[Senate Hearing 109-165]
[From the U.S. Government Publishing Office]
S. Hrg. 109-165
A PENSION DOUBLE HEADER: REFORMING HYBRID AND MULTI-EMPLOYER PENSION
PLANS
=======================================================================
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 REFORMING HYBRID AND MULTI-EMPLOYER PENSION PLANS, FOCUSING
ON THE CAUSES OF UNCERTAINTY FOR HYBRIDS AND MULTI-EMPLOYER PLANS,
INCLUDING FUNDING PROBLEMS AND PROPOSALS TO RESTORE STABILITY AND
SOLVENCY
__________
JUNE 7, 2005
__________
Printed for the use of the Committee on Health, Education, Labor, and
Pensions
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21-771 WASHINGTON : 2005
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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, JUNE 7, 2005
Page
DeWine, Hon. Mike, Chairman, Subcommittee on Retirement Security
and Aging, opening statement................................... 1
Mikulski, Hon. Barbara, a U.S. Senator from the State of
Maryland, opening statement.................................... 2
Prepared statement........................................... 2
Lynch, Timothy P., President and CEO, Motor Freight Carriers
Association, Washington, DC; Randy G. DeFrehn, Executive
Director, National Coordinating Committee for Multi-Employer
Plans, Washington, DC; Jeffrey Noddle, Chairman of the Board,
President and CEO, Supervalu, INC., on behalf of The Food
Marketing Institute; and John Ward, President, Standard
Forwarding Company, East Moline, IL, on behalf of The Multi-
Employer Pension Plan Alliance................................. 5
Prepared statements of:
Mr. Lynch................................................ 7
Mr. DeFrehn.............................................. 17
Mr. Noddle............................................... 24
Mr. Ward................................................. 29
Enzi, Hon. Michael B., Chairman, Committee on Health, Education,
Labor, and Pensions, prepared statement........................ 39
Sweetnam, William F., Jr., Attorney, The Groom Law Group,
Presenting the testimony of James M. Delaplane, Jr., on behalf
of The American Benefits Council, Washington, DC; Ellen
Collier, Director of Benefits, Eaton Corporation, Cleveland,
OH, on behalf of The Coalition to Preserve The Defined Benefit
System; and David Certner, Director, Federal Affairs, AARP,
Washington, DC................................................. 47
Prepared statements of:
Mr. Delaplane............................................ 49
Ms. Collier.............................................. 61
Mr. Certner.............................................. 71
ADDITIONAL MATERIAL
Statements, articles, publications, letters, etc.:
The American Society of Pension Professionals and Actuaries.. 92
(iii)
A PENSION DOUBLE HEADER: REFORMING HYBRID AND MULTI-EMPLOYER PENSION
PLANS
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TUESDAY, JUNE 7, 2005
U.S. Senate,
Subcommittee on Retirement Security and Aging, Committee on
Health, Education, Labor, and Pensions,
Washington, DC.
The subcommittee met, pursuant to notice, at 10:06 a.m., in
Room 430, Dirksen Senate Office Building, Hon. Mike DeWine,
chairman of the subcommittee, presiding.
Present: Senators DeWine, Enzi, Isakson, Kennedy, Harkin
and Mikulski.
Opening Statement of Senator DeWine
Senator DeWine. Good morning. Welcome all of you. I call to
order this hearing of the Subcommittee on Retirement Security
and Aging.
I would like to take this opportunity to express my strong
support for hybrid pension plans and for multi-employer plans.
Both types of plans provide valuable retirement security for
millions of American workers. Both plans, however, are in
trouble.
This hearing will explore the causes of uncertainty for
hybrids and multi-employer plans. For hybrids it is conflicting
legal opinion. For multi-employer plans the problem is
financial uncertainty. We must find ways to clear barriers out
of the way so the plans can in fact survive.
I am encouraged by the proposals that are being offered to
address the legal and the economic problems of these plans. At
the first hearing of this subcommittee in April, in talking
about the current crisis in the private pension system, I said
that a taxpayer bailout is really just not an option.
The witnesses at today's hearing are not coming here hat in
hand. Rather, they are presenting real life concerns and
offering real world solutions. In the case of the multi-
employer plans today's witnesses are united, united in their
commitment to getting the financial affairs in order without a
taxpayer bailout.
Let me at this point, before I introduce the panels, turn
to my partner in this endeavor, my friend who has worked with
me on so many other issues, Senator Mikulski.
Opening Statement of Senator Mikulski
Senator Mikulski. Good morning. Mr. Chairman, I want to
thank you for convening this very crucial panel, and I pledge
to you a bipartisan effort to come to grips with these issues.
These issues, the pensions that people rely upon, the pension
guarantee that we need to ensure stability of funding, is too
important to be engaged in politics.
America is facing a challenge. Corporations are challenged
to fulfill their pension responsibilities, and that means
America is also facing challenges.
We both come from a manufacturing base and we know how
challenged many of those are, and we also know how challenged
the defined benefit plans are. We know that there have been
transitions. We know the multi-employer plans have challenges
also.
We have to make sure we listen to business and to workers
and protect these pensions without forcing a one-size-fits-all
solution and to protect all the workers while pensions are
changing. Many people are losing their sleep over the pension
issue. It has a tremendous impact on employees and retirees and
on productivity, especially those who experience reduction in
their pensions or fear that they will be reduced or eliminated.
We also need to work with the private sector to protect the
good guy businesses who still want to offer pensions to their
employees and to their retirees.
I know we are going to focus in this first panel on the
multi-employer pension plans, and we talked about that at the
pension benefit guaranty corporation hearing we had last month.
We know that now we are looking at 25 percent of the PBGC fund
to cover multi-employer plans, everything from grocery clerks
to people in the building trades. We have to take a look at how
we reform, but that in an over-exuberance of reform we do not
have unintended negative consequences.
The cash balance plans provide an even bigger challenge on
how we can get ourselves ready for the innovation economy, and
understand the portability and mobility of younger workers, but
not discriminate those people who built America's companies,
and made them great. We need to make sure that plans are
protected in this transition from a manufacturing economy to a
more innovation economy.
Again I look forward to listening to our witnesses,
learning from our witnesses, and working with you on a
bipartisan basis.
[The prepared statement of Senator Mikulski follows:]
Prepared Statement of Senator Mikulski
Introduction
Mr. Chairman, I want to thank you for this important
hearing. America is facing a challenge. Corporations are unable
to fulfill their pension responsibilities. That means American
workers are facing a challenge. That's why I want to work with
my colleagues in the Senate to help save pension plans that are
in trouble. Though today we are talking specifically about Cash
Balance and Multi-Employer pension plans. This is part of the
larger discussion on how to protect the retirement of America's
workers.
Retirement Security
Retirement security is one of the most important issues we
face today. Everyone wants to retire with dignity and financial
security, yet, every day I pick up the paper and see another
article on our pension system in crisis. From the United
Airlines bankruptcy settlement, to the PBGC funding shortfall,
we have a real problem on our hands!
Indeed, many people are losing sleep over this. The morale
of both employees and retirees is suffering. Especially those
who have experienced reductions in their pension benefits.
Promises made must be promises kept but that isn't easy
given these difficult economic times. We in Congress must work
to protect both ``good guy'' businesses who still offer
pensions to their employees and the retirees who rely so
heavily on their pensions. Though we must protect the older
worker while pension funds are changing we must keep in mind
that ``one size does not fit all.'' For example, we must
remember, young workers like cash balance plans, so any
solution we design to protect our older workers must ``do no
harm'' to younger workers as well.
Conclusion
Though pension funding is not yet in crisis, we need to
take steps now to prevent our companies from true crisis, our
workers from true crisis, and shore up the solvency of pension
plans. It is clear that pension reform is needed. I welcome and
look forward to hearing from our witnesses today.
Senator DeWine. Senator, thank you very much.
Senator DeWine. Today we are going to hear from two panels
of extremely qualified witnesses. The first panel will focus on
the funding problems of the multi-employer pension plans, and
the legislative proposals designed to restore stability and
solvency.
First to speak will be Randy DeFrehn. Mr. DeFrehn, thank
you very much for joining us today.
He is the Executive Director of the National Coordinating
Committee for Multi-Employer Plans. Mr. DeFrehn is perhaps the
most knowledgeable person on the extremely complicated issues
of multi-employer plans, and we look forward to his clear and
concise presentation.
Following his testimony, the next witness will be Mr. Tim
Lynch, who is the President and CEO of the Motor Freight
Carriers Association. He will testify to the current funding
crisis, discuss proposals being offered by a broad coalition of
management and union groups.
Next we will hear from Mr. Jeffrey Noddle, Chairman of the
Board, President and CEO of SUPERVALU, America's largest food
wholesaler and seventh largest grocery retailer. In Ohio of
course we know their good work. Senator Mikulski, no doubt, has
had the occasion to shop at Shoppers Food Warehouse and other
places. We look to hearing from Mr. Noddle about the views of
the Food Marketing Institute and how they would have us reform
the law on multi-employer plans.
Closing out the first panel will be Mr. John Ward,
President of Standard Forwarding Company, a trucking firm based
in East Moline, IL. His firm is perhaps the exception, a
growing trucking company that is adding new active participants
to the Teamsters Central States Pension Plan. He will express
his concerns about some of the proposed multi-employer reforms
and how they impact small firms. Mr. Ward is appearing on
behalf of the Multi-Employer Pension Plan Alliance.
The second panel will discuss the important issue of hybrid
pension plans. These most typically are cash balance plans or
pension equity plans.
The first witness we will hear from will be William
Sweetnam, an attorney with the Groom Law Group in Washington,
DC. Mr. Sweetnam will be delivering the testimony of James
Delaplane, who was supposed to appear today but was called out
of town for a family emergency. Both Mr. Sweetnam and Mr.
Delaplane represent the American Benefits Council. It is a
public policy organization representing principally Fortune 500
companies and other organizations that assist employers in
providing benefits to employees.
We will also hear from Ellen Collier, Director of Benefits
at the Eaton Corporation in Cleveland. Her company, a
diversified industrial manufacturer with over 27,000 employees
in 100 locations in the United States, converted to a hybrid
pension plan design. She will describe the process and care
with which the company undertook such a change.
Finally, we are pleased to have as a witness, David
Certner, Director of Federal Affairs for AARP. Mr. Certner is
well known to the members of this committee, and we once again
appreciate his willingness to testify.
Let me just make a final comment before we begin the
testimony. I want to point out that it is my understanding that
Chairman Enzi, chairman of the full committee, intends to move
a comprehensive reform bill out of the full HELP Committee this
summer, sometime before the August recess. Meeting that
schedule is certainly going to take a lot of hard work and a
high degree of bipartisan cooperation. The hearing today is
testimony I think really to the willingness of Republicans and
Democrats to work together to solve our country's pension
problems. Both sides want to get these issues out in the open,
and we want to get them resolved and resolved as quickly as
possible.
So let me at this point turn to our witnesses. Mr. DeFrehn,
we will start with you. We are going to have 5 minute rounds
and we are going to ask you to keep your statements to 5
minutes. We have your written testimony in front of us, and if
we could have everyone follow the 5 minute rule, then we will
have ample time for questions.
Thank you very much.
STATEMENTS OF TIMOTHY P. LYNCH, PRESIDENT AND CEO, MOTOR
FREIGHT CARRIERS ASSOCIATION, WASHINGTON, DC; RANDY G. DeFREHN,
EXECUTIVE DIRECTOR, NATIONAL COORDINATING COMMITTEE FOR MULTI-
EMPLOYER PLANS, WASHINGTON, DC; JEFFREY NODDLE, CHAIRMAN OF THE
BOARD, PRESIDENT AND CEO, SUPERVALU, INC., ON BEHALF OF THE
FOOD MARKETING INSTITUTE; AND JOHN WARD, PRESIDENT, STANDARD
FORWARDING COMPANY, EAST MOLINE, IL, ON BEHALF OF THE MULTI-
EMPLOYER PENSION PLAN ALLIANCE
Mr. DeFrehn. Thank you, Senator. If I might ask your
indulgence though, if it would be all right for Mr. Lynch to
lead off, and then I will follow his comments.
Senator DeWine. You can do that if that is all right with
Mr. Lynch.
[Laughter.]
Senator DeWine. Is that all right with you, Mr. Lynch?
Mr. Lynch. It is now.
[Laughter.]
Mr. Lynch. Thank you, Mr. Chairman and Senator Mikulski for
having this hearing.
I am here today as a representative of trucking industry
employers, who by virtue of their collective bargaining
agreement are major participants in a number of multi-employer
pension plans.
In addition, I was a participant in discussions that began
last October with other industry and labor representatives,
resulting in a coalition proposal that we believe addresses
many of the problems facing multi-employer plans.
In my written statement I have provided the subcommittee
with information about recent trends in the trucking industry
and the relationship between our collective bargaining
agreement and the pension funds that I would like to submit for
the record.
For my oral testimony I would like to focus on a process by
which we arrived at our recommendations and then summarize
those recommendations. The coalition proposal represents what I
believe is a unique opportunity in that it is the only reform
proposal that has the full support of contributing employers,
organized labor and those responsible for the governance,
administration of multi-employer plans, in other words, all of
the parties most directly affected by the MEPA statute. I would
respectfully suggest that the effort to bring all those diverse
interests to common ground is worthy of serious congressional
consideration.
When we began our discussions last October, not
surprisingly, the employer representatives were intent on
protecting the economic interests of the contributing
employers. Similarly, the union representatives were intent on
protecting the benefits of retirees and the future benefits of
the active employees.
The underlying equation of multi-employer plans is that new
employers will replace exiting employers, thus maintaining a
balance of contributing employers. Unfortunately, for plans in
the trucking industry, generally referred to as mature plans,
that equation is seriously out of balance with many more
bankruptcies than new entering employers. There are only so
many avenues to pursue to improve the financial condition of
these plans, more contributing employers, more contributions
from current employers, benefit modifications, better
investment returns or some form of Government assistance.
Our working group quickly concluded that Government
assistance was unlikely, an increase in the number of
contributing employers doubtful, and better investment returns,
while hopefully on the horizon, are nonetheless speculative.
That left additional contributions and benefit modifications.
It is to the credit of those in the working group and the
interests that they represent that we all recognize the risk
and concern attendant to both additional contributions and
benefit modifications.
Any significant increases in employer contributions run the
very real risk of jeopardizing the large pool of small
employers typically involved in multi-employer plans.
Conversely, any significant modifications in the benefit plan
raises significant issues of labor/management relations, and
frankly, issues of fundamental fairness with retirees.
Had I written this proposal myself or in concern with other
contributing employer representatives, it would look very
different. I feel confident that the same holds true for our
union counterparts. But had we abandoned our joint efforts and
gone our separate ways we very well could have won the
rhetorical battle but lost the substantive war. We chose to
compromise and present a package of recommendations that we
believe will address the problems. With that as background, I
would like to summarize the main features of our proposal.
First, because of the diversity of multi-employer plans we
concluded that a one-size-fits-all approach would not be
beneficial. Consequently, our proposal categorizes plans as
healthy, at-risk and severely underfunded, and targets remedial
programs to fit plans in those categories.
Second, unlike single-employer plans, multi-employer plans
function as a quasi PBGC with contributing employers assuming
plan liabilities and shielding the Federal agency from that
responsibility, literally to the last-man-standing principle.
Unfortunately, most of the tools available to address funding
problems are not available to the plan trustees or are viewed
as last resort remedies by Federal agencies. The coalition
proposal gives additional tools to the trustees to address
short term funding problems as well as the long term objective
to balance plan assets and liabilities.
Third, all parties to the plans deserve more timely and
meaningful disclosure of information about the status of the
plans and the coalition proposal does that. Additionally, the
proposal establishes an early warning system for those at risk
plans. Under our proposal the most difficult and controversial
remedies, additional employer contributions and benefit
modifications, are reserved for those plans that face the most
severely underfunded problems. This is in part designed as a
strong incentive to plan trustees to do all they can to solve
the problems before entering what we call the ``Red Zone.''
Finally, with respect to withdrawal liability for the
remaining contributing employers in the trucking industry, this
is the proverbial between a rock and a hard place issue. These
employers have no ability to control the extent of their
potential liability when other contributing employers withdraw
from the plan.
I have about 20 seconds?
Senator DeWine. That will be fine.
Mr. Lynch. Thank you. Withdrawal liability was intended to
address that problem. However, that has not been the case. From
a public policy perspective it is difficult to justify a denial
or reduction of benefits to these nonsponsored participants.
However, if that remains Government policy, it is equally
difficult to justify allowing withdrawing employers to fully
escape or significantly limit their liability responsibilities.
The coalition proposals attempts to strengthen and clarify
withdrawal liability rules to protect the remaining
contributing employers from assuming a disproportionate and
unfair burden from nonsponsored participants.
Thank you.
Senator DeWine. Good. Thank you very much.
[The prepared statement of Mr. Lynch follows:]
Prepared Statement of Timothy P. Lynch
Mr. Chairman and members of the committee, good morning. My name is
Timothy Lynch and I am the President and CEO of the Motor Freight
Carriers Association (MFCA). I want to begin by thanking Chairman
DeWine and the other members of the Subcommittee on Retirement Security
and Aging for holding this hearing to discuss suggestions for securing
the long term viability of the multi-employer pension system.
I am here today as a representative of an association of trucking
industry employers who by virtue of their collective bargaining
agreement are major participants in a number of multi-employer plans.
Their companies are key stakeholders in these funds. The employers I
represent are concerned about the current framework for multi-employer
plans and strongly believe that if not properly addressed, the problems
will increase and possibly jeopardize the ability of contributing
employers to finance the pension plans. The end result could put at
risk the pension benefits of their employees and retirees.
While we were supportive of Congressional efforts last year to
address short term relief for multi-employer plans under the Pension
Funding Stability Act, we believed then, and continue to hold the view,
that significant reform needs to occur if we are to secure the long
term viability of these plans. The financial difficulties facing the
Central States pension fund are well known to this committee, but
Central States is not alone. Nor are the factors contributing to the
problems of Central States unique. The challenges facing these pension
funds need immediate attention.
In my testimony today, I will outline a series of recommendations
that are the result of many months of discussion and negotiation among
the parties most directly affected by the MPPAA statute. These
recommendations represent a unique opportunity in that they are the
only reform proposal that has the full support of contributing
employers, organized labor, and those responsible for the governance
and administration of multi-employer plans. I would respectfully
suggest that the effort to bring all these diverse interests to common
ground is worthy of Congressional consideration.
MOTOR FREIGHT CARRIERS ASSOCIATION
MFCA is a national trade association representing the interests of
unionized, general freight truck companies. MFCA member companies
employ approximately 60,000 Teamsters in three basic work functions:
local pick up and delivery drivers, over-the-road drivers and
dockworkers. All MFCA member companies operate under the terms and
conditions of the Teamsters' National Master Freight Agreement (NMFA),
one of three national Teamster contracts in the transportation
industry.
Through its TMI Division, MFCA was the bargaining agent for its
member companies in contract negotiations with the Teamsters for the
current National Master Freight Agreement (April 1, 2003--March 31,
2008). Under that agreement, MFCA member companies will make
contributions on behalf of their Teamster-represented employees to 90
different health & welfare and pension funds. At the conclusion of the
agreement, MFCA companies will be contributing $12.39 per hour per
employee for combined health and pension benefits, or a 33 percent
increase in benefit contributions from the previous contract. This is
in addition to an annual wage increase.
DESCRIPTION OF PLANS
MFCA member companies, along with UPS, car-haul companies and food
related companies are typically the largest contributing employers into
most Teamster/trucking industry sponsored pension plans. The Teamster/
trucking industry benefit plans vary widely in size, geographic scope
and number of covered employees. The two largest plans--the Central
States Pension Fund and the Western Conference of Teamsters Pension
Fund--have reported assets of $18 and $24 billion respectively and
cover over 1 million active and retired employees in multiple States.
As Taft-Hartley plans, these pension funds are jointly-trusteed (an
equal number of labor and management trustees) and provide a defined
benefit (although some plans offer a hybrid defined benefit/defined
contribution program). MFCA member companies are represented as
management trustees on most of the plans to which they make
contributions. In an effort to help improve the management of the
plans, MFCA member companies have made a concerted effort to nominate
as management trustees individuals with backgrounds in finance, human
resources, and employee benefits.
RELATIONSHIP BETWEEN COLLECTIVE BARGAINING AND THE PENSION PLANS
In a report to Congress last year, the General Accounting Office
(GAO) stated that multi-employer plans ``contribution levels are
usually negotiated through the collective bargaining agreement'' and
that ``[b]enefit levels are generally also fixed by the contract or by
the plan trustees.'' In our case, that is only partially correct: the
NMFA only establishes a contribution rate. It does not set a pension
benefit level. It is worth reviewing for the committee the relationship
between collective bargaining and the multi-employer pension plans.
Like most multi-employer plans, our plans are maintained and funded
pursuant to collective bargaining agreements. During each round of
bargaining, the industry and union bargain agree on the per-hour
contribution rate required to be paid by employers to the plans for
pension and health benefits. Once the rate is established, however, the
role of the collective bargaining process and of the collective
bargaining parties with respect to the plans--in terms of the level of
benefits, the administration of delivering those benefits, management
of plan assets, etc.--is over. For employers, the only continuing role
in the plans is to make the required contractual contributions. That
is, unless the plan, over which the employers have no control, runs
into financial crisis. I will talk more about that in a moment.
Each multi-employer pension plan is a separate legal entity managed
by an independent board of trustees. It is not a union fund controlled
by the union. Nor is it an employer fund, over which the employer has
control. Rather, by law, the plans are managed independently by their
trustees under a complex set of statutory and regulatory requirements.
Although the trustees are appointed half by the union and half by the
employer each trustee has a legal obligation to act not in the interest
of the union or employer that appointed them, but rather with a
singular focus on the best interests of the plans participants.
Trustees who do not act in the best interest of participants may be
held personally liable for breach of their fiduciary duty.
As noted earlier, employers' role with respect to multi-employer
pension plans is limited to making contributions unless the plan runs
into financial difficulty. Under current law, employers are ultimately
responsible for any funding deficiency that the multi-employer plan may
encounter. Specifically, if a multi-employer plan hits a certain
actuarially calculated minimum funding level, employers in the fund are
assessed a 5 percent excise tax and their pro-rata share of the funding
shortfall or face a 100 percent excise tax on the deficiency.
HOW WE GOT TO WHERE WE ARE
1980 was a watershed year in the history of the trucking industry.
In that year Congress passed two major legislative initiatives--the
Motor Carrier Act (MCA) and the Multi-Employer Pension Plan Amendments
Act (MPPAA)--that radically altered the profile of the industry and the
landscape for industry sponsored pension plans. The first brought about
deregulation of the trucking industry and ushered in an era of
unprecedented market competition. The second, while perhaps not
recognized at the time, upset the essential balance between exiting and
entering employers that is key to maintaining a viable multi-employer
pension program.
To put this in some perspective, I have included in my statement
(Appendix A), a list of the top 50 general freight, LTL carriers who
were operating in 1979, the year just prior to enactment of MCA and
MPPAA. Of those 50, only 7 are still in operation and of those 7 only 5
are unionized. Virtually all of the 43 truck companies no longer in
business had unionized operations, and consequently were contributing
employers to industry sponsored pension plans. There have been no
subsequent new contributing employers of similar size to replace these
departed companies. And beyond the top 50 there were literally
hundreds, perhaps thousands, of smaller unionized truck operators who
also have fallen by the wayside. The simple fact is that since 1980
there has not been a single trucking company of any significant size to
replace any of the departed companies on the Top 50 list.
And what happens when these companies leave the plans? Their
employees and retirees become the responsibility--not of the PBGC--but
of the plans and their remaining contributing employers. In short, the
remaining contributing employers function as a quasi-PBGC ensuring the
full pension benefit.
One of the key elements of the MPPAA statute was the ability to
recover assets from withdrawing employers or withdrawal liability.
Unfortunately, that has not been the case. One of the largest trucking
industry plans reports that bankrupt (withdrawing) employers ultimately
pay less than 15 percent of their unfunded liability. And what happens
when these liabilities are not fully recovered? They become the
responsibility of the remaining contributing employers. This represents
one of major differences between the treatment of liabilities of single
versus multi-employer pension plans.
Nothing highlights the inequity of this situation more than the
bankruptcies of two contributing employers: Consolidated Freightways
(CF) and Fleming Companies. Both companies were in the top 10 category
of contributing employers to the Central States plan. They also
sponsored their own company, single-employer plan for their non
collective bargaining covered employees. The PBGC has assumed
responsibility for the CF plan with a potential liability in excess of
$250 million and the Fleming plan with a projected liability in excess
of $350 million or a combined liability for PBGC of over $600 million.
Conversely, the Fleming and CF employees/retirees covered under
multi-employer pension plans like Central States will now be the
responsibility of the remaining contributing employers (less whatever
these plans can recover in withdrawal liability payments). These
beneficiaries will be entitled to a guaranteed full pension benefit.
This will only add further cost to what is already one very stark
financial fact of life for the Central States fund: half of its annual
benefit payments now go to beneficiaries who no longer have a current
contributing employer.
MEPPA delineates a very different role for PBGC with respect to
single-employer versus multi-employer plans. The GAO report identifies
four: monitoring, providing technical assistance, facilitating
activities such as plan mergers, and financing in the form of loans for
insolvent plans. In contrast to PBGC's more aggressive role with
single-employer plans, these are relatively passive activities. It was
not until the recent Congressional debate over whether to provide
limited relief to multi-employer plans that attention was focused on
the need to have a better understanding of the true financial condition
of these plans. And underlying that need was a concern whether the
relief would provide assistance for a truly short-term issue or mask a
more fundamental, long-term problem.
Furthermore, the remedies available to multi-employer plans in the
form of amortization relief, short fall methodology or waivers are
often viewed as ``last resort'' solutions. There are no intermediate
steps that can assist a plan well before it reaches this point.
RECOMMENDATIONS FOR LEGISLATIVE ACTION
Last October, we began participating in a small working group of
trucking company and union representatives to try to develop
recommendations that would be acceptable to multi-employer plans,
unions and contributing employers. The objective was to develop a
legislative proposal that would alleviate the short-term consequences
of funding deficits and promote long-term funding reform for multi-
employer plans. As a representative of contributing employers, I
entered those discussions with a clear mission to protect the economic
interests of my membership. My union counterparts entered with a
similar mission to protect the interests of their membership.
Early on in those discussions, we agreed on several fundamental
issues that ultimately formed the basis for our recommendations.
Because of the diversity of multi-employer plans, a one-
size-fits-all approach would not be productive. Instead remedial
programs would be targeted to those plans facing the greatest financial
problems.
Multi-employer plans function as a quasi-PBGC, with
contributing employers assuming plan liabilities and shielding the
Federal agency from that responsibility until plan bankruptcy.
Unfortunately, plan trustees don't have all the tools available to the
PBGC to address funding problems.
Furthermore, most of the tools available to address
funding problems become available too late in the process and are often
viewed as ``last-resort'' remedies by Federal agencies.
All parties to the plans deserve more timely and
meaningful disclosure of information about the status of the plans.
The need to establish an early warning system for ``at
risk'' plans and a separate category for ``severely underfunded''
plans.
The burden to fix the problem of severely underfunded
plans should not be borne disproportionately by any one party to the
plans. To do otherwise would, in fact, jeopardize the continued
viability of the plan and its defined benefits.
This process ultimately was expanded to include employer and union
representatives from other industries. The result is a coalition
proposal that has the support of a wide range of business and labor
organization interests.
From the contributing employer perspective, the key elements of the
coalition proposal are the following.
FUNDING RULES
Under the proposal, multi-employer plans will be required to have
strong funding discipline by accelerating the amortization periods,
implementing funding targets for severely underfunded plans and
involving the bargaining parties in establishing funding that will
improve plan performance over a fixed period of time. In addition, the
proposal limits the ability for plan benefit enhancements unless the
plan reaches certain funding levels.
FUNDING VOLATILITY
By virtue of their collective bargaining agreements, contributing
employers must make consistent payments regardless what gains are
achieved in the financial markets. (This is in contrast to single-
employer plans that may avoid contribution payments in lieu of above
average market returns). However, the volatility of these plans occurs
in the form of funding deficiencies. The coalition proposal addresses
this situation by allowing the plans to use existing extension and
deferral methods to permit time for the bargaining process to address
the underfunding over a rational period of time.
EARLIER WARNING SYSTEM
The coalition proposal establishes a ``yellow zone'' or early
warning system. The goal of the yellow zone concept is to make sure
plans are cautious in the ability to have affordable benefit levels.
Additionally, plans in the yellow zone must improve their funded status
in a responsible manner, one that does not put extreme pressure on the
benefits provided or eliminate the ability for employers to operate in
a highly competitive marketplace. The coalition proposal strikes a
reasonable balance through creation of a bright line standard for an
improving funded status but not one that creates an insurmountable and
unreasonable financial burden on contributing employers. While it is
important that yellow zone plans develop a program for funding
improvement, the burden to do so should be commensurate with the
ability to recover over a rational period of time.
PLANS WITH SEVERE FUNDING PROBLEMS
Under the coalition proposal, plans facing severe funding problems
are in a ``red zone'' or essentially reorganization status. When a plan
is in reorganization status, extraordinary measures will be necessary
to address the funding difficulties. It is here that the concept of
shared responsibility for balancing plan assets and liabilities fully
comes into play. Reorganization contemplates a combination of
contribution increases--above those required under the collective
bargaining agreement--and benefit reductions--though benefits at normal
retirement age are fully protected--to achieve balance.
TRANSPARENCY AND DISCLOSURE
The Pension Funding Stability Act of 2004 greatly improved the
transparency of multi-employer plans. The coalition proposal expands
those disclosures and places additional disclosure requirements for
plans that are severely underfunded in the red zone.
WITHDRAWAL LIABILITY
For the remaining contributing employers in the trucking industry,
this is the proverbial ``between a rock and a hard place'' issue. These
employers have no ability to control the extent of their potential
liability when other contributing employers withdraw from the plan.
Withdrawal liability was intended to address that problem. However, as
I indicated earlier, one large trucking industry plan estimates it
recovers on average less than 15 percent of assets required to cover
the benefit liabilities. Non-sponsored participants now make up 50
percent of the benefit pool in Central States.
From a public policy perspective, it is difficult to justify a
denial or reduction of benefits to these non-sponsored participants.
However, if that remains Government policy it is equally difficult to
justify allowing withdrawing employers to fully escape or significantly
limit their liability responsibilities. The coalition proposal attempts
to strengthen and clarify withdrawal liability rules to protect the
remaining contributing employers from assuming a disproportionate and
unfair burden from non-sponsored participants.
Mr. Chairman, thank you for giving me the opportunity to present
the views of the Motor Freight Carriers Association. I look forward to
working with the members and staff of this committee to develop a long
term solution to the problems facing multi-employer pension plans. I
would be happy to answer any questions you may have.
TOP 50 LTL CARRIERS IN 1979
1. Roadway Express; 2. Consolidated Freightways; 3. Yellow Freight
System (Yellow Transportation); 4. Ryder Truck Lines; 5. McLean
Trucking; 6. PIE; 7. Spector Freight System; 8. Smith's Transfer; 9.
Transcon Lines; 10. East Texas Motor Freight; 11. Interstate Motor
Freight; 12. Overnite Transportation; 13. Arkansas Best Freight (ABF
Freight System); 14. American Freight System; 15. Carolina Freight
Carriers; 16. Hall's Motor Transit; 17. Mason & Dixon Lines; 18. Lee
Way Motor Freight; 19. TIME-DC Inc.; 20. Wilson Freight Co.; 21.
Preston Trucking Co.; 22. IML Freight; 23. Associated Truck Lines; 24.
Central Freight Lines; 25. Jones Motor-Alleghany; 26. Gateway
Transportation; 27. Bowman Transportation; 28. Delta Lines; 29. Garrett
Freightlines; 30. Branch Motor Express; 31. Red Ball Motor Freight; 32.
Pilot Freight Carriers; 33. Illinois-California Exp.; 34. Pacific Motor
Trucking; 35. Central Transport; 36. Brown Transport; 37. St. Johnsbury
Trucking; 38. Commercial Lovelace; 39. Gordons Transports; 40. CW
Transport; 41. Johnson Motor Lines; 42. System 99; 43. Thurston Motor
Lines; 44. Watkins Motor Lines; 45. Santa Fe Trail Transportation; 46.
Jones Truck Lines; 47. Merchants Fast Motor Lines; 48. Murphy Motor
Freight; 49. Maislin Transport; 50. Motor Freight Express.
Bold = Still Operating on 4/1/04
[Exhibit 1 can be found in committee files.]
Senator DeWine. Are you ready, sir?
Mr. DeFrehn. Yes, I am. Thank you.
Senator DeWine. Very good.
Mr. DeFrehn. Mr. Chairman, Senator Mikulski, thank you for
inviting me to participate in today's hearing on this important
topic. I appear before you on behalf of the nearly 10 million
participants of multi-employer defined benefits plans, both in
my capacity as Executive Director of the National Coordinating
Committee for Multi-Employer Plans, and as a member of a broad
based coalition of employers and employee organizations who
recognize the important role such plans play in the lives of
our participants, their families and the communities in which
they live.
You have just heard how all of the major trucking industry
employer associations, large individual employers, and the
Teamsters have been full partners in the development of the
coalition proposal. Given the size and complexity of their
plans and the problems they currently face, it is entirely
appropriate they should be fully involved. However, this
represents far more than a trucking industry initiative. The
coalition represents the interests of funds in virtually all
aspects of the economy, including construction, service,
garment, hospitality, long shore, mining, paper, chemical,
aerospace and trucking industries.
The construction industry, which makes up more than half of
all multi-employer plans, is the largest block of coalition
members, including the Associated General Contractors, Bechtel
Corporation, the Washington Group, all of the major specialty
contractor associations and all 15 of the construction trade's
unions. The entertainment industry is also represented by both
employer and labor groups, and although FMI has expressed
reservations that the coalition proposal does not go far enough
for some of their members in certain areas, the major labor
groups representing their employees, the United Food and
Commercial Workers and the Teamsters, participate in the
development of and fully endorse the proposal.
Last, two other groups not usually associated with multi-
employer issues, the U.S. Chamber of Commerce and the American
Benefits Council, also support the proposal.
The proposal itself embodies several important
propositions. First, funding rules should be strengthened to
help plans avoid problems over which they have some control.
Second, plans should receive relief from situations over which
they have no control. Third, the stakeholders must share the
burden presented when the unavoidable occurrence threatens the
long term viability of the plans. Fourth, these plans are a
creation of the collective bargaining process and the process
is best equipped for finding solutions acceptable to all the
stakeholders. Fifth, the future of the plans will be
jeopardized when active employees no longer derive any benefit
from continued participation, and sixth, reduction of accrued
benefits should only occur as an alternative to more
significant reductions that would occur if the plans were to
fail and go to the PBGC guaranty levels.
The proposal focuses on three broad areas of reform based
on the relative funding health of the plans. Plans that are
currently well funded are required to amortize plan
improvements more quickly than under current rules. Also, tax
laws that have forced the plans to increase cost to protect
contributing employers' tax deductions should be changed to
provide a buffer against the unexpected.
Plans that begin to see an erosion in their funded
position, a funded ratio below 80 percent, must implement a
benefit security plan that requires the funding level to be
improved over time. Any amendment to the plan of benefits must
have offsetting contribution increases that exceed the cost of
that amendment.
Plans with severe funding problems would be placed in
reorganization under revised rules, and the plan fiduciaries
and bargaining parties would be provided with additional tools
to bring the plan assets and liabilities into balance. Once in
reorganization, notice would be given to all stakeholders. The
employers would be subjected to all surcharges in lieu of being
assessed extra contractual contributions and excise taxes.
Certain restrictions would apply immediately to benefit
payments that expedite the depletion of the fund. Trustees
would be required to develop and distribute to all stakeholders
a plan or reorganization to bring the plan out of
reorganization within roughly three bargaining cycles.
Options to current benefit and contribution structures,
including possible amortization extensions and mergers, but
which would also include possible elimination of certain
benefits that are currently protected under anti-cutback rules,
would be developed by the trustees and submitted to the
parties. Schedules showing the amount of benefit modifications
necessary to bring the plan out of reorganization would be
presented to the bargaining parties who would then bargain over
the appropriate combination of modifications and contribution
increases. The plan or reorganization and schedules would be
revised and distributed to stakeholders at least annually.
