[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



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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


                                 ------                                
                            C O N T E N T S

                              ----------                              
                                                                   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

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                                ------                                


                         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.

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