[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]
STRENGTHENING PENSION SECURITY AND DEFINED BENEFIT PLANS: EXAMINING
THE FINANCIAL HEALTH OF THE PENSION BENEFIT GUARANTY CORPORATION
=======================================================================
HEARING
before the
COMMITTEE ON EDUCATION
AND THE WORKFORCE
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
__________
September 4, 2003
__________
Serial No. 108-29
__________
Printed for the use of the Committee on Education and the Workforce
Available via the World Wide Web: http://www.access.gpo.gov/congress/
house
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COMMITTEE ON EDUCATION AND THE WORKFORCE
JOHN A. BOEHNER, Ohio, Chairman
Thomas E. Petri, Wisconsin, Vice George Miller, California
Chairman Dale E. Kildee, Michigan
Cass Ballenger, North Carolina Major R. Owens, New York
Peter Hoekstra, Michigan Donald M. Payne, New Jersey
Howard P. ``Buck'' McKeon, Robert E. Andrews, New Jersey
California Lynn C. Woolsey, California
Michael N. Castle, Delaware Ruben Hinojosa, Texas
Sam Johnson, Texas Carolyn McCarthy, New York
James C. Greenwood, Pennsylvania John F. Tierney, Massachusetts
Charlie Norwood, Georgia Ron Kind, Wisconsin
Fred Upton, Michigan Dennis J. Kucinich, Ohio
Vernon J. Ehlers, Michigan David Wu, Oregon
Jim DeMint, South Carolina Rush D. Holt, New Jersey
Johnny Isakson, Georgia Susan A. Davis, California
Judy Biggert, Illinois Betty McCollum, Minnesota
Todd Russell Platts, Pennsylvania Danny K. Davis, Illinois
Patrick J. Tiberi, Ohio Ed Case, Hawaii
Ric Keller, Florida Raul M. Grijalva, Arizona
Tom Osborne, Nebraska Denise L. Majette, Georgia
Joe Wilson, South Carolina Chris Van Hollen, Maryland
Tom Cole, Oklahoma Tim Ryan, Ohio
Jon C. Porter, Nevada Timothy H. Bishop, New York
John Kline, Minnesota
John R. Carter, Texas
Marilyn N. Musgrave, Colorado
Marsha Blackburn, Tennessee
Phil Gingrey, Georgia
Max Burns, Georgia
Paula Nowakowski, Staff Director
John Lawrence, Minority Staff Director
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C O N T E N T S
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Page
Hearing held on September 4, 2003................................ 1
Statement of Members:
Boehner, Hon. John A., a Representative in Congress from the
State of Ohio.............................................. 2
Prepared statement of.................................... 3
Miller, Hon. George, a Representative in Congress from the
State of California........................................ 4
Statement of Witnesses:
Kandarian, Steven A., Executive Director, Pension Benefit
Guaranty Corporation, Washington, DC....................... 53
Prepared statement of.................................... 55
Walker, David M., Comptroller General of the United States,
U.S. General Accounting Office, Washington, DC............. 8
Prepared statement of.................................... 11
Additional materials supplied:
Pagon, Alex, National Taxpayers Union Foundation, Policy
Paper on ``The Next Big Bailout? How Underfunded Pensions
Put Taxpayers at Risk.'', submitted for the record......... 72
U.S. General Accounting Office, Graphs Submitted for the
Record..................................................... 71
STRENGTHENING PENSION SECURITY AND DEFINED BENEFIT PLANS: EXAMINING THE
FINANCIAL HEALTH OF THE PENSION BENEFIT GUARANTY CORPORATION
----------
Thursday, September 4, 2003
U.S. House of Representatives
Committee on Education and the Workforce
Washington, DC
----------
The Committee met, pursuant to notice, at 10:40 a.m., in
room 2175, Rayburn House Office Building, Hon. John A. Boehner
(Chairman of the Committee) presiding.
Present: Representatives Boehner, Ballenger, McKeon,
Johnson, Biggert, Platts, Tiberi, Osborne, Carter, Porter,
Musgrave, Blackburn, Burns, Miller, Kildee, Owens, McCarthy,
Tierney, Grijalva, Majette, Van Hollen, and Bishop.
Staff present: David Connolly, Jr., Professional Staff
Member; Stacey Dion, Professional Staff Member; Chris Jacobs,
Staff Assistant; Ed Gilroy, Director of Workforce Policy;
Christine Roth, Workforce Policy Counsel; Jo-Marie St. Martin,
General Counsel; Kevin Smith, Senior Communications Counselor;
Kevin Frank, Professional Staff Member; and Deborah Samantar,
Committee Clerk/Intern Coordinator. Michele Varnhagen, Minority
Labor Counsel/Coordinator; Mark Zuckerman, Minority General
Counsel; Ann Owens, Minority Clerk; and Daniel Weiss, Minority
Special Assistant to the Ranking Member.
Chairman Boehner. A quorum being present, the Committee on
Education and the Workforce will come to order. We're holding
this hearing today to hear testimony on strengthening pension
security and defined benefit plans, and examining the financial
health of the Pension Benefit Guaranty Corporation (PBGC).
Under Committee Rule 12(b), opening statements are limited
to the Chairman and the Ranking Member of the Committee.
Therefore, if other Members have statements, they will be
included in the record. And with that, I ask unanimous consent
for the hearing record to remain open for 14 days to allow
Members' statements and other extraneous material referenced
during the hearing to be submitted for the official hearing
record. Without objection, so ordered.
STATEMENT OF THE HON. JOHN A. BOEHNER, CHAIRMAN, COMMITTEE ON
EDUCATION AND THE WORKFORCE
I want to welcome all of you here today, and thank our
distinguished witnesses for coming to testify on this very
important subject. Strengthening the pension security of
American workers is a top priority for this Congress, and
today's hearing is the third in a series held by the Education
and the Workforce Committee that examines the future of defined
benefit plans.
Today's defined benefit system is in a very precarious
state. The number of employers offering defined benefit pension
plans has declined from 112,000 in 1985 to just more than
30,000 last year. More and more employers are freezing or
terminating their defined benefit plans, and either shifting to
401(k) defined contribution plans, or stop offering pension
plans to their workers altogether.
This situation is exacerbated by the fact that the
financial health of defined benefit plans, and the Federal
agency that insures them, the Pension Benefit Guaranty
Corporation, are in jeopardy. On July 23rd, the General
Accounting Office announced that it was including the PBGC on
its list of ``high risk'' programs that require additional
Federal oversight, noting that there are structural problems in
the defined benefit pension system that are jeopardizing the
financial health of the agency.
As we all know, over the last year the PBGC has been forced
to assume the obligations of paying out basic pension benefits
for several large pension plans, and the agency's surplus has
quickly evaporated. During Fiscal Year 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
over a year. And as of April, that burden has grown to now $5.4
billion, the largest in agency history.
The cause of the deficit is no secret. There have been a
number of companies in the steel and airline industries that
have gone bankrupt and PBGC has been forced to take over their
unfunded pension plans. To make matters worse, according to the
PBGC there is an additional $35 billion in unfunded pension
benefits among financially weak companies that are looming on
the horizon, pension benefits that may eventually, I want to
reiterate, may eventually become the PBGC's responsibility.
Although the agency has enough resources to make benefit
payments for the near future, this poses a serious question of
whether a taxpayer bailout of the PBGC would be necessary if
the financial condition of the agency continues to deteriorate.
It's another reason why we are exploring this issue. More than
a decade ago, the Federal Government stepped in to bail out the
savings and loan industry (S&L) at the cost of billions of
dollars. According to the Federal Deposit Insurance Corporation
(FDIC), the bailout cost taxpayers approximately $124 billion.
While there are some obvious differences between the savings
and loan bailout and the problems of defined benefit plans,
it's important that we work to prevent another S&L-type bailout
that saddles hard-working taxpayers with a tab for billions of
dollars. The alarming trend of underfunded defined benefit
plans we see today only increases the pressure on the PBGC,
threatening its ability to protect and insure worker pension
benefits and putting taxpayers' interests in real jeopardy.
While the financial condition of the PBGC certainly looks
dire at the moment, we must also remember that the agency has
been in deficit before. In fact, just over a decade ago, the
agency was similarly designated ``high risk'' by the GAO. And
the PBGC was taken off the list after its financial health
improved, largely because of stock market gains and the
improvement in our economy. Our goal, however, is not a PBGC
whose financial condition is contingent on the state of the
economy, but an agency that is on sound financial footing so
that it can, in fact, meet its goal of protecting the pension
benefits of American workers who have defined benefit plans.
Earlier this March, Congressman Johnson and I requested
that the GAO study the PBGC and assess why the agency had
accumulated such a significant deficit, and determine what
other liability risks the agency faces. I am pleased that David
Walker is here today to present some of the agency's findings.
I am also pleased that Steven Kandarian is here to discuss the
current financial condition of the agency, and the impact it
has on workers and their benefits.
With more struggling companies facing severe underfunding
problems in their pension plans, the financial health of the
PBGC has become an even more critical issue for millions of
workers who rely on defined benefit plans. We need to ensure
that workers have as many retirement security choices available
to them as possible. Strengthening the PBGC will enhance the
retirement security of millions of working families who rely on
the safe and secure benefits that defined benefit pension plans
provide.
I am looking forward to working with the Administration and
my colleagues on the Committee on this issue as we move ahead.
[The prepared statement of Chairman Boehner follows:]
Statement of Hon. John A. Boehner, Chairman, Committee on Education and
the Workforce
I'd like to welcome everyone and thank our distinguished witnesses
for coming to testify on this very important subject. Strengthening the
pension security of American workers is a top priority for this
Congress, and today's hearing is the third in a series held by the
Education & the Workforce Committee that examines the future of defined
benefit pension plans.
Today's defined benefit system is in a precarious state. The number
of employers offering defined benefit pension plans has declined from
112,000 in 1985 to just more than 30,000 last year. More and more,
employers are freezing or terminating their defined benefit plans and
either shifting to 401(k) defined contribution plans or stop offering
pension plans to their workers altogether.
This situation is exacerbated by the fact that the financial health
of defined benefit plans and the federal agency that insures them, the
Pension Benefit Guaranty Corporation, are in jeopardy. On July 23, the
General Accounting Office announced that it was including the PBGC on
its list of ``high-risk'' programs that require additional federal
oversight, noting that there are structural problems in the defined
benefit pension system that are jeopardizing the financial health of
the agency.
As we all know, over the last year the PBGC has been forced to
assume the obligations of paying out basic pension benefits for several
large pension plans, and the agency's surplus has quickly evaporated.
During fiscal year 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. And as of April, that burden had grown
to $5.4 billion, the largest in agency history.
The cause of this deficit is no secret. There have been a number of
companies in the steel and airlines industries that have gone bankrupt
and the PBGC has taken over their underfunded pension plans. To make
matters worse, according to the PBGC there is an additional $35 billion
in unfunded pension benefits among financially weak companies looming
on the horizon--pension benefits that may eventually become the PBGC's
responsibility.
