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United States General Accounting Office: 
GAO: 

Testimony: 

Before the Senate Finance Committee: 

For Release on Delivery: 
Expected at 2:00 p.m. 
Wednesday, February 27, 2002: 

Private Pensions: 

Key Issues to Consider Following the Enron Collapse: 

Statement of David M. Walker: 
Comptroller General of the United States: 
		
GAO-02-480T: 

Mr. Chairman and Members of the Committee: 

I am pleased to be here today to provide you with preliminary
observations on some of the challenges facing our nation's private 
pension system. Pension income is crucial to American retirees' 
standard of living. About half of Americans over 65 receive payments 
from pensions and savings plans, and such income represents about 18 
percent of their total income. Over 70 million workers participate in 
pension and savings plans, and such plans in 1997 represented about 
$3.6 trillion in retirement savings. 

The federal government encourages employers to sponsor and maintain 
pension and savings plans for their employees. The private pension 
system is voluntary and consists of defined benefit plans and defined 
contribution plans. Defined benefit plans promise to provide a level 
of retirement income that is generally based on salary and years of 
service. Defined contribution plans are based on the contributions to 
and investment returns on the individual accounts. Such plans include 
thrift savings plans, profit-sharing plans, and employee stock 
ownership plans (ESOPs). 

The financial collapse of the Enron Corporation and its effect on the 
company's workers and retirees suggests certain vulnerabilities in 
these selected savings mechanisms. Enron's retirement plans, which 
included a defined benefit cash balance plan, a defined contribution 
401(k) plan, and an ESOP, caused Congress to question specifically the 
use of employer stock as the company match, the continued existence of 
floor offsets, and the practice of investment freezes or lockdowns 
during changes in plan administrators. The financial losses suffered 
by participants in Enron's retirement plans have raised questions 
about the benefits and limitations of such private pension and savings 
plans and the challenges employees face in saving for retirement 
through their employer-provided plans. 

You asked me here today to help provide context for considering how to 
address the vulnerabilities the Enron case may suggest. Accordingly, I 
will discuss three areas that, because of the experience with Enron, 
appear particularly salient to policymakers' decisions: (1) the 
importance of investment diversification and related investor 
education issues; (2) the crucial role of disclosure, and what 
information employees need and can expect about their company and 
their pension plans; and (3) the importance of fiduciary rules in 
safeguarding employee pension assets. In discussing these three 
issues, I will also address certain plan design issues such as floor-
offsets, using company stock in pension plans, and plan operation 
issues, such as investment freezes or lockdowns. My observations are 
based on prior GAO work, a preliminary review of Enron's and other 
public companies' plans, discussions with industry experts and senior 
regulatory officials, and my personal experience, including my former 
position as Assistant Secretary of Labor for Pension and Welfare 
Benefit Programs. 

In summary, the collapse of the Enron Corporation and the accompanying 
loss of Enron employees' retirement savings appear to highlight 
vulnerabilities in the private pension system and help focus attention 
on strengthening several aspects of this system. Diversification of 
pension assets is crucially important, particularly in a world where 
the use of defined contribution plans—those plans in which employees 
bear the investment risk—is increasing. If both the employees' 401(k) 
contributions and the company match are largely in employer stock, as 
was the case at Enron, employees risk losing not only their jobs 
should the company go out of business, but also a significant portion 
of their retirement savings. The Enron situation suggests the 
importance of encouraging employees to diversify but any action would 
have to be balanced against the desires of employers and employees to 
maintain a portion of retirement savings in company stock. In 
addition, the Enron situation illustrates the need to provide 
employees with investment education and advice that will enable them 
to better manage their retirement savings. 

Workers need clear and understandable information about their pension 
plans to make wise retirement saving decisions. While disclosure rules 
state that plan sponsors must provide plan participants with a summary 
of benefits and rights under their pension plan and notification when 
plan benefits are changed, such information is not always clear, 
particularly in describing complex plans, like floor-offset 
arrangements. We have also observed in earlier work that wide 
variation exists in the type and amounts of information workers 
receive about plan changes that can potentially reduce pension 
benefits, and enhanced disclosure requirements may be warranted. 
Furthermore, employees, like other investors, need reliable and 
understandable information about a company's financial condition and 
prospects. 

