[Senate Hearing 108-285]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 108-285

 SAFEGUARDING AMERICA'S RETIREMENT SECURITY: AN EXAMINATION OF DEFINED 
   BENEFIT PENSION PLANS AND THE PENSION BENEFIT GUARANTY CORPORATION

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

                                HEARING

                               before the

     FINANCIAL MANAGEMENT, THE BUDGET, AND INTERNATIONAL SECURITY 
                              SUBCOMMITTEE

                                 of the

                              COMMITTEE ON
                          GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE


                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                               __________

                           SEPTEMBER 15, 2003

                               __________

      Printed for the use of the Committee on Governmental Affairs



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                   COMMITTEE ON GOVERNMENTAL AFFAIRS

                   SUSAN M. COLLINS, Maine, Chairman
TED STEVENS, Alaska                  JOSEPH I. LIEBERMAN, Connecticut
GEORGE V. VOINOVICH, Ohio            CARL LEVIN, Michigan
NORM COLEMAN, Minnesota              DANIEL K. AKAKA, Hawaii
ARLEN SPECTER, Pennsylvania          RICHARD J. DURBIN, Illinois
ROBERT F. BENNETT, Utah              THOMAS R. CARPER, Delaware
PETER G. FITZGERALD, Illinois        MARK DAYTON, Minnesota
JOHN E. SUNUNU, New Hampshire        FRANK LAUTENBERG, New Jersey
RICHARD C. SHELBY, Alabama           MARK PRYOR, Arkansas

           Michael D. Bopp, Staff Director and Chief Counsel
      Joyce A. Rechtschaffen, Minority Staff Director and Counsel
                      Amy B. Newhouse, Chief Clerk

                                 ------                                

     FINANCIAL MANAGEMENT, THE BUDGET, AND INTERNATIONAL SECURITY 
                              SUBCOMMITTEE

                PETER G. FITZGERALD, Illinois, Chairman
TED STEVENS, Alaska                  DANIEL K. AKAKA, Hawaii
GEORGE V. VOINOVICH, Ohio            CARL LEVIN, Michigan
ARLEN SPECTER, Pennsylvania          THOMAS R. CARPER, Delaware
ROBERT F. BENNETT, Utah              MARK DAYTON, Minnesota
JOHN E. SUNUNU, New Hampshire        FRANK LAUTENBERG, New Jersey
RICHARD C. SHELBY, Alabama           MARK PRYOR, Arkansas

                   Michael J. Russell, Staff Director
              Richard J. Kessler, Minority Staff Director
                       Tara E. Baird, Chief Clerk
                            C O N T E N T S

                                 ------                                
Opening statements:
                                                                   Page
    Senator Fitzgerald...........................................     1
    Senator Akaka................................................     4

                               WITNESSES
                       Monday, September 15, 2003

Malcolm Wicks, Minister for Pensions, British Government.........     6
Peter R. Fisher, Under Secretary for Domestic Finance, U.S. 
  Department of the Treasury.....................................     8
Steven A. Kandarian, Executive Director, Pension Benefit Guaranty 
  Corporation....................................................     9
Christopher W. O'Flinn, Vice President, Corporate Human 
  Resources, AT&T, on behalf of the ERISA Industry Committee.....    23
Kathy Anne Cissna, Director of Retirement Plans, R.J. Reynolds, 
  on behalf of the American Benefits Council.....................    24
Norman P. Stein, Law Professor, University of Alabama, on behalf 
  of the Pension Rights Center...................................    26
JoOhn P. Parks, Vice President, Pension Practice Council, 
  American Academy of Actuaries..................................    28
J. Mark Iwry, Senior Fellow, The Brookings Institution...........    30

                     Alphabetical List of Witnesses

Cissna, Kathy Anne:
    Testimony....................................................    24
    Prepared statement...........................................    98
Fisher, Peter R.:
    Testimony....................................................     8
    Prepared statement...........................................    43
Iwry, J. Mark:
    Testimony....................................................    30
    Prepared statement...........................................   142
Kandarian, Steven A.:
    Testimony....................................................     9
    Prepared statement with attachments..........................    54
O'Flinn, Christopher W.:
    Testimony....................................................    23
    Prepared statement with attachments..........................    72
Parks, John P.:
    Testimony....................................................    28
    Prepared statement with attachments..........................   125
Stein, Norman P.:
    Testimony....................................................    26
    Prepared statement...........................................   116
Wicks, Malcolm:
    Testimony....................................................     6

                                Appendix

Charts submitted for the Record by Senator Fitzgerald
    Total Underfunding, Insured Single-Employer Plans............   157
    PBGC Net Position, Single-Employer Program, FY 1980-FY 2002..   158
    Uncertain Futures............................................   159
    Single-Employer Premium Income, FY 1992-FY 2002..............   160

 
 SAFEGUARDING AMERICA'S RETIREMENT SECURITY: AN EXAMINATION OF DEFINED 
   BENEFIT PENSION PLANS AND THE PENSION BENEFIT GUARANTY CORPORATION

                              ----------                              


                       MONDAY, SEPTEMBER 15, 2003

                                     U.S. Senate,  
                  Subcommittee on Financial Management,    
                  the Budget, and International Security,  
                  of the Committee on Governmental Affairs,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 2:31 p.m., in 
room SD-342, Dirksen Senate Office Building, Hon. Peter G. 
Fitzgerald, Chairman of the Subcommittee, presiding.
    Present: Senators Fitzgerald and Akaka.

            OPENING STATEMENT OF SENATOR FITZGERALD

    Senator Fitzgerald. Good afternoon. The Subcommittee will 
come to order.
    Today, we are conducting an oversight hearing on the 
challenges facing the Nation's defined benefit pension plans. 
Broadly speaking, we will examine, one, the financial condition 
of the Pension Benefit Guaranty Corporation, the PBGC, the 
government-sponsored corporation which insures defined benefit 
pension plans; two, how Congress can help shore up the PBGC; 
and three, how Congress and the administration can help improve 
the accuracy of the actuarial and funding practices of company-
sponsored plans and thereby help bolster the retirement 
security of millions of American workers.
    The Nation's private sector defined benefit pension system 
is breaking down and needs to be fixed. Financially weak 
companies have for years made pension promises that they could 
not deliver and then simply dumped their unfunded pension 
promises off onto the PBGC. The PBGC is now being crushed by 
the weight of those claims.
    Financially strong companies with responsibly managed 
defined benefit pension plans should be concerned because they 
may be unfairly forced to pay for the irresponsible promises of 
the financially weak and irresponsible companies. And taxpayers 
should be concerned, as well. If current trends continue, the 
taxpayers themselves may someday be called upon to pay for the 
pension promises of the irresponsible and financially weak 
companies that dump their pension plans on the PBGC.
    If the current situation seems reminiscent of the savings 
and loan crisis of the late 1980's, that is because it is. And 
just as weak S&Ls then sent hoards of lobbyists to Washington 
asking Congress to prevent a day of reckoning, so, too, we now 
have companies with weak and underfunded pension plans flooding 
Congress with pleas for further indulgences. Let us hope that 
this time around, Congress doesn't succumb to the siren song of 
those who would urge us to roll the problem over into future 
years.
    The reason we are here now is because the problem has been 
rolled over repeatedly in the past on the promise that things 
will get better tomorrow. Well, in my judgment, tomorrow is 
here, and we ought to act before it is too late.
    Although pension fund assets totaled $1.6 trillion at the 
end of 2002, estimates indicate that private sector defined 
benefit pension plans are now collectively underfunded by 
nearly $400 billion. As illustrated in our first chart at the 
end of the dais, the level of underfunding has increased 
sharply in the last 2 years.\1\
---------------------------------------------------------------------------
    \1\ Chart entitled ``Total Underfunding, Insured Single-Employer 
Plans'' appears in the Appendix on page 157.
---------------------------------------------------------------------------
    The steel industry has already staked its claim against the 
PBGC, taking the top three spots for the largest claims 
submitted to the pension insurer in the last 2 years. Bethlehem 
Steel, whose pension plan terminated in 2003, had $3.9 billion 
in claims. LTV's pension plan terminated in 2002, with $1.9 
billion in claims. And National Steel filed claims of $1.3 
billion in 2003.
    In its last filing prior to termination, Bethlehem Steel 
reported that its pension plan was 84 percent funded on a so-
called current liability basis. The trouble is, if a plan 
terminates, the legislative definition of current liability is 
typically a figure that is far less than the actual amount of 
money that is needed to pay the benefits that are owed. Thus, 
it turns out that Bethlehem Steel's pension plan, which was 84 
percent funded on a so-called current liability basis, was 
actually only 45 percent funded on a termination basis. As a 
result, the other companies that remain in the PBGC insurance 
program, or perhaps even someday the taxpayers themselves, will 
have to pay over 50 percent of the benefits which Bethlehem 
Steel promised its workers but apparently never funded.
    It is here worth noting that despite its remarkably low 
level of funding, the laws currently on the books allowed 
Bethlehem Steel to make no cash contributions whatever in the 3 
years prior to its plan's termination.
    The PBGC's financial health has deteriorated dramatically 
in recent months, and I would like to refer you to the second 
chart.\2\ The PBGC has experienced a swing from a $7.7 billion 
accumulated surplus at the end of fiscal year 2001 to a $5.7 
billion deficit as of July 31, 2003. This swing amounts to a 
$13.4 billion swing within 22 months. The PBGC now faces its 
largest deficit ever, with the likelihood of additional severe 
losses in the immediate and intermediate future.
---------------------------------------------------------------------------
    \2\ Chart entitled ``PBGC Net Position, Single-Employer Program, FY 
1980-FY 2002'' appears in the Appendix on page 158.
---------------------------------------------------------------------------
    PBGC's record losses are primarily attributable to the 
recent termination of several severely underfunded pension 
plans sponsored by financially troubled and bankrupt companies. 
The combination of a decline in equity valuations and near 
record low interest rates has resulted in a double whammy for 
defined benefit pension plans.
    Now, I would like to refer you to the third chart.\1\ This 
is a chart that was copied with permission from the Wall Street 
Journal. As it illustrates, the unfunded pension liabilities of 
financially weak companies have soared in recent years. The 
PBGC currently estimates that when it closes out its fiscal 
year for 2003, the financially weak companies will have 
underfunded their liabilities by $80 billion. This figure is up 
$45 billion from last year's estimate.
---------------------------------------------------------------------------
    \1\ Chart entitled ``Uncertain Futures'' appears in the Appendix on 
page 159.
---------------------------------------------------------------------------
    Further complicating the financial stability of the PBGC is 
a steady decline of premium income. And for this, you can refer 
to the fourth chart.\2\ It shows premium income declining from 
$1.1 billion in 1996 to just $787 million in 2002. This 
leveling off in 2002 results from more underfunded plans 
qualifying for exemption from paying the variable rate premium 
and an increasing number of plans being terminated. Premium 
income in 2002 at $787 million was substantially less than it 
was 10 years ago, in 1993, when it was $890 million. With a 
shift to more defined contribution plans, such as 401(k)s, it 
is unlikely that premiums will increase significantly in the 
foreseeable future.
---------------------------------------------------------------------------
    \2\ Chart entitled ``Single-Employer Premium Income, FY 1992-FY 
2002'' appears in the Appendix on page 160.
---------------------------------------------------------------------------
    At the same time that the PBGC's premium income has been 
falling, the benefits that the PBGC has become obligated to pay 
have been skyrocketing. Benefits paid in 1993 were $720 
million. Last year, they were $1.5 billion, and this year, the 
benefits paid are likely to reach $2.5 billion, over three 
times the benefits paid in 1993 and many times the amount that 
the PBGC is taking in in premium income.
    Obviously and quite simply, the long-term survival and 
success of the PBGC will be in jeopardy if the PBGC's premium 
income continues to decline and its benefit payments continue 
to rise at such a rapid rate. In my judgment, Congress must act 
quickly to force companies which sponsor defined benefit 
pension plans to do a better job of funding them, to stem the 
tide of terminations by financially weak companies, and to 
figure out a way to increase the PBGC's premium income, 
probably by converting to a more sufficiently risk-based 
system.
    The plight of the PBGC is of great consequence to our 
Nation. The PBGC's two insurance programs, the single-employer 
insurance program and the multi-employer program, insure the 
pension benefits of over 44 million participants in more than 
32,000 private defined benefit pension plans. As many as 1.8 
million of those participants are in my home State of Illinois.
    In July of this year, the U.S. General Accounting Office 
designated the PBGC single-employer pension insurance program 
as ``high risk.'' This action is of particular significance 
because it marks only the third time in the history of the 
GAO's high-risk list that an agency or program has been added 
independently of the GAO's biennial report.
    We cannot lose track among the acronyms and dollar figures 
of the toll this issue might have on working people across 
America. It is cruel and unacceptable to pull the rug from 
under hard-working Americans by telling them some of their 
deserved and promised pension benefits no longer exist. It is 
also unacceptable to force the taxpayers to bail out the PBGC.
    These principles should be our ground zero commitment to 
American workers, that government has an obligation to make 
companies live up to the promises they make to their workers 
and that it has an obligation to protect taxpayers from picking 
up the tab of a failed system.
    United Airlines, headquartered in my State, which on a 
termination basis has underfunded its pension plan by some $7.5 
billion, has recently been pushing for legislation that would 
allow it to receive a 5-year moratorium on deficit reduction 
contributions and then have 20 years thereafter to amortize the 
additional unfunded liability accruing during that time. The 
big risk, of course, is that United's pension plan would become 
even more unfunded and would eventually be terminated. The PBGC 
would then be stuck with hefty liabilities, United workers 
would lose benefits, and other companies would be forced to pay 
for one industry's unfunded promises.
    Special interest legislation such as that proposed by 
United is exactly the sort which, in my judgment, will make the 
problem worse. As one of our distinguished witnesses said 
earlier this year, when you are in the hole, the first rule is 
to stop digging. I plan to do what I can to make sure that 
Washington does no more digging.
    Clearly, changes are needed in the defined benefit pension 
system. In July, the administration proposed changes to improve 
the accuracy and transparency of pension information. The 
administration proposal focuses on three key areas: Improving 
the accuracy of plan sponsors' liability calculations, 
increasing the transparency of pension plan information, and 
strengthening pension funding to protect workers and retirees. 
We look forward to hearing more about this proposal from our 
witnesses.
    In addition, this hearing will explore a number of issues 
and challenges facing the Nation's pension system and the PBGC. 
These include replacement of the 30-year Treasury bond rate; 
strengthening of funding rules; accurate measurement of assets 
and liabilities; current liability versus termination 
liability, the definition of those terms; declining PBGC 
premium revenue; increasing the extent to which pension 
contributions are tax deductible--they are only deductible now, 
as I understand it, up to the amount of your required 
contributions and it is difficult to make excess contributions 
in years that the company is doing well; the allowance of so-
called alternative investments that some companies have been 
allowed to make; and another hot topic, the effect of cash 
balance plans.
    We look forward to hearing the views of our witnesses on 
these and other issues affecting the Nation's pension system as 
well as their recommendations on ways to ensure the financial 
stability of the PBGC and the pension plans of companies the 
PBGC insures. At stake is nothing less than the financial 
security of millions of Americans who rely or are planning to 
rely on their company funded pension plans in their retirement 
years.
    Now, before turning to our witnesses for testimony, I want 
to introduce the Ranking Democrat. Senator Akaka has arrived, 
and I thank Senator Akaka for being here. Would you like to 
make an opening statement.

