Private Pensions: Changing Funding Rules and Enhancing Incentives
Can Improve Plan Funding (29-OCT-03, GAO-04-176T).		 
                                                                 
Over the last few years, the total underfunding in the		 
defined-benefit pension system has deteriorated to the point	 
where the Pension Benefit Guaranty Corporation (PBGC), the	 
federal agency responsible for protecting private sector defined 
benefit plan benefits, estimates that total plan underfunding	 
grew to more than $400 billion as of December 31, 2002, and still
exceeded $350 billion as of September 4, 2003. PBGC itself faced 
an estimated $8.8 billion accumulated deficit as of August 31,	 
2003. Deficiencies in current funding and related regulations	 
have contributed to several large plans recently terminating with
severely underfunded pension plans. This testimony provides GAO's
observations on a variety of regulatory and legislative reforms  
that aim to improve plan funding and better protect the benefits 
of millions of American workers and retirees while minimizing the
burden to plan sponsors of maintaining defined-benefit plans.	 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-176T					        
    ACCNO:   A08780						        
  TITLE:     Private Pensions: Changing Funding Rules and Enhancing   
Incentives Can Improve Plan Funding				 
     DATE:   10/29/2003 
  SUBJECT:   Federal funds					 
	     Funds management					 
	     Pension plan cost control				 
	     Program management 				 
	     Retirement pensions				 
	     Strategic planning 				 

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GAO-04-176T

United States General Accounting Office

GAO Testimony

Before the Committee on Education and the Workforce, House of
Representatives

For Release on Delivery Expected at 10:30 a.m. EST

Wednesday, October 29, 2003 PRIVATE PENSIONS

    Changing Funding Rules and Enhancing Incentives Can Improve Plan Funding

Statement of Barbara D. Bovbjerg, Director, Education, Workforce, and Income
Security Issues

GAO-04-176T

Highlights of GAO-04-176T, a report to the Committee on Education and the
Workforce, House of Representatives

Over the last few years, the total underfunding in the defined-benefit
pension system has deteriorated to the point where the Pension Benefit
Guaranty Corporation (PBGC), the federal agency responsible for protecting
private sector defined benefit plan benefits, estimates that total plan
underfunding grew to more than $400 billion as of December 31, 2002, and
still exceeded $350 billion as of September 4, 2003. PBGC itself faced an
estimated $8.8 billion accumulated deficit as of August 31, 2003.
Deficiencies in current funding and related regulations have contributed
to several large plans recently terminating with severely underfunded
pension plans.

This testimony provides GAO's observations on a variety of regulatory and
legislative reforms that aim to improve plan funding and better protect
the benefits of millions of American workers and retirees while minimizing
the burden to plan sponsors of maintaining defined-benefit plans.

October 29, 2003

PRIVATE PENSIONS

Changing Funding Rules and Enhancing Incentives Can Improve Plan Funding

Recent terminations of severely underfunded pension plans suggest that
current funding rules do not provide adequate mechanisms for maintaining
adequate funding of pension plans. Funding inadequacies place the
retirement security of millions of American workers and retirees, along
with PBGC, at risk. While external factors, such as falling stock prices,
low interest rates, and slow economic growth, have contributed to
widespread pension underfunding, the defined-benefit system also faces
structural problems that extend beyond cyclical economic conditions.
Stagnant growth of the defined-benefit system, along with several large
recent terminations of underfunded pension plans, has left PBGC in a
precarious financial condition as the insurer of pension benefits.

There are two general approaches to funding reform that may improve the
funding of defined-benefit pension plans. The first approach would change
the funding requirements directly. These measures could address reforms to
the use of termination liability instead of current liability, additional
funding requirements, and lump-sum distributions. The second, more
indirect approach would seek to improve plan funding by providing better
incentives for sponsors to keep their plans better funded. Options in this
category could include requirements broadening the disclosure of plan
investments and termination liability information to plan participants and
their representatives. These reforms, as part of a comprehensive package,
could increase the likelihood that workers and retirees receive promised
benefits, while not creating an undue regulatory or financial burden on
sponsors.

Recent unfavorable economic conditions have contributed to widespread
underfunding and conspired to place well-meaning plan sponsors in
difficult positions. Although comprehensive reform should include
improving plan funding as the key vehicle to stabilize the long-term
health of the defined-benefit system, Congress may seek to balance
improvements in funding and accountability against the short-term needs of
some sponsors who may have difficulty making plan contributions.

www.gao.gov/cgi-bin/getrpt?GAO-04-176T.

To view the full product, including the scope and methodology, click on
the link above. For more information, contact Barbard D. Bovbjerg at (202)
512-7215 or [email protected]..

Figure 2: Total Underfunding in PBGC-Insured Single-Employer Plans,
1980-2003

Dollars in billions 400

350

300

250

200

150

100

50

0 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Source: PBGC.

Note: Figure for 2003 is an estimate, as of September 4, 2003.

Mr. Chairman and Members of the Committee:

I am pleased to be here today to discuss improving the funding of
single-employer defined-benefit plans.1 As all of you are aware, this is a
crucial issue threatening the retirement security of millions of America's
workers and retirees. Underfunded plans sponsored by weak or bankrupt
employers have drained the financial resources of the Pension Benefit
Guaranty Corporation (PBGC), the backstop federal agency that insures the
benefits promised by these plan. PBGC's single-employer insurance program
currently faces an estimated deficit of $8.8 billion as of August 31,
2003, following the largest 1-year loss in the agency's history. This
deficit could likely increase during the next few years, with PBGC
estimating that by the end of fiscal year 2003, total underfunding in
financially troubled firms could exceed $80 billion.2 We believe that an
appropriate comprehensive policy response can stabilize the funding of
these pension plans, thereby protecting workers' benefits for the
foreseeable future. Reforming the rules that regulate how sponsors fund
their pension plans is an essential part of this response. I hope my
testimony will help clarify some of the key issues as the Congress and the
relevant agencies choose how to respond to these serious financial
challenges. As you requested, I will discuss some options to improve the
funding status of defined-benefit plans.