Finally, fiduciary standards form the cornerstone of private pension 
protections. These standards require plan sponsors to act in a manner 
that is solely in the interest of plan participants and beneficiaries. 
In the end, investigations of Enron's actions related to its plans 
will determine whether plan fiduciaries acted in accordance with these 
responsibilities. In light of Enron, policymakers may wish to consider 
whether current fiduciary standards are sufficient or whether they 
require strengthening, and act accordingly to address these 
fundamental principles of pension management. 

The Enron collapse provides the Congress with clear examples of issues 
it may wish to consider when deciding whether and how to strengthen 
the security of plan benefits. These issues include employees' need 
for enhanced education and appropriate investment advice, plan designs 
such as floor-offset arrangements and the use of employer stock in 
retirement savings plans, and plan operations, such as plan investment 
freezes and lockdowns. Addressing these issues will require balancing 
the need for greater participant protections with the potential 
increase in employer burden that could undermine their willingness to 
sponsor or contribute to such plans. 

Background: 

The Internal Revenue Code (IRC) defines pension plans as either 
defined benefit or defined contribution and includes separate 
requirements for each type of plan. The employer, as plan sponsor, is 
responsible for funding the promised benefit, investing and managing 
the plan assets, and bearing the investment risk. If a defined benefit 
plan terminates with insufficient assets to pay promised benefits, the 
Pension Benefit Guaranty Corporation (PBGC) provides plan termination 
insurance to pay participants' pension benefits up to certain limits.
Under defined contribution plans, employees have individual accounts 
to which employers, employees, or both make periodic contributions. 
Plans that allow employees to choose to contribute a portion of their 
pre-tax compensation to the plan under section 401(k) of IRC are 
generally referred to as 401(k) plans. In many 401(k) plans employees 
can control the investments in their account while in other plans the 
employer controls the investments. ESOPs may also be combined with 
other pension plans, such as a profit-sharing plan or a 401(k) plan. 
[Footnote 1] Investment income earned on a 401(k) plan accumulates tax-
free until an individual withdraws the funds. In a defined 
contribution plan, the employee bears the investment risk, and plan 
participants have no termination insurance. 

The Internal Revenue Service (IRS) and the Pension and Welfare 
Benefits Administration (PWBA) of the Department of Labor (DOL) are 
primarily responsible for enforcing laws related to private pension 
plans. Under the Employee Retirement Income Security Act of 1974 
(ERISA), as amended, IRS enforces coverage and participation, vesting, 
and funding standards that concern how plan participants become 
eligible to participate in benefit plans, earn rights to benefits, and 
reasonable assurance that plans have sufficient assets to pay promised 
benefits. IRS also enforces provisions of the IRC that apply to 
pension plans, including provisions under section 401(k) of the IRC. 
PWBA enforces ERISA's reporting and disclosure provisions and 
fiduciary standards, which concern how plans should operate in the 
best interest of participants. 

Since the 1980's, there has been a significant shift from defined 
benefit plans to defined contribution pension plans. Many employers 
sponsor both types of plans, with the defined contribution plan 
supplementing the defined benefit plan. However, most of the new 
pension plans adopted by employers are defined contribution plans. 
According to the Department of Labor, employers sponsored over 660,000 
defined contribution plans as of 1997 compared with about 59,000 
defined benefit plans. As shown in figure 1, defined contribution 
plans covered about 55 million participants, while defined benefit 
plans covered over 40 million participants in 1997. 

Figure 1: Participants in Private Pension Plans, 1997: 

[Refer to PDF for image: stacked multiple line graph] 

The graph depicts total participants in millions for both defined 
contribution plans and defined benefit plans for the time period of 
1975 through 1997. 

