Highlights of a GAO Forum: The Future of the Defined Benefit
System and the Pension Benefit Guaranty Corporation (01-JUN-05,
GAO-05-578SP).
Employer-sponsored defined benefit pension plans face
unprecedented challenges in the midst of significant changes in
our nation's retirement landscape. Many defined benefit plans and
the federal agency that insures them, the Pension Benefit
Guaranty Corporation (PBGC), have accumulated large and growing
deficits that threaten their survival. Meanwhile, the percentage
of American workers covered by defined benefit plans has been
declining for about 30 years, reflecting a movement toward
defined contribution plans (e.g., 401(k) plans) and perhaps
fundamental changes in how our society thinks about who should
bear responsibility and risk for the retirement income security
of American workers. It is imperative that policymakers address
not only the challenges facing the defined benefit system and the
PBGC, but also consider broader questions about overall
retirement income policy. To address these issues, GAO convened a
diverse group of knowledgeable individuals who have been
influential in shaping the defined benefit pensions debate over
the years. Participants included government officials,
researchers, accounting experts, actuaries, plan sponsor and
employee group representatives, and members of the investment
community.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-05-578SP
ACCNO: A25857
TITLE: Highlights of a GAO Forum: The Future of the Defined
Benefit System and the Pension Benefit Guaranty Corporation
DATE: 06/01/2005
SUBJECT: Employee retirement plans
Financial management
Interest rates
Investment planning
Pensions
Retirement
Retirement income
Strategic planning
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GAO-05-578SP
[IMG]
June 2005
HIGHLIGHTS OF A GAO FORUM
The Future of the Defined Benefit System and the Pension Benefit Guaranty
Corporation
What Participants Said
Forum participants debated both the specifics of potential changes to the
regulations governing America's defined benefit pension system and broader
ideas about how policymakers should address retirement income security.
There were varying levels of agreement on the following statements:
o Current pension funding rules do not adequately ensure sound funding
in plans that are at the greatest risk of termination, and the federal
government needs to do more to hold employers accountable for the benefit
promises they make.
o Addressing deficiencies in the pension funding rules would be more
effective and more important than reforming the PBGC premium structure,
since policymakers should focus on getting employers to fulfill the
promises they make to employees.
o Greater pension funding flexibility could help maintain adequate
pension funding and remove disincentives that have stopped plan sponsors
from contributing more to their plans in the past.
o PBGC's premium structure should better reflect the risk that a pension
plan presents to the solvency of PBGC's pension insurance program.
o Improvements should be made to the transparency and timeliness of
pension plan financial information that is reported to plan participants,
regulators, and those who invest in the plan sponsor's stocks and bonds.
o Any reforms of pension funding rules and premium structures would be
easier to achieve by separately addressing "legacy costs"-the costs from
terminated and currently underfunded defined benefit plans.
o Although the traditional defined benefit system has been in retreat
for about 30 years, this trend might be halted if policymakers would
clarify the legal ambiguities surrounding cash balance and other hybrid
plans.
o Rather than focusing on promoting certain types of pension plans,
policymakers should identify and encourage those features of pension plans
(both defined benefit and defined contribution) that are most likely to
provide sufficient income security for American retirees.
United States Government Accountability Office
Contents
Introduction from the 1
Comptroller General of
the United States
Background 4
Funding Rules 8
PBGC Premiums 15
Transparency of Pension Plan Information 18
Emerging Issues 20
PBGC's Mandate 25
Appendixes
Appendix I: Forum Agenda 28
Appendix II: Forum Participants 31
Appendix III: Comptroller General's Presentation Slides 35
Appendix IV: GAO Contacts and Staff Acknowledgments 57
Related GAO Products
Figures Figure 1: Assets, Liabilities, and Net Financial Position of
PBGC's
Single-Employer Insurance Program, 1980-2004
This is a work of the U.S. government and is not subject to copyright
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Introduction from the Comptroller General of the United States
Employer-sponsored defined benefit pension plans, which have served as a
cornerstone of private sector retirement income security for several
decades, face unprecedented challenges in the midst of significant changes
in our nation's retirement landscape. Many defined benefit plans and the
federal agency that insures them, the Pension Benefit Guaranty Corporation
(PBGC), have accumulated large and growing deficits that threaten their
future survival. At the end of fiscal year 2004, PBGC reported a $23.3
billion accumulated deficit in its primary pension insurance program, the
single-employer program, and estimates that it is exposed to an additional
$96 billion in potential losses from underfunded plans sponsored by
non-investment-grade companies.1 While these deficits have surged in the
last 3 years, the percentage of American workers covered by defined
benefit plans has been declining for about 30 years, reflecting a movement
toward defined contribution plans (e.g., 401(k) plans) and perhaps
fundamental changes in how our society thinks about who should bear
responsibility and risk for the retirement income security of American
workers. The recent public debate over the merits of including individual
accounts as part of a more comprehensive Social Security reform proposal
should lead us to consider fundamental questions about overall retirement
income policy. As part of this effort, it is imperative that policy makers
address the challenges facing the defined benefit system and the PBGC.
Policymakers need to confront these challenges now because over 40 million
Americans are counting on the private sector defined benefit system for at
least part of their retirement income. The sooner action is taken, the
more flexibility there will be to strengthen the financial condition of
poorly funded defined benefit plans and the PBGC. Much of PBGC's exposure
stems from large, underfunded pension plans in certain industries with
structural weaknesses, which may be attributed, at least in part, to
certain macroeconomic forces such as deregulation and globalization. These
and other terminated and underfunded plans have increased both the costs
of the pension insurance program and PBGC's exposure to risk. Because
current law requires PBGC to finance itself through the collection of
insurance premiums, the assets of failed plans, and related investment
earnings, companies with healthier pension plans have borne increased
premium costs over the years to help cover PBGC's deficits. It is unclear
how much longer companies with well-funded
1PBGC also manages an insurance program for multiemployer plans, which
covers approximately 10 million participants. This insurance program had
an accumulated deficit of $236 million at the end of fiscal year 2004.
Introduction from the Comptroller General of the United States
pension plans will be willing to pay higher premiums and remain within the
defined benefit system. The nature of any related legislative reforms will
likely have a bearing on this issue.
In two important ways, the current condition of the PBGC is a microcosm of
the larger federal government and our Social Security system. First, PBGC
has a large and growing deficit, which should be addressed sooner rather
than later. And second, PBGC's pension insurance program is emblematic of
a large number of federal government programs that must be reexamined
because of fundamental changes in the world since they were enacted. The
Employee Retirement Income Security Act of 1974 (ERISA), which among other
things established the PBGC, was passed in response to trends and
challenges that existed at a time when defined benefit plans were growing
and most pension plan participants in the private sector were enrolled in
defined benefit plans. At that time, Congress and the American people may
well have expected continued growth of defined benefit plans in the
decades to come.
In light of changes in the retirement landscape that have taken place over
the last 30 years and the immediate financial and structural challenges
facing the defined benefit system and the PBGC, GAO convened this forum to
address problems with the existing defined benefit system, and to discuss
broader issues of retirement income security. The forum brought together a
diverse group of knowledgeable individuals who have been influential in
shaping the defined benefit pensions debate over the years. Participants
included government officials, researchers, accounting experts, actuaries,
plan sponsor and employee group representatives, and members of the
investment community (See app. I for the forum's agenda and app. II for a
list of forum participants). All brought a commitment to forward thinking
and an eagerness to move beyond defining and measuring the problem to
discussing how to broaden understanding and public dialogue so that action
could be both more immediate and more informed.
The forum was designed to create a space where a rich, meaningful, and
unattributed discussion could take place and a mutual understanding among
the various stakeholders involved could be achieved. In particular, the
forum sought to identify some possible approaches and strategies that
could address the underlying structural problems and long-term challenges
facing the defined benefit pension system and the PBGC. In smaller
discussion groups, participants talked about pension funding rules, PBGC's
premium structure, and transparency and disclosure of pension plan
financial information. In these discussions and in plenary sessions,
Introduction from the Comptroller General of the United States
participants also considered a number of other issues, including
attributes of retirement savings plans that government should promote and
whether "legacy costs"-costs from terminated and currently underfunded
defined benefit plans-should be addressed separately in any proposals to
reform pension funding and premium rules. Also, participants debated
whether PBGC should primarily serve as a social insurance program, a
marketbased insurer, or a hybrid.