Although the agency has enough resources to make benefit payments
for the near future, this poses a serious question of whether a
taxpayer bailout of the PBGC would be necessary if the financial
condition of the agency continues to deteriorate. And that is another
reason we are exploring this issue. More than a decade ago, the federal
government stepped in to bail out the savings and loan industry at the
cost of billions of dollars. According to the Federal Deposit Insurance
Corporation (FDIC), the bailout cost taxpayers approximately $124
billion. While there are some obvious differences, it is important that
we work to prevent another S&L-style bailout that saddles hard-working
taxpayers with a tab for billions of dollars. The alarming trend of
underfunded defined benefit plans we see today only increases the
pressure on the PBGC, threatening its ability to protect and insure
worker pension benefits and putting taxpayers'' interests in real
jeopardy.
While the financial condition of the PBGC certainly looks dire at
the moment, we must also remember that the agency has been in deficit
before. In fact, just over a decade ago, the agency was similarly
designated ``high risk'' by GAO. The PBGC was taken off the list after
its financial health improved, largely because of stock market gains
and an improved economy. Our goal, however, is not a PBGC whose
financial condition is contingent on the state of the economy, but an
agency that is on sound financial footing so that it can protect the
pension benefits of American workers who have defined benefit plans.
Earlier this March, Sam Johnson and I requested that GAO study the
PBGC, assess why the agency had accumulated such a significant deficit,
and determine what other liability risks that the agency faces. I am
pleased that David Walker is here to present some of the agency's
findings at today's hearing. I am also pleased that Steve Kandarian is
here to discuss the current financial condition of the agency, and the
impact it has on workers and their benefits.
With more struggling companies facing severe underfunding problems
in their pension plans, the financial health of the PBGC has become an
even more critical issue for millions of workers who rely on defined
benefit plans. We need to ensure that workers have as many retirement
security choices available to them as possible. Strengthening the PBGC
will enhance the retirement security of millions of working families
who rely on the safe and secure benefits that defined benefit pension
plans provide.
I look forward to working with the administration and my colleagues
on this issue as we move ahead.
______
Chairman Boehner. Let me now yield to my colleague and
friend, the gentleman from California, Mr. Miller.
STATEMENT OF THE HON. GEORGE MILLER, RANKING MINORITY MEMBER,
COMMITTEE ON EDUCATION AND THE WORKFORCE
Mr. Miller. Thank you very much, Mr. Chairman, and thank
you for convening this hearing on what I consider a most
important matter, and I'm sure many of our colleagues share
that belief.
For over a year, the Bush administration has repeatedly
ignored our urgent request to wake up to the serious problem of
pension underfunding. For example, I wrote the administration
in July of 2002 to take action when the pension deficits
skyrocketed from $26 billion to over $100 billion, and we heard
nothing.
Now, over a year later, the problem is worse and festering.
As the PBGC will testify, the pension plans are now $400
billion in the red nationally, and the largest liability in
history, and the PBGC is reporting a $5.7 billion deficit as of
July 31st. The administration's failure to take decisive action
on pensions, its failed economic policy, and its utter neglect
of our manufacturing industries have together precipitated the
largest underfunding of private pensions in history.
Today, hard-working Americans are already taking it on the
chin. Three million private-sector workers have lost their jobs
since 2001, the long-term unemployed have been left to fend for
themselves when their extended unemployment benefits have run
out, workers in the manufacturing sectors have seen their jobs
vanish overseas, not to return, and their industry is ignored
by the Bush administration's economic policies.
Working families have already lost billions in
irreplaceable life savings in their 401(k) plans as the stock
market crumbled and corporate abuse ran rampant. Pensions of
millions of Americans are threatened by the administration's
cash balance proposals, which may cost older workers up to
half--half--of their expected pension benefits.
Mr. Chairman, as you know, the GAO is very concerned about
the conditions of the private pensions and the strength of the
agency that is responsible for guaranteeing those pensions. In
July it was announced that it had placed the PBGC on a list of
Federal programs that are ``high risk'' for failure.
Today, the GAO in its analysis further makes clear that our
pension rules are clearly broken and in need of reform. Some of
the biggest companies that PBGC has taken over or on the
pension watch list have been able to exploit pension rules
riddled with loopholes and escape hatches. Over the past few
years, companies have been permitted to publish their annual
reports of rosy financial pictures about their pensions, while
at the same time running the plan into the ground through
reductions and freezes in pension contributions. Conflicts
between company managers push for bottom line and the plan's
obligations to protect the participants clearly compromise the
safe and sound pension practices at many companies.
Worse still, current law allows a plan's real financial
condition to be kept secret from workers and investors. This
failure of accountability and transparency has eerie
similarities to the Enron debacle, while the CEO's were able to
jump ship without even alerting the rank-and-file employees the
ship was going down.
Today, Congressman Doggett and I will introduce legislation
to open up these reports--referred to as the 4010 forms--to
public scrutiny. There must be transparency and accountability
for billions of dollars promised to hard-working employees. The
administration now says it supports the publication of these
secret rules, and my understanding is that PBGC is working
toward that effort. And we welcome that.
But we also know that a request by the full Committee is a
means by which we can get this material to the Committee. Now,
I have made that request as the Ranking Member, and have been
told it must come from the full Committee. I hope that the full
Committee will join us in that request so that we can start the
process of creating transparency and information that employees
and pensioners are entitled to.
As overdue as this hearing is, it is still an important
one, and I thank you for calling it, for our Committee and for
the Congress. But it will be meaningless if the recommendations
for change that will be discussed today are ignored and that
Congress opts instead for a quick fix that will likely mask and
the only deepen the problems of unfunded pension liabilities.
In July, the Ways and Means Committee and the
administration proposed to scrap the 30-year treasury rate as
an index for calculating the interest on future pension
liabilities. They propose we jury-rig a new formula that by one
estimate will cut pension contributions for the first 3 years
by some $50 annually. This is in the system that has historic
debts and historic contingent liabilities, and we're now
talking about a major retreat in contributions to be made at
the same time.
I am concerned about this approach. I am concerned that it
will drive pension deficits higher. It was devised without the
input of the PBGC and without the understanding of how it would
impact on PBGC and its rising deficit. It was devised without
the understanding of what it would mean to the future premium
contribution hikes and liability claims. And it was devised
without telling the taxpayers whether it would put them on the
hook for billions of dollars of catastrophic claims that PBGC
can't pay.
And even more irresponsibly, the backers of this approach
are urging Congress to support the proposals without addressing
the real causes of pension underfunding detailed in the GAO
report that you have requested.
In mid-July, I requested the PBGC provide me the detailed
analysis of these proposals. I specifically asked what effects
these proposals would have on the short and long-term pension
underfunding on PBGC's, at that time, $3.6 billion deficit, and
on the premiums required to the fund's operations. The PBGC
apparently doesn't have a clue at this time.
It appears that no one from the administration ever asked
the PBGC to look at this before it made this proposal. I was
promised this information for today's hearing, and we still
don't have it. I think this Committee should be very concerned
about this administration appears to have not done its homework
when billions of hard-earned retirement benefits are at stake.
The administration must stop dithering and get on about
pension reform.
Its neglect of the manufacturing industry, its
mismanagement of our economy has resulted in devastating job
loss for millions of employees, and now threatens the nest eggs
for millions of other Americans. Creating one new job in the
Commerce Department is hardly the adequate response. It is a
blind eye to the of the baby boomers retiring in the next 10 to
15 years, to the chronic underfunding of plans, to the
exploding PGBC deficits, and is negligent and it is
irresponsible by the administration.
The American people's anxiety about the future of their
retirement is highly justified in light of this
administration's failure to seriously address the underlying
problems of our pension system. The administration and this
Committee have an obligation to get serious about retirement
security and to develop real solutions that will do more than
paper over the critical pension underfunding.
I know that some people have suggested that this thirty-
year bond fix is just temporary. That we can fix it in 3 years
from now. Well, those are the same people who gave us the tax
cuts with sunsets and suggested we could just raise those taxes
3 years from now, or 4 years from now. It is simply not
realistic in the political climate in this country, or the
position of this administration, or the concerns about the
corporations, about increasing those costs at that time.
I would also say that I think that this hearing takes on
additional urgency with respect to the American people with the
actions that were taken yesterday by Ella Spitzer. And that is
the people, we have been told, that 60 percent of the American
families own stock. They own it through their pension plans,
and most of that is in mutual funds. And now we see that some
of the great names in the American financial institutions are
once again gaming--gaming the buying and selling of mutual
funds for their own private personal benefit to the detriment
of the pension plans that hold those mutual funds.
We need transparency, and we need it now. And we need it in
mutual funds, we need it in pension funds, we need it in the
PBGC. The American worker is entitled to this, and they must
have this. And they must have it now. They have seen the three-
legged stool of the 401(k) plan, their pension plans,
threatened, in some cases devastated, in some cases wiped out.
And this comes from the same people--the ignoring of this
problem comes from the same people who are suggesting that the
next operation is to simply have every American have a little
voucher, go into the mutual fund system for themselves.
Well we've already seen now that the big boys are playing
the mutual funds in a far different way. So now on every front
where Americans have planned for their retirement, for their
nest egg, for taking care of their future, for taking care of
their children and their grandchildren. On every front, their
assets are now under assault. On every front, their assets are
now at greater risk now than they were a year ago, 2 years ago,
or 3 years ago.
And yes, we understand the impact of the economy on that.
But we cannot have a system that is just at the whim of the
economy and/or the stock market. They're entitled to a stable
system that they know that they can count on, that they can
plan ahead for when they're 50, when they're 55, when they're
60, when they're 62, and they're 65. Today an American worker
cannot do that. They cannot do that. They cannot be assured of
where they will be in the future with their retirement nest
eggs. This Congress owes them better.
And I thank you again, Mr. Chairman, for holding this
hearing. It has been a long time coming. But it's urgent, and
the information that we will receive today I think will make
even additional hearing urgent in this matter with respect to
our obligation to the American people. Thank you.
Chairman Boehner. Thank you for your opening statement, Mr.
Miller. I appreciate your optimism.
Mr. Miller. Hey, with this hearing, it's looking up.
Chairman Boehner. We have a distinguished panel with us
today, and it's my pleasure to introduce them. Our first
witness will be Mr. David Walker. Mr. Walker began his 15-year
term as the seventh Comptroller General of the United States in
November 1998. Prior to his appointment, Mr. Walker had
extensive executive-level experience in both government and
private industry, and we're glad that you're with us.
Our second witness will be Mr. Steven Kandarian. He is the
Executive Director of the Pension Benefit Guaranty Corporation,
a self-financing government corporation that provides insurance
for defined benefit pension plans nationwide. The PBGC
administers two insurance programs covering more than 44
million workers in about 32,500 plans. And as executive
director, Mr. Kandarian is responsible for the corporation's
operations that involve assets of more than $25 billion,
benefit payments of more than $1.5 billion, and benefit
obligations to some 783,000 workers and retirees in more than
3,100 pension plans.
Mr. Kandarian comes to the PBGC with extensive experience
in financial asset management, investment banking, and
government regulation. And prior to joining the PBGC, he was a
founder and managing director of Orian Partners, L.P., managing
director of Lee Capital Holdings, and an investment banker with
Rotan Mosul, Inc., from Houston, Texas.
So with that, we want to welcome both of you to this
hearing today, and I see that we have votes on the House floor.
I think what would be in the best interest of the witnesses and
the continuity of this hearing is that the Members go vote now.
