible contributions). For example, if assets fall 
below the accumulated benefit obligation, accounting rules may force a 
major hit to the company's net worth. If assets fall below the 
liability for vested benefits, companies must pay an additional premium 
to the PBGC. If assets fall below 90 percent of current liability, 
contributions can increase dramatically.
    A list of the penalties follows. If policymakers want to increase 
the incentives for funding, then the threshold for one or more of the 
penalties could be increased (e.g., the threshold for security).


------------------------------------------------------------------------
  If the funding ratio
       falls below                             Then
------------------------------------------------------------------------
125%                      No Sec.  420 transfer to the company post-
                           retirement health plan

                          Company cannot use the prior year valuation
------------------------------------------------------------------------
110%                      Restrictions on the size of lump sums to the
                           top 25
------------------------------------------------------------------------
100%                      Accounting rules may force a hit to net worth
                           if unfunded ABO > $0
                          PBGC variable premiums are payable
                          Companies must pay quarterly contributions
                          PBGC files lien on company if missed
                           contributions > $1 M
                          PBGC financial filings required if underfunded
                           over $ 50 M
                          Must report certain corporate transactions to
                           PBGC if underfunded
                          Bankrupt firms cannot increase benefits
------------------------------------------------------------------------
90%                       Additional deficit reduction contributions
                           required
                          Notice to employees with funding ratio and
                           PBGC guarantees required
------------------------------------------------------------------------
60%                       Security required for plan amendments
------------------------------------------------------------------------

    We believe many employers will contribute enough to reach a key 
threshold margin in order to avoid these problems.
    Being forced to fund when the plan sponsor cannot afford it and 
being precluded from funding when the plan sponsor can afford it is 
unreasonable, self-defeating, and difficult for the PBGC. We hope 
Congress will consider making this fix, which does not cause problems 
(because it is voluntary), except for reducing tax revenues. However, 
we don't believe that the revenue loss will be as large as might be 
expected because it may not be used heavily in the near future and, to 
the extent that it is used, it will reduce contributions in the future. 
In addition, it could reduce PBGC claim amounts and the number of 
underfunded terminations.
    We at the American Academy of Actuaries hope that a permanent 
alternative to the 30-year Treasury rate can be enacted quickly. In 
addition, we are also very interested in working with Congress and the 
PBGC to consider funding ideas further. Thank you for holding this 
hearing and inviting us to speak before you today.

[GRAPHIC] [TIFF OMITTED] T8996H.001

[GRAPHIC] [TIFF OMITTED] T8996I.001

                                 