This report summarizes the ideas and themes that surfaced at the forum and
the collective discussion of the forum participants as well as subsequent
comments received from participants based on a draft of this report.
I want to thank all the forum participants for taking the time to share
their knowledge, insights, and perspectives. These will be of value to the
American people and to their representatives in Congress as they
communicate with their constituents about the need for change in the
defined benefit system and the PBGC. We at GAO will also benefit from
these insights as we carry out our mission to help Congress examine the
ways to ensure the sustainability of the system and the solvency of the
PBGC while ensuring the pension benefits earned by millions of Americans.
I look forward to working with the forum's participants on this and other
issues of mutual interest and concern in the future.
David M. Walker Comptroller General
of the United States
Background Before the enactment of the Employee Retirement Income Security
Act of 1974, companies had been sponsoring pension plans for almost 100
years.1 During the mid-20th century, private pension plans gained in
popularity and grew from covering 19 percent of the workforce in 1945 to
40 percent in 1960.2 However, few rules governed the funding of these
plans, and participants had no guarantees that they would receive the
benefits promised. When Studebaker's pension plan failed in the 1960s,
thousands of plan participants lost most or all of their pensions. Such
experiences captured national attention and prompted the passage of ERISA
to better protect the retirement income of Americans covered by private
sector pension plans. Among other things, ERISA created the PBGC to
protect the benefits of plan participants, subject to certain limits, in
the event that plan sponsors could not meet the benefit obligations under
their plans. ERISA also established rules for funding defined benefit
pension plans, instituted pension insurance premiums, promulgated certain
fiduciary rules, and developed annual reporting requirements. Now, when a
plan is terminated with insufficient assets to pay promised benefits, PBGC
assumes responsibility for the plan and for paying benefits to
participants. Although PBGC provides insurance protection for over 29,000
single-employer pension plans, covering 34.6 million people, the
percentage of private sector workers covered by a defined benefit plan has
dropped from 39 percent in 1975 to 21 percent in 2004.
To try to ensure that plans have sufficient assets to pay for their
benefit obligations, ERISA created minimum funding standards. Under
current law, if a plan becomes sufficiently underfunded, the plan sponsor
is required to make an additional contribution, known as a deficit
reduction contribution. The funding rules also set maximum levels for
tax-deductible contributions. However, prior GAO work has shown that the
pension funding rules were not designed to ensure that plans have the
means to meet their benefit obligations in the event that plan sponsors
run into financial distress.3
1Wooten, James A., The Employee Retirement Income Security Act of 1974, A
Political History, (2004), Berkeley: University of California Press, p.17.
2Wooten, p.34.
3GAO, Pension Benefit Guaranty Corporation: Single-Employer Pension
Insurance Program Faces Significant Long-Term Risks, GAO-04-90
(Washington, D.C.: Oct. 29, 2003) and Private Pensions: Recent Experiences
of Large Defined Benefit Plans Illustrate Weaknesses in Funding Rules,
GAO-05-294 (Washington, D.C.: May 31, 2005).
PBGC receives no direct federal tax dollars to support the single-employer
pension insurance program.4 Instead, the program receives the assets of
terminated underfunded plans and any of the sponsor's assets that PBGC
recovers during bankruptcy proceedings.5 PBGC finances the unfunded
accrued liabilities of terminated plans with premiums paid by plan
sponsors and income earned from the investment of program assets. Since
its inception, PBGC's single-employer program has received most of its
premium income from flat-rate premiums, which companies pay each year for
every participant in a defined benefit plan they sponsor. Initially, the
flat-rate premium was set at $1 per participant per year. This rate was
raised several times and since 1991 has been set at $19. In 1987, a
variablerate premium was added to provide an incentive for sponsors to
better fund their plans. For each $1,000 of unfunded vested benefits, plan
sponsors pay a premium of $9. In fiscal year 2004, PBGC received nearly
$1.5 billion in premiums, including more than $800 million in variable
rate premiums, but paid out more than $3 billion in benefits to plan
participants or their beneficiaries.
To meet the information needs of the federal agencies that administer
federal pension laws, the PBGC, the Department of Labor, and the Internal
Revenue Service jointly develop the Form 5500, to be used by pension plan
administrators to meet their annual reporting requirements under ERISA and
the Internal Revenue Code (IRC). This form and its attached statements and
schedules are used to collect detailed plan information about assets,
liabilities, insurance, and financial transactions, plus financial
statements audited by an independent qualified public accountant, and for
defined benefit plans, an actuarial statement. We have reported in prior
work that Form 5500 information may often be of limited value because,
when it becomes available, its information is generally at least 2 years
old.6 In addition to requiring the Form 5500, if a company's pension plans
reach a certain level of underfunding, ERISA requires the company to
provide
4If funds generated are insufficient to meet operating cash needs in any
period, PBGC has available a $100 million line of credit from the U.S.
Treasury for liquidity purposes.
5According 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 must be split between PBGC (for unfunded
guaranteed benefits) and participants (for unfunded nonguaranteed
benefits).
6See GAO, Private Pensions: Publicly Available Reports Provide Useful but
Limited Information on Plans' Financial Condition, GAO-04-395 (Washington,
D.C., Mar. 31, 2004).
detailed financial information to PBGC in what is called a 4010 filing.
The 4010 filing includes proprietary information about the plan sponsor,
its total pension assets, and its total benefit obligations were the
company to terminate its pension plans immediately. Under current law,
PBGC is not permitted to disclose this information to the public. Last,
publicly traded corporations whose defined benefit plans are material to
their financial statements must provide information about the effect of
their pensions on their balance sheet and operations in a footnote to
their 10-K filings to the Securities and Exchange Commission.
The single-employer program has had an accumulated deficit-that is, the
value of program assets has been less than the present value of benefits
and other obligations-for much of its existence. (See fig. 1.) In fiscal
year 1996, the program had its first accumulated surplus, and by fiscal
year 2000, the accumulated surplus had increased to about $10 billion, in
2002 dollars. However, the program's finances reversed direction in 2001,
and at the end of fiscal year 2002, its accumulated deficit was about $3.6
billion. In July 2003, we designated PBGC's single-employer insurance
program as high risk, given its deteriorating financial condition and
long-term vulnerabilities.7 In fiscal year 2004, the single-employer
program incurred a net loss of $12.1 billion, and its accumulated deficit
increased to a record $23.3 billion, up from $11.2 billion a year earlier.
Furthermore, PBGC estimated that total underfunding in single-employer
plans exceeded $450 billion, as of the end of fiscal year 2004.
7See GAO, Pension Benefit Guaranty Corporation Single-Employer Insurance
Program: Long-Term Vulnerabilities Warrant "High Risk" Designation,
GAO-03-1050SP (Washington, DC: July 23, 2003).
Figure 1: Assets, Liabilities, and Net Financial Position of PBGC's
Single-Employer Insurance Program, 1980-2004
Dollars in billions 70 60 50 40 30 20 10 0 -10 -20 -30
-23.305
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Fiscal year
Assets Liabilities Net position Source: Pension Benefit Guaranty
Corporation.
Recently, the Administration has proposed wide-ranging reform for defined
benefit pension plans and PBGC's single-employer insurance program.
Specifically, the proposal's objectives are to (1) reform the funding
rules to ensure sponsors keep pension promises; (2) reform premiums to
better reflect a plan's risk and restore PBGC to financial health; and (3)
improve disclosure to workers, investors, and regulators about pension
plan status. Similarly, in previous reports dating back to 1992, we have
emphasized that reforming these three areas is critical to restoring
financial health to PBGC's pension insurance program and ensuring
retirement security for millions of American workers.
Funding Rules Participants generally agreed that current pension funding
rules do not adequately ensure sound funding in plans that are at the
greatest risk of termination and the federal government needs to do more
to hold employers accountable for the benefit promises they make. Many
said that successfully reworking the funding rules would be the best way
to bring about stability in the defined benefit system and PBGC's
finances. Some participants suggested that the funding rules provide more
flexibility to allow for larger contributions to plans during favorable
economic conditions, thus improving plans' chances of surviving difficult
economic conditions. Forum participants also addressed the importance of
properly measuring pension plan assets and liabilities in order for
funding rules to function properly. Participants generally agreed that the
timing of expected benefit payments should affect measurement of
liabilities, but they disagreed on the merits of utilizing a yield curve
to measure these liabilities.
