[Senate Hearing 109-122]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 109-122

              PBGC REFORM: MENDING THE PENSION SAFETY NET

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

                                HEARING

                               BEFORE THE

             SUBCOMMITTEE ON RETIREMENT SECURITY AND AGING

                                 OF THE

                    COMMITTEE ON HEALTH, EDUCATION,
                          LABOR, AND PENSIONS
                          UNITED STATES SENATE

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                                   ON



 EXAMINING PROPOSALS TO REFORM THE PENSION FUNDING RULES AND PREMIUMS 
          PAYABLE TO THE PENSION BENEFIT GUARANTY CORPORATION

                               __________

                             APRIL 26, 2005

                               __________

 Printed for the use of the Committee on Health, Education, Labor, and 
                                Pensions



                    U.S. GOVERNMENT PRINTING OFFICE
20-955                      WASHINGTON : 2005
_____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov  Phone: toll free (866) 512-1800; (202) 512ï¿½091800  
Fax: (202) 512ï¿½092250 Mail: Stop SSOP, Washington, DC 20402ï¿½090001


          COMMITTEE ON HEALTH, EDUCATION, LABOR, AND PENSIONS

                   MICHAEL B. ENZI, Wyoming, Chairman

JUDD GREGG, New Hampshire            EDWARD M. KENNEDY, Massachusetts
BILL FRIST, Tennessee                CHRISTOPHER J. DODD, Connecticut
LAMAR ALEXANDER, Tennessee           TOM HARKIN, Iowa
RICHARD BURR, North Carolina         BARBARA A. MIKULSKI, Maryland
JOHNNY ISAKSON, Georgia              JAMES M. JEFFORDS (I), Vermont
MIKE DeWINE, Ohio                    JEFF BINGAMAN, New Mexico
JOHN ENSIGN, Nevada                  PATTY MURRAY, Washington
ORRIN G. HATCH, Utah                 JACK REED, Rhode Island
JEFF SESSIONS, Alabama               HILLARY RODHAM CLINTON, New York
PAT ROBERTS, Kansas

               Katherine Brunett McGuire, Staff Director

      J. Michael Myers, Minority Staff Director and Chief Counsel

                                 ______

             Subcommittee on Retirement Security and Aging

                      MIKE DeWINE, Ohio, Chairman

JOHNNY ISAKSON, Georgia              BARBARA A. MIKULSKI, Maryland
ORRIN G. HATCH, Utah                 JAMES M. JEFFORDS (I), Vermont
JEFF SESSIONS, Alabama               JEFF BINGAMAN, New Mexico
PAT ROBERTS, Kansas                  HILLARY RODHAM CLINTON, New York
MICHAEL B. ENZI, Wyoming (ex         EDWARD M. KENNEDY, Massachusetts 
officio)                             (ex officio)

                   Karla L. Carpenter, Staff Director

              Ellen-Marie Whelan, Minority Staff Director

                                  (ii)






                            C O N T E N T S

                               __________

                               STATEMENTS

                        TUESDAY, APRIL 26, 2005

                                                                   Page
DeWine, Hon. Mike, Chairman, Subcommittee on Retirement Security 
  and Aging, opening statement...................................     1
Mikulski, Hon. Barbara A., a U.S. Senator from the State of 
  Maryland, opening statement....................................     2
    Prepared statement...........................................     2
Belt, Bradley, Executive Director, Pension Benefit Guaranty 
  Corporation, Washington, DC....................................     3
    Prepared statement...........................................     6
Enzi, Hon. Michael B., Chairman, Committee on Health, Education, 
  Labor, and Pensions, prepared statement........................    12
MacFarlane, Ian, Market Strategist, Medley Global Advisors, New 
  York, NY; Sallie Ballantine Bailey, Senior Vice President-
  Finance and Controller, the Timken Company, Canton, OH; Ron 
  Gebhardtsbauer, Senior Pension Fellow, American Academy of 
  Actuaries, Washington, DC; and Alan Reuther, Legislative 
  Director, United Auto Workers, Washington, DC..................    15
    Prepared statements of:
        Mr. MacFarlane...........................................    17
        Ms. Bailey...............................................    21
        Mr. Gebhardtsbauer.......................................    31
        Mr. Reuther..............................................    33

                          ADDITIONAL MATERIAL

Statements, articles, publications, letters, etc.:
    Kennedy, Hon. Edward M., a U.S. Senator from the State of 
      Massachussetts.............................................    50
    Response to question of Senator Kennedy by Ron Gebhardtsbauer    51
    Response to questions of Senator Kennedy by Bradley Belt.....    54
    Response to questions of Senator Mikulski by Bradley Belt....    58
    Prepared statement of the National Rural Electric Cooperative 
      Association................................................    59

                                 (iii)

  

 
              PBGC REFORM: MENDING THE PENSION SAFETY NET

                              ----------                              


                        TUESDAY, APRIL 26, 2005

                                       U.S. Senate,
     Subcommittee on Retirement Security and Aging, of the 
       Committee on Health, Education, Labor, and Pensions,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 10:05 a.m., in 
Room 430, Dirksen Senate Office Building, Hon. Mike DeWine, 
chairman of the subcommittee, presiding.
    Present: Senators DeWine, Enzi, Isakson, and Mikulski.

                  Opening Statement of Chairman DeWine

    Senator DeWine. Good morning. I would like to welcome 
everyone to the first hearing of the Subcommittee on Retirement 
Security and Aging. I look forward to an active hearing 
schedule, both in the area of pensions and in aging issues. I 
also look forward to working with Ranking Member Mikulski 
again. The Senator and I have worked together in the past and 
have a great relationship, and Barbara, I look forward to 
working with you again. We worked together on aging issues in 
the 106th Congress when we collaborated together on the 
reauthorization of the Older Americans Act.
    Today, we will be looking at the Pension Benefit Guaranty 
Corporation, the agency charged with insuring the defined 
benefit pension plans. The agency's deficit sits at $23 billion 
right now and there have been some spectacular pension plan 
failures in recent years that have greatly worsened its 
financial position. The administration has proposed a 
combination of higher premiums to be paid by plan sponsors and 
higher funding standards as a means of reducing the under-
funding in the system.
    With this hearing, we will address several questions. What 
is the correct level to which we should increase the PBGC 
premiums, what is the optimal level of increased funding that 
will result in better funded plans without forcing the plan 
sponsors to abandon their plans or declare their bankruptcy and 
yet protect the financial integrity of the PBGC? I stress that 
last phrase, protect the financial integrity, because a 
taxpayer bailout is simply not an option.
    We will hear first from Mr. Bradley Belt, Executive 
Director of the PBGC. We welcome you this morning and look 
forward to your testimony.
    Mr. Belt. Thank you, Mr. Chairman.
    Senator DeWine. Barbara, let me move--before we get to your 
testimony--to Senator Mikulski for her comments. Barbara, thank 
you very much.

                 Opening Statement of Senator Mikulski

    Senator Mikulski. Mr. Belt, just a few words. First of all, 
Senator, I want to thank you for holding this hearing and want 
to thank Senator Enzi for taking such a keen interest in the 
area of pensions and even changing the name of our 
subcommittee. Also, we want to thank his staff, the full 
committee staff, for also helping with the research.
    Once again, I look forward to working with you. We were the 
ones that finally reauthorized the Older Americans Act, so we 
are a kind of ``get it done'' team here, and I particularly 
cherish the relationship because of your collegiality and 
civility, and we are Northeast-Midwest Corridor Senators. Both 
Senator DeWine and I come from States that have had a 
manufacturing base. We know that these companies now are either 
challenged or teeter-tottering, and some have either faded away 
or filed bankruptcy.
    America faces a challenge, particularly in its 
manufacturing area, about what happens when corporations or 
companies for a variety of reasons can no longer take care of 
their pension responsibilities. We saw it firsthand in Maryland 
when Bethlehem Steel--Bethlehem Steel--closed and offshored its 
pension onto the PBGC. We are concerned that that could happen 
all over.
    We know that the funding now is not a crisis, but it could 
come sooner than later and we need now to fully understand 
exactly what we need to do to shore up the solvency of the 
Pension Benefit Guaranty Corporation by first doing no harm, 
second, making sure we look out for those people who count on a 
pension plan, and later, whatever changes we make, we must make 
sure that we don't further exacerbate the problems that good 
guy business face in the new global economy.
    Mr. Chairman, I would like my full statement to go into the 
record and look forward to the advice of these very able 
witnesses, and thank you.
    Senator DeWine. Senator, thank you very much.
    [The prepared statement of Senator Mikulski follows:]

                 Prepared Statement of Senator Mikulski

Introduction

    Thank you to Chairman DeWine for holding this hearing. We 
look forward to hearing about the financial status of the 
Pension Benefit Guaranty Corporation, known as PBGC, and begin 
exploring ways to fix some of the problems they are having.
    I know how important this is. PBGC is now insuring the 
pensions of over 40 million workers. These Americans are 
counting on their pension to be there when they retire. This is 
an important leg of the three-legged stool: pension, social 
security, and savings.

Maryland

    This is especially important for Maryland. In 2002 when 
PBGC took over the pensions for Bethlehem Steel it was the 
largest pension plan ever assumed by the PBGC. While we 
appreciated the PBGC being there to guarantee the pensions for 
nearly 100,000 Bethlehem steel workers, many of whom lived in 
Maryland, there were also some problems encountered during the 
takeover. While it is important for the PBGC to be there to 
protect the pensions of Americans, we must also protect the 
businesses who have made the commitment to provide these 
pensions.

Current Problems Facing the PBGC

    We know that the funding of the PBGC is not a crisis but a 
real problem that many American workers will face come 2040. It 
is important that we take steps to shore up the solvency of the 
Pension Benefit Guaranty Corporation, but we must first ``do no 
harm.''
    Any steps we make should not come at the expense of our 
employer-provided pension system. We fully understand that 
employer provided pension plans are voluntary, not mandatory. 
Over 40 million Americans rely on the pension plans that the 
PBGC insures. If the rules governing such plans get too 
draconian, employers can discontinue their plans.
    I worry that the administration's pension funding proposals 
does not balance the competing goals of improving the PBGC's 
finances and maintaining an environment that is conducive to 
employers continuing their pension plans.
    For employees we need to make sure that pension promises 
made by employers are kept. Some PBGC funding rules may need to 
be changed but these promises are long-term commitments. For 
businesses, we must assure that short term difficulties don't 
result in long term problems, forcing companies to choose 
between continuing their pension plan and continuing their 
business. Solutions to address short-term funding difficulties 
must be balanced between the long-term solvency of the PBGC and 
the overall health of pensions in America.

Closing

    I'm on the side of: (1) employees who are counting on 
promised pensions when they retire; (2) good guy businesses who 
have made the commitment and still provide pensions to their 
workers; and (3) taxpayers who shouldn't have to bail out the 
troubled PBGC.
    I appreciate what a difficult task this is. I look forward 
to hearing from our witnesses today, getting the facts about 
the current status of the PBGC and exploring ways to improve 
it's solvency while protecting the pensions of America.
    Senator DeWine. Mr. Belt?

STATEMENT OF BRADLEY BELT, EXECUTIVE DIRECTOR, PENSION BENEFIT 
              GUARANTY CORPORATION, WASHINGTON, DC

    Mr. Belt. Mr. Chairman, Ranking Member Mikulski, thank you 
for the opportunity to appear before you this morning on such a 
vitally important issue. I appreciate the opportunity to 
discuss the challenges facing our Nation's defined benefit 
system and the administration's proposals to meet these 
challenges.
    I would like to begin by asking the committee to envision a 
world in which defined benefit pension plans were fully funded. 
In such a world, workers and retirees would not lose promised 
benefits. Responsible companies would not have to pay higher 
pension insurance premiums. And taxpayers would not face the 
risk of a costly rescue of the Federal pension insurance 
program.
    Unfortunately, that is not the world we inhabit. On the 
contrary, ours is a world in which too many corporate defined 
benefit plans have terminated without enough assets to cover 
the liabilities. Responsible companies and perhaps even 
taxpayers are on the hook for picking up the tab, and most 
importantly, too many workers and retirees have their 
expectations of a financially secure retirement shattered.
    Mr. Chairman, this is not about the PBGC. The agency is 
only a conduit. This is about retirement security. Consider the 
Bethlehem Steel worker who started at the mill in January of 
1972 at age 19 and retired in April of 2002 at age 50 with just 
over 30 years of service. Every month, this worker was 
receiving a pension check from Bethlehem Steel in the full 
amount he had earned, $3,641. But when the plan terminated in a 
woefully underfunded State, statutory limits on PBGC's 
insurance coverage reduced his monthly benefit to $1,192, a 67 
percent reduction.
    This is the human toll exacted by the failure of companies 
to adequately fund the pension promises they have made to their 
workers. Moreover, PBGC's record deficit raises the specter 
that workers in failed pension plans will lose twice, once when 
their company failed to live up to its promises, and a second 
time when the government cannot fulfill its guarantee.
    At a recent meeting, workers and retirees in a terminated 
pension plan were told that the PBGC has sufficient assets to 
pay benefits for perhaps as long as 20 years. That was small 
comfort to one 45-year-old participant who noted with dismay 
that PBGC could run out of money just as he was preparing to 
retire.
    The administration believes that the pension promises 
companies have made to their workers and retirees must be kept. 
That is why the administration's proposed comprehensive reforms 
are designed to strengthen the financial health of the defined 
benefit system. Underfunding in the pension system must be 
corrected now to protect worker benefits and ensure that 
taxpayers are not put at risk of being called upon to pay for 
broken promises.
    Mr. Chairman, we recognize that the defined benefit system 
is a voluntary one and we have made every effort to balance the 
interest of all the system's stakeholders. Not surprisingly, 
some in the pension community have complained that we are being 
too tough on them, that the reforms will cause them to exit the 
system.
    Let us be clear. Under the status quo, we have seen an 
exodus from defined benefit plans over the past 20 years. Under 
the status quo, we have seen a growing number of plans that are 
substantially underfunded terminate. Maintaining the status quo 
is not going to save the system.
    We believe that the proposed reforms are not only necessary 
to address the systemic flaws that have led us to this hearing, 
but that they are also fair, responsible, and measured.
    While some issues raised by sponsors and other stakeholders 
warrant further consideration, many of the arguments are 
without merit. I would like to briefly touch upon a few of 
them.
    For example, we are told the proposal would increase 
volatility and make contributions more unpredictable. This 
simply isn't true. The risk and volatility associated with 
defined benefit plans is a function of the investment and 
business decisions made by plan sponsors. Our objective is only 
to ensure that this risk is transparent to all stakeholders. 
Current smoothing rules simply masks the risks and volatility. 
Moreover, companies have the means under current law to manage 
these risks in accordance with their own risk tolerances and 
the administration proposal provides additional tools to 
control volatility, including 7-year amortization of pension 
deficits and the enhanced ability to pre-fund benefits in good 
economic times.
    We are told that the corporate community cannot tolerate 
the use of a corporate bond yield curve to discount pension 
liabilities, even though yield curves are used regularly to 
value other financial instruments, such as mortgages and 
certificates of deposit. Discounting future benefit cash flows 
using rates from a spot yield curve is the most accurate way to 
measure plans' liability and does not change the obligations 
that make up the plan liabilities in any way.
    We are told that corporate credit ratings should not be 
used to determine pension funding or PBGC premiums, but it is 
both reasonable and fair to require higher plan contributions 
and premium payments from companies that pose a higher risk of 
underfunded terminations. Even so, the administration provides 
a 5-year phase-in to the higher at-risk funding target for any 
plan whose sponsor becomes financially weak.
    We are told that companies will have no incentive to make 
extra pension contributions if they can't take advantage of 
credit balances, yet it is the credit balance feature of 
current law that allowed companies like Bethlehem Steel, U.S. 
Airways, and United Airlines, PBGC's largest claims, to avoid 
making contributions to their plans for several years prior to 
termination. This is true, notwithstanding the fact that they 
were already substantially underfunded and the amount of 
underfunding grew significantly during the run-up to 
termination.
    We believe sponsors would have ample incentive under the 
administration's proposal to make more than the minimum 
required contributions for three reasons. First, they would 
generate a larger tax deduction. Second, they would shorten the 
amortization period. And third, their risk-based premiums would 
be lower.
    Finally, Mr. Chairman, we are told that the proposal on 
PBGC premiums would put an inappropriate burden on employers 
with well-funded plans and would result in volatility and an 
added burden on financially-stressed companies. It is 
understandable that plan sponsors would rather not pay higher 
premiums or subsidize underfunded plans of financially-weak 
sponsors. The ultimate issue is who pays for past and future 
claims.
    As I noted, the administration believes that companies that 
make the promises to their workers should pay for them, which 
is why we have put so much emphasis on strengthening the 
funding rules. But changes to premiums are still necessary to 
compensate for the losses that have and inevitably will occur.
    Mr. Chairman, the administration's pension reform proposal 
is necessary to improve the financial health of defined benefit 
pension plans and strengthen the Federal pension insurance 
program that stands behind them. We look forward to working 
with you and the committee to enact pension reform legislation, 
and I would be pleased to answer any of your questions.
    Senator DeWine. Mr. Belt, thank you very much.
    [The prepared statement of Mr. Belt follows:]

                 Prepared Statement of Bradley D. Belt

                                SUMMARY

    In an ideal world, pension promises would be fully funded and 
retirees would receive the full benefits they have earned. But reality 
is that companies fail to adequately fund plans and workers too often 
are robbed of a secure retirement when an underfunded pension plan 
terminates. Structural flaws in the system that have allowed 
underfunding must be corrected now to protect the 35 million workers 
and retirees in the single-employer system and to ensure that the 
burden of unfunded pensions does not eventually have to be shifted to 
taxpayers.
    The administration has proposed reforms to correct these flaws. We 
believe the proposals are fair and responsible. This testimony 
addresses objections that we feel are not warranted:
    (1) Assertion: Contributions would be more volatile and 
unpredictable if current law smoothing mechanisms were eliminated. In 
fact, current law smoothing rules mask true liability but do not 
eliminate volatility. Employers decide the extent to which they will 
manage that risk. The proposal increases transparency by measuring 
liability more accurately. It also provides additional tools to manage 
volatility, including 7-year amortization of pension deficits and an 
enhanced ability to pre-fund benefits in good economic times.
    (2) Assertion: Valuing pension liabilities using a yield curve will 
be too difficult and expensive. Yield curves are used regularly to 
value other financial instruments such as mortgages and certificates of 
deposit. Discounting future benefit cash flows using rates from a spot 
yield curve is the most accurate way to measure a plan's liability and 
does not change the obligations that make up plan liabilities in any 
way.
    (3) Assertion: Corporate credit ratings should not be used to 
determine pension funding or PBGC premiums. It is both reasonable and 
fair to require higher plan contributions and premium payments from 
companies that pose a higher risk of underfunded terminations. Even so, 
the administration provides a 5-year phase-in to the higher ``at-risk'' 
funding target for any plan whose sponsor becomes financially weak.
    (4) Assertion: Companies will have no incentive to make extra 
pension contributions if they can't take advantage of current law 
credit balances. Credit balances allowed Bethlehem Steel, US Airways, 
and United (PBGC's largest claims) to avoid making contributions for 
several years prior to termination, despite substantial underfunding in 
their plans. Our proposal gives important incentives to contribute more 
than the minimum: a larger tax deduction and lower risk-based premiums.
    (5) Assertion: The proposed PBGC premium structure would put an 
inappropriate burden on employers with well-funded plans and would 
result in volatility and an added burden on financially stressed 
companies. It is understandable that plan sponsors would rather not pay 
higher premiums or subsidize underfunded plans of financially weak 
sponsors. The ultimate issue is who pays for past and future claims.
                                 ______
                                 
    Mr. Chairman, Ranking Member Mikulski, and members of the 
committee, good morning. I want to commend you for holding this timely 
and important hearing. I appreciate the opportunity to discuss the 
financial challenges facing the defined benefit pension system and the 
pension insurance program, and the administration's proposals for 
meeting these challenges.
    Before I outline some of the reasons why fundamental and 
comprehensive pension reform is so urgently needed, I think it would be 
helpful to step back, take a look at the big picture, and ask three 
questions:

     Where are we?
     How did we get here? and
     What needs to be done?

Where Are We?

    A secure retirement depends on all three legs of the so-called 
retirement stool--Social Security, personal savings, and private 
pension plans. As you know, the President has made retirement security 
a top national priority, and he is committed to strengthening each leg 
of the stool. I would like to focus my comments on one vitally 
important leg: defined benefit pension plans.
    Private-sector defined benefit plans have been and are intended to 
be a source of stable retirement income for more than 44 million 
American workers and retirees. Unfortunately, as I discuss more fully 
below, the defined benefit system is under severe stress--the number of 
defined benefit plans has fallen precipitously over the past 2 decades, 
the percentage of the workforce covered by such plans has dropped by 
half, and, in many cases, benefits are being frozen or the plans are 
being closed to new participants.
    More ominously, there have been a growing number of instances in 
which plans have been terminated by their sponsors with assets far 
insufficient to pay the promised benefits. This results in lost 
benefits for a number of participants in those plans, threatens the 
long term financial solvency of the insurance program, requires 
sponsors that have acted responsibly to pay higher premiums, and 
potentially could lead to a call for a rescue of the program with 
taxpayer funds.
    I would emphasize that this has occurred under the current 
statutory and regulatory framework. In order to stop the hemorrhaging 
in the system, to put the insurance program on a sound financial 
footing, and to best protect the benefits of millions of workers and 
retirees, the administration believes that comprehensive pension reform 
is critically needed. If we do nothing or merely tinker at the margins 
the inevitable outcome will be a continued erosion of this important 
retirement security leg and continued large losses for participants, 
premium payers and potentially taxpayers.

State of the Defined Benefit System

    Traditional defined benefit pension plans, based on years of 
service and either final salary or a flat-dollar benefit formula, 
provide a stable source of retirement income to supplement Social 
Security. The number of private sector defined benefit plans reached a 
peak of 112,000 in the mid-1980s. At that time, about one-third of 
American workers were covered by defined benefit plans.

