[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]


 
                  PBGC'S UNFUNDED PENSION LIABILITIES:
                  WILL TAXPAYERS HAVE TO PAY THE BILL?

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

                                HEARING

                               before the

                        COMMITTEE ON THE BUDGET
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                               __________

              HEARING HELD IN WASHINGTON, DC, JUNE 9, 2005

                               __________

                            Serial No. 109-7

                               __________

           Printed for the use of the Committee on the Budget


  Available on the Internet: http://www.access.gpo.gov/congress/house/
                              house04.html






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                        COMMITTEE ON THE BUDGET

                       JIM NUSSLE, Iowa, Chairman
JIM RYUN, Kansas                     JOHN M. SPRATT, Jr., South 
ANDER CRENSHAW, Florida                  Carolina,
ADAM H. PUTNAM, Florida                Ranking Minority Member
ROGER F. WICKER, Mississippi         DENNIS MOORE, Kansas
KENNY C. HULSHOF, Missouri           RICHARD E. NEAL, Massachusetts
JO BONNER, Alabama                   ROSA L. DeLAURO, Connecticut
SCOTT GARRETT, New Jersey            CHET EDWARDS, Texas
J. GRESHAM BARRETT, South Carolina   HAROLD E. FORD, Jr., Tennessee
THADDEUS G. McCOTTER, Michigan       LOIS CAPPS, California
MARIO DIAZ-BALART, Florida           BRIAN BAIRD, Washington
JEB HENSARLING, Texas                JIM COOPER, Tennessee
ILEANA ROS-LEHTINEN, Florida         ARTUR DAVIS, Alabama
DANIEL E. LUNGREN, California        WILLIAM J. JEFFERSON, Louisiana
PETE SESSIONS, Texas                 THOMAS H. ALLEN, Maine
PAUL RYAN, Wisconsin                 ED CASE, Hawaii
MICHAEL K. SIMPSON, Idaho            CYNTHIA McKINNEY, Georgia
JEB BRADLEY, New Hampshire           HENRY CUELLAR, Texas
PATRICK T. McHENRY, North Carolina   ALLYSON Y. SCHWARTZ, Pennsylvania
CONNIE MACK, Florida                 RON KIND, Wisconsin
K. MICHAEL CONAWAY, Texas
CHRIS CHOCOLA, Indiana

                           Professional Staff

                     James T. Bates, Chief of Staff
       Thomas S. Kahn, Minority Staff Director and Chief Counsel


                            C O N T E N T S

                                                                   Page
Hearing held in Washington, DC, June 9, 2005.....................     1
Statement of:
    Hon. David M. Walker, Comptroller General of the United 
      States.....................................................     6
    Hon. Douglas Holtz-Eakin, Director, Congressional Budget 
      Office.....................................................    22
Prepared statement of:
    Mr. Walker...................................................     7
    Mr. Holtz-Eakin..............................................    26


  PBGC'S UNFUNDED PENSION LIABILITIES: WILL TAXPAYERS HAVE TO PAY THE 
                                 BILL?

                              ----------                              


                         THURSDAY, JUNE 9, 2005

                          House of Representatives,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to call, at 9:31, in room 210, 
Cannon House Office Building, Hon. Jim Nussle (chairman of the 
committee), presiding.
    Members present: Representatives Nussle, Ryan, Conaway, 
Chocola, Spratt, Moore, Neal, Edwards, Cooper, Davis, Case, and 
Schwartz.
    Chairman Nussle. The budget hearing will come to order.
    I understand that there are members who are still trying to 
get to the Hill as a result of the early morning fire at the 
Rayburn Building, but we will begin the hearing.
    Our witnesses have time constraints. I know members will 
have time constraints as a result of votes on the floor being 
done today, approximately 1 o'clock.
    This is a full committee hearing on PBGC's [Pension Benefit 
Guaranty Corporation] unfunded pension liabilities, and we have 
an opportunity today to hear from two expert witnesses who have 
testified often before our committee. We welcome back: David 
Walker, the Comptroller General, and Douglas Holtz-Eakin, the 
Director of the Congressional Budget Office [CBO].
    Good morning, and welcome to this hearing.
    I understand that you, General Walker, have a plane to 
catch, I believe at 11:30 a.m. So we will try and get into this 
as quickly as possible. And I ask members to be as succinct as 
possible.
    The focus of today's hearing is really three-fold.
    First, to look at the magnitude of the problems facing our 
Nation's system of pension benefits and the implications of 
those problems, not only for future pensioners, but also for 
taxpayers as a whole.
    Second, to discuss how the Federal budget might better 
account for unfunded obligations or the enormous projected 
shortfalls of our Nation's pension guarantee system.
    Third, to review some of the areas likely in need of 
reform. And I am not talking about any specific proposal today 
that I am offering or that I would assume any other members are 
offering, but rather what key areas we need to look at or 
address if we are going to try and tackle this.
    I think most people of working age have a pretty good grasp 
of what the pension plans are all about. And while maybe not to 
the extent of my father's generation, many of us in their 40's 
and 50's who are planning for or getting ready, near 
retirement, are counting on at least pensions to be a portion 
of that retirement.
    So I don't have to tell anybody why the guarantee of 
promised pension benefits is a very critical issue, for not 
only our Nation's workers and retirees, but we will find out 
today, as well for our taxpayers.
    The subject has been gaining quite a bit of steam in the 
press in the last few weeks. I am not sure that there is a 
clear understanding of why pension benefits are facing such a 
large shortfall in the future as I read the press accounts. So 
I will just give a quick overview from the way I see it, and 
this is in part why we have a hearing today.
    For about the last 30 years, the Employee Retirement Income 
Security Act mandated companies that offered employee defined 
benefit pension plans to obtain insurance for these plans 
through the PBGC Corporation, or the Pension Benefit Guaranty 
Corporation.
    The intent was to ensure that the promised retirement 
benefits of U.S. workers would be maintained, even if the 
company became insolvent or for some reason the pension plan 
failed.
    So in a nutshell, if the pension plan collapsed, the PBGC 
would take over, pool its current assets with those of other 
failed plans, then use the resources, coupled with premiums 
from other participating companies that are purchasing the 
insurance, to pay for benefits.
    Now in theory, the PBGC was supposed to be completely self-
financing. The assets it assumed when it took over the failed 
pension plan, combined with the insurance premiums that were 
paid to the corporation by the participating companies, were 
supposed to be adequate to supply the resources to satisfy the 
pension promises.
    But as we are discovering, and as most of us here know, 
that is not what has been happening. According to PBGC, its 
current total assets fall short about $23 billion of the amount 
needed to pay all of the benefits currently promised to pension 
beneficiaries.
    As equity values declined during the recession of the 2000-
2001 time period, several major pension benefit plans were 
terminated and turned over to PBGC with substantial 
underfunding, including the LTV Corporation, Bethlehem Steel 
and the now-terminated United Airlines plan.
    Because these plans are large and also substantially 
underfunded, they have created a significant shortfall for the 
PBGC. And according to the Congressional Budget Office, that is 
not even half the story we are going to hear today from their 
soon-to-be-released report that I think is going to be part of 
the testimony today. Just to peek at that a moment, we 
understand that CBO is going to estimate that it could rise 
another $75 billion, or the difference between projected future 
obligations of the PBGC and the agency's projected resources.
    All told, PBGC is expected to run about $100 billion short 
of the resources needed to pay promised benefits from failed 
private pension plans, according to the report, as I understand 
it. To make matters worse, the Center on Federal Financial 
Institutions, which tracks pensions, tells us that on the 
current path, all PBGC assets will be exhausted, completely 
gone, by 2021, just 15 years from now.
    So where does that leave us? Well, under the current 
scenario, if and when PBGC's assets fall short, the choice is 
really one of two right now. Either for pension holders to lose 
about $100 billion in promised retired benefits, or for the 
taxpayers to get slapped with about a $100 billion bill for 
failed private pension plans.
    In the realm of fairness, I don't think either one of those 
choices is going to be very palatable, and in the realm of 
politics, probably very difficult. So I think we need to talk 
about how we are going to solve this problem, and if you look 
at how the budget fails to recognize the problem, it even gets 
worse.
    First, we have a problem accounting for the balances in 
PBGC. The current budget figures do not reflect the true cost 
to the Government of taking over failed plans. It only reflects 
the agency's annual cash flow, which in 2004 showed that the 
agency had a net surplus of $247 million, even though it was 
carrying $23 billion in unfunded liabilities from pension plans 
it had already taken over. And that doesn't include the 
unfunded liabilities from pension plans it will likely take 
over, which again, according to CBO, would be as much as about 
$75 billion.
    The PBGC's so-called unfunded obligations are a prime 
example of similar problems in other large government programs, 
especially insurance programs.
    Most of us recall the enormous tax burden that came to us 
in the 1980s when the savings and loan debacle occurred, and 
when savings and loans collapsed. Due in large part to 
insufficient accounting, we missed the warning signs on that 
one, and it led to a major fiscal crisis. Policy experts have 
long advocated finding ways to report these obligations 
regularly, and if possible, to budget for them.
    Back in 1997, Congressman Cardin and I began an effort to 
have the budget reflect actual costs of government liabilities, 
including likely risks. So I am especially looking forward to 
the discussion today, particularly in light of the warnings 
that we have received, looking at the shortfalls for PBGC. We 
need to talk about accrual accounting. There are many members 
who are leaders in that regard and have bills and legislation 
and ideas.
    One final note: I am sure that this is a good area for 
finger pointing. If that is the case, not only today and in 
coming months, as to who is to blame for the state of the 
Nation's pension systems, but I think we need to keep a couple 
of things in mind.
    One is that defined benefit plans and the PBGC were created 
in a different time, really for a different economy. American 
companies were competing with other American companies, who 
were also figuring pension benefits into their bottom line.
    Today, companies are competing in a global marketplace, 
which is much different than when these plans and PBGC were 
developed. As of today, many newly industrialized nations have 
little or no employee benefits to add to their bottom line.
    These same companies are also competing with new American 
companies, who don't offer defined benefit pensions, but rather 
defined contribution plans, which are less expensive and don't 
burden the company with the risk of those plans. So while 
defined benefit pension plans are becoming less and less common 
in newer companies and nearly nonexistent overseas, companies 
who still offer these plans can find themselves at a 
substantial financial disadvantage to those companies who 
don't.
    The second point I would make is that the same demographic 
changes that are putting enormous stress on Social Security, 
such as the static workpool, the aging population, the longer 
life expectancies and significantly higher wages and thus 
higher benefits are causing some of the imbalances in the 
pension system.
    Point three, and perhaps most important, would be that PBGC 
was set to be self-financing, yet it cannot achieve that goal 
if a number of large, severely underfunded pension plans fail. 
A plan underfunding destabilizes the whole system, and yet the 
rules we have created to prevent it are complicated, 
ineffective, and too often easily evaded.
    All of that said, for the loyal workers who were promised 
benefits and are counting on those benefits to help fund their 
retirement, that explanation provides exactly no relief. They 
expect, and rightly so, that the benefits that are the ones 
they were promised are received. And the American taxpayers are 
the ones who stand to be the biggest losers in all of this, 
simply through default, I will guess that bailing out private 
pension plans is not high on their priority list of how they 
would like to have their tax dollars spent.
    So no question, I can't imagine anyone that can find an 
easy answer to correct this problem. It is going to be a 
difficult balancing act, but nevertheless, we have to start 
understanding this problem and its fiscal consequences for our 
economy and for our budget immediately.
    I would like to thank the leadership of my friend and 
colleague Mr. Spratt, who requested this hearing. I was eager 
to join him in holding the hearing, but he requested it. I 
appreciate his leadership in coming forward and asking that we 
hold this very important hearing today. And with that, I would 
turn to him for any comments he would like to make.
    Mr. Spratt. Mr. Chairman, thank you very much, first of all 
for holding the hearing as I requested and also for your 
opening statement, because I think you have stated the problems 
squarely that we have to confront.
    I also want to thank our two witnesses, Comptroller General 
David Walker and CBO Director Douglas Holtz-Eakin. They are 
regulars at our hearings, but we always are the beneficiaries 
for their wisdom and advice and their analytical input to the 
decisions we have to make.
    Rather than repeat or plow over ground that the chairman 
just covered, let me simply say that we clearly have more 
things to do on the Budget Committee than just priorities about 
spending and revenues. We need to be one of the committees in 
Congress that looks forward to problems that are not yet fully 
fleshed out and try to bring timely attention to them so that 
they can be resolved earlier, at a lesser cost and with better 
solutions than we do typically when we leave things to the 
crisis stage to be addressed.
    And PBGC, the Pension Benefit Guaranty Corporation, falls 
squarely in that realm.
    We have the largest cash budget in the world, the Federal 
budget. As a consequence, there are a number of accrual that we 
simply don't recognize, don't accommodate, don't even include, 
except in appendices nobody ever reads, to our budget.
    So one of the questions that we have to ask ourselves today 
and in future hearings of this kind is with our cash budget, 
our non-accrual budget, how do we nevertheless make budget 
issues like the accumulation of accrued liabilities for the 
pensions of the United States, the defined benefit pensions, 
something that is annually considered, particularly when the 
system is not adequately assessing the risk, underfunding, the 
health of corporate sponsors.
    One of the problems clearly we have here that you can 
discern just from a superficial reading of the testimony of the 
two witnesses that is about to be presented, is that there are 
so many factors that we don't yet have a good handle for.
    The statement of the shortfall in the Pension Guaranty 
trust fund may relate to the fact that a financially healthy 
and very able corporation has simply not funded adequately its 
pension plan, but nevertheless, it is a corporate parent or 
sponsor of that plan, stands liable for the assets it may not 
reflect any kind of necessary liability to the Government.
    Secondly, the plan may be invested in gilt-edge assets, or 
it may be invested in assets whose net realizable value cannot 
be achieved with the liquidation of those assets.
    There are a whole host of problems like this what we simply 
haven't resolved. We have coasted along with this program for a 
long time, and now we have some hard questions to ask:
    How do you adjust the premiums to reflect the financial and 
economic reality? How do you baseline those premiums so that 
when we do the budget every year, we can tell the policy 
changes actually affect or improve or worsen the baseline, 
which the CBO is trying to develop now.
    But Dr. Holtz-Eakin, as I read your testimony, I think you 
would describe it as a work in progress. You aren't really 
through with it, which is an illustration of how difficult it 
is to get your hands around this problem.
    As difficult as it may be, politically and simply 
institutionally, to address the proper response to is, we need 
to be paying close attention to it and bending every effort to 
get this done, not only to get it done, but done right, so that 
we can put this plan on a firm basis for the future.
    With that, let me end, and I will welcome again our two 
witnesses and say we look forward to your testimony today and 
your help in the future as we address this problem.
    Chairman Nussle. Thank you, Mr. Spratt.
    And my understanding is that, General Walker, you will go 
first with your testimony.
    Welcome back to the committee. Thank you for your 
leadership in not only bringing this problem to our attention, 
but also in giving us ideas of solutions. We are pleased to 
receive your testimony.
    Your written testimony will be made part of the record. And 
I would also ask unanimous consent that all members have the 
opportunity to place an opening statement in the record.
    Mr. Walker.

 STATEMENT OF HON. DAVID M. WALKER, COMPTROLLER GENERAL OF THE 
                         UNITED STATES

    Mr. Walker. Thank you, Mr. Chairman, Ranking Member Spratt, 
and other members of the House Budget Committee. It is a 
pleasure to be back before you, this time to talk about the 
Pension Benefit Guaranty Corporation and related issues.
    In the interest of full and fair disclosure, let me remind 
the members that in a prior life, before I was Comptroller 
General of the United States, I was a head of the PBGC, 
Assistant Secretary of Labor for Pensions and Health, and a 
Trustee of Social Security and Medicare. I think that all of 
those are relevant to today's topic.
    I would respectfully suggest that what we have before us is 
a subset of a much greater challenge, namely the Pension 
Benefit Guaranty Corporation is a subset of a broader 
challenge, which is the state of retirement security in the 
United States, which includes Social Security, Medicare, 
private pensions, retiree health, long-term care, and that that 
is a subset of the broader fiscal challenge that the United 
States faces because of known demographic trends, rising health 
care costs and revenues that mismatch promises that have made.
    So it is very appropriate and important for this committee 
to have this hearing to understand how this issue fits within 
the broader context.
    Unfortunately, while this is a significant challenge, it is 
one of the less material challenges, as you will see. With the 
aid of your technology, I would like to just show you a few 
graphics to make several points that I think might be helpful.
    I would note that each member should have received this 
morning this report on a forum that we recently held at GAO 
(Government Accountability Office) on PBGC and the defined 
benefit pension system. This report is being released this 
morning and has been posted to our website.
    The first slide, please.
    You have seen this before. This is the disembodiment chart. 
This is the U.S. budget in the long term. Due to known 
demographic trends, rising health care costs and lower revenues 
as a percentage of the economy, depending upon what assumptions 
you use--in this particular case, that discretionary spending 
grows by the rate of the economy, that all tax cuts are made 
permanent and that the Social Security and Medicare trustees' 
estimates of the costs of those programs under the intermediate 
assumptions are realistic--you can see this is a very sour 
outlook and an unacceptable path for the only superpower on 
Earth.
    Next, please.
    This represents the PBGC. The left bar is assets. The right 
bar is liabilities. The line represents their accumulated 
deficit.
    They have gone from a $9.7 billion surplus in 2000 to a 
$23.3 billion accumulated deficit in 2004. I could show you 
another graphic which would look very similar, which is the 
Federal budget.
    Next.
    This represents the state of defined benefit pension plans, 
based upon GAO's recently issued report. The bottom line is 
that the most recent data that was available to the Government 
was 2002. This is 2005; 2003 data is just now becoming 
available. That is a problem in and of itself.
    Based upon the trends from 1995 to 2002, the bottom line 
with this chart is that the overall state of funding in the 
defined benefit system deteriorated during that period of time.
    Next, please.
    This chart shows that very few cash contributions were made 
by the 100 largest plans in the system during the period 1995-
2002, in part because of flaws in the current funding rules.
    There are fundamental flaws in the current funding rules. 
People are not required to deliver on their promises. People 
are making promises that they realistically cannot keep. People 
are doing what the law minimally requires, versus what is the 
right thing to do.
    As we all know, the law represents the minimum standard of 
acceptable behavior. Hopefully, people should do what is right. 
Unfortunately in this case, many are not.
    Next, please.
    This represents how the state of underfunding in the entire 
defined benefit system has deteriorated dramatically since 
2000. The purple represents the possible losses to the PBGC, in 
other words, entities that are deemed to be high risk as it 
relates to PBGC.
    You can see that the PBGC's exposure has increased 
significantly. At the end of 2004, it represented about $100 
billion. That is in addition to the $23.3 billion accumulated 
deficit.
    Next, please.
    This is an example of the problem with the funding rules. 
Two of the largest losses in PBGC's history, Bethlehem Steel 
and LTV, and I am going through the period 2002, because that 
is the data that we had. These represented two of the largest 
losses in the history of the PBGC insurance system. These 
companies made no cash contributions in the last years of their 
life.
    And guess what: They weren't required to, based upon the 
law. In fact, they had significant credits available to them, 
such that at least one of these plans wouldn't have had to make 
contributions the next year and possibly thereafter. At the 
same time, on termination they were only funded at about 50 
percent of the level of accrued benefits.
    If that doesn't illustrate that the system is broken, I 
don't know what would.
    I think that is it, I believe, with regard to the graphics.
    Thank you very much, and I appreciate the opportunity to be 
with you. I look forward to having the opportunity to answer 
any questions that you may have.
    [The prepared statement of David Walker follows:]

Prepared Statement of Hon. David M. Walker, Comptroller General of the 
                             United States

    Mr. Chairman and members of the committee, I am pleased to be here 
today to discuss the problems and long-term challenges facing the 
defined benefit (DB) pension system, the Pension Benefit Guaranty 
Corporation (PBGC), the retirement security of workers and retirees 
covered by DB plans, and American taxpayers. In particular, I will 
discuss the factors contributing to those problems and suggest elements 
of the comprehensive reform necessary to address them.\1\ As I have 
noted before, these problems are a subset of the broader challenges 
facing the Federal Government and our nation's retirement income 
system.\2\ These programs, which include Social Security, Medicare, and 
Medicaid, represent large, growing, and unsustainable claims on the 
Federal budget because America's population is aging, life expectancies 
are increasing, workforce growth is slowing, and health care costs are 
rising.
    The long-term effect of Federal retirement programs on the budget 
is so significant that neither slowing the growth of discretionary 
spending nor allowing tax cuts to expire--nor both options combined--
would by themselves eliminate our long-term fiscal imbalance (see fig. 
1). Therefore, as we discussed in our 21st Century Challenges 
report,\3\ tough choices need to be made about the appropriate role and 
size of the Federal Government--and how to finance that government--and 
how to bring the panoply of Federal policies, programs, functions and 
activities into line with the realities of today's world and tomorrow's 
challenges. More specifically to Federal retirement policy, we need to 
make choices about how to promote current and long-term economic 
security in retirement. In that latter context, comprehensively 
considering our citizens' needs for income, health care, and long-term 
care is important.
    From our nation's overall fiscal perspective, continuing on our 
current unsustainable fiscal path will gradually erode, if not suddenly 
damage, our economy, our standard of living, and ultimately our 
national security.
    Therefore, we must fundamentally reexamine major spending and tax 
policies and priorities in an effort to recapture our fiscal 
flexibility and ensure that our programs and priorities respond to 
emerging security, social, economic and environmental changes and 
challenges.