Funding Rules Need Participants generally agreed that strengthening the
funding rules is vital to Strengthening to Prevent alleviating the defined
benefit system's finances. They suggested some Severe Plan Underfunding
changes to the funding rules that they thought would better ensure
adequate plan funding and reduce PBGC's exposure to underfunded plans.
Minimum Funding Requirements
Generally speaking, defined benefit pension plans insured by the PBGC are
subject to minimum funding requirements that are determined by ERISA and
the Internal Revenue Code. Essentially, plan liabilities are measured in
two ways:
(1) according to an actuarial valuation method that relies on a number of
demographic and economic assumptions and (2) according to a more uniform
measure that is prescribed by law, though still subject to some discretion
by the plan sponsor. In general, the required contribution is the expected
increase in the liability during the year, plus an amount to amortize any
unfunded liabilities from past years. If the value of plan assets falls
below 90 percent of the liability on the more uniform measure, the plan
sponsor must generally make a deficit reduction contribution to the plan.
Plan assets can be measured at either their market value or their
actuarial value, which smoothes out volatility in market valuations,
though actuarial asset values cannot deviate more than 20 percent from the
market value of assets.
o Minimum funding and deficit reduction contribution rules could be
tightened. Some participants expressed concern that the threshold for
requiring a deficit reduction contribution is not sufficiently stringent.
Some suggested that the minimum required funding ratio of a plan's assets
to its current liability should be raised from the current level of 90
percent. One participant noted that the funding rules allow companies
considerable latitude in deciding how much to contribute to their pension
plans in any given year.8 Many participants also agreed that addressing
deficiencies in the pension funding rules would be more effective and more
important than reforming the PBGC premium structure, since policymakers
should focus on getting employers to fulfill the promises they make to
employees.
o Participants suggested ways to limit PBGC's exposure to plan
underfunding. Participants suggested that policymakers act to limit both
underfunding in pension plans and PBGC's exposure to pension underfunding
by (1) curbing distribution of lump sum payments, (2) limiting federal
guarantees of shutdown benefits,9 and (3) restricting plans from
increasing benefits when they are severely underfunded.
o Participants generally agreed that lump sum distributions from plans
should be eliminated or at least discouraged because, on a large scale,
they can increase the probability of insolvency in underfunded plans. For
example, where participants in an underfunded plan believe that the PBGC
guarantee may not cover their full benefits in the event of a plan
termination, many may elect to receive their benefits in a lump sum rather
than risk reduced annuity payments from PBGC if the plan terminates. This
may create a "run on the bank," exacerbating the possibility of the plan's
insolvency as assets
8Sponsors of underfunded plans may sometimes avoid or reduce cash
contributions if they have earned funding credits as a result of favorable
experience, such as contributing more than the minimum in the past. For
example, contributions beyond the minimum may be recognized as a funding
credit. These credits are not measured at their market value and accrue
interest each year at the plan's long-term expected rate of return on
assets, which is called the valuation interest rate.
9Shutdown benefits provide employees additional benefits, such as early
retirement benefit subsidies in the event of a plant shutdown or permanent
layoff. However, in general, plant shutdowns are inherently unpredictable,
so it is difficult to recognize the costs of shutdown benefits in advance,
and current law does not allow advance funding for the cost of benefits
arising from future unpredictable contingent events (See 26 U.S.C.
412(m)(4)(D)). Shutdown benefits can suddenly and dramatically increase
plan liabilities, and the related additional benefit payments drain plan
assets.
are liquidated more quickly than expected, potentially leaving fewer
assets to pay benefits for other plan participants. Forum participants
said lump sum distributions could be discouraged by (1) setting minimum
funding requirements according to a plan's expected lump sum distribution
frequency (i.e., plans with higher lump sum distribution frequencies would
have to maintain higher funding levels); (2) establishing a two-tier
minimum funding requirement for lump sum distributions, which would only
allow executives to receive lump sums if a certain threshold were reached,
and would only allow other employees to receive lump sums if another
funding level was met; or (3) linking lump sum distributions to plan
funding status. For instance, if the plan were 80 percent funded,
participants would not be able to receive more than 80 percent of their
benefit in a lump sum and the remaining 20 percent would either be
forfeited or reduced and paid out as an annuity. This would require
amending existing laws that do not permit cutbacks in earned pension
benefits.
o Some participants suggested ways to limit PBGC's exposure to shutdown
benefits. One option would be to require plans to prefund shutdown
benefits by including them in current liability measures. Alternatively,
shutdown benefits could be guaranteed at a lower level than regular
pension benefits earned. For example, shutdown benefits could be subject
to phase-in provisions that are based on the timing of factory closures,
rather than the timing of amendments to plans that introduce or increase
shutdown benefits. Currently, plant shutdowns prior to plan terminations
usually result in higher claims for PBGC than if these events take place
concurrently.
o Most participants generally agreed that either plans should be
restricted from increasing benefits in underfunded plans or the federal
government should consider further limiting PBGC's guarantees of benefit
increases under certain circumstances. Some participants expressed
concerns that under current funding rules, plan sponsors can increase
benefits for participants in underfunded plans, even if the plan sponsor
may not ultimately be able to pay for these benefit increases. Thus, there
are incentives for financially troubled plan sponsors and their employees
to agree on pension benefit increases, in lieu of wage increases, because
at least part of the benefit increases are guaranteed by PBGC. However, at
least one participant said there should not be reductions in PBGC
guarantees or limits to benefit increases.
Current Rules Discourage Companies from Better Funding Their Pensions
Maximum Contribution Regulations
Generally speaking, a plan sponsor may make a tax-deductible contribution
to its pension plan of an amount that is at least as much as the plan's
unfunded current liability. Other rules may allow for a larger deduction.
Contributions beyond the deductible amount may be subject to a tax. In the
1980s and early 1990s Congress reduced employers' maximum tax-deductible
contributions, imposed excise taxes on employer contributions that were
not tax-deductible, and placed penalties on withdrawals of surplus assets.
Several participants said that greater pension funding flexibility could
help maintain adequate pension funding and remove disincentives that have
stopped plan sponsors from contributing more to their plans in the past.
o Current funding rules do not follow the business cycle. Some
participants said that the maximum pension plan contribution levels set by
law are too restrictive because they do not allow companies to make
tax-qualified contributions to their plans when they can most afford it.
Consequently, when the economy and equity prices decline, plan sponsors
may be forced to make contributions when they can least afford them.
Participants suggested raising the current limit on the amount companies
can contribute to their pension plans on a taxqualified basis during
profitable times so their plans would remain in better financial condition
in the event of a recession or stock market decline. Some participants
said, that in recent years, the maximum funding restrictions have
prohibited plan sponsors from making additional tax-qualified
contributions when cash was readily available to the employer.10 However,
at least one participant noted that increasing the limits on
tax-deductible contributions to pension plans would reduce federal tax
revenues. Furthermore, in one participant's opinion, the companies most
likely to overfund their pension plans are those in healthy financial
condition that are least likely to submit a claim to PBGC.
o Taxes on plan reversions discourage firms from making additional
contributions during profitable times. Some participants said that excise
taxes present disincentives for plan sponsors to contribute more than the
required minimum to their pension plans. They explained that if the rate
of return on a plan's assets is greater than the growth in its
10Recent research shows that many employers could have contributed more to
their pension plans during the 1990s by using a more conservative interest
rate to measure their plans' current liabilities. One study concludes that
a firm's strategic use and commitment to its pension program are the most
important factors explaining contributions to defined benefit plans over
time. A recent GAO study shows that in 1996, among the 100 largest plans
measured by current liability, 16 of the 30 plans that had a maximum
deductible contribution of zero could have increased their maximum
deductible contribution by choosing a lower discount rate. See T.
Ghilarducci and W. Sun, "Did ERISA Fail Us because Firms' Pension Funding
Practices Are Perverse?," Paper presented at the 57th Annual Meeting of
the Industrial Relations Research Association (Philadelphia, PA: January
2005); GAO, Private Pensions: Recent Experiences of Large Defined Benefit
Plans Illustrate Weaknesses in Funding Rules, GAO-05-294 (Washington,
D.C.: May 31, 2005); and PBGC analysis, unpublished.
liabilities, as happened during much of the 1990s, the plan sponsor would
be required to pay a 50 percent reversion tax plus corporate tax on any
surplus money that the employer receives when a plan is terminated with
sufficient assets to satisfy the plan's liabilities. Thus, as companies
consider their long-term cash needs, they might be reluctant to contribute
more than the minimum as long as the reversion tax impedes them from
recovering any excess plan funds. One participant asked whether the
reversion tax should be reduced from its current rate of 50 percent to a
rate that would better reflect the true economic value of the tax deferral
that companies gain from funding their plans.