We have how many votes? We have two votes, and so for
everyone's purpose, we will be back and resume in approximately
30 minutes. Committee will stand in recess.
[Recess.]
Chairman Boehner. The Committee will come to order. Let me
apologize to our distinguished witnesses and all of the members
of the audience for our delay. Welcome to the U.S. House. With
that, Mr. Walker, you can begin your testimony.
STATEMENT OF DAVID M. WALKER, COMPTROLLER GENERAL OF THE UNITED
STATES, U.S. GENERAL ACCOUNTING OFFICE, WASHINGTON, D.C.
Mr. Walker. Mr. Chairman, Mr. Miller. It's a pleasure to be
before you today in order to talk about the financial condition
of the PBGC and related retirement income security issues.
As you know, Mr. Chairman, this is an issue that I have had
a longstanding interest in while proudly serving as Comptroller
General of the United States. For Members of the Committee, I
was Deputy Executive Director and then Acting Executive
Director of the PBGC from 1983 to 1985, and I was Deputy
Assistant Secretary and then Assistant Secretary of Labor from
1985 until 1989. And so the issue of retirement income security
in general and PBGC in particular is one of longstanding
interest to me.
With regard to the issue at hand, as you mentioned, Mr.
Chairman, GAO designated the single-employer insurance program
within the PBGC as being added to our high-risk list in July of
this year. We did it off cycle. We normally just update that
list every 2 years in January of the odd year. In this
particular case, we took not an unprecedented action, but a
non-frequent action, and that was to add it off cycle.
The reason that we added the PBGC single-employer insurance
program is several-fold. Number one, it is a very important
program to millions of American workers and retirees. Number
two, there are significant potential exposures to the American
taxpayer. Number three, the PBGC had gone from a roughly $10
billion accumulated surplus to roughly a $5 billion accumulated
deficit in less than 2 years. Number four, the degree of
underfunding in the defined benefit plan universe had increased
dramatically.
It is my understanding that Executive Director Kandarian is
going to say that they estimate it is about $350 billion today.
And the so-called watch list, or the higher-risk list for the
PBGC, has increased, as I understand Executive Director
Kandarian is going to say, to about $80 billion. Furthermore,
if you analyze the risk that the PBGC faces, it faces a large
and disproportionate degree of risk in industries that are
affected by increasing global and domestic competition that are
very much disproportionately affected by the transition from
the industrial age to the knowledge age.
As a result, we believe there are serious issues that need
to be addressed. There are a number of parties that say that we
ought to take a wait-and-see attitude here. And it is true that
the PBGC has over $25 billion in assets, and therefore there is
not an immediate crisis. It has enough assets and investments
to be able to pay benefits on a timely basis for a significant
period of time.
However, based upon our analysis, and as noted in my
testimony, we believe that there are certain structural
problems that call for reform. And if I can, Mr. Chairman, I
want to use Bethlehem Steel as a case study to illustrate some
of those problems. And this is a matter of public record. As
you know, Bethlehem Steel has been terminated. It represents
one of the largest terminations in the history of PBGC. But I
think it illustrates some of the systemic problems that we need
to deal with.
The first board, which is also in my testimony,
demonstrates how the funding percentage, or the funding ratio
of Bethlehem Steel declined dramatically in the last several
years. And that would be the solid black line. If you look at
the dark gray bar, that represents liabilities. If you look at
the white bar, that represents assets. We all know that there
was a significant decline in the stock market over the last
several years, combined with a dramatic decline in interest
rates. The result of that was lower asset values, higher
liability costs, and the funding percentage declined
dramatically.
But what's interesting is the following two. Next, please.
Despite the fact that there was a dramatic decline in the
relative funding status of this plan, Bethlehem Steel did not
make, nor was it required to make, under the current minimum
funding requirements in Federal law, any contribution to its
pension plan for the years 2000, 2001, or 2002.
The second chart after this makes another point. And that
is that despite the fact that it obviously represented a
significant risk to the PBGC, not solely because of the funding
status of the plan, but because of the financial condition of
the sponsor, because of a number of other factors, it did not
pay any variable rate or risk-related premiums from 1998
forward. How can this be?
Now, there are a number of other factors associated with
Bethlehem Steel, such as the fact that they have a number of
very lucrative early retirement benefits that can be triggered
by a plant shut-down or a significant lay-off that exist as
well, and, frankly, was probably one of the reasons why PBGC
took the decision to terminate it involuntarily in order to
avoid additional losses on the insurance system. But to me,
Bethlehem Steel illustrates a broader systemic issue.
We have got some fundamental systemic challenges that need
to be addressed. And if I can, Mr. Chairman, just quickly, and
then I'll turn it over to Executive Director Kandarian. There
are several areas where we believe additional action is
necessary as outlined in my testimony. Not only to assure the
adequacy of the current system, but also as a matter of equity
to plan sponsors and as a matter of retirement security for
American workers and retirees.
First, there needs to be additional transparency in order
to provide checks and balances to try to encourage sponsors who
have poorly funded plans to fund their plans and additional
transparency in the area of the funding status, plan
investment, and PBGC guarantee limits.
Second, the minimum funding requirements need to be
reviewed and hopefully strengthened, where they focus on
underfunded plans that represent a real risk. And with
consideration of cash-flow, what the cash flow is with regard
to the plans, and also potentially the waiver provisions.
Number three, consideration should be given to modifying
the full funding limits to provide additional flexibility for
sponsors with plans that are underfunded or not well funded, to
be able to make more contributions in good times, because they
may not have the ability to make better contributions in bad
times.
Number four, the PBGC program guarantees, and its variable-
rate insurance premium structure needs to be reviewed and
possibly revised. For example, the basis under which so-called
``shutdown benefits'' are insured, whether or not the phase-in
should begin as the guarantee as of the date of the shutdown,
or the layoff, versus when it was put into the plan, needs to
be reviewed and considered. Also issues such as the variable
rate premium need review to base the variable rate premium more
on real risk, not just the funding status of the plan.
And last, other possible reforms, dealing with issues such
as whether or not there ought to be additional restrictions on
the benefit increases when plans are significantly underfunded,
additional restrictions on the ability to get lump sums, which
could create a run on the bank, and whether or not we ought to
close down so-called floor offset arrangements, which in
substance allow plan sponsors to have significant investments
in employer securities and circumvent the ERISA requirements
for diversification when there are defined-benefit promises
involved.
In summary, Mr. Chairman, Mr. Miller and other Members of
the Committee, PBGC faces a serious challenge. There is not an
immediate crisis. However, there are systemic problems which we
believe call for reform. This is not just an issue of PBGC's
financial condition. It's an issue of retirement security for
American workers and retirees. And we look forward to working
with this Committee and the Congress to try to address these
issues. Thank you, Mr. Chairman.
[The prepared statement of Mr. Walker follows:]
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Chairman Boehner. Mr. Walker, thank you very much for your
testimony. We appreciate your willingness to come today and all
of the efforts of the GAO to help us get the substance of what
really is a longer-term problem that this Committee will
address.
Mr. Kandarian, you may begin.
STATEMENT OF STEVEN A. KANDARIAN, EXECUTIVE DIRECTOR, PENSION
BENEFIT GUARANTY CORPORATION, WASHINGTON, D.C.
Mr. Kandarian. Mr. Chairman, Ranking Member Miller, Members
of the Committee. Thank you for holding this hearing on pension
funding and the financial health of PBGC.
Defined benefit pension plans continue to be important for
the retirement security of millions of Americans. But recently,
there has been a sharp deterioration in plan funding. When
underfunded plans terminate, three groups can lose.
Participants lose when their benefits are reduced, other
businesses lose if premiums go up, and ultimately, taxpayers
lose if Congress calls on them to support PBGC.
In July, the Administration proposed improving the ways
pension liabilities were calculated, increasing the
transparency of pension funding, and providing new safeguards
against underfunding by financially troubled companies. The
Administration also called for funding reforms. In addition to
urging the Committee to act upon these important measures, my
testimony today will focus on PBGC's financial condition, plan
underfunding and some of the challenges facing the defined
benefits system.
During Fiscal Year 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 1 year. Based on
our latest unaudited financial report, the deficit has grown to
$5.7 billion as of July 31, 2003. As David Walker has just
testified, GAO recently placed PBGC's single-employer insurance
program on its high-risk list. My hope is that GAO's high-risk
designation will spur reforms to better protect the retirement
security of American workers.
As of December 31, 2000, total underfunding in single-
employer plans was less than $50 billion. Because of declining
interest rates and equity values, as of December 31, 2002, 2
years later, underfunding exceeded $400 billion; the largest
number ever recorded. Even with recent rises in the stock
market and interest rates, PBGC projects the underfunding still
exceeds $350 billion today.
Because large plans typically invest more than 60 percent
of their assets in equities, there is a mismatch between
pension assets and pension liabilities, which tend to be bond-
like in nature. With the market conditions over the last 3
years, this asset/liability mismatch caused many plans to
become significantly underfunded.
In addition to massive underfunding and vulnerability to
equity market volatility, the defined benefits system faces
other serious challenges, including adverse demographic trends
and weaknesses in the pension-funding rules. While each of
these challenges is discussed in my written testimony, given
time constraints I will focus on four key weaknesses in the
funding rules.
First, the funding targets are set too low. Employers will
stop making contributions when the plan is funded at 90 percent
of current liability, a measure that reflects past legislative
compromises, not the amount of money needed to pay all benefit
liabilities if a plan terminates. As a result, employers can
stop making contributions before a plan is sufficiently funded
to protect participants.
In its last filing prior to termination, Bethlehem Steel
reported that it was 84 percent funded on a current liability
basis. At termination, the plan was only 45 percent funded on a
termination basis, with total underfunding of $4.3 billion.
Similarly, in its last filing prior to termination, the U.S.
Airways pilots plan reported that it was 94 percent funded on a
current liability basis. At termination, it was only 33 percent
funded on a termination basis, with total underfunding of $2.5
billion.
Second, the funding rules also allow contribution holidays.
Even seriously underfunded plans may not be required to make
annual contributions. Bethlehem Steel, for example, made no
cash contributions to its plan for 3 years prior to
termination. U.S. Airways pilots plan had no contributions for
4 years prior to termination.
Third, the funding and premium rules do not reflect the
risk of loss to participants and premium payers. The same
funding and premium rules apply regardless of a company's
financial health. But PBGC has found that nearly 90 percent of
the companies representing large claims against the insurance
system have had junk bond credit ratings for 10 years prior to
termination.
Fourth, because of the structure of the funding rules,
contributions to plans can be extremely volatile. After years
with little or no required contributions, companies could be
faced with sharp spikes in funding. Although our complicated
funding rules were designed, in part, to minimize the
volatility of contributions, the current rules have failed to
achieve this goal.
Mr. Chairman, we must make fundamental changes in the
funding rules that will put underfunded plans on a predictable,
steady path to better funding. The Administration is working on
comprehensive reforms that will get pension plans better funded
and eliminate some of the risk shifting and moral hazard in the
current system. It is our hope that these reforms will put the
defined benefits system on a stable footing for the long term.