    Chairman MCCRERY. Thank you, Mr. Gebhardtsbauer. Let me 
begin with you. Changing the current 30-year Treasury rate has 
been controversial as it relates to lump sum payments, lump sum 
distributions from plans. Why should the Congress apply a new 
interest rate to the calculation of lump sum payments?
    Mr. GEBHARDTSBAUER. The Academy actually doesn't take a 
position on what it should be, just that the current rate that 
is being used, the Treasury rate, is very low, and what it does 
is it creates a lump sum which is sometimes larger than what it 
would cost to buy an annuity. So, for instance, you could take 
the lump sum out of the pension plan, go across the street and 
buy a larger annuity, but a lot of people don't buy the 
annuity. They take the lump sum, and they spend it and might 
spend it too quickly. In addition, if they had taken the 
annuity, they would have the annuity for the rest of their 
life. So, I think good public policy is to encourage annuities 
and not encourage lump sums.
    In addition, if they take an annuity, they had the chance 
to provide an annuity not only for themselves for the rest of 
their life, no matter how long they live, but also for their 
survivor; again, another public policy issue. In addition, if 
they run out of money, they may fall upon SSI and Medicaid. So, 
it becomes an issue for the government in the future. Having 
these interest rates so low, the government is in fact 
encouraging employees to take lump sums.
    In addition, from the employer side, the more people take 
lump sums, especially in an underfunded pension plan, they get 
a hundred percent of their money when they take the lump sum 
out. If you have an underfunded plan that makes the plan worse 
funded. It defunds the pension plan and so it leaves the people 
who are remaining with less, and so the employers end up having 
to put more money into the pension plan than they originally 
intended.
    These lump sums at one time were at a much higher interest 
rate back when the employer set up the pension plan. This 
determined how much the pension plan was going to cost. Now the 
lump sums are so much more, the pension plan will cost more.
    Chairman MCCRERY. Explain succinctly why current law, the 
30-year Treasury rate encourages a pensioner to take the lump 
sum rather than the annuity.
    Mr. GEBHARDTSBAUER. If I was to give advice to a pensioner, 
I would have to tell them that if they came up to me and said, 
``Which is more valuable, this annuity or this lump sum?'' I 
would have to tell them the lump sum is more valuable. So, the 
advice they would get from an experienced practitioner like 
myself would encourage them to take the annuity and they may 
then not take the annuity.
    Chairman MCCRERY. Why is it more valuable?
    Mr. GEBHARDTSBAUER. For instance, they can go across the 
street and buy an annuity. In fact, at John Hancock, one of the 
actuaries there told me, it is common knowledge, everybody 
there knows the price of annuities. So, they do take lump sums. 
They don't even have to go across the street. They go across 
the hall and buy a bigger annuity than what the pension plan 
would have provided.
    Chairman MCCRERY. So, in other words, they can take the 
lump sum distribution and purchase in the private marketplace 
an annuity which will pay them monthly benefits in excess of 
the monthly benefits they would receive from their company's 
pension.
    Mr. GEBHARDTSBAUER. That is right. It defunds the pension 
plan because they are taking out more money from the pension 
plan than was needed to pay for that pension.
    Chairman MCCRERY. Also the company is paying more in effect 
than they had guaranteed the employee under their pension plan.
    Mr. GEBHARDTSBAUER. That is correct.
    Chairman MCCRERY. Okay. The Department of Treasury has 
proposed an extension of--a 2-year extension of the relief we 
provided in last year's tax bill with no changes. If we extend 
last year's tax relief, would it provide the same amount of 
relief as it did last year?
    Mr. GEBHARDTSBAUER. This is probably a good question for 
Ken, but there is a concern if you extend the temporary 
provision that it still leaves a lot of uncertainty and 
eventually will have to address this issue with more hearings 
and what are we going to do in 2 years from now. So, creating a 
definite result, a permanent result, is much preferred.
    So, there is the uncertainty problem, like when Ken said he 
has to make projections for the analysts, what are our 
contributions going to be. We don't know what it is going to 
be. As far as what the result is going to be you can see it on 
the chart over here. Using 120 percent of the Treasury rate, 
because it is a 4-year average right now it is above Treasury 
rates, but it's gradually coming down because Treasury rates 
over the last 4 years have been coming down, so the rate next 
year would be lower than the rate this year.
    Chairman MCCRERY. So, it would not provide the same amount 
of relief.
    Mr. GEBHARDTSBAUER. It would be better than going back to 
the 105 percent of the Treasury rate; yes, 120 percent would be 
better but it would not be quite as good as the interest rate 
today.
    Chairman MCCRERY. Would you recommend any changes to the 
temporary fix?
    Mr. GEBHARDTSBAUER. The Academy actually hasn't thought 
about it. We just found out today that people at the Department 
of Treasury are considering continuing the temporary fix for 
another 2 or 3 years or something like that. So, we actually 
have not gotten together to think about whether it is 
appropriate or not, because we have been thinking about what 
should be a permanent rate; and we think a permanent rate 
should be a function of corporate bond rates, because that is 
what insurance companies use to price their annuities, and that 
is also what you can immunize your benefit payments with by 
buying corporate bonds. As you all know, Treasury rates are 
much lower now compared to corporate bond rates than they were 
in the past when Congress originally chose to use Treasury 
rates.
    Chairman MCCRERY. I have some more questions but I am going 
to yield to Mr. McNulty and the rest of the Committee, then I 
will get back to my other questions. Mr. McNulty.
    Mr. MCNULTY. Thank you, Mr. Chairman.
    Professor Stein, following on to that previous 
conversation, for the purposes of lump sum distributions you 
advocate a more conservative interest rate than that used for 
plan funding and other statutory purposes. It would seem that 
this approach provides a built-in incentive or incentives to 
elect the lump sum benefit over an annuity. Shouldn't pension 
policy strive for neutrality between the two?
    Mr. STEIN. You have to think about this from the 
participants perspective. If you are looking at equivalency 
from the participants' perspective, the participants generally 
are not going to have access to the same rates of return that 
an insurance company that provides an annuity would or the same 
kind of return that a plan can get--so when a participant is 
thinking about equivalencies they are thinking about what kind 
of return can I reasonably get, and that is going to be a lower 
rate of return than the kind of corporate bond discount rates 
that we have been talking about today.
    So, from the participant's viewpoint I am not certain that 
the point is really accurate that this necessarily would favor 
annuities. I can also tell you what Ron said is right; people 
do look at relative values of annuities. When I call Ron--and I 
have called Ron in the past--Ron always asks what kind of rate 
of return does the participant think they can get, which is a 
very important fact.
    We also don't believe that most participants are primarily 
motivated by the size of the annuity in deciding whether to 
take a lump sum or not. In a lot of cases, the employee is 
leaving the employer and just doesn't want the employer to have 
control of the retirement wealth, wants to get that money out 
of the employer's hands. Indeed, I have seen many situations 
where participants are considering a choice of a lump sum or a 
subsidized early retirement benefit. Very often in plans the 
lump sum does not include the subsidized value of the Federal 
retirement benefit. Even in such situations, however, 
participants often initially lean toward the lump sum, even 
though it is far less valuable. So, I don't think relative 
value is the primary motivator in many cases.
    I think the kind of situation Ron was talking about, the 
employees of John Hancock who are probably getting fairly 
substantial lump sums, I think they are very sensitive to the 
extra value in the lump sum and they can probably approximate 
the same kind of returns that the plan hopes to get. I think 
when you are thinking about, for example, somebody who has 
mandatorily cashed out with $5,000 or less, they are not going 
to be able to achieve that same rate of return. In addition, if 
you want them to preserve those benefits by rolling them over, 
it is much more likely if the benefit is larger that at least 
part of it is going to go into an IRA and be there for 
retirement.
    Mr. MCNULTY. I thank the professor and I thank the other 
witnesses as well, and this is all I have for right now, Mr. 
Chairman.
    Chairman MCCRERY. Mr. Ryan.
    Mr. RYAN. No questions.
    Chairman MCCRERY. Mr. Collins.
    Mr. COLLINS. Thank you, Mr. Chairman. Mr. Gebhardtsbauer, 
did I get that right?
    Mr. GEBHARDTSBAUER. You did a great job, better than I did 
for my first 8 years.
    Mr. COLLINS. I liked Ron. It was a lot shorter.
    Mr. GEBHARDTSBAUER. You can call me Ron.
    Mr. COLLINS. Thank you. Two questions. You mentioned a 
while ago that we had procedures that forced companies to make 
contributions when--that were not having such a good year, and 
we prohibited them from making contributions when they were 
having good years. I saw for a minute, and then again I may be 
right; you have not got this mixed up with alternative minimum 
tax, have you?
    Mr. GEBHARDTSBAUER. In fact, this particular slide up here 
talks about that. When interest rates----
    Mr. COLLINS. You didn't understand the question. You have 
not gotten your testimony mixed up with the alternative minimum 
tax, have you? That is kind of the way it basically works, too. 
Tell me about that. Tell me why in years of good profits, and 
of course there are bad years, that we limit and require----
    Mr. GEBHARDTSBAUER. I think employees have learned a lot 
about risk lately. When you have a well-funded plan, there are 
a lot of things you can do that you can't do now. When you have 
a well-funded plan, you can move money into the health plan. If 
you have over 110 percent of your liabilities covered with 
assets, you can pay lump sums to all the employees, including 
the top employees. Under 110 percent, you are restricted what 
you can pay in lump sums. Under 110 percent you have to pay 
PBGC's premiums; under 90 percent you have to contribute more.
    Mr. COLLINS. What limits the contribution in good years?
    Mr. GEBHARDTSBAUER. This chart shows about how at one time 
when interest rates were much higher, when the rules were made, 
employers could put money in, even though they had their 
liabilities covered with assets. The rules don't work as well 
when interest rates are low like right now. When interest rates 
are low, hourly plans can only put up to 100 percent of their 
liabilities. It can't create a margin.
    The rules say that the full funding limit is the greater of 
two numbers, and I apologize if I get too detailed here, but 
one is based on projecting--it is a projected number, but it 
uses long-term average interest rates. Whereas the number that 
is in effect right now, that is normally bigger, is what they 
called the unfunded current liability number, and that is based 
on the Treasury rate right now; and it says that you can't put 
any more in this, and the reason for that is because the 
government wants to make sure that employers can't just put in 
anything they want in good years.
    Mr. COLLINS. Are there tax provisions that limit the 
contributions in the good years, is that the basic bottom line?
    Mr. GEBHARDTSBAUER. Yes.
    Mr. COLLINS. That is where I was. That is what I was 
asking.
    Mr. GEBHARDTSBAUER. That is right. What the rules do now, 
at 100 percent you can't put anything in. Then if you fall 
below 90 percent, then you don't have what is called the 
comfort zone, you have to immediately put in the deficit 
reduction contribution. You are treated as if you are a very 
poorly funded plan and you have to put a lot more than you ever 
thought you would have to put in. So, a lot of companies went 
from zero in the nineties, now they are hit by this heavy-duty 
contribution.
    Mr. COLLINS. What are the tax provisions that limit in good 
years.
    Mr. GEBHARDTSBAUER. In section 404 there is one rule that 
talks about the full funding limit--I think 404(a).
    Mr. PORTER. I don't remember the exact reference but there 
is an excise tax. If you are at the full funding limit and you 
want to put a contribution in your plan, the Tax Code imposes 
an excise tax, nondeductible, for having made that 
contribution. So, in our plan's case, since we were a full 
funding limit from 1985 till 2002, if we had made a $100 
million contribution in 1985, we would have had cumulative 
excise taxes on that one contribution of $170 million to $180 
million, and we still would not be able to take the tax 
deduction. So, while it was permissible to put a contribution 
in, the board of directors probably would have let me go, 
because it's a dumb financial decision. I think the rule back 
then was a result of a little bit of a tug-of-war between 
funding policy, where you want to make sure the plans are 
funded well enough, and revenue, which says if we let companies 
put too much in, it is going to impact the Federal revenues 
because it is a tax-deductible contribution. So, there is a cap 
on what can be contributed, and it is enforced by an excise 
tax.
    Mr. COLLINS. Does this contribute to the airline industry 
problem?
    Mr. GEBHARDTSBAUER. I don't know enough about the airline 
industry to know.
    Mr. COLLINS. They are underfunded, aren't they?
    Mr. STEIN. Certainly plausible. There is another aspect to 
this, too. When the full funding limit was created was the era 
when employers were terminating plans to capture surplus 
assets, and the legislative history of that provision suggested 
that one reason that we are putting this full funding 
limitation in is because the plan might be terminated and the 
employer might withdraw the money for non-pension purposes. To 
a very large extent that has been corrected now, because you 
have the excise tax when the employer takes a reversion from a 
terminated plan, and thus there is no longer the incentive that 
Congress might have envisioned for gaming. I think most people 
think that the only reason to keep something like the full 
funding limitation in is as a revenue raiser, and it may not be 
a very good reason. It has really created problems, although 
Congress has addressed many of them recently.
    Mr. COLLINS. If we don't keep them fully funded and they go 
belly up, then who takes care of it?
    Mr. STEIN. Well, two people take care of it: The PBGC and 
the participants, if their benefits exceed the PBGC guarantees.
    Mr. COLLINS. Same folks.Thank you, Mr. Chairman. I knew the 
Tax Code was at the bottom of this pit, causing this problem, 
sucking the wind out of it. Just couldn't get Mr. 
Gebhardtsbauer to come to that point.
    Mr. GEBHARDTSBAUER. Norman mentioned another provision and 
that was the excise tax, as Congress may have gone too far 
there on the excise tax. They put in a 50 percent excise tax. 
If you end up putting more money in the plan, you want to 
encourage companies to put more money in the plan. If they do 
now and then 20 years down the road if the stock markets have 
done well, they maybe have way too much money in the pension 
plan, they can't get it out, and if they do take it out they 
have to terminate the plan in order to take it out; and in 
order to do that, they end up giving 50 percent of that in 
certain situations, plus 35 percent income tax, plus State 
income tax, so it can be up to like 90 percent of their 
reversion. If you think $100 million of that surplus is yours, 
it's actually $90 million goes to government and you get $5 or 
$10 million, so that is discouraging employers to put more 
money in.
    Chairman MCCRERY. Mr. Pomeroy.
    Mr. POMEROY. Mr. Chairman, I want to begin by thanking you 
for holding this hearing. I think this is a very important 
issue. The questions have been excellent and the witnesses have 
been excellent as well. We really need to force I think some 
activity here, and I think this hearing has done a good bit of 
that.
    Mr. Gebhardtsbauer, you ought to have a little medal 
because you have got the longest darn name I have seen in the 
Committee on Ways and Means.
    Mr. GEBHARDTSBAUER. Thank you for inviting me back, still.
    Mr. POMEROY. Do you know, or the actuaries know by virtue 
of your clientele about activity relative to freezing plans?
    Mr. GEBHARDTSBAUER. With freezing, I have just heard a lot 
of actuaries talk about how a lot of them are either freezing, 
or a lot of them are talking to their actuaries about freezing 
and what is the consequence or what would we have to do in 
order to freeze. So, that is a concern, I know, for a lot of 
actuaries talking to their clients. In addition, in your prior 
question I believe you were asking PBGC if there might be a way 
for them to determine something on that, because when people 
file premiums, they tell PBGC how many employees are still in 
the pension plan. So, if it is not going up anymore, that might 
be an indication; or if it is going down, that would be an 
indication that the plan is being frozen.
    Mr. POMEROY. That is true. I don't want to burden employers 
with significant additional paperwork but it would seem like a 
notification of plan frozen would be--would produce data that 
would be useful in evaluating where our pension universe is, 
but would not be very hard on the employers. Correct--would 
that be useful data?
    Mr. GEBHARDTSBAUER. I guess they are already reporting 
something like that, because when you amend the pension plan 
you have to provide the Department of Labor and the 
participants information. I don't know if that is still being 
provided to the Department of Labor, but it could just be 
provided quicker now.
    Mr. STEIN. The 204(h) requires whenever you reduce benefit 
accruals that you notify the Department of Labor.
    Mr. POMEROY. If this Committee wanted to find activity 
relative to plans being frozen, we could look to the Department 
of Labor and they would have a universe of data they could pull 
for us.
    Mr. STEIN. I think we would all be hesitant to say ``yes,'' 
they will definitely have that data, but I think we would all 
be willing to say they ``probably will have it.''
    Mr. POMEROY. I will ask and we will tell you, we will find 
out. I think we need to find out that information.
    Mr. STEIN. There are other pressures, other than I think 
the funding pressures, that might be causing employers to look 
into freezing plans.
    Mr. POMEROY. I actually was--my next question was going to 
be is the pressure on DB plans today about as severe as anyone 
has seen, so it is a good segue into what your observation was 
going to be, Mr. Stein.
    Mr. STEIN. I am probably not the--the funding issue comes 
at a time when we are having a maturing population as well, and 
in traditional DB plans maturing populations cost employers 
more money. So, you keep hearing the term ``perfect storm.'' I 
think it is an overused metaphor, but the low interest rates 
coinciding with asset values--but you also have the 
demographics which are costly to employers.
    Mr. POMEROY. Employers trying to make their stock more 
attractive to investors, so they are making these kinds of 
changes for purposes of capping or limiting the unknown 
liabilities going forward on their pension plans. I agree with 
you I think there is very severe pressure on all sides.
    Mr. STEIN. It is very hard for the employee who has been in 
one of these DB plans for 20 or 25 years and all of a sudden 
finds----
    Mr. POMEROY. They lose out on the bargain, Mr. Porter, from 
your business perspective.
    Mr. PORTER. I think if you look at what a corporation goes 
through in deciding how to spend benefits dollars, there are 
tensions. One tension is the business leaders in particular 
product lines want to see their costs variable. They want costs 
to go up when their employment costs are up; they want their 
costs to go down when employment times are down. Pensions 
frequently work counter cyclical to that. They say okay, if I 
am going to bear the cost of a counter cyclical expense, what 
am I getting for that, what am I buying in terms of employee 
relations, what am I buying in terms of quality of life?
    The equation here historically has been pension plans can 
fund more effectively than an individual can invest. It has 
been a long-term proposition. If I have a dollar to spend in a 
pension plan versus a dollar to spend in a 401(k) because I as 
a company can weather the storms up and down, up and down, I 
can provide a more valuable annuity out of a DB plan than I can 
out of a DC plan, and the 401(k) is totally the employee's 
risk. So, historically employers have been willing to spend and 
accept the volatility of pension funding and expense on the 
proposition that it is a better deal for their employees, and 
dollar-for-dollar of benefits delivered is less expensive. 
What's happened in recent years, with changes in funding laws 
and changes in pressures and global pressure, is that the 
benefits of having a DB plan have deteriorated, and we have to 
focus on what is happening now.
    Mr. POMEROY. Benefits for who? The employer or the 
employee?
    Mr. PORTER. Perceived benefit from an employer perspective, 
what is my tradeoff? If I can get some value in employee 
relations, value for what I am delivering for my employees at a 
reasonable cost that would be important to do, but if the cost 
of providing those benefits now outweighs the benefits 
perceived to be delivered, then the employers tend to have less 
of an interest in a DB plan. The 30-year T-bills as they affect 
funding right now, make it more expensive to fund a pension 
plan than to fund a 401(k). Ultimately the employees get better 
value out of a 401(k) for the dollars spent by the employer.
    Mr. POMEROY. The employer gets better value?
    Mr. PORTER. Dollar for dollar, if I historically look at it 
and said if I could put a dollar in, let us look at a cost and 
the benefit delivered down the road, the DB plan was cheaper 
because I could earn more in it. As you make funding more 
onerous and put pressures on corporations, therefore, to 
perhaps reduce the amount of equities in their portfolios, the 
equation starts to change and it is no longer more cost 
effective for the employer to fund through a DB plan. For the 
same amount of ultimate benefits delivered, it may just be as 
cost effective to fund through a 401(k). So, what I am seeing, 
not so much in my own company but talking with other companies, 
the Council, and to my contacts, is companies are making the 
decision that all the hassle just isn't worth the risk anymore.
    Mr. POMEROY. I really believe that is a loser for 
employees, because I still think it is a better deal. That 
captures it all as far as I am concerned from employees, and if 
they don't perceive the value today, they will when they are 
80-years-old and broke and they are not getting an annuity 
every month, sustaining their income in retirement years no 
matter how long they live. I really think that we are rushing 
toward an absolute train wreck in terms of how this is all--in 
terms of income security and retirement, and the demise of the 
pension that we are presiding over is an important part of 
that.
    Mr. PORTER. When you look back at when ERISA was first 
enacted, there was a lot of discussion of a three-legged stool: 
investments, Social Security, and private pensions. What they 
were really talking about was a two-legged stool: capital 
accumulation and wealth--and income guarantees. Social Security 
and DBs tended to be income sources. Personal savings, now 
401(k), is capital accumulation. The movement has been away 
from preservation of income toward development of capital.
    If you hear the debate as I am hearing it, toward 
transparency and accuracy--what we are discussing is a debate 
between accuracy for pension funding versus smoothing. I think 
that is the same debate we have had for a lot of years, because 
smoothing is a bedrock of pension funding. Transparency is a 
bedrock of capital accumulation. So, as I look at the question 
of accuracy versus smoothing, I say accuracy is a short-term 
measure. Smoothing is a long-term measure. Accuracy is 
something investment markets want. Smoothing is something that 
we need for a strong DB social policy.
    So, it is a fundamental tug-of-war between capital 
accumulation and income guarantees; and it is a tug-of-war 
between whether we want to have a social policy in this Nation 
to preserve income protection for the elderly or if we want to 
go to a capital accumulation market-based economy.
    Mr. POMEROY. I believe what you said was so perfectly 
expressed and right on point. How ironic that maybe last decade 
we get jerked over to the asset accumulation side, but to be 
this decade still not focused more on the income security side, 
when next decade, in 2010, there will be 78 million Americans 
that will turn 65 the next decade. We are doing nothing to pre-
position ourselves for that, either with public resources or 
privately.
    I used to be an insurance commissioner. I remember the days 
when there was a lot of insecurity about insurance company 
solvency and a lot of pressure on insurance regulators that to 
get a mark to market you have got to have this capitalized, you 
have got to have capital requirement of mark to market. Not 
everybody cashed in on the same day. That is a ludicrous 
artificial measure that didn't in any way reflect the likely 
liabilities, any scenario of liabilities on life insurance 
companies, so we pushed back and resisted.
    It seems like that dynamic has a lot of application to this 
question. This is why smoothing, I believe, is a much more 
appropriate measure over time than some kind of artificial 
reserving requirement these companies will never have to meet 
based on the actual draw on their pension funds.
    I thank the gentlemen very much. I know Mr. Stein is dying 
to contribute, but I am out of time unless the Chairman would 
so provide. It has been an excellent panel. All three of you, 
thank you very much.
    Chairman MCCRERY. Mr. Porter, in your written testimony you 
noted that the PBGC's funding situation is serious but does not 
require increases in pension funding or PBGC premiums. If we 
were to increase premiums, would that increase the likelihood 
of plans being frozen or terminated and therefore being added 
to PBGC's liability?
    Mr. PORTER. That is a real good question and I think all of 
this works together dynamically. If we don't fix funding, that 
increases the liability that companies terminate their pension 
plan. Every pressure on a company will increase that pressure. 
The question is which of those evils do you like least or which 
of the evils can you live with the most? I personally believe a 
sound, funding policy for our Nation, with appropriate 
recognition of the long term, is what is going to be best. If 
we do something Draconian today--and by that I would simply 
say, well, we just do nothing and let the current temporary fix 
expire and nothing changes, that would be so dramatic that PBGC 
would see significant increases in their liabilities.
    So, I would analyze the alternatives and say that the 
latter one is the worst alternative. All of them could have 
some negative effect. What we need is to find the best balance 
that will protect the system, not only the PBGC but the 
retirement system in our Nation. That is my view.
    Chairman MCCRERY. Let us talk about a replacement for the 
30-year Treasury rate. When the 30-year Treasury rate was 
selected as the benchmark, it was thought to be transparent and 
difficult to manipulate and dependable, to be an accurate 
proxy, forever. Now we know that wasn't true. How can we know 
that any replacement that we choose will remain an accurate 
proxy in the future?
    Mr. PORTER. I don't know that there are any guarantees in 
this life. What we know from experience is that anything based 
on a government rate is subject to the unilateral decision of 
the Department of Treasury or of the Fed to take action on 
those bonds, so that those can be changed rather dramatically 
very quickly.
    On the other hand, considering market-based bonds, which 
are based on corporate rates, there is a large number of 
corporations issuing bonds, it seems highly unlikely that the 
actions of one employer or one bond agency would have as 
dramatic an impact as the actions of one government. So, I 
don't believe there is a guarantee, but I think it is a much 
better approach.
    Chairman MCCRERY. Should we give the Department of Treasury 
the latitude to adjust the interest rate to ensure its 
accuracy?
    Mr. PORTER. I am not sure what that latitude would mean, so 
it is hard to respond.
    Chairman MCCRERY. So, you would be content to just tie the 
interest rate to some corporate bond mix that would float 
with----
    Mr. PORTER. I think with our proposal and what is in H.R. 
1776 is that the Department of Treasury has the ability to 
monitor various corporate bond indices. If one of them somehow 
is out of line they can get it out of the mix. So, they have 
some flexibility around that, but they don't have flexibility 
to say, well, we are going to abandon corporate bonds and go to 
something else.
    Chairman MCCRERY. Okay.
    Mr. PORTER. I think that kind of monitoring is probably 
appropriate.
    Chairman MCCRERY. Okay. In his testimony in the first 
panel, Mr. Kandarian noted that healthy, well-funded plans tend 
to subsidize the unhealthy, underfunded plans by paying 
premiums to support those plans when they are terminated and 
taken over. How does your company feel about paying higher 
premiums to subsidize the underfunded plans, and should we 
strengthen the funding rules to reduce or eliminate this cross-
subsidizing?
    Mr. PORTER. Nobody likes to pay more premiums. As we had 
been paying premiums for these years with really no reasonable 
expectation that we would ever need to rely on the PBGC's 
support, that is all money we have paid for social costs. It is 
effectively a tax to protect the program, and a fair amount of 
taxes is probably reasonable.
    The real question is how big will it get, and to the extent 
that corporations that have been responsible plan sponsors will 
have to pay for those that have been less responsible. Our 
pension plan was founded in 1904 so we are 1 year shy of 100 
years in the plan, started funding it in the early twenties.
    Mr. PORTER. We have been a responsible employer funding our 
plans, and nobody from a company like that likes the idea that 
they might have to take over somebody's liabilities who perhaps 
wasn't acting as responsibly. Having said that, something that 
is fair and balanced should be acceptable--that is what this 
whole bill is about, is a fair and balanced proposal--has to be 
considered.
    Chairman MCCRERY. Mr. Stein, last question. You argue that 
a replacement rate should more closely track annuity plan rates 
and that a corporate bond rate misses the target. Can you tell 
us by how much you think the corporate bond rate overstates the 
target and also how much you think the 30-year Treasury rate 
understates the target?
    Mr. STEIN. Yes. Let me start by saying that I talked to a 
couple of people before the hearing. If Portman-Cardin were 
adopted, I think the discount rate or the interest rate that we 
would be using would be in the mid-7 range, 7.5, 7.6. Just as a 
gut reaction that seems to be very high, higher than it should 
be.
    What the rate should be, it is very difficult. Really, when 
you are talking about annuity pricing, you are talking about 
what somebody--how much you have to pay somebody to accept 
these liabilities in an open market. One of the concerns I have 
about using a corporate bond rate is, those are bonds that have 
some level of risk and we are depending on outside agencies 
whose track record is nowhere near perfect to tell us how much 
risk each of those companies reflected in a particular index 
is. The index itself is not entirely transparent. Only some 
companies are rated, some of the rating agencies charge to be 
rated.
    The advantage of using some Federal rate as a start and 
then adding basis points to it, rather than taking the 
corporate rate and subtracting basis points from it is--we 
always know, I think, what a riskless rate of return means; 
what it means is stable, does not change from time to time. 
Five years from now we may be back here because it turns out 
that the corporate bond rates turn out not to really be what 
insurers are using to price annuities.
    So, I know in speaking with some actuaries they said, well 
70 or 80 basis points or 50 basis points less than the 
corporate bond rate would replicate annuity pricing now. Of 
course, PBGC does a survey of insurance companies for 
determining the interest rates it uses. That has some problems, 
too, but that is another approach that might be taken.
    I hesitate to say I agree with the Department of Treasury 
here. I think there is a real need for a permanent fix now, but 
I think it is an issue that really requires more thought than 
has been given.
    I do note that when I speak to actuaries in private they 
often say, I can't say this publicly, but the corporate rate is 
too high. They all agree the Treasury rate is at least somewhat 
too low. Some people have suggested the applicable Federal 
rate, which is used for a lot of purposes in the Internal 
Revenue Code, might be a starting point. I think there are some 
problems with that, but that is another possibility. I would 
actually like to see you get a bunch of people in a room and be 
able to close the doors and none of their clients will know 
what they say, and have them come out with sort of a base-
closing kind of recommendation. That might be something that 
could be done quickly.
    There are other problems with the funding rules right now 
that probably need to be addressed in unison with discount 
rates; for example, the mortality rates that we are using are 
not accurate for a lot of industries. In many cases they 
overstate and in some cases understate liabilities. That 
probably needs to be fixed, too. Portman-Cardin does have 
something in there that would fix that problem for blue-collar 
industries, but we are still awaiting accurate mortality tables 
for white-collar industries.
    Chairman MCCRERY. Mr. Gebhardtsbauer.
    Mr. GEBHARDTSBAUER. I wanted to mention that if Congress 
some time ago had decided that they wanted to approximate what 
the annuity rate was, they could have said Treasury rate plus 
50 basis points, but because Treasury rates are much lower now, 
if you took the Treasury rate and added 50 basis points you 
wouldn't be close enough. It would be better if Congress had 
taken the corporate rate, say, and subtracted 50 basis points 
or half a percent or 70 basis points. It depends on what 
corporate rate you are using. The reason is, at least right 
now, insurance companies primarily invest in corporate bonds 
and mortgages, that kind of investment. They don't invest as 
much in Treasury bonds. So, it would be a much better 
approximation.
    I also agree with the GAO report that said that it is hard 
to know exactly what insurance companies are going to be 
charging in the future. They may change their methods someday 
in the future. So, they also recommended that if you do set 
something to an annuity rate, which is kind of hard to 
estimate, you might want to create a Committee of actuaries and 
economists inside and outside the government to set it. That is 
one of the problems with basing it on an annuity rate. In fact, 
insurance companies don't all agree and use the same rate. 
There is a range even today among several different insurance 
companies. So, what is the appropriate rate is a little bit 
unclear. So, that is why if you were to do a proxy, it would be 
much better to take the corporate rate and subtract something, 
rather than Treasury bond and add something.
    Chairman MCCRERY. Well, just to be clear in case anybody is 
wondering why we don't just go to the market and say what is 
your interest rate that you are paying on annuities, generally 
insurance companies don't divulge that, do they?
    Mr. GEBHARDTSBAUER. There is a survey right now that the 
PBGC collects on a quarterly basis, where they get the group 
annuity pricing rates for a handful of large insurance 
companies, but the information is kept private. We actually 
don't have the details. Then they produce what they call--
actually they don't call it an interest rate, they call it an 
interest factor, because it is not exactly right. They combine 
it with a slightly old mortality table to get the interest 
rate. So, you can't use PBGC's rate. In fact, when I was there 
at the PBGC as the Chief Actuary, we wanted to improve the way 
we calculated the PBGC interest rate based on this survey of 
insurance companies. We asked Congress not to use our interest 
rate anymore even though we based it on the survey, because we 
wanted to change it and perfect it, but we didn't want to 
perfect everybody's lump sum in the whole country. That is when 
Congress did decide to use the 30-year Treasury rate for lump 
sums.
    Chairman MCCRERY. So, why wouldn't we want to use that 
survey now instead of corporate bonds, some mix of corporate 
bonds?
    Mr. GEBHARDTSBAUER. I guess some people are concerned about 
the survey because only the PBGC is involved in it. The PBGC is 
also concerned about it being used, too, because then they 
can't do something with it because they wouldn't want to 
manipulate all the lump sums in the country without Congress 
being involved in that decision. An alternative would be maybe 
a Committee, maybe like GAO was talking about, getting this 
survey and the Committee could include people in the government 
and people in the private sector and actuaries and economists 
who could use that survey to come up with what the appropriate 
pricing for lump sums if you wanted to use an annuity rate.
    Chairman MCCRERY. Well, I think what we are looking for is 
the most accurate measure.
    Mr. GEBHARDTSBAUER. The Committee question of what is the 
most accurate measure, I have to admit I don't know exactly 
what is--I know the Department of Treasury was talking about 
the perfect answer. I don't know. I would say something in the 
range of annuity prices or corporate bonds. Maybe it gets back 
to something that Norman was talking about, too, if the 
participant says I want my lump sum. He was saying that they 
maybe cannot make as good an investment as the insurance 
company. Actually there are reasons why participants can 
actually do better. If they are 40, and they take the lump sum 
from the company, they are not restricted like insurance 
companies. Insurance companies are restricted to only having 
bonds generally, they can't have equities. Whereas individuals 
can have equities. The probability is that they will have more 
money by the time they retire if they invest in a mixture, a 
diversified portfolio of bonds and stocks, than they would if 
they had left it with an insurance company and only earned a 
bond rate. Now, there is the probability that they may not do 
as well, but likely over 20 years the stock market has always 
done better than bonds.
    We don't know that the future will be exactly like the 
past, but the probability is they will actually earn a higher 
rate of return than an insurance company. So, that is why an 
active employee getting a lump sum at a younger age--it doesn't 
necessarily say the perfect answer is the annuity pricing.
    Mr. PORTER. Let me add to that. What Ron has described is 
about what the PBGC will do for their internal purposes. It is 
change from time to time depending on how they calculate and do 
their survey. To the extent they do that and because other 
things are tied to it, there is an impact; just like other 
things are tied to the 30-year T-bonds and a unilateral action 
has changed them.
    If you take the chart that the Academy of Actuaries has--I 
keep a copy of that every month in my folder because it is 
great stuff, he sends it to me every month. If you look at all 
the various interest rates that are plotted on here, everything 
seems to work together nicely. It doesn't matter which rate you 
use, they all seem to follow fairly well, with the exception of 
the 30-year T-bond. So, if you want something that is less 
subject to manipulation, you need something that is market 
based.
    Chairman MCCRERY. Okay. Thank you very much. Appreciate 
your testimony. We look forward to working with you some more 
to solve this problem. The hearing is adjourned.
    [Whereupon, at 5:34 p.m., the hearing was adjourned.]
    [Submissions for the record follow:]
                           Statement of AARP
    AARP is a nonprofit membership organization of 35 million persons 
age 50 and over dedicated to addressing the needs and interests of 
older Americans. Of those 35 million members, approximately 45% are 
working. Each of the AARP publications--the BULLETIN and AARP: The 
Magazine--reaches more households than any other publication in the 
United States.
    AARP fosters the economic security of individuals as they age by 
seeking to increase the availability, security, equity, and adequacy of 
pension benefits. AARP and its members have a substantial interest in 
ensuring that participants have access to pension plans that provide 
adequate retirement income.
    AARP would like to express its strong concern about proposals to 
change plan funding rules that would have a significant negative impact 
on single-sum retirement benefits for millions of employees in defined 
benefit pension plans. As your Committee and the Congress consider 
substitutes for the 30-year Treasury interest rate and related changes 
to these pension provisions, we urge you to protect and preserve 
participants' benefits, including annuities and single sums. While it 
is appropriate to review the use of the 30-year Treasury rate for 
funding purposes, the law should maintain a more conservative 30-year 
Treasury rate for determining the value of benefits payable in a single 
sum.
Overview
    The interest rate on 30-year Treasury bonds is a key element of the 
statutory provisions determining the value of single-sum benefits in 
defined benefit plans, the employer's ability to cash out pension 
benefits without the employee's consent, the contributions required of 
employers sponsoring underfunded plans, and the premiums those 
employers must pay the Pension Benefit Guaranty Corporation, as well as 
other provisions. Proposals to move away from the 30-year Treasury bond 
interest rate have been prompted by two distinct factors: First, 30-
year Treasury bond rates have become artificially lower because of the 
Treasury's decision to stop issuing the 30-year bond. Second, generally 
low interest rates (including the 30-year Treasury rate) combined with 
a weak stock market are currently imposing added funding pressures on 
employers that sponsor defined benefit plans.
    However, American workers too are feeling the pressure of falling 
rates and a weak market. These developments have dramatically lowered 
both the account balances and the expected returns that working 
families have been counting on for a more secure retirement. Congress 
should not compound this hardship by changing the law to reduce 
guaranteed benefit amounts. At a minimum, Congress should retain an 
interest rate for determining single-sum benefit amounts that is 
consistent with the historical level of the 30-year Treasury rate. This 
can be done by maintaining the traditional relationship or spread 
between the current statutory single-sum rate and any higher market 
rate that may be selected for funding purposes.
    In addition, to the extent that legislation prescribes any new 
single-sum interest rate benchmark, even one that attempts to replicate 
the traditional spread for the 30-year Treasury rate (after adjusting 
for the effect of Treasury debt reduction, buy-backs and discontinuance 
of the 30-year Treasury bond), fundamental fairness to employees 
dictates that any such change be phased in very gradually.\1\
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    \1\ Thus, for the reasons set out in this statement, AARP opposes 
conforming the single-sum rate to the funding rate, and giving 
participants only transition relief with respect to the resulting 
benefit reductions, as some have proposed. See, for example, section 
705 of H.R. 1776, the Pension Preservation and Savings Expansion Act of 
2003, introduced on April 11, 2003 by Reps. Portman and Cardin.
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Funding Rates and Single-Sum Rates Have Been and Should Continue to Be