[End of figure] 

The number of employer-sponsored 401(k) plans has also increased 
substantially in recent years, increasing from over 17,000 in 1984 to 
over 265,000 plans in 1997. In 1997, 401(k) plans accounted for 40 
percent of all employer-sponsored defined contribution plans and 
approximately 37 percent of all private pension plans. Approximately 
33.8 million employees actively participated in a 401(k) plan, and 
these plans held about $1.3 trillion in assets as of 1997.[Footnote 2] 

The continued growth in the number of defined contribution plans and 
plan assets is encouraging, but concerns remain that many workers who 
traditionally lack pensions may not be benefiting from these plans, 
and the overall percentage of workers covered by pensions has remained 
relatively stable for many years. Furthermore, the trend toward 
defined contribution plans and the increased availability of lump-sum 
payments from pension plans when workers change jobs raises issues of 
whether workers will preserve their pension benefits until retirement 
or outlive their retirement assets. 

Similar to other large companies, Enron sponsored both a defined 
benefit plan and a defined contribution plan, covering over 20,000 
employees. Enron's tax-qualified pension plans consisted of a 401(k)-
defined contribution plan, an employee stock ownership plan, and a 
defined benefit cash balance plan. Under Enron's 401(k) plan, 
participants were allowed to contribute from 1 to 15 percent of their 
eligible base pay in any combination of pre-tax salary deferrals or 
after-tax contributions subject to certain limitations.[Footnote 3] 
Enron generally matched 50 percent of all participants' pre-tax 
contributions up to a maximum of 6 percent of an employee's base pay, 
with the matching contributions invested solely in the Enron 
Corporation Stock Fund. Participants were allowed to reallocate their 
company matching contributions among other investment options when 
they reached the age of 50.[Footnote 4] 

Enron's employee stock ownership plan,[Footnote 5] like other ESOPs, 
was designed to encourage employee ownership in their company. The 
plan provided employee retirement benefits for workers' service with 
the company between January 1, 1987, and December 31, 1994. No new 
participants were allowed into the ESOP after January 1, 1995. 

Finally, Enron sponsored a cash balance plan, which accrued retirement 
benefits to employees during their employment at Enron. An employee 
was eligible to be a member of the cash balance plan immediately upon 
being employed. According to DOL officials, the cash balance plan did 
not have any investments in Enron stock as of the end of 2000. If the 
plan is unable to pay promised benefits and is taken over by PBGC, 
vested participants and retirees will receive their promised benefits 
up to the limit guaranteed under ERISA. 

Greater Diversification and Investment Sophistication May Be Needed: 

The Enron collapse points to the importance of prudent investment 
principles such as diversification, including diversification of 
employer matching contributions. Diversification helps individuals to 
mitigate the risk of holding stocks by spreading their holdings over 
many investments and reducing excessive exposure to any one source of 
risk. Many workers are covered by participant-directed 401(k) plans 
that allow participants to allocate the investment of their account 
balances among a menu of investment options, including employer stock. 
Additionally, many plan sponsors match participants' elective 
contributions with shares of employer stock. 

When the employer's stock constitutes the majority of employees' 
account balances and is the only type of matching contribution the 
employer provides, employees are exposed to the possibility of losing 
more than their job if the company goes out of business or into 
serious financial decline. They are also exposed to the possibility of 
losing a major portion of their retirement savings. For example, DOL 
reports that 63 percent of Enron's 401(k) assets were invested in 
company stock as of the end of 2000. These concentrations are the 
result both of employee investment choice and employer matching with 
company stock. The types of losses experienced by Enron employees 
could have been limited if employees had diversified their account 
balances and if they had been able to diversify their company matching 
contributions more quickly. 

Companies prefer to match employees' contributions with company stock 
for a number of reasons. First, when a company makes its matching 
contribution in the form of company stock, issuing the stock has 
little impact on the company's financial statement in the short term. 
Second, stock contributions are fully deductible as a business expense 
for tax purposes at the share price in effect when the company 
contributes them. Third, matching contributions in company stock puts 
more company shares in the hands of employees who some officials feel 
are less likely to sell their shares if the company's profits are less 
than expected or in the event of a takeover. Finally, companies point 
out that matching with company stock promotes a sense of employee 
ownership, linking the interests of employees with the company and 
other shareholders. 