               OPENING STATEMENT OF SENATOR AKAKA

    Senator Akaka. Yes, Mr. Chairman. I want to say good 
afternoon to you and our panelists. I want to thank you, Mr. 
Chairman, for holding this hearing today and, again, thank our 
witnesses for sharing their insights with us this afternoon.
    Although more employers offer defined contribution plans 
such as a 401(k) plan than defined benefit plans, we must 
ensure that the Pension Benefit Guaranty Corporation is able to 
protect the retirement security of the estimated 34 million 
hard-working Americans participating in single-employer defined 
benefit pension plans. I am concerned that the PBGC lacks 
sufficient reserves to carry out its statutory responsibility 
of providing workers with protection when their former 
employers are no longer able to support their retirement 
benefits.
     Comptroller General David Walker recently testified before 
the House Committee on Education and the Workforce about the 
risks that PBGC is and will be facing. He noted that in fiscal 
year 2002, PBGC's termination of defined benefit plans offered 
by Anchor Glass, Bethlehem Steel, and Polaroid accounted for a 
$4.2 billion loss to PBGC. While these plans represent the 
largest losses to PBGC in their respective industries, they are 
just three examples. In its latest review, GAO found that many 
of the single employer defined benefit plans are severely 
underfunded, which led Congress' non-partisan auditor to place 
the PBGC on its high-risk list in July.
    The PBGC has faced deficit situations before. The agency 
was on the high-risk list in 1990, due to weak funding rules 
and ran deficits during the mid-1980's and early 1990's. 
Congress enacted legislation to strengthen minimum funding 
standards and to enhance rules on variable rate premiums paid 
by defined benefit pension plans.
    Although the PBGC has faced problems before, to which 
Congress responded, it is critical that we act once again to 
ensure that PBGC is self-supporting. Most PBGC revenue comes 
from premiums set by Congress and paid by the private sector 
employers that sponsor defined benefit plans. Other sources of 
income are assets from terminated plans taken over by the PBGC, 
investment income, and recoveries collected from companies when 
they end underfunded pension plans.
    To shore up the financial foundations of PBGC, there must 
be greater transparency of plan information so that workers 
understand the stability of their plans and the contributions 
that are made by their employers. Employees should know if the 
company for which they work will be unable to pay employee 
pensions.
    There are those who believe we should adopt limited, short-
term changes to pension funding rules and just wait out the 
current economic conditions that pose risks to the PBGC. Others 
recommend measures to address loopholes in funding rules. The 
administration has proposed changing the rate at which an 
employee's contribution is calculated over the long term. It is 
crucial that we work together to secure the retirement security 
of American workers.
    I look forward to discussing what can be done to guarantee 
that companies honor their pension commitments, and when these 
promises cannot be met, what must be done to make sure that the 
PBGC is sufficiently funded to carry out its statutory mission 
as insurer of the private defined benefit pension plans.
    We look forward to the hearing and the testimony, Mr. 
Chairman, and I thank you for holding this hearing.
    Senator Fitzgerald. Thank you, Senator Akaka.
    I am pleased to tell you that we have a special guest here 
from the Nation of Great Britain, our great friend and ally, 
Malcolm Wicks, who is the Pension Minister in British Prime 
Minister Tony Blair's cabinet. Mr. Wicks was appointed in 2001 
as the Parliamentary Under Secretary of State for Work at the 
Department for Work and Pensions. Mr. Wicks has had a 
distinguished career of service to the British Government, also 
having served as Parliamentary Under Secretary of State for 
Lifelong Learning at the Department for Education and 
Employment, and as Chairman of the Education Select Committee, 
and as a Member of Parliament.
    Mr. Wicks, we are delighted to have you here. I understand 
that you are working on some new legislation in Great Britain 
and I would like to give you the opportunity to address the 
panel for as long as you would like to go on. Thank you very 
much for being here.

  TESTIMONY OF MALCOLM WICKS, MINISTER FOR PENSIONS, BRITISH 
                           GOVERNMENT

    Mr. Wicks. Mr. Chairman, may I first of all thank you, and 
indeed Senator Akaka, for this opportunity to say a few words. 
I promise to detain the Subcommittee only a few minutes, 
because knowing the Subcommittee system in my own country, you 
have important work to do and important witnesses. But I thank 
you for your kindness and courtesy in giving me this 
opportunity, which as both a Parliamentarian myself and as a 
Minister, I genuinely regard as a very great privilege.
    May I say that the close relationship between Great Britain 
and the United States extends to social policy, and I think we 
are increasingly learning a great deal from one another. We are 
here on a relatively short visit to Washington, essentially to 
listen and learn.
    The United Kingdom, like your country, finds itself in a 
situation where pensions as increasingly rising up the agendas 
that count, particularly the agenda of public opinion. Our 
demographics are not dissimilar. I am struck by the fact that 
whereas 100 or so years ago, many working Americans, and 
certainly many working Britains, never outlived their working 
life. Today, there is the concept of retirement and, indeed, in 
the 21st Century in the United States and Great Britain, many 
of our citizens may have retirements lasting 20, or indeed, 
increasingly 30 or more years. So this couldn't be more 
important as an issue.
    I do not believe that we face crisis. I think we overuse 
the term ``crisis.'' We should use it properly and in context. 
But we all face in our democracies very formidable challenges.
    Like in the United States, in the United Kingdom, there is 
concern about occupational pensions, defined benefit or final 
salary schemes, and we plan to legislate in our coming session 
in the House of Commons to introduce what we will call pension 
protection funds, drawing very much on the experience of the 
Pension Benefit Guaranty Corporation. And may I say that we 
have had useful meetings in Washington over the last few days, 
not the least with Steven Kandarian and his colleagues this 
morning. I am grateful to him and, indeed, the cooperation they 
are giving to our officials who are asking some very detailed 
and searching questions about the Corporation's operation.
    Senators I am very grateful for this opportunity and thank 
you very much.
    Senator Fitzgerald. Minister, thank you very much for being 
here. We thank you for joining us today, and good luck on 
setting up your form of the PBGC. Thank you very much.
    At this time, I would like to welcome our first panel with 
two distinguished witnesses. Our first witness is the Hon. 
Peter R. Fisher, the Under Secretary for Domestic Finance of 
the U.S. Department of the Treasury. Secretary Fisher was sworn 
in on August 9, 2001. His experience and understanding of the 
financial markets proved invaluable as our Nation and our 
financial system responded to the terrorist attacks of 
September 11.
    Secretary Fisher's accomplishments include his leadership 
in helping to improve and streamline our government's fiscal 
practices and policies, enacting terrorism risk insurance, 
promoting job creation and investment, developing policies on 
deposit insurance reform, advocating for enhanced disclosure by 
government-sponsored enterprises, working to prevent identity 
theft, and improving Federal debt management practices.
    Under Secretary Fisher will be departing the Department of 
Treasury in the next month. In my judgment, his departure will 
be a great loss for the entire Federal Government.
    I would also like to welcome Steven A. Kandarian, who is 
the Executive Director of the Pension Benefit Guaranty 
Corporation. Prior to joining the PBGC, Mr. Kandarian was 
managing director and founder of Orion Partners, L.L.C., in 
Boston, Massachusetts, where he managed a private equity fund 
specializing in venture capital and corporate acquisitions. He 
also was managing director of Lee Capital Holdings, a private 
equity firm also based in Boston, and was an investment banker 
in Houston, where he specialized in mergers and acquisitions 
and initial public offerings.
    The government is especially grateful to have an individual 
with such extensive private sector financial experience at the 
helm of the PBGC during this difficult time. His grasp of the 
issues surrounding the pension system and the PBGC, as well as 
his innovative ideas, are a significant and timely addition to 
the public policy debate underway.
    Again, I want to thank you both for being here and I would 
tell Minister Wicks, it won't be rude if you get up. You don't 
have to wait through the whole hearing, and you can stay as 
long as you like, but we will not feel hurt if you have other 
commitments, so thank you.
    Under Secretary Fisher.

 TESTIMONY OF PETER R. FISHER,\1\ UNDER SECRETARY FOR DOMESTIC 
            FINANCE, U.S. DEPARTMENT OF THE TREASURY

    Mr. Fisher. Thank you, Mr. Chairman, and thank you for 
those generous and kind introductory remarks. Mr. Chairman, 
Ranking Member Akaka, I am very pleased to be here with Steve 
Kandarian to discuss our defined benefit pension system. Mr. 
Kandarian will discuss the current financial condition of the 
PBGC and I would like to discuss the administration's proposals 
for strengthening the long-term health of our defined benefit 
pensions.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Fisher appears in the Appendix on 
page 43.
---------------------------------------------------------------------------
    Pension plan underfunding and the PBGC's deficit are 
symptoms of a serious structural problem in the defined benefit 
pension system. As you noted, Mr. Chairman, the GAO reached the 
same conclusion in placing the PBGC's single employer insurance 
program on its list of high-risk government programs. The time 
to fix the system is now, while the problems are still 
manageable.
    In our view, the best way to protect the PBGC is to be sure 
that pension plans are adequately funded. This is also the best 
way to provide pension security for our Nation's workers and 
retirees.
    Pension problems can be placed into two priority 
categories, comprehensive reform issues that need our prompt 
attention and more narrowly-focused issues that need Congress' 
immediate attention.
    Comprehensive reform issues include strengthening pension 
funding rules, reexamining and updating certain key actuarial 
assumptions, and shoring up the PBGC's insurance program 
overall. My written testimony, which I ask to be included in 
the record, outlines the full range of issues the Congress and 
the administration will need to address to achieve 
comprehensive reform. Let me now just summarize the three areas 
where we have asked Congress for immediate action.
    First, accurate measurement of pension liabilities. Fixing 
the pension funding rules won't help unless we ensure that we 
are accurately measuring the pension liabilities on which those 
rules rely. Our first step is replacing the 30-year Treasury 
rate required under current law to be used as a discount rate 
in measuring pension liabilities for minimum funding purposes.
    The administration recommends that pension liabilities 
ultimately be discounted with rates drawn from a corporate bond 
yield curve that takes into account the term structure of 
pension plans' liabilities. For the first 2 years, pension 
liabilities would be discounted using a blend of corporate 
rates. A phase-in to the appropriate yield curve discount rate 
would begin in the third year and would be fully applicable by 
the fifth year. Using the yield curve is essential to match the 
timing of future benefit payments with the resources necessary 
to make those payments. Our proposal is consistent with well 
established best practice in financial accounting, can be 
readily implemented by plan sponsors, and provides a transition 
period for implementation.
    Second, we think we need greater transparency of pension 
funding. There is no requirement under current law that workers 
and retirees covered by defined benefit pension plans receive 
regular, timely information on their plan's financial 
condition. We propose to remedy this by requiring that each 
year, sponsors provide each participant with the value of his 
or her pension plan's assets and the level of liabilities 
measured on both a current liability and a termination basis. 
Not only will disclosure of this information be valuable for 
those covered by plans, it will provide a powerful incentive 
for sponsors to keep their plans well funded.
    Third, containing the risks to the PBGC of underfunded 
plans. Underfunded plans sponsored by financially weak firms 
which pose the greatest risk to the PBGC have few restrictions 
in expanding benefits. The administration proposes to add some 
protection for the PBGC by strengthening the restrictions on 
those plans in making new promises.
    In summary, Mr. Chairman, we face a real problem today. We 
need to act this year in these three areas that I have 
identified and then we will have provided the basis for which 
to move on to comprehensive reform. The administration stands 
ready to work with this Subcommittee and the rest of Congress 
to accomplish these goals. Thank you very much.
    Senator Fitzgerald. Thank you, Mr. Secretary.
    Mr. Kandarian, you may proceed with your opening statement.