     Figure 1: Composition of Spending as a Share of GDP Assuming 
 Discretionary Spending Grows With GDP After 2005 and All Expiring Tax 
                        Provisions Are Extended


    Notes: Although expiring tax provisions are extended, revenue as a 
share of gross domestic product (GDP) increases through 2015 due to (1) 
real bracket creep, (2) more taxpayers becoming subject to the 
alternative minimum tax, and (3) increased revenue from tax-deferred 
retirement accounts. After 2015, revenue as a share of GDP is held 
constant.

    PBGC is an excellent example of the need for Congress to reconsider 
the role of government programs, in general, and Federal retirement 
programs, in particular, in light of past changes and 21st century 
challenges. In 1974, Congress passed the Employee Retirement Income 
Security Act (ERISA) to respond to trends and challenges that existed 
at that time.\4\ Among other things, ERISA established PBGC to pay the 
pension benefits of defined benefit plan participants, subject to 
certain limits, in the event that an employer could not.\5\ When ERISA 
was enacted, defined benefit pension plans were the most common form of 
employer-sponsored private pension and were growing both in number of 
plans and in number of participants. Today, defined benefit pensions 
cover an ever-decreasing percentage of the U.S. labor force, a fact 
that raises questions about Federal policy on pensions in general, and 
defined benefit plans and the PBGC, in particular.
    I would now like to outline the challenges facing the defined 
benefit pension system and PBGC and suggest a framework for evaluating 
potential policy responses. In summary, a combination of recent events, 
long-term structural problems, and weaknesses in the legal framework 
governing pensions has left PBGC with a significant long-term deficit 
and many large plans badly underfunded. Lower interest rates and equity 
prices since 2000 have combined to significantly increase pension 
underfunding through an increase in the present value of pension 
liabilities, and decreases in the value of pension plan assets. 
Meanwhile, intense cost competition as a result of globalization and 
deregulation has led to bankruptcies of plan sponsors in key industries 
like steel and airlines, and is exposing PBGC to the risk of 
significant future losses in these and other industries. This 
competitive restructuring has occurred simultaneously with a long-term 
decline in defined benefit plan participation that threatens PBGC's 
revenue base. In addition, the basic legal framework governing pension 
insurance and plan funding has failed to safeguard the benefit security 
of American workers and retirees and the PBGC's financial condition. 
Too many companies are making pension promises that they are not 
required to deliver on, in part because of perverse incentives and 
``put options'' created under the current pension insurance system.
    PBGC's current premium structure does not properly reflect the 
risks to its insurance program and facilitates moral hazard by plan 
sponsors. Further, as we have shown in a recent report, current pension 
funding rules have not provided sufficient incentives, transparency, 
and accountability mechanisms for plan sponsors to properly fund their 
benefit obligations and deliver on their promises.\6\ As a result, 
bankrupt plan sponsors, acting rationally and within the rules, have 
transferred the obligations of their large and significantly 
underfunded plans to PBGC. These weaknesses in the legal framework 
contribute to and are exacerbated by a lack of transparent information 
that makes it difficult for interested stakeholders to understand the 
true financial condition of and risk associated with selected pension 
plans.
    Given pension plans' crucial significance to our nation's 
retirement security net, it is useful to compare the challenges facing 
PBGC's insurance program and Social Security. Both systems require 
meaningful, comprehensive reform that restores solvency, assures 
sustainability, and protects the benefits of participants. Similar to 
that of Social Security, PBGC's current condition does not represent a 
crisis, though delaying reform will result in serious adverse 
consequences for individuals, the Federal budget, and our economy. 
Furthermore, like Social Security, PBGC has plenty of cash on hand 
today to pay benefits to participants in the short term, but it faces 
large and growing unfunded obligations and escalating cash flow 
deficits in the future.
    The termination of United Airlines' defined benefit pension plans 
is just the latest in a recent series of large, underfunded plans taken 
over by PBGC, and will not be the last. In July 2003, GAO designated 
PBGC's single-employer insurance program as ``high-risk,'' given its 
deteriorating financial condition and long-term vulnerabilities.\7\ At 
the end of fiscal year 2004, PBGC estimated that it was exposed to 
almost $100 billion of underfunding in plans sponsored by companies 
with credit ratings below investment grade. Though smaller in scale 
than Social Security, Medicare, and Medicaid, PBGC's deficit threatens 
to worsen our government's long-term fiscal position.\8\ While PBGC is 
not explicitly backed by the full faith and credit of the U.S. 
Government,\9\ policymakers would undoubtedly face intense pressure to 
provide PBGC the resources to continue paying earned pension benefits 
to millions of retirees if PBGC were to become insolvent.
    In light of the intrinsic problems facing the defined benefit 
system, meaningful and comprehensive reform will be needed to ensure 
that workers and retirees receive the benefits promised to them and to 
secure PBGC's financial future. At this time, the Administration, 
Members of Congress, and others have proposed reforms that seek to 
address many of the problems facing PBGC and the defined benefit 
system. This is a promising development that can be a critical first 
step in addressing part of the long-term fiscal problems facing this 
country.
                               background
    Before enactment of the Employee Retirement Income Security Act of 
1974 (ERISA), few rules governed the funding of defined benefit pension 
plans, and participants had no guarantees that they would receive their 
promised benefits. Among other things, ERISA created the PBGC to 
protect the benefits of plan participants in the event that plan 
sponsors could not meet the benefit obligations under their plans. 
ERISA also established rules for funding defined benefit pension plans, 
instituted pension insurance premiums, promulgated certain fiduciary 
rules, and developed annual reporting requirements. When a plan is 
terminated with insufficient assets to pay its guaranteed benefits, 
PBGC takes over the plan and assumes responsibility for paying benefits 
to participants. According to PBGC's 2004 annual report, PBGC provides 
insurance protection for over 29,000 single-employer pension plans, 
which cover 34.6 million workers, retirees, and their 
beneficiaries.\10\
    PBGC receives no direct Federal tax dollars to support the single-
employer pension insurance program. Instead, the program receives the 
assets of terminated underfunded plans and any of the sponsor's assets 
that PBGC recovers during bankruptcy proceedings.\11\ PBGC finances the 
unfunded liabilities of terminated plans with premiums paid by plan 
sponsors and income earned from the investment of program assets. 
Premiums have two components: a per participant charge paid by all 
sponsors (currently $19 per participant), and a variable-rate premium 
that some underfunded plans pay based on the level of unfunded 
benefits.\12\
    The single-employer program has had an accumulated deficit--that 
is, program assets have been less than the present value of benefits 
and other obligations--for much of its existence. (See fig. 2.) In 
fiscal year 1996, the program had its first accumulated surplus, and by 
fiscal year 2000, the accumulated surplus had increased to about $10 
billion, in 2002 dollars. However, the program's finances reversed 
direction in 2001, and at the end of fiscal year 2002, its accumulated 
deficit was about $3.6 billion. In fiscal year 2004, the single-
employer program incurred a net loss of $12.1 billion, and its 
accumulated deficit increased to $23.3 billion, up from $11.2 billion a 
year earlier. Furthermore, PBGC estimated that total underfunding in 
single-employer plans exceeded $450 billion, as of the end of fiscal 
year 2004.

  Figure 2: Assets, Liabilities, and Net Financial Position of PBGC's 
                   Single-Employer Insurance Program


    In defined benefit plans, formulas set by the employer determine 
employee benefits. DB plan formulas vary widely, but benefits are 
frequently based on participant earnings and years of service, and 
traditionally paid upon retirement as a lifetime annuity, or periodic 
payments until death. Because DB plans promise to make payments in the 
future, and because tax-qualified DB plans must be funded, employers 
must use present value calculations to estimate the current value of 
promised benefits.\13\ The calculations require making assumptions 
about factors that affect the amount and timing of benefit payments, 
such as an employee's retirement age and expected mortality, and about 
the expected return on plan assets, expressed in the form of an 
interest rate. The present value of accrued benefits calculated using 
mandated assumptions is known as a plan's current liability. Current 
liability provides an estimate of the amount of assets a plan needs 
today to pay for accrued benefits.
    ERISA and the Internal Revenue Code (IRC) prescribe rules regarding 
the assumptions that sponsors must use to measure plan liabilities and 
assets. While different assumptions will change a plan's reported 
assets and liabilities, sponsors eventually must pay the amount of 
benefits promised; if the assumptions used to compute current liability 
differ from the plan's actual experience, current liability will differ 
from the amount of assets actually needed to pay benefits.\14\
    Funding rules generally presume that a pension plan and its sponsor 
are ongoing entities, and plans do not necessarily have to maintain an 
asset level equal to current liabilities every year. However, the 
funding rules include certain mechanisms that are intended to keep 
plans from becoming too underfunded. One such mechanism is the 
additional funding charge (AFC), which applies to plans with more than 
100 participants.\15\ The AFC requires plan sponsors to make additional 
contributions to plans that fall below a prescribed funding level. With 
some exceptions, plans with reported asset values below 90 percent of 
current liabilities are affected by the AFC rules.
 pbgc's problems stem from recent events, long-term structural trends, 
      and weaknesses in the legal framework governing db pensions
    A combination of recent events, long-term structural problems, and 
weaknesses in the legal framework governing the DB system has left PBGC 
with a significant long-term deficit and many large plans badly 
underfunded. Lower interest rates and equity prices since 2000 have 
combined to significantly increase pension underfunding through an 
increase in the present value of pension liabilities, and decreases in 
the value of pension plan assets. Meanwhile, intense cost competition 
as a result of globalization and deregulation has led to bankruptcies 
of plan sponsors in key industries like steel and airlines, and is 
exposing PBGC to the risk of significant future losses in these and 
other industries. This competitive restructuring has occurred 
simultaneously with a long term decline in defined benefit plan 
participation that threatens PBGC's revenue base. In addition, the 
basic legal framework governing pension insurance and plan funding has 
failed to safeguard the benefit security of American workers and 
retirees and the PBGC's financial condition. Too many companies are 
making pension promises that they are not required to deliver on, in 
part because of perverse incentives and ``put options'' created under 
the current pension insurance system.
    PBGC's current premium structure does not properly reflect the 
risks to its insurance program and facilitates moral hazard by plan 
sponsors. Further, current pension funding rules have not provided 
sufficient incentives, transparency, and accountability mechanisms for 
plan sponsors to properly fund their benefit obligations and deliver on 
their promises. As a result, bankrupt plan sponsors, acting rationally 
and within the rules, have transferred the obligations of their large 
and significantly underfunded plans to PBGC. These weaknesses in the 
legal framework contribute to and are exacerbated by a lack of 
transparent information that makes it difficult for interested 
stakeholders to understand the true financial condition of and risk 
associated with selected pension plans.
     recent economic factors exacerbated the underfunding of large 
                 terminated plans by bankrupt sponsors
    Over the last 5 years, many large pension plans have been adversely 
affected by simultaneous declines in broad equity indexes and long-term 
interest rates, as well as by the financial difficulties of their plan 
sponsors.\16\ Poor investment returns from stock market declines 
affected the asset values of pension plans to the extent that plans 
invested in stocks. According to the ERISA Industry Committee, assets 
in private sector defined benefit plans totaled $2.056 trillion at the 
end of 1999, dropped to $1.531 trillion at the end of 2002, and climbed 
back to $1.8 trillion by the end of 2004.\17\ Lower equity values since 
the end of 1999 have been particularly problematic because interest 
rates have also declined and thus increased the present value of plan 
liabilities.\18\ Some sponsors of large pension plans that were 
terminated were not in sufficiently strong financial condition to meet 
their pension funding requirements because of weaknesses in their 
primary business activities. Bankruptcies and pension plan terminations 
increased around the U.S. economic recession of 2001 and around prior 
recessions.\19\
    These conditions played a part in increasing the unfunded 
liabilities of plans terminated by bankrupt sponsors since 2000. For 
example, according to the filing of its annual regulatory report for 
pension plans, Bethlehem Steel's plan went from 86 percent funded in 
1992 to 97 percent funded in 1999. From 1999 to its plan termination in 
December 2002, plan funding fell to less than 50 percent as assets 
decreased and liabilities increased and sponsor contributions were not 
sufficient to offset the changes.
  long-term declines of key industries and in defined benefit pension 
   coverage have contributed to pbgc's weakening financial condition
    Long-term trends in some sectors of the economy and in defined 
benefit pension coverage are threatening both PBGC's future solvency 
and the economic security in retirement of workers and retirees. PBGC's 
risk of inheriting underfunded pensions largely stems from the fact 
that more than half of the pension participants it insures are in the 
manufacturing and airline sectors, which have been exposed to lower 
cost competition because of several factors including globalization and 
deregulation.\20\ A potentially exacerbating risk to PBGC is the 
cumulative effect of bankruptcy in these industries: if a critical mass 
of firms go bankrupt and terminate their underfunded pension plans, 
their competitors may also declare bankruptcy to similarly avoid the 
cost of funding their plans.
    PBGC also faces the possibility of long-term revenue declines from 
demographic changes in the population of defined benefit plan 
participants and a shrinking number of DB plans. Over the long term, an 
aging population of defined benefit plan participants threatens to 
reduce PBGC's ability to raise premium revenues as participants die and 
are not replaced by enough new participants. The percentage of 
participants who are active workers has declined from 78 percent in 
1980 to just under 50 percent in 2002. Furthermore, PBGC cannot 
effectively diversify its risk from the terminations of plans in 
declining economic sectors because companies in other growing 
industries have generally not sponsored new defined benefit plans. As 
plan sponsors in weak industries go bankrupt and terminate their 
pension plans, PBGC not only faces immediate changes in its financial 
position from taking over underfunded plans, but also faces losses of 
future revenues from these terminated plans.
    A related factor eroding PBGC's premium base is the growth of lump-
sum pension distributions. More and more plan participants are exiting 
the defined benefit system by taking lump-sum distributions from their 
plans. After a lump-sum distribution is paid, the participant is out of 
the defined benefit system and the plan sponsor no longer has to 
contribute to the pension insurance system on the participant's behalf. 
In addition, lump-sum distributions to participants in underfunded 
plans can create the effect of a ``run on the bank'' and worsen a 
plan's underfunding. In such cases, the plan may terminate without 
enough assets to pay full benefits to other participants and PBGC may 
incur losses.
    The increasing prevalence of lump-sum distributions in defined 
benefit plans and the growth of defined contribution plans also raise 
significant questions about whether many Americans will enjoy an 
economically secure retirement.\21\ Many Americans are at risk of 
outliving their retirement assets as life expectancies, health care, 
and long-term care costs continue to increase.
legal framework has not encouraged adequate plan funding, contributing 
                    to pbgc's financial difficulties
    Existing laws and regulations governing pension funding and 
premiums have contributed to PBGC's financial difficulties and exposed 
PBGC to greater risks from the companies whose pension plans it 
insures. PBGC's current premium structure does not properly reflect the 
risks to its insurance program and facilitates moral hazard by plan 
sponsors. Further, the pension funding rules, under ERISA and the IRC, 
have not ensured that plans have the means to meet their benefit 
obligations in the event that plan sponsors run into financial 
distress. First, the current rules likely allowed plans to appear 
better funded than they actually were, in both good years and bad 
years. And even these reported funding levels indicated significant 
levels of underfunding in our study of the 100 largest DB plans.\22\ 
Second, plan sponsors often substituted ``account credits'' for cash 
contributions, even as the market value of plan assets may have been in 
decline. And third, the AFC, the primary mechanism for improving the 
financial condition of poorly funded plans, was ineffective in doing 
so. These weaknesses contribute to and are exacerbated by a lack of 
transparent information that makes it difficult for plan participants, 
investors, and others to have a clear understanding of their plan's 
financial condition. As a result, financially weak benefit plan 
sponsors, acting rationally and within the current law, have been able 
to avoid large contributions to underfunded plans prior to bankruptcy 
and plan termination, thus adding to PBGC's current deficit.
    pbgc's premium structure does not properly reflect risks to the 
                           insurance program
    PBGC's current premium structure does not properly reflect risks to 
the insurance program. The current premium structure relies heavily on 
flat-rate premiums, which, since they are unrelated to risk, result in 
large cost shifting from financially troubled companies with 
underfunded plans to healthy companies with well-funded plans. PBGC 
also charges plans a variable-rate premium based on the plan's level of 
underfunding. However, these premiums do not consider other relevant 
risk factors, such as the economic strength of the sponsor, plan asset 
investment strategies, the plan's benefit structure, or the plan's 
demographic profile. PBGC is currently operated somewhat more on a 
social insurance model, since it must cover all eligible plans 
regardless of their financial condition or the risks they pose to the 
solvency of the insurance program.
    In addition to facing firm-specific risk that an individual 
underfunded plan may terminate, PBGC faces market risk that a poor 
economy may lead to widespread underfunded terminations during the same 
period, potentially causing very large losses for PBGC. Similarly, PBGC 
may face risk from insuring plans concentrated in vulnerable industries 
affected by certain macroeconomic forces such as deregulation and 
globalization that have played a role in multiple bankruptcies over a 
short time period, as has happened recently in the airline and steel 
industries. One study estimates that the overall premiums collected by 
PBGC amount to about 50 percent of what a private insurer would charge 
because its premiums do not adequately account for these market 
risks.\23\ Others note that it would be hard to determine the market-
rate premium for insuring private pension plans because private 
insurers would probably refuse to insure poorly funded plans sponsored 
by weak companies.
                    pbgc is subject to moral hazard
    Current pension funding and insurance laws create incentives for 
financially troubled firms to use PBGC in ways that Congress likely did 
not intend when it formed the agency in 1974. At that time, PBGC was 
established to pay the pension benefits of participants, subject to 
certain limits, in the event that an employer could not. However, since 
that time, some firms with underfunded pension plans may have come to 
view PBGC coverage as a fallback, or ``put option,'' for financial 
assistance. The very presence of PBGC insurance may create certain 
perverse incentives that represent what economists call moral hazard--
where struggling plan sponsors may place other financial priorities 
above funding up their pension plans because they know PBGC will pay 
guaranteed benefits. Firms may even have an incentive to seek Chapter 
11 bankruptcy in order to escape their pension obligations. As a 
result, once a plan sponsor with an underfunded pension plan 
experiences financial difficulty, these moral hazard incentives may 
exacerbate the funding shortfall for PBGC.
    This moral hazard effect has the potential to escalate, with the 
initial bankruptcy of firms with underfunded plans creating a vicious 
cycle of bankruptcies and terminations. Firms with onerous pension 
obligations and strained finances could see PBGC as a means of shedding 
these liabilities, thereby providing these companies with a competitive 
advantage over other firms that deliver on their pension commitments. 
This would also potentially subject PBGC to a series of terminations of 
underfunded plans in the same industry, as we have already seen with 
the steel and airlines industries in the past 20 years.
    Moral hazard effects are likely amplified by current pension 
funding and pension accounting rules that may also encourage plans to 
invest in riskier assets to benefit from higher expected long-term 
rates of return. In determining funding requirements, a higher expected 
rate of return on pension assets means that the plan needs to hold 
fewer assets in order to meet its future benefit obligations. And under 
current accounting rules, the greater the expected rate of return on 
plan assets, the greater the plan sponsor's operating earnings and net 
income. However, with higher expected rates of return comes greater 
risk of investment volatility, which is not reflected in the pension 
insurance program's premium structure. Investments in riskier assets 
with higher expected rates of return may allow financially weak plan 
sponsors and their plan participants to benefit from the upside of 
large positive returns on pension plan assets without being truly 
exposed to the risk of losses. The benefits of plan participants are 
guaranteed by PBGC, and weak plan sponsors that enter bankruptcy can 
often have their plans taken over by PBGC.
current funding rules do not provide sufficient incentives for sponsors 
                     to adequately fund their plans
    The pension funding rules, under ERISA and the IRC, have not 
provided sufficient incentives for plan sponsors to properly fund their 
benefit obligations. The funding rules generally presume that pension 
plans and their sponsors are ongoing entities and therefore allow for a 
certain extent of plan underfunding that can be made up over time. 
However, the measures of plan funding used to determine contribution 
requirements can significantly overstate the true financial condition 
of a plan. And even these reported funding levels indicated significant 
levels of underfunding in our study of the 100 largest DB plans.\24\ 
Furthermore, when plan sponsors make contributions to their plans, they 
can use account credits, rather than cash, even in cases when plans are 
underfunded. The funding rules include certain mechanisms--primarily, 
the AFC--that are intended to prevent plans from becoming too 
underfunded. However, our analysis shows that for several reasons, the 
AFC proved ineffective in restoring financial health to poorly funded 
plans.
    rules may allow plans to overstate their current funding levels
    Current funding rules may allow plans to overstate their current 
funding levels to plan participants and the public. Because many plans 
in our sample chose legally allowable actuarial assumptions and asset 
valuation methods that may have altered their reported liabilities and 
assets relative to market levels, it is possible that funding over our 
sample period was actually worse than reported.
    Although as a group, funding levels among the 100 largest plans 
were reasonably stable and strong from 1996 to 2000, by 2002, more than 
half of the largest plans were underfunded (see fig. 3). On average, 
each year 39 of these plans were less than 100 percent funded, 10 had 
assets below 90 percent of their current liabilities, and 3 plans were 
less than 80 percent funded. In 2002 there were 23 plans less than 90 
percent funded.