    Senator DeWine. The administration's proposals would 
require some employers to make much larger pension 
contributions starting right away. How much modeling has the 
administration done to determine how many companies would not 
be able to meet those sudden increases in cash flow demand, and 
how certain are you that we will not see more bankruptcies as a 
direct result of this proposal or that you are not turning some 
of those probable problems into really definite problems for 
the PBGC?
    Mr. Belt. A very good question, Mr. Chairman. Let me first 
note that we have to compare the administration's proposal 
relative to current law. Current law has more onerous funding 
requirements than does the President's proposal. Under current 
law, many companies are sucked into the DRC requirements, 
deficit reduction contribution requirements, and the 
amortization period could be as short as 3 years under current 
law. It is under current law that the airlines and others are 
having a very difficult time meeting their funding obligations.
    The administration proposal provides a much more measured 
time frame within which to fund the pension plan fully, a 7-
year time frame. In addition, we provide additional incentives 
to fund up, if the company has the ability to do so, relative 
to current law.
    I would also note that we make no changes to current law 
relative to the ability to obtain a waiver if there is a 
temporary business hardship confronting the company that they 
can apply to the IRS, and the IRS consults with the PBGC and 
they may have the ability to obtain some funding relief. So we 
believe that there are ample mechanisms available both under 
current law as well as the President's proposal to address 
those issues. But the bottom line is, I do not believe that the 
administration proposal relative to current law is any more 
likely to force anybody into bankruptcy.
    Senator DeWine. We have seen press reports about abuses at 
the credit rating agencies, yet the administration has proposed 
giving those entities enormous power, including the power to 
stop benefit payment options and accruals that have been 
collectively bargained and the power to undercut an 
individual's retirement planning. How do you respond to 
criticism that the government would be giving this power to 
nameless analysts who are basically not subject to significant 
oversight?
    Mr. Belt. Mr. Chairman, I would simply note that it is not 
really the government that gives them this power. These 
agencies have this power under current law. Rightly or wrongly, 
that is the way the current market structure works. These 
companies really set the cost of capital for companies that 
they cover each and every day in the marketplace. It is a 
combination of credit ratings, credit spreads on their publicly 
traded debt, as well as financial instruments like the credit 
default swaps market.
    In addition, there are numerous other instances within 
government where there are credit risk elements used to price 
premiums or to apply to underwriting requirements, for example. 
As you know, the SEC recognizes the credit rating agencies 
under SEC proposals. In addition, the banking regulators use a 
credit risk element that pertains to the premiums as well as 
the underwriting requirements or capital standards that banks 
must live up to.
    Senator DeWine. Senator Mikulski?
    Senator Mikulski. Thank you very much, Mr. Chairman, and I 
note Senator Enzi is here. I was just complimentary to you, 
Senator, about encouraging us to look at the pension issue. It 
is like a big convergence in the Senate today. The Finance 
Committee is holding a hearing on the solvency of Social 
Security and we on the PBGC, and I believe that there are 
strong similarities.
    Tell me, what is the solvency of the PBGC? In other words, 
where are you and how long will you be okay, and are you okay?
    Mr. Belt. As we reported, at the end of the last fiscal 
year, we had a deficit of $23 billion. We also have substantial 
exposure to potential future losses. Those numbers have grown 
substantially, as well. The overall underfunding in the system 
has grown, and we estimate at the end of last year it was more 
than $450 billion. In addition, we have nearly $100 billion of 
exposure to plans that are sponsored by companies which are at 
a higher risk of default or terminating the pension plans, 
junk-rated sponsors.
    So there is a substantial amount of losses that have 
already been incurred and a substantial amount of future losses 
that we could reasonably expect, particularly if there are no 
changes to the current regulatory and funding rules.
    There has been the question raised as to, well, there is no 
problem because the PBGC is sitting on $40 billion of assets, 
and indeed, under our current business model, we have 
sufficient liquidity to pay benefits for a number of years yet. 
The problem is that the hole gets deeper each and every day.
    If, for example, I take over United Airlines' pension 
plans----
    Senator Mikulski. Could I jump in, because I have only a 
few minutes. So what you are saying is, right now, you have $23 
billion in debt----
    Mr. Belt. Of unfunded obligations----
    Senator Mikulski. [continuing]. Unfunded obligations, and 
this is why I believe Senator Enzi told us to have this hearing 
You know, the American worker who has ever had to turn to PBGC 
sees this almost as the FDIC of pensions, and if I might say 
too, dear colleagues and so on, I am worried that this could be 
like another savings and loan crisis. It all looked okay, and 
then 1 day, all of a sudden, America had this tremendous 
unfunded liability because we didn't stand sentry in the way we 
needed to. They are not identical, but that is the way the 
worker thinks and I know my colleague from Georgia is just 
shaking his head.
    So number one, reform is needed. You could be hit by a 
tsunami if all of these companies go under fast. Am I correct?
    Mr. Belt. We have certainly seen that occur in the steel 
industry. We have seen that now to some extent in the airline 
industry.
    Senator Mikulski. Right.
    Mr. Belt. We also have exposure to other industry sectors.
    Senator Mikulski. That is exactly right. So my question 
then is, what would be, in terms of must do, should do, would 
like to do reforms, and when, to really move this to solvency 
and not leave the American people with an incredible unfunded 
liability and, therefore, devastating the lives that depend on 
it? It is a $100 million obligation. Just put the people behind 
those numbers and it is really scary.
    Mr. Belt. That is an excellent question, Senator Mikulski. 
Clearly, the most important thing is to make sure the plans are 
fully funded. We need to strengthen the funding rules. We have 
funding rules in place now, but they demonstrably have failed. 
We would not have instances of companies terminating pension 
plans at only 30, 40, 50 percent funding levels, with billions 
of dollars of underfunded liability, if the funding rules 
worked.
    There are inevitably going to be business cycles. 
Companies, for a variety of reasons, are going to fail. We 
can't change that. What we need to change is that if they are 
sponsoring a pension plan when that company fails, the pension 
plan is fully funded so the workers and other premium payers 
and the taxpayers are not put at risk.
    Senator Mikulski. Well, let me raise a question, because I 
am so glad you talked about Bethlehem Steel, and I have another 
question related to them that I will submit in writing.
    But when I met with Bethlehem Steel executives before the 
crisis and then the consolidation, etc., those executives 
assured me that the best steel pension plan was funded. Now, 
this was in the 1990s, and these were honorable men, so I don't 
dispute what they said. They said, oh, thank God, the market is 
doing well. Our pension is funded. So I breathed a sigh of 
relief that at least while we worked on other things, like 
dumping and predatory practices, etc, the pension was funded.
    Then, bang, Bethlehem Steel says goodbye, a melancholy 
goodbye, you know, and then the pension wasn't funded. Thank 
God for PBGC. But as you have indicated, their pension was 
reduced. Thirty years, 35 years of black smoke, bad backs, 
varicose veins, working in rough, tough work, and what the hell 
did it mean? They are feeling that very keenly.
    So my question to you is surrounding this--and I see my 
time is up--is they tell workers one thing, then it doesn't 
work out. I am into the prevention so we don't have to 
intervene. Is there a different way we can do this?
    Mr. Belt. Certainly one of the issues there which caught 
everybody by surprise, although the PBGC had the relevant 
information, we are not able to disclose it, is that they were 
able to report on a current liability basis, which bears very 
little relationship to economic reality, that they were fully 
funded in the years leading up to the termination, and I have a 
slide in my written testimony that demonstrates that, 91, 99, 
80-plus-percent funded, whereas, in fact, on a termination 
basis, they were only 45 percent funded.
    Senator Mikulski. See, that is what they were telling me.
    Mr. Belt. And the issue is obviously we need better 
liability measures, which is one of the core elements of the 
administration's proposal, so that, in fact, everybody has an 
understanding of what it means to be fully funded or not fully 
funded. Right now, you have current liability, you have 
termination liability, you have FAS liability, you have the 
full funding limitation. Nobody knows what it means when 
somebody says, oh, we are fully funded.
    Senator Mikulski. Well, thank you. Mr. Chairman, you have 
been very gracious, but I think we see how complicated and 
technical this is. The other thing that happened was--and I am 
going to submit this question in writing, with your indulgence 
of an extra minute--the guys got their checks and the women who 
also worked there, and then they were told that your agency 
made an overpayment and then they had to give back thousands of 
dollars. It was a mess. It is too complicated to go into here, 
sir.
    I would like to submit a letter to you giving the 
background and two things. One, can we get any of their money 
back for them? And number two, how could we prevent--because 
they were hit by a double-whammy. They lost their pension. They 
got money from you, and then they were told they got too much. 
But let me submit that in writing and go on to other questions 
of my colleagues.
    Mr. Belt. I am aware of that recoupment issue and we would 
be delighted to address that more fully.
    Senator Mikulski. Thank you. I really look forward to 
working with you, sir.
    Senator DeWine. Thank you, Senator.
    Senator Isakson?
    Senator Isakson. Thank you, Mr. Chairman.
    Director Belt, in the answer to the question preceding the 
last exchange with the Senator from Maryland, I think I got you 
right. You were making a comment where the goal would be to see 
to it that if companies ran into financial difficulties and 
bankruptcy became inevitable, that the pension fund would be 
funded so that they could meet their obligations to their 
retirees. Was that a correct statement of the goal?
    Mr. Belt. That is correct.
    Senator Isakson. Given the current climate that we are in, 
where we have had a stock market period from late 1999 through 
2002 which caused a lot of problems in the actuarial 
underpinnings of these pension funds and other things that have 
happened, in accomplishing that goal, we do go back to running 
the risk, however, of which comes first, the bankruptcy or the 
fully funding the pension fund, is that not correct?
    Mr. Belt. That is certainly an issue under current law. We 
would believe it would be less of an issue, Senator Isakson, 
under the administration's proposal since we provide a smoother 
funding path than does current law, which has--in which the 
deficit reduction contribution rules are implicated.
    Senator Isakson. That is a longer amortization period, 
correct?
    Mr. Belt. It is as short as 3 years under current law.
    Senator Isakson. Correct. There is a third component. There 
are a number of components to pension plans, but one of those 
components are the benefits that have been promised, defined 
benefits that have been promised to the retiree, but it is 
possible for those retirees to amend their own benefits as a 
part of a plan reorganization, is it not?
    Mr. Belt. They can amend future benefits. There are rules 
in place which do not allow them to give up, in a sense, 
accrued benefits.
    Senator Isakson. Yes. There is a constitutional right of 
contract, I think, for the ones that are earned to date, but 
future ones can be amended, is that not correct? In that case, 
that also can be a part of the solvency of a pension plan, 
couldn't it, a combination of a change in the amortization, 
i.e., in the President's proposal or another proposal, plus 
beneficiaries amending their future benefits that would 
otherwise be calculated in the actuarial figures, am I correct 
there?
    Mr. Belt. Certainly those are things that can be done under 
current law, and if it is covered by a collective bargaining 
agreement, that would be subject to any strictures in the CBA.
    Senator Isakson. This is probably not a fair question to 
ask you in your position, but it seems to me in all cases that 
if the company and the employees can solve the problem, we are 
always better than the Pension Benefit Guaranty Corporation 
having to take it over, would that not be correct?
    Mr. Belt. Senator, certainly I think everybody's interest 
is best served if companies are able to honor the pension 
promises they made to their workers, they maintain those plans. 
Everyone is hurt when the PBGC has to step in and take over an 
underfunded pension plan. By the same token, I think we would 
all agree that we need to make sure that any actions we take do 
not simply result in further losses down the line or exacerbate 
the moral hazard that already exists in the system.
    Senator Isakson. That is a very responsible answer and I 
appreciate that answer.
    The Senator from Maryland, she was thinking exactly what I 
have been saying. I was in the residential real estate business 
during the days of the Office of Thrift Supervision and the 
savings and loan bailout, and although the guarantees made by 
the FSLIC and the problems were different, in quotes, than the 
pension issue, there are many, many similarities. Leading up to 
the failure of the savings and loan associations were a series 
of well-intended but poorly thought out government decisions 
that affected the S&L industry and put it in a precarious 
situation. I think there is an analogy there with where we are 
with pensions today.
    Mr. Belt. I agree wholeheartedly.
    Senator Isakson. We need to be very careful that for the 
best of intentions, we don't make decisions that have the worst 
of ramifications for the Pension Benefit Guaranty Corporation 
and for those future retirees, as well. But I think it is the 
best, clearest example of what could happen if we don't act 
responsibly and in such a way to maximize the benefit of these 
pension funds to survive in a joint venture between those 
future beneficiaries and current beneficiaries, the company 
hopefully still staying in business and having you as an 
absolute worst case fallback, both from a standpoint of the 
beneficiary as well as the American taxpayer.
    I see my time is up, so I will end with that comment, Mr. 
Chairman.
    Senator DeWine. Senator Enzi?
    The Chairman. Thank you, Mr. Chairman. I appreciate your 
holding this hearing. I would ask that my full statement be a 
part of the record.
    Senator DeWine. It will be made a part of the record.
    [The prepared statement of the Senator Enzi follows:]

                   Prepared Statement of Senator Enzi

    On March 15, the HELP and Finance Committees held a joint 
forum to look into the long-term future of private sector 
retirement security plans. A general consensus was reached by 
our 17 participants that our Nation's private defined benefit 
plans have been extremely beneficial, and in some cases 
essential, for many workers' retirement needs.
    I appreciate Chairman DeWine holding today's hearing to 
explore the mechanics of our defined benefit system and the 
administration's proposal to increase the schedule of premiums 
that pension plans pay to the Pension Benefit Guaranty 
Corporation (PBGC).
    While the administration has proposed setting new premiums, 
it should be done in the broader context of pension reform. 
However, we must be able to determine the correct way to value 
assets and liabilities of the plans before we can get to the 
question of how to set the premiums.
    Our private sector defined benefit system is a voluntary 
system--a system that everyone agrees we should preserve. A 
taxpayer bailout is not an option. This committee needs to find 
out that if costs are raised too drastically and too quickly 
whether individual companies and their employees may not be 
able to bear the additional costs. My fear is that the 
administration's proposal will lead to the collapse of the 
overall defined benefit system.
    We do not want to destroy what is left of the defined 
benefit pension plan system in the United States by setting up 
a premium schedule that can be otherwise viewed as a 
confiscatory tax system on plan sponsors.
    Restoring the PBGC to solvency and removing it from the GAO 
``Watch List'' are important. However, they are not the only 
priorities, and some may say that they are not the highest 
priorities. Getting money into employees' pension plans and 
having workers and companies negotiate within their means are 
certainly more important than simply increasing pension costs 
on pension plan sponsors. It is irresponsible of companies that 
do otherwise. Overall reform will be that much more difficult 
to achieve if companies are strong-armed into a short-term fix 
of the system.
    Clearly, these issues are all interrelated and that is why 
comprehensive pension legislation is necessary to stabilize the 
private sector defined benefit system.
    Recently, many household-name companies have announced that 
they are freezing their defined benefit plans: Sears, Ford, 
Motorola, GE, Xerox, and Rockwell-Collins, and the list goes on 
and on. These are not bankrupt companies. They are the not the 
``bad actors'' that the administration has been criticizing. 
Yes, they have had to look at their business plans and budgets. 
CFOs and CEOs must evaluate how much volatility and liability 
they are willing to take onto their balance sheets and their 
earnings per share in order to keep their defined benefit plans 
active.
    Certainly we need to shore up the finances of the PBGC. But 
we must ask, are we making the defined benefit system better, 
or do we hasten its demise?
    With regard to the defined benefit pension plan system, 
Congress needs to take the Hippocratic oath: First do no harm.
    I look forward to the testimony of Mr. Belt and the other 
panel of outstanding witnesses to help us understand these very 
difficult but timely issues.
    Thank you Mr. Chairman.
    The Chairman. This is being done at a particularly critical 
time because the Budget Committee is trying to reach some 
agreement at the moment on what language will be in there that 
you will have to deal with in order to solve this vast problem. 
I have a lot of confidence in you and Senator Mikulski to be 
able to get that done.
    Senator Mikulski. OK.
    [Laughter.]
    The Chairman. I will be right there helping.
    Senator DeWine. We have confidence you will help get the 
right figure, too, Mr. Chairman.
    [Laughter.]
    The Chairman. We are working on that. We are having some 
difficulty.
    Senator DeWine. I understand.
    The Chairman. Mr. Belt, the administration's proposal 
doesn't expressly rate a pension plan on its asset allocation 
or mandate a specific investment strategy. In hearings before 
other committees, the administration witnesses have expressed a 
preference for plans to invest in bonds in order to bear the 
market risk themselves rather than engaging in the moral hazard 
of rolling the dice on stock. But while the administration plan 
doesn't demand a shift to bonds, many believe that is the 
logical and desired result. The elimination of the 4-year 
weighted average is one such change.
    Isn't such insistence on a nonsmoothed interest rate the 
same as telling plans to invest in bonds? What would happen to 
the pension plan's rate of return if it completely insulated 
the PBGC from losses by investing 100 percent in bonds?
    Mr. Belt. That is an excellent question, Senator Enzi. I 
want to make one point of clarification. I have certainly never 
said, and I don't believe any administration official has ever 
indicated, nor is it part of the administration's proposal, 
that companies should shift into bonds. Those are business 
decisions best made by the company, by the CEO and CFO and CIO 
as to how they allocate assets in the pension plan.
    What I think we are trying to say is that there are risks 
embedded in those decisions. Let us just make sure that those 
risks are transparent and understood by all the stakeholders.
    I know there have been some who have said, well, this is 
going to cause a massive shift into equities if all of a sudden 
this risk becomes transparent to shareholders, to participants, 
and others. I don't believe personally that that will be the 
case, and it is very interesting. I know we have a witness that 
will talk about the UK experience on the second panel as to 
what has transpired there.
    The same argument was made in the UK with respect to the 
adoption of FRS 17, which was going to require mark-to-market 
of assets and liabilities, as well. But has that been the 
experience? No. As of the end of 2004, the asset allocation to 
equities by UK pension plans, according to Russell Mellon, was 
just over 65 percent. It was just over 68 percent the year 
before, and that 3 percent shift was not all into equities. It 
was into hedge funds. There has not been a massive shift.
    The Chairman. So you are saying that the elimination of the 
4-year weighted average isn't insistence on a nonsmoothed 
interest rate?
    Mr. Belt. It is----
    The Chairman. We should tell people to invest in bonds?
    Mr. Belt. It would be--we would certainly--we definitely 
believe that there should not be smoothing, that that simply 
masks risk and volatility. We do not believe that that would 
necessarily lead to a shift in asset allocations. If 
companies--we believe companies should be prudently managing 
both the assets and liabilities. Heretofore, they have been 
able to take substantial risk, but it is the company that bears 
the up-side of that risk. It is the pension insurance program 
that bears the consequences of a mis-bet.
    The Chairman. To clarify my original question, I mote that 
in questions and answers in front of the Senate Finance 
Committee, the Tax Benefits Council at Treasury told the 
committee that if sponsors don't want to suffer through 
volatility, they should invest in bonds.
    Mr. Belt. There are numerous mechanisms under both current 
law as well as the administration's proposal to take risk off 
the table should they choose to do so. If they want to 
volitionally take on that additional risk, as long as that is 
transparent to the shareholders, to participants, and everyone, 
all the other stakeholders, that is a business decision we 
believe should be made by the company.
    The Chairman. In a study by the Center on Federal Financial 
Institutions, Doug Elliott expresses the concern of many that 
the premium proposal in the President's budget relies so 
heavily on variable premiums collected on underfunding that it 
is likely to drive underfunding down to a level where no 
reasonable premium rate could bring in the projected dollar 
amount. How do you respond to that criticism?
    Mr. Belt. It is very difficult to model behavioral changes. 
Our past experience is that under current law, most companies 
tend to simply contribute the minimum, not the maximum allowed 
by law, notwithstanding some assertions to the contrary. But I 
guess in some respects, that would be a nice problem to have. 
That is, everybody becomes fully funded so we don't have to 
charge higher premiums. That is the whole notion of an 
insurance system. If you don't have losses, you can keep 
premiums down as low as possible. That is the reason why we put 
so much emphasis on the funding rules.
    The Chairman. My time has expired.
    Senator DeWine. Mr. Belt, thank you very much. We look 
forward to working with you on the subcommittee and appreciate 
your time very much.
    Mr. Belt. Thank you all.
    Senator DeWine. Thank you.
    Let me invite our second panel to come, and as you all come 
up, I will begin to introduce the second panel.
    On the second panel, we will hear from Ian MacFarlane of 
Medley Global Advisors. Mr. MacFarlane will tell us about the 
experience in the United Kingdom with pension reform, pension 
insurance agencies, and the impact recent changes there have 
had on the viability of the pension schemes, as they call them.
    Next, we will hear from Sallie Bailey, Vice President for 
Finance of the Timken Company of Canton, OH. She will give us 
observations regarding the administration's proposals to 
increase the PBGC premiums and funding standards from the plan 
sponsors' perspective.
    The last two witnesses will be Ron Gebhardtsbauer, former 
Chief Actuary of the PBGC and now the Senior Pension Fellow at 
the American Academy of Actuaries, and finally, Mr. Alan 
Reuther, Legislative Director of the United Auto Workers.
    We welcome all of you here and appreciate very much all of 
you being here.
    Mr. MacFarlane, we will start with you. Thank you very 
much.

STATEMENTS OF IAN MacFARLANE, MARKET STRATEGIST, MEDLEY GLOBAL 
 ADVISORS, NEW YORK, NY; SALLIE BALLANTINE BAILEY, SENIOR VICE 
 PRESIDENT-FINANCE AND CONTROLLER, THE TIMKEN COMPANY, CANTON, 
OH; RON GEBHARDTSBAUER, SENIOR PENSION FELLOW, AMERICAN ACADEMY 
  OF ACTUARIES, WASHINGTON, DC; AND ALAN REUTHER, LEGISLATIVE 
         DIRECTOR, UNITED AUTO WORKERS, WASHINGTON, DC

    Mr. MacFarlane. Thank you very much, Mr. Chairman, ladies 
and gentlemen.
    There was an actuarial estimate of the deficit of defined 
benefit schemes for the top 100 companies which was carried out 
in the middle of 2004. That showed that the deficit on those 
defined benefit schemes amounted to about 42 billion pounds 
Sterling. Now, that might not have much relevance to you in the 
United States, but that constitutes about 9 months of profits 
the previous year of those 100 companies. That is pre-tax 
profits.
    I think there is a lot of similarity between the problems 
which the United Kingdom has gone through in the years since 
the new millennium and what is occurring here in the United 
States. Both countries are grappling with aging populations, 
increasing longevity, and mature pension schemes which are 
creating a demand for increased cash flow. The pension debate 
promises to be at the center of political debate in both 
countries for many years.
    Given the vastness of the topic, I shall limit my remarks 
here to the UK experience with FRS accounting standards and its 
relevance in particular to the proposed introduction of a 
contemporaneous interest rate for the discounting mechanism in 
the United States.
    The implications of the UK experience with FRS 17 for the 
United States, I think, are unambiguous. Increased transparency 
is to be welcomed. Demographic trends and lower expected 
investment returns cry out for it. But volatility in company 
accounts could well be the unintended side effect, threatening 
dividend payments and employment. In this case, the objective 
of ensuring retirees' financial security is jeopardized by the 
threat of them not getting to retirement within the scheme.
    According to Adair Turner, the Chairman of the Pension 
Commission, between 60 and 70 percent of defined benefit 
schemes are now closed to new entrants in the United Kingdom. 
The cost of pension provisions have become too much for the 
employer in a cost-conscious environment. While FRS 17 was not 
the primary cause, at a minimum, it added additional 
administrative burdens, and at worst, created enough 
uncertainties to prompt asset classes to switch out of equities 
into fixed-income, and there is one particular example, Boots, 
where they actually moved 100 percent into fixed-income to try 
and take the volatility off their balance sheet. And their 
experience subsequent to that has actually been that they have 
run surpluses at a time when a lot of the other companies have 
actually run--schemes have run deficits.
    What is FRS 17? FRS 17 is an accounting standard which was 
introduced in the UK to improve the transparency of future 
pension costs measured in terms of a surplus or deficit. They 
key point is its primary aim, to provide shareholders with a 
snapshot, and the emphasis is on a snapshot, of future costs at 
a particular point in time. This means that calculated pension 
costs can sometimes change dramatically from year to year.
    I started by quoting the fact that in the middle of 2004, 
the estimated deficit was about 42 billion. The estimated 
deficit the previous year was about 55 billion, so about a 13 
billion pound shift, which is quite dramatic, and that was the 
result of improved investment performance, as well moving the 
opposite direction in interest rates, which actually raised the 
actual accounting liability.
    Concerns over FRS 17 have, therefore, focused primarily on 
the volatility of imparts to company accounts, owing to the 
capture of market noise and the sensitivity of actuarial events 
to even small changes in assumptions. Again, if we take that 
point in mid-2004, if you were to have raised the interest rate 
on the corporate bonds by 1.5 percent, that would have 
eliminated that deficit. By the same token, and just extending 
that analysis a little bit further, if Britain was to actually 
go into the European exchange rate mechanism, the net result--
or to join the Euro--the net impact of that would be to add 
about 20 billion pounds onto that 42 billion pound figure, or 
to actually increase the deficit by 50 percent. Likewise, if 
you were to actually change the actuarial assumptions because 
people are living longer, that would add another 20 billion.
    What I am trying to drive at here is these deficits and 
surpluses can swing around very dramatically in response to 
just very, very small changes in assumptions, and this speaks 
to the weakness of a snapshot approach, I think.
    The background to the introduction of FRS 17 is important 
in understanding how problems thrown up by FRS 17 emerged. The 
accounting standard did not initiate the trend to higher 
pension costs, but merely accentuated them. It was conceived at 
a time when equity returns peaked, just after Advanced 
Corporation Tax, which allowed pension funds to claim a tax 
credit on dividends, had been abolished, and at a time when 
many companies had been taking a contribution holiday. Through 
the 1990s, a lot of companies were actually running surpluses. 
The shift from surplus to deficit was very dramatic and 
happened very quickly and, therefore, went contributing. FRS 17 
helped bring home to them the costs of ending that holiday.
    Now also peculiar facts in the UK which also--a high ratio 
of equities in the total. I think the point I want to drive at 
here is essentially that FRS 17 has actually served to 
exacerbate the trends which were already evident.
    It therefore seems to me that a snapshot approach in 
increasing volatility also potentially works in reverse in 
terms of the efficient allocation of capital, which increased 
transparency is supposed to bring about. Defined benefit 
schemes tend to be more prevalent in the old industries who are 
not growth companies but more value-oriented dividend payers, 
and I think that is key. It would be a shame if noise disrupted 
the painful transition many of these companies in the United 
States are currently facing from developed market competition, 
and I think that is the evidence, or the lesson which the 
United Kingdom provides for the United States as it has its 
pension debate.
    Thank you very much.
    [The prepared statement of Mr. MacFarlane follows:]

                Prepared Statement of Ian P. MacFarlane

    My name is Ian MacFarlane, a Director at Medley Global Advisors in 
New York, a leading firm of macro political advisors and I am appearing 
here as someone with experience in the provision of pension fund 
products within the United Kingdom, and elsewhere in the globe, over 
the last 25 years.
    As the United States debates the issue of pension fund reform, the 
UK experience with the pension accounting standard FRS 17 between 2001 
and 2004, and a new pension bill (The Pensions Bill 2004), are I think 
very relevant to the United States. This is particularly so at a time 
when both countries are grappling with aging populations, increasing 
longevity and mature pension schemes. The pension debate promises to be 
at the center of political debate in both countries for many years. 
Given the vastness of the topic I shall limit my remarks here to the UK 
experience with the FRS 17 accounting standard and its relevance, in 
particular, to the proposed introduction of a contemporaneous interest 
rate for the discounting mechanism in the United States.
    The implications of the UK experience with FRS 17 for the United 
States are I think unambiguous. Increased transparency is to be 
welcomed. Demographic trends and lower expected investment returns cry 
out for it. But volatility in company accounts could well be the 
unintended side effect, threatening dividend payments and employment. 
In this case the objective of ensuring retirees financial security is 
jeopardized by the threat of them not getting to retirement within the 
scheme.
    I say this against the backdrop of what can only be described as a 
crisis within the UK pension funds industry. FRS 17 was not the cause 
of the crisis but has certainty not helped. According to Adair Turner, 
the Chairman of the Pension Commission, between 60 percent and 70 
percent of defined benefit schemes are now closed to new entrants. The 
costs of pension provision have become too much for the employer, in a 
cost conscious environment. While FRS 17 was not the primary cause, at 
the minimum it added additional administrative burdens and at worst 
created enough uncertainty to prompt asset class switches out of 
equities into fixed income to obviate the uncertainties on company 
balance sheets. This has not always been consistent with maximizing 
investment returns for any given level of risk. All of this is 
occurring at a time when as the Pension Commission concluded ``people 
must save more or work longer.''
    Well they are not saving more. Since 1997 the rate of growth of 
consumer spending has exceeded GDP growth by 6.5 percent points. If 
ever there was a time when defined schemes were needed it is now. This 
is a pattern, at least in respect of consumption, eerily reflected in 
the United States.
    FRS 17 is an accounting standard introduced in the UK to improve 
the transparency of future pension costs measured in terms of a surplus 
or deficit. Its primary aim is to provide shareholders with a snapshot 
of future costs at a particular point in time. This means that 
calculated pension costs can change sometimes dramatically from year to 
year. Under the previous accounting standard of SSAP24, which was 
predicated on the assumption that pensions were a long-term commitment, 
the principles and guidelines were left for company directors to 
interpret. Effectively the impact was to produce a stable pension 
expense from year to year. Initially the provisions of FRS 17 could be 
merely attached as a note to company accounts, under transitional 
arrangements, but as from 1 January this year full implementation has 
made it mandatory to include them in the reported figures for non 
listed companies. Listed companies now have to switch to IAS 19 (an 
option non-listed companies can also choose) which will be very similar 
to FRS 17 after a technical amendment. For clarity I will limit my 
remarks to the historic experience with FRS 17.
    Concerns over FRS 17 have focused primarily around the volatility 
it imparts to company accounts, owing to the capture of market noise 
and the sensitivity of actuarial estimates to even small changes in 
assumptions. What could be viewed as a healthy situation 1 year could 
be construed as a parlous situation the following year. For example, an 
increase in the longevity assumptions of employees or even the discount 
rate could lead to a shift to deficit or a sharp increase in the 
deficit. Because the approach is snapshot, this shortfall could then 
threaten the ability of a company to pay a dividend, although there had 
been no deterioration in the financial position of the company from the 
previous year. The share price would be hit and the cost of capital 
would effectively rise, reducing economic growth, if repeated across 
the market.
    The background to the introduction of FRS 17 is important in 
understanding how problems thrown up by FRS 17 emerged. The accounting 
standard did not initiate the trend to higher pension costs, but merely 
accentuated them. It was conceived at a time when equity returns peaked 
(2001), just after Advanced Corporation Tax which allowed pension funds 
to claim a tax credit on dividends had been abolished, and at a time 
when many companies had been taking a contribution holiday. FRS 17 
helped bring home to them the costs of ending the holiday.
    The issues were further complicated by the fact that the benchmark 
for the UK pension industry was the default of the median holdings of 
various assets across all funds, rather than related to the liability 
structure of the individual fund. As equity returns declined post 2000 
many funds found themselves with deficits, or in some instances an 
asset mix inappropriate to the cash flow demands as the scheme aged, 
both related to over exposure to equities. The median holding of 
equities in some asset mixes frequently rose over 80 percent. No 
effective re-balancing of the asset mix portfolios was under taken over 
the previous 30 years, and as equity returns exceeded bond returns the 
ratio of equities in the asset mix drifted up. Unsurprisingly 
individual schemes have recently begun to shift to client specific 
benchmarks.
    FRS 17 was therefore always going to expose deficits in the funding 
requirements of individual pension plans. To that end it has to be 
argued that in principle the accounting standard was an important step 
forward relative to the subjective approach of the SSAP24 guidelines. 
The issue is the volatility that the snapshot approach imparts to 
company Profit and Loss Accounts. This strikes at the heart of the 
proposal to use a contemporaneous discount rate rather than the 4-year 
average here in the United States. Such an approach would merely 
introduce noise into the equation.
    And despite all the greater transparency and rigor and efforts to 
move away from the subjectivity of SSAP24 there have still been quite 
on occasion large disparities in the numbers used for key assumptions. 
Variations in the discount rate used, which should be among the least 
controversial assumption, illustrate this point well.
    Theoretically the discount rate across funds which should coalesce 
around the yield on AA corporate bonds with a maturity of greater than 
15 years. But for 2003 a survey by actuaries Barnett Waddingham found 
that the discount rate used by 42 FTSE 100 companies varied between 
5.25 percent and 5.6 percent compared with 5.2 percent and 6 percent 
the previous year. To the extent that the assumptions have to be 
clearly stated, however, a comparison across funds can be made.
    The use of the corporate bond rather than a matching yield under 
the previous arrangements could also be argued to increase the 
accounting liability, via increasing the demand for corporate bonds and 
lowering interest rates. The growth in the UK corporate bond market 
over the last 5 years is grounds for suspicion that this is indeed the 
case. But, it could also equally be argued that the cash flow demands 
of mature pension funds, notwithstanding the decision by Boots to 
switch 100 percent into fixed income, would have resulted in an 
increased appetite in their own right.
    There has also been a belief that FRS 17 has meant the effective 
end of defined benefit schemes (final salary schemes) for new joiners 
for a company where one exists (i.e. the schemes close for new 
entrants). Again although the increasing shift to new employees joining 
defined contribution rather than defined benefit schemes has also been 
accelerated by the process, the increased costs to employers had also 
meant that the tendency had already been in place in the early 1990s. 
Based on figures compiled by the Government Actuarial Department there 
had already been a sharp fall in participation in defined benefit 
schemes between 1990 and 2001 prior to FRS 17.
    I should like to conclude where I started by re-iterating the 
importance of transparency and an accurate assessment of future pension 
costs. It is the basis on which a free economy, or specifically how the 
stock market, best allocates capital. But it also seems to me that a 
snapshot approach in increasingly volatility also potentially works in 
reverse. And defined benefit schemes tend to be more prevalent in the 
old industries, who are not growth companies, but more value orientated 
dividend payers. It would be a shame if noise disrupted the painful 
transition many of these companies in the United States are currently 
facing from developing market competition.