   TESTIMONY OF STEVEN A. KANDARIAN,\1\ EXECUTIVE DIRECTOR, 
              PENSION BENEFIT GUARANTY CORPORATION

    Mr. Kandarian. Mr. Chairman, Ranking Member Akaka, thank 
you for holding this hearing on pension funding and the 
financial health of PBGC.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Kandarian with attachments 
appears in the Appendix on page 54.
---------------------------------------------------------------------------
    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.
    In July, the administration proposed improving the way 
pension liabilities are 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 Subcommittee 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 benefit 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 you just mentioned, 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 the 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 the recent rises in the stock 
market and interest rates, PBGC projects that 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 of 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 benefit 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 can 
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 benefits 
if a plan terminates. As a result, employers can stop making 
contributions before a plan is sufficiently funded to protect 
participants.
    Second, the funding rules often 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 
plan termination, and the U.S. Airway pilots' plan had no cash 
contributions for 4 years before the plan was terminated.
    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 can 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 to 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 
benefit 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, Mr. Chairman, for inviting me to testify. I will 
be happy to answer any questions.
    Senator Fitzgerald. Thank you both very much. We appreciate 
your being here and appreciate your good insights in your 
opening statements.
    Mr. Kandarian, I would like to begin with you. You focus 
mainly on trying to shore up the funding of the plans 
themselves. You noted that the funding targets are probably too 
low. I do want to address that later on, but at the outset, I 
want to address the problem with your premium revenue being so 
low compared to the benefits you are paying out. Obviously, 
that is not sustainable.
    You are getting less premium revenue now than you were 10 
years ago and claims against you, or benefits that you have to 
pay out, have tripled, roughly, in the last 10 years. If I 
understand it, you are going to pay out about how much this 
year, $2.5 billion, is that correct?
    Mr. Kandarian. Our current run rate, Mr. Chairman, is $2.5 
billion. We anticipate in fiscal 2003 that number going up to 
perhaps $2.9 billion.
    Senator Fitzgerald. In this fiscal year?
    Mr. Kandarian. Fiscal 2003, beginning October 1. Oh-four, 
pardon me.
    Senator Fitzgerald. OK. So going up to $2.9 billion next 
year?
    Mr. Kandarian. Yes.
    Senator Fitzgerald. And how much in premium income do you 
have?
    Mr. Kandarian. We are taking in just under $800 million a 
year in the single-employer program currently.
    Senator Fitzgerald. OK. So you are eating into your trust 
funds to pay these claims on an ongoing basis. Obviously, this 
isn't sustainable for the long term, barring some kind of 
incredible upturn perhaps in the equity funds that you hold, 
but those are only about 30 percent of your overall trust 
funds, isn't that correct?
    Mr. Kandarian. Yes. Our equity investment allocation is 
approximately 30 percent today. What would have to happen for 
us to get back in balance would be a dramatic improvement in 
our equity returns, premium income that would continue at these 
levels or perhaps higher because the variable rate premium may 
kick in a little bit stronger, but we still do not anticipate 
under the current rules that that number would exceed $1 
billion. It would be less than $1 billion a year.
    Senator Fitzgerald. OK. So the question I have for you is 
are our insurance premiums sufficient? It doesn't look to me 
like they are anywhere close to being sufficient.
    Mr. Kandarian. Well, the administration is looking at all 
these different avenues. We have no specific proposal at this 
point in time on premiums. But, really, the first thing I hope 
we can do is, in addition to studying the correct measure of 
these liabilities, is to get these plans better funded so that 
when they do come into this agency, that instead of coming in 
50 percent funded, they come in 80 or 90 percent funded if 
there is a need for PBGC insurance.
    Senator Fitzgerald. So it is more manageable if you have to 
take them over. What about funds that are leaving the PBGC? 
There is an increasing number of pension plans that are just 
leaving the fund. They are switching their workers over to 
defined contribution plans. That is also having a negative 
effect on your premium income, correct?
    Mr. Kandarian. Well, the premiums are determined based upon 
numbers of plan participants. That number has pretty well 
leveled off. So it is driven by that number as well as the 
variable rate premium amount.
    So what really happened in the last few years was the 
variable rate premium was coming down, largely because of the 
way it is measured and because plans did get well funded in the 
late 1990's with the stock market boom. But those rules have a 
lag effect to them. The variable rate premium will start to 
increase, but again, we don't anticipate it going up above $1 
billion, which at one point we did have in premiums.
    Senator Fitzgerald. Now, I was struck by the figures that 
Bethlehem Steel, prior to its termination, claimed to be 84 
percent funding in its last filing prior to termination----
    Mr. Kandarian. Right.
    Senator Fitzgerald [continuing]. On a so-called current 
liability basis, and current liability, it is a very 
complicated definition. I tried to unscramble it yesterday. I 
had several staff members working on it and we found why there 
is a whole industry of ERISA lawyers out there and why they are 
highly compensated. It is very convoluted. It is not a simple 
definition. I gather there are all sorts of different ways of 
calculating it.
    But the bottom line is, whatever current liability is in 
ERISA, it seems to be something less than the actual amount of 
money you have to put in to pay off the claims. You found that 
Bethlehem Steel was 84 percent funded on a current liability 
basis, but on a termination basis, only 54 percent funded.
    Mr. Kandarian. Yes, Senator. What occurred there was, as 
you mentioned, the definition of current liability is 
dramatically different, especially in the case as we had here 
recently with declining asset values and declining interest 
rates, which drove up stated liabilities. So the definition of 
current liability results in these much higher stated amounts 
of funding, and, in fact, for the 5 years before Bethlehem 
Steel came into our agency on a terminated basis, the company 
made no variable rate premium payments to us.
    The variable rate premium is supposed to reflect these 
underfunded plans, and here was the largest underfunding the 
agency ever had taken on in its history by a factor of two and 
there was no variable rate premium paid to the agency for 5 
years. In addition, over the last 5 years, only about $40 
million of cash contributions went into this pension plan that 
was $4.3 billion underfunded when it finally came in. So the 
current liability measure can really be misleading when a 
company is in a death spiral and terminates its pension plan.
    Senator Fitzgerald. Now, some of the later witnesses are 
going to criticize you for focusing on termination liability 
because they say that that is a number taken by calculating the 
cost of buying annuities from insurance companies when 
terminating a plan and that, in fact, you don't buy annuities. 
So why do you think termination liability is an important 
number?
    Mr. Kandarian. Well, when a company terminates its pension 
plan, even if the company doesn't go out of business, they can 
do what is called a standard termination simply to exit the 
system and start using some other vehicle, perhaps 401(k)s. 
They go to insurance market and they price out these 
liabilities in the marketplace and they basically defease these 
liabilities with insurance companies, and the question becomes, 
even for a company that is going out of business, if they had 
enough money in the pension plans, and occasionally one of 
several pension plans may have enough money in it to buy a 
standard termination annuity in the group annuity market, those 
obligations, those liabilities won't come to the agency under 
law. They will go right to the insurance market.
    So it is really an apples-to-apples basis of what did these 
liabilities cost in the private marketplace, and for the 
government to say, we are going to price these liabilities 
higher or lower, I think would be wrong.
    Senator Fitzgerald. Senator Akaka, you may have questions 
you want to ask at this point, and then I will ask some 
questions of Secretary Fisher.
    Senator Akaka. Thank you very much, Mr. Chairman. I do have 
some questions.
    If I may digress for just a moment, I would like to thank 
Mr. Fisher for bringing the challenges of the Postal Service to 
the attention of the administration. As the former Chairman of 
the Committee's Postal Subcommittee, I appreciate your interest 
and efforts in this area.
    I also want to add my welcome to Minister Wicks for being 
here with us today.
    Now, let me turn to the issue at hand--the need to protect 
workers' pensions insured by the PBGC. As the testimony of our 
panelists will show, there are diverse views and little 
consensus on how the complex issues of pension funding should 
be approached. I am concerned that the administration proposal 
could unfairly impact unionized workers.
    The Department of Labor estimates that 69 percent of 
unionized workers have pension plans as compared to 14 percent 
of non-union workers. The U.S. manufacturing industry is more 
likely to employ a unionized workforce because manufacturing 
jobs are more likely to be unionized and are more likely to 
offer pensions.
    Mr. Fisher, do you believe that the administration's 
proposal would affect union employees' pension plans?
    Mr. Fisher. Senator, first, let me be very clear. We 
certainly hope that it will affect their pension plans by 
getting them better funding.
    The connection, as I see it, is that there are in heavy 
manufacturing a tradition of higher rates of unionization and 
of older workforces at this point, and we have already at this 
hearing discussed some of the problems in the steel industry. 
If we don't get to accurate measurement of pension liabilities, 
those very workers are the ones who will be most greatly at 
risk to have underfunded pension plans.
    So we think it is of paramount importance to make sure that 
their retirement security is as protected as we can make it to 
get to accurate measure of liability and that motivated the 
administration's proposals we made in July.
    Senator Akaka. Thank you, Mr. Fisher.
    Mr. Kandarian, in your testimony, you mentioned that PBGC 
is responsible for paying current and future benefits to 
783,000 people in over 3,000 terminated defined benefit plans. 
Furthermore, PBGC operates from premiums that it receives from 
program participants, and your testimony states that PBGC 
receives no Federal tax dollars.
    My question to you today is, what incentives could keep 
employers' well-funded pensions with PBGC?
    Mr. Kandarian. What incentives could keep companies in the 
defined benefit system? I think probably the best incentive is 
to get this system on a stable footing, and there are a number 
of ways to do that.
    First, as Secretary Fisher has mentioned, having accurate 
measure of liabilities is very important. Disclosure is very 
important, and if I may digress to the question you asked Mr. 
Fisher a moment ago, it is important for union members to know 
the status of their pension plans. Are they well funded? Are 
they underfunded?
    If all they hear are these current liability-type numbers 
that the Chairman mentioned, they may be misled into thinking 
that if a company is in trouble financially, that their plan is 
well funded and they won't lose any benefits, when, in fact, 
their plan may be highly underfunded if the plan terminates. 
Our disclosure proposals would enable workers to learn what the 
real numbers are. It would enable unions, in particular, to put 
pressure on companies potentially to make sure these plans are 
properly funded.
    So I think the proposals the administration has talked 
about would be very beneficial to the system and many of the 
workers that you are referring to and you are concerned about.
    Senator Akaka. Mr. Kandarian, I have another question. 
Since PBGC does not receive any taxpayer dollars and is not 
backed by the Federal Government, how does the PBGC invest the 
premiums that it receives from employers and does this strategy 
need to be changed to address the additional benefit payments 
as a result of the recent terminations of large underfunded 
plans?
    Mr. Kandarian. The narrow answer to your question is the 
premium dollars are all invested in U.S. Treasury securities, 
long-duration U.S. Treasury securities. Those are very safe, of 
course. They aren't necessarily the highest returning 
securities.
    The broader question, I think, would be where are the other 
dollars we have invested, and those are from the trust funds, 
the plan assets that come in to us from a terminated pension 
plan, and those dollars since 1994 have been invested largely 
in the U.S. stock market. The PBGC Board is now considering 
current investment policies and we anticipate soon that there 
will be some feedback for the agency as to whether to retain 
the existing direction or to modify that direction in any way.
    Senator Akaka. Mr. Chairman, my time has expired. I have 
further questions.
    Senator Fitzgerald. OK. Thank you.
    Mr. Fisher, I want to give you an opportunity to describe 
the administration's proposal for having a yield curve that 
would be used in making the calculations regarding a plan's 
liabilities. Historically, we have used a 30-year Treasury 
rate, and since you had a role in phasing out the 30-year 
Treasury bond, now we are looking for a new benchmark and 
corporate America would like to take advantage of corporate 
bond yields, but the administration has proposed that we apply 
a yield curve to more tightly estimate the liabilities a plan 
faces. Could you explain the administration's proposal in that 
regard?
    Mr. Fisher. Certainly. Thank you, Mr. Chairman. The 
administration has agreed with a number of members of the 
pension community that moving to a corporate interest rate more 
closely tracks the quality of the promise. That is, a pension 
liability is like the liability of a company, so like a bond 
rating that a company issues, a pension promise is a promise 
made by a corporate sponsor. So at a conceptual level, we share 
that it would be appropriate to move from the U.S. Treasury 
yield curve, which reflects the full faith and credit of the 
United States, to a high-grade corporate credit.
    However, in the interests of accuracy, we think that it is 
very important, indeed, incumbent on us, to reflect the time 
structure of the benefit promises that companies have made. 
Using a single interest rate really distorts, especially when 
you use a long-term interest rate, distorts the valuation of a 
series of promises or liabilities.
    To use a very simple example, if I owe you $100 next year 
and I also owe you $100 10 years from now, if we use a single 
10-year rate to value both of those in present value terms, we 
are going to significantly understate the value today of the 
burden I face in paying you that $100 next year.
    Given the demographics in our country of an aging 
population, particularly in industries with defined benefit 
plans, we think it is especially important to reflect these 
payments that will be made over the coming years in coming to 
an accurate measure of the pension plan.
    Now, it is really--mechanically, it is a very simple two-
step process. Plan actuaries come up with estimates, and this 
is the difficult part, the estimates of how many dollars have 
to be paid out in each year, and they have to do that no matter 
what interest rate is used. Once they come up with those 
estimates of how many dollars are paid in 1, 2, 3, 4, or 5 
years, they then have to apply an interest rate to discount 
those to present values.
    Well, at that step in the operation, you can apply the same 
interest rate to all of the different annual payments and come 
up with what we know will be an inaccurate measure, or you can 
apply the correct interest rate, a 1-year rate for the 1-year 
flow, a 5-year rate for the 5-year flow, and come up with the 
most accurate measure of liabilities that we know of. This is 
standard practice now in banking and in financial markets. We 
think it is the right way for us to measure pension liabilities 
to be accurate. This may seem complicated for the layman, but 
for those whose job it is to value money sums across time, this 
is really standard industry practice today.
    Senator Fitzgerald. Well, the goal here is just to make the 
judgment of the liabilities more accurate, isn't that correct?
    Mr. Fisher. Absolutely, Senator.
    Senator Fitzgerald. Why do you think anybody would oppose 
making those judgments more accurate?
    Mr. Fisher. Well, an uncle taught me--I had an uncle who 
was a physicist--that habit is the most underestimated 
variable. And in this area of pension accounting, there is a 
habit of using a single interest rate for the last 30 years. It 
was embedded in statute in 1987. I think financial market 
practices have been evolving over the last 20 years and now it 
is time for these statutes to catch up.
    Senator Fitzgerald. Isn't it true, though, that the 
Financial Accounting Standards Board is now referencing using 
different discount rates depending on the maturity of the 
obligation in the pension----
    Mr. Fisher. I know they are in the process of reviewing 
their rules, and just as we have been reviewing the statutory 
framework, they have been reviewing the accounting framework. 
We all know this is the best practice that we need to be 
evolving toward.
    Senator Fitzgerald. And, in fact, some actuaries presumably 
do this. I believe I read somewhere that there is something in 
the website of an actuarial association that refers to a way of 
matching the maturity of the obligations with the fund's 
assets. And so it is likely to become an increasing practice 
and you are just trying to make it more accurate.
    Now, I think the critics who are going to testify after 
you, the one criticism that I suspect they will have of this 
plan, is that the market for corporate bonds, especially long-
term corporate bonds, can be rather thin. So whatever yield 
curve is out there isn't all that solid. Obviously, we don't 
have as deep a corporate bond market as we do have in 
Treasuries. Do you have a response to that criticism?
    And would you only be talking about AAA-rated companies or 
investment grade rated corporates? Obviously, they would 
probably like the highest discount rate they could get, so 
maybe they would even want the low investment grade corporates 
to be used as a benchmark, but that is not what you have in 
mind.
    Mr. Fisher. No, Senator. First, let me be clear. If the 
legislation is enacted as the administration has proposed, we 
would imagine an extensive rulemaking process under the 
Administrative Procedures Act, fully transparent for all 
interested groups to comment and have an opportunity to look at 
all the details of the index that we would create. That is step 