Some pension experts have said that easing employer restrictions on 
when employees are allowed to sell their company matching 
contributions would increase their ability to diversify. In 1997, a 
majority of the Pension and Welfare Benefits Administration Advisory 
Council working group on employer assets in ERISA plans recommended 
that participants in 401(k) plans be able to sell employer stock when 
they become vested in the plan.[Footnote 6] Additionally, legislation 
has recently been introduced that would limit the amount of employer 
stock that can be held in participants' 401(k) accounts and provide 
participants greater freedom to diversify their employer matching 
contributions. Proponents of allowing employees to diversify employer 
stock matching contributions more quickly say that this would benefit 
both employers and employees by maintaining the tax and financial 
benefits for the company while providing employees with more 
investment freedom and increased retirement benefit security. However, 
others have expressed concern that further restrictions on employer 
plan designs may reduce incentives for employers to sponsor plans or 
provide matching contributions. 

Even with opportunities to diversify, studies indicate that employees 
will need education to improve their ability to manage their 
retirement savings. Numerous studies have looked at how well 
individuals who are currently investing understand investments and the 
markets.[Footnote 7] On the basis of those studies, it is clear that 
among those who save through their company's retirement programs or on 
their own, large percentages of the investing population are 
unsophisticated and do not fully understand the risks associated with 
their investment choices. For example, one study found that 47 percent 
of 401(k) plan participants believe that stocks are components of a 
money market fund, and 55 percent of those surveyed thought that they 
could not lose money in government bond funds. Another study on the 
financial literacy of mutual fund investors found that less than half 
of all investors correctly understood the purpose of diversification. 
These studies and others indicate the need for enhanced investment 
education about such topics as investing, the relationship between 
risk and return, and the potential benefits of diversification. 

In addition to investor education, employees may need more
individualized investment advice. Such investment advice becomes even 
more important as participation in 401(k) plans continues to increase. 
ERISA does not require plan sponsors to make investment advice 
available to plan participants. Under ERISA, providing investment 
advice results in fiduciary responsibility for those providing the 
advice, while providing investment education does not. ERISA does, 
however, establish conditions employers must meet[Footnote 8] in order 
to be shielded from fiduciary liability related to investment choices 
made by employees in their participant-directed accounts. In 1996, DOL 
issued guidance to employers and investment advisers on how to provide 
educational investment information and analysis to participants 
without triggering fiduciary liability. DOL recently issued guidance 
about investment advice making it easier for plans to use independent 
investment advisors to provide advice to employees in retirement plans. 

Industry representatives that we spoke with said more companies are 
providing informational sessions with investment advisors to help 
employees better understand their investments and the risk of not 
diversifying. They also said that changes are needed under ERISA to 
better shield employers from fiduciary liability for investment 
advisors' recommendations to individual participants. ERISA currently 
prohibits fiduciary investment advisors from engaging in transactions 
with clients' plans where they have a conflict of interest, for 
example, when the advisors are providing other services such as plan 
administration. As a result, investment advisors cannot provide 
specific investment advice to 401(k) plan participants about their 
firm's investment products without approval from DOL. Various 
legislative proposals have been introduced that would address 
employers' concern about fiduciary liability when they make investment 
advice available to plan participants and make it easier for fiduciary 
investment advisors to provide investment advice to participants when 
they also provide other services to the participants' plan. However, 
concerns remain that such proposals may not adequately protect plan 
participants from conflicted advice. 

Enhanced Disclosure Could Help Employees Understand Investment Risks 
They Face: 

Enron's failure highlights the importance of plan participants 
receiving clear information about their pension plan and any changes 
to it that could affect plan benefits. Current ERISA disclosure 
requirements provide only minimum guidelines that firms must follow on 
the type of information they provide plan participants. Improving the 
amount of disclosure provided to plan participants and also ensuring 
that such disclosure is in plain English could help participants 
better manage the risks they face. 