Other provisions include withdrawal liability statutes,
changes to the withdrawal liability statutes to make it more
difficult for contributing employers to shift their
responsibility to remaining employers upon withdrawal from the
fund.
Clearly the provisions in this proposal, quite different
than would have been included in a document drafted
independently by either employer or employee representatives,
nevertheless, it represents an excellent compromise and a
responsible way to address the current problems. As with any
carefully negotiated compromise, however, its strength and
indeed that of the coalition itself, lies in preserving the
elements of the proposal as closely as possible to the
original. The more changes that are introduced into the
substance of the proposal, the greater the likelihood that
certain groups will withdraw their support. For that reason, we
recommend the document to you in its entirety, and request your
help in seeing it enacted into law.
In closing, I would like to thank you for your attention
and for the invitation to participate in this discussion and
look forward to your questions.
Senator DeWine. Thank you very much.
[The prepared statement of Mr. DeFrehn follows:]
Prepared Statement of Randy G. DeFrehn
Mr. Chairman and members of the committee, I am pleased to be here
today to discuss the subject of reforming multi-employer defined
benefit pension plans. I appear here on behalf of a broad coalition of
plans, employers, employer associations and labor organizations that
sponsor multi-employer plans which has put forth a carefully
negotiated, balanced proposal for multi-employer pension plan reform.
The coalition proposal has evolved through the efforts of many of the
system's largest stakeholders since the Pension Funding Equity Act of
2004 failed to provide meaningful relief to even a single multi-
employer plan, despite the laudable efforts of a majority of the
Members of this Chamber. A list of those groups who are participants in
the coalition is enclosed with my written remarks, but it is important
to note that they represent the overwhelming majority of employers and
virtually all of the unions in the construction, trucking,
entertainment, service and food industries and the membership of the
National Coordinating Committee for Multi-Employer Plans (NCCMP) which
directly represents over 600 jointly managed pension, health, training
and other trust funds and their sponsoring organizations across the
economy. The NCCMP is a non-profit, non-partisan advocacy organization
formed in 1974 to protect the interests of plans and their participants
following the passage of ERISA and the increasingly complex legislative
and regulatory environment that has evolved since then.
BACKGROUND
There are nearly 1,600 multi-employer defined benefit pension plans
in the country today. They provide benefits to active and retired
workers and their dependents and survivors in virtually every area of
the economy. Because of their attractive portability features, multi-
employer plans are most prevalent in industries, like construction,
which are characterized by mobile workforces. According to the latest
information from the Pension Benefit Guaranty Corporation, multi-
employer plans cover approximately 9.7 million participants, or about
one in every four Americans who still have the protection of a
guaranteed income provided by a defined benefit plan. With few
exceptions, these are mature plans that were created through the
collective bargaining process 50 to 60 years ago and have provided
secure retirement income to many times that number of participants
since their inception. Although some mistakenly refer to them as
``union plans'' the law has required that these plans be jointly
managed with equal representation by labor and management on their
governing boards since the passage of the Labor Management Relations
(Taft-Hartley) Act in 1947. This active participation by both
management and labor representatives (most of whom are participants in
the plans) provides a clear distinction between single-employer and
multi-employer plans. They are more extensively regulated under both
labor and employee benefits laws and regulations and the watchful eyes
of the Department of Labor, the Internal Revenue Service and the
Pension Benefit Guaranty Corporation. Most important among these laws
and regulations, Taft-Hartley requires that the fiduciaries who serve
on these joint boards must manage these plans for the ``sole and
exclusive benefit'' of plan participants, and ERISA imposes fiduciary
obligations on plan fiduciaries that put at risk the personal assets of
those who fail to meet their obligations.
It is estimated that there are over 65,000 employers that
contribute to multi-employer plans. The vast majority of which are
small employers. For example, in the construction industry, which makes
up more than 50 percent of all multi-employer plans (but just over one-
third of the participants), it is estimated that as many as 90 percent
of all such employers employ fewer than 20 employees. By sponsoring
these industry plans, employers are able to ensure that their employees
have access to comprehensive health and pension benefits and, through
the jointly managed training and apprenticeship plans, the employers
have access to a readily available pool of highly skilled labor, none
of which could be feasible for individual employers to provide.
Funding for multi-employer plans comes from the negotiated wage
package agreed to in the collective bargaining process. For example, if
the parties agree to an increase in the wage package of $1.00 per hour
over 3 years, the $1.00 may be allocated as $.40 to the health benefit
plan, $.20 to pensions, $.05 to the training fund and the remaining
$.35 taken in increased wages. Although for tax purposes, contributions
to employee benefit plans are considered to be employer contributions,
the funding comes from monies that would otherwise be paid to the
employee in the form of wages. For the overwhelming majority of such
employers, their regular involvement with the plans is limited to
remitting their monthly payments to the trust funds as required
pursuant to their collective bargaining agreements. For most
contributing employers, these funds are the perfect substitute for a
large financial commitment to human resources functions, providing
administrative services and meeting today's complex compliance
requirements while providing economies of scale that would otherwise
make such benefit plans unaffordable for small business.
Since the passage of the Multi-Employer Pension Plans Amendments
Act of 1980, participants of multi-employer plans have been covered by
the benefit guarantee provisions of the PBGC. Unlike single-employer
plans, however, the PBGC is the insurer of last resort for multi-
employer plans. Instead, the employers who contribute to these plans
self-insure against the risk of failure of another. Under the multi-
employer rules, employers who no longer contribute, or cease to have an
obligation to contribute to the plan, must pay their proportionate
share of any unfunded vested benefits that exist at the time of their
departure. This obligation, known as withdrawal liability, recognizes
the shared obligations of employers in maintaining an industry wide
skilled labor pool in which employees may move among contributing
employers dozens of times during their career. This system of shared
risk has protected both the participants and the PBGC, as evidenced by
the fact that it has had to intervene in fewer than 35 cases over the
past 25 years. The reduced risk to the PBGC is also reflected in a much
lower premium--$2.60 per participant per year, versus $19 per
participant per year plus a variable premium for single-employer plans.
The PBGC guarantees a much lower benefit for multi-employer plans--a
maximum of $12,700 per year for a participant who retires at normal
retirement age after 30 years of service (adjusted proportionally for
greater or less service), compared with a maximum benefit under the
single-employer guarantee of approximately $44,000 annually. As of the
latest PBGC annual report, the multi-employer guaranty program showed a
projected deficit of approximately 1 percent of that projected for the
single-employer guaranty fund.
This system of pooled risk has been both one of the greatest
strengths and major weaknesses of the multi-employer system. In the
early 1980s, the presence, or even the threat of withdrawal liability
produced a chilling effect on the growth of multi-employer plans that
has persisted in several industries despite the fact that most have had
no unfunded benefits for most of that time. On the other hand, for
many, the threat of unfunded liabilities provided an incentive to plan
fiduciaries to adopt and follow conservative funding and investment
policies that, in combination with a robust economy, led the plans to
become fully funded.
Nevertheless, rather than being able to build a buffer against
future economic downturns, this success led plans to experience
problems at the top of the funding spectrum. In the late 1980s and
throughout the 1990s, plans began to hit the full funding limits of the
tax code. Under these provisions, employers that contribute to plans in
excess of these limits were precluded from receiving current deductions
for their contributions to the plans. Compounding the situation,
employers who continued to make their contributions also faced an
excise tax for doing so, despite the fact that the collective
bargaining agreements to which they were signatory obligated them to
continue to make them. Although in rare instances the bargaining
parties negotiated ``contribution holidays,'' timing considerations and
the fact that in most cases the plan fiduciaries and bargaining parties
were different people meant that plan trustees had no choice other than
to increase plan costs by improving benefits to bring plan costs up to
the level of plan income to protect the deductibility of employer
contributions. Further, once adopted, many of the actions taken to
improve the plan of benefits cannot be rescinded under the anti-cutback
provisions of the law which have evolved since ERISA was first passed.
It is estimated that over 75 percent of multi-employer defined benefit
pension plans were forced to make these benefit improvements as a
result of the maximum deductible limits. Overall, multi-employer plans
were very well funded as the plans approached the end of the
millennium, with the average funded position for all multi-employer
plans at 97 percent (see The Segal Company Survey of the Funded
Position of Multi-Employer Plans--2000).
In the 3 years that followed, however, these same plans suffered
significant losses as the crisis of confidence over the accounting
scandals and corporate excesses exemplified by Enron, Tyco, and
WorldCom, sent the markets into a deep and prolonged contraction. For
the first time since the ERISA funding rules were adopted in 1974; in
fact, for the first time since before the beginning of World War II,
the markets experienced 3 consecutive years of negative performance.
Not only were plans unable to meet their long-term assumed rates of
return on their investments, virtually all institutional investors saw
the principal of their trusts decline. For many of these mature multi-
employer plans that depend on investment income for as much as 80
percent of their total income, the loss of significant portions of the
trust caused a rapid depletion of what for most had been significant
credit balances in their funding standard accounts. Although the most
recent report showing the funded position of multi-employer plans shows
a significant decline from the 97 percent in 2000, the average funded
position is still relatively healthy at 84 percent. Nevertheless, these
investment losses have left a number of plans at all levels of funding
facing credit balances approaching zero, meaning these plans face a
funding deficiency in the near future (see The Segal Company Survey of
the Funded Position of Multi-Employer Plans--2004). According to the
most recent estimates, as many as 15 percent of all plans are projected
to have a funding deficiency by the year 2008 and an additional 13
percent face the same fate by 2012 (assuming benefit levels and
contribution rates remain unchanged).
The implications of a funding deficiency for contributing
employers, the plans and their participants are potentially
devastating. Once a plan's credit balance drops below zero,
contributing employers are assessed by the plan trustees for additional
contributions in an amount equal to their proportionate share of the
amount necessary for the plan to meet its minimum funding requirements.
This is above the amounts they have contributed pursuant to their
collective bargaining agreements. In addition, they are required to pay
an excise tax by the IRS equal to 5 percent of that assessment. In the
event that all contributing employers fail to make up the shortfall in
a timely fashion, the excise tax may be increased to 100 percent of the
shortage.
For many of the contributing employers, especially those in
industries (like, but not limited to, construction) which traditionally
have small profit margins, they have bid their work throughout the year
based on their fixed labor costs (including the negotiated pension
contributions). For them, receiving an assessment for what could be
multiples of the total contributed for the year, could be enough to
drive them into bankruptcy. In this instance, the concept of pooled
risk among contributing employers means that the shortage amounts as
well as the excise taxes owed by the bankrupt employers would be
redistributed among the remaining employers, invariably pulling some at
the next tier into a similar fate. As more and more employers fail,
those companies that are more financially secure begin to worry about
being the ``last man standing.'' The result is that they will also seek
ways to abandon the plan before all of their assets are at risk. When
all of the employers withdraw, the assets of the plan will be
distributed in the form of benefit payments until the assets on hand
are sufficiently depleted to qualify for assistance from the PBGC. At
that point, participants' benefits will be reduced to the maximum
guaranteed levels, as noted above, which are likely to represent only a
fraction of the amount to which they would otherwise be entitled at
normal retirement age.
A BALANCED, NEGOTIATED INDUSTRY-WIDE RESPONSE
Trustees of most plans faced with the prospects of an impending
funding deficiency have already taken action to address the problem to
the extent possible. For the most part, that has involved reducing
future accrual rates or ancillary benefits that have not yet been
accrued, as the current anti-cutback regulations prohibit reducing
benefits that have already been accrued. In many cases, this has
involved substantial reductions (e.g. 40 percent by the Western
Conference of Teamsters, 50 percent by the Sheet Metal Workers National
Pension Plan and the Central States Teamsters Pension Plan, and 75
percent in the case of the Plumbers and Pipefitters National Pension
Plan). But because the financial impact of adjusting only future
benefits can be limited, these actions on their own may be insufficient
to avoid a funding deficiency. Additionally, the modest recovery of the
investment markets experienced in 2004 is only marginally helpful. For
example, a $1 billion fund in 2000 that suffered a 20 percent decline
in assets through 2003 would have to realize an annualized rate of
return of 15 percent every year for the remainder of the decade to get
to the financial position by 2010 it would have had it achieved a
steady rate of 7.5 percent for the full 10 year period. Other relief,
including funding amortization extensions under IRC section 412(e) or
the use of the Shortfall Funding Method, have been effectively
precluded as options by the IRS. Consequently, the only alternative
available requires a legislative solution.
Following the failed attempt at relief in the Pension Funding
Equity Act of 2004, various groups began to evaluate alternatives that
might help plans get by avoidable situations, while attempting to help
plans that were placed at risk by unavoidable external forces. The
objective was to find ways to provide additional tools to the plan
fiduciaries and bargaining parties for plans that face imminent funding
deficiencies to bring liabilities and resources into balance. From
April 2004 through early May 2005 a broad cross section of groups,
including those that were on different sides in the earlier debate,
entered into extensive negotiations to develop a set of specifications
for reform that the full group could agree on. The specifications for
reform that resulted from those negotiations reflect a carefully
conceived compromise between employer and labor groups, undoubtedly
quite different from what either group would have designed
independently, but reflective of a desire by all parties to preserve
the plans and the maximum benefits payable to plan participants today
and in the future. That initial group was expanded through meetings
with numerous employer and labor groups and the result was the current
coalition proposal, a copy of which is included as an addendum to this
testimony. A summary of that proposal is as follows:
SUMMARY OF COALITION PROPOSAL
The proposed specifications for multi-employer reform is comprised
of three major components and supplemented with several clarifying and
remedial changes intended to make the system work more effectively for
plans, their participants and sponsors.
The first component is applicable to all plans and has two major
provisions geared to strengthening funding requirements for plan
amendments that increase or decrease plan costs (specifically unfunded
actuarial accrued liabilities) related to past service and to shorten
the amortization of costs for improvements that are to be paid out over
a shorter period to the payment period.
The other major provision would allow plans to build a ``cushion''
against future contractions in the plan's funded position by increasing
the maximum deductible limit to 140 percent of the current limits and
would repeal the combined limit on deductions for multi-employer
defined benefit and defined contribution plans.
The second component applies to plans that have potential funding
problems, defined in the coalition proposal as being plans that have a
funded ratio of less than 80 percent using the market value of assets
compared to the actuarial value of its actuarial accrued liability.
Such plans would be required to develop and adopt a ``benefit security
plan'' that would improve the plan's funded status. Plans in this
category would not be able to adopt amendments to improve benefits
unless the additional contributions related to such amendment more than
offset the additional costs to the plan. Amendments that violate that
restriction would be void, the participants would be notified and the
benefit increase would be cancelled.
To provide additional tools to plans to avoid funding problems,
plans would have ``fast track'' access to 5 year amortization
extensions and the Shortfall Funding Method if certain criteria were
met. IRS authorization could be withheld only in certain circumstances
and applications would need to be acted upon within 90 days or the
approval would be automatic. Additional restrictions that currently
apply to plans with amortization extensions would also apply.
The third and most critical component involves plans that have
severe funding problems or will be unable to pay promised benefits in
the near future. The clear intent of this provision is to prevent a
funding deficiency that could trigger a downward spiral of the plan and
its contributing employers and a reduction in the ultimate benefit
payable to the PBGC guarantee levels. This is accomplished by providing
the bargaining parties with additional tools beyond those currently
available to bring the plan's liabilities and resources back into
balance.
The proposal modifies the current reorganization rules to provide a
meaningful option to plan sponsors, much like a Chapter 11 bankruptcy
reorganization. ERISA currently has reorganization rules governing
plans that are nearing insolvency, but those rules were adopted at a
time when the major concern was a plan's ability to meet its payment
obligations to current pensioners. Today, even those plans with the
most severe funding problems have sufficient assets to meet their
obligations to current pensioners. The coalition proposal suggests
several new triggers to reorganization that reflect the problems of
mature plans, recognizing that funding ratios below 65 percent, a
plan's short term solvency and a plan's demographic characteristics
(i.e. the relationship between the present value of benefits earned by
inactive vested and retired participants to that of currently active
participants) can play an important role in a plan's ability to meet
its obligations to all participants, current and future.
Once a plan is in reorganization, notice would be given to all
stakeholders and the Government Agencies with jurisdiction over the
plans that the plan is in reorganization and describing the possible
consequences. Once in reorganization, plans would be prohibited from
paying out full or partial lump sums, social security level income
options for people not already in pay status, or other 417(e) benefits
(except for the $5,000 small annuity cash outs). Within 30 days,
contributing employers would be required to begin paying a surcharge of
5 percent above their negotiated contribution rates. If the bargaining
agreement covering such contributions expires more than 1 year from the
date of reorganization, the surcharge would increase to 10 percent
above the negotiated rate and remain there until next round of
bargaining. Once in reorganization, the normal funding standard account
continues to run, but no excise taxes or supplemental contributions
will be imposed if the plan encounters a funding deficiency.
Not later than 75 days before the end of the 1 year of
reorganization, the plan fiduciaries must develop a rehabilitation plan
to take the plan out of reorganization within 10 years. The plan would
set forth the combination of contribution increases, expense reductions
(including possible mergers), benefit reductions and funding relief
measures (including amortization extensions) that would need to be
adopted by the plan or bargaining parties to achieve that objective.
Annual updates to the plan of rehabilitation would need to be adopted
and reported to the affected stakeholders. Although the proposal
anticipates the loosening of the current anti-cutback rules with
respect to ancillary benefits (such as subsidized early retirement
benefits, subsidized joint and survivor benefits, and disability
benefits not yet in pay status), a participant's core retirement
benefit at normal retirement age would not be reduced. Additionally,
with one minor exception which follows current law regarding benefit
increases in effect less than 60 months, no benefit for pensioners
already in pay status would be affected. Finally benefit accruals for
active employees could not be reduced below a specified ``floor'' as a
means of ensuring that the active employees whose contributions support
all plan funding, remain committed to the plan.
The proposal anticipates that these ancillary benefits become
available as part of a menu of benefits that can be modified to protect
plans from collapsing under the weight of previously adopted plan
improvements that are no longer sustainable, but that cannot be
modified under the current anti-cutback restrictions. Without such
relief participants would receive lower overall benefits on plan
termination and the plan would be eliminated for future generations of
workers. Within 75 days of the end of the first year a plan is in
reorganization, the plan trustees must provide the bargaining parties
with a schedule of benefit modifications and other measures required to
bring the plan out of reorganization under the current contribution
structure (excluding applicable surcharges). If benefit reductions
alone are insufficient to bring the plan out of reorganization, the
trustees shall include the amount of contribution increases necessary
to bring the plan out of reorganization (notwithstanding the floor on
benefit accruals noted above). The trustees shall also provide any
other reasonable schedule requested by the bargaining parties they deem
appropriate.
The bargaining parties will then negotiate over the appropriate
combination from among the options provided by the trustees. Under this
proposal, benefits for inactive vested participants are subject to
reduction to harmonize the impact on future benefits for this group as
well as for active participants.
The proposal includes suggestions for: bringing the current rules
on insolvency in line with the proposed reorganization rules;
strengthening withdrawal liability provisions; and providing
construction industry funds with additional flexibility currently
available to other industries to encourage additional employer
participation. It also addresses recent court rulings, with one
amendment that allows trustees to adjust the rules under which retirees
can return to work and still receive their pension benefits and another
that permits plans to rescind gratuitous benefit improvements for
current retirees adopted after the date they retired and stopped
generating employer contributions.
CONCLUSION
For more than half a century, multi-employer plans have provided
benefits for tens of millions of employees who, using standard
corporate rules of eligibility and vesting, would never have become
eligible. They offer full portability as workers move from one employer
to another in a system that should be held out as a model for all
defined benefit plans. More importantly, the system of collective
bargaining and the checks and balances offered by joint employer--
employee management has enabled the private sector to take care of its
own without the need for Government support.
Yet the current funding rules, previously untested under the
unprecedented unfavorable investment climate experienced in recent
years, have the potential not only to undermine the retirement income
security of millions of current and future workers and their
dependents, but to force large numbers of small businesses out of
business and eliminating participants' jobs.
The United States Senate and House of Representatives have been
presented with an ideal opportunity to enact meaningful reform
supported by both the employer and employee community who have
coalesced behind a responsible proposal that will enhance plan funding
and provide safeguards to plans, participants, sponsoring employers and
the PBGC, without adding to the already burgeoning debt. Although the
proposal includes certain provisions that are distasteful to both
parties, it is a compromise product of careful negotiations by
employers and the employees' legally recognized representatives. The
alternative is not the continuation of the status quo, but a much worse
fate that includes: the loss not only of accrued ancillary benefits,
but a substantial portion of a participant's normal retirement benefit
as plans are assumed by the PBGC; the demise of potentially large
numbers of small businesses and the loss, not only of pension benefits,
but the jobs from which such benefits stem; and an increase in taxpayer
exposure at the PBGC, an agency that is already overburdened.
We urge the committee to wholeheartedly support this proposal and
look forward to working with you to see it enacted into law.
In closing, I would like to thank you for taking the time to engage
in this important discussion and for the opportunity to be with you
here today.
Senator DeWine. Mr. Noddle?
Mr. Noddle. Chairman DeWine, Senator Mikulski, thank you
for allowing me to testify. As you put it, I am Chairman of the
Board, President and Chief Executive Officer of SUPERVALU. I am
also Chairman of the Board of the Food Marketing Institute,
which represents 26,000 retail food stores, and I am also a
Board member of the IGA Independent Grocers Alliance.
SUPERVALU is a Minnesota based Fortune 100 company with
58,000 employees in 41 States. As you pointed out, we are the
largest publicly held food wholesaler and the seventh largest
food company in the United States. SUPERVALU participates in 17
defined benefit multi-employer plans, providing retirement
benefits to approximately 22,000 of our SUPERVALU employees.
Overall, supermarkets employ 3.5 million Americans. About
1.33 million of these are covered by collective bargaining
agreements. While the industry provides a variety of single-
employer and multi-employer retirement plans, most of the union
workforce participates in multi-employer pension plans. In
total, multi-employer pension plans cover about 9.7 million
people. They are governed by ERISA like their single-employer
plan counterparts. Unlike single-employer plans, however,
multi-employer plans are also governed by the Multi-Employer
Pension Plan Amendment Act of 1980 and the Taft-Hartley Act,
which requires plans' boards of trustees to have equal
representation by both union and management.
Multi-employer plans are funded by employer contributions
and governed by joint boards of trustees. They are not union
plans. Two of the biggest differences between single-employer
and multi-employer plans are the funding mechanisms that are
used and the manner in which benefit levels are established. In
a single-employer plan, companies generally establish a benefit
level first with the contribution level increasing or
decreasing each year. Multi-employer plans generally work in
the opposite manner. Contributions are almost always
established first through the collective bargaining process.
Then benefit levels are set by a plan's joint board of
trustees.
Given this background, I ask you to support FMI's pension
reform proposals. We believe they provide a reasonable
framework for multi-employer plans to work through the problems
now facing all pension plans. We are not asking for a
Government bailout. Rather, we ask you to help us establish a
framework to solve our own pension problems without putting
financial pressure on the PBGC.
First, we seek greater transparency of information from
multi-employer plans. Employers have great difficulty in
obtaining current financial information unless they serve on
the board of trustees. We believe plans should be required to
provide the most current financial information upon request to
both contributing employers and plan participants. Without
current financial information, companies cannot engage in
collective bargaining in an informed manner and work with the
plan trustees to address any underfunding problems.
In the case of SUPERVALU, as I mentioned, we have 17 plans,
but we only have trustees on 7 of those so the transparency
issue is quite vital to us on the balance of those plans.
Second, we ask Congress to adopt mechanisms to allow boards
of trustees to better manage their funding. Our proposals
dovetail well with the coalition proposal that includes a
stoplight system of identification for plan funding. Green Zone
plans are more than 80 percent funded, Yellow Zone plans are 65
to 80 percent, and Red Zone plans are less than 65 percent. The
FMI proposal focuses on Yellow Zone plans providing a more
specific mechanism to address funding concerns. Allow me to
applaud the coalition efforts of employees and labor to tackle
these very important issues in hopes of a meaningful reform.
Our proposal creates an early warning system that requires
plan actuaries and boards of trustees to look at both the
plan's current funding level and 7 years into the future. As a
result, future funding problems are recognized early when there
is time to correct them before the plan reaches a crisis stage.
When a plan falls within the Yellow Zone the trustees must
prepare a funding improvement plan using quantifiable
benchmarks to improve the plan's funding. The trustees must
also adopt a schedule of solutions to allow employers and
unions engaged in collective bargaining to agree to
contribution levels that are appropriate for the benefits
provided by the plan.
We believe this mechanism addresses the unique nature of
multi-employer plans where collective bargaining agreements fix
contribution rates for several years into the future.
Again, Chairman DeWine, Senator Mikulski, I thank you for
the opportunity to testify on this topic, and I will be glad
later to answer questions.
[The prepared statement of Mr. Noddle follows:]
Prepared Statement of Jeffrey Noddle
Chairman DeWine, Senator Mikulski and members of the committee,
good morning. My name is Jeff Noddle and I am the chairman of the
board, president and chief executive officer for SUPERVALU INC. I am
currently chairman of the board for the Food Marketing Institute (FMI),
as well as a board member for the Independent Grocers Alliance, Inc.
(IGA) and chairman of its governance committee, as well as other
corporate, civic and industry organizations. In addition, I serve on
the board of the Food Industry Center at the University of Minnesota
and the Academy of Food Marketing at Saint Joseph's University,
Pennsylvania.
I want to thank you for the opportunity to testify on behalf of the
26,000 retail food stores represented by FMI regarding legislation to
achieve comprehensive pension reform and retirement security. We would
like to share our concerns about the future of multi-employer plans and
some suggestions we have for better management of these plans.
Before I proceed, I would like to take a moment to tell you about
my company. SUPERVALU INC., is a Fortune 100 company, based in
Minneapolis, MN. We are the largest publicly held food wholesaler in
the United States and this country's 7th largest grocery retailer.
SUPERVALU manages a well-rounded portfolio of national and regional
grocery retail banners that we constantly refine to address dynamic
customer preferences and trends in the market. Since 1870, the enduring
mission of our 58,000 employees is to serve our customers better than
anyone else could serve them.
Each week, SUPERVALU serves over 10 million customers in its more
than 1,500 corporately owned stores in 41 States. Our corporate retail
stores include Cub Foods in Minnesota, Wisconsin and Illinois, Bigg's
in Ohio, Shopper's Food Warehouse in Virginia and Maryland, Shop-N-Save
in Missouri, Illinois and Pennsylvania, and Save-A-Lot throughout the
country. We operate 41 distribution centers, which supply more than
3,200 independent stores, in addition to our corporate banners.
SUPERVALU participates in 17 defined benefit multi-employer plans,
providing retirement benefits to approximately 22,000 SUPERVALU
employees throughout the United States.
Industry-wide, supermarkets employ approximately 3.5 million
Americans, providing employees with good wages and excellent benefits,
so employment in the industry is a proven path to success for the
American worker. The industry provides a variety of retirement plans
among the wide range of benefits it provides. Supermarkets offer
benefits to associates and management alike through almost every
conceivable type of pension plan, including defined benefit, defined
contribution--profit sharing and 401(k), hybrid, cash balance and
employee stock ownership plans. The industry's defined benefit pension
plans include both single-employer plans (those sponsored by an
individual company and common in the steel, automotive and airline
industries) and multi-employer plans, in which many companies join
together to fund and operate the plans (common in the grocery and
construction industries).
Multi-employer plans are governed, in part, by ERISA, like their
single-employer plan counterparts. Unlike single-employer plans,
however, multi-employer plans are also governed by the Taft-Hartley
Act, which mandates that their Boards of Trustees have equal
representation by Union and Management Trustees. They are also governed
by the Multi-Employer Pension Plan Amendments Act of 1980, which
amended ERISA and provided special rules for multi-employer pension
plans.
Approximately 1.33 million people in the supermarket workforce are
covered by collective bargaining agreements (labor contracts).
Unionized associates who work in the stores are primarily represented
by the United Food & Commercial Workers Union. Warehouse workers and
drivers are generally represented by the International Brotherhood of
Teamsters. Most of these employees are participants in multi-employer
pension plans.
Multi-employer pension plans are an important part of the Nation's
private sector retirement system, providing pension benefits for
approximately 9.7 million workers and retirees in the United States. As
I mentioned earlier, in 1980, Congress recognized some of the funding
and operational differences between single-employer pension plans and
multi-employer pension plans. As a result, Congress amended ERISA and
established separate and distinct rules for multi-employer plans under
the Multi-Employer Pension Plan Amendments Act of 1980. Multi-employer
plans provide retirement coverage for unionized employees of multiple
employers within an industry or trade. The multi-employer plans are NOT
union plans.
Two of the biggest differences between single-employer pension
plans and multi-employer plans are the funding mechanism used and the
manner in which benefit levels are established. In a single-employer
plan, companies generally establish a benefit level first, with the
contribution level increasing or decreasing each year depending upon
changes in a plan's demographics as well as investment gains or losses
during each plan year. Conversely, contributions to multi-employer
plans are almost universally set at fixed rates established through
collective bargaining by contributing employers and Unions representing
the companies' employees. Benefit levels are then set by a plan's Board
of Trustees, which, as I stated earlier, must consist of an equal
number of representatives of Employers and Unions.
This funding mechanism and the tax laws existing under ERISA in the
late 1990s contributed to some of the funding problems multi-employer
plans currently encounter. In the late 1990s, these plans' investment
gains caused many plans to become overfunded to the point at which
contributing companies' contributions (which were fixed by collective
bargaining agreements) would not be treated as deductible contributions
under the Internal Revenue Code if benefits were not increased (known
as the full funding limit). A host of multi-employer plans attempted to
reward long-term participants by increasing benefit levels
retroactively under the theory that the long-term participants should
be rewarded for the prior contributions made on their behalf and the
resulting investment gains from those contributions. When the stock
markets suffered huge losses from 2000-2002, these plans were unable to
decrease the benefits granted for past service due to restrictions
under ERISA. Even plans that did not increase benefits for past service
suffered greatly from the 2000-2002 bear market.
Another difference between single-employer plans and multi-employer
plans is the amount of control any one employer has over the operation
of a multi-employer plan. As I stated earlier, the Board of Trustees of
multi-employer plans are required by law to be managed by Boards of
Trustees equally represented by Unions and Employers. Most Boards of
Trustees consist of 3-4 Union representatives and 3-4 Employer
representatives. Unless a company employs a large percentage of the
plan's participants, it generally does not have a representative on the
Board of Trustees. Furthermore, in many cases, employers do not even
have the ability to vote on who represents them on the Board of
Trustees. As a result, many employers who bargain in good faith with
Unions to contribute to these plans and make contributions in good
faith to these plans have no say in the operation of the plans and, in
fact, receive little or no information concerning the plans' operations
or funding levels.
Chain supermarket companies generally participate in several local,
regional or national plans, depending on the company's size and area of
operation. Some companies participate in as many as 50 multi-employer
pension plans. So, it is common for even large employers to contribute
to many multi-employer plans on which they do not have a Trustee seat.
For example, while SUPERVALU contributes to 17 multi-employer pension
plans, we have a Trustee seat on only 7 of these plans.
A third difference between single-employer plans and multi-employer
plans is in the amount of Government intervention with plans supported
by companies that go bankrupt. In the single-employer plan arena,
pension plans of bankrupt companies generally are taken over by the
Pension Benefit Guarantee Corporation, which guarantees a reduced
benefit to plan participants and is financially responsible to pay this
benefit. This results in a financial burden on the PBGC. Conversely,
when a contributing employer to a multi-employer plan goes bankrupt,
the plan absorbs the loss, the company's employees continue to receive
unreduced pension benefits, and the remaining contributing employers
are required to bear the burden of paying these pension benefits. In
fact, even when a multi-employer plan has a withdrawal liability claim
against the bankrupt employer it rarely, if ever, collects the full
amount of the claim because withdrawal liability claims are treated as
general unsecured claims under the current bankruptcy laws. The Pension
Benefit Guarantee Corporation is rarely called upon to assist multi-
employer plans due to these rules. Even if the PBGC is needed to assist
a multi-employer plan that, as a whole, becomes insolvent, the PBGC
assistance is only in the form of a loan and solvent contributing
employers are called upon to increase contributions to the plan, over
and above any amounts they agreed to contribute through collective
bargaining.
As an example, a food industry company, Fleming Companies, filed
for bankruptcy in 2003. Fleming had a single-employer pension plan that
was taken over by the PBGC, which is required to shoulder the financial
burden of paying benefits to the plan's participants. As part of the
law under which the PBGC operates, plan participants and retirees may
have their retirement benefits reduced. Fleming Companies also
contributed to several multi-employer pension plans on behalf of its
unionized employees. The PBGC did not step in to provide financial
assistance for these multi-employer plans and unionized employees did
not have their retirement benefits reduced. Rather, other employers
contributing to the multi-employer plans are required by law to absorb
any funding deficiency. In the case of Fleming, we estimate this
amounts to over $100 million dollars spread throughout several multi-
employer plans. Finally, even though these multi-employer plans were
able to file claims for withdrawal liability with the bankruptcy court,
we understand the plans received only 5-10 cents on the dollar for
their claims because, under bankruptcy law, the plans are unsecured
creditors.
Given this background, I am here today to ask you to support the
supermarket and food distribution industry's proposals to modify the
laws governing multi-employer pension plans. We believe these proposals
will provide a reasonable and rational framework for multi-employer
pension plans to work through the problems now facing all pension plans
(both single-employer and multi-employer). We are not asking for a
Government bail out; rather, we are asking you to help us establish a
framework that will allow us to solve our own pension problems without
monetary intervention by the Government and without putting financial
pressures on the Pension Benefit Guarantee Corporation. We believe
that, if Congress acts now, multi-employer plans can solve their own
problems so they do not become a burden on the Federal Government.
Our proposed reform focuses on two areas. First, we seek greater
transparency of information from multi-employer plans. Second, we ask
Congress to adopt mechanisms to allow Boards of Trustees to manage
their own funding situations in a better manner.
As for transparency, the supermarket and food distribution industry
is very concerned about the lack of transparency in multi-employer
plans. Some of these plans are seriously underfunded, but employers
have had considerable difficulty in obtaining current financial
information about the funding deficiency. We believe there should be
rules requiring these plans to provide the most current financial
information, upon request, to both contributing employers and plan
participants. In a single-employer plan, the employer has direct and
continual involvement in the financial management of their pension
plan; there is no such direct involvement by employers in multi-
employer plans. Without this current information, it is difficult to
engage in collective bargaining in an informed manner and to work with
the plan trustees to address the underfunding problem.
Our industry's second area of proposed reform attempts to provide a
mechanism for underfunded plans to work through their funding issues.
It is a proposal that would dovetail well with a proposal put forth by
the trucking industry. Earlier this year a group within the trucking
industry, including, United Parcel Service, YellowRoadway, the Motor
Freight Carriers Association, the International Brotherhood of
Teamsters, the National Coordinating Committee on Multi-Employer Plans
(NCCMP) and Central States Teamsters Pension Plan, came together and
negotiated a proposal to address funding reforms. Their proposal
focused on plans with funding levels below 65 percent. It also included
a proposal for plans that are between 65 percent and 80 percent funded.
At the same time, FMI and members of its Pension Task Force were
independently developing long-term pension reform proposals. Earlier
this year, FMI met with the trucking industry to discuss our respective
visions of multi-employer pension plan reform.
FMI applauds the trucking industry's efforts. Due to philosophical
differences, we came out of our discussions with different, but
complimentary policy proposals. The trucking industry proposal includes
a stop-light system of identification for multi-employer pension plan
finding, which includes Green Zone plans (above 80 percent funded),
Yellow Zone plans (65 percent-80 percent funded), and Red Zone plans
(less than 65 percent funded).
FMI's Task Force focused on the Yellow Zone plans, providing what
we believe is a more specific mechanism to allow Yellow Zone plans to
address their funding concerns. As a result, the FMI member companies
drafted ideas for benchmarks, transparency, and funding reform that we
believe will wrap around the trucking industry's proposals and provide
comprehensive funding reform that will serve all multi-employer plans
well into the future.
