Private Pensions: The Pension Benefit Guaranty Corporation and	 
Long-Term Budgetary Challenges (09-JUN-05, GAO-05-772T).	 
                                                                 
More than 34 million workers and retirees in over 29,000	 
single-employer defined benefit plans rely on a federal insurance
program managed by the Pension Benefit Guaranty Corporation	 
(PBGC) to protect their pension benefits. However, the		 
single-employer insurance program's long-term viability is in	 
doubt, and this may have significant implications for the federal
budget. In fiscal year 2004, PBGC's single-employer pension	 
insurance program incurred a net loss of $12.1 billion, and the  
program's accumulated deficit increased to $23.3 billion.	 
Further, PBGC has estimated that it is exposed to almost $100	 
billion of underfunding in plans sponsored by companies with	 
credit ratings below investment grade. This testimony provides	 
GAO's observations on the nature of the challenges facing PBGC	 
and why it is preferable for Congress to act sooner rather than  
later. This testimony also notes the broader context in which	 
reform proposals should be considered and the criteria that GAO  
has suggested for reform.					 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-05-772T					        
    ACCNO:   A26239						        
  TITLE:     Private Pensions: The Pension Benefit Guaranty	      
Corporation and Long-Term Budgetary Challenges			 
     DATE:   06/09/2005 
  SUBJECT:   Budget obligations 				 
	     Federal employee retirement programs		 
	     Financial analysis 				 
	     Future budget projections				 
	     Interest rates					 
	     Investment planning				 
	     Pension plan cost control				 
	     Pensions						 
	     Program management 				 
	     Retirement 					 
	     Strategic planning 				 

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GAO-05-772T

United States Government Accountability Office

GAO 	Testimony before the Committee on the Budget, House of
Representatives

For Release on Delivery

Expected at 9:30 a.m. EDT PRIVATE PENSIONS:

Thursday, June 9, 2005

  The Pension Benefit Guaranty Corporation and Long-Term Budgetary Challenges

Statement of David M. Walker Comptroller General of the United States

GAO-05-772T

[IMG]

June 9, 2005

PRIVATE PENSIONS

The Pension Benefit Guaranty Corporation and Long-Term Budgetary Challenges

  What GAO Found

A combination of recent events, long-term structural problems, and
weaknesses in the legal framework governing the defined benefit system has
left PBGC with a significant long-term deficit and many large plans badly
underfunded. Lower interest rates and equity prices since 2000 have
increased the present value of pension liabilities and lowered the value
of significant portions of pension plan assets. Meanwhile, PBGC is exposed
to significant risk from underfunded plans in key industries at the same
time that its revenue base is threatened by the long-term decline in
defined benefit plan participation. In addition, the basic legal framework
governing pension insurance and plan funding has failed to help ensure
that plan sponsors deliver on their pension promises and safeguard the
PBGC's financial condition. PBGC's current premium structure does not
properly reflect the risks to its insurance program and facilitates moral
hazard behavior by plan sponsors. Further, current pension funding rules
have not provided sufficient incentives for plan sponsors to properly fund
their benefit obligations. As a result, bankrupt plan sponsors, acting
rationally and within the rules, have transferred the obligations of their
large and significantly underfunded plans to PBGC. These weaknesses
contribute to and are exacerbated by a lack of timely, accurate and
transparent information that make it difficult for participants,
investors, and others to have a clear understanding of the true financial
condition of pension plans.

Comprehensive reform is required to ensure that workers and retirees
receive the benefits promised to them. Ideally, effective reform would

o  	improve the accuracy of plan funding measures while minimizing
complexity and maintaining contribution flexibility;

o  	revise the current funding rules to create incentives for plan
sponsors to adequately finance promised benefits;

o  	develop a more risk-based PBGC insurance premium structure and
provides incentives for sponsors to fund plans adequately;

o  	address the issue of underfunded plans paying lump sums and granting
benefit increases;

o  modify PBGC guarantees of certain plan benefits

o  	resolve outstanding controversies concerning hybrid plans by
safeguarding the benefits of workers regardless of age; and

o  	improve plan information transparency for pension plan stakeholders
without overburdening plan sponsors.

Pension reform is only part of a broader fiscal, economic and retirement
security challenge. Looking ahead in the federal budget, Social Security,
together with Medicare and Medicaid, will dominate the federal
government's future fiscal outlook. Reform should also be considered in
the context of the problems currently facing our nation's Social Security
system. Importantly, as is the case with Social Security, acting sooner
rather than later will make comprehensive pension reform less costly and
more feasible.

                 United States Government Accountability Office

Mr. Chairman and Members of the Committee:

I am pleased to be here today to discuss the problems and long-term
challenges facing the defined benefit (DB) pension system, the Pension
Benefit Guaranty Corporation (PBGC), the retirement security of workers
and retirees covered by DB plans, and American taxpayers. In particular, I
will discuss the factors contributing to those problems and suggest
elements of the comprehensive reform necessary to address them.1 As I have
noted before, these problems are a subset of the broader challenges facing
the federal government and our nation's retirement income system.2 These
programs, which include Social Security, Medicare, and Medicaid, represent
large, growing, and unsustainable claims on the federal budget because
America's population is aging, life expectancies are increasing, workforce
growth is slowing, and health care costs are rising.

The long-term effect of federal retirement programs on the budget is so
significant that neither slowing the growth of discretionary spending nor
allowing tax cuts to expire-nor both options combined-would by themselves
eliminate our long-term fiscal imbalance (see fig. 1). Therefore, as we
discussed in our 21st Century Challenges report,3 tough choices need to be
made about the appropriate role and size of the federal government-and how
to finance that government-and how to bring the panoply of federal
policies, programs, functions and activities into line with the realities
of today's world and tomorrow's challenges. More specifically to federal
retirement policy, we need to make choices about how to promote current
and long-term economic security in retirement. In that latter context,
comprehensively considering our citizens' needs for income, health care,
and long-term care is important.

From our nation's overall fiscal perspective, continuing on our current
unsustainable fiscal path will gradually erode, if not suddenly damage,
our economy, our standard of living, and ultimately our national security.

1Many of these elements are explored in greater detail in a report that
GAO is releasing today. GAO, Comptroller General's Forum: The Future of
the Defined Benefit System and the Pension Benefit Guaranty Corporation,
GAO-05-578SP (Washington, D.C.: June 9, 2005).

2GAO, Long-Term Fiscal Issues: The Need for Social Security Reform,
GAO-05-318T (Washington, D.C.: Feb. 9, 2005).