Effective Funding Rules Require Accurate Measures of Plan Assets and
Liabilities
Yield Curve Approach
Current rules require all plans to measure current liability with a
discount rate based on a high-quality corporate bond index. However, a
single rate for all plans may not accurately estimate the present value of
plan obligations since demographic factors such as the average age of plan
participants can vary between plans. In theory, the present value of a
plan's benefit obligations may be more accurately estimated by discounting
expected future benefit payments at the market interest rate for bonds
that mature when benefit payments are due (i.e., plans that cover
predominantly older workers and retirees would use a shorter-term interest
rate). Generally, bonds with shorter maturities have lower yields.
Discounting benefit payments at a lower interest rate, assuming all other
factors equal, results in a greater current liability. The Administration
has proposed replacing the single corporate bond rate with a series of
corporate bond rates, the so-called yield curve.
Rate of Return Assumptions
Pension funding rules require plan sponsors to estimate a long-term
expected rate of return on plan assets. The higher this rate, the lower
the value of assets a plan needs to meet minimum funding requirements,
according to its actuarial funding method. However, other uniform (though
still subject to some discretion) measures of pension funding may override
these actuarial funding measures and result in additional contribution
requirements. For further information see GAO-04-395.
Participants discussed a number of pension funding issues related to
measurement of pension assets and liabilities. There was general agreement
on broad principles, but disagreement over the costs and benefits of
specific proposals.
o Measures of plan liabilities should consider the timing of benefit
payments, though not necessarily using a yield curve. Participants
generally agreed that the duration (a measure related to the timing of a
set of cash flows) of plan liabilities should affect their measurement and
required funding levels. Some participants recommended tying liabilities
to a yield curve to more accurately measure them. This could also
encourage plans to adopt investment strategies, based on the yield curve,
of holding bonds of the same duration as the plan's liabilities. Thus,
changes in interest rates would have similar effects on both plan assets
and liabilities and would not significantly change the funding status of a
plan. Opponents of the yield curve approach argued that it might not
improve accuracy of liability measures because an imbalance of supply and
demand for bonds of certain durations could skew interest rates. It was
added that the yield curve is only likely to improve the accuracy of
pension measurements when short-and long-term interest rates significantly
differ, and only then for plans with workers that are particularly old or
young; thus, it may not be worth the significantly greater administrative
expense of using a yield curve. Another participant said there are
reasonable alternatives to using a yield curve that produce similar
results. For example, plans could calculate the average duration of their
liabilities and then use the corresponding interest rate to determine
their current liability.
o Flexibility in rate of return assumptions may encourage riskier
investments. Some participants said that plan sponsors have incentives to
invest in riskier assets so they can more readily justify assumptions of
higher expected rates of return on plan assets. One participant said
funding rules should not make it easier for companies to make bets using
employees' pension assets. It was also noted that funding rules do not
differentiate among types of plan assets and thus a fully funded plan can
still present a risk to PBGC because an asset-liability mismatch would
leave it exposed to market risk. Other participants, however, noted that
some plan sponsors have greater tolerance for pension investment risk than
others and should be allowed to invest according to their own strategy.
o Market valuations improve transparency but may not be optimal for plan
funding. Participants generally agreed that mark-to-market valuations of
plan assets and liabilities increase transparency and provide the best
measure of a plan's current funding status, but opinions varied about
whether the benefits of increased transparency outweighed the costs.11
Some participants said that plan sponsors might accept mark-to-market
accounting for disclosure purposes, but some participants said that plan
sponsors would not support it for plan funding purposes. Opponents of
mark-to-market accounting said it would increase volatility of plan
funding, making it harder for firms to develop long-term funding and cash
flow management strategies. One participant said plan sponsors may
discontinue their pension plans if they do not believe they can predict
and manage the cost of funding pension benefits. Another added that the
only way to manage the uncertainty of mark-to-market accounting would be
to shift most pension plan assets from equities to bonds, a change which
would have significant ramifications for U.S. financial markets.12
Proponents of market valuation of plan assets and liabilities said that
the benefits of increased transparency and accuracy outweigh concerns over
increased volatility in pension funding. One participant said
incorporating mark-to-market methodology in both the pension funding and
accounting rules would become increasingly harder to avoid because it is
becoming standard financial accounting practice around the world as
investors and regulators demand more transparency. Some participants said
that mark-to-market accounting would compel plan sponsors to manage
volatility by investing in bonds to match the duration of their plan
assets and liabilities. This would both eliminate the market risk to which
PBGC is currently exposed and lead to betterfunded pension plans. Another
participant said that not switching to market valuations would allow
companies to continue using accounting and reporting rules to obscure the
true cost of their pensions, leading to a hidden subsidy for plans.
11Mark-to-market accounting refers to recording the price or value of a
liability, security, portfolio, or account according to its current market
value rather than its book value or a notional value, such as an actuarial
value.
12By contrast, certain actuarial funding methods aim to maintain
relatively smooth contributions to plans over time on the presumption that
returns on investments in a portfolio of stocks and bonds will vary from
year to year, but will revert to a long-term average that can be
estimated. Based on the estimated average rate of return, annual
contributions may be estimated and budgeted by the plan sponsor.
PBGC Premiums
Risk and PBGC Premiums
Currently, 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 plan sponsors may be subject to a variable-rate premium
based on a plan's level of underfunding, premiums do not consider other
relevant risk factors, such as the plan's investment strategies, benefit
structure, demographic profile, or the financial strength of the plan
sponsor. For further information see GAO-04-90.
Most participants generally agreed that PBGC's premium structure should
better reflect risk and that the government should more strongly emphasize
variable-rate premiums. Some said that increasing the flat-rate premium is
necessary for reforming the defined benefit insurance system. Others urged
government regulators to look at ways to measure the risk a pension plan
poses to PBGC, including the financial strength of the plan sponsor and
how plan assets are invested, in addition to the plan's funding status.
Pension plans invested heavily in equities expose PBGC to substantial
risk, especially during volatile periods in the equity markets.
o PBGC's premium structure could better reflect risk. Participants
generally agreed that PBGC's premium structure should continue to consist
of two parts: a flat-rate premium met by all plan sponsors and a
variable-rate premium paid by those companies that create additional risks
for the pension insurance system. However, some participants said that the
government should make the current premium structure more risk-based by
placing stronger emphasis on the variable-rate premium and requiring all
underfunded plans to pay it, a condition that does not presently exist.13
Moreover, a more expensive variable-rate premium could provide incentives
for companies to adequately fund their pension plans. In addition, at
least two participants said that increasing the annual flat-rate premium
from $19 to $30 per person, as proposed by the Administration, would still
be inexpensive for the insurance that PBGC provides. Furthermore, one
participant added that flat-rate premiums should be tied to an index, such
as wage growth, to ensure that premiums would rise as benefits grow.
However, other participants urged caution about the extent to which the
government raises premiums. They said the higher costs could hasten both
the failure of unhealthy plans and the exit of healthy plans from the
defined benefit system.
13Sponsors of underfunded plans can avoid paying the variable-rate premium
if they are at the full funding limit in the year preceding the premium
payment year after applying any contributions and credit balances. One of
the ways plans earn credits is by contributing more than required in
previous years. Credits can then be used to offset minimum funding
contributions in later years. For example, Bethlehem Steel met this
criterion and only contributed about $71.3 million to its pension plan
during years 1997 through 2001 as compared with the approximately $3.0
billion it contributed from 1986 through 1996. PBGC terminated Bethlehem
Steel's pension plan in December 2002, resulting in a total loss of nearly
$3.7 billion for the agency.
o Accurately assessing risk profiles of pension plans is necessary for
developing risk-based premiums. In order to price risk-based premiums, one
participant noted that the government needs to develop a system that
accurately assesses the risk that a plan poses to the pension insurance
system. Presently, PBGC uses credit ratings, in part, to determine which
companies' pension plans pose the greatest risk of termination.14 However,
some participants said that because credit ratings are lagging indicators,
they may not sufficiently measure a company's risk to PBGC. Furthermore,
credit ratings could lead to inaccurate assessments of risk for PBGC
because they may not penalize investment grade companies with underfunded
and unhealthy pension plans. Instead, one participant said that PBGC needs
new ways to gauge its risks and discussed the idea of "stress testing"
plans for weaknesses.15 These tests, possibly performed as a mandatory
service by the financial services industry, could be periodically reported
to government regulators.