The FMI Task Force formulated its proposals in meetings with top
actuaries and pension attorneys, where it became evident that the
requirements of today's laws encourage plans to take a short-term,
``snapshot'' approach to determine their benefit formulas and funding
requirements at the expense of sound long-term funding projections. The
FMI Yellow Zone proposal attempts to create a mechanism whereby multi-
employer plan actuaries are required to look at both the plan's current
funding level and far ahead into the future (7 years) to make sure the
plan will remain at an appropriate funding level. As a result,
potential future funding problems are recognized early, when there is
time to correct them in a reasonable and timely manner. This time is
needed to allow the Boards of Trustees to act to adopt objective
measures to improve a Yellow Zone plan and prevent it from becoming a
Red Zone plan.
Once a Yellow Zone plan is identified as such, the plan's Board of
Trustees will be required to prepare a Funding Improvement Plan that
will improve the plan's funding ratio (within specified guidelines) and
will postpone any deficiency in the plan's funding standard account.
The trustees will also be required to adopt a schedule of solutions
that will allow employers and unions engaged in collective bargaining
in the future to agree to contribution levels that are appropriate for
the benefits provided by the plan. The schedule of solutions in the FMI
Yellow Zone proposal ranges from employer contribution increases to
reductions in future employee benefit accruals, or a combination of
both.
We believe that creating this mechanism will accurately address the
unique nature of multi-employer plans, in which collective bargaining
agreements fix contribution rates for several years into the future and
where, under ERISA, trustees are prohibited from retroactively reducing
the benefit levels for plan participants. As a result, all parties
(contributing employers, unions, and trustees) will have the ability to
act responsibly on behalf of employees by providing an accurate measure
of expected liabilities over a longer time-frame and by providing a
schedule of solutions to correct any funding problems on the horizon
before they reach a crisis stage. We believe the FMI Yellow Zone
proposal provides these solutions in a manner that will also maintain
the collective bargaining rights of all the parties.
While many of the multi-employer plans in our industry are well
funded, the funding standard account in some of these plans could reach
a crisis state in 4 to 6 years if some of the laws governing these
plans are not changed. Even plans that are currently 100 percent funded
could have a significant deficiency in their standard funding account
in future years. Therefore, we urge Congress to act now so defined
benefit multi-employer pension plans can remain an important part of
the Nation's retirement system well into the future.
In summary, we in the retail food industry are very concerned about
the Nation's pension funding and retirement funding problems. Those of
us who contribute to and participate in multi-employer pension plans
are asking Congress to recognize the ways in which these plans differ
from single-employer pension plans and to enact amendments to existing
laws that will establish mechanisms to help us correct our problems
ourselves. Multi-employer pension plans have not, in the past, been a
burden to the Federal Government or the PBGC, and we are not now asking
for any financial assistance from the Government. Rather, we ask for
your help now, so we can continue to provide great retirement benefits
for our millions of employees and retirees well into the future without
ever becoming a burden on the Federal Government.
Again, Chairman DeWine, Senator Mikulski and members of this
committee, I thank you for the opportunity to testify on this important
topic. I am glad to answer any of your questions.
(Food Marketing Institute (FMI) conducts programs in research,
education, industry relations and public affairs on behalf of its 1,500
member companies--food retailers and wholesalers--in the United States
and around the world. FMI's U.S. members operate approximately 26,000
retail food stores with a combined annual sales volume of $340
billion--three-quarters of all food retail store sales in the United
States. FMI's retail membership is composed of large multi-store
chains, regional firms and independent supermarkets. Its international
membership includes 200 companies from 50 countries).
Senator DeWine. Mr. Ward?
Mr. Ward. Chairman DeWine, Senator Mikulski, thank you for
having me. My name is John Ward, and I am the President of
Standard Forwarding Company, a small, family owned union
trucking company located in East Moline, IL. I appear before
you today both on behalf of my company and the members of the
Multi-Employer Alliance.
Our alliance was formed in 2004 to represent the interests
of smaller, family owned businesses. All our members
participate in the Teamsters Central States Plan, which is now
severely underfunded by 11 to 15 billion and incurred a funding
deficiency last year.
Significant underfunding of these plans will result in
deficiency penalties being imposed upon us, imperiling our
businesses and our employees.
Despite never missing a pension contribution, and despite
having no say in who or how the plans are run, our share of the
plans unfunded liability now significantly exceeds the net
worth of our small businesses.
Standard Forwarding is typical of the firms that make up
the alliance. Our company was founded in 1934 and provides
transportation services to Midwestern firms. We employ 440
people and generate in excess of 50 million in annual revenue.
Standard Forwarding has been a union firm for the majority of
our 71 years. We believe that our Teamster employees are among
the best in the industry. As demand for our services has grown,
we have expanded our workforce with union employees.
Unfortunately, every additional employee that I hire
increases our portion of the unfunded pension liability. In
2001 our company employed 211 Teamsters and had a withdrawal
liability of $3.2 million. Three years later we employed 290
Teamsters and had a withdrawal liability of $20 million. The
liability exceeded our net worth by $16 million, and mind you,
this is a successful, profitable company.
Ironically, the Multi-Employer Act of 1980 severely
penalizes companies like ours for growing union jobs. The
alliance recommends various reforms to current law that are
urgently needed to protect the benefits of workers and save our
companies. The most pressing need is to repeal current law that
imposes excise taxes and additional contributions on employers
when a plan reaches funding deficiency. These potential costs
are beyond our ability to pay. We support much of the funding
deficiency reforms in the UPS Teamsters legislative proposal.
However, it is vital that we secure additional safeguards
to prevent the plans from imposing unlimited additional
contributions which could bankrupt our companies. Congress
should resist proposals to impose withdrawal liability on a
company that uses independent contractors or driver leasing
companies. Controlled group rules should be limited so that
withdrawal liability is confined to the contributing employer
or when entities are solely created to avoid liability.
We support establishing objective funding standards that
would prohibit benefit increases when there is insufficient
income and assets to fund them. Congress should also permit
funding of plans up to 140 percent without penalty. More timely
and accurate disclosure of financial information by the plans
is obviously necessary.
Last, we urge Congress to restore the provisions of ERISA
that existed prior to the passing of MEPA in 1980. At that time
a company's portion of the unfunded liability was limited to 30
percent of its net worth. It is patently unfair and contrary to
the principles of the American dream that any employer should
lose all of the equity built up over generations. There has
been a steady decline in the number of multi-employer plans,
from 2,200 in 1980 to 1,700 in 2003. It is no coincidence that
this decline occurred with the passing of MEPA.
In 1982, George Lehr, the Executive Director of the Central
States pension plan, said, and I quote, ``In the long run,
employer liability is the single most damaging thing pension
funds will be facing. In theory, it's a wonderful law; in
practice, it doesn't work.'' History has proven Mr. Lehr right.
Congress must create an environment that encourages
existing and new employers to participate in these plans.
Current law has created an iron curtain that simply drives
employers away. Our suggested reforms provide balance to the
UPS Teamsters proposal. They would protect workers' benefits
and the vitality of the small companies that employ them.
Thank you very much for the opportunity to appear, and I
would be happy to answer any questions.
Senator DeWine. Good.
[The prepared statement of Mr. Ward follows:]
Prepared Statement of John Ward
EXECUTIVE SUMMARY
Chairman DeWine, Senator Mikulski and members of the subcommittee,
I thank you for the opportunity to testify on multi-employer pension
plans. My name is John Ward and I am the President of Standard
Forwarding Company which is a small, family owned union trucking
company located in East Moline, Illinois. I appear before this
subcommittee both on behalf of my company and the other trucking
company members of the Multi-Employer Pension Plan Alliance (MEPA
Alliance).
The MEPA Alliance was formed last year in response to the financial
crisis that arose in the Central States pension plan to which we all
are long time contributing employers. It is an understatement to say we
were shocked to learn that this plan had become so severely underfunded
that it reached a deficiency in 2004 that would trigger Federal excise
tax penalties and additional contributions that our companies could not
afford to pay.
Unless significant reform is enacted multi-employer plans will
ultimately lose the fight. Rather than creating an environment that
encourages employers to grow their businesses and participate in these
plans, the law has created a death spiral with traps and penalties that
will forever drive current and prospective employers away. In fact, in
a March 5, 1982 Wall Street Journal article, George Lehr, the Executive
Director of the Central States pension plan said in a reference to
withdrawal liability: ``In theory, it's a wonderful law; in practice,
it doesn't work. In the long run, employer liability is the single most
damaging thing pension funds will be facing.''
[Exhibit 1--See Editors note after the conclusion of this
statement.]
The smaller businesses that have participated in the Central States
pension plan were kept in the dark about its financial deterioration;
neither the plan administrator nor the trustees informed us of the dire
financial condition until they needed our assistance in seeking
legislation that would allow them to postpone this deficiency. At that
time, we realized that we needed to seek our own representation and
make our case for meaningful reform of these plans and the governing
law.
The alternative of doing nothing places in jeopardy the future of
smaller, family owned companies, such as Standard Forwarding, that have
been built up and have operated over several generations. Substantive
legislative reform of multi-employer pension laws is the single most
important legislative issue now confronting the unionized trucking
industry.
Unless Congress addresses this year the chronic and now dire
underfunding in many of the Teamster multi-employer plans, many smaller
union firms will be forced into bankruptcy. We face a classic case of
double jeopardy. We cannot afford current law on funding deficiency
that mandates additional contributions and excise tax penalties. We
also cannot afford the portion of the UPS/Teamsters reform proposal
which permits the Funds to establish unlimited levels of pension
contributions and then expel companies for not paying. If we are
expelled from the Central States pension plan, our companies will be
forced to pay a withdrawal liability that has grown so large that it
now substantially exceeds the net worth of our companies. Obviously,
this means immediate bankruptcy.
We desperately need the assistance of Congress and we need it soon.
We appreciate that Congress is willing to address not only reforms to
the single-employer defined benefit system, but also to the multi-
employer pension plan system. Both are at risk today.
The MEPA Alliance members recommend that this subcommittee focus on
the following critical areas:
Repeal of the current tax law that imposes punitive excise
taxes and additional contributions on employers in severely underfunded
plans. We generally support some aspects of the reform proposals
developed by other groups, but with a safeguard so that plans may not
expel smaller employers and impose withdrawal liability if they cannot
bear the cost of the plan-imposed additional pension contributions.
Plan-imposed contributions should be capped at 15 percent above the
employer's contributions under its prior collective bargaining
agreement.
Ideally, the withdrawal liability rules should be
repealed, rather than tightened. Short of this, we support reenactment
of the law prior to the Multi-Employer Pension Plan Amendments Act of
1980 (MPPAA) that properly and fairly held that no more than 30 percent
of any employer's net worth can be taken when it withdraws from an
underfunded plan. It is patently unfair that a family owned company can
be stripped of all of the assets it has built up over generations
notwithstanding that the company has made all its required pension
contributions.
Refrain from making the withdrawal liability rules even
more onerous as UPS/Teamsters have proposed. That proposal would impose
withdrawal liability when a company uses independent contractors or
third party driver leasing companies to meet customer needs. The
trucking industry rule should not be repealed and the current rule that
reduces liability for a company in liquidation should be maintained. As
will be discussed, the withdrawal liability rules established in 1980
have discouraged new employers from entering these plans and have
sealed the fate of these plans by causing a declining participation
base.
Limit the controlled group rules so that withdrawal
liability is confined to the contributing employer and any related,
fractionalized entities that were separated out from the contributing
employer to avoid withdrawal liability. We also support repealing the
``pay now and dispute later'' provisions of MPPAA.
Establish objective funding standards for all plans that
would prohibit benefit increases when there is insufficient income and
assets to fund those benefit promises. Benefit increases should not be
allowed in plans that have a funding ratio below 90 percent. As early
as 1996, the Multi-Employer Plan Solvency Coalition reported that
trustees of the Central States plan had imprudently increased benefits
beyond the means to pay for them and that it would exacerbate the
underfunding crisis. Benefit promises should be made only when they can
be paid. Similarly, the Alliance believes that Congress should move to
eliminate or substantially increase any high end caps on funding of the
plans and permit funding up to 140 percent of full funding without
penalty.
Require timely and accurate disclosure of the key
financial information by the plans to all participating employers,
their employees and the PBGC. There needs to be sunshine in the dark
rooms of these plans that have withheld information from contributing
employers and plan participants in the past. Too much is at stake to
tolerate the nondisclosure of this financial and actuarial data to all
but the union and the employer companies that have trustees on these
plans.
Create an objective Congressional Commission to study and
make recommendations on how to fairly apportion and pay for the huge
underfunding that has arisen in these plans, and in particular the
benefits being paid to retirees that no longer have an employer
contributing to these plans. The Central States plan currently pays
approximately $1 billion annually to 100,000 retirees that lack a
contributing employer. Those benefits consume nearly 100 percent of the
annual contributions received by the plan from all the remaining
employers. Contributing employers can no longer shoulder this entire
burden which is mounting each year.
The Alliance members are committed to achieving these legislative
reforms for multi-employer plans to promote plan solvency, preserve
pension benefits and save our smaller companies through a fair
realignment of pension responsibilities and liabilities.
THE PLIGHT OF SMALLER BUSINESSES LIKE STANDARD FORWARDING
Standard Forwarding is typical of the transportation firms that
make up the Alliance members. Our company, based in East Moline,
Illinois, was founded in 1934 and provides transportation services to
companies over the five State area of Iowa, Illinois, Indiana,
Minnesota and Wisconsin. Our dedicated employees deliver a high quality
of service that has been a factor in the success of our customers which
in turn has driven our expansion. We now employ 440 employees, generate
over $50 million in revenue annually, operate 250 tractors and 700
trailers, and use the latest information technology found in the
trucking industry.
Standard Forwarding has been a union-represented trucking company
for the majority of our 71 years in business. We believe our Teamster
employees are among the best trucking employees in the industry. As
demand for our services has grown, Standard Forwarding, unlike many
contributing employers to the Central States pension plan, has expanded
our union workforce. Unfortunately, every additional union employee I
hire only increases our portion of the unfunded pension liability in
this plan. This liability has increased at a cruel pace that exceeds
any profitability or equity growth that our company could ever hope to
generate. Consider that in 2001, Standard Forwarding employed 211 union
employees and had a withdrawal liability of $3.2 million. This was $2
million more than our corporate equity. A mere 3 years later, in 2004,
we had increased our union employees to 292 and our withdrawal
liability had mushroomed to $20 million, which exceeded our equity by
$16 million!
As hard as it may be to believe, the Federal pension law created by
the Multi-Employer Pension Plan Amendment Act of 1980 severely
penalizes our company, and other companies like it, for growing union
jobs.
In fact, that law has also made it impossible to sell our company.
No prudent investor is willing to inherit the mounting liabilities that
come with acquiring a unionized firm that participates in an
underfunded plan, such as the Central States plan.
Contrary to the principles of the American dream, growing our
company significantly increases our liability and wipes out any stake
that we may have built up in our businesses. Sadly, MPPAA even
precludes us from applying our expertise to other business ventures.
Under the so-called controlled group regulations, the assets of an
affiliated company are also at risk to pay for withdrawal liability if
the owners have controlling interest in both Standard Forwarding and
the affiliated company.
Many of you on this subcommittee may be or once may have been
owners of small businesses or worked in a family owned business.
Consider for a moment what you would do if your family business were
faced with a decision to participate in a multi-employer pension plan
like Central States? Would you do it knowing that one day you could
wake up and your family's life work was wiped out because of it? That
is the stark reality I face with Standard Forwarding. It is a nightmare
that I share with all the Alliance members. Only Congress has the
ability to rectify the problem.
Smaller businesses lack both the capital and diversification to
weather much longer the financial crisis in these multi-employer
pension plans. We have absolutely no control over the negotiation or
setting of benefits or contributions in these plans and, as mentioned
earlier, it is difficult for us to even obtain timely and accurate
financial information from them. The trustees are not accountable to
us. They represent either the Teamsters union or one of the major
national companies that pay their salary. We also lack the leverage at
the collective bargaining table of those national companies. In sum, we
cannot reform or change these plans from within, or at the bargaining
table. We need your assistance.
THE DETERIORATING FINANCIAL CONDITION OF THE MAJOR TEAMSTER PENSION
PLANS
Much of the discussion in this testimony focuses on the Central
States pension plan. That is because all the Alliance members
participate in that multi-employer pension plan and it is the second
largest Teamster pension plan with over $17 billion in assets. However,
financial information on several other significant Teamster plans,
which are also severely underfunded or at risk, is attached to this
testimony. [Exhibits 2-4]. Central States may be one of the worst
plans, but it is not alone.
The deteriorating financial condition of these plans is widespread
because no new employers are willing to join and be exposed to
withdrawal liability. Deregulation of the trucking industry and the
passing of MPPAA in 1980 commenced the slow, but steady, decline of the
unionized trucking industry. Many unionized employers have ceased
operations and the Teamsters have lost over 100,000 jobs in the freight
sector. This in turn has dwindled the contribution base of these plans.
For example, there are now more retirees drawing pensions from the
Central States plan than active workers on whose behalf employers are
making contributions. [Exhibit 5]. The plan is experiencing a 2 percent
decline annually in the contribution base. With more and more workers
reaching retirement age, the situation worsens each year. The average
age of a union truck driver is approximate 55 years old.
Consequently, the Central States pension plan has an annual
negative cash flow of over $1 billion. It must rely on the returns on
its investments each year to cover this expanding shortfall in revenue.
For a while the rapid increases in the stock market masked these
problems. But the stock crash in 2001 caused these plans assets to
plummet and they are unlikely to change in the near or long-term
future. The Central States plan, which reached a funding deficiency in
2004, is experiencing another bad year in 2005. It is projecting
another $1.2 billion loss; for the first quarter 2005, it lost $461
million and had a negative return on investments.
Since the passage of the Multi-Employer Pension Plan Amendments Act
of 1980, there has been a steady decline in these multi-employer plans.
There were approximately 2,200 plans in 1980 and fewer than 1,700
remained by 2003. Only five new plans have been created since 1992. The
number of active participants in these plans has decreased by 1.4
million since 1980. Thus, Central States is not alone in this financial
struggle; it is however on the front burner having already reached a
funding deficiency.
The seven largest Teamster plans were collectively underfunded by
$16-23 billion in 2002, depending on the method of calculating the
assets. In 2003, the Central States plan alone was underfunded by $11.1
billion. It has been estimated that underfunding in this plan has
further increased in 2004 to $15 billion. Many of these other plans are
as financially strapped as the Central States plan, based on the 2002
data. These Teamster plans account for one quarter of the $100 billion
in total multi-employer pension plan underfunding.
However well intentioned, the changes made to the pension laws in
1980 have exacerbated the financial problems of these plans rather than
strengthened them. These plans cannot continue to exist without new
employers and more active participants. MPPAA shut the door on future
participation by imposing withdrawal liability on all employers for
plan underfunding. The problems confronting these multi-employer plans
are systemic and they will not solve themselves.
It is both shortsighted and patently unfair to propose an alleged
solution which could force smaller contributors out of business rather
than a solution that encourages them to grow their businesses, increase
union jobs and continue to make plan contributions.
THE IMPACT OF PLAN UNDERFUNDING ON SMALLER BUSINESSES
Underfunding in multi-employer plans creates serious financial
problems for all employers in the plans, but especially for smaller
firms that lack access to capital that is available to publicly-traded
companies.
First, there is a cash flow problem when a plan, like Central
States, reaches a funding deficiency. The employers, by law, are
obligated to pay for this deficiency to put the plan back within the
minimum funding standards of ERISA. Compounding the funding deficiency
payments are excise tax penalties that are imposed.
Exhibits 6-8 illustrate how the combination of additional
contributions and excise tax penalties would destroy the finances of a
smaller company with 100 employees. A funding deficiency of
approximately $400 million, an amount consistent with the Central
States plan's estimates for 2004, would increase this company's pension
contributions by 40 percent. It would incur an additional 5 percent
excise tax penalty that goes not to the plan but the general treasury
and therefore does not help plan solvency. This company may be able to
survive the first year of the funding deficiency. However, in the
second year, it will be forced out of business because the additional
contributions then would increase to 135 percent of current
contributions to the plan, and the excise tax penalty would be an
additional 100 percent of the prior year's deficiency.
The second way in which plan underfunding harms employers is when a
withdrawal from a plan occurs. While a cessation of operations is the
most common way in which withdrawal liability results, it can also
arise through a change in operations, a terminal shutdown, a decline in
union workers, involuntarily by strike or decertification of a union by
the employees, expulsion by the pension fund, or disclaimer of
continued representation of the bargaining unit by the union.
The financial impact of withdrawal liability is now overwhelming.
The amounts of liability, which are calculated on a pro-rata share of
underfunding, now far exceed the ability of most companies to pay; it
exceeds their entire net worth. The withdrawal liability of Standard
Forwarding for 2004 is $20 million which is well beyond our means.
Bankruptcy would be our only recourse.
For the MEPA Alliance members, the costs associated with withdrawal
liability that would be owed the Central States plan can be as high as
5 times their net worth and 10 times the profits in their most
profitable year.
While the MEPA Alliance has focused on the harsh financial reality
of underfunding on employers, ultimately it will impact the employees'
pensions and the Federal Government through the PBGC. If these plans
cannot regain solvency, they face termination. The employees are only
guaranteed payments of approximately $1,000 per month, which is far
below the $3,000 a month maximum benefit under the Central States plan.
Therefore, they could lose up to two-thirds of their benefits. The PBGC
would be obligated to pay that amount, if plan assets were
insufficient.
Therefore, employers, employees and their Union representatives,
and the Federal Government all have a vested interest in solving this
problem promptly.
THE NEEDED CONGRESSIONAL REFORMS
1. Full and Timely Disclosure of Plan Financial Information
The time is long overdue for complete, timely and accurate
disclosure of the key financial information by these plans. The
financial condition of the Central States plan has been a guarded
secret, with only the union and four major transportation companies
privy to the most up-to-date information.
Under current law the multi-employer pension plans provide annual
reports almost 9 months after the end of the current fiscal year.
Therefore, the Central States plan will release its 2004 information in
September of this year. There is simply no reason why this annual
report information in the Form 5500 cannot be disclosed much sooner,
such as within 3 months after the end of the fiscal year. The key
financial information, including the annual actuarial reports, should
be released to all participating employers and employees, by written
communication or posting it on the plan's Web site. The Alliance
members also believe that these pension funds, like mutual funds,
should be required to provide quarterly updates. These updates are now
provided by the Central States plan to the court overseeing the fund,
so this would not be a new or burdensome requirement.
Consideration should also be given to mandating a change in the
make-up of the Board of Trustees, which is now controlled by the union
and largest transportation companies. A rotation of employer
representation, to allow for participation by smaller employers, may be
appropriate.
2. Repeal of the Federal Excise Tax and Current Funding Deficiency
Rules is Essential
Under current law, the combination of Federal excise tax penalties
and additional mandated payments under the minimum funding standards
will drive smaller trucking companies out of business within 1 to 2
years. They simply lack the cash to pay an additional 135 percent of
contributions. These rules should be replaced with new reorganization
procedures that apply to any plan that is severely underfunded or at
risk of becoming severely underfunded. A severely underfunded plan
should be defined as one that has a funding ratio of assets to
liabilities of 65 percent. An at-risk plan should be defined as one
with a funding ratio below 80 percent. It is simply imprudent to wait
for a plan to become severely underfunded, or near terminal, before
remedial, reorganization measures are imposed.
While the Alliance members support the general framework of the
legislative proposal made by UPS/Teamsters and the national LTL
carriers, safeguards need to be built into that proposal to protect
smaller employers. Under their proposal, when a plan goes into
reorganization, additional contributions can be imposed on employers up
to 10 percent of the existing contribution rate of the employer. This
10 percent cap remains until the next collective bargaining agreement
is negotiated. At that time, the pension plan will become involved in
the collective bargaining process by submitting schedules to the
parties based on the funding needs of the plans. The pension plan could
submit a schedule that requires a 40 to 100 percent, or more, increase
in pension contributions that a smaller employer cannot afford to pay.
Under their proposal, the employer could be expelled from the plan,
withdrawal liability then would be imposed, forcing bankruptcy upon the
company. This unprecedented delegation of power to the plan to impose
additional contributions needs to be restrained for the good of all
employers. The Alliance members believe that a cap on additional
contributions should be set at 15 percent above the rate under the
prior collective bargaining agreement.
3. Re-establishment of Limitations on Employer Liability
Nothing could be more unfair or more anti-business than a law that
provides that even though you have made all of the pension payments
agreed to with your union, you still can lose all of your company's
assets if a plan becomes underfunded resulting from the actions of
others outside your control. Essentially, the changes made to the
Federal multi-employer pension laws in 1980, made all contributing
employers bear the burden for the pensions of workers who never
performed any jobs for their company and for the pension obligations of
their competitors who have gone out of business. That violates the most
basic American principle, that a person and business should be allowed
to prosper from the fruits of their labor.
The Alliance members believe that Congress should restore the law
in effect prior to 1980 that limited the liability of an employer in an
underfunded plan to 30 percent of the employer's net worth. Ideally,
the concept of joint liability of all employers for plan underfunding
should be repealed. It has only served to deter new employers from
joining these plans and it has not improved the financial condition of
the plans which was the main rationale behind the concept of withdrawal
liability.
Even unions recognize this plight. As stated as early as 1982:
``The International Ladies Garment Workers Union hopes the PBGC will
permit its multi-employer plan to exempt the small entrepreneur who
simply wants to sell his business and retire. `He's tired, he wants to
quit or he has a few bad seasons and feels another bad season would
wipe him out,' observes the union's president, Sol Chaikin. `My own
feeling is that it would be cruel and unusual punishment for our union
pension fund to demand his unfunded liabilities going back 20 years.
That would leave him without a penny. '''
The plans will tell the subcommittee that they generally only
collect 10 percent of the amount owed when an employer withdraws
because few assets are left when an employer ceases operations. The
PBGC has testified that they collect a comparable 10 percent amount
when a single-employer goes into bankruptcy.
Just as the Federal Government has found it intolerable that 90
percent of these costs in single-employer plans are passed on to the
PBGC, the employers in multi-employer plans find it intolerable that
they are made to bear this huge expense. In fact, they can no longer
shoulder this cost. No company should have all it's assets on the line
for an obligation it never made to workers who were never employed by
them. The 30 percent net worth standard needs to be restored by
Congress.
4. Withdrawal Liability Rules Should Be Eliminated Not Made More
Onerous
The current law is extremely onerous on contributing employers to
multi-employer pension plans. First, they are made liable for plan
underfunding that they had no part in the making. Then, they are
required to pay the withdrawal liability assessed by a plan before they
have the right to contest it in arbitration. Moreover, the plan's
determination and calculation of withdrawal liability is presumed
correct until proven otherwise by the employer. It is patently unfair
and contrary to normal rules of American jurisprudence to require
employers to pay this alleged liability before the liability is even
established.
Likewise, the fund can sue all the affiliated companies and
individuals that have majority ownership interest in the participating
company and affiliated companies and seek to make them jointly liable
for the withdrawal liability. All employers would be well served by
repealing these ``pay now and dispute later'' rules and controlled
group liability regulations.
Further, it is wholly inappropriate to tighten the withdrawal
liability rules, as proposed by UPS/Teamsters. No company should be
exposed to withdrawal liability when it uses owner operators,
independent contractors or third party leasing companies to perform
transportation services at its facilities. That is contrary to Federal
labor law and labor policy. It will only harm trucking companies and
their customers. It will provide a basis for these plans to expel
employers and drive them into bankruptcy.
The trucking industry rule should also not be repealed. This rule
is one of the few beneficial exceptions to withdrawal liability that
Congress created in 1980. More trucking employers will only enter these
plans if they have an assurance that they will not be on the hook for
past underfunding. Congress must resist attempts to tighten the noose
of these withdrawal liability rules.
5. Pension Promises Should Be Made Only When They Can Be Paid
In 1992, the PBGC became aware that the alarming rise in pension
plan underfunding was due in part to benefit increases that could not
be sustained by the income to these plans. It is neither fair to the
employers nor to the employees to increase benefit levels that cannot
be sustained by the contributions to the plan and the return on the
investments. Yet that is what has occurred. Consequently, these plans
have had to make recent changes to future benefit accruals and in other
areas permitted under current law.
What is needed is an objective standard that governs future benefit
increases. In the past, bills have been introduced in Congress that
would allow a plan to increase benefits only when it is at least 90
percent funded. Such an approach makes sense and the Alliance members
support it to ensure that future benefits can be paid. Otherwise, they
are only false promises that increase the withdrawal liability of
employers.
6. The Need For A Congressional Study On Long Term Solutions To Plan
Underfunding
While all the above reforms are vital to the short-term viability
of these plans and their contributing employers, there remains a need
for Congress to address the significant past underfunding in these
plans. The Central States plan has $11-15 billion in accumulated
underfunding. Our recommended reforms will prevent this plan from
becoming worse, but it will not solve the ills created in the past.
At best, we project that the plan, which is now about 65 percent
funded, may become 75 percent funded with our suggested changes. The
reason for this modest improvement is that cost of the benefits to the
retirees, who have no contributing employer, is consuming all the
contributions to the plan, a situation that is getting worse each year.
It is unsustainable over the long-term. We believe that an objective
study is necessary to remedy the problem. A Congressional study
commission is an appropriate method to develop meaningful and fair
solutions for employers, retirees and the Government. We therefore ask
that Congress fund such a study and require a report back, with
recommendations, within 1 year.
conclusion
The Alliance members recognize that defined benefit plans, both
single-employer and multi-employer plans, once were the pillars for
creating a sound retirement income for workers in this country. The sad
reality today, however, is that countless numbers of businessmen and
women will not offer them to their workers because of the onerous rules
and liabilities that attach to them under ERISA and MPPAA.
The basic elements of opportunity and incentives are missing from
the equation. Meaningful reforms of the law, as discussed above, can
revitalize these plans. Without change, the plans will continue to
decline in numbers, in financial strength and as retirement vehicles
for workers.
The Alliance sincerely appreciates the opportunity to address this
important issue with the Senate Subcommittee on Retirement Security and
Aging. We will do all we can to assist you in this difficult, but
critical, decision making process. This is the single most important
legislative issue confronting unionized trucking companies. It is not
an overstatement to say change is necessary for the very survival of
the smaller, family-owned, union trucking company members of the
Alliance.
[Editors Note--Due to the high cost of printing, previously
published materials submitted by witnesses are not reprinted. Exhibit 1
can be found in committee files. See prepared statement of Mr. Lynch
for Exhibits 2-8.]
Senator DeWine. Very interesting comments from all of you.
Let me ask the whole panel this question. We have consistently
heard that trustees of multi-employer plans will not produce
information about funded status, projections about shortfalls,
other relevant information that contribute to an employer's
need for planning purposes, and participants really need to be
confident about their retirement plans. How do you respond to
these criticisms about multi-employer plans? Are some plans
more secretive than others, and are they the exception rather
than the rule? Mr. Ward?
Mr. Ward. I can only speak with regard to Central States'
plan, but it is very difficult to get information from them.
Our withdrawal liability for a particular year, for instance,
is not available until around September of the following year,
9 to 10 months after the year is closed. Likewise, finding out
that it is in severe trouble was not information that was
shared until it was almost too late.
Senator DeWine. Mr. Noddle?
Mr. Noddle. Generally almost all the plans are difficult to
get information from, but it is also the timeliness of them. It
takes about a year to 2 years to understand the exact financial
condition of any of the plans, and in this day and age, with
the technology that we have, there is no reason that there
should not be quicker information and more transparency in
these numbers.
Senator DeWine. Mr. Lynch?
Mr. Lynch. In my testimony I indicate that the members of
my association by and large do have trustees on these plans,
and consequently the thought is that they would have more
access to information. The fact of the matter is, that is
marginally true. It is a difficult process, and I agree with
the other witnesses, that in our view it is really an issue of
timing. Waiting for information that is a year and a half old--
and let us face it, if you have good news to report, you are
probably not going to wait until the very last date of the
filing. If you do not have such good news to report, you will.
And typically that results in a situation where some of the
steps that could be taken are perhaps a little too late.
Now, I am a trustee on a plan. In response though on the
other side, from the trustee perspective, I am a trustee on a
plan, and the day I was sworn in, if you will, the first
question I got was, you have your trustee liability insurance
paid up, right? You are constantly reminded by the attorneys in
these plans of your fiduciary responsibilities and the amount
of information, the type of information you are allowed to
discuss, and frankly, not discuss if it has not been publicly
disclosed.
Senator DeWine. Mr. DeFrehn?
Mr. DeFrehn. I guess my experience is a little bit
different than what the others have had. I have had extensive
experience with dozens if not hundreds of plans over the years,
and the simple fact of the matter is that the timing on
releasing of information, particularly withdrawal liability, is
in part a function of the way that the code is designed and the
information that has to go into the complex calculations that
take place.
On the other hand, for the most part, I think that you will
find that the willingness of most plans to share information
that is available is fairly high. There are notable exceptions
to that. One thing that should be noted by the committee is
that in last year's Pension Funding Equity Act, there were
significant disclosure requirements added that will become
effective at the beginning of next year, and I think that a
large part of the concerns of most contributing will in fact be
remedied because it requires additional information on current
financial status to be provided to them as well as participants
and the sponsoring unions.
Senator DeWine. Mr. DeFrehn, let me ask you another
question. What actions have been taken to stabilize their
funding?
Mr. DeFrehn. The funding of?
Senator DeWine. Multi-employer plans.
Mr. DeFrehn. If you look back over the years, I guess I try
to take a historical perspective on withdrawal liability. I
would agree with the comments that everyone has made here, that
it is both a good thing and a bad thing, and I think both
parties look at it that way. In some ways it has created
financial burdens for smaller employers, as it has for larger
employers, and there is certainly, room for improvement there.
On the other hand the fact that there is withdrawal
liability, unfunded liabilities, has caused the trustees of the
plans to adopt more conservative funding policies over the
years, and if you look back to the funding levels of most
plans, most multi-employer plans, it was quite high. In 1999
the average funded position of multi-employer plans was 97
percent. In fact, it caused--the funding level of those plans
caused plans to have to adopt benefit improvements they would
not otherwise have in order to protect contributions to the
deductibility of contributions made by contributing employers.
So the problem is simply that there is a disconnect here
between the funding levels, the reliance of mature funds on
investment income, and what has happened over the last 3 years
in particular.
Senator DeWine. Senator Mikulski?
Senator Mikulski. Thank you very much, Mr. Chairman. First
of all, thank you for this selection of witnesses. I think we
have covered quite a broad base. Mr. Noddle, my father was a
small grocer. He was a member of the Independent Grocers
Association before the family closed its business in the late
1970s. So we have an understanding. I think what has been
instructive for me is how many different plans many of you have
to be members of, and, Mr. Ward, you have your own challenges
as a small business, and just complying with this must be
really a challenge. And for the men in the freight forwarding
business, you got rising gasoline prices, you got rising
pension costs, you got rising heartburn.
[Laughter.]
I see certain consensus emerging: No. 1, more transparency
in the process; No. 2, the right to know in a timely way; No.
3, some type of risk assessment because one size does not fit
all, and really a prevention mechanism so there is the Green
Zone, regardless of how you parse it, Mr. Noddle, you have one
viewpoint, Mr. Lynch, you have another, but by and large you
are talking about an early warning system; and then a rating of
the Green Zone, Yellow Zone and Red Zone. Would you say that
those are the four or five items on which there is a consensus
around which we could begin to build some of the first--kind of
first tier reforms. Mr. Lynch, would you say that is the
consensus?
Mr. Lynch. I would agree. I would add maybe one other one,
and that is the requirement that plans really do develop a
funding plan for the next 10 years to show improvement in the
funded status of the plan. It would almost seem, why do we have
to have a law to do that? But in many cases, until a plan hits
a severe funding problem, there is really no requirement for
that so----
Senator Mikulski. Is that in the reforms that have been
recommended through the various----
Mr. Lynch [continuing]. Yes, they are.
Senator Mikulski. --things that I have read, the so-called
10 year amortizing?
Mr. Lynch. That is another issue, but a 10 year plan that
shows an improvement in the funded status of the plan.
Senator Mikulski. Mr. Noddle, Mr. Ward, were those the
consensus items, or did you have another item to either
disagree--we welcome any disagreement.