Different
    Some have argued that the interest rates used to determine plan 
funding and the rates used to determine the amount of single sum 
distributions should be identical. But those rates are not the same 
today, have not been the same for years, and should continue to differ 
if Congress amends the relevant provisions. Under current law, the rate 
used to determine the present value (the single-sum equivalent) of a 
pension annuity benefit is the 30-year Treasury interest rate. By 
contrast, the rate used to determine contributions to underfunded plans 
for 2002 and 2003 can be as high as 120% of a four-year weighted 
average of 30-year Treasury interest rates.
    Not only have the single-sum rate (the 30-year Treasury rate) and 
the maximum permissible funding rate been different, but the 
relationship between them has not remained constant from year to year. 
The spread between the two rates has varied as the four-year weighted 
average has changed and as Congress reduced the highest permitted 
funding rate for underfunded plans from 110% of the four-year weighted 
average (established in the Omnibus Budget Reconciliation Act of 1987) 
to 105% over a five-year period before increasing it temporarily to 
120% of that average.
    It is appropriate that the rates for these different purposes be 
different, and that the single-sum rate be a more conservative rate. 
Employees and employers have different needs and different capacities 
to bear risk. In particular, an employer is in a different position in 
relation to the risk that interest rate volatility will increase plan 
liabilities than an employee is in when confronting the risk that 
interest rate volatility will reduce her single-sum benefit below its 
anticipated level. Employers often can compensate for uncertainties in 
the market by funding more in advance and, if the plan's funded status 
deteriorates, by contributing more to make up for that after the fact.
    By contrast, employees nearing retirement--who are counting on a 
single sum of a specific value based on disclosures received from the 
plan--need greater protection from the risk that a rise in rates will 
reduce the benefit they have reasonably been expecting. Older employees 
in particular may not have sufficient time to adjust to a benefit 
reduction. And as plans provide employees more and improved disclosure 
of expected single-sum and other benefit values, employees will tend to 
place increasing reliance on the expected level of their benefits.
    In recent times, we are seeing all too graphically the effects of 
market risk on individual employees' retirement benefits in defined 
contribution plans (particularly where employees are not diversified 
because their accounts are over-concentrated in employer stock) and in 
individual retirement accounts. For employees, defined benefit pension 
plans can provide a refuge from market risk and other investment risk. 
But if the benefits in defined benefit plans--which millions of 
employees have been earning over many years--are reduced during the low 
points in the business cycle, when markets and plan asset values are 
down, that would undermine the risk protective function of these 
plans--one of the principal virtues of the defined benefit system.
    There is no good time to cut pension benefits; but the worst time 
to do so is when employees have suffered major declines in their 401(k) 
and IRA balances and when the interest rates and other returns they can 
expect from investing pension distributions are so low. Low interest 
rates for determining single-sum distributions are not out of line with 
the low interest rates available to individuals on their investments 
outside of qualified plans.

