Pension Benefit Guaranty Corporation: Single-Employer Pension	 
Insurance Program Faces Significant Long-Term Risks (29-OCT-03,  
GAO-04-90).							 
                                                                 
More than 34 million participants in 30,000 single-employer	 
defined benefit pension plans rely on a federal insurance program
managed by the Pension Benefit Guaranty Corporation (PBGC) to	 
protect their pension benefits, and the program's long-term	 
financial viability is in doubt. Over the last decade, the	 
program swung from a $3.6 billion accumulated deficit		 
(liabilities exceeded assets), to a $10.1 billion accumulated	 
surplus, and back to a $3.6 billion accumulated deficit, in 2002 
dollars. Furthermore, despite a record $9 billion in estimated	 
losses to the program in 2002, additional severe losses may be on
the horizon. PBGC estimates that financially weak companies	 
sponsor plans with $35 billion in unfunded benefits, which	 
ultimately might become losses to the program.			 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-90						        
    ACCNO:   A08789						        
  TITLE:     Pension Benefit Guaranty Corporation: Single-Employer    
Pension Insurance Program Faces Significant Long-Term Risks	 
     DATE:   10/29/2003 
  SUBJECT:   Financial management				 
	     Pension plan cost control				 
	     Retirement pensions				 
	     Strategic planning 				 
	     Risk management					 

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GAO-04-90

United States General Accounting Office

GAO

                       Report to Congressional Requesters

October 2003

PENSION BENEFIT GUARANTY CORPORATION

  Single-Employer Pension Insurance Program Faces Significant Long-Term Risks

GAO-04-90

Highlights of GAO-04-90, a report to congressional requesters

More than 34 million participants in 30,000 single-employer defined
benefit pension plans rely on a federal insurance program managed by the
Pension Benefit Guaranty Corporation (PBGC) to protect their pension
benefits, and the program's long-term financial viability is in doubt.
Over the last decade, the program swung from a $3.6 billion accumulated
deficit (liabilities exceeded assets), to a $10.1 billion accumulated
surplus, and back to a $3.6 billion accumulated deficit, in 2002 dollars.
Furthermore, despite a record $9 billion in estimated losses to the
program in 2002, additional severe losses may be on the horizon. PBGC
estimates that financially weak companies sponsor plans with $35 billion
in unfunded benefits, which ultimately might become losses to the program.

GAO is not recommending executive action. However, given the long-term
nature of the financial risks to PBGC's single-employer insurance program,
the Congress should consider a comprehensive response that includes
changes to strengthen plan funding and improve the transparency of plan
information as well as consider proposals to modify program guarantees. In
addition, PBGC's premium structure should be re-examined to see whether
premiums can better reflect the risk posed by various plans to the pension
system.

www.gao.gov/cgi-bin/getrpt?GAO-04-90.

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

October 2003

PENSION BENEFIT GUARANTY CORPORATION

Single-Employer Pension Insurance Program Faces Significant Long-Term Risks

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. Factors that contributed to
the severity of the plans' underfunded condition included a sharp stock
market decline, which reduced plan assets, and an interest rate decline,
which increased plan termination costs. For example, PBGC estimates losses
to the program from terminating the Bethlehem Steel pension plan, which
was nearly fully funded in 1999 based on reports to the Internal Revenue
Service (IRS), at $3.7 billion when it was terminated in 2002. The plan's
assets had decreased by over $2.5 billion, while its liabilities had
increased by about $1.4 billion since 1999.

The single-employer program faces two primary risks to its long-term

financial viability. First, the large losses in 2002 could continue or
accelerate if, for example, structural problems in particular industries
result in additional bankruptcies. Second, revenue from premiums and
investments might be inadequate to offset program losses.
Participant-based premium revenue might fall, for example, if the number
of program participants decreases. Because of these risks, GAO has
recently placed the single-employer insurance program on its high-risk
list of agencies with significant vulnerabilities to the federal
government.

While the recent decline in the single-employer program's financial
condition is not an immediate crisis, the threats to the program's
long-term viability should be addressed. Several reforms might be
considered to reduce the risks to the program's long-term financial
viability. These include strengthening funding rules applicable to poorly
funded plans, modifying program guarantees, restructuring premiums, and
improving the availability of information about plan investments,
termination funding, and program guarantees. Under each reform, several
possible actions could be taken. For example, one way to modify program
guarantees is to phase-in certain unfunded benefits, such as "shutdown
benefits," which may provide significant early retirement benefit
subsidies to participants affected by a plant closing or a permanent
layoff.

Participants and Plans Covered by the Single-Employer Insurance Program,
1980-2002

2002 dollars (in billions) 30 25

20

15

10

5

0

-5

-10 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002

                         Assets Liabilites Net position

Source: PBGC annual reports.

Contents

Letter

Results in Brief
Background
Termination of Severely Underfunded Plans Was Primary Factor in

Financial Decline of Single-Employer Program PBGC Faces Long-Term
Financial Risks from a Potential Imbalance of Assets and Liabilities
Several Reforms Might Reduce the Risks to the Program's

Financial Viability Conclusion Matters for Congressional Consideration
Agency Comments

                                       1

                                      3 4

16

24

32 39 41 41

Appendix I Scope and Methodology

Appendix II 	Key Legislative Changes That Affected the Single-Employer
Program

Appendix III The Administration Proposal for Pension Reform

Appendix IV 	Differences in Interest Rate Calculations Contribute to
Differences between Termination and Current Liabilities

Appendix V 	Comments from the Pension Benefit Guaranty Corporation 53

Appendix VI GAO Contacts and Staff Acknowledgments 54

Contacts 54 Staff Acknowledgments 54

Table

Table 1: Key Legislative Changes to the Single-Employer Insurance Program
Since ERISA Was Enacted

Figures

Figure 1: Flat- and Variable-Rate Premium Income for the Single-Employer
Pension Insurance Program, Fiscal Years 1975-2002 10

Figure 2: Participants and Plans Covered by the Single-Employer Insurance
Program, 1980-2002 11

Figure 3: Market Value of Single-Employer Program Assets in Revolving and
Trust Funds at Year End, Fiscal Years 1990-2002 13

Figure 4: Total Return on the Investment of Single-Employer Program
Assets, Fiscal Years 1990-2002 14

Figure 5: Assets, Liabilities, and Net Position of the Single-Employer
Pension Insurance Program, Fiscal Years 1976-2002 16

Figure 6: Assets, Liabilities, and Funded Status of the Bethlehem Steel
Corporation Pension Plan, 1992-2002 18 Figure 7: Total Return on Stocks in
the S&P 500 Index, Calendar Years 1992-2002 19 Figure 8: Interest Rates on
Long-Term High-Quality Corporate

Bonds, 1990-2002 21 Figure 9: PBGC Premium and Investment Income,
1976-2002 28 Figure 10: Distribution of PBGC-Insured Participants by
Industry,

2001 30

Figure 11: Average Termination and Current Liability Funding Ratios for
Plans Submitting Termination Liability Data to PBGC under Section 4010 of
ERISA, Plan Years 1996 - 2001 50

Figure 12: PBGC Termination, and Highest and Lowest Current Liability,
Interest Rates, 1996-2002 52

Abbreviations

EBSA Employee Benefits Security Administration
ERISA Employee Retirement and Income Security Act
IRC Internal Revenue Code
IRS Internal Revenue Service
OMB Office of Management and Budget
PIMS Pension Insurance Modeling System
PBGC Pension Benefit Guaranty Corporation
SAR Summary Annual Report
SARS Severe Acute Respiratory Syndrome
S&P 500 Standard and Poor's 500

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United States General Accounting Office Washington, DC 20548

October 29, 2003

The Honorable John Boehner
Chairman
Committee on Education and the Workforce
House of Representatives

The Honorable Sam Johnson
Chairman
Subcommittee on Employer-Employee Relations
Committee on Education and the Workforce
House of Representatives

The Pension Benefit Guaranty Corporation's (PBGC) single-employer
insurance program is a federal program to insure the benefits of the more
than 34 million workers and retirees participating in private defined-
benefit pension plans.1 Over the last few years, the program's finances
have taken a severe turn for the worse. From a $3.6 billion accumulated
deficit in 1993, the program registered a $10.1 billion accumulated
surplus
(assets exceeded liabilities) in 2000 before returning to a $3.6 billion
accumulated deficit, in 2002 dollars.2 More fundamentally, the long-term
viability of the program is at risk. Even after assuming responsibility
for
several severely underfunded pension plans and recording over $9 billion
in estimated losses in 2002, PBGC estimated that as of September 30, 2002,
it faced exposure to approximately $35 billion in additional unfunded

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.

2PBGC estimates that its deficit had grown to about $8.8 billion at the
end of August 2003 based on its latest unaudited financial report.

liabilities from ongoing plans that were sponsored by financially weak
companies and may terminate.3

This risk involves an issue beyond PBGC's current and future financial
condition; it also relates to the need to protect the retirement security
of millions of American workers and retirees. This report highlights some
of the key issues in the debate about how to respond to the financial
challenges facing the federal insurance program for single-employer
defined-benefit plans. As you requested, we addressed the following
issues: (1) what factors contributed to recent changes in the
single-employer pension insurance program's financial condition, (2) what
are the risks to the program's long-term financial viability, and (3) what
changes to the program might be considered to reduce those risks?

To identify the factors that contributed to recent changes in the
single-employer program's financial condition, we 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. To identify the primary risks
to the long-term viability of the program and options to address the
challenges facing the single-employer program, we interviewed pension
experts at PBGC, at the Employee Benefits Security Administration of the
Department of Labor, and in the private sector and reviewed analyses and
other documents provided by them. To obtain additional information as to
the risks facing PBGC from certain industries, we discussed with PBGC,

3PBGC estimates that by the end of fiscal year 2003, the amount of
underfunding in financially troubled companies could exceed $80 billion.
According 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).