Mr. Noddle. I would just offer two things, Senator. First
of all, yes, I think those are the basic pillars of a very
cooperative agreement that most parties I think would adhere
to. The thing we feel very strongly about is that there should
be certain measurable, quantifiable benchmarks along the way,
and that should be a component of it. If it is left to judgment
at times the outcome might not be strong.
Senator Mikulski. You mean real criteria for Green, Yellow;
is that what you are talking about?
Mr. Noddle. Yes, and within those also very clear
benchmarks within those zones. The other concern that we have
is that in the Yellow Zone, we think a lot of the plans, a lot
of the ideas that are being focused on the red areas or those
under 65 percent. What we were trying to focus on in those
plans in the 65 to 80, not that the under 65 does not need a
lot of attention here, but we want to get ahead of this. We do
not want these to become--once you are faced with a crisis it
is almost too late.
Senator Mikulski. Yeah. So you get late information, which
means that they have been in the Red Zone or Yellow going to
Red, but you are waiting 18 months for dated information, which
you know because it is dated and not good. Then you are really
into a bailout. And then the good-guy employers, from what you
are saying, are left holding the bag for everybody else. And so
who in the heck wants to get into this. I mean is that it in a
nutshell?
Mr. Noddle. Yes, it is. And within the plan, if you are in
a Yellow Zone plan and you create a plan over a long period of
time, you would have benchmarks within that plan that both
labor and employers would understand what those benchmarks are,
and so that the collective bargaining process then could go
forward knowing what those benchmarks are.
Senator Mikulski. And everybody, including as the union or
the employer comes to the table, you would then have accurate
information so you know that when you are bargaining what
essentially the situation is, the adequate. What is the fiscal
situation? In other words, you can bargain for a pension of
$50,000 a year, but if there is only a pension funding for 38--
--
Mr. Noddle. Senator, there should be no debate over what
the numbers are. The debate should be over how to solve the
problem.
Senator Mikulski [continuing]. That is exactly right.
Mr. Noddle. Not what the numbers are.
Senator Mikulski. Right.
Mr. Ward? Is that, remember what I said, transparency,
early warning system, the right to know information in a timely
way, and precise, and then some type of rating system.
Mr. Ward. Yes, I would agree completely with that. I would
maybe add to that the deficiency, funding deficiency penalties
and payments that kick in at----
Senator Mikulski. That excise tax issue you raised?
Mr. Ward [continuing]. Yes. I think we would all agree that
we also have to deal with that. In fact, Congress did deal with
that temporarily a couple of years ago, so that is one----
Senator Mikulski. And that is one of the issues where you
are doubly penalized, so therefore if you have already gone
Yellow to Red or you are trying to get out of Red, if you
trigger these taxes it keeps you further in the hole, am I
correct?
Mr. Ward [continuing]. In fact, they are so onerous that
they would bankrupt our company in a short period of time, so
yes.
Senator Mikulski. My time is up, and the chairman of the
full committee is here. In my second round I am going to ask
how many Government agencies do you have to deal with in
compliance, and does that make any sense, or is that another
reform?
Mr. Ward. Thank you.
Senator DeWine. Chairman Enzi.
The Chairman. Thank you, Mr. Chairman. I want to
congratulate you and the ranking member on your dedication and
diligence and understanding of this issue and the work that you
are doing on it. Our charge was quite limited, but obviously
needs to be expanded to take care of a number of the problems
that we have in these areas, and congratulate you on the
witnesses that we have today.
[The prepared statement of Senator Enzi follows:]
Prepared Statement of Senator Enzi
Today's hearing will focus on two key issues in the defined
benefit world that are crying out for reform: hybrid single-
employer plans and multi-employer pension plans. I think it is
safe to say that every member of this subcommittee, and every
member of the full Health, Education, Labor, and Pensions
Committee is committed to the stability and strength of the
defined benefit system. Today we will look at ways to promote
stability and strength for hybrid and multi-employer pension
plans.
In the view of many, hybrid pension plans, such as cash
balance and pension-equity plans, are the last best hope for
preserving the single-employer defined benefit system. Quite
frankly, defined benefit plans are in competition with defined
contribution plans. The lower costs, risks, and frustrations
that are presented by 401(k) plans have contributed to the
accelerating decline in the number of traditional pension
plans. Hybrid plans were devised as an alternative to outright
termination of a traditional pension plan followed by a switch
to a defined contribution plan. Hybrid plans provide
portability to workers who change jobs while retaining the risk
of investment declines on the employer.
The legal status of hybrid plans has been called into
question in recent years. The principal criticism of hybrid
plans is that they ``cut benefits'' of older workers. That
allegation is incorrect. As we all know, a cut-back of vested
benefits is specifically prohibited under section 411 (d)(6) of
the Internal Revenue Code. The penalty for cutting back an
accrued vested benefit is plan disqualification. At this
hearing we will hear arguments from the AARP that these plans
are age discriminatory, and we will hear from two other
witnesses why they think they are not. The witnesses will tell
us what reforms are advisable and necessary to clear up this
issue.
We will also hear of the financial crisis facing some of
the multi-employer plans. Multi-employer pension plans provide
essential retirement security to 9 million workers, yet there
is much we do not know about these plans. Both labor and
management are coming to Congress seeking reforms to the
current system to empower them to get the financial affairs of
their plans in order. Billions of dollars are at stake and the
survival of hundreds of small and medium-sized companies may be
in doubt, depending on the decisions Congress makes. It is
essential that we understand the causes and scope of the
problem and ensure that we have the information and
transparency to prevent such crises from sneaking up on us in
the future.
I am pleased with the many bi-partisan discussions that
Senators and their staffs have been having in the last 3 months
over the details of comprehensive reform of the single-employer
defined benefit system. I fully anticipate that the HELP
Committee will be able to produce a bill this summer before the
August recess. The issues raised today, assuming consensus can
be reached, may also be included in the package of reforms that
goes to the Senate floor.
Senator Enzi. I will get into some fairly specific
questions.
Mr. Lynch, in testifying before a House subcommittee last
year, you stated that serious consideration should be given to
whether additional procedural or legal controls over the
management of the plans could prevent serious funding issues.
Something as simple as imposing funding policy guidelines that
mandate clear targets for the plan's unfunded liability. Your
suggestion of imposing funding policy guidelines caught my eye.
I realize that your coalition has rejected the benchmarks for
the Yellow Zone, but are those benchmarks not the equivalent of
imposing funding policy guidelines that you advocated last
year?
Mr. Lynch. Yes.
[Laughter.]
Mr. Lynch. I guess the easiest way to explain this from our
vantage point is there is clearly a need to have not just
simply: we hope you are going to do a better job on the one
hand. On the other hand we cannot have criteria that is so
stringent that the plans and the trustees simply cannot meet
them, or in order to meet them there would have to be such
draconian increases in employer contributions, where you would
get back to putting in jeopardy a lot of the smaller
contributing employers.
So we are walking a somewhat careful line here. I think it
is hard to argue against, and I certainly testified in favor of
just such a plan. But that plan cannot be so stringent as to
strangle these plans before they have an opportunity to
actually get back on sound financial footing.
The Chairman. Thank you.
Mr. DeFrehn, your Red Zone proposal mandates a minimum
participation accrual rate of 1 percent. That puts a floor on
how much the trustees can cut benefits even temporarily. I note
that another witness is asking for a ceiling on contribution
increases, at least for small businesses. How can the plans
ever get out of financial trouble if Congress takes options off
the table?
Mr. DeFrehn. One of the concerns of the coalition and of
the multi-employer community generally, is that by eliminating
future accruals all together, the active employees who actually
fund these plans from the deferral of their wages as a
collective bargaining agreement is reached, there is a wage
package that is settled upon. The parties then discuss how that
wage package gets allocated. A portion of it may go to health
benefits, a portion to pensions and some into the wages. If you
get to the point where the future accrual for active employees
is eliminated all together, you eliminate the incentive for
them to want to have a portion of their wages go into a plan
for which they get no future benefits. So we believe strongly
that it is important to not take the entire benefit away and
that there should be a floor on that.
With respect to Mr. Ward's comments about the cap on
withdrawal liability, that is an issue that affects plan--
participating employers who leave the plan at a time when there
are unfunded liabilities. And unfortunately, withdrawal
liability creates no winners. But someone has to pay for those
benefits. It is either going to be the employer who made the
promises in the first place in agreeing to participate in the
plan, or it is going to be the participant through reduced
benefits, or it is going to be the PBGC, and I believe at this
point the PBGC is off the table, and the participants, while
our proposal suggests that perhaps some ancillary benefits
could be reduced when the plan is facing imminent danger, we do
not believe that benefits should be invaded at a point where
the plans are relatively healthy.
The Chairman. Have you done any economic modeling on the
FMI Yellow Zone proposal?
Mr. DeFrehn. Yes, we have. Two plans, I can give you some
examples. One----
The Chairman. Would you mind sharing that with the
committee?
Mr. DeFrehn [continuing]. Sure.
The Chairman. Because then we can get into more detail than
we could through an answer here.
Mr. DeFrehn. Certainly we can get you the details.
The Chairman. Thank you.
Mr. DeFrehn. Sure.
The Chairman. Mr. Noddle, what is your concern if only the
Red Zone provisions were to be enacted?
Mr. Noddle. Well, Senator the way we look at it, the Red
Zone is a crisis situation and it has to be managed as a
crisis. The Yellow Zone is a pending, looming problem that if
not addressed will become a Red Zone crisis. So simply I cannot
think of any reason why we would not want to get more
transparency, more early warning into these plans, have a look
into these plans to see so that the trustees and the collective
bargaining process can sit down, not debate over what the
numbers might or might not be, and say, we have a long-term
problem here. How do we protect the retirement benefits for the
people that we have promised them to? So let us do this over a
longer period of time.
That to me is just prudent. We do that in every other part
of our business every single day in trying to anticipate what
the future is going to be, how do we fund it, how do we react
to it? I do not know why this would be any different.
The Chairman. Thank you. My time has expired.
Senator DeWine. Senator Isakson?
Senator Isakson. Let me take a pass for now.
Senator DeWine. Sure, sure.
Barbara?
Senator Mikulski. I will pick up on that question I said I
wanted to ask, and start with you, Mr. DeFrehn. When I asked
for the consensus, I am sorry, I advertently overlooked getting
your opinion, and share it. Here is my question, what are the
agencies involved that you all face in compliance? Do you have
essentially a one-stop shop? Are you dealing with a
multiplicity of agencies? Which takes us to the compliance.
Then what are the agencies, or are these agencies involved in
helping with this so-called warning system and the enforcement
of this? And what recommendations do you have and what
generally has been the cost of your compliance? I mean those
are fairly meaty, but it sounds like while you are trying to
run a business, be a labor union and bargain in good faith for
both your workers, but understanding you need a solvent company
to be able to work for one, it just seems to be layers and
layers of complexity, where you all cannot get what you need to
do the job, and then I have a feeling you are dealing with
about three different agencies within the Government.
By the way, I want to thank you for two things. One,
testifying today, but not dumping, not dumping the problem on
us, telling us to come up with the solutions. Obviously, you
have done a tremendous amount of work on coming up with
viewpoints, even if they disagree, there is consensus, and also
for not dumping the liability. So we appreciate this, and
therefore I'm going to have this partnership.
Mr. DeFrehn, could you help me with these issues related to
Government and governance?
Mr. DeFrehn. Sure. The three Government agencies that we
work with most are the Department of Labor, the Internal
Revenue Service and the Pension Benefit Guaranty Corporation.
I think your assessment of how complex and multilayered the
process is is accurate. Unfortunately, it is not terribly
responsive to the kinds of problems that we address and I
mentioned in my oral testimony about making sure that plans
that are subject to circumstances beyond their control be able
to take advantage of the relief mechanisms that the law
provides. Certainly over the past several years, the Internal
Revenue Service in particular has been deficient in terms of
its ability to respond to requests from plans that are facing
funding deficiencies through the existing remedies under
Section 412(e) of the code. There are at the present time about
30 applications, some of which have been sitting there for as
long as 2 years.
Senator Mikulski. Wow.
Mr. DeFrehn. And the Agency has not taken action on those
applications. So that the parties, the contributing parties
have an idea as to whether they actually do have a funding
deficiency or not. Those are applications that would permit the
plans to have an extended amortization period for their
liabilities.
Senator Mikulski. Mr. Lynch? We could just go down.
Mr. Lynch. There is not a lot to add except that when, as
members of the committee know, when we were working on that
short-term relief bill 2 years ago, a 1\1/2\ ago, there was a
fairly strong focus on the single-employer problem and the
interest rate issue. We were generally viewed as the skunk at
the picnic I guess coming along.
Part of the difficulty we have with some of these agencies
is I think the plans have by and large worked very well, and so
there has not been a lot of attention paid to them, and
consequently, I think there was a certain reluctance on the
part of some of these agencies to really step forward and say,
this is what we think needs to be done to address the problems
of multi-employer plans.
So as a corporate representative, and I am generally loathe
to be suggesting more Government involvement, but I do think it
would be useful for agencies like the PBGC--and I know they
have created a new department over there, a reorganization, and
the new department to look at the multi-employer issues. But I
think that is very important, that they get a better handle on
what the issues are.
Senator Mikulski. One of the things that I would hope, and
then there would be a follow-up conversation after this hearing
is, do we need one agency that is the primary one-stop shop?
No. 2, is the pension guaranty really coming in when people
have been not only in the Red Zone but it is when Red Zones are
almost irredeemable and on the verge of us assuming liability?
And then what is the role of Department of Labor in this? Mr.
Noddle, do you have comments?
Mr. Noddle. The only one, Senator, that I would add that
has not been mentioned is that as a public company that we have
to deal with is the whole area of finance, the GAAP accounting
and FASB and that is a whole other arena which we have to
assess our liabilities----
Senator Mikulski. Senator Enzi's area as Mr. Accountant
here.
Mr. Noddle [continuing]. And they may not always be in sync
also with the way certainly the plans or trustees look at
things. So the only thing that has not been mentioned that I
would add is that.
Senator Mikulski. So we have at least some policy
recommendations that are at least the beginning of a consensus.
Then we get into both compliance and enforcement, in which they
should be a tool to resolving the problem before there is
bankruptcy and insolvency, or essentially the dumping of the
liability onto the pension guaranty. You see what I am trying
to get at? Good policies and then a way where good guys who
want to participate, good-guy companies that feel the
Government is on their side, not just triggering excise taxes
and forcing small businesses like you, Mr. Ward, into
bankruptcy.
Do you have any thoughts on this? Because you are a family-
owned business, and very sympathetic to this.
Mr. Ward. Thank you very much. I could not add much at all
to how you have described the complexity in dealing with
various Government agencies and I do like the idea of a single
point of reference, so to speak, that we could go to in dealing
with these kinds of issues, and particularly gain some help.
But if I could give you some perspective as a small
employer on this particular mess that we are in right now, and
the thing that concerns me is I look--I probably do not look at
it like they do, at the level of detail. I run a small
business. I am trying to grow a small business. I am doing it
with union employees. There is a lot of pride involved in that
aspect of what we are doing. We are one of the last of the
Mohicans really in terms of small union carriers that are
growing. Mind you though, where is the incentive, when on paper
our withdrawal liability exceeds the entire net worth of our
company? From a business case standpoint, there is no business
case. Without pride, this business should be shut down.
If there is some opportunity though at some point to limit
the amount of withdrawal that exists out there, I believe at
least the current carriers that are there would find incentive
to continue to operate and continue to push forward.
Senator Mikulski. So that is the incentive thing to keep
people engaged in this multi-employer.
Mr. Ward. Without it, put yourself outside the fund as an
employer that the union would maybe organize, and they would
bring you to the table and ask you, ``Would you like to
participate in this multi-employer fund?'' Never in a million
years would you do it. You would take your nonunion company
down through a strike if need be to avoid the withdrawal
liability. There is absolutely no way any new employer is going
to come into this fund because of that disincentive that exists
out there. And it exists as a current employer, and I believe
that is why you do not see more people like me growing union
businesses.
Senator Mikulski. Thank you. I appreciate that.
Thank you.
Senator DeWine. Senator Enzi?
The Chairman. I would defer to Senator Isakson.
Senator DeWine. Senator Isakson?
Senator Isakson. I do have one question, and I apologize
for being late, I have just come from an hour of the Finance
Committee hearing on single-employer pension benefit programs.
This is a very complex issue, but I would like to hear each
one of you discuss one aspect. There are two schools of
thought. One school of thought is to extend the amortization of
liability to give companies in trouble a chance to have the
best of both worlds, and that is not be forced into bankruptcy
and still be able to meet their liability without the liability
of the fund going into pension benefit guaranty.
The other is the short window recovery, meaning if you have
an unfunded liability of $9 million, it is 3 million over 3
years to make it whole, whereas the more liberal approach might
be to let you amortize that over a longer period of time. I
think I heard Mr. Lynch say--and it may have been Mr. DeFrehn,
I am not sure--about the threat if you had this short-term
window, required cash contribution, of how many companies it
would force into bankruptcy, that is similar to exactly what
the aviation industry faces today on the single-employer plans.
If you all could just help me for 1 minute, and you
probably already addressed all of this, but just give me your
response to that, what you think is preferential, I would like
to hear it.
Mr. DeFrehn. Amortization extensions can help, and actually
we are a part of the proposal that was offered in the earlier
versions of the Pension Funding Equity Act last year for plans.
The key though is that the extension be tied to a
reasonable interest rate, and that seems to be part of the
problem that the IRS has with acting on the 412(e)
applications. I guess that is my only comment on that.
Mr. Lynch. I think the challenge there is that you want
short-term remedies to address short-term unexpected problems,
market downturns, unexpected downturns. What you do not want
are remedies that mask what is a much deeper problem and I
think that is what we all have to wrestle with.
Central States, large pension fund, Central States cut
their accrual rate from 2 percent down to 1 percent, but they
amortized that change over 30 years. It is going to take them a
long time to get the benefit in terms of all the actuarial
calculations of that change, and we would like to see those
things, not only the cuts, but also any improvements to be
amortized over a shorter period of time, and we think that
makes a lot of sense.
Mr. Noddle. There is no simple solution, one single
resolution that is going to solve this problem. These are long-
term plans with long-term funding, and in order to solve this
problem we have to look at it over longer perspective, and not
everybody is going to retire tomorrow anyway.
You know, one thing that has not been mentioned that I am
sure that you realize, that I did not realize, frankly, till I
got deeper into this issue, in the year 1999 and 2000, for
example, funds were required to increase their benefits because
their investment returns were high enough that there was an
overfunding status in these plans. The way the regulations are
written, if you do not increase your benefits, you lose your
tax deductibility for the money you put in because you are
overfunded. Rather than putting that money away for a rainy
day, the plans and the trustees were forced to increase
benefits. These are the kinds of things I think that we have
that we have to clean up in these plans. And it takes a long-
term view of the plans to resolve all those things.
Thank you.
Senator Isakson. Thank you.
Mr. Ward. Senator, I do not think I could add much to that.
I would just say that we focus mostly on the plan that Mr.
Lynch represents, the proposals that he has made. With regard
to those issues, I think we are very much in acceptance of
those.
Senator Isakson. Thank you.
Thank you, Mr. Chairman.
Senator DeWine. Senator Enzi?
The Chairman. I have a couple more questions here to get an
understanding. Mr. Noddle, when you go into collective
bargaining on one of these plans, do you bargain for benefits
or for contributions? How do you know if the benefit you agreed
to will cover the benefits that the trustees have promised? Why
are the contributing employers on the hook for promised
benefits if they did not promise benefits?
Mr. Noddle. We do not bargain for and negotiate for
benefits. We negotiate for funding levels, and this is what
comes into the transparency issue and the lack of timely
information. If all the information was clearly available on a
timely basis to all parties, then the collective bargaining
process goes forward in a much more quality way in terms of
dealing with this thing.
We negotiate funding levels, and then the trustees make
decisions on what kind of benefit levels there will be. That is
why the transparency issue and the early warning are so
critical to this, so that we can sit down at the table,
intelligent on both sides of the table, no dispute over what
the numbers say, and one expert says one thing and another
expert says another thing. We should have a common information
transparency, and we say: Here is our collective problem; how
do we solve this? And we are going to get such higher quality
resolutions to our agreements if we are able to do that.
The Chairman. Thank you.
Mr. Ward, along that same line of timely and accurate
information, in your written statement you wrote: the financial
condition of the Central States plan has been a guarded secret
with only the union and four major transportation companies
privy to the most up to date information.
What information have you sought in the past that you did
not get, or that you did not get in a timely fashion? What
additional information do you need? Do you ask for information
other than the estimated withdrawal liability?
Mr. Ward. What we would like to receive would be more
timely information with regard to the condition of the plan
itself, and we do not get that information. Granted, we do not
ask, but it has never been available to use. We see it really
at the end of 9 months after the end of the particular period
in a report through our request for withdrawal liability, just
so that we know where that stands at that point.
The Chairman. I understand that your withdrawal liability
increased in recent years from 2-3/10 million to 20 million; is
that due entirely to the increased employment of teamster
members, or was it the decline of the financial condition of
the plan or other withdrawals from the Central States plan?
Mr. Ward. All of the above. We grew our employment from the
low 200s number of Teamsters that we employed to 294. We are
over 300 today. And calculating withdrawal, they take your
contributions over the last 10 years, factor that into the
unfunded vested benefit that exists out there, essentially what
the liability is, and we have a pro rata share. And with all
the carriers that have exited, all the companies that have
exited the multi-employer plan, it has just compounded that
problem significantly. Add to that, obviously, some of the
market conditions prior, but we would suggest that we have been
pointing to these issues as far back as MEPA has been in
existence, back until 1980.
As Mr. Noddle has suggested, we do not negotiate the
benefits. It is very frustrating for us to see a withdrawal
liability continue to exist and grow as we grow our business,
yet have no say in the setting of those benefits, or for that
matter, who sits on the trustee panel.
The Chairman. Thank you very much. I know we have another
panel that we have to get to.
Senator DeWine. I want to thank all of you very much. We
could go on. We appreciate it. It has been very, very helpful.
We could go on for a couple hours, I think, but you have all
been very helpful. I think it has been an excellent panel, so
thank you very much.
Senator Mikulski. Mr. Chairman, I concur, and I would
welcome the ideas, first of all, additional policy issues
raised by the chairman and Mr. Enzi, and I would also like
thoughts on governance issues, and help getting some breathing
room because the compliance costs must be significant and
confusing. Thank you.
Senator DeWine. We would ask the second panel to come up.
They have already been introduced. At this point, I will turn
the gavel over to the chairman of the full committee, Chairman
Enzi.
The Chairman. [Presiding] We will go ahead with the next
panel then, and appreciate again the participation of everyone.
Mr. Sweetnam?
STATEMENTS OF WILLIAM F. SWEETNAM, JR., ATTORNEY, THE GROOM LAW
GROUP, PRESENTING THE TESTIMONY OF JAMES M. DELAPLANE, JR., ON
BEHALF OF THE AMERICAN BENEFITS COUNCIL, WASHINGTON, DC; ELLEN
COLLIER, DIRECTOR OF BENEFITS, EATON CORPORATION, CLEVELAND,
OH, ON BEHALF OF THE COALITION TO PRESERVE THE DEFINED BENEFIT
SYSTEM; AND DAVID CERTNER, DIRECTOR, FEDERAL AFFAIRS, AARP,
WASHINGTON, DC.
Mr. Sweetnam. Mr. Chairman, Ranking Member Mikulski, I
appreciate the opportunity to appear today, taking the place of
James Delaplane.
The Chairman. Could we ask that as you are leaving that you
leave quietly?
Sorry to interrupt.
Mr. Sweetnam. That is quite all right. I am a partner at
the Groom Law Group, and I am appearing here on behalf of the
American Benefits Council. The Council is an organization
representing Fortune 500 employers and other entities that
assist employers in providing benefits to employees. Many of
our members sponsor cash balance or other hybrid defined
benefit plans.
In our written statement we describe the current legal
uncertainty regarding hybrid plans, and provide recommendations
to resolve it. But rather than summarize my statement, let me
outline a number of significant issues that are pressed upon a
chief executive as a result of this legal uncertainty and the
negative effects that could well flow from the lack of a clear
set of rules.
Under the current pension environment chief executives are
finding it difficult to justify a defined benefit plan. These
companies voluntarily sponsor a defined benefit plan even
though many of their competitors do not. These plans provide
valuable benefits to participants and their families and
relieve pressure on Government programs. Companies fund their
plans through employer contributions. They bear the investment
risk and pay premiums to the PBGC to finance insurance
guarantees. In fact, over 20 percent of the premiums come as a
result of coverage under hybrid plans. Many American companies
have restructured their businesses in order to stay competitive
in the world marketplace.
The workforce likewise has changed. There are fewer
employees who spend their entire career with one employer, more
mid-career hires, and there is fierce recruitment competition
for talented individuals. In analyzing these developments, many
companies have found that a traditional defined benefit plan
does not deliver meaningful benefits to this new workforce.
Many companies have also found that a majority of the total
pension benefits were going to a small share of workers who
stayed for a full career. In addition, many companies
discovered that they were inappropriately encouraging their
employees to retire early and go work for competitors. As part
of this analysis, many companies have looked to cash balance
and other hybrid plans to meet their needs and the needs of
their new workforce. A hybrid plan will deliver benefits more
equitably to workers of all tenures, and offer the portability
and transparency that employees say that they want.
It is worth noting that the vast majority of participants
fare better under a hybrid plan then under a traditional
defined benefit plan. In response to this analysis many
companies have realized the benefits a hybrid plan can provide
to both employees and to the employer's ability to compete, and
as a result, a number of employers have converted their
traditional defined benefit plan into a hybrid plan. Many such
conversions grandfather a significant group of older workers in
the prior plan. Many also make ongoing contributions to
employees cash balance accounts that increase with age and
service. Many conversions were well received by their
employees, and new employees can now see the defined benefit
plan as a plus, especially after they receive their annual
pension statement.
So is this a positive story about how our voluntary pension
system evolves to meet changing employer and employee needs?
One would think so, but unfortunately, the story does not end
there. Despite significant legal authority to the contrary, a
single Federal judge has ruled that the basic cash balance
design violates the Pension Age Discrimination statute.
Incredibly, he ruled that compound interest in a defined
benefit plan is discriminatory. Under this theory each of the
1,200 hybrid plans in this country is illegal. Under this
decision a cash balance plan is illegal regardless of whether
the cash balance plan is a new plan or whether there was
significant grandfathering of old benefits.
So what are the questions that many CEOs are facing in
light of this decision? Well, the damages in these age
discrimination lawsuits can be enormous, and several other
companies already face copycat suits. The fact that a company
grandfathered its older workers or increased cash balance
contributions as workers age does not matter in these suits.
Nor does it matter that employees are happy, since the basic
design of the plan and not the conversion has been challenged.
It only takes one employee to file suit. So companies that
provide a pension benefit that is designed to provide benefits
to a wide range of employees find themselves in legal limbo
with potentially devastating legal liabilities.
Another concern is on the impact on the company's balance
sheet. Given the size of these damage awards, a company's
auditors are concerned about this potential liability.
Another factor that raises the concerns of many CEOs is
that Congress has prevented the regulatory agencies from
addressing the age discrimination issue and is now considering
legislation that would, for the first time, grant employees a
legal entitlement to future retirement benefits not yet earned.
With these concerns, many CEOs are thinking, why not just
have a 401(k) plan like many of my competitors? As an interim
step, some companies have decided to freeze their cash balance
plan or not let any new employees participate in the plan.
Mr. Chairman and the members of this committee, as
policymakers dedicated to the retirement security of American
families, I cannot imagine this is the story you want
unfolding. Yet this is reality. A recent survey indicates that
41 percent of hybrid plan sponsors will freeze their benefits
within a year absent legal certainty.
So it is within your power to change this story. First make
it clear that the basic hybrid plan designs do not violate age
discrimination rules. Second, provide legal certainty for
employers that have converted to hybrid plans in good faith.
And third, reject mandates for future conversions that will
discourage employers from making new benefit commitments.
Thank you and I will be happy to answer questions.
The Chairman. Thank you.
[The prepared statement of Mr. Delaplane follows:]
Prepared Statement of James M. Delaplane, Jr.
Chairman DeWine, Senator Mikulski, thank you very much for the
opportunity to appear before you today. My name is James Delaplane, and
I am a partner with the law firm of Davis and Harman LLP. I serve as
Special Counsel to the American Benefits Council (Council), and I am
appearing today on the Council's behalf. The Council is a public policy
organization representing principally Fortune 500 companies and other
organizations that assist employers of all sizes in providing benefits
to employees. Collectively, the Council's members either sponsor
directly or provide services to retirement and health plans covering
more than 100 million Americans.
The Council is very pleased, Mr. Chairman, that you have called
this hearing to examine the important policy issues involving hybrid
defined benefit plans. Many of our members sponsor cash balance and
pension equity plans, and the Council believes that the legal
uncertainty currently enveloping these hybrid defined benefit plans is
one of the most significant and pressing retirement policy issues
presently before Congress. Congressional action to provide legislative
clarity and certainty for hybrid plans is urgently needed to prevent
(1) the demise of these plans, (2) the resulting exit from the defined
benefit system by a large number of American employers, and (3) the
harm to the retirement income prospects of millions of American
families that will unquestionably result.
Mr. Chairman, we believe it is absolutely critical that the effort
to craft hybrid legislation be led by the congressional committees of
jurisdiction and we thank you for spearheading this effort. As you are
well aware, pension policy is a notoriously complex and technical area,
one in which it is easy to produce unintended results, such as
disincentives for employers to remain in our voluntary pension system.
The legislative process works best when those who are most
knowledgeable about an area are the ones to tackle the complex issues.
We applaud your commitment to avoid what has sometimes occurred in the
past with respect to hybrid plans--haphazard and incomplete debate
pursued outside of the committees of jurisdiction and as part of the
appropriations process.
In my testimony today, I hope to convey the value of the defined
benefit system and hybrid plans specifically for millions of Americans
and their families. I will describe the current legal and regulatory
landscape that is endangering the continued existence of hybrid plans,
and set forth why the Council and its members believe congressional
action is urgently needed to prevent the extinction of these retirement
programs. Lastly, I will describe the Council's recommendations for
resolving this hybrid pension crisis.
THE VALUE OF THE DEFINED BENEFIT SYSTEM
The defined benefit pension system helps millions of Americans
achieve retirement security. It does this by providing employer-funded
retirement income that is guaranteed to last a lifetime. Employees are
not typically required to make any contributions toward their benefits
in these plans and the assets of the plan are managed by investment
professionals. Employers, rather than employees, bear the investment
risk of ensuring that plan assets are sufficient to pay promised
benefits. And insurance from the Pension Benefit Guaranty Corporation
means employees' retirement benefits are largely guaranteed even if the
plan or the employer's business experiences financial trouble.
As of 1999 (the most recent year for which official Department of
Labor statistics have been published), nearly 19 million retirees were
receiving benefits from defined benefit plans, with over $119 billion
in benefits paid out in that year alone.\1\ Given that America's
personal savings rate remains one of the lowest among industrialized
Nations \2\ and that average balances in 401(k) plans are quite modest,
\3\ there is no doubt that in the absence of defined benefit pensions
fewer Americans would be financially prepared for retirement.
Furthermore, the absence of defined benefit pensions would result in
increased strain on Federal entitlement and income support programs,
not to mention an increase in the number of American seniors living in
poverty.
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\1\ U.S. Census Bureau, Statistical Abstract of the United States:
2004-2005, Chart No. 532 (Source: U.S. Department of Labor, Pension and
Welfare Benefits Administration, Private Pension Plan Bulletin, winter
2003, and unpublished data).
\2\ The Organization for Economic Cooperation and Development, Main
Economic Indicators (Paris: OECD, January 2004).
\3\ In fact, data from the Employee Benefit Research Institute
shows that in 2002 the average 401(k) account balance for workers age
21 to 64 was only $33,647 and the median (mid-point) 401(k) account
balance was a mere $14,000. EBRI Notes, Vol. 26 No. 1, (January 2005).
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Given these statistics, the value of defined benefit plans to many
American families is undeniable. Yet we have seen an alarming decline
in defined benefit plan sponsorship \4\ and today is a particularly
precarious time for the defined benefit system. Employers are
increasingly exiting the defined benefit system for a variety of
reasons, including uncertainty about how future pension liabilities
will be measured, a flawed pension funding regime marked by complexity
and volatility, the prospect of new and more onerous pension funding
and premium requirements, potential changes to the rules governing
pension accounting, and, most relevant for our discussion today, legal
uncertainty surrounding hybrid defined benefit plans.\5\ Objective
observers agree that policymakers must take action to address these
threats or defined benefit plans and the income they provide to
American retirees will become increasingly scarce.\6\
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\4\ The total number of PBGC-insured defined benefit plans has
decreased from a high of more than 114,000 in 1985 to 31,238 in 2004.
PBGC Pension Insurance Data Book 2004, 56 & 87. This downward trend
becomes even more sobering if you look at just the past several years.
Not taking into account pension plan freezes (which are also on the
rise but not officially tracked by the Government), the PBGC reported
that the number of defined benefit plans it insures has decreased by
8,000 (or 21 percent) in just the last 5 years. Id.
\5\ The Council last year released a white paper discussing in
detail the multiple threats to the defined benefit system, along with
recommendations for ensuring that defined benefit pension plans remain
a viable retirement plan design. See American Benefits Council,
Pensions at the Precipice: The Multiple Threats Facing our Nation's
Defined Benefit Pension System (May 2004), available at http://
www.americanbenefitscouncil.org/documents/definedbenefits paper.pdf.
\6\ ``Policymakers should take action sooner rather than later in
order to create greater regulatory certainty for plan sponsors.
Decisions are needed on the status of cash balance pension plans,
permanent funding rules, and interest rates to be used in plan
calculations, accounting treatment related to using smoothing versus
mark-to-market for investment returns and interest rates, and rules and
premiums under Title IV of ERISA and the Pension Benefit Guaranty
Corporation. Until these kinds of policy decisions are made, further
erosion of the defined benefit system can be expected to continue.''
Jack VanDerhei and Craig Copeland, Employee Benefit Research Institute,
ERISA At 30: The Decline of Private-Sector Defined Benefit Promises and
Annuity Payments? What Will It Mean?, Issue Brief No. 269 (May 2004).
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Mr. Chairman, we know that in addition to addressing the hybrid
pension issues that are the subject of today's hearing, this
subcommittee and the Congress as a whole will be spending considerable
time in the months ahead considering potential reforms to the funding
rules for defined benefit plans. The Council recently published its
recommendations for pension funding reform, \7\ and we would welcome
the opportunity in a future setting to visit with you and other members
of the subcommittee on these important defined benefit plan issues.
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\7\ American Benefits Council, Funding Our Future: A Safe and Sound
Approach to Defined Benefit Pension Plan Funding Reform (February
2005), available at http://www.americanbenefitscouncil.org/documents/
fundingpaper021604.pdf.
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THE SPECIFIC ADVANTAGES OF HYBRID DEFINED BENEFIT PLANS
Hybrid plans are defined benefit pensions that also incorporate
attractive features of defined contribution plans. The most popular
hybrid plans are the ``cash balance'' design and the ``pension equity''
design. In a cash balance plan, employers provide annual ``pay
credits'' to an employee's hypothetical account and ``interest
credits'' on the balance in the account. In a pension equity plan,
employers provide credits for each year of service and these credits
are multiplied by an employee's final pay to produce a lump sum figure.
Hybrid plans not only offer the security of employer funding and
assumption of investment risk, Federal guarantees and required lifetime
and spousal benefit options, but also show account balances in lump sum
format, are portable, and provide for a more even benefit accrual
pattern across a worker's entire career.\8\ Hybrid plan participants
are able to reap these rewards typical of defined contribution plans
without bearing any concomitant loss of security (i.e., a decline in
account balance due to stock market conditions).
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\8\ Traditional defined benefit plans tend to provide the bulk of
earned benefits at the very end of a worker's career.
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Employers like hybrid plans primarily because the benefits in the
plans are so tangible to employees, resulting in greater appreciation
of the pension program. In fact, a survey found that the dominant
motives for employer conversions to hybrid plans were employee
appreciation of the plan, facilitating communication with employees,
and the ability to show the benefit amount in a lump sum format.\9\
Many assume that conversions are pursued to cut employer pension costs.