If companies do not fund the pension promises they make,
someone else will have to pay. Either workers, in the form of
reduced benefits, other companies, in the form of higher
premiums, or taxpayers in the form of a PBGC bailout. We should
not pass off the cost of today's problems to future
generations.
Thank you for inviting me to testify. I will be happy to
answer any questions.
[The prepared statement of Mr. Kandarian follows:]
Statement of Steven A. Kandarian, Executive Director, Pension Benefit
Guaranty Corporation, Washington, DC
INTRODUCTION
Mr. Chairman, Ranking Member Miller, and Members of the Committee:
Good morning. 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 funding and the financial health of
PBGC, and for your continuing interest in the retirement security of
America's workers.
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 and 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 benefits to nearly 1 million people in fiscal year 2003.
Similarly, benefit payments that exceeded $1.5 billion dollars in
fiscal year 2002 will rise to nearly $2.5 billion in fiscal year 2003.
Defined benefit pension plans continue to be an important source of
retirement security for 44 million American workers. But there has been
a sharp deterioration in the funded status of pension plans, and the
PBGC now has a record deficit as the result of the recent terminations
of large underfunded plans.
When underfunded pension plans terminate, three groups can lose:
participants can see their benefits reduced, other businesses can see
their PBGC premiums go up, and ultimately Congress could call on
taxpayers to support the PBGC.
Recently, the Administration issued our initial set of proposals to
deal with the problem of pension underfunding. It has four parts:
First, as the necessary initial step toward comprehensive
reform of the funding rules, it improves the accuracy of
pension liability measurement to reflect the time structure of
each pension plan's benefit payments. This would be
accomplished by measuring a plan's liabilities using a yield
curve of highly rated corporate bonds to calculate the present
value of those future payments.
Second, it requires better disclosure to workers, retirees,
investors and creditors about the funded status of pension
plans, which will improve incentives for adequate funding.
Third, it provides new safeguards against underfunding by
requiring financially troubled companies with highly
underfunded plans to immediately fund or secure additional
benefits and lump sum payments. Similarly, it prohibits
unfunded benefit increases by those severely underfunded plans
sponsored by corporations with below investment- grade debt.
And fourth, it calls for additional reforms to protect
workers'' retirement security by improving the funded status of
defined benefit plans.
Treasury Under Secretary Peter Fisher and Labor Assistant Secretary
Ann Combs testified on July 15 about these proposals. In my testimony
today I would like to focus on plan underfunding, PBGC's financial
condition, and the challenges facing the defined benefit system that
need to be addressed with additional reforms.
PBGC estimates that the total underfunding in the single-employer
defined benefit system exceeded $400 billion as of December 31, 2002,
the largest number ever recorded. (See Chart 1) When the PBGC is forced
to take over underfunded pension plans, the burden often falls heavily
on workers and retirees. In some cases, participants lose benefits that
were earned but not guaranteed by the pension insurance system. In all
cases, workers lose the opportunity to earn additional benefits under
the terminated pension plan.
PBGC's premium payers--employers that sponsor defined benefit
plans--also pay a price when an underfunded plan terminates. Although
PBGC is a government corporation, it is not backed by the full faith
and credit of the U.S. government and receives no federal tax dollars.
When PBGC takes over underfunded pension plans, financially healthy
companies with better-funded pension plans end up making transfers to
financially weak companies with chronically underfunded pension plans.
If these transfers from strong to weak plans become too large, then
over time strong companies with well-funded plans may elect to leave
the system.
In the worst case, PBGC's deficit could grow so large that the size
of the premium increase necessary to close the gap would be
unacceptable to responsible premium payers. If this were to occur,
Congress could call upon U.S. taxpayers to pick up the cost of
underfunded pension plans through a Federal bailout of PBGC. In
essence, all taxpayers would shoulder the burden of paying benefits to
the 20 percent of private-sector workers who still enjoy the security
of a defined benefit plan.
PBGC's Deteriorating Financial Condition
As a result of record pension underfunding and the failure of a
number of plan sponsors in mature industries, PBGC's financial position
has deteriorated sharply in the last two years. During fiscal year
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. The $11.3 billion loss is more than five times larger
than any previous one-year loss in the agency's 28-year history.
Moreover, based on our latest unaudited financial report, the deficit
had grown to $5.7 billion as of July 31, 2003. (See Chart 2)
Because of this extraordinary one-year loss, the dramatic increase
in pension underfunding, and the risk of additional large claims on the
insurance program, the General Accounting Office (GAO) recently placed
PBGC's single-employer program on its ``high risk'' list. In its report
to Congress, GAO points to systemic problems in the private-sector
defined benefit system that pose serious risks to PBGC. For example,
the insured participant base continues to shift away from active
workers, falling from 78% of all participants in 1980 to only 53% in
2000. In addition, GAO's report notes that the insurance risk pool has
become concentrated in industries affected by global competition and
the movement from an industrial to a knowledge-based economy. My hope
is that GAO's ``high risk'' designation will spur reforms to better
protect the stakeholders in the pension insurance system--participants
and premium payers.
Reasons for PBGC's Current Financial Condition
PBGC's record deficit has been caused by the failure of a
significant number of highly underfunded plans of financially troubled
and bankrupt companies. (See Chart 3) These include the plans of
retailers Bradlees, Caldor, Grand Union, and Payless Cashways; steel
makers including Bethlehem, LTV, National, Acme, Empire, Geneva, and
RTI; other manufacturers such as Singer, Polaroid, Harvard Industries,
and Durango; and airlines such as TWA. In addition, PBGC has taken over
the failed US Airways pilots plan. Mr. Chairman, pension claims against
PBGC 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.
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 for the Eastern Airlines plans and $800 million
for the Pan American Airlines plans. Those claims seem modest in
comparison to the steel 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
the financially troubled airline sector is larger still, totaling $26
billion.
PBGC premiums have not kept pace with the growth in pension claims
or in pension underfunding. (See Chart 4) Premium income, in 2002
dollars, has fallen every year since 1996, even though Congress lifted
the cap on variable-rate premiums that year. The premium has two parts:
a flat-rate charge of $19 per participant, and a variable-rate premium
of 0.9 percent of the dollar amount of a plan's underfunding, measured
on a ``current liability'' basis. As long as plans are at the ``full
funding limit,'' which generally means 90 percent of current liability,
they do not have to pay the variable-rate premium. That is why
Bethlehem Steel, the largest claim in the history of the PBGC, paid no
variable-rate premium for five years prior to termination.
CHALLENGES FACING THE DEFINED BENEFIT PENSION SYSTEM
The funding of America's private pension plans has become a serious
public policy issue. Recent financial market trends--falling interest
rates and equity returns--have exposed underlying weaknesses in the
pension system, weaknesses that must be corrected if that system is to
remain viable in the long run. In addition to falling interest rates
and equity returns, there are serious challenges facing the defined
benefit system: substantial underfunding, adverse demographic trends,
and weaknesses in the pension funding rules.
Concurrent Falling Interest Rates and Stock Market Returns
The unprecedented, concurrent drops in both equity values and
interest rates have caused the unfunded liabilities of most defined
benefit pension plans to increase dramatically over the last three
years. (See Chart 5) Some argue that the current problems are cyclical
and that they will disappear as the stock market recovers, but it is
not reasonable to base pension funding on the expectation that the
stock market gains of the 1990s will repeat themselves.
In order to understand how pension plans got so underfunded, it is
important to consider how mismatching assets and liabilities affects
pension plan funding levels. Pension plan liabilities tend to be bond-
like in nature. For example, both the value of bonds and the value of
pension liabilities have risen in recent years as interest rates fell.
Were interest rates to rise, both the value of bonds and the value of
pension liabilities would fall. The value of equity investments is more
volatile than the value of bonds and less correlated with interest
rates. Most companies prefer equity investments because they have
historically produced a higher rate of return than bonds. These
companies are willing to accept the increased risk of equities and
interest rate changes in exchange for expected lower pension costs over
the long term. Similarly, labor unions support investing in equities
because they believe it results in larger pensions for workers.
Investing in equities rather than bonds shifts some of these to the
PBGC.
Pension Underfunding
Pension liabilities represent financial obligations of plan
sponsors to their workers and retirees. Thus, any pension underfunding
is a matter of concern and may pose risks to plan participants and the
PBGC. In ongoing, healthy companies, an increase in the amount of
underfunding can affect how secure workers feel about their pension
benefits, even though the actual risk of loss maybe low, at least in
the near-term. Of immediate concern is chronic underfunding in
companies with debt below investment-grade or otherwise financially
troubled, where the risk of loss is much greater. Some of these
financially troubled companies have pension underfunding significantly
greater than their market capitalization.
As detailed in our most recent annual report, plans that are
sponsored by financially weak companies had $35 billion in unfunded
vested benefits. Of this $35 billion, about half represented
underfunding in airline and steel plans. By the end of this fiscal
year, the amount of underfunding in financially troubled companies
could exceed $80 billion. As I previously noted, the Administration has
already made specific legislative recommendations to limit the PBGC's
growing exposure to such plans.
Demographic Trends
Demographic trends are another structural factor adversely
affecting defined benefit plans. Many defined benefit plans are in our
oldest and most capital intensive industries. These industries face
growing pension and health care costs due to an increasing number of
older and retired workers.
Retirees already outnumber active workers in some industries. (See
Chart 6) In some of the plans we have trusteed in the steel industry,
only one out of every eight pension participants was an active worker.
The Detroit Free Press recently reported that pension, retiree health
and other retiree benefits account for $631 of every Chrysler vehicle's
cost, $734 per Ford vehicle, and $1,360 for every GM car or truck. In
contrast, pension and retiree benefit costs per vehicle for the U.S.
plants of Honda and Toyota are estimated to be $107 and $180
respectively. In a low-margin business, retiree costs can have a
serious impact on a company's competitiveness.
Demographic trends have also made defined benefit plans more
expensive. Americans are living longer in retirement as a result of
earlier retirement and longer life spans. Today, an average male worker
spends 18.1 years in retirement compared to 11.5 in 1950, an additional
seven years of retirement that must be funded. (See Chart 7) Medical
advances are expected to increase life spans even further in the coming
years.
Weaknesses in the Funding Rules
When PBGC trustees underfunded plans, participants often complain
that companies should be legally required to fund their pension plans.
The fact is, current law is simply inadequate to fully protect the
pensions of America's workers when their plans terminate. There are
many weaknesses with the current funding rules. I would like to focus
on six:
First, the funding targets are set too low. Employers can stop
making contributions when the plan is funded at 90 percent of ``current
liability.'' The definition of current liability is a creature of past
legislative compromises, and has no obvious relationship to the amount
of money needed to pay all benefit liabilities if the plan terminates.
As a result, employers can stop making contributions before a plan is
sufficiently funded to protect participants, premium payers and
taxpayers.
Current liability assumes the employer will continue in business.
As a result, it doesn't recognize the early retirements--often with
subsidized benefits--that take place when an employer goes out of
business and terminates the pension plan. Current liability also
doesn't recognize the full cost of providing annuities as measured by
group annuity prices in the private market. If the employer fails and
the plan terminates, pension benefits are measured against termination
liability, which reflects an employer's cost to settle pension
obligations in the private market.