1A defined-benefit plan promises a benefit that is generally based on an
employee's salary and years of service. The employer is responsible for
funding the benefit, investing and managing plan assets, and bearing the
investment risk. In contrast, under a defined contribution plan, benefits
are based on the contributions to and investment returns on individual
accounts, and the employee bears the investment risk. There are two
federal insurance programs for defined-benefit plans: one for
single-employer plans and another for multiemployer plans. Our work was
limited to the PBGC program to insure the benefits promised by
single-employer defined-benefit pension plans. Single-employer plans
provide benefits to employees of one firm or, if plan terms are not
collectively bargained, employees of several unrelated firms.

2According to PBGC, for example, companies whose credit quality is below
investment grade sponsor a number of plans. PBGC classified such plans as
reasonably possible terminations if the sponsors' financial condition and
other factors did not indicate that termination of their plans was likely
as of year-end. See PBGC 2002 Annual Report, p. 41. The independent
accountants that audited PBGC's financial statement reported that PBGC
needs to improve its controls over the identification and measurement of
estimated liabilities for probable and reasonably possible plan
terminations. According to an official, PBGC has implemented new
procedures focused on improving these controls. See Audit of the Pension
Benefit Guaranty Corporation's Fiscal Year 2002 and 2001 Financial
Statements in PBGC Office of Inspector General Audit Report,
2003-3/23168-2 (Washington, D.C.: Jan. 30, 2003).

To identify the types of reform that may improve funding for
defined-benefit (DB) pension plans, we reviewed proposals for reforming
the single-employer program made by the Department of the Treasury, PBGC,
and pension professionals. We also discussed with PBGC officials, and
examined annual reports and other available information related to the
funding and termination of three pension plans: the Anchor Glass Container
Corporation Service Retirement Plan, the Pension Plan of Bethlehem Steel
Corporation and Subsidiary Companies, and the Polaroid Pension Plan. We
selected these plans because they represented the largest losses to PBGC
in their respective industries in fiscal year 2002. PBGC estimates that,
collectively, the plans represented over $4 billion in losses to the
program at plan termination. At the request of this committee, we will
release a report at the end of this month on the financial condition of
the PBGC single-employer pension program and related issues of pension
plan reform.

To summarize my responses, there are two general approaches to funding
reform that may improve the funding of defined-benefit pension plans. The
first approach would change the funding requirements directly. These
measures could encompass reforms to the use of current and termination
liability in plan funding calculations,3 additional funding requirements,
credit balances, unfunded benefits or benefit increases, and lump-sum
distributions. The second, more indirect approach would seek to improve
plan funding by providing better incentives for sponsors to keep their
plans better funded. Options in this category could include requirements
broadening the disclosure of plan investments and termination liability
information to plan participants and their representatives, the
restructuring of PBGC's variable-rate premium to incorporate risk factors
other than the level of underfunding, and making modifications to certain
guaranteed benefits that could decrease losses incurred from underfunded
plans. Reforms adopted to directly change the funding requirements or
improve plan funding through providing incentives for sponsors are not
mutually exclusive, and several variations exist within each reform
option. These reforms, taken separately or in coordination, could increase
the likelihood of plans receiving adequate funding to ensure that workers
and retirees receive promised benefits.

3A plan's termination liability measures the value of accrued benefits
using assumptions appropriate for a terminating plan, while its current
liability measures the value of accrued benefits using assumptions
specified in applicable laws and regulations.

Background

Before enactment of the Employee Retirement and Income Security Act
(ERISA) of 1974, few rules governed the funding of defined-benefit pension
plans, and participants had no guarantees that they would receive the
benefits promised. When Studebaker's pension plan failed in the 1960s, for
example, many plan participants lost their pensions.4 Such experiences
prompted the passage of ERISA to better protect the retirement savings of
Americans covered by private pension plans. Along with other changes,
ERISA established PBGC to pay the pension benefits of participants,
subject to certain limits, in the event that an employer could not.5 ERISA
also required PBGC to encourage the continuation and maintenance of
voluntary private pension plans and to maintain premiums set by the
corporation at the lowest level consistent with carrying out its
obligations.6

Under ERISA, the termination of a single-employer defined-benefit plan
results in an insurance claim with the single-employer program if the plan
has insufficient assets to pay all benefits accrued under the plan up to
the date of plan termination.7 PBGC finances the unfunded liabilities of
terminated plans partially through premiums paid by plan sponsors.
Currently, plan sponsors pay a flat-rate premium of $19 per participant
per year; in addition, some pay a variable-rate premium, which was added
in

4The company and the union agreed to terminate the plan along the lines
set out in the collective bargaining agreement: retirees and
retirement-eligible employees over age 60 received full pensions, and
vested employees under age 60 received a lump-sum payment worth about 15
percent of the value of their pensions. Employees whose benefit accruals
had not vested, including all employees under age 40, received nothing.
James A. Wooten, "The Most Glorious Story of Failure in Business:' The
Studebaker-Packard Corporation and the Origins of ERISA." Buffalo Law
Review, vol. 49 (Buffalo, NY: 2001): 731.

5Some defined-benefit plans are not covered by PBGC insurance; for
example, plans sponsored by professional service employers, such as
physicians and lawyers, with 25 or fewer employees.

6See section 4002(a) of P.L. 93-406, Sept. 2, 1974.

7The termination of a fully funded defined-benefit pension plan is termed
a standard termination. Plan sponsors may terminate fully funded plans by
purchasing a group annuity contract from an insurance company under which
the insurance company agrees to pay all accrued benefits or by paying
lump-sum benefits to participants if permissible. Terminating an
underfunded plan is termed a distress termination if the plan sponsor
requests the termination or an involuntary termination if PBGC initiates
the termination. PBGC may institute proceedings to terminate a plan if,
among other things, the plan will be unable to pay benefits when due or
the possible long-run loss to PBGC with respect to the plan may reasonably
be expected to increase unreasonably if the plan is not terminated. See 29
U.S.C. 1342(a). PBGC may pay only a portion of the claim because ERISA
places limits on PBGC's benefit guarantee.