While this has been the case for some companies, for most employers it
is neither the rationale for the conversion nor the reality that
results.\10\ We trust you will agree that when employers do conclude
that costs must be reduced, it is better for them to retain an
affordable defined benefit plan (and one that fits the realities of the
modern workforce) than to not have one at all.
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\9\ Sylvester J. Schieber, et al., Watson Wyatt Worldwide, The
Unfolding of a Predictable Surprise: A Comprehensive Analysis of the
Shift from Traditional Pensions to Hybrid Plans 44 (February 2000) (96
percent of respondents indicated employees' appreciation of the plan
was either very important or important in the decision to convert to a
hybrid plan; 93 percent of respondents indicated facilitation of
communication and the ability to show the benefit amount in a lump sum
format were either very important or important in the decision to
convert to a hybrid plan).
\10\ Data released shows that retirement plan costs have increased
an average of 2.2 percent following a conversion, and when companies
that were in severe financial distress were excluded from the pool,
this figure increased to 5.9 percent. Watson Wyatt Worldwide, Hybrid
Pension Conversions Post-1999: Meeting the Needs of a Mobile Workforce
3 (2004). Conversions are often accompanied by improvements to other
benefit programs, such as 401(k) plans, bonuses, and other post-
retirement benefits. Another recent survey found that when these
improvements are taken into account, 65 percent of respondents expected
the costs of providing retirement benefits following a cash balance
conversion to increase or remain the same. Mellon Financial
Corporation, 2004 Survey of Cash Balance Plans 15. Another survey,
conducted in 2000, also found that overall costs following a conversion
were expected to increase or remain the same in 67 percent of the
cases. PricewaterhouseCoopers, Cash Balance Notes 4 (May 2000).
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Hybrid plans and their level benefit accrual pattern are also
effective in helping employers attract and retain employees in today's
fluid job market where few individuals plan or expect to stay with one
employer for a career.\11\ Employees likewise appreciate hybrid plans
because they are more transparent, more portable, and deliver benefits
more equitably to short, medium and longer-service employees than
traditional pensions, while also retaining the favorable security
features of the defined benefit system.\12\
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\11\ Women rank promoting portable pensions as their top retirement
policy priority. Center For Policy Alternatives And Lifetime
Television, Survey: Women's Voices 2000.
\12\ The Federal Reserve, Cash Balance Pension Plan Conversions and
the New Economy 5 (Oct. 2003) (``[R]easons that workers may want
pensions include the desire to earn tax-favored returns, or to realize
economies of scale on the transaction costs of investment, although
both of these goals can be realized in a [defined contribution] plan as
well as a [defined benefit] plan. In a [defined benefit] plan workers
may also realize the opportunity to insure to some degree against
mortality, inflation, macroeconomic, and disability risks through
inter-and intra-generational risk sharing'').
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The unique value of hybrid plans in meeting employee retirement
plan preferences is demonstrated in a recent survey. The survey reveals
that workers prefer two retirement plan attributes above all others--
the portability of benefits and benefit guarantees.\13\ It is only
hybrid plans that can deliver both these advantages. Traditional
defined benefit plans typically do not provide for portability, and
benefits in 401(k) and other defined contribution plans are not
guaranteed. Indeed, if policymakers were working from a clean slate to
produce the ideal retirement plan today, they would likely develop a
hybrid plan. Clearly, preserving hybrid plans as a viable pension
design is critical if employers are to maintain retirement programs
that meet employee needs and preferences.
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\13\ Watson Wyatt Worldwide 2004, supra note 10 at 6.
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Perhaps most important of all, studies show that nearly 80 percent
of participants build higher retirement benefits under a hybrid plan
than a traditional plan of equal cost.\14\ Why? Traditional defined
benefit plans tend to award disproportionate benefits (often as much as
75 percent of total benefits under the plan) to employees with
extremely long service. Yet very few employees spend a career with a
single-employer.\15\ Hybrid plans were designed to respond to this
reality. The advantage of hybrid plans for most workers is confirmed by
a recent study that shows that if an employee changes jobs just three
times in the course of his career, she or he can expect to receive in
excess of 17 percent more in retirement benefits from participating in
cash balance plans than if his or her employers had provided
traditional plans instead.\16\
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\14\ Watson Wyatt Worldwide 2000, supra note 9 at 24-25.
\15\ Watson Wyatt Worldwide 2004, supra note 10 at 6-7. In fact,
only 9.5 percent of employees work in the same job for 20 years or
more. Employee Benefit Research Institute.
\16\ Watson Wyatt Worldwide 2004, supra note 10 at 6. The Federal
Reserve has likewise reported that ``conversions have generally been
undertaken in competitive industries that are characterized by tight
and highly mobile labor markets. Since mobile workers benefit most from
such conversions, we conclude that this trend may have positive
implications for the eventual retirement wealth of participants.'' The
Federal Reserve, supra note 12 at 3.
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The advantages of the hybrid plan are not reserved for younger
workers. Even longer-service workers often fare better under a hybrid
plan.\17\ One of the many ways in which hybrid plan sponsors address
the needs of longer-service and older employees is by contributing pay
credits that increase with the age and service of employees. Recent
surveys show that 74 percent of cash balance plan sponsors provide pay
credits that increase with age or service,\18\ while 87 percent of
pension equity plan sponsors do the same.\19\
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\17\ Watson Wyatt Worldwide 2000, supra note 9 at 23-25 (February
2000) (Among the 78 plans studied, on average a worker age 50 with 20
years of service would have earned benefits 1.48 times as great if he
had participated in a cash balance plan rather than a traditional
plan).
\18\ Mellon Financial Corporation, supra note 10 at 12.
\19\ Watson Wyatt Worldwide 2004, supra note 10 at 2.
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Employers also devote significant energy and resources to
developing transition assistance programs to help older and longer-
service employees who may not accrue as much in benefits on a going
forward basis under a hybrid plan as they would under the prior
traditional plan. Successful conversion assistance techniques vary, but
generally include one or more of the following: grandfathering some or
all current employees in the prior pension plan, allowing certain
employees to choose whether to remain in the traditional plan or move
to the hybrid plan, providing whichever benefit is greater under either
the traditional or new formula, providing additional transition pay
credits in an employee's account over some period of time, or making
extra one-time contributions to employees' opening account balances.
Employers draw from these varying techniques and apply them to smaller
or larger groups of employees as appropriate to suit the needs of their
workforce and carry out the goals of the conversion. Studies conducted
within the last few years show that employers provide older and longer-
service employees with these special transition benefits in nearly all
conversions.\20\ Indeed, employers' already significant focus on the
needs of older workers has only increased in light of public and
congressional interest in the effect of conversions.
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\20\ Mellon Financial Corporation, supra note 10 at 11 (90 percent
of conversions contain special transition benefits); Watson Wyatt
Worldwide 2004, supra note 10 at 4 (89 percent of conversions contain
special transition benefits). In those instances where these special
transition benefits are not provided, it is usually because the
business is in financial distress at the time of the conversion.
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As this data reveals, hybrid plans are proving extremely successful
in delivering valuable, appreciated, and guaranteed retirement benefits
to employees of all ages.
THE LEGAL AND REGULATORY LANDSCAPE
Let me now turn to a discussion of the history of hybrid plans and
how the current uncertainty in the legal and regulatory landscape came
about. The first cash balance plan was adopted in 1985 and the first
pension equity plan was adopted in 1993. For nearly 15 years after
adoption of the first cash balance plan, the Internal Revenue Service
(IRS) regularly issued determination letters for hybrid plan
conversions indicating that the plans and conversions satisfied all
Internal Revenue Code requirements (including those related to age
discrimination). In 1999, however, the IRS announced a moratorium on
such letters partly in response to several high-profile conversions
that were receiving significant congressional and media scrutiny. As a
result of this scrutiny and after thorough review of the issues through
numerous congressional hearings in the committees of jurisdiction,
Congress in 2001 enacted legislation to require employers to provide a
more detailed and more understandable advance notice to participants
regarding any hybrid conversion (or any other defined benefit plan
amendment) that significantly reduced future benefit accruals.\21\ At
the time, some in Congress proposed various benefit mandates and design
restrictions as a response to cash balance conversions, but these
proposals were all rejected. Congress concluded that the best response
to the issues that had been raised was to ensure absolute transparency
for employees about how their benefits would be affected by hybrid plan
conversions.
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\21\ ERISA section 204(h); Treas. Reg. 54.4980F-1 (Notice
requirements for certain pension plan amendments significantly reducing
the rate of future benefit accrual) (Note: paragraphs (c) and (d) of A-
8 of the regulations pertaining to application of the notice
requirements to certain amendments reducing early retirement benefits
or retirement-type subsidies are proposed and not yet final).
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Benefit Plateaus (``Wear-Away''). Let me now turn to a discussion
of one of the conversion issues that has generated questions and
concerns throughout the congressional review of hybrid plans--so called
``wear-away.'' At the outset, it is important to understand that
parallel rules in ERISA and the Internal Revenue Code protect all
benefits that an employee has already earned for service to date.\22\
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\22\ ERISA section 204(g); Internal Revenue Code section 411(d)(6).
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Thus, despite assertions to the contrary, existing benefits are
never reduced in a hybrid plan conversion.
``Wear-away'' is the term used for the benefit plateau effect that
some employees can experience in conjunction with a cash balance
conversion. When employers convert to a cash balance plan, they
typically provide an opening balance in employees' cash balance
account. A benefit plateau results if the value of the employee's cash
balance account is less than the value of the benefit he or she accrued
under the prior plan as of the date of the conversion. Until the value
of the cash balance account catches up to the value of the previously
accrued benefit, it is the higher accrued benefit to which the worker
is entitled if he or she departs the company--hence the plateau.\23\ We
believe that the term ``wear-away'' is, in fact, confusing and even
misleading, as the employee always receives the higher of the two
benefit levels and nothing earned is taken away. Thus, we use the term
benefit plateau throughout the discussion below.
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\23\ It is worth noting that the use of benefit plateaus as a
method of transitioning between benefit formulas has been expressly
approved under IRS pension regulations for many years. See e.g., Treas.
Reg. 1.401(a)17-1 (discussing wear-away of benefits in connection
with applicable compensation limits), Treas. Reg. 1.401(a)(4)-13
(regarding correct use of wear-aways in connection with non-
discrimination rules), Rev. Proc. 94-13, 1994-1 C.B. 566 (1994)
(providing model language including references to wear-aways for use by
plans in complying with I.R.C. 401(a)(17)). Indeed, plateau periods
can result from constructive and necessary plan changes, such as
updating plan mortality assumptions to provide more accurate benefits,
aligning the benefits of employees from different companies in the wake
of business acquisitions and mergers, or revising a plan to meet new
statutory requirements (such as legislative restrictions on the amount
of benefits that may be paid under a plan).
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There have been three leading causes of this plateau effect in the
conversion context.
First, the plateau can result simply from a change in the
rate of interest on 30 year Treasury bonds. Our pension laws require
that when benefits earned in a defined benefit plan are converted from
an annuity payable at retirement into a lump sum present value, this
calculation must be performed using the 30 year Treasury bond rate.\24\
As interest rates on 30-year bonds fall, the lump sum present value of
the benefit earned by the employee prior to the conversion will
increase.\25\ The result can be that although a worker's previously
earned benefit and opening cash balance account were both equal to
$50,000 at the time of conversion, a decrease in 30-year bond interest
rates can increase the value of the previously earned benefit to
$55,000. Until the cash balance account reaches $55,000, this worker
will experience a benefit plateau.
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\24\ ERISA section 205(g); Internal Revenue Code section 417(e).
This required use of the 30-year Treasury bond rate was not changed by
the legislation enacted in April 2004 replacing the 30-year rate for
pension funding calculations.
\25\ This is because one needs a larger pool of money today to grow
to an equivalent benefit at age 65 if that pool will be earning less in
interest.
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Second, benefit plateaus can result when employers
translate the previously accrued traditional benefit into an opening
cash balance account using an interest rate higher than the 30 year
bond rate. When this is done, the value of the opening cash balance
account will be lower than what the employee would be eligible to take
under the prior plan (since the present value of that benefit must be
calculated using the 30 year bond rate). The result is that workers
will plateau at the higher level until the cash balance account catches
up. Employers generally use a higher interest rate when they believe
the 30 year Treasury bond rate is historically low (which has been the
case in recent years).\26\ Yet because using a higher interest rate can
produce benefit plateaus and plateaus have been of concern to
employees, few employers have set opening balances in this way. The
clear trend has been for employers to determine opening account
balances using the Treasury rate or a rate more favorable for
employees.\27\ Thus, this use of higher interest rates has not been a
frequent cause of benefit plateaus in recent years.
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\26\ This is yet another reminder of how important it is for
Congress to move quickly to enact a permanent replacement for the 30
year Treasury bond rate, including for calculations that determine lump
sum benefits in defined benefit plans.
\27\ In a 2000 study of cash balance conversions, Watson Wyatt
reports that of the 24 plans it reviewed that converted to a hybrid
design since 1994, 22 of them (92 percent) set opening account balances
using the Treasury rate or a rate more beneficial to employees. Watson
Wyatt Worldwide 2000, supra note 9 at 40; Mellon Financial Corporation,
supra note 10 at 6 (77 percent of 101 cash balance conversions did the
same).
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Third, benefit plateaus can result when employers
eliminate early retirement subsidies (on a prospective basis) from the
pension.\28\ A plateau can result in this instance because workers who
have already earned a portion of an early retirement subsidy prior to a
conversion will typically have a previously earned benefit under the
prior plan that is higher than the opening cash balance account (which
is typically based on the normal retirement age benefit earned under
the prior plan as of the date of the conversion and does not include
the value of any early retirement subsidy).\29\ Presuming an employee
leaves the company at a time when he or she is entitled to receive the
early retirement subsidy, the prior plan benefit may be greater than
the cash balance account. Elimination of the early retirement subsidies
on a prospective basis is the primary cause of benefit plateaus in most
conversion cases where plateaus are seen today. It should be noted that
benefit plateaus can also occur in cases where early retirement
subsidies are eliminated from traditional defined benefit plans.
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\28\ An early retirement subsidy provides an enhanced benefit if
the employee leaves the company at a specified time prior to normal
retirement age. For example, a fully subsidized early retirement
benefit might provide an employee the same pension at age 55, say,
$1,500 per month for life, which he would not normally receive until
age 65. The ability to earn the higher pension without any actuarial
discount for the additional 10 years of payments provides a strong
financial incentive to retire at the earlier age. The value of such an
early retirement subsidy decreases every year until normal retirement
age, at which point no subsidy remains.
\29\ Opening account balances do not typically include the value of
early retirement subsidies because doing so would provide the value of
the subsidy to a large number of workers who will work until normal
retirement age and therefore not be entitled to the subsidized early
retirement benefits. Those few employers that have included some or all
of the subsidy in opening accounts have done so as a particular
conversion assistance technique.
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While some may be concerned about the plateau effect resulting from
subsidy removal, Mr. Chairman, we feel strongly that employers must
maintain their flexibility to eliminate these early retirement
subsidies on a going forward basis. Early retirement subsidies are
certainly a preferable alternative to layoffs and can help a company
manage its workforce in a humane way. But employers will never adopt
such features in their plans if policymakers make it difficult or
impossible to eliminate these subsidies prospectively when they no
longer make sense. Today, for example, given the significant shortages
that employers experience in certain job categories, it makes no sense
for them to continue to offer highly-productive employees rich
financial incentives to retire in their 50s. While current law protects
any subsidy that employees have already earned for their service to
date, it wisely allows employers to remove such incentives from their
plan going forward.
Moreover, any legislative requirement that employers maintain
ongoing early retirement subsidies in their pension plans would be out
of step with congressional actions regarding our Nation's public
pension system, Social Security. Congress has raised the Social
Security retirement age--and may once again consider doing so as part
of the current effort to address the system's solvency--and repealed
the Social Security earnings test, partly in order to encourage older
Americans to work longer. Requiring employers to continue to offer
private pension plan incentives to retire early would be flatly
inconsistent with these actions.
Although we understand that benefit plateaus can be confusing and
even upsetting to some employees, they result from interest rate
anomalies and valid actions taken by employers to eliminate early
retirement subsidies. Nonetheless, given the employee concern, many
employers design their conversions to mitigate these plateaus or
eliminate them altogether. Moreover, the disclosure requirements
enacted by Congress in 2001 (and implemented by the Treasury Department
through regulations) ensure that employees are fully aware of the
possible benefit plateau effects of a conversion. The Council believes
these steps appropriately respond to the concerns that have been raised
about plateaus.
Age Discrimination Principles. Subsequent to Congress' enactment of
disclosure legislation, the Treasury Department and IRS drafted
proposed regulations in consultation with the Equal Employment
Opportunity Commission addressing retirement plan design and age
discrimination principles. These proposed regulations were issued in
December 2002. Among other items, the proposed regulations established
the validity of the cash balance design under the pension age
discrimination statute and provided guidelines on how employers could
convert from traditional to hybrid pension designs in an age-
appropriate manner.
Disregarding the interpretation contained in the proposed
regulations and other legal authorities, one Federal district court
judge dramatically shifted the focus of the debate surrounding hybrid
plans by declaring in July 2003 in the case of Cooper v. IBM that
hybrid plan designs were inherently age discriminatory.\30\ According
to the court's flawed logic, simple compound interest is illegal in the
context of defined benefit pension plans.\31\ Under the Cooper court's
reasoning, a pension design is discriminatory even if the employer
makes equal contributions to the plan on behalf of all its workers and,
ironically, even in many instances where the design provides greater
contributions for older workers. Such a conclusion flies in the face of
common sense.\32\ It would hold all 1,200 plus hybrid pension plans,
\33\ regardless of whether adopted as new plans or through conversion
from traditional plans, to be in violation of the pension age
discrimination laws.
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\30\ Cooper v. IBM Pers. Pension Plan, 274 F. Supp. 2d 1010 (S.D.
Ill. 2003). The pension age discrimination statute in question provides
that the rate of a participant's benefit accrual may not decline on
account of age. The district court interpreted this rule to mean that
the amount of annuity benefit received at age 65 for a year of service
cannot be less for an older worker than a younger worker. The
defendants in the case argued that it is nonsensical from an economic
perspective to compare the age 65 benefit accrual rate of a 25 year old
and a 64 year old because the 64 year old will receive his or her
benefit much sooner and have a much shorter period of time to accrue
interest. In other words, the ``time value'' of money must be taken
into account. The court itself acknowledges the strength of this
argument, stating, ``From an economist's perspective, Defendants have a
good argument.'' Nonetheless, the court goes on to argue that the age
discrimination laws require rejection of basic economic common sense.
\31\ The court's reading of the 1986 pension age discrimination
statute would invalidate a broad range of long-standing pension
designs, including contributory defined benefit plans (common in the
State and local Government sector and among multi-employer plans),
plans that are integrated with Social Security and plans with pre-
retirement indexation to help protect employees from the effect of
inflation. These plans were all regarded as perfectly age appropriate
when Congress enacted the pension age statute.
\32\ If the Cooper court's reasoning were applied to the Social
Security program, even it would be considered age discriminatory.
\33\ The most recent Government data indicates that as of the year
2000 there were 1,231 hybrid plans covering more than 7 million
participants. PBGC, supra note 4 at 3-6.
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The conclusion that all hybrid plan designs are inherently age
discriminatory begs the question why the Internal Revenue Service
issued favorable determination letters for 15 years blessing hybrid
plan designs and issued proposed regulations providing that the cash
balance plan design is not inherently age discriminatory. It is
surprising, at a minimum, that the Cooper decision completely ignored
this history. Even more astonishing is the fact that the Cooper
decision ignores the legislative history of the pension age
discrimination statute adopted in 1986. That legislative history makes
clear that the intent of Congress was limited to prohibiting the
practice of ceasing pension accruals once participants attained normal
retirement age.\34\ Moreover, an example in the 1986 legislative
history that clarifies a separate but related pension issue describes
approvingly a type of plan (a ``flat dollar'' plan) that would be
deemed age discriminatory under the Cooper decision.\35\ It makes
absolutely no sense that Congress would use as an example of a viable
pension design one that would fail the age discrimination prohibition
it was enacting at the very same time.\36\ Lastly, prior to the Cooper
decision, numerous other Federal district courts addressed and rejected
charges that the basic hybrid plan designs were age discriminatory.\37\
These too were ignored in the Cooper decision. Importantly, another
Federal district court decision decided subsequent to Cooper has
rejected its logic and concluded that the cash balance pension design
is age appropriate.\38\
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\34\ H.R. Conf. Rep. NO. 1012, 99th Cong., 2d Sess. at 376-379. A
number of other Federal district courts that have had the opportunity
to review this issue have likewise concluded that the pension age
discrimination statute is only applicable to benefit accruals after a
participant has reached normal retirement age. See Tootle v. ARINC,
Inc., 222 F.R.D. 88, 92-94 (D. Md. 2004); Engers v. AT & T Corp., No.
98-3660, letter op. at 9 (D. N.J. June 6, 2001); Eaton v. Onan, 117 F.
Supp. 2d 812, 827-29 (S.D. Ind. 2000).
\35\ H.R. Conf. Rep. NO. 1012, 99th Cong., 2d Sess. at 381.
\36\ Eaton acknowledged this inconsistency and concluded it was
illogical to read the pension age discrimination statute in such a way
as to invalidate this example and with it a wide variety of defined
benefit plans. 117 F. Supp. 2d at 830, 834.
\37\ Campbell v. BankBoston, N.A., 206 F. Supp. 2d 70 (D. Mass.
2002) (rejecting the notion that hybrid plan designs are inherently age
discriminatory, the court stated that a ``claim based on the fact that
older workers will have a smaller amount of time for interest to accrue
on their retirement accounts . . . is not permitted under the [age
discrimination laws].''), aff'd 327 F.3d 1 (1st Cir. 2003); Eaton v.
Onan, 117 F. Supp. 2d 812, 826 (S.D. Ind. 2000) (in holding that the
cash balance pension design is not age discriminatory the court stated:
``Plaintiffs' proposed interpretation would produce strange results
totally at odds with the intended goal of the OBRA 1986 pension age
discrimination provisions'').
\38\ Tootle v. ARINC, Inc., 222 F.R.D. 88 (D. Md. 2004).
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Spurred on by the Cooper decision, cash balance critics in Congress
pushed through an appropriations prohibition preventing the Treasury
Department from finalizing its age regulations addressing hybrid plan
designs and conversions.\39\ Congress at the same time directed the
Treasury Department to make legislative recommendations regarding
conversions from traditional to cash balance plans.\40\ In the relevant
legislative history, however, Congress did make clear that ``[t]he
purpose of this prohibition is not to call into question the validity
of hybrid plan designs (cash balance and pension equity). The purpose
of the prohibition is to preserve the status quo with respect to
conversions through the entirety of fiscal year 2004 while the
applicable committees of jurisdiction review the Treasury Department's
legislative proposals.'' \41\
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\39\ See Section 205 of the fiscal year 2004 Omnibus Appropriations
Act (PL 108-199).
\40\ These Treasury Department recommendations were included in the
Bush Administration's fiscal year 2005 and fiscal year 2006 budget
submissions to Congress.
\41\ H.R. Conf. Rep. NO 401, 108th Cong., 1st Sess. at 1185 (2003).
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While the Cooper decision is an isolated one, and there is clear
and significant authority to the contrary concluding that hybrid plans
are age appropriate, Cooper is a high-profile case that has led to
copycat class action lawsuits being filed against a number of other
employers for the alleged discriminatory nature of their plan design.
Applying the rationale in the Cooper rulings, ultimate damages against
the defendant were projected to be between $1 and $6 billion dollars.
It is this range of figures that are required to overcome and ``correct
for'' the natural operation of compound interest. Indeed, should the
defendant in the Cooper case lose its planned appeal on the cash
balance plan and related design issues, it has agreed to settle these
two particular claims for $1.4 billion. Employers are understandably
extremely anxious about the crippling effect of such lawsuits and
potential damage awards, and are concerned that they will be next on
the growing list of companies targeted for class-action suits. While
employers certainly expect the anomalous Cooper decision ultimately to
be overturned on appeal, such a result is many months, if not years,
away and many hybrid plan sponsors are likely to find the intervening
risks to their businesses and shareholders to be unbearable.
THE NEED FOR CONGRESSIONAL ACTION
Mr. Chairman, the operation of the hybrid pension system is at a
standstill. Employers cannot get determination letters from the IRS
regarding the compliance of their plans with legal guidelines. The
regulatory agencies that normally assist the smooth functioning of the
system through issuance of periodic interpretive guidance have been
told by Congress through the appropriations process not to do so. Any
final resolution of the age discrimination question by the Federal
appellate courts is years away at a minimum.
Moreover, the judicial system is not the appropriate forum for
resolving an issue of this sort, which has far-reaching public policy
ramifications. The very nature of the judicial process makes it
difficult for these types of broad public policy issues to receive
thorough examination much less appropriate handling. Not all
stakeholders are present before the court and the system-wide
ramifications are intentionally given less weight than the narrow legal
issues.
Perhaps some are tempted to view this current legal uncertainty and
regulatory standstill as a victory of sorts. Perhaps they will see the
slowdown in the number of hybrid plan conversions as a positive
development for employees. They should not. As we noted earlier, other
pressures in the defined benefit system are already prompting employers
to consider freezes or terminations of their plans. Indeed, a recent
survey reported that 27 percent of defined benefit plan sponsors have
already frozen at least some element of their defined benefit pension
program.\42\ The hostile climate for hybrid plans and the litigation
risks and extreme damage potential are unfortunately starting to make
the decision to freeze an easier and easier one for corporate decision-
makers.\43\ If employers are pushed to abandon hybrid plans, we will
lose a retirement vehicle that delivers higher benefits to the vast
majority of employees and meets workers' key retirement plan needs--for
portability and benefit guarantees--all while utilizing transition
methods that protect older workers. How, exactly, is this good for
employees and their families?
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\42\ Society of Actuaries' Survey on the Prevalence of Traditional
and Hybrid Defined Benefit Plans, prepared by Matthew Greenwald and
Associates, Inc. (March 2005).
\43\ A majority of companies have made it clear that if hybrid
plans become untenable they will be offering only a 401(k)/defined
contribution program going forward. They will not be reverting to a
traditional defined benefit plan design. Deloitte Consulting LLP,
Pension Crisis Prompting Majority of Surveyed Companies to Change or
Consider Changing Their Plans 2 (2004). While defined contribution
plans provide valuable retirement benefits, defined benefit plans
provide unique retirement security features for employees and their
families that are hard to replicate. Employees are typically best
served by the ability to participate in both types of plans. The
Council believes that our Nation's retirement income policy should be
crafted to promote maximum flexibility so that employers and employees
can utilize the plan or plans that best suit their needs.
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The prospect of hybrid plan freezes and terminations poses another
risk--to the Pension Benefit Guaranty Corporation (PBGC). We must be
mindful that many of the companies that sponsor hybrid plans are
financially strong companies in healthy industries. These strong
companies today pay insurance premiums to the PBGC. If these employers
are forced to exit the defined benefit system, the loss of premiums
could aggravate the long-term financial challenges faced by the agency.
Hybrid plan participants comprise 21 percent of all plan participants
protected by the PBGC insurance program. Hence employer insurance
premiums on these participants comprise 21 percent of the revenue
generated by the PBGC through its per-participant premium program.\44\
If hybrid plans were removed from the defined benefit system, future
premiums to the PBGC would be reduced significantly.
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\44\ This figure is derived from data collected by the PBGC
indicating that, as of the year 2000, the PBGC protected 34,342,000
single-employer defined benefit plan participants, 7,155,000 of whom
participate in hybrid plans. PBGC, supra note 4 at 6.
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Mr. Chairman, the situation today is distressingly clear. The harms
that result from today's legal uncertainty are unmistakable. The
regulatory agencies and courts are unable to act effectively to prevent
these harms. Only through prompt legislative action can Congress rescue
hybrid defined benefit plans and prevent the damage to the retirement
security of millions of American families that will unquestionably
result from their demise.
RECOMMENDATIONS
Clarify the Age Appropriateness of the Hybrid Plan Designs. The
first and most important step for Congress to take is to clarify that
the cash balance and pension equity designs satisfy current age
discrimination rules. Congress must make clear that the legal
interpretation holding these designs discriminatory merely because the
accounts of younger workers have more years to earn interest is
unfounded. Rather, Congress must clarify that age discrimination in
defined benefit plans is measured by reference to the formula spelled
out in the plan document. If, under the formula, benefits do not
decline on account of age, then the plan meets the legal requirements.
In hybrid plans, this approach would look to the pay credits
contributed on workers' behalf under the plan formula. If the pay
credits for older workers are the same, or greater, than the pay
credits for younger workers, then the pension age discrimination rules
are satisfied.\45\ This clarification is consistent with the legal
authorities and with plain common sense. It will end the needless legal
jeopardy in which every hybrid plan sponsor today finds itself and will
preserve the important benefits that millions of employees today earn
under these plans.
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\45\ The hybrid plan proposals made by the Treasury Department in
the Bush Administration's fiscal year 2005 budget contain a provision
recognizing that this is the appropriate way to evaluate age
discrimination for hybrid plans. However, this clarification regarding
the hybrid plan designs is prospective only in the Treasury
recommendations, leaving employers with hybrid plans already in
existence open to legal suit regarding the legality of their plan
designs.
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Provide Legal Certainty for Past Hybrid Conversions. In addition to
clarifying the age appropriateness of the hybrid plan designs, the
Council believes it is essential for Congress 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. Transition methods, such as
benefit plateaus, that have not given rise to concerns about age
discrimination in other contexts should not now do so merely because of
the context of hybrid plan conversions.
Resolve Legal Uncertainties with Anti-Employee Effects. Beyond
resolving the questions about the basic hybrid designs and the
treatment of past conversions, the Council believes Congress should
take a number of additional steps to provide legal clarity regarding
hybrid plans. Addressing these additional issues will very concretely
aid the employees who participate in hybrid plans.
Whipsaw. First, we recommend that you make clear that, so
long as a cash balance plan does not credit interest in excess of a
market rate of return, the proper benefit payment to a departing
employee is that employee's account balance. This will remedy the so-
called ``whipsaw'' problem that has forced employers to reduce the rate
of interest they pay on employees' cash balance accounts.\46\
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\46\ Whipsaw is the term used to describe the anomaly that occurs
when employers must project a departing employee's cash balance account
forward to normal retirement age using the plan's interest crediting
rate and then must discount the resulting amount back to a present
value using the statutorily-mandated 30 year Treasury bond rate. When
an employer's interest crediting rate is higher than the 30 year rate,
this process results in a plan liability to the employee in an amount
greater than the employee's actual account balance. The only way to
avoid this ``whipsaw'' effect is to reduce a plan's interest crediting
rate to the same 30 year rate the law requires for discounting future
benefits into present value lump sums. In the wake of several court
decisions mandating this whipsaw effect, this is what cash balance
sponsors around the country have done to insulate themselves from
liability. However, the unfortunate result is that employees in cash
balance plans earn lower rates of interest on their accounts than would
otherwise be the case. Even a modestly lower rate of interest earned on
an account over the course of a career can translate into a significant
reduction in the ultimate account balance at retirement.
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The Treasury Department helpfully included this same resolution of
the whipsaw problem in its legislative recommendations contained in the
Bush Administration's fiscal year 2005 budget proposal. As with the
provision regarding hybrid plan design, however, the recommended
whipsaw fix was prospective only. This would require employers to
continue to pay low interest rates on employees' existing cash balance
accounts.
Inclusion of Early Retirement Subsidies. Second, we
recommend that you make clear that employers may include some or all of
the value of early retirement subsidies in employees' opening account
balances. A number of employers have chosen to do this as a conversion
technique to assist those nearing early retirement eligibility, but
some in the regulatory agencies are suggesting that to do so is
problematic under our current pension age discrimination rules.
Protection of ``Greater Of'' Transition Method. Third, we
recommend that you make clear that employers that voluntarily choose to
offer employees the greater of the benefits in the prior traditional or
new hybrid plan do not run afoul of the pension back-loading rules.
Some regulators have suggested this ``greater of'' conversion approach
violates these rules.
Protection of Employee-Friendly Transition Techniques.
Fourth, some conversion approaches that employees and Members of
Congress have praised (choice, greater of, grandfathering in the prior
plan) are likely to violate the non-discrimination rules over time.
Why? The group of typically older employees who remain under the prior
plan formula will over time and very naturally have a greater and
greater proportion of so-called highly-compensated employees (those
making $95,000 and above) and may well be the only group eligible for
continued accrual of benefit features exclusive to the prior
traditional plan (e.g., early retirement subsidies). This creates a
problem under the non-discrimination rules. We urge you to make clear
that these employee-friendly conversion techniques can be pursued.
Reject Benefit Mandates That Prevent Employers from Modifying
Benefit Programs. Some in Congress are seeking to impose specific
benefit mandates when employers convert to hybrid pension plans. For
example, some have proposed requiring employers to pay retiring
employees the greater of the benefits under the prior traditional or
new hybrid plan. Others have proposed requiring 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. Pursuant to a
directive from Congress, the Treasury Department has also made
legislative recommendations regarding requirements for hybrid plan
conversions undertaken in the future. Despite earlier proposed
regulations that would have clarified the legality of the hybrid plan
designs and made clear that conversions could be undertaken without
special benefit requirements, the Treasury's legislative proposal would
require employers to pay benefits at least as high as were provided
under the prior traditional plan for a period of 5 years following the
conversion.
These proposals may perhaps sound innocuous to some, and indeed
some employers have voluntarily adopted the transition techniques that
would be mandated under these proposals, but each of the proposals
embraces a fundamental and truly radical shift in the rules of the game
for our Nation's voluntary employer-sponsored benefits system. Under
these proposals, Congress would be (1) guaranteeing employees future
retirement plan benefits for service that the employees have not yet
performed, and (2) preventing employers from changing the benefit
programs they voluntarily offer. Indeed, Congress would be converting
the natural and understandable hopes and wishes of employees that their
benefits will remain the same into concrete legal rights. Such
enshrinement of expectations is a fundamental departure from the
existing rules of the voluntary benefits system. The Council believes
this would be an extremely unwise--and extremely counterproductive--
step for Congress to take.
Under such regimes, it is unfortunately clear what actions
employers will take in our voluntary benefits system. If they conclude
that a traditional defined benefit plan is no longer meeting business
and employee needs, they will not remain in the defined benefit system
through conversion to a hybrid plan. They will exit the defined benefit
system altogether knowing they can avoid these unprecedented mandates
by simply utilizing a defined contribution plan going forward. As
discussed above, this is typically not the response that best serves
employees' retirement income needs.
Perhaps even more damaging than pushing employers from the defined
benefit system is the dangerous precedent that would be set by these
mandates that seek to enshrine expectations. Employers will naturally
ask themselves whether, if other developments in the benefits and
compensation landscape come in for heightened scrutiny, Congress will
respond by preventing them from making changes to those programs
(through imposition of greater of, mandated choice or hold-harmless
requirements). Will employers be unable to redesign their health plans?
Will they be unable to remove early retirement subsidies from their
traditional defined benefit plans? Will they be unable to reduce cash
bonuses? Will they be unable to shift from profit-sharing to matching
contributions in their defined contribution plans? Will they be unable
to reduce the degree of price discount in their stock purchase
programs? Where exactly will it end? There appears to us to be no
principled stopping point.
Given the extremely significant administrative burdens, financial
costs and legal exposure that already accompany voluntary employer
sponsorship of benefit programs today, we hope all who believe in
employer-provided benefits as we do will see that these are not the
questions you want stirring in the minds of corporate decision-makers.
They can only result in a world where employees are offered fewer
benefits.
CONCLUSION
The American Benefits Council believes that hybrid defined benefit
plans play an invaluable role in delivering retirement income security
to millions of Americans and their families. Nevertheless, hybrid plans
are facing legal uncertainties that threaten their continued existence.
Of these, the most pressing threat is a rogue judicial interpretation
that declares all hybrid plans in the Nation illegal. To prevent
widespread abandonment of hybrid plans by employers and the resulting
harm to employees, we hope Congress will provide the legislative
certainty and clarity for hybrid pension plans we have recommended
above.
Thank you again, Mr. Chairman and Senator Mikulski, for the
opportunity to appear today. I would be pleased to answer any questions
you may have.