The Historical Relationship Between the Rate for Determining Single-Sum 
        Benefits
and the Highest Rate Permitted for Funding Underfunded Plans Can and 
        Should

Be Preserved
    The American Academy of Actuaries has indicated that 30-year 
Treasury bond rates were roughly 100 basis points (or 1%) lower than 
long-term corporate bond rates from 1983 through 1998 (while the 
funding rate--the highest interest rate allowed for funding underfunded 
plans--was close to the corporate bond rates).\2\ The Academy's 2002 
paper on this issue stated that Treasury rates have been about 200 
basis points lower since the beginning of 2000,\3\ although the past 
few months have seen this spread return closer to the more historical 
difference of 100 basis points. The Academy's paper attributed only a 
portion of the increase in the spread to federal debt reduction and 
buy-backs, attributing the remainder of the increase to the recent 
flight to safe investments such as Treasury bonds.\4\
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    \2\ During most of this period, the highest permissible funding 
rate for underfunded plans would have been 110% of the four-year 
trailing average of the 30-year Treasury rate. Thus, for example, at a 
time when the 30-year Treasury rate was 10%, the funding rate would 
have been 11% (assuming the four-year trailing average did not differ 
from the current rate).
    \3\ Parks, J. and R. Gebhardtsbauer, American Academy of Actuaries, 
Alternatives to the 30-Year Treasury Rate (A Public Statement by the 
Pension Practice Council of the American Academy of Actuaries), July 
17, 2002, pages 4-5 and Charts I and II (comparing 30-year Treasuries 
to Moody's composite long-term corporate index).
    \4\ Id. at 5.
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    The spread between the rate used to determine single-sum benefits 
and maximum rate required to be used for funding should be preserved, 
after adjusting appropriately for the effects of Treasury debt 
reduction and buybacks and Treasury's decision to discontinue issuance 
of the 30-year Treasury bond. Under this approach, assuming the law is 
changed to replace the 30-year Treasury rate for pension funding with a 
standard that is based on a different rate or rates, the rate used to 
determine single-sum benefits (including present values for purposes of 
involuntary cash-outs) would be set at a specified number of basis 
points below the funding rate(s). In addition, transition relief should 
be provided to employees to buffer the effect of any increase in the 
single-sum rate that is associated with an adjustment to reflect the 
Treasury buybacks and the discontinued status of the 30-year Treasury 
bond.\5\
---------------------------------------------------------------------------
    \5\ Id. at 5.
---------------------------------------------------------------------------
    As a related matter, because of employees' vulnerability to risk, 
Congress should consider whether they need greater protection from 
single-sum interest rate volatility than current law provides. This 
might be accomplished through the use of a trailing average of interest 
rates or by other means.

Lower Single-Sum Rates Are Consistent With Good Pension Policy
    Some argue that single-sum interest rates should be increased 
significantly to reduce the value of single sums and discourage 
employees from electing them. The theory is that single-sum payments 
are undesirable as a matter of policy, and that reducing the value of 
single sums would promote retirement security by discouraging employees 
from choosing them. But national pension policy should enhance 
retirement security by minimizing ``leakage,'' or cash-outs, of 
benefits from the pension system, rather than reducing the value of 
employees' single-sum benefits. In fact, by preserving larger single 
sums, individuals will ultimately realize greater retirement security.
    The notion that reducing the single sum calculation will indirectly 
discourage such payments--and that fewer single sums mean greater 
preservation of benefits--glosses over a number of important realities 
in the pension system.
    First, in many cases, employees have no choice between a single-sum 
payment and annuity or other benefits. Involuntary cash-outs of 
benefits that do not exceed $5,000 in present value represent a very 
substantial percentage of all single-sum distributions. These payments 
are chosen not by employees, but by employers.
    Paying involuntary single sums allows plan sponsors to reduce costs 
by no longer paying PBGC premiums for the cashed-out employees and by 
saving the administrative cost of maintaining the benefits and related 
records. When an employee receives a single-sum payment, whether 
voluntarily or otherwise, the cost of maintaining those assets shifts 
to the employee (such as the cost of investing and administering the 
assets in an IRA or taxable account). Indeed, this shift of cost to the 
individual is yet another reason the more conservative Treasury bond 
rate is the appropriate benchmark.
    Increasing the single-sum interest rate would also shift the 
benefits of more employees below the $5,000 threshold, thereby 
subjecting more employees to involuntary cash-out. It is these small 
single-sum distributions that are most often consumed instead of rolled 
over to another plan or IRA.
    Second, when employees do have a choice between an annuity and a 
single-sum benefit, it is not at all evident that their choices are 
determined by incremental differences in the actuarial value of the 
annuity compared to that of the single sum. Employees' choices seem to 
be more sensitive to a variety of other factors that create a highly 
uneven ``playing field'' between annuities and single-sum options.\6\ 
These other factors--which might favor or disfavor the single sum--
include
---------------------------------------------------------------------------
    \6\ By contrast, employers' choices are more sensitive to such 
differences because their funding and other calculations are aggregate 
in nature, often covering thousands of employees over many years.

         the tendency of many employees to prefer large, 
        immediate cash payments (without regard to any mathematical 
        comparison of the actuarial values of the single-sum and 
---------------------------------------------------------------------------
        annuity options);

         the inclination of some employees to prefer a single 
        sum because of the belief that funds invested outside the plan 
        would earn larger returns than any growth that might occur if 
        some or all of the benefits remained in the plan (again without 
        regard to actuarial comparisons);

         the current environment, where an annuity guaranteed 
        for life may be more preferable because it will always tend to 
        be more secure than a single-sum payment, which might diminish 
        in value if the employee invested it outside the plan (again 
        without performing or studying actuarial comparisons);

         the fact that some plans heavily subsidize early 
        retirement annuities but not single-sum options, so that the 
        early retirement annuity has a significantly greater actuarial 
        value than the single sum;

         the expectation of an employee who is in ill health 
        that his or her life expectancy will be brief and that a single 
        sum payment is therefore preferable almost without regard to 
        the comparative actuarial analysis; or

         the wide differences in the availability of single-
        sum options among defined benefit plans sponsored by various 
        employers--some offering no single sums (with the possible 
        exception of involuntary cash-outs), others offering single 
        sums only at retirement age, and others offering single sums 
        upon termination of employment at any age\7\; and
---------------------------------------------------------------------------
    \7\ Defined benefit plan sponsors that offer single-sum 
distributions generally are not required to do so, just as they are not 
required to make single-sum cash-outs of small benefits; they choose to 
do so.

         the strong tendency of hybrid plan designs, which 
        portray the single sum as the presumptive form of benefit, to 
        move people to a single-sum payment. In fact, cash balance 
        plans and other hybrid plan designs may well be the most 
        dramatic factor currently promoting a shift from annuities to 
        single sums.\8\
---------------------------------------------------------------------------
    \8\ In fact, plan sponsors' interest in offering single-sum 
distributions--whether responding to or stimulating employee interest 
in single sums, or some of both--has been one of the motives for the 
widespread conversion of traditional defined benefit pension plans to 
cash balance pension plans. Many cash balance plans present the single 
sum to employees as the presumptive form of benefit, and are adopted 
with the purpose of reducing the volatility that can affect single-sum 
benefits in traditional defined benefit plans. Moreover, cash balance 
plans, far more often than traditional defined benefit plans, typically 
offer single sums at termination of employment as opposed to only at 
retirement age. Accordingly, cash balance participants ordinarily 
decline the annuity (which the plan is required to offer) in favor of 
the single sum.

    In practice, factors such as these generally overwhelm the effect a 
particular level of interest rate will have on the likelihood that a 
given individual will opt for a single sum as opposed to an annuity. 
Employees choosing between single sums and annuities do not generally 
think or behave like actuaries. This is further evidenced by the fact 
that participants in traditional defined benefit plans often choose 
unsubsidized single sums over subsidized early retirement annuities, 
even when the latter are actuarially far more valuable. Such plan 
designs are not uncommon, and are yet another reason why interest rates 
for single-sum purposes can reasonably be lower than the rates that 
apply for plan funding purposes.

Reduced Single-Sum Amounts May Encourage Defined Benefit Plans to Offer 
        Single-Sum Options
    Lower interest rates for determining single-sum options, which 
result in larger single-sum amounts, may discourage at least some plan 
sponsors from offering single-sum options. Conversely, legislation 
increasing the level of the interest rate benchmark for computing 
single sums would likely have the effect of increasing the number of 
defined benefit plans offering single sums (and the number of plans 
offering single sums at termination of employment instead of only at 
early retirement age) by making single sums less costly for the plan. 
(This is in addition to generating more nonconsensual single-sum 
payments by pushing more employees below the involuntary cash-out 
threshold, as discussed above.) As a result, such a change not only 
would reduce the value of single-sum benefits across the board, but 
could result in even greater leakage from the defined benefit system.
Single-Sum Payments Should Not Always be Avoided
    It is not even clear as a general proposition that single-sum 
payments are to be avoided because they necessarily promote more 
leakage of benefits. Many pension distributions are made when employees 
leave their jobs before reaching retirement age. At such a point in an 
employee's life, a single-sum payment might be the best choice from a 
policy standpoint, provided it was rolled over to another employer plan 
or IRA. By contrast, an immediate annuity could begin the consumption 
of retirement savings before retirement age; and leaving the benefit in 
the former employer's traditional defined benefit plan might well cause 
the value of the benefit to erode with inflation.
    While a single sum is the form of payment that is most at risk to 
be consumed before retirement, it is also the form that may best serve 
the preservation of retirement savings through the rollover of such 
funds. Again, it is not the single sum that should be avoided, but the 
premature consumption of those funds prior to retirement. In fact, 
larger single sums, if preserved, will ultimately lead to greater 
retirement security.