1987 to provide an incentive for sponsors to better fund their plans. The
variable-rate premium, which started at $6 for each $1,000 of unfunded
vested benefits, was initially capped at $34 per participant. The variable
rate was increased to $9 for each $1,000 of unfunded vested benefits
starting in 1991, and the cap on variable-rate premiums was removed
starting in 1996.

Following the enactment of ERISA, however, concerns were raised about the
potential losses that PBGC might face from the termination of underfunded
plans. To protect PBGC, ERISA was amended in 1986 to require that plan
sponsors meet certain additional conditions before terminating an
underfunded plan. For example, sponsors could voluntarily terminate their
underfunded plans only if they were bankrupt or generally unable to pay
their debts without the termination.

The single-employer program has had an accumulated deficit-that is,
program assets have been less than the present value of benefits and other
liabilities-for much of its existence. (See fig. 1.) In fiscal year 1996,
the program had its first accumulated surplus, and by fiscal year 2000,
the accumulated surplus had increased to about $10 billion, in 2002
dollars. However, the program's finances reversed direction in 2001, and
at the end of fiscal year 2002, its accumulated deficit was about $3.6
billion. PBGC estimates that this deficit grew to $8.8 billion by August
31, 2003, its largest deficit in the program's history both in real and
nominal terms. From less than $50 billion as of December 31, 2000, the
total underfunding in single-employer plans grew to more than $400 billion
as of December 31, 2002, and still exceeds $350 billion according to
recent estimates by PBGC. (See fig 2.) Despite the program's large
deficit, according to a PBGC analysis, the single-employer program was
estimated to have enough assets to pay benefits through 2019, given the
program's conditions and PBGC assumptions as of the end of fiscal year
2002.8 However, losses since that time may have shortened the period over
which the program will be able to cover promised benefits. In July of this
year, because of serious risks to

8The estimate assumes: (1) a rate of return on all PBGC assets of 5.8
percent and a discount rate on future benefits of 5.67 percent; (2) no
premium income and no future claims beyond all plans with terminations
that were deemed "probable" as of September 30, 2002; (3) administrative
expenses of $225 million in fiscal year 2003, $229 million per year for
fiscal years 2004-2014, and $0 thereafter; (4) mid-year termination for
"probables"; and (5) that PBGC does not assume control of "probable"
assets and future benefits until the date of plan termination.

the single-employer program's viability, we placed the PBGC on our
high-risk list.9

 Figure 1: Assets, Liabilities, and Net Position of the Single-Employer Pension
                   Insurance Program, Fiscal Years 1976-2002

2002 Dollars in billions 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Assets Liabilities Net position

                          Source: PBGC annual reports.

Note: Amounts for 1986 do not include plans subsequently returned to a
reorganized LTV Corporation. We adjusted PBGC data using the Consumer
Price Index for All Urban Consumers: All Items.

9See U.S. General Accounting Office, Pension Benefit Guaranty Corporation
Single-Employer Insurance Program: Long-Term Vulnerabilities Warrant "High
Risk" Designation, GAO-03-1050SP (Washington, D.C.: July 23, 2003).

Figure 2: Total Underfunding in PBGC-Insured Single-Employer Plans, 1980 -
2003

Dollars in billions 400

350

300

250

200

150

100

50

0 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Source: PBGC.

Note: 2003 figure is an estimate, as of September 4, 2003.

For the most part, liabilities of the single-employer pension insurance
program are comprised of the present value of insured participant
benefits. PBGC calculates present values using interest rate factors that,
along with a specified mortality table, reflect annuity prices, net of
administrative expenses, obtained from surveys of insurance companies
conducted by the American Council of Life Insurers.10 In addition to the
estimated total liabilities of underfunded plans that have actually
terminated, PBGC includes in program liabilities the estimated unfunded
liabilities of underfunded plans that it believes will probably terminate
in the near future.11 PBGC may classify an underfunded plan as a probable
termination when, among other things, the plan's sponsor is in liquidation
under federal or state bankruptcy laws.

10In 2002, PBGC used an interest rate factor of 5.70 percent for benefit
payments through 2027 and a factor of 4.75 percent for benefit payments in
the remaining years.

11Under Statement of Financial Accounting Standard Number 5, loss
contingencies are classified as probable if the future event or events are
likely to occur.

Several Factors Have Contributed to PBGC's Current Financial Difficulties

As we reported to this committee in September of this year,12 several
factors have contributed to PBGC's and plans' current financial
difficulties. The financial condition of the single-employer pension
insurance program returned to an accumulated deficit in 2002 largely due
to the termination, or expected termination, of several severely
underfunded pension plans. In 1992, we reported that many factors
contributed to the degree plans were underfunded at termination, including
the payment at termination of additional benefits, such as subsidized
early retirement benefits, which have been promised to plan participants
if plants or companies ceased operations.13 These factors likely
contributed to the degree that plans terminated in 2002 were underfunded.
Factors that increased the severity of the plans' unfunded liability in
2002 were the recent sharp decline in the stock market and a general
decline in interest rates.

In many cases, sponsors did not make the contributions necessary to
adequately fund the plans before they were terminated. For example,
according to annual reports (Annual Return/Report of Employee Benefit
Plan, Form 5500) submitted by Bethlehem Steel Corporation, in the 7 years
from 1992 to 1999, the Bethlehem Steel pension plan went from 86 percent
funded to 97 percent funded. (See fig. 3.) From 1999 to plan termination
in December 2002, however, plan funding fell to 45 percent as assets
decreased and liabilities increased, and sponsor contributions were not
sufficient to offset the changes. According to a survey,14 the Bethlehem
Steel defined-benefit plan had about 73 percent of its assets (about $4.3
billion of $6.1 billion) invested in domestic and foreign stocks on
September 30, 2000. One year later, assets had decreased $1.5 billion, or
25 percent, and when the plan was terminated in December 2002, its assets
had been reduced another 23 percent to about $3.5 billion-far less than
needed to finance an estimated $7.2 billion in PBGC-guaranteed
liabilities.15 Surveys of plan investments by Greenwich Associates

12See U.S. General Accounting Office, Pension Benefit Guaranty
Corporation: Single-Employer Pension Insurance Program Faces Significant
Long-Term Risks, GAO-03-873T (Washington, D.C.: Sept. 4, 2003).

