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Before the Committee on Education and the Workforce, House of 

United States General Accounting Office:


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

Wednesday, October 29, 2003:

Private Pensions:

Changing Funding Rules and Enhancing Incentives Can Improve Plan 

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


GAO Highlights:

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

Why GAO Did This Study:

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

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

What GAO Found:

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

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

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

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

[End of section]

Mr. Chairman and Members of the Committee:

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

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

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


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

Under ERISA, the termination of a single-employer defined-benefit plan 
results in an insurance claim with the single-employer program if the 
plan has insufficient assets to pay all benefits accrued under the plan 
up to the date of plan termination.[Footnote 7] PBGC finances the 
unfunded liabilities of terminated plans partially through premiums 
paid by plan sponsors. Currently, plan sponsors pay a flat-rate premium 
of $19 per participant per year; in addition, some pay a variable-rate 
premium, which was added in 1987 to provide an incentive for sponsors 
to better fund their plans. The variable-rate premium, which started at 
$6 for each $1,000 of unfunded vested benefits, was initially capped at 
$34 per participant. The variable rate was increased to $9 for each 
$1,000 of unfunded vested benefits starting in 1991, and the cap on 
variable-rate premiums was removed starting in 1996.

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

The single-employer program has had an accumulated deficit--that is, 
program assets have been less than the present value of benefits and 
other liabilities--for much of its existence. (See fig. 1.) In fiscal 
year 1996, the program had its first accumulated surplus, and by fiscal 
year 2000, the accumulated surplus had increased to about $10 billion, 
in 2002 dollars. However, the program's finances reversed direction in 
2001, and at the end of fiscal year 2002, its accumulated deficit was 
about $3.6 billion. PBGC estimates that this deficit grew to $8.8 
billion by August 31, 2003, its largest deficit in the program's 
history both in real and nominal terms. From less than $50 billion as 
of December 31, 2000, the total underfunding in single-employer plans 
grew to more than $400 billion as of December 31, 2002, and still 
exceeds $350 billion according to recent estimates by PBGC. (See fig 
2.) Despite the program's large deficit, according to a PBGC analysis, 
the single-employer program was estimated to have enough assets to pay 
benefits through 2019, given the program's conditions and PBGC 
assumptions as of the end of fiscal year 2002.[Footnote 8] However, 
losses since that time may have shortened the period over which the 
program will be able to cover promised benefits. In July of this year, 
because of serious risks to the single-employer program's viability, we 
placed the PBGC on our high-risk list.[Footnote 9]

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

[See PDF for image]

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

[End of figure]

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

[See PDF for image]

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

[End of figure]

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

Several Factors Have Contributed to PBGC's Current Financial 

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

In many cases, sponsors did not make the contributions necessary to 
adequately fund the plans before they were terminated. For example, 
according to annual reports (Annual Return/Report of Employee Benefit 
Plan, Form 5500) submitted by Bethlehem Steel Corporation, in the 7 
years from 1992 to 1999, the Bethlehem Steel pension plan went from 86 
percent funded to 97 percent funded. (See fig. 3.) From 1999 to plan 
termination in December 2002, however, plan funding fell to 45 percent 
as assets decreased and liabilities increased, and sponsor 
contributions were not sufficient to offset the changes. According to a 
survey,[Footnote 14] the Bethlehem Steel defined-benefit plan had about 
73 percent of its assets (about $4.3 billion of $6.1 billion) invested 
in domestic and foreign stocks on September 30, 2000. One year later, 
assets had decreased $1.5 billion, or 25 percent, and when the plan was 
terminated in December 2002, its assets had been reduced another 23 
percent to about $3.5 billion--far less than needed to finance an 
estimated $7.2 billion in PBGC-guaranteed liabilities.[Footnote 15] 
Surveys of plan investments by Greenwich Associates indicated that 
defined-benefit plans in general had about 62.8 percent of their assets 
invested in U.S. and international stocks in 1999.[Footnote 16]

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

[See PDF for image]

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

[End of figure]