Figure 3: Almost One-Fourth of the Largest Pension Plans Were Less than 
         90 Percent Funded on a Current Liability Basis in 2002


    Reported funding levels may have been overstated for a number of 
reasons. These include the use of above-market interest rates, which 
leads to an understatement of the cost of settling benefit obligations 
through the purchase of group annuity contracts. Also, actuarial asset 
values may have differed by as much as 20 percent from current market 
value of plan assets. The funding rules allow for smoothing out year-
to-year fluctuations in asset and liability values so that plan 
sponsors are gradually, and not suddenly, affected by significant 
changes in interest rates and the values of their assets. When current 
interest rates decline, the use of a 4-year weighted average interest 
rate lags behind, and thus measurements of the present value of plan 
liabilities do not accurately reflect the cost of settling a plan's 
benefit obligations.\25\
    The terminations of the Bethlehem Steel and LTV Steel pension plans 
in 2002 (two of the largest plan terminations, to date) illustrate the 
potential discrepancies between reported and actual funding. In 2002, 
the Bethlehem Steel Corporation reported that its plan was 85.2 percent 
funded on a current liability basis, yet the plan terminated later that 
year with assets of less than half of the value of promised benefits. 
In 2001, LTV Steel reported that its plan for hourly employees was 80 
percent funded, yet when the plan terminated in March 2002, it was only 
52 percent funded. From these terminations PBGC's single-employer 
program suffered losses of $3.7 billion and $1.6 billion, 
respectively.\26\
   most sponsors most years made no cash contributions to plans but 
    satisfied funding requirements through use of accounting credits
    The amount of contributions required under IRC minimum funding 
rules is generally the amount needed to fund benefits earned during 
that year plus that year's portion of other liabilities that are 
amortized over a period of years. This minimum contribution requirement 
may be met by the plan sponsor putting cash into the plan or by 
applying earned funding credits. These funding credits are not measured 
at their market value and are credited with interest each year, 
according to the plan's long-term expected rate of return on 
assets.\27\ When the market value of a plan's assets declines, the 
value of funding credits may be significantly overstated.
    For the 1995 to 2002 period, the sponsors of the 100 largest plans 
each year on average made relatively small cash contributions to their 
plans (see fig. 4). Annual cash contributions for the 100 largest plans 
averaged approximately $97 million on plans averaging $5.3 billion in 
current liabilities (in 2002 dollars). This average contribution level 
masks a large difference in contributions between 1995 and 2001, during 
which period annual contributions averaged $62 million (in 2002 
dollars), and in 2002, when contributions increased significantly to 
$395 million per plan. Further, in 6 of the 8 years in our sample, a 
majority of the largest plans made no cash contribution to their plan. 
On average each year, 62.5 plans received no cash contribution, 
including an annual average of 41 percent of plans that were less than 
100 percent funded.

 Figure 4: Most Large Plans Received No Annual Cash Contribution, 1995-
                                  2002


    Note: Average contributions for 2002 are largely driven by one 
sponsor's contribution to its plan. Disregarding this $15.2 billion 
contribution reduces the average plan contribution for 2002 from $395 
million to $246 million.

    As stated earlier, Bethlehem Steel and LTV Steel both had plans 
terminate in 2002 that were only about 50 percent funded. Yet each plan 
was able to forgo a cash contribution each year from 2000 to 2002, 
instead using credits to satisfy minimum funding obligations, primarily 
from large accumulated credit balances from prior years. Despite being 
severely underfunded, each plan reported an existing credit balance at 
the time of termination.
  afc, primary mechanism for improving funding of underfunded plans, 
                           proved ineffective
    The funding rules' primary mechanism for improving the financial 
condition of underfunded plans, the additional funding charge proved 
ineffective in helping underfunded plans for four main reasons:
    1. Very few plans in our sample were actually assessed an AFC 
because the rules, despite the statutory threshold of a 90 percent 
funding level for some plans to owe an AFC, in practice require a plan 
to be much more poorly funded to be subject to this requirement.\28\ 
From 1995 to 2002, an average of only 2.9 of the 100 largest DB plans 
each year were assessed an additional funding charge, even though on 
average 10 percent of plans each year reported funding levels below 90 
percent. Over the entire 8-year period, only 6 unique plans that were 
among the 100 largest plans in any year from 1995 to 2002 owed an AFC. 
These 6 plans owed an AFC during the period a total of 23 times in 
years in which they were among the 100 largest plans, meaning that 
plans that were assessed an AFC were likely to owe it again.
    2. AFC rules also specify a current liability calculation method 
that may overstate actual plan funding, relative to market-value 
measures, thereby reducing the number of plans that might be assessed 
an AFC. The specified interest rate for this calculation exceeded 
current market rates in 98 percent of the months between 1995 and 2002.
    3. The AFC rules generally call for sponsors to pay only a 
percentage of their unfunded liability, rather than requiring 
restoration of full funding. On average, by the time a plan was 
assessed an AFC, it was significantly underfunded and was likely to 
remain chronically underfunded in subsequent years. Among the 6 plans 
that owed the AFC, funding levels rose slightly from an average of 75 
percent when the plan was first assessed an AFC to an average of 76 
percent, looking collectively at all subsequent years. All of these 
plans were assessed an AFC more than once.
    4. Plan sponsors can meet the AFC requirement by applying funding 
credits earned in prior years in place of cash contributions. The 
account value of these credits, which accumulate interest, may not 
reflect the underlying value of the assets in the plan. Many plans 
experienced significant market value losses of their assets between 
2000 and 2002 while they were able to apply these funding credits. 
Among the 100 largest plans, just over 30 percent of the time a plan 
was assessed an AFC, the funding rules allowed the sponsor to forgo a 
cash contribution altogether that year.
    The experience of two large terminated plans illustrates the 
ineffectiveness of the AFC. For example, Bethlehem Steel's plan was 
assessed an AFC of $181 million in 2002, but the company made no cash 
contribution that year, just as it had not in 2000 or 2001, years in 
which the plan was not assessed an AFC. When the plan terminated in 
late 2002, its assets covered less than half of the $7 billion in 
promised benefits. LTV Steel, which terminated its pension plan for 
hourly employees in 2002 with assets of $1.6 billion below the value of 
benefits, had its plan assessed an AFC each year from 2000 to 2002, but 
for only $2 million, $73 million, and $79 million, or no more than 5 
percent of the eventual funding shortfall. Despite these AFC 
assessments, LTV Steel made no cash contributions to its plan from 2000 
to 2002. Both plans were able to apply existing credits instead of cash 
to satisfy minimum funding requirements. In addition, both sponsors had 
unused funding credits at the time their plans were terminated.
 weaknesses in funding rules amplified by lack of transparency hinders 
                          sound policy making
    Unclear measures of pension funding and a lack of timely 
information have made it difficult for plan participants, investors, 
regulators, and policy makers to accurately assess the financial 
condition of pension plans. Without timely and reasonably accurate data 
about the financial condition of pension plans, the various 
stakeholders cannot make timely and informed decisions on retirement 
savings, employment, and other key life issues. The primary regulatory 
filing for pension plans--the Form 5500--requires multiple measures of 
pension assets and liabilities, yet none of these measures tell PBGC 
and plan participants what share of the benefit obligations are funded 
in the event of plan termination. Furthermore, by the time these 
regulatory reports are publicly available, the information is usually 
at least 2 years old.\29\ In a time of significant changes in interest 
rates and equity prices, it is possible that reported measures of 
pension funding will substantially differ from current measures of plan 
funding. PBGC does receive more current information about plans that 
are underfunded by at least $50 million. This more current information 
includes estimates of funding measures if the plan were to be 
terminated; however, by law this information is not disclosed to the 
public.
    Our cash-based budgetary framework for Federal insurance programs 
also contributes to a lack of transparency that, at worst, may create 
disincentives for policy makers to enact reform measures.\30\ With the 
current cash-based reporting, premiums for insurance programs are 
recorded in the budget when collected, and outlays are reported when 
claims are paid.\31\ This focus on annual cash flows generally does not 
adequately reflect the government's cost for Federal insurance programs 
because the time between the extension of the insurance, the receipt of 
premiums and other collections, the occurrence of an insured event, and 
the payment of claims may extend over several budget periods. As a 
result, the government's cost may be understated in years that a 
program's current premium and other collections exceed current payments 
and overstated in years that current claim payments exceed current 
collections. This is especially problematic in the case of pension 
insurance because of the erratic occurrence of plan terminations as 
well as the mismatch between premium collections and benefit payments 
that can extend over several decades.
    Cash-based budgeting also may not be a very accurate gauge of the 
economic impact of Federal insurance programs. Although discerning the 
economic impact of Federal insurance programs can be difficult, private 
economic behavior generally is affected when the government commits to 
providing insurance coverage. In the case of PBGC, the existence of 
pension insurance may encourage plan sponsors and employees to agree to 
pension benefit increases in lieu of wage increases when the plan 
sponsor faces economic difficulties.\32\
    Cash-based budgeting for Federal insurance programs may provide 
neither the information nor incentives necessary to signal emerging 
problems, make adequate cost comparisons, control costs, or ensure the 
availability of resources to pay future claims. Because the cash-based 
budget delays recognition of emerging problems, it may not provide 
policy makers with information or incentives to address potential 
funding shortfalls before claim payments come due. Policy makers may 
not be alerted to the need to address programmatic design issues 
because, in most cases, the budget does not encourage them to consider 
the future costs of Federal insurance commitments. Thus, reforms aimed 
at reducing costs may be delayed. In most cases, by the time costs are 
recorded in the budget, policy makers do not have time to ensure that 
adequate resources are accumulated to pay for them or to take actions 
to control them. The late budget recognition of these costs can reduce 
the number of viable options available to policy makers, ultimately 
increasing the cost to the government.
retirement income security requires meaningful and comprehensive reform
    In light of the intrinsic problems facing the defined benefit 
system, meaningful and comprehensive pension reform is required to 
ensure that workers and retirees receive the benefits promised to them 
and to secure PBGC's financial future. While PBGC's current financial 
condition does not represent a crisis, delaying reform will result in 
serious adverse consequences for plan participants, the Federal budget, 
and our nation's economy. At this time, the Administration, Members of 
Congress, and others have proposed reforms that seek to address many of 
the problems facing PBGC and the defined benefit system.\33\ Such 
comprehensive effective pension reform would likely include elements 
that would improve measures of pension funding and enhance transparency 
of plan information, strengthen funding rules (while preserving some 
contribution flexibility for plan sponsors, modify certain PBGC 
guarantees, develop an enhanced and more risk-based insurance premium 
structure, and resolve outstanding controversies concerning hybrid 
plans, such as cash balance plans.\34\
              gao has suggested elements of pension reform
    Pension reform is a challenge because of the necessity of fusing 
together so many complex, and sometimes competing, elements into a 
comprehensive proposal. Ideally, effective reform would
     improve the accuracy of plan funding measures while 
minimizing complexity and maintaining contribution flexibility;
     revise the current funding rules to create incentives for 
plan sponsors to adequately finance promised benefits;
     develop a more risk-based PBGC insurance premium structure 
and provides incentives for sponsors to fund plans adequately;
     address the issue of underfunded plans paying lump sums 
and granting benefit increases;
     modify PBGC guarantees of certain plan benefits (e.g., 
shutdown benefits);
     resolve outstanding controversies concerning hybrid plans 
by safeguarding the benefits of workers regardless of age; and
     improve plan information transparency for pension plan 
stakeholders without overburdening plan sponsors.
    Furthermore, if policy makers decide to provide measures of relief 
to sponsors of poorly funded pension plans, there should be mechanisms 
built into such laws that would prevent any undue exacerbation of 
PBGC's financial condition.
    Developed in isolation, solutions to some of these concerns could 
erode the effectiveness of other reform components or introduce 
needless complexity. As deliberations on reform move forward, it will 
be important that each of these individual elements be designed so that 
all work in concert toward well-defined goals. Even with meaningful, 
carefully crafted reform, it is possible that some defined benefit plan 
sponsors may choose to freeze or terminate their plans. While these are 
serious concerns, the overarching goals of balanced pension reform 
should be to protect workers' benefits by providing employers the 
flexibility they need in managing their pension plans while also 
holding those employers accountable for the promises they make to their 
employees.
    The debate over defined benefit pension reform should not take 
place in isolation of larger related issues. Challenges in the defined 
benefit system, together with the recent public debate over the merits 
of including individual accounts as part of a more comprehensive Social 
Security reform proposal, should lead us to consider fundamental 
questions about how who should bear certain risks and responsibilities 
for economic security in retirement.
     Individual savings require greater responsibility and 
offer greater potential rewards and the possibility of bequeathing any 
unused retirement savings. However, longevity risk--the risk of 
outliving retirement savings--and poor investment choice are 
significant concerns, particularly as health care and long-term care 
costs and life expectancies continue to rise.
     The Federal Government is in the best position to share 
risk across the population, and social insurance programs, including 
Social Security, Medicare, and Medicaid already reflect this fact. 
However, the current structure of existing Federal retirement programs 
is unsustainable.
     Employer-sponsored pensions can alleviate longevity risk 
for plan participants and are generally presumed to be better placed to 
manage investment risk. However, poor management of plans can lead to 
shortfalls in funding that can damage the competitiveness of the plan 
sponsors. Furthermore, many employers are cutting or reducing retiree 
health benefits, and even employee health benefits, as growing health 
care costs threaten their competitiveness.
         experts identified a variety of broad pension reforms
    Earlier this year, GAO convened a forum on the future of the 
defined benefit system and the PBGC that included a diverse group of 
about 40 pension experts, representing various interests, to discuss 
various reforms to the defined benefit pension system.\35\ In addition 
to debating changes to the funding rules and PBGC premiums, 
participants also talked about ways to address pension legacy costs 
(the costs of terminated and underfunded pension plans) and features of 
pension plans that government policy should encourage.
    According to participants in the GAO forum, resolution of pension 
legacy costs and clarification of the legal status of cash balance and 
other hybrid pension plans could play a significant role in shoring up 
the defined benefit system.\36\ Separating legacy costs from the 
existing and future liabilities of the remaining defined benefit plans 
might encourage plan sponsors to remain in the defined benefit system. 
Many plan sponsors are concerned that through increased PBGC premiums, 
they may be required to pay for the failures of other companies to 
responsibly fund and manage their pension plans. Some participants 
added that resolving legacy costs could be a key component of any 
pension reform legislation that tightened the funding rules and 
assessed premiums according to PBGC's risk. Also, some participants 
supported, and other participants opposed, the idea of separately 
addressing the pension legacy costs of specific industries, such as 
airlines and steel, which have imposed the most significant costs on 
PBGC. Separately addressing pension legacy costs does not necessarily 
imply a taxpayer bailout, as some participants suggested other ways to 
cover their cost, such as through an airline ticket fee to cover the 
airlines' share of PBGC's deficit. Others noted that resolving the 
uncertain legal status of cash balance and other hybrid pension plans 
could encourage greater participation in the defined benefit system. 
Expanding the universe of pension plan sponsors could lead to an 
increase in PBGC's premium income.
    Some forum participants also suggested that the debate over Federal 
retirement policy needs to move beyond distinctions between defined 
benefit and defined contribution plans. Others added that discussions 
of retirement policy need to focus on ways to create incentives and 
remove barriers for employers to set up retirement plans, and how to 
get American workers to build adequate retirement savings and security. 
This may be achieved by thinking about the interaction of private 
pensions and Social Security and by looking at hybrid pension plans, 
such as cash balance plans and plans that combine the best features of 
defined benefit and defined contribution plans. Participants suggested 
new pension plan designs be developed that explore the following 
features:
     allowing automatic participation of the covered population 
in order to expand pension coverage generally;
     improving the portability of pension benefits to 
accommodate workers who frequently change jobs;
     providing for professional money management and pooled 
investment risk;
     minimizing early withdrawals and borrowing--a problem 
known as leakage--from retirement savings; and
     providing incentives to receive benefits in the form of a 
fixed annuity, rather than a lump-sum distribution.
                              conclusions
    Widely reported recent large plan terminations by bankrupt sponsors 
and the resulting adverse consequences for plan participants and the 
PBGC have pushed pension reform into the spotlight of national concern. 
Our analysis here suggests that a variety of factors have contributed 
to the current state of affairs: recent declines in interest rates and 
financial markets, a soft economy, industry restructuring because of 
changes in the national and world economies, weaknesses in the legal 
framework governing pensions that has encouraged moral hazard by 
sponsors, the underfunding of plans, and a lack of timely, accurate, 
useful and transparent information that limits participants, unions, 
investors and other stakeholders from being able to make accurate and 
timely decisions.
    In light of the intrinsic problems facing the defined benefit 
system, meaningful and comprehensive pension reform is required to 
ensure that workers and retirees receive the benefits promised to them. 
At this time, the Administration, Members of Congress, and others have 
proposed reforms that seek to address many of the problems facing PBGC 
and the defined benefit system. This is a promising development that 
can be a critical first step in addressing part of the long-term fiscal 
problems facing this country. Such reform will demand wisdom and 
patience, given the necessity of fusing together so many complex, and 
sometimes competing, elements into a comprehensive proposal. Ideally, 
effective reform would
     improve the accuracy of plan funding measures while 
minimizing complexity and maintaining contribution flexibility;
     revise the current funding rules to create incentives for 
plan sponsors to adequately finance promised benefits;
     develop a more risk-based PBGC insurance premium structure 
and provides incentives for sponsors to fund plans adequately;
     address the issue of underfunded plans paying lump sums 
and granting benefit increases;
     modify PBGC guarantees of certain plan benefits (e.g., 
shutdown benefits);
     resolve outstanding controversies concerning hybrid plans 
by safeguarding the benefits of workers regardless of age; and
     improve plan information transparency for pension plan 
stakeholders without overburdening plan sponsors.
    However, it is also necessary to keep in mind that pension reform 
is only part of the broader fiscal, economic, workforce, and retirement 
security challenges facing our nation. If you look ahead in the Federal 
budget, Social Security, together with the rapidly growing health 
programs (Medicare and Medicaid), will dominate the Federal 
Government's future fiscal outlook. These are far larger and more 
urgent challenges, representing an unsustainable burden on future 
generations. Furthermore, pension reform should be considered in the 
context of the problems facing our nation's Social Security system. How 
we reform DB pensions has crucial implications for directions taken in 
reforming Social Security. For example, pension reforms that reduce the 
scope of the private pension system or change the dominant form of 
private pension design may have consequences for those elements of 
Social Security reform packages that reduce benefits or include an 
individual accounts feature.
    This also means that acting sooner rather than later will make 
reform less costly and more feasible. Though smaller in scale than 
actuarial deficits in Social Security, Medicare, and Medicaid, PBGC's 
deficit threatens to worsen our government's long-term fiscal position. 
Finally, as with Social Security, it is also important to evaluate 
pension reform proposals as comprehensive packages. The elements of any 
reform proposal interact; every package will have pluses and minuses, 
and no plan will satisfy everyone on all dimensions. If we focus on the 
pros and cons of each element of reform by itself, we may find it 
impossible to build the bridges necessary to achieve consensus.
    We look forward to working with Congress on these crucial issues.
    Mr. Chairman, this concludes my statement. I would be happy to 
respond to any questions you or other members of the Committee may 
have.
                                endnotes
    1. Many of these elements are explored in greater detail in a 
report that GAO is releasing today. GAO, Comptroller General's Forum: 
The Future of the Defined Benefit System and the Pension Benefit 
Guaranty Corporation, GAO-05-578SP (Washington, D.C.: June 9, 2005).
    2. GAO, Long-Term Fiscal Issues: The Need for Social Security 
Reform, GAO-05-318T (Washington, D.C.: Feb. 9, 2005).
    3. GAO, 21st Century Challenges: Reexamining the Base of the 
Federal Government, GAO-05-325SP (Washington, D.C.: Feb. 2005).
    4. One impetus for the passage of ERISA was the failure of 
Studebaker's defined benefit pension plan in the 1960s, in which 
thousands of plan participants lost most or all of their pensions.
    5. Some defined benefit plans are not covered by PBGC insurance; 
for example, plans sponsored by professional service employers, such as 
physicians and lawyers, with 25 or fewer employees.
    6. GAO, Private Pensions: Recent Experiences of Large Defined 
Benefit Plans Illustrate Weaknesses in Funding Rules, GAO-05-294 
(Washington, D.C.: May 31, 2005).
    7. GAO, Pension Benefit Guaranty Corporation Single-Employer 
Insurance Program: Long-Term Vulnerabilities Warrant ``High Risk'' 
Designation, GAO-03-1050SP (Washington, DC: July 23, 2003).
    8. For additional discussion of these broader fiscal challenges, 
see GAO, Our Nation's Fiscal Outlook: The Federal Government's Long-
Term Budget Imbalance, at http://www.gao.gov/special.pubs/longterm/
longterm.html.
    9. PBGC is authorized to borrow up to $100 million from the U.S. 
Treasury to cover temporary cash shortfalls.
    10. PBGC also guarantees a smaller pension benefit for 
approximately 10 million participants in multiemployer pension plans.
    11. According to PBGC officials, PBGC files a claim for all 
unfunded benefits in bankruptcy proceedings. However, PBGC generally 
recovers only a small portion of the total unfunded benefit amount in 
bankruptcy proceedings, and the recovered amount is split between PBGC 
(for unfunded guaranteed benefits) and participants (for unfunded 
nonguaranteed benefits).
    12. The additional premium equals $9.00 for each $1,000 (or 
fraction thereof) of unfunded vested benefits. A plan's sponsor may be 
exempt from paying the variable rate premium if the plan met a 
specified funding threshold in the previous plan year.
    13. Present value calculations reflect the time value of money--
that a dollar in the future is worth less than a dollar today, because 
the dollar today can be invested and earn interest. Using a higher 
interest rate will lower the present value of a stream of payments 
because it implies that a lower level of assets today will be able to 
fund those future payments.
    14. A plan's current liability may differ from its termination 
liability, which measures the value of accrued benefits using 
assumptions appropriate for a terminating plan. For further discussion 
of current versus termination liability, see appendix IV of GAO, 
Pension Benefit Guaranty Corporation: Single-Employer Pension Insurance 
Program Faces Significant Long-Term Risks, GAO-04-90, (Washington, 
D.C.: Oct. 29, 2003).
    15. The AFC was introduced by the Omnibus Budget Reconciliation Act 
of 1987. See Pub. L. No. 100-203 (1987).
    16. Broad equity indexes in the U.S. have risen since 2002 but 
remain significantly below their peak levels of 2000.
    17. ERISA Industry Committee, Consensus Proposals for Pension 
Funding, PBGC Reform, and Hybrid Pension Plans, (Washington, D.C.: May 
2005). Asset totals in 2002 and 2004 include billions of dollars in 
contributions by plan sponsors since 1999.
    18. Falling interest rates raise the price of group annuities that 
a terminating plan must purchase to cover its promised benefits and 
increase the likelihood that a terminating plan will not have 
sufficient assets to make such a purchase. A potentially offsetting 
effect of falling interest rates is the possible increased return on 
fixed-income assets that plans hold. When interest rates fall, the 
value of existing fixed-income securities with time left to maturity 
rises.
    19. Three of the last five annual increases in bankruptcies 
coincided with recessions, and the record economic expansion of the 
1990s is associated with a substantial decline in bankruptcies. Annual 
plan terminations resulting in losses to the single-employer program 
rose from 83 in 1989 to 175 in 1991, and after declining to 65 in 2000, 
the number reached 93 in 2001. The last three recessions on record in 
the United States occurred during 1981, 1990-91, and 2001 (See 
www.bea.gov/bea/dn/gdpchg.xls).
    20. The causes of restructuring are likely industry-specific. For 
example, the U.S. airline industry, which has many pension plans in 
poor financial condition, has faced profit pressures as a result of 
severe price competition, terrorism, the war in Iraq, and the outbreak 
of severe acute respiratory syndrome (SARS), creating bankruptcies and 
uncertainty about the future financial health of the industry.
    21. A major factor contributing to the increase in lump-sum 
distributions from defined benefit plans is the growing prevalence of 
hybrid plans, such as cash balance plans, which typically offer lump 
sums. Hybrid plans are a form of DB plan that determines benefits on 
the basis of hypothetical individual accounts.
    22. GAO-05-294.
    23. Boyce, Steven, and Richard A. Ippolitio, ``The Cost of Pension 
Insurance,'' The Journal of Risk and Insurance, (2002) Vol. 69, No. 2, 
pp.121-170.
    24. For further details of this study, covering 1995-2002, see GAO-
05-294. These 100 plans are not a closed group. The 100 largest plans, 
as measured by current liability, changed from year to year for various 
reasons, including mergers and divestitures of plan sponsors. A total 
of 187 distinct plan identifiers were included in our sample, and 25 of 
them were in each year's sample.
    25. Conversely, when interest rates rise, the opposite would be 
true, and the weighted average would make the cost of settling plan 
liabilities higher than the current market rate would indicate.
    26. Several factors may explain the wide discrepancy between 
reported funding levels and actual funding levels at termination. 
Reported funding levels may use an actuarial value of assets, which may 
exceed the market value at termination. In addition, termination 
liabilities are valued using a different interest rate than that used 
for current liabilities. Further, current liabilities and termination 
liabilities may be measured at different times. Unfunded shutdown 
benefits may also raise termination liabilities. For more discussion of 
the differences between termination and current liabilities, see GAO-
04-90, appendix IV.
    27. See 26 U.S.C. 412(b).
    28. A plan is not subject to an AFC if the value of plan assets (1) 
is at least 80 percent of current liability and (2) was at least 90 
percent of current liability for at least 2 consecutive of the 3 
immediately preceding years.
    29. For further information about problems with the content and 
timeliness of regulatory reports on pensions, see GAO, Private 
Pensions: Government Actions Could Improve the Timeliness and Content 
of Form 5500 Pension Information, GAO-05-491 (Washington, D.C.: June 3, 
2005), and Private Pensions: Publicly Available Reports Provide Useful 
but Limited Information on Plans' Financial Condition, GAO-04-395 
(Washington, D.C.: Mar. 31, 2004).
    30. GAO, Budget Issues: Budgeting for Federal Insurance Programs, 
GAO/T-AIMD-98-147 (Washington, D.C.: Apr. 23, 1998), and Budget Issues: 
Budgeting for Federal Insurance Programs, GAO/AIMD-97-16 (Washington, 
D.C.: Sept. 30, 1997).
    31. PBGC's premium collections and benefit payments are recorded in 
the budget on a cash basis, regardless of when the commitments are 
made. The premiums paid by participants are held in a revolving fund. 
PBGC's budget treatment is complicated by the use of a second account 
for some activities which is not included in the Federal budget. This 
account records the assets and liabilities that PBGC acquires from 
terminated plans. As a result, the budget only reports PBGC's net 
annual cash flows between its on-budget account and all other entities, 
including the other PBGC account. It does not provide information on 
liabilities PBGC incurs when it takes over an underfunded plan or other 
changes in PBGC's assets and liabilities.
    32. GAO-05-578SP.
    33. For example, earlier this year, the Administration released a 
proposal that focuses on reforming the funding rules; improving 
disclosure to workers, investors, and regulators about pension plan 
status; and adjusting premiums to better reflect a plan's risk to PBGC. 
See U.S. Department of Labor, Employee Benefits Security 
Administration, Strengthen Funding for Single Employer Pension Plans, 
February 7, 2005.
    34. For greater detail, see GAO-04-90.
    35. GAO, Comptroller General's Forum: The Future of the Defined 
Benefit System and the Pension Benefit Guaranty Corporation, GAO-05-
578SP (Washington, DC: June 2005). Participants included government 
officials, researchers, accounting experts, actuaries, plan sponsor and 
employee group representatives, and members of the investment 
community.
    36. Cash balance plans are a type of defined benefit plan that look 
more like a defined contribution plan to participants. As with other 
defined benefit plans, the sponsor is responsible for managing the 
plan's commingled assets and complying with the minimum funding 
requirements. However, information about benefits is communicated to 
plan participants through the use of hypothetical account balances, 
which makes the plan appear like an individual account-based defined 
contribution plan. The hypothetical account balances communicated to 
plan participants do not necessarily bear any relationship to actual 
assets held by the plan.