13See U.S. General Accounting Office, Pension Plans: Hidden Liabilities
Increase Claims Against Government Insurance Programs, GAO/HRD-93-7
(Washington, D.C.: Dec. 30, 1992).

14Pensions & Investments, vol. 29, Issue 2 (Chicago: Jan. 22, 2001).

15According to the survey, the Bethlehem Steel Corporation's pension plan
made benefit payments of $587 million between Sept. 30, 2000, and Sept.
30, 2001. Pensions and Investments, www.pionline.com/pension/pension.cfm
(downloaded on June 13, 2003).

indicated that defined-benefit plans in general had about 62.8 percent of
their assets invested in U.S. and international stocks in 1999.16

Figure 3: Assets, Liabilities, and Funded Status of the Bethlehem Steel
Corporation Pension Plan, 1992-2002

Dollars in billions

Percent

8.0

7.0

6.0

5.0

4.0

3.0

2.0

1.0

0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Assets

Current liabilities Funded percentage Source: Annual Form 5500 reports and
PBGC.

                                      120

                                      100

                                       80

                                       60

                                       40

                                       20

                                       0

Note: Assets and liabilities for 1992 through 2001 are as of the beginning
of the plan year. During that period, the interest rate Bethlehem Steel
used to value current liabilities decreased from 9.26 percent to 6.21
percent. Assets and liabilities for 2002 are PBGC estimates at termination
in December 2002. Termination liabilities were valued using a rate of 5
percent.

These recent events and their consequences for PBGC's finances have
occurred in the context of the long-term stagnation of the defined-benefit
system. The number of PBGC-insured plans has decreased steadily from
approximately 110,000 in 1987 to around 30,000 in 2002.17 While the number
of total participants in PBGC-insured single-employer plans has grown
approximately 25 percent since 1980, participation has declined as

162002 U.S. Investment Management Study, Greenwich Associates, Greenwich,
Conn.

17In contrast, defined-contribution plans have grown significantly over a
similar period- from 462,000 plans in 1985 to 674,000 plans in 1998.

a percentage of the private sector labor force. Further, the percentage of
participants who are active workers has declined from 78 percent in 1980
to 53 percent in 2000. Manufacturing, a sector with virtually no job
growth in the last half-century, accounted for almost half of PBGC's
single-employer program participants in 2001, suggesting that the program
needs to rely on other sectors for any growth in premium income. Unless
something reverses these trends, PBGC may have a shrinking plan and
participant base to support the program in the future as well as the
likelihood of a participant base concentrated in certain, potentially more
vulnerable industries.

Minimum Funding Rules Did Not Prevent Plans from Being Severely
Underfunded

Internal Revenue Code (IRC) minimum funding rules, which are designed to
ensure plan sponsors adequately fund their plans, did not have the desired
effect for the terminated plans that were added to the single-employer
program in 2002. The amount of contributions required under IRC minimum
funding rules is generally the amount needed to fund benefits earned
during that year plus that year's portion of other liabilities that are
amortized over a period of years.18 Also, the rules require the sponsor to
make an additional contribution if the plan is underfunded to the extent
defined in the law. Under the additional funding requirement rule, a
single-employer plan sponsored by an employer with more than 100 employees
in defined-benefit plans is subject to a deficit reduction contribution
for a plan year if the value of plan assets is less than

90 percent of its current liability. However, a plan is not subject to the
deficit reduction contribution if the value of plan assets (1) is at least
80 percent of current liability and (2) was at least 90 percent of current
liability for each of the 2 immediately preceding years or each of the
second and third immediately preceding years. To determine whether the
additional funding rule applies to a plan, the IRC requires sponsors to
calculate current liability using the highest interest rate allowable for
the plan year.19

In 1987, the minimum funding rules incorporated by ERISA in the IRC were
amended to require that plan sponsors calculate each plan's current

18Minimum funding rules permit certain plan liabilities, such as past
service liabilities, to be amortized over specified time periods. See 26
U.S.C. 412(b)(2)(B). Past service liabilities occur when benefits are
granted for service before the plan was set up or when benefit increases
after the set up date are made retroactive.

19See 26 U.S.C. 412(l)(9)(C).

liability, using a discount rate based on the 30-year Treasury bond rate,
and to use that calculation to assess the plan's funding level.20 If plans
are funded below certain thresholds as defined in the IRC, employers are
to determine minimum contribution amounts on the basis of those
assessments. Employers must make additional contributions to the plan if
it is underfunded to extent defined in the law.21 If a plan is fully
funded as defined in the law, employers are precluded from making
additional tax-deductible contributions to the plan. In 2002, the Congress
acted to provide temporary relief to DB plan sponsors by raising the top
of the permissible range of the mandatory interest rate.22 As discussed in
a report we issued earlier this year,23 concerns that the 30-year Treasury
bond rate no longer resulted in reasonable current liability calculations
has led both

20Under the IRC, current liability means all liabilities to employees and
their beneficiaries under the plan. See 26 U.S.C. 412(l)(7)(A). In
calculating current liabilities, the IRC requires plans to use an interest
rate from within a permissible range of rates. See 26 U.S.C. 412(b)(5)(B).
In 1987, the permissible range was not more than 10 percent above, and not
more than 10 percent below, the weighted average of the rates of interest
on 30-year Treasury bond securities during the 4-year period ending on the
last day before the beginning of the plan year. The top of the permissible
range was gradually reduced by 1 percent per year beginning with the 1995
plan year to not more than 5 percent above the weighted average rate
effective for plan years beginning in 1999. The weighted average rate is
calculated as the average yield over 48 months with rates for the most
recent 12 months weighted by 4, the second most recent 12 months weighted
by 3, the third most recent 12 months weighted by 2, and the fourth
weighted by 1.