3GAO, 21st Century Challenges: Reexamining the Base of the Federal
Government, GAO-05-325SP (Washington, D.C.: Feb. 2005).

Therefore, we must fundamentally reexamine major spending and tax policies
and priorities in an effort to recapture our fiscal flexibility and ensure
that our programs and priorities respond to emerging security, social,
economic and environmental changes and challenges.

Figure 1: Composition of Spending as a Share of GDP Assuming Discretionary
Spending Grows with GDP after 2005 and All Expiring Tax Provisions Are
Extended

Notes: Although expiring tax provisions are extended, revenue as a share
of gross domestic product (GDP) increases through 2015 due to (1) real
bracket creep, (2) more taxpayers becoming subject to the alternative
minimum tax, and (3) increased revenue from tax-deferred retirement
accounts. After 2015, revenue as a share of GDP is held constant.

PBGC is an excellent example of the need for Congress to reconsider the
role of government programs, in general, and federal retirement programs,
in particular, in light of past changes and 21st century challenges. In
1974, Congress passed the Employee Retirement Income Security Act (ERISA)

to respond to trends and challenges that existed at that time.4 Among
other things, ERISA established PBGC to pay the pension benefits of
defined benefit plan participants, subject to certain limits, in the event
that an employer could not.5 When ERISA was enacted, defined benefit
pension plans were the most common form of employer-sponsored private
pension and were growing both in number of plans and in number of
participants. Today, defined benefit pensions cover an ever-decreasing
percentage of the U.S. labor force, a fact that raises questions about
federal policy on pensions in general, and defined benefit plans and the
PBGC, in particular.

I would now like to outline the challenges facing the defined benefit
pension system and PBGC and suggest a framework for evaluating potential
policy responses. In summary, a combination of recent events, long-term
structural problems, and weaknesses in the legal framework governing
pensions has left PBGC with a significant long-term deficit and many large
plans badly underfunded. Lower interest rates and equity prices since 2000
have combined to significantly increase pension underfunding through an
increase in the present value of pension liabilities, and decreases in the
value of pension plan assets. Meanwhile, intense cost competition as a
result of globalization and deregulation has led to bankruptcies of plan
sponsors in key industries like steel and airlines, and is exposing PBGC
to the risk of significant future losses in these and other industries.
This competitive restructuring has occurred simultaneously with a
long-term decline in defined benefit plan participation that threatens
PBGC's revenue base. In addition, the basic legal framework governing
pension insurance and plan funding has failed to safeguard the benefit
security of American workers and retirees and the PBGC's financial
condition. Too many companies are making pension promises that they are
not required to deliver on, in part because of perverse incentives and
"put options" created under the current pension insurance system.

PBGC's current premium structure does not properly reflect the risks to
its insurance program and facilitates moral hazard by plan sponsors.

4One impetus for the passage of ERISA was the failure of Studebaker's
defined benefit pension plan in the 1960s, in which thousands of plan
participants lost most or all of their pensions.

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.

Further, as we have shown in a recent report, current pension funding
rules have not provided sufficient incentives, transparency, and
accountability mechanisms for plan sponsors to properly fund their benefit
obligations and deliver on their promises.6 As a result, bankrupt plan
sponsors, acting rationally and within the rules, have transferred the
obligations of their large and significantly underfunded plans to PBGC.
These weaknesses in the legal framework contribute to and are exacerbated
by a lack of transparent information that makes it difficult for
interested stakeholders to understand the true financial condition of and
risk associated with selected pension plans.

Given pension plans' crucial significance to our nation's retirement
security net, it is useful to compare the challenges facing PBGC's
insurance program and Social Security. Both systems require meaningful,
comprehensive reform that restores solvency, assures sustainability, and
protects the benefits of participants. Similar to that of Social Security,
PBGC's current condition does not represent a crisis, though delaying
reform will result in serious adverse consequences for individuals, the
federal budget, and our economy. Furthermore, like Social Security, PBGC
has plenty of cash on hand today to pay benefits to participants in the
short term, but it faces large and growing unfunded obligations and
escalating cash flow deficits in the future.

The termination of United Airlines' defined benefit pension plans is just
the latest in a recent series of large, underfunded plans taken over by
PBGC, and will not be the last. In July 2003, GAO designated PBGC's
single-employer insurance program as "high-risk," given its deteriorating
financial condition and long-term vulnerabilities.7 At the end of fiscal
year 2004, PBGC estimated that it was exposed to almost $100 billion of
underfunding in plans sponsored by companies with credit ratings below
investment grade. Though smaller in scale than Social Security, Medicare,
and Medicaid, PBGC's deficit threatens to worsen our government's longterm
fiscal position.8 While PBGC is not explicitly backed by the full faith

6GAO, Private Pensions: Recent Experiences of Large Defined Benefit Plans
Illustrate Weaknesses in Funding Rules, GAO-05-294 (Washington, D.C.: May
31, 2005).

7GAO, Pension Benefit Guaranty Corporation Single-Employer Insurance
Program: Long-Term Vulnerabilities Warrant "High Risk" Designation,
GAO-03-1050SP (Washington, DC: July 23, 2003).

8For additional discussion of these broader fiscal challenges, see GAO,
Our Nation's Fiscal Outlook: The Federal Government's Long-Term Budget
Imbalance, at http://www.gao.gov/special.pubs/longterm/longterm.html.

Background

and credit of the U.S. government,9 policymakers would undoubtedly face
intense pressure to provide PBGC the resources to continue paying earned
pension benefits to millions of retirees if PBGC were to become insolvent.

In light of the intrinsic problems facing the defined benefit system,
meaningful and comprehensive reform will be needed to ensure that workers
and retirees receive the benefits promised to them and to secure PBGC's
financial future. At this time, the Administration, members of Congress,
and others have proposed reforms that seek to address many of the problems
facing PBGC and the defined benefit system. This is a promising
development that can be a critical first step in addressing part of the
long-term fiscal problems facing this country.

Before enactment of the Employee Retirement Income Security Act of 1974
(ERISA), few rules governed the funding of defined benefit pension plans,
and participants had no guarantees that they would receive their promised
benefits. Among other things, ERISA created the PBGC to protect the
benefits of plan participants 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. When a plan is terminated with insufficient
assets to pay its guaranteed benefits, PBGC takes over the plan and
assumes responsibility for paying benefits to participants. According to
PBGC's 2004 annual report, PBGC provides insurance protection for over
29,000 single-employer pension plans, which cover 34.6 million workers,
retirees, and their beneficiaries.10

PBGC receives no direct federal tax dollars to support the single-employer
pension insurance program. Instead, the program receives the assets of
terminated underfunded plans and any of the sponsor's assets that PBGC

9PBGC is authorized to borrow up to $100 million from the U.S. Treasury to
cover temporary cash shortfalls.