  Results in Brief

and reviewed annual and actuarial reports for the 2003 distress
termination of the U.S. Airways pension plan for pilots. To determine what
changes might be considered to reduce those risks, we reviewed proposals
for reforming the single-employer program made by the Department of the
Treasury, PBGC, and pension professionals. We performed our work from
April through September 2003 in accordance with generally accepted
government auditing standards. Our scope and methodology are explained
more fully in appendix I.

The termination, or expected termination, of several severely underfunded
pension plans was the major reason for PBGC's single-employer pension
insurance program's return to an accumulated deficit in 2002. Several
underlying factors contributed to the severity of the plans' underfunded
condition at termination, including a sharp decline in the stock market,
which reduced plan asset values, and a general decline in interest rates,
which increased the cost of terminating defined-benefit pension plans.
Falling stock prices and interest rates can dramatically reduce plan
funding as the sponsor approaches bankruptcy. For example, while annual
reports indicated the Bethlehem Steel Corporation pension plan was almost
fully funded in 1999 based on reports to IRS, PBGC estimates that the
value of the plan's assets was less than 50 percent of the value of its
guaranteed liabilities by the time it was terminated in 2002. The current
minimum funding rules and other rules designed to encourage sponsors to
fully fund their plans were not effective at preventing it from being
severely underfunded at termination.

Two primary risks could affect the long-term financial viability of the
single-employer program. First, and most worrisome, the high level of
losses experienced in 2002, due to the bankruptcy of companies with large
underfunded defined-benefit pension plans, could continue or accelerate.
This could occur if the economy recovers slowly or weakly, returns on plan
investments remain poor, interest rates remain low, or the structural
problems of particular industries with pension plans insured by PBGC
result in additional bankruptcies. Second, PBGC might not receive
sufficient revenue from premium payments and its own investments to offset
the losses experienced to date or those that may occur in subsequent
years. This could happen if participation in the single-employer program
falls or if PBGC's return on assets falls below the rate it uses to
calculate the present value of benefits promised in the future. Because of
its current financial weaknesses, as well as the serious, long-term risks
to the program's future viability, we recently placed PBGC's
single-employer insurance program on our high-risk list.

Several reforms might be considered to reduce the risks to the
single-employer program's long-term financial viability. These include
strengthening funding rules applicable to poorly funded plans, modifying
program guarantees, restructuring premiums, and improving the availability
of information about plan investments, termination funding, and program
guarantees. Under each reform, several possible actions could be taken.
For example, one way to modify program guarantees is to phase-in certain
unfunded benefits, such as "shutdown benefits." In addition, one way
premiums could be restructured would be to base them, not only on the
degree of plan underfunding, but also on the economic strength of the plan
sponsor, the degree of risk of the plan's investment portfolio, the plan's
benefit structure, and participant demographics.

Because the magnitude and uncertainty of the long-term financial risks
pose particular challenges for the PBGC's single-employer insurance
program and the protection of the retirement security of millions of
American workers and retirees, this report considers a matter for
congressional consideration regarding several reforms that might be
considered to reduce the risks to the single-employer program's long-term
financial viability.

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

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.

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 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 65.8 Additionally, benefit
increases in the 5 years immediately preceding plan termination are not
fully guaranteed, though PBGC will pay a portion of these increases.9 The
guarantee is limited to certain benefits, including so-called shutdown
benefits-significant subsidized early retirement benefits-that are
triggered by layoffs or plant closings that occur before plan termination.
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.

Following 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

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).

8The amount guaranteed by PBGC is reduced for participants under age 65.

9The guaranteed amount of the benefit increase is calculated by
multiplying the number of years the benefit increase has been in effect,
not to exceed 5 years, by the greater of (1) 20 percent of the monthly
benefit increase calculated in accordance with PBGC regulations or (2) $20
per month. See 29 C.F.R. 4022.25(b).

terminate their underfunded plans only if they were bankrupt or generally
unable to pay their debts without the termination. Key amendments to ERISA
affecting the single-employer program are listed in appendix II.

Concerns about PBGC finances also resulted in efforts to strengthen the
minimum funding rules incorporated by ERISA in the Internal Revenue Code
(IRC). In 1987, for example, the IRC was amended to require that plan
sponsors calculate each plan's current liability,10 and make additional
contributions to the plan if it is underfunded to the extent defined in
the law.11 As discussed in a report we issued earlier this year,12
concerns that the 30-year Treasury bond rate no longer resulted in
reasonable current

10Under 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 top of the permissible
range was increased to 20 percent above the weighted average rate for 2002
and 2003. 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.

11Under 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).

12U.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).

liability calculations has led both the Congress and the administration to
propose alternative rates for these calculations.13

Despite the 1987 amendments to ERISA, concerns about PBGC's financial
condition persisted. In 1990, as part of our effort to call attention to
high-risk areas in the federal government, we noted that weaknesses in the
single-employer insurance program's financial condition threatened PBGC's
long-term viability.14 We stated that minimum funding rules still did not
ensure that plan sponsors would contribute enough for terminating plans to
have sufficient assets to cover all promised benefits. In 1992, we also
reported that PBGC had weaknesses in its internal controls and financial
systems that placed the entire agency, and not just the single-employer
program, at risk.15 Three years later, we reported that legislation
enacted in 1994 had strengthened PBGC's program weaknesses and that we
believed improvements had been significant enough for us to remove the
agency's high-risk designation.16 Since that time, we have continued to
monitor PBGC's financial condition and internal controls. For example, in
1998, we reported that adverse economic conditions could threaten PBGC's
financial condition despite recent improvements;17 in 2000, we reported
that contracting weaknesses at PBGC, if uncorrected, could

13In October 2003, the House passed the Pension Funding Equity Act of Act
of 2003 (H.R. 3108), which for plan years beginning in 2004 and 2005 would
temporarily change the permissible range and interest rate for current
liability calculations to not above and not more than 10 percent below,
the weighted average of a rate based on one or more indices of
conservatively invested long-term corporate bonds. In July of 2003, the
Department of the Treasury unveiled The Administration Proposal to Improve
the Accuracy and Transparency of Pension Information. Its 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. See appendix III.

14Letter to the Chairman, Senate Committee on Governmental Affairs and
House Committee on Government Operations, GAO/OCG-90-1, Jan. 23, 1990.
GAO's high-risk program has increasingly focused on those major programs
and operations that need urgent attention and transformation to ensure
that our national government functions in the most economical, efficient,
and effective manner. Agencies or programs receiving a "high risk"
designation receive greater attention from GAO and are assessed in regular
reports, which generally coincide with the start of each new Congress.

15U.S. General Accounting Office, High-Risk Series: Pension Benefit
Guaranty Corporation, GAO/HR-93-5 (Washington, D.C.: Dec. 1992).

16U.S. General Accounting Office, High-Risk Series: An Overview,
GAO/HR-95-1 (Washington, D.C.: Feb. 1995).

17U.S. General Accounting Office, Pension Benefit Guaranty Corporation:
Financial Condition Improving but Long-Term Risks Remain, GAO/HEHS-99-5
(Washington, D.C.: Oct. 16, 1998).

result in PBGC paying too much for required services;18 and this year, we
reported that weaknesses in the PBGC budgeting process limited its control
over administrative expenses.19

In 1997, we reported that the cash-based federal budget, which focuses on
annual cash flows, does not adequately reflect the cost or the economic
impact of federal insurance programs, including the single-employer
pension insurance program.20 This is true because, generally, cost is only
recognized in the budget when claims are paid rather than when the
commitment is made. The cost of pension insurance is further obscured in
the budget because while its annual net cash flows reduce the budget
deficit, PBGC's growing long-term commitment to pay pension benefits has
no effect on the deficit. For example, the liabilities from terminated
underfunded pension plans taken over by PBGC are not recognized in the
budget. We concluded that the use of accrual concepts in the budget for
PBGC and other insurance programs has the potential to better inform
budget choices. We also stated, however, that agencies, such as PBGC,
might need to develop and test methodologies that would enable them to
generate reasonable and unbiased cost estimates of the risk assumed by the
government, which are critical to the successful implementation of
accrual-based budgeting for insurance programs.21 As such, as a first step
toward developing an accrual-based budget, we recommended that the Office
of Managemetn and Budget (OMB) encourage agencies to develop methodologies
and provide cost information on a risk-assumed basis in the budget
document along side the cash-based budget information it currently
provides. OMB agreed with our conclusions and noted that they would like
to pursue such improvements but was not doing so because it did not have
the expertise that would be required.

18U.S. General Accounting Office, Pension Benefit Guaranty Corporation:
Contracting Management Needs Improvement, GAO/HEHS-00-130 (Washington,
D.C.: Sept. 18, 2000).

19U.S. General Accounting Office, Pension Benefit Guaranty Corporation:
Statutory Limitation on Administrative Expenses Does Not Provide
Meaningful Control,

GAO-03-301 (Washington, D.C.: Feb. 28, 2003).

20U.S. General Accounting Office, Budget Issues: Budgeting for Federal
Insurance Programs, GAO/AIMD-97-16 (Washington D.C.: Sept. 30, 1997).

21In most cases, the risk-assumed approach would be analogous to a premium
rate-setting process in that it looks at the long-term expected cost of an
insurance commitment at the time the insurance commitment is extended. The
risk assumed by the government is essentially that portion of a full
risk-based premium not charged to the insured.