21Under the additional funding requirement rule, a single-employer plan
sponsored by an employer with more than 100 employees in defined-benefit
plans is subject to a deficit reduction contribution for a plan year if
the value of plan assets is less than 90 percent of its current liability.
However, a plan is not subject to the deficit reduction contribution if
the value of plan assets (1) is at least 80 percent of current liability
and (2) was at least 90 percent of current liability for each of the 2
immediately preceding years or each of the second and third immediately
preceding years. To determine whether the additional funding rule applies
to a plan, the IRC requires sponsors to calculate current liability using
the highest interest rate allowable for the plan year. See 26 U.S.C.
412(l)(9)(C).

22The top of the permissible range of the 30-year Treasury rate for
determining a plan's current liability was temporarily increased to 20
percent above the weighted average rate for 2002 and 2003. This temporary
measure expires at the end of 2003.

23See U.S. General Accounting Office, Private Pensions: Process Needed to
Monitor the Mandated Interest Rate for Pension Calculations, GAO-03-313
(Washington, D.C.: Feb. 27, 2003).

Congress and the administration to propose alternative rates for these
calculations.24

While minimum-funding rules may encourage sponsors to better fund their
plans, plans can earn funding credits, which can be used to offset minimum
funding contributions in later years, by contributing more than required
according to minimum funding rules. Therefore, sponsors of underfunded
plans may avoid or reduce minimum funding contributions to the extent
their plan has a credit balance in the account, referred to as the funding
standard account, used by plans to track minimum funding contributions.25

Additionally, the rules require sponsors to assess plan funding using
current liabilities, which a PBGC analysis indicates have been typically
less than termination liabilities.26 A plan's termination liability
measures the value of accrued benefits using assumptions appropriate for a
terminating plan, while its current liability measures the value of
accrued benefits using assumptions specified in applicable laws and
regulations. Current and termination liabilities differ because the
assumptions used to calculate them differ. Interest rates are a key
assumption in calculating the present value of future pension benefits:
while all sponsors calculate current liabilities using a rate based on the
30-year Treasury bond rate, ERISA requires sponsors of some underfunded
plans to report plan termination liability information to PBGC. These
sponsors calculate termination liability using a rate published by PBGC,
based on surveys of

24Recently, the U.S. House of Representatives passed the Pension Funding
Equity Act (H.R. 3108), which replaces the 30-year Treasury rate with a
blend of corporate bond index rates for 2 years through 2005. In July of
2003, the Department of the Treasury unveiled The Administration Proposal
to Improve the Accuracy and Transparency of Pension Information. The
proposal's stated purpose is to improve the accuracy of the pension
liability discount rate, increase the transparency of pension plan
information, and strengthen safeguards against pension underfunding.

25See 26 U.S.C. 412(b).

26For the analysis, PBGC used termination liabilities reported to it under
29 C.F.R. sec 4010.

insurance companies performed by the American Council of Life Insurers.27

Other aspects of minimum funding rules may limit their ability to affect
the funding of certain plans as their sponsors approach bankruptcy.
According to its annual reports, for example, Bethlehem Steel contributed
about $3.0 billion to its pension plan for plan years 1986 through 1996.
According to the reports, the plan had a credit balance of over $800
million at the end of plan year 1996. Starting in 1997, Bethlehem Steel
reduced its contributions to the plan and, according to annual reports,
contributed only about $71.3 million for plan years 1997 through 2001. The
plan's 2001 actuarial report indicates that Bethlehem Steel's minimum
required contribution for the plan year ending December 31, 2001, would
have been $270 million in the absence of a credit balance; however, the
opening credit balance in the plan's funding standard account as of
January 1, 2001, was $711 million. Therefore, Bethlehem Steel was not
required to make any contributions during the year.

Other IRC funding rules may have prevented some sponsors from making
contributions to plans that in 2002 were terminated at a loss to the
single-employer program. For example, on January 1, 2000, the Polaroid
pension plan's assets were about $1.3 billion compared to accrued
liabilities of about $1.1 billion-the plan was more than 100 percent
funded. The plan's actuarial report for that year indicates that the plan
sponsor was precluded by IRC funding rules from making a tax-deductible
contribution to the plan.28 In July 2002, PBGC terminated the Polaroid
pension plan, and the single-employer program assumed responsibility for
$321.8 million in unfunded PBGC-guaranteed liabilities for the plan. The
plan was about 67 percent funded, with assets of about $657 million to pay
estimated PBGC-guaranteed liabilities of about $979 million.

27Sponsors are required to provide PBGC with termination liability
information if, among other things, the aggregate unfunded vested benefits
at the time of the preceding plan year of plans maintained by the
contributing sponsor and the members of its controlled group exceed $50
million, disregarding plans with no unfunded benefits. See 29 U.S.C.
1310(b). Among the information to be provided to PBGC is the value of
benefit liabilities determined using the assumptions applicable to the
valuation of benefits to be paid as annuities in trusteed plans
terminating at the end of the plan year. See 29 C.F.R. 4010.8(d)(2).

28See 26 U.S.C. 404(a)(1) and 26 U.S.C. 412(c)(7). The sponsor might have
been able to make a contribution to the plan had it selected a lower
interest rate for valuing current liabilities. Polaroid used the highest
interest rate permitted by law for its calculations.