    Senator DeWine. Ms. Bailey?
    Ms. Bailey. Thank you very much. Chairman DeWine, Ranking 
Member Mikulski, and other members of the committee, thank you 
for the opportunity to speak with you today.
    My name is Sallie Ballantine Bailey and I am the Senior 
Vice President and Controller of the Timken Company. Part of my 
responsibility is to oversee all financial aspects of the 
company's defined benefit and defined contribution plans, and I 
agree with your committee that there is an urgent need for 
pension reform in the United States.
    Today, however, I come as a spokesperson for the National 
Association of Manufacturers in conjunction with the American 
Benefits Council, Business Roundtable, ERISA Industry 
Committee, and the U.S. Chamber of Commerce. On behalf of these 
organizations, I am here as a single voice to emphasize the 
need to strengthen our Nation's voluntary employee-sponsored 
defined benefit system.
    For decades, the Timken Company has sponsored defined 
benefit plans for our associates. Currently, 29,000 of our 
active and retired associates are covered by benefit plans. In 
2004 alone, we contributed $189 million to our plans and paid 
more than $140 million in pension benefits. Our benefits are, 
and will continue to be, an important part of a comprehensive 
benefit program to attract and retain talented associates.
    Approximately 34 million Americans who work in a variety of 
industries rely on voluntary single-employer defined benefit 
plans. These plans are a critical element of their retirement 
security. We know that in the absence of these plans, fewer 
Americans will be financially prepared for retirement and more 
Americans will need to rely on the country's already strained 
Federal entitlement programs.
    In short, the need for reform is clear and we commend this 
administration for recognizing that fact and we support some 
aspects of their package. However, we have serious concerns 
about many other parts of the proposal.
    We are concerned that the administration's reform effort is 
focused on reducing the deficits of the PBGC. Although it must 
be protected, we cannot lose sight of the fact that the PBGC 
was established to enhance retirement security. It would be an 
unfortunate decision to strengthen the PBGC while weakening the 
entire voluntary defined benefit system. We believe that 
unwarranted increases in PBGC premiums would be a detriment 
over the long-term because it would divert cash from pension 
contributions and investments in plant, property, and 
equipment, research and development, and hiring new employees.
    The PBGC has stated that it has enough funds to meet 
current needs, which is why we should take time to make sure 
that we are examining all the actions. We believe that, as a 
whole, the administration's package would do more harm than 
good. It is critical to find an appropriate balance between 
protecting the PBGC and strengthening the voluntary defined 
benefit system.
    We believe, overall, the administration's proposal would 
burden pension plans with unwarranted PBGC premium increases. 
The proposal's premium hikes are potentially enormous, and if 
adopted, the premium will cause operating cash flow that could 
be used for pension contributions, capital investments, and R&D 
to be diverted to the PBGC.
    We dramatically reduce the predictability and funding of 
premium obligations. The long-term corporate bond rate adopted 
by Congress last year must be made permanent. The proposal to 
use a spot interest rate to value pension liabilities would 
make pension rules even more volatile and unpredictable, and it 
wouldn't improve plan funding or accuracy. It would only 
interfere with our ability to develop reliable business plans.
    It would introduce a counterproductive use of credit 
ratings. An employer's credit rating is not directly tied to 
their pension plan. Pension assets are held in a separate 
trust, usually by a bank. Credit ratings are not a good 
indicator of a company's ability to make pension contributions. 
Think of it in simpler terms. If a homeowner temporarily loses 
his or her job, does having that knowledge give the lender the 
right to automatically increase the interest rate and payoff 
amount on the mortgage loan?
    It creates a strong disincentive to prefund. We support 
reforms to the credit balance provision, but as it stands now, 
the proposal eliminates credit balances. We should be 
encouraging employers to make extra contributions in good times 
so they will have a cushion for the bad times. A fully funded 
defined benefit plan is less expensive in terms of cash 
requirement and its income statement impact than an underfunded 
plan.
    The Timken Company and the organizations we are 
representing today strongly believe that the administration's 
proposal comes with very negative consequences for the 
retirement security of American workers. Furthermore, the 
restrictions placed on employers under these proposals would 
only force them to exit the system. In some cases, it could tip 
some employers into bankruptcy, costing American workers not 
only their retirement savings, but their jobs.
    Mr. Chairman and members of the committee, thank you for 
the opportunity to present our views. We look forward to 
working with you on developing solutions to the long-term 
funding challenges facing our pension system. The time is now 
to have a full debate on pension funding. It is extremely 
important to be sure that the issue of PBGC premiums is 
included in the overall pension reform, not in the Federal 
budget, and we must remember that our pension policies must be 
driven by what is best for American workers, American retirees, 
and employers.
    Thank you for your consideration.
    Senator DeWine. Ms. Bailey, thank you very much.
    [The prepared statement of Ms. Bailey follows:]

             Prepared Statement of Sallie Ballantine Bailey

    Chairman DeWine, Ranking Member Mikulski, and members of the 
subcommittee, thank you for the opportunity to appear before you this 
morning on this critical issue. I appreciate the opportunity to discuss 
the challenges facing our Nation's defined benefit system, as well as, 
the reforms that can meet these challenges.
    My name is Sallie Ballantine Bailey. I am the Senior Vice 
President-Finance and Controller for The Timken Company, which is a 
leading global manufacturer of highly engineered bearings, alloy steels 
and related products and services. Timken has operations in 27 
countries, sales of $4.5 billion in 2004 and employs 26,000 associates 
worldwide.
    Today, I am serving as a spokesman for the National Association of 
Manufacturers and on behalf of the American Benefits Council, Business 
Roundtable, the ERISA Industry Committee and the U.S. Chamber of 
Commerce. These organizations are steering committee members of The 
Pension Coalition, a broad based business coalition which is dedicated 
to advancing retirement security through voluntary employer-sponsored 
plans. We come before you today with a single voice to emphasize the 
need to strengthen our Nation's voluntary, employer-sponsored defined 
benefit pension system.
    The administration has stepped forward with proposals to reform the 
pension funding rules and the premiums payable to the Pension Benefit 
Guarantee Corporation (PBGC). There are a number of themes in the 
administration's package that we support. For example, we agree that 
the funding rules need to be strengthened. We also agree that measures 
to allow employers to make larger contributions during good economic 
times are long overdue. Improved disclosure rules would also be 
beneficial. Meaningful safeguards should also be considered to protect 
the PBGC from benefit enhancements adopted at a time when the plan 
sponsor is unlikely to properly fund those enhancements.
    At the same time, we are concerned that much of this reform effort 
is focused on reducing the deficits at the PBGC. Although the PBGC must 
be protected, we cannot lose sight of the fact that the PBGC was 
established to protect retirement security in the defined benefit 
system. It would be a distressing calamity if the PBGC was strengthened 
but the entire defined benefit system was weakened. We believe that the 
administration's pension funding scheme will do far more harm than 
good. Taken as a whole, the administration's package could have grave 
consequences for the millions of Americans who rely on defined benefit 
plans for their retirement security. It will be critical for Congress 
to find an appropriate balance between protecting the PBGC and 
strengthening the defined benefit pension system.
    Pension plans play a vital role in the lives of American workers 
and retirees. Across the country, some 34 million Americans rely on 
single-employer, private-sector defined benefit pension plans as a 
critical element of their retirement security. More than 18 million of 
these Americans are active workers from a diverse range of industries. 
Single-employer defined benefit plans paid benefits to retired workers 
and their families of more than $120 billion during 1999 (the most 
recent year for which official Department of Labor statistics have been 
published). In the absence of defined benefit pensions, it is certain 
that fewer Americans would be financially prepared for retirement, more 
American seniors would live in poverty, and many more Americans would 
be forced to rely even more heavily on already strained Federal 
entitlement programs.
    For decades, The Timken Company has sponsored defined benefit 
pension plans to provide for our associates' retirement security. Over 
29,000 of our active and retired U.S. associates are covered by defined 
benefit pension plans. In 2004 alone, we paid $189 million into our 
plans and made payments to retired participants in excess of $140 
million. We are proud of our pension plans and look forward to 
maintaining them for years to come.
    That reforms are needed is clear. Employers have been exiting the 
defined benefit system in alarming numbers in recent years. Just since 
2001, nearly a quarter of Fortune 1000 companies announced their 
decision to either freeze or actively consider freezing their defined 
benefit pension plans. Both terminations and freezes have truly 
unfortunate consequences for American workers--current employees 
typically earn no additional pension benefits and new hires have no 
defined benefit program whatsoever.
    The primary factors driving this trend are uncertainty regarding 
funding obligations; barriers to contributing during good times; and 
the lack of clear guidance on cash balance and other hybrid plans. 
Reforms are needed to address these issues and encourage employers to 
stay in the voluntary defined benefit plan system. We support taking 
the following steps:

Five Pension Reform Proposals That Would Improve Retirement Security

     Make the Long Term Corporate Bond Rate Permanent. The best 
way to protect the pension system for future retirees is to make 
permanent the long-term corporate bond rate that Congress adopted last 
year. The long-term corporate bond rate reflects a conservative and 
realistic rate of return that will provide an economically sound 
measure of future pension obligations.
     Allow Employers to Contribute to Plans During Good 
Economic Times. Barriers that prevent employers from making 
contributions to their plans should be eliminated. Reforms are needed 
to rules that prevent employers from contributing. In the past, The 
Timken Company would have liked to contribute more, but ultimately was 
forced to limit contributions to the maximum amount that would be tax 
deductible.
     Adjust Credit Balances For Real Market Returns. Credit for 
prefunding (``credit balances'') encourages companies to fund their 
plans during good times, which helps employers better plan their 
product investments, accelerates plan funding and reduces risk to the 
PBGC. However, plans with poor investment results have been able to use 
credit balances to meet their minimum required contributions. We 
support reforms to the application of credit balances.
     Provide Timely and Appropriate Disclosure. Participants 
should have timely and meaningful funding information on their 
retirement plans. Reforms are needed to provide full and fair 
disclosure without creating undue administrative burdens or unnecessary 
concerns among participants.
     Confirm the Legality of Hybrid Plan Designs. Nearly a 
third of large employers with defined benefit plans maintain hybrids 
and, according to the PBGC, there are more than 1,200 of these plans 
providing benefits to more than 7 million Americans as of the year 
2000. It is critical that Congress confirm the legality of hybrid plan 
designs.
    These reforms will help create a robust and sustainable defined 
benefit plan system. As mentioned above, there are a number of elements 
of the administration's proposals that are consistent with our reform 
proposals. For example, we both agree that better disclosure to plan 
participants is needed. Similarly, we support proposals to change the 
tax rules to permit employers to contribute more to their plans when 
they have the ability to do so.

Top Four Concerns With the Administration's Proposals

    However, we have serious concerns about other elements of the 
administration's proposals. Our primary concerns are that the 
administration's proposals would:

     Dramatically Reduce the Predictability of Funding and 
Premium Obligations. The administration's proposal to use a spot 
interest rate to value pension liability and mark-to-market treatment 
of assets would make the funding rules even more volatile and 
unpredictable than they already are, without improving accuracy or plan 
funding. This would severely handicap the ability of employers to make 
long-term business plans.
     Introduce a Troubling and Counterproductive use of Credit 
Ratings. The administration's proposal to base contributions and PBGC 
premiums on credit ratings would create the potential for a vicious 
downward corporate spiral. Lower credit ratings that increase funding 
liability, premium burdens and business pressures could lead to further 
downgrades, creating a vicious circle that drags a company down and 
prevents its recovery.
     Create a Strong Disincentive to Fund. Employers need to be 
encouraged to make extra contributions in good times so that they will 
have a sufficient cushion for the bad times. We support reforms to the 
credit balance provisions. The administration's proposal to eliminate 
credit balances would discourage employers from making extra 
contributions except in unusual circumstances. It goes without saying 
that such a restriction would be a major step backward.
     Burden Pension Plans with PBGC Premium Increases That are 
Unwarranted. No one denies that the PBGC faces a serious situation. 
However, the PBGC's unspecified but potentially enormous increase in 
premiums could be devastating for many plans, particularly plans 
sponsored by midsize to smaller employers.

    Taken as a whole, we believe the administration's proposals would 
have very adverse consequences for the retirement security of American 
workers. The additional barriers, risks and burdens under the 
administration's proposals will only force employers to exit the system 
through plan freezes and terminations, thereby eroding the retirement 
security of American workers. In the worst case, the administration's 
proposals could tip some employers into bankruptcy--costing those 
workers not only their retirement savings but potentially their jobs.
    We owe it to American workers and their families to ensure that 
changes, no matter how well-intentioned, are not counter-productive. We 
support proposals strengthening, without tearing down, a system that is 
a core part of how employers provide, and millions of Americans 
receive, retirement income security.
    We also owe it to American workers and their families to have a 
full debate on pension funding reform. In recent weeks, there has been 
discussion of including proposed increases in the premiums payable to 
the PBGC in the fiscal year 2006 budget resolution. The House budget 
resolution, for example, appears to contemplate premium increases of 
$18 billion over the next 5 years--which is effectively a tax increase 
of over 240 percent for companies maintaining defined benefit plans. 
Setting premium increase targets in the fiscal year 2006 budget 
resolution will make a full examination of pension funding reform 
virtually impossible. Pension funding and PBGC premiums are 
inextricably intertwined. Changes to PBGC premiums should only be 
considered in conjunction with changes to the funding rules as a whole. 
Any premium increases to hit budget targets will only handicap reform 
discussions. Excessive and unreasonable premium increases in the budget 
resolution would inevitably put short-range budget objectives ahead of 
the long-term retirement security that is needed. The budget process is 
simply the wrong place to make comprehensive pension law and we urge 
you to not include premium increases in the fiscal year 2006 budget 
resolution. Pension policy must be driven by what is best for American 
workers and retirees, not by the need to fill an arbitrary hole in the 
Federal budget.
    The remainder of this testimony describes the reforms that we 
believe should be enacted and highlights our concerns with the 
administration's pension reform proposals.

Funding the PBGC Appropriately

    The financial stability of the PBGC is important but not at the 
expense of the health of the defined benefit system overall. To put 
this in perspective, private sector defined benefit pension plans pay 
more than $110 billion in benefits to retirees every year. By 
comparison, in 2004 the PBGC paid just over $3 billion in benefits. 
Similarly, over 44 million Americans receive or will receive benefits 
from defined benefit plans, while the PBGC's present and future benefit 
population at the end of 2004 was only 1 million. It is critical that 
any reforms target the specific problems. The vast majority of defined 
benefit pension plans are not a threat to the PBGC--but onerous and 
volatile rules will threaten the vast majority of plans and the 
companies that sponsor them.
    The administration has proposed dramatic increases in premiums to 
address the PBGC's reported deficit. This proposal gives us great 
concern for several reasons. First, the proposed increase in the flat 
dollar premium from $19 to $30 and its indexing is strikingly 
inappropriate. This is a substantial increase on the employers that 
have maintained well-funded plans through a unique confluence of lower 
interest rates and a downturn in the equity markets. It is wrong to 
require these employers to pay off the deficit created by underfunded 
plans that have transferred liabilities to the PBGC. Second, the 
unspecified increase in the variable rate premium will become a source 
of great volatility and burden for companies struggling to recover. 
This could well cause widespread freezing of plans by companies that 
would otherwise recover and maintain ongoing plans. Many of these plans 
are well-funded by any other measure, but under the administration's 
proposal might be deemed ``underfunded'' and now be required to pay 
variable rate premiums on top of the higher base premium. This would 
only be exacerbated by the fact that the PBGC has proposed an 
unprecedented delegation of authority to its Board, rather than 
Congress, to determine the required premiums. A premium increase misses 
the point. The solution to underfunding is better funding rules, not 
higher premiums.
    We are very concerned that PBGC premium increases not become a tool 
used to reduce the Federal budget deficit. The administration's fiscal 
year 2006 budget reflects a $26 billion increase in revenue 
attributable to the PBGC's premium increase. Proper pension policy 
should be driven by what is best for American workers and retirees, not 
by the need to fill an arbitrary hole in the Federal budget.
    In addition, there has been a striking lack of clarity about the 
real nature of the PBGC deficit. The PBGC has reported a $23 billion 
deficit as of the end of fiscal year 2004 but there are a number of 
questions about the PBGC's situation. First, nearly three quarters ($17 
billion) of the PBGC's reported deficit represents ``probable'' 
terminations rather than claims from plans already trusteed by the 
PBGC. Second, the PBGC's numbers are based on a below-market interest 
rate. The deficit would be substantially less using a market-based 
interest rate. Third, swings in the PBGC surplus-deficit do not provide 
Congress with an accurate picture of the PBGC's ability to pay 
benefits. In fact, the PBGC can pay benefits for many, many years into 
the future. Finally, it is not clear why the PBGC has unilaterally 
moved away from equities to lower-earning investments that hinder its 
ability to reduce its deficit. No one denies that the PBGC faces a 
serious situation, and our proposals for funding reform are evidence 
that the employer community is serious and committed to shoring up the 
PBGC's financial condition. However, these are troubling questions that 
should be addressed before taking the very harmful step of increasing 
PBGC premiums.
    The best way to ensure a stable defined benefit system is to 
encourage plan sponsors to remain in the system, not to make the system 
so costly that they cannot afford to stay. The proposed substantial 
increase in the flat premium and the potentially huge increase in the 
variable rate premium will force plan sponsors to divert resources to 
the PBGC and away from pension plan contributions, capital investments, 
job creation, research & development and other growth activities.

Make the Long Term Corporate Bond Rate

    Since last year, a long-term corporate bond rate averaged over 4 
years has been used to determine ``current liability'' for the funding 
and deduction rules and to determine unfunded vested benefits for 
purposes of PBGC variable rate premiums. However, the measurement rate 
defaults to the rate on the now defunct 30-year Treasury bond beginning 
in 2006 if no further action is taken. It is widely agreed that the 30-
year Treasury bond is no longer a realistic measure of future 
liabilities and would inappropriately inflate pension contributions and 
PBGC variable rate premiums. A return to an inappropriate and 
inaccurate measure of pension liabilities and the resulting inflated 
contributions caused by the defunct 30-year Treasury bond rate would be 
devastating for the ongoing vitality of defined benefit plans. It would 
be enormously disruptive for plan sponsors who must be able to project 
future cash flow demands as a part of prudent business planning. The 
uncertainty of the interest rate in effect today severely hinders 
effective planning and could curtail economic growth.
    We strongly believe the best way to support and enable the defined 
benefit pension system is to make permanent the 4-year weighted average 
of the long-term corporate bond rate that Congress adopted last year. 
As Congress has already recognized, the long-term corporate bond rate 
provides a realistic picture of future pension liabilities and is the 
best measure to ensure the adequacy of pension funds for future 
retirees. It reflects a very conservative estimate of the rate of 
return a plan can be expected to earn and thus is an economically sound 
and realistic discount rate.
    The administration has proposed, as an alternative to both the 30-
year Treasury bond rate and the long-term corporate bond rate, a near-
spot rate ``yield curve'' comprised of conservative, high-quality 
corporate bonds. We agree with the administration that there is a 
compelling need for a permanent interest rate so that employers can 
project their future contribution obligations and make long-term 
business plans. In addition, we agree that the permanent interest rate 
should be based on high-quality corporate bonds. However, we have 
serious concerns about four aspects of the administration's ``yield 
curve'' proposal. First, the yield curve interest rate is a ``near-spot 
rate'' rather than a 4-year weighted average rate. It will saddle 
employers with unpredictable and potentially volatile funding 
obligations. Second, the yield curve proposal would apply different 
interest rates to different payments to be made by the plan based on 
the date on which that payment is expected to be made. This is an 
unnecessarily complex methodology. Third, we are concerned that the 
administration's mechanisms for creating interest rate assumptions 
would require excessive and unnecessary contributions for some mature 
plans, which could be very harmful for employers, workers, and the 
economy. Fourth, the proposed yield curve is opaque and will be 
difficult for businesses to use in long-term planning and for Congress 
to oversee. We discuss these concerns in more detail below.

Preventing the Volatility That Would Be Created by Spot Valuations

    Our primary concern with the administration's yield curve proposal 
is the use of spot valuations. Companies need to be able to make 
business plans based on cash flow and liability projections. Volatility 
in pension costs can have dramatic effects on company projections and 
thus can be very disruptive. It is critical that these contribution 
obligations be predictable. The essential elements facilitating 
predictability under current law are use of the 4-year weighted average 
of interest rates and the ability to smooth out fluctuations in asset 
values over a short period of time (subject to clear, longstanding 
regulatory limitations on such smoothing). The administration's yield 
curve proposal would, however, eliminate both smoothing elements, 
dramatically increasing the volatility and unpredictability of funding 
requirements.
    Let us be clear--spot valuations do not mean tighter funding 
standards. The spot or smoothed rate only relates to when contributions 
are due. As interest rates rise, a spot rate will result in smaller 
contributions and vice versa. Over the long-term--which should be the 
focus in pension funding--contributions will essentially be the same 
regardless of whether a spot or smoothed rate is used. Similarly, the 
value of pension assets will essentially be the same over the long 
term, regardless of whether spot or smoothed asset valuations are used. 
Further, spot valuations would not add any appreciable accuracy. 
Pension liabilities span many years and spot valuations are not 
meaningful for these liabilities. A spot interest rate for 90 days is 
simply not a particularly accurate measure of liabilities that in many 
cases span more than 40 years.
    Spot rates would also have very negative implications for the U.S. 
economy. Spot valuations likely would require larger contributions 
during economic downturns and smaller contributions during economic 
upturns. Larger contributions reduce capital spending. This exaggerates 
downturns and upturns. The result is that the economy overheats during 
upturns and has deeper recessions during downturns. The two key 
elements of smoothing under the current rules provide a significant 
counter-balance to this phenomenon, and should be preserved.
    Some have suggested that sponsors of defined benefit plans can 
manage the spot rate by investing in bonds and financial derivatives 
that hedge against interest rate movements. Hedging in this way would 
be very expensive. Plans should not be effectively forced to incur this 
cost. Over time, pension plans earn more on investments in equities 
than in bonds. If plan earnings decline because plans are compelled to 
invest in bonds or other low-yielding instruments, the overall costs 
for plan sponsors will rise. As plans become more expensive, it goes 
without saying that there will be fewer plans remaining and that the 
heightened cost will discourage employers from increasing benefits in 
the plans that do remain.
    Further, if a fundamental change in the pension funding rules 
should force a movement of pension funds out of equities and into bonds 
or other low-yielding instruments, it could have a marked effect on the 
stock market, the capital markets, and capital formation. At the end of 
2003, private-sector defined benefit plans held equities worth about 
$900 billion and the market impact of a portfolio shift of this 
magnitude is extremely difficult to predict.
    It is far from clear whether plans can insulate themselves from 
both volatility and liability by investing in bonds. First, it is 
doubtful that there could ever be enough high-quality corporate bonds, 
particularly at the long durations that characterize pension 
liabilities. Second, even if there were enough high-quality bonds to go 
around, it is not possible to immunize all risks. Even the staunchest 
bond proponents acknowledge that there are numerous pension liabilities 
that cannot be accurately anticipated. For example, because mortality 
cannot be predicted with precision, it is not possible to shield a plan 
that makes life annuity payments. Similarly, the number of people who 
retire and take available subsidies can only be estimated and thus that 
liability cannot be protected against.

Avoiding Unnecessary Complexity and Lack of Accountability

    We are concerned that the administration's yield curve would add 
significant complexity without providing any real benefit. The proposal 
would generate numerous and different interest rates for each 
participant. This level of complexity could be managed by some large 
companies but it will impose an unjustifiable burden on small and mid-
sized companies across the country.
    Further, we are concerned that the interest rate constructed by the 
Treasury Department would be opaque. The markets for corporate bonds of 
many durations are so thin that the interest rates used would actually 
need to be ``made up'', i.e., extrapolated from the rates used for the 
other bonds. Considerable discretion is exercised in creating a yield 
curve and, in some respects, it appears to be as much art as science. 
This type of a discretionary, non-market interest rate would be 
virtually impossible for employers to model internally as part of 
corporate planning and would also be particularly difficult for 
Congress to oversee.

Ensuring Appropriate Funding

    We are deeply concerned that the yield curve aspect of the proposal 
could produce an effective interest rate for some plans that is too low 
and therefore will overstate liability. Relative to the weighted long-
term corporate bond rate in effect this year, the administration's 
proposal could increase pension liabilities for some mature plans by 10 
percent or more. In some cases, the immediate liability increase could 
be even greater. Using a lower effective discount rate than the long-
term corporate bond rate could result in contributions that far exceed 
what is needed to pay benefits. Excessive contributions are in no one's 
interest, especially for mature plans in industries that can least 
afford to have a sudden required increase in funding obligations.
    The consequences of excessive contribution obligations are 
painfully clear. This is precisely what happened when inflated pension 
contributions were mandated by the obsolete 30-year Treasury bond rate. 
Employers that confront inflated contribution obligations will have 
little choice but to stop the financial bleeding by freezing or 
terminating their plans. Both terminations and freezes have truly 
unfortunate consequences for workers--current employees typically earn 
no additional pension accruals and new hires will not be able to 
participate in a defined benefit plan. Government data reveals that 
defined benefit plan terminations accelerated prior to the temporary 
long-term corporate bond rate fix in the Pension Funding Equity Act of 
2004, with a 19 percent drop in the number of plans insured by the PBGC 
from 1999 to 2002. Just as troublesome, the statistics above do not 
reflect plans that have been frozen. While the government does not 
track plan freezes, reports make clear that these freezes are already 
on the upswing.
    Further, inflated pension contributions divert precious resources 
from investments that create jobs and contribute to economic growth. In 
fact, a recent study by Business Roundtable concluded that the use of a 
spot rate during 2003 would have cost the economy approximately 300,000 
jobs. Facing pension contributions many times greater than they had 
anticipated, employers will not hire new workers, invest in job 
training, build new plants, and pursue new research and development. 
Furthermore, inflating pension liabilities and forcing unnecessary 
contributions would drive up the cost of doing business and will put 
U.S. companies at a further competitive disadvantage relative to 
foreign corporations that do not have similar obligations. For these 
reasons, it is important for funding to remain rational, predictable, 
and stable. These are precisely the steps that would help lower our 
Nation's unemployment rate, spur individual and corporate spending, 
generate robust economic growth, and keep U.S. companies competitive in 
the global marketplace.

Preventing Unnecessary Bankruptcies

    It is important to recognize that an employer's credit rating is 
not directly tied to the ability of the sponsor of a defined benefit 
plan to provide promised benefits. Corporate debt is not the same as 
pension obligations. The pension plan is a separate entity. One of the 
hallmarks of U.S. pension law is that pension assets must be held in a 
separate trust or similar dedicated vehicle. The ability of a company 
to continue to make benefit payments and appropriate levels of 
contributions is not determined by its credit rating. A plan that has 
sufficient assets to pay benefits will pay those benefits even if the 
plan sponsor does not have adequate assets to pay its debts or has debt 
that is rated below investment grade.
    We are deeply concerned about the administration's proposal to base 
the application of the pension funding and premium rules on the 
creditworthiness of the employer sponsoring the plan. The 
administration's package of proposals creates a serious risk of 
potentially forcing unnecessary bankruptcies on ``at risk'' companies 
that could have otherwise continued to fund their pensions for many 
years. Its proposals to trigger variable funding rules and base PBGC 
premiums and benefit guarantees on the determination of the 
creditworthiness of the plan sponsor and the members of the sponsor's 
controlled group are wrongheaded. In effect, the employer's liability 
is treated as increasing when the employer's credit rating slips, even 
though the plan's benefit payment obligations remain unchanged.
    Forcing ``at risk'' employers to fund their plans based on 
termination liability is not appropriate. Termination is not relevant 
to an on-going plan, especially if the plan sponsor is not going 
bankrupt. On the consumer side, this proposal is analogous to the 
relationship between a mortgage lender and homeowner. If the homeowner 
receives a job-related demotion, does having that knowledge give the 
lender the right to automatically increase the interest rate and payoff 
amount on the mortgage loan? The use of credit ratings to determine 
funding or PBGC premium obligations could have significant 
macroeconomic effects. Such use would put severe additional pressures 
on employers experiencing a downturn in their business cycle. If the 
lower credit ratings create additional funding burdens and business 
pressures, which could lead to further downgradings, creating a vicious 
circle that further drags a company down. This could well happen to a 
company that today is able to fund additional contributions to pull 
itself out of the underfunding problem and thus raise its credit 
ratings. In short, a creditworthiness test would make it more difficult 
for a struggling company to recover. That is not in anyone's interest, 
including the PBGC, which could be forced to assume plan liabilities if 
the company does not recover. We must be careful not to lose sight of 
the fact that the best insurance for plans, participants and 
beneficiaries, and for the PBGC is a healthy plan sponsor. The best way 
to protect the PBGC is to ensure that plans are appropriately funded, 
regardless of the plan sponsor's credit rating.
    It is also clear that the PBGC's proposal would classify many plans 
as at risk that will never be terminated. The mere fact that a 
company's debt is not rated as investment grade does not mean that it 
will terminate its plans. However, the consequence of these ``false 
positives'' could well be self-fulfilling, with employers forced to 
terminate as a result of a downward spiral. Moreover, employers that 
have non-investment grade debt but are improving their situation would 
get no credit for such improvement.
    Finally, a creditworthiness test would inevitably result in the 
government determining the creditworthiness of at least some American 
businesses. Many privately held employers are not rated by any of the 
nationally recognized agencies. The PBGC has recommended conferring 
regulatory authority to develop guidelines for rating private 
companies. This would be a disturbing and far-reaching expansion of the 
PBGC's authority beyond its original legislative intent.