Preserving the Value of Single-Sum Benefits Need Not Cause Underfunding
    Some have urged an increase in the interest rate for single-sum 
benefits (to an amount equal to the annuity rate) on the ground that 
plans that pay single sums will otherwise become underfunded or 
``defunded.'' However, the principal problem here appears to be 
constraints imposed by the IRS on the ability of underfunded defined 
benefit plans to fund for projected single sums as opposed to 
annuities.\9\ One possible solution would be to change the IRS position 
to clearly allow plans to be funded taking into account the size and 
frequency of anticipated single-sum payments.
---------------------------------------------------------------------------
    \9\ The Pension Practice Council of the American Academy of 
Actuaries has stated that ``[I]f participants can elect single sums 
(generally determined using a 30-year Treasury rate or a possibly-lower 
plan rate), then plans should be allowed to use that single sum 
interest rate in determining liabilities.'' Parks, J. and R. 
Gebhardtsbauer, American Academy of Actuaries, Alternatives to the 30-
Year Treasury Rate (A Public Statement by the Pension Practice Council 
of the American Academy of Actuaries), July 17, 2002, page 8, n15. The 
actuaries suggest revising IRS Notice 90-11 ``to allow the actuary to 
determine a plan's liabilities reflecting expected single sum amounts 
for that percentage of participants who are expected to elect lump sums 
. . .''
---------------------------------------------------------------------------
Congress Has Other Means to Promote Preservation
    Congress has more positive and more effective means of promoting 
preservation of benefits than reducing benefits paid in single-sum 
form. The law can encourage rollovers and plan-to-plan transfers, while 
discouraging pre-retirement withdrawals that are not rolled over or 
transferred. For example, the Economic Growth and Tax Relief 
Reconciliation Act of 2001 (EGTRRA) not only has liberalized the 
availability of tax-deferred rollovers but provides for automatic 
rollover of involuntary cash-outs to IRAs unless distributees 
explicitly direct a different disposition. (The automatic rollover 
provision, section 657 of EGTRRA, will not be effective until after the 
Labor Department issues administrative guidance.) Such changes, 
strongly supported by AARP, are the types of changes that will promote 
preservation without reducing benefits.

Interest Rate Policy Should Address Needs of Both Employers and 
        Employees
    Plan sponsors have valid concerns about their funding obligations, 
particularly following Treasury's decision to stop issuing the 30-year 
Treasury bond. At the same time, employees have a valid interest in the 
preservation of their benefits, including those in the form of a single 
sum. This point was made repeatedly and forcefully to Congress by 
constituents receiving single-sum payments in the mid-1990s after 
enactment of the Retirement Protection Act (part of the GATT 
legislation), which reduced single-sum payments by raising the 
statutory interest rate. Aggrieved pension participants blamed Congress 
and the Executive Branch for not only the portion of the reduction in 
single sums that was attributable to the legislative change, but also 
the portion of the reduction that was attributable to a rise in 
interest rates that occurred shortly after the legislation was enacted. 
We can expect a similar reaction from participants in the future if 
they find that Congress again has reduced their single-sum benefits.

Conclusion
    Congress must recognize both the important plan funding concerns of 
employers and the needs of the employees our pension system is designed 
to serve. The conservative 30-year Treasury rate is an appropriate 
single-sum benchmark that recognizes the shift of risk and cost to the 
individual who receives a single-sum payment, and a rate consistent 
with the 30-year Treasury rate should be maintained. Should Congress 
deem it appropriate to provide funding relief to plan sponsors, that 
relief should not come at the expense of individuals' guaranteed 
benefit amounts. It is particularly important to protect employees from 
reductions in their pension benefits at a time when they are already 
struggling with significant declines in their personal and retirement 
savings accounts. Congress should therefore continue to prescribe 
different interest rates for these different purposes to address the 
legitimate needs of both employers and employees.

                                 

     Statement of Donald W. Fisher, Ph.D., American Medical Group 
                   Association, Alexandria, Virginia

    On behalf of the American Medical Group Association, I am 
submitting this statement for the Committee on Ways and Means 
Subcommittee on Select Revenue Measures' hearing record of April 30, 
2003. The American Medical Group Association (AMGA) represents medical 
group practices, including some of the nation's largest, most 
prestigious integrated health care delivery systems. AMGA medical group 
practice members deliver health care to more than 50 million patients 
in 40 states; the average AMGA member group has 272 physicians and 13 
satellite locations.
    AMGA endorses the approach of the Pension Preservation and Savings 
Expansion Act of 2003 (HR 1776) introduced by Representatives Portman 
and Cardin, and urges the Subcommittee Members to support this bill. 
This thoughtful approach represents a constructive contribution to the 
dialogue and directs the discussion in a positive direction.
    Many AMGA members, large integrated group practices, own and 
operate healthcare facilities and employ large numbers of employees, 
providing them many benefits, including defined-benefit pension plans 
for employees and retirees. The specter of using of the 30-year 
Treasury Bond rate to value pension fund liabilities--and the resulting 
misleading and inaccurate designation of underfunded pension plans--
threatens the financial security of employers, employees, and retirees.
    Use of the 30-year Treasury Bond rate, a low and discontinued 
valuation rate, to calculate future pension fund liabilities 
inaccurately and artificially enlarges pension fund liabilities of all 
employers--some by almost 20%. As a result, the short-term funding 
levels are mischaracterized as inadequately low, requiring 
significantly inflated employer contributions and variable premium 
payments.
    Large integrated medical group practices face extraordinary pension 
contributions that, if continued, will require diversion of resources 
needed for medical service delivery to maintain fund payment levels. If 
not remedied, the options confronting AMGA members, like other large 
companies, are to freeze their defined pension plans or discontinue 
this important benefit to workers and retirees.
    Not-for-profit medical groups need these funds to fulfill their 
community commitment to patient care and medical service for the needy. 
Although our member medical group practices are still analyzing the 
impact, they are already reporting that it would be disastrous, 
diverting hundreds of thousands of dollars that are needed to maintain 
provision of healthcare services. Initial reports from some smaller 
members indicate increased contributions in the $200,000-$300,000 
range; large members anticipate payments of almost half a million.
    While the impact is considerable for other large employers as well, 
consider the detrimental local and national impact this could have on 
healthcare services provided by large medical group practices of 
national and international renown.
    We applaud Representatives Portman and Cardin for their Pension 
Preservation and Savings Expansion Act of 2003 (HR 1776) that proposes 
a permanent, consistent pension calculation rate through use of stable, 
long-term indices as the basis of the rate benchmark.
    AMGA urges the Subcommittee Members to consider this legislation 
that corrects the present valuation method for determining pension 
liabilities by implementing a predictable, accurate evaluation of 
necessary contributions.
    Thank you.

                                 

Statement of Connecticut Hospital Association, Wallingford, Connecticut
    Founded in 1919, the Connecticut Hospital Association (CHA) has 
been representing hospitals and health-related member organizations for 
over 80 years. CHA's diverse membership includes all 31 Connecticut 
acute-care hospitals and their related healthcare organizations, short-
term specialty hospitals, long-term care facilities, nursing homes, 
hospices, home health agencies, ambulatory care centers, clinics, 
physician group practices and many other organizations. CHA provides 
legislative and regulatory advocacy on behalf of our members by 
supporting initiatives that are in the interests of our members and 
their patients. Like other employers, Connecticut hospital and 
healthcare employers have been hard hit by spiraling pension plan 
costs. Declining asset returns and dropping interest rates have 
collided, resulting in unprecedented, unreasonable and unmanageable 
financial strains for hospitals and other employers.
    CHA is submitting this testimony to be part of the record of the 
April 30, 2003 hearing on the challenges facing pension plan funding. 
Connecticut hospitals need pension funding liability reform, and we 
urgently request your support of legislation to permanently replace the 
30-year Treasury bond as the interest rate used to calculate defined 
benefit pension plan liabilities and lump sum payments.
    The temporary funding relief enacted by Congress in 2002 through 
the Job Creation and Worker Assistance Act (P.L. 107-147) expires at 
the end of 2003. When that happens, the permissible interest rates that 
must be used to calculate a plan's current liability and variable rate 
PBGC premiums will revert to lower rates based on 30-year Treasuries. 
As Chairman McCrery noted in his opening remarks, Congress chose a 
four-year weighted average of the 30-year Treasury rate as a benchmark 
interest rate assumption in calculating whether pension plans meet 
various funding requirements because the 30-year Treasury bond rate was 
deemed to be transparent, difficult to manipulate, and a fair proxy for 
the price an insurer would charge for a group annuity that would cover 
accrued benefits if the plan were terminated. However, in 2001 the 
Treasury Department discontinued issuing 30-year bonds and the interest 
rate on the outstanding bonds has fallen significantly. Chairman 
McCrery quoted a recent report by the General Accounting Office that 
states the rate has ``diverged from other long-term interest rates, an 
indication that it also may have diverged from group annuity rates.''
    When the temporary funding relief expires at the end of this year, 
reverting to the artificially low Treasury bill interest rates will 
force hospitals and other employers to unnecessarily increase the 
funding of their defined benefit plans, diverting desperately needed 
resources from their services and businesses. In the case of hospitals, 
which are facing escalating pharmaceutical and technology costs, an 
expensive and growing workforce shortage, reductions in Medicare and 
Medicaid reimbursement rates, and spiraling medical liability insurance 
premiums, this additional financial burden can result in onerous plan 
design changes.
    If the temporary funding relief measure expires without a 
reasonable replacement to the 30-year Treasury bill interest rate, 
Connecticut hospitals will face financial hits that they simply cannot 
absorb. Here are some examples of what has happened to Connecticut 
hospital pension funding requirements:

          In the case of one community hospital with an operating 
        budget of about $70 million, the hospital would have an 
        additional funding requirement of $2-3 million next year, 
        solely due to the change in interest rate.

          In the case of a small community hospital, required pension 
        funding jumped from $2.8 million to $4.8 million in one year.

          Another mid-sized hospital reports their pension 
        contribution will be up between $1-2 million.

          A large, urban hospital reports that between 1999 and 2002, 
        its pension plan's current liability funded percentage has 
        declined by 20 percentage points, 12 percentage points of which 
        are attributable to declining rates according to their 
        actuaries.

          Another small community hospital reports a nearly 10-fold 
        increase in their cash funding, from $258,000 in 2003 to $2.3 
        million in 2004, despite asset returns that were better than 
        the major benchmarks.

          At a meeting of hospital leaders earlier this month, the 
        impact of dramatically increased pension funding costs was 
        discussed. Several hospitals are evaluating plan revisions to 
        cut benefits as the only solution to an untenable financial 
        strain.

    We urge your support of a solution to address this issue of 
unnecessary increased funding resulting from the use of the obsolete 
30-year Treasury bond rate. Without a swift and permanent solution, 
such as the reform proposal introduced as part of the Pension 
Preservation and Savings Expansion Act of 2003 (H.R. 1776), hospitals 
and other employers will continue to be burdened with artificially 
inflated plan liabilities that compete for precious resources and will 
continue to need to question their ability to commit to defined benefit 
programs for their staffs. Action is needed immediately in order to 
avoid difficult decisions by employers regarding cost containment 
actions needed for the new plan year.

                                 

               Statement of the ERISA Industry Committee

    Mr. Chairman and members of the Subcommittee, The ERISA Industry 
Committee appreciates the opportunity to present its views on the 
funding of defined benefit pension plans.
    ERIC is a nonprofit association committed to the advancement of the 
employee retirement, health, incentive, and benefit plans of America's 
largest employers. ERIC's members provide comprehensive retirement, 
health care coverage, incentive, 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 cost and 
effectiveness, and the role of those benefits in the American economy.
    ERIC has a unique interest in funding rules for defined benefit 
plans because about 95% of the ERIC membership sponsor defined benefit 
pension plans. They also provide 401(k), health, and other benefits.

Summary
    In 2001 the U.S. Treasury ceased to issue the 30-year Treasury bond 
on which the funding of defined benefit plans is statutorily based. As 
a result, we are left with an artificial interest rate that fails to 
reflect any rational basis with which to regulate pension plan funding. 
The lack of a rational rule has created uncertainty that, among other 
effects, has caused the stock of sound companies to be undervalued by 
stock analysts concerned about their potential future funding 
obligations.
    Prompt action to replace the defunct 30-year Treasury bond rate for 
purposes of regulating pension plans is critical to protect the 
retirement security of millions of American workers and to avoid 
undercutting the ability of many companies to fuel national economic 
recovery.
    ERIC urges the Committee to replace the 30-year Treasury rate with 
a composite rate of high-quality, long-term corporate bond indices that 
would be selected through Treasury regulations. ERIC also proposes to

         Coordinate the new rate with related mortality 
        assumptions;
         Phase in the new rate for lump sum calculations; and
         Reduce the frequency with which employers bounce in 
        and out of the current liability funding and quarterly 
        contribution requirements.