14Credit ratings are generally considered to be a useful proxy for a
firm's financial health. Ratings typically take into consideration the
creditworthiness of guarantors, or insurers, or other forms of credit
enhancement on the obligation and take into account the currency in which
the obligation is denominated. An investment grade rating implies that the
debtor will probably repay its obligations when due.
15Stress testing is a risk management tool used to evaluate the potential
impact on a firm of a specific event or movement in a set of financial
variables. Stress tests help firms gauge their potential vulnerability to
exceptional but plausible events. Bank for International Settlements:
Stress Testing at Major Financial Institutions: Survey Results and
Practice (January 2005); Bank for International Settlements: A Survey of
Stress Tests and Current Practice at Major Financial Institutions (April
2001).
Rates of Return and Earnings
For corporate financial statements, the expected rate of return is used to
calculate the annual expected investment return on pension assets, which
factors into the measurement of pension expense. To calculate a dollar
amount for the expected return, the expected rate of return is multiplied
by the value of the pension assets. This expected return is used instead
of the actual return in the calculation of pension expense, which has the
effect of smoothing out the volatility of investment returns from year to
year. If the expected return on plan assets is high enough, a company may
report a negative pension expense--or pension income on its financial
statements. For further information see GAO-04-395.
o Investment strategies should factor into assessments of plan risk. Some
participants said that pension plans' investment strategies should be
considered when evaluating how much risk plans pose to PBGC's insurance
program. Some participants said there is a belief that investing in
equities lowers a company's pension costs because the higher expected
returns will result in lower cash contributions. During most of the 1990s,
investments in equities produced returns that exceeded growth in plan
liabilities, and in many cases, these investment gains relieved plan
sponsors of the need to make any contributions to their pension plans to
meet funding requirements. However, at least one participant said
investments in equities, even for fully funded plans, can lead to severe
plan underfunding, especially during volatile periods in the equity
markets. For example, it was pointed out that negative stock market
returns from 2000 to 2002 resulted in rapid deterioration in the funding
status of pension plans. Others added that under the current funding rules
and premium structure, PBGC will remain exposed to moral hazard as long as
plan sponsors can promise benefits that they might not be able to afford
because plan investment risk is not properly priced.16 Some participants
said that companies could reduce plan funding volatility by investing in
bonds because plan liabilities have characteristics that are similar to
bonds such as present values that are sensitive to changes in interest
rates. However, plan sponsors may be reluctant to do this because it would
generally have a negative effect on the corporate earnings they report in
their financial statements.
Other participants, however, said that returns on assets have surpassed
expectations over the past decade, despite stock market declines since
2000. Thus, asset allocations have not been the problem, and over time,
most employers can withstand the volatility of equity markets. The bigger
problem, according to at least one participant, is that liabilities have
increased faster than expected, particularly because of low interest
rates.
16Moral hazard surfaces when the insured parties-in this case, plan
sponsors-engage in behavior in which they would not have otherwise engaged
had they not been insured against certain losses. In the case of the
pension insurance system, this might include the willingness of parties to
enter into agreements that increase pension liabilities, rather than
taking wage increases.
Transparency of Pension Plan Information
Participants generally agreed that further steps should be taken to
increase the transparency and timeliness of plan financial information to
plan participants, regulators, and investors. Such steps could include
requiring additional disclosures in corporate financial statements and
enhancing annual reports to plan participants.
o Corporate financial statements are an important source of up-to-date
plan financial information, but additional information could help. Forum
participants generally agreed that recent changes in corporate financial
statement accounting rules related to pensions had improved the
transparency of pension information.17 In particular, one person noted
that investors and others now have key pieces of data, such as asset
allocations, projected pension contributions, and projected benefit
payments. However, several participants said that much of the information
on pensions in corporate financial statements, while helpful to
knowledgeable investors, would be of limited usefulness to average plan
participants. While forum participants supported the Financial Accounting
Standards Board's efforts to improve the transparency of pension
information, they suggested additional changes that would be helpful to
plan participants, investors, and regulators. Suggested changes included
requiring companies to provide
o plan cash flow projections;
o projected minimum funding contributions;
o statements in the Management Discussion and Analysis section on
long-term trends in a company's pensions and implications for the plan
sponsor; and
o disaggregated pension plan information, such as separate plan
information based on domestic versus foreign plans and tax-qualified
versus non-tax-qualified plans.
17In December 2003 the Financial Accounting Standards Board issued a
revision to its accounting standard on pension disclosures. Some of the
new disclosure requirements include a description of how pension assets
are invested, a narrative description of how the expected rate of return
on assets was selected, and the employer's estimated contribution to plans
in the following year. The revised standard does not change the general
approach used in the financial statements of aggregating this information
across all pension plans.
Summary Annual Reports
ERISA requires plans to provide participants and beneficiaries receiving
benefits from the plan a Summary Annual Report each year. The Summary
Annual Report summarizes the plan's financial status based on information
that the plan administrator provides to the Department of Labor on its
annual Form 5500.
While such changes would further enhance the transparency of pension
information, at least one participant noted that it is important not to
burden companies with additional or overlapping reporting and disclosure
requirements.
o The 4010 filing requirement could be revised to better reflect risks to
PBGC. Some participants said that the current 4010 filing requirement
should be revised to better target PBGC's risks. They agreed that the
current 4010 underfunding threshold of $50 million is too low, given the
relative values of assets and liabilities in most large plans. There was
support for revising the threshold so that only those plans that truly
represent a risk to PBGC would be required to file. One participant noted
that the 4010 provision, as originally proposed, was based on a percentage
of underfunding rather than a flat dollar amount. However, plan sponsors
objected to the percentage measure, and the flat dollar amount was a
compromise.
Participants' opinions varied on the need to publicly disclose 4010
information. It was suggested that plan funding information in 4010
filings be made public because it is much timelier than Form 5500 data and
more accurately measures the funding of a pension plan in the event of
termination. However, concerns were raised about the ability of investors
and plan participants to understand this information, which may cause
unnecessary concern about the financial health of the plan and plan
sponsor. One participant noted that there are legitimate business reasons
not to disclose 4010 information to the public. For example, many plan
sponsors view the detailed plan funding information as proprietary.
o Participants should receive more complete and timely information on
plan financial status and PBGC-guaranteed benefits. Many participants
agreed that plan participants should be provided more meaningful and
timely information on the financial condition of their pension plans as
well as information about PBGC-guaranteed benefits. For example,
participants may have trouble understanding the implications of funding
information about a multibillion dollar pension plan. Data in the Summary
Annual Reports sent to plan participants are based on Form 5500 filings.
Consequently, Summary Annual Reports suffer from the same lack of timely
data as does the Form 5500. Forum participants noted that the financial
condition of a plan can change significantly by the time regulators
receive the Form 5500 and plan
participants receive their Summary Annual Report. To address this lack of
timely information, participants suggested
o moving the Form 5500 from a paper-based filing to an electronic filing;
and
o varying the filing deadlines for the Form 5500 according to the
importance of the information provided. For example, estimated plan
funding information could be filed earlier than other data. This would
also allow plan sponsors to send out Summary Annual Reports earlier.
Another participant pointed out that beyond providing plan participants
with plan financial information, plan participants need to be better
educated about information on the Form 5500 and Summary Annual Report as
well as how the U.S. pension system works overall. Thus, plan participants
could better understand the information they receive about their pension
benefits.
Many forum participants said plan participants and beneficiaries should
receive information annually on their expected retirement benefits and the
extent to which these benefits are guaranteed by PBGC. One person
suggested that plan participants be provided information about their
accrued benefits and the effect on their benefits of working both up to
their company's normal retirement age and beyond it. Another forum
participant stated that information about the limits on benefits
guaranteed by PBGC is important because, as occurred with some in the
airline industry, participants may face a significant reduction in
benefits if their plan is taken over by PBGC.
Emerging Issues According to participants, the debate over funding rules,
premiums, and the role of the PBGC should take place amidst fundamental
policy discussions about how to promote retirement income security,
particularly since the traditional defined benefit pension system has
weakened. In light of debates over issues such as an individual account
component to Social Security, simplification of the tax code, and pension
reform, policymakers should think about how to delegate responsibility for
asset management and risk among individuals and entities that can pool and
professionally manage risk, such as employers, insurers, and the
government. However, as policymakers think about the future of retirement,
the past failures of many large defined benefit plans continue to weigh on
the defined benefit
system. Participants suggested a few ways to address the legacy costs of
terminated and presently underfunded plans, especially those in industries
that have been deregulated or more affected by globalization, but noted
there are not any easy options.