  Strengthening Plan Funding Rules Can Help Sponsors Maintain Well-Funded Plans

Several types of reforms might be considered to improve the funding of
defined-benefit pension plans. Some options for reform would directly
address funding requirements and related rules. Funding rules could be
revised to require increased minimum contributions to underfunded plans
and to allow additional contributions to fully funded plans. This approach
would improve plan funding over time and improve the security of workers'
benefits, while limiting the losses PBGC would incur when a plan is
terminated. Such a change would require some sponsors to allocate
additional resources to their pension plans, which may cause the plan
sponsor of an underfunded plan to provide less generous wages or benefits
than would otherwise be provided. Also, such funding rule changes could
take years to have a meaningful effect on PBGC's financial condition. As
examples of such funding rule revisions, the IRC could be amended to:

o  	Base Additional Funding Requirement and Maximum Tax-Deductible
Contributions on Plan Termination Liabilities, Rather than Current
Liabilities. Since plan termination liabilities typically exceed current
liabilities, such a change regarding deficit reduction contributions would
likely improve plan funding and, therefore, reduce potential claims
against PBGC. One potential problem with this approach is the difficulty
plan sponsors would have in determining the appropriate interest rate to
use in valuing termination liabilities. As we reported, selecting an
appropriate interest rate for termination liability calculations is
difficult because little information exists on which to base the
selection.29

o  	Change Requirements For Making Additional Funding Contributions. IRC
requires sponsors to make additional contributions under two
circumstances: (1) if the value of plan assets is less than 80 percent of
its current liability or (2) if the value of plan assets is less than 90
percent of its current liability, depending on plan funding levels for the
previous 3 years. Raising the threshold would require more sponsors of
underfunded plans to make the additional contributions.

o  	Limit the Use of Credit Balances by Severely Underfunded Plans to
Avoid Additional Contributions. For sponsors who make contributions in any
given year that exceed the minimum required contribution, the excess plus
interest is credited against future required contributions. Limiting the
use of credit balances to offset contribution requirements

29GAO-03-313.

might also prevent sponsors of significantly underfunded plans from
avoiding cash contributions. For example, in the absence of a credit
balance, Bethlehem Steel would have been due to pay at least $270 million
to its pension plan for the plan year ending December 31, 2001; however,
because it showed a credit balance of $711 million as of January 1, 2001,
Bethlehem was not required to make any cash contributions for that year.
Limitations might also be applied based on the plan sponsor's financial
condition. For example, sponsors with poor cash flow or low credit ratings
could be restricted from using their credit balances to reduce their
contributions.

o  	Limit Lump-Sum Distributions by Plans That Are Significantly
Underfunded. Defined-benefit pension plans may offer participants the
option of receiving their benefit in a lump-sum payment. Allowing
participants to take lump-sum distributions from severely underfunded
plans, especially those sponsored by financially weak companies, allows
the first participants who request a distribution to drain plan assets,
which might result in the remaining participants receiving reduced
payments from PBGC if the plan terminates.30 A "tiered system" may be set
up whereby a plan that does not meet a certain funding ratio threshold
might be prohibited from allowing highly compensated employees from taking
benefits as lump sums; below a lower funding ratio threshold, lump-sum
withdrawals for all employees might be prohibited. However, the payment of
lump sums by underfunded plans may not directly increase losses to the
single employer program because lump sums reduce plan liabilities as well
as plan assets.

o  	Raise the Level of Tax-Deductible Contributions. IRC and ERISA
restrict tax-deductible contributions to prevent plan sponsors from
contributing more to their plan than is necessary to cover accrued future
benefits.31 This can prevent employers from making plan contributions
during periods of strong profitability. Raising these limitations might
result

30The administration's proposal would require companies with below
investment grade credit ratings whose plans are less than 50 percent
funded on a termination basis to immediately fully fund or secure any new
benefit improvements, benefit accruals, or lump sums.

31Employers are generally subject to an excise tax for failure to make
required contributions or for making contributions in excess of the
greater of the maximum deductible amount or the ERISA full-funding limit.

in pension plans being better funded, decreasing the likelihood that they
will be underfunded should they terminate.32

o  	Expand Restrictions on Unfunded Benefit Increases. Currently, plan
sponsors must meet certain conditions before increasing the benefits of
plans that are less than 60 percent funded.33 Increasing this threshold,
or restricting benefit increases or accruals when plans reach the
threshold, could decrease the losses incurred by PBGC from underfunded
plans. One disadvantage is that it could result in lower pension benefits
for affected workers. In addition, plan sponsors have said that the
disadvantage of such changes is that they would limit an employer's
flexibility with regard to setting compensation, making it more difficult
to respond to labor market developments. For example, a plan sponsor might
prefer to offer participants increased pension payments or shutdown
benefits instead of offering increased wages because pension benefits can
be deferred- providing time for the plan sponsor to improve its financial
condition- while wage increases have an immediate effect on the plan
sponsor's financial condition.

o  	Improve Funding of Shutdown Benefits. Shutdown benefits provide
significant early retirement benefit subsidies or other benefits offered
to participants affected by a plant closing or a permanent layoff. Such
benefits are primarily found in the pension plans of large unionized
companies in the auto, steel, and tire industries. In general, shutdown
benefits cannot be adequately funded before a shutdown occurs. Rules could
mandate accelerated funding of shutdown benefits after they go into
effect. However, if a plant shutdown coincides with the bankruptcy of a
company and the termination of the pension plan, it may be impossible for
the bankrupt sponsor to fund these benefits.

In addition to funding rules, plan sponsors need an accurate funding
"target" that provides enough funding to pay promised current and future
benefits while not leading sponsors to "overfund" their pension plans,

32For example, one way to do this would be to allow deductions within a
corridor of up to

130 percent of current liabilities. Gebhardtsbauer, Ron. American Academy
of Actuaries

testimony before the Subcommittee on Employer-Employee Relations, House
Committee

on Education and the Workforce, Hearing on Strengthening Pension Security:
Examining

the Health and Future of Defined-benefit Pension Plans. (Washington, D.C.:
June 4, 2003),

9.