    A composite corporate bond rate is generally recognized as a 
reasonable proxy for annuity purchase rates, which corresponds to the 
rationale for choosing 30-year Treasury rates as a benchmark in 1987. 
The proposed composite rate is higher than today's 30-year Treasury 
rate. But this is appropriate because the current use of the Treasury 
rate overstates the minimum funding needed to assure retirement 
security for plan participants.
    The overstatement of liabilities frequently is requiring the 
diversion of hundreds of millions of dollars in a single company. 
Overstating liabilities is forcing some employers to make economically 
rational decisions to freeze, modify, or abandon their defined benefit 
plans, thus adversely impacting retirement security. Use of the defunct 
30-year Treasury rate also causes participants to elect lump sums in 
circumstances where they would be better protected by an annuity.
    Other possible replacements for the 30-year Treasury rate do not 
provide the combination of simplicity, transparency, relevance, 
immunity from manipulation, and availability provided by a composite 
corporate bond rate.
    Congress must be careful not to overreact to reports raising 
concerns about the current status of pension funding. Part of the 
problem is that current law mismeasures the severity of any problems. 
In addition, the combined impact of a dramatic drop in asset values 
combined with an increase in calculated liabilities due to low interest 
rates is unusual and is not a sound platform for major reshaping of 
pension funding requirements.
    At the same time, Congress should recognize its ability and 
responsibility to improve the climate for defined benefit plans in the 
future. For example, Congress imposed ever-harsher deduction limits on 
voluntary contributions to pension plans during the 1980s and 1990s, a 
trend that the Grassley-Baucus pension reform measures enacted as part 
of the Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L. 
107-16) began to reverse. Had restrictive deduction limits not been 
imposed during recent decades, many plans would be better funded today 
despite the current economic slowdown.
    Finally, the current financial status of the Pension Benefit 
Guaranty Corporation (PBGC) should be monitored by Congress, but does 
not require any action at this time. The PBGC's funded ratio still is 
stronger than it has been for most of its history, and the corporation 
is abundantly able to pay promised benefits to participants in plans it 
trustees for the foreseeable future.

Overview of Funding Rules
    To ensure that a defined benefit pension plan has sufficient assets 
to pay benefits when participants retire, ERISA and the Internal 
Revenue Code require the plan's sponsor to make minimum contributions 
to the pension plan. These minimum required contributions are 
calculated using reasonable assumptions and are equal to the normal 
cost of the plan plus amounts necessary to amortize over specified 
periods unfunded past service liabilities, experience gains or losses, 
waived funding deficiencies, changes in actuarial assumptions, and 
certain other items. Most defined benefit plans are funded under these 
original ERISA rules, as modified over time.
    A plan that is either significantly or persistently underfunded 
will be subject to an additional set of funding rules. Basically, these 
rules look at whether a plan is likely to be able to buy annuities to 
cover its current level of accrued benefit promises. If a plan is far 
from being able to buy annuities, the rules require that additional 
cash be put into the plan, accelerating the pace of pension funding. 
These rules, commonly called the ``current liability'' funding rules, 
were added to the law in 1987 and modified in 1994, and are the focus 
of our discussion today.
    The current liability funding rules require the sponsor to use a 
specified mortality table and to calculate liabilities using an 
interest rate that is within a range of rates based upon the four-year 
weighted average of 30-year Treasury bonds. As amended in 1994, 
amendments, the permissible range is no lower than 90% of the 30-year 
bond average and no higher than 105% of the 30-year bond average. For 
2002 and 2003 only, a plan may use a rate of up to 120% of the 30-year 
bond average. Congress enacted this short term-higher range last March 
(P.L. 107-147) in recognition of the fact that, as a result of the rise 
of budget surpluses followed by the decision of the Treasury to cease 
issuing 30-year bonds, the 30-year bond rate had dropped to levels that 
produced highly inaccurate and inflated calculations of pension 
liability.
    The current liability rules come into play if, using these mandated 
assumptions, a plan is significantly or persistently underfunded--that 
is, if plan assets are less than 80% of current liabilities or if a 
plan's assets are less than 90% of current liabilities for two of the 
last three years. Plans with any unfunded current liabilities must also 
make contributions on a quarterly basis during the plan year instead of 
making one annual contribution after the end of the plan year.
    Current liability is also calculated to determine whether a plan 
sponsor will pay a $19 per participant flat rate premium tax to the 
Pension Benefit Guaranty Corporation, or whether the sponsor must, in 
addition, pay a variable rate premium tax based on the plan's unfunded 
vested benefit liability.
    The 30-year Treasury rate is also used (without averaging and 
without the corridor available for funding purposes) to calculate the 
minimum lump sum that may be paid to a plan participant.

What happens if the 30-year Treasury rate is not promptly replaced?
    If Congress fails to act, 2004 current liability calculations will 
be dictated by a maximum rate of 105% of the four-year weighted average 
of (defunct) 30-year Treasury bonds. Using the rates in effect on 
January 1, 2003, as a proxy, this would mean that plans would be forced 
to calculate their current liabilities with a maximum interest rate of 
5.82% compared to 7.41% under the ERIC proposal. If this were to 
occur--

         Current liability calculations would increase by 15% 
        or more.
         Many additional companies, including companies with 
        plans that are in fact well-funded, would become subject to the 
        special funding rules. Both they and those already subject to 
        the rules would experience a spike in their contribution 
        requirements. This will unnecessarily divert money that 
        otherwise would have be spent to build a new plant, buy 
        equipment, pay for research and development, and support jobs.
         Plans that become subject to the current liability 
        funding rules also must notify employees of their underfunded 
        status (even if the plan is not underfunded using reasonable 
        measures), and must pay variable rate premiums to the PBGC. 
        Business operations of these plan sponsors also come under 
        increased scrutiny by the PBGC.

    There is no economic justification for these consequences. Thus, it 
is apparent that affected companies will find their support for defined 
benefit plans diminished. A strong financial incentive will be created 
to limit future liabilities. Where cash is in short supply, companies 
will have no option but to freeze their plans.
    There is additional fall-out just from the uncertainty companies 
currently face. CEOs and CFOs need to know now whether they will be 
able to purchase a new plant and equipment, to invest in research and 
development, and to accomplish other vital business objectives.
    Consequences of the funding squeeze, caused in part by the 
continued reliance on the 30-year Treasury rate, already are occurring. 
A recent survey by Deloitte & Touche indicated that more than four out 
of ten defined benefit plan sponsors are either making or are 
considering making fundamental changes to their defined benefit plans. 
About a quarter of those making or considering changes either already 
have or are inclined to freeze benefits in the plan.
    Action on a replacement rate is needed now. Analysts already are 
steering investors away from companies with a cloudy contribution 
forecast. Action by the end of the second quarter, after which planning 
for 2004 becomes critical, is vital. Delay means damage to plans and 
their participants, damage to companies, and damage to companies' 
ability to fuel economic recovery.

Why should a composite corporate bond rate be selected as the 
        replacement for 30-year Treasury rates?
    The current liability funding rules are designed to shore up 
funding in a plan that would have a serious shortfall if it were to 
terminate and purchase annuities to provide benefit payments. Thus, as 
the GAO reported less than two weeks ago, ``the interest rates used in 
current liability and lump-sum calculations should reflect the interest 
rate underlying group annuity prices and not be subject to 
manipulation.'' (GAO-03-313)
    Insurance companies tend to invest in long-term corporate debt. 
Therefore, a composite corporate bond rate will track changes in 
annuity purchase rates.
    ERIC'S composite rate is composed of high-quality, long-term 
corporate bond indices. High quality (generally the top two quality 
levels) provides a reasonable level of security for pension plan 
sponsors to defreeze their liabilities.
    ERIC's composite rate indices also are comprised of bonds with 
average maturities of 25-30 years (implying durations of 10-12 years), 
which corresponds to the typical duration of pension plan liabilities.
    When the 30-year Treasury bond rate was selected as a compromise 
basis for the new pension funding rules established in 1987, Treasury 
rates were closer to corporate bond rates than they are today. 
Moreover, mortality assumptions in use at the time were outdated, so 
having an interest rate that was overly conservative made sense.
    The composite corporate bond rate in the ERIC proposal is based on 
indices that are published by major investment houses, based on 
disclosed methodology, and publicly available. The composite rate is 
based on information familiar to plan actuaries; it is simple for plans 
to implement; it is transparent, and it is strongly immune from 
manipulation.

What about mortality assumptions?
    Under current law, Treasury is required periodically (and at least 
every five years) to review the mortality table required for current 
liability funding calculations and to update the table as appropriate 
to reflect the actual experience of pension plans (including permitting 
plan-specific adjustment factors such as employment classification, 
lifetime income, and other relevant demographic factors) and projected 
trends in such experience. An update in the required table is overdue.
    ERIC recommends that the use of the RP 2000 Combined Mortality 
Table, produced by the Society of Actuaries based on a large study of 
pension plan experience, be required for funding and variable rate 
premium purposes at the time the composite rate becomes effective. Use 
of the new table will have the effect of increasing current liability 
calculations for most plans, partially offsetting the effects of 
adopting the composite corporate bond replacement for the 30-year 
Treasury bond.
    ERIC proposes no changes for mortality assumptions for lump-sum 
distributions, since they already are being updated under a separate 
provision of law.

What about lump sum distributions?
    It is important that the lump sum discount rate reflect the plan's 
discount rate. Any disconnect between the lump sum rate and the funding 
rate will cause plan distributions to either exceed or fall short of 
estimates used in the plan.
    Today's low rate also presents participants deciding between a lump 
sum distribution and an annuity a choice that is overwhelmingly 
weighted toward the lump sum. This is in direct contravention of long-
established policy that the choice should be economically neutral. As 
use of lump sums increases, fewer joint and survivor benefits are 
selected, adversely affecting long-term participant security. In 
addition, the plan's funding level is adversely impacted.

         Lump sums paid under a defunct Treasury rate are, in 
        fact, windfall benefits that have damaging side effects for 
        long term retirement policy and for the company sponsoring the 
        plan.
         Elderly widows and widowers and others who outlive 
        their assets and have no retirement income stream other than 
        Social Security constitute one of the most vulnerable pockets 
        of poverty today. The current lump sum structure will increase 
        the number of spouses and others left adrift in the future if 
        that lump sum is dissipated.
         Actuarial estimates indicate that a lump sum benefit 
        under the current inappropriate discount rate increases the 
        cost of the benefit to the plan by 17-40%. Many plans cannot 
        absorb these costs and have been freezing or curtailing 
        benefits. Thus, while some current retirees receive a windfall 
        based on an anomaly in the government debt structure, future 
        retirees will receive reduced benefits overall.
         Finally, Internal Revenue Code section 417(e) not 
        only dictates the minimum lump sum rate, but also the rate that 
        regulations encourage companies to use as the interest credit 
        rate in cash balance plans. Thus, maintaining an artificially 
        low lump sum rate for some current retirees means that millions 
        of participants in cash balance plans are losing benefits 
        compared to what they would be earning if the rate were 
        rational.

    ERIC proposes that the new interest rate be phased in over a three-
year period. The three-year phase-in will align the two rates over time 
while ensuring that the shift from a defunct 30-year Treasury rate to 
the composite rate will not have abrupt effects on participants at or 
very near retirement.
    Historically, the lump sum discount rates have averaged about 7%. 
Today's mandated rate is 4.92%. Under the ERIC proposal, if current 
rates remained in effect without change, this would gradually increase 
to a level of about 6.23% over a three-year period--still short of 
historical averages. The phase-in is designed to roughly approximate 
normal fluctuations of interest rates in a given year. Thus the changes 
would be within the margins of change that already occur on a year-to-
year basis. In addition, in the second and third years, lump sums of 
many employees would increase from estimates made today because 
additional years of age and service would be included in the 
calculation.

What's wrong with selecting another government rate or a yield curve 
        instead of a composite corporate bond rate?
    Any other government rate is going to suffer from the same 
weaknesses as the 30-year Treasury rate--any relation to annuity 
purchase prices will be tangential or accidental. Indeed, as the GAO 
noted (p. 5), ``Treasury rates' proximity to group annuity purchase 
rates might be adversely affected if investors' demand for risk-free 
securities increases, causing Treasury rates to decline relative to 
other long-term rates.''
    Government rates reflect the government's cost of borrowing, not 
the rate of return on an insurance company's portfolio. Thus they 
inherently lack relevancy for the purpose at hand.
    Corporate bond yield curves might enable a plan to more closely 
approximate its group annuity purchase rate. However, the extra 
precision involved is outweighed by several drawbacks. For example:

         There has been little public discussion of a yield 
        curve, a complicated proposal. Adequate consideration of a 
        yield curve between now and July, when a replacement for 30-
        year Treasuries must be in place, could not occur. It would 
        need substantially more time for debate and analysis. There are 
        a number of highly technical issues involved in switching to a 
        yield curve that have not been explored or addressed.
         Companies already unsure of their cash flow situation 
        will be thrown into even greater confusion, to the detriment of 
        their ability to participate productively in the economy.
         Since it would make no sense to average a yield curve 
        over four years, an annual rate likely would be used. Unless 
        some other ``smoothing'' mechanism is devised, this will 
        substantially increase pension funding volatility.
         In addition to decreasing pension funding volatility, 
        the current averaging mechanism gives plan sponsors the ability 
        to estimate funding obligations well in advance of the year for 
        which they are due. Basing contributions on an unknowable 
        ``spot rate'' decreases the ability of sponsors to plan capital 
        commitments.
         Introducing volatile, unpredictable cash flow 
        requirements is a significant burden on plan sponsors. As a 
        result, maintaining a defined benefit plan will become less and 
        less economically feasible for more companies. It would be 
        impossible for Congress to overestimate the negative impact of 
        turning at this point in time to a pension funding system that 
        increased the volatility and unpredictability of required 
        pension contributions.
         A yield curve would likely increase required 
        contributions in plans with large numbers of retirees. This 
        could cause very severe economic hardship for those companies.
         A yield curve, combined with the current law 
        deduction limits, would result in less ability for a plan 
        sponsor to fund the plan while participants are younger because 
        it would delay the ability to deduct maximum contributions to 
        periods when the workforce is more mature and declining, and 
        when the company may face new or different economic pressures. 
        It would, in effect, negate some of the good of the Grassley-
        Baucus amendment in EGTRRA, which phases out deduction limits 
        that had a similar effect of delaying funding over the past 
        decades.
         If a ``precise'' interest rate such as a yield curve 
        is mandated, a precise mortality assumption also must be 
        considered. Otherwise, industrial plans whose participants have 
        shorter life spans will be required to excessively fund their 
        pension plan. However, such use of such an assumption is likely 
        to be controversial and will require additional discussion, as 
        it will have different impacts on different plans.
         It is unclear how a yield curve would be applied for 
        purposes of lump sum payments, raising a host of additional 
        issues.
         A yield curve is likely to be far less transparent 
        than a composite index; it may be more vulnerable to 
        manipulation; it will be more difficult for the government to 
        police, and it certainly will be more complicated.