These recent events and their consequences for PBGC's finances have 
occurred in the context of the long-term stagnation of the defined-
benefit system. The number of PBGC-insured plans has decreased steadily 
from approximately 110,000 in 1987 to around 30,000 in 2002.[Footnote 
17] While the number of total participants in PBGC-insured single-
employer plans has grown approximately 25 percent since 1980, 
participation has declined as a percentage of the private sector labor 
force. Further, the percentage of participants who are active workers 
has declined from 78 percent in 1980 to 53 percent in 2000. 
Manufacturing, a sector with virtually no job growth in the last half-
century, accounted for almost half of PBGC's single-employer program 
participants in 2001, suggesting that the program needs to rely on 
other sectors for any growth in premium income. Unless something 
reverses these trends, PBGC may have a shrinking plan and participant 
base to support the program in the future as well as the likelihood of 
a participant base concentrated in certain, potentially more vulnerable 

Minimum Funding Rules Did Not Prevent Plans from Being Severely 

Internal Revenue Code (IRC) minimum funding rules, which are designed 
to ensure plan sponsors adequately fund their plans, did not have the 
desired effect for the terminated plans that were added to the single-
employer program in 2002. The amount of contributions required under 
IRC minimum funding rules is generally the amount needed to fund 
benefits earned during that year plus that year's portion of other 
liabilities that are amortized over a period of years.[Footnote 18] 
Also, the rules require the sponsor to make an additional contribution 
if the plan is underfunded to the extent defined in the law. Under the 
additional funding requirement rule, a single-employer plan sponsored 
by an employer with more than 100 employees in defined-benefit plans is 
subject to a deficit reduction contribution for a plan year if the 
value of plan assets is less than 90 percent of its current liability. 
However, a plan is not subject to the deficit reduction contribution if 
the value of plan assets (1) is at least 80 percent of current 
liability and (2) was at least 90 percent of current liability for each 
of the 2 immediately preceding years or each of the second and third 
immediately preceding years. To determine whether the additional 
funding rule applies to a plan, the IRC requires sponsors to calculate 
current liability using the highest interest rate allowable for the 
plan year.[Footnote 19]

In 1987, the minimum funding rules incorporated by ERISA in the IRC 
were amended to require that plan sponsors calculate each plan's 
current liability, using a discount rate based on the 30-year Treasury 
bond rate, and to use that calculation to assess the plan's funding 
level.[Footnote 20] If plans are funded below certain thresholds as 
defined in the IRC, employers are to determine minimum contribution 
amounts on the basis of those assessments. Employers must make 
additional contributions to the plan if it is underfunded to extent 
defined in the law.[Footnote 21] If a plan is fully funded as defined 
in the law, employers are precluded from making additional tax-
deductible contributions to the plan. In 2002, the Congress acted to 
provide temporary relief to DB plan sponsors by raising the top of the 
permissible range of the mandatory interest rate.[Footnote 22] As 
discussed in a report we issued earlier this year,[Footnote 23] 
concerns that the 30-year Treasury bond rate no longer resulted in 
reasonable current liability calculations has led both Congress and the 
administration to propose alternative rates for these 
calculations.[Footnote 24]

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

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

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

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

Strengthening Plan Funding Rules Can Help Sponsors Maintain Well-Funded 

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

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

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

* Limit the Use of Credit Balances by Severely Underfunded Plans to 
Avoid Additional Contributions. For sponsors who make contributions in 
any given year that exceed the minimum required contribution, the 
excess plus interest is credited against future required contributions. 
Limiting the use of credit balances to offset contribution requirements 
might also prevent sponsors of significantly underfunded plans from 
avoiding cash contributions. For example, in the absence of a credit 
balance, Bethlehem Steel would have been due to pay at least $270 
million to its pension plan for the plan year ending December 31, 2001; 
however, because it showed a credit balance of $711 million as of 
January 1, 2001, Bethlehem was not required to make any cash 
contributions for that year. Limitations might also be applied based on 
the plan sponsor's financial condition. For example, sponsors with poor 
cash flow or low credit ratings could be restricted from using their 
credit balances to reduce their contributions.

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

* Raise the Level of Tax-Deductible Contributions. IRC and ERISA 
restrict tax-deductible contributions to prevent plan sponsors from 
contributing more to their plan than is necessary to cover accrued 
future benefits.[Footnote 31] This can prevent employers from making 
plan contributions during periods of strong profitability. Raising 
these limitations might result in pension plans being better funded, 
decreasing the likelihood that they will be underfunded should they 
terminate.[Footnote 32]