one that I think is very important.
    As I explained in my written testimony, toward the back of 
a rather extensive testimony, I will concede, we do think that 
a few adjustments will be necessary to deal with the problem 
that there may be spotty liquidity along the yield curve. We 
would not be adjusting for the level of rates. But we would 
look to the Treasury yield curve for the structure of interest 
rates, the shape of the yield curve, to make some adjustments, 
as is very common in the creation of fixed-income indices in 
our financial markets. I want to be very clear about that. That 
is not a--we would look to high-grade corporate bond, whether 
AAA or AA. We are not wedded to that, but that is the sort of 
issue we would like to be fleshing out through----
    Senator Fitzgerald. Do you have the power to promulgate 
this rule now without Congress' authorization? You do have a 
lot of power under the current ERISA law, don't you, to 
reference----
    Mr. Fisher. I don't believe that we would have the 
authority under current law to create a curve and have the 
curve be used in valuing the minimum funding requirements.
    Senator Fitzgerald. OK. You have to have legislative help 
on this and replacing the 30-year Treasury rate. We are now 
using, is it 120 percent of the 30-year Treasury----
    Mr. Fisher. Yes, that is----
    Senator Fitzgerald [continuing]. Temporarily until 
December, and we have got to have legislation before the end of 
the year, and, in fact, the sooner the better so companies can 
plan for their liabilities next year.
    Mr. Fisher. Absolutely, Senator.
    Senator Fitzgerald. I have a couple of more questions for 
Mr. Kandarian. Right now, companies file a statement with you 
that shows their termination liability, but that is kept secret 
and it is not open to the public, not to stockholders of the 
company, and not to plan members, is that correct?
    Mr. Kandarian. Currently, there is a Section 4010 filing 
that companies with more than $50 million in underfunding file 
with us. So a plan has to be, generally speaking, one of the 
larger plans and to be significantly underfunded and they file 
this form with us which we typically receive within 3\1/2\ 
months of the year end.
    Senator Fitzgerald. I am trying to figure out how it came 
to the point that these filings are secret. Wouldn't it be in 
the public's interest, particularly if you are a worker at the 
company who is a participant in the pension plan, to know the 
termination liability of the company?
    Mr. Kandarian. I think the way it came about in the last go 
around in the legislation was that companies were reluctant to 
have this information in the marketplace, and they gave reasons 
why, and that was the compromise at that point in time.
    The administration, however, feels that at least some of 
this data should be made public so that shareholders and 
financial market analysts see this information, as well as 
workers and plan participants.
    Senator Fitzgerald. So in certain cases, this could be bad 
news that is being kept from the public, whether from investors 
or from members of the pension plan.
    Do you have any idea--I believe there were some articles 
last Friday, a Reuter's one I recall specifically, that 
discussed that United Airlines is considering terminating its 
plan and dumping its liabilities on the PBGC. My understanding 
is that the claim the PBGC filed in the bankruptcy court 
earlier this year was for a $7.5 billion claim for termination 
liability.
    What would be the effect on the PBGC if a pension plan the 
size of United and as underfunded as United's plan were to be 
terminated and handed off to you?
    Mr. Kandarian. Well, we don't today anticipate that all the 
pension plans of United would come to us in the near future, 
but there is no way for us to control that, obviously, and that 
will play out in the marketplace with United's efforts to 
emerge from Chapter 11. So we are hopeful that they can do 
that, but we don't have much control over that at our agency.
    The $7.5 billion number was a contingent claims or 
placeholder that we put into the record in a bankruptcy 
proceeding should the plans terminate and come to us. But it 
wasn't our stating that we thought it was going to come to us.
    In terms of what it would do to our financial situation, as 
we mentioned, we are currently $5.7 billion in deficit. You 
correctly note our claim is for--our contingent claim is for 
$7.5 billion. However, we don't guarantee 100 percent of 
benefits and we cap out benefits, especially for highly 
compensated individuals, which some people in the airlines 
would fit into. So I don't have an exact number for you today, 
but we would anticipate more than $5 billion would be the 
impact upon us should all those plans come to the agency. 
Again, we are not predicting that to be the case. I am simply 
trying to be responsive to your question.
    Senator Fitzgerald. OK. I know the administration hasn't 
made a proposal in this regard, but it seems to me that the 
premiums should be more risk-based than they now are. Could you 
explain to me to what extent premiums for PBGC insurance are 
risk-based today? I analogize to banking, where they went to 
risk-based premiums a number of years ago after the S&L 
debacle.
    Mr. Kandarian. Well, today there are, again, two elements 
to the premiums paid to PBGC under a single-employer program. 
One is a fixed rate, $19 per participant. There is no risk-
based component to that. It is regardless of how risky a plan 
is to the agency.
    The variable rate premium is nine-tenths of one percent of 
so-called underfunding, but it is defined, again, based upon 
this current liability-type measure, which as we know, is 
wanting oftentimes during situations of bankruptcy and 
termination. So there is very little truly risk-based aspects 
to the current----
    Senator Fitzgerald. Isn't that kind of unfair to the--you 
do have many well-funded, responsibly managed plans in your 
fund, and isn't it unfair that they are paying the same 
premiums as some terribly underfunded pensions?
    Mr. Kandarian. Well, certainly those who are paying the $19 
and are overfunded and are AA or AAA credits, I imagine are 
paying more than what would be a typical private sector 
insurance rate for their plan in many cases.
    Senator Fitzgerald. It strikes me--I know that you guys 
have received a lot of flack from some in the corporate world 
that you are being real tough on the pensions, but I am giving 
you ideas on how you could be a whole lot tougher, aren't I. 
Mr. Fisher.
    Mr. Fisher. If I could, Senator, just to jump in here, to 
clear something----
    Senator Fitzgerald. Maybe you could pull the microphone a 
little closer.
    Mr. Fisher. Just to underscore a point I think Director 
Kandarian made a few minutes ago, there really are two ways to 
come at this. You are suggesting that premiums are too low 
given the level of risk. The other side of it, we would all 
rather see less risk in the system.
    So one reason why the administration hasn't yet come 
forward with an issue on--recommendation on the premiums is to 
see how far can we go in reforming the measurement and the 
funding rules and then come back and look at the balance of how 
much risk is in the system, what should the premium structure 
be. But we fully take your point and we believe that a thorough 
review of the premium structure should be part of any 
comprehensive reform.
    Senator Fitzgerald. So the passage of your plan, if it 
helps to shore up the funding of the pension plans that are out 
there, could ultimately save the members in the PBGC from 
having to endure a premium increase and could save them money.
    Mr. Kandarian. I think that is right, yes. And I have 
testified several times before Congress in the last 2 years. I 
think in virtually all my testimonies, I have always started by 
saying our first choice is for the dollars to go into the plans 
to better fund the plans.
    Senator Fitzgerald. Rather than just into premiums. Now, I 
have to ask a question about two things, Mr. Kandarian. What 
about non-standard assets? I understand that in some cases, you 
have allowed some companies to put stock that is not publicly 
traded, for example, into their pension plans in lieu of cash. 
When do you allow that, and is it an exemption to rules that 
allows you to allow alternative investments?
    Mr. Kandarian. Let me start by saying those are Title I 
issues under ERISA, which is really the jurisdiction of the 
Department of Labor that is not here today. I don't want to 
speak for them, but I can give you some general guidelines and 
information on that.
    Current law prohibits companies from putting in more than 
10 percent of employer securities into their defined benefit 
pension plans in terms of assets. So we already have that 
safeguard.
    In addition, there are securities that sometimes require 
exemptions to place into these pension plans, regardless of the 
10 percent level, because they may not be tradable or one thing 
or another. And that is looked at on a case-by-case basis by 
the Department of Labor.
    Senator Fitzgerald. In general, companies have to put cash 
or marketable securities into their plans?
    Mr. Kandarian. Yes.
    Senator Fitzgerald. Do you ever require plans to 
collateralize, in effect, their unfunded pension liabilities? 
Can you take security? Can you take a lien on any corporate 
assets as a means of enforcing the company's viability?
    Mr. Kandarian. I am trying to think here, but the place 
where I recall seeing security use would be in the cases of 
waivers granted by the IRS. Oftentimes in granting the waiver, 
the IRS will require securities being put up in lieu of cash.
    Senator Fitzgerald. But by and large, when a company files 
bankruptcy and terminates its plan, you don't have any security 
for the unfunded liability, by and large.
    Mr. Kandarian. In bankruptcy, we are generally an unsecured 
creditor, that is correct. There are some exceptions to that, 
non-bankrupt subsidiaries. We have a stronger standing in 
bankruptcy as to non-bankrupt subsidiaries. We also have a 
stronger position in bankruptcy for missed minimum funding 
payments and for missed premiums to the agency. But generally 
speaking, that is a very small percentage of the exposure the 
agency faces. Typically, we get back less than 5 cents on the 
dollar in bankruptcy on the underfunded amount.
    Senator Fitzgerald. My final question, and then I will turn 
it over to Senator Akaka if he has any more questions of this 
panel, would be for Secretary Fisher. My understanding is that 
during the 1990's, Congress closed some opportunities in the 
tax code that companies formerly had to put more than the 
required payments into their pension plans and to get a tax 
deduction for those payments, and apparently during the 1990's, 
we severely cut down the extent to which companies can get a 
tax deduction for contributions to their pension plans. And as 
a result, in the late 1990's when corporate America was 
generally doing very well, we didn't see any excess 
contributions to pension plans in the aggregate, and in fact, 
my understanding is there is an excise tax if you put more than 
your minimum necessary payments into your pension plan.
    Has the administration looked at all about perhaps 
enhancing the deductibility of corporate contributions to their 
pension plans?
    Mr. Fisher. Yes, Mr. Chairman. The administration has said 
that we are prepared to review the deductibility after we get 
to accurate measurements. We don't think it is appropriate to 
have their cake and eat it, too, to have measures of funding as 
you have described of current liability, suggesting they are 
fully funded, when deep down on some other basis we realize 
they may not be as well funded.
    If we can get to a shared understanding of an accurate 
measure of the liability, then we are prepared to review the 
deductibility to try to provide a smoothing--excuse me, that is 
an inappropriate term---- [Laughter.]
    Less volatility in funding provided by companies. So we are 
prepared to review that. One does have to take care in 
designing those rules, especially for small companies----
    Senator Fitzgerald. There can be abuses.
    Mr. Fisher. There can be abuses, and that is something the 
IRS and the Treasury will look out for. But we are prepared to 
review all those rules in the context of accurate measures of 
liabilities.
    Senator Fitzgerald. Senator Akaka, I don't know if you have 
any questions.
    Senator Akaka. Thank you, Mr. Chairman. I just have three 
more questions.
    Secretary Fisher, the administration's proposal would use 
corporate bond rates for calculating future pension 
liabilities. As a result, businesses would be able to make 
smaller contributions to worker pensions and assume a higher 
rate of return. There are concerns that this proposal could 
drive pension deficits higher at the expense of workers' 
pension savings. American taxpayers would be at risk if PBGC is 
underfunded and cannot pay the claims of failed pensions.
    What will it cost taxpayers if PBGC cannot pay the amount 
necessary to cover pension claims?
    Mr. Fisher. Senator, if I could take your question in two 
parts, first, I want to be very clear that the administration 
does not support simply using a corporate bond rate. If we 
simply took a single long-term corporate bond rate, it would 
have the implications that you suggest of potentially leading 
to underfunding.
    We feel, however, if you tie that to the use of the yield 
curve, as I have outlined, then we will get to better funding 
over time and more accurate funding for those plans with 
younger or older workforces. They will be appropriately funded. 
So the two go together.
    As the colloquy has already, I think, demonstrated, as has 
been brought out, the PBGC does not carry the full faith and 
credit of the United States. It is a government corporation, 
but does not have a call on the Treasury. So any underfunding 
of the PBGC, its deficit, which began to eat into its ability 
to meet its obligations, would be an issue that would be before 
Congress. It would be up to the then-Congress, together with 
the administration, to decide on whatever legislation would be 
needed.
    But in the absence of adequate funding to meet payments, 
which we don't foresee in the immediate future, but given the 
current deficit looks to be in the years ahead, in the absence 
of that, something would have to give. Congress would have to 
enact legislation.
    Senator Akaka. Thank you, Secretary Fisher.
    Director Kandarian, the management consulting firm Towers 
Perrin estimates that the administration's proposal to alter 
funding rules could cut pension contributions by $50 billion 
annually during the first 3 years, which would leave more 
pensions underfunded.
    The question is, in your opinion, what effect would the 
administration's proposal have on PBGC's deficit?
    Mr. Kandarian. As Mr. Fisher has just testified, really, 
what we are trying to do is get the accurate measure of these 
liabilities. So if we can get that right measure utilized, over 
time, we believe these plans will be better funded.
    Now, I will also say that the administration's proposal and 
other proposals up on the Hill contemplate a long-term 
corporate bond rate for 2 years, which is not the 
administration's long-term proposal but it is a transition 
proposal, and yes, that would provide some funding relief in 
the short term, but we think that makes some sense given 
current economic situations, environment.
    Senator Akaka. Mr. Kandarian, you and the Comptroller 
General testified 2 weeks ago before the House Committee on 
Education and the Workforce. At the hearing, Mr. Walker 
recommended that Congress consider ways to strengthen the 
funding of pension plans and to improve transparency by making 
information available to workers on the health of their pension 
plans. What are your views on these recommendations?
    Mr. Kandarian. Well, as I mentioned before, we welcomed 
GAO's analysis. We have read it carefully. The administration, 
as Mr. Fisher has noted, is currently undertaking the task of 
fundamental review of the entire system, including the funding 
rules and including a number of factors, and we hope to have 
our proposal, our broader proposal outlined in the not-too-
distant future.
    Senator Akaka. I thank you, Mr. Secretary and Mr. Director, 
for your responses. Thank you, Mr. Chairman.
    Senator Fitzgerald. Thank you, Senator Akaka.
    Mr. Kandarian and Secretary Fisher, thank you so much for 
being here. We will take your written testimony and submit that 
for the record. Secretary Fisher, we wish you the best of luck 
after you leave the Treasury at the end of this month. As I 
said at the start of the hearing, I think you have done a 
wonderful job and should be commended for it, so best of luck 
to you. Thank you both very much for testifying.
    Now, we can bring the second panel of witnesses up to the 
table and we will take about a two-minute recess just so that 
people can stretch before we start with their testimony. Thank 
you.
    [Recess.]
    Senator Fitzgerald. I would now like to resume our hearing, 
and I would like to introduce our second panel of witnesses.
    Christopher O'Flinn is the Chairman of the ERISA Industry 
Committee and he serves as the Vice President of Corporate 
Human Resources at AT&T. Mr. O'Flinn also is a trustee of the 
Employee Benefits Research Institute and a member of the 
Advisory Council on Pensions to the New York State Controller.
    Kathy Cissna is the Director of Retirement Plans for R.J. 
Reynolds. She is here today to testify in her capacity as a 
board member of the American Benefits Council, ABC, which 
represents Fortune 1000 companies and service providers. ABC's 
members either sponsor directly, administer, or service 
retirement, health, and stock compensation plans covering more 
than 100 million Americans.
    Professor Norman Stein, who I gather his mother lives in 
Illinois, he told me, is here today. Did you grow up in 
Illinois? Were you born in Illinois?
    Mr. Stein. Well, it depends when you think childhood ends. 
I was 21 when my parents moved here, but they would say I grew 
up there.
    Senator Fitzgerald. You left when you were 21?
    Mr. Stein. No, I moved there when I was 21.
    Senator Fitzgerald. Oh, you moved there when you were 21. 
Well, that is still enough to make you an honorary constituent, 
even though I gather you are in Alabama.
    Professor Stein is here today to speak on behalf of the 
Pension Rights Center. He is currently the Director of the 
Pension Counseling Clinic and the Douglas Arant Professor of 
Law at the University of Alabama.
    John Parks is the Vice President of the Pension Practice 
Council for the American Academy of Actuaries. In addition, he 
is the President of MMC&P Retirement Benefits Services and is 
an enrolled actuary with 41 years of experience in the 
actuarial and employee benefits field.
    J. Mark Iwry is a non-resident Senior Fellow in the 
Brookings Institution's Economic Studies Program. Mr. Iwry 
served as benefits tax counsel of the U.S. Department of the 
Treasury from 1995 to 2001. Prior to joining the Treasury 
Department, he served as a partner in the law firm of Covington 
and Burling and specialized in pensions and other employee 
benefits.
    Again, I would like to thank all of you for being here to 
testify. In the interest of time, the Subcommittee would 
appreciate it if you could submit your full statements for the 
record and try and summarize your full statements in about a 5-
minute opening statement. You could talk off the top of your 
head, as I am sure each of you are able, because you know this 
area so well, and we would appreciate that.
    Mr. O'Flinn--I know a lot of Flinns. I have never met an 
O'Flinn, but I gather that is probably Irish, like Fitzgerald.