    Chairman Nussle. I thank the witness.
    Next we will hear from the distinguished Director of the 
Congressional Budget Office.
    Welcome back. Your entire testimony will be made part of 
the record, and you may proceed.

   STATEMENT OF DOUGLAS HOLTZ-EAKIN, DIRECTOR, CONGRESSIONAL 
                         BUDGET OFFICE

    Mr. Holtz-Eakin. Thank you, Mr. Chairman, Mr. Spratt and 
members of the committee.
    The CBO is indeed pleased to be here and have a chance to 
testify once more. The PBGC issue is an important and timely 
one, and there is an enormous range of issues which we might 
explore, perhaps in the question-and-answer.
    I am going to restrict these remarks to the work that is 
ongoing at the CBO at the request of the committee, which is 
focused on budgeting for loans, guarantees and insurance in the 
Federal budget.
    I will make three main points. The first will be to provide 
a sense of the scale of the economic commitment represented by 
insurance for defined benefit pension plans.
    The second will be to raise the question of just how much 
of this commitment will be picked up by the U.S. taxpayer.
    And the third will be to explore effective ways to inform 
the Congress and other stakeholders of the budgetary resources 
that might be involved in these commitments.
    Now I want to echo the comments of Mr. Spratt and emphasize 
at the outset that this is a work in progress. As we continue 
our work, and refine our approach, the numbers will change.
    Nevertheless, we believe that our work is sufficiently 
mature that one can get a sense of the magnitudes involved. We 
are here today to talk about that.
    The numbers that you will see and hear today have in front 
of them labels like economic costs. These are different, and 
deliberately different, from traditional budget estimates.
    Indeed, our goal is to step back and look at cost in a 
different and broader context. In fact, we try to estimate the 
market value of the financial resources that are being 
transferred to or within the pension system.
    So with those opening warning labels, let's take a look at 
the three questions.
    Question No. 1: How big is the insurance problem 
represented by the PBGC? And here the technique is to try to 
estimate market values. Figuratively, we are trying to answer 
the question, how big a check would you need to write to the 
financial markets to purchase the insurance policy of the PBGC?
    I will skip the financial rocket science buried in the 
computations and simply point out that we are going through the 
steps a financial analyst would go through in deciding how 
large an insurance premium to demand.
    Step one is to estimate the probability of a sponsor's 
bankruptcy. Our estimates are based on the initial assets and 
liabilities of those firms that sponsor defined benefit plans. 
Using projected evolutions in the value of those assets and 
liabilities, we calculate the probabilities of bankruptcy, 
given economic conditions in the future.
    Step two is to estimate the distribution of underfunding 
which will be present in any plan, given that bankruptcy did 
occur.
    To do that, we need to take into account both the current 
funding rules and any potential changes that the Congress might 
wish to consider, so as to be able to project the contributions 
that would have been made by these firms before they arrive at 
bankruptcy.
    Step three is to do the valuation of that particular 
underfunding. When a plan goes into bankruptcy and it is handed 
over to the PBGC, economic conditions are likely to be bad. And 
markets demand greater compensation for agreeing to give up 
valuable cash in bad times than they do in good times.
    The experience of recent years is illustrative. Bad times 
are characterized by broad economic dips which place pressures 
on cash flows for firms. Revenues tend to be weak and equity 
market performance is typically less than stellar, which in 
this case would reduce the value of assets in pension plans.
    Poor economic times are also typically characterized by low 
interest rates, which raise the valuation of the liabilities of 
pension plans.
    So in the circumstances where markets are most unwilling to 
hand over valuable cash are exactly those same circumstances in 
which pension plans would likely end up at the PBGC. Markets 
will price that risk and they will charge a premium in order to 
come up with money in those circumstances.
    Given those three broad pieces of the analysis, we can 
gauge the costs facing the PBGC from an economic point of view. 
The first slide gives you a notion of two kinds of costs.
    The first is what we refer to as sunk costs. These are the 
costs of those plans which are in actuality or in effect 
already at the PBGC. This is the $23 billion number of the 
liabilities of the PBGC in excess of assets that they have 
collected already. And those cannot be avoided by prospective 
policy changes.
    Mr. Spratt. And that is for the duration of the plans that 
the government has taken over, then. There is no time limit to 
that, except that eventually all the employees who have an 
inexorable benefit get their adjusted benefit payment, and that 
is it.
    Mr. Holtz-Eakin. That is right. And that is that bottom 
number.
    But the remaining numbers are forward-looking costs over 
different horizons: 10, 15, or 20 years. Those are the likely 
value of insurance to defined benefit plans over the next 
decade or two decades.
    So the first number indicates that markets would require a 
$48 billion check to cover claims in the next 10 years at the 
PBGC. Clearly, as one allows time to go forward, the 
probability of more plans arriving at the PBGC----
    Mr. Spratt. And this is the present value of expected 
terminations over a 10-year period of time. Going out for 10 
years.
    Mr. Holtz-Eakin. This is the check now----
    Mr. Spratt. Present value.
    Mr. Holtz-Eakin. The check now, present value, to cover 
terminations over the next 10 years, in market terms. Or 15 or 
20.
    It gives you a sense of the scale of the financial 
resources that will be necessary at the PBGC in order to cover 
the future obligations of the defined benefit pension system.
    Now those estimates assume the continuation of current 
funding policies and premiums.
    One could imagine changing policy and looking at the 
effects on cost.
    The next slide shows 10-year effects of some illustrative 
policies.
    Raising the flat-rate premium, currently $19, to $30 would 
lower prospective net costs over the next 10 years in present 
value from $48 billion to $45 billion, a saving of $3 billion 
at the PBGC.
    You could also change the risk of portfolios held by 
pension plans.
    Currently portfolios are about 70 percent invested in 
equities. Limiting them to a maximum of 30 percent equities 
would make the assets of the pension plan safer in financial 
terms. This change produces larger savings, $7 billion over the 
10-year horizon, bringing the prospective costs to $41 billion.
    Or going in the other direction, one could make permanent 
the temporary discount rate increase that have been in place 
for the past 2 years, as a result of using corporate rates to 
replace the rate on 30-year Treasury bonds. If that change were 
made permanent, it would raise the prospective costs of 
insurance by $5 billion, to a total of $53 billion.
    Although estimates are not yet available, I would note that 
some other policy changes have potentially larger effects than 
changing premiums and discount rates. Those changes involve 
funding rules or definitions of liabilities.
    In the former category are policies like the 
administration's proposal to distinguish for funding purposes 
between the investment-grade firms and those firms that have 
fallen below investment grade. Those kinds of funding changes 
could have a dramatic impact.
    Changing funding requirements through changes in the 
definition of liabilities could also reduce PBGC costs. The 
examples of Bethlehem and LTV that Mr. Walker pointed to are 
situations in which shut-down benefits, lump-sum cashouts, all 
the things that go on close to termination, raised liabilities 
dramatically. Bringing those factors more fully into the 
funding requirements would in fact be a beneficial step.
    Next slide.
    The second important question is just what is the 
taxpayers' exposure to this potential liability? Under current 
law, it is in principle zero. The law requires that the PBGC be 
self-financing. The taxpayer has no legal liability to pick up 
any residual claims on the PBGC.
    Nonetheless, when its assets are exhausted the PBGC will 
find itself in uncharted territory.
    Mr. Spratt. If I could interrupt, I think what you are 
assuming there is that our liability is to the extent of the 
trust fund and no further, are you not?
    Mr. Holtz-Eakin. That is right. It would be confined to the 
assets that the PBGC has taken from failed plans, plus any 
premiums that they have built up.
    There is no statutory provision that would allow PBGC to 
automatically go to the general fund of the Treasury or to the 
taxpayers as a whole. That would require congressional action.
    Mr. Spratt. If the PBGC in fact guarantees the scheduled 
percentage of pension benefit payable, then we have a 
substantial cost beyond the liability of the trust fund, the 
resources of the trust fund.
    Mr. Holtz-Eakin. Absolutely. And the question then is how 
would that cost be picked up? Would it be borne by the workers 
in the form of dramatically reduced pension benefits? Or, would 
pressures rise to the point where the Congress would consider 
devoting more resources, going to the taxpayer and funding the 
PBGC?
    There are clearly pressures of that sort.
    In some industries, notably airlines at present, proposals 
have been made to stretch out payments to the pension plans. In 
fact, this would raise PBGC's cost. And if Congress goes that 
route, it would be hard to imagine turning around and not 
actually honoring that kind of a commitment to the worker.
    Mr. Walker. With your indulgence, Doug, if I can, having 
been head of the agency, the PBGC is not backed by the full 
faith and credit of the U.S. Government. The PBGC has the 
ability to borrow up to $100 million from the U.S. Government. 
That is all they have.
    But from a practical standpoint, if the PBGC becomes 
insolvent--and I think it is only a matter of when, not a 
matter of if, unless there is dramatic and fundamental reform, 
then there would be tremendous political pressure put on you to 
be able to step in.
    The numbers that CBO has come up with, which I think are 
excellent, show you the potential exposure to the budget and to 
the taxpayers if the Government came in to bail out the PBGC. 
Legally the Government is not required to do so, but 
practically you would so under tremendous pressure to do so.
    Mr. Holtz-Eakin. And that would lead you to what would 
happen under different policy changes. And there, the range is 
enormous. Literally, the sky could be the limit. You could pick 
up the entire economic price tag that we have tried to sketch 
out. Or, you could stick to current law and have zero.
    It is important in thinking through any policy changes to 
recognize both the scale of the commitment that we have tried 
to lay out, but also that there will be feedback from other 
parts of the budget.
    In particular, large increases in premiums which reduce 
measured profitability will have revenue effects. And the 
committee would be served well to think comprehensively about 
the impact of those proposals. And we would be happy to help 
you with that.
    One of the issues that would arise there as well would be 
the degree to which it should be an explicit policy to 
subsidize insurance to defined benefit pension plans.
    Is it a policy goal to provide resources to the defined 
benefit system as a whole? Or should it be the case that the 
insurance should not cost the taxpayer anything? If the latter, 
then should it be priced and regulated in a way that the firms 
come up with the full cost?
    And then finally, let me close and turn to the question of 
what is the best way to present this information to the 
Congress and to this committee?
    The next slide shows two vehicles for presenting the 
information. One is the standard budget documents including the 
appendices. And the second would be the financial statements of 
the U.S. Government.
    Under current law, as has been noted, all that is shown in 
the budget are the cash flows of one part of the PBGC, the on-
budget fund, which is an incomplete financial picture of the 
agency as a whole.
    The financial statements for PBGC include a report of 
probable claims and a contingent liability for claims that are 
reasonably possible, which is disclosed in a footnote.
    So the current reporting is far short of the kinds of 
numbers that might be available if one were to adopt the 
structure we have outlined.
    On the budget, you could stick with the current setup. Or 
one could move toward the direction that the chairman proposed 
several years ago and actually accrue the costs, including 
perhaps the market risks of providing insurance in bad times.
    Or you could pick a middle ground, which would be to 
reflect in the budget the de facto subsidy on an annual basis 
to the premiums that firms are paying for this valuable 
insurance against the risks of default on employee 
compensation.
    So there are a variety of stylized budget options that one 
could go to there, and we could work out more.
    And finally, in the financial statements, it would be 
straightforward to reflect the full market value of this 
insurance, the economic costs de facto being borne by the 
system as a whole. And that would improve the nature of the 
reporting as well.
    So I am pleased to have a chance to present this 
preliminary look at our work. It is work that we have done 
under the leadership of the committee. We are quite pleased 
with the status of things and look forward to working further 
with you to bring it to fruition.
    [The prepared statement of Douglas Holtz-Eakin follows:]

  Prepared Statement of Douglas Holtz-Eakin, Director, Congressional 
                             Budget Office

    Chairman Nussle, Mr. Spratt, and Members of the Committee, I am 
pleased to discuss the ongoing work that the Congressional Budget 
Office (CBO) is doing at the request of this Committee on budgeting for 
loans, guarantees, and insurance. Today, I will focus on the economic 
costs, Federal costs, and budgetary treatment of the Pension Benefit 
Guaranty Corporation's (PBGC's) insurance of defined benefit pension 
plans.
    At the outset of my statement, however, I would emphasize two 
important caveats. First, CBO's efforts to estimate the costs of PBGC 
and to identify alternative, potentially more effective budgetary 
treatments constitute a work in progress. With further refinements, 
CBO's estimates and findings are likely to change somewhat. Second, the 
estimates that I will be reporting today are market measures of the 
value of financial resources being transferred to or within the 
defined-benefit pension system under current law. They are not budget 
cost estimates, nor do the estimates of the effects of changes in 
policy represent the budget scoring for legislation that would effect 
those changes.
    As economic--rather than budget cost--measures, the estimates 
provide an opportunity to think broadly about Federal policy toward 
defined-benefit pension plans. Under current policy, the full cost of 
those pensions is not being shouldered by the plans' sponsors. Rather, 
because the current rules permit plans to be underfunded and because 
pension insurance is underpriced for many plans, some of the costs are 
being borne by the plans' beneficiaries and, potentially, by taxpayers. 
From a budgetary perspective, the key question is, how much should 
taxpayers be required to contribute to the defined-benefit pension 
system?
    Under current law, PBGC is liable for insured benefits only to the 
extent that it has resources from insurance premiums, investment 
income, the assets of terminated plans, and recoveries from sponsors. 
However, because PBGC is a Federal insurance agency, there is a 
widespread belief that its obligations have at least an implied Federal 
guarantee that commits the government to use general revenues to honor 
insured claims.
    In pursuing the objective of reducing or eliminating Federal costs, 
policymakers have several general types of approaches available. One 
group consists largely of regulatory instruments, including raising 
premiums and adjusting them for risk, tightening the pension funding 
rules, improving the measurement and reporting of pension liabilities, 
and attempting to increase the discipline of private sponsors' funding 
decisions. Higher premiums--in particular, ones linked to PBGC's risk 
exposure--would offset losses on future claims. More accurate 
measurement of plans' liabilities would make the existing funding rules 
and premium schedule more effective.
    If beneficiaries understood that they were at risk from plans' 
underfunding, they would have incentives to press for higher funding or 
perhaps another form of compensation. Accordingly, increased 
requirements for plans to publicly and frequently disclose sufficient 
information about their financial condition could be useful in reducing 
Federal costs. Alternatively, privatizing PBGC so that losses were 
absorbed by its shareholders or by private reinsurers would also bring 
the force of market discipline to the task of controlling PBGC's 
losses.
    Policymakers could also use budget instruments to help move toward 
eliminating Federal costs for PBGC. Increasing the transparency of 
PBGC's own financial condition and performance could be as useful as 
doing so for the pension plans. For instance, the agency's budget 
accounts could be reconfigured to recognize the accruing cost to the 
government from pension insurance.
    The Congress may also decide that, for various reasons, subsidizing 
the defined-benefit pension system is desirable. In that case, 
policymakers may be willing to accept some level of expected funding 
through general revenues. The same policy instruments could be used to 
limit taxpayers' exposure as would be used to eliminate it.
    The economic costs of PBGC insurance to taxpayers (if the implicit 
guarantee is honored) are substantial. In thinking about reducing those 
costs, however, it is critical to distinguish between costs already 
incurred and prospective costs. PBGC had accumulated losses of $23.3 
billion at fiscal year-end 2004 for single-employer plans that had been 
terminated or whose termination the agency regarded as probable. 
``Sunk'' costs for plans that have been terminated (in actuality or in 
effect) cannot be avoided, and policy decisions can determine only who 
will bear those costs. However, policy changes can reduce prospective 
costs.
    CBO estimates that the economic costs to the public of PBGC 
insurance for single-employer plans net of premium collections over the 
next 10 years is $48 billion. That figure describes the estimated net 
present value of the financial resources that the program will be 
transferring to sponsors of and participants in defined-benefit 
pensions. It is also the price that the government would have to pay to 
private insurers bidding in competitive markets to take on the 
obligations that PBGC will assume in that period with current premiums 
and funding rules. Adding sunk costs and prospective costs together 
results in a total of $71 billion for the upcoming decade, $83 billion 
for 15 years, and $91 billion for 20 years.
    In terms of the particular instruments that could be used, CBO's 
calculations suggest the following:
     Premium collections would have to rise fivefold in order 
to cut net Federal costs to zero through increases in premiums alone. 
For well-funded plans, which do not pay a premium for underfunding, the 
increase would be relatively modest, but for severely underfunded 
plans, which do pay an underfunding premium ($9 per $1,000 of 
underfunding per year), the increase could constitute a large increase 
in costs.
     Some proposals that the Administration has made, if 
enacted, could measurably reduce the economic costs of the system. For 
example, increasing premiums from $19 to $30 per participant would 
reduce 10-year net economic costs by $3 billion, while the proposed 
tighter rules for calculating pension liabilities and the proposed 
requirements for increased funding by financially distressed sponsors 
could reduce prospective economic costs significantly.
     Other policy changes such as reducing the maximum share of 
a pension plan's assets that could be invested in equities (stocks) to 
30 percent from the current unregulated level of about 70 percent would 
reduce costs by $7 billion over 10 years.
     Some changes currently being considered could increase 
prospective costs. For example, making permanent a legislated increase 
in the discount rate used to calculate the present value of pension 
liabilities would increase PBGC's net costs by $5.3 billion. Increasing 
the average time permitted for closing a plan's funding gap by 2 years 
would raise net costs by $6 billion.
     Changing the budgetary treatment of PBGC or changing its 
ownership by paying a private entity to take it over would not directly 
affect net costs but could increase the visibility of those costs and 
contribute to improved monitoring by the Congress.