PBGC receives no direct federal tax dollars to support the single-employer
pension insurance program. The program receives the assets of terminated
underfunded plans and any of the sponsor's assets that PBGC recovers
during bankruptcy proceedings.22 PBGC finances the unfunded liabilities of
terminated plans with (1) premiums paid by plan sponsors and (2) income
earned from the investment of program assets.

Initially, plan sponsors paid only a flat-rate premium of $1 per
participant per year; however, the flat rate has been increased over the
years and is currently $19 per participant per year. To provide an
incentive for sponsors to better fund their plans, a variable-rate premium
was added in 1987. 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. Figure 1 shows that, after
increasing sharply in the 1980s, flat-rate premium income declined from
$753 million in 1993 to $654 million in 2002, in constant 2002 dollars.23
Income from the variable-rate premium fluctuated widely over that period.

22According to PBGC officials, PBGC files a claim for all unfunded
benefits in bankruptcy proceedings. However, PBGC generally recovers only
a small portion of the total unfunded benefit amount in bankruptcy
proceedings, and the recovered amount is split between PBGC (for unfunded
guaranteed benefits) and participants (for unfunded nonguaranteed
benefits).

23In 2002 dollars, flat-rate premium income rose from $605 million in 1993
to $654 million in 2002.

Figure 1: Flat- and Variable-Rate Premium Income for the Single-Employer
Pension Insurance Program, Fiscal Years 1975-2002

Income (2002 dollars in millions)

1,400

1,200

1,000

800

600

400

200

0 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 Fiscal year

Variable-rate premiums

Flat-rate premiums

Source: PBGC.

Note: PBGC follows accrual basis accounting, and as a result, included in
the fiscal year 2002 statement an estimate of variable-rate premium income
for the period covering January 1 through September 30, 2002, for plans
whose filings were not received by September 30, 2002. We adjusted PBGC
data using the Consumer Price Index for All Urban Consumers: All Items.

The slight decline in flat-rate premium revenue over the last decade, in
real dollars, indicates that the increase in insured participants has not
been sufficient to offset the effects of inflation over the period.
Essentially, while the number of participants has grown since 1980, growth
has been sluggish. Additionally, after increasing during the early 1980s,
the number of insured single-employer plans has decreased dramatically
since 1986. (See fig. 2.)

Figure 2: Participants and Plans Covered by the Single-Employer Insurance
Program, 1980-2002

Number of participants (millions) Number of plans (thousands)

40 120

110 35 100

30 90

80 25 70

20 60

50 15 40

10 30

20 5 10

00

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

Fiscal year

Source: PBGC.

Insured participants

Plans

The decline in variable-rate premiums in 2002 may be due to a number of
factors. For example, all else equal, an increase in the rate used to
determine the present value of benefits reduces the degree to which
reports indicate plans are underfunded, which reduces variable-rate
premium payments. The Job Creation and Worker Assistance Act of 2002
increased the statutory interest rate for variable-rate premium
calculations from 85 percent to 100 percent of the interest rate on
30-year U.S. Treasury securities for plan years beginning after December
31, 2001, and before January 1, 2004.24

Investment income is also a large source of funds for the single-employer
insurance program. The law requires PBGC to invest a portion of the funds
generated by flat-rate premiums in obligations issued or guaranteed by the
United States, but gives PBGC greater flexibility in the investment of
other

24See section 405, P.L. 107-147, Mar. 9, 2002.

assets.25 For example, PBGC may invest funds recovered from terminated
plans and plan sponsors in equities, real estate, or other securities and
funds from variable-rate premiums in government or private fixed-income
securities. According to PBGC, however, by policy, it invests all premium
income in Treasury securities. As a result of the law and investment
policies, the majority of the single-employer program's assets are
invested in U.S. government securities. (See fig. 3.)

25PBGC accounts for single-employer program assets in separate trust and
revolving funds. PBGC accounts for the assets of terminated plans and plan
sponsors in a trust fund, which, according to PBGC, may be invested in
equities, real estate, or other securities. PBGC accounts for
single-employer program premiums in two revolving funds. One revolving
fund is used for all variable-rate premiums, and that portion of the
flat-rate premium attributable to the flat-rate in excess of $8.50. The
law states that PBGC may invest this revolving fund in such obligations as
it considers appropriate. See 29 U.S.C. 1305(f). The second revolving fund
is used for the remaining flat-rate premiums, and the law restricts the
investment of this revolving fund to obligations issued or guaranteed by
the United States. See 29 U.S.C. 1305(b)(3).

Figure 3: Market Value of Single-Employer Program Assets in Revolving and
Trust Funds at Year End, Fiscal Years 1990-2002

Market value (2002 dollars in billions)

25

20

15

10

5

0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Other

Equities

U.S. Government securities

Source: PBGC annual reports.

Note: Other includes fixed-maturity securities, other than U.S. government
securities, such as corporate bonds. In 2002, fixed-maturity securities,
other than U.S. government securities, totaled $946 million. We adjusted
PBGC data using the Consumer Price Index for All Urban Consumers: All
Items.

Since 1990, except for 3 years, PBGC has achieved a positive return on the
investments of single-employer program assets. (See fig 4.) According to
PBGC, over the last 10 years, the total return on these investments has
averaged about 10 percent.

Figure 4: Total Return on the Investment of Single-Employer Program
Assets, Fiscal Years 1990-2002

Total return (percent) 30 27.7 25

20

15

10

5

0

-5

-6.4 -10

  1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Fiscal year

                          Source: PBGC annual reports.

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.26 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.27 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.

26In 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.

27Under Statement of Financial Accounting Standard Number 5, loss
contingencies are classified as probable if the future event or events are
likely to occur.

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. 5.) In fiscal year 1996,
the program had its first accumulated surplus, and by fiscal year 2000,
the accumulated surplus had increased to almost $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 estimated that this deficit had grown to $8.8 billion by
August 31, 2003. Despite this 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 2002.28 Losses since that time may have
shortened the period over which the program will be able to cover promised
benefits.

28The 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 2004-14, 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.

Figure 5: Assets, Liabilities, and Net Position of the Single-Employer
Pension Insurance Program, Fiscal Years 1976-2002

2002 Dollars in billions

30

25

20

15

10

5

0

-5

-10 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

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.

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.29 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

Source: PBGC annual reports.

  Termination of Severely Underfunded Plans Was Primary Factor in Financial
  Decline of Single-Employer Program

29U.S. General Accounting Office, Pension Plans: Hidden Liabilities
Increase Claims Against Government Insurance Programs,
GAO/HRD-93-7(Washington, D.C.: Dec. 30, 1992).

stock market and a general decline in interest rates. The current minimum
funding rules and variable-rate premiums were not effective at preventing
those plans from being severely underfunded at termination.

PBGC Assumed Responsibility for Several Severely Underfunded Plans in 2002

Total estimated losses in the single-employer program reported in PBGC
annual reports increased from $705 million in fiscal year 2001 to $9.3
billion in fiscal year 2002. In addition to $3.0 billion in losses from
the unfunded liabilities of terminated plans, the $9.3 billion included
$6.3 billion in losses from the unfunded liabilities of plans that were
expected to terminate in the near future. Nearly all of the terminations
considered probable at the end of fiscal year 2002 have already occurred.
For example, in December 2002, PBGC involuntarily terminated an
underfunded Bethlehem Steel Corporation pension plan, which resulted in
the single-employer program assuming responsibility for about $7.2 billion
in PBGC-guaranteed liabilities, about $3.7 billion of which was not funded
at termination.

Much of the program's losses resulted from the termination of underfunded
plans sponsored by failing steel companies. PBGC estimates that in 2002,
underfunded steel company pension plans accounted for 80 percent of the
$9.3 billion in program losses for the year. The three largest losses in
the single-employer program's history resulted from the termination of
underfunded plans sponsored by failing steel companies: Bethlehem Steel,
LTV Steel, and National Steel. All three plans were either completed
terminations or listed as probable terminations for 2002. Giant vertically
integrated steel companies, such as Bethlehem Steel, have faced extreme
economic difficulty for decades, and efforts to salvage their
defined-benefit plans have largely proved unsuccessful. According to
PBGC's executive director, underfunded steel company pension plans have
accounted for 58 percent of PBGC single-employer losses since 1975.

Plan Unfunded Liabilities Were Increased by Stock Market and Interest Rate
Declines

The termination of underfunded plans in 2002 occurred after a sharp
decline in the stock market had reduced plan asset values and a general
decline in interest rates had increased plan liability values, and the
sponsors did not make the contributions necessary to adequately fund the
plans before they were terminated. The combined effect of these factors
was a sharp increase in the unfunded liabilities of the terminating plans.
According to annual reports (Annual Return/Report of Employee Benefit
Plan, Form 5500) submitted by Bethlehem Steel Corporation, for example, in
the 7 years from 1992 to 1999, the Bethlehem Steel pension plan went from
86 percent funded to 97 percent funded. (See fig. 6.) 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.

Figure 6: 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

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 used by Bethlehem
Steel 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.

A decline in the stock market, which began in 2000, was a major cause of
the decline in plan asset values, and the associated increase in the
degree that plans were underfunded at termination. For example, while
total returns for stocks in the Standard and Poor's 500 index (S&P 500)
exceeded 20 percent for each year from 1995 through 1999, they were
negative starting in 2000, with negative returns reaching 22.1 percent in
2002. (See fig. 7.) Surveys of plan investments by Greenwich Associates

indicated that defined-benefit plans in general had about 62.8 percent of
their assets invested in U.S. and international stocks in 1999.30

Figure 7: Total Return on Stocks in the S&P 500 Index, Calendar Years 1992-2002

                             Total return (percent)

                                   37.6 -22.1

             1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

                          Source: Standard and Poor's.