    A yield curve may impose these drawbacks on the defined benefit 
system for no real long-term gain over the more simple approach of a 
composite corporate bond rate.

What can Congress do to help?
    Besides prompt enactment of a replacement for 30-year Treasury bond 
rates, Congress has important opportunities to improve the climate for 
defined benefit plans.

         Congress can provide for additional stability in 
        companies' funding requirements by enacting ERIC's proposals 
        regarding the volatility and quarterly contribution rules.
         Congress can also provide for increased deductibility 
        for voluntary contributions made in excess of the current 
        required amounts.


Should Congress be concerned about allegations that the PBGC is in 
trouble?
    The short answer is, ``No.'' Congress should monitor the financial 
status of the PBGC, but should recognize that the PBGC's funded status 
is better than it has been for most of its existence. It is in fact not 
in trouble and appears readily able to weather the current economic 
slowdown.
    Should long-term problems emerge, there will be ample time and 
resources to address PBGC issues, unless short-sighted measures drive 
PBGC's premium payors away from the defined benefit system.
    The loss of the PBGC's surplus should not be a surprise in the 
current economic circumstances and is, in itself, not a cause for 
alarm. Indeed, given the requirement in ERISA sec. 4002 that the PBGC 
``maintain premiums established by the corporation . . . at the lowest 
level consistent with carrying out its obligations under this title,'' 
maintaining a surplus might be in violation of the corporation's 
charter.
    The economic health of the PBGC is determined not by whether it has 
a surplus or deficit at any point in time but by its ability to pay 
benefits to participants of plans it trustees. The PBGC has sufficient 
assets to pay benefits for the foreseeable future. In fact, the PBGC 
has operated successfully in a deficit situation for most of its 
history. (see chart)
    The real security of the PBGC lies not in imposing new rules that 
force cash-strapped companies to choose between survival and putting 
more money into their pension plans. It lies in fostering a vibrant 
system with lots of companies maintaining defined benefit plans on 
which they pay premium taxes to the PBGC.
    We appreciate the opportunity to appear before the Committee and 
will be pleased to respond to questions and engage in further 
discussions either at or after the hearing.

                                 

              Statement of Jeremy Gold, New York, New York

Recommendation
    I propose that the ERISA Current Liability be computed using 
discount rates that are directly and simply related to the Treasury 
yield curve. I identify two possible formats: i) a constant ``spread'' 
above the Treasury yield curve, expressed in basis points, e.g., the 
Treasury yield curve plus 50 basis points; or ii) the Current Liability 
may be set equal to a constant percentage (a ``multiplier factor'') of 
the principal value determined using the Treasury yield curve with no 
spread, e.g., 90% of the principal value computed using the curve.
    These two formats are similar in substance and effect. A 50 basis 
point spread is approximately equal to a multiplier that is between 90 
and 95%.
    Although ERISA rules for funding and for lump sum payments to 
individual participants have been linked historically by their common 
reference to the 30-year Treasury bond, my commentary addresses the 
issue of the Current Liability (a funding measure) only. I would be 
happy to comment on lump sum payments at another time.

Structure and Level
    Almost all of my recommendation deals with issues of structure. 
These are distinct from what I call issues of level. I mention below 
several objective criteria for structure; basing the Current Liability 
on the Treasury yield curve meets these criteria, while basing it on 
corporate rates or annuity purchase rates does not. With the 
economically sound building blocks provided by the Treasury curve, 
legislation may allow for pragmatic adjustment of the level of the 
Current Liability. For example, legislation could specify that the 
Current Liability is the discounted value based on the curve plus 50 
basis points, or that it be 90% of the discounted value based on the 
unadjusted Treasury yield curve. For a given set of underlying cash 
flows, a high value (a high level) for the Current Liability is 
produced by a strict standard; a low value or level is produced by a 
lenient standard.
    Although many of those who offer testimony in this matter are 
primarily concerned with issues of level, they will argue in terms of 
both level and structure. Thus, for example, one may recommend Treasury 
rates because the Treasury market is very liquid (a structural matter) 
or because Treasury rates are low (i.e., a strict level). This is 
unfortunate because we can gain a great deal by a careful separation of 
these issues. The long-term rationality and efficiency of the pension 
system is highly dependent on a well-defined structure. The immediate 
needs, however, of all constituent parties are closely related to the 
strictness of the Current Liability measurement. A strict standard will 
immediately stress the pension plans that are weakly funded by weak 
sponsors. A lenient standard may help weaker companies and their 
sponsors over the near term, and may be necessary in these difficult 
times. Over the long run, lenient standards burden today's strong 
companies and threaten the plan participants, taxpayers and the PBGC of 
tomorrow.
    The structural basis of the Current Liability is the mechanical 
process that turns market rates and measures into the discounted 
liability value. A sound structure will incorporate three critical 
features: transparency, objectivity and hedge-ability. The present 
statutory basis fails on all criteria.

Current Liability and the Treasury Yield Curve
    Defined benefit pension plans promise future cash flows to 
participants. At any time, some of these promises have already been 
earned by participating employees (accrued benefits). The Current 
Liability is defined by ERISA as a measure of the value of these 
accrued benefits. This measure entered ERISA via OBRA '87, a public 
law, was amended by RPA '94, and by JWCCA '02. The liability cash flows 
are discounted to arrive at their present value. For 2002 and 2003, the 
discount rate is no greater than 120% of a weighted average of real and 
virtual 30-year bonds over a four year period. This definition is 
complicated, out of touch with current market values of similar 
promises, opaque, and generally not hedge-able.
    Despite the shortcomings of the measure, the concept of a Current 
Liability representing the value of accrued benefits is very important. 
When we compare the market value of plan assets to a market-based 
valuation of the Current Liability, we have taken the single most 
important measure of the financial status of that pension plan. This 
single measure can provide valuable information to plan participants, 
investors in the corporation that sponsors the plan, and to the 
public--especially to the PBGC who must underwrite the financial health 
of the plan in order to protect the participants.
    The market-based measure of the Current Liability, in the context 
of the PBGC guarantee, can best be accomplished using the Treasury 
yield curve. Although there are some practical problems with every 
potential measure\1\, the problems associated with other measures dwarf 
those of the Treasury yield curve. The shortcomings of other measures 
are discussed briefly below.
---------------------------------------------------------------------------
    \1\ In the Treasury yield curve case we can note that some benefit 
cash flows occur after the longest outstanding Treasury securities 
mature and that liquidity premiums differ between ``on-the run'' and 
``off-the-run'' issues.
---------------------------------------------------------------------------
    The Treasury yield curve is visible every day in markets all over 
the world. These markets (particularly those open in the U.S. during 
working hours) are extremely liquid and transparent and objective. 
Numerous other securities including interest rate derivatives, swaps 
and corporate bonds are priced in relation to the Treasury yield curve. 
This means that the cash flows that underlie the Current Liability may 
be measured and hedged with great accuracy.

The Importance of Hedge-Ability
    The importance of transparency, liquidity and objectivity offered 
by the Treasury yield curve (in comparison to all other potential 
measures) should be obvious. The importance of hedge-ability may be 
less obvious. Many of my fellow actuaries have limited appreciation for 
this issue. Actuaries use statistical models to develop distributions 
of possible future outcomes. Among the variables whose outcomes they 
analyze in this fashion are future asset values and interest rates. 
Actuaries often argue that they need to use artificial (i.e., non-
market) asset values and liability discount rates so that the 
(artificially-measured) funding status is rendered more predictable 
than the underlying uncontrolled market values.
    Thus actuaries strive for predictability in the face of volatile 
markets. They have yet to appreciate this: ``volatility is a property 
of markets; it is not a disease for which actuarial and accounting 
treatment is the cure.''
    Modern finance has taught many of us that hedging is the far far 
better way to cope with such volatility. Whereas artificial actuarial 
values paper over volatility, hedging allows the risk bearer to accept, 
dispose or otherwise manage risk exposure and its impact.
    As pension accounting becomes more transparent, as it must and will 
in the near future, hedging will be the mechanism of choice for 
managers of corporate pension plan exposures. As the statutory basis 
for funding becomes more transparent, as it must in the near future, 
hedging will be the mechanism of choice for managers of corporate 
pension plan exposures. The old approach, wherein the actuary smoothed 
over the financial realities, shall pass.

The ``Spread'' or the ``Multiplier Factor''
    The primary thrust of my comments is aimed at the structure of the 
current liability measure. Thus I stress transparency, objectivity and 
hedge-ability. While the structure may be of great importance in the 
long run (a good structure promotes market efficiency, fairness among 
plan sponsoring companies, and rational management of pension risks), 
the level of the Current Liability is of the utmost importance today; 
it will have an immediate impact on the solvency of the PBGC, the cash 
flow obligations of plan sponsors and the public's sense of how well we 
have all dealt with what some refer to as a ``crisis.''
    To protect the virtues of good structure for the long run, we must 
separate the level issue from the structure. Many of the participants 
in the current debate have sacrificed structure in order to abet their 
arguments in re level. Those who have suggested averaging rates, 
annuity measurement schemes, and the use of corporate bonds (rather 
than Treasuries) make structural arguments but their motivation is 
often based on level.
    Level is important and urgent. I recommend a system that allows 
Congress to address the level issue directly and transparently. I 
propose that the measurement system incorporate only one level setting 
dial. This dial may be effected in one of two fashions:

        1. Built on the solid structure of the Treasury yield curve, 
        we can add a constant ``spread'' in interest rates. A strict 
        standard would incorporate a small spread, perhaps 25 to 50 
        basis points. A more lenient standard could use a greater 
        spread. The effect of the spread is to lower the current 
        liability and thus allow for any level of minimum funding 
        desired. Those who favor the use of double-A corporate bonds 
        might achieve the same general level by using the Treasury 
        curve plus 100 basis points. While I would like the spread to 
        remain constant (i.e., set by statute), a workable system could 
        delegate the regular determination of the spread to the 
        regulatory agencies. The Treasury curve with a spread remains 
        objective, transparent and hedge-able.
        2. Using the Treasury curve with a zero spread, we can 
        multiply the resulting principal value by a ``factor'' designed 
        to accommodate valid concerns about the level of the measure. 
        Roughly speaking, a factor of 90% to 95% would have about the 
        same impact as a spread of 50 basis points. This approach 
        remains objective, transparent and hedge-able.

    Although it is possible to compound the effects of a spread and a 
multiplier factor, the simpler the system is, the more benefit we will 
get from the soundness of the structure. Each adjustment tool--each 
degree of freedom--weakens the structure. We must be able to address 
the issue of level, but we should do it with the minimum number of 
minimally invasive tools. That minimum number is one. Use a spread or 
use a factor. Resist the temptation to fine tune the process with 
compound control mechanisms.

Undesirable Alternative Measures
    The current system is undesirable in at least two ways--failure to 
use the whole curve and averaging over time. The four-year averaging of 
30-year bonds was adopted to reduce market volatility and to make the 
resulting measure more ``predictable'' in the actuarial sense. In a 
financial world that is progressively more transparent and market-
oriented, this averaging is self-defeating. It renders hedging (and 
rational risk management) impossible.
    The use of a corporate yield curve, while far superior to the 
current system, is inferior to the Treasury-based recommendation that I 
have made. Corporate bond measures are always more subjective and less 
transparent than Treasury measures. Many corporate bonds are issued 
with call provisions that are inappropriate for the measure of pension 
liabilities; adjustments to neutralize such provisions are always 
technical, complicated, and at least slightly subjective. Additionally, 
promises made by the PBGC are backed (in spirit if not in statute) by 
the U.S. government. Promises made by the U.S. government and its 
agencies are more highly valued by the capital markets than are the 
promises made by any corporation.
    The private annuity market for pension plan terminations is an 
exceptionally poor basis for statutes relating to the funding of 
pension plans covered by PBGC guarantees. Whereas Treasury securities 
trade in the hundreds of billions of dollars every day, the private 
annuity closeout business amounts to less than two billion dollars 
annually. In the last several months the PBGC has acquired liabilities 
representing
a decade of transactions in the private annuity market. The market for 
any such closeouts in excess of ten million dollars consists of an 
oligopoly of mildly motivated competitors. The ``sweet spot'' for such 
placements is in the neighborhood of one hundred million dollars; a 
handful of transactions may reach this size annually. In this range, a 
moderately competitive group of companies will offer effective rates 
that might exceed Treasury rates. For smaller placements, much lower 
(after expenses) rates apply.
    Annuity pricing is also problematic in that insurance companies 
combine their gross interest rate with assumptions concerning 
mortality, retirement ages, etc., as well as with loadings for profit 
and expenses. These demographic assumptions are commonly much stricter 
than those used by the plan actuary under ERISA. Combining an insurer's 
gross interest rate with the plan's regular actuarial assumptions will 
severely understate the annuity purchase price.