10PBGC also guarantees a smaller pension benefit for approximately 10
million participants in multiemployer pension plans.

recovers during bankruptcy proceedings.11 PBGC finances the unfunded
liabilities of terminated plans with premiums paid by plan sponsors and
income earned from the investment of program assets. Premiums have two
components: a per participant charge paid by all sponsors (currently $19
per participant), and a variable-rate premium that some underfunded plans
pay based on the level of unfunded benefits.12

The single-employer program has had an accumulated deficit-that is,
program assets have been less than the present value of benefits and other
obligations-for much of its existence. (See fig. 2.) 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 fiscal year 2004, the single-employer program incurred a net
loss of $12.1 billion, and its accumulated deficit increased to $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.

11According 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).

12The additional premium equals $9.00 for each $1,000 (or fraction
thereof) of unfunded vested benefits. A plan's sponsor may be exempt from
paying the variable rate premium if the plan met a specified funding
threshold in the previous plan year.

Figure 2: Assets, Liabilities, and Net Financial Position of PBGC's
Single-Employer Insurance Program

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.

In defined benefit plans, formulas set by the employer determine employee
benefits. DB plan formulas vary widely, but benefits are frequently based
on participant earnings and years of service, and traditionally paid upon
retirement as a lifetime annuity, or periodic payments until death.
Because DB plans promise to make payments in the future, and because
taxqualified DB plans must be funded, employers must use present value
calculations to estimate the current value of promised benefits.13 The
calculations require making assumptions about factors that affect the
amount and timing of benefit payments, such as an employee's retirement
age and expected mortality, and about the expected return on plan assets,
expressed in the form of an interest rate. The present value of accrued

13Present value calculations reflect the time value of money-that a dollar
in the future is worth less than a dollar today, because the dollar today
can be invested and earn interest. Using a higher interest rate will lower
the present value of a stream of payments because it implies that a lower
level of assets today will be able to fund those future payments.

benefits calculated using mandated assumptions is known as a plan's
current liability. Current liability provides an estimate of the amount of
assets a plan needs today to pay for accrued benefits.

ERISA and the Internal Revenue Code (IRC) prescribe rules regarding the
assumptions that sponsors must use to measure plan liabilities and assets.
While different assumptions will change a plan's reported assets and
liabilities, sponsors eventually must pay the amount of benefits promised;
if the assumptions used to compute current liability differ from the
plan's actual experience, current liability will differ from the amount of
assets actually needed to pay benefits.14

Funding rules generally presume that a pension plan and its sponsor are
ongoing entities, and plans do not necessarily have to maintain an asset
level equal to current liabilities every year. However, the funding rules
include certain mechanisms that are intended to keep plans from becoming
too underfunded. One such mechanism is the additional funding charge
(AFC), which applies to plans with more than 100 participants.15 The AFC
requires plan sponsors to make additional contributions to plans that fall
below a prescribed funding level. With some exceptions, plans with
reported asset values below 90 percent of current liabilities are affected
by the AFC rules.

14A plan's current liability may differ from its termination liability,
which measures the value of accrued benefits using assumptions appropriate
for a terminating plan. For further discussion of current versus
termination liability, see appendix IV of GAO, Pension Benefit Guaranty
Corporation: Single-Employer Pension Insurance Program Faces Significant
Long-Term Risks, GAO-04-90, (Washington, D.C.: Oct. 29, 2003).

15The AFC was introduced by the Omnibus Budget Reconciliation Act of 1987.
See Pub. L. No. 100-203 (1987).

  PBGC'S Problems Stem from Recent Events, Long-Term Structural Trends, and
  Weaknesses in the Legal Framework Governing DB Pensions

A combination of recent events, long-term structural problems, and
weaknesses in the legal framework governing the DB system has left PBGC
with a significant long-term deficit and many large plans badly
underfunded. Lower interest rates and equity prices since 2000 have
combined to significantly increase pension underfunding through an
increase in the present value of pension liabilities, and decreases in the
value of pension plan assets. Meanwhile, intense cost competition as a
result of globalization and deregulation has led to bankruptcies of plan
sponsors in key industries like steel and airlines, and is exposing PBGC
to the risk of significant future losses in these and other industries.
This competitive restructuring has occurred simultaneously with a long
term decline in defined benefit plan participation that threatens PBGC's
revenue base. In addition, the basic legal framework governing pension
insurance and plan funding has failed to safeguard the benefit security of
American workers and retirees and the PBGC's financial condition. Too many
companies are making pension promises that they are not required to
deliver on, in part because of perverse incentives and "put options"
created under the current pension insurance system.

PBGC's current premium structure does not properly reflect the risks to
its insurance program and facilitates moral hazard by plan sponsors.
Further, current pension funding rules have not provided sufficient
incentives, transparency, and accountability mechanisms for plan sponsors
to properly fund their benefit obligations and deliver on their promises.
As a result, bankrupt plan sponsors, acting rationally and within the
rules, have transferred the obligations of their large and significantly
underfunded plans to PBGC. These weaknesses in the legal framework
contribute to and are exacerbated by a lack of transparent information
that makes it difficult for interested stakeholders to understand the true
financial condition of and risk associated with selected pension plans.

    Recent Economic Factors Exacerbated the Underfunding of Large Terminated
    Plans by Bankrupt Sponsors

Over the last 5 years, many large pension plans have been adversely
affected by simultaneous declines in broad equity indexes and long-term
interest rates, as well as by the financial difficulties of their plan
sponsors.16 Poor investment returns from stock market declines affected
the asset values of pension plans to the extent that plans invested in
stocks. According to the ERISA Industry Committee, assets in private

16Broad equity indexes in the U.S. have risen since 2002 but remain
significantly below their peak levels of 2000.

sector defined benefit plans totaled $2.056 trillion at the end of 1999,
dropped to $1.531 trillion at the end of 2002, and climbed back to $1.8
trillion by the end of 2004.17 Lower equity values since the end of 1999
have been particularly problematic because interest rates have also
declined and thus increased the present value of plan liabilities.18 Some
sponsors of large pension plans that were terminated were not in
sufficiently strong financial condition to meet their pension funding
requirements because of weaknesses in their primary business activities.
Bankruptcies and pension plan terminations increased around the U.S.
economic recession of 2001 and around prior recessions.19

These conditions played a part in increasing the unfunded liabilities of
plans terminated by bankrupt sponsors since 2000. For example, according
to the filing of its annual regulatory report for pension plans, Bethlehem
Steel's plan went from 86 percent funded in 1992 to 97 percent funded in
1999. From 1999 to its plan termination in December 2002, plan funding
fell to less than 50 percent as assets decreased and liabilities increased
and sponsor contributions were not sufficient to offset the changes.