The Chairman. Ms. Collier?
Ms. Collier. Chairman Enzi, Senator Mikulski, thank you for
the opportunity to appear today. My name is Ellen Collier, and
I am the Director of Benefits for Eaton Corporation. Eaton is a
diversified industrial manufacturer with world headquarters in
Cleveland, OH. We have over 56,000 employees worldwide,
including 29,000 employees in more than 40 States. Our business
has changed considerably over the past 10 years, a result of
more than 100 acquisitions and divestitures.
I am appearing today on behalf of the Coalition to Preserve
the Defined Benefit System, a broad-based employer coalition
that works exclusively on legislative and regulatory issues
related to hybrid plans. This is a critical time for defined
benefit pension plans, and hybrid plans in particular.
Congressional action is urgently needed to confirm the validity
of cash balance and pension equity designs. If Congress does
not act to clarify the current legal uncertainty, employers,
facing the threat of class action lawsuits, will increasingly
be forced to abandon these retirement programs.
Given the success of hybrid plans in delivering meaningful
guaranteed retirement benefits to today's workers, abandonment
of these programs would be disastrous for our employees and for
our Nation's retirement system. Employees will lose if the
current uncertainty persists.
Let me now discuss why we at Eaton concluded that a cash
balance plan was right for us. Eaton's diverse business nature
and acquisition activity created a challenge for our retirement
programs to continually attract and retain high-level talent
and to reduce the confusion resulting from multiple pension
structures. We began to examine different pension alternatives
in the mid 1990s. While this was under way we acquired Aeroquip
Vickers, a company with about 5,000 nonrepresented employees.
These employees had no defined benefit pension plan, making the
development of a new pension program even more urgent.
We considered several options for a new pension design, but
in the end we decided that a cash balance plan was best for
Eaton and our employees. Why? The simplicity, visibility,
portability and ease at integrating acquired companies into
Eaton. Once we settled on an ongoing design we had to make sure
we responded to the needs of employees who were already in
other pension designs. All new hires would start in the cash
balance program, 1/1/02, as would the Aeroquip Vickers
employees. 15,000 nonrepresented employees would receive an
informed choice, effective 1/1/03, between remaining in their
traditional defined benefit plan and switching to the cash
balance plan.
Employee reaction to our cash balance design was
overwhelmingly positive. It is important to note that choice
may not make sense for all companies. Employers need to have
flexibility to modify retirement plans to meet their individual
business needs. Let me emphasize Eaton did not introduce a cash
balance plan to reduce costs. In fact, the new cash balance
design has increased our costs.
Although the choice process required a significant amount
of time and resources and money, the cost of congressional
inaction would be far greater. If certain proposed judicial
remedies were applied to Eaton, the cost to modify our plan
could curtail discretionary spending in vital areas like
research and development. Furthermore, there would be increased
litigation, confusion and complexity if we were forced to
modify or freeze our plans at this time.
The resulting damage to employee morale and trust would
greatly disrupt Eaton's day to day manufacturing operations.
Without legislative action, our efforts to align our benefit
structure with our business needs will have been wasted.
Mr. Chairman, legislation is the only effective way to
address today's uncertainty surrounding the hybrid pension
designs. Why? Congress has indicated through the appropriations
process that it does not want these important policy issues
being determined by the agencies, and final resolution of the
age discrimination issue by appellate courts is years away at a
minimum. This will be too late to address the litigation risks
that are already beginning to drive employers from the system.
In the meantime, retirement security of millions of American
families will remain in limbo. To provide widespread
abandonment of pension plans by employers, Congress must
clarify the legality of hybrid plans.
Thank you again for the opportunity to appear here. I would
be pleased to answer any questions.
The Chairman. Thank you very much.
[The prepared statement of Ms. Collier follows:]
Prepared Statement of Ellen Collier
Chairman DeWine, Senator Mikulski, thank you for the opportunity to
appear today. My name is Ellen Collier and I am the Director of
Benefits at Eaton Corporation. Eaton Corporation is a diversified
industrial manufacturer headquartered in Cleveland, Ohio. We have over
56,000 employees worldwide, including over 29,000 employees in 100
locations in the U.S. The States with our greatest concentration of
employees are North Carolina, Michigan, Ohio, South Carolina, Iowa and
Pennsylvania. In total, we have employees in over 40 States.
Eaton has four main business groups that manufacture highly-
engineered components: Fluid Power, which manufactures hydraulic
components, hoses and connectors, and Aerospace products; Electrical,
which manufactures residential and commercial power distribution
equipment; Automotive, which manufactures engine valves, lifters and
superchargers; and Truck, which manufactures transmissions for heavy
and medium duty trucks.
Our 2004 sales were nearly $10 billion, and we sold products in
more than 125 countries. The business mix of the company has evolved
significantly in the past 10 years as a result of more than 100
acquisitions and divestitures. About 65 percent of Eaton's revenues
come from businesses that we acquired in the past 7 to 10 years.
I am appearing today on behalf of the Coalition to Preserve the
Defined Benefit System, a broad-based employer coalition that works
exclusively on legislative and regulatory issues related to hybrid
pension plans. The Coalition's more than 75 member companies, which
range from modest-size organizations to some of the largest
corporations in the U.S., sponsor hybrid defined benefit plans covering
more than 1.5 million participants.
THE NEED FOR LEGISLATIVE ACTION
I want to thank you for calling this hearing to address what is one
of the most pressing challenges today in the defined benefit system--
the legal uncertainty surrounding hybrid plans, and in particular the
radical judgment by a single court that hybrid plans are age
discriminatory. Congressional action is urgently needed to confirm the
dominant view--expressed by all other legal authorities--that the cash
balance and pension equity designs satisfy current age discrimination
rules. Absent such action by Congress to clarify the current legal
environment, employers facing the threat of copycat class action
lawsuits over the validity of their plan designs will increasingly be
forced to abandon these important retirement programs. Given the
success of hybrid plans in delivering meaningful, guaranteed retirement
benefits to today's workers, \1\ abandonment of these programs would be
a disastrous result for employees and for our Nation's retirement
system. Moreover, with the long-term solvency challenges facing the
Social Security program, it is more important than ever to encourage
employers to offer robust workplace retirement programs--or certainly
not discourage them from doing so. None of us should kid ourselves that
somehow employees win if the current uncertainty persists. Nor should
any of us assume that a retreat from hybrid plans will be accompanied
by a return to traditional defined benefit plans. Indeed, it is far
more likely that employers will abandon defined benefit plans
altogether.
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\1\ Nearly 80 percent of employees earn higher benefits under a
hybrid plan than under a traditional defined benefit plan of equal
cost. Watson Wyatt Worldwide, The Unfolding of a Predictable Surprise:
A Comprehensive Analysis of the Shift from Traditional Pensions to
Hybrid Plans 24-25 (February 2000). As discussed below, those employees
who do better under a traditional defined benefit plan are typically
granted transition assistance and/or remain under the traditional
formula after the hybrid plan is introduced.
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Congress has before it a number of pressing issues involving our
Nation's defined benefit pension system, including the need to enact a
permanent interest rate to govern the measurement of pension
liabilities and required contributions. These are important issues to
Eaton and Coalition members generally but we sincerely hope that
congressional attention to pension reform funding issues will not
distract from the critical task of acting this year to address the
hybrid plan issues.
To give you a feel for the valuable role hybrid plans play, let me
now discuss why we at Eaton concluded that a cash balance plan was
right for us. Our experience is comparable to those of many other
companies in our Coalition.
THE NEED FOR A NEW PENSION DESIGN
Eaton's presence in various lines of business, and our substantial
acquisition activity, created a challenge for our retirement programs:
we needed to continue to attract and retain high-level talent to remain
competitive and continue our growth, and we also needed to reduce the
confusion and administrative cost resulting from multiple pension
structures inherited through various acquisitions. Through different
acquisitions and across different lines of business we had six ongoing
pension designs for 15,000 non-union represented employees. These
included two final average pay designs, one Social Security offset
design, two flat-dollar multi-employer designs, and one cash balance
design. Based on employee survey results, we also knew we needed to
make our pension plans easier for employees to understand.\2\
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\2\ This correlates with the general experience of other employers.
Surveys show that the most important factors underlying employer
conversions to hybrid plans are improving communication about and
employee appreciation of the pension plan, as well as being able to
show benefits in a lump sum format. Watson Wyatt Worldwide 2000, supra
note 1 at 44.
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Eaton began to examine pension plan alternatives in the mid-1990's.
We knew the resulting design would need to be attractive to high-skills
talent, easy to understand, and suitable to a mobile workforce. This
attention to mobility was important--not only because of general trends
in the labor marketplace, but also because within Eaton we have
employees that transfer between business groups with different pension
plans. Under our existing traditional designs, one employee could have
benefits from two pension plans, simply by transferring from Pittsburgh
(headquarters of our Electrical group) to Minneapolis (headquarters of
our Fluid Power group). Finally, any new retirement program would have
to permit seamless integration of new employees brought on as a result
of acquisitions. This was necessary in order to provide equitable and
uniform benefits across our workforce and to enhance Eaton's ability to
grow.
While the examination of pension plan alternatives was underway,
Eaton acquired Aeroquip Vickers, a company with about 5,000 non-union
represented employees. These employees had a defined contribution plan
from the prior owner, but no ongoing defined benefit plan--their
pension plan had been frozen many years before. We at Eaton felt
strongly that we wanted to provide these employees once again with the
security of a defined benefit plan--in addition to Eaton's 401(k) plan
(which has an employer match). We knew that employer funding and
assumption of investment risk, professional investment management and
Federal insurance guarantees translated into tangible retirement income
and significant peace of mind for employees. Thus, the need to
integrate the Aeroquip Vickers employees into Eaton's benefit structure
and our desire to offer them a defined benefit pension made the
development of a new pension design even more urgent.\3\
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\3\ Eaton's growth through acquisition is a trend that has
continued. Just last year, we acquired Powerware, a company with over
1,100 U.S. employees and a frozen pension plan. Because of this
acquisition, all former Powerware employees regained pension coverage
by participating in the Eaton Personal Pension Account.
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KEY CONSIDERATIONS
We considered several options for a new pension design, including a
final average pay plan, a cash balance plan, and a pension equity plan
(the other primary variety of hybrid pension plan). We also considered
a defined contribution-only program (which we did not prefer, since it
lacked the security of a defined benefit plan). In the end, the
simplicity, visibility, portability, and ease with which an acquired
company could be integrated led us to choose a cash balance design.\4\
Along the way, we kept abreast of all regulatory and judicial
developments to ensure we were designing a plan that would meet the
relevant legal standards. Like most other companies that consider
switching to a hybrid plan, Eaton engaged the full range of outside
consultants and experts to do appropriate due diligence and assist us
with the conversion process.
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\4\ Once again, Eaton's reasons are consistent with those of other
employers that move to hybrid plans. Watson Wyatt Worldwide 2000, supra
note 1 at 44.
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Now that the basic hybrid designs have been called into question,
employers facing a set of circumstances similar to ours would have far
fewer options. One choice would be to stay with the traditional pension
design, which tends to deliver meaningful benefits to a relatively
small number of career-long workers, has limited value as a recruitment
device in today's marketplace and makes integration of new employees
difficult. The other alternative would be to exit the defined benefit
system and provide only a defined contribution plan, which while an
important and popular benefit offering, provides none of the security
guarantees inherent in defined benefit plans. As these alternatives
make clear, it is employees that lose out as a result of today's
uncertainty surrounding hybrid plans.
As we at Eaton analyzed our specific situation, we took into
account the needs of employees that were already in our other pension
designs. We knew that a cash balance design might not meet the needs of
every current employee in our existing traditional plans. However, we
also knew that forcing current workers to remain in their existing
traditional defined benefit plan, while working side-by-side with new
workers who earned what might be perceived as a more valuable benefit
under the new cash balance design, was also not desirable.
Once we settled on cash balance as our new ongoing design, we then
focused on the particular transition approach we would adopt. We were
aware of the diversity of transition approaches and knew that each of
these transition techniques had proven successful at addressing the
needs of particular companies' older workers. Such approaches include
grandfathering employees in the prior traditional plan, offering
employees the choice between the prior traditional and new hybrid
formulas, providing the ``greater of'' the benefits under the prior or
hybrid plan, providing transition pay credits or making one-time
additions to employees' opening cash balance accounts.
These special transition techniques are used in the vast majority
of conversions, and the variety of approaches provides the flexibility
companies need to address their unique circumstances and employee
demographics.\5\ Indeed, congressional concerns about how older and
longer-service workers are treated during conversions have been
successfully addressed by employers through the use of the variety of
transition protections.\6\
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\5\ Mellon Financial Corporation, 2004 Survey of Cash Balance Plans
11 (90 percent of employers provide special transition benefits);
Watson Wyatt Worldwide, Hybrid Pension Conversions Post-1999: Meeting
the Needs of a Mobile Workforce 4 (2004) (89 percent of employers
provide special transition benefits). Those employers that do not (and
that simply convert the prior accrued benefit into an opening account
balance without additional transition techniques) are typically
experiencing financial distress at the time of the conversions. Yet
despite their financial challenges, they are interested in retaining a
defined benefit plan that delivers meaningful benefits across their
workforce.
\6\ This discussion of conversions highlights another reason why
legislative action is so urgently needed. Many employers that have
converted to hybrid plans using these successful and generous
conversion methods have nonetheless been unable to obtain a
determination letter from the Internal Revenue Service (IRS) stating
that their plan complies with the requirements of the Internal Revenue
Code. This is due to the fact that the IRS announced a moratorium on
issuance of such letters for hybrid conversions in September 1999
pending review of some of the hybrid issues by the IRS national office.
Memorandum from the Internal Revenue Service to the EP/EO Division
Chiefs (Sept. 15, 1999). It has become clear that the IRS will not
begin issuing determination letters (for either past conversions caught
up in the moratorium or new conversions) until Congress resolves the
legal uncertainty surrounding hybrid plans. The absence of
determination letters harms both employers and employees. The
determination letter process works as a partnership between employers
and the Government to ensure that plans are maintained in accordance
with our Nation's very complex pension statutes and regulations. The
fact that this process has broken down means that employers are not
getting the definitive guidance they rely upon to operate their plans
in full compliance with the law.
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We decided that all 15,000 current non-union employees--regardless
of age or service--would be able to choose whether to remain in their
existing traditional plan or earn a pension benefit under the cash
balance formula. This choice would be effective 01/01/03. In addition,
all of the recently acquired non-union Aeroquip Vickers employees would
enter the new cash balance plan on 01/01/02, and all non-union Eaton
employees hired on or after 01/01/02 would enter the new cash balance
plan.
We should emphasize that Eaton did not introduce a cash balance
plan to reduce cost, and in fact the new plan increased costs in the
short-term, and will slightly increase plan costs in the long-term.
This is described in more detail below.
DESCRIPTION OF PLAN DESIGN
Our new cash balance design--the Eaton Personal Pension Account, or
EPPA--consists of several important features. Each participant earns
monthly pay credits based on the sum of their age and years of service
(including any service with an acquired company). These credits range
from 5 percent of pay up to 8 percent, increasing as the sum of age and
years of service increases. To reiterate, we contribute higher pay
credits to the cash balance account of older employees and those with
longer service. Indeed, providing pay credits that increase with age or
service is the typical approach in hybrid plans.\7\ Under Eaton's plan,
the pay credits accumulate, with interest based on the rate of interest
for 30 year Treasury bonds, to create the ``personal pension account.''
Our design benefits employees of a company acquired by Eaton since it
recognizes past service with that company when calculating the level of
pay credits. The cash balance design is also helpful in recruiting mid
career talent, since age (and not just service) is a component in the
calculation of pay credits. Note that we received an IRS determination
letter for this basic cash balance design in November of 2002 as it
applied to the new Eaton hires and the Aeroquip Vickers employees (none
of whom experienced a conversion).\8\ We have also received
determination letters for our other active cash balance plan and
another cash balance plan that has since been frozen due to a spin-off.
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\7\ Seventy-four percent of 146 employer respondents to a Mellon
survey provided pay credits in their cash balance plans that increased
with age or service. Mellon Financial Corporation, supra note 5 at 9.
Eighty-seven percent of pension equity plans analyzed in a recent
Watson Wyatt study provided pay credits that increased with age or
service. Watson Wyatt Worldwide 2004, supra note 5 at 2.
\8\ Due to the IRS moratorium on determination letters discussed
above, we do not have a determination letter for our core cash balance
conversion affecting Eaton employees as of 12/31/02.
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An employee who chose to switch to the new Eaton Personal Pension
Account would start with an opening account balance equal to the value
of their pension benefit under the existing traditional pension plan--
including any early retirement subsidies or supplements.\9\ Since one
of our goals with the new design was to make our pension plan easier
for employees to understand, we felt that using an opening balance
approach, as opposed to using the existing traditional formula for past
benefits and a cash balance formula for future benefits (the so-called
``A+B'' approach), was appropriate. To calculate these opening
balances, we assumed a retirement date of the later of age 62 or 01/01/
06. Employees whose prior pension formula was tied to their final pay
(this included the vast majority of the employees eligible for making
an informed pension choice) also received indexing credits on the
opening balance amount for as long as they remained active employees.
These indexing credits were based on annual changes in the Consumer
Price Index (CPI) to mimic the effect that pay increases would have had
on the employees' prior pension benefit. These indexing credits were in
addition to the ongoing interest and pay credits mentioned above. So,
each month a participant's balance would increase by pay credits,
interest credits on the prior balance (including any past pay credits),
and indexing credits (on the opening balance only).
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\9\ An early retirement subsidy in a pension plan provides a
financial bonus for employees to retire early. To provide a simple
example of a fully subsidized benefit, a worker retiring at age 55
might receive the full $1,000 per month pension benefit he would
normally only be entitled to at age 65. In other words, there is no
actuarial reduction in benefits for the early retirement date. One
thousand dollars per month for life beginning at age 55 is more
valuable than $1,000 per month for life beginning at age 65; hence the
subsidy. The subsidy declines in value if the employee remains at the
company beyond age 55 and has no remaining value if the employee works
until 65. In contrast, early retirement supplements are additional
temporary benefits payable until Social Security normal retirement age.
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Employers have taken a variety of approaches to the question of
whether to include early retirement subsidies in employees' opening
account balances. Some have chosen not to do so since it is impossible
to know at the time of conversion whether employees will actually leave
the company at a time in the future when they would have qualified for
the subsidy. Others, like Eaton, have included some or all of the value
of the subsidy in the opening cash balance account as one technique to
minimize the effect of the conversion for employees nearing early
retirement eligibility.
It is important to note that current law protects any subsidy that
an employee may have already earned at the time of a conversion. To
qualify for this subsidy, the employee must of course retire at the
retirement eligibility age. Of equal importance, current law also
allows employers to remove such incentives from their plans on a going
forward basis.
A final, but important, note regarding our plan design change is
that we made several costly changes to the existing traditional plans
as well. Our intention was to remove certain differences in the plan
designs in order to make the choice process even more equitable. For
instance, we added a non-spousal death benefit and an enhanced
disability pension provision to the traditional plans--both were
features of the new cash balance design--to ensure that an employee's
choice would not be skewed by concerns over unexpected death or
disability. We had concluded that the existing ``spouse-only'' death
benefit in our traditional plans was not meeting the needs of single
parents working at Eaton.
Along with changes in our pension plan, we also made important
changes in our 401(k) savings plan. These changes included permitting
diversification of the company stock matching contribution. The
decision to permit diversification had been made prior to news reports
of troubled company savings plans, such as Enron. Under the changes we
have adopted, all company stock matching amounts are fully
diversifiable.
INFORMED CHOICE PROCESS
After deciding on the design, and to give existing employees
choice, we had to ensure that the new plan and the choice were
communicated clearly to all affected participants. For the recently
acquired Aeroquip Vickers employees, who would be receiving a new
pension for the first time since joining Eaton, we issued Summary Plan
Descriptions, held onsite meetings, and created a Web site where
employees could model future EPPA benefits under a variety of economic
assumptions.
For the choice process, we drafted written communication materials
with the intent of satisfying--and, in fact, exceeding--ERISA section
204(h).\10\ Each employee received a detailed Decision Guide, an
individualized Personal Choice Statement, and an easy-to-read Quick
Comparison Chart. In developing these materials, we kept in mind the
high standard that had been set by Kodak--whom Senator Moynihan
publicly cited as the ``gold standard'' for hybrid conversion
communications--during its choice process, and strived to meet or
exceed it. In addition, we made continual use of employee focus group
feedback to refine these materials.
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\10\ Section 204(h) of ERISA requires employers to provide advance
notice of amendments to defined benefit plans that provide for a
significant reduction in the rate of future benefit accrual. Congress
amended section 204(h) as part of the Economic Growth and Tax Relief
Reconciliation Act of 2001 to require employers to provide a more
detailed and more understandable notice of any hybrid conversion or
other plan amendment that significantly reduces future accruals. This
reflected Congress' view that the appropriate response to the issues
that had been raised about cash balance conversions was to ensure
transparency rather than to impose benefit mandates on employers. The
Treasury Department has subsequently issued regulations carrying out
this expanded notice requirement. Notice of Significant Reduction in
the Rate of Future Benefit Accrual, 68 Fed. Reg. 17,277 (Apr. 9, 2003)
(to be codified at 26 C.F.R. pts. 1, 54, and 602).
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The Decision Guide explained, in detail, the features of the
participant's existing traditional plan and the EPPA, including details
regarding the calculation of the opening balance. This document
displayed charts of both options--the current plan and the EPPA--and
how they compared at future ages under a certain set of assumptions,
using hypothetical examples. In addition, we explained the concept of
wear-away, \11\ and graphically described the effect it could have on
employees. The Quick Comparison Chart was a side-by-side comparison of
the main provisions of each option. We should note that Eaton's
approach minimized the effect of wear-away. The inclusion of early
retirement supplements and subsidies in employees' cash balance opening
accounts, as well as the effect of indexing credits, mitigated the
effect of, and shortened the duration of, wear-away in most cases. In
fact, often it was the inclusion of early retirement supplements in the
value of the protected benefit under the existing traditional design--a
pro-employee change that is not required by law--that caused an
appearance of wear-away.\12\
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\11\ Wear-away is the benefit plateau effect that some employees
can experience incident to a cash balance conversion. When employers
change to a cash balance plan, they typically provide an opening
account balance in the cash balance account. A benefit plateau results
if the value of the employee's cash balance account is less than the
value of the benefit he accrued under the prior plan as of the time of
the conversion. Until the value of the cash balance account catches up
to the value of the previously accrued benefit, it is the higher
accrued benefit to which the worker is entitled--hence the term
``plateau.'' This benefit plateau typically results from the fact that
the prior accrued benefit includes an early retirement subsidy while
the opening account balance does not. It should be noted that wear-away
has long been approved by the Treasury Department and Internal Revenue
Service as a valid method for transitioning between benefit formulas.
\12\ Those employees who experienced a wear-away as part of the
conversion process did so only because they chose the new cash balance
formula, concluding that even with some period of wear-away the new
cash balance design was best for them.
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The Personal Choice Statement used actual individualized
participant data so that each employee could compare their estimated
future benefit accruals under each option, under a certain set of
assumptions. The data used for these statements was audited in advance
of, and in anticipation of, this project. In particular, each of the
15,000 eligible employees was asked to review and confirm or correct
their work history so that accurate service data was used for any
estimate.
After the written materials were sent out, we held over 250
educational meetings and web casts at all 100 U.S. and Puerto Rico
locations. Spouses and financial advisors of employees were also
invited to attend these meetings, which were led by independent third
party pension experts.
We also developed a Web site where employees could model
individualized scenarios based on their own differing economic
assumptions, including salary increases and interest rate assumptions.
In addition, the Choice Website contained all the educational
information that was included in the written materials.
If employees had questions, they could call the Pension Choice
Helpline, where independent third party pension experts answered
questions about the different plans and ran individualized comparisons
on the spot. If there was a question that the Pension Choice Helpline
representatives could not answer, we made sure the employee was
connected to someone at Eaton who could answer his or her question.
If an employee did not make a choice, he or she remained in his or
her existing traditional plan. In addition, we permitted employees to
make a one-time change in their initial choice during a ``grace
period.''
THE RECEPTION
At the end of the day, we wanted to make sure that all participants
had enough information to make an informed choice. Based on the
overwhelmingly positive reaction we received from employees, we believe
we accomplished that goal.
Across the board, employee reaction was very positive regarding the
pension choice process. The vast majority of employees said that the
materials provided helped them make an informed decision. In fact,
employee feedback indicates that this process helped employees
understand their existing traditional pension plan as well as the new
cash balance option. In addition, we received many comments that this
process only strengthened the trust that existed between Eaton and its
employees. We received no letters of complaint and encountered no
disruption in daily business operations during the conversion process.
In the end, about one-third of eligible employees chose the EPPA.
The breakdown by age and service went as expected. Of the employees
more than 20 years away from retirement, over 60 percent elected to
switch to the EPPA. Of the employees at retirement age or within 10
years of retirement, over 80 percent elected to remain in their
existing traditional pension plan. However, there were several
instances where, after modeling personalized scenarios and reviewing
examples in the Decision Guide, employees close to or at retirement
eligibility chose the EPPA. It was not unusual for the EPPA to provide
a greater benefit for a retirement-eligible employee some years in the
future, largely due to the inclusion of early retirement supplements
and subsidies in the opening balance and the application of indexing
credits. Had we kept these employees in their current pension design,
we would have deprived them of a chance to increase their pension
benefit, even at a point late in their careers. Of the employees
between 10 and 20 years from retirement, over 40 percent switched to
the EPPA.
I was in the ``in-between'' group mentioned above, and although I
chose to remain in the existing traditional plan, both benefit designs
had distinct advantages depending on my expectations regarding my
future career path. Before joining Eaton, I worked at a company where I
participated in a cash balance plan for 12 years. As a mid-career hire
at Eaton, and as a full-time working mother, it's important to me to
have retirement benefits that fit my needs. The employee reaction to
Eaton's decision to implement a cash balance plan and provide an
informed choice was overwhelmingly positive. This, along with similar
data from numerous surveys, indicates that employees understand and
appreciate the need for companies to have flexible retirement programs
that fit the needs of today's workforce.
All in all, the choice process set a new standard at Eaton for
communicating change throughout the company. However, we recognize that
choice may not be the right answer for other businesses and other
employee populations, and under different circumstances, it might have
been the wrong answer for Eaton. Some employers, for example, have
focused on grandfathering employees or pursuing a ``greater of''
approach rather than asking their employees to choose between the
plans. Other companies, while scrupulously protecting benefits already
earned (as current law requires), have been limited by economic
circumstances in the degree of special transition benefits they can
provide.
Our Coalition believes it would be extremely unwise to mandate
particular transition techniques for future conversions, as some in
Congress have proposed to do, since a broad range of methods is
available to ensure that employees are treated fairly in the transition
process. One mandated conversion method--or even several--would deny
employers needed flexibility to customize their transition approaches
to their particular workforce. Such conversion mandates--to pay the
greater of the traditional or hybrid benefits or to offer choice, for
example--also provide employees with a guaranteed right to future
benefits that have not yet been earned.
These mandates would represent a disturbing shift in the basic
norms of American industrial relations. Employee hopes or expectations
as to future benefits would be converted into explicit legal
entitlements. This profound change from existing principles suggests
that the terms and conditions of a worker's employment may not be
revised from those in existence at the time the employee is hired. Such
a regime would rob employers of the ability to adapt to changed
circumstances and would undermine the business flexibility on which
America's prosperity and robust employment are built. Presumably,
policymakers would not restrict employers from being able to alter--on
a prospective basis--their 401(k) match level or the design of their
health plan--but this is exactly the kind of restriction that mandated
conversion techniques impose. Our Coalition sees no end to the harm if
Congress goes down the path of converting expectations into legal
rights. Certainly, employers will be extremely reluctant to institute
any new benefit programs in the future, and those employers that today
do not offer pension or health plan coverage for their employees will
be extremely unlikely to do so.
THE COST
It is very important to note that Eaton did not introduce a cash
balance plan to reduce costs. In fact, the long-term ongoing cost of
the EPPA is slightly higher than the steady-State costs of the prior
pension plan designs. In addition, we incurred higher short-term costs
due to the fact that most participants maximized their benefits, and
therefore the cost to Eaton, when they made their individual pension
choice. Outside of direct plan costs, Eaton spent several million
dollars in the overall choice effort, including consulting fees,
communication materials and pension modeling tools, as well as lost
work hours due to employee meetings.
Based on press accounts about cash balance conversions, one might
expect that Eaton's cost experience is atypical. This is not the case.
Recent surveys confirm that conversions to hybrid plans typically
increase costs. Recent data from a Watson Wyatt Worldwide study
examining 55 large companies that have recently converted from
traditional defined benefit plans to hybrid plans shows that retirement
plan costs increased by an average of 2.2 percent following a
conversion.\13\ This figure further increased to 5.9 percent when seven
companies that were in severe financial distress were excluded from the
pool.\14\
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\13\ Watson Wyatt Worldwide 2004, supra note 5 at 3.
\14\ Id. In addition, conversions are often accompanied by
improvements to other benefit programs, such as 401(k) plans, bonuses,
and other post-retirement benefits. In fact, one recent survey found
that when these improvements are taken into account, 65 percent of
respondents expected the costs of providing retirement benefits
following a cash balance conversion to increase or remain the same.
Mellon Financial Corporation, supra note 5 at 15. Another survey,
conducted in 2000, also found that overall costs following a conversion
were expected to increase or remain the same in 67 percent of the
cases. PricewaterhouseCoopers, Cash Balance Notes 4 (May 2000).
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THE RAMIFICATIONS IF CONGRESS DOES NOT PROVIDE CLARITY
If Congress does not move quickly to provide legal certainty for
hybrid plans, many Americans may soon lose valuable retirement
benefits. The current legal landscape is ominous. One rogue judicial
decision has made the threat of age discrimination class action
litigation a very real concern for employers with hybrid and many other
forms of defined benefit plans.\15\ This is no longer a mere
theoretical threat as numerous employers with hybrid plans have now
been sued in copy-cat class action suits alleging that the very design
of their hybrid plans is age discriminatory. Asserted damage claims in
these suits reach astronomical figures--into the hundreds of millions
and even billions of dollars--and the potential amounts of these awards
continue to grow the longer the plans remain in effect. In Eaton's
case, the cost to modify our plan for alleged ``age discrimination'' in
its design would curtail our ability to commit funds for other
important functions, such as for research and development--and this is
for a plan that has not yet been in existence for 4 years!
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\15\ This decision, Cooper v. IBM Pers. Pension Plan, 274 F. Supp.
2d 1010 (S.D. IL 2003), held that the cash balance and pension equity
hybrid designs were inherently age discriminatory. The court concluded
that such pension designs violate the pension age discrimination
statute, which provides that the rate of a participant's benefit
accrual may not decline on account of age. The court interpreted the
pension age discrimination statute to mean that the amount of annuity
benefit received at normal retirement age for a period of service
(e.g., 1 year) cannot be less for an older worker than a younger
worker. Such a conclusion is clearly contrary to the basic ``time value
of money'' principle that a younger worker will have a longer period of
time to accrue interest, and thus will have a larger benefit amount at
retirement based on an equal contribution today. Under the Cooper
decision, any pension plan that contains a compound interest feature is
inherently age discriminatory. This misguided logic not only impugns
hybrid plans, but also contributory defined benefit plans (common among
State and local Government employers), plans that are integrated with
Social Security, and plans that provide indexing of benefits to guard
against inflation. All other Federal courts that have addressed this
issue, including those that have handed decisions down subsequent to
the Cooper case, have reached the opposite conclusion and indicated
that the cash balance design is age appropriate. Tootle v. ARINC, Inc.,
222 F.R.D. 88 (D. Md. 2004); Campbell v. BankBoston, N.A., 206 F. Supp.
2d 70 (D. MA 2002); Eaton v. Onan, 117 F. Supp. 2d 812 (S.D. IN 2000).
See also Godinez v. CBS Corp., 31 Employee Benefits Cas. (BNA) 2218
(C.D. CA 2002), afff'd, No. 02-56148, 2003 U.S. App. LEXIS 23923 (9th
Cir. 2003); Engers v. AT&T, No. 98-3660 (D. NJ June 6, 2001).
Nonetheless, a number of employers have now been sued for the alleged
discriminatory nature of their plan design based on the Cooper
decision.
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Beyond the cost in dollars, there would be increased complexity in
the administration of our benefit programs and the programs would be
harder to understand should we have to ``correct'' for the natural
effect of compound interest. Moreover, any change to our well-received
conversion process would greatly disrupt our day-to-day business
operations. If a remedy would require Eaton to redo the choice process,
there would be even more confusion, complexity and business disruption.
Worst of all, there would be a huge impact on employee morale and
employee trust. Eaton prides itself on building trust with its
employees, and we believe that the cash balance conversion experience
strengthened that trust.
Like the majority of other employers who switch to a cash balance
design, Eaton made every effort to act in ``good faith'' during our
conversion. As opposed to adopting a less costly, less secure and less
controversial defined contribution design, Eaton incurred additional
cost through the conversion process, provided a variety of
communications materials and tools, used a fair conversion method, and
minimized the effects of wear-away.\16\ Without legislative
clarification that our cash balance design is age appropriate, the
efforts we made to align our benefit structure with our business needs,
while at the same time enhancing benefits for and strengthening trust
with our employees, will have been wasted.
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\16\ As noted above, while Eaton was able to provide a generous
``choice'' conversion, it is by no means the only suitable method by
which employers can change benefit designs and does not reflect the
business realities for all companies.
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In today's economic climate, prudent business leaders seek to
minimize corporate risks not associated with the company's core
business. As you are aware, sponsorship of a defined benefit plan of
any variety entails a number of costs and uncertainties for a company,
and such costs and uncertainties are likely to increase in the coming
months as a result of legislation to reform the pension funding rules
and increase the premiums employers pay to the Pension Benefit Guaranty
Corporation. The very real litigation risks hybrid plan sponsors face
today are over and above these extremely significant costs and
uncertainties accompanying defined benefit plan sponsorship generally.
Absent congressional action to mitigate the specific risks associated
with hybrid plan sponsorship, business leaders will likely be forced to
terminate or freeze hybrid pension plans in order to limit exposure to
class-action litigation with 9 or 10 figure damage awards. Indeed, in
light of these litigation risks, a number of large U.S. employers have
already frozen their hybrid pension plans in recent months, deciding to
no longer offer any sort of defined benefit pension program to their
new hires. It should be noted that the bulk of employers that have
moved to hybrid plans have concluded that the traditional pension
design no longer meets the needs of large numbers of their current and
future employees. Thus, these employers are extremely unlikely to
return to a traditional defined benefit plan after freezing or
terminating their hybrid plan. The recent freezes by large employers
bear this out. The unfortunate freezes and terminations of recent
months will only become more widespread should legislative resolution
of the hybrid issues take longer.
Why must Congress be the one to act to clarify the validity of the
hybrid designs? First, Congress has indicated through the
appropriations process that it does not want these important policy
issues being determined by the Federal regulatory agencies. As a
result, the Treasury Department has withdrawn its proposed regulations
addressing hybrid plans and age discrimination principles, which had
the potential to settle the open issues regarding hybrid plans. Second,
final resolution of the age discrimination question by appellate courts
is years away at a minimum, too late to address the litigation risks
that are beginning to drive employers from hybrid plans and the defined
benefit system. Neither are the courts the appropriate forum to
consider the broad public-policy ramifications (for employees and their
families, for employers, and for our Nation's retirement policy) of
holding the cash balance and pension equity designs to be age
discriminatory.
In order to prevent widespread abandonment of hybrid plans by
employers--and the loss of retirement security this would produce for
millions of American families--Congress must clarify that the cash
balance and pension equity designs are age appropriate under current
law. Congress should also provide legal protection for the hybrid plan
conversions that have already taken place in good faith reliance on the
legal authorities operative at that time. Finally, should Congress
decide to establish rules to govern future conversions, our Coalition
strongly recommends that it avoid the mandates guaranteeing future
benefits that will merely accelerate employers' departure from the
defined benefit system.