                      Estimating the Costs of PBGC

    The recent takeover of several airlines' pension plans by the 
Pension Benefit Guaranty Corporation has focused attention on and 
raised concerns about this program's costs to the government, 
taxpayers, the plans' sponsors, and the plans' participants. However, 
the budgetary and financial information currently available about PBGC 
is not very informative about the likely costs of the takeovers or the 
incidence of those costs.
    One reason for the absence of such information is that Federal 
pension insurance gives a large number of beneficiaries valuable but 
highly uncertain claims to future payments. A natural approach to 
determining the costs of such claims is to find market prices for 
equivalent uncertain commitments. Although no exact match is currently 
available in private markets, finance specialists have developed 
techniques for using the prices of securities that are bought and sold 
to price contracts that are not traded. In the case of PBGC, the value 
of defined-benefit pension insurance is equivalent to a type of put 
option. Specifically, the option held by a pension plan's beneficiaries 
is to sell, or put, the assets of the plan to PBGC at a price equal to 
the value of the insured liabilities, contingent on the financial 
distress of the sponsor.
    CBO has used those techniques along with publicly available 
information to project the three key determinants of PBGC's costs: the 
probability of a sponsor's bankruptcy, which is necessary before the 
put can be exercised; the probability distribution of the plan's 
underfunding (the plan's liabilities minus its assets) at termination, 
which is the value of the put option when it is exercised (or when the 
plan is transferred to PBGC); and market risk (the correlation of 
PBGC's claims with bad economic conditions), which affects the discount 
rate used to calculate the present value of the option.
    The resulting estimated costs are the market value of the financial 
resources transferred to the defined-benefit pension system by PBGC. 
The estimates are based on information contained in Securities and 
Exchange Commission filings by publicly traded sponsors of defined-
benefit pension plans. (Data on privately held companies and 
confidential filings that sponsors of publicly traded companies with 
significantly underfunded plans submit to PBGC are not available to 
CBO.) In the data available to CBO, plans' total liabilities amount to 
about 88 percent of those reported by PBGC. Therefore, CBO has scaled 
its estimates of PBGC's costs by a factor of 1.14 to adjust them to the 
size of the defined-benefit pension system.
    The estimates are subject to considerable uncertainty for many 
reasons. CBO's estimates rely on firms' reports that are based on 
generally accepted accounting principles of pension assets and 
liabilities, whereas PBGC's figures rely on firms' reports for the 
Internal Revenue Service and under the Employee Retirement Income 
Security Act, which indicate a higher initial level of underfunding. 
Also, CBO's estimates are based on assumptions that simplify the 
complexities of the defined-benefit pension system. For example, all 
plans are assumed to fund pensions with the same mix of assets and to 
exhibit the same jump in liabilities at termination.
    Using those assumptions, CBO estimates that under current policy, 
the market price of PBGC insurance going forward for existing plans for 
10 years is $48 billion (net of premiums and assets of terminated plans 
and recoveries). That figure conveys the present value of the 
commitment to take on PBGC's net obligations for existing single-
employer plans for the next 10 years. With the $23.3 billion in 
accumulated losses reported by PBGC at year-end 2004, the combined 
total of historical and prospective 10-year costs is about $71 billion.
    The $23.3 billion in accumulated losses are sunk costs that cannot 
be avoided by policy changes now and that will be difficult to recover 
from surviving sponsors. As a consequence, policymakers have greater 
latitude in focusing on the second component of costs: claims that are 
prospective under current policy and, therefore, may be avoided.

              Measures to Reduce the Federal Costs of PBGC

    Two general regulatory approaches may be useful in reducing the 
future net costs of PBGC insurance. The first is to raise insurance 
premiums and adjust them for risk. The second is to reduce the level of 
risk in the defined-benefit pension system.
                            raising premiums
    Raising premiums would require sponsors to pay a larger share of 
costs. To cut Federal costs to zero through higher premiums alone would 
require a fivefold increase in PBGC's receipts from premiums. Those 
higher premiums might be manageable for well-funded plans, which 
currently pay only a flat charge of $19 per year per participant for 
insurance. However, for firms with plans that are significantly 
underfunded, their current annual premiums also include a charge of $9 
per $1,000 of underfunding. A hypothetical firm with 1,000 participants 
and $50 million in underfunding would pay premiums of $469,000 per 
year, of which $450,000 is the charge for underfunding. Therefore, for 
some firms, the increase in premiums could be significant--perhaps to 
the point of causing them to adjust the form and level of compensation 
that they offer.
                     reducing or charging for risk
    An alternative to a proportionate increase in premiums for all 
sponsors would be to make premiums more sensitive to the risk that 
various plans pose for PBGC. Although the extra charge for underfunding 
currently provides some adjustment based on risk, increasing the 
variation in premiums on the basis of risk could reduce the current 
cross-subsidies from low-risk sponsors and plans to high-risk ones. 
Some risk-adjusted premiums could also strengthen incentives for 
sponsors to reduce risk--which could lower the premium rate required to 
achieve any given level of net costs.
    With this approach, premiums would be higher for sponsors that were 
more likely to encounter financial distress and whose plans would tend 
to be more deeply underfunded at termination. For example, premiums 
could vary with the volatility of the market value of a firm and its 
pension assets, the ratio of the firm's liabilities to its equity 
(leverage), and the firm's credit rating. The resulting range of 
premiums could be substantially wider than it is under current policy 
because risk varies significantly among plans. If, for example, 
premiums were set so that PBGC's expected net cost for insuring an 
investment-grade company (which is within the top four broad ratings 
categories) was the same as that for a lower-rated company, they would 
need to be about 20 times higher per dollar of liability for the lower-
rated company.
    Another important correlate of plans' risk that could provide a 
basis for adjusting premiums is the ratio of a pension plan's assets in 
equities to its total assets. Sponsors appear to prefer a high 
proportion of equities because they expect higher average returns on 
stocks than on bonds. If realized, that risk premium would reduce the 
cash contributions a sponsor must make to its plan in order to fund the 
promised pension benefits. Of course, such investments entail the risk 
that the stock market will do poorly and the plan will become 
underfunded.
    Plans with a high proportion of common stocks, rather than high-
quality bonds or other fixed-income securities, exhibit more volatility 
in the value of their assets than do plans holding more debt 
securities. Plans with a high share of stocks are thus at greater risk 
of underfunding when the sponsors encounter financial distress. That 
increase in risk to PBGC means that fair (full-cost) premiums would be 
about 16 percent lower for plans with an equity share of 30 percent 
rather than the average of almost 70 percent currently found in 
defined-benefit pension plans. Such an adjustment in premiums could 
create incentives for firms' investment decisions that could lower 
costs and improve the match between the risk posed and the premiums 
paid. An alternative to relying on the incentive effects of risk-based 
premiums to reduce risk would be to limit, through law or regulation, 
the share of assets that plans could invest in stocks.
    The current structure of premiums tends to disconnect them from 
risk because PBGC's costs vary more closely with plans' liabilities 
rather than their number of participants. The per-participant charge 
also tends to lower the premium per dollar of insured liabilities for 
firms with a high proportion of older or high-wage employees compared 
with firms whose workforce is predominantly younger or lower paid and 
therefore has few accumulated pension benefits. At the current rate of 
$19 per participant, those effects may be small, but if rates were 
raised to be fair on average, the effects on firms' behavior could be 
significant.
    A major source of risk to PBGC is the potentially large gap between 
the level of pension liabilities reported under the current definitions 
and funding rules and the economic value of those liabilities at plans' 
termination. PBGC often reports that plans that appeared to be well-
funded prior to termination turn out to be deeply underfunded when they 
are transferred to the agency. For example, Bethlehem Steel's plan was 
84 percent funded on the basis of current reporting requirements but 
was only 45 percent funded at termination.\1\ Underfunding can increase 
as a sponsor approaches bankruptcy for several reasons, including the 
discretion that the law allows in calculating the present value of a 
plan's liabilities and in valuing assets at their purchase price rather 
than current market value. (Those same funding rules also permit many 
plans that are effectively underfunded to avoid paying the variable-
rate premium of $9 per $1,000 of underfunding.) Changing the definition 
and measurement of liabilities and tightening the funding rules, 
especially for sponsors with a greater chance of financial distress, 
could lessen the risk to PBGC and to the defined-benefit pension 
system.
---------------------------------------------------------------------------
    \1\ Statement of Bradley D. Belt, Executive Director, Pension 
Benefit Guaranty Corporation, before the Senate Committee on Finance, 
March 1, 2005.
---------------------------------------------------------------------------

               Increasing the Visibility of PBGC's Costs

    The policy changes needed to reduce the costs of pension insurance 
might be facilitated by increasing the visibility of PBGC's costs 
through changes in the budgetary treatment of pension insurance or 
other means. The present budgetary treatment focuses on the cash 
inflows to PBGC's on-budget account, primarily from premiums, interest 
income, and transfers from an off-budget trust fund, which holds the 
assets of plans taken over by PBGC. The inflows are netted against 
Federal outlays for pension benefits in plans run by PBGC's trustees 
and for administrative expenses. That treatment delays the recognition 
of insurance claims, often for decades, from when they are realized at 
a plan's termination to when benefits are paid. As a consequence, and 
despite large losses, PBGC's budgetary position has contributed to 
reducing the Federal deficit in every year except for fiscal year 2003, 
when the on-budget account recorded net outlays of $229 million. For 
fiscal year 2004, net budget outlays for PBGC were once again negative, 
representing a net cash inflow of $247 million. Such budgetary 
treatment is not designed to indicate or suited to describing the 
expected risk and magnitude of losses in the pension insurance system.
    The financial statements issued by PBGC include losses on plans 
that have been terminated and those whose takeover the agency can 
foresee. In addition, PBGC publishes financial projections based on its 
Pension Insurance Modeling System, which indicate that the midpoint of 
the agency's distribution of accumulated deficits in 10 years is about 
$30 billion. Although both of those indicators of PBGC's financial 
status provide useful information to policymakers and are good starting 
points for further analysis, the first focuses primarily on losses that 
have occurred, including losses on probable terminations (the $23.3 
billion cited earlier); and the latter excludes the cost of market 
risk.
    Information on the present market value of future transfers to the 
defined-benefit pension system net of future premiums might be provided 
to the Congress through a supplementary reporting system or through 
changes in budget presentation. The first approach would offer the 
advantage of avoiding the need for changes to the budget, which are 
difficult to make piecemeal; the second, the advantage of citing budget 
numbers, which are more frequently used for policy decisions than 
supplementary information is.
    Budgetary treatments of pension insurance that would better 
indicate full costs should be the following:
     Timely. According to a recommendation of the President's 
Commission on Budget Concepts, the budget should reflect outlays when 
the government incurs the obligation to pay.\2\ In the case of PBGC, 
that point suggests that costs should include losses on pension plans 
when they are terminated.
---------------------------------------------------------------------------
    \2\ President's Commission on Budget Concepts, Report of the 
President's Commission on Budget Concepts (October 1967), p. 36.
---------------------------------------------------------------------------
     Based on Market Value. In general, the budget uses market 
prices to measure the value of inputs consumed by various Federal 
programs. For consistency, market prices should be used in estimating 
insurance costs. For PBGC, the market price of risk is significant 
because the events that precipitate a transfer of pension liabilities 
to PBGC, including low investment returns, high rates of financial 
distress, and low interest rates, occur when the market value of all 
assets is down.
     Prospective. The costs relevant to budgeting are those to 
which the government is committing in the budget period. Although sunk 
costs need to be recorded and paid, it is those costs that are being 
incurred in the budget period that are the focus of decisions. Of 
course, the extent to which the government is committing to pay under 
current law is restricted to the resources available to PBGC from 
premiums, assets of terminated plans, and recoveries from sponsors.
    The current budgetary treatment of PBGC recognizes the inflow of 
premium collections during the budget period but not the value of 
claims arising under the insurance. It thus falls short of having the 
attributes outlined above. CBO is currently exploring budgetary 
alternatives that might attain those qualities. One possibility would 
be to estimate the net prospective economic costs of PBGC over a 
specified period and to treat those values as the budget baseline costs 
of the program. Future year budgets could recognize the changes in the 
value of the insurance due to changes in law, regulation, or variables 
such as insured liabilities or interest rates. In the language of 
credit reform, those changes in costs might be treated either as 
reestimates (the result of unexpected economic changes) or 
modifications (the result of policy changes).
    Another possibility would be to structure the accounts to recognize 
as budget costs the unpaid fair-value premiums for PBGC insurance. That 
is, estimates of the annual premiums required to cut the net budget 
costs of insurance to zero could be compared with the premiums expected 
to be paid by sponsors, and the difference could be shown as the budget 
costs of PBGC.
    A more extreme approach would be to transfer PBGC to private 
owners. That step would probably accelerate the recognition of past 
losses in the budget because the current deficit would have to be 
covered, presumably by Congressional appropriations, before a private 
entity would be willing to assume the program's obligations. In 
addition, a private owner might require either an annual or lump-sum 
payment from the government to continue to operate the insurance 
program under current funding rules and premiums. Because PBGC 
insurance is mandatory for defined-benefit pension plans, the 
government would probably remain involved in regulating the terms of 
the insurance--which raises the question of the amount of risk and 
responsibility the government effectively could transfer to private 
owners. Nevertheless, the risk to the government would most likely be 
less than it is under current policy.

