[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
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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
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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.]