Timing
    Despite my admonitions, the issue of level is critical today and we 
must be willing to compromise to avoid jolts to the system that may be 
so damaging in the short run that any long run structural benefits are 
lost.
    It will be necessary to allow a transition to any new standard. I 
suggest two possible ways that this might be accomplished:

        1. Commence with a large yield spread (or a low multiplier) 
        for the year 2004. If, for example, 2004 used The Treasury 
        yield curve plus 200 basis points, 2005 might use the curve 
        plus 150, 2006 curve plus 100, 2007 and thereafter curve plus 
        50. A similar result might be obtained using the Treasury curve 
        with no spread and a multiplier of 65% in 2004 increasing to 
        95% for 2007 and thereafter.
        2. Blend the ultimate approach with the current system. In 
        2004, compute a value based on the same rule as 2003. Compute 
        as well a value based on the Treasury curve (perhaps plus 50 
        basis points). The Current Liability for 2004 would be 75% of 
        the first value and 25% of the second. In 2005, after similar 
        computation, the Current Liability would be 50% of the first 
        and 50% of the second value. By 2007, we would use the Treasury 
        curve.

    Some have contended that actuarial computer programs may have 
difficulty implementing a yield curve approach. With all the technology 
available today, this is something of a red-herring. No actuary or firm 
serving substantial clients would be unable to implement the yield 
curve approach for 2004. Once the future cash flows based on accrued 
benefits are known, the liability may be computed in less than 15 
minutes using a spreadsheet program and a published yield curve. 
Nonetheless, it is possible that actuaries serving only small clients 
may have some difficulty. Certainly a deferral of application until 
2005 may be accommodated for pension plans with fewer than 100 
participants.

Thank You
    Thank you very much for the opportunity to express my views. I 
would be happy to respond to questions or to provide additional 
material and discussion upon request.
    I enclose the short article ``How to Stop the Insanity'' soon to be 
published in the Pension Section News of the Society of Actuaries.

                                 ______

                                 How to

                           Stop the Insanity!

                             by Jeremy Gold

    At the 2002 Enrolled Actuaries Meeting, Donald Segal and Tonya 
Manning asked ERISA authorities to ``Stop the Insanity.'' In the 
authors' response to comments on our article ``Reinventing Pension 
Actuarial Science,'' Larry Bader and I have said that funding rules 
require societal, or political, judgments. In this article, I try to 
identify and delimit, the public's interest in defined benefit plan 
funding. Thus, for the time being, I put aside the pursuit of a new 
theory of pension actuarial science in favor of a practical proposal to 
Stop the Insanity.
    As Segal and Manning have documented, twenty-nine years of ERISA 
have resulted in a chaotic deluge of overlapping, often contradictory, 
measurements and restrictions designed to regulate the funding of 
qualified defined benefit plans for U.S. employees. We may understand 
such rules as the expression of the public's interest in what otherwise 
would be a matter of private contracts between employers and employees. 
Although the public interest in these matters is legitimate, we can do 
the public will in a fashion that will Stop the Insanity.
    Public interest in the funding of private defined benefit plans 
comprises two issues:

         Funding should be sufficient to secure promises that 
        have been made by employers and earned by employees--i.e., 
        accrued benefits, measured at market values.
         Tax-deductible contributions should be limited. Such 
        limitation may also be defined in relation to the value of 
        accrued benefits.

    The public does not have an interest in:

         Patterns of contributions over time, although this 
        may be important to plan sponsors and their constituents.
         Normal costs.
         Gain and loss amortization.
         Past service costs and amortizations.
         Interest on liabilities.
         Expected returns on assets.

    I believe that the six bullets above, the basics of the traditional 
actuarial funding processes that underlie ERISA, contribute to the 
Segal-Manning Insanity. Pre-ERISA, these components helped the actuary 
rationalize the sponsor contribution budgeting process. When the public 
chose to intervene, it framed the problem in terms of these components 
and attempted to control funding outcomes by controlling these inputs. 
Much of the insanity arose in response to undesirable outcomes. Thus, 
for example, the PBGC saw the need to define and measure the Current 
Liability after plans that met ERISA's minimum funding rules failed to 
achieve adequate funding levels.
    My Sane proposal defines two simple limits: a minimum (sufficiency 
level) below which contributions are required and a maximum (excess 
level) above which no contributions are allowed. Between these levels, 
the public has no interest and plan funding is entirely discretionary. 
Actuaries may design funding schemes therein, employers may negotiate 
with employees and their representatives therein, stockholders and 
lenders may argue with management therein. The public does not care.
    My proposal is the ultimate safe harbor. Within the harbor, 
actuaries and plan sponsors may use the elemental actuarial building 
blocks much as a sailor uses the tiller and the positions of sails to 
guide a boat. As long as the boat neither runs aground nor heads out to 
the open sea, the Coast Guard can rest easy.
    The public must choose its measures of sufficiency and excess very 
carefully. Although setting the levels will be inherently political, 
the liability measure should be financially sound, transparent, and 
objective. Discounting the cash flows implied by benefit accruals to 
date at the Treasury yield curve meets these tests. Once set, the 
measures should be administered with minimal discretion and subjected 
to minimal political interference. Most of the political debate should 
be focused on setting the heights of the lower (sufficient) and upper 
(excessive) bars, each defined in terms of the ratio of market-valued 
assets to the objective liability measure.
    Suppose, and I really mean this as an example and not as a 
recommendation, that the lower bar is set at 100% and that any 
shortfall must be one-third funded currently. The shortfall has no 
history and no amortization schedule. If the plan is three million 
dollars short, the sponsor must fund one million dollars currently 
regardless of whether it was underfunded or overfunded last year. There 
is no schedule for the other two million. If the plan remains 
underfunded next year, the sponsor must contribute one-third of the 
shortfall determined at that time. I would expect PBGC premiums to be 
collected from all qualified plans with a basic per-capita amount for 
plans that are sufficiently funded and increased amounts for plans in 
shortfall. Shortfall plans might be further restricted from making 
benefit increasing amendments.
    The tradeoff for the rigorous attack on poorly funded plans is the 
freedom offered to the great majority of well-funded plans. This 
combination should provide substantial incentive to sponsors to manage 
the asset/liability positions of their plans prudently as well as to 
exercise caution in granting benefit increases.
    Suppose, again as an example not a recommendation, the upper bar is 
set at 150%. The sponsor of a plan that is one million dollars short of 
this ceiling would be permitted to contribute and deduct one million 
dollars if it desired. From the public perspective, it seems to me that 
plans funded above the upper bar should be free to recoup such excess 
funding without excise taxes and without strings on the redeployment of 
such monies (after payment of appropriate income taxes). The IRS may 
want to limit this practice for companies that appear to be taking 
undue advantage.
    The initial bar-setting process may be as technically complicated 
and as political as the public will choose to demand/tolerate. Congress 
will be the arena for the bar-setting process; the regulatory agencies 
will administer that which Congress devises. Congress might choose to 
assign authority for lower-bar issues to the DOL and the PBGC and 
upper-bar issues to the IRS.
    An example of a technical, complicating issue that lies within the 
initial process: those who share my financial economics perspective may 
want the lower bar to be set to recognize the nature of the plan's 
asset/liability mismatch. Plans invested in a liability-matching 
fashion might have a lower bar set at 95%, while poorly matched plans 
might face a bar set at 115%.
    A second example: if Congress is concerned about tax losses 
attributable to excessive inside build-up as well as excessive 
contributions, they may wish to define an upper-upper bar above which 
funds would be mandatorily reverted and taxed. Congress may also deem 
it necessary to limit tax deductions for small plans that principally 
serve as tax shelters for owner-employees or other narrow groups.
    I have tried to suggest a practical response to the Segal-Manning 
plea for sanity. The success of such a simplification scheme requires 
that:

         The basis for liability measurement be scientific, 
        objective and market oriented. The thumb should be off the 
        scale with respect to measurement.
         Setting the levels of the lower and upper bars should 
        be as simple as possible, but no more so.

    Looking beyond the immediate and practical, I hope that the inner 
harbor will provide substantial room for pension actuarial science to 
evolve, free of much of the regulation that has stunted its growth over 
the last three decades. We really do need to revisit and revitalize our 
science.

                                 

                      Statement of March of Dimes

    On behalf of 1,500 staff and over 3 million volunteers nationwide, 
thank you for the opportunity to submit the March of Dimes' views on 
funding challenges being faced by the employer-sponsored defined 
benefit pension system. The March of Dimes is a nonprofit organization 
working to improve the health of mothers, infants and children by 
preventing birth defects and infant mortality through research, 
community services, education, and advocacy. Of relevance to this 
hearing, the March of Dimes sponsors a defined benefit pension plan for 
its employees, which serves as an important tool for attracting and 
retaining high-caliber employees who are committed to the mission of 
the March of Dimes. If retirement plans such as the March of Dimes 
defined benefit plan are to remain viable as a long-range planning tool 
providing retirement income security for current and future employees, 
Congress must take quick action to relieve the very real funding 
pressures now faced by these plans.
    Congress has long recognized the importance of helping Americans 
achieve retirement income security, and defined benefit plans, in 
particular, offer a number of features that are critical components of 
retirement security. Under defined benefit plans, benefits are 
generally funded by the employers and the employer bears the investment 
risk that plan assets will be adequate to pay benefits earned under the 
plan. Importantly, benefits are offered in the form of a life annuity, 
which protects participants and their families against the risk of 
outliving their retirement income.
    Like many other employers, the March of Dimes is concerned about 
funding pressures that are straining the stability of the nation's 
defined benefit pension system. One of the primary sources of this 
funding pressure is tied to the required use of an obsolete interest 
rate--the 30-year Treasury bond rate--as the benchmark for a variety of 
pension calculations, including those involving pension liabilities, 
pension insurance premiums, and lump-sum distribution calculations. 
Fortunately, there are positive steps that Congress can take to address 
these funding pressures and enable employers, including the March of 
Dimes, to provide financially sound pension programs. First and 
foremost, there is an urgent need to enact a permanent and 
comprehensive replacement for the 30-year Treasury bond rate, which can 
be achieved by promptly enacting the provision included in the Pension 
Preservation and Savings Expansion Act (H.R. 1776), recently introduced 
by Representatives Portman and Cardin. Their proposal offers a balanced 
and carefully structured solution to a complicated and urgent pension 
funding problem. The March of Dimes commends their leadership in 
offering a bipartisan and workable solution to this pressing matter, 
and we urge Congress to act quickly to provide this relief to defined 
benefit plans and to protect the pensions of current and future plan 
participants.

Conclusion
    Mr. Chairman and Ranking Member McNulty, thank you for calling this 
hearing to explore this important retirement policy question, and for 
your efforts to find a solution to the defined benefit funding crisis 
that will enable American workers now and in the future to benefit from 
the unique advantages of defined benefit pension plans.

                                 

                                                            Mayo Clinic
                                                   Washington, DC 20036
                                                           May 12, 2003

    On behalf of Mayo Clinic I am submitting this statement for the 
hearing record. Mayo Clinic is a multi-specialty integrated medical 
group practice, with clinics and hospitals in Minnesota, Florida, 
Arizona, Wisconsin, and Iowa. We are a not-for-profit organization, 
dedicated to the missions of patient care, education, and research.
    Like many other large employers, Mayo has a defined-benefit pension 
plan available to substantially all our employees. The plan currently 
covers about 34,600 current employees and 3,200 retirees. The use of 
the 30-year Treasury Bond as a benchmark for calculating future 
liabilities is creating a short-term funding problem that has required 
significant contributions to the fund in the past year, and will 
require even greater contributions over the next few years. While we 
are committed to adequate funding of our pension plan, the current 
liability valuation methodology based on the 30-year bond is creating a 
short term funding crisis for pension plan sponsors across the country 
and deserves correction. We need a more realistic valuation methodology 
that appropriately considers the long-term nature of pension 
liabilities and the true investment return plan sponsors like Mayo can 
expect in funding them.
    While many large corporations are in positions similar to ours, we 
want to note for the subcommittee that this is a problem that 
significantly affects not-for-profit organizations as well. 
Contributions to the pension plan come out of the funds otherwise used 
to fund our tax-exempt missions of patient care, education and 
research. Thus, a smoother and more predictable schedule of pension 
contributions is extremely important in assuring uninterrupted 
education and research activities.
    We therefore urge the subcommittee to consider legislation to 
correct the current valuation methodology for determining pension 
liabilities. At a minimum, the current temporary provision should 
remain in place while a permanent solution can be determined--one that 
will allow a more stable and predictable schedule of contributions over 
time.
    Thank you for your attention to this important issue.
                                                             Sincerely,

                                                         Bruce M. Kelly
                                       Director of Government Relations

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