Enron's pension plans illustrate the complex nature of some plan 
designs that may be difficult for participants to understand. For 
example, Enron's pension plans included a floor-offset arrangement. 
Such arrangements consist of separate, but associated defined benefit 
and defined contribution plans. The benefits accrued under one plan 
offset the benefit payable from the other. In 1987, Congress limited 
the use of such plans. However, plans in existence when the provision 
was enacted, including Enron's plan, were grandfathered. In addition, 
Enron's conversion of its defined benefit plan from one type of 
benefit formula to another illustrates the types of changes and their 
consequent affect on benefits that plan participants need to 
understand. Enron's defined benefit plan was converted from a final 
average pay formula—-where the pension benefit is a percentage of the 
participant's final years of pay multiplied by his or her length of 
service—-to a cash balance formula, which expresses the defined 
benefit as a hypothetical account balance. As we have previously 
reported, conversions to cash balance plans can be advantageous to 
certain groups of workers—for example, those who switch jobs 
frequently—but can lower the pension benefits of others.[Footnote 9] 

The extent to which Enron employees were informed or understood the 
effect of the floor-offset or the conversion of their defined benefit 
plan to a cash balance formula is unclear. As stated in a prior GAO 
report on cash balance plans,[Footnote 10] we found wide variation in 
the type and amounts of information workers receive about plan changes 
and that can potentially reduce pensions benefits. Based in part on 
our recommendations, the Congress, under the Economics Growth and Tax 
Relief Reconciliation Act of 2001, required that employers provide 
participants more timely and clear information concerning changes to 
plans that could reduce their future benefits. The Treasury Department 
is responsible for issuing the applicable regulations implementing 
this requirement.[Footnote 11] 

Other types of information may also be beneficial to plan 
participants. Currently, ERISA requires that plan administrators 
provide each plan participant with a summary of certain financial data 
reported to DOL. As we previously reported,[Footnote 12] the Secretary 
of Labor could require that plan administrators provide plan 
participants with information about the employers' financial condition 
and other information. Such information could enable employees to be 
more fully informed about their holdings and any potential risks 
associated with them. 

ERISA Requires Fiduciaries to be Prudent and Reasonable: 

Under ERISA, fiduciaries are held to high but broad standards. Persons 
who perform certain tasks, generally involving the use of a plan's 
assets, become fiduciaries because of those duties. Others, such as 
the plan sponsor, the plan administrator, or a trustee are fiduciaries 
because of their position. Fiduciaries are required to act solely in 
the interest of plan participants and beneficiaries. They are to 
adhere to a standard referred to as the prudent expert rule, which 
requires them to act as a prudent person experienced in such matters 
would in similar circumstances. Fiduciaries are required to follow 
their plan's documents and act in accordance with the terms of the 
plan as it is set out. If fiduciaries do not perform their duties in 
accordance with ERISA standards, they may be held personally liable 
for any breach of their duty. 

Yet, even with the high standards and broad guidance provided by 
ERISA, in some cases the actions of fiduciaries can seem to conflict 
with the best interests of plan participants. During the period when 
revelations about Enron's finances were contributing to the steady 
devaluation of Enron's stock price, Enron's plan fiduciaries imposed a 
lockdown on the 401(k) plan, preventing employees from making 
withdrawals or investment transfers.[Footnote 13] Enron imposed the 
lockdown to change recordkeepers, an acceptable practice. Some 
observers, however, have questioned whether Enron employees were 
sufficiently notified about the lockdown. Observers have also 
questioned the equity of treatment between Enron senior executives and 
Enron workers during the lockdown. Enron's employees were unable to 
make changes to their 401(k) accounts during the plan's lockdown 
period. However, Enron executives did not face similar restrictions on 
company stock not held in the plan. Fairness would suggest that 
company executives should face similar restrictions in their ability 
to sell company stock during lockdown periods when workers are unable 
to make 401(k) investment changes. This is especially true for those 
executives who serve as pension plan fiduciaries, including plan 
trustees. 

Conclusion: 

The Enron collapse, although not by itself evidence that private 
pension law should be changed, serves to illustrate what can happen to 
employees' retirement savings under certain conditions. Specifically, 
it illustrates the importance of diversification for retirement 
savings as well as employees' need for enhanced education, appropriate 
investment advice, and greater disclosure. All of these may help them 
better navigate the risks they face in saving for retirement. 

In addition to the broad issues of diversification and education, 
Enron's collapse raises questions about the relationship between 
various plan designs and participant benefit security. In particular, 
Congress may wish to consider whether further restrictions on floor-
offset arrangements are warranted, whether to provide additional 
employee flexibility in connection with matches in the form of 
employer stocks, and whether to limit the amount of employer stock 
that can be held in certain retirement saving plans. Resolving these 
issues will require considering the tradeoffs between providing 
greater participant protections and employers' need for flexibility in 
plan design. Finally, Congress will have to weigh whether to rely on 
the broad fiduciary standards established in ERISA that currently 
govern fiduciary actions or to impose specific requirements that would 
govern certain plan administrative operations such as plan investment 
freezes or lockdowns. 