For example, in its last filing prior to termination, Bethlehem
Steel reported that it was 84 percent funded on a current liability
basis. At termination, however, the plan was only 45 percent funded on
a termination basis--with total underfunding of $4.3 billion. (See
Chart 8) Similarly, in its last filing prior to termination, the US
Airways pilots plan reported that it was 94 percent funded on a current
liability basis. At termination, however, it was only 33 percent funded
on a termination basis--with total underfunding of $2.5 billion. (See
Chart 9) It is no wonder that the US Airways pilots were shocked to
learn just how much of their promised benefits would be lost. In
practice, a terminated plan's underfunded status can influence the
actual benefit levels. Under the Administration's already-announced
transparency proposal, participants would have been aware of the lower
funding level on a termination basis.
Second, the funding rules often allow ``contribution holidays''
even for seriously underfunded plans. Bethlehem Steel, for example,
made no cash contributions to its plan for three years prior to plan
termination, and US Airways made no cash contributions to its pilots
plan for four years before the plan was terminated. When a company
contributes more than the minimum required contribution, it builds up a
``credit balance'' for minimum funding. It can then treat the credit
balance as a payment of future required contributions, even if the
assets in which the extra contributions were invested have lost some or
all of their value.
Third, the funding rules do not reflect the risk of loss to
participants and premium payers. The same funding rules apply
regardless of a company's financial health, but a PBGC analysis found
that nearly 90 percent of the companies representing large claims
against the insurance system had junk-bond credit ratings for 10 years
prior to termination. (See Chart 10)
Fourth, the minimum funding rules and the limits on maximum
deductible contributions require companies to make pension
contributions within a narrow range. Under these minimum and maximum
limits, it is difficult for companies to build up an adequate surplus
in good economic times to provide a cushion for bad times.
Fifth, current liability does not include reasonable estimates of
expected future lump sum payments. Liabilities must be calculated as if
a plan will pay benefits only as annuities. Even if it is clear that
most participants will choose lump sums, and that these lump sums may
be more expensive for the plan than the comparable annuity, the minimum
funding rules do not account for lump sums because they are not part of
how current liability is calculated.
Sixth, because of the structure of the funding rules under ERISA
and the Internal Revenue Code, defined benefit plan contributions can
be extremely volatile. After years of the funding rules allowing
companies to make little or no contributions, many companies are
suddenly required to make contributions of hundreds of millions of
dollars to their plans at a time when they are facing other economic
pressures. Although the law's complicated funding rules were designed,
in part, to minimize the volatility of funding contributions, the
current rules clearly have failed to achieve this goal. Masking market
conditions is neither a good nor a necessary way to avoid volatility in
funding contributions.
PBGC Premiums
As I noted earlier, because PBGC is not backed by the full faith
and credit of the federal government and receives no federal tax
dollars, it is the premium payers--employers that sponsor defined
benefit plans--who bear the cost when underfunded plans terminate.
Well-funded plans represent the best solution for participants and
premium payers. However, PBGC's premiums should be re-examined to see
whether they can better reflect the risk posed by various plans to the
pension system as a whole.
REFORMS NEEDED TO PROTECT THE DEFINED BENEFIT SYSTEM
Mr. Chairman, we must make fundamental changes in the funding rules
that will put underfunded plans on a predictable, steady path to better
funding. Improvements in the funding rules should set stronger funding
targets, foster more consistent contributions, mitigate volatility, and
increase flexibility for companies to fund up their plans in good
economic times.
At the same time, we must not create any new disincentives for
companies to maintain their pension plans. Pension insurance creates
moral hazard, tempting management and labor at financially troubled
companies to make promises that they cannot or will not fund. The cost
of wage increases is immediate, while the cost of pension increases can
be deferred for up to 30 years and shutdown benefits may never be pre-
funded. In exchange for smaller wage increases today, companies often
offer more generous pension benefits tomorrow, knowing that if the
company fails the plan will be handed over to the PBGC. This unfairly
shifts the cost of unfunded pension promises to responsible companies
and their workers. At some point, these financially strong companies
may exit the defined benefit system, leaving only those companies that
pose the greatest risk of claims.
In addition to the proposals the Administration has already
introduced to accurately measure pension liabilities, improve pension
disclosure, and protect against underfunding, the Departments of Labor,
Treasury, and Commerce, and the PBGC are actively working on
comprehensive reform. We are examining how to eliminate some of the
risk shifting and moral hazard in the current system. We are crafting
proposals to get pension plans better funded, especially those at risk
of becoming unable to meet their benefit promises. And we are re-
evaluating statutory amortization periods and actuarial assumptions
regarding mortality, retirement, and the frequency and value of lump
sum payments to ensure they are consistent with the goal of improved
funding.
CONCLUSION
Mr. Chairman, we should not pass off the cost of today's pension
problems to future generations. If companies do not fund the pension
promises they make, someone else will have to pay--either workers in
the form of reduced benefits, other companies in the form of higher
PBGC premiums, or taxpayers in the form of a PBGC bailout.
Thank you for inviting me to testify. I will be happy to answer any
questions.
______
[Attachments to Mr. Kandarian's statement follow:]
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Chairman Boehner. Well, thanks both of our witnesses for
your excellent testimony.
Before I ask Mr. Walker the first question, I should
mention to all of my colleagues that there has been some
discussion about a short-term fix to the 30-year interest rate.
And in discussions with various colleagues on both sides of the
aisle, there is some concern that the 3-year short-term fix may
be too long. I would put myself in the category of one of those
who believes that if we are going to extend the short-term fix,
that 2 years is probably more than enough.
Second, as I mentioned in my opening statement, this is our
third in a series of hearings, and it is my intention, and I
think the intention of Mr. Miller and others that this
Committee, and this Congress take its responsibility seriously
to look at the long-term health and the long-term problems of
defined benefit plans, and for us to do the hard work of
dealing with it.
This is a very important issue for over 40 million
Americans who depend on defined benefit plans. And for us to
look the other way at this very serious problem, which has gone
on for some time, would be criminal neglect on the part of
public-policymakers. What I would like to see is a short-term,
2-year adjustment to the 30-year rate, with a commitment on the
part of the Congress to complete our work on defined benefit
plan restructuring by the end of next year, so that the plan's
sponsors have a year to get ready for the new rules. I think
this is a reasonable and responsible way to proceed, and
without a lot of consultation from my staff and colleagues, I
have just said it.
So having said that, Mr. Walker, let's get back to your
first chart. As we begin to see in the year 2000, the
liabilities were beyond the assets in the Bethlehem Steel plan.
From the year 2000 until the plan was terminated, were there
any increases in benefits offered by the company to its
employees?
Mr. Walker. I would have to ask Mr. Kandarian to answer
that, since they are the ones providing the guarantees.
Chairman Boehner. All right. Mr. Kandarian?
Mr. Kandarian. The answer is yes, Mr. Chairman. In 1999,
Bethlehem negotiated significant improvements in the pension
plan with its workers. At that point in time, Bethlehem Steel
was a very weakened company. Our guarantee phases in over 5
years, 20 percent a year, so we guaranteed 60 percent of those
increased benefits. It cost the agency about $80 to $100
billion, we estimate.
Chairman Boehner. $80 to $100 billion?
Mr. Kandarian. Million dollars.
Chairman Boehner. Million dollars.
Mr. Kandarian. Excuse me.
Chairman Boehner. Under the current rules, can companies
that are underfunded, in some cases seriously underfunded, in
fact, negotiate higher benefits for their employees?
Mr. Kandarian. They can. There is a very weak rule that
says if you are below 60 percent of the so-called current
liability measure, that there are some restrictions. But that
measure often times does not apply, as you can see from the
slide up there. The current liability measure was at the 80 to
90 percent level for a number of years with Bethlehem Steel
before termination.
Mr. Walker. One of the things you may want to consider, Mr.
Chairman, is whether that 60 percent ought to be raised. I
think another factor that has to be considered is what the
cash-flows related to these plans are, and whether or not plan
sponsors ought to be required to make certain minimum
contributions if they have significant negative cash-flows,
while obviously being concerned about volatility, as well.
Chairman Boehner. Let me ask both of you. The PBGC does, in
fact, have about a $25 billion net balance, or cap. Would that
be correct? Describe what the typical billion is.
Mr. Kandarian. Let me get the numbers. Yes, we have over
$30 billion in liquid assets, which are mostly in U.S.
Treasury, and some in the liquid end of the stock market, and
our liabilities are higher than that.
Chairman Boehner. Now, we understand from the testimony of
both of you that from a long-term basis, there is trouble
ahead. But from a short-term basis, in terms of the assets that
you have available and the liabilities that you have currently,
and those that you foresee, look into your crystal ball. Where
does the problem really show up in terms of your cash-flow?
Mr. Kandarian. It is hard to say, but let me give you some
facts. We have a little over $30 billion in assets today. We
are currently paying out at a running rate of $2.5 billion in
benefits.
Chairman Boehner. Annually?
Mr. Kandarian. Annually. We think that number will go up to
about $3 billion starting next year. Now, what happens from
there is anyone's guess, based upon what ends up being taken by
the agency over the next few years.
Chairman Boehner. And the $30 billion that you have today,
I presume you have additional premiums coming. Where do you
expect that balance to be in the future?
Mr. Kandarian. The premiums run about $800 million a year
currently. We anticipate that number could go up a little bit,
based upon the variable rate premium increasing over time. But
still it would be less than $1 billion a year, based upon
current law. Now that would have to account for any new
terminations that came into the system, and one of the things I
have been concerned about as Executive Director is the size of
the underfunding of these terminated plans as of late.
Back in 1991, during the last economic slump, a very large
plan for us was $600 million or $800 million underfunded. As
mentioned, Bethlehem Steel's claim against the insurance system
was $3.9 billion, so owers of a magnitude larger than the kinds
of claims we received a decade ago. And the premiums have been
essentially flat, or declining, in the last decade.
Mr. Walker. Mr. Chairman, you are correct that $30 billion
in cash and liquid investments are obviously available to pay
benefits for a considerable period of time. However, I would
respectfully suggest that they have serious structural issues
that cry out for reform now. I mean, the real question is, they
face a disproportionate amount of risk in industries that are
faced by increasing global competition. For example, steel,
airlines, auto, heavy equipment manufacturing. The magnitude of
the potential losses in those industries are huge.
And furthermore, we have to keep in mind, this is a
voluntary system. The risk exists that you could have a lot of
healthy sponsors exit the system, and therefore we can have a
run on the system and create a real problem. And so I think the
sooner that Congress acts, the better. I am very encouraged by
your comment, Mr. Chairman, about the need for fundamental
reform in a timely manner.
Chairman Boehner. My time has expired. I may come back for
a second round of questions. Let me recognize Mr. Miller.
Mr. Miller. Thank you very much.
Mr. Walker, do you have an estimate of what you think that
universe of potential liability is? You mentioned, we know
there are a couple of other steel companies that are in play
that people are talking about either going under or being taken
over. The airlines, you can read it both ways. From the
competitors or from the market, what-have-you, whether all of
them are going to survive. Do you have an estimate of what
the--
Mr. Walker. Mr. Miller, I think that the PBGC is in the
best position. As I understood Executive Director Kandarian,
their latest watch list, if you will, comprises about $80
billion in potential underfunding. And presumably in doing
that, they are looking not only at the amount of underfunding
in the plan, but also the financial strength of the sponsor.