    TESTIMONY OF CHRISTOPHER W. O'FLINN,\1\ VICE PRESIDENT, 
    CORPORATE HUMAN RESOURCES, AT&T, ON BEHALF OF THE ERISA 
                       INDUSTRY COMMITTEE

    Mr. O'Flinn. Your guess is correct, Mr. Chairman. Let me 
add that my son is about to become a constituent when he moves 
to Chicago on the first of October.
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    \1\ The prepared statement of Mr. O'Flinn with attachments appears 
in the Appendix on page 72.
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    Senator Fitzgerald. Oh, great.
    Mr. O'Flinn. Thank you for the opportunity to address the 
Subcommittee on behalf of ERIC. ERIC has a unique interest in 
today's hearing. Our members are all large employers who 
sponsor defined benefit plans, and as a group, they actually 
pay the bulk of the premium taxes collected by the PBGC. So our 
overriding interest is in maintaining both a vital defined 
benefit plan system and a financially sound PBGC along the 
lines that the Chairman outlined at the beginning of the 
hearing.
    If we have a message that we would like to leave with the 
Subcommittee today, it would be that any delay in enacting a 
composite corporate bond rate as a replacement for the 30-year 
Treasury bond which takes effect in January 2004 for the 
current liability test will prevent firms from contributing to 
the economic recovery and will drive even the largest U.S. 
companies away from the defined benefit system.
    We think that failure to act to replace the 30-year bond 
means that many companies will face totally unnecessary and 
draconian cash calls beginning in the spring of next year. And 
moreover, as we speak today, chief financial officers across 
the country are being advised of the likelihood of these cash 
calls, and that is having a chilling effect on continued 
benefit accruals, Mr. Chairman, under the defined benefit 
system, and also a chilling effect on other alternative uses 
for that cash, including investment in new jobs and investment 
in all capital investment, which is essential for our continued 
recovery.
    In other words, we think the time to act to replace the 30-
year bond is now and only then will we have a stable platform 
of rational interest rates to move forward to consider other 
challenges in the pension law, some of which were very well 
described by Director Kandarian and Secretary Fisher.
    I would like to turn to the PBGC itself and echo the words 
of Minister Wicks that crisis is a word that should be used 
very carefully. We think that, as Secretary Fisher said when he 
began his testimony, there are issues and they are manageable 
now if we address them. Our concern is not that the issues are 
wrong or not there, but that they be addressed in a logical way 
that gives light to all the connected issues around them.
    Our written testimony goes into greater detail. I would 
like just to mention a few points in that testimony.
    First, even after becoming trustees of the Bethlehem Steel 
plan, the PBGC has a funded ratio of over 90 percent. And 
according to our calculations, as supplemented by the American 
Society of Pension Actuaries, the assets of the PBGC divided by 
the current level of benefits, inflated as they are, are 
sufficient to pay, continue to pay benefits for approximately 
18 years. That is assuming no growth in the assets and no 
additional premiums.
    In other words, Mr. Chairman, while this can be compared by 
some people to the S&L debacle, we don't agree with that. We 
think it is a little bit early to use that kind of description. 
The agency is not insolvent. It is a long way from becoming 
insolvent. And yet, there are issues and they are serious 
issues affecting the pensions of Americans, including our 
employees, and we are concerned about them. But we want to move 
deliberately because of the related and consequential effects 
of some of the things being proposed by the administration.
    I would only mention a couple of these in the interest of 
time, but one of them is that the interest rate not only 
affects perhaps the premium structure of the plan and perhaps 
what might be the funding for corporations, but it affects the 
benefits of the employees who are relying on the PBGC to pay 
benefits.
    If the PBGC uses an overly conservative interest rate to 
discount--to arrive at the present liabilities of the benefits 
it has taken on, it will allocate more assets than necessary to 
pay for the guaranteed benefits, which has the highest order of 
priorities, or one of the highest order of priorities against 
the assets, leaving less assets available for the non-
guaranteed benefits, meaning that those benefits won't get paid 
to the employees. So it is very important to get this discount 
rate right for all of the people who are interested in the 
calculation, and that is not only the PBGC and the plan 
sponsors but the employees themselves.
    Thank you, Mr. Chairman. I would be delighted to answer 
questions.
    Senator Fitzgerald. Thank you, Mr. O'Flinn. Ms. Cissna.

   TESTIMONY OF KATHY ANNE CISSNA,\1\ DIRECTOR OF RETIREMENT 
   PLANS, R.J. REYNOLDS, ON BEHALF OF THE AMERICAN BENEFITS 
                            COUNCIL

    Ms. Cissna. Mr. Chairman, thank you for the opportunity to 
appear today on behalf of the American Benefits Council, which 
is, as you said, a public policy organization representing 
principally Fortune 500 companies and other organizations that 
assists employers of all sizes in providing benefits to 
employees.
---------------------------------------------------------------------------
    \1\ The prepared statement of Ms. Cissna appears in the Appendix on 
page 98.
---------------------------------------------------------------------------
    Like you, the Council and its members are very concerned 
about the health of our defined benefit pension system, a 
system that is facing an unprecedented series of threats that 
require immediate policy action.
    In our view, the most pressing of these threats is the need 
to replace the obsolete 30-year Treasury bond interest rate for 
pension calculations with a realistic rate. Because of the 
discontinuation of the 30-year Treasury bond, its yield has 
reached historic lows and no longer correlates with rates on 
other long-term bonds. The use of this rate inflates pension 
contributions in excess of what is necessary to fund promised 
benefits.
    In 2003 and 2004 alone, contributions by Fortune 1000 
companies are projected to exceed $80 billion per year, more 
than four times what was required just 2 years ago. More than 
half of these contributions are attributable to the 
inflationary effect of the broken 30-year Treasury rate.
    Today's artificially inflated funding requirements harm 
employees, employers, and the economy at large. Facing pension 
contributions many times greater than anticipated, employers 
are having to defer steps such as hiring workers, building new 
plants, and pursuing research and development. For some 
employers, these inflated pension contributions are too much to 
bear and they have been forced to terminate or freeze their 
pension plans.
    The Council strongly endorses replacing the obsolete 30-
year Treasury rate with a blend of high-quality corporate bond 
rates. A conservative corporate bond rate would be transparent, 
not subject to manipulation, and provide the kind of 
predictability that is necessary to plan pension costs. The use 
of a corporate bond rate, which is much more conservative than 
what pension funds will actually earn, would also ensure that 
plans are funded responsibly.
    This is why stakeholders from across the ideological 
spectrum, from business owners to organized labor, agree that a 
corporate bond rate should replace the 30-year Treasury rate.
    Senator Judd Gregg, Chairman of the Health, Education, 
Labor, and Pensions Committee, has introduced a bill, S. 1550, 
that would do exactly that. We urge the Members of this 
Subcommittee to cosponsor S. 1550 and we recommend its prompt 
adoption by the Senate.
    Separately, the Treasury Department has put forward a 
proposal to utilize the so-called yield curve concept to 
replace the 30-year Treasury rate. While a fully-developed 
yield curve proposal still has not been issued, it does appear 
to involve a significant change to a more volatile and 
complicated structure under which the applicable interest rates 
would vary with the schedule and duration of payments due to 
each plan's participants.
    We believe the yield curve and the associated proposals to 
eliminate interest rate averaging would exacerbate funding 
volatility and increase complexity, all for only a marginal 
potential increase in accuracy.
    Despite inclusion in legislation to be considered by the 
Senate Finance Committee as soon as Wednesday, there are still 
a host of unanswered questions created by the yield curve. In 
fact, the development of the methodology for developing the 
yield curve is yet undefined, as is its impact on funding rules 
in general or plans or participants. It leaves employers with 
many unanswered questions and is unrealistic to believe that 
all of the outstanding issues could be addressed in the short 
time available.
    To the extent that this type of major overhaul of our 
pension funding rules is considered, it should be done as a 
part of a more fundamental and thoughtful review by Congress. 
In the interim, we should be cautious of enacting the yet 
unexplored yield curve approach, but should move urgently to 
replace the 30-year Treasury rate with a corporate bond blend 
before any more American workers are frozen out of secured 
pensions.
    I also want to briefly address the concerns that we have 
heard raised about the financial status of the PBGC. While the 
PBGC's deficit should be considered seriously, we do not see 
cause for alarm. Indeed, the PBGC has operated in a deficit 
position throughout much of its history.
    The PBGC has total assets in excess of $25 billion and 
earns money from investments on those assets. While the 
liabilities, as we have heard, exceed those investments, the 
pension obligations underlying those abilities come due not 
immediately, like the situation might have been in the S&L 
crisis, but over many decades. The relatively modest size of 
the PBGC's deficit in relation to its assets ensures that it 
will remain solvent far into the future, a point that the PBGC 
itself has acknowledged repeatedly.
    The best recipe for a stable PBGC is to encourage healthy 
companies to remain in the defined benefit system, an aim that 
will be furthered by the policy changes we are advocating 
today.
    Thank you for this opportunity to appear, and I would be 
happy to answer questions.
    Senator Fitzgerald. Thank you very much. Professor Stein.