33IRC provides generally that a plan less than 60 percent funded on a
current liability basis may not increase benefits without either
immediately funding the increase or providing security. See 26 U.S.C.
401(a)(29).

siphoning resources from other productive firm specific activities. The
interest rate sponsors use to determine plan liabilities can affect this
target and, therefore, plan funding. In 1987, when the 30-year Treasury
bond rate was adopted for use in certain pension calculations, the
Congress intended that the interest rate used for current liability
calculations would, within certain parameters, reflect the price an
insurance company would charge to take responsibility for the plan's
pension payments. However, selecting a replacement rate that will provide
an accurate funding target may be difficult because little information
exists on which to base the selection. In taking action to replace the
30-year Treasury bond rate, it is important to consider the impact that
any change may have on funding. If Congress mandates the use of a rate
that is "too high," plans are more likely to appear better funded, but
minimum and maximum employer contributions would decrease, possibly
increasing the likelihood of plan underfunding. In addition, some plans
would reach full-funding limitations and avoid having to pay variable-rate
premiums, and PBGC would receive less revenue. Conversely, a rate that is
"too low" would make plans appear worse funded, with more plans likely to
increase contributions and possibly pay variable-rate premiums. Thus, it
may well be prudent for Congress to make any provision replacing the
30-year Treasury bond rate temporary to facilitate more comprehensive
funding reform to take shape.

In addition to direct changes to the funding rules, other reforms may
result in improved plan funding by improving incentives for sponsors to
maintain proper funding in their plans. These measures may prevent plans
from terminating with severely underfunded balances, thus better
protecting workers, retirees, and PBGC. For example, improving the
availability of information to plan participants and others about plan
investments, termination funding status, and PBGC guarantees may give plan
sponsors additional incentives to better fund their plans, making
participants better able to plan for their retirement. The restructuring
of PBGC's premium

34Other than a survey conducted for PBGC, no mechanism exists to collect
information on actual group annuity purchase rates. Compared to other
alternatives, the PBGC interest rate factors may have the most direct
connection to the group annuity market, but PBGC factors are less
transparent than market-determined alternatives. Long-term market rates
may track changes in group annuity rates over time, but their proximity to
group annuity rates is uncertain. For example, an interest rate based on a
long-term market rate, such as corporate bond indexes, may need to be
adjusted downward to better reflect the level of group annuity purchase
rates. However, as we stated in our report earlier this year, establishing
a process for regulatory adjustments to any rate selected may make it more
suitable for pension plan liability calculations. See GAO-03-313.

  Other Reforms Might Enhance Sponsor Incentives to Maintain Plan Funding

rates could also provide an incentive for plan sponsors to better fund
their plans. It is also possible that basing changes to premium rates on
the degree of risk posed by different plans may encourage financially
healthy companies to remain in or enter the defined-benefit system while
discouraging riskier plan sponsors. Moreover, it may be appropriate to
consider modifying certain benefit guarantees that could decrease losses
incurred by PBGC from underfunded plans. ERISA could be amended to:

o  	Require Greater Disclosure of Information on Plan Investments. Some
information on the allocation of plan investments among asset classes-such
as equity or fixed income-may be available from Form 5500s prepared by
plan sponsors, but that information is not readily accessible to
participants and beneficiaries. Additionally, some plan investments may be
made through common and collective trusts, master trusts, and registered
investment companies, and asset allocation information for these
investments might need to be obtained from Form 5500s prepared by those
entities or from their prospectuses. As such, improving the availability
of plan asset allocation information to participants may give plan
sponsors an incentive to increase funding of underfunded plans or limit
riskier investments. Moreover, only participants in plans below a certain
funding threshold receive annual notices regarding the funding status of
their plans, and the information plans must currently provide does not
reflect how the plan's assets are invested. One way to enhance notices
provided to participants could be to include information on how much of
plan assets are invested in the sponsor's own securities.35 This would be
of concern because should the sponsor become bankrupt, the value of the
securities could be expected to drop significantly, reducing plan funding.
Although this information is currently provided in the plan's Form 5500,
it is not readily accessible to participants. Additionally, if the
defined-benefit plan has a floor-offset arrangement and its benefits are
contingent on the investment performance of a defined-contribution plan,
then information provided to participants could also disclose how much of
that defined-contribution plan's assets are invested in the sponsor's own
securities.

o  	Require Greater Disclosure of Plan Termination Funding Status. Under
current law, sponsors are required to report a plan's current liability
for funding purposes, which often can be lower than termination liability.

35Although ERISA permits plan sponsors to invest plan assets in employer
stock, defined-benefit plans may not acquire any qualified employer
security or real property if immediately after the acquisition the
aggregate fair market value of such assets exceeds 10 percent of the fair
market value of the plan's total assets.

In addition, only participants in plans below a certain funding threshold
receive annual notices of the funding status of their plans.36 As a
result, many plan participants, including participants of the Bethlehem
Steel pension plan, did not receive such notifications in the years
immediately preceding the termination of their plans. Expanding the
circumstances under which sponsors must notify participants of plan
underfunding might give sponsors an additional incentive to increase plan
funding and would enable more participants to better plan their
retirement. Under the Administration's proposal, all sponsors would be
required to disclose the value of pension plan assets on a termination
basis in their annual reporting. The Administration proposes that all
companies disclose the value of their defined-benefit pension plan assets
and liabilities on both a current liability and termination liability
basis in their Summary Annual Report (SAR).37

o  	Increase or Restructure Variable-Rate Premium. PBGC charges plan
sponsors a variable-rate premium based on the plan's level of
underfunding, premiums, with sponsors paying $9 per $1,000 of unfunded
liability. However, the recent terminations of Bethlehem Steel, Anchor
Glass, and Polaroid, plans that paid no variable-rate premiums shortly
before terminating with large underfunded balances, suggest that the
current structure of the variable-rate premium does not provide a strong
enough incentive to improve plan funding or is too easily avoidable. The
rate could be adjusted so that plans with less adequate funding pay a
higher rate. In addition, premium rates could be restructured based on the
degree of risk posed by different plans, which could be assessed by
considering the financial strength and prospects of the plan's sponsor,
the risk of the plan's investment portfolio, participant demographics, and
the plan's benefit structure-including plans that have lump-sum,38
shutdown

36The ERISA requirement that plan sponsors notify participants and
beneficiaries of the plan's funding status and limits on the PBGC
guarantee currently goes into effect when plans are required to pay
variable-rate premiums and meet certain other requirements. See 29 U.S.C.
1311 and 29 C.F.R. 4011.3.