17ERISA Industry Committee, Consensus Proposals for Pension Funding, PBGC
Reform, and Hybrid Pension Plans, (Washington, D.C.: May 2005). Asset
totals in 2002 and 2004 include billions of dollars in contributions by
plan sponsors since 1999.

18Falling 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. A potentially offsetting effect of falling interest
rates is the possible increased return on fixed-income assets that plans
hold. When interest rates fall, the value of existing fixed-income
securities with time left to maturity rises.

19Three 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
2001. The last three recessions on record in the United States occurred
during 1981, 1990-91, and 2001 (See www.bea.gov/bea/dn/gdpchg.xls).

    Long-Term Declines of Key Industries and in Defined Benefit Pension Coverage
    Have Contributed to PBGC's Weakening Financial Condition

Long-term trends in some sectors of the economy and in defined benefit
pension coverage are threatening both PBGC's future solvency and the
economic security in retirement of workers and retirees. PBGC's risk of
inheriting underfunded pensions largely stems from the fact that more than
half of the pension participants it insures are in the manufacturing and
airline sectors, which have been exposed to lower cost competition because
of several factors including globalization and deregulation.20 A
potentially exacerbating risk to PBGC is the cumulative effect of
bankruptcy in these industries: if a critical mass of firms go bankrupt
and terminate their underfunded pension plans, their competitors may also
declare bankruptcy to similarly avoid the cost of funding their plans.

PBGC also faces the possibility of long-term revenue declines from
demographic changes in the population of defined benefit plan participants
and a shrinking number of DB plans. Over the long term, an aging
population of defined benefit plan participants threatens to reduce PBGC's
ability to raise premium revenues as participants die and are not replaced
by enough new participants. The percentage of participants who are active
workers has declined from 78 percent in 1980 to just under 50 percent in
2002. Furthermore, PBGC cannot effectively diversify its risk from the
terminations of plans in declining economic sectors because companies in
other growing industries have generally not sponsored new defined benefit
plans. As plan sponsors in weak industries go bankrupt and terminate their
pension plans, PBGC not only faces immediate changes in its financial
position from taking over underfunded plans, but also faces losses of
future revenues from these terminated plans.

A related factor eroding PBGC's premium base is the growth of lump-sum
pension distributions. More and more plan participants are exiting the
defined benefit system by taking lump-sum distributions from their plans.
After a lump-sum distribution is paid, the participant is out of the
defined benefit system and the plan sponsor no longer has to contribute to
the pension insurance system on the participant's behalf. In addition,
lumpsum distributions to participants in underfunded plans can create the
effect of a "run on the bank" and worsen a plan's underfunding. In such

20The causes of restructuring are likely industry-specific. For example,
the U.S. airline industry, which has many pension plans in poor financial
condition, has faced profit pressures as a result of severe price
competition, terrorism, the war in Iraq, and the outbreak of severe acute
respiratory syndrome (SARS), creating bankruptcies and uncertainty about
the future financial health of the industry.

cases, the plan may terminate without enough assets to pay full benefits
to other participants and PBGC may incur losses.

The increasing prevalence of lump-sum distributions in defined benefit
plans and the growth of defined contribution plans also raise significant
questions about whether many Americans will enjoy an economically secure
retirement.21 Many Americans are at risk of outliving their retirement
assets as life expectancies, health care, and long-term care costs
continue to increase.

    Legal Framework Has Not Encouraged Adequate Plan Funding, Contributing to
    PBGC's Financial Difficulties

Existing laws and regulations governing pension funding and premiums have
contributed to PBGC's financial difficulties and exposed PBGC to greater
risks from the companies whose pension plans it insures. PBGC's current
premium structure does not properly reflect the risks to its insurance
program and facilitates moral hazard by plan sponsors. Further, the
pension funding rules, under ERISA and the IRC, have not ensured that
plans have the means to meet their benefit obligations in the event that
plan sponsors run into financial distress. First, the current rules likely
allowed plans to appear better funded than they actually were, in both
good years and bad years. And even these reported funding levels indicated
significant levels of underfunding in our study of the 100 largest DB
plans.22 Second, plan sponsors often substituted "account credits" for
cash contributions, even as the market value of plan assets may have been
in decline. And third, the AFC, the primary mechanism for improving the
financial condition of poorly funded plans, was ineffective in doing so.
These weaknesses contribute to and are exacerbated by a lack of
transparent information that makes it difficult for plan participants,
investors, and others to have a clear understanding of their plan's
financial condition. As a result, financially weak benefit plan sponsors,
acting rationally and within the current law, have been able to avoid
large contributions to underfunded plans prior to bankruptcy and plan
termination, thus adding to PBGC's current deficit.

21A major factor contributing to the increase in lump-sum distributions
from defined benefit plans is the growing prevalence of hybrid plans, such
as cash balance plans, which typically offer lump sums. Hybrid plans are a
form of DB plan that determines benefits on the basis of hypothetical
individual accounts.

22 GAO-05-294.

PBGC's Premium Structure Does Not Properly Reflect Risks to the Insurance
Program

PBGC Is Subject to Moral Hazard

PBGC's current premium structure does not properly reflect risks to the
insurance program. The current premium structure relies heavily on
flatrate premiums, which, since they are unrelated to risk, result in
large cost shifting from financially troubled companies with underfunded
plans to healthy companies with well-funded plans. PBGC also charges plans
a variable-rate premium based on the plan's level of underfunding.
However, these 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 plan's demographic profile. PBGC is
currently operated somewhat more on a social insurance model, since it
must cover all eligible plans regardless of their financial condition or
the risks they pose to the solvency of the insurance program.

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, potentially
causing very large losses for PBGC. Similarly, PBGC may face risk from
insuring plans concentrated in vulnerable industries affected by certain
macroeconomic forces such as deregulation and globalization that have
played a role in multiple bankruptcies over a short time period, as has
happened recently in the airline and steel 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 adequately
account for these market risks.23 Others note that it would be hard to
determine the market-rate premium for insuring private pension plans
because private insurers would probably refuse to insure poorly funded
plans sponsored by weak companies.