 TESTIMONY OF NORMAN P. STEIN,\1\ LAW PROFESSOR, UNIVERSITY OF 
        ALABAMA, ON BEHALF OF THE PENSION RIGHTS CENTER

    Mr. Stein. Mr. Chairman, Members of the Subcommittee, I am 
Norman Stein. I teach at the University of Alabama School of 
Law and also direct the law school's pension counseling clinic, 
whose funding from the Administration on Aging has made it 
possible for us to help hundreds of individuals with their 
pension problems. I appear here today on behalf of the Pension 
Rights Center, a consumer organization dedicated to protecting 
the pension rights of workers and their families.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Stein appears in the Appendix on 
page 116.
---------------------------------------------------------------------------
    The issues you are looking at today fuse together broad 
issues of economic and social policy with arcane concepts of 
actuarial science. But these issues are critical, not only to 
the participants in defined benefit plans and to their 
families, but also to the economic and moral health of our 
Nation. The decisions that we make about this program today 
will determine the long-term sustainability of the traditional 
defined benefit plan, which is a crown jewel of our private 
sector retirement system.
    The first question I want to address briefly is whether the 
Pension Benefit Guaranty Corporation is really in crisis. The 
PBGC's deficit status is not a new phenomena. As the GAO has 
reported, over the last decade, the program has swung from a 
huge deficit to a huge surplus and now back to a deficit. How 
has this latest swing happened? Conventional wisdom has it that 
there are three significant reasons for PBGC's current large 
deficit.
    First, economic factors have resulted in the termination of 
several defined benefit plans with large unfunded liabilities. 
Second, low interest rates have increased the present value of 
the PBGC's benefit obligations. Third, the PBGC's investment 
portfolio has declined in value. Some have called the 
combination of these three factors a perfect storm.
    But how long will this perfect storm last? Two of the three 
storm fronts, low interest rates and low equity returns, may be 
transitory. Interest rates might rise and equity markets might 
rebound. If this happens, the PBGC's financial situation might 
improve dramatically and this perfect storm may turn out to 
have been the perfect tempest in a teapot.
    I want to turn now to funding of defined benefit plans. The 
current funding rules for defined benefit plans have not proven 
adequate to ensure that all defined benefit plans will be 
sufficiently well funded to satisfy their benefit commitments. 
I want to highlight two observations from our testimony, and 
not the observations where we happen to agree with the 
witnesses who just spoke but the two where we differ.
    First, some have suggested that the interest rate for 
discounting plan liabilities be increased from the 30-year 
Treasury rate to long-term corporate bond rates. The result of 
such a change in many cases would be a reduction of a firm's 
plan contributions and an exacerbation of plan underfunding. We 
would urge that the appropriate discount rate should be pegged 
to riskless or nearly riskless instruments, such as government-
issued bonds, because after all, the participants in the system 
perceive their guaranteed benefits as being without risk.
    The inappropriateness of the corporate bond rate can be put 
in perspective by looking at how the use of such a rate would 
affect PBGC's own liabilities. I have spoken with several 
actuaries who estimate that such an alchemic change would 
reduce PBGC's aggregated liabilities by between 5 and 15 
percent, substantially reducing or perhaps almost eliminating 
the PBGC's current deficit, which after all is the reason we 
are here today.
    Second, the administration has proposed that plan 
liabilities be discounted to present value using a yield curve 
derived from interest rates on high-quality corporate bonds. 
For some plans, a yield curve based on corporate bond rates 
would actually reduce funding obligations, which we think is 
counterproductive to the goal of improving overall plan 
funding. For other plans, those with a mature workforce and 
many retirees, a yield curve would substantially increase 
funding and perhaps force bankruptcies and create job loss in 
important sectors of our economy.
    I want to turn now briefly to some of our observations on 
other issues relevant to the PBGC. First, to strengthen the 
PBGC, Congress in the future might consider allocating 
appropriations to the PBGC from general revenues. Such 
appropriations are, we believe, justifiable, since many of the 
funding issues that defined benefit plans are today 
experiencing have resulted from the low interest rates created 
by Federal fiscal policy and the decision by the Federal 
Government to stop issuing 30-year Treasury obligations. And as 
you have already suggested, Mr. Chairman, to some extent, we 
have a tax today already, but it happens to be on those people 
who sponsor healthy defined benefit plans and it might be 
fairer to have that burden spread to a broader tax base.
    Second, to stem the flight of employers from the defined 
benefit system and leaving the system's unfunded liabilities 
for those employees who remain in the system, we might also 
consider imposing an exit charge or withdrawal liability when 
firms terminate their defined benefit plans.
    Third, rules should be adopted to deter practices where 
firms siphon off plan assets to non-pension purposes in years 
when economic conditions are favorable, thus diminishing the 
plan's cushion for harder economic times.
    Finally, some have suggested reducing the interest rates 
used to value single-sum payments from pension plans. While the 
Pension Rights Center has never been an advocate of lump sum 
distribution options, it has always taken the position that 
once a firm promises an employee a benefit, it should not be 
able to break that promise.
    Employees view pension plans as contracts and the interest 
rate used for valuing lump sums is a part of those contracts. 
Those who would change the interest rates are, in effect, 
asking Congress to relieve them of the bargain they made with 
their workers.
    I would be happy to take any questions. Thank you.
    Senator Fitzgerald. Thank you, Professor. Mr. Parks.

TESTIMONY OF JOHN P. PARKS,\1\ VICE PRESIDENT, PENSION PRACTICE 
             COUNCIL, AMERICAN ACADEMY OF ACTUARIES

    Mr. Parks. Chairman Fitzgerald, thank you for inviting me 
to testify on defined benefit pension plan funding. It is a 
personal honor of a lifetime for me to be here.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Parks with attachments appears in 
the Appendix on page 125.
---------------------------------------------------------------------------
    My name is John Parks and I am Vice President of the 
Pension Practice Council of the American Academy of Actuaries. 
The Academy is a nonpartisan public policy organization that 
represents actuaries and assists the public policy process 
through the presentation of clear and objective actuarial 
analysis.
    The combined impact of the decline in the equity market and 
reduced interest rates are currently creating a funding 
challenge for defined benefit pension plans in our country. It 
is important also to remember that for at least the last 10 
years, there has been a steady shift away from the guaranteed 
retirement income from defined benefit plans and toward the 
self-annuitization through defined contribution plans.
    The danger in this transfer of financial mortality risks to 
individuals is largely unseen because the people affected have 
mostly not yet retired. We must deal, therefore, not only with 
the current financial conditions, but also with the longer-
range challenges facing defined benefit plans in general.
    It is a critical part of this retirement economics 
challenge to see that defined benefit plans are supported and 
plan sponsors are provided with the incentive to maintain and 
cultivate these programs. Some special advantages of these 
plans include, for employees, a secure, stable income 
guaranteed for life, and a reduction in the spreading of 
mortality and investment risk. For employers, these plans 
provide contribution flexibility and maintain a stable 
workforce. For the Nation, defined benefit plans help to reduce 
our dependence on social programs, such as Medicare, Medicaid, 
and Social Security, and they reduce poverty among the elderly.
    In 1975, just after the Employee Retirement Income Security 
Act we signed into law, 40 percent of the labor force 
participated in DB plans and 16 percent participated in a DC 
plan. Today, however, the reverse is true. Only 21 percent 
participate in a DB plan while 46 percent participate in 
defined contribution plans. Our concern is not just the funding 
of DB plans. Our concern is the survival of the DB plans as a 
primary source of financial security for retirees.
    The first issue I would like to discuss is funding. We must 
simplify the rules. Years of almost annual amendments to ERISA 
have continually increased the administrative burdens on those 
who try to maintain defined benefit programs. Those companies 
who sponsored DB plans are now questioning the future of their 
programs under the current financial strains of the economy, 
mandated rigid and short-range irrational minimum and maximum 
funding requirements, arcane pension laws and regulations. 
Simplification is necessary to reduce the regulatory cost of DB 
plans and level the playing field and provide a viable system 
with stable rules to attract new plan adoption, all of which 
are needed to meet the financial security of retiring 
Americans.
    Just one quick example. There are 13 different amortization 
rules for paying off liabilities in the funding code under 
Internal Revenue Code Section 412. Our suggestions include 
complete rewriting of the minimum funding standards and 
providing for fewer and faster amortization periods.
    The second funding concern is the maximum tax deductible 
contribution limitation. These funding rules create volatile 
contribution patterns and discourage adequate funding margins. 
Almost by definition, the rules inhibit contributions when the 
economy is strong and require substantial contributions when 
the economy declines and plan sponsors can least afford them. 
Some of our suggestions for revising these rules include 
increasing tax deductible contribution maximum to reflect 
increases in unfunded liability, allowing all negotiated 
benefits to be reflected, reflecting lump sum payments in 
current liability, and allowing a deduction for normal costs in 
all years.
    The next funding concern are the rules relating to 
withdrawals from pension plans. Incentives for employers to 
increase their funding margins may not work unless we also 
address the one-sided nature of the funding equations. 
Employers who try to protect the plan by making additional 
contributions have very little opportunity to use those 
contributions if it turns out they weren't needed. Our 
suggestions would be only to allow reversions if assets exceed 
some very high threshold, such as 150 percent of current 
liability.
    Fixing the discount rate--current law defines this interest 
rate in terms of 30-year Treasury notes. This rate is used for 
the determination of cash contributions, variable PBGC rates, 
and other key pension calculations. They have been artificially 
depressed, rising the current measure of costs associated with 
plans. Our recommendation is that a replacement benchmark using 
high-grade long-term corporate bonds is a reasonable proposal 
consistent with the intended measurement. However, while the 
various funding rules are studied, the period of temporary 
enactment should be 5 years rather than 2 or 3 years as 
proposed.
    In summary, defined benefit plans, once the most common 
form of retirement security for American workers, have lost 
much of their attraction for corporations. The exodus of the 
PBGC premium payer, a risk that has not been receiving proper 
attention regrettably continues. The complicated solvency rules 
with 3 years of low interest rates and market returns have 
created a funding crisis. At the same time, plan participants 
are starting to appreciate the value of being covered under a 
DB plan. The high risk of personal ruin through self-
annuitization is yet to be fully realized.
    In our haste to fix the funding crisis, we must be careful 
not to create an environment that discourages the continuation 
of existing DB plans. Thank you.
    Senator Fitzgerald. Thank you very much, Mr. Parks. Mr. 
Iwry.