37Participants and individuals receiving benefits from their plan must
receive a Summary Annual Report (SAR) from their plan's administrator each
year. The SAR summarizes the plan's financial status based on information
that the plan administrator provides to the Department of Labor on its
annual Form 5500. This document must generally be provided no later than
nine months after the close of the plan year.

38For example, a plan that allows a lump-sum option-as is often found in a
cash-balance and other hybrid plan-may pose a different level of risk to
PBGC than a plan that does not.

benefit, and floor-offset provisions.39 One advantage of a rate increase
or restructuring is that it might improve accountability by providing for
a more direct relationship between the amount of premium paid and the risk
of underfunding. A disadvantage is that it could further burden already
struggling plan sponsors at a time when they can least afford it, or it
could reduce plan assets, increasing the likelihood that underfunded plans
will terminate. A program with premiums that are more risk-based could
also be more challenging for PBGC to administer.

o  	Phase-in the Guarantee of Shutdown Benefits. PBGC is concerned about
its exposure to the level of shutdown benefits, or benefit increases that
are unfunded at termination.40 PBGC could phase-in the guarantee of such
benefits. Similar to benefit increases prior to termination, the agency
could perhaps guarantee an additional 20 percent of shutdown benefits each
year after the benefits are offered, with full benefits (up to PBGC
limits) guaranteed only after 5 years. Phasing in guarantees from the date
of the applicable shutdown could decrease the losses incurred by PBGC from
underfunded plans.41 A phase-in might cause workers to put pressure on
sponsors to fund these benefits or benefit increases, or demand
alternative forms of compensation. Modifying these benefits would reduce
the early retirement benefits for participants who are in plans with such
provisions and are affected by a plant closing or a permanent layoff.
Dislocated workers, particularly in manufacturing, may suffer additional
losses from lengthy periods of unemployment or from finding reemployment
only at much lower wages.

39Under the floor-offset arrangement, the benefit computed under the final
pay formula is "offset" by the benefit amount that the account of another
plan, such as an Employee Stock Ownership Plan, could provide.

40PBGC guarantees benefits up to certain limits. PBGC may pay only a
portion of the claim because ERISA places limits on the PBGC benefit
guarantee. For example, PBGC generally does not guarantee annual benefits
above a certain amount, currently about $44,000 per participant at age 65.
Additionally, benefit increases in the 5 years immediately preceding plan
termination are not fully guaranteed, though PBGC will pay a portion of
these increases. The guarantee does not generally include supplemental
benefits, such as the temporary benefits that some plans pay to
participants from the time they retire until they are eligible for Social
Security benefits.

41Currently, some measures exist to limit the losses incurred by PBGC from
certain terminated plans. PBGC is responsible for only a portion of all
benefit increases that the sponsor adds in the 5 years leading up to
termination.

Conclusion

Widespread underfunding in the defined-benefit pension system potentially
threatens the retirement security of millions of American workers. The
termination of severely underfunded plans can significantly reduce the
benefits promised to workers and retirees. It also threatens the solvency
of PBGC's single-employer insurance program, with, in the worse case,
Congress facing the choice of a bailout or of letting affected workers and
retirees lose the pension benefits they depend on. While the pension
system does not face an immediate crisis, these serious financial
challenges suggest that meaningful, if perhaps difficult, comprehensive
action needs to be taken. Such action would be aimed towards the
improvement of the long-term funding status of plans and the
accountability of plan sponsors, especially those that represent a clear
risk to PBGC, plan participants, and their beneficiaries.

Undoubtedly, unfavorable economic conditions have contributed to
widespread underfunding and conspired to place well-meaning sponsors in
very difficult positions to maintain their plans' funding. Although
comprehensive reform should include improving plan funding as the key
vehicle to stabilize and enhance the long-term health of the
defined-benefit system, Congress may seek to balance improvements in
funding and accountability against the short-term needs of some sponsors
who may have difficulty making contributions to their plans. Relief
measures should be carefully targeted to those sponsors that may need it
most urgently, with some provision for this aid to eventually lead to
improved plan funding. In crafting this reform, the Congress should be
wary of temporary rule changes directed exclusively to short-term problems
that could increase the risk that plans terminate in even worse financial
straits than they suffer today.

It is important to keep in mind that the factors contributing to the
deterioration of pension plan funding go beyond the effects of the recent
economic downturn. The defined-benefit system has shown signs of
stagnation for the past 2 decades, with a steady decline in the number of
plans and a decreasing proportion of working participants. PBGC's
participant base may also be concentrated in more vulnerable industries.
Concerns about PBGC's long-run financial viability, and not just the
recent alarming jump in its accumulated deficit, prompted us to put the
single-employer program on our high-risk list. While it is unlikely that
any rules can guarantee that all plans are fully funded at all times, nor
should that be their goal, regulations should strive to maintain the
overall health of the system and prevent poor economic conditions from
creating a general funding crisis.

In addition to the administration's current proposal, the Treasury
Department, Labor Department, and PBGC are considering reforms that seek
to address many of these issues and include elements of the options that I
have identified in my testimony, such as increased transparency for plan
participants. The private defined-benefit pension system is at a
crossroads, facing a threat of continued financial erosion and decline.
However, we also have the opportunity and the challenge to broadly move
the system back to a solid, stable financial footing that will provide
needed retirement benefits to workers and retirees for decades to come.

Mr. Chairman, this concludes my statement. I would be happy to respond to
any questions that you or other members of the Committee may have.

For information regarding this testimony, please contact Barbara D.
Bovbjerg, Director, Education, Workforce, and Income Security Issues, on
(202) 512-7215 or Charles A. Jeszeck on (202) 512-7036. Individuals who
made key contributions to this testimony are Mark M. Glickman, Jeremy
Citro, Daniel F. Alspaugh, and John M. Schaefer.

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