For example, does it have a junk bond rating for its debt, or
whatever it might be?
Mr. Miller. Can you elaborate on that, Mr. Kandarian?
Mr. Kandarian. That is correct. The $80 billion estimate
that we have right now relates to companies with less than
investment-quality credit ratings; junk bond ratings, and
termination liability for their pension promises.
Mr. Miller. Let's look at that universe for a second,
because I think it raises kind of a central point of tension.
And that is, how much can you get those companies that are in
that situation, to help us cure the problem? They would argue
that if they have to make these contributions, then they can't
make an investment that is necessary to turn the company
around, or they can't stay afloat because they have a cash-flow
problem.
So what do we do with those companies? I mean, there is a
bias in the marketplace today against defined benefit plans.
You don't go there if you don't have to go there. Now you are
telling companies that theoretically, for one reason or
another, are sick that they may continue in existence for a
considerable period of time that we need a greater call--PBGC
needs a greater call on some of their assets in terms of
premiums or--something so that we don't inherit the full load.
What are you tipping?
Mr. Walker. Well, first, it is a complicated issue. Number
two, there is no question that you have to address this in a
manner that recognizes reality. You can't end up having a huge
increase in contribution requirements happen all at once,
especially in circumstances where they are struggling to
survive.
I do think you need three things, and we have some specific
suggestions in our testimony. We clearly need additional
transparency. Because right now, the plan participants,
beneficiaries, and other stakeholders don't necessarily know
the funding condition of the plan. They don't necessarily have
an appreciation for the PBGC guarantees. They need to know
that, and if they know that, not only will they be able to plan
better, but they will be able to bring together pressures for
people to consider additional funding as appropriate and
possible, if you will.
Second, some of these industries have good times. Bethlehem
Steel had some good times, OK? And we need to provide more
flexibility for them to make additional contributions on a tax-
deductible basis when they do have good times. So you need
transparency, and you need incentives, which can also charge
them more premiums.
There are a number of specific examples that we have, but I
think you need to get on with these reforms, because the real
risk exists; there's never going to be a good time. And the
longer we wait, the bigger the problem is going to be, and the
higher the risk that the good companies who don't represent a
risk might exit the system.
Mr. Miller. If I could encourage that the Chairman has
suggested the timeline that he has suggested for this Committee
to look at your reforms. Two, I would hope that with the
administration, if the PBGC or whatever would forward those
recommendations to us. I know you have been working on them,
and trying to make them all come together, but it obviously
would help this process greatly if we would have the
recommendations from the administration. You have articulated
those recommendations and those positions, but technically this
is a very complicated business. We need to see how you
translate those into the technical changes that have to be
made.
And the third thing would be, it seems to me, that if we
are going to have a short-term fix, the shorter I think the
better, because I think it forces decisions to be made. I would
also hope that we would have immediate transparency, so that
while we are working on the problem, we will have a full
understanding of what really is taking place within this
universe of actual liabilities and potentially future
liabilities and the status of those claimants. Those potential
claimants. I mean, I think we kind of have to know where we are
before we start recalculating this system. I think it would be
very important that we have that kind of transparency as soon
as possible, while we are engaging in the legislative process.
Mr. Walker. Mr. Miller, if I could also address your
concerns expressed about the funding rules. The current funding
rules are relatively weak on what are called basic ERISA
funding rules of 1974. You then have something called the
deficit reduction contribution component of the funding rules,
which unfortunately kick in rather late in the process. But
when they do kick in, they are extremely strong, and can be
very, very harsh in terms of the impact upon companies at a
time when they are least able to make contributions to their
underfunded pension plans, which is the point that you are
referring to.
And one of the things we are looking at within the
Administration is trying to make the system less volatile so
that the funding rules going forward would have more
predictable, steady contributions, even during good years, and
then wouldn't have such harsh spikes during the difficult times
for these companies.
Mr. Miller. Let me just say, if I might. One of the
problems, it seems to me, is that the good years sometimes are
represented by paper assets. We had a good year during the
stock market increases, and it evaporated one March. The good
years don't reflect the long-term commitments. Obviously
companies want to take advantage of that appreciation in their
stock, or the stocks that they hold in their pension plans, and
to some extent they should be able to. But you're writing a
high percentage of assets based upon the whims of the market
that have nothing to do with the health of the company,
necessarily. And I would assume that in the industry, if you
were going to provide an annuity, you wouldn't have this same
mix of assets supporting that annuity.
Mr. Walker. Well, I think part of the idea touching on the
same thing is there needs to be a more stable, more certain and
predictable level of funding that plans have to make in good
times and bad. Now, the fact of the matter is, we have had a
significant decline in asset values over the last several
years, but they are starting to turn around. The market is
starting to come back up, interest rates are starting to go
back up, which is generally bad, but for pension plans good,
believe it or not. And for the PBGC good.
And so we have to have a system that recognizes reality. We
have to have more stable and certain contributions in good
times and bad to eliminate this volatility. And that means
strengthening the minimum funding requirements, and also
providing somewhat additional flexibility for tax deductibility
within the corridor when plans are reasonably well funded.
Mr. Miller. Thank you.
Mr. Kandarian. Mr. Miller, you correctly point out the
asset liability mismatch oftentimes seen in pension plans, and
there is a tradeoff. Corporations want to offer plans that are
affordable, and they feel that historically equity returns have
outperformed bond returns, and this is a long-term promise.
Therefore, this helps make the plans more affordable to
corporations, and helps them retain these plans.
At the same time, unions want these plans to offer generous
benefits to the workers. They also look at long-term equity
returns in excess of bond returns and say, if the company
invests some percentage in the stock market, we can have better
benefits for our workers.
But the problem is the one you note. During bad times, when
things reverse, interest rates go down, so liabilities go up.
Stock market values go down, so assets go down. And especially
if a plan terminates with a financially weak company, the
impact upon the PBGC and the system can be pretty dramatic. We
saw that with Bethlehem Steel.
Mr. Miller. The corporate management of these plans is, in
some cases, and with the agreement of unions and others, it
becomes a little island of fantasy in this huge sea of reality.
It just doesn't reflect either the obligations of the PBGC or
the potential obligations of the taxpayer. Now, we hope to be
able to postpone all of that.
Mr. Kandarian. Well, there are some historical aspects to
this. At one time, when these plans first were created and
first invested along these bases, plans were relatively small,
and corporations, in terms of market caps, were very large. So
the relatively small change in asset values was not
overwhelming to some of these companies.
Today, some of these plans are very, very large compared to
the market caps of those same businesses, because of how many
retirees there are today in these more mature industries. So
the dynamics have changed, and corporations themselves have to
look at this issue and make a decision as to what level of risk
they feel they can assume in their pension plans.
Mr. Miller. Thank you, Mr. Chairman.
Chairman Boehner. The Chair recognizes the gentleman from
North Carolina, Mr. Ballenger. And after Mr. Ballenger's
questions, we are going to the floor for another 15-minute
vote.
Mr. Ballenger. Thank you, Mr. Chairman. I have a basic
question. If you look at the Bethlehem Steel pension plan, and
instead of the statistics that you have there, you drew a line
for the number of employees working at Bethlehem Steel over
that same period of years, and the number of retirees of the
same period of years, I think you are going to have two lines
going in the opposite directions. This shows why you compounded
the whole situation with fewer and fewer people working, maybe
because they figured out a better way to make steel, or because
business stunk and they lost business overseas.
Therefore, you have fewer people paying in, and you have
more people living longer, and it obviously is a no-win
situation. It is going to be a disaster. It didn't take a
genius to see there was going to be a train wreck. That is one
of the problems.
Another one that you see is a lot of corporations that are
going bankrupt are now being sold to somebody else. Do the
liabilities that they have go with that purchase of their
bankrupt corporation?
Mr. Walker. Let me address the first. I will let Executive
Director Kandarian address the second.
You are correct, that if you had a line that showed
employment and number of retirees, they would be going in the
opposite direction. That deals with the dependency ratio. A lot
of these industries that represent a high risk to the PBGC have
that type of factor.
It also means that their cash-flows, the amount of money
they are going to have to start paying out for benefits, are
going to be a lot quicker than otherwise the minimum funding
standards would assume, because they are basically shooting for
funding targets over 15 to 30 years. That is one of the reasons
why I believe that one of the things that has to be considered
is to look at the cash-flows here, and how the cash-flows might
have to be built into the minimum funding requirements more.
Mr. Kandarian. Let me make two statements. One, in the case
of Bethlehem Steel, I think there was one active worker to
eight retirees and terminated vested workers. So you saw that
kind of imbalance. That actually would not be a financial
problem for either Bethlehem Steel or the PBGC if the plan were
fully funded. When the plan is not fully funded, you now have
this enormous underfunded liability in the case of Bethlehem
that has to be, in effect, amortized over a number of years
going forward upon their existing labor base, which as you
noted, had shrunk dramatically.
In competitive markets, both in terms of domestic
competition from non-unionized steel companies and
international competitions, that is a very difficult thing for
a company like Bethlehem to overcome.
When Bethlehem finally came to an end as a company, it had
roughly $8 billion in liabilities. Over $4 billion was pension
liabilities, and over $2 billion was health care-related for
retirees. So $6 billion out of $8 billion were related to so-
called legacy costs. That was overwhelming, and they were
unable to afford those kinds of benefits going forward, and pay
for those kinds of benefits.
Your second question concerns what happens to those
liabilities. In the case of the pension liabilities, they came
to us. And workers, in most cases, will get 100 percent of the
benefits that had accrued and vested at that point in time.
Mr. Ballenger. Does that mean the other steel companies
that bought the assets didn't pick up any of the liabilities?
Mr. Kandarian. That's correct. In bankruptcy, they were
able to buy assets and assume whatever liabilities they choose
to assume in an auction process.
Now, let's pop up the Bethlehem case. There was a company
called International Steel Group that bought that business.
They had already bought LTD Steel's assets before, and they
paid about $1.5 billion for those assets they picked up. Again,
remember, there is over $4 billion of liabilities on the
pension plan alone. So if you think the assets are worth $1.5
billion positive, if you can subtract out the liabilities that
someone is asking you to assume for the pension liability, you
have a negative purchase price, which obviously doesn't work.
Once the bankruptcy process ran its course, and the best
bids came in, there was no way that plan could be assumed any
longer in the private sector.
Mr. Ballenger. But the steel company that bought the assets
didn't pick up any of the liabilities, so it was a pretty good
bargain at $1 billion, or $600 million, whatever.
Mr. Kandarian. Well, I won't speak to whether it was a good
or bad bargain.
Mr. Ballenger. It is better than it would have been if they
had to pick up all the liabilities. They would never have
bought the liabilities.
Mr. Kandarian. The same case occurred when U.S. Steel
purchased National Steel's assets, the pension plan came to us.
Mr. Ballenger. Thank you, Mr. Chairman.
Chairman Boehner. The Committee will stand in recess for 15
to 20 minutes.
[Recess.]
Chairman Boehner. The Committee will come to order.
With the continuing uncertainty as to the floor schedule, I
think it would be in the best interest of our witnesses and all
of our guests that we end today's hearing. For Members who may
have questions, I suggest that they submit their written
questions to either Mr. Walker or Mr. Kandarian and, obviously,
I would think both of you would be in a position to replay.