  TESTIMONY OF J. MARK IWRY,\1\ SENIOR FELLOW, THE BROOKINGS 
                          INSTITUTION

    Mr. Iwry. Thank you, Mr. Chairman. Having spent much of the 
previous decade in the Treasury Department regulating private 
pensions and benefits, including involvement in the previous 
efforts a decade ago to reform the pension funding rules and 
shore up PBGC's finances, I am convinced, Mr. Chairman, that 
Congress does have to act both in the short- and long-term 
here, but that there is no ``silver bullet,'' no simple 
solution to these problems. That is because Congress has to 
take into account several different interests that are highly 
legitimate, that are in tension with one another, and that must 
be balanced against one another.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Iwry appears in the Appendix on 
page 142.
---------------------------------------------------------------------------
    Congress needs to begin with short-term funding relief and 
then follow on with permanent, comprehensive improvement of the 
funding rules that would specifically require more adequate 
funding over the long term to protect workers' retirement 
security, with special attention to reducing chronic 
underfunding. And as Mr. Kandarian and Mr. Fisher suggested, 
Congress needs to improve disclosure, both the transparency and 
the promptness of disclosure regarding the material facts of 
pension plan funding.
    At the same time, Congress needs to take into account the 
potential impact of large funding demands on a plan sponsor's 
overall financial condition and on economic growth. It has to 
minimize funding volatility for plan sponsors so that the 
required increases in funding from year to year follow a 
reasonably smooth path.
    As Mr. Kandarian has said, the deficit reduction 
contribution, that is, the minimum funding requirement that is 
accelerated when a plan falls below a certain funded threshold, 
is too volatile. It starts too late. It ends too early. The 
funding path it puts plans on is not optimal.
    The targets that the deficit reduction contribution are 
keyed to need to be revisited. The rules allow inappropriate 
holidays to companies that should be contributing, as the 
Bethlehem Steel case illustrates. And employers are precluded 
from funding for lump-sum distributions even if those impose 
higher liabilities than the annuities that employees could 
elect. IRS administrative guidance, notice 90-11, precludes the 
company from actually taking into account the value of the 
lump-sum distribution to the extent that it might impose more 
of a funding obligation than a life annuity, and that needs to 
be fixed.
    While doing all of this, Congress needs to protect the 
reasonable expectations of employees and retirees with respect 
to their promised benefits, and to the extent possible, avoid 
discouraging employees from continuing to provide pension 
benefits. We also need to avoid penalizing those plan sponsors 
that are funding their plans adequately and that are, like the 
PBGC, not part of the problem but, in fact, part of what is 
right with the system.
    More generally, we need to continue encouraging employers 
to adopt and to continue maintaining defined benefit pension 
plans. This may suggest an emphasis on requiring sponsors to 
fund adequately in preference to directly restricting their 
ability to provide benefit improvements and in preference to 
curtailing the PBGC's guarantee.
    To that end, I think that the defined benefit system would 
benefit from a resolution of the cash balance controversy that 
would settle the law governing these plans in a reasonable way.
    A major portion of the defined benefit universe in recent 
years has taken the form of cash balance plans, as hundreds of 
plan sponsors have shifted from the traditional defined benefit 
plan to this new hybrid format. The precise application of the 
governing statutes to these plans has been the subject of 
uncertainty, litigation, and controversy, as you know, Mr. 
Chairman.
    I suggest that Congress could and should resolve the cash 
balance controversy in a way that gives older workers 
substantial protection from the adverse effects of a conversion 
while allowing employers to maintain cash balance plans without 
concern that they would be treated as if they were age 
discriminatory or otherwise in violation of the law, and that 
allows employers the reasonable flexibility that they need to 
change their plans, to make amendments going forward, and the 
flexibility they need to determine how, but not whether, to 
protect older workers in these conversions.
    I will be happy to answer any questions, Mr. Chairman.
    Senator Fitzgerald. Thank you very much, Mr. Iwry.
    Ms. Cissna and Mr. O'Flinn, Mr. Iwry suggested that he felt 
that Mr. Kandarian and Secretary Fisher were correct in calling 
for enhanced disclosure and transparency. What is wrong with 
enhanced disclosure and transparency insofar as don't we want 
pension plan beneficiaries to know the status of the plans they 
are in and don't we want shareholders of a corporation to know 
the full extent of any problems that a company may have in an 
underfunded pension plan?
    Ms. Cissna. I think it would be erroneous to say that 
anybody is not in favor of accurate disclosure. I think the 
only thing that concerns Council members is that good 
transparent disclosure be properly representative to the people 
it is being directed to.
    I personally, as a plan sponsor, as a plan administrator, 
am concerned that certain levels of panic could be created by 
inappropriate disclosures to the extent that participants in a 
plan might begin doing irresponsible things, like taking lump-
sum distributions when perhaps that is not in their best 
interest, because as you mentioned yourself, the rules for how 
you determine what is underfunding are so complicated that most 
of our participants don't really appreciate them.
    Senator Fitzgerald. Mr. O'Flinn.
    Mr. O'Flinn. I would agree with Kathy's comments, Mr. 
Chairman. First of all, I would also agree with the prior panel 
that there is a need for additional disclosure. For example, 
under the current disclosure rules dictated by FASB, you would 
be hard pressed to estimate the future cash contributions 
required to the plan. So if you were interested in the free 
cash flow of the company, you basically might be missing a big 
element unless you hired actuaries to dig through the material 
and make their own estimates.
    So we would agree, there is need for additional disclosure. 
The particular disclosure that--we think that we would like to 
hear what FASB has to say about that. They are aware of these 
problems. They have an ongoing task force addressing them. If 
there is a theme to the overall hearing, Mr. Chairman, that we 
think fits here, it is what is the rush? Let us let the experts 
fully flesh out everything that happens from what is being 
proposed here before we commit to a specific set of actions.
    And in terms of the termination benefits, termination 
benefits basically evaluate the plan as if everyone is leaving 
the day of the valuation. So all of the early retirement 
benefits, which normally would not be used, since most people 
retire later than the early retirement benefits, come into play 
and explode the liabilities of the plan.
    Senator Fitzgerald. But when a plan terminates, don't you 
often have people leaving, people retiring early, taking money 
right away? So if the company goes bankrupt and terminates its 
plan, don't you have a flood of claims all of a sudden on the 
plan?
    Mr. O'Flinn. Yes, you do, but let me take some figures from 
the PBGC's last annual report. They ensure $1.5 or $1.6 
trillion in benefits and approximately $35 billion of that, 
which is a little bit more than 2 percent, is underfunding 
attributable to so-called financially weak companies. Now, for 
disclosure on those 2 percent, should everyone behind the $1.6 
billion [sic] do an evaluation and publicize it as if they were 
going to go out of business tomorrow when the likelihood of 
that happening is extremely small?
    Senator Fitzgerald. Mr. Iwry.
    Mr. Iwry. Mr. Chairman, I think that the representatives of 
the ERISA Industry Committee and the American Benefits Council 
have a responsible and legitimate concern regarding the risk of 
a type of disclosure that would be not constructive and not 
helpful and potentially not cost effective. But I do think 
there is a reasonable middle ground here.
    We certainly need to improve disclosure and there are at 
least two specific ways in which that could realistically 
happen. One is where companies are already sponsoring very 
underfunded plans. Right now, it is an aggregate of $50 million 
of underfunding, which perhaps should be made more sensitive to 
the actual extent of underfunding as a percentage rather than 
just the absolute amount and maybe even sensitive to the 
financial condition of the plan sponsor.
    But we now have these disclosures that you alluded to 
earlier that are confidential and that to the PBGC when 
underfunding has exceeded a certain amount. Those ought to be 
made public, but not to the extent they would compromise 
proprietary corporate information, and that is a large part of 
the concern that the plan sponsors have. You can disclose the 
funded status of the plan. You can disclose the assets and 
liabilities without disclosing the company's own finances in a 
way that isn't already required to be disclosed by law.
    Second, you can disclose liabilities in a more accurate 
way.
    Senator Fitzgerald. Isn't the problem that the financially 
weakest companies don't want that information disclosed because 
then everybody would know how weak they are?
    Mr. O'Flinn. That is right, and I think also some 
financially stronger companies don't want certain information 
disclosed because of competitive considerations, where the 
securities laws and other rules already require a certain 
amount of disclosure. But certainly, we can have much improved 
disclosure of the plans' funded status, not just information 
provided to the PBGC, but provided to employees, investors, and 
everyone else.
    And then you could have termination liability, which as you 
indicate, is often a realistic depiction of what would happen 
if the plan actually terminated in the near future, reflecting 
early retirements and plan shutdowns that don't get taken into 
account under current, so-called current liability 
determinations. You can have this termination liability as an 
additional disclosure for companies that are less solid. That 
is, one could consider whether termination liability ought to 
be required to be disclosed once a company is either below 
investment grade in its ratings or is otherwise--or is 
relatively underfunded in its pension plans. In other words, 
once a company ceases to be sound and soundly funding its plan, 
employees have a different degree of interest in knowing what 
might happen in the then somewhat more realistic scenario that 
the plan would terminate.
    Senator Fitzgerald. Professor Stein, you said in your 
opening statement that you believed that we should not adopt a 
high-grade corporate bond discount rate, that it should be 
based on as riskless a rate as possible, on a Treasury note of 
some kind. Given that we are losing the 30-year Treasury bond, 
that it is being done away with and that it is more and more 
scarce, are you suggesting that we start using intermediate 
grade Treasuries as a discount rate?
    Mr. Stein. Well, my solution would be to begin reissuing 
30-year Treasuries and, in fact, reissuing bonds of even longer 
duration. I think the government's decision to stop issuing 30-
year Treasury bonds, I think has had perhaps some good 
consequences, which are some speculative potential good 
consequences down the road, but I think they have also created 
problems, particularly in the area of pension plans.
    I think also for funding, there is some discussion now 
among actuaries about whether plans should be funded in a way 
similar to what the yield curve suggests, that there should be 
more of a matching of assets with liabilities, and if that is 
to happen, a lot of the way it is going to happen is because 
the government starts issuing notes of longer duration.
    Senator Fitzgerald. What happens, Ms. Cissna, if we do 
adopt a high-grade corporate reference and then all of a sudden 
the 30-year Treasury does come back? After all, Secretary 
Fisher is leaving the Treasury at the end of the month and I 
think he was one of the people who was behind doing away with 
the 30-year Treasury. Then would you stick with the high-grade 
corporates or would you want to go back to the 30-year 
Treasury, even though it would increase your payments? Wouldn't 
that be a better----
    Ms. Cissna. Well, I think that that is somewhat 
hypothetical and I am not sure that I am in any means able to 
answer a hypothetical question like that. I still think that 
you have to focus on the fact that the high-grade corporate 
bond rate is still a very conservative rate when compared to 
the way pension funds are actually going to be invested. And to 
the extent that you have a divergence between the actual 
investment ability of the plan and the way you have to value 
its liabilities, these are the things that are going to lead 
employers to be afraid of defined benefit plans, afraid of the 
system, and to look more and more at freezing and terminating 
plans.
    Senator Fitzgerald. Mr. Parks, what do you think of the 
Treasury's idea for using a yield curve?
    Mr. Parks. Our concern about the use of a yield curve is 
the implication of complexity in the calculations that it would 
mandate for each individual and each pension plan. I am not 
certain that long range, it might be a logical solution, but 
the current set of funding rules as it relates to defined 
benefit plans are already a collage of confusion, and I am 
afraid that this imposition of the yield curve without knowing 
the implications of all those confusing calculations that are 
currently necessary is premature and we would like to have the 
opportunity to study it in depth.
    Senator Fitzgerald. But it is true that it is now 
considered a best practice, isn't it, in the actuarial world to 
try and match the liabilities with a similarly maturing asset, 
is it not?
    Mr. Parks. I believe that is a best practice in the 
financial world. I am not sure that from the perspective of the 
actuarial implications in a defined benefit pension plan we yet 
know that.
    Senator Fitzgerald. Would it concern you that if we don't 
use a yield curve, we would just be adopting a higher discount 
rate from corporate Treasuries than we have now with the 
government risk-free Treasury bonds? If we just adopt a 
corporate bond rate as our discount rate, we are just allowing 
companies to put a whole lot less into their pensions, aren't 
we?
    Mr. Parks. Well, you can adopt a corporate bond discount 
rate, adjusted in some way to compensate for that, such as 
subtracting a certain amount of basis points or multiplying by 
a percentage.
    Senator Fitzgerald. I don't think that is what these 
companies have in mind. [Laughter.]
    Ms. Cissna. Mr. Chairman, if I could interject, I think 
that our position would be that, as I mentioned, the corporate 
bond blend is still a conservative approach to valuing the 
liabilities of vibrant pension plans, and the more that we can 
do to continue to support the defined benefit system and to 
continue to allow employers to fund responsibly without being 
burdened by the volatility and the unpredictability that may be 
established through the use of a yield curve, we are going to 
be better off.
    Senator Fitzgerald. I wonder if Mr. Parks would like to 
comment--I gather you have some great familiarity with ERISA. 
You have to deal with it. Actuaries have to actually plod 
through the statute and figure out what some of the 
definitions, such as current liability, mean. The case of 
Bethlehem Steel illustrates this well--in its last filing, 
Bethlehem Steel on a current liability basis was 84 percent 
funded. But then when the PBGC took it over, it found that it 
was actually only 54 percent funded on a termination basis 
because the problem is that the legislative definition of 
current liability is really more a political definition as far 
as I can tell than an actuarial definition.
    The bottom line is, current liability under ERISA is 
something far less than the actual amount of money that needs 
to be put into the plan to pay the benefits that are owed. Is 
that accurate? Have you figured out why this is so?
    Mr. Parks. You are correct in analyzing that the current 
liability definition is extremely complex. Actuaries love 
complexity, but even to me, it is confusing.
    But maybe perhaps the best way to describe it, and in a 
broad way, the difference between the termination liability and 
the calculation of current liability, with all of its 
machinations, is that current liability assumes that the plan 
is an ongoing entity and termination liability is the end of 
the line and, therefore, you have to cash in the chips and 
measure it at one point in time. On an ongoing basis, we can 
consider factors such as rates of return which reflect the 
equity markets. But on a termination basis, we have to pay the 
piper and measure as of this point in time.
    Senator Fitzgerald. Well, it seems to make sense, then, to 
calculate it in both ways, right? Termination basis and the so-
called current liability and have disclosure of both in case 
the plan does, in fact, terminate, like apparently United 
Airlines is considering terminating and they have a termination 
liability of $7.5 billion. Would any of you care to comment?
    Mr. O'Flinn. I would, Mr. Chairman. First, Bethlehem Steel 
and all the steel companies got some relief from the funding 
rules when they were last revised in 1994, and to the extent 
that contributed to their underfunding, I think it is a little 
unfair to say the current law, which essentially does not 
completely apply to them, is a reason for changing the current 
law.
    In terms of the disclosure, I wonder what the purpose of 