Resolving the hybrid pension issues appropriately is particularly
urgent given the many challenges American families face in achieving
retirement security. With Social Security facing solvency problems that
could well result in benefit reductions, with personal savings rates at
near-historic lows, with employees bearing significant market risk in
401(k) and other defined contribution plans, with retiree medical costs
continuing to soar and with life expectancy continuing to increase, now
is precisely the wrong time to encourage employers to depart from the
hybrid pension plans that provide guaranteed, employer-funded
retirement benefits in a way that suits today's mobile workers. Yet
this is precisely what will occur if Congress does not act.
CONCLUSION
Mr. Chairman, I want to thank you once again for calling this
hearing. Legislation is the only effective way to address today's
uncertainty surrounding hybrid pension designs and prevent further
erosion of the retirement benefits of American families. Our Coalition
looks forward to working with you and members of the committee to
achieve this objective.
Thank you, again, for the opportunity to appear today. I would be
pleased to answer any questions you may have.
The Chairman. Mr. Certner?
Mr. Certner. Mr. Chairman, Senator Mikulski and members of
the subcommittee, I am David Certner, the Director of Federal
Affairs of AARP. Thank you for the opportunity to testify on
the important legal and policy issues surrounding older workers
and cash balance plans.
While cash balance plans are often called hybrid plans,
they are defined benefit plans under the law, and they must
therefore follow all the rules for defined benefit plans. AARP
has long questioned the legal basis for cash balance plans
because these plans cannot fit within all the defined benefit
plan rules. Also, there are significant age discrimination
questions that arise when employers convert a defined benefit
plan to a cash balance formula. Treasury and the IRS recognized
these problems when they placed a moratorium on conversions in
1999.
We believe that regardless of what one thinks of the cash
balance design, that a careful review of the legal distinction
between defined benefit and defined contribution plans, makes
clear that hybrid cash balance plans do not fit within the
current legal framework. The recent court decision in Cooper v.
IBM agreed that cash balance plans do not fit within current
law.
But we urge this committee to address the legal framework
for cash balance plans, and at the same time provide strong and
effective protections for older workers involved in cash
balance plan conversions.
Traditional defined benefit plans typically provide only
small benefits early in a worker's career and larger benefits
later in the career for those who devote much of their working
lives to the company. It is therefore unfair for employers that
have sponsored this type of plan to eliminate these promised,
larger late career benefits, just when longer-serving workers
are about to obtain them. But that is precisely the damage
caused by conversions of traditional pensions to cash balance
plans unless older workers are given appropriate transition
relief to address this pension pay cut, in essence that is
brought about by conversions.
Planned conversions change the rules in the middle of the
game, and older, longer service workers have the most to lose.
They generally lose out on the larger late-career benefits.
They have less time to accumulate benefits under the new cash
balance formula, and they are less able to leave their current
job if benefits are cut because they typically have fewer job
prospects.
Worker outrage, adverse publicity and legal concerns have
increasingly caused plan sponsors converting to cash balance
plans to recognize the harm to older workers and to put in
place protective transition provisions, just as we have heard
from my colleague here at the panel. We urge Congress to, in
effect, codify the better practices that many employers have
already adopted in order to protect older workers and cash
balance conversions.
AARP believes that cash balance plans can have a role to
play in the private pension system if and only if they are
designed and adopted in a manner that protects the millions of
older workers who have given up their wages in exchange for the
traditional defined benefit promise.
Provided that these protections for older and longer-
service workers can be adopted, AARP would support the
enactment of a reasonable legislative solution that would
provide the legal certainty for cash balance plans. Right now
it's not good for either employers or employees to be operating
under an uncertain legal framework.
However, Congress should not legitimize conversions that
many employers themselves have found to be unfair and harmful
to older employees. One such unfair--and again, we believe--
illegal practice because it is based on age, is the so-called
``wear-away.'' Wear-away simply means the time it takes for the
new plan formula in essence to catch up to the guaranteed
benefits under the old plan formula. Wear-away is in effect a
period of time when no new benefits can be earned and that can
last for over 10 years of time. Employers have recognized this
problem and many have taken steps to preclude wear-away. AARP
commends the most recent Treasury Department proposal to ban
any type of wear-away, and we urge Congress to do the same.
Many employers have also sought to address the large future
pension cut that is experienced by older workers by giving them
choice or by grandfathering older workers in the traditional
plan formula. These and other protections have now raised the
bar with respect to cash balance conversions in the private
sector. In any effort to clarify the law, Congress should not
now lower the bar by enacting weakening legislation that
invites the market to return to the lower standards of the
1990s. Instead, Congress needs to hold all companies that
voluntarily choose a cash balance plan to a standard that many
companies have been willing and able to meet on their own.
The cash balance format deserves protection from legal
challenge only if it protects older workers from the harm
caused by moving to that structure.
We look forward to working to finally resolve this issue
through legislation that will strengthen the defined benefit
system and protect older workers and address the legal
uncertainties surrounding cash balance plans.
Thank you.
[The prepared statement of Mr. Certner follows:]
Prepared Statement of David Certner
SUMMARY
1. AARP believes cash balance plans have a role to play in the
private pension system if--and only if--they are designed and adopted
in a manner that protects the millions of older workers who have given
up wages in exchange for traditional defined benefit pensions. Provided
that protections for older and longer-service workers can be adopted,
AARP could support the enactment of a reasonable legislative solution
that would provide legal certainty for cash balance plans.
2. Traditional defined benefit pension plan designs typically
provide only small benefits early in a worker's career, and larger
benefits later in the career for those who devote much or all of their
working lives to the company. It is therefore unfair for employers that
have sponsored this type of plan for years to pull the rug out from
under older workers by eliminating these promised larger, late-career
benefits just when long-serving workers are about to obtain them. Yet
that is precisely the damage caused by conversions of traditional
pensions to cash balance plans--unless older workers are given
appropriate transition relief to address the impact of the ``pension
pay cut'' brought about by conversions.
3. When conversions change the rules in the middle of the game,
older, longer-service workers are the most vulnerable. They generally
have less time to accumulate benefits under a new cash balance formula,
are less able to leave their current job if benefits are cut because
they typically have fewer job prospects, and are less able to adjust to
changes that may dramatically reduce their retirement security (for
example, they have less time to adjust by increasing their saving for
retirement).
4. Worker outrage, adverse publicity and legal concerns have
increasingly caused plan sponsors converting to cash balance plans to
recognize the harm to older workers and to put in place more protective
transition provisions. Congress should, in effect, codify the better
practices many employers have already put in place in order to
legitimize cash balance plans and protect older workers.
5. However, Congress should not legitimize conversions of a type
that many employers have themselves found to be unfair and harmful to
older, longer-service employees. The steps many employers have taken in
conversions to preclude wear-away of benefits and to give older workers
``choice'' or ``grandfathering'' in the traditional plan formula and
other protections have raised the bar with respect to cash balance
conversions. Congress must not now lower the bar by enacting weakening
legislation that invites the market to return to the lower standards of
the 1990s. Instead, Congress needs to hold all companies that
voluntarily choose to convert to a cash balance plan to a standard many
companies have been willing and able to meet on their own.
6. The cash balance format deserves protection from legal challenge
only if it protects older workers from the harm caused by moving to
that structure. We look forward to finally resolving this issue through
legislation that will strengthen defined benefit pension plans, protect
older workers, resume the IRS determination letter process, and address
the legal uncertainty surrounding cash balance plans.
______
Chairman Dewine, Ranking Member Mikulski, distinguished members of
the subcommittee, I am David Certner, Director of Federal Affairs, of
AARP. AARP is a nonprofit membership organization of over 35 million
persons age 50 or older, about 45 percent of whom are still working.
AARP fosters the economic security of individuals as they age by
seeking to increase the availability, security, equity, and adequacy of
pension benefits. AARP and its members have a substantial interest in
ensuring that participants have access to pension plans that provide
adequate retirement income and that the benefits accrued under a plan
are not reduced because of age.
I. WHAT ARE CASH BALANCE AND OTHER HYBRID PLANS?
Congress provided a detailed structure in defining retirement plans
under ERISA \1\ and the Internal Revenue Code (``IRC''). All retirement
plans are either defined benefit plans or defined contribution plans,
even if they have features of both. A defined contribution (or
``individual account'') plan provides an individual account for each
participant, with the benefits at retirement consisting of
contributions the employer and employees have made, plus income and
gains, and minus expenses, losses, and forfeitures. [ERISA section
3(34)]. A defined benefit plan is defined as any retirement plan other
than an individual account plan. [ERISA section 3(35)]. Traditionally,
the benefit at retirement under a defined benefit plan is based on a
benefit formula that takes into account years of service and, under
many plans, final salary or wages.
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\1\ The employee Retirement Income Security Act of 1974, as
amended.
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Recognizing that defined contribution plans and defined benefit
plans--and their methods of accruing or accumulating benefits--are
fundamentally different, Congress prescribed a different set of rules
for each (including rules governing the timing of benefit accruals,
valuation of benefits, certainty of benefit determinations, and
expression of accrued benefits).\2\ A plan sponsor may not pick and
choose which rules to follow, but must follow all the rules depending
upon the plan design selected.
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\2\ Where the statute does permit a mix of defined benefit and
defined contribution rules, it so specifies, as in the case of one type
of pension--target benefit plans.
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Cash balance pension plans (and other plans, such as pension equity
plans) are so-called ``hybrid'' plan designs.\3\ Cash balance plans are
defined benefit plans that have been designed to resemble defined
contribution plans. Instead of presenting the benefit in terms of an
annuity payable at retirement, as traditional defined benefit plans do,
cash balance plans portray a participant's benefit as a lump sum amount
that increases over time, and, in practice, pay most benefits in the
form of lump sums.
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\3\ In the interest of simplicity, this testimony limits the
discussion to the most common type of hybrid defined benefit pension
plan, the cash balance plan.
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In most cash balance plans, the benefit is defined by reference to
a ``hypothetical account.'' The hypothetical account is credited with
an annual pay credit (usually a percentage of pay, such as 5 percent of
pay each year) plus a hypothetical rate of return (usually tied to an
index, such as a Treasury bond rate) on the account balance (an
``interest credit''). As in all defined benefit plans--and consistent
with the hypothetical nature of these ``individual accounts''--the
employer contributes assets to the plan, the assets are invested for
the plan as a whole instead of earmarking particular assets or
investments for the individual accounts of particular participants, the
employer (including those to whom it delegates) manages the plan, and
the employer is permitted flexible funding. This means that, at any
given time, there may be more benefits promised in the hypothetical
accounts than there are assets in the plan.
The employer's contribution obligation depends upon its estimate of
the present value of total future benefit obligations and its
investment gains and losses, not on fixed or promised annual
contributions to individual accounts. Employers generally benefit from
the ``spread'' between what the employer promises in interest credits
and what the plan actually earns (the interest arbitrage) while
assuming the investment risk if asset returns are less than needed to
pay promised benefits. Since defined benefit plan rules allow for
flexible funding, any investment shortfall can be made up over several
years.
AARP also has long questioned the legal basis for the hybrid cash
balance formula itself (in addition to the significant age
discrimination issues that arise when employers convert defined benefit
pension plans to a cash balance formula). We believe that a careful
review of the legal distinction between defined benefit and defined
contribution plans makes clear that the most common designs for hybrid
cash balance plans do not fit within the current legal framework of the
Internal Revenue Code (IRC), the Age Discrimination in Employment Act
(ADEA) and ERISA (see Appendix A). In fact, the recent court decision
in Cooper v. IBM agreed with this legal analysis. We urge the committee
to address the legal framework for cash balance plans and provide
strong and effective protections for older workers involved in cash
balance pension plan conversions.
II. CONVERSIONS OF TRADITIONAL PLANS TO CASH BALANCE PLANS
The growth of cash balance plans has resulted mainly not from new
plan formation but from conversions of existing traditional defined
benefit plans. Employers have converted to cash balance and other
hybrid plan designs for a number of reasons, including a desire to
reduce plan costs and limit future pension obligations as the bulge of
``baby boomers'' nears retirement and hence moves through the years of
greatest pension cost to employers (and greatest pension value to
employees); to increase employee appreciation (since many employers
believe employees do not well understand or appreciate the traditional
defined benefit plan); to eliminate costly early retirement subsidies
and final average pay features; to increase pension surpluses that, in
the 1990s, often contributed to reported corporate earnings; to
redistribute benefits under the plan from older, longer-service
employees to younger and newer workers; and to achieve these objectives
without terminating the defined benefit plan and adopting a new defined
contribution plan, which often would entail income and excise taxes and
would terminate the interest arbitrage.
In general, the direct and immediate result of a conversion of a
traditional plan formula to a cash balance formula is a reduction in
future benefits for older workers. A 1998 survey by the Society of
Actuaries found that in cash balance conversions, the average benefit
reduction for an older employee was 70 percent to 85 percent of 1
year's wages, but younger workers saw a benefit increase of 10 percent
to 40 percent of 1 year's wages.\4\ Moreover, the actuaries that design
cash balance plans have been on record acknowledging that conversions
to cash balance formulas ``help employers cut pension benefits and
change retirement plans,'' especially for older workers. Ellen E.
Schultz, Actuaries Become Red-Faced Over Recorded Pension Talk, Wall
St. J., May 5, 1999, at C-1. Indeed, plan actuaries have at times
bluntly acknowledged this reality.\5\
---------------------------------------------------------------------------
\4\ Id. at 18.
\5\ In an illuminating exchange, Amy Viener, an actuary at William
M. Mercer, Inc., responded to an inquiry about whether cash balance
plans reduce benefits: ``Converting to a cash-balance plan does have an
advantage as it masks a lot of the changes. . . . You switch to a cash
balance plan where the people are probably getting smaller benefits, at
least the older-longer service people, but they are really happy, and
they think you are great for doing it. . . .'' Id. at C-19. A co-
panelist of Ms. Viener's at another meeting stated, ``It is not until
they are ready to retire that they understand how little they are
actually getting.'' Ms. Viener responded, ``Right, but they're happy
while they're employed.'' Id.
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III. HOW CONVERSIONS HARM OLDER WORKERS: THE PENSION PAY CUT THAT
BREAKS THE PENSION PROMISE
A. The General Adverse Impact on Older Workers from Conversion to a
Cash Balance Pension Plan.
For employees, the change in plan design from a traditional defined
benefit pension plan to a cash balance plan can have significant
impact. For older workers, absent transition relief, it is almost
always highly detrimental, amounting to a significant ``pension pay
cut.''
By depriving older workers--especially long service older workers--
of the benefit of their increased years of service and their peak
earning years (including any early retirement subsidies), employers who
make this dramatic change break the implicit promises made to older
workers in the traditional defined benefit pension plan. These
employees have given up wages and may have made career and retirement
decisions based upon the expectation of a certain pension benefit, only
to see that expectation disappear--replaced by the new cash balance
plan formula under which their age precludes them from earning
comparable benefits.
In addition, some older workers may suffer a wear-away period--a
period of time when no new benefits are accrued under the new plan.
Older workers thus experience a double whammy--loss of the more
beneficial defined benefit formula, as well as the lack of time to
benefit from the new plan formula (with the potential for no new
benefits at all).
B. The Specific Adverse Impacts on Older Workers from Conversion to
a Cash Balance Pension Plan.
The conversion to a cash balance plan adversely affects older,
longer service workers in at least four ways:
1. Conversion deprives older workers of the benefits derived from
long service and a higher salary they would have received in the
traditional defined benefit plan.
A traditional defined benefit plan often has a benefit formula that
is based on number of years worked and final average salary. In
addition, the annuity value is determined by number of years from
retirement age, with greater value for those closest to normal
retirement age. This final average pay benefit formula design provides
smaller value in the early years of employment, with the greatest value
coming in the last years of employment.
Because this plan is designed to benefit longer service workers,
older workers generally can accrue larger benefits under this
traditional type of formula, especially if they are long-service
workers. Younger, more mobile workers receive less from this plan
design. A younger worker covered by a traditional formula, in addition
to being many years from retirement age, generally has a lower salary
and a smaller number of years of service. The result is a small benefit
after only a few years of work. As one begins to approach retirement
age, and as one's salary and number of years in the plan increase,
benefits begin to grow more dramatically. The bulk of benefits can be
expected in the years just prior to retirement.
2.Conversion deprives older workers of early retirement subsidies
often provided in traditional plans.
The effect of increasing age and higher salary can be magnified by
eligibility for an early retirement subsidy. Many traditional defined
benefit plans include such a subsidy, generally based on a combination
of number of years of service and age. Older employees who become
eligible for these subsidies can see an additional spike in the value
of their pensions. Conversions commonly eliminate these subsidies.
3. Depending upon the conversion formula, older workers may be
subject to a significant wear-away, causing them to work for many years
before earning any additional retirement benefits.
Compounding the adverse impact of the change in benefit formula,
the benefits under the new plan, in essence, may take many years to
catch up to the benefits already earned under the old plan formula.
During this catch-up period, the employee would accrue no new benefits.
This freeze of pension accruals stands in sharp contrast to employees'
expectation that their final years of service would result in the
greatest increase in their retirement benefits.
Such a wear-away can occur if the employer designs the conversion
to give employees an ultimate pension benefit equal to the greater of
(i) their old formula benefit (earned based on service before the
conversion and fixed as of the conversion) and (ii) their cash balance
earned under the new formula. Under this ``greater-of'' approach, as
long as the frozen old formula benefit exceeds the new formula benefit,
the participant is not actually earning any additional benefits under
the plan. The participant's total benefit is effectively frozen after
the conversion until the new formula benefit grows larger than (wears
away) the old. This could take 10 years or more. In the meanwhile,
older participants suffer an age-based cessation of accruals.
A wear-away can affect participants who retire early as well as
those who retire at the ``normal retirement age'' (typically 65). This
is especially true if the old benefit formula provided a subsidized
early retirement benefit before the conversion. In such a case, a
participant who qualifies for the early retirement subsidy (before or
after the conversion) might experience a period of years after
conversion in which continued service for the plan sponsor generates no
net increase in the early retirement benefit. This freeze of early
retirement accruals would continue for as long as the new-formula (cash
balance) benefit the participant would receive at early retirement age
remains less than the old-formula benefit she would receive at that
age.
Older participants commonly will have more to lose from wear-away
of subsidized early retirement benefits than from wear-away of the
normal (typically age 65) retirement benefit. There may be more dollars
at stake, and most employees retire before age 65.\6\
---------------------------------------------------------------------------
\6\ For more information on preventing wear-away of early
retirement benefits, see Appendix B.
---------------------------------------------------------------------------
Wear-away is neither required nor necessary in a conversion. In any
event, because wear-away is always based in part on age, it runs afoul
of the prohibitions against age discrimination. A plan sponsor can, and
often does, prevent wear-away by providing that the ultimate plan
benefit is the sum of the participant's benefits accrued under the
traditional plan (the old formula frozen benefit) and the cash balance
formula. (This is often referred to as the ``sum-of'' or ``A+B''
approach.) \7\
---------------------------------------------------------------------------
\7\ Because calculation of a wear-away following a conversion is
based directly on age, it violates the pension accrual laws. ADEA
section 4(i). While age is not the only element in determining wear-
away, it is an essential element in determining the actuarial
equivalence of the earned benefit. See Appendix A.
---------------------------------------------------------------------------
4.Older workers are disadvantaged because they have fewer years in
which to accumulate significant pension amounts under the cash balance
formula.
A typical cash balance formula provides for a much larger accrual
of benefits at an earlier age than a traditional defined benefit plan.
Since a younger employee has a longer period of time before normal
retirement age, the amount in the plan's hypothetical account will
continue to earn interest credits for a much longer period of time,
leading to greater benefits. Fewer years until normal retirement age
means older workers have less compounding and thus smaller benefits.
As a result, the conversion to a cash balance formula has the
practical and substantive effect of often dramatically reducing or
ceasing accruals to the pensions of older and/or long service workers.
Older employees have reported reductions in their expected benefits in
the tens and even hundreds of thousands of dollars. In contrast,
younger mobile workers, who had accumulated little under the prior plan
design, may see a higher accrual rate.
In the early years of the traditional plan, an employee receives
small benefits in return for the promise of greater benefits as the
employee continues to work. The change in plan design to a cash balance
plan undermines completely that benefit trade-off. Older workers find
that having completed those years in the traditional plan when benefits
were small--and having now reached the stage when benefits will begin
to grow considerably--the conversion to the cash balance plan deprives
them of those expected higher benefits. These conversions give new
meaning to the term ``sandwich'' generation.
The pension laws generally prohibit plans from reducing accrued
benefits that an individual has previously earned. However, the law
does not require an employer to continue any particular plan design,
nor indeed even continue any plan, into the future. The conversion to a
cash balance plan uses this permissive nature of our voluntary pension
system in a way that undermines the expectations of employees. Despite
having worked for years under a plan design that gave small benefits at
the beginning but promised higher benefits at the end of one's career,
the same employees are suddenly switched to a pension package that
provides the very opposite. Unlike reductions in benefit formulas in
which everyone may feel the pain equally, a conversion to a cash
balance plan (absent special transition relief) produces clear winners
and losers (the losers being the older, longer-serving employees). And,
in some cases, this has been done in a manner that has masked the
actual negative effects (as discussed earlier), at least for a time.
IV. WEAR-AWAY IN A CONVERSION IS AGE DISCRIMINATORY
The wear-away period often associated with cash balance
conversions--the period of time after the conversion when no benefits
are earned--is an unlawful and impermissible reduction or cessation in
benefit accruals based on age. Because calculation of a wear-away
following a conversion is based directly on age, it violates the
pension accrual laws. While age is not the only factor in determining
wear-away, it is always an essential element. See Appendix A.
V. BETTER PRACTICES BY PLAN SPONSORS
The harm to older workers caused by cash balance conversions has
given rise to outrage on the part of older and longer-service employees
who have been affected and a higher level of awareness by other
employees, including those potentially affected by future conversions.
(In some cases, employee anger has been exacerbated by the fact that
some conversions have imposed painful reductions in future benefits--
including wear-aways on older workers--even when the plan had
substantial surplus assets, and the gains in pension surplus associated
with this ``pension pay cut'' were used to improve reported corporate
earnings and consequently increase performance-based executive pay).
The damage caused by conversions that pulled the rug out from older and
longer-serving employees has also generated considerable adverse
publicity, public and employee relations problems for plan sponsors,
and major court challenges to the legitimacy of cash balance plans and
practices.
As controversy erupted over cash balance conversions, the Internal
Revenue Service in the fall of 1999 suspended its issuance of
determination letters approving cash balance plan conversion
amendments. Treasury and IRS announced that they were reviewing the age
discrimination and associated legal issues raised by conversions, and
received hundreds of public comments.
This controversy and related developments convinced many plan
sponsors to address the transition problems raised by conversions.
While conversions in previous years were often unprotective, many
employers have more recently addressed the transition issue by
providing relief to their older, longer-service workers. More and more
companies--fearful of negative media attention and the reaction of a
more knowledgeable workforce, and concerned that their actions might be
age discriminatory or otherwise unlawful--have designed more and better
transition protection. This protection has come in a number of forms.
Many companies have simply permitted their older employees the option
of staying under the old formula, while others have automatically
grandfathered older and/or longer-serving employees in the old formula.
Some, like CSX, whose CEO at the time was Treasury Secretary John Snow,
did not apply the conversion to any existing employees. Other companies
have provided added benefit protections such as significantly higher
pay credits or opening balances for older workers. In short, many in
the private sector have responded to the problems with cash balance
conversions by raising the bar for transition protection.
VI. ACTIVITY IN THE EXECUTIVE BRANCH, CONGRESS, AND THE COURTS
In December 2002, Treasury and IRS proposed regulations that would
have given a green light to plan sponsors to again convert their
traditional plans to cash balance plans without adequate protection for
employees. (67 Fed. Reg. 76123). The proposed regulations would have
protected the cash balance design under the age discrimination and
other statutory provisions without adequately protecting participants.
The regulations had they become final would, in effect, have blessed
conversions that are not protective--thus plan sponsors would have been
less likely to offer their employees choice, grandfather employees in
the old plan formula, or use other protective practices that many
companies had already adopted. Worse yet, the regulations would have
permitted age-based wear-away periods, a practice clearly contrary to
the letter as well as the spirit of the age law, and simply bad
retirement policy.
In 2003, many thousands of individual contacts regarding the
proposed regulations were made to Treasury by workers concerned about
the impact of conversions on their pension benefits. (Over 60,000
contacts were made to Treasury and elected officials through the AARP
Web site after the proposed regulations were issued). In July 2003,
while Treasury was considering comments on its regulatory proposal, a
Federal district court ruled that the basic common cash balance plan
design impermissibly reduced the rate of benefit accrual on the basis
of age and thus violated ERISA's age discrimination provisions (Cooper
v. IBM Personal Pension Plan and IBM Corp., 274 F. Supp. 2d 1010 (S.D.
Ill. 2003)).\8\ (See Appendix A). IBM appealed the decision to the
Seventh Circuit Court of Appeals, where the appeal is still pending.
---------------------------------------------------------------------------
\8\ Other Federal Courts have ruled differently, holding that the
basic cash balance design is not age discriminatory. See Appendix A.
---------------------------------------------------------------------------
Following the IBM decision, Congress responded to Treasury's
proposed regulations by passing amendments to the Treasury
appropriations legislation that, directed Treasury and IRS to stop work
on the regulations and instead to put forward a legislative proposal
providing transition relief for older and longer-service participants
affected by cash balance conversions. In response, Treasury withdrew
the proposed regulations \9\ and made a legislative proposal (included
in the Administration's fiscal year 2005 and fiscal year 2006 budgets).
We were pleased that Treasury's legislative proposal recognized the
problem with wear-away and the unfair treatment of older workers and
recommended a ban on any wear-away of benefits at any time after a cash
balance conversion.\10\
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\9\ See IRS Announcement 2004-57, in response to Section 205 of the
Consolidated Appropriations Act of 2004, Pub. L. 108-199, which
prohibited the use of Federal funds to issue any rule or regulation to
implement the proposed regulations.
\10\ The Treasury proposal would provide that hybrid plans are not
age discriminatory and would permit cash balance plans to distribute
the participant's account balance as a lump sum provided that the plan
does not credit interest in excess of a market rate of return. The
proposal states that it is prospective only.
---------------------------------------------------------------------------
In recognition of the transition problem faced by workers, the
Treasury proposal also included a 5 year ``hold harmless'' period after
each cash balance plan conversion. This would require that each
participant's benefits under the cash balance plan for each of the 5
years after the conversion be at least as valuable as the benefits the
participant would have earned under the traditional plan had the
conversion not occurred. While the proposal is a step in the right
direction, it is not sufficiently protective of older, longer-service
workers, and it fails to reflect ongoing trends in the marketplace. In
addition, because the transition problem is largely one that impacts
older and longer service workers, any proposal can be tailored more
narrowly to protect this more vulnerable class of workers. More recent
conversions have afforded more protection to older workers. These
trends, not adequately reflected in Treasury's proposal, are further
confirmation that employers can and should do the right thing for their
employees. Instead of lowering the bar, Congress now needs to hold all
companies that voluntarily choose to convert to a cash balance plan to
a standard that many companies have been willing and able to meet on
their own.
One approach that AARP has supported was introduced by Senator
Harkin in the 108th Congress. It would require employers that convert
to cash balance plans to allow employees who are at least age 40 or
have at least 10 years of service the choice to remain under their
traditional pension formula until retirement instead of switching to
cash balance. In addition, other approaches have been discussed, such
as choice or grandfather treatment for employees whose combined age and
service exceed a specified number of ``points'' (e.g., 55).
VII. WHAT CONGRESS SHOULD DO NOW
AARP believes hybrid plans have a role to play in the private
pension system if--and only if--they are designed and adopted in a
manner that protects the millions of older workers who have given up
wages in exchange for traditional defined benefit pensions. Provided
that protections for older and longer-service workers can be adopted,
AARP could support the enactment of a reasonable legislative solution
that would provide legal certainty for cash balance plans. Legislative
protections should codify the better practices that many employers have
already chosen to follow when converting to cash balance, such as
eliminating wear-away of early as well as normal retirement benefits
and adequate grandfathering or hold-harmless protection for those
workers who are vulnerable in conversions. Treasury's proposal is a
step in the right direction. However, its 5 year hold harmless period
falls short of what would be adequate and of the better practices many
employers have followed. At the same time, the more adequate
protections could be crafted to preserve flexible options for plan
sponsors. Among other things, the protections could appropriately be
limited to a narrower class of employees than the Treasury proposal
would cover--to those employees whose age and years of service exceed a
specified level. In addition, we are open to considering other
alternatives that adequately protect older, longer-service employees.
Of course, AARP would oppose legislation that would legitimize
hybrid plans that are unfair and harmful to older, longer-service
employees. The cash balance structure deserves protection from legal
challenges only if it protects older workers from the harm caused by
moving to that structure. Now that many employers have recognized the
harm and have raised the bar by providing reasonable protections,
Congress must not now lower the bar by enacting weakening legislation
that invites the market to return to the lower standards of the 1990s.
Instead, Congress now needs to hold all companies that voluntarily
choose to convert to a cash balance or other hybrid plan to a standard
that many companies have been willing and able to meet on their own.
We look forward to working with Congress, the Administration,
employees and retirees, plan sponsors, and other stakeholders to forge
legislation that will strengthen defined benefit pension plans, protect
older workers, resume the IRS determination letter process, and address
the legal uncertainty surrounding cash balance pension plans.
APPENDIX A
CASH BALANCE PLANS VIOLATE THE AGE DISCRIMINATION LAWS BECAUSE THE RATE
OF BENEFIT ACCRUAL DECREASES ON ACCOUNT OF AGE
Cash balance plans that incorporate a uniform allocation or
interest credit rate formula--as they typically do--violate section
411(b)(1)(H) of the Code and the counterpart provisions of the ADEA and
ERISA (ADEA section 4(i) \11\ and ERISA section 204(b)(1)(H)) because
benefits accrue at a lower rate for older employees than they do for
younger employees. See Cooper v. IBM Personal Pension Plan and IBM
Corp., 274 F. Supp. 2d 1010 (S.D. Ill. 2003).\12\
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\11\ ADEA 4(i)(A), 29 U.S.C. 623(i)(A), makes it unlawful for
an employer: `` . . . to establish or maintain an employee pension
benefit plan which requires or permits (A) in the case of a defined
benefit plan, the cessation of an employee's benefit accrual, or the
reduction of the rate of an employee's benefit accrual, because of age
. . . ''
\12\ Other district courts have analyzed the issue differently. The
benefit accrued issue in the Cooper v. IBM district court decision has
been appealed to the Seventh Circuit Court of Appeals.
---------------------------------------------------------------------------
Cash balance plans reduce the rate of benefit accrual based on age
in two ways. The first is the age-based reductions in benefit accrual
rates inherent in the cash balance formula itself. This age-based
decline in accrual rates affects all employees in a cash balance plan.
The second is reductions in accrual rates suffered by older workers
under the cash balance plan when compared to the old plan (due either
to a wear-away or to the lower rate of accrual in the cash balance
plan).
Because calculation of a wear-away following a conversion is based
directly on age, it violates the pension accrual laws. While age is not
the only element in determining wear-away, it is an essential element
in determining the actuarial equivalence of the earned benefit.
Moreover, declining accrual rates in cash balance plans based on age
are the diametric opposite of the often increasing accrual rates in
traditional defined benefit pension plans. For this reason, conversions
to cash balance pension plans can have a dramatic impact on the
retirement security of older employees.
APPENDIX B
LEGISLATION SHOULD PREVENT THE POST-CONVERSION WEAR-AWAY OF EARLY
RETIREMENT BENEFITS
1. Early Retirement Wear-away Should Be Prevented By Use Of The
Sum-Of Approach For Subsidized Early Retirement Benefits.
As noted, a wear-away period can occur if, as is often the case,
the traditional defined benefit plan provided a subsidized early
retirement benefit before the conversion. In such a case, a participant
who qualifies for the early retirement subsidy (before or after the
conversion) might experience a period of years after the conversion in
which continued service for the plan sponsor generates no net increase
in the early retirement benefit because the value of the new-formula
benefit at early retirement age remains less than the value of the old-
formula benefit at that age.
Any cash balance plan legislation should make clear that this type
of wear-away period (an ``early retirement benefit wear-away'') as well
as normal retirement benefit wear-away--is prohibited. Early retirement
benefit wear-away can affect many participants in converted plans,
including those who are subject to a wear-away of their normal
retirement benefit. The harm to older workers and the age
discrimination concerns raised by the normal retirement benefit wear-
away also apply to the early retirement benefit wear-away. Moreover, an
early retirement benefit wear-away can continue long past the time when
a normal retirement benefit wear-away has ended.
The early retirement benefit wear-away can be prevented by
grandfathering or by applying the ``sum of'' (or ``A + B'') approach
described above to early retirement benefits. (This could be done in
tandem with a similar approach to normal retirement benefits or an
adequately protective ``greater of'' approach with an appropriate
opening account balance for normal retirement benefits). As a result, a
participant who retired while entitled to a subsidized early retirement
benefit under the old formula would receive the sum of that subsidized
early retirement benefit annuity and the excess of the cash balance
account over its opening account balance (in other words, the
subsidized early retirement annuity plus the increase in the cash
balance account).
Consistent with the nature of subsidized early retirement benefits,
this approach would be contingent. It would not apply unless the
participant was entitled to a subsidized early retirement benefit under
the terms of the old plan formula at the time the participant took his
or her benefit under the converted plan (whether the participant first
qualified for the subsidized early retirement benefit before or after
the conversion).
The plan sponsor could offer the participant the choice of taking
the increase in the account balance as a lump sum, as opposed to taking
it in the form of an annuity that is added to the old-formula
subsidized early retirement annuity.
2. Incorporating The Early Retirement Subsidy In The Opening
Account Balance Would Be Inappropriate.
Incorporating the value of the early retirement subsidy in the
opening account balance would violate the prohibition against age
discrimination. If the opening account balance were allowed to
incorporate the value of the early retirement subsidy from the old
formula, older participants could be given smaller opening account
balances--and also smaller lump sum distributions upon retirement--than
otherwise identical younger participants who qualify for the early
retirement subsidy. In addition, because the subsidized early
retirement benefit is contingent, including the subsidy in the opening
account balance of all participants could create substantial windfalls
for those participants who ultimately do not qualify to receive the
subsidy.
The Chairman. I want to thank all of you for your testimony
and for providing it briefly for us. Your full testimony will
be a part of the record.
I want to know some more about this wear-away. Mr.
Sweetnam, could you explain the issue and how it is different
in conversions to hybrid plans than changes made in traditional
defined benefit plans?
Mr. Sweetnam. What the wear-away is--and we call it a
benefit plateau--is where you have a protected benefit. The law
protects everything that you have accrued up until the time of
a change. So where you have that protected benefit, you are
always going to get that.
What happens sometimes when you start a new cash balance
plan, is that you will have a benefit under the new cash
balance plan that may be lower than the protected benefit. Now,
there are a couple reasons why that benefit may be lower. One
may be because of changes in interest rates because sometimes
what you do when you start off a new cash balance plan is that
you take your old benefit and convert it into a lump sum
distribution and make that your opening account balance. Well,
if the interest rates changes on the protected benefit, that
will mean that there is a wear-away. Some people call that
inadvertent wear-away.
Another thing that can happen is, is that if you have under
your protected benefit, early retirement subsidies--and an
early retirement subsidy is something where you are promising
really an increase in benefits for those people that leave
early. But that increase in benefit goes down over time as you
get closer to normal retirement age. One of the things that can
happen in wear-away is where you have set up your cash balance
benefit without including early retirement subsidy, something
that I would note that AARP thinks is age discriminatory if you
put early retirement subsidies in that opening account balance.
So here if you leave early, you may have a period of time
where that early retirement subsidy, you take that under your
old benefit formula, your old protected benefit formula, and
that might be greater than the other benefit formula.
There was a third type of wearaway which really is not used
that much, and that was where people set up that opening
account balance using a very different interest rate than the
current interest rate used to pay out benefits. Since the
current interest rate used to pay out benefits, which is based
off of the 30-year Treasury rate, it is so slow many companies
did not do that, and our testimony talks a little bit about
that.
The Chairman. Could you also cover the whipsaw theory of
liability a little bit so that we know how it affects the
employer's behavior and the employee's benefits?