Current pension funding and insurance laws create incentives for
financially troubled firms to use PBGC in ways that Congress likely did
not intend when it formed the agency in 1974. At that time, PBGC was
established to pay the pension benefits of participants, subject to
certain limits, in the event that an employer could not. However, since
that time, some firms with underfunded pension plans may have come to view
PBGC coverage as a fallback, or "put option," for financial assistance.
The very presence of PBGC insurance may create certain perverse incentives
that represent what economists call moral hazard-where struggling plan
sponsors may place other financial priorities above funding up their

23Boyce, Steven, and Richard A. Ippolitio, "The Cost of Pension
Insurance," The Journal of Risk and Insurance, (2002) Vol. 69, No. 2,
pp.121-170.

Current Funding Rules Do Not Provide Sufficient Incentives for Sponsors to
Adequately Fund Their Plans

pension plans because they know PBGC will pay guaranteed benefits. Firms
may even have an incentive to seek Chapter 11 bankruptcy in order to
escape their pension obligations. As a result, once a plan sponsor with an
underfunded pension plan experiences financial difficulty, these moral
hazard incentives may exacerbate the funding shortfall for PBGC.

This moral hazard effect has the potential to escalate, with the initial
bankruptcy of firms with underfunded plans creating a vicious cycle of
bankruptcies and terminations. Firms with onerous pension obligations and
strained finances could see PBGC as a means of shedding these liabilities,
thereby providing these companies with a competitive advantage over other
firms that deliver on their pension commitments. This would also
potentially subject PBGC to a series of terminations of underfunded plans
in the same industry, as we have already seen with the steel and airlines
industries in the past 20 years.

Moral hazard effects are likely amplified by current pension funding and
pension accounting rules that may also encourage plans to invest in
riskier assets to benefit from higher expected long-term rates of return.
In determining funding requirements, a higher expected rate of return on
pension assets means that the plan needs to hold fewer assets in order to
meet its future benefit obligations. And under current accounting rules,
the greater the expected rate of return on plan assets, the greater the
plan sponsor's operating earnings and net income. However, with higher
expected rates of return comes greater risk of investment volatility,
which is not reflected in the pension insurance program's premium
structure. Investments in riskier assets with higher expected rates of
return may allow financially weak plan sponsors and their plan
participants to benefit from the upside of large positive returns on
pension plan assets without being truly exposed to the risk of losses. The
benefits of plan participants are guaranteed by PBGC, and weak plan
sponsors that enter bankruptcy can often have their plans taken over by
PBGC.

The pension funding rules, under ERISA and the IRC, have not provided
sufficient incentives for plan sponsors to properly fund their benefit
obligations. The funding rules generally presume that pension plans and
their sponsors are ongoing entities and therefore allow for a certain
extent of plan underfunding that can be made up over time. However, the
measures of plan funding used to determine contribution requirements can
significantly overstate the true financial condition of a plan. And even

these reported funding levels indicated significant levels of underfunding
in our study of the 100 largest DB plans.24 Furthermore, when plan
sponsors make contributions to their plans, they can use account credits,
rather than cash, even in cases when plans are underfunded. The funding
rules include certain mechanisms-primarily, the AFC-that are intended to
prevent plans from becoming too underfunded. However, our analysis shows
that for several reasons, the AFC proved ineffective in restoring
financial health to poorly funded plans.

Rules May Allow Plans to Overstate Their Current Funding Levels

Current funding rules may allow plans to overstate their current funding
levels to plan participants and the public. Because many plans in our
sample chose legally allowable actuarial assumptions and asset valuation
methods that may have altered their reported liabilities and assets
relative to market levels, it is possible that funding over our sample
period was actually worse than reported.

Although as a group, funding levels among the 100 largest plans were
reasonably stable and strong from 1996 to 2000, by 2002, more than half of
the largest plans were underfunded (see fig. 3). On average, each year 39
of these plans were less than 100 percent funded, 10 had assets below 90
percent of their current liabilities, and 3 plans were less than 80
percent funded. In 2002 there were 23 plans less than 90 percent funded.

24For further details of this study, covering 1995-2002, see GAO-05-294.
These 100 plans are not a closed group. The 100 largest plans, as measured
by current liability, changed from year to year for various reasons,
including mergers and divestitures of plan sponsors. A total of 187
distinct plan identifiers were included in our sample, and 25 of them were
in each year's sample.

Figure 3: Almost One-Fourth of the Largest Pension Plans Were Less than 90
Percent Funded on a Current Liability Basis in 2002

Percentage of 100 largest DB plans 100

80

60

40

20

0 1995 1996 1997 1998 1999 2000 2001 2002 Year

Less than 80% funded

80% to less than 90% funded

90% to less than 100% funded

100% to less than 110% funded

110% funded or above

Source: GAO analysis of PBGC Form 5500 research data.

Reported funding levels may have been overstated for a number of reasons.
These include the use of above-market interest rates, which leads to an
understatement of the cost of settling benefit obligations through the
purchase of group annuity contracts. Also, actuarial asset values may have
differed by as much as 20 percent from current market value of plan
assets. The funding rules allow for smoothing out year-to-year
fluctuations in asset and liability values so that plan sponsors are
gradually, and not suddenly, affected by significant changes in interest
rates and the values of their assets. When current interest rates decline,
the use of a 4-year weighted average interest rate lags behind, and thus
measurements of the

present value of plan liabilities do not accurately reflect the cost of
settling a plan's benefit obligations.25

The terminations of the Bethlehem Steel and LTV Steel pension plans in
2002 (two of the largest plan terminations, to date) illustrate the
potential discrepancies between reported and actual funding. In 2002, the
Bethlehem Steel Corporation reported that its plan was 85.2 percent funded
on a current liability basis, yet the plan terminated later that year with
assets of less than half of the value of promised benefits. In 2001, LTV
Steel reported that its plan for hourly employees was 80 percent funded,
yet when the plan terminated in March 2002, it was only 52 percent funded.
From these terminations PBGC's single-employer program suffered losses of
$3.7 billion and $1.6 billion, respectively.26

Most Sponsors Most Years Made No Cash Contributions to Plans but Satisfied
Funding Requirements through Use of Accounting Credits

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. This minimum contribution requirement may be met by the plan
sponsor putting cash into the plan or by applying earned funding credits.
These funding credits are not measured at their market value and are
credited with interest each year, according to the plan's long-term
expected rate of return on assets.27 When the market value of a plan's
assets declines, the value of funding credits may be significantly
overstated.