the disclosure is. What is the purpose of the vast majority of 
companies disclosing a liability which the high probability is 
they will never pay, recognizing that it could have a chilling 
effect on even creating that liability, which has certain 
legitimate purposes. In other words, a lot of the liability is 
early retirement benefits and they are very beneficial to 
people who are being laid off from an ongoing concern.
    Senator Fitzgerald. Don't we want the members in the plan 
to pressure their companies to better fund their pensions and 
don't we want to deter companies from promising things to their 
workers that at the end of the day they can't deliver? Haven't 
we been going on too long in this country with companies, maybe 
in union negotiations, saying, hey, we can't give you a raise 
this year, but I will tell you what. We will sweeten your 
pension benefits. And the reality is, they have no ability to 
ever pay those sweetened pension benefits. Aren't we just 
allowing companies to make promises that they can't keep, and 
then when the workers don't get their pension at the end of the 
day, isn't the rug being pulled out from under them? Mr. Iwry.
    Mr. Iwry. Mr. Chairman, that is why I suggest, consistent 
with what you were saying earlier, that there be disclosure of 
the liability under both scenarios, that is, ongoing and in the 
event that the plan terminates--the current liability and the 
termination liability, or liability on a termination basis--at 
least in circumstances where the second scenario, that is, that 
the plan will not continue, becomes more likely. Perhaps it is 
a reasonable weighing of costs and benefits here to trigger 
that second disclosure in circumstances where that scenario of 
termination does become more realistic.
    I would add, with respect to your broader point about the 
negotiated increases, that in devising an appropriate policy to 
restrain unfunded benefit improvements and to protect the PBGC 
and ultimately the taxpayers from inappropriate shifting of 
liability, we do need to take into account, in fairness, that 
the union plans typically are so-called flat benefit plans. 
That is, they pay a benefit equal to X-dollars per month for 
each year that an employee works for the company. If the 
employee's wages go up, as people's wages normally go up over 
their career, that formula doesn't keep up with the wage 
increases or with cost-of-living increases unless it is amended 
from time to time to increase that dollar amount.
    By contrast, in the salaried world, the plans are typically 
based upon pay. They provide a pension that is a multiple of 
people's final average salary or career average salary or make 
contributions in a cash balance plan that are proportional to 
that year's pay. So they amount to something like career 
average salaries. So when that plan continues unamended, it is 
keeping up with inflation and, indeed, it is keeping up with 
salary increases in a way that the unionized flat benefit plan 
is not.
    And, of course, that has served the purposes of management 
and unions over the years. The union has been able to negotiate 
an increase every 3 or 5 years during their collective 
bargaining and bring that back to their members. But to the 
extent that it is just keeping up with cost of living or with 
wage increases, we might want to take that into account when we 
set a restraining policy there.
    Mr. Stein. There is another side to that. We actually talk 
about this also in our written testimony. But for the most 
part, the kind of plans that Mark has just described, 
negotiated plans and a flat benefit formula, the quirk in the 
funding rules makes it--means you can't fund these inflationary 
increases, which we know are going to happen, and in order to 
kind of treat these plans the same way we would treat final pay 
plans, you would probably want to address this on both the 
funding side and the guarantee side.
    Senator Fitzgerald. You can't fund benefit increases that 
are going to take place because of inflation?
    Mr. Stein. In a final pay plan, you effectively can. But in 
these kinds of plans that Mark is describing, generally, you 
cannot.
    Mr. Iwry. Mr. Chairman, I think our point is--I agree with 
Professor Stein--the union bargained plan cannot anticipate the 
future negotiated increases, even though it is understood that 
it is likely the plan will be updated to keep up with inflation 
or wage increases. But until that increase has actually been 
negotiated and gone into effect, the actuary can't anticipate 
it in the funding. So the rules are skewed to some degree or 
structured in a way that has the effect of discouraging 
adequate funding.
    That is not to say that is the only reason. In some cases, 
management will choose not to fund those plans too much, partly 
out of concern that if they create a surplus of assets in the 
plan, then the union will come back and ask for increases 
because the money is there. So there are a lot of dynamics 
there.
    What I am suggesting is, that in restraining increases that 
may not be prudent and may not be sufficiently well funded to 
be fully responsible, we take into account the desire, I think, 
of everyone on this panel and the previous panel to maintain 
the health of the overall defined benefit system and to 
continue encouraging employers to sponsor and improve defined 
benefit plans.
    Senator Fitzgerald. What about all the exemptions and 
loopholes that have developed in recent years? We talked about 
Bethlehem Steel not making any payments for 5 years. That was 
apparently the result of the last time Congress amended ERISA 
in 1994. It seems like that was a very unwise amendment that we 
gave at the time. Does anybody know specifically where that 
exemption is in the law and shouldn't those loopholes be 
closed? Professor Stein.
    Mr. Stein. There are a number of ways in which both the 
variable premium structure and the deficit reduction 
contribution don't work exactly as we would like them, and they 
tend to be fairly technical.
    One problem with the deficit reduction contribution is if a 
plan has a funding credit, which is a complex idea, but it can 
date back to contributions that were made years and years 
earlier, even though the plan now is seriously underfunded, 
those credits can actually substantially reduce the 
contributions you would want those plans to make.
    But there are--generally speaking, we agree with much of 
what the PBGC has said in earlier testimony. We think that the 
variable premium and the deficit reduction contribution need 
some fixing.
    Senator Fitzgerald. Mr. Parks, I know you mentioned in your 
opening statement enhancing the tax deductibility of, I guess 
you might call them excess pension contributions and the tax 
deductibility of which was reduced in the 1990's. Do you have 
any specific recommendations in that regard? A company, I 
gather, cannot go over its required contribution before it 
starts incurring tax penalties?
    Mr. Parks. That is correct, and as a matter of fact, they 
may even be compelled to pay an excise tax if they contribute 
in excess of the maximum deductible contributions.
    Senator Fitzgerald. Why would we impose an excise tax on 
somebody doing it? I gather there were problems with small 
companies maybe dumping money into the executive pension fund, 
but can't we target a law better? Mr. Iwry, you were at the 
Treasury Department at the time.
    Mr. Iwry. I was, Mr. Chairman, and I think that you may be 
referring principally to the so-called full funding limitation, 
which was imposed more stringently in 1987. Has just been 
phased down and will be repealed 3\1/2\ months from now.
    Now, as you might expect from having grappled with the 
statute before this hearing, there is not just one full-funding 
limitation, there are two, but the one that had presented the 
most problems or aroused the most concern on the part of plan 
sponsors trying to fund fully in good times has been slated for 
repeal and will go out of existence on January 1. Now, I am not 
suggesting that that necessarily is enough and that we ought to 
stop there, but----
    Senator Fitzgerald. There are other full-funding 
limitations elsewhere in the statute.
    Mr. Iwry. Yes, and they serve a reasonable purpose. The 
question is whether they ought to be fine-tuned.
    Senator Fitzgerald. It sounds like the whole statute needs 
to be dramatically simplified, and maybe we should have some 
actuaries working on this as opposed to politicians. 
[Laughter.]
    Mr. Stein. There is actually a very interesting article in 
the recent edition of your magazine, Contingencies, by an 
actuary called Jeremy Gold, who is sort of an iconoclast, but 
he has suggested a very simple way of funding plans, which is 
you basically have a corridor based on current liabilities and 
you can go so much below it and so much above it, and if you 
get too far below, you have to start making immediate 
contributions to bring it up to whatever the minimum target is, 
whatever the floor is. He says, basically, just establish a 
floor and ceiling based on the liabilities.
    Senator Fitzgerald. But your definition of what your 
current liabilities are is very important----
    Mr. Stein. That would have to be worked out----
    Senator Fitzgerald [continuing]. And I gather there is a 
lot of mischief in that.
    Mr. Stein. That would have to be worked out and it would be 
a miracle if you could work it out in a way that avoided 
complexity.
    Senator Fitzgerald. Now, I am not going to go on much 
longer. The afternoon has been dragging on. You all have been 
terrific witnesses. But I know, Ms. Cissna and Mr. O'Flinn, you 
were--I think Mr. O'Flinn specifically--you made a reference to 
it is really only about 2 percent of the companies that are 
financially weak and have really badly funded pension plans. 
That would mean that most companies with defined benefit plans 
have managed them responsibly, they are in pretty good fiscal 
shape, and the trouble we are in is resulting from a very small 
number of bad actors.
    I would think, therefore, that it would be in the interest 
of the 98 percent of companies that are strong and are good 
actors to get really tough on the ones who aren't, because 
ultimately, the well-funded plans may have to pick up the tab 
for the poorly-funded plans in terms of increased insurance 
premiums to the PBGC.
    Mr. O'Flinn. That is a fair characterization, Mr. Chairman. 
I think in terms of disclosure, something along the lines that 
Mr. Iwry was describing earlier, we have much less concern with 
than a broad-brush approach that puts out data that may be 
misinterpreted and is really irrelevant to a member of the 98 
percent.
    Senator Fitzgerald. But a company that has a very well 
funded pension plan, even on a termination basis, I would think 
they might even want that information out, because then 
analysts could see, and their employees could see that it is 
really well funded. Maybe they wouldn't want their workers 
pressing for more pension sweeteners, but to some extent, that 
would help some of the companies. It might remove some doubt 
about whether a company's pension plan has a severe problem.
    Mr. O'Flinn. I think that many companies have early 
retirement benefits to service a very small portion of the 
population which can be expected to leave before what you might 
call expected retirement, and that is their primary purpose. To 
do evaluation which basically assumes that many more people--
virtually all the people are going to use those who qualify for 
them at the time of the valuation is--I don't know what you 
would call it, a red herring, something that would involve 
hours of explanation to people who, frankly, have enough 
trouble understanding the current liability test now. I am 
speaking from the employees' point of view.
    To explain that there is a government-required number, 
that, on its face, would raise concern because I don't believe 
very many companies are funded, well funded on a termination 
basis, at least the large companies in our organization who 
maintain robust early retirement benefits. They are funded for 
how they are expected to use them, but they are not funded on a 
termination basis.
    Ms. Cissna. Nor do they anticipate terminating.
    Mr. O'Flinn. Exactly. They are funded for how they are 
expected to occur, with the advice of their actuaries and 
accountants who are monitoring their situation.
    Ms. Cissna. And, Mr. Chairman, if I could add, I think it 
is also--I think you will agree with me on this, I don't know, 
but fairly short sighted to assume that the sponsors of 
reasonably well-funded plans aren't doing a lot of asset 
liability modeling anyway, looking at when those assets are 
going to be required, what the payment schedules are going to 
be. It is not like these things are being ignored completely.
    Senator Fitzgerald. Do you think, both Ms. Cissna and Mr. 
O'Flinn, that your members object if there were a requirement 
that plans whose funding falls below a certain level be frozen, 
that they couldn't sweeten benefits anymore, all to shelter the 
PBGC from further risk?
    Ms. Cissna. Well, freezing is a tough word. I mean, 
freezing is a lot different also than not enhancing. If you are 
going to tell my participants that they can't earn another 
penny after today----
    Senator Fitzgerald. Well, if the plan is----
    Ms. Cissna [continuing]. Because on a termination basis, 
which the plan does not intend to do, it looks somewhat 
unfunded.
    Senator Fitzgerald. Well, I think the administration's 
proposal is if you are not 50 percent funded on a current 
liability basis, then you can't sweeten your pensions at all. 
To me, it should be a much stricter requirement than that. I 
would think if you weren't 100 percent funded, that you 
shouldn't be able to sweeten your benefits. I think that would 
protect the other companies, the 90 percent that are healthy 
and financially responsible with their plans.
    Mr. O'Flinn. We do think that work needs to be done on what 
liability the PBGC takes over, particularly recently created 
liability. And, of course, the law has some relief in that 
regard already. But remember, Mr. Chairman, there are new 
companies that start pension plans that are maybe far away from 
100 percent funding. So you would have to take into 
consideration that category, as well. I agree, a well-
established plan would aim for probably somewhat higher than 
100 percent funding on an ongoing basis, but it may take a 
while to get there.
    Senator Fitzgerald. Professor Stein.
    Mr. Stein. Yes. There is an alternative path which some 
people have suggested, which is if you have a seriously 
underfunded plan, to try and develop rules that will allow, as 
Kathy said, the regular benefits to continue but to ensure that 
the deficit doesn't grow, that is, all new benefits would have 
to be immediately funded and the deficit can't become any 
worse, that is, you amortize the deficit over some period of 
time, perhaps an extended period of time, which would at least 
say to the PBGC, this plan can continue. We don't have to 
prematurely terminate it. Our situation, it might not get 
better, but at least it won't get worse.
    Senator Fitzgerald. Mr. Iwry.
    Mr. Iwry. Yes, Mr. Chairman. I agree. We have a 5-year 
phase-in now, as you know, of the PBGC's guarantee, so that 
benefits added shortly before termination are not fully 
guaranteed. Now, that may not go far enough toward protecting 
the PBGC, but I think the administration's proposal to not only 
prevent sweetening of benefits, as you say, but to prevent 
continuation of the existing level of benefits--that is, their 
proposal to require freezing of additional accruals and 
suspension of lump-sum payments in excess of $5,000 per 
person--I think those proposals are probably too draconian, 
that we ought to be looking at accelerated funding of what are 
really new promises.
    And again, I would suggest taking into account the cost of 
living updating that occurs automatically in the non-union 
plans but has to be negotiated periodically in the union plans, 
putting that into the mix when we think about what the policy 
ought to be with respect to sweeteners. To what extent is that 
meeting reasonable expectations of the workers, who, after all, 
don't control the funding of their sponsors' plans and, of 
course, don't control the financial condition of their 
sponsors.
    Senator Fitzgerald. We are going to close shortly, and I 
want to ask one final question. As all of you know, General 
Motors has taken some dramatic actions to strengthen its 
pension funds, going to the capital markets to borrow, I 
gather, $15 billion and having the corporation assume the debt 
and putting the proceeds in the pension fund. Would anybody 
care to comment on this strategy and whether other companies 
should be encouraged to follow?
    Mr. Stein. It has been suggested that there are some 
accounting benefits, given the way the accounting treatment of 
pension funding works, that by putting the money in the plan 
and then assuming a higher rate of return, General Motors will 
actually be able to have some extra earnings added to its 
annual operating earnings. But frankly, I would rather see the 
money in the plan than not in the plan, so whatever its 
motives----
    Senator Fitzgerald. Do you know what percentage funded they 
are now?
    Mr. Stein. No.
    Senator Fitzgerald. OK. They had $15 billion that went a 
long way, I think, in any case.
    Mr. Stein. Yes, but if their motives are impure, the 
effects are very good, so God bless them.
    Senator Fitzgerald. OK. [Laughter.]
    Well, thank you all very much. You all have been excellent 
witnesses and we appreciate your time and attention on a 
complex matter. Thank you for being here. We will keep the 
record open until the close of business tomorrow, if you would 
like to have any further statements put in the record or if 
Senators would like to have further statements put in the 
record.
    Thank you all very much. This hearing is adjourned.
    [Whereupon, at 5:01 p.m., the Subcommittee was adjourned.]


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