There will be other opportunities as the series of hearings
continues for you to be back and help us as we begin to not
only assess the problems that exist in the current defined
benefit system, but, more importantly, the fine line that we
are going to have to walk in terms of the possible solutions to
fix these problems to ensure the retirement security of
millions of American workers. So I want to thank all of you.
This hearing is concluded.
[Whereupon, at 12:55 p.m., the Committee was adjourned.]
[Additional material provided for the record follows:]
Graphs Submitted for the Record from the U.S. General Accounting Office
[GRAPHIC] [TIFF OMITTED] T0134.047
[GRAPHIC] [TIFF OMITTED] T0134.048
------
The Next Big Bailout?
How Underfunded Pensions Put Taxpayers at Risk
NTUF Policy Paper 143
By Alex Pagon
August 18, 2003
The Pension Benefit Guaranty Corporation (PBGC), a quasi-public
institution that insures private pensions, faces falling income, rising
liabilities, and expected losses that are greater than its assets. In
addition, the pension programs of the companies insured by the PBGC
have record levels of underfunding. The General Accounting Office
classifies the PBGC as a ``high risk'' program requiring urgent
transformation and reform. 1 Tough luck for pensioners
getting ready to retire? Not really, because someone else--the American
taxpayer--is the ultimate guarantor of those pensions.
In the past two years falling asset prices and failing
manufacturers have eroded the financial foundation of the PBGC, and the
crushing weight of the troubled programs it insures portends a
potential collapse that would require taxpayers to rescue the affected
pensions. The pension plans of the companies in the S&P 500 that offer
defined benefit pensions face deficits totaling at least $182 billion,
and possibly more if the economy performs erratically. 2
Furthermore, pension failures are on a rising trajectory. In 2002 and
2003, the PBGC sustained losses significantly greater than its assets
and posted its worst deficit in the PBGC's 29-year history.
3 The PBGC manages more failed pensions than ever before,
and the yearly benefits it disburses more than doubled over the past
two years. 4
However, even if better economic times (i.e., rising asset prices
and healthier companies) were to relieve some financial pressure, the
PBGC still faces changing demographics that threaten the institution's
long-term solvency. Nearly all the firms in the service and technology
sectors, which contain healthy companies driving much of the growth in
the economy, no longer offer defined benefit pensions. Thus, the PBGC
relies on mature, often sclerotic, companies for the bulk of its income
from insurance premiums. Also, as Americans now spend more time in
retirement than ever before, the ratio of workers to pensioners
continues to decline. 5 Consequently, the shifting
demographics continually force the PBGC to do more with less. A decline
in asset prices will not create a collapse; it will, however,
accentuate the unsustainable current trends and bring the day of
reckoning closer for taxpayers.
Fortunately, several measures to reform the current system could
reduce the burden placed on taxpayers. Correction of the problems in
the current insurance pricing schedule, conversion to defined
contribution plans, and competition in the pension insurance market
would ensure the long-term security of the private pension system and
remove taxpayers'' ultimate liability for failed pension plans.
6
The Pension Benefit Guaranty Corporation--Born from Hard Times
In 1963, the auto manufacturer Studebaker terminated its employee
pension plan, leaving its workers without the retirement benefits
promised them. This prompted the federal government to introduce
legislation to ensure that workers would receive a portion of their
promised pensions even if their employer went bankrupt or closed out
its pension plan.
In 1974, Congress passed the Employee Retirement Income Security
Act, which created the PBGC. The PBGC's mission is to insure private
pension plans as a quasi-public institution that is entirely self-
sufficient. That is, the agency does not rely on taxes for its
operating budget. Instead, the PBGC finances its operations through
income from insurance premiums charged to the companies it insures and
income from its investments. However, since the PBGC is a federally
chartered agency, there is an implicit guarantee that Congress would
not allow this institution to fail.
When a private pension fails or is in danger of failing, the PBGC
terminates and assumes control of the pension accounts and disburses
the promised benefits to the plan's participants. If the pension
accounts have insufficient funds to cover the promised benefits, the
PBGC uses its assets in order to make pensioners whole. However, in
some scenarios the PBGC, due to its limited resources, can only provide
the retirees it supports with a fraction of their original pensions.
The agency only insures defined benefit pension plans, which are
traditional pensions controlled and managed by the employer. The
employer promises to pay the employee a certain amount of money every
month (a defined benefit) upon retirement. These pension programs stand
in contrast with defined contribution plans, which are pensions
controlled by the employee. The employer regularly places a certain
amount (a defined contribution) of money in the employee's account, and
the employee controls and manages his or her own pension portfolio.
The concept of a defined contribution pension is newer than the
defined benefit plan, but the popularity and prevalence of such
arrangements (e.g. 401(k) plans) are rapidly increasing. In fact, many
companies, especially in the service sector, are converting their
defined benefit pensions into defined contribution plans. Now defined
benefit plans remain almost exclusively in heavily unionized
manufacturing industries.
Throughout its 29-year history, the PBGC has generally met its
obligations to the pensioners it supports, but it now faces a
predicament that threatens its self-sufficiency.
The Hard Times Continue
The defined benefit pension plan is fast becoming a relic of past
decades in which workers spent their entire careers with the same
company, yet the PBGC was designed for that rigid employment structure.
Consequently, the PBGC is struggling to stay ahead of the changing
demographics that threaten to stretch the agency's responsibilities
beyond its resources.
The pool of performing pension plans that contribute to the
insurance premium income of the PBGC is shrinking as many of the new
firms (especially in the technology sector) have never offered defined
benefit plans, while existing healthy firms (most prevalently in the
service sector) are transferring their employees into defined
contribution programs (e.g. 401(k) plans). Since the PBGC insures only
traditional defined benefit plans, the agency loses premium income as
companies leave the defined benefit system.
Further exacerbating the flight of firms from the traditional
pension system is the principle of adverse selection. Due to several
inadequacies of the PBGC's current insurance premium pricing schedule,
healthy firms that responsibly manage their pensions pay a higher
insurance premium due to the losses incurred by mismanaged funds. As a
result, well-run firms understandably restructure their pension
programs into defined contribution plans in order to eliminate the cost
of subsidizing poorly performing funds through insurance premiums. The
PBGC's 2002 annual report illustrates a steady decline in premium
incomes over the past seven years. 7
[GRAPHIC] [TIFF OMITTED] T0134.049
While the number of workers and companies paying insurance premiums
to the PBGC is variable, the PBGC is still obligated to pay the
pensions of all the retirees it supports. The continual increases in
the number of years Americans spend in retirement further exacerbates
the PBGC's mounting difficulties in supporting a body of pensioners
that is growing relative to the active workforce. The number of
participants in plans managed by the PBGC rose 53 percent from 2000 to
2002 (the estimates for 2003 are not yet available). 8
Furthermore, the average length of retirement increased 20 percent,
from 15 years in 1975 (the year of the PBGC's inception) to 18 years in
2000. 9 Consequently, the number of beneficiaries supported
and the amount of benefits paid by the agency continue to grow at
accelerating rates. In the past two years alone, the benefits paid by
the PBGC increased by 140 percent, from $1.043 billion in 2001 to $2.5
billion in 2003. 10 These troubling trends reflect the
rising number of bankruptcies in the manufacturing sector, which holds
the large majority of programs insured by the PBGC.
[GRAPHIC] [TIFF OMITTED] T0134.050
[GRAPHIC] [TIFF OMITTED] T0134.051
Furthermore, the PBGC projects an increase in the coming years in
the number of failures among these pension plans.
The PBGC incurs losses when it terminates an underfunded pension
plan. In the past, the agency covered the losses with little difficulty
because its premium income exceeded the losses. However, losses
sustained from completed and probable terminations of pension plans
increased nearly 50-fold over the past two years. 11
In addition, the losses registered by the PBGC in the past two
years (2002 and 2003) alone is 18 times greater than all the combined
losses incurred from 1993 to 2001. 12 Most ominous is the
fact that the PBGC estimates that it will sustain a $35 billion loss
from plan terminations in 2003, and its assets total only $25.43
billion. 13 Its projected losses for the current year are
138 percent of its total assets.
[GRAPHIC] [TIFF OMITTED] T0134.052
The concurrence of declining premium income, rapidly rising
benefits obligations, and astronomical increases in losses sustained
from plan terminations have eroded the PBGC's positive financial
situation and drives the agency closer to insolvency.
Private Pension Problems
As of August, Standard & Poor's estimated that those companies in
the S&P 500 offering defined benefit pension plans would face an
accumulated underfunding amount of $182 billion by year-end. Although
this is somewhat better than the $212 billion S&P estimate made in
early 2003, The Wall Street Journal cautioned that ``the woes--are far
from over...,'' and other sources have placed the figure above $300
billion. 14 Even the lower amount still represents more than
12 percent of the value ($1.5 trillion) of all pension benefits insured
by the PBGC. 15
Why such huge shortfalls? As interest rates decrease, a company
must place more money in its pension program because the plan must have
enough funding to guarantee its ability to meet its future pension
obligations. When interest rates fall, the company assumes a lower rate
of return on the money in the pension program. Therefore, to meet the
prescribed level of expected future funding, the firm must put more
money into the fund to make up for the lower expected returns. Most
companies did not place any more money in their pensions as interest
rates fell during the end of the last decade because the significant
appreciation of the equity assets in the funds covered the assumed
future decline in returns from a lower interest rate.
Then asset prices declined sharply, leaving pension funds with
record levels of underfunding. Further compounding the current deficits
is the fact that many companies used the surpluses in their pension
programs during the good times of the late 1990s to pay for non-pension
activities. A study by Goldman Sachs has estimated that these firms
will have to direct $160 billion toward their pension plans over the
next two years in order to reach an adequate level of funding in
pension accounts. 16
Two probable consequences of this action are a decline in reported
earnings and a small reduction in output. The portion of cash flow or
retained earnings devoted to filling the deficit in pension plans will
effectively decrease a company's reported earnings. This decline, in
turn, might contribute to a decline in the respective firm's share
price as investors begin to worry about the company's earnings. Also,
some analysts predict that placing cash in pension accounts to cover
deficits could trim output, as firms must divert funds from more
productive capital investment. 17 Thus, even under current
trends of slightly rising interest rates and asset prices, the threat
these shortfalls now pose to a recovery underscores the need for long-
term reform.
There are several companies and industries that best demonstrate
the difficulties facing individual pension plans and the potential
losses the PBGC would incur if these companies went bankrupt or the
PBGC terminated their pension plans for lack of adequate funding.
Perhaps the current situation of General Motors's (GM) pension plan
best illustrates the dire straits in which many companies find their
pension programs. After the recent decline in asset prices, the value
of the company's pension plan assets fell considerably, and a recent
report by Credit Suisse First Boston estimated that GM's pension plan
has been underfunded by $29.4 billion (137 percent of the corporation's
market capitalization). 18
Recently, the auto manufacturer issued $17.6 billion in debt, using
about $10 billion of the proceeds to shore up its pension position.
19 GM didn't use any of the cash it has on hand for fear
that such a move would negatively impact its reported earnings.