Eliminating Prefunding Barriers

    One aspect of the administration's proposal that we strongly 
support is the proposal to reform the tax rules governing the 
deductibility of pension plan contributions. Specifically, we support 
the administration's proposal to increase the deduction limits from 100 
percent of current liability to 130 percent. In fact, we would 
recommend increasing the 130 percent figure to 150 percent to ensure 
that there is an adequate cushion. For deduction purposes, current 
liability is today based on the 30-year Treasury bond rate, not the 
long-term corporate bond rate. We propose that current liability should 
be based on the long-term corporate bond rate for all purposes. This 
would, in isolation, actually decrease the deduction limit for many 
plans by 10 or 15 percent (and by more for a few plans). Accordingly, 
to ensure that the deduction limit for most plans is increased by 30 
percent compared to current law, the limit should be increased to 
approximately 150 percent.
    We also support repealing the excise tax on nondeductible 
contributions with respect to defined benefit plans. The excise tax on 
nondeductible contributions only discourages employers from desirable 
advance funding. Finally, we support repealing the combined plan 
deduction limit for any employer that maintains a defined benefit plan 
insured by the PBGC. Under present law, if an employer maintains both a 
defined contribution plan and a defined benefit plan, there is a 
deduction limit on the employer's combined contributions to the two 
plans. Very generally, that limit is the greatest of:

    (1) 25 percent of the participant's compensation,
    (2) The minimum contribution required with respect to the defined 
benefit plan, or
    (3) The unfunded current liability of the defined benefit plan.

    Without repeal of this provision, the sponsor of a plan with large 
numbers of retirees might lose its ability to make deductible 
contributions to its defined contribution plan because, in a mature 
plan, the number of active participants is small compared to the number 
of retired participants. This deduction limit can also cause very 
significant problems for any employer that would like to make a large 
contribution to its defined benefit plan. There is no supportable 
policy reason for preventing an employer from soundly funding its plan. 
Defined benefit plans and defined contribution plans are each subject 
to appropriate deduction limits that are based on the particular nature 
of each type of plan. There is no policy rationale for an additional 
separate limit on combined contributions.

Encouraging Advance Funding

    We are concerned about elements of the administration's funding 
proposal that could discourage employers from contributing more than 
the minimum required contribution. Under current law, if a company 
makes a contribution in excess of the minimum required contribution, 
the excess plus interest can be credited against future required 
contributions. This credit for prefunding (``credit balances'') helps 
to mitigate volatile and unpredictable funding requirements by allowing 
and encouraging a sponsor to increase funding during good times. The 
proposal, however, does not give employers who prefund direct credit 
for their excess contributions.
    There have been suggestions that the current law credit balance 
system has been a factor in terminating plans assumed by the PBGC. 
These suggestions ignore the fact that but for the credit balance 
system, companies would have contributed less, resulting in more 
underfunding and more liabilities assumed by the PBGC.
    Critics have pointed out that credit balances are not immediately 
adjusted if the underlying value of the assets decreases. Consequently, 
plans with poor investment results have been able to use credit 
balances that are larger than the assets they represent. We support 
carefully targeted reforms that address this investment result problem. 
These reforms must be administrable and need to be applied 
prospectively. It would be fundamentally unfair to change the rules 
retroactively for employers that made contributions in reliance on 
current law credit balance rules. It is critical, however, that we 
preserve appropriate incentives to advance fund. Without these 
incentives, there is a significant risk that employers will only pre-
fund to the minimum required by law. The result would be a less well-
funded system, which is in no one's interest.

Providing Timely and Appropriate Disclosure

    We believe that participants should have timely and high-quality 
data regarding the funded status of their plans. It is important that 
participants have the information they need to evaluate their 
retirement security. These rules should be structured to provide full 
and fair disclosure without creating undue administrative burdens on 
plans or causing unnecessary alarm among participants.
    In this context, existing disclosure requirements should be 
enhanced, while at the same time avoiding the creation of costly and 
confusing new requirements. A starting point might be the 
administration's general proposal to improve the summary annual report 
(``SAR''), but with significant modifications that would make the 
information disclosed more immediate and more meaningful. One of the 
problems with the SAR under current law is that the information 
disclosed is not timely, a problem which is not addressed by the 
administration's proposal. In fact, the information currently provided 
can be almost 2 years old.
    One possible solution would be to require plans to disclose in the 
SAR their funded percentage. However, instead of reporting percentages 
as of the first day of the plan year for which the SAR is provided 
(information that is almost 2 years old), the percentage could be 
reported as of the first day of the subsequent year, using (1) the fair 
market value of assets as of that date and (2) the liabilities as of 
that date based on a projection from the preceding year. This would 
mean more timely disclosure. A plan maintained by a public company 
could also be required to disclose the year-end funded status of the 
plan as determined for purposes of financial accounting for the 2 most 
recent years available. This approach would provide much more 
information than under present law or under the administration's 
proposal. In addition, unlike the administration's proposal, financial 
accounting information that is already circulated and disclosed for the 
company as a whole could be disaggregated into the amounts for 
individual plans and provided to participants. By using information 
available to employees through financial reports and media statements, 
the possibilities for confusion would be greatly reduced.

Confirming the Legality of Hybrid Plan Designs

    Hybrid defined benefit pension plans, such as cash balance and 
pension equity plans, were developed to meet the needs of today's 
mobile workforce by combining the best features of traditional defined 
benefit plans and defined contribution plans. Nearly a third of large 
employers with defined benefit plans maintain hybrids and, according to 
the PBGC, there are more than 1,200 of these plans providing benefits 
to more than 7 million Americans as of the year 2000. These plans are 
defined benefit plans and many of the same funding issues described 
above are relevant. They also face unique issues.
    Despite the significant value that hybrid plans deliver to 
employees, current legal uncertainties threaten their continued 
existence. As a result of one court decision, every employer that today 
sponsors a hybrid plan finds itself in potential legal jeopardy. It is 
critical that this uncertainty be eliminated. Legislation is needed to 
clarify that the cash balance and pension equity designs satisfy 
current age discrimination and other related ERISA rules. In addition 
to clarifying the age appropriateness of the hybrid plan designs, we 
believe it is essential to provide legal certainty for the hybrid plan 
conversions that have already taken place. These conversions were 
pursued in good faith and in reliance on the legal authorities in place 
at the time.
    Some legislators propose imposing specific benefit mandates when 
employers convert to hybrid pension plans. For example, they would 
require that employers pay retiring employees the greater of the 
benefits under the prior traditional or new hybrid plan. Others would 
require employers to provide employees the choice at the time of 
conversion between staying in the prior traditional plan or moving to 
the new hybrid plan. We strongly urge you to reject these mandates. 
Mandates are fundamentally anathema to the voluntary nature of our 
employer-provided retirement system. Inflexible mandates will only 
drive employers from the system and reduce the competitiveness of 
American business. Employers must be permitted to adapt to changing 
business circumstances while continuing to maintain defined benefit 
plans.

Conclusion

    Mr. Chairman and members of the committee, thank you for the 
opportunity to present our views. We look forward to participating with 
the committee in a comprehensive discussion of the long-term funding 
challenges facing our pension system and proposals to provide 
additional protection to the PBGC. Our Nation's defined benefit system 
stands at a cross-roads. There are reforms that will revitalize the 
system and there are reforms that will be too much for the system to 
bear. We owe it to American workers and their families to ensure that 
any reforms preserve a robust defined benefit system well into the 
future.

    Senator DeWine. Mr. Gebhardtsbauer, thank you for joining 
us.
    Mr. Gebhardtsbauer. Thank you, Mr. Chairman and 
distinguished committee members. Thank you for inviting us to 
testify on these important issues. I am Ron Gebhardtsbauer and 
I am a Senior Pension Fellow at the American Academy of 
Actuaries.
    I will first address your questions on the PBGC deficit. 
Most of PBGC's $23 billion deficit last September 30 was from 
probable terminations, and a good portion of it could have been 
avoided if the law allowed two things: One, freezing the 
guarantees in those pension plans, as suggested by the 
administration, but in addition, also allowing PBGC to work out 
pension financing deals with weak employers. Currently, PBGC's 
only recourse is to take over the pension plan, which is a very 
costly remedy. It would be very valuable if Congress could fix 
this remedy soon, along with enacting a permanent interest 
rate.
    You also asked about the effect of large increases in PBGC 
premiums. Some employers will respond by funding their pension 
plans quickly to 100 percent, which is a good result, but it 
will result PBGC's premium income. In fact, many healthy 
companies will go further and eventually terminate their 
pension plans, which would further reduce PBGC's future income. 
It will not be easy to pay off this $23 billion deficit.
    With respect to pension funding, the Academy is encouraged 
that the administration has taken significant steps in framing 
reform. Its use of one funding rule improves transparency and 
simplicity. Solvency is improved by targeting 100 percent 
funding levels and allowing greater deductible contributions. 
However, while the use of the one funding rule eliminates a 
funding cliff, which is very helpful, the proposal would still 
have volatility anyway due to requiring the use of market 
assets and only 90-day smoothing of average interest rates. 
Solvency is of paramount importance, but unless volatility and 
predictability are also addressed, many employers will 
terminate their defined benefit pension plans.
    For example, if the proposal were enacted, you could go to 
tell your CEO just before the year-end holiday that there will 
be no contributions next year. However, if the stock market 
values drop by 33 percent around the year end, as they did in 
October 1987, you would have to call up your boss, the CEO, on 
January 1 and tell him that there will, in fact, be a required 
contribution next year, and in fact, it will be bigger than any 
contribution your company ever paid to the pension plan. That 
is right after you had told him that there maybe wouldn't be a 
contribution at all next year.
    Our first chart over here on my left shows similar 
volatility problems with interest rates. In 1986, the 30-year 
Treasury rate fell by a huge 1.8 percent, or 180 basis points. 
Unfortunately, the 90-day average fell even more. It fell 260 
basis points. Thus, 90-day averaging would not reduce 
volatility, as intended. It would exacerbate it in this 
particular case. Even 2-year smoothing has this problem.
    Employers could reduce these problems by holding more 
assets in bonds, as has been discussed already, and that could 
increase participant shareholder value. However, many employers 
have told us they would rather freeze and terminate their DB 
pension plans than move to bonds because getting just the low 
returns on bonds could make their pension plans too expensive. 
These terminations would have negative repercussions for 
national retirement security, for the markets, for employers, 
for employees, and the PBGC. This outcome can be avoided, 
though.
    The green line on the second chart, notice how it--this is 
for a pension plan that was, say, about 60 percent funded, and 
the green line shows that if the proposal had been in effect in 
the past, the minimum contribution would have fallen to zero 
abruptly in 1997. This is under the administration's rules. 
They would fall to zero. And then they would jump back 
dramatically in 2001 and 2002.
    Senator Mikulski. What is the green line? We don't have a 
green line.
    Mr. Gebhardtsbauer. Oh, okay. The green line is the 
administration proposal and it shows what the minimum 
contributions would have been if it had been enacted over the 
last 10 years. So initially for this particular plan, it would 
have been high and fallen to zero dramatically so that a strong 
company could put in more, but a weak company would just put in 
what the very bare minimum is. It would fall to zero, and then 
it would jump back up in 2001.
    Congress could reduce this volatility and improve 
predictability and improve solvency by doing three things. One, 
they could smooth funding ratios or assets and liabilities; or 
two, they could place a cap on very large changes in the 
minimum contribution; and three, they could shorten the 
amortization period. In fact, the red line shows possibly a 
better way of doing this. It actually gets a better solvent 
plan by smoothly reducing the contribution instead of all of a 
sudden dropping it to zero, and then when the stock market did 
well, they smoothly bring it back up. And in that particular 
case, a company that paid in contributions under this red line, 
the pension plan would always be more solvent, always be better 
funded than under the administration proposal.
    Another problem with eliminating smoothing is that many 
other pension rules would become unpredictable, such as 
quarterly contributions and the onset of benefit freezes, and 
these problems could be reduced by smoothing funding ratios or 
triggering provisions only if the pension plan was funded below 
a certain threshold for 2 years in a row, and also giving 
employers an opportunity to cure the problem through 
contributions or security.
    Finally, as my time is short, I see, I will just quickly 
mention two final concerns. One, some employers have already 
stopped contributing to their pension plan because of the 
current proposal eliminating credit balances.
    And number two, greater deductible contributions in the 
proposal are a very good idea, but they won't work unless 
employers get some economic value for super-surpluses in their 
pension plans, and I can explain these later in Q&A.
    Thank you very much for the opportunity to speak.
    Senator DeWine. Thank you very much.
    [The prepared statement of Mr. Gebhardtsbauer follows:]

      Prepared Statement of Ron Gebhardtsbauer, MAAA, EA, FCA, FSA

    The American Academy of Actuaries is the public policy organization 
for actuaries of all specialties within the United States. In addition 
to setting qualification standards and standards of actuarial practice, 
a major purpose of the Academy is to act as the public information 
organization for the profession. The Academy is nonpartisan and assists 
the public policy process through the presentation of clear, objective 
analysis. The Academy regularly prepares testimony for Congress, 
provides information to federal elected officials and congressional 
staff, comments on proposed federal regulations, and works closely with 
state officials on issues related to insurance.

  AN ANALYSIS OF THE ADMINISTRATION'S SINGLE EMPLOYER PENSION FUNDING 
                                PROPOSAL

    Thank you, Chairman DeWine and ranking member Mikulski, for 
inviting me to testify on reform of the Pension Benefit Guaranty 
Corporation (PBGC), as well as other aspects of the administration's 
single-employer pension funding reform proposal.
    The Pension Practice Council of the American Academy of Actuaries 
believes that a healthy defined benefit (DB) system is essential to the 
financial security of our Nation's retirees. The financial status of 
the PBGC is one of a number of crucial elements that needs to be 
addressed as part of a larger focus on pension reform. Within the 
context of the following analysis of the administration's funding 
reform proposal, we address many of the issues relevant to this 
hearing.
    The administration's recent proposal reflects many of the funding 
reform principles discussed in our paper, Pension Funding Reform for 
Single Employer Plans; \1\ namely: solvency, predictability, 
transparency, incentives for funding, flexibility, avoidance of moral 
hazards, and simplicity. In particular, their proposed use of one 
funding rule and one amortization period improves transparency and 
simplicity. Flexibility is enhanced by their provision to increase the 
maximum deductible contribution. In addition, they eliminate rules that 
currently allow sponsors of underfunded plans to avoid paying 
contributions and variable premiums.
    However, the proposal may cause employers to decide their only 
viable alternative is to freeze and/or terminate their pension plan due 
to concerns that their minimum required pension contributions could 
become too volatile and unpredictable.\2\ Plan terminations would have 
negative repercussions for national retirement security, the markets, 
employee morale, the PBGC,\3\ and an employer's ability to manage its 
workforce. This outcome can be avoided. In this statement, we identify 
how some of these concerns can be addressed to ensure a strong pension 
system.

Solvency

    Funding targets: The administration's proposal sets a funding 
target of 100 percent of accrued benefits and increases the funding 
target if the credit rating of the plan sponsor falls below investment 
grade status. However, the additional funding to the administration's 
``at-risk'' liability may be too late, because a company may already be 
too weak to make the additional contributions. Unfortunately, healthy 
companies may balk at funding to the higher ``at-risk'' liability 
because the additional funds may never be needed, nor could they be 
accessed without paying prohibitive taxes of over 90 percent.
    Funding margins: Rather than creating a different structure of 
liability calculations for companies with low credit ratings, Congress 
could devise a set of funding rules that naturally lead toward the 
creation of a funding margin. For example, once the funding level 
exceeds the initial target liability, a minimum contribution (e.g., the 
normal cost) could be required until assets reach the ``at-risk'' 
liability or the accrued liability with salary projection (as in 
current law). This would create funding margins, which are what kept 
traditional salaried plans so much better funded than hourly plans in 
the past; encourage funding discipline; and avoid the need for ratings. 
Alternatively, the normal cost could be phased out by $1 for every $5 
of surplus instead of for every $1 of surplus as in the administration 
proposal. This would also build a funding margin and help the employer 
avoid volatile minimum contributions.
    At-risk liability: The administration's proposal determines the 
funding target for weak companies using an assumption that all 
employees will retire as soon as possible.\4\ However, this may not 
represent the most valuable benefit. For example, in many pension 
plans, the earliest possible benefit is payable at age 55, while a much 
more subsidized retirement benefit may be payable at the employee's 
30th year of service, which might occur at a later age. If this 
subsidized benefit occurs soon after age 55, the employee may very 
likely delay retirement in order to the get the subsidy. Fortunately, 
the administration proposal would require the use of the actuary's best 
estimate of the liability, if it is greater than the prescribed 
liability. This may solve the problem of potentially undervaluing the 
at-risk liability.
    Assumption setting: History has shown that using the law and 
regulations to specify actuarial assumptions has not been successful, 
as evidenced by the delays in setting the discount assumption and the 
continuing debate on replacing the currently required 1983GAM mortality 
table. We recommend that the law allow actuaries to set the mortality 
assumption, since it differs by plan. The law and actuarial standards 
both now require each assumption to be individually reasonable, which 
is a major change from when Congress first started specifying 
assumptions. If there are concerns, then actuaries could be required to 
justify their assumptions in writing if they seem out of the ordinary.
    Valuation dates: We do not understand why the administration's 
restriction on valuation dates needs to be imposed. If anything, it is 
hoped that more plans could use prior year valuation data \5\ (along 
with year-end market assets), in order for companies and associations 
to budget in advance for their contributions and to disclose funded 
status information to participants in a more timely manner.

Predictability and Hedgeability

    The administration's 90-day smoothing provision will cause problems 
for both sponsors of bond-immunized pension plans as well as sponsors 
of diversified stock portfolios. For the immunization sponsors, the 90-
day smoothing provision will make it difficult for plans to hedge their 
liabilities, since bond prices will not rise and fall with liabilities 
using a smoothed discount rate. (They should be allowed to use market 
liabilities, just as they can now elect to use market assets.) For the 
diversified stock portfolio sponsors, 90 days does not provide enough 
smoothing to make contributions predictable. Their contributions will 
be volatile (and vary greatly depending on the date valued), unless 
there is some mechanism to reduce the volatility.
    Contribution volatility: We suggested the creation of an anti-
volatility mechanism (AVM) in the predictability section of our funding 
reform paper. It would place a cap on large increases in the minimum 
contribution, such as 25 percent of the normal cost, or 2 percent of 
the plan's accrued liability, if greater. It would enable faster 
elimination of underfunding than one might first surmise, because the 
effect is cumulative. Our analysis shows that the cap would rarely be 
applied more than 3 years in a row, and that assets could reach the 
funding target as quickly as the administration's proposal if desired. 
Other ways to reduce volatility would be to average funding ratios or 
smooth assets and liabilities.\6\
    Reduce cyclical nature of minimum contributions with credit 
balance: Minimum contributions can be large in difficult times and 
small (or zero) in good times, which is very hard on employers and 
exacerbates the cyclical nature of our country's economy. Credit 
balances can fix this problem by encouraging employers to contribute 
more in good times, knowing that the excess contribution will enable 
them to contribute less in difficult times. Eliminating the credit 
balance would create a powerful disincentive for companies to 
contribute anything more than the minimum required contribution. For 
example, if they leave the money on the outside of the plan they get 
dollar-for-dollar credit for it when they use it to pay the minimum 
contribution in the following year. However, if they contribute it to 
the pension plan, they may not get any credit for it the next year 
because the amortization rules in the administration proposal are so 
one-sided. At most they would only get 1/7th of the credit. Thus, there 
would be a tremendous reluctance to take a chance on contributing an 
additional amount to the plan, if plan sponsors knew that they might 
need that cash to pay next year's contribution.
    Some of the objections to the use of credit balances could be 
overcome by growing credit balances at the same rate that plan assets 
grow, instead of at the valuation rate. The other objection is that 
credit balances allowed several sponsors of distress-terminated plans 
to avoid contributions right before their plans terminated with 
insufficient funds to pay all benefits. However, with the above fix, 
the credit balance provision would only increase the assets in the 
plan. Taking advantage of a credit balance would only return plan 
assets back to where they would have been had the employer never 
contributed more than the minimum. Thus, the objective should be to 
make sure the minimum funding rules are strong enough, not eliminate 
the credit balance.
    If there is still a concern that credit balances can eliminate 
contributions to underfunded plans, then a compromise rule could 
prohibit using the credit balance from offsetting the full contribution 
when a plan is underfunded. The underfunded plan could be required to 
pay the normal cost, unless it gets a waiver from the IRS, provides 
security, or freezes accruals.
    Volatile plan design: The administration's abrupt freezing and 
unfreezing of benefit accruals will make plan administration and 
employee notification very difficult, disrupt employee expectations, 
and call on actuaries to estimate liabilities before employee data is 
available.\7\ This problem is exacerbated by having to freeze benefits 
for certain plans if the actuarial valuation is not completed by a 
specified time--even if there is nothing in the plan's demographics or 
assets to indicate that the funding status has deteriorated since the 
prior valuation.
    A remedy to this problem could be to require an accrual freeze only 
if the funding ratio is less than the threshold for two consecutive 
valuation dates, and to allow employers to cure the problem by a 
contribution or security after the first valuation showing a 
deficiency. Similar rules could also be provided for:

     the Internal Revenue Code (IRC) Sec. 401(a)(29) threshold 
requiring security for amendments;
     the 100 percent threshold for IRC Sec. 412(m) quarterlies 
and for having to pay the variable rate premium;
     the 125 percent threshold for IRC Sec. 420 transfers to 
retiree health plans; and
     the thresholds in IRC Sec. 412(c)(9)(B) which allows use 
of a prior valuation.

    Congress should consider freezing benefits in all plans under the 
threshold (60 percent in the administration's plan), not just those of 
weak employers. This would encourage healthy employers to fund their 
plans when they can, and it avoids the need for the government to rate 
companies.
    Eliminating lump sums will also disrupt employee expectations, and 
could easily cause a ``run on the bank,'' which not only hurts the 
PBGC, but also the workers and retirees remaining in the plan. Ways to 
avoid this problem include:
     Increase the threshold for prohibiting lump sums to 100 
percent of target liability (or more). There is less concern about a 
``run on the bank'' in paying a lump sum when a plan is over-funded. 
Note: the current rules in the Code of Federal Regulations (CFR) 
1.401(a)(4)-5(b)(3) already restrict lump sums for highly compensated 
employees (HCEs) or the top 25 when funding ratios are less than 110 
percent. They could be applied to all HCEs.
     Keep the plan well funded, or require the plan sponsor to 
contribute the unfunded portion of the lump sum, in addition to the 
minimum contribution.
     Phase in the lump-sum ban by only allowing payment of the 
funded portion of the lump sum. For example, if the plan is 90 percent 
funded, pay 90 percent of the lump sum.
     Allow or require sponsors to eliminate the lump-sum 
provision without violating IRC Sec. 411(d)(6), as long as it is 
replaced by a 20-year certain and life annuity. (And allow insurance 
companies to pay the lump-sum value if the annuitant signs over the 
pension to the insurer).
    Outlawing shutdown benefits in their entirety (as proposed by the 
administration) may not be necessary in cases where the plan's funding 
is adequate and/or plan sponsor can cover the increased benefits. These 
contingent benefits have been responsible for some of the most dramatic 
losses absorbed by the PBGC and present considerable funding 
challenges. However, they have also proved to be valuable to employees 
and a valuable tool for workforce management in many circumstances.
    Congress could consider a proposal that would allow a plan sponsor 
the option of eliminating these benefits without violating IRC Sec. 
411(d)(6). For those employers who wish to retain these benefits, 
perhaps the following could be considered:

     Retain the ability to provide these benefits if the plan 
is well enough funded to cover the incremental benefits.
     Treat the shutdown benefits as an ad hoc amendment, 
similar to an early retirement window, that would phase in PBGC 
guarantees from the date of the shutdown and trigger the proposed 
funding requirements. Under this scenario, incremental shutdown 
benefits would not be payable if the employer could not make the 
additional contributions required under the proposed rules.
     Increase the variable premium to reflect the liabilities 
that would be created by these benefits.

Transparency

    Disclosure: We agree with the administration's proposal to require 
more timely and meaningful disclosure of trends in funding ratios, and 
in fact, would go further. We would require year-end disclosure for all 
plans. We would also suggest requiring a breakdown of plan assets by 
equities, bonds (long, medium, short, and government vs. corporate), 
and other assets to help participants project funding ratios from the 
most recent information. This is already required on an aggregated-plan 
basis for financial statement disclosure, so this should not require 
much additional effort for plan sponsors. However, we would not require 
disclosure of the at-risk liability for plans of healthy sponsors, 
since it would not be relevant and could mislead participants.
    Earlier Schedule B actuarial information: The administration's 
proposal would require the Schedule B earlier for plans with more than 
100 participants. As noted above, we would include year-end asset 
information and estimates of year-end liabilities, since similar 
calculations are already performed for accounting statements and 
variable premiums (using estimates for significant events). We would 
also suggest applying this disclosure rule to all plans, regardless of 
size, as long as estimates can be used. However, we would not require 
information on the funding standard account until the final 
contributions are made, which can be up to 8\1/2\ months after the end 
of the plan year.
    PBGC guarantees: We would also suggest simplifying PBGC guarantees 
(as discussed in the transparency section of our funding reform paper) 
so that the Employee Retirement Income Security Act (ERISA) Sec. 4011 
notice to employees, which discloses benefits that would be lost if 
their pension plan terminated in distress, is more understandable.

Incentives to Fund; Flexibility

    Expanding asset transfer rules: Increasing deductible amounts as 
provided in the administration proposal will help us have better funded 
plans after market declines.\8\ \9\ However, it will not work unless 
employers can access a plan's super surplus (above a high threshold) to 
use for other purposes, such as other employee benefits. Otherwise, 
employers will be reluctant to take a chance on contributing additional 
amounts that may later be inaccessible. While some employee advocates 
have concerns about this issue, we think it can be constructed in a 
tight enough way to benefit the employees, while at the same time 
addressing the concern that the pension plan could be insufficient 
someday. See the discussion on this in our funding reform paper.
    Retain credit balance provisions: The credit balance provisions 
provide incentives to employers to contribute more in good years. (See 
the earlier discussion on reducing the cyclical nature of minimum 
contributions with credit balance.) In addition, plan sponsors who 
accumulated credit balances in good faith under the current rules with 
the expectation that they were building a cushion for use in future 
years should not lose that promise.
    The administration's proposal to preclude funding of nonqualified 
deferred compensation (unless the employee pension plan is similarly 
funded) is an attempt to encourage sponsors to fund the employee plan. 
However, we don't think it will work, in part because amounts funded 
for nonqualified deferred plans are already subject to creditors' 
claims and would generally be forfeited if the qualified plan fails. A 
real incentive would be to securitize a mirror nonqualified plan to the 
extent the employee qualified plan is funded, as discussed in the 
incentives to fund section of our funding reform paper.