Policymakers Should Think Broadly about Retirement Income Security
Cash Balance Pension Plans
Cash balance plans are a type of defined benefit plan that look more like
a defined contribution plan to participants. As with other defined benefit
plans, the sponsor is responsible for managing the plan's commingled
assets and complying with the minimum funding requirements. However,
information about benefits is communicated to plan participants through
the use of hypothetical account balances, which makes the plan appear like
an individual accountbased defined contribution plan. The hypothetical
account balances communicated to plan participants do not necessarily bear
any relationship to actual assets held by the plan.
Participants recognized the decline of defined benefit pension plans and
encouraged policymakers to broadly consider how best to promote retirement
income security. Among other things, participants suggested that decision
makers clarify the legal status of cash balance and other hybrid pension
plans.
o The traditional defined benefit system is under threat. Participants
broadly agreed that while employer-sponsored defined benefit plans have
played an important role in providing secure retirements to millions of
Americans, the traditional defined benefit pension system is in a decline
that is likely to continue. Reasons cited for this decline include a
regulatory structure that is biased in favor of defined contribution
plans, recent investment experiences that have resulted in significant
plan underfunding and uncertainty over potential changes in funding rules,
pension accounting standards, and PBGC premiums. Furthermore, workers
often do not recognize the importance of certain features of defined
benefit pensions until they approach retirement. However, some
participants wondered whether adoption of individual accounts as part of
Social Security would lead employees to value defined benefit plans more
highly.
o Clarifying the legal status of cash balance plans may encourage some
companies to remain in the defined benefit system. Several participants
stated that lawmakers need to clarify the status of cash balance and other
hybrid plans as soon as possible to prevent the further demise of the
defined benefit system and the PBGC. Cash balance plans constitute
approximately 20 percent of large defined benefit plans, and some sponsors
of cash balance plans have already exited the defined benefit system
because of the legal uncertainty they face. Their exit, and the potential
exit of other cash balance plan sponsors, is gradually reducing the PBGC's
premium base and potentially placing even greater strain on those who
remain behind in the defined benefit system.
o Policymakers should encourage certain pension plan features rather than
certain plan types. Some participants suggested that the debate
over federal retirement policy needs to move beyond distinctions between
defined benefit and defined contribution plans. Participants widely agreed
on the value of defined benefit pension plans but disagreed over whether
the federal government should promote defined benefit plans more than
other vehicles for retirement savings. Others added that discussions of
retirement policy need to focus on ways to create incentives and remove
barriers for employers to set up retirement plans and how to get American
workers to build adequate retirement savings and security. This may be
achieved by thinking about the interaction of private pensions and Social
Security and by looking at hybrid pension plans, such as cash balance
plans and plans that combine the best features of defined benefit and
defined contribution plans. Participants suggested that pension plans
include the following features:
o automatic participation;
o portability of benefits to accommodate workers who frequently change
jobs;18
o allow participants to pass on accumulated wealth to their heirs;
o professional money management;
o pooled investment risk;
o ability for participants to work longer;
o minimal leakage (early withdrawals and borrowing) from retirement
savings; and
o incentives to receive benefits in the form of a fixed annuity, rather
than a lump sum distribution.
18One participant questioned whether employers are the proper nexus for
pension plans in today's world since many of them cannot bear the risk of
investing plan assets and being liable for making up investment losses.
Addressing Legacy Costs of Failed and Underfunded Pension Plans
Participants spoke about the advantages, disadvantages, and significant
challenges to separating legacy costs from current and future funding and
premiums rules. They also proposed several ways to pay for legacy costs.
o Separately addressing legacy costs could encourage future participation
in the defined benefit system and ease passage of reform proposals.
Separating legacy costs from the existing and future liabilities of the
remaining defined benefit plans might encourage plan sponsors to remain in
the defined benefit system. Many plan sponsors are concerned that, through
increased PBGC premiums, they may be required to pay for the failures of
other companies to responsibly fund and manage their pension plans.
Presently, companies that sponsor healthy plans are subsidizing weak
plans, and it is unclear how much longer companies with well-funded
pension plans will be willing to remain within the defined benefit system.
Some participants noted that resolving the matter of legacy costs could be
a key component of any pension reform legislation that tightened the
funding rules and assessed premiums according to risk. Such a proposal
would essentially strike a deal between the federal government and
employers that would settle PBGC's unfunded liabilities through an
infusion of general revenues, while imposing stricter pension funding
standards on plan sponsors to minimize the possibility of significant
future underfunding in the defined benefit system. Others added that if
legacy costs are addressed separately, it would be possible to establish a
more functional, riskbased insurance system. And, one participant added,
resolution of pension legacy costs would bring a measure of security to
millions of American retirees and workers who face uncertainty about their
pension benefits. While participants generally supported separating
pension legacy costs from ongoing pension liabilities, many opposed
limiting the scope to specific industries such as air transportation and
steel, which have been affected by globalization and deregulation.
o Separately addressing legacy costs could set a bad precedent. Requiring
taxpayers or other companies to pay for failed private sector pension
plans sends a message that the government will bail out companies who
poorly design and manage their benefit plans or businesses. Furthermore,
according to one participant, paying for defined benefit plan legacy costs
with federal tax revenues would increase the federal government's deficit,
perhaps by as much as $100 billion, according to one participant.
o Defining legacy costs is difficult. Participants provided different
definitions of legacy costs in the defined benefit system. Some noted that
any underfunded terminated plan that has been trusteed by PBGC represents
a legacy cost. Another proposed defining legacy costs as any unfunded
current liability. And one person pointed out that we may not even be able
to accurately determine the extent of the legacy costs in the defined
benefit system because they will eventually include costs for events that
have not yet happened.
o Determining who pays for legacy costs is politically challenging. Many
participants said that it is not reasonable to expect the companies
remaining in the defined benefit system to pay for the costs of plans that
have failed. Requiring them to do so would drive the healthy plans and
plan sponsors out of the defined benefit system. On the other hand, it is
hard to equitably shift the costs of these benefits to the general
population, especially since a large percentage of Americans do not have
any form of private pension.
o Participants suggested several ways to address pension legacy costs:
o Taxpayer bailout. Some participants said that relative to the entire
federal budget, a taxpayer bailout would not cost much over a long period
of time, and this would be a small price to pay for shoring up an
important part of the nation's private pension system.
o Industry-specific fees. Some participants said that those industries
that have placed the greatest burden on the defined benefit system should
be required to fund at least their share of the legacy costs. For example,
the government could impose a fee on airline tickets that would cover the
underfunded airline plans that have been taken over by PBGC.
o Consolidate plans in distressed industries. One participant suggested
that pension plans from financially distressed companies in troubled
industries (e.g., airlines, steel) be grouped together into multiemployer
plans that would be jointly managed by a board of trustees representing
employer, employee, and goverment interests. Such a plan would be required
to follow a set of investment guidelines that would limit future funding
risk.
o Security trading commissions. One participant suggested imposing a
securities trading commission on the financial services
industry to help cover legacy costs, because they have benefited over the
years from managing pension plan assets and have an interest in the
continuance of the defined benefit system.
o Expand universe of defined benefit plans. Another participant suggested
that the government seek to expand the defined benefit universe, primarily
by resolving the legal status of cash balance plans. Having more employers
in the system would distribute the costs across a wider population.
o Wait for higher interest rates. Others suggested that much of the
underfunding problem will eventually be solved by rising interest rates,
which would reduce the present value of benefit obligations. However,
higher interest rates could lead to lower stock and bond prices and thus
reduce the market value of pension plan assets.