                     The Administration's Proposals

    The Bush Administration has proposed several changes in the 
defined-benefit pension system intended to reduce its financial 
shortfall and increase transparency.\3\ Generally, the Administration 
would raise premiums and permit further risk-adjustment of them; change 
the measure of plans' liabilities and funding requirements; and 
increase public disclosures of plans' funding status. Plans' sponsors 
would also be permitted to fund the liabilities at higher levels during 
good economic conditions (without loss of tax benefits) as a buffer 
against underfunding during bad economic conditions and to use a higher 
discount rate to calculate plans' liabilities. Most of those changes 
are consistent with the objective of reducing the Federal costs of 
pension insurance. More specifically, the major provisions being 
proposed would do the following:
---------------------------------------------------------------------------
    \3\ Details are available at www.dol.gov/ebsa/pdf/sepproposal2.pdf.
---------------------------------------------------------------------------
     Raise the fixed premium per participant from $19 to $30 
per year and index the premium to future wage growth. CBO estimates 
that this change would reduce the prospective 10-year economic costs of 
PBGC insurance by $3 billion.\4\
---------------------------------------------------------------------------
    \4\ This estimate does not reflect the budget saving that would be 
credited to this provision.
---------------------------------------------------------------------------
     Authorize PBGC's directors (the Secretaries of Labor, 
Treasury, and Commerce) to adjust the variable-rate portion of the 
premium so that PBGC's income would cover expected losses. The change 
would require more than a sixfold increase in the premiums paid by 
plans' sponsors.
     Require that plans' liabilities reflect the effects of 
early retirements, lump-sum distributions, and increased longevity. The 
proposal would also require sponsors with credit ratings below 
investment-grade to calculate pension liabilities by assuming that 
employees retire at the earliest opportunity, thereby increasing 
estimated liabilities. Such sponsors would also be required to fund 
completely any increases in the plans' benefits. Although it is 
difficult to estimate the effect of the tighter rules for calculating 
liabilities, they are potentially the largest source of savings among 
the Administration's proposals.
     For the purpose of discounting in calculating pension 
liabilities, funding requirements, and premiums, mandate the use of a 
3-month average of interest rates on corporate bonds whose duration 
matches the scheduled payments to beneficiaries. The proposal would 
make permanent the change from a Treasury rate to a corporate rate for 
discounting pension liabilities. It would permit plans' sponsors to 
avoid making up the additional underfunding that resulted from the 
legislated increase in discount rates for 2004 and 2005. According to 
CBO's estimates, this proposal would increase PBGC's costs by $5 
billion over 10 years.
    The Administration's proposals incorporate many of the policy 
options discussed here to reduce PBGC's risk exposure and to improve 
the transparency of the system. However, they also omit several options 
that are relatively important for reducing risk exposure and cross-
subsidies between sponsors. First, premiums would continue to be 
unrelated to the risk of how pension assets are invested. Second, no 
new limitations would be placed on sponsors' investment policies. 
Third, the proposals retain a fixed charge per worker, rather than 
establishing charges per dollar of coverage, which would perpetuate a 
transfer from plans with younger, lower-paid workers to those with a 
higher proportion of older workers, higher-paid workers, and retirees.
    Chairman Nussle. Thank you to both of our witnesses for 
their testimony.
    Let me begin by welcoming a new member to the committee, 
Chris Chocola, who is here from Indiana. He is filling the slot 
that was vacated as a result of Mr. Portman's appointment as 
U.S. Trade Representative. We welcome you to the committee, 
look forward to your tenure.
    Welcome to the committee. You have a $100 billion liability 
to deal with. That is just today. [Laughter.]
    I look forward to your answer to that. We always give those 
problems to the new members.
    Let me begin by asking, we have a draft report that I 
requested on PBGC, on the liability. And as I have seen--and it 
is not, as I understand it, ready for public announcement, 
because you are going through the final analysis of the report 
before it is realized.
    But could you give the committee an understanding of the 
$23 billion versus $100 billion numbers that are going to be 
compared, that you have talked about a little bit today, but 
just to punctuate that one final time. Is it $23 billion that 
we are looking at as a long-term liability or are we really 
talking about $100 billion, or near $100 billion, as a long-
term liability?
    Mr. Holtz-Eakin. Well, $100 billion is a much more sensible 
estimate than $23 billion. The $23 billion is done, it has 
already happened. Nothing can change that. There will be more 
in the future. And the $100 billion number is a forward-looking 
estimate of what we know about already and the additional 
claims likely to arrive in the future.
    Chairman Nussle. And my understanding is for those who were 
not here during the S&L crisis--and I was not here during it, 
but just coming in at the end of it, my recollection is that it 
was approaching a $100-billion concern or crisis as well.
    So we are talking about a gigantic challenge that as you 
were speculating, while there may not be a legal statutory 
obligation, chances are there will be a political answer and a 
practical answer that needs to be provided.
    We have put in reconciliation for--as far as I am 
concerned, and this is the reason I was so adamant about making 
sure that we had this instruction available to the Education 
and Workforce Committee--available to their jurisdiction, as I 
remember, about $12.6 billion of jurisdiction, so that they can 
begin to address the problem. Our thumbnail budget estimate was 
in the $5 billion range, although that is not a number that is 
obligatory to the committee to follow.
    Given the opportunity to begin to address this today in a 
vehicle such as reconciliation, what would be your 
recommendations of a--and I understand there is no such thing 
as a quick fix, but would be your first things first if we 
could approach this, what would be your recommendations to us 
as a committee and to the Congress of the first things first?
    Given an opportunity of some jurisdiction now and a vehicle 
to accomplish it in reconciliation, what should we consider 
approaching first this year, in the next 3 or 4 months, in 
order to begin to address the problem?
    Mr. Holtz-Eakin. You go first, I will go second.
    Mr. Walker. Mr. Chairman, just a point of clarification. 
Are you talking about this committee and what is within your 
jurisdiction, or are you talking about the Congress as whole?
    Chairman Nussle. Both, but we gave the Education and 
Workforce, we also obviously have jurisdiction in Ways and 
Means that can be used, but let's keep it to the Congress as a 
whole.
    Mr. Walker. First, I think it is absolutely critical not 
just for this area but for other areas within the Federal 
budget that we need to have more transparency over the true 
discounted present-value cost and exposure associated with this 
and other types of Federal programs.
    Secondly, I think it is very important that when Congress 
is thinking about making changes in the law that it consider 
the discounted present-value dollar cost, not just the 10-year 
cash flow numbers, for what the potential implications are, 
positive or negative, with regard to the Federal budget.
    Thirdly, with regard to dealing with the structural 
imbalance, as you saw from the excellent CBO analysis, some of 
the proposals that people are discussing, like increasing base 
premiums, making a few adjustments with regard to the 
guarantees, won't come close to solving the problem.
    You need to have a package of reforms, just like Social 
Security, you need comprehensive pension reform--things like 
enhanced transparency with regard to underfunded plans for both 
plan participants as well as other key stakeholders, including 
the Government; much tougher funding rules for plans that 
really represent exposure yet additional flexibility to make 
tax deductible contributions in good times, especially for 
plans that may not be in trouble today but could be tomorrow; 
additional restrictions on the ability to pay lump sum benefits 
when a plan is underfunded, therefore having a rush on the bank 
potentially; additional PBGC reforms, not just premium reforms, 
both flat and variable rate, which should be more risk-related 
than it is today, but also issues associated with what types of 
benefits are guaranteed, and under what circumstances are they 
guaranteed.
    You may also need to look at the interaction of the 
bankruptcy law and the pension rules, as well as certain other 
provisions.
    One of the things that the Congress is going to need to 
consider is the fact that an overwhelming majority of PBGC's 
losses are concentrated in a relatively few firms in less than 
a handful of industries.
    That is also likely to be the case going forward.
    Historically, it has been steel and airlines.
    Going forward, it is likely to be more steel, airlines, 
autos, and auto-related. Therefore, to a certain extent one of 
the things the Congress is going to have to debate is is the 
PBGC serving as a backdoor industrial policy mechanism? Should 
the PBGC and the premium payers of the PBGC be funding the cost 
of global competition and domestic deregulation in some of 
these industries, and frankly poor management in others?
    There are some very important issues to think about. 
Clearly comprehensive pension reform is absolutely essential, 
just as Social Security reform is essential.
    Last comment, Mr. Chairman. The challenges here are 
strikingly similar to Social Security. The only difference is 
the numbers. Every day that we wait, the bigger the numbers are 
going to get.
    Thank you.
    Mr. Holtz-Eakin. I think that it is important to recognize 
that the kinds of economic costs that are present under current 
law are reflective of the reporting environment, the ability to 
actually understand the net asset position of these plans, the 
regulatory environment, and then also the pricing of that 
insurance, that comes last.
    The reality is that if one moves to a reconciliation target 
in the current budgetary framework, with the cash flow of the 
on-budget fund as the centerpiece, the focus will have to be 
premiums, specifically on raising premiums.
    Our estimate is that it would take an enormous increase in 
premiums as a whole, a five-fold increase, in order to bring 
the net economic costs down to zero. But this is underpriced 
insurance. Raising the premiums would show up in 
reconciliation. It would be a desirable policy from this 
perspective.
    It is also possible to affect the pace at which underfunded 
plans make up the shortfall, do their catch-up contributions, 
or their DRCs. And that would have some cost-saving 
implications as well?
    The rest, over a 5-year horizon, is largely baked in the 
cake. It is servicing the benefit payments that are going out. 
And that is very difficult to affect with policy in the near 
term. It is more desirable to think longer term from that 
perspective.
    The last thing to remember in doing both those is to 
remember there will be feedback to the revenue side of the 
budget. And you won't get everything that you might think if 
you just focus on the outlay side.
    Chairman Nussle. Well, it gives us an opportunity this 
year, as a result of reconciliation. It is a floor, it is not a 
ceiling, meaning that the reconciliation process gives us an 
opportunity to open the door a crack, but we could, in fact, go 
to a much more comprehensive approach, as you are requesting or 
suggesting in your advice to Congress.
    I would hope that the committees of jurisdiction hear your 
concerns today. And I will make sure that I relate them to the 
chairman as well, that we have a challenge here that can be 
addressed in the near term with some policies that similar to 
Social Security are easier now than they will be 5 years from 
now or 10 years from now, if we even get that far before the 
crisis manifest itself.
    So thank you for your testimony.
    Mr. Spratt.
    Mr. Spratt. Thank you both for your testimony. If we could 
go back, first to General Walker, with the last chart you 
showed, which related to the Bethlehem and I believe the LTV 
collapse and the consequent assumption of liability by PBGC. If 
we could have that chart on the screen, please.
    You indicated that, No. 1, I think you averted to this, 
when the PBGC finally took hold of the plan assets of Bethlehem 
and LTV, they found out that there was a lot less there than 
they had previously thought.
    Why is that? Does it have something to do with the fact 
that 4010, Section 4010 of ERISA (Employee Retirement Income 
Security Act), provides confidentiality to these numbers and 
they don't get the attention they would get in full public 
scrutiny? How is it we can delude ourselves about the balances 
in a plan that we are insuring?
    Mr. Walker. That is part of the problem, Mr. Spratt. Right 
now, if you look in the pension area, you will find that there 
are a number of different numbers that are calculated, some of 
which are disclosed, some of which are not disclosed.
    You will calculate numbers with regard to the funding 
status of the plan for determining what your required 
contributions are under the minimum funding standards. You will 
calculate numbers for purposes of PBGC variable rate premiums. 
You will calculate numbers for purposes of public reporting, 
especially if you are a public company and file a 10-K.
    You will generally find that certain things tend to happen 
in connection with troubled companies. No. 1, they use very 
optimistic discount rates to determine what their liabilities 
are, so they serve to understate their liabilities.
    Secondly, and when they had good times with regard to their 
asset increases, during times of good markets, they carried 
forward those credits, and they are allowed to do that under 
current law, even though those gains could have totally 
evaporated and turned into losses since then. However, under 
current law they are still allowed to consider them for 
purposes of meeting their funding requirements.
    In the case of LTV Steel, there were shutdown benefits, 
those are benefits that arise when a plant shuts down. 
Therefore the degree of underfunding can increase dramatically 
overnight. As you can see in this graphic, it did.
    The bottom line with regard to your premise is, one of the 
first things we have to start with is transparency. All too 
frequently, the information that is provided to plan 
participants and beneficiaries, to the Government and to other 
key stakeholders is outdated and misleading.
    We need to provide more timely, accurate and useful 
information. Transparency is a powerful force in trying to 
encourage people to do things that they otherwise should do.
    And right now, 4010 is a problem.
    Mr. Spratt. As I understand it, there is a provision in 
FASB 87, Financial Accounting Standard Board Rule 87, which 
deals with the actuarial present value of benefits. And if the 
plan assets are beneath the actuarial present value, then the 
difference has to be recorded as a liability on your balance 
sheet. I guess it gets booked to revenues for that time period, 
too.
    But in any event, why is that not enough? And if it is not 
enough, are you saying then that we need to rescind, we need to 
radically change the disclosure rules with respect to the 
shelter, the veil that is allowed by Section 4010 of ERISA?
    Mr. Walker. There is clearly a need for a change in the law 
here, Mr. Spratt. The fact of the matter is, you are correct 
that there is a different accounting treatment under generally 
accepted accounting principles for pension costs, versus what 
has to be provided to plan participants and beneficiaries. It 
is also very different than what the funding rules are.
    The amounts that are provided in the 10-K, the annual 
report filing with the SEC (Securities and Exchange Commission) 
for public companies, is usually a lot more reflective of 
reality. It is important that more realistic information be 
provided in a more timely manner to plan participants and 
beneficiaries and other interested parties than is the case 
under current law.
    Mr. Spratt. Do you agree with that basically, Dr. Holtz-
Eakin?
    Mr. Holtz-Eakin. Yes. I think this is a two-step process. 
The first is to make sure there is transparency to workers, to 
the PBGC, and to shareholders, so they can monitor better the 
status of these plans. Similarly, you would like to have better 
transparency of the PBGC to the Congress itself, so you can 
monitor the status of that commitment.
    And second, once you have transparency, what is it that you 
would like to reveal? Given that this is an insurance product 
and insurance products are about volatility, I think it is 
desirable to recognize these things as close to market value as 
possible so that you can know when a bad thing is happening and 
insurance is going to kick in.
    The current reporting structure which emphasizes smoothing 
is at odds with providing good information about an insurance 
product.
    Mr. Spratt. What is the policy behind it? Is there a 
concern there would be a run on the stock if there were a 
substantial liability or unfunded actuarial value?
    Mr. Walker. I think it is important to note that PBGC does 
receive certain information under this section----
    Mr. Spratt. Confidentially.
    Mr. Walker (continuing). Yes, it is confidential. That is 
correct.
    I think it is important to note that a lot of key 
stakeholders aren't like plan participants. Presumably, if they 
were very sophisticated investors and they were very familiar 
with FASB 87 and FASB 88, if they read the financial statements 
of the company closely, and if they looked at the footnotes of 
the financial statements, a sophisticated player might be able 
to understand what is going on.
    However, a vast majority of workers and retirees aren't in 
that category. Therefore, we need to provide it in a more 
timely and user-friendly fashion, because ultimately this is 
not just about PBGC. Ultimately, it is about the retirement 
income security of American workers and retirees, because PBGC 
does not guarantee all benefits.
    There are limits as to what PBGC guarantees. As a result, 
significant losses can be imposed on workers and retirees.
    Mr. Spratt. Dr. Holtz-Eakin, you have made reference to 
premium increases, but you didn't talk about the two types of 
premiums--the fixed-rate and the variable-rate premium--and you 
also didn't indicate what sort of magnitude of increase would 
be necessary to truly mitigate this problem.
    Could you address that?
    Mr. Holtz-Eakin. Well, our rough estimate is that overall, 
if you take both of them, it is about a fivefold increase. The 
fixed-rate increase looks far less burdensome on average than 
does a variable-rate increase.
    The variable rate is hitting those firms which have 
underfunded plans. They are typically in less than stellar 
financial health themselves. And so imposing that kind of a 
premium increase is a far more problematic initial step. I 
mean, that is just too abrupt.
    Both are appropriate policy instruments. It is important to 
use the variable rate to reflect the risk to the PBGC.
    Whether you tie that to the kinds of assets in the plans, 
or whether you tie it to underfunding, there are a variety of 
ways you can go. I think both premiums can be used more fully 
to price better. The fixed rate is easier to adjust in the near 
term. The variable rate should be structured to provide good 
long-term incentives.
    Mr. Spratt. Well, just for basic clarification, the fixed 
rate applies to every defined benefit plan that is insured by 
PBGC. It is $19 per plan participant.
    Mr. Holtz-Eakin. Yes.
    Mr. Spratt. And one of the proposals, then, would be to 
increase that amount.
    Obviously, to the extent that it becomes an onerous 
increase, you risk the possibility that healthy, financially 
solid and stable firms might decide to withdraw as opposed to 
paying and convert to defined contribution rather than defined 
benefit plans. Is that a concern?
    Mr. Holtz-Eakin. For the fixed premium, ballpark numbers--
suppose you use the $19 to $30 as the canonical proposal, that 
looks like a couple of pennies per hour in terms of labor 
compensation.
    Since this is about ensuring that labor compensation 
promised at one point in time is actually delivered at another, 
that doesn't strike many people as a really big increase from 
the point of view of making sure that, that commitment is 
honored.
    The variable rate is very different; $9 per $1,000 of 
underfunding, a sixfold increase in that, or something that 
would be necessary to make our kinds of numbers dramatically 
smaller, would be a big financial burden if instituted----
    Mr. Spratt. And the downside risk is that plans would 
terminate and withdraw and then you lose all their 
contributions.
    Mr. Holtz-Eakin. Yes.
    Mr. Spratt. Fixed and variable.
    Mr. Walker. If I can, Mr. Spratt?
    Mr. Spratt. General Walker?
    Mr. Walker. The $19 has not changed since the early 1990s, 
so if you index it for inflation it goes to $30. Obviously, 
people would prefer for them not to go up, just like people do 
not like tax increases--but the relative burden is not likely 
to be that significant.
    One has to be careful, however, because you have to decide 
how much money you need and then how to raise that money.
    The current variable-rate premium right now does not 
reflect risk. The current variable-rate premium right now is 
based solely on the degree of underfunding.
    It does not consider the assets in the plan. It does not 
consider the nature of the plan and potentially pop-up 
liabilities that can come due. It does not consider a number of 
important factors that really correlate with risk.
    For example, 80 percent of PBGC's losses that have occurred 
to date for big plans have been attributable to companies that 
had a junk-bond status 10 years from the date that they 
terminated--80 percent.
    Therefore, actual losses bear a very high correlation to 
the financial condition of the sponsor.
    Yes, additional premium revenues are necessary, but there 
ought to be more of a risk-based variable-rate premium.
    You have to be careful not to raise the base rate too much, 
to where you encourage the exodus that you talked about. If we 
are going to have a variable or so-called risk-related premium, 
it really ought to relate to risk--it doesn't right now.
    Mr. Spratt. Well, we have got a chart up here now which 
indicates how low the premium used to be.
    I used to fill out a 5500 C, as I recall it, for a small 
firm, a bank, a small bank that we ran. And I think my time 
engaged in filling out the form was more expensive than the 
premium we had to remit with the form, particularly when you 
tried to understand what OMB (Office of Management and Budget) 
was putting in the fine print on it.
    But thank you both for your testimony. I may have further 
questions, but I want to allow others the opportunity.
    Thank you very much for your presentations.
    Chairman Nussle. Before I turn to the next member, let me 
welcome a special guest that is here with Director Holtz-Eakin. 
I understand your son is here, welcome Colin. Your dad does a 
great service to our country and for our Congress, and we 
welcome you to the Budget Committee.
    Mr. Chocola for 5 minutes.
    Mr. Chocola. Thank you, Mr. Chairman.
    First time showing up early in Congress has been rewarded. 
Thank you. I appreciate the opportunity to serve on the 
committee with you.
    And thank you both for being here today. I just quickly 
want to follow up on some of your comments, especially Mr. 
Walker.
    You talked about transparency a lot. You talked about this 
is a subset of greater challenges.
    I used to work with a publicly traded company, and we were 
required to follow things like accrual accounting practices. 
And it allowed us to plan for things. And I think in order to 
meet a challenge, you have to be able to define a challenge.
    If we budgeted on an accrual basis, would we be able to 
achieve some of that transparency and be able to plan for these 
challenges in a better fashion?
    Mr. Walker. No question.
    It would make your reconciliation process tougher, because 
the numbers would be a lot bigger than you are seeing right 
now.
    But as you know, there are certain things right now that 
are on an accrual basis, certain kinds of credit activities. 
But this is not on an accrual basis.
    I agree with Doug Holtz-Eakin that we not only need changes 
in the budget process, we need changes in the financial 
reporting process, and I am trying to make that a reality.
    Mr. Chocola. Do you agree, Mr. Holtz-Eakin?
    Mr. Holtz-Eakin. I am more cautious than some about moving 
the Federal Government full-scale to an accrual framework, for 
a whole variety of reasons, and I will spare you the sermon--we 
can talk about it later.
    I think it is important that the information be entered in 
the policy process, that this committee and the Congress in 
general know the accrual status of Federal programs.
    Budgeting is, in the end, a year-by-year event. The 
delivery of budget authority is a management tool by which you 
allow people to exercise policy options, and that is a cash 
flow operation.
    And so I think there is a place for both in thinking about 
how the Congress does its business.
    Mr. Chocola. Mr. Walker, would you talk about it in the 
terms of the bigger challenges that you referred to earlier? 
There is a sense of Social Security--I mean, this is a subset 
of bigger challenges. The need for transparency is a much 
bigger issue than just this, isn't it?
    Mr. Walker. Absolutely. Let me give you some numbers.
    PBGC has a $23.3 billion accumulated deficit based upon the 
numbers we have seen from CBO, which are very similar to the 
numbers that PBGC has disclosed itself.
    You can easily add another $90 billion to $100 billion on 
top of that, so that gets you about $120 billion or so.
    Social Security has a discounted present-value unfunded 
commitment right now of about $4 trillion. There are 12 zeros 
behind that. It is going up every year. That number is just for 
75 years, not for perpetuity.
    The U.S. Government has liabilities and unfunded 
commitments of $45 trillion, which went up over $13 trillion in 
the last year alone.
    So this is a subset of a range of issues, and we need to 
start dealing with them.
    Mr. Chocola. And if the Federal Government were a publicly 
traded company and it reported its liabilities like the Federal 
Government reports its liabilities, it would be understating 
its liabilities, wouldn't it?
    Mr. Walker. Well, let's talk about what current rules are 
and what I am trying to get changed.
    By the way, both GAO and CBO sit on the Federal Accounting 
Standards Advisory Board (FASAB), which is the body that 
recommends accounting and reporting changes.
    Right now, there is a separate statement which contains 
many of the numbers that I gave you. You can go to and see the 
$4 trillion, for example, for Social Security; you can see the 
almost $30 trillion for Medicare. They are not currently deemed 
to be liabilities for a lot of reasons.
    One of the things that we need to do is we need to provide 
better transparency over trust fund versus nontrust fund 
activity, because as we all know they are not really trust 
funds; they are subaccounts of the general ledger.
    We need to provide more transparency with regard to the 
total liabilities and unfunded obligations, the related burden 
on a per-capita basis, and how it fits intergenerationally.
    We are dedicated to further improving Federal financial 
reporting. In addition to that, because not enough people read 
the financial statements, I am not going to ask you to raise 
your hand. But I can tell you in the last month, I have given 
speeches to hundreds or thousands of people, and less than five 