A stock market decline as severe as the one experienced from 2000 through
2002 can have a devastating effect on the funding of plans that had
invested heavily in stocks. For example, according to a survey,31 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.32 Over that same general period, stocks in the S&P 500 had a
negative return of 38 percent.

302002 U.S. Investment Management Study, Greenwich Associates, Greenwich,
Conn.

31Pensions & Investments, vol. 29, Issue 2 (Chicago: Jan. 22, 2001).

32According to the survey, the Bethlehem Steel Corporation 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).

In addition to the possible effect of the stock market's decline, a drop
in interest rates likely had a negative effect on plan funding levels by
increasing plan termination costs. Lower interest rates increase plan
termination liabilities by increasing the present value of future benefit
payments, which in turn increases the purchase price of group annuity
contracts used to terminate defined-benefit pension plans.33 For example,
a PBGC analysis indicates that a drop in interest rates of 1 percentage
point, from 6 percent to 5 percent, increased the termination liabilities
of the Bethlehem Steel pension plan by about 9 percent, which indicates
the cost of terminating the plan through the purchase of a group annuity
contract

34

would also have increased.

Relevant interest rates may have declined 3 percentage points or more
since 1990.35 For example, interest rates on long-term high-quality
corporate bonds approached 10 percent at the start of the 1990s, but were
below 7 percent at the end of 2002. (See fig. 8.)

33Present value calculations reflect the time value of money: A dollar in
the future is worth less than a dollar today because the dollar today can
be invested and earn interest. The calculation requires an assumption
about the interest rate, which reflects how much could be earned from
investing today's dollars. Assuming a lower interest rate increases the
present value of future payments.

34The magnitude of an increase or decrease in plan liabilities associated
with a given change in discount rates would depend on the demographic and
other characteristics of each plan.

35To terminate a defined-benefit pension plan without submitting a claim
to PBGC, the plan sponsor determines the benefits that have been earned by
each participant up to the time of plan termination and purchases a
single-premium group annuity contract from an insurance company, under
which the insurance company guarantees to pay the accrued benefits when
they are due. Interest rates on long-term, high-quality fixed-income
securities are an important factor in pricing group annuity contracts
because insurance companies tend to invest premiums in such securities to
finance annuity payments. Other factors that would have affected group
annuity prices include changes in insurance company assumptions about
mortality rates and administrative costs.

 Figure 8: Interest Rates on Long-Term High-Quality Corporate Bonds, 1990-2002

Interest rate (percent)

 Jan.-90 Jan.-91 Jan. -92 Jan. -93 Jan. -94 Jan. -95 Jan. -96 Jan. -97 Jan. -98
                      Jan. -99 Jan. -00 Jan. -01 Jan. -02

                       Source: Moody's Investor Services.

Minimum Funding Rules and Variable-Rate Premiums Did Not Prevent Plans
from Being Severely Underfunded

IRC minimum funding rules and ERISA variable rate premiums, 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.36 Also, the rules
require the sponsor to make an additional contribution if the plan is
underfunded to the extent defined in the law. However, plan funding is
measured using current liabilities, which a PBGC analysis indicates have
been typically less than termination liabilities.37 Additionally, 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

36Minimum 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.

37For the analysis, PBGC used termination liabilities reported to it under
29 C.F.R. sec 4010.

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.38

While minimum funding rules may encourage sponsors to better fund their
plans, the rules require sponsors to assess plan funding using current
liabilities, which a PBGC analysis indicates have been typically less than
termination liabilities. Current and termination liabilities differ
because the assumptions used to calculate them differ. For example, some
plan participants may retire earlier if a plan is terminated than they
would if the plan continues operations, and lowering the assumed
retirement age generally increases plan liabilities, especially if early
retirement benefits are subsidized. With respect to two of the terminated
underfunded pension plans that we examine, for example, a PBGC analysis
indicates:

o  	The retirement age assumption for the Anchor Glass pension plan on an
ongoing plan basis was 65 for separated vested participants. However, the
retirement age assumption appropriate for those participants on a
termination basis was 58-a decrease of 7 years. According to PBGC,
changing retirement age assumptions for all participants, including
separated vested participants, resulted in a net increase in plan
liabilities of about 4.6 percent.

o  	The retirement age assumption for the Bethlehem Steel pension plan on
an ongoing plan basis was 62 for those active participants eligible for
unreduced benefits after 30 years of service. On the other hand, the
retirement age assumption for them on a plan termination basis was 55-the
earliest retirement age. According to PBGC, decreasing the assumed
retirement age from 62 to 55 approximately doubled the liability for those
participants.

As shown in appendix IV, changes in the interest rates used to calculate
termination and current liabilities also play a role in determining to
what extent termination liabilities differ from current liabilities.

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

38See 26 U.S.C. 412(b).

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 cash 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 the IRC funding rules from making a
tax-deductible contribution to the plan.39 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.

Another ERISA provision, concerning the payment of variable-rate premiums,
is also designed to encourage employers to better fund their plans. As
with minimum funding rules, the variable-rate premium did not provide
sufficient incentives for the sponsors of the plans that we reviewed to
make the contributions necessary to adequately fund their plans. None of
the three underfunded plans that we reviewed, which became losses to the
single-employer program in 2002 and 2003, paid a variable-rate premium in
the 2001 plan year. Plans are exempt from the variable-rate premium if
they are at the full-funding limit in the year preceding the premium
payment year, in this case 2000, after applying any contributions and
credit balances in the funding standard account. Each of these three plans
met this criterion.

39See 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.

  PBGC Faces Long-Term Financial Risks from a Potential Imbalance of Assets and
  Liabilities

Two primary risks threaten the long-term financial viability of the
single-employer program. The greater risk concerns the program's
liabilities: large losses, due to bankrupt firms with severely underfunded
pension plans, could continue or accelerate. This could occur if returns
on investment remain poor, interest rates stay low, and economic problems
persist. More troubling for liabilities is the possibility that structural
weaknesses in industries with large underfunded plans, including those
greatly affected by increasing global competition, combined with the
general shift toward defined-contribution pension plans, could jeopardize
the long-term viability of the defined-benefit system. On the asset side,
PBGC also faces the risk that it may not receive sufficient revenue from
premium payments and investments to offset the losses experienced by the
single-employer program in 2002 or that this program may experience in the
future. This could happen if program participation falls or if PBGC earns
a return on its assets below the rate it uses to value its liabilities.

Several Factors Affect the Degree to Which Plans Are Underfunded and the
Likelihood That Plan Sponsors Will Go Bankrupt

Plan terminations affect the single-employer program's financial condition
because PBGC takes responsibility for paying benefits to participants of
underfunded terminated plans. Several factors would increase the
likelihood that sponsoring firms will go bankrupt, and therefore will need
to terminate their pension plans, and the likelihood that those plans will
be underfunded at termination. Among these are poor investment returns,
low interest rates, and continued weakness in the national economy or
specific sectors. Particularly troubling may be structural weaknesses in
certain industries with large underfunded defined-benefit plans.

Poor investment returns from a decline in the stock market can affect the
funding of pension plans. To the extent that pension plans invest in
stocks, the decline in the stock market will increase the chance that
plans will be underfunded should they terminate. A Greenwich Associates
survey of defined-benefit plan investments indicates that 59.4 percent of
plan assets were invested in stocks in 2002.40 Clearly, the future
direction of the stock market is very difficult to forecast. From the end
of 1999 through the end of 2002, total cumulative returns in the stock
market, as measured by the S&P 500, were negative 37.6 percent. In 2003,
the S&P 500 has partially recovered those losses, with total returns (from
a lower starting point) of 14.7 percent through the end of September. From
January 1975, the beginning of the first year following the passage of
ERISA, through

402002 U.S. Investment Management Study, Greenwich Associates, Greenwich,
CT.

September 2003, the average annual compounded nominal return on the S&P
500 equaled 13.5 percent.

A decline in asset values can be particularly problematic for plans if
interest rates remain low or fall, which raises plan liabilities, all else
equal. The highest allowable discount rate for calculating current plan
liabilities, based on the 30-year U.S. Treasury bond rate, has been no
higher than 7.1 percent since April, 1998, lower than any previous point
during the 1990s.41 Falling interest rates raise the price of group
annuities that a terminating plan must purchase to cover its promised
benefits and increase the likelihood that a terminating plan will not have
sufficient assets to make such a purchase.42 An increase in liabilities
due to falling interest rates also means that companies may be required
under the minimum funding rules to increase contributions to their plans.
This can create financial strain and increase the chances of the firm
going bankrupt, thus increasing the risk that PBGC will have to take over
an underfunded plan.

Economic weakness can also lead to greater underfunding of plans and to a
greater risk that underfunded plans will terminate. For many firms, slow
or declining economic growth causes revenues to decline, which makes
contributions to pension plans more difficult. Economic sluggishness also
raises the likelihood that firms sponsoring pension plans will go
bankrupt. Three of the last five annual increases in bankruptcies
coincided with recessions, and the record economic expansion of the 1990s
is associated with a substantial decline in bankruptcies. Annual plan
terminations resulting in losses to the single-employer program rose from
83 in 1989 to 175 in 1991, and after declining to 65 in 2000, the number
reached 93 in

43

2001.

41The U.S. Treasury stopped publishing a 30-year Treasury bond rate in
February 2002, but the Internal Revenue Service publishes rates for
pension calculations based on rates for the last-issued bonds in February
2001. Interest rates to calculate plan liabilities must be within a
"permissible range" around a 4-year weighted average of 30-year Treasury
bond rates; the permissible range for plan years beginning in 2002 and
2003 was 90 to 120 percent of this 4-year weighted average.