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

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

In addition to funding rules, plan sponsors need an accurate funding 
"target" that provides enough funding to pay promised current and 
future benefits while not leading sponsors to "overfund" their pension 
plans, siphoning resources from other productive firm specific 
activities. The interest rate sponsors use to determine plan 
liabilities can affect this target and, therefore, plan funding. In 
1987, when the 30-year Treasury bond rate was adopted for use in 
certain pension calculations, the Congress intended that the interest 
rate used for current liability calculations would, within certain 
parameters, reflect the price an insurance company would charge to take 
responsibility for the plan's pension payments. However, selecting a 
replacement rate that will provide an accurate funding target may be 
difficult because little information exists on which to base the 
selection.[Footnote 34] In taking action to replace the 30-year 
Treasury bond rate, it is important to consider the impact that any 
change may have on funding. If Congress mandates the use of a rate that 
is "too high," plans are more likely to appear better funded, but 
minimum and maximum employer contributions would decrease, possibly 
increasing the likelihood of plan underfunding. In addition, some plans 
would reach full-funding limitations and avoid having to pay variable-
rate premiums, and PBGC would receive less revenue. Conversely, a rate 
that is "too low" would make plans appear worse funded, with more plans 
likely to increase contributions and possibly pay variable-rate 
premiums. Thus, it may well be prudent for Congress to make any 
provision replacing the 30-year Treasury bond rate temporary to 
facilitate more comprehensive funding reform to take shape.

Other Reforms Might Enhance Sponsor Incentives to Maintain Plan 

In addition to direct changes to the funding rules, other reforms may 
result in improved plan funding by improving incentives for sponsors to 
maintain proper funding in their plans. These measures may prevent 
plans from terminating with severely underfunded balances, thus better 
protecting workers, retirees, and PBGC. For example, improving the 
availability of information to plan participants and others about plan 
investments, termination funding status, and PBGC guarantees may give 
plan sponsors additional incentives to better fund their plans, making 
participants better able to plan for their retirement. The 
restructuring of PBGC's premium rates could also provide an incentive 
for plan sponsors to better fund their plans. It is also possible that 
basing changes to premium rates on the degree of risk posed by 
different plans may encourage financially healthy companies to remain 
in or enter the defined-benefit system while discouraging riskier plan 
sponsors. Moreover, it may be appropriate to consider modifying certain 
benefit guarantees that could decrease losses incurred by PBGC from 
underfunded plans. ERISA could be amended to:

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

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

* Increase or Restructure Variable-Rate Premium. PBGC charges plan 
sponsors a variable-rate premium based on the plan's level of 
underfunding, premiums, with sponsors paying $9 per $1,000 of unfunded 
liability. However, the recent terminations of Bethlehem Steel, Anchor 
Glass, and Polaroid, plans that paid no variable-rate premiums shortly 
before terminating with large underfunded balances, suggest that the 
current structure of the variable-rate premium does not provide a 
strong enough incentive to improve plan funding or is too easily 
avoidable. The rate could be adjusted so that plans with less adequate 
funding pay a higher rate. In addition, premium rates could be 
restructured based on the degree of risk posed by different plans, 
which could be assessed by considering the financial strength and 
prospects of the plan's sponsor, the risk of the plan's investment 
portfolio, participant demographics, and the plan's benefit structure-
-including plans that have lump-sum,[Footnote 38] shutdown benefit, and 
floor-offset provisions.[Footnote 39] One advantage of a rate increase 
or restructuring is that it might improve accountability by providing 
for a more direct relationship between the amount of premium paid and 
the risk of underfunding. A disadvantage is that it could further 
burden already struggling plan sponsors at a time when they can least 
afford it, or it could reduce plan assets, increasing the likelihood 
that underfunded plans will terminate. A program with premiums that are 
more risk-based could also be more challenging for PBGC to administer.

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


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

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

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

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

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

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


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

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

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

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

[5] Some 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.

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

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

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

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

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

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

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

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

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

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

[16] 2002 U.S. Investment Management Study, Greenwich Associates, 
Greenwich, Conn.

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

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

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

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

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

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

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

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

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

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

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

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

[29] GAO-03-313.

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

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

[32] For example, one way to do this would be to allow deductions 
within a corridor of up to 130 percent of current liabilities. 
Gebhardtsbauer, Ron. American Academy of Actuaries testimony before the 
Subcommittee on Employer-Employee Relations, House Committee on 
Education and the Workforce, Hearing on Strengthening Pension Security: 
Examining the Health and Future of Defined-benefit Pension Plans. 
(Washington, D.C.: June 4, 2003), 9.

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

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

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

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

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

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

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

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

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