25Conversely, when interest rates rise, the opposite would be true, and
the weighted average would make the cost of settling plan liabilities
higher than the current market rate would indicate.

26Several factors may explain the wide discrepancy between reported
funding levels and actual funding levels at termination. Reported funding
levels may use an actuarial value of assets, which may exceed the market
value at termination. In addition, termination liabilities are valued
using a different interest rate than that used for current liabilities.
Further, current liabilities and termination liabilities may be measured
at different times. Unfunded shutdown benefits may also raise termination
liabilities. For more discussion of the differences between termination
and current liabilities, see GAO-04-90, appendix IV.

27See 26 U.S.C. 412(b).

For the 1995 to 2002 period, the sponsors of the 100 largest plans each
year on average made relatively small cash contributions to their plans
(see fig. 4). Annual cash contributions for the 100 largest plans averaged
approximately $97 million on plans averaging $5.3 billion in current
liabilities (in 2002 dollars). This average contribution level masks a
large difference in contributions between 1995 and 2001, during which
period annual contributions averaged $62 million (in 2002 dollars), and in
2002, when contributions increased significantly to $395 million per plan.
Further, in 6 of the 8 years in our sample, a majority of the largest
plans made no cash contribution to their plan. On average each year, 62.5
plans received no cash contribution, including an annual average of 41
percent of plans that were less than 100 percent funded.

Figure 4: Most Large Plans Received No Annual Cash Contribution, 1995-2002

Note: Average contributions for 2002 are largely driven by one sponsor's
contribution to its plan. Disregarding this $15.2 billion contribution
reduces the average plan contribution for 2002 from $395 million to $246
million.

As stated earlier, Bethlehem Steel and LTV Steel both had plans terminate
in 2002 that were only about 50 percent funded. Yet each plan was able to
forgo a cash contribution each year from 2000 to 2002, instead using
credits to satisfy minimum funding obligations, primarily from large

accumulated credit balances from prior years. Despite being severely
underfunded, each plan reported an existing credit balance at the time of
termination.

AFC, Primary Mechanism for Improving Funding of Underfunded Plans, Proved
Ineffective

The funding rules' primary mechanism for improving the financial condition
of underfunded plans, the additional funding charge proved ineffective in
helping underfunded plans for four main reasons:

1. 	Very few plans in our sample were actually assessed an AFC because the
rules, despite the statutory threshold of a 90 percent funding level for
some plans to owe an AFC, in practice require a plan to be much more
poorly funded to be subject to this requirement.28 From 1995 to

2002, an average of only 2.9 of the 100 largest DB plans each year were
assessed an additional funding charge, even though on average 10 percent
of plans each year reported funding levels below 90 percent. Over the
entire 8-year period, only 6 unique plans that were among the 100 largest
plans in any year from 1995 to 2002 owed an AFC. These 6 plans owed an AFC
during the period a total of 23 times in years in which they were among
the 100 largest plans, meaning that plans that were assessed an AFC were
likely to owe it again.

2. 	AFC rules also specify a current liability calculation method that may
overstate actual plan funding, relative to market-value measures, thereby
reducing the number of plans that might be assessed an AFC. The specified
interest rate for this calculation exceeded current market rates in 98
percent of the months between 1995 and 2002.

3. 	The AFC rules generally call for sponsors to pay only a percentage of
their unfunded liability, rather than requiring restoration of full
funding. On average, by the time a plan was assessed an AFC, it was
significantly underfunded and was likely to remain chronically underfunded
in subsequent years. Among the 6 plans that owed the AFC, funding levels
rose slightly from an average of 75 percent when the plan was first
assessed an AFC to an average of 76 percent, looking collectively at all
subsequent years. All of these plans were assessed an AFC more than once.

28A plan is not subject to an AFC 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 at least 2 consecutive of the 3 immediately
preceding years.

Weaknesses in Funding Rules Amplified by Lack of Transparency Hinders
Sound Policy making

4. 	Plan sponsors can meet the AFC requirement by applying funding credits
earned in prior years in place of cash contributions. The account value of
these credits, which accumulate interest, may not reflect the underlying
value of the assets in the plan. Many plans experienced significant market
value losses of their assets between 2000 and 2002 while they were able to
apply these funding credits. Among the 100 largest plans, just over 30
percent of the time a plan was assessed an AFC, the funding rules allowed
the sponsor to forgo a cash contribution altogether that year.

The experience of two large terminated plans illustrates the
ineffectiveness of the AFC. For example, Bethlehem Steel's plan was
assessed an AFC of $181 million in 2002, but the company made no cash
contribution that year, just as it had not in 2000 or 2001, years in which
the plan was not assessed an AFC. When the plan terminated in late 2002,
its assets covered less than half of the $7 billion in promised benefits.
LTV Steel, which terminated its pension plan for hourly employees in 2002
with assets of $1.6 billion below the value of benefits, had its plan
assessed an AFC each year from 2000 to 2002, but for only $2 million, $73
million, and $79 million, or no more than 5 percent of the eventual
funding shortfall. Despite these AFC assessments, LTV Steel made no cash
contributions to its plan from 2000 to 2002. Both plans were able to apply
existing credits instead of cash to satisfy minimum funding requirements.
In addition, both sponsors had unused funding credits at the time their
plans were terminated.

Unclear measures of pension funding and a lack of timely information have
made it difficult for plan participants, investors, regulators, and policy
makers to accurately assess the financial condition of pension plans.
Without timely and reasonably accurate data about the financial condition
of pension plans, the various stakeholders cannot make timely and informed
decisions on retirement savings, employment, and other key life issues.
The primary regulatory filing for pension plans-the Form 5500--requires
multiple measures of pension assets and liabilities, yet none of these
measures tell PBGC and plan participants what share of the benefit
obligations are funded in the event of plan termination. Furthermore, by
the time these regulatory reports are publicly available,

the information is usually at least 2 years old.29 In a time of
significant changes in interest rates and equity prices, it is possible
that reported measures of pension funding will substantially differ from
current measures of plan funding. PBGC does receive more current
information about plans that are underfunded by at least $50 million. This
more current information includes estimates of funding measures if the
plan were to be terminated; however, by law this information is not
disclosed to the public.