people have read the financial statements of the U.S. 
Government.
    One of the things we need is a user friendly and concise 
summary annual report, in plain English, and with charts and 
graphs. I am working with Treasury and OMB to make that happen.
    You need to change the budget process too. You don't have 
to go to full accrual budgeting--there are pluses and minuses 
there.
    My understanding is you were just talking about this area 
rather than overall.
    I do, however, think that there needs to be more 
transparency with regard to these commitments and 
contingencies, and they need to be accrual numbers. And that 
would be a positive first step to help ensure that these issues 
are actually considered, discussed and debated.
    Mr. Chocola. Mr. Chairman, if I could, I have been baited 
into this, I cannot resist.
    The PBGC, like many, in principle, private entities, is 
different. It was intended to be a funded system. Firms were 
either supposed to self insure, by putting aside sufficient 
funds to meet the promise of this deferred compensation, or 
purchase insurance against adverse economic events that allowed 
them to meet that commitment as well. That is standard 
operating procedure. And it was intended to be funded either 
through internal resources or purchased resources in that 
fashion.
    Government programs are very different and in some cases, 
were never intended to be funded--Social Security and, in 
particular, Medicare.
    And my reservation with full accrual accounting is best 
exemplified by Medicare and Medicaid, where if one takes at 
face value the history of the growth of health care costs and 
simply extrapolates that into the future, you cannot compute 
the present value.
    And so the unfunded liability--the funded or unfunded 
liability is infinite.
    The only way to actually make the computation work is to 
assume that at some point in the future health care costs grow 
more slowly, and that would be a technical assumption made by 
someone--either GAO, CBO, OMB--in consultation with committees.
    It strikes me as extraordinarily arbitrary to place the 
budgeting framework of U.S. Government on something that 
capricious as an assumption that 30 years from now health care 
costs will grow more slowly.
    That is a reservation I have about implementing that kind 
of thinking in the government context.
    Mr. Walker. The trustees have to do that every year, and 
they have been doing it for many years. Under generally 
accepted accounting principles for public-sector companies, as 
you know--you used to be involved--you have to do the same 
thing.
    Nothing is perfect, but I think we need to see some 
numbers. They need to be on the radar screen. Right now, they 
are not.
    You can't solve a problem until you agree that you have a 
problem. You also need to see whether or not you are making 
progress or making it worse.
    Chairman Nussle. Mr. Neal.
    Mr. Neal. Thank you, Mr. Chairman.
    Mr. Chairman, let me congratulate you for holding this 
hearing this morning. It is timely, and I think it speaks to 
one of the fundamental problems with this Congress. I 
frequently refer to this Congress, as you know, as the Stepford 
Congress. Whatever the administration says, the majority in 
this Congress goes along with.
    As the war in Iraq goes badly, we insist it is going fine. 
Cut taxes five times with two wars, and we would say, well, the 
budget is fine, we don't have to worry about the deficits. And 
then the argument becomes, well, it would have been worse if we 
didn't cut taxes in terms of the temporary recession we 
experienced.
    It seems as though that transparency reference that you 
made at least 25 times in your opening statement, Mr. Walker, 
really is something that Congress has been very slow to come 
to.
    And the chairman indicated he came here at the end of the 
S&L issue. I was here in the middle of it and I remember what 
that was like as we deregulated the industry, we allowed people 
to get into businesses which they had no former experience and 
certainly no discipline, as they began to loan money.
    And now we find ourselves here with the pension problems 
that we have, and in some measure it is a reflection, I think, 
of the lack of will by the Congress to do what they are 
supposed to do, and that is to ask questions.
    Now, having said that, let me point out that I recall when 
President Clinton offered his health care plan, that was vetted 
from every conceivable angle. People like myself opposed it 
because we didn't think that the questions were being answered 
in the right way.
    The current Congress goes along with everything the 
administration says. Never is there a question. We hear time 
and again answers from the administration that cause Members of 
Congress to swoon in front of them rather than to ask them 
about the true problems.
    And now we have this issue here in front of us about 
pension liability.
    And let me specifically speak to the issue of the multi-
employer pension plans.
    We have done some things here in the last few years to 
address the issue of single employer pension plans. But we 
really haven't addressed the multiple employer pension plan.
    Would the two witnesses care to speak to those issues?
    Mr. Walker. I can speak to it, having been head of the 
PBGC. There are two principal kinds of defined benefit plans 
that the PBGC insures. One is the single employer pension plan, 
which typically is sponsored by a particular company for its 
employees and retirees. Another is a multi-employer pension 
plan, which typically is sponsored by a trade union. It could 
be the Teamsters, it could be other types of unions, and where 
the nature of the benefit promised is somewhat different, but 
it is a defined benefit promise.
    Importantly, the insurable event is different for multi-
employer plans versus single employer plans. For single 
employer plans, it is termination. That was the use for LTV, 
Bethlehem, and United.
    For multi-employer, it is insolvency. In other words, when 
the money runs out and you can't pay benefits. There are 
significant exposures in the multi-employer plan universe. They 
are not likely to be realized as quickly, just like Social 
Security. When the trust fund runs to zero, that represents 
insolvency. In the case of Social Security today, the program 
already has a $4 trillion deficit.
    So that is the primary difference.
    Mr. Holtz-Eakin. A good opportunity for me to make clear to 
the committee that our work focused exclusively on the single 
employer plans. That judgment was made because if you look at 
the $23 billion--sunk costs in the single employer plans--there 
is about a $0.2 billion comparable number for the multi-
employer plans.
    So we focused on the bigger problem first.
    Mr. Neal. Thank you.
    Mr. Chairman, I want to reiterate what I said at the 
beginning. I want to thank you for holding this hearing. And I 
want to say that whether--the trouble we have here, I think, in 
the Congress, whether it is global warming or it is tobacco, it 
is really hard to get answers to questions.
    And I want to tell you, for those of you who have an 
institutional memory here, we hammered witnesses on the S&L 
issue, of all political parties. They were dragged--I was on 
the Banking Committee at the time, for two painful terms. We 
clobbered those witnesses as they came before us regardless of 
their political party or their affiliation or who they were 
close to. During the Clinton health care plan, we hammered away 
at them day after day.
    It is the job of the Congress to ask questions and not to 
accept everything the administration says. And that is why we 
find ourselves now trying to play catch-up with giving a lot of 
answers to questions.
    So I do thank you sincerely, Mr. Chairman, for holding this 
hearing.
    Chairman Nussle. Mr. Conaway.
    Mr. Conaway. Thank you, gentlemen.
    Thank you, Mr. Chairman, I appreciate that.
    The reporting requirement that PBGC gets under law versus 
what FASB requires obviously are not the same. I do not know 
that the FASB disclosures are all that great either. There are 
some suggestions that additional information, more information 
as to the types of assets within plans and the extent that 
companies use their own stock to fund their annual 
contributions.
    Could you talk to us a little bit about the nature of the 
assets and the fiduciary responsibilities that the plan 
trustees have of diversifying investments out of their 
portfolio?
    Mr. Walker. Having been a prior Assistant Secretary of 
Labor for ERISA, I had to oversee the fiduciary responsibility 
provisions. There are fiduciary responsibility provisions that 
relate to all private pension plans. Prudence is one of those. 
Diversification in order to minimize the possibility of large 
and unexpected losses is an element of this.
    For defined benefit pension plans, which we are talking 
about here, there is a statutory limitation that employers can 
not invest more than 10 percent of the value of the assets in 
the plan in qualifying employer securities. But that 10 percent 
is determined as of the time that the contribution is made to 
the plan, so it could vary from 10 percent, depending upon 
market trends.
    There are, however, certain types of plans called floor 
offset plans where you have a defined benefit plan in 
conjunction with the defined contribution plan. By the way, 
Enron had one. Under these plans, you can evade that 10 percent 
limit in employer stock under current law. I think this needs 
to be addressed. It needs to be stopped because it represents 
undue exposure for plan participants and beneficiaries and to 
the PBGC.
    You are making a good point that you just can't look at the 
assets and you just can't look at the liabilities and the net 
difference. You have to understand the nature of the assets, 
the nature of the liabilities and that is why I am saying the 
current deficit----
    Chairman Nussle. Sorry to interrupt. We are OK. It is the 
Senate.
    Mr. Walker. We are OK?
    Chairman Nussle. I knew this was a hot hearing. I hope we 
did not catch on fire. [Laughter.]
    You are in a different world.
    Mr. Walker. Thank you. OK. On the other side of the Hill, 
right? We will not say anymore.
    The fact of the matter is, you need to get below the 
bottom-line numbers, because it makes a difference as to what 
true risk and true volatility are.
    Mr. Conaway. As you used Bethlehem Steel and LTV, the 
differential between what was being reported as the unfunded, 
about 85 percent, versus what actually, that 60 percent.
    What role did the plans holding LTV or Bethlehem Steel 
stock? Because once the company goes bankrupt, any exposure to 
that stock means that you have caused a problem. That 
exacerbated the problem.
    Do you know off the top of your head?
    Mr. Walker. I will have to provide that for the record. The 
primary difference was, No. 1., the differences in the interest 
rates and No. 2, the fact in the case of LTV or Bethlehem, I 
think it was, there were significant shut-down benefits that 
popped up overnight that caused the funding level to decline 
dramatically.
    So primarily interest rates and shut-down benefits. I will 
provide the rest for the record.
    Mr. Holtz-Eakin. Congressman, I want to note for the 
committee again, when we did our work, it was entirely off the 
publicly available information that we can get through the 10-K 
filings.
    It remains an unfinished task to crosswalk our estimates to 
the estimates of the PBGC. The confidentiality provisions under 
law preclude that quite frankly. I think a policy issue going 
forward is the degree to which that confidentiality is an 
important part of the way that PBGC should operate.
    Mr. Conaway. Mr. Walker, you showed a chart that was 
updated all the way through 2002 and made some reference to the 
stale date. Why is that information not more readily available?
    Mr. Walker. Two reasons. Under current law, people are not 
required to file it until, I think, about 7\1/2\ months after 
the end of the year. After they file it, it takes a 
considerable amount of time for the information to be processed 
by the Government.
    Historically, the Government has waited until all of the 
returns were processed before they provided information 
publicly.
    So I think there are several issues here. By the way, we 
have issued a report on this which I am happy to make available 
to you and the other members.
    I think you need to look at requiring accelerated 
reporting, at least with regard to plans that represent a risk 
with regard to their financial condition. I also think we need 
to move to electronic reporting, especially for large companies 
possibly requiring electronic reporting by large companies. 
Certain other government agencies have already done that for 
other required reports.
    Clearly, the Department of Labor needs to improve their 
processes and possibly reconsider how they are processing these 
returns, so they don't wait until the end. They also need to 
analyze this information more on an installment basis rather 
than on a completion basis.
    Mr. Conaway. Thank you, gentlemen.
    Mr. Chairman, thank you.
    Chairman Nussle. Mr. Moore.
    Mr. Moore. Thank you, Mr. Chairman.
    And thank you, Mr. Spratt, for requesting this hearing.
    Mr. Chairman, I also appreciate your convening the hearing.
    Gentlemen, would it be safe and reasonable for us Members 
of Congress to assume that the pension benefits of employees 
are created basically the same as the pension benefits of 
corporate executives?
    Mr. Walker. No.
    Mr. Moore. Why not?
    Mr. Walker. Well, two reasons. One, there are two types of 
plans that typically corporate executives have. Many times they 
are covered under the defined benefit pension plan that would 
be subject to PBGC guarantee limits. Obviously, they have more 
exposure if they are, because the maximum benefit guarantee for 
PBGC is about $45,000 a year at the normal retirement age. 
Therefore, typically, they would have a lot more lucrative 
benefits based upon their salary. So they would take more of a 
haircut.
    Secondly, typically, most corporate executives, especially 
for public companies, have non-qualified deferred compensation 
plans that are not subject to the Employee Retirement Income 
Security Act. They typically provide for very lucrative 
benefits, and typically, a vast majority of their benefits are 
this way. They may or may not be funded.
    They may be subject to additional risk in bankruptcy, but 
there are ways to provide funding and security to avoid any 
problem in bankruptcy. That is a very controversial topic.
    Mr. Moore. And what would those ways be, if you can tell us 
briefly, Mr. Walker?
    Mr. Walker. Well, there are certain types of tax planning 
and trust vehicles that have been used in the past that have, 
in some cases, withstood bankruptcy. I would be happy to 
provide details for you if you would like.
    Mr. Moore. Well, the intent of my question was not to give 
further protection to the corporate executives, but to find out 
if maybe, if they had additional risk and the same risk that 
employers have, that maybe things might change. Any thoughts 
there, about how to make that happen?
    Mr. Walker. Well, I think there are some people that have 
talked about whether and to what extent there should be more of 
a mutuality of interest with regard to this risk. I would be 
happy to talk to you about that further, because there are some 
complicating factors.
    I mean, it is one thing if the executives have been there 
since the beginning and maybe they were some that made the 
promises that they could not deliver on or they decided not to 
fund the pension plan and to do something else with the money.
    It is another issue if you have somebody who is new 
management, who is coming in to try to help save the company, 
they weren't part of the problem, and your need to be able to 
attract and retain top talent.
    So I would be happy to talk to you about it further. But I 
think it is a fact and circumstances issue.
    Mr. Moore. Thank you, Mr. Walker.
    You said to us, go look at the numbers, and they are on a 
site or someplace. And you were talking about a $30 trillion 
dollar Medicare unfunded liability? Is that correct, sir?
    Mr. Walker. Close to $30 trillion.
    Mr. Moore. And $4 trillion for Social Security.
    Mr. Walker. That is correct.
    Mr. Moore. Where do we go look at those numbers?
    Mr. Walker. Well, first, they are in the Social Security 
and Medicare trustees reports, which come out every year.
    Secondly, the number for last year, fiscal 2004, which is 
somewhat lower than that, but still staggering, is in the 
annual report of the U.S. Government, which is also available 
on Treasury's website and our website as well.
    Mr. Moore. You also made the statement, I believe, and this 
may not be an exact quote but close, I think, they are not 
trust funds. Did you say something like that?
    Mr. Walker. If you look at ``Webster's Dictionary,'' these 
do not qualify as trust funds----
    Mr. Moore. I understand that.
    Mr. Walker. They are sub-accounts of the general ledger. In 
fact, if you look at the financial statements of the U.S. 
Government, you will not find a liability equal to the amount 
of bonds that are in these trust funds, because the left hand 
owes the right hand.
    One of the things that I am pushing for is to provide more 
transparency over what is going on, because last year, our 
deficit really wasn't $412 billion, it was $567 billion, 
because we spent every dime of the Social Security surplus.
    Mr. Moore. I practiced law for 28 years before I came to 
Congress. And in Kansas and I think probably most other states, 
there is a requirement that attorneys who have client's funds 
in their possession deposit them in a true trust account. And 
it is an absolute no-no to touch those funds, because you can 
be prosecuted perhaps and disbarred for doing that.
    Would there be any benefit to the U.S. Government having a 
true trust fund for deposit of Social Security monies that are 
later to be paid out for benefits?
    Mr. Walker. I think there are two issues. One, even if you 
had a true trust fund, if you are going to invest the same way 
that you are investing right now, I am not sure that would 
really change anything.
    Mr. Moore. Of course, we are not investing right now, we 
are spending, are we not, on----
    Mr. Walker. Well, we are spending it----
    Mr. Moore (continuing). A lot of other things, right?
    Mr. Walker. We are spending every dime of the Social 
Security surplus on other government expenses. We are replacing 
it with a non-readily marketable bond backed by the full faith 
and credit of the U.S. Government, guaranteed as to principal 
and interest, but it is only as good as the ability of the 
Government to tax, to cut other spending, or to go out and 
borrow, typically from foreigners, in order to be able to fund 
our deficits and debt.
    Mr. Moore. Thank you, sir.
    Chairman Nussle. Mr. Ryan.
    Mr. Ryan. A couple of questions I wanted to ask already 
were asked, such as Mr. Chocola's on accrual accounting.
    Let me ask you about the difference between multi-employer 
pension plans and single employer pension plans. Mr. Walker, I 
think with multi-employer pension plans, the risk is spread to 
the rest of the employers in the pool, so there is another line 
of risk exposure away from the Government with respect to multi 
versus single, correct?
    Mr. Walker. That is correct.
    Mr. Ryan. And so looking at the provisions we are facing 
within this Congress on multi-employer pension plans, do you 
think--and this is a question for both of you--that we can, 
through reforms, transparency, smoothing, all these other 
things--and you have seen the proposals up here--that we can 
reform multi-employer pension plans sufficiently in this 
Congress?
    We are looking at reconciliation. What are the first things 
first that we do? It appears that we can't fully fix the 
single-employer problem. Can we, in your estimation, fully fix 
the multi-employer problem?
    Mr. Walker. Well, candidly, it is my understanding, Mr. 
Ryan, that the administration's proposals do not go to multi-
employer plans, and I am not familiar if there are legislative 
proposals up here that do.
    Mr. Ryan. There are, and they are from multiple sources. I 
think the Teamsters have one for the red zone, the food 
distributors for the yellow zone.
    You know, there are a lot of groups that are involved in 
multi-employer pension plans who have come up with proposals. 
Ed and Labor, not a committee I serve on, is doing hearings on 
these things.
    So you haven't had a chance to look at these various multi-
employer pension proposals?
    Mr. Walker. I haven't, but I will be happy to take a look 
at it.
    Mr. Ryan. Yes, I would love to hear your opinion as to 
whether or not those cover the job of fixing the plan.
    Doug, have you taken a look at any of these solutions?
    Mr. Holtz-Eakin. We haven't looked at those. The one 
distinguishing difference here is the degree to which you can 
get additional monitoring from the other firms in a multi-
employer plan.
    And so if you can make that monitoring more effective, you 
can get a lot of bang for the buck out of things that do not 
have a lot of----
    Mr. Ryan. Because they have an incentive to make sure--so 
more transparency is clearly a great starting point for the 
multis.
    On the singles, should I take away from this testimony, 
from both of you, that at first blush, the premium increase is 
just the first no-brainer? Then we are going to have to look at 
transparency, other things like that. And given where we are 
with respect to reconciliation, that is the best place to 
start?
    Mr. Holtz-Eakin. The fixed premium is certainly the place 
to start. Thinking hard about what you want the variable 
premium to do and whether you want it to address underfunding 
and risk and how quickly you move that is a bit harder.
    Mr. Ryan. OK, let us go to accrual quickly. I got the 
impression from the answer to Mr. Chocola's questioning that, 
Mr. Walker, you think it is right and proper that we do full 
accrual accounting of all the assets and liabilitieson the 
books.
    Doug, I got from you that you think it is just a tough 
computation to make, especially when you are talking about 
health care.
    Mr. Holtz-Eakin. I also think it is different. I mean, it 
reflects an attempt to transfer private sector accounting into 
the Government, and government is different. It has the power 
to tax. In the end, government programs are funded up to the 
point of economic rationale. You can tax the resources and 
provide them for the Government budget.
    There is no private entity that has a comparable power, who 
can print money as a government can.
    So I am nervous about simply carbon-copying private sector 
reporting and budgeting into the government sector. They are 
different.
    Mr. Ryan. Actually, I think that is a very good argument 
when applied to Social Security, which is when you price 
benefit guarantees, the cost of pricing a benefit guarantee 
would be theoretically lower for the Federal Government because 
it has the power to tax any given year than versus pricing, 
say, a benefit guarantee in the private sector. Would not the 
same argument apply?
    Mr. Holtz-Eakin. In those circumstances where the 
Government has the ability to pool across a greater set of 
risks, it will do better than the private sector. And what you 
want to do is look for those opportunities where the Government 
has a comparative advantage in risk spreading.
    Mr. Ryan. So you would agree on both sides, the Social 
Security side of the ledger as well?
    Mr. Holtz-Eakin. Not necessarily on all Social Security 
matters. You and I have been there.
    Mr. Ryan. That is why I wanted to bait you into that.
    Mr. Walker. If I can, Mr. Ryan, there are two issues. One 
is the issue of financial statements, and we do have accrual 
accounting for financial statements. However, right now the 
only thing that is deemed to be a liability on Social Security 
and Medicare is due and unpaid benefits.
    We do disclose the discounted present value numbers of the 
difference between promised benefits and funded benefits, that 
is a $4 trillion number for Social Security and roughly a $30 
trillion number for Medicare.
    Mr. Ryan. Is the 30 a 75-year number?
    Mr. Walker. It is a 75-year number. We do disclose that. It 
is not deemed to be a liability. I would debate whether or not 
it is a liability, because of some of the fundamental 
differences between a pension plan and social insurance 
program.
    The other side of the coin--but it needs more transparency.
    At the same point in time, the other side of the coin is, 
what do you do for budget purposes? So for financial 
statements, we need accrual concepts. The debate is whether or 
not it is a liability. We need more transparency and enhanced 
reporting in any event.
    On the budget side, it is different.
    Mr. Ryan. But you both agree that accrual is appropriate 
when we are talking about single employer----
    Mr. Walker. Well, they already have it. They are subject to 
generally acceptable accounting principles. For example, PBGC's 
$23.3 billion deficit at September 30, 2004, include United 
Airlines, which did not terminate until this year.
    Now, why did it include United Airlines? Because under 
generally accepted accounting principles, if it is 
identifiable, probable and estimatable, you have to book it as 
a liability on an accrual basis.
    Interestingly, if you end up increasing PBGC's premiums, 
that will help the Federal budget. That will help PBGC in the 
short term. But they will still have a huge hole. So it might 
make them look like they are better off than they are, but in 
reality they are still in a huge whole.
    Mr. Ryan. And there is some peril to that.
    What is the infinite horizon number on Medicare trustees? I 
don't know off the top of my head.
    Mr. Walker. I remember Social Security's number is over $10 
trillion. I do not remember the Medicare number.
    Mr. Ryan. You don't know Medicare?
    Mr. Walker. Not off the top of my head but I will be happy 
to provide it for the record.
    Mr. Ryan. Thanks.
    Chairman Nussle. Mr. Edwards.
    Mr. Edwards. Mr. Chairman, let me first thank you for 
holding this meeting.
    Mr. Spratt, for asking for it.
    I think as an institution, we are good sometimes at 
addressing immediate crises. We are reactive, though, as an 
institution. We are not very good at trying to prevent crises 
10, 20 years down the line. I think it is important that you 
start the first process, educating Members of Congress that 
there is a serious problem here.
    General Walker, I guess this is a request, perhaps, as you 
play a leadership role in addressing this problem, I hope you 
will address the issue of corporate responsibility and 
fairness.
    I think our capitalist system, which is the greatest 
capitalist system in the history of the world, depends on 
trust, as you know better than I do.
    And while the key issue here is protecting the pension 
benefits of workers and not exposing taxpayers to too much 
liability, the fact is that if corporate CEOs are getting 
golden parachutes, the very same CEOs who in many cases are 
responsible for making the poor management decisions that drove 
their corporations into bankruptcy, they are being protected 
with golden parachutes by boards, and workers are getting the 
shaft and losing their pensions altogether, a great percentage 
of them, you are really going to lose trust in this system.
    And I hope that aspect of it, while the numbers of 
corporate execs may be limited, I think it is a huge issue that 
Mr. Moore dealt with. And I hope somehow we deal with that.
    And I know you have to be careful. You don't want to punish 
corporate CEO and executives that were not responsible for 
driving a company into bankruptcy and you don't want to set up 
kinds of disincentives to corporate executives so that none of 
them would ever want to set up a defined benefit plan.
    But within those limitations, I hope that issue is seen as 
not just a minor side issue, but an important part of the 
public's confidence in our system.
    Let me ask this. I haven't looked carefully at the status 
of General Motors, but I understand their bonds are at junk 
bond level now. If tomorrow--let us be clear, General Motors is 
not going to go bankrupt tomorrow--but if General Motors would 
go bankrupt, what would be the implications on PBGC of that, in 
terms of dollar exposure? If you were to assume the Federal 