Mr. Sweetnam. Whipsaw is when you decide how much the
benefit has to be paid out when you convert a benefit stream
into a lump sum distribution. The way that you--the law says
that you must calculate a lump sum distribution--is you take
the future payment stream and you discount it using the 30-year
Treasury rate. So if you were going to take an immediate
distribution from your cash balance plan, what you do is you
take the interest rate that you are guaranteeing under your
cash balance plan, use that interest rate to determine what the
benefit would be at age 65, discount that back to current using
the 30-year Treasury rate.
Well, if you use an interest rate that is different than
the 30-year Treasury rate, what you are going to have is a
benefit that is higher in doing this discounting than the
benefit that you had actually promised people.
Now, unfortunately what this does is either one of two
things. It forces employers to use as a crediting rate the 30-
year Treasury rate, which makes employees a little bit mad
because they know that the company is making more money in that
pension plan than the 30-year Treasury rate. And then, No. 2,
what it does is that if a company tries to do a good thing and
do a better interest rate crediting, what happens is that they
have to pay even more money than was actually promised.
Unfortunately, there have been three circuit court cases that
have confirmed this whipsaw theory, and I believe that it is
something that the Congress really has to address.
Mr. Certner. Mr. Chairman, I think this is a classic
example of why the hybrid cash balance plan does not fit within
the DB plan rules.
The Chairman. I got that from your testimony.
Mr. Certner. The whipsaw is exactly something----
The Chairman. I really need to ask Ms. Collier a question
here. I am sure you will get some other opportunities to speak
on it.
Ms. Collier, given what you know about the uncertainty of
the law in the hybrid plans, what do you think Eaton would have
done with its traditional plan, keep it or convert it to a
401(k) plan? If the law is not clarified soon would you
unconvert the hybrid plan and return to traditional design?
Ms. Collier. I am dreading that possibility. I can honestly
say that we would not entertain the notion of just completely
reverting the employees who converted voluntarily via our
choice program back to a traditional program. I have already
seen from peer companies in my industry and elsewhere, with the
uncertainty around cash balance plans, what employers by and
large have already started to choose to do is to freeze the
defined benefit plan and just put in 401(k) plans. I have
served as a recommendation for different firms, and people come
to me based on our experience, and they are not coming any more
asking about switching to a cash balance plan. They are all
abandoning the retirement program and just putting in the
401(k) plan.
The Chairman. Thank you. My time has expired.
Senator Mikulski?
Senator Mikulski. I want to thank all members of the panel
for their testimony.
Essentially my State represents kind of what is happening
and why there would be a need for a hybrid plan. Most of the
jobs in the Baltimore community, and even those who work for
Government were defined benefit. We are transforming ourselves
into an innovation economy. Research, technology, development,
biotech, infotech, you name it, and younger workers are very
different.
This then takes me--I could ask questions to all of you,
but, Ms. Collier, I would like to stick with you because you
actually went through this. No. 1, what do you think helped
with the whole issue of morale and also to protect you from
lawsuits around the so-called age discrimination? It is not so
much age discrimination, it is the length of time, the length
of work time issue. You could go to work, for example, in a
defined benefit plan, particularly in manufacturing, at age 20
and 30 years later you are 50, so you would be eligible for
that famous 30-years-and-out that so many workers did.
Ms. Collier. Right.
Senator Mikulski. Could you tell me, No. 1, you had good
information. What all did you do that managed the morale issue
and the information issue, and would that be lessons learned?
And would you recommend that that type of information
requirement be mandated?
Ms. Collier. Well, actually we did follow, Senator
Mikulski, some requirements that came out. When we were
designing our program, wear-away was a big issue and disclosure
was a big issue, and Congress passed a law in 2001 enhancing
the disclosure requirements. And we feel like we equaled or
exceeded those.
We also learned from past practices of other employers and
we built upon those, and I think that is a common thread
throughout industry. We had a very, very detailed communication
campaign. We had over 250 meetings at our 100 sites throughout
the country, Web sites.
Senator Mikulski. So you went over and beyond the Federal
requirement which is why people----
Ms. Collier. Yes, we did. We went over and beyond the
Federal requirement, but I think a lot of employers do
voluntarily. There is about 90 percent in a survey from Watson
Wyatt last year that would indicate that about the high 80s or
low 90s of employers do provide transition benefits.
Senator Mikulski [continuing]. Did that manage the morale
and deal with the fear issue?
Ms. Collier. It did. We did not have one complaint on our
cash balance conversion, and in fact, I think people were very
grateful for the opportunity. We had a lot of confusion within
Eaton. We used to be strictly in the automotive and truck
industry and we are in five businesses.
Senator Mikulski. I understand. Let us go to the so-called
length of time possible discrimination issue, and then the
concern over real lawsuits, the copycats, etc. That is why
people are bailing out of hybrid and going to 401(k) because
they do not have to deal with it. Is that right?
Ms. Collier. Yes. And I think----
Senator Mikulski. But here is my question, which is how did
you deal with it? What did you do to be able to deal with these
two different types of pensions now, and how did you deal with
the older employees?
Ms. Collier [continuing]. The older employees, we did not
want to preclude them, because our transition methodology was
choice. And I have been involved in others where it was
transition credits or grandfathering or a variety of
techniques. But because ours was choice we did not want to
preclude the older employees from choosing into the cash
balance plan.
Senator Mikulski. Well, walk me through the case study.
Could your workers actually--they could choose to stay with
the----
Ms. Collier. Stay in their plan, and we had 5 or 6
different plans that they were already in, or they could choose
into. It was a one-time option to choose into the cash balance.
Senator Mikulski [continuing]. Let me ask it in my own way.
Ms. Collier. OK.
Senator Mikulski. For those who had been 20 years, they
could choose to stay in the defined benefit or whatever was the
version of those 5 plans, or they could transfer into the new
plan.
Ms. Collier. Yes.
Senator Mikulski. And that was up to them. But once you
made your choice, that was it. You could not say, whoops or----
Ms. Collier. No. But in order to prevent the whoops we had
individualized packages, we had Web sites that you could model
your own interest rates. We fully disclose the wear-away and
the impact of it in meetings and individually on people's
statements and hypothetically.
Senator Mikulski [continuing]. How did you deal with the
issues on which lawsuits are usually done? Was it because you
offered choice, or how did you deal with it economically?
Ms. Collier. Well, the lawsuits at the time we were looking
at the plan actually were coming down in favor of the plans not
being age discriminatory, but obviously we looked at those, and
we felt that choice and heavy disclosure would prevent us from
being exposed to lawsuits.
Senator Mikulski. And has your legal counsel advised you
that then under current law that would be compliant, or are you
scared that in the absence of better legal clarification and
some of the recommendations that we would hope to build on a
consensus.
Ms. Collier. We are very concerned about absent legal
requirements and legal clarification.
Senator Mikulski. So in other words, we could end up
penalizing the good guys.
Ms. Collier. Absolutely.
Senator Mikulski. Which is the 401(k). You are kind of on
your own. In some companies it is almost Darwinian, but here
you are trying to have the benefits of protecting one school of
thought or approach to work, and then as well as the new
workers who will be portable?
Ms. Collier. Yes.
Senator Mikulski. Yet you feel that because the hybrid
plan, even though they say they might move in 4 or 5 years,
there would be now a stake in them staying because you have a
good pension.
Ms. Collier. Right.
Senator Mikulski. And it is clear and in some ways you have
the information about what to expect.
Ms. Collier. Yes.
Senator Mikulski. What you are worried about, that for
these efforts to accommodate the new economy, you could be
penalized because we have an outdated framework.
Ms. Collier. Absolutely, and we were making our decisions
in good faith based on a lot of legislative guidance that was
out there at the time, and we had actually received a
termination letter on our plan. We received that prior to the
choice process. So we had a lot of guidance that would indicate
we were within legal boundaries.
Senator Mikulski. Thank you.
And I appreciate--for the men there, it was excellent, but
I am kind of a case study person and this was very helpful to
me. Thank you.
The Chairman. Senator Isakson?
Senator Isakson. If I can, I want to follow up with Ms.
Collier for a second. Evidently Eaton had made a number of
acquisitions, so how many different defined benefit plans did
Eaton have?
Ms. Collier. That were involved in the conversion, we had
6, and then we have about 15 represented plans including two
multi-employer plans.
Senator Isakson. When you made this acquisition of the
company that had 5,000 employees who had no plan, that was kind
of the trigger to say, hey, we need to take a look at what we
are going to do--we are a growing company--for the future. And
that is when you created the choice and the cash balance
option. So the other 5 plans, people had the choice, if they
were vested in any of those 5 plans, to stay in that plan----
Ms. Collier. Actually, even if they were not vested.
Senator Isakson [continuing]. Even if they were not vested
they had the choice of staying in that plan or opting out cash
balance; is that correct?
Ms. Collier. Correct.
Senator Isakson. Mr. Certner, I want to ask you a question,
and I want to try and frame this in the right way because I
think it gets to the heart of this issue. Eaton was a growing
concern from a relatively small business to what anybody would
consider to be a significant national company, large number of
employees, multiple State, etc, and in those acquisitions and
in the different plans it finally found itself in a position
where it wanted to centralize its benefit plan, create a
mechanism where it was as fair and uniform as possible for both
new acquirees as well as older people.
In your statements about the issue on age discrimination
and defined benefit plans you kept referring to expectations of
employees. Now here is my question. It sounds to me like Mrs.
Collier's company, Eaton, by offering choice, allowed anybody
who had earned any level of defined benefit to have the choice
to keep it or have the choice to go out, but did not allow
anybody to be guaranteed expectations if they had done other
things. I guess what I am saying is on this whole age
discrimination issue and on the whole issue of benefits, it
seems like we have to deal with what people should expect,
reasonably expect, and what companies should be able to expect
to be able to deal with changing times. I would like for you to
address that for a second.
Mr. Certner. If I understand what Eaton has done, which is
basically to give all of the employees choice of which plan to
go into, we have no problem as a matter of policy with that
kind of decision. We think a cash balance plan is a legitimate
plan design that a company may wish to choose as a matter of
policy, and as long as the older workers are protected--I think
they even went beyond that by providing it to all workers--then
we do not have any problem with that as a matter of policy.
Of course what I have said earlier, and I think what the
courts have said, is that, regardless of what we may think is a
good policy, that we are still dealing with the law today and
we think the law basically is saying that these hybrid cash
balance plans do not exist under the framework that we
currently have today, but as a matter of policy we think it is
appropriate to change that framework to make sure that we can
do plans like cash balance plans in the future, so long as we
are doing what we did in our company, which is to protect the
old workers, to let them stay in the old plan if they wanted
to. That way you can adapt your plans to changing times while
still protecting the people who have already put a lot of years
into a plan where really in the traditional plan context, you
do not earn a whole lot in those early years in the plan, and
so if they are protecting them by keeping them in the plan, we
have no problem with the policy that has been accomplished by
her company.
Senator Isakson. It seems to me, continuing on that theme
for a second, it seems to me that we are at a point of where we
are going to go one direction or another. We do not have the
luxury of much time. We have to deal with the Cooper v. IBM
case. We have to deal with that one way or another. Second, we
have to deal with the reality of what is happening in the
workplace, and I am dealing with it in terms of aviation
pensions right now.
It seems like to me that if we can provide companies with
the ability to preserve benefits to the maximum extent possible
and make conversions for the future so there is an option for
defined benefits, we are far better off than if we take a
position that because current law says X based on
interpretation, we are going to force all plans to go into just
401(k) type plans. If we take your testimony out to the Nth
degree in terms of what we did here in Congress, would we not
more or less, based on what Mr. Sweetnam and Ms. Collier said,
be in a position where everything is going to be just defined
contribution plan and there will be no defined benefit plans?
Mr. Certner. Yes, and we do not think that would be a good
approach, and so the cash balance concept is not a bad idea as
a matter of policy. It does have a number of benefits we think
for employers. As long as we deal with the transition issue for
employees who are currently under the traditional plan we think
we can make this work, and we think we can create a good
statutory framework and amend the law to make sure that cash
balance plans are legal, are not subject to challenge at the
same time that we protect the older workers' benefits.
Senator Isakson. I see my time is up. I will yield back.
The Chairman. Senator Kennedy?
Senator Kennedy. Thank you, Mr. Chairman. I want to thank
our Senators Mikulski and DeWine for helping so much in
chairing this hearing this morning, and I thank you as well for
the focus and attention you have given this issue previously.
Our general roundtable was enormously helpful and valuable, and
your working with the Finance Committee, all of us hope that we
can work together. We do have some shared responsibility, and I
thank all of those who have worked to bring us to this point.
We have some important meetings that are coming down the road
next week, next Thursday I believe.
I think all of us were struck this morning when we saw in
the Post and the major report in the New York Times as well
about the pension plans falling further behind this whole
reporting process. I was here at the time when we passed that
ERISA in 1974 I believe. I think we are going to get a lot of
questions about that reporting. We are not getting into that,
as I understand, today, but this is just one additional feature
of a very complex but enormously important kind of issue in
terms of retirement security that I think is increasingly of
concern to workers as they have listened to the debate and
discussion on Social Security, as they see a lot of their
savings gradually disappear, the costs going up in so many
different areas, and these pensions so at risk.
I think what we have seen is what has happened with the
single pension program, and I think we heard earlier--I will
look forward to read through the testimony--about the
importance of taking action now with the multi-employer. We
have an opportunity to take action now, and with the combined
sort of recommendation of business and labor to make some very
important progress. I think the points that are being made here
again this morning by our panel are excellent and very, very
important to us.
But generally, when people start talking about pensions
their eyes glaze over when the words just come out of your
mouth, but I think what we are finding out in real terms, this
is at the heart and the soul about security for millions of
Americans, and we have to address it.
I welcome Senator Isakson mentioning about the airlines,
because we are not going to look at dealing with these kinds of
issues. We are just going to be so far behind the ball. And I
am troubled that we have not gotten some recommendations from
the administration to deal with this issue here.
I do not know, just in the time I have left, Mr. Certner,
whether you have reacted or responded to the administration's
general proposal. Have you commented on that earlier? I
apologize if you have. I do not want you--I will take the
opportunity to read on through it, but if you might want to
just use the few minutes I have left to just sort of elaborate
on it.
Mr. Certner. I think you are referring to the funding
proposal from the administration. I think we are facing a very
difficult time in the pension funding world because we are
coming out of a time period where we have had some downturn in
the market, we have lower interest rates which means
liabilities are going to be projected to be larger, and we have
had a little bit of a slower time in the economy, and so many
companies right now are finding it very difficult to make up
some of the funding shortfall that they have seen. I think some
of the numbers you probably see in that report is suggesting
that funding shortfall has really grown pretty substantially
because we have had this kind of perfect storm of events I
think that are affecting companies dramatically.
But in part, the PBGC is really designed to fill in the
gaps when these kinds of times occur. If companies did not go
under and lose some of the benefits for individuals, we would
not need a PBGC in the first place. So the fact that the PBGC
would have to step in now and then I think is anticipated. The
fact that we are going to have some bad times when there is
going to be more stress on the PBGC I think is going to be
anticipated, and I think as we move forward and try to correct
some of the funding inadequacies, we really do have to make
sure we meet that proper balance of ensuring that plans are
properly funded to pay their future benefits, but not overly
burdened so that they will want to get out of the system. I
think that is the kind of balance that we are all struggling
with right now.
Senator Kennedy. Do you favor a moratorium now, ending
pensions over a period of time till we have an opportunity to
address these issues in the Congress? Should we give some
thought to that as well?
Mr. Certner. Well, I do not know that we need to act
precipitously about matters for the PBGC. It is not an
immediate cash flow crisis. They can certainly continue to pay
benefits for years and years.
Senator Kennedy. What, have they gone from, what 23 billion
surplus to what is it now? What are the figures now?
Mr. Certner. They are in the red now. I am not sure what
the latest numbers in this report are. I mean I think that is
what you saw happen when the stock market burst, when interest
rates went down with the slower economy, you suddenly saw a
dramatic turnaround. A dramatic turnaround in the whole economy
affects the PBGC just as much as it affects the rest of the
economy, and PBGC is really seeing and experiencing the
negative effects of that economy now.
Senator Kennedy. As I understand, it is 23 billion in
deficit now at the present time. Have this panel or earlier
panels commented upon these retirement programs, the fairness
issues that have been raised? Have you talked about that at all
today? I do not know whether any of you have. I can see the
blinking red light here. Any of you have any particular,
comments about this previously, written about it, thought about
it, or have some recommendations on some of those issues which
are the basic equity issues where the workers got short shrift
and there is substantial benefit that goes to the CEOs?
Do not all jump in on that at one time.
[Laughter.]
Mr. Certner. Senator, one of the problems that employees
certainly are facing is that they obviously are not the ones
that caused the pension underfunding problem. They are now
perhaps close to retirement. They are looking and depending on
these pension plans. Many of them may be seeing dramatic
reductions in their expected pensions. There are some proposals
out there to further reduce, for example, the amounts that
individuals can take out of the plans, and I think we have to
be very cautious about what we are doing particularly to
individuals who are at or near retirement and changing their
benefit expectations, when they in essence had no control, no
responsibility over the funding of these plans.
Senator Kennedy. Thank you, Mr. Chairman. Thank you very
much.
The Chairman. Thank you.
Senator Harkin?
Senator Harkin. Thank you very much, Mr. Chairman, and
thank you for holding this hearing, Mr. Chairman. The issue of
cash balance pensions, especially conversions, is one I have
been involved in for a long, long time, and last year I called
together a number of people in this room to start meeting on
this and to try to work out a broad consensus to get over this
hump on this thing. I know my staff has had many more meetings
with some of the people here today.
I think both employee and employer groups seem to be asking
for some kind of retroactive guidance. We need a clearer
picture of rights and responsibilities, and we need to find
some common ground on which to proceed.
I have never been one opposed to cash balance plans. I want
to make that clear. Under the new kinds of work that people are
doing, and people do not sometimes stay with a company for 40
years like they used to. I mean people shift jobs a lot in our
society today, and cash balance plans answer that kind of a
need.
The real rub comes though is when you convert, and the
terrible thing that has happened to so many people by companies
converting from a defined benefit plan to a cash balance plan.
I happen to agree with whoever said that they are not--these
really are not defined benefit plans, by the way, and what
happens with wear-away.
Again, I remind people here that I had an amendment, a
sense of the Senate resolution I offered in the Senate in 2000.
It was approved overwhelmingly by the Senate, that wear-away
should not be permitted, should not be permitted. That was in
2000. So we have got to find a way that we can, if the
companies want to make the conversions, it is done fairly, but
that protects the accrued benefits of the older workers.
I think the Treasury Department, I think, is a pretty good
starting point. I want to particularly thank Secretary Snow--I
will say that publicly--for the approach set forth in their
proposal. It is a vast improvement over the proposed regulation
of December 2002. Senator Durbin and I met with Secretary Snow
in January of 2003 just prior to his confirmation vote, and he
said he had worked for fair transition rules. We talked about
the rules that they had had at the CSX Railroad from which he
had come. So I believe that Treasury's legislative proposal is
a good starting point. So again, the issue here of trying to
protect older workers.
Now, Mr. Certner, before I left to take a phone call you
were about to respond to an issue of wear-away that Mr.
Sweetnam was talking about, and I wanted to ask you to finish
your thought on that because I want to say something about it
too, but I wanted you to finish your comment on the wear-away
situation.
Mr. Certner. Thank you, Senator. I do want to thank you for
your leadership on this issue because I think some of the
actions you have taken earlier on has enabled Treasury to put
out a better more constructive proposal that we can work from.
Wear-away is based on many factors, how many years you have
worked, what the plan design is, but always age is a factor in
determining the length of the wear-away. And the law is very
clear that you cannot stop or reduce pension accruals based on
someone's age, and in a wear-away situation, clearly the older
you are, the longer your wear-away period. We have seen wear-
away periods, and these are periods in essence where you are
running in place, you are not earning any additional pension in
the plan because your benefit in the new plan still has not
caught up to what you would have gotten in the old plan. We
have seen wear-away periods that can be 15 years. These are
clearly violative of the letter and spirit of the law, and we
believe that they are illegal currently today. We are glad that
treasury has formally said we should ban all forms of wear-
away. We are glad that most companies now have moved away from
having a wear-away situation. You do not need a wear-away when
you do a conversion to a cash balance plan. But we think they
are illegal today and we would welcome the law clarifying that.
Senator Harkin. How do you feel--I will ask all three of
you, starting with Mr. Sweetnam--how do you feel about the
opportunity for older, longer-serving workers to choose between
an old and a new plan, and what would you think about what
would the period of grandfathering be that you might come up
with, Mr. Sweetnam?
Mr. Sweetnam. Well, the American Benefits Council is very
concerned about having that sort of a grandfathering provision.
Plans are voluntary, and we do not want to have a one-size-
fits-all solution. By having some sort of a mandatory
grandfather, what that is saying is that you cannot change your
plan, you as an employer cannot change your plan with regard to
those employees. Now, that is very different than being able to
change your plans in order to react to changes in the workplace
and to moving into this.
Now, we think that currently the marketplace has been
working in a way that people are reflecting, companies are
reflecting those sorts of concerns, but let the marketplace
work and let it be not one-size-fits-all, but let everybody do
what best suits their particular market.
Senator Harkin. Are you opposed to letting a person, let us
say an older worker who is aged 45 or 50, who has participated
in a plan for 20 years, and the company wants to put in a cash
balance plan. Are you opposed to having that person choose
between keeping the defined benefit plan or having to go on the
cash balance plan?
Mr. Sweetnam. I am not opposed--the Council is not opposed
to allowing that to happen. We are opposed to mandating that
happening. For example, what if you were in a situation where--
--
Senator Harkin. So then you are saying that a company can
come in, go to cash balance and force a wear-away, you are all
for that?
Mr. Sweetnam [continuing]. Senator, wear-away is actually a
concept that has been used in various other situations with
regard to changes in law that have come out of congressional
mandates. For example, caps on the amount of compensation that
you can have. When that cap was put in, Congress allowed and
the IRS mandated that one way that you could reflect this was
to do wear-away, wear-away those higher benefits. And so wear-
away is a concept that is littered throughout employee
benefits.
Senator Harkin. And congress has said, we do not want that
to happen in cash balance conversions because it is unfair.
Mr. Certner. The Treasury has proposed doing away with
wear-away.
Senator Harkin. I know that. In fact the regulation you
worked on when you were at IRS, Mr. Sweetnam, has been done
away with, and treasury has done away with that. Mr. Certner is
absolutely right on that. Treasury has moved beyond that, and
that is why I thanked Treasury because I think now we are
getting to better ground rules here, where older workers can
have some choice. I am not fixed on any period of years.
Treasury says 5. I think that may be a little bit longer. I do
not know what the proper thing is there. But we have
legislation some of us introduced that said anyone over 40 with
10 years or more of service ought to get to choose. Let them
choose which one they want.
Ms. Collier. Senator, my concern would be the law of
unintended consequences with that, because even the threat of
mandates I believe is already starting to drive employers from
the defined benefits system, and right now I have peer
companies in my competitor group that have completely stopped
their defined benefit system and gone to straight 401(k)
without any such transition requirements.
Senator Harkin. The only mandate that we are giving is the
mandate that they be allowed to choose. We are not saying which
one they have to choose, but they should be allowed to choose.
Mr. Sweetnam. But, Senator, what that does is it says that
really what you are saying is that you should either do this
one-size-fits-all or terminate your plan----
Senator Harkin. No.
Mr. Sweetnam [continuing]. --because you are not giving----
Senator Harkin. What I am saying is that if you want to go
to a cash balance plan, that is fine, but that the older
workers who have been in a defined benefit plan for a long
time, ought to be able to choose, should I stick with the plan
that I have had or go with the other one. Now, I would remind
you that Secretary Snow and the CSX Railroad, that is what they
did, and it worked out just fine, and other companies are doing
that.
Mr. Sweetnam [continuing]. What the American Benefits
Council says is that we want people to have the opportunity to
design their plans and their conversions whichever way they
want. If what you are saying is that the employer does not have
the ability to change its plan unless they do a grandfather, so
the choices to the employer are one of three under that. One,
maintain the plan which does not meet the current needs; two,
maintain the plan for a period of years, which is whatever
under your legislation is 10 years; or 3, terminate the plan
and go to a 401(k). We do not think that those should be the
options. We think that we should have much more flexibility and
that the employer community has been able to deal with this in
the marketplace to reflect their own needs, and we think that
is the way that it should be.
Senator Harkin. Maybe we are just talking past each other,
but your second point that you pointed out there, I would
define it differently than that. I would say that the employer
could switch a plan, go to a cash balance plan. But for those
older workers who could choose if they had over 10 years of
service and they were over 40 years of age, then the employer
would have two plans. They would have a plan that would be
phased out over time that would be for the older workers that
wanted to stay in defined benefit. Then they could have the
cash balance plans for the younger workers.
Mr. Sweetnam. But what that is doing is it is not giving
the employer the ability to make the change. It is putting that
decision someplace else. And what we say is having that sort of
a requirement will result in more companies deciding to get out
of the defined benefit system, because then they can make that
change. Because you are not saying that--in this legislation
you are not saying that I cannot terminate the plan. You are
just saying that if you want to move to one particular type of
plan, that you have to give choice there. But if you wanted to
terminate the plan, you have no choice, employee, you have no
choice.
Senator Harkin. Under the law right now you can terminate a
plan.
Mr. Sweetnam. That is true.
Senator Harkin. Anybody can terminate a plan. Why do they
not? Because workers will leave and go to another place to
work.
Mr. Sweetnam. Senator, I think there is a reason why it
makes sense in a conversion from a traditional plan to a cash
balance plan to give that choice that you do not do in other
circumstances, and that is because under traditional defined
benefit plans the way it works is when you are younger you have
a small accrual and when you are older you have a larger
accrual.
Senator Harkin. That is right.
Mr. Sweetnam. But in a cash balance plan it is exactly the
reverse. When you are younger you basically accrue much larger
benefits over time. When you are older you do not accrue as
much. So when you convert from one to the other, you flip the
plan design around completely, and that is why when you do that
kind of a change it is completely appropriate to have some kind
of grandfathering or choice as they realize they need to do in
Eaton to be fair, and it is not the same as in other
circumstances where you may want to make a design change in the
plan or reduce the formula.
Here you are completely flipping the formula on its head,
and it is so appropriate in that circumstance to have an
appropriate transition for the older worker. Otherwise they
lose. They get the worse parts of both plans and they can never
catch up. They will be way behind. And we have heard this from
thousands of our members. This is a very complicated issue, but
this is not an issue that we brought out to our members.
This is an issue that we heard about from all the
individuals and all the companies that were affected by this,
and you do not normally get this kind of self-created outrage
in pension plans unless people really feel wronged here, and it
is not as if these companies in many cases were on hard times
and going out of business, did not have the money. These were
companies that had very often surpluses in their plans that
were readjusting their benefits but they were creating winners
and losers in their plan and the losers were always the longer
service older workers, and that is why providing some kind of a
grandfathering choice or other kind of transition protection
makes sense in the cash balance context.
You are not mandating that the employer do anything. You
are just saying that if you choose to go this route--and you
have many routes you can go--but if you choose to go the route
of changing to a cash balance plan, here is a set of rules that
you need to follow.
The Chairman. I want to thank everybody for participating
in this. We have a vote that is already at the halfway point.
The time has been greatly extended already, and you may submit
any questions you want to either panel, and I would hope that
you would all respond timely and with the same enthusiasm and
ability that you have already demonstrated. I have a whole
bunch of questions that I would also like to ask of each of
you.
And one of the things that kind of ties both the panels
together I think is that I think the hybrid plans are actually
asking for less than the multi-employer plans, but both need
solutions and we need to work on both of them.
so with that, I will adjourn this hearing and leave the
record open so that we can submit additional questions.
Thank you all.
[Additional material follows.]
ADDITIONAL MATERIAL
Prepared Statement of the American Society of Pension Professionals and
Actuaries
The American Society of Pension Professionals & Actuaries (ASPPA)
appreciates the opportunity to submit our comments to the Senate
Health, Education, Labor and Pensions (HELP) Committee on reforming
cash balance or similar hybrid defined benefit pension plans.
ASPPA is a national organization of approximately 5,500 retirement
plan professionals who provide consulting and administrative services
for qualified retirement plans covering millions of American workers.
ASPPA members are retirement professionals of all disciplines,
including consultants, administrators, actuaries, accountants, and
attorneys. Our large and broad-based membership gives it unusual
insight into current practical problems with ERISA and qualified
retirement plans, with a particular focus on the issues faced by small
to medium-sized employers. ASPPA's membership is diverse, but united by
a common dedication to the private retirement plan system.
ASPPA commends the Senate HELP Committee for examining the issue of
hybrid plans. These plans constitute vital and powerful tools for
building a stronger and more effective national retirement system.
THE IMPORTANCE OF A DEFINED BENEFIT PLAN SYSTEM
The importance of promoting defined benefit plan coverage for our
Nation's workers cannot be overstated. There are approximately 80
million working Americans who are not covered by a defined benefit
plan. This represents 75 percent of our private workforce not covered
by a plan that provides guaranteed benefits. The lack of defined
benefit plan coverage is even more acute among small business workers.
Less than 2 percent of the 40 million workers who are employed at firms
with less than 100 employees are covered by a defined benefit plan.
The Americans not covered by a defined benefit plan will not have
their benefits affected by a cash balance ``conversion'' since they are
not currently covered in a defined benefit plan to begin with. They
work at companies that you have never heard of, companies that do not
have commercials on TV, but companies that will lead our economic
recovery. Don't these workers at these companies deserve a chance at a
more secure retirement?
Some of these workers, if they are fortunate enough, at least have
been covered by a defined contribution plan, such as a 401(k) plan.
However, 401(k) plan benefits, unlike defined benefit plans, are
completely dependent on the amount contributed and are affected by
investment income and expenses.
Due to recent declines in the stock market, millions of American
workers relying solely on 401(k) plans have been forced to delay
retirement or seriously reevaluate their retirement standard-of-living
expectations. The effect is more than just not being able to buy that
dream retirement home. It can be the difference between being able to
afford adequate long-term care or needed, but expensive, prescription
drugs. These unfortunate consequences would have been greatly
diminished if these Americans had been covered by a defined benefit
plan providing guaranteed retirement benefits not subject to the whims
of investment markets.
Defined benefit pension plans provide a guaranteed monthly
retirement benefit for employees. This annuity benefit continues for
the life of the worker and cannot be exhausted. 401(k) plan benefits,
on the other hand, are not guaranteed. Ultimately, the level of
benefits from a 401(k) plan and the length of time they continue to be
paid are unknown to the retiree. Without increased defined benefit plan
coverage, as Americans live longer than ever before, there is a greater
risk that many Americans will outlive their retirement savings.
Faced with defined contribution plan account losses, a cash balance
plan funded with employer contributions and with a guaranteed rate of
return is an attractive option in today's market. Any worker covered
only by a defined contribution plan would welcome the prospect of
coverage under an employer-funded cash balance plan that provides more
certainty.
CASH BALANCE GUIDANCE NEEDED
For better or worse, the last and best hope for promoting new
defined benefit plan coverage is cash balance or similar hybrid plans.
The good news is that there are thousands of businesses throughout the
country who, in light of current developments in the stock market,
might be interested in adopting a defined benefit plan such as a cash
balance plan for their workers. Such plans could potentially cover
millions of American workers. However, there are a number of
significant legal uncertainties associated with cash balance plans
because of the way benefits are accrued and distributed when compared
to traditional defined benefit pension plans. Employers face
uncertainty over how age discrimination rules apply to cash balance
plans. Although these issues are technical in nature, they are critical
to the legal operation of the plan.
Unlike their larger counterparts, small and mid-sized businesses
cannot afford high-priced lawyers to provide legal opinions to help
sort through the various unanswered questions. Until all of the
important legal uncertainties surrounding cash balance plans are
resolved in a clear and unambiguous way, small and mid-sized companies
will refrain from offering these valuable defined benefits to
employees.
Ironically, according to a survey published in PLANSPONSOR
magazine, interest in defined benefit plan coverage among employees has
increased by 20 percent as employees find it difficult to manage their
401(k) plan accounts. However, small and mid-sized businesses are no
longer interested in traditional defined benefit plans because of their
inherent funding uncertainties and because employees simply do not
understand them. Cash balance plans can provide employers with more
predictable funding requirements and, because of their ``account-
based'' nature, they are often more appreciated by employees.
ASPPA is focused on employees currently without a defined benefit
plan. Faced with consistent 401(k) plan account losses, a cash balance
plan funded with employer contributions and with a guaranteed rate of
return looks pretty good right now. Any worker covered only by a 401(k)
plan would welcome the prospect of coverage under a cash balance plan
funded by the employer and certainty respecting investments. In fact,
putting aside the issue of ``conversions,'' no rational or cogent
policy argument can be made that workers without any preexisting
defined benefit plan are also better off without a cash balance plan.
ASPPA understands, nevertheless, that there are important issues
applicable to conversions that must be resolved. However, we believe
that because of the important role cash balance or other hybrid plans
will play in the creation of new defined benefit plans, Congress should
separately address issues surrounding conversions from defined benefit
to cash balance plans. The goal should be to provide the 80 million
working Americans with no defined benefit plan the opportunity for a
more secure retirement.
Given all of the competing interests striking the appropriate
balance is not an easy task. We commend you for your efforts and urge
you to stay the course.
SUMMARY
Any legislative or regulatory policy must keep in mind the vital
role defined benefit plans play in providing working Americans with a
more secure retirement. Account-based defined benefit plans, like cash
balance plans, constitute vital and powerful tools for building a
stronger and more effective private retirement system. ASPPA believes
that legislation clarifying the legal status of cash balance or other
hybrid plans will most certainly lead to a significant number of new
plans, particularly among small and mid-sized employers, providing
defined benefits to employees who have never before had such benefits.
ASPPA urges Congress to enact hybrid legislation as rapidly as possible
so that millions of working Americans at small and mid-sized companies
nationwide have the opportunity to achieve a secure retirement future.
Prepared Statement of UPS
UPS is pleased to submit this statement in support of the Multi-
Employer Pension Plan Coalition's proposal. This legislation draws from
the work product of a large coalition of employers, organized labor,
pension plan trustees, actuaries and trade associations that have
worked for months to develop proposed legislation that protects the
long term benefits of workers participating in Multi-Employer Pension
Plans (MEPP's).
UPS believes that this legislation is a balanced solution that
meets the key criteria for addressing outdated pension rules: it
effectively corrects the funding problems of MEPP's, it ensures that
employers properly fund their pension promises on behalf of workers,
and it protects taxpayers by setting up early warnings and safeguards.
As part of that broad-based Coalition, and on behalf of over
127,000 active UPS employees participating in these plans to help
secure the legislation's enactment, UPS wants to be on record in
support of the Proposal.
The key elements in the Multi-Employer Pension Plan title of the
Proposal provide the following:
Stricter Funding Requirements for Benefit Increases: Plans
will be subject to stricter funding levels that limit the trustee's
ability to increase benefits if the plan is not properly funded.
Transparency and Employer Contributions: Trustees must
notify all participants if their plan is significantly under funded and
employers must increase their contributions to help improve the funding
levels.
Strong Reliance on Collective Bargaining: The
contributions to the plan, and benefits received from the plan, will
remain part of the collective bargaining process.
New Powers for Managing the Plans: The plan's trustees
will be granted the tools to balance plan assets and promised future
benefit payouts. It is important to note that vested benefits are not
required to be cut. However, a limited power to make necessary
adjustments to those benefits will now rest with the union and employer
designated trustees of a plan. That authority is but one of several
tools which would be provided to trustees to avert greater risks to
workers' pensions.
In many ways, the trustees of MEPP's are called upon to provide the
same type of protections that are assigned to the Pension Benefit
Guarantee Corporation (PBGC) for single-employer pension plans. This
legislation now gives MEPP trustees the needed authority to address
problems early-on. Such early responses will help avoid the need for
later PBGC intervention and taxpayer-provided relief.
UPS commends its partners in the Coalition for their spirit of
cooperation and compromise. The product of those efforts is a balanced
and reasonable solution for a serious problem. UPS will continue to
work with the Coalition to ensure enactment of the Proposal this year.
For further information regarding UPS's position on this
legislation, please contact Marcel Dubois at 202-675-3345.
[Whereupon, at 12:09 p.m., the subcommittee was adjourned.]