42A potentially offsetting effect of falling interest rates is the
possible increased return on fixed-income assets that plans, or PBGC,
hold. When interest rates fall, the value of existing fixed-income
securities with time left to maturity rises.

43The last three recessions on record in the United States occurred during
1981, 1990-91, and 2001. (See www.bea.gov/bea/dn/gdpchg.xls.)

Weakness in certain industries, particularly the airline and automotive
industries, may threaten the viability of the single-employer program.
Because PBGC has already absorbed most of the pension plans of steel
companies, it is the airline industry, with $26 billion of total pension
underfunding, and the automotive sector, with over $60 billion in
underfunding, that currently represent PBGC's greatest future financial
risks. In recent years, profit pressures within the U.S. airline industry
have been amplified by severe price competition, recession, terrorism, the
war in Iraq, and the outbreak of Severe Acute Respiratory Syndrome (SARS),
creating recent bankruptcies and uncertainty for the future financial
health of the industry. As one pension expert noted, a potentially
exacerbating risk in weak industries is the cumulative effect of
bankruptcy: if a critical mass of firms go bankrupt and terminate their
underfunded pension plans, others, in order to remain competitive, may
also declare bankruptcy to avoid the cost of funding their plans.

Because the financial condition of both firms and their pension plans can
eventually affect PBGC's financial condition, PBGC tries to determine how
many firms are at risk of terminating their pension plans and the total
amount of unfunded vested benefits. According to PBGC's fiscal year 2002
estimates, the agency is at potential risk of taking over $35 billion in
unfunded vested benefits from plans that are sponsored by financially weak
companies and could terminate.44 Almost one-third of these unfunded
benefits, about $11.4 billion, are in the airline industry. Additionally,
PBGC estimates that it could become responsible for over $15 billion in
shutdown benefits in PBGC-insured plans.

PBGC uses a model called the Pension Insurance Modeling System (PIMS) to
simulate the flow of claims to the single-employer program and to project
its potential financial condition over a 10-year period. This model
produces a very wide range of possible outcomes for PBGC's future net
financial position.45

44This estimate comprises "reasonably possible" terminations, which
include plans sponsored by companies with credit quality below investment
grade that may terminate, though likely not by year-end. Plan participants
have a nonforfeitable right to vested benefits, as opposed to nonvested
benefits, for which participants have not yet completed qualification
requirements.

45PBGC began using PIMS to project its future financial condition in 1998.
Prior to this, PBGC provided low-, medium-, and high-loss forecasts, which
were extrapolations from the agency's claims experience and the economic
conditions of the previous 2 decades.

Revenue from Premiums and Investments May Not Offset Program's Current
Deficit or Possible Future Losses

To be viable in the long term, the single-employer program must receive
sufficient income from premiums and investments to offset losses due to
terminating underfunded plans. A number of factors could cause the
program's revenues to fall short of this goal or decline outright. For
example, fixed-rate premiums would decline if the number of participants
covered by the program decreases, which may happen if plans leave the
system and are not replaced. Additionally, the program's financial
condition would deteriorate to the extent investment returns fall below
the assumed interest rate used to value liabilities.

Annual PBGC income from premiums and investments averaged $1.3 billion
from 1976 to 2002, in 2002 dollars, and $2 billion since 1988, when
variable-rate premiums were introduced. Since 1988, investment income has
on average equaled premium income, but has varied more than premium
income, including 3 years in which investment income fell below zero. (See
fig. 9.)

Figure 9: PBGC Premium and Investment Income, 1976-2002

Income (2002 dollars in millions)

3.5

3.0

2.5

2.0

1.5

1.0

0.5

0

-0.5

-1.0 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

                     Source: PBGC annual financial reports.

Premium income

Investment income

Note: We adjusted PBGC data using the Consumer Price Index for All Urban
Consumers: All Items.

Premium revenue for PBGC would likely decline if the total number of plans
and participants terminating their defined-benefit plans exceeded the new
plans and participants joining the system. This decline in participation
would mean a decline in PBGC's flat-rate premiums. If more plans become
underfunded, this could possibly raise the revenue PBGC receives from
variable-rate premiums, but would also be likely to raise the overall risk
of plans terminating with unfunded liabilities. Premium income, in 2002
dollars, has fallen every year since 1996, even though the Congress lifted
the cap on variable-rate premiums in that year.

The decline in the number of plans PBGC insures may cast doubt on its
ability to increase premium income in the future. The number of
PBGC-insured plans has decreased steadily from approximately 110,000 in
1987 to around 30,000 in 2002.46 While the number of total participants in

46In contrast, defined-contribution plans have grown significantly over a
similar period- from 462,000 plans in 1985 to 674,000 plans in 1998.

PBGC-insured single-employer plans has grown approximately 25 percent
since 1980, 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. (See fig 10.) In addition, a growing percentage of
plans have recently become hybrid plans, such as cash-balance plans, that
incorporate characteristics of both defined-contribution and
defined-benefit plans. Hybrid plans are more likely than traditional
defined-benefit plans to offer participants the option of taking benefits
as a lump-sum distribution. If the proliferation of hybrid plans increases
the number of participants leaving the program by taking lump sums instead
of retirement annuities, over time this would reduce the number of plan
participants, thus potentially reducing PBGC's flat-rate premium
revenue.47 Unless something reverses these trends, PBGC may have a
shrinking plan and participant base to support the program in the future
and that base may be concentrated in certain, potentially more vulnerable
industries.

47If a plan sponsor purchases an annuity for a retiree from an insurance
company to pay benefits, this would also remove the retiree from the
participant pool, which would have the same effect on flat-rate premiums.

Figure 10: Distribution of PBGC-Insured Participants by Industry, 2001

Information

Transportation and public utilities

Finance, insurance, and real estate

Other

Services

Manufacturing Source: PBGC.
Note: Percentages do not sum to 100 due to rounding.

Even more problematic than the possibility of falling premium income may
be that PBGC's premium structure does not reflect many of the risks that
affect the probability that a plan will terminate and impose a loss on
PBGC. While PBGC charges plan sponsors a variable-rate premium based on
the plan's level of underfunding, premiums do not consider other relevant
risk factors, such as the economic strength of the sponsor, plan asset
investment strategies, the plan's benefit structure, or the plans
demographic profile. Because these affect the risk of PBGC having to take
over an underfunded pension plan, it is possible that PBGC's premiums will
not adequately and equitably protect the agency against future losses. The
recent terminations of Bethlehem Steel, Anchor Glass, and Polaroid, plans
that paid no variable-rate premiums shortly before terminating with large
underfunded balances, lend some evidence to this possibility. Sponsors
also pay flat-rate premiums in addition to variable-rate premiums, but
these reflect only the number of plan participants and not other risk
factors that affect PBGC's potential exposure to losses. Full-funding
limitations may exacerbate the risk of underfunded terminations by
preventing firms from contributing to their plans during strong economic
times when asset values are high and firms are in the best financial
position to make contributions.

It may also be difficult for PBGC to diversify its pool of insured plans
among strong and weak sponsors and plans. In addition to facing
firm-specific risk that an individual underfunded plan may terminate, PBGC
faces market risk that a poor economy may lead to widespread underfunded
terminations during the same period, which potentially could cause very
large losses for PBGC. Similarly, PBGC may face risk from insuring plans
concentrated in vulnerable industries that may suffer bankruptcies over a
short time period, as has happened recently in the steel and airline
industries. One study estimates that the overall premiums collected by
PBGC amount to about 50 percent of what a private insurer would charge
because its premiums do not account for this market risk.48

The net financial position of the single-employer program also depends
heavily on the long-term rate of return that PBGC achieves from the
investment of the program's assets. All else equal, PBGC's net financial
condition could improve if its total net return on invested assets
exceeded the discount rate it used to value its liabilities.49 For
example, between 1993 and 2000 the financial position of the
single-employer program benefited from higher rates of return on its
invested assets and its financial condition improved. However, if the rate
of return on assets falls below the discount rate, PBGC's finances would
worsen, all else equal. As of September 30, 2002, PBGC had approximately
65 percent of its single-employer program investments in U.S. government
securities and approximately 30 percent in equities. The high percentage
of assets invested in Treasury securities, which typically earn low yields
because they are considered to be relatively "risk-free" assets, may limit
the total return on PBGC's portfolio.50 Additionally, PBGC bases its
discount rate on surveys of insurance company group annuity prices, and
because PBGC invests differently than do insurance companies, we might
expect some divergence between the discount rate and PBGC's rate of return
on assets. PBGC's return on total invested funds was 2.1 percent for the
year ending September 30, 2002, and 5.8 percent for the 5-year period
ending on that

48Boyce, Steven, and Richard A. Ippolito, "The Cost of Pension Insurance,"
The Journal of Risk and Insurance (2002) vol. 69, No.2, p. 121-170.

49PBGC's investment income needs to cover the increase in the present
value of future benefits from existing claims. Investment income above
this level would improve PBGC's net financial condition, all else equal.
Conversely, investment income below the present value of future claims
will increase PBGC's deficit, all else equal.

50The return on fixed-income assets sold before maturity may also be
affected by capital gains (or losses). The price of a bond moves in the
opposite direction as interest rates, and so if interest rates fall,
bondholders may reap capital gains.

date. For fiscal year 2002, PBGC used an annual discount rate of 5.70
percent to determine the present value of future benefit payments through
2027 and a rate of 4.75 percent for payments made in the remaining years.