Avoid Moral Hazards

    Risk-related premiums: The administration's proposal changed the 
rules for determining the risk-related premium by requiring the 
earliest retirement age assumption for weak companies, and by using the 
same discount rate as for funding. In addition, the full funding limit 
(FFL) exemption is gone, so employers will not be able to avoid paying 
a variable premium as in the past--unless they are 100 percent funded.
    However, we are concerned that the administration's proposal lets 
the PBGC board set the premium rate and funding policy without limits, 
and without any input from its premium payers. For example, the PBGC 
board could decide to set the premium at an amount that would require 
the remaining DB plans to quickly pay for all of the PBGC's past 
underfunding. This would require a premium that is greater than is 
actuarially required from the remaining plans that have not abused the 
PBGC. Since Congress has never clearly stated whether the PBGC should 
be funded like an insurance company, a pension plan, or a pay-as-you-go 
government agency, this rule puts that decision in the hands of the 
Board without any input from Congress. At a minimum, Congress should 
set limits on how large the premium increases can be and how well PBGC 
should be funded. In addition, we note that it is better for Congress 
to tighten the funding rules than for the PBGC to increase premiums.
    PBGC could avoid some distress terminations: The administration's 
proposal freezes benefits and PBGC guarantees when employers enter 
bankruptcy. With these powers, the PBGC's losses are limited. We 
suggest, therefore, that the PBGC could be given the authority to work 
out pension financing deals with employers, without having to threaten 
plan termination--its only recourse under current law. This will be 
especially important if PBGC cannot get (1) higher priority in 
bankruptcy for its missed contribution claims or (2) the ability to 
perfect its liens against companies in bankruptcy.

Simplicity

    Yield curve: The administration's proposal generally provides 
simpler rules. One exception is their requirement to use a corporate 
bond yield curve. While we appreciate the theoretical value of using a 
yield curve and could adjust our models to incorporate this, a cost-
benefit analysis will show that, in practice, the yield curve 
complicates valuation and lump-sum calculations without adding 
meaningful accuracy.
    For example, using a yield curve will not change the liability, 
except on a very mature plan during the few times when the yield curve 
is steep. And it will change the liability by only a small amount 
(e.g., 3 percent, which would only increase liabilities from $10 
million to $10.3 million). At the same time it will decrease the 
liability for a very young plan, so it may not increase the PBGC's 
variable premium income by much at all. Furthermore, requiring more 
accuracy for the discount rate, while prohibiting more accuracy on the 
mortality table, is not consistent. It is interesting to note that 
using collar mortality differentials would be enough to undo the small 
differences created by using yield curves. Thus, Congress should give 
regulators the ability to simplify the yield curve calculations, if 
they find it less valuable than initially thought. Note that the PBGC 
itself originally used a yield curve for multi-employer calculations, 
but replaced it with the simplified method they use for single employer 
plans.
    Furthermore, the yield curve won't work for the portion of a plan's 
assets invested in Treasury bonds. Recent experience has shown that 
Treasury bond prices can increase when corporate bond prices decrease, 
and vice versa.
    In addition, although the proposal phases in the financial effect 
of the yield curve over a 3-year period, it requires that actuarial 
valuation systems be revised to accommodate these calculations in time 
for the 2006 valuation. We suggest that, at a minimum, a simplified 
yield curve be adopted, something similar to the interest rate 
structure used by the PBGC. This part of the proposed changes should be 
delayed to allow for the required reprogramming.

Transition

    Three-year transition: The administration's proposal has a 3-year 
transition period, which may not be sufficient time for contribution 
volatility concerns, especially if the credit balance provision is 
eliminated. In addition, if the administration's proposal is adopted 
without modification, financial observers suggest the need for a longer 
transition to allow financial markets to adapt to a potential shift in 
pension asset allocations between stocks and bonds. The bond market, in 
particular, will need more time for issuers to supply pension plans 
with the long-dated instruments needed to better match assets to 
liabilities, without driving interest rates down and exacerbating the 
problem. A longer transition would be less disruptive. Our anti-
volatility mechanism (AVM) could also assist in providing a better 
transition.

Encourage DB Plans

    We applaud the administration's proposal for clarifying the age 
discrimination and whipsaw issues for hybrid plans. However, the 
administration's proposal also reaffirms its earlier savings account 
ideas, requires a 5-year maintenance rule for DB plans converting to 
cash balance plans, and doesn't resolve retroactivity concerns for 
prior conversions. These three concerns could cause the widespread 
elimination of all DB plans by further making it easier to sponsor a 
defined contribution plan than a DB plan. By continuing to propose 
changes that undermine the formation and maintenance of traditional DB 
plans the administration's proposal could seriously harm DB plans, even 
though DB plans provide vast financial value and benefits to 
individuals, employers, the markets, and the Nation. We suggest that DB 
plans need equal treatment with 401(k) arrangements.
    At one time policy favored DB plans because (1) they were more 
likely to provide a lifetime income and (2) they cover almost all 
employees. With lower tax rates for capital gains and stock dividends, 
the equilibrium for deciding whether to sponsor a DB or DC plan with 
all its associated coverage requirements and complex rules, versus just 
providing cash to employees, has been greatly harmed. We recommend that 
Congress return its historic tax advantage to retirement plans by 
taxing pension distributions at the same rates.

Summary

    The administration proposes many valuable changes. For Congress to 
strengthen national retirement security, they must provide an 
environment that encourages employers to keep their DB plans and pay 
premiums to PBGC. At a minimum, reform should include:

     controlling the volatility of contributions (by, for 
example, using the anti-volatility mechanism);
     retaining the credit balance concept (with modifications) 
to reduce the cyclical nature of minimum contributions and provide 
incentives for employers to make contributions in good years; and
     allowing employers to access super surpluses for other 
uses, such as other employee benefits, as an incentive for employers to 
contribute more in good years.
    At the American Academy of Actuaries, we are dedicated to applying 
our understanding of DB plans to working with the administration and 
Congress to shape a strong system of financial security for our 
Nation's retirees.

References

    \1\ This paper can be found at http://www.actuary.org/pdf/pension/
funding--single.pdf.
    \2\ The administration's use of one funding rule eliminates the DRC 
funding cliff, which is good, but it would increase volatility anyway 
due to requiring the use of market assets and only 90-day averaging of 
market interest rates. For example, equities declined by 33 percent in 
October of 1987. That could have doubled an employer's minimum 
contribution. In addition, if only 90-day averaging were in use in 1982 
and 1986, the interest rate would have decreased by about 300 basis 
points in those 2 years, which could have more than doubled an 
employer's minimum contribution. Some employers might decide to move 
more of their plan assets into bonds (to dampen the volatility of the 
plan's underfunding and thus the minimum contribution). However, 
surveys suggest that many employers have concerns that their 
contributions would increase too much due to lower expected returns on 
bonds, and that their employees would rather take their chances 
investing in the stock market in a defined contribution (DC) plan. 
Another option would be for employers to fund their plan more to create 
a funding margin (which could help employers avoid volatile minimum 
contributions), but this may not be widely adopted unless Congress 
relaxes the rules regarding access to surplus assets.
    \3\ The PBGC could lose their healthy premium payers, but not the 
weak employers with underfunded plans, because the latter would not be 
able to fund enough to unilaterally terminate the plan under applicable 
rules. In addition, under the administration's funding proposal, weak 
employers may still invest large percentages in equities but not build 
up funding margins to protect the plan from equity declines.
    \4\ They also add a loading factor to reflect the cost of 
purchasing a group annuity, even where a significant portion of the 
liability may reflect lump-sum payments.
    \5\ Liabilities a year later could be determined by adjustments for 
the accrual of benefits, the passage of time, and changes in interest 
rates and significant events, as is done when utilizing the alternative 
method for determining PBGC variable premiums.
    \6\ Smoothing interest rates over 2 years may not be adequate. For 
example, in 1986, a 2-year weighted average of interest rates would 
have been just as volatile as the market interest rates, and the 1-year 
average would have been more volatile (i.e., the 1-year average changed 
by 350 basis points from January 1986 to January 1987).
    \7\ The administration proposal requires actuaries to certify that 
the funded status of a plan exceeds a certain threshold within three 
months after the beginning of the plan year, in order to stop an 
accrual freeze. Typically the actuarial valuation is not complete by 
then, nor does the actuary have the data. If actual data later shows 
the plan is even more poorly funded, the retroactive effects on 
participants could be a cause for concern.
    \8\ In 2002, many plans could not deduct their unfunded ABO at 
year-end, even though they wanted to. The administration's proposal can 
be very helpful here.
    \9\ The administration might consider increasing the maximum 
deduction to 150 percent of their target liabilities (which are based 
on corporate bond rates), since the current rules allow deductions 
using 90 percent of Treasury rates. However, this idea would have to be 
balanced with revenue concerns. We also suggest that the administration 
consider repealing the combined plan limit. At a minimum, it should use 
130 percent (or 150 percent) of liabilities to conform with the 
administration's revised rule for DB plans, and it should eliminate the 
excise tax for non-deductible contributions, since the reversion excise 
tax is sufficient for employers to not make excess contributions. See 
these and other ideas in our paper on maximum contributions found at 
http://www.actuary.org/pdf/pension/deduct--letter--051404.pdf.

    Senator DeWine. Mr. Reuther?
    Mr. Reuther. Thank you, Mr. Chairman. The UAW appreciates 
the opportunity to testify before this subcommittee on PBGC 
reform and pension funding issues.
    We strongly urge Congress to consider these issues together 
in a deliberative manner so it can formulate policies that 
truly benefit workers and retirees, employers, the PBGC, and 
the entire defined benefit pension system. These pension 
policies should not be dictated by arbitrary deficit reduction 
targets.
    In particular, the UAW urges the HELP Committee to insist 
on the provisions in the Senate's budget resolution relating to 
the PBGC and to oppose the counterproductive House provisions 
that would require the committee to produce much higher savings 
attributable to the PBGC. In our judgment, the dangerous House 
budget provisions could preclude the adoption of sound policies 
to improve pension plan funding and could force the adoption of 
extreme PBGC pension increases that would drive many employers 
to exit the defined benefit pension system.
    It is important to recognize at the outset that there is no 
immediate crisis at the PBGC. As the administration has 
admitted, the PBGC has sufficient assets to pay all guaranteed 
benefits for many years to come. There also is general 
agreement that the PBGC's projected deficit is directly 
attributable to the widespread bankruptcies in the steel and 
airline industries.
    The UAW strongly opposes the administration's proposals 
relating to the PBGC that would cut the guarantees provided to 
workers and retirees and place strict, arbitrary limits on 
benefits provided by pension plans, sharply increase the flat 
and variable premiums paid by employers, and link the variable 
premium to the credit rating of a company, and give the PBGC a 
lien in bankruptcy proceedings for any unpaid pension 
contributions.
    The cuts in PBGC guarantees and pension benefits would 
unfairly punish tens of thousands of workers and retirees, 
reducing the adequacy of their retirement benefits and having a 
discriminatory impact on blue-collar workers.
    The premium increases would impose a significant economic 
burden on many companies and could trigger an exodus of 
employers from the defined benefit pension system.
    The bankruptcy lien would punish troubled companies and 
their retirees and lead to more liquidations, lost jobs, and 
lost retiree health benefits, as well as more pension plan 
terminations and even greater liabilities being transferred to 
the PBGC.
    Instead of these harmful counterproductive proposals, the 
UAW believes the PBGC can be strengthened through a number of 
approaches. First, the UAW believes the overall funding of 
pension plans can be improved through the series of balanced 
reforms described in section three of our testimony. By taking 
these steps now to improve the funding of pension plans, 
Congress can improve the security of benefits to workers and 
retirees and also reduce the long-term exposure of the PBGC.
    The UAW opposes the funding proposals advanced by the 
administration. They would result in highly volatile funding 
requirements, making it more difficult for companies to plan 
their cash flow and liability projections. In addition, these 
proposals would impose significant economic burdens on many 
employers, punishing companies that are already experiencing 
economic difficulties. The proposals also would discourage 
companies from contributing more than the bare minimum during 
good economic times and instead impose sharply higher 
countercyclical funding requirements during economic downturns.
    Second, the UAW supports the enactment of a new plan 
reorganization process in situations where the employer has 
filed for Chapter 11 bankruptcy. We believe this type of 
process could be a powerful tool for enabling struggling 
employers to continue their pension plans while protecting 
workers and retirees to the maximum extent feasible, and also 
preventing unfunded pension liabilities from being transferred 
to the PBGC. This approach would be beneficial for workers, for 
retirees, for companies, and for the PBGC.
    Third, the UAW believes that resolving the legal 
uncertainties surrounding cash balance plans could encourage 
more employers to remain in the defined benefit pension system 
to the benefit of the PBGC as well as workers and retirees.
    Fourth, the UAW believes the best way to deal with the 
steel and airline liabilities that have or will be assumed by 
the PBGC is to have the Federal Government finance these 
liabilities over a 30-year period. This would be far less 
costly than the administration proposal to increase 
significantly the amounts that could be contributed to 
individual retirement and savings accounts. In our judgment, 
this approach would be far better for workers and retirees, for 
employers, for the PBGC and the entire defined benefit pension 
system.
    In conclusion, the UAW looks forward to working with the 
members of this subcommittee as you consider these important 
issues. Thank you.
    Senator DeWine. Mr. Reuther, thank you very much.
    [The prepared statement of Mr. Reuther follows:]

                   Prepared Statement of Alan Reuther

                                SUMMARY

    The UAW believes Congress should adopt balanced proposals to 
strengthen the PBGC and the security of pension benefits for workers 
and retirees, to improve the funding of pension plans, and to encourage 
employers to remain in the defined benefit pension system. Congress 
should consider the PBGC and pension funding issues together in a 
deliberative manner that will enable it to formulate policies that 
truly benefit workers, retirees and employers, as well as the PBGC and 
the entire defined benefit pension system. Pension policy should not be 
dictated by arbitrary deficit reduction targets.
    There is no ``crisis'' at the PBGC. It has sufficient assets to pay 
all guaranteed benefits for many years to come. The PBGC's growing 
deficit is directly attributable to the widespread bankruptcies in the 
steel and airline industries.
    The UAW strongly opposes the administration's proposals to cut the 
PBGC guarantees and pension benefits for workers and retirees. These 
changes would unfairly punish tens of thousands of workers and 
retirees. We also oppose the administration's proposals to drastically 
increase the flat and variable premiums paid by employers to the PBGC. 
This would impose a significant economic burden on employers, and could 
encourage an exodus of employers from the defined benefit pension 
system. Finally, the UAW opposes the administration's proposal to give 
the PBGC a lien in bankruptcy proceedings for any unpaid pension 
contributions. This would punish troubled companies and their retirees, 
and lead to more liquidations, lost jobs and lost retiree health 
benefits.
    The UAW believes the PBGC can be strengthened through a number of 
approaches that would protect the interests of workers and retirees, 
employers and the entire defined benefit pension system. First, the UAW 
believes that the overall funding of pension plans can be strengthened 
through the reforms specified in Section III of this testimony. Second, 
the plan reorganization process described in Section II of this 
testimony would help to reduce the number of bankruptcy cases that 
result in pension plan terminations and liabilities being transferred 
to the PBGC, by providing greater flexibility to adjust funding and 
benefit obligations. Third, resolving the legal uncertainties 
surrounding cash balance plans could encourage more employers to remain 
in the defined benefit pension system. Fourth, the best way to deal 
with the steel and airline pension liabilities that have already or 
will soon be assumed by the PBGC is to have the Federal Government 
finance these liabilities over a 30-year period.

                                 ______
                                 
                              INTRODUCTION

    The UAW appreciates the opportunity to testify before the 
Subcommittee on Retirement Security and Aging of the Senate Committee 
on Health, Education, Labor, and Pensions on the subject of: ``PBGC 
Reform: Mending the Pension Safety Net.'' We look forward to working 
with the subcommittee as it considers the important issues relating to 
the Pension Benefit Guarantee Corporation (PBGC) and the funding of 
single-employer defined benefit pension plans (hereafter referred to as 
``pension plans'').
    The UAW represents 1,150,000 active and retired employees in the 
automobile, aerospace, agricultural implement and other industries. 
Most of our active and retired members are covered under negotiated 
pension plans.
    The UAW has a long and proud history of involvement in legislation 
relating to these pension plans. We were in the forefront of the decade 
long struggle to enact ERISA, which led to the establishment of the 
PBGC. We also were actively involved in the enactment of legislation in 
1987 and again in 1994 to strengthen the funding of pension plans and 
the PBGC.
    The UAW believes Congress should adopt balanced proposals that will 
bolster the PBGC and the security of pension benefits for workers and 
retirees. We also support measures to strengthen the funding of pension 
plans and encourage employers to continue these plans.
    Unfortunately, the package of proposals advanced by the 
administration will not achieve these objectives. In our judgment, the 
administration's pension proposals are dangerous and counterproductive. 
They would punish employers who are already experiencing financial 
difficulties, resulting in more pension plan terminations and loss of 
retirement benefits, more bankruptcies, plant closings and layoffs, 
more liabilities being dumped on the PBGC, and more employers choosing 
to exit the defined benefit pension system. As a result, these 
proposals would be bad for employers, bad for workers and retirees, bad 
for the PBGC and bad for the entire defined benefit pension system.
    The UAW urges the subcommittee to reject the administration's 
proposals, and instead to put forward a bipartisan package of proposals 
that will improve the funding of pension plans and bolster the PBGC, 
without punishing employers, workers and retirees. We stand prepared to 
work with the subcommittee to achieve these objectives.

                  I. RELATIONSHIP TO BUDGET RESOLUTION

    The UAW believes it is imperative that Congress consider the PBGC 
and pension funding issues together in a deliberative manner that will 
enable it to formulate policies that truly benefit workers, retirees, 
and employers, as well as the PBGC and the entire defined benefit 
pension system. Pension policy should not be dictated by the need to 
fill a budget hole or arbitrary deficit reduction targets.
    Although increases in the PBGC premium are scored as a ``savings'' 
for budget purposes, the truth is they are a tax on employers that 
sponsor pension plans. We believe Congress should consider the impact 
of such increases on companies and the pension system generally, and 
not simply view this as a ``cash cow'' to reduce the deficit.
    The UAW is particularly concerned about reports that the budget 
resolution conference report may require the Health, Education, Labor 
and Pensions Committee to produce much higher ``savings'' attributable 
to the PBGC than was originally proposed in the budget resolution 
passed by the Senate. This in turn could preclude the adoption of sound 
policies that would improve pension plan funding and reduce plan 
terminations, but might also reduce general revenues. In addition, it 
could force the adoption of extreme premium increase proposals--such as 
those proposed by the administration--that would impose a 60 percent 
increase in the flat rate premium and enormous increases in variable 
rate premiums levied on employers. The UAW submits that premium 
increases of this magnitude will drive many employers to exit the 
defined benefit system, thereby undermining retirement security for 
millions of workers and retirees and ultimately weakening the PBGC.
    For these reasons, the UAW strongly urges the HELP Committee to 
insist on the provisions in the Senate's budget resolution relating to 
the PBGC, and to oppose the counterproductive House provisions.

            II. PENSION BENEFIT GUARANTY CORPORATION (PBGC)

    It is important, at the outset, to underscore that there is no 
``crisis'' at the PBGC. As the administration has admitted, the PBGC 
has sufficient assets to pay all guaranteed benefits for many years to 
come (at least until 2020, and possibly longer). Thus, the reports 
about the PBGC's growing deficit should not create a stampede towards 
extreme, counterproductive proposals. Congress should approach this 
issue in a deliberative manner, and make sure that any remedies do not 
cause more harm to workers, retirees, employers and the defined benefit 
pension system.
    There is no mystery about what has caused the PBGC to have a 
growing deficit. In the recent past the PBGC was projecting a 
significant surplus. But bankruptcies in the steel industry led to the 
terminations of a number of pension plans with the largest unfunded 
liabilities ever assumed by the PBGC. Now, bankruptcies in the airlines 
industry are threatening to result in plan terminations with even 
bigger unfunded liabilities. Thus, there is no dispute that the PBGC's 
deficit is directly attributable to the widespread economic 
difficulties and bankruptcies in the steel and airline industries.
    Unfortunately, the administration has come forward with three 
dangerous and counterproductive proposals to address the PBGC's 
projected deficit. In our judgment, these proposals would unfairly 
punish workers and retirees. They would also punish employers who are 
already experiencing economic difficulties, leading to more 
bankruptcies and job loss, as well as more plan terminations. Moreover, 
these proposals would encourage employers to exit the defined benefit 
system, increasing the danger of even bigger pension liabilities being 
transferred to the PBGC.

A. Limits on PBGC Guarantees and Pension Benefits

    The UAW opposes the administration's proposals to cut the PBGC 
guarantees. These include freezing the guarantees when an employer 
files for Chapter 11 bankruptcy, and effectively eliminating any 
guarantee for plant closing benefits. These changes would unfairly 
punish tens of thousands of workers and retirees, reducing their 
retirement benefits and leaving them with a sharply reduced standard of 
living.
    It is important to emphasize that, under current law, workers and 
retirees often lose a portion of their benefits when a plan is 
terminated. Because of the 5-year phase in rule and other limits, 
workers and retirees typically lose a portion of their benefits 
attributable to recent benefit improvements and certain early 
retirement benefits. The UAW believes that these benefit losses should 
not be made worse by further reductions in the scope of the PBGC 
guarantees.
    The UAW also strongly opposes the administration's proposals to 
place strict, arbitrary limits on benefits provided by pension plans 
that are less than 100 percent funded. These proposals would have a 
sharply negative impact on workers and retirees. In effect, they would 
reduce the adequacy of retirement benefits provided by pension plans to 
tens of thousands of workers and retirees. We are particularly troubled 
by the administration's proposals to freeze benefit accruals, which 
would have an especially devastating impact on workers and their 
families.
    The UAW is also outraged by the administration's radical proposal 
to prohibit pension plans from even offering plant-closing benefits. 
These types of benefits have been an important means of cushioning the 
economic impact of plant closings as companies struggle to reorganize. 
By making it possible for more workers to retire with an adequate 
income, these benefits reduce the number of workers who have to be laid 
off and wind up drawing unemployment insurance and retraining benefits. 
It makes no sense, therefore, to prohibit plans from even offering this 
type of benefit, regardless of how well funded they may be.
    The UAW also is concerned about the discriminatory impact of the 
administration's proposals on blue-collar workers and retirees covered 
under so-called flat dollar plans. It is patently unfair to place 
restrictions on benefit improvements in flat dollar plans where the 
parties simply attempt to adjust benefits in accordance with the growth 
in wages, but to allow the benefit improvements that occur 
automatically in salary related plans for white collar and management 
personnel. In our judgment, any proposals should treat both types of 
plans in an even-handed manner. In addition, it is unfair to outlaw 
plant closing benefits that primarily benefit blue collar workers, 
while still allowing golden parachutes for top management.
    Contrary to the impression created by the administration, current 
law does not allow employers and unions to ``conspire'' to increase 
benefits without regard to the funded status of a pension plan, and to 
then terminate the plan and dump these unfunded benefit promises onto 
the PBGC. By virtue of the 5-year phase in rule, the PBGC may not fully 
guarantee all benefit improvements preceding a plan termination. Thus, 
so-called ``death bed'' benefit increases are not guaranteed and do not 
result in any increase in the PBGC's liabilities.
    The UAW does recognize that pension plans that are less than fully 
funded have experienced problems with the payment of lump sum 
distributions. In some cases, the payment of lump sums has drained 
assets from these plans, unnecessarily jeopardizing the continuation of 
the plans and the payment of benefits to other participants and 
beneficiaries. Thus, the UAW would support reasonable limitations on 
the payment of lump sums in such plans.
    In addition, the plan reorganization process proposed by the UAW in 
Section II D 2 of this testimony would provide greater flexibility to 
adjust benefits and funding obligations in situations where an employer 
has filed for Chapter 11 bankruptcy. This would enable more employers 
in Chapter 11 cases to continue their pension plans, while protecting 
workers and retirees to the maximum extent possible. In our judgment, 
this flexible approach is far better than the arbitrary, one-size-fits-
all benefit limits suggested by the administration.

B. Premium Increases

    The UAW opposes the administration's proposal to drastically 
increase the flat premium paid by all sponsors of single employer 
defined benefit pension plans from $19 to $30, and to index the premium 
for future increases in wages. We also oppose the administration's 
proposal to impose a huge increase in the variable rate premium charged 
to employers who sponsor plans that are less than fully funded, and to 
have the amount of this premium vary depending on the credit rating of 
a company.
    First, the magnitude of these premium increases would impose 
significant economic burdens on many companies. This would be 
especially hard on companies that are already experiencing economic 
difficulties and on medium-sized and small businesses. It would also 
exacerbate the competitive disadvantage for many older manufacturing 
companies with large legacy costs.
    Second, the change in the structure of the variable rate premium--
specifically, linking it to a company's credit rating--would have the 
perverse affect of punishing companies that are already in difficult 
economic situations. Again, this would exacerbate the competitive 
disadvantage facing many older manufacturing companies.
    In light of these factors, the UAW believes the administration's 
premium proposals would be counterproductive. At a minimum, these 
proposals would encourage an exodus of employers from the defined 
benefit pension system. This could undermine the retirement income 
security of millions of workers and retirees. It would also narrow the 
premium base for the PBGC, and thereby increase its financial 
difficulties. In the end, there is a real danger that the PBGC and the 
defined benefit pension system could enter into a death spiral, with a 
constantly shrinking premium base and growth in the pension liabilities 
being transferred to the PBGC.

C. PBGC Lien for Unpaid Contributions

    The UAW opposes the administration's proposal to give the PBGC a 
lien in bankruptcy proceedings for any unpaid pension contributions. 
This would punish troubled companies and their retirees, and lead to 
more liquidations, lost jobs and lost retiree health benefits. It could 
also result in more plan terminations and even greater pension 
liabilities being transferred to the PBGC.
    Companies do not lightly take the step of filing for Chapter 11 
bankruptcy. They do so only when they are experiencing significant 
economic difficulties and are unable to pay all debts when due. Chapter 
11 bankruptcy, by definition, is a zero sum situation. To the extent 
one creditor is given a higher priority or greater claim on the 
company's assets, this necessarily means that the other creditors will 
receive less.
    Thus, granting the PBGC a lien against a company's assets for any 
unpaid pension contributions necessarily means that other creditors--
lending institutions, suppliers and other vendors, and the workers and 
retirees--would recover less. This would inevitably trigger a number of 
counterproductive, harmful consequences.
    First, lenders would be more reluctant to provide the financing 
that is critically important to ensuring the successful reorganization 
of companies in Chapter 11 proceedings. Without this financing, there 
would be more liquidations and hence more job loss. Even worse, the 
negative ramifications on the lending community would extend to 
companies that have not yet filed for Chapter 11 bankruptcy, but who 
are experiencing economic difficulties and are potential candidates for 
Chapter 11. To protect themselves, lenders would be forced to charge 
higher costs to these troubled companies or even refuse financing. The 
end result could be more bankruptcies, and even more job loss.
    Second, retirees would be particularly hard hit by any PBGC lien 
for unpaid pension contributions, since this would significantly reduce 
their ability to collect on claims for retiree health insurance 
benefits. In many of the Chapter 11 cases where there is an underfunded 
pension plan, the single biggest group of unsecured creditors are the 
retirees with their claim for health insurance benefits. If the PBGC is 
given a lien for unpaid pension contributions, the practical result 
would often be that there are no assets left to provide any retiree 
health insurance benefits. Thus, the net result of increasing the 
PBGC's recovery would be to punish the retirees--the very people the 
PBGC was created to protect.
    Third, other suppliers and vendors would also be negatively 
impacted by the granting of a lien to the PBGC for unpaid pension 
contributions. In many bankruptcies, this means that these other 
businesses would get a significantly reduced recovery for their claims. 
This could jeopardize their ability to continue in business, leading to 
a chain reaction of more bankruptcies and job loss.
    Fourth, it is highly questionable whether the PBGC would ultimately 
benefit by being granted a lien for unpaid pension contributions. To 
the extent this proposal forces more companies to liquidate more 
quickly, there would be more plan terminations and even more pension 
liabilities transferred to the PBGC.
    The PBGC already has significant leverage in bankruptcy proceedings 
because of the enormous claims it has for unfunded liabilities, and 
because of its ability to affect the timing and other aspects of plan 
terminations. There is simply no need to increase the PBGC's leverage, 
to the detriment of workers, retirees, employers, and the entire 
defined benefit pension system.