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

Contacts and Acknowledgments: 

For further information regarding this testimony, please contact Barbara
D. Bovbjerg, Director, or George A. Scott, Assistant Director, 
Education, Workforce, and Income Security (202) 512-7215. Individuals 
making key contributions to this testimony include Joseph Applebaum, 
Jeremy Citro, Tamara Cross, Patrick DiBattista, Raun Lazier, and Roger 
Thomas. 

[End of section] 

Footnotes: 

[1] When an ESOP is combined with a 401(k) plan, it is called a KSOP. 

[2] "Private Pension Plan Bulletin: Abstract of 1997, Form 5500 Annual 
Reports." US Department of Labor, Pension and Welfare Benefits 
Administration. Winter 2001. 

[3] Participants were immediately fully vested in their voluntary 
contributions and employees hired after July 1999 are fully vested in 
their company contributions after 1 year of service. 

[4] For defined benefit plans, ERISA limits the amount of employer 
stock and real property that can be held to 10 percent of plan assets. 
However, defined contribution plans, including 401(k) plans, ESOPs, 
and other defined contribution plans with individual accounts, are 
generally exempt from this requirement. While the vast majority of 
401(k) plans are thus not subject to any restriction on the amount of 
employer stock that it may hold, there are limited circumstances under 
which the 10 percent limitation could apply to a 401(k) plan. 

[5] The ESOP provided for three subaccounts, (1) a savings subaccount 
where the plan allocated shares of Enron stock equal to 10 percent of 
each participant's base pay; (2) a retirement subaccount where the 
plan allocated shares of Enron stock based on each participant's age, 
years of service, and base pay; and (3) a special subaccount for 
participants active on December 31, 1994, where the participants 
received an allocation to this account and the defined benefit portion 
of their retirement plan. This allocation in total equaled 5 percent 
of their base pay and was in lieu of an accrual to their 1995 defined 
benefit plan. According to Enron plan documents, the vested portion of 
a participant's retirement subaccount was used to offset the benefit 
they earned from Enron's cash balance plan from January 1, 1987 
through December 31, 1994. The offset was calculated using the value 
of the shares of Enron stock based on the earlier of when the shares 
were distributed or when the shares were available to be withdrawn 
from the ESOP. Once a plan participant has access to the shares of his 
or her retirement subaccount, the shares' value is used to offset the 
benefit they have earned from the Enron defined benefit plan for their 
service between January 1, 1987, and December 31, 1994. 

[6] Pension and Welfare Benefits Administration Advisory Council on 
Employee Welfare and Pension Benefits Plans, Report of the Working 
Group on Employer Assets in ERISA Employer-Sponsored Plans, November 
13, 1997. 

[7] U.S. General Accounting Office, Social Security: Capital Markets 
and Educational Issues Associated With Individual Accounts, 
[hyperlink, http://www.gao.gov/products/GAO/GGD-99-115] (Washington, 
D.C., June 1999). 

[8] These include a minimum number of investment options and related 
material that must be provided to participants. 

[9] U.S. General Accounting Office, Private Pension Plans: 
Implications of Conversions to Cash Balance Plans, [hyperlink, 
http://www.gao.gov/products/GAO/HEHS-00-185], (Washington, D.C., 
September 2000). 

[10] See footnote 9. 

[11] Public Law 107-16. 

[12] U.S. General Accounting Office, 401(k) Pension Plans: Extent of 
Plans' Investments in Employer Securities and Real Property, 
[hyperlink, http://www.gao.gov/products/GAO/HEHS-98-28] (Washington, 
D.C., November 1997). 

[13] The Department of Labor is investigating Enron to determine 
whether there were any ERISA violations in the operation of the 
company's employee benefit plans. DOL also recently reached an 
agreement with Enron to appoint an independent fiduciary to assume 
control of the company's retirement plans. 

[End of section]