Government would make the benefits, pension benefits of their 
employees.
    Mr. Holtz-Eakin. I think the honest answer is: We don't 
know. The PBGC knows, but they can't tell us. I mean, the 
filings are confidential. It is a substantial pension risk. It 
is a very big number.
    Mr. Edwards. We can generally--we could probably do some 
decent estimating. You have to do that all the time as an 
economist, and I respect that. I assume you could estimate the 
average worker's pension benefit, given an average expected 
life expectancy, would cost so much. And if GM went under, I 
mean, are we talking about $50 billion, $1 trillion, at least 
just to put it in perspective?
    Mr. Holtz-Eakin. We can produce a rough estimate.
    Mr. Edwards. OK.
    Mr. Walker. I think that what one could do, and I will be 
happy to provide something for the record, is to look at the 
10-K for General Motors and possibly get a sense as to what the 
potential magnitude is.
    I don't know the number off the top of my head. It is my 
understanding that if that were to happen, it would be a 
substantial loss, possibly the largest in the history of the 
agency.
    Mr. Ryan. Will the gentleman yield, just for a quick 
clarification?
    Mr. Edwards. Be glad to.
    Mr. Ryan. Is it not true that General Motors is not 
underfunded, and they floated $18 billion of bonds about 2 
years, and they are not declared an underfunded plan? Is that 
not the case?
    Mr. Holtz-Eakin. I think that is right. That is what we are 
going to check.
    Mr. Ryan. Yes. But Ford and Chrysler are lower than GM. GM 
does not have an underfunded pension plan, to my understanding.
    Mr. Holtz-Eakin. Yes. And I am not familiar with the nature 
of their investments.
    Mr. Ryan. They are my larger----
    Mr. Holtz-Eakin. Right. OK. OK.
    Mr. Edwards. Well, we will follow up on that issue.
    Let me ask this.
    Dr. Holtz-Eakin, when we reduced the corporate tax rate in 
the last several years, what was it reduced from, and to what 
level today?
    Mr. Holtz-Eakin. It is 35 percent now. It has been much 
higher in the past. It is now 34 percent for manufacturers.
    Mr. Edwards. What role did the economic implications, if 
you were to take those companies that your own report says many 
of the underfunded plans are sponsored by financially healthy 
firms. What if we deferred that tax cut until those pension 
investment plans for those corporations were considered 
adequate enough to----
    Mr. Holtz-Eakin. I don't know off the top of my head. I 
would be happy to go through that to the best of our ability 
and get back to you.
    Mr. Edwards. OK. Final question: Has anybody looked at the 
270 companies that have underfunding within $50 million as of 
2002, what kind of pension plan that corporate executives in 
those 270 companies have? Has anybody looked at that?
    Mr. Holtz-Eakin. We haven't.
    Have you?
    Mr. Walker. We haven't looked at that.
    I think one has to be careful about General Motors, because 
the fact of the matter is, you have to look at the nature of 
their plan. If their plans have shutdown benefits, which it is 
very possible that they could, then they could look fine from 
the standpoint of the 10-K, because they are not considering 
the shutdowns.
    But there could be real problems if in fact they actually 
terminate and there are huge benefits that pop up overnight.
    We can't take a whole lot of comfort in the 10-K numbers. 
You have to look below the numbers. You have to look at the 
nature of the assets. You have to look at the nature of the 
plan and the nature of the benefit obligations to truly get a 
true sense as to what the real exposure is.
    Mr. Edwards. My time is up, but I would just hope someone 
could take a look at that in a broad brush figure, just to get 
a sense of what the numbers would be.
    Chairman Nussle. Mr. Cooper.
    Mr. Cooper. Thank you, Mr. Chairman.
    Thank you, Mr. Spratt, for requesting this hearing.
    As always, thank the witnesses. I appreciate your 
leadership on these issues, and even more so on the larger 
deficit and debt issues.
    I would like to reiterate a comment made at the outset of 
this hearing, that as bad as these problems are with PBGC, they 
are relatively small set of problems in comparison with the 
larger deficit and debt issues that we face.
    And I hope that all our colleagues will take it to heart, 
some of the warnings particularly David Walker has made, 
because the chart that you showed at the outset of the hearing, 
when by 2040 it will take all government revenues just to 
service the debt and there will be very little, if any, money 
left over for national defense or Social Security or Medicare 
or anything, clearly should illustrate we are on the wrong 
path.
    But this Congress is not deviating from that wrong path. In 
fact, we are probably accelerating, because I think General 
Walker has said that, I think this is an exact quote: 
``Arguably, 2004 was the worst year in American fiscal 
history,'' because we promised $13 trillion worth of stuff that 
we aren't paying for.
    Eight trillion dollars of that was in one bill, the 
Medicare drug bill. And that bill, as I recall from the last 
session, has almost a billion in funding to educate Americans 
about the bill and transition into it and things like that.
    Poor General Walker has hardly any budget to tell people 
about the dangers posed by promising $8 trillion in one piece 
of legislation that is not paid for.
    So if we put this hearing in perspective, these problems 
are grave, but not nearly as grave as the larger problems. And 
I would hope we could have more hearings on the larger 
problems.
    And with the chairman's indulgence, perhaps we can do that.
    Very few issues can shake a society to its foundations, but 
I think this is one. As we fly back and forth to Washington in 
airports, we are approached by dozens of airport workers, 
scared, because they are afraid their airline is going to 
declare bankruptcy, and they don't really know what PBGC will 
or will not do for them. Upper income folks over $45,000 are 
particularly concerned.
    But is it not true--my understanding is that an employee 
who works for what they thought was a good American company, 
works for 20 or 30 years, has a defined benefit plan, that 
should that company go bankrupt, that employee, despite a 
lifetime of work and hard service is just an unsecured creditor 
in the bankruptcy proceedings. So they would come after a long 
line of secured creditors and others who would have a prior 
claim on the assets of that company.
    Is that a correct understanding?
    Mr. Holtz-Eakin. I think the crucial issue is where does 
the PBGC stand in line in bankruptcy. And indeed, they don't 
have any preferred status in bankruptcy. And as a result, 
cannot claim assets and other resources to honor the benefit.
    Mr. Cooper. With a woefully underfunded, underprepared 
PBGC, they are going to start looking to us, the U.S. Congress 
and to the American taxpayer almost immediately.
    Because they thought they were already part of an ownership 
society. They thought they already owned their pension. They 
thought it was due them.
    And these people are waking up and suddenly finding that 
their entire retirement plan is possibly shaken, if not 
destroyed.
    Mr. Walker. Mr. Cooper, Doug is correct in saying that the 
issue is not about the individual participants. If the plan 
terminates, is underfunded, and is guaranteed by PBGC, then the 
PBGC stands in line.
    A vast majority of their claims typically are unsecured 
claims. There are certain circumstances in which they could 
have secured or priority claims, but those are generally the 
exception rather than the rule.
    Therefore, that is why it is important not just to think 
about this as a PBGC issue, there are real losses imposed on 
participants, even if PBGC steps in and even if PBGC is 
adequately funded for today and tomorrow.
    Mr. Cooper. If they were listening to this hearing, they 
would have heard already that these multi-employer plans are 
safer, because there at least you have multiple managements 
watching the store.
    They would have also heard that a lot of our CEOs have made 
sure that they were taken care of through nonqualified plans, 
so they don't have to worry about PBGC or anything. Their plan 
is funded and safe and removed from bankruptcy and taken care 
of.
    So the average poor worker, who all they have done is do a 
good job at their job their entire life would have to feel a 
little worried at this point.
    And they realize theirs is a single employer plan, so there 
hasn't been that level of safeguard. The PBGC is underfunded. 
Their boss or bosses have taken care of themselves and really 
probably don't care in terms of their own financial interests. 
That seems to be a society in which it is more dog eat dog than 
the Golden Rule.
    Mr. Walker. Excuse me, I think we have to be careful, a 
significant majority of sponsors of single employer defined 
benefit plans are responsible and a majority of the plans are 
well-funded.
    Regarding multi-employer plans, I think we have to be 
careful, because they are not necessarily better off. It is 
individual facts and circumstances.
    There are troubled multi-employer plans too.
    Mr. Cooper. I would agree. Most plans are properly run. But 
if you are in the airline industry or the steel industry or 
some of these other industries, you are likely to be extremely 
concerned.
    And I worry that our government looks so out of touch. If 
we can't even get data that is more than 3 years old, we look 
clueless and hopeless in trying to protect people and their 
earned benefits.
    So this is the situation.
    I appreciate your testimony. I see my time has expired. But 
this should be an urgent matter, not as big as the overall debt 
crisis that we face, but an urgent matter for this Congress to 
face up to.
    I thank the gentleman.
    Chairman Nussle. Mr. Case.
    Mr. Case. Thank you.
    We are all taking off on Mr. Cooper's comments about going 
through airports. I am married to a United Airlines flight 
attendant, who used to be a Pan American flight attendant. That 
is called a double PBGC whammy. Not only do I not want to go 
through airports nowadays, I don't even want to go home. 
[Laughter.]
    Let me ask you a bigger picture question, because I think 
we obviously have a problem, a looming crisis. And one more 
large bankruptcy is going to turn it into a full-blown crisis.
    I think it is important for us to understand the 
generational extent of the problem. Let me make a statement and 
get your reaction to it. In the next 25 to 50 years, are we 
going to have a substantial population of defined benefit 
plans? Because it strikes me that in the big picture, they are 
moving toward some form of obsolescence.
    I am talking about private plans, by the way. State and 
county governments and the Federal Government--well, the 
Federal Government is pretty much out of it at this point, but 
State and county governments are still in the defined benefit 
arena, and they can figure that out, that doesn't really affect 
us.
    But in the private sector, are we looking at getting 
through a bubble here, a 25-year bubble? I don't know the 
figures about whether new companies or old companies are 
creating new defined benefit plans, or whether they are 
primarily trying to shift the risk, the overall risk, over to 
the employees or come up with a different program that will 
somehow yield really the defined contribution model being the 
pension model, if we have that model at all, from a private 
employment perspective.
    Is there any anecdotal or empirical evidence that that is 
happening?
    Mr. Holtz-Eakin. Well, there is lots of evidence on trends. 
The defined benefit plan used to be the preferred model. But a 
greater fraction of the labor force is now covered by defined 
contribution plans than defined benefit plans. So certainly as 
a fraction of workers, defined benefit plans are going down, 
defined contribution plans are going up.
    In terms of absolute numbers, there are more workers 
covered than ever by defined benefit plans.
    Defined benefit plans will be an important part of the 
landscape for quite a while to come. Even if they diminish as a 
fraction of the total.
    Mr. Walker. I differ somewhat on this. First, my wife is a 
Delta Airlines retired flight attendant, so I feel your pain.
    Mr. Case. Condolences.
    Mr. Walker. I haven't felt it yet, but we may in the 
future.
    Defined benefit plans have been declining in number. The 
number of participants covered in defined benefit plans are 
such that more and more represent retirees, rather than 
actives.
    Thirdly, the only types of defined benefit plans that have 
really showed any life, as far as creating them, are so-called 
hybrid plans, that look more like defined contribution plans, 
but they provide some type of a defined promise, like cash 
balance plans.
    One of the reasons is because when the Congress imposed the 
reversion tax, in other words, when sponsors terminate their 
plans, take out excess money, when they are well-funded, they 
have to pay excise taxes on that. As a result a lot of 
sponsors, rather than going from a defined benefit plan to a 
defined contribution plan, which is clearly where the growth is 
in the private sector and it is likely to stay for a number of 
years for a variety of reasons, many went to a hybrid plan as a 
way that they could move toward the defined contribution world, 
have potentially less volatility and uncertainty with regard to 
their risk, and be able to obtain the economic benefit of the 
surplus without having to pay excise taxes.
    I think it is highly unlikely that the traditional defined 
benefit plan will resurge any time in the near future, at 
least.
    Mr. Case. Let me ask you, from a perspective of foreign 
competition, if you know, when our companies go out there and 
try and compete in the world with a defined benefit plan, are 
they at a distinct competitive disadvantage at that point, 
because I assume that it is true.
    I don't really know what is happening in China, for 
example, in terms of private pension plans. But it would seem 
to me that if the trend here over time is that the competition 
in increasingly from China, especially in classic defined 
benefit plan country like manufacturing, that you would see the 
companies of our country in manufacturing evolve away from 
defined benefit plans because it is just simply uncompetitive 
when they look overseas at a place like China.
    Mr. Holtz-Eakin. I think it is useful to do that in two 
steps. Step one is to determine the nature of overall 
compensation relative to the productivity of the workers? That 
determines fundamental competitiveness.
    And pensions are part of that compensation. And the issue 
with the defined benefit plans and the PBGC is, in those 
circumstances, whether at a firm level or at an industry level 
or an economy level, competitiveness changes and compensation 
needs to be restructured, i.e., you have to change the way you 
do business.
    How can past promises be preserved for the future? That is 
the nature of the insurance, because you will never be able to 
fully anticipate whether today's compensation bargain is the 
right one for tomorrow.
    But given these structures, employees have done the work. 
You have promised the compensation. You have to somehow either 
put the resources aside or buy insurance to make sure that they 
get paid for their past labor. And so you want to break the 
question of competitiveness between total compensation and the 
competitiveness that that delivers--versus assuring that the 
commitments of the past are honored.
    Those are two different problems.
    Mr. Walker. The biggest competitive challenge that we face 
is health care, by far. That is truly a competitive 
disadvantage.
    Secondly, if you look at the nature of past losses and 
exposure, in the defined benefit system to the PBGC and the 
planned participants and beneficiaries, they are concentrated 
overwhelmingly in industries that have one of two 
characteristics--number one, increasing global competition, and 
number two, domestic deregulation.
    Those are where a vast majority of the losses are.
    Mr. Case. Thank you.
    Chairman Nussle. Mr. Davis.
    Mr. Davis. Thank you, Mr. Chairman.
    General, Mr. Holtz-Eakin, welcome to you today.
    You were saying, General Walker, that your belief is that 
the overwhelming majority of corporate actors are responsible 
in this area and that the overwhelming majority of companies 
have made the appropriate decisions in terms of contributing to 
their pension plans.
    I would contrast that a little bit with some observations 
that I saw in The Washington Post a few days ago, and you may 
or may not want to comment on the veracity of these statements.
    There was an observation from the GAO that said that 
because of the rules and the requirements as to the 
contributions, that over 60 percent of the largest companies 
between 1995 and 2002 did not make adequate new contributions 
to their plans.
    The Republican chairman of the Senate Finance Committee, 
Senator Grassley, bemoaned the fact that, as he put it, ``the 
rules themselves were full of very serious holes.''
    As I listen to this argument, I have this image in my mind 
of the bankruptcy debate that we had just a couple of months 
ago. And in interest of full disclosure, I voted for the 
bankruptcy bill because I tend to prefer bright-line standards 
over no standards.
    But during that debate over bankruptcy, there were a lot of 
people on, frankly, both sides of the aisle, on my side, on the 
chairman's side, who kept using the phrase ``personal 
responsibility'' over and over again.
    And it sounds great, this idea of personal responsibility, 
this idea that people pay their bills, which is better known as 
another way of keeping your promises, because when you enter an 
arrangement with a creditor and promise to pay them, that is a 
promise, in effect.
    And we got very outraged about the idea that, well, people 
making $45,000 a year were shirking their duties and they were 
trying to get in Chapter 7 when they didn't need to be, and we 
got all bent out of shape about all of these middle-class 
people walking around who just didn't want to pay their bills, 
weren't being responsible.
    It seems pretty clear to me that we are talking about 
another kind of moral responsibility here.
    When a company enters an arrangement with an employee and 
provides a pension, that strikes me that, that is as moral a 
promise as the one a creditor makes with a debtor, and that--
vice versa--and that ultimately there are companies in America, 
some of them with the excuse of hard times, some of them 
without that excuse, who are simply taking advantage of fairly 
soft rules and not adequately funding their plan.
    And I am reminded, frankly, of something that the 42d 
President of the United States, Bill Clinton, used to say a 
lot. He used to, when he was making my party one that 
identified with personal responsibility again, he would use the 
phrase that for all of our talk about personal responsibility, 
we shouldn't lose sight of the fact that the greatest flight 
from responsibility in this country in the 1980s and 1990s came 
at the top and not the bottom of the economic sphere.
    And I would submit that, frankly, that is where we are 
again. Frankly, the bankruptcy bill that we passed and that I 
voted for should have given priority to the PBGC.
    Frankly, we ought to be finding ways, across the aisle, to 
incentivize companies to do the right things for their 
employees. We ought to be doing things to incentivize them to 
contribute to their pension plans.
    And we shouldn't just be so cavalier about this idea that 
when companies get in trouble the first people they ask to 
sacrifice are the people who are earning their profits for them 
every single day.
    I think that this is a matter of moral responsibility. And 
would either of you care to comment on that proposition?
    Mr. Walker. Well, let me comment on the GAO report, because 
I reviewed it, and it is referenced in my testimony.
    Basically, overall funding levels have deteriorated during 
the period 1995 to 2002, but most plans were well-funded.
    Here is what happens. When companies start to get into 
trouble, they start using the rules such that they will do what 
they are minimally required to do under the law, rather than 
what is right.
    My personal view is, is that people ought to not make 
promises that they can't deliver on and that the law should be 
structured to maximize the chance that they are held 
responsible and accountable to do that in the vast majority of 
circumstances.
    But the simple fact of the matter is, history has shown 
that when people get in trouble, pensions are not a priority, 
they do the minimum, and therefore there is a put option 
exercised on the PBGC which ultimately represents a contingent 
liability to the taxpayer.
    Last thing. I have been very outspoken on the need for 
corporate governance reform, and on the need for additional 
transparency and accountability in the private sector. GAO and 
I were very actively involved in Sarbanes-Oxley and other 
issues, and we will continue to be.
    Mr. Davis. Well, I appreciate that.
    If I can just wrap up, Mr. Chairman, in just 10 seconds.
    I mean, frankly, all the people in my party who are sitting 
around looking for a big idea for us to talk about, this ought 
to be one of our big ideas, how we keep our commitment to 
employees every day and how we stop companies from shirking 
their responsibilities by taking advantage of loopholes.
    If it is good enough for people who are filing bankruptcy--
you know, sometimes I wish that we cared as much about the 
people who vote for us, as we do the people who write us 
checks.
    Chairman Nussle. Ms. Schwartz.
    Ms. Schwartz. Thank you, Mr. Chairman. And thank you also 
for this hearing.
    And I appreciate the most recent questions, and in 
particular I know there was a lot of discussion about, 
generally, transparency and knowing more about what is going 
on.
    But I am really interested in that, because of Mr. Davis 
and Mr. Cooper asking very much about the employee, about the 
plan participants. And I know there has been a lot of 
discussion about personal responsibility, about individual 
employees being able to take on pretty important decisions 
about how they invest and save for the future.
    I do not agree with the president's plan to privatize 
Social Security. But I do agree that Americans should have both 
flexibility and ability to make retirement investment decisions 
and be given more flexibility and information to do that.
    We are now faced with the whole concern you have about 
pensions and about their not being there. And you have been 
calling for more information to us, Congress, to you, to just 
make sure we don't end up with too many underfunded pensions.
    But even looking at the president's proposal and some of 
his ideas, which I think some of them are good ones, how much 
information is going to be available to employees along the 
way? To what degree do you think they ought to know and have 
access to information in an understandable way?
    Everyone can say, look, stockholders, shareholders, 
employees, can go to annual meetings and they can look through 
all that information. But I think all of us who have been 
employees, our eyes glaze over when we have our 5-minute 
meeting with the human resources person when we first get 
hired, and we never see them again, until we retire.
    And then we say, ``Well what did the fine print say?'' And 
there are a lot of years in between.
    And how can we in an ongoing way provide information to 
employees or require companies to provide that information to 
employees about the status of their pension plans, changes that 
have been made, the degree to which they are funded or 
unfunded,even the concern today is, they have been funded 
adequately, but it has not been doing well, so that the value 
has gone down and maybe appropriately the company says I am 
going to take some money out of there, put it in there, try and 
invest in the company. It will do better. Employees will 
ultimately do better and I will be able to pay back the pension 
plan.
    It sounds a little bit like what the Government is doing 
with some Social Security trust funds.
    But it is maybe not an outrageous notion, except when it 
doesn't work. And when in fact, they are paying far too little 
in and it ends up in a disaster, which then the taxpayers have 
to pay and employees don't get all that they should.
    So my question is, what can we and should we be doing to 
require companies to be more straightforward with their 
employees and provide information in a really consumer friendly 
way, if you could say that, and encourage employees to take all 
the personal responsibility they can to understand the reality 
that they are in? So not just dealing with the fear that 
everybody has about what next, but what can actually be done to 
help the employee be a part of the solution, if they can be at 
all?
    Mr. Walker. I think it is important to note that under 
current law, plan participants and beneficiaries are required 
to get a summary annual report. They have the opportunity to 
receive the Form 5500, which is the annual report that is filed 
with the Government. They obviously have an opportunity to 
look, if it is a public company, at the 10-K.
    I think the problem is is that some of the information that 
they are giving is not in a very useful and usable format. It 
is provided as part of a tremendous amount of information and 
people don't really understand what is important.
    I think one of the answers is, you need to give them more 
timely, more market-based information and in a way that they 
are more likely to pay attention to it, understand about it, 
and care about it.
    I think that should be a key element of any comprehensive 
reform proposal.
    Ms. Schwartz. OK. You need to be more specific about that 
as we go forward, about what that would mean.
    I guess the next question would be, do you think that they 
should be able to take any action--I am not sure what that 
would be. But what happens when they get all this information 
and they find out that it is going to be pretty tough going 
forward? What then do they do about it?
    Mr. Walker. Well, it depends. I mean, the fact of the 
matter is, if it is a collectively bargained plan, and if they 
knew more about it, employees could end up bringing more 
pressure on those who represent them to try to be able to make 
sure that the plan is adequately funded.
    If it is not a collectively bargained plan, employees could 
bring more pressure on management in order to try to make sure 
that people are not just avoiding the problems.
    Transparency and sunshine is a powerful force. A lot of bad 
things can happen if they are done in the dark. So I think we 
need to include this.
    Ms. Schwartz. OK. I appreciate that. And again, the 
information be in a really consumer-usable way is really the 
point. So thank you very much.
    Thank you, Mr. Chairman.
    Chairman Nussle. I thank the gentlelady.
    Thank you very much, both of you, for your testimony today. 
This is an opportunity to be in some ways a canary in the mine 
shaft. And we hope that the warnings will be taken by our 
colleagues on other committees.
    We will certainly make sure that they understand what 
happened on some of the testimony here today, and hopefully we 
can begin to use the reconciliation process this year to usher 
through some new proposals with regard to PBGC to help 
alleviate the challenges that are obviously upcoming, from your 
testimony.
    Mr. Walker.
    Mr. Walker. One quick thing, Mr. Chairman.
    I just want to refamiliarize you and the other members on 
the committee with our ``21st Century Challenges'' report. 
Several of the members, including yourself as chair, noted that 
this is a subset of a much bigger problem.
    There are 202 illustrative questions that need to be asked 
and answered about the base of the Federal Government in here. 
One of them relates to PBGC.
    This is an important issue, but it is a subset of a much 
bigger challenge. We look forward to working with you and 
others to try to address them in the future.
    Thank you.
    Chairman Nussle. I thank you.
    And without anything further to come before the committee, 
we will stand adjourned.
    [Whereupon, at 11:30 a.m., the committee was adjourned.]

                                  
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