PBGC's Mandate Many participants said there is a conflict in PBGC's
mandates to promote defined benefit plans and insure them all at the
lowest cost while remaining self-financed. Some participants advocated for
PBGC serving as a social insurance program because a market-based program
would increase costs for companies and make it difficult for many to
maintain their plans. Others argued that the agency should become more of
a market-based insurer so as to manage the risks it faces. For example,
PBGC should have both the authority to adjust premium rates and a higher
standing in bankruptcy proceedings. These participants also said that the
current social support system is problematic because guaranteed PBGC
insurance encourages weak plan sponsors to make benefit promises they
cannot keep. In addition, participants debated the optimal investment
strategies for PBGC's portfolio of assets.
o PBGC should play a social insurance role. Some participants said PBGC
should serve as part of a wider government effort to promote defined
benefit plans. This may require the federal government to transfer general
revenues to PBGC occasionally. At least two participants acknowledged that
the federal pension insurance system is flawed because, when it was
designed, nobody anticipated the collapse of entire industries along with
their pension plans. Nonetheless, one participant said the legislative
history shows that PBGC was not intended to be run like a commercial
insurance company and that the insurance component of PBGC was drafted on
a social support system model. It was emphasized that transforming PBGC
into a market-based
insurer would adversely affect both sponsors and participants by
dramatically increasing premium rates and making it difficult for
companies to maintain their defined benefit pension plans. Some
participants also said that without fixing the funding rules, the defined
benefit system cannot be properly insured.
o PBGC should operate more like a commercial insurer. Some participants
said that PBGC should remain self-financing, like a commercial insurance
program. A few participants pointed out that PBGC has limited ability to
control and manage its risks in the way that any commercial insurer
normally can. Some participants suggested that
o PBGC should have the authority to set and adjust premiums and
o PBGC should be able to act sooner to work with any plan sponsor
entering bankruptcy and restructure a plan to try to obtain long-term
refunding if the plan would otherwise be terminated.
One participant stated that PBGC's present role as a social insurer does
not encourage healthy plans and is contributing to the decline of defined
benefit plans because, in effect, it provides loan guarantees of promises
made by weak employers to their employees. Employers can thus promise
benefits they may not be able to afford, since they can pass the cost off
to PBGC.
o PBGC would benefit from improved standing in bankruptcy, but this would
create other challenges. Participants broadly disagreed over what ought to
be PBGC's standing in bankruptcy. While improving PBGC's standing in
bankruptcy would help PBGC recover more money in plan terminations, a
change in the rules needs to carefully consider the impact on existing
creditors and the access of plan sponsors to the credit markets. Some
participants noted the following:
o Under current law, it is too easy for companies to shed their pension
obligations during bankruptcy proceedings in order to emerge from
bankruptcy, and
o Improving PBGC's standing in bankruptcy would slightly increase the
cost of credit for plan sponsors and would slightly increase PBGC's
administrative expenses. It is not clear whether these cost increases can
be accurately modeled.
o PBGC's investment strategy may not be optimal. Participants debated
PBGC's investment strategy, and some of them felt that PBGC has not
invested in an optimal portfolio of assets. It was suggested that PBGC
invest more heavily in high-quality corporate bonds, since they offer a
higher rate of return than Treasury bonds and are nearly as safe as
investments. Furthermore, one person suggested that there is a conflict of
interest in PBGC's investment policy since the Secretary of the Treasury
sits on PBGC's board. Another participant said that PBGC's investments in
equities multiply its exposure to market risk because most large plans it
insures are heavily invested in equities. In a stock market decline, the
value of PBGC's equity portfolio would fall at the same time that the
assets of the plans it insures decline in value. Thus it would make more
sense if PBGC were to sell short the Standard & Poor's 500 stock index. It
was also suggested that PBGC invest long in bonds of well-funded companies
and sell short the bonds of poorly funded companies.
Appendix I
Forum Agenda
The Future of the Defined Benefit System and the PBGC
Agenda
8:30
9:00
9:15
9:30
9:45
Thursday, February 3, 2005
Registration, breakfast
Welcome and Introduction David M. Walker, Comptroller General of the
United States
Brief overviews of topics for breakout groups
o Pension funding rules
Ron Gebhardtsbauer, Senior Research Fellow, American Academy of Actuaries
o PBGC premiums and guarantees Brad Belt, Executive Director, PBGC
o Pension transparency/accounting David Zion, Director, Credit Suisse
First Boston
Presentation of Administration's Pension Reform Proposal Ann L. Combs,
Assistant Secretary, Employee Benefits Security Administration, Department
of Labor
Break and move to discussion groups
o Breakout group discussions
o Strengthening funding rules
o Enhancing transparency of plan financial information
Appendix I Forum Agenda
Facilitators:
Doug Elliott, President, Center on Federal Financial Institutions Olivia
S. Mitchell, Professor of Insurance & Risk Management, The Wharton School,
University of Pennsylvania Dallas Salisbury, President, Employee Benefits
Research Institute
11:30 Break / Pick up box lunches for working lunch
11:45 Reports from breakout groups and discussion
o Presentation of points of consensus and disagreement
o Plenary discussion based on reports from groups Moderator: David M.
Walker
12:45 Plenary Discussion of Broader Defined Benefit Plan Issues
o Presentation of pre-forum survey responses
o Discussion topics:
What is likely to be the future role of DB plans in providing retirement
income for private sector workers?
To what extent should the federal government promote DB plans or should
the government take a more neutral posture on private retirement plan
design?
Was PBGC designed to fulfill a social insurance purpose, or act as a
self-sustaining insurer?
How do we keep PBGC solvent without overburdening the employers remaining
in the DB system?
Do we need a more explicit national policy to address structural
weaknesses in certain industries, with large underfunded pensions?
How will/should Social Security and/or tax reform affect the DB plan
system?
Appendix I Forum Agenda
Moderators:
David M. Walker Barbara D. Bovbjerg, Director, Education, Workforce, and
Income Security Issues, GAO
2:15 Wrap-up
2:30 Adjourn
Appendix II
Forum Participants
The Future of the Defined Thursday, February 3, 2005
Benefits System and the PBGC
Moderator David M. Walker Comptroller General of the United States U.S.
Government Accountability Office
Participants Eddie Adkins Member, Employee Benefits Technical Resource
Panel American Institute of Certified Public Accountants
Joseph A. Applebaum
Chief Actuary, U.S. Government Accountability Office
Brad Belt
Executive Director, Pension Benefit Guaranty Corporation
Richard Berner
Managing Director, Chief U.S. Economist, Morgan Stanley
David S. Blitzstein
Director, Negotiated Benefits Department United Food and Commercial
Workers International Union
Teresa Bloom
Chief of Government Affairs American Society of Pension Professionals and
Actuaries
Bill Bortz
Associate Benefits Tax Counsel, U.S. Department of the Treasury
Phyllis Borzi
Research Professor
The George Washington University School of Public Health
Barbara D. Bovbjerg
Director, Education, Workforce, and Income Security Issues U.S. Government
Accountability Office
Appendix II
Forum Participants
Ann L. Combs
Assistant Secretary, Employee Benefits Security Administration U.S.
Department of Labor
Julia Lynn Coronado
Senior Research Associate, Watson Wyatt & Company
Randy G. DeFrehn
Executive Director, National Coordinating Committee for Multiemployer
Plans
John W. Ehrhardt
Principal & Consulting Actuary, Milliman, Inc.
Doug Elliott
President, Center on Federal Financial Institutions
Karen Ferguson
Director, Pension Rights Center
Peter Fisher
Managing Director, Blackrock
Ron Gebhardtsbauer
Senior Pension Fellow, American Academy of Actuaries
Gary A. Glynn
President, US Steel and Carnegie Pension Fund
Carol D. Gold
Director, Employee Plans, Tax Exempt & Government Entities Internal
Revenue Service
Jeremy Gold
Jeremy Gold Pensions
Britt Harris
Chief Executive Officer, Bridgewater Associates, Inc.
Nell Hennessy
President, Fiduciary Counselors Inc.