The magnitude and uncertainty of these long-term financial risks pose
particular challenges for the PBGC's single-employer insurance program and
potentially for the federal budget. In 1990, we began a special effort to
review and report on the federal program areas we considered high risk
because they were especially vulnerable to waste, fraud, abuse, and
mismanagement. In the past, we considered PBGC to be on our high-risk list
because of concerns about the program's viability and about management
deficiencies that hindered that agency's ability to effectively assess and
monitor its financial condition. The current challenges to PBGC's
single-employer insurance program concern immediate as well as long-term
financial difficulties, which are more structural weaknesses rather than
operational or internal control deficiencies. Nevertheless, because of
serious risks to the program's viability, we have placed the PBGC
single-employer insurance program on our high-risk list.

Several types of reforms might be considered to reduce the risks to the
single-employer program's long-term financial viability. These reforms
could be made to

strengthen funding rules applicable to poorly funded plans;

modify program guarantees;

o  restructure premiums; and

o  	improve the availability of information about plan investments,
termination funding status, and program guarantees.

Several variations exist within these options.

Several Reforms Might Reduce the Risks to the

o

Program's Financial

o

  Viability

Strengthening Plan Funding Rules Might Reduce Program Risks

Funding rules could be strengthened to increase minimum contributions to
underfunded plans and to allow additional contributions to fully funded
plans.51 This approach would improve plan funding over time, while
limiting the losses PBGC would incur when a plan is terminated. However,
even if funding rules were to be strengthened immediately, it could take
years for the change to have a meaningful effect on PBGC's financial
condition. In addition, 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. 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 problem with this approach is the difficulty plan sponsors would
have determining the appropriate interest rate to use in valuing
termination

51If the Congress chooses to replace the 30-year Treasury rate used to
calculate pension plan liabilities, the level of the interest rate
selected can also affect plan funding. For example, if a rate that is
higher than the current rate is selected, plan liabilities would appear
better funded, thereby decreasing minimum and maximum employer
contributions. In addition, some plans would reach full-funding
limitations and avoid having to pay variable-rate premiums. Therefore,
PBGC would receive less revenue. Conversely, a lower rate would likely
improve PBGC's financial condition. In 1987, when the 30-year Treasury
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 plans pension payments.
However, in the late 1990s, when fewer 30-year Treasury bonds were issued
and economic conditions increased demand for the bonds, the 30-year
Treasury rate diverged from other long-term interest rates, an indication
that it also may have diverged from group annuity purchase rates. In 2001,
Treasury stopped issuing these bonds altogether, and in March 2002, the
Congress enacted temporary measures to alleviate employer concerns that
low interest rates on the remaining 30-year Treasury bonds were affecting
the reasonableness of the interest rate for employer pension calculations.
Selecting a replacement rate is difficult because little information
exists on which to base the selection. Other than the 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 also 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.

liabilities. As we reported, selecting an appropriate interest rate for
termination liability calculations is difficult because little information

                                       52

exists on which to base the selection.

o  	Change requirement for making additional funding contributions. The
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. 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
might also prevent sponsors of significantly underfunded plans from
avoiding cash contributions. Such 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. 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.53 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. The IRC and ERISA
restrict tax-deductible contributions to prevent plan sponsors from
contributing

52GAO-03-313.

53The 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-sum distributions.

more to their plan than is necessary to cover accrued future benefits.54
Raising these limitations might result in pension plans being better
funded, decreasing the likelihood that they will be underfunded should
they terminate. 55

Modifying Program Guarantee Would Decrease Plan Underfunding

Modifying certain guaranteed benefits could decrease losses incurred by
PBGC from underfunded plans. This approach could preserve plan assets by
preventing additional losses that PBGC would incur when a plan is
terminated. However, participants would lose benefits provided by some
plan sponsors. ERISA could be amended to:

o  	Phase in the guarantee of shutdown benefits. PBGC is concerned about
its exposure to the level of shutdown benefits that it guarantees.
Shutdown benefits provide additional benefits, such as significant early
retirement benefit subsidies 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. Phasing in guarantees from the date of the
applicable shutdown could decrease the losses incurred by PBGC from
underfunded plans.56 However, 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.

o  	Expand restrictions on unfunded benefit increases. Currently, plan
sponsors must meet certain conditions before increasing the benefits of

54Employers 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.

55For 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, Committee on Education and the Workforce,
U.S. House of Representatives, Hearing on Strengthening Pension Security:
Examining the Health and Future of Defined Benefit Pension Plans.
(Washington, D.C.: June 4, 2003), 9.

56Currently, some measures exist to limit the losses incurred by PBGC from
newly 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.

plans that are less than 60 percent funded.57 Increasing this threshold,
or restricting benefit increases or accruals when plans reach the
threshold, could decrease the losses incurred by PBGC from underfunded
plans. 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.

Restructuring the Program's Premium Structure Might Improve Its Financial
Viability

PBGC's premium rates could be increased or restructured to improve PBGC's
financial condition. Changing premiums could increase PBGC's revenue or
provide an incentive for plan sponsors to better fund their plans.
However, premium changes that are not based on the degree of risk posed by
different plans may prompt financially healthy companies to exit the
defined-benefit system and discourage other plan sponsors from entering
the system. Various actions could be taken to reduce guaranteed benefits.
ERISA could be amended to:

o  	Increase or restructure variable-rate premium. The current
variable-rate premium of $9 per $1,000 of unfunded liability could be
increased. The rate could also be adjusted so that plans with less
adequate funding pay a higher rate. Premium rates could also 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,58 shutdown benefit, and floor-offset provisions.59 One

     advantage of a rate increase or restructuring is that it might improve

57IRC 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).

58For 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.

59Under 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.

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  	Increase fixed-rate premium. The current fixed rate of $19 per
participant annually could be increased. Since the inception of PBGC, this
rate has been raised four times, most recently in 1991 when it was raised
from $16 to $19. Such increases generally raise premium income for PBGC,
but the current fixed-rate premium has not reflected the changes in
inflation since 1991. By indexing the rate to the consumer price index,
changes to the premium would be consistent with inflation. However, any
increases in the fixed-rate premium would affect all plans regardless of
the adequacy of their funding.

Increasing Transparency of Plan Information Might Encourage Sponsors to
Better Fund Plans, Reducing Program Risks

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. ERISA could
be amended to:

o  	Disclose information on plan investments. Information on the
allocation of plan investments among asset classes-such as equity or fixed
income-is available from Form 5500s prepared by plan sponsors, but that
information is not affirmatively furnished 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. Improving the accessibility of plan asset allocation
information 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. This would be of concern because should the
sponsor becomes 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  	Disclose 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. In addition, only
participants in plans below a certain funding threshold receive annual
notices of the funding status of their plans.60 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.61

o  	Disclose benefit guarantees to additional participants. As with the
disclosure of plan funding status, only participants of plans below the
funding threshold receive notices on the level of program guarantees
should their plan terminate. Termination of a severely underfunded plan
can significantly reduce the benefits participants receive. For example,
59-year old pilots were expecting annual benefits of $110,000 per year on
average when the U.S. Airways plan was terminated in

60The 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.

61Participants 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 9
months after the close of the plan year.

2003, while the maximum PBGC-guaranteed benefit at age 60 is $28,600 per
year.62 Expanding the circumstances under which plan sponsors must notify
participants of PBGC guarantees may enable more participants to better
plan for their retirement.

Additionally, in 1997, we reported that the current cash-based budget for
federal insurance programs, such as the single-employer pension insurance
program generally provides incomplete and misleading information on the
cost and fiscal impact of those programs.63 We stated that accrual-based
reporting would recognize the cost of the insurance commitment when the
decision is made to provide the insurance, regardless of when the cash
flows occur. This earlier recognition of the cost of the government's
commitment would, among other things, provide an opportunity to control
costs and build budget reserves for future claims. However, we also
reported that agencies, such as PBGC, might need to develop and test
methodologies to generate the risk-assumed cost estimates critical to the
successful implementation of accrual-based budgeting for insurance
programs. In its comments on our report, OMB stated that, while it agreed
with our conclusions and would like to pursue such improvements, it was
not doing so because it did not have the expertise that would be required.
Given the record losses that the single-employer pension insurance program
sustained in 2002 and the deteriorating financial condition of PBGC it is
more important than ever to acquire the necessary expertise and invest in
the development of loss estimation methodologies and tools.

Conclusion 	While the recent decline in the single-employer program's
financial condition is not an immediate crisis, threats to the program's
long-term viability should be addressed. The insolvency of PBGC
potentially

62However, the actual benefit paid by PBGC depends on a number of factors
and may exceed the maximum guaranteed benefit. For example, PBGC expects
that the average annual benefit paid to U.S. Airways pilots who are 59
years of age with 29 years of service will be about $85,000, including
nonguaranteed amounts. PBGC said that many US Airways pilots will receive
more than the $28,600 maximum limit because, according to priorities
established under ERISA, pension plan participants may receive benefits in
excess of the guaranteed amounts if there are enough assets or recoveries
from the plan sponsors. For example, a participant who could have retired
3 years prior to plan termination (but did not) may be eligible to receive
both guaranteed and nonguaranteed amounts. PBGC letter in response to
follow-up questions from the Committee on Finance, U.S. Senate
(Washington, D.C.: Apr. 1, 2003).

63GAO/AIMD-97-16, 143.

threatens the retirement security of millions of Americans because
termination of severely underfunded plans can significantly reduce the
benefits participants receive. It also poses risks to the general
taxpaying public who ultimately would be made responsible for paying
benefits that PBGC is unable to afford. These risks require that
meaningful, if perhaps difficult, steps be taken that improve the
long-term funding status of plans and accountability of plan sponsors,
especially those that represent a clear risk to PBGC and plan participants
and their beneficiaries. In contrast, reforms intended to provide
immediate relief to struggling plan sponsors- such as exempting plans from
the additional funding requirement or increasing the discount rate-might
actually increase the risk that plan sponsors terminate with severely
underfunded plans in the not so distant future if the economic fortunes of
those sponsors do not improve.