D. A Positive Approach to Strengthening the PBGC

    Instead of the harmful, counterproductive proposals advanced by the 
administration, the UAW believes that the PBGC can be strengthened 
through a number of approaches that would protect the interests of 
workers and retirees, employers and the entire defined benefit pension 
system.
1. Improve Pension Funding
    First, the UAW believes that the overall funding of pension plans 
can be strengthened through the reforms described in Section III of 
this testimony. By taking steps now to improve the funding of pension 
plans, Congress can improve the security of benefits for workers and 
retirees, and also reduce the long-term exposure of the PBGC. These 
reforms can also encourage employers to continue defined benefit 
pension plans, while avoiding counterproductive burdens on employers 
who are experiencing economic difficulties.
2. Plan Reorganization Process
    Second, the UAW supports the enactment of a new ``plan 
reorganization'' process for underfunded plans in situations where the 
employer has filed for Chapter 11 bankruptcy reorganization. We believe 
that this type of process could provide better flexibility in the 
adjustment of benefits and funding obligations, and thereby enable more 
companies in financial distress to continue their pension plans. This 
would be beneficial for the participants and beneficiaries because it 
would allow them to still have their pension plan and to keep some 
benefits that would otherwise be lost in the event of a plan 
termination. At the same time, this would be beneficial for the PBGC 
because it would require the employer to continue making some 
contributions to the plan and prevent the unfunded liabilities from 
being transferred to the PBGC. Employers would also benefit from this 
plan reorganization option because it would provide greater flexibility 
in adjusting benefits and funding obligations, so that continuation of 
the pension plan becomes manageable.
    To make sure that this plan reorganization process is not abused, 
the UAW believes it should only be available to employers that have 
already taken the difficult step of filing for Chapter 11 bankruptcy 
reorganization. Furthermore, the bankruptcy court should be empowered 
to approve benefit and funding modifications beyond those already 
permitted under current law only if they are approved by all of the 
stakeholders: that is, by the PBGC, the employer, and union (or, in the 
case of non-represented participants, an independent fiduciary 
appointed by the bankruptcy court). Finally, the permissible benefit 
modifications should be restricted to non-guaranteed benefits that 
would be lost anyway in the event of a plan termination. Permissible 
funding modifications should extend to 30-year amortization of existing 
unfunded liabilities.
    The UAW believes that this type of plan reorganization process 
could be a powerful tool for enabling struggling employers to continue 
their pension plans, while protecting workers and retirees to the 
maximum extent feasible, and also reducing the exposure of the PBGC. 
This process could provide the flexibility that is needed to address 
different economic situations that are presented in Chapter 11 cases, 
rather than the one-size fits all approach proposed by the 
administration.
3. Cash Balance Plans
    Third, the UAW believes that traditional defined benefit pension 
plans are better for workers and retirees than cash balance plans. At 
the same time, we recognize that cash balance plans are better than 
defined contribution plans or no pension plan at all. In recent years, 
the UAW has negotiated cash balance plans to cover new employees at 
Delphi, Visteon and other auto parts companies. This recognizes the 
difficult economic situations facing domestic producers in this 
industry.
    Unfortunately, the continuing legal uncertainty concerning cash 
balance plans is causing some employers to shift to defined 
contribution plans or not to offer any pension plan at all. This was 
vividly demonstrated by the recent announcement by IBM that it would 
only provide a defined contribution plan for future employees. This 
trend is disturbing, both because it is bad for the future retirement 
income security of workers and retirees, and because it could further 
undermine the premium base for the PBGC.
    For these reasons, the UAW supports legislation to resolve the 
legal uncertainties surrounding cash balance plans, by making it clear 
that they are not per se a violation of age discrimination laws. We 
also support allowing greater flexibility for cash balance plans in 
setting interest credits. At the same time, in situations where a 
traditional defined benefit plan is converted to a cash balance plan, 
we believe reasonable transition relief should be provided to older 
workers who are near retirement. This combination of reforms would 
protect the legitimate retirement expectations of older workers, while 
at the same time allowing employers to remain in the defined benefit 
pension system (and continuing paying premiums to the PBGC) through the 
vehicle of cash balance plans.
4. Steel and Airline Pension Liabilities
    Fourth, the UAW believes that the best way to deal with the steel 
and airline pension liabilities that have already or will soon be 
assumed by the PBGC is to have the Federal Government finance these 
liabilities over a 30 year period. This could be accomplished by having 
the Federal Government (or the PBGC) issue 30-year bonds, and then have 
the Federal Government pay the interest on these bonds as it comes due. 
We believe this approach would cost the Federal Government about $1-2 
billion per year, depending on the magnitude of the airline pension 
liabilities that are ultimately assumed by the PBGC.
    The UAW recognizes that the Federal Government is already running 
substantial budget deficits. But this infusion of Federal funds to 
strengthen the PBGC can easily be afforded by our Nation. For example, 
in its current budget, the administration has proposed significant 
increases in the amounts that individuals can contribute to various 
individual retirement and savings accounts (so-called RSAs and LSAs). 
This involves a substantial tax expenditure that will flow 
overwhelmingly to upper income individuals. The Congressional Research 
Service has estimated that this proposal will cost the equivalent today 
of $300 to $500 billion over 10 years. The UAW submits that these funds 
could better be used to strengthen the PBGC and protect the retirement 
benefits of average working families in defined benefit pension plans.
    Whatever the difficulties, the fact remains that using general 
revenues to gradually finance the PBGC's steel and airline related 
pension deficit is better than all of the other options currently being 
considered. Specifically, it is better than punishing workers and 
retirees by cutting the PBGC guarantees. It is better than punishing 
companies that sponsor pension plans by drastically increasing their 
PBGC premiums. And it is better than punishing companies that are 
experiencing financial distress by giving the PBGC a greater claim in 
bankruptcy proceedings. These other options will inevitably hurt 
workers and retirees and employers that sponsor pension plans. They 
will also lead to more bankruptcies and job loss. And they will drive 
employers away from the defined benefit pension system, creating a 
death spiral for the PBGC.
    The truth is the PBGC was never designed to handle widespread 
bankruptcies and pension plan terminations across entire industries, as 
we have seen in steel and are now witnessing in airlines. Indeed, the 
seminal case that led to the creation of the PBGC was the Studebaker 
situation, in which a single auto company went out of business and 
terminated its pension plan. Obviously, the entire auto industry did 
not go bankrupt or terminate its pension plans then.
    When the PBGC was created by Congress, it was modeled after the 
Federal Deposit Insurance Corporation (FDIC), which insures bank 
deposits for individuals. The FDIC was designed to handle isolated bank 
failures, not the collapse of a broad section of the banking industry. 
When the savings and loan crisis occurred in the 1980s, Congress wisely 
recognized that the costs associated with S&L failures should not be 
shifted onto the backs of individual depositors, nor onto the backs of 
other banking institutions. Congress recognized that those alternatives 
would impose unacceptable hardships on individuals and other banks, and 
would have a counterproductive impact on the rest of the banking system 
and our entire economy. As a result, Congress decided to have the 
Federal Government finance the S&L liabilities over many years, at a 
cost of hundreds of billions of dollars.
    The same principles make sense in the case of the steel and airline 
pension liabilities that have or will be assumed by the PBGC. Shifting 
those costs onto workers and retirees or employers that sponsor pension 
plans would simply lead to unacceptable hardships and counterproductive 
economic consequences. The best approach--for workers and retirees, for 
employers that sponsor pension plans, for troubled companies and for 
our entire economy--is to spread those costs gradually and broadly 
across society by having the Federal Government finance them over 30 
years.
    This approach would not reward ``bad actors.'' The steel and 
airline bankruptcies and pension plan terminations were caused by many 
factors, including the policies (or non-policies) of the Federal 
Government relating to trade, deregulation, energy and health care, as 
well as the shocks flowing from the terrorist attacks on September 
11th. In our judgment, it is entirely appropriate to now ask the 
Federal Government to help pay for the pension costs flowing from those 
policies and events.
    Indeed, Congress already has endorsed this notion in a more limited 
context. In the Trade Act of 2002, Congress provided for a new 65 
percent tax credit to pay for retiree health benefits for retirees 
whose pension plans have been terminated and taken over by the PBGC, 
and who are between the ages of 55-65. Through this provision, Congress 
effectively used general revenues to pay for part of the costs 
associated with providing retiree health benefits to this group of 
retirees. This provision was designed primarily as a response to the 
bankruptcies (and pension plan terminations) in the steel industry, 
which had resulted in thousands of steelworker retirees losing their 
health benefits. It reflected a recognition by Congress that our trade 
and health care policies had played a role in the steel company 
bankruptcies and the loss of retiree health benefits. The UAW submits 
that the same principles now justify using general revenues to pay for 
the pension costs flowing from the steel and airline bankruptcies and 
plan terminations.
    Similarly, Congress has a long history of using general revenues to 
respond to disasters across our Nation. This includes floods, 
hurricanes, droughts and many other types of catastrophes. The UAW 
submits that the devastation that has occurred in our steel and 
airlines industries is no less worthy of Federal assistance.
    There is no danger this type of approach will create a ``moral 
hazard'' leading to worse pension funding and more problems in the 
future. This is because the UAW is proposing that the infusion of 
general revenues to pay for the airline and steel pension liabilities 
be coupled with the package of reforms to strengthen the funding of 
other pension plans and with the new plan reorganization process that 
will help troubled companies to continue their pension plans and reduce 
the future exposure of the PBGC.
            iii. strengthening the funding of pension plans
    The UAW supports balanced legislation to strengthen the funding of 
pension plans. These reforms should be designed to ensure that benefits 
promised by employers to workers and retirees are adequately funded, 
thereby improving the security of these benefits and also reducing the 
PBGC's exposure for unfunded pension liabilities.
    However, the UAW believes it is imperative that any new funding 
rules should be structured so as to provide predictable, stable funding 
obligations for employers and to reduce the volatility of required 
contributions from year to year. New funding rules should also 
encourage employers to contribute more than the bare minimum in good 
times, and avoid counter-cyclical requirements that punish employers 
during economic downturns.
    Unfortunately, the funding proposals advanced by the administration 
fail to meet these common sense objectives. The UAW strongly opposes 
the administration's funding proposals because they would result in 
highly volatile pension funding obligations, would reduce incentives 
for employers to contribute more than the bare minimum, and would 
punish employers who are already experiencing economic difficulties.

A. Interest Rate Assumption

    The UAW strongly opposes the administration's proposal to require 
employers to use a so-called yield curve in establishing the interest 
rate assumption for pension plans. Under this proposal, the interest 
rate would be based on a near-spot rate (averaged over only 90 days), 
with a different interest rate being applied to each payment expected 
to be made by the plan based on the date on which that payment will be 
made.
    This proposal has a number of fundamental problems. First, it would 
be extremely complicated, imposing considerable administrative burdens 
on plan sponsors. These burdens may discourage employers from 
continuing defined benefit pension plans (especially small- and mid-
sized companies).
    Second, contrary to the administration's assertions, the yield 
curve would not provide greater ``accuracy'' in setting the interest 
rate assumption. Because there is no real market for corporate bonds of 
many durations, these interest rates would largely be fictitious.
    Third, the yield curve would result in highly volatile funding 
requirements that would fluctuate widely as interest rates change over 
time. This increased volatility would create enormous difficulties for 
employers, who need stability and predictability in their funding 
obligations. Indeed, the increased volatility would be a powerful 
incentive for employers to exit the defined benefit system.
    Fourth, the yield curve would impose higher funding obligations on 
older manufacturing companies that have larger numbers of retirees and 
older workers. As a result, it would exacerbate the competitive 
disadvantage that many of the companies currently have because of heavy 
legacy costs, and would punish companies that are already experiencing 
economic difficulties.
    Instead of this dangerous and counterproductive yield curve 
proposal, the UAW urges the HELP Committee to make permanent the long 
term corporate bond interest rate assumption that was included in the 
temporary legislation enacted by Congress last year. In our judgment, 
this long term corporate bond interest rate assumption would provide an 
economically sound and accurate basis for valuing pension liabilities, 
would be administratively simple for plan sponsors to implement, would 
result in stable and predictable funding obligations for employers, and 
would avoid imposing unfair, counter-cyclical funding burdens on older 
manufacturing companies.
    At the same time, the UAW urges the HELP Committee to allow 
employers to use collar-adjusted mortality tables in valuing their plan 
liabilities. This would enable employers to more accurately value the 
future benefit obligations, especially for older manufacturing 
companies with larger numbers of retirees and older workers.

B. Improving Plan Funding

    The UAW strongly opposes the administration's proposal to throw out 
the existing funding rules in their entirety, and to replace them with 
new funding rules based on spot valuations of assets and liabilities, 
with no smoothing mechanisms, and with funding targets tied to a 
company's credit rating. These changes would introduce an enormous 
element of volatility into pension funding requirements. This would 
make it much more difficult for companies to plan their cash flow and 
liability projections, and thus would provide yet another powerful 
incentive for employers to exit the defined benefit pension system. In 
addition, these changes would punish companies that are already 
experiencing economic difficulties and have poor credit ratings by 
imposing sharply higher funding obligations on these employers. The net 
result could be more bankruptcies, job loss and plan terminations, with 
even more unfunded liabilities being transferred to the PBGC.
    Instead of this counterproductive approach, the UAW urges the HELP 
Committee to support changes in the existing deficit reduction 
contribution (DRC) rules that would lead to improved funding of pension 
plans, but also provide smoother, more predictable funding obligations 
for employers and less onerous, counter-cyclical burdens on employers 
experiencing a temporary downturn. We believe this could be 
accomplished through two changes: (1) modifying the trigger for the DRC 
so that it applies to a broader universe of plans, and also is 
triggered more quickly when a plan becomes less than fully funded; and 
(2) reducing the percentage of the funding shortfall that must be made 
up in any year, so there will be a smoother path towards full funding. 
These changes would help to ensure that more employers are required to 
make up funding shortfalls in their plans, and are required to begin 
taking this action sooner. At the same time, these changes would avoid 
wild swings in a company's funding obligations that can have negative, 
counter-cyclical effects, especially on employers who are already 
experiencing economic difficulties.
    The UAW also urges the HELP Committee to adopt changes to the 
general ERISA funding rules to shorten the amortization period for plan 
amendments from 30 to 15 years. This would bring this amortization 
period more in line with the average remaining working life of most 
participants. It would require more rapid funding of benefit 
improvements, and thereby help to improve the overall funding of 
pension plans.
    Finally, the UAW supports modifying the definition of ``current 
liability'' to take into account lump-sum distributions reasonably 
projected to be taken by plan participants. This would require plans to 
provide adequate funding to cover anticipated lump sum distributions, 
and help to prevent situations where plans have been drained because of 
such distributions.

C. Credit Balances and Use of Excess Pension Assets

    The UAW strongly opposes the administration's proposal to 
completely eliminate credit balances, which are currently created when 
an employer contributes more than the minimum required under existing 
funding rules. By eliminating credit balances entirely, the 
administration's proposal would have the perverse effect of 
discouraging companies from contributing more than the bare minimum 
during good economic times. This, in turn, could make the funded status 
of pension plans even worse.
    Instead of this counterproductive approach, the UAW urges the HELP 
Committee to modify the existing rules regarding credit balances on a 
prospective basis, so that employers are required to value new credit 
balances according to the actual market performance of the extra 
amounts contributed by the employer. This would eliminate problems that 
have arisen when the actual market performance diverges from plan 
assumptions. But it would still preserve the important incentive that 
credit balances provide for employers to contribute more than the 
minimum required under the funding rules.
    The UAW also supports increasing the deduction limit from 100 
percent to 130 percent of current liability. This would allow employers 
to contribute more during good economic times, and to build up a bigger 
cushion to help during economic downturns.
    In addition, the UAW supports modifying the current rules on the 
use of excess pension assets, so that employers are allowed to use 
these assets for health care expenditures for active and retired 
employees, not just for retirees. This would provide yet another 
incentive for employers to better fund their pension plans during good 
economic times, by providing greater assurance that companies can 
always benefit economically from surplus pension assets.

                               CONCLUSION

    The UAW appreciates this opportunity to testify before this 
subcommittee on Retirement Security and Aging to express our views on 
the subject of: ``PBGC Reform: Mending the Pension Safety Net.'' We 
urge Congress to reject the administration's harmful and 
counterproductive proposals, and instead to fashion a constructive 
package that will strengthen the funding of pension plans, protect 
workers and retirees, provide stability and predictability to employers 
that sponsor pension plans and encourage them to remain in the defined 
benefit pension system, and place the PBGC on a sound and sustainable 
path.
    We look forward to working with members of the subcommittee as you 
consider these important pension issues. Thank you.

    Senator DeWine. Mr. MacFarlane, can you summarize simply 
the primary reasons that British firms have recently frozen an 
estimated 60 percent to 70 percent of defined benefit plans? 
And then after you finish, I wonder if, Ms. Bailey, if you have 
any thoughts on this. I know Timken has some familiarity with 
this because you are in the UK.
    Mr. MacFarlane. The first is cost. The second is investment 
performance. The investment performance, I think, is 
particularly related to the United Kingdom, where the industry 
default benchmark which is used by most schemes was not a 
specific benchmark related to liabilities of that particular 
fund, but rather an industry default, and what that meant over 
a 30-year period was that the ratio of equities in the overall 
asset mix drifted up, and as it drifted up, of course, that was 
fine through the 1990s, but from 2000 to 2003 in particular, as 
the equity markets rolled over, that really hurt investment 
performance.
    The other issue was the fact that interest rates were 
falling steadily, and as interest rates fall steadily, the 
actuarial liability of current liabilities rises.
    And last but not least, the point which I was pushing a lot 
was FRS 17 and the volatility which that imparts in balance 
sheets. At a minimum, what it does is it adds administrative 
burden, worse because it is a snapshot approach. It creates a 
considerable amount of volatility and, therefore, companies 
would rather do without that particular burden.
    Senator DeWine. Ms. Bailey?
    Ms. Bailey. Yes, thank you, Mr. Chairman. The only addition 
I would make to Mr. MacFarlane's statements is that liquidity 
in the UK fixed-income market is very different than the 
liquidity in the U.S. fixed-income market, and what has 
happened is as UK pension plans had to look to put more into 
fixed income, there were fewer bonds, whether they were 
government treasuries or whether they were corporate bonds, 
fewer bonds to invest in, which may likely have been part of 
what was bringing down the interest rates during that same time 
period.
    Senator DeWine. Mr. Reuther, I wonder if you could give us 
your opinion about why there are so many employers that seem to 
be walking away from their defined benefit pension plans.
    Mr. Reuther. Well, I think there are various factors. Some 
of it has to do with cost and looking at the nature of the 
workforce. That is why we think it is so important that the 
changes in the funding rules and the premiums not be 
counterproductive and not, in effect, send a signal to 
employers that your costs are going to become unpredictable or 
that they are going to go through the roof if you decide to 
stay in the defined benefit pension system.
    Senator DeWine. Senator Mikulski?
    Senator Mikulski. Mr. Chairman, this is indeed a very 
content-rich panel. But what strikes me is both the UAW and Ms. 
Bailey and the business groups seem to be in alignment with the 
yellow flashing lights about the President's proposal, and it 
goes to some of the questions I have about often the unintended 
consequences of reform.
    Defined benefits seem to be primarily in mature industries, 
probably primarily in manufacturing or farm equipment or many 
things like that. And they are often unionized.
    My question would be, what would be the consequences of 
increased premiums? Will they pull out of their plan? Will 
troubled industries, maybe that are just trying to even dig 
out, then even be more exacerbated because they have to put 
money into the pension guarantee when they need to put money 
into digging out or their own plant or their health plan? We 
are not only talking about this.
    Ms. Bailey and Mr. Reuther, how do you see this, and what 
would be the answer, because I don't think we can have one-
size-fits-all reform. How do you reward the good guys that are 
stable and so on, the good guy corporations? No. 2, if you 
weren't troubled, what should be the role, therefore, of 
government--of the pensions' involvement with you, not to 
exacerbate the problem, but not to leave the taxpayer with an 
increasingly growing unfunded liability? Can you help me out 
with this?
    Ms. Bailey, do you want to start, and then Mr. Reuther?
    Ms. Bailey. Certainly. I would start with saying that I 
think we need full debate on this issue and we need targeted 
reform and we need time to get through the complexity of the 
issues that we have talked about today. So I think it would be 
a disservice to the groups that I represent as well as a 
disservice to the committee to go forward with some simplistic 
answer to this question. We need to be able to look at it in 
the broad nomenclature of pension reform.
    But that having been said, if we look specifically at this 
premium issue, what we have to remember is those premiums are 
not paid by the companies. Those premiums are paid by the plan 
assets. And so----
    Senator Mikulski. They are paid by what?
    Ms. Bailey. They are paid by the trust. So, in other words, 
the premiums don't specifically come from the Timken Company. 
In our case, the Timken Company would pay the premiums to our 
trust, which holds the assets associated with the pension plan, 
and then the pension plan would pay the premiums to the PBGC. 
So there is an intermediary. It doesn't go directly from the 
Timken Company to the PBGC.
    But more importantly, or in addition to that, what we need 
to remember is that we are looking at very high increases in 
the current budget reform related to PBGC premiums, and by----
    Senator Mikulski. You mean the 19 to 30 flat----
    Ms. Bailey. Yes.
    Senator Mikulski. Yes.
    Ms. Bailey. Along with the way the variable--there is 
uncertainty as to how the variable premiums would actually even 
be calculated. So we don't know today how the variable premiums 
would be calculated, and what that will do is take funds away 
that could be contributed to the pension plan, and rather than 
going in as a contribution to the pension plan, those same 
funds could go as contributions to, in a sense, to fund the 
PBGC's deficit versus contributions to improve the funding 
status of an individual pension plan.
    Senator Mikulski. So you believe, number one, full debate.
    Ms. Bailey. Yes.
    Senator Mikulski. No. 2, that one size doesn't fit all. And 
number three, this new increase in the, I will call it the flat 
fee, could also have consequences yet to be determined.
    Mr. Reuther, and then Mr. Gebhardtsbauer?
    Mr. Reuther. We very much agree that the premium increase 
proposals will send a powerful signal to employers to exit the 
defined benefit system, both the magnitude of the premium 
increases and also the variable premium being tied to the 
credit rating of a company. We think you will see companies 
freezing their plans or terminating them to the detriment both 
of the PBGC, because that will further narrow the premium base, 
and also to the detriment of the workers and retirees.
    The impact on companies is compounded when you add in the 
administration's funding proposals, which are both volatile, 
don't give credit to companies when they contribute more than 
the bare minimum----
    Senator Mikulski. Let me jump in here. As you know, Toyota 
is really rapidly pushing ahead. General Motors has got some 
rocky times here. Ford has had rocky times. Have they told you 
what the consequences of these would be, or is that an 
inappropriate question to ask you?
    Mr. Reuther. We obviously are in discussion with the auto 
companies----
    Senator Mikulski. When I say inappropriate, sometimes that 
is labor negotiations are more privileged than to be discussed 
in an open hearing.
    Mr. Reuther. We are in discussions with the auto companies 
and other major employers that we have collective bargaining 
agreements with and the uniform reaction is very negative to 
these proposals, both the premium proposals and the funding 
proposals. In effect, what is happening is you are asking other 
employers that sponsor defined benefit pension plans to assume 
the burden of paying for the steel and airline liabilities that 
have been transferred to the PBGC, and I would just submit that 
in the end, that is going to be counterproductive, that that 
will drive employers away from the defined benefit system, 
which is what we don't want.
    Senator Mikulski. Thank you, Mr. Reuther.
    Mr. Chairman, Senator Enzi, I went to an incredible party 
on the weekend. My General Motors plant closes on May 13. It 
was the--it made the mini-van. We had 20 good years. They 
actually opened the plant in 1935, during the depression, the 
same year my father opened his little grocery store. So we have 
been kind of living together.
    The workers, most of the workers at this plant were 
eligible for retirement because we had Allison Transmission, 
where the younger workers went. But there was a feeling--no one 
was jittery. No one was boiling mad. And when I circulated 
among many of the workers who were either retirees or about to 
be retirees, it had a sense of security. Did they think it was 
going to be like the good times, like the old times? No. But 
did they have a sense of security? And that had made all of the 
difference.
    I am just really scared about what is happening here, 
because when you look at those men and women, and I just only 
use that as an example, but it is the sense of security that 
has enabled them to be productive workers, come to an end. 
There is an inevitable end at this factory, sad but inevitable, 
and we accepted it.
    And we really, I tell you, we have to really put our 
shoulder to the wheel, but my eyes are glazing over here. This 
is pretty complicated. They are not glazing over. I mean, I 
feel like I need five pairs of glasses and 20 assistants and 
going to the London School of Economics.
    [Laughter.]
    But I think other than that, I am ready to go. But I do 
think that this is what it is all for. I don't know if you all 
are experiencing the same thing. Thank you.
    Mr. Gebhardtsbauer. I would be glad to stop by and help 
out. I am an actuary, and I have got those five glasses, so--
    [Laughter.]
    Senator Mikulski. OK.
    Mr. Gebhardtsbauer. We had something, in fact, in our paper 
on just how to fix some of these funding rules. We like a lot 
of the stuff that is in the proposal from the administration, 
but there were some concerns that we had and one is we would 
encourage, and, in fact, require companies to put more money in 
in the good years. That would answer your concern about having 
them put a lot in in the years when they are weak. Put it in 
earlier when the employers are doing well.
    And right now, actually, the rules do require companies 
with pension plans for salaried employees to put money into the 
pension plan even when they are more than 100 percent funded. 
The administration proposal actually stops at 100 percent and 
says, once you are 100 percent funded, you don't have to put 
any more in. And so good companies are hoping we will put more 
money in, but our concern is weak employers won't.
    So what we would encourage is more companies to put more 
money in when the company is strong. In addition, to encourage 
more money going into the pension plan, the credit balance does 
that. In addition, the administration also would allow you to 
put more money in. They don't require it, but they would allow 
you to put more money in. We think that is a great idea except 
that a lot of employers won't do that.
    Back before I was the Chief Actuary of the PBGC, I was a 
pension consultant, and I would give my clients three numbers. 
Here is the minimum you have to put in under the law. Here is 
the maximum the law will allow a deduction. But here is my 
recommended contribution. Employers would put the recommended 
in. But then after a certain law was passed, now all they do is 
just put in the minimum, only what is required.
    And that law that is talked about is--I think it is going 
to be a tough one to look at, but I think we can get something 
so that both employers and employees would feel okay with this 
idea, and what it is, it is the idea that if you have a super-
surplus in your pension plan, in other words, if you have lots 
of money in your pension plan, you have contributed a lot, you 
are up at 150 percent, and then the stock market does well, now 
you have a 200 percent funded pension plan. You can't get an 
economic value from that.
    And some people are talking, even people who represent 
employers have talked about the possibility if you are way 
overfunded, being able to move some of that money into the, 
say, the employee health plan so that the employee health plan 
is continued. And at one time back in the 1990s, there was a 
debate on this and the debate didn't go well and it didn't 
pass, and I know the Academy was very concerned about some of 
the provisions in the bill in the 1990s because it would 
actually let you take money out when the pension plan was 
underfunded.
    But if you put a good threshold on it and say you can't 
take money out when it is below this, then employers are more 
likely to want to pay the recommended contribution, put more 
into the pension plan in the good years so that in bad years or 
after stock markets go down, there will still be a solvent 
pension plan. Thank you.
    Senator DeWine. Senator Isakson?
    Senator Isakson. Thank you, Mr. Chairman.
    Ms. Bailey, on that line of conversation, in your printed 
testimony, you had some comments on eliminating prefunding 
barriers. Would you elaborate a little bit on that?
    Ms. Bailey. I am sorry, Senator, could you point me to 
which part of the testimony you are referring to?
    Senator Isakson. Page 10 of your testimony, eliminating 
prefunding barriers, tax deductibility----
    Ms. Bailey. Yes, absolutely. Thank you very much. Right on 
with that, I guess two points. One is that during good times, 
companies should be able to put in--I think we are looking at 
150 percent----
    Senator Isakson. Right.
    Ms. Bailey. [continuing]. Trying to ask the current law to 
be increased to 150 percent so that we can get full tax 
deductibility, and right now, there is a limit in terms of what 
the funding is and how much--I am sorry, there is a confusion 
between--there is a limit on how much of a pension contribution 
can actually be tax deductible, and so clearly, an employer has 
no incentive to put money in that is going to be greater than 
the amount that is tax deductible for that current year.
    And so what we are asking is that employers have the 
opportunity to put funds in--to increase the tax deductibility 
of pension contributions so that during the good times, we have 
another incentive to put more funds in and improve the funding 
of the plan.
    Another point I would like to make, if I might, is that it 
is always in an employer's best interest from a financial 
statement--particularly a publicly-traded company--from a 
financial statement point of view to have a fully-funded 
pension plan, because pension expense--part of pension expense 
is the normal service costs, but part of the pension expense 
which shows up on employers' financial statements are the 
interest costs associated with the liability for the unfunded 
part of the plan, and if you go and look at some of your 
constituency organizations, you will see that their earnings 
are depressed by the amount of the pension expense associated 
with that liability.
    So it is always in an employer's best interest, from not 
only providing retirement security to our associates, but it is 
in our best interests in terms of how we deal with capital 
markets to have a fully-funded plan, and so I think, again, 
what I would ask the committee to do is look for reforms which 
will help us in all parts of the variety of complexity we are 
looking at to make things simple and transparent, but let us 
look at the entire part of it together and give employers an 
opportunity to, in good times, contribute more to pension 
plans.
    Senator Isakson. I take it, Mr. Gebhardtsbauer, that you 
would agree with her comments in terms of lowering those 
barriers to prefunding and the comment on tax, as well?
    Mr. Gebhardtsbauer. Right. Yes, we would agree. In fact, 
the administration proposal even does allow you to put money 
into the pension plan until your assets get up to 130 percent 
funding, and I think Ms. Bailey was talking about 150 percent, 
and there are good reasons for that, because right now, the 
calculations are done at Treasury rates and now it is going to 
be corporate bond rates, so 150 percent using corporate bonds 
makes sense.
    In fact, in addition to what she mentioned that you can't 
get it fully deductible, you can also possibly have an excise 
tax because you have put more money in the plan. So it was a 
good thing, but we are going to excise tax you.
    Senator Isakson. Right.
    Mr. Gebhardtsbauer. And then the other problem is the 
administration has gone to a certain point saying, yes, you can 
put the money in, but if the stock market does really well, you 
can't use that money, and there are pension plans out there 
that are still 200 percent funded and they can't do anything 
with that surplus money in the pension plan.
    So I think even the UAW has talked about this idea of 
allowing employers, when you have a really well-funded plan, 
take some of the excess out and put it in the employee health 
plan. A lot of employers are talking about cutting back on 
their employee health plans. If there was excess money in the 
pension plan, then that could be used, and then you would be 
willing to put more money in the pension plan if you knew you 
could use it for some of these other reasons.
    Senator Isakson. Mr. Reuther, I think your comment with 
regard to steel and aviation favored a 30-year amortization, is 
that what you said?
    Mr. Reuther. That is correct.
    Senator Isakson. Specific to those two industries?
    Mr. Reuther. To the liabilities that have been transferred 
to the PBGC from those industries, yes.
    Senator Isakson. Not to pick on you, Mr. Gebhardtsbauer, 
but do you agree with that?
    Mr. Gebhardtsbauer. Yes. In fact, in our proposal, we 
suggested that right now--in fact, it was at the beginning, the 
first paragraph--right now, all the PBGC can do, for instance, 
with United Airlines was to terminate it. But if they had the 
ability to freeze benefits, then their liabilities aren't going 
to go up anymore. They are not at risk of having this 
unreasonable increase in liabilities. So at that point, maybe 
they could work out a deal with the airlines.
    I am not saying that all airlines and steel plants should 
get it automatically. I think it is something that the PBGC 
should be able to go into negotiations with certain companies 
and deal with the particular situation they have. I think even 
a former Executive Director of the PBGC and I think someone 
from Northwest Airlines suggested this in a Wall Street Journal 
article, that if you can freeze benefits, then the PBGC should 
be able to work out a financing deal. They may not go all the 
way to 30 years. PBGC may not want it to go all the way. But 
maybe give them a break. If you are going to freeze your 
benefits, maybe we can give you a break on funding for a short 
period during the tough times.
    Senator Isakson. And that is far superior to just having to 
assume the liability of the pension fund.
    Mr. Gebhardtsbauer. Right. PBGC in September had $23 
billion in its deficit, its underfunding, and almost all of 
that was probable. Now it is pretty much--they are all starting 
to take a lot of that over. They have taken over U.S. Airways, 
United. It would be great if they had something besides the 
atomic bomb, you know, we are going to take you over. That is 
the only power they have right now.
    Senator Isakson. Thank you.
    Mr. Gebhardtsbauer. They need some regulatory authority.
    Senator Isakson. Thank you, Mr. Chairman.
    Senator DeWine. Senator Enzi?
    The Chairman. Thank you. This has been an extremely 
educational morning and extremely helpful morning. Right now, 
the negotiations are going on on the budget regarding the 
Pension Benefit Guaranty numbers, and what we have been 
shooting for on the Senate side is some flexibility so that we 
could actually solve the problem instead of just raising rates, 
which makes great window dressing but it doesn't solve the 
problem.
    So I really appreciate having all of you on the panel. I 
really appreciate the additional information that you gave us 
in the lengthier testimony. There are a lot of ideas there that 
I think can lead us to a solution that will work with as little 
pain as possible. There is some pain involved in it no matter 
how we do it at this point, but I can't tell you how happy I am 
that you have served on the panel.
    You realize that gives us the right to ask you questions in 
writing, which we can only ask you to answer, but we can get 
considerably more detailed in some of those answers and it also 
keeps the audience from going to sleep. I have some of those, 
particularly for Mr. Gebhardtsbauer, because in my State 
legislative career as well as here, I have placed a lot of 
credibility in an outside actuary taking a look at what is 
being asked. I have never been disappointed.
    Since I got here, we had a little railroad issue, and it 
was having some serious consequences. Several times, they asked 
me if I would vote for the bill and I said, well, I need to see 
an outside actuary. Get me some information. How much is this 
going to hurt? Will it hurt? Will it help? After about their 
third visit to me, they brought an outside actuary report and I 
got to visit with them a little bit too, and it confirmed that 
the plan would be better if we made the changes. So I was one 
of the few Republicans that voted for the railroad change, and 
I am very relieved at how it has come out.
    But I do appreciate all the testimony. Mr. Gebhardtsbauer, 
there is much being made about plan sponsors, about the need 
for predictability and the problems of volatility. Do you feel 
there is a greater need for smoothing of asset values and 
liabilities, and if so, is there a consensus in the actuarial 
community about how these should be smoothed and whether it 
should be done at the front end or the back end? I think that 
has to do with your chart.
    Mr. Gebhardtsbauer. Great question. Actually, actuaries, as 
in your experiences in the past, we are more like advisors. We 
don't say exactly how you should do it, and in particular at 
the Academy, we don't take positions that endorse particular 
legislation, and so we have actually talked about three ways of 
doing something.
    One way would be to smooth the assets and the liabilities, 
sort of at the front end of the calculation, or you could 
smooth the funding ratios. You could look at the funding ratio 
this year and last year and smooth them. Or you could smooth 
the contribution. Another way of talking about that is actually 
not smoothing the contribution, but, in fact, by the way, back 
to that chart, I apologize to Senator Mikulski and you all. I 
got a copy now of what you have, and this is my simpler chart, 
which is two lines. That is the one you have. And so the green 
line up here is actually a purple line on yours and that 
actually gets into answering your question.
    When we did this calculation, we smoothed the contribution, 
but you can also do it through smoothing assets and liabilities 
or through smoothing the funding ratios. But by smoothing it, 
you will notice the contribution went gradually down. That red 
line went gradually down instead of all of a sudden going to 
zero, as in the administration proposal. So, in fact, what that 
meant was in the good years, the employers actually had to put 
more money into their pension plans, so the pension plans were 
actually better funded.
    So the reason why I am bringing that up is that you can 
have smoothing and have better solvent plans than even in the 
administration proposal. So you can have both. You don't have 
to sacrifice one for the other. I know a lot of people talk 
about if you are for smoothing, that means you are against 
solvency, but that doesn't have to be the case. You can want 
solvent, 100 percent funded plans and have smoothed 
contributions.
    The Chairman. Thank you. I will have a lot more questions 
for all of you. I really appreciate it.
    Senator Mikulski. Mr. Chairman, I want to really think 
about what we heard here today. I think it was an excellent 
primer on the issues, the challenges, and a variety of 
solutions and look forward to working with you in additional 
hearings and really solving--dealing with this in a way that 
does not exacerbate the problem.
    Senator DeWine. I want to thank our panelists. You have got 
us off to a very good start. You have been very informative, 
very, very helpful, and we look forward to working with all of 
you.
    As Senator Enzi said, you can anticipate some written 
questions, so we appreciate it. Thank you all very much.
    [Additional material follows.]