Our cash-based budgetary framework for federal insurance programs also
contributes to a lack of transparency that, at worst, may create
disincentives for policy makers to enact reform measures.30 With the
current cash-based reporting, premiums for insurance programs are recorded
in the budget when collected, and outlays are reported when claims are
paid.31 This focus on annual cash flows generally does not adequately
reflect the government's cost for federal insurance programs because the
time between the extension of the insurance, the receipt of premiums and
other collections, the occurrence of an insured event, and the payment of
claims may extend over several budget periods. As a result, the
government's cost may be understated in years that a program's current
premium and other collections exceed current payments and overstated in
years that current claim payments exceed current collections. This is
especially problematic in the case of pension insurance because of the
erratic occurrence of plan terminations as well as the

29For further information about problems with the content and timeliness
of regulatory reports on pensions, see GAO, Private Pensions: Government
Actions Could Improve the Timeliness and Content of Form 5500 Pension
Information, GAO-05-491 (Washington, D.C.: June 3, 2005), and Private
Pensions: Publicly Available Reports Provide Useful but Limited
Information on Plans' Financial Condition, GAO-04-395 (Washington, D.C.:
Mar. 31, 2004).

30GAO, Budget Issues: Budgeting for Federal Insurance Programs,
GAO/T-AIMD-98-147 (Washington, D.C.: Apr. 23, 1998), and Budget Issues:
Budgeting for Federal Insurance Programs, GAO/AIMD-97-16 (Washington,
D.C.: Sept. 30, 1997).

31PBGC's premium collections and benefit payments are recorded in the
budget on a cash basis, regardless of when the commitments are made. The
premiums paid by participants are held in a revolving fund. PBGC's budget
treatment is complicated by the use of a second account for some
activities which is not included in the federal budget. This account
records the assets and liabilities that PBGC acquires from terminated
plans. As a result, the budget only reports PBGC's net annual cash flows
between its on-budget account and all other entities, including the other
PBGC account. It does not provide information on liabilities PBGC incurs
when it takes over an underfunded plan or other changes in PBGC's assets
and liabilities.

mismatch between premium collections and benefit payments that can extend
over several decades.

Cash-based budgeting also may not be a very accurate gauge of the economic
impact of federal insurance programs. Although discerning the economic
impact of federal insurance programs can be difficult, private economic
behavior generally is affected when the government commits to providing
insurance coverage. In the case of PBGC, the existence of pension
insurance may encourage plan sponsors and employees to agree to pension
benefit increases in lieu of wage increases when the plan sponsor faces
economic difficulties.32

Cash-based budgeting for federal insurance programs may provide neither
the information nor incentives necessary to signal emerging problems, make
adequate cost comparisons, control costs, or ensure the availability of
resources to pay future claims. Because the cash-based budget delays
recognition of emerging problems, it may not provide policy makers with
information or incentives to address potential funding shortfalls before
claim payments come due. Policy makers may not be alerted to the need to
address programmatic design issues because, in most cases, the budget does
not encourage them to consider the future costs of federal insurance
commitments. Thus, reforms aimed at reducing costs may be delayed. In most
cases, by the time costs are recorded in the budget, policy makers do not
have time to ensure that adequate resources are accumulated to pay for
them or to take actions to control them. The late budget recognition of
these costs can reduce the number of viable options available to policy
makers, ultimately increasing the cost to the government.

In light of the intrinsic problems facing the defined benefit system,
meaningful and comprehensive pension reform is required to ensure that
workers and retirees receive the benefits promised to them and to secure
PBGC's financial future. While PBGC's current financial condition does not
represent a crisis, delaying reform will result in serious adverse
consequences for plan participants, the federal budget, and our nation's
economy. At this time, the Administration, members of Congress, and others
have proposed reforms that seek to address many of the problems

  Retirement Income Security Requires Meaningful and Comprehensive Reform

32GAO-05-578SP.

facing PBGC and the defined benefit system.33 Such comprehensive effective
pension reform would likely include elements that would improve measures
of pension funding and enhance transparency of plan information,
strengthen funding rules (while preserving some contribution flexibility
for plan sponsors, modify certain PBGC guarantees, develop an enhanced and
more risk-based insurance premium structure, and resolve outstanding
controversies concerning hybrid plans, such as cash balance plans.34

    GAO Has Suggested Elements of Pension Reform

Pension reform is a challenge because of the necessity of fusing together
so many complex, and sometimes competing, elements into a comprehensive
proposal. Ideally, effective reform would

o  	improve the accuracy of plan funding measures while minimizing
complexity and maintaining contribution flexibility;

o  	revise the current funding rules to create incentives for plan
sponsors to adequately finance promised benefits;

o  	develop a more risk-based PBGC insurance premium structure and
provides incentives for sponsors to fund plans adequately;

o  	address the issue of underfunded plans paying lump sums and granting
benefit increases;

o  modify PBGC guarantees of certain plan benefits (e.g., shutdown
benefits);

o  	resolve outstanding controversies concerning hybrid plans by
safeguarding the benefits of workers regardless of age; and

o  	improve plan information transparency for pension plan stakeholders
without overburdening plan sponsors.

33For example, earlier this year, the Administration released a proposal
that focuses on reforming the funding rules; improving disclosure to
workers, investors, and regulators about pension plan status; and
adjusting premiums to better reflect a plan's risk to PBGC. See U.S.
Department of Labor, Employee Benefits Security Administration, Strengthen
Funding for Single Employer Pension Plans, February 7, 2005.

34For greater detail, see GAO-04-90.

Furthermore, if policy makers decide to provide measures of relief to
sponsors of poorly funded pension plans, there should be mechanisms built
into such laws that would prevent any undue exacerbation of PBGC's
financial condition.

Developed in isolation, solutions to some of these concerns could erode
the effectiveness of other reform components or introduce needless
complexity. As deliberations on reform move forward, it will be important
that each of these individual elements be designed so that all work in
concert toward well-defined goals. Even with meaningful, carefully crafted
reform, it is possible that some defined benefit plan sponsors may choose
to freeze or terminate their plans. While these are serious concerns, the
overarching goals of balanced pension reform should be to protect workers'
benefits by providing employers the flexibility they need in managing
their pension plans while also holding those employers accountable for the
promises they make to their employees.