The factors contributing to the deterioration of PBGC's financial
condition go beyond the effects of the recent economic downturn. For
example, current funding rules do not provide adequate protection to PBGC
or workers and retirees against losses from financially weak sponsors with
significantly unfunded benefits, leaving PBGC to pay benefits at least to
guaranteed levels. In addition, PBGC guarantees other types of benefits,
such as shutdown benefits, that employers have promised their employees
but are not required to fund until shutdown occurs. Furthermore, the
premiums paid by pension sponsors to participate in the single-employer
program do not account for all the risks posed by plans and, therefore,
some sponsors may not be paying enough to compensate PBGC for the risks it
undertakes. Although these issues can affect employee retirement funds,
employers who are going bankrupt may not be required to notify pension
participants of the funding status of their pensions, leaving participants
unable to plan for a future that may include less income than they were
anticipating.

In addition to the reforms in the administration's proposal, the Treasury
Department, Labor Department, and PBGC are considering several areas-
funding rules, actuarial assumption, and other areas such as PBGC
premiums-for reform. However, the challenges facing PBGC suggest that a
broader, more comprehensive response is needed. For example, as we stated
in an earlier report,64 the interest rate used for current liability
calculation should reflect the group annuity purchase rate. However, any
changes to the interest rate should consider related provisions such as

64GAO-03-313.

averaging, minimum and maximum rates, and changes to the mortality table.
Furthermore, irrespective of the discount rate chosen, differences in plan
cash flows should be given consideration in making any changes to the
current funding standards. Without a comprehensive approach, efforts to
improve the long-term financial condition of PBGC may not be effective.

  Matters for Congressional Consideration

Agency Comments

Given the multidimensional and serious nature of the financial risks to
PBGC's single-employer insurance program, to millions of pension plan
participants and potentially to the federal budget, the Congress should
consider pension reform that is comprehensive in scope and balanced in
effect. Such a comprehensive response should include changes to strengthen
plan funding, especially for underfunded plans, and improve the
transparency of plan information as well as consider proposals to
restructure program guarantees, for example those concerning shutdown
benefits. In addition, PBGC's premium structure should be re-examined to
see whether premiums can better reflect the risk posed by various plans to
the pension system. In any case, reforms in these areas should be based on
a thorough analysis of their effects on the potentially competing
interests of protecting retirees' pensions and minimizing the burden on
sponsors.

Essential elements of this reform would include proposals to require plans
to calculate liabilities on a termination basis and disclose this
information to all participants annually. Particularly with regard to
disclosure, the Congress should consider requiring that all participants
receive information about plan investments and the minimum benefit amount
that PBGC guarantees should their plan be terminated.

To improve the transparency of the potential cost to the government and
taxpayers of the PBGC's pension guarantees, the Congress may also wish to
encourage the development and reporting of accrual based risk-assumed cost
estimates in the federal budget in conjunction with the current cash-based
estimates. Such forward looking estimates could more clearly reflect the
financial condition of the program and provide information and incentives
necessary to assess the future implications of programmatic decisions.

We provided a draft of this report to Labor, Treasury, and PBGC. PBGC also
provided written comments, which appear in appendix V, that incorporate
comments from the Treasury and Labor Departments and represent the views
of the Commerce Department. Labor, Treasury, and

PBGC also provided technical comments, which we incorporated as
appropriate.

We are sending copies of this report to the Secretary of Labor, the
Secretary of the Treasury, and the Executive Director of the PBGC,
appropriate congressional committees, and other interested parties. We
will also make copies available to others on request. In addition, the
report will be available at no charge on GAO's Web site at
http://www.gao.gov.

If you have any questions concerning this report, please contact me at
(202) 512-7215 or Charles A. Jeszeck at (202) 512-7036. Other contacts and
acknowledgments are listed in appendix VI.

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

                       Appendix I: Scope and Methodology

To identify the changes in the financial condition of the single-employer
program, we reviewed and analyzed Pension Benefit Guaranty Corporation
(PBGC) financial statements for 1991 through 2002, and obtained additional
financial information on the program from PBGC for 1974 through 1990. To
identify the factors that contributed to recent changes in the
single-employer program's financial condition, we 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. We also reviewed analyses of
the program's financial condition and plan funding issues prepared by
actuaries and other pension professionals. To examine the difference
between termination and current liability, and identify the factors that
cause that difference, we obtained summary level termination liability
data, and limited data for specific plans, submitted by plans to PBGC
under section 4010 of the Employee Retirement and Income Security Act
(ERISA) of 1974, as amended.

To identify the primary risks to the long-term viability of the program
and options to address the challenges facing the single-employer program,
we interviewed pension experts at PBGC, at the Employee Benefits Security
Administration (EBSA) of the Department of Labor, and in the private
sector and reviewed analyses and other documents provided by them. These
include data on PBGC's income, cash flows, premium structure and base,
investments, and assets and liabilities. To obtain additional information
as to the risks facing PBGC from certain industries, we discussed with
PBGC, and reviewed annual and actuarial reports for, the 2003 distress
termination of the U.S. Airways pension plan for pilots.

To determine what changes to the single-employer program might be
considered to reduce the risks that it faces, we reviewed and analyzed
proposals from the administration, the American Academy of Actuaries, and
various pension plan organizations and legislative proposals introduced
during the 108th Congress. We also spoke with officials from PBGC, EBSA,
and the Department of the Treasury; research actuaries; and individuals
from organizations that represent plan sponsors.

Appendix I: Scope and Methodology

We performed our work at PBGC and EBSA from April through September 2003
in accordance with generally accepted government auditing standards.

Appendix II: Key Legislative Changes That Affected the Single-Employer Program

As part of the ERISA, the Congress established PBGC to administer the
federal insurance program. Since 1974, the Congress has amended ERISA to
improve the financial condition of the insurance program and the funding
of single-employer plans (see table 1).

Table 1: Key Legislative Changes to the Single-Employer Insurance Program Since
                               ERISA Was Enacted

Year Law Number Key provisions

1974 ERISA P.L. 93-406 	Created a federal pension insurance program and
established a flat-rate premium and minimum and maximum funding rules.

1986 Single-Employer Pension Plan Amendments P.L. 99-272 Raised the
flat-rate premium and established financial distress Act of 1986 enacted
as Title XI of the Consolidated Omnibus Budget Reconciliation Act of 1985
criteria that sponsoring employers must meet to terminate an underfunded
plan.

1987 Pension Protection Act enacted as part of P.L. 100-203 Increased the
flat-rate premium and added a variable-rate the Omnibus Budget
Reconciliation Act of premium for underfunding calculated on the basis of
80 percent 1987 of the 30-year Treasury rate. In addition, established a
permissible range of 90-110 percent around the weighted average the
30-year Treasury rate as the basis for current liability calculations,
increased the minimum funding standards, and established a full-funding
limitation based on 150 percent of current liability.

1994 Retirement Protection Act enacted as part of P.L. 103-465 Raised the
basis for variable-rate premium calculation from 80 the Uruguay Rounds
Agreements Act, also percent to 85 percent of the 30-year Treasury rate
(effective July referred to as the General Agreement on 1997). Phased out
the cap on the variable-rate premium. Tariffs and Trade Strengthened
funding requirements by narrowing the permissible range of the allowable
interest rates to 90-105 percent of the weighted average the 30-year
Treasury rate and standardizing mortality assumptions for the current
liability calculation. Also, established 90 percent of current liability
as the minimum full-funding limitation.

                                                Phased in increases in the    
1997 Taxpayer Relief Act of 1997 P.L. 105-34 current liability funding     
                                                limit to155                   
                                                   percent for plan years     
                                                   beginning in 1999 with     
                                                         incremental          
                                                increases to 170 percent for  
                                                plan years beginning in 2005. 
        The Economic Growth and Tax             Accelerated the phasing out   
2001           Relief            P.L. 107-16 of the 160 percent            
                                                full-funding                  
                                                   limitation and repealed it 
        Reconciliation Act of 2001                for plan years beginning in 
                                                                     2004 and 
                                                         thereafter.          

2002 The Job Creation and Worker Assistance P.L. 107-147 Temporarily
expanded the permissible range of the statutory Act of 2002 interest rates
to 90-120 percent of the weighted average the 30-year Treasury rate for
current liability calculations and temporarily increased the PBGC
variable-rate premium calculations to 100 percent of the 30-year Treasury
rate for plan years beginning after December 31, 2001, and before January
1, 2004.

Source: Public Law.

Appendix III: The Administration Proposal for Pension Reform

On July 8, 2003, the U.S. Treasury Department announced "The
Administration Proposal to Improve the Accuracy and Transparency of
Pension Information." The proposal presented four areas of change in order
to improve pension security for Americans: (1) the accuracy of the pension
liability discount rate, (2) the transparency of pension plan information,
(3) safeguards against pension underfunding, and (4) comprehensive funding
reforms. Subsequent congressional testimony by the Treasury Department and
the U.S. Labor Department highlighted other areas of the pension system
that the administration is considering reforming.

1. Improving the Accuracy of the Pension Liability Discount Rate

Sponsors must use a discount rate to calculate the current value of their
plans' pension obligations and of lump-sum withdrawals.1 Currently, this
rate is based on the rate of 30-year Treasury bonds, securities that have
not been newly issued since 2001. There is concern that too high a
discount rate would lead to pension underfunding, while too low a rate
would cause businesses to have to put more money into their pension funds
to pay promised benefits. The administration recommended replacing the
30-year Treasury bond rate with a yield curve based on high-quality,
long-term corporate bond rates. It claims that pension discount rates
should reflect the risk embodied in assets held by insurance companies to
make group annuity payments, and that these assets consists largely of
highly rated corporate-issued bonds.