                          ADDITIONAL MATERIAL

                 Prepared Statement of Senator Kennedy

    Defined benefit plans are a critical part of our retirement 
system, covering over 40 million workers, retirees and their 
families. All of us agree we need to strengthen our defined 
benefit system. We need to find ways to expand coverage of 
workers and encourage employers to start new defined benefit 
plans. And we must require companies to adequately fund their 
pension plans. At the same time we must not take extreme 
measures that would drive companies out of the system. The 
number of defined benefit plans is already on the decline--we 
cannot afford to hasten this trend.
    The administration has suggested a proposal to revise 
funding rules which companies have been using for years, and in 
most cases, decades. While I agree that we must protect 
pensions that workers have earned, I am concerned that the 
President's proposal would have the opposite effect. Indeed, it 
would cut benefits that workers have been promised. And 
penalizing companies that offer pensions by drastically 
increasing the cost of those pensions will hurt workers and 
retirees, as well as jeopardizing the long-term stability of 
the Pension Benefit Guaranty Corporation (PBGC).
    One of my chief concerns is the administration's approach 
to workers' benefits. This proposal would make workers pay the 
price when companies falter, effectively giving companies a 
permission slip to break their pension promises to workers. It 
would take away benefits increases that workers have been 
promised. And when companies get in trouble, it would freeze 
workers' benefits as well as the pensions they are guaranteed 
by the PBGC. Such changes would unfairly punish workers and 
retirees.
    The proposal would also prohibit companies from offering 
shut-down benefits. These benefits have been vital to workers 
and their families in sectors like our steel industry, which 
has faced intense international competition in recent years. 
Tens of thousands of steel retirees who have seen their plants 
close and their jobs eliminated now rely on these benefits to 
support themselves and their families. Taking away these 
benefits will be disastrous for these families and their 
communities.
    We must do more to strengthen companies' promises to 
workers. But this should be done by requiring companies to pay 
for what they've promised by contributing more to their pension 
plans, not by taking away workers' retirement.
    The administration argues that the changes it proposes are 
necessary to protect the PBGC. But we need to remember the PBGC 
was created to protect workers' pensions, not the other way 
around. We should also bear this principle in mind when 
considering the administration's proposal to drastically expand 
payment of premiums to the PBGC. I commend Chairman Enzi for 
his efforts to ensure that pension policy will drive our 
debate, rather than balancing the budget. While I agree that 
reasonable increases are acceptable, we should not be 
drastically increasing costs for employers who want to do the 
right thing by providing these guaranteed benefits to their 
workers.
    Astonishingly, the administration's proposal ignores the 
greatest threat to the PBGC: the difficulties faced 
restructuring industries. Our airline industry has been hit by 
global terrorism, increased competition, and now record high 
fuel prices. The PBGC projects that over 90 percent of the 
underfunding it will assume stems from steel and airline 
companies; and indeed, just last Friday, the PBGC terminated 
four pension plans at United Airlines. I am concerned that the 
agency seems to have no plan to address the very real short-
term crisis that could be caused by termination of additional 
airline pension plans and the loss of benefits by hundreds of 
thousands of retirees at airline and steel companies.
    The PBGC should be focusing on ways to help troubled 
pension plans before they fail. Currently, the PBGC's only 
option is termination: this is untenable. A plan termination is 
a losing situation for all the parties: workers see their 
benefits cut, and the PBGC assumes more liabilities. We need an 
approach that gives workers a say in what happens to their 
pension plans, instead of imposing automatic pension cuts. This 
would help workers and retirees by preserving at least some of 
the benefits that would otherwise be lost if the PBGC were to 
take over their plan. It would help employers to continue to 
fund their plans; and it would help the PBGC by reducing its 
exposure to plan losses.
    Instead this administration is focusing on long-term 
changes that do nothing to address these immediate issues and 
would make pensions much more expensive for companies with 
older workers and manufacturing companies. The President's 
proposal would punish companies that are already experiencing 
economic difficulties, by adopting a Yield Curve of corporate 
bond rates that would mean increased volatility and complexity 
that present a huge burden for employers. All of these factors 
will force many employers to drop their defined benefit pension 
plans.
    This is the wrong direction for us to take. We all agree 
that changes to our funding rules are needed, but we should be 
sure that our solutions fit the problems our pension system is 
confronting. I look forward to working with my colleagues on 
finding ways to protect and strengthen our defined benefit 
system.
     Response to Question of Senator Kennedy by Ron Gebhardtsbauer
                     American Academy of Actuaries,
                                                      May 31, 2005.
Hon. Ted Kennedy,
U.S. Senate,
Washington, DC 20510-6300.

    Dear Senator Kennedy: We appreciate the opportunity to respond to 
your question following the April 26, 2005 hearing of the Subcommittee 
on Retirement Savings and Aging on PBGC Reform.

    Question. The American Academy of Actuaries has proposed a number 
of solutions to tighten existing pension funding rules. How would these 
proposals compare with what the Administration is proposing in terms of 
improving pension funding levels?
    Answer. We must note that while we make suggestions on various ways 
to improve the pension funding rules, we do not offer one particular 
suggestion. However, we have provided some specific responses to the 
request below. More details can be found in our 60-page issue analysis, 
Pension Funding Reform for Single Employer Plans, and our analysis of 
the administration's pension funding proposal (March 2005). In addition 
to these papers, which apply only to single-employer pension plans, the 
Academy has presented a separate paper, Principles of Pension Funding 
Reform for Multiemployer Plans, because there are so many differences 
between single and multiemployer plans.
    Targeting a 100 Percent Ceiling Funding Level: The administration 
provision that improves funding levels the most is their requirement 
that sponsors fund all their plans until they are 100 percent funded 
for accrued benefits. The current rules were designed around a 90 
percent funding target. In addition, the administration proposal 
requires PBGC variable premiums until the plan is 100 percent funded. 
That creates an incentive to contribute up to the 100 percent funding 
level. The Academy also suggested these two ideas. However, the 
administration target is also a ceiling. As soon as the 100 percent 
funding level is reached, minimum contributions stop. We would go 
further, as suggested in the section on funding margins (see below).
    At-Risk Liability Target: The administration proposal increases the 
funding target if the credit rating of the plan sponsor falls below 
investment grade. However, the additional funding to the 
administration's ``at-risk'' liability may happen too late, because a 
company may already be too weak to make the additional contributions. 
Thus, it may not have the intended impact. For example, some plans in 
bankruptcy have not paid their minimum contributions even under the 
current rules, which don't include the at-risk increase. Some 
practitioners have suggested that this provision may cause employers of 
plans that have much larger termination liabilities to seek bankruptcy 
protection to avoid these larger funding obligations.
    The Academy considered suggesting these higher funding targets for 
all companies, but the additional funds may never be needed and any 
excess funds cannot be accessed without paying prohibitive taxes of 
over 90 percent. For example, some companies have been below investment 
grade for many, many years without going bankrupt, and investment 
bankers consider it unlikely they ever will, so the higher at-risk 
calculation using earlier retirement ages would be inaccurate. Another 
response would be for Congress to consider requiring funding margins 
for all plans as suggested below.
    Speed to Funding Target: The administration would require sponsors 
to fund a plan's underfunding over 7 years (or possibly 10 years). The 
Academy has not taken a position on how fast the amortization should 
be, but has suggested anywhere from 5 years (the current number of 
years for benefit improvements to be guaranteed by the PBGC phase-in) 
to 15 years (if the plan doesn't deplete itself with the payment of 
lump sums). Of course, 5-year amortization would improve funding levels 
the most, but the trade off would be that contributions would be higher 
and more volatile.
    The administration proposed an amortization rule that some are 
calling one-sided (or the high-water-mark method), because their 
amortization payments do not decrease if the plan experiences unusually 
good asset returns or liability loses. Under this rule, plans would 
probably reach 100 percent funding sooner than 7 years.
    As an alternative, the Academy suggested an anti-volatility rule 
that would keep the contribution from falling or increasing too fast. 
The attached chart, used for my April 26, 2005 testimony, shows that if 
the administration proposal had been applied in the economic scenario 
of the past 10 years, the minimum contribution for the sample plan 
would have fallen quickly to zero in the late 1990s, and jumped back up 
in 2002. The anti-volatility rule we suggest would have kept the 
minimum contribution from falling so fast, so funding ratios would have 
been higher. In fact, in all economic scenarios we studied, the funding 
ratios were about as good as or better than the funding ratios produced 
by the administration proposal. Faster 5-year amortization and our 
creation of funding margins also play a part in that analysis.
    Creating Funding Margins: The minimum required contribution under 
the administration proposal is zero after 100 percent funding is 
reached. However, due to the increased volatility risk and the 
penalties for plans being less than 100 percent funded, the 
administration's proposal may drive sponsors to reduce their risk by 
building up funding margins and/or allocating more assets to bonds to 
avoid the penalties for underfunding (e.g., variable premium, quarterly 
contributions, benefit freezes). This would be a positive outcome for 
the PBGC. However, we do not think this will be enough motivation for 
weak employers with poorly funded plans to contribute the large amounts 
needed to avoid these penalties, or to move to bonds.
    The Academy suggests that more than encouragement might be needed 
for all plans to build up funding margins. Strong companies may build 
funding margins, but the weak employers will only contribute the 
minimum required, and their plans are the ones that are more likely to 
be taken over by the PBGC. Ways to require contributions above 100 
percent funding levels would be as follows:

     Require a contribution equal to the cost of current year 
accruals until some higher threshold is reached, such as 100 percent + 
X percent of accrued liabilities, 100 percent of accrued liabilities 
using projected pay (or projected multipliers for hourly plans), or 100 
percent of accrued liability including contingent benefits, or
     Phase out the normal contribution more gradually than the 
dollar-for-dollar phase-out in the administration proposal. For 
example, the minimum contribution could equal the normal cost plus the 
surplus divided by a N-year amortization factor. This could be the same 
factor used in amortizing the deficit for underfunded plans, which 
would make for a very simple formula.
    These rules could be relaxed if the employer increases its 
allocation to bonds and/or reduces its exposure to subsidized early 
retirement benefits and subsidized lump sums.
    Penalties for Underfunding: The administration increases the 
incentives for funding by increasing or adding new penalties for 
underfunding (e.g., no benefit improvements if funded under 80 percent, 
benefits frozen and lump sums eliminated at 60 percent funding levels). 
We have made similar suggestions. However, to reduce the possibility of 
a run-on-the-bank, we suggest a provision that would allow the plan to 
pay the lump sum only to the extent funded.
    For example, if the plan is 90 percent funded, then it could pay 90 
percent of the lump sum. Alternatively, the rules could increase the 
minimum contribution by the underfunded portion of the lump sum. 
Sponsors also could be encouraged to eliminate their lump-sum 
provisions and replace them with a 20-year certain life annuity, which 
would make sure that unhealthy employees would not lose value. We also 
note that the current rules in the Code of Federal Regulations (CFR) 
1.401(a)(4)-5(b)(3) already restrict lump sums for highly compensated 
employees (HCEs) or the top 25 when funding ratios are less than 110 
percent. They could be applied to all HCEs.
    The penalties are also more volatile under the administration 
proposal, because they use market assets and market liabilities. Some 
sponsors might avoid them by increasing funding levels or investing 
more pension assets in bonds, as suggested above.
    Incentives for Improved Funding: The administration proposal has 
less incentive for employers to contribute more than the minimum, due 
to (1) eliminating the credit balance and (2) not allowing employers 
any economic advantage for super surpluses. In fact, their proposal to 
eliminate the credit balance has already discouraged some employers 
from contributing this year, even though they may be cash rich due to a 
law encouraging repatriation of funds from oversees. We would tighten 
up the rules for the credit balance, such as growing it at the same 
rate at which the plan assets grow (as discussed in the Academy's fact 
sheet on credit balances). With this fix, credit balances could 
actually increase the funding levels shown in PBGC's white paper on 
funding. Congress could also restrict the use of the credit balance if 
funding falls below a specified level, or it could always require that 
the normal cost be paid. These would improve funding levels beyond 
those found in the administration proposal.
    The administration proposal would allow deductible contributions 
until plan assets equaled 130 percent of liabilities, which is good, 
but it only allows greater contributions. It won't work unless sponsors 
can get economic value for plan surpluses, as suggested in our analysis 
of the administration proposal on pages 5 and 6.
    The Academy had concerns about prior proposals to access plan 
assets in the 1990s, but that is because the threshold, based on a 
smoothed liability number, was set far too low. In addition, the 
proposal encouraged companies to take the surplus by eliminating the 
excise tax for only a short period. There are better ways to make this 
idea work for both employers and employees, and we would be happy to 
work with you on this.
    Assumption Setting: The administration proposal sets the retirement 
assumption for at-risk companies, but as discussed earlier, it would 
produce inaccurate assumptions for companies that are poorly rated, but 
have a low probability of terminating. History has shown that using the 
law and regulations to specify actuarial assumptions has not been 
successful, as evidenced by the delays in setting the discount 
assumption and the long-running debate on replacing the currently 
required 1983GAM mortality table. We recommend that the law allow 
actuaries to set the mortality assumption because mortality experience 
differs by plan participant populations. Large plans could use actual 
experience (with an assumption for expected mortality improvement), and 
smaller plans could use tables with collar adjustments, as suggested in 
our December 2003 letter to the Internal Revenue Service on this issue. 
The law and actuarial standards both now require each assumption to be 
individually reasonable for single employer plans, which is a stronger 
rule than when Congress first started specifying assumptions. We also 
suggest the actuary continue to set the retirement assumption. If there 
are concerns that the individually reasonable rules are not strong 
enough, then actuaries could be required to justify their assumptions 
in writing if they seem out of the ordinary.
    Yield Curves: The administration's yield curve provision, when 
compared with an equivalent rate determined from a typical plan, would 
increase the liability numbers by around 1 percent for unusually mature 
plans and decrease them by around 1 percent for unusually young plans. 
A single interest rate could be selected to achieve the same liability 
amount for a typical plan. Thus, instead of a plan being say 100 
percent funded, for example, the unusually old or young plans might be 
99 percent funded or 101 percent funded, respectively. If the yield 
curves are steep, which happens in recessions, then the results would 
be further apart, but analysis has shown it would be at most 3 percent 
or 4 percent. Thus, in aggregate, the charts in PBGC's white paper 
showing total funding in the pension system would be about the same. 
The charts showing the plans that PBGC takes over (and PBGC's deficit) 
would be worse, since they are more likely to take over mature plans 
during recessions, but the difference is so small that the change to 
their graphs would be subtle.



    In summary, you will note from above, that the use of an anti-
volatility mechanism and an equivalent rate instead of a yield curve, 
and the retention of a modified credit balance provision, if done in 
connection with funding margins, will achieve similar and sometimes 
better funding levels when compared with the administration proposal, 
particularly if a shorter amortization period is used. I hope these 
comments have been helpful in responding to your question. Please let 
Heather Jerbi or myself know if we can be of further assistance by 
calling us at 202-223-8196.
            Sincerely,
              Ron Gebhardtsbauer, MAAA, EA, FCA, FSA, MSPA,
                                             Senior Pension Fellow,
                                     American Academy of Actuaries.
                                 ______
                                 
        Response to Questions of Senator Kennedy by Bradley Belt
    Question 1. The President's Proposal would require companies to 
take future benefits that they have promised workers and in some cases 
would abruptly cut off workers' future earned pensions. Has the PBGC 
done any projections of what percentage of plans would be subject to 
these restrictions and how many workers would see their pension 
benefits harmed? What are the results of these projections?
    Answer 1. The President's proposal would prevent plans from making 
false promises they can't afford to keep, promises that workers may 
rely on to their detriment. Requiring that new benefits be either fully 
funded or delayed until existing benefits are reasonably funded 
prevents workers, retirees and their families from finding out too late 
that the benefits they were promised are not there.
    Under the President's proposal, the benefit limitations will apply 
only when a plan's funded status falls below acceptable levels and will 
depend on the financial health of the plan sponsor. Plans with 
financially weak sponsors that are funded at a level less than or equal 
to 80 percent of their target funding liability will be restricted from 
offering lump sums or increasing benefits. If funding is less than or 
equal to 60 percent of target liabilities, accruals will also stop. 
Plans with healthy sponsors will be restricted from increasing benefits 
if they are funded at a level less than or equal to 80 percent of their 
funding target and from offering lump sums if they are at a level less 
than or equal to 60 percent of their funding target.
    PBGC used its Pension Insurance Modeling System (PIMS) to model the 
effects of the proposal on a sample of 369 large pension plans. The 369 
plans are loaded into the model with data on assets and current 
liabilities as of January 1, 2002, the most recent data available. The 
sample plans are not intended to reflect the entire universe of single-
employer defined benefit plans. (Information about the PIMS model may 
be found at http://www.pbgc.gov/publications/databook/databk98.pdf).
    The table below shows the number of plans in the sample of 369 
plans that would fall into each of the benefit limitation categories as 
of January 1, 2002, had the benefit limitation provisions been in 
effect at that time. The table also shows the limitations that apply in 
each category.

                        Distribution of 369 Sample Plans, By Benefit Limitation Category
----------------------------------------------------------------------------------------------------------------
                                         Financially weak sponsor                     Healthy sponsor
     Target liability funded     -------------------------------------------------------------------------------
           percentage*             Plans (number and                       Plans (number and
                                     % of sample)         Restriction        % of sample)         Restriction
----------------------------------------------------------------------------------------------------------------
Over 80%........................  14 plans(4%)......  No restrictions...  64 plans (45%)....  No restrictions.
Over 60% but less than or equal   44 plans (12%)....  No benefit          119 plans (32%)...  No benefit
 to 80%.                                               increases or lump                       increases.
                                                       sums.
60% or less.....................  16 plans (4%).....  No benefit          12 plans (3%).....  No benefit
                                                       increases, lump                         increases or lump
                                                       sums or accruals.                       sums.
----------------------------------------------------------------------------------------------------------------
* Market value of assets divided by target liability as of 1-01-02.

    Note that the numbers and percentages in the above table will vary 
significantly over time as discount rates, asset returns, employer 
contribution rates and other factors vary, and have changed since then.
    Also note that employers may ``fund up'' their plans to avoid 
benefit restrictions.