Appendix II
Forum Participants
Robert H. Herz
Chairman, Financial Accounting Standards Board
J. Mark Iwry
Nonresident Senior Fellow, The Brookings Institution
Dennis M. Kass
Chairman and CEO, Jennison Associates
Jim Klein
President, American Benefits Council
Betty Krikorian
Principal, BLK Consulting
James B. Lockhart
Deputy Commissioner, Social Security Administration
Olivia S. Mitchell
Professor of Insurance and Risk Management The Wharton School, University
of Pennsylvania
Michael Peskin
Managing Director, Morgan Stanley
Alan Reuther
Legislative Director, United Auto Workers
Elizabeth Robinson
Deputy Director, Congressional Budget Office
Dallas Salisbury
President, Employee Benefit Research Institute
Scott Sprinzen
Managing Director, Corporate and Government Ratings Standard & Poor's
Carol Stacey
Chief Accountant, Division of Corporation Finance U.S. Securities and
Exchange Commission
Appendix II
Forum Participants
Gene Steuerle
Senior Fellow, Urban Institute
Mark J. Ugoretz
President, ERISA Industry Committee
Kim Walker
Chair, CIEBAQwest Asset Management CompanyCaptain
Duane Woerth
President, Air Line Pilots Association
David Zion
Director, Credit Suisse First Boston
Appendix III
Comptroller General's Presentation Slides
The Future of the
Defined Benefit System
and the PBGC
February 3, 2005
Appendix III Comptroller General's Presentation Slides
Challenges Facing the DB System
1) Large accumulated deficits for many active plans, the PBGC, and the
U.S. Government
2) Structural weaknesses in certain industries with large, underfunded DB
plans
3) PBGC has limited control over its risks
4) Decline in DB plans
5) Changing demographics and workforce trends
6) Legal and regulatory uncertainties
7) Social Security reform initiatives
Appendix III Comptroller General's Presentation Slides
Appendix III Comptroller General's Presentation Slides
Appendix III Comptroller General's Presentation Slides
Appendix III Comptroller General's Presentation Slides
Appendix III Comptroller General's Presentation Slides
PBGC's Risk is Concentrated
in a Few Industries...
o Legacy costs in industries facing significant globalization,
deregulation, and competitive and technological changes and challenges
- e.g., steel and air transportation sectors
o Potential domino effect of plan terminations
- Plan terminations by a few may encourage competitors to declare
bankruptcy to terminate their plans, too
o Raises Question: Should financial difficulties of certain industries,
including pension underfunding, be addressed separately from wider efforts
to reform the DB system?
Appendix III Comptroller General's Presentation Slides
Exposure of Single-Employer Program
Source: PBGC
Appendix III Comptroller General's Presentation Slides
Appendix III Comptroller General's Presentation Slides
PBGC Cannot Limit Its Risk
o PBGC must insure all eligible plans, is subject to certain "put option"
risks, and is exposed to market risk from plan investments
o PBGC premiums do not reflect:
- Plan sponsor's financial position
- Risk in plan's investment portfolio
- Plan's benefit structure
- Plan's demographic profile
o PBGC is insurer of last resort
o PBGC's revenue base is shrinking
Appendix III Comptroller General's Presentation Slides
Employee Preference: DC vs. DB
o AAA/SOA survey conclusion: People tend to prefer the type of retirement
plan in which they are already enrolled (most active participants are in
DC plans today)
o The traditional DB system provides a certain and secure benefit but may
be ineffective for building retirement assets for those who change jobs
frequently
- Vesting provisions
- Backloading of accruals
- Lack of portability
Appendix III Comptroller General's Presentation Slides
Appendix III Comptroller General's Presentation Slides
Appendix III Comptroller General's Presentation Slides
Legal & Regulatory Uncertainties
o Employer concern over status of cash balance plans
o Employer concern over potential changes to:
- Pension funding rules
- PBGC premiums and other insurance reforms
- Pension accounting rules
o Lack of action by policymakers may drive more employers away from DB
plans
Appendix III Comptroller General's Presentation Slides
Social Security Reform Initiatives
o Social Security is not adequately funded to deliver on promised
benefits beginning in 2042
o Social Security reform is being debated
o Social Security reform may involve modified benefits and individual
accounts
o What implications will Social Security reform have on private pensions,
in general, and on DB plans, in particular?
Appendix III Comptroller General's Presentation Slides
Defined Benefit Plan Weaknesses Have
Serious Implications for National
Retirement Policy
o Current Issues:
- Protecting the benefits of workers in terminated plans
- Improving funding of DB plans going forward
- Addressing the PBGC's financial exposure
o Broader Issues: What is the future role of DB plans in ensuring
retirement income security?
- Revitalized DB system vs. smoother transition to a DC world
- Impact of Social Security reform on the private DB and DC system and
personal savings arrangements
Appendix III Comptroller General's Presentation Slides
Role of PBGC?
Social Insurance Financially Sound Program vs Insurer
o Encourage growth of o No federal budget private pension plans
appropriations
o Cover all eligible plans o Limited to borrowing $100M from
o Ability to exercise "put Treasuryoptions" on the system
o Limited ability to
o Limited "risk-related" encourage funding
premiums and moderate losses
Appendix III Comptroller General's Presentation Slides
Other Broad Issues
o Is the pension insurance model still viable as the number of DB plans
declines?
o Different theoretical frameworks for pension funding: actuarial vs.
financial economics view
o Dealing with pension legacy costs in an open, deregulated, and dynamic
economy
Appendix III Comptroller General's Presentation Slides
Broad Goals for Reform
of the DB System
o Improve transparency of plan financial information
o Provide incentives and safeguards for plan sponsors to improve plan
funding
o Hold plan sponsors accountable for adequately funding their plans
Appendix III Comptroller General's Presentation Slides
Potential Steps
Improve Transparency
o Disclose plan investments, funding status, and benefit guaranty
limitations to plan participants and others
o Review and possibly revise pension accounting rules (FAS 87)
Appendix III Comptroller General's Presentation Slides
Potential Steps
Modify Funding Rules and Premiums
o Strengthen funding rules applicable to poorly funded plans
o Raise full funding limitations
o Adjust pension premiums to reflect risk
Appendix III Comptroller General's Presentation Slides
Potential Steps
Other Regulatory Steps
o Clarify legal status of cash balance plans
o Eliminate floor/offset arrangements with significant investment
concentrations in employer securities
o Limit lump sums and benefit increases in underfunded plans
o Modify program guarantees (e.g., phase-in rules)
o Modify bankruptcy laws?
Appendix IV
GAO Contacts and Staff Acknowledgments
Contacts Barbara D. Bovbjerg, Director (202) 512-7215
Staff In addition to the contact above, David A. Eisenstadt, Benjamin A.
Federlein, Jason S. Holsclaw, George A. Scott, and Derald L. Seid made
Acknowledgments important contributions to organizing this forum and
producing this report.
Related GAO Products
Private Pensions: Government Actions Could Improve the Timeliness and
Content of Form 5500 Pension Information, GAO-05-491. Washington, D.C.:
June 3, 2005
Private Pensions: Recent Experiences of Large Defined Benefit Plans
Illustrate Weaknesses in Funding Rules, GAO-05-294. Washington, D.C.: May
31, 2005.
Pension Benefit Guaranty Corporation Structural Problems Limit Agency's
Ability to Protect Itself from Risk, GAO-05-360T. Washington, D.C.: March
2, 2005.
Private Pensions: Airline Plans' Underfunding Illustrates Broader Problems
with the Defined Benefit Pension System. GAO-05-108T. Washington, D.C.:
October 7, 2004.
Pension Plans: Additional Transparency and Other Actions Needed in
Connection with Proxy Voting. GAO-04-749. Washington, D.C.: August 10,
2004.
Private Pensions: Publicly Available Reports Provide Useful but Limited
Information on Plans' Financial Condition. GAO-04-395. Washington, D.C.:
March 31, 2004.
Private Pensions: Timely and Accurate Information Is Needed to Identify
and Track Frozen Defined Benefit Plans. GAO-04-200R. Washington, D.C.:
December 17, 2003.
Pension Benefit Guaranty Corporation: Single-Employer Pension Insurance
Program Faces Significant Long-Term Risks. GAO-04-90. Washington, D.C.:
October 29, 2003.
Private Pensions: Changing Funding Rules and Enhancing Incentives Can
Improve Plan Funding. GAO-04-176T. Washington, D.C.: October 29, 2003.
Pension Benefit Guaranty Corporation: Long-Term Financing Risks to
Single-Employer Insurance Program Highlight Need for Comprehensive Reform.
GAO-04-150T. Washington, D.C.: October 14, 2003.
Related GAO Products
Pension Benefit Guaranty Corporation: Single-Employer Pension Insurance
Program Faces Significant Long-Term Risks. GAO-03-873T. Washington, D.C.:
September 4, 2003.
Options to Encourage the Preservation of Pension and Retirement Savings:
Phase 2. GAO-03-990SP. Washington, D.C.: July 29, 2003.
Private Pensions: Participants Need Information on Risks They Face in
Managing Pension Assets at and during Retirement. GAO-03-810. Washington,
D.C.: July 29, 2003.
Private Pensions: Process Needed to Monitor the Mandated Interest Rate for
Pension Calculations. GAO-03-313. Washington, D.C.: February 27, 2003.
Answers to Key Questions About Private Pension Plans. GAO-02-745SP.
Washington, D.C.: September 18, 2002.
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