The debate over defined benefit pension reform should not take place in
isolation of larger related issues. Challenges in the defined benefit
system, together with 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 how who should bear certain risks and responsibilities for economic
security in retirement.

o  	Individual savings require greater responsibility and offer greater
potential rewards and the possibility of bequeathing any unused retirement
savings. However, longevity risk-the risk of outliving retirement
savings-and poor investment choice are significant concerns, particularly
as health care and long-term care costs and life expectancies continue to
rise.

o  	The federal government is in the best position to share risk across
the population, and social insurance programs, including Social Security,
Medicare, and Medicaid already reflect this fact. However, the current
structure of existing federal retirement programs is unsustainable.

o  	Employer-sponsored pensions can alleviate longevity risk for plan
participants and are generally presumed to be better placed to manage
investment risk. However, poor management of plans can lead to shortfalls
in funding that can damage the competitiveness of the plan sponsors.
Furthermore, many employers are cutting or reducing retiree health
benefits, and even employee health benefits, as growing health care costs
threaten their competitiveness.

    Experts Identified a Variety of Broad Pension Reforms

Earlier this year, GAO convened a forum on the future of the defined
benefit system and the PBGC that included a diverse group of about 40
pension experts, representing various interests, to discuss various
reforms to the defined benefit pension system.35 In addition to debating
changes to the funding rules and PBGC premiums, participants also talked
about ways to address pension legacy costs (the costs of terminated and
underfunded pension plans) and features of pension plans that government
policy should encourage.

According to participants in the GAO forum, resolution of pension legacy
costs and clarification of the legal status of cash balance and other
hybrid pension plans could play a significant role in shoring up the
defined benefit system.36 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. Some participants added that resolving legacy costs
could be a key component of any pension reform legislation that tightened
the funding rules and assessed premiums according to PBGC's risk. Also,
some participants supported, and other participants opposed, the idea of
separately addressing the pension legacy costs of specific industries,
such as airlines and steel, which have imposed the most significant costs
on PBGC. Separately addressing pension legacy costs does not necessarily
imply a taxpayer bailout, as some participants suggested other ways to
cover their cost, such as through an airline ticket fee to cover the
airlines' share of PBGC's deficit. Others noted that resolving the
uncertain legal status of cash balance and other hybrid pension plans
could encourage greater participation in the defined benefit system.
Expanding the universe

35GAO, Comptroller General's Forum: The Future of the Defined Benefit
System and the Pension Benefit Guaranty Corporation, GAO-05-578SP
(Washington, DC: June 2005). Participants included government officials,
researchers, accounting experts, actuaries, plan sponsor and employee
group representatives, and members of the investment community.

36Cash 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 account-based defined contribution plan. The
hypothetical account balances communicated to plan participants do not
necessarily bear any relationship to actual assets held by the plan.

of pension plan sponsors could lead to an increase in PBGC's premium
income.

Some forum participants also suggested that the debate over federal
retirement policy needs to move beyond distinctions between defined
benefit and defined contribution plans. 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 new pension plan
designs be developed that explore the following features:

o  	allowing automatic participation of the covered population in order to
expand pension coverage generally;

o  	improving the portability of pension benefits to accommodate workers
who frequently change jobs;

o  	providing for professional money management and pooled investment
risk;

o  	minimizing early withdrawals and borrowing-a problem known as
leakage-from retirement savings; and

o  	providing incentives to receive benefits in the form of a fixed
annuity, rather than a lump-sum distribution.

Conclusions 	Widely reported recent large plan terminations by bankrupt
sponsors and the resulting adverse consequences for plan participants and
the PBGC have pushed pension reform into the spotlight of national
concern. Our analysis here suggests that a variety of factors have
contributed to the current state of affairs: recent declines in interest
rates and financial markets, a soft economy, industry restructuring
because of changes in the national and world economies, weaknesses in the
legal framework governing pensions that has encouraged moral hazard by
sponsors, the underfunding of plans, and a lack of timely, accurate,
useful and transparent information that limits participants, unions,
investors and other stakeholders from being able to make accurate and
timely decisions.

In light of the intrinsic problems facing the defined benefit system,
meaningful and comprehensive pension reform is required to ensure that
workers and retirees receive the benefits promised to them. At this time,
the Administration, members of Congress, and others have proposed reforms
that seek to address many of the problems facing PBGC and the defined
benefit system. This is a promising development that can be a critical
first step in addressing part of the long-term fiscal problems facing this
country. Such reform will demand wisdom and patience, given the necessity
of fusing together so many complex, and sometimes competing, elements into
a comprehensive proposal. Ideally, effective reform would

o  	improve the accuracy of plan funding measures while minimizing
complexity and maintaining contribution flexibility;

o  	revise the current funding rules to create incentives for plan
sponsors to adequately finance promised benefits;

o  	develop a more risk-based PBGC insurance premium structure and
provides incentives for sponsors to fund plans adequately;

o  	address the issue of underfunded plans paying lump sums and granting
benefit increases;

o  modify PBGC guarantees of certain plan benefits (e.g., shutdown
benefits);

o  	resolve outstanding controversies concerning hybrid plans by
safeguarding the benefits of workers regardless of age; and

o  	improve plan information transparency for pension plan stakeholders
without overburdening plan sponsors.

However, it is also necessary to keep in mind that pension reform is only
part of the broader fiscal, economic, workforce, and retirement security
challenges facing our nation. If you look ahead in the federal budget,
Social Security, together with the rapidly growing health programs
(Medicare and Medicaid), will dominate the federal government's future
fiscal outlook. These are far larger and more urgent challenges,
representing an unsustainable burden on future generations. Furthermore,
pension reform should be considered in the context of the problems facing
our nation's Social Security system. How we reform DB pensions has crucial
implications for directions taken in reforming Social Security. For
example, pension reforms that reduce the scope of the private pension
system or change the dominant form of private pension design may have

consequences for those elements of Social Security reform packages that
reduce benefits or include an individual accounts feature.

This also means that acting sooner rather than later will make reform less
costly and more feasible. Though smaller in scale than actuarial deficits
in Social Security, Medicare, and Medicaid, PBGC's deficit threatens to
worsen our government's long-term fiscal position. Finally, as with Social
Security, it is also important to evaluate pension reform proposals as
comprehensive packages. The elements of any reform proposal interact;
every package will have pluses and minuses, and no plan will satisfy
everyone on all dimensions. If we focus on the pros and cons of each
element of reform by itself, we may find it impossible to build the
bridges necessary to achieve consensus.

We look forward to working with Congress on these crucial issues.

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

Contact and 	For further information, please contact Barbara Bovbjerg at
(202) 5127215. Individuals making key contributions to this testimony
include

Acknowledgments David Eisenstadt and Charlie Jeszeck.

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