    Question 2. Many of us are concerned that a number of burdens in 
the President's plan would drive healthy companies out of our voluntary 
defined benefit system. Has the agency projected what percentage of 
employers has the agency projected may leave the defined benefit system 
as a direct result of the President's plan? If not, why not? If so, 
will you please share your results with us?
    Answer 2. We have heard these assertions before, but we have never 
seen any evidence that they are valid. We have not seen any qualitative 
analysis that the administration's proposal will drive healthy 
companies out of the system. Indeed, under current laws and 
regulations, thousands of companies are exiting the system. The number 
of single-employer defined benefit plans insured by PBGC has been 
declining for many years--from a high of 112,000 in 1985 to 54,000 in 
1995, and to 30,000 in 2004.
    The administration's proposal would strengthen the system by 
placing both individual pension plans and the pension insurance program 
on sounder financial footings. Under the current system, there are 
significant disincentives for new employers to create defined benefit 
plans, such as the substancial deficit of the sponsor-financed 
insurance fund. Prospective defined benefit sponsors are also aware 
that the current complex system of funding fules allows some sponsors 
to transfer the risks of their funding and investment decisions to that 
same insurance system. We believe that these considerations--risk 
transfers and administrative complexities--also make defined benefit 
plans unattractive to prospective plan sponsors.
    The administration's proposal will correct these flaws. Simplifying 
the rules, tightening funding requirements, and returning the pension 
insurance program to financial health will make defined benefit plans 
more attractive to employers who are now outside the system.
    The administration also believes that Congress should act promptly 
to clarify the legal status of cash balance and other hybrid pension 
plans. Nearly all the new defined benefit plans created in recent years 
have been alternative benefit structures, such as arrangements for 
small businesses (e.g., insurance contracts under Codesection 412(i)) 
and cash balance or pension equity plans, which are designed to meet 
the needs of a younger, more mobile workforce. Unfortunately, as a 
result of a singel Federal court decision, the legal status of these 
types of plans is in question.\1\
---------------------------------------------------------------------------
    \1\ Cooper v. IBM Personal Pension Plan, 274 F. Supp. 2d 1010 (S.D. 
Ill. 2003) (holding that cash balance plans violate age discrimination 
provisions of ERISA). Other courts, however, have disagreed. Tootle v. 
ARINC, Inc. , 222 F.R.D. 88 (D. Md. 2004); Eaton v. Onan Corp. , 117 F. 
Supp. 2d 812 (S.D. Ind. 2000).
---------------------------------------------------------------------------
    There are difficulties inherent in modeling future behavior. For 
example, if employers choose to leave the defined benefit system, they 
must contribute enough to eliminate the underfunding to do so. If they 
contribute that much, the plans would no longer be underfunded and 
would be much less of a financial burden on the employer. Given the 
amount of underfunding in some plans, sponsors may not have sufficient 
cash resources available to enable a standard termination. In addition, 
there are other limits on an employer's ability to leave the pension 
system, including collective bargaining agreements.

    Question 3. By changing the pension funding rules, you will also 
change the funding percentage of pension plans. For example, a plan 
that is 100 percent funded today may only be 85 percent funded under 
the President's new framework, and, if it is a below-investment grade 
rated company, it may be 80 percent funded or less. Has PBGC modeled 
how companies' funding percentages will be affected? I ask that you 
provide us with that information.
    Answer 3. One of the problems with current law is that a plan's 
funding percentage is measured differently for different purposes. A 
plan may be 100 percent funded under one measure and only 80 percent 
funded under another. So, the answer to the question ``how much will a 
particular plan's funding percentage change'' under the proposal 
depends on which measure is used as a starting point. For purposes of 
this question and answer, we will assume the starting point is the 
current liability funded ratio as that is one of the most common 
measurements. It is the ratio of assets (which may be determined under 
a formula that smoothes fluctuations in the market value of assets by 
averaging the value over a number of years) to current liability (which 
is the liability measure used in the deficit reduction contribution 
calculation). Current liability is a ``smoothed'' liability in that it 
is based on a 4-year weighted average bond yield. The current liability 
ratio, however, does not provide a true picture of a plan's funded 
level, thereby masking the underfunding problem.
    The President's proposal uses a ``mark to market'' approach to 
replace both the liability and asset measures. Assets will be valued at 
market value rather than smoothed. Target liabilities will be valued 
using a corporate bond yield curve and other assumptions appropriate to 
the financial health of the plan sponsor. In addition, under the 
proposal, the mandated mortality table underlying the liability 
calculations will be updated to reflect mortality improvements.
    It is difficult to predict exactly how a particular plan will be 
affected. Furthermore, it is important to note that the impact depends 
largely on the economic environment at the time of the comparison. For 
example, when interest rates are rising, using a ``mark to market'' 
approach results in lower liabilities. However, in an environment where 
interest rates are dropping, the liability would be higher under a 
``mark to market'' approach.
    Using the same 369 plans and the PIMS model discussed in our 
response to question (1), we compared the funded ratios based on 
current liability and smoothed assets with the ratios based on target 
liability and market value of assets. As of January 1, 2002, using the 
administration's proposed measures resulted in an average decrease in 
funded ratios of 25.0 percentage points for plans of financially weak 
sponsors and 17.2 percentage points for plans of healthy sponsors. Note 
that the results would be different in other economic environments, and 
likely have changed since 2002. For example, the smoothed values of 
assets generally exceeded market values as of January 1, 2002, but that 
may not be the case at the time of implementation of a change in the 
law (2006).

    Question 4. The administration has proposed eliminating shutdown 
benefits. These benefits are very prevalent in the steel and rubber 
industries, which are subject to cyclical downturns. The elimination of 
these benefits would be devastating for workers and families and even 
whole towns because in many cases, the plant that is closing may be the 
only major employer in a community. Has the administration looked at 
the devastating economic effects this policy will have on communities 
like this?
    Answer 4. The administration has not proposed eliminating shutdown 
benefits. Rather, the administration proposal would prospectively 
prohibit these benefits from being paid from pension plan assets. These 
benefits could continue to be provided outside the pension plan.
    The reason for this approach is that shutdown benefits are more in 
the nature of severance benefits rather than retirement benefits and 
should not be paid by pension plans. Moreover, shutdowns frequently 
occur in financially-troubled companies with underfunded plans. When 
shutdown benefits are paid prior to plan termination, they drain the 
plan of assets that would otherwise go to pay non-guaranteed retirement 
benefits after plan termination. These benefits generally are not 
funded until the shutdown occurs, by which time it is often too late. 
However, despite the lack of funding, shutdown benefits may be 
guaranteed if the shutdown occurs before the plan termination date, 
often imposing large losses on the insurance program.

    Question 5. I understand that a large part of the agency's 
projected $23 billion deficit is attributable to predicted airline 
pension plan terminations. The PBGC should thus be focused on short-
term solutions to address this immediate issue, but no such solutions 
are proposed in the President's plan. What is the current estimate of 
what portion of this projected deficit is attributable to airline 
pension plans? What steps has PBGC taken or will it take in the near 
future to prevent these airline pension plans from terminating and to 
protect workers from losing their benefits?
    Answer 5. In general, PBGC is not able to break down its current 
deficit by plan or by industry. We do track total claims by industry as 
plans are trusteed. Of the $20.6 billion of claims for plans that had 
been trusteed by PBGC through September 30, 2004, $2.9 billion or 14 
percent were from the airline industry. Since September 30, 2004, PBGC 
has taken claims of an additional $9.7 billion for plans that had not 
been trusteed as of that date, but had already been included in our 
deficit as part of ``probable'' claims of $16.9 billion. Of the $9.7 
billion, $8.9 billion was for airlines and $0.8 billion was for other 
plans. We also trusteed ``non-probable'' plans with claims of $0.4 
billion. The combined results are shown in the chart below.

             PBGC Claims From Airlines and Other Industries
------------------------------------------------------------------------
                                                  Plans of
                                    All Plans     Airlines   Other Plans
------------------------------------------------------------------------
Claims for Plans Trusteed as of 9/       $20.6         $2.9        $17.7
 30/04...........................      billion      billion      billion
                                                      (14%)        (86%)
Claims for Probables Trusteed or          $9.7         $8.9         $0.8
 Announced Since 9/30/04.........      billion      billion      billion
                                                      (92%)         (8%)
Claims for Other Trusteeships 9/          $0.4                      $0.4
 30/04 to 4/30/05................      billion                   billion
                                                                  (100%)
    Total........................        $30.7        $11.8        $18.9
                                       billion      billion      billion
                                                      (38%)        (62%)
------------------------------------------------------------------------

    We understand the financial difficulties the airlines are facing. 
Congress and the administration have provided assistance to the 
airlines in the form of grants, loan guarantees, and short-term funding 
relief when such assistance was determined to be appropriate.
    The administration's pension reform proposal would strengthen the 
funding rules to improve the health of the entire defined benefit 
pension system. This is particularly important for those underfunded 
plans that pose the greatest risk of terminating. Neither the defined 
benefit system nor the pension insurance system is designed to provide 
targeted relief to specific industries. It is designed to insure 
benefits for participants in plans that fail.
    Weak funding rules have been the cause of current difficulties, and 
we believe that further weakening funding requirements will only 
exacerbate the problem. It is not in the best interests of 
participants, other premium payers, or the taxpayer to allow companies 
to effectively borrow from their employees and the insurance fund to 
meet their financial obligations.
    I would also emphasize that the majority of losses incurred by the 
PBGC to date have been in industries other than airlines and that the 
majority of the insurance fund exposure to ``reasonably possible'' 
claims is in other industry sectors. The financial pressures on the 
pension insurance program are not unique to the airline industry.
    Current law allows plan sponsors to obtain funding waivers if they 
are experiencing temporary substantial business hardship. The IRS can, 
in consultation with the PBGC, impose conditions on obtaining a waiver 
that will protect the interests of participants and the pension 
insurance program. As the airline situation is not temporary, relief is 
not permitted under current law. Providing this relief would not solve, 
and might worsen, the problem for workers, retirees, and the pension 
insurance program.
    PBGC will use the tools at its disposal to ensure that companies, 
including airlines, comply with applicable laws and regulations before 
they are able to shed their pension obligations onto the insurance 
program. Ultimately, however, current law allows companies to shift 
those costs if they are able to demonstrate to a bankruptcy judge that 
they would not be able to emerge from bankruptcy with their pension 
plans intact. The court makes that determination, not PBGC.
       Response to Questions of Senator Mikulski by Bradley Belt
    PBGC took over the pension plan of Bethlehem Steel in December of 
2002. PBGC now pays the pensions of Bethlehem Steel retirees and will 
pay the benefits of workers who have not yet retired. After the 
takeover, Beth Steel retirees continued to collect their normal pension 
benefits. Nearly 1 year later, PBGC told thousands of the retirees 
their monthly benefit check was more than it should have been--
something PBGC calls ``benefit overpayments.'' These retirees were also 
told they had to repay the ``overpayment.'' A reduction in benefits for 
someone on a fixed income is hard enough--but to repay the PBGC is 
truly a hardship.
    These overpayments affected about 3,000 Maryland retirees and about 
11,000 Bethlehem Steel retirees. Some of them were expected to repay as 
much as $15,000!
    After this happened, I wrote to PBGC to ask forgiveness of these 
overpayments. There are other Federal agencies that forgive 
overpayments and I asked if the same could be done for these workers. I 
was told by Steven Kandarian (former Executive Director) that the PBGC 
is required by law to recoup any overpayments.
    I understand that calculating pension benefits can be complicated, 
but we all know that most elderly Americans do not have extra money to 
be paying government agencies for administrative glitches. Though you 
many not see it as the fault of the PBGC, it certainly is not the fault 
of the individual steel worker.
    There must be a better way!

    Question 1. How do we make sure something like this doesn't happen 
in the future?
    Answer 1. We agree that we must find a better way, but in doing so 
we should understand what caused the problem in the first place. By way 
of brief background, Bethlehem Steel chose to operate a chronically 
underfunded pension plan for many years. Bethlehem Steel did this by 
taking full advantage of very weak minimum funding rules that are 
statutorily established under ERISA and the Internal Revenue Code. As a 
result, by October 2001, when Bethlehem Steel filed for bankruptcy, its 
pension plan was only 45 percent funded, with over $4 billion of 
unfunded pension promises.
    Unfortunately, under current law there is no way to prevent this 
from happening again. As long as the law allows companies to 
significantly underfund their plans, as Bethlehem did and hundreds of 
other companies are still doing today, then retirees are at risk of 
losing the benefits they earned through a lifetime of hard work.
    When these companies go bankrupt and their plans are terminated, 
retirees continue to receive benefits at the plan level, rather than at 
the lower limits provided under Title IV of ERISA, until the plans are 
trusteed by PBGC. This process often takes many months because of 
delays in signing trusteeship agreements, the tremendous complexity of 
the company/union negotiated plan provisions, and the complexity 
inherent in the statutory guarantee limits and asset allocation rules 
under Title IV of ERISA. As a consequence, overpayments can continue 
for some time. By law, the PBGC is required to seek repayment of those 
overpayments.
    The best way to protect retirees in future terminations from 
difficulties like those faced by retirees in the Bethlehem plan is for 
Congress to promptly pass the administration's pension reform package. 
Companies should be required to fully fund their own pension promises; 
to be open about the financial condition of their pension plans; and to 
stop making new, empty promises when they have failed to fund their 
past pension commitments. Until Congress acts to prevent these abuses, 
retirees will continue to suffer.

    Question 2. What would you suggest we do to prevent this hardship 
on retirees?
    Answer 2. The PBGC already makes every effort to mitigate the 
impact of recoupment on retirees. We inform them about the benefit 
limitations of ERISA that apply to terminated plans so that they are 
aware of the potential overpayments in the benefits they are receiving 
after the plans terminate. We apply the statutory benefit limitations 
of ERISA as quickly as we can. And we seek repayment in a way that 
mitigates hardship.
    We mitigate recoupment hardship in several ways. Under the 
regulation that implements the statutory recoupment requirement, a 
participant's (and any survivor's) monthly benefit payable by the PBGC 
under Title IV of ERISA is reduced by an amount that would result in 
the overpayment being repaid over the participant's expected remaining 
lifetime, based on the participant's age, without interest. Regulations 
provide that the recoupment amount is limited to 10 percent of the 
monthly benefit payable by the PBGC. (The vast majority of recoupment 
amounts are much less than 10 percent.) When the overpayment amount has 
been fully repaid, without interest, the PBGC stops recoupment and 
restores the full benefit payable under Title IV of ERISA.

    Question 3. Given computing power now available, why is there such 
a delay in the overpayments?
    Answer 3. The PBGC must have access to plan and participant records 
before we can even start the process of determining benefits payable by 
the PBGC. In some plans, access is difficult or delayed because 
terminating a pension plan may be contentious or simply of secondary 
importance to the employer. In other situations, plan and participant 
records are in disarray or missing.
    The PBGC worked with Bethlehem Steel, other creditors, and the 
unions, to see if the pension plan could continue; but by December 2002 
it became clear that the plan's termination was inevitable. 
Unfortunately, even though Bethlehem's CEO had said publicly for many 
months that plan termination was unavoidable, the company refused to 
sign the trusteeship documents until April 30, 2003. During this 5-
month period, Bethlehem continued paying retirees their full plan 
benefits knowing that thousands of the payments they were making each 
month were in excess of the limits set by law and would ultimately have 
to be repaid.
    Upon becoming trustee on April 30, 2003, and finally gaining access 
to the company's pension records, the PBGC began reviewing benefits 
being paid to Bethlehem's 70,000 retirees. During this initial review 
process we must analyze each participant's benefit in light of the very 
complex set of guarantee limits and asset allocation rules required by 
Title IV of ERISA. This process took 6 months and resulted in PBGC's 
identifying 11,000 retirees whose benefit payments were in excess of 
the statutory guarantee limits. PBGC notified participants and reduced 
benefits of those being overpaid. Unfortunately, these participants had 
been receiving their full plan benefits for 11 months after the date 
the plan ended.
    The PBGC is acutely aware of the need to calculate participants' 
guaranteed benefits as early as possible. We are constantly striving to 
find methods to enable us to calculate benefits earlier. As we did in 
Bethlehem Steel, the PBGC now starts the analysis of pension plan 
provisions and policy issues (where applicable) as soon as we become 
aware of an impending termination.

     Prepared Statement of the National Rural Electric Cooperative 
                              Association

    Mr. Chairman, and members of the committee, the National Rural 
Electric Cooperative Association (NRECA) is a not-for-profit national 
service organization representing approximately 930 not-for-profit, 
consumer-owned rural electric cooperatives that serve over 37 million 
Americans in 47 States. Our members are generally small businesses (as 
few as four employees), with a median of 43 employees across the 
country. With over 58,000 total employees and retirees of NRECA's 
members enrolled in NRECA-sponsored defined benefit (DB) pension plans 
throughout the United States, I thank Chairman DeWine and Ranking 
Member Mikulski for convening this hearing on the critical issue of 
preserving private-sector retirement savings plans, and the PBGC, in 
the future.
    We remain committed to the consumers we serve as well as to the 
cooperative employees who ensure the consistent delivery of safe and 
affordable energy throughout rural America. In pursuit of this goal, 
the vast majority of our members provide their employees with the 
NRECA-sponsored and administered ``multiple-employer'' DB pension plan 
under  413(c) of the Code. Approximately 900 individual rural electric 
cooperatives participate in NRECA's DB Plan covering over 58,000 total 
employees and retirees throughout the United States. The principle of 
Cooperation Among Cooperatives calls on cooperatives to ``serve their 
members most effectively and strengthen the cooperative movement by 
working together . . . .'' NRECA's ``multiple-employer'' DB pension 
plan is a shining example of this principle, as it provides 
cooperatives with a convenient and affordable mechanism to pool 
resources, maximize group purchasing power and leverage economies of 
scale that would otherwise be unavailable to small businesses like 
cooperatives. Our DB plan is one of our most popular member benefits.
    Concerns with the administration's Proposal on Defined-Benefit 
Plans-- NRECA believes that the administration has raised very 
important issues that need to be addressed in order to strengthen the 
private retirement plan system. We support certain principles 
underlying the administration's proposal, including the need to 
strengthen funding requirements and improve disclosure. However, we 
have several concerns with respect to the proposal that we believe need 
to be addressed to avoid causing harm to the system--particularly in 
the areas pertaining to predictability, how the PBGC values plan assets 
and liabilities, and how these PBGC calculations could force rural 
electric cooperatives from the voluntary defined-benefit plan system. 
As this hearing is focused on the PBGC, I will address those specific 
issues first.
    PBGC Premiums. First, we have serious questions about the size of 
PBGC's deficit, especially since the deficit number that PBGC has 
announced was determined based on a below-market and inappropriate 
interest rate. We also have questions about the extent to which small 
increases in interest rates and the equity markets would reduce the 
PBGC deficit. We strongly urge that no legislative action be taken on 
premiums until those fundamental issues are resolved.
    To address this ``deficit,'' the administration has proposed more 
than a 50 percent increase in the flat-rate premium (from $19 per 
participant to $30), and has proposed indexing the premium 
prospectively. This proposal alone would raise $2 billion over 5 years. 
In addition, the administration proposes raising an additional $13.5 
billion (for a total of $15.5 billion over 5 years) in its fiscal year 
2006 Budget.
    The proposed increase in the flat-rate premium and additional 
premium increases in the fiscal year 2006 Budget would be a direct 
``tax hike'' on our consumer-owners. How so?
    It is important to remember that electric cooperatives operate ``at 
cost,'' meaning that any increases in operational costs or government 
fees have to be passed on directly to our consumer-owners. For example, 
if the administration's proposal to raise this $15.5 billion comes from 
flat-rate premiums alone, the current $19 per participant figure would 
have to be raised to approximately $104.
    This would result in a stunning ``tax hike'' of just under $5 
million that would have to be borne by our consumer-owners in 2006 
alone. This would also unfairly burden all other employers that have 
stayed in the defined benefit plan system through the perfect storm of 
low interest rates and low equity values.
    In your State of Ohio alone, Mr. Chairman, this would mean that the 
25 co-ops that participate in NRECA's defined-benefit plan would have 
to pass on nearly $100,000 in electricity rate increases to their 
consumer-owners with no additional benefits whatsoever. Here is how the 
proposal would affect all members of the subcommittee:


----------------------------------------------------------------------------------------------------------------
                                                                                                   Increased
                                                                Employee                        electricity cost
            Senator                    State         Co-ops   participants                        to consumer-
                                                                                                     owners
----------------------------------------------------------------------------------------------------------------
Isakson........................  Georgia..........        46          3988    ...............           $338,980
Sessions.......................  Alabama..........        21          1934    ...............           $164,390
Roberts........................  Kansas...........        30          1265    ...............           $107,525
DeWine.........................  Ohio.............        25          1172  x $85............            $99,620
Hatch..........................  Utah.............         7           481  PBGC.............            $40,885
Bingaman.......................  New Mexico.......        11           415  Premium..........            $35,275
Mikulski.......................  Maryland.........         2           158  Increase.........            $13,430
Jeffords.......................  Vermont..........         2            98    ...............             $8,330
Clinton........................  New York.........         8           153    ...............            $13,005
----------------------------------------------------------------------------------------------------------------
   Total Electricity Rate Increase For Subcommittee Member States                                       $821,440
----------------------------------------------------------------------------------------------------------------

    For Chairman Enzi's constituents, Wyoming's 13 co-ops that 
participate in NRECA's defined-benefit plan would have to pass on 
nearly $34,000 in electricity rate increases to their consumers with no 
additional benefits whatsoever. A complete state-by-state and co-op by 
co-op breakdown of the administration proposed 547 percent increase in 
PBGC flat-rate premiums and its affect on rural electric cooperative 
consumer-owners is available.
    More globally, NRECA strongly believes that these massive increases 
in premiums would have extremely adverse effects on the defined benefit 
plan system, leading to many fewer plans and lower benefits.
    The administration has also proposed that the PBGC's Board control 
the level of the variable rate premium (which is renamed the risk-based 
premium) to cover PBGC's expected losses and improve its financial 
condition. We have grave concerns about the PBGC setting its own 
premiums. That is a Congressional function and should remain so.
    Further, any dramatic increase in the variable rate premium would 
inappropriately burden those plans experiencing a downturn in its 
sponsor's business cycle, harming the Plan's ability to recover. This 
is contrary to the interests of the participants, the Plan sponsors, 
and the PBGC.
    Finally, we believe that any proposed increases in PBGC premiums 
should not be considered as part of the fiscal year 2006 budget 
resolution. As pension funding and PBGC premiums are inextricably 
intertwined, we firmly believe that setting premium increase targets in 
the fiscal year 2006 budget resolution will make a full discussion of 
pension funding reform virtually impossible.
    These concerns with specific PBGC issues, however, cannot be viewed 
in a vacuum. All other aspects of the administration's DB pension 
proposal will have a direct impact on the function, utility, and 
obligations of the PBGC in the future.
    Predictability. The administration has proposed that a plan's 
funding and premium obligations be based on a spot valuation of assets 
and a near-spot valuation of interest rates. It can be shown based on 
historical data that such snapshot valuations are not accurate measures 
of a plan's funded status for the following year. Moreover, such 
snapshot valuations cause severe planning problems, as discussed below.
    A critical issue for Cooperatives and all employers that sponsor 
defined benefit plans is predictability. This is especially true in the 
utility area, where Cooperatives need to be able to make cash flow and 
capital investment projections that are taken into account for purposes 
of setting rates. Under the administration's spot valuation proposal, a 
plan's funded status could easily vary by over 10 percent during the 
last 3 months of a year, thereby dramatically altering the following 
year's funding and variable rate premium requirements. This is an 
unworkable situation for Cooperatives and will clearly hurt planning 
and growth, as well as cause many Cooperatives and other companies to 
leave the defined benefit plan system.
    There are two ways to address the predictability concern. The 
first, which NRECA supports, is to retain the current-law rules that 
permit changes in asset values and interest rates to be recognized over 
time to mitigate short-run changes in liabilities (by reason of 
interest rate fluctuations) and in the fair market value of plan assets 
(``front-end smoothing''). The second, which NRECA opposes, is to use 
spot valuations to measure assets and liabilities, but ``smooth'' on 
the ``back-end'' by smoothing both contribution obligations and the 
application of the numerous other rules that are based on a plan's 
funded status. We strongly believe that the latter approach would be 
quite complex and, in the end, unworkable.
    Liability Measurement. The administration has proposed using a 
near-spot yield curve to measure liabilities. NRECA has two major 
concerns with respect to this aspect of the proposal. First, as 
discussed above, preserving the current-law interest rate averaging 
rules is critical.
    Second, use of a yield curve should not have the effect of lowering 
the effective interest rate for the average plan.
    We do not favor the yield curve, but if a yield curve is used, it 
needs to be based on a 4-year weighted average of yield curve interest 
rates. The yield curve would also need to be based on rates both above 
and below the long-term corporate bond rate so that the effective rate 
for the average plan is the long-term corporate bond rate.
    Lump Sum Distributions. NRECA's DB Plan offers lump sums and 
approximately 92 percent of our participants elect a lump sum 
distribution. A very large number of those participants--particularly 
the older participants--roll over their lump sum distribution to an IRA 
and prudently manage their IRA savings during retirement. This lump sum 
option is a highly valued feature of our plan.
    The administration has proposed applying a yield curve to determine 
the amount of a lump sum distribution. We believe that this would 
result in artificially large lump sums that could threaten the ongoing 
viability of our Plan. Moreover, this proposal makes very little sense. 
Since retirees with longer life expectancies are increasingly (and 
prudently) investing in equities, determining their lump sum benefits 
based on hypothetical bonds that they are not investing in is 
inappropriate. And it will be impossible to explain to employees 
working side by side that their lump sum benefits are calculated using 
different interest rates based on their age. In addition, contrary to 
sound public policy, artificially large lump sums make annuities look 
unattractive, increasing the risk that employees will outlive their 
assets.
    We strongly believe that after a significant transition period 
(i.e., 5 to 7 years), lump sum distributions should be determined based 
on the long-term corporate bond rate.
    Credit Rating. Under the administration's proposal, a plan's 
funding target or liability would be increased based on a company's 
credit rating, resulting in potentially dramatic increases in funding 
and premiums for companies in junk bond status.
    As applied specifically to NRECA's DB plan, the administration's 
credit rating proposal is simply unworkable. Our plan is a multiple 
employer plan (not a multiemployer plan) in which nearly 900 different 
cooperatives participate. Depending on how one interprets this unclear 
part of the administration's proposal, either all 900 cooperatives 
would be rated by the Federal Government or approximately 20 of the 
bigger ones would be rated. We strongly object to the Federal 
Government getting into the business of evaluating the viability of our 
Cooperatives. And if some cooperatives are rated as in junk bond 
status, and others are not, it begs the question--why should that 
affect our Plan in any way since our Plan is a single plan that does 
not terminate if a Cooperative goes out of business or otherwise leaves 
the Plan?
    Administration officials have publicly admitted that they never 
considered multiple employer plans in developing their proposal, which 
simply does not work in that context.
    Credit Balances. Current law is carefully structured to be neutral 
with respect to advance funding. If a company pre-pays future funding 
obligations, the plan has a ``credit balance'' that can be used to 
offset future funding obligations.
    The administration has proposed eliminating credit balances. We see 
this as both unfair (with respect to existing credit balances) and ill-
advised. It is ill-advised because it can be shown mathematically that 
the administration's proposal will systematically discourage companies 
from contributing above the minimum amount required.
    Summary. Cooperative businesses are special because they are owned 
by the consumers they serve and because they are guided by principles 
that reflect the best interests of those consumers. One of these 
principles is Concern for Community, which calls on all Cooperatives to 
work for the sustainable development of their communities through 
policies accepted by their members. Being able to work with our members 
and their employees to provide a safe and secure retirement to their 
workers is part of our Concern for Community.
    NRECA strongly believes that any reforms to the DB retirement 
savings system should continue to encourage workers to provide for 
their own economic security, while at the same time encourage employers 
to continue to sponsor benefit plans. We hope to continue our work with 
the subcommittee to address the challenges of administering and 
participating in a DB pension plan, particularly ``multiple-employer'' 
plans like NRECA, so they remain a viable vehicle in the future for 
companies trying to do the right thing--providing meaningful retirement 
benefits to their employees.
    For more information, please contact Chris Stephen, Director & 
Counsel, Employee Benefits Policy, National Rural Electric Cooperative 
Assoc., 4301 Wilson Boulevard, Mail Code:IFS7-301, Arlington, VA 22203, 
Phone: 703-907-6026, Fax: 703-907-6126, Cell: 202-494-3011.

    [Whereupon, at 11:30 a.m., the subcommittee was adjourned.]