(Earnings placed in the pension program can't be reported as earnings
for financial statement purposes. However, revenues from a bond
offering are not considered earnings. Therefore, placing the proceeds
from its debt issuance in the pension plan allows the company to claim
the money that would have otherwise been placed in the pension fund as
earnings.) Nonetheless, a further decline in asset prices (motivated,
perhaps, by worries about the quality of earnings) would leave the
automaker holding onto a hugely underfunded pension and a significant
chunk of debt.
Furthermore, when one considers how the shifting demographics
affect GM, the situation begins to look a lot like Social Security's
predicament. GM currently supports about 450,000 pensioners, and it
only employs roughly 200,000 workers, many of whom are nearing
retirement. 20 As the average life expectancy continues to
rise and retirees live longer after leaving the workforce, the ratio of
workers to pensioners will continue to decline. So, GM must somehow
raise the ratio of workers'' contributions to pensioners'' benefits,
but the United Auto Workers Union has voiced its opposition to cuts in
benefits. If the automaker cannot convince workers to accept reduced
benefits or to switch their pensions to defined contribution plans, GM
will continually face rising pension obligations, which undermine a
company's profitability. When the music stops it will be the taxpayer
left without a chair.
Unfortunately, GM is not the only large company continuing to face
pension difficulties. In fact, the airline and steel industries
represent the two most imminent (and sizable) threats to the solvency
of the PBGC. Even though the two industries combined represent less
than five percent of the total participants in plans insured by the
PBGC, they account for 71 percent of the claims against the PBGC.
21
US Airways and United Airlines are currently in bankruptcy
proceedings, while Delta Airlines and the parent company of American
Airlines both have pensions underfunded by amounts greater than 300
percent of their respective market capitalizations. 22 The
airline industry has a total pension underfunding of $18 billion, and
almost all carriers are losing money. 23 In the past two
years, the PBGC terminated the pension plans of Bethlehem Steel ($3.9
billion), LTV Steel ($1.9 billion), and National Steel ($1.3 billion)--
which are the three largest pensions ever terminated by the PBGC--and
their combined liabilities equal 44 percent of all the claims in the
29-year history of the PBGC. 24
Furthermore, companies in the manufacturing sector hold many of the
pension plans facing significant deficits. Over the past decade, this
sector experienced, and continues to experience, a disproportionate
share of business failures. If this trend continues, more companies
like Bethlehem, National, and LTV Steel will fold, leaving large
pension programs in the care of the PBGC. The mounting risks of pension
failures and the changing demographics of defined benefit pensions are
worrisome trends that threaten to inundate the PBGC with
responsibilities much larger than its resources can manage.
Recommendations
Government-sponsored enterprises are renowned for their economic
inefficiency, and the PBGC is no exception. Reforms are necessary to
prevent a taxpayer-financed bailout. The recommendations for reform
center on three principles: correction of the insurance pricing
schedule, conversion to defined contribution plans, and competition
among private insurers to produce an optimal pension insurance market.
The current method of levying insurance premiums on pension plans
has several flaws that reduce the PBGC's income and fail to create a
strong incentive structure to encourage the responsible management of
pension funds. The adjustment of premiums to better reward prudent
administration and punish sloppy supervision of pension plans offers a
simple market-based solution.
Currently, the PBGC charges each pension fund $19 yearly per
participant to insure the plan, and it may also levy a small,
additional charge on underfunded plans. 25 This gives rise
to the dangers of adverse selection and moral hazard by not creating a
substantial differentiation between the charges imposed on well-managed
funds and poorly-run plans. A formula that accounts for the financial
situation of each fund more completely would determine the premium
based on the plan's underfunding and risk of failure. This will create
the proper incentives for a company and ensure adequate funding of its
pension. If the firm pays a higher premium when its fund runs a
deficit, the company in question bears additional insurance costs,
which serve as an inducement to restore the proper level of funding.
Pension insurance differs from nearly every other form of insurance
due to the principle of market risk. Other types of insurance, such as
auto, life, and medical insurance, do not have to account for changes
in the market. That is, fluctuations in the economy do not
significantly affect the probability of car collisions and medical
emergencies. However, changes in economy-wide variables influence
bankruptcy rates and pension underfunding. This principle, that
economic fluctuations affect pension failures, is market risk.
The PBGC's current insurance premium pricing schedule does not
completely account for this market risk. In a study of the PBGC's
formula, Steven Boyce, a Senior Economist at the PBGC, and Richard A.
Ippolito, a Professor at the George Mason Law School, conclude ``the
pricing schedule currently enforced by the PBGC only vaguely resembles
one that meets a market standard [and] the premium structure ignores
the fact that claims are highly correlated with wealth in the economy.
26 Furthermore, this failure to effectively account for
market risk creates a yearly subsidy of $1 billion. 27 The
underwriters of the insurance, the taxpayers, will bear the costs of
this subsidy.
Thus, creating a pricing schedule that includes the market risk of
a pension will add $1 billion every year to the PBGC's premium income,
which will enable the agency to better meet its obligations and improve
its financial situation. Taxpayers will likewise save a considerable
amount of money in the long term through the elimination of this
subsidy. The adjustment of the PBGC's premium pricing schedule will
create strong, positive incentives for companies to better fund and
manage their pension plans, and a formula that will completely account
for the market risk in each pension.
Furthermore, the elimination of this subsidy will remove a
significant distortion of the market that dissuades employers from
properly funding their defined benefit plans and offering defined
contribution plans. This will give employees more options from which
they can choose their preferred pension plan.
While public policy ought to be neutral in the realm of personal
choice, defined contribution plans are rapidly gaining popularity. Both
defined benefit and defined contribution plans have their advantages
and disadvantages, so employers and employees must decide which option
is best for them. However, the current subsidization of defined benefit
plans distorts this principle of choice. Today's workforce is much more
flexible than those of the past decades. Employees rarely stay with one
employer throughout their career and many now work for a considerable
time beyond the age of retirement. Defined contribution plans better
accommodate this flexible workforce than defined benefit programs
because the defined contribution plans are portable between different
employers, the employee controls his or her pension fund, and there is
no penalty for working beyond the age of retirement. Defined benefit
plans tend to work in the opposite direction.
Current trends show that defined contribution plans are rapidly
gaining popularity and many more workers are choosing to place their
retirement funds in these plans while the number of employees enrolled
in defined benefit plans continues to decline. 28
Consequently, this subsidy is an obstacle to the employees who wish to
convert their pensions into defined contribution plans, and its
elimination will encourage the conversion of defined benefit plans into
defined contribution plans.
Finally, the economic distortions of a monopoly are well
recognized, and the PBGC is a government-created monopoly. Therefore,
it is in the best interests of consumers to introduce competition into
this market. State governments require all automobile drivers to
purchase auto insurance, but they do not sanction a monopolistic
insurance company that possesses the sole right to offer insurance to
drivers within the state. In fact, the competition among auto insurance
companies is strong and beneficial to drivers, as well as taxpayers.
Pension insurance is no different. Competition among insurance
firms to provide insurance for pension holders would effectively remove
the PBGC from the pension insurance market. Then insurance companies
and their shareholders, who are willing to voluntarily bear the risk of
pension failure, would replace taxpayers, who do not voluntarily bear
the same risk, as the ultimate guarantors of the private pension plans.
Competition on the open market for pension insurance would reduce the
costs of providing pensions for employees and remove the risk and
responsibility of pension failures from taxpayers.
Correction of the insurance pricing schedule, conversion to defined
contribution plans, and competition among private insurers will ensure
the long-term stability and security of private pension plans.
Furthermore, taxpayers will no longer bear the costs of possible
pension failures. Instead, those willing to bear the risk of providing
and insuring pensions will be responsible for the successes and
failures of those pension plans.
Conclusion
Congress must reform its regulation of the private pension system
to ensure the security of pensions (correction), expand the personal
pension choices available to employees (conversion), and remove the
potential cost to taxpayers (competition). A resolution of the PBGC's
conundrum may not be as easy as ``A-B-C'', but remembering the ``Three
Cs'' is sure to save tax dollars and give lawmakers a valuable
economics lesson to boot.
About the Author
Alex Pagon served as an Associate Policy Analyst for the National
Taxpayers Union Foundation, the research and educational arm of the
non-partisan National Taxpayers Union. For further information, visit
www.ntu.org.
Notes
1 ``Long-Term Vulnerabilities Warrant ``High Risk''
Designation,'' General Accounting Office Press Statement, July 23,
2003.
2 Bryan-Low, Cassell, ``Gloom Lifting for Pension
Plans,'' The Wall Street Journal, August 15, 2003.
3 Pension Benefit Guaranty Corporation, 2002 Annual
Report, p. 15, p. 51.
4 Statement of Steven A. Kandarian before the Committee
on Finance, United States Senate, March 11, 2003, p. 1.
5 Ibid, p. 5.
6 The terms correction and conversion as propositions
for pension reform are the creation of James H. Smalhout. Smalhout,
James H., The Uncertain Retirement, (Chicago: Irwin Professional
Publishing, 1996).
7 PBGC, 2002 Annual Report, p. 51.
8 Ibid.
9 Statement of Steven A. Kandarian before the Committee
on Finance, United States Senate, March 11, 2003, p. 6.
10 PBGC, 2002 Annual Report, p. 51.
11 Ibid, p. 46, p. 51.
12 Ibid.
13 Ibid.
14 Bryan-Low, Cassell, ``Gloom Lifting for Pension
Plans,'' The Wall Street Journal, August 15, 2003. For the higher
estimate, see Svaldi, Aldo, ``Underfunded Pensions Poised to Steal
Accounting Spotlight Nationwide,'' Denver Post, March 17, 2003.
15 Statement of Steven A. Kandarian before the Committee
on Finance, United States Senate, March 11, 2003, p. 1.
16 Evans, David, ``Earnings Time Bomb Looms in US as
Pension Fund Losses Mount,'' Bloomberg, December 30, 2002, p. 4.
17 Ibid, p. 3.
18 ``Filling the Big Hole in Pension Plans,'' David L.
Babson & Company, Inc., July 8, 2003, p. 4.
19 ``GM Pleased with Record Debt Offering,'' AFX News,
Ltd., July 7, 2003.
20 Schneider, Greg, ``Pension Needs Fueling GM's Sales
Push,'' The Washington Post, June 25, 2003, p. E1.
21 Statement of Steven A. Kandarian before the Committee
on Finance, United States Senate, March 11, 2003, p. 7.
22 ``AMR Pension Underfunding Estimated at 601% of
Market Value,'' Communications Workers of America Press Statement, July
7, 2003, p. 1.
23 Statement of Steven A. Kandarian before the Committee
on Finance, United States Senate, March 11, 2003, p. 7.
24 Ibid, p. 4.
25 ``Retirement Protection Act of 1994--Summary of Major
Reforms,'' Pension Benefit Guaranty Corporation, p. 1.
26 Boyce, Steven, and Richard A. Ippolito, ``The Cost of
Pension Insurance,'' The Journal of Risk and Insurance, 2002, Vol. 69,
No. 2, p. 124.
27 Ibid.
28 Foster, Ann C., ``Defined Contribution Retirement
Plans Become More Prevalent,'' Compensation and Working Conditions,
June 1996, pp. 42-44.