Similarly, the administration proposed using the same yield curve to
discount lump-sum distributions from plans. Currently, lump sums are
calculated using the 30-year Treasury rate, a rate that may differ from
the one used to calculate current plan liabilities. The administration
proposal would have plans discounting lump sums and plan liabilities at
the same rate. For both lump sums and liabilities, the administration
proposes phasing in the yield curve beginning in the third year, with the
phase-in complete by the fifth year.

Sponsors would compute liabilities by choosing rates along the yield curve
based on when the plan is due to make benefit payments. Thus, sponsors
would discount benefits due farther in the future at a longer-term rate
than those paid in the near future. Since long-term rates tend to exceed
short-

1GAO-03-313.

Appendix III: The Administration Proposal for Pension Reform

term rates, this would imply that plans with a higher proportion of older
workers and retirees would use lower rates to discount their liabilities
than those with younger workers. Similarly, the proposal would also have
plans use a discount rate along the yield curve for lump sums that
reflects the life expectancy of retirees, with lump sums for older workers
discounted at a shorter-term rate than those for younger workers.

To further increase pension discount rate accuracy, the administration
further proposed reducing the use of smoothing in calculating plan
liabilities. Sponsors currently use a discount rate on plan liabilities
based on a 4-year moving average of interest rates. The administration
claimed that such smoothing reduces the accuracy of liability measures
because the discount rate is not necessarily based on current market
conditions, which may mask changes in plan solvency. The proposal would
reduce the smoothing period, over a 3-year phase-in beginning in the third
year, to a 90-day moving average.

2. Increasing the Transparency of Pension Plan Information

To increase transparency, the administration proposal calls for plans to
disclose liabilities on a termination basis, as well as on a current
liability basis, in their annual reporting. Currently, a sponsor must
disclose its plan's current liability, which is intended to reflect the
value of liabilities in an ongoing plan, using a discount rate based on
the 30-year Treasury bond rate. Termination liability reflects the cost to
a company of paying an insurer to meet its pension obligations should the
plan terminate. This is calculated by using a PBGC interest factor, which
is based on a survey of insurance companies and may reflect group annuity
purchase rates, rather than by using the 30-year Treasury bond rate.
Termination liability is often higher than current liability.

The proposal would also have pension plans with more than $50 million of
underfunding make public their plan assets, liabilities, and funding
ratios, information that PBGC already collects. Currently, section 4011 of
the ERISA, as amended, requires that sponsors of plans that are less than
90 percent funded send notices to workers and retirees describing the
plan's funding status and the limits of PBGC guarantees.2

2In addition, section 4010 of ERISA requires that plan sponsors with more
than $50 million in plan underfunding file annual financial and actuarial
information with PBGC, though this information is not made public.

Appendix III: The Administration Proposal for Pension Reform

The proposal would also have plans disclose liabilities calculated by
using a duration-matched yield curve, even before the yield curve is fully
phased in for funding purposes. That is, sponsors would disclose the value
of their liabilities by using a discount rate on the yield curve that
reflects the duration of its plan liabilities, with a plan with more
benefits owed far in the future using a longer-term discount rate than one
with more benefits owed in the near future.

3. Strengthening Safeguards against Pension Underfunding

Currently, a plan generally may not provide unfunded or unsecured benefit
increases greater than $10 million if the plan's funding ratio falls below
60 percent of current liability. To strengthen pension funding, the
administration proposed prohibiting benefit increases by the plan
sponsored by firms with a credit rating below investment grade and with a
funding ratio below 50 percent of termination, as opposed to current
liability. In addition, the plan would also be frozen-with no accruals
resulting from additional service, age or salary growth-and lump-sum
payments would also be prohibited unless the employer contributed cash or
provided security to fully fund any added benefits. For firms already in
bankruptcy, the administration would fix the benefit guarantee as of the
date the plan sponsor filed for bankruptcy.

4. Supporting Comprehensive Funding Reforms

In addition to the reforms above, the proposal states that the
administration is exploring additional reforms to improve the funding
status of defined benefit plans. These include:

o  	Changing rules regarding minimum contributions of underfunded plans.

o  Raising limits on tax-deductible contributions.

o  Limiting the use of credit balances.

o  Reducing new benefit amortization periods.

o  Updating mortality tables.

o  Making retirement assumptions accurate.

o  Making lump-sum estimates accurate.

o  Limit or eliminate certain unfunded benefit guarantees.

o  Restructuring PBGC premiums to reflect risk.

o  	Applying the same principles of accuracy and transparency to the
multiemployer pension program.

                    Appendix IV: Differences in I rest Rate

Appendix IV: Differences in Interest Rate Calculations Contribute to Differences
between Termination and Current Liabilities

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. Interest rates are a key
assumption in calculating the present value of future pension benefits,
and the degree that the interest rates used to calculate termination and
current liabilities differ would contribute to the degree that the two
liability measures differ. Generally:

o  	Liabilities determined on a termination basis should be calculated
using an interest rate that reflects the factors that insurance companies
consider in pricing the group annuities they sell to pension plan sponsors
who terminate their defined benefit plans. However, information needed to
determine actual group annuity purchase rates is not available since
annuity purchases are private transactions between insurance companies and
purchasers. Instead, under PBGC regulations, sponsors who are required by
ERISA, as amended, to report plan termination liability information to
PBGC, calculate that liability using a rate published by PBGC.1 PBGC
determines that rate based on surveys of insurance

companies performed by the American Council of Life Insurers.

o  	Current liabilities are to be calculated using an interest rate from
within a range of permissible rates based on 30-year Treasury rates, as
specified in the Internal Revenue Code.2

Figure 11 shows that funding ratios using termination liabilities were
typically lower than funding ratios using current liabilities, for plans
reporting termination liabilities to PBGC under section 4010 of ERISA, as
amended. In 1996, for example, the average funding ratio based on
termination liability was 69 percent, but the average funding ratio based

1Sponsors 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).

2See footnote 10.

Appendix IV: Differences in Interest Rate Calculations Contribute to
Differences between Termination and Current Liabilities

on current liability was 99 percent.3 Termination liability funding ratios
are typically lower than current liability funding ratios because
termination liabilities are typically greater than current liabilities.

Funding ratio

99

100

90

80

70

60

50

40

30

20

10

0 1996 1997 1998 1999 2000 2001 Plan year

4010 termination liability funding ratio

5500 current liability funding ratio

Source: PBGC.

Note: Current liability is reported as of the beginning of the plan year,
and termination liability is reported as of the end of the plan year.
Therefore, in figure 11, current liability funding ratios are as of the
beginning of the plan year, and termination liabilities are as of the end
of the preceding plan year. As a result, any changes in plan benefits that
went into effect at the beginning of a plan year would be reflected in
that year's current liability funding ratio but not its termination
liability funding ratio. Funding ratios are calculated by dividing assets
by liabilities.

Figure 12 shows that the PBGC rate used to calculate termination
liabilities, and the maximum and minimum rates used to calculate current

3We have reported averages for the plans submitting termination liability
information to PBGC, instead of ratios for specific plans, because ERISA
generally precludes the disclosure of the information submitted by plans
to PBGC as part of the 4010 process. See 13 U.S.C. 1310(c).

Appendix IV: Differences in Interest Rate Calculations Contribute to
Differences between Termination and Current Liabilities

liabilities, varied considerably 1996 through 2001. In the first 3 years,
PBGC termination liability rates were typically less than current
liability rates, but in the following 2 years, termination liability rates
were typically higher than current liability rates. Lower interest rates
result in higher liability values, and higher rates result in lower
liability values.4 As a result, when the PBGC termination rate was high,
relative to the current liability rate, termination liabilities would be
reduced relative to current liabilities, causing the gap between the two
funding ratios to narrow, as it did in 2001.

4When interest rates are lower, for example, more money is needed today to
finance future benefits because it will earn less income when invested. To
illustrate the effect of a change in interest rates on the present value
of a stream of future payments: at a 6 percent interest rate, a promise to
pay $1.00 per year for the next 30 years has a present value of about $14.
If the interest rate is reduced to 1.0 percent, however, the present value
of $1.00 per year for 30 years increases to about $26.

Appendix IV: Differences in Interest Rate Calculations Contribute to
Differences between Termination and Current Liabilities

Figure 12: PBGC Termination, and Highest and Lowest Current Liability,
Interest Rates, 1996-2002

Interest rate
8

7

6

5

0
1/1996 1/1997 1/1998 1/1999 1/2000 1/2001 1/2002

Month

PBGC termination liability rate Maximum current liability rate Minimum
current liability rate

Source: PBGC and the IRS.

Note: PBGC published two rates, one for the first 20 to 25 years of a
valuation period and another for the remaining years. The figure shows the
PBGC rate for the first part of the valuation period.

Page 53 GAO-04-90 Pension Benefit Guaranty Corporation

Appendix VI: GAO Contacts and Staff Acknowledgments

Contacts

  Staff Acknowledgments

(130248)

Charles A. Jeszeck, Assistant Director (202) 512-7036 Daniel F. Alspaugh,
Analyst-in-Charge (425) 904-2177

In addition to those named above, Joseph Applebaum, Mark M. Glickman,
Corinna Nicolaou, David Noguera, John M. Schaefer, George A. Scott, and
Roger J. Thomas made important contributions to this report.

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