oversight

Pension Benefit Guaranty Corporation: Single-Employer Pension Insurance Program Faces Significant Long-Term Risks

Published by the Government Accountability Office on 2003-09-04.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                              United States General Accounting Office

GAO                           Testimony
                              Before the Committee on Education and
                              the Workforce, House of Representatives


For Release on Delivery
Expected at 10:30 a.m.
Thursday, September 4, 2003   PENSION BENEFIT
                              GUARANTY
                              CORPORATION
                              Single-Employer Pension
                              Insurance Program Faces
                              Significant Long-Term Risks
                              Statement of David M. Walker
                              Comptroller General of the United States




GAO-03-873T
                                                September 4, 2003


                                                PENSION BENEFIT GUARANTY
                                                CORPORATION
Highlights of GAO-03-873T, a testimony
before the Committee on Education and
                                                Single-Employer Pension Insurance
the Workforce, U.S. House of
Representative
                                                Program Faces Significant Long-Term
                                                Risks


More than 34 million participants in            The single-employer pension insurance program returned to an accumulated
30,000 single-employer defined                  deficit in 2002 largely due to the termination, or expected termination, of
benefit pension plans rely on a                 several severely underfunded pension plans. Factors that contributed to the
federal insurance program                       severity of plans' underfunded condition included a sharp stock market
managed by the Pension Benefit                  decline, which reduced plan assets, and an interest rate decline, which
Guaranty Corporation (PBGC) to
protect their pension benefits, and
                                                increased plan termination costs. For example, PBGC estimates losses to
the program's long-term financial               the program from terminating the Bethlehem Steel pension plan, which was
viability is in doubt. Over the last            nearly fully funded in 1999 based on reports to IRS, at $3.7 billion when it
decade, the program swung from a                was terminated in 2002. The plan's assets had decreased by over $2.5 billion,
$3.6 billion accumulated deficit                while its liabilities had increased by about $1.4 billion since 1999.
(liabilities exceeded assets), to a
$10.1 billion accumulated surplus,              The single-employer program faces two primary risks to its long-term
and back to a $3.6 billion                      financial viability. First, the large losses in 2002 could continue or
accumulated deficit, in 2002                    accelerate if, for example, structural problems in particular industries result
dollars. Furthermore, despite a                 in additional bankruptcies. Second, revenue from premiums and investments
record $9 billion in estimated
                                                might be inadequate to offset program losses. Participant-based premium
losses to the program in 2002,
additional severe losses may be on              revenue might fall, for example, if the number of program participants
the horizon. PBGC estimates that                decreases. Because of these risks, we have recently placed the single-
financially weak companies                      employer insurance program on our high-risk list of agencies with
sponsor plans with $35 billion in               significant vulnerabilities to the federal government.
unfunded benefits, which
ultimately might become losses to               While there is not an immediate crisis, there is a serious problem that relates
the program.                                    to the need to protect the retirement security of millions of American
                                                workers and retirees and should be addressed. Agency officials and others
This testimony provides GAO's                   have suggested taking a more proactive approach and have identified a
observations on the factors that
                                                variety of options to address the challenges facing the single-employer
contributed to recent changes in
the single-employer pension                     program that should be considered. The first, would be to improve the
insurance program's financial                   transparency of information about plan funding, plan investments, and
condition, risks to the program's               PBGC guarantees; a second would be to strengthen funding rules to ensure
long-term financial viability, and              that poorly funded plans are better funded in the future; and a third would be
options to address the challenges               to reform PBGC by restructuring certain unfunded benefit guarantees, such
facing the single-employer                      as so-called “shutdown benefits,” and program premiums.
program.                                        __________________________________________________________________
                                                Program Assets, Liabilities, and Net Position, Fiscal Years 1976-2002
                                                2002 dollars (in billions)
                                                 30
                                                 25
                                                 20
                                                 15
                                                 10
                                                  5
                                                  0
                                                 -5
www.gao.gov/cgi-bin/getrpt?GAO-03-873T.         -10
                                                    1976 1978 1980              1982    1984   1986     1988       1990   1992   1994     1996   1998   2000   2002
To view the full product, including the scope
and methodology, click on the link above.                                      Assets                 Liabilites                 Net position
For more information, contact Barbara
                                                Source: PBGC annual reports.
Bovbjerg at (202) 512-7215 or
bovbjergb@gao.gov.
Mr. Chairman and Members of the Committee:

I am pleased to be here today to discuss the serious financial challenges
facing the Pension Benefit Guaranty Corporation’s single-employer
insurance program. This federal program insures the benefits of the more
than 34 million workers and retirees participating in private defined-
benefit pension plans.1 Over the last few years, the finances of PBGC’s
single-employer insurance program,2 have taken a severe turn for the
worse. From a $3.6 billion accumulated deficit in 1993, the program
registered a $10.1 billion accumulated surplus (assets exceeded liabilities)
in 2000 before returning to a $3.6 billion accumulated deficit, in 2002
dollars.3 More fundamentally, the long-term viability of the program is at
risk. Even after assuming responsibility for several severely underfunded
pension plans and recording over $9 billion in estimated losses in 2002,
PBGC estimates that as of September 30, 2002, it faces exposure to
approximately $35 billion in additional unfunded liabilities from ongoing
plans that are sponsored by financially weak companies and may
terminate.4




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.
2
 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 related firms.
3
 PBGC estimates that its deficit had grown to about $5.4 billion at the end of March 2003
based on the midyear financial report.
4
 According to PBGC, for example, companies whose credit quality is below investment
grade sponsor a number of plans. PBGC classifies 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, 3003).




Page 1                                                                        GAO-03-873T
This involves an issue beyond PBGC’s current and future financial
condition it also relates to the need to protect the retirement security of
millions of American workers and retirees. I hope my testimony will help
clarify some of the key issues in the debate about how to respond to the
financial challenges facing the federal insurance program for single-
employer defined-benefit plans. As you requested, I will discuss (1) the
factors that contributed to recent changes in the single-employer pension
insurance program’s financial condition, (2) risks to the program’s long-
term financial viability, and (3) options to address the challenges facing
the single-employer program.

To identify the factors that contributed to recent changes in the single-
employer program’s financial condition, we discussed with PBGC officials,
and examined annual reports and other available information related to,
the funding and termination of three pension plans: the Anchor Glass
Container Corporation Service Retirement Plan, the Pension Plan of
Bethlehem Steel Corporation and Subsidiary Companies, and the Polaroid
Pension Plan. We selected these plans because they represented the
largest losses to PBGC in their respective industries in fiscal year 2002.
PBGC estimates that, collectively, the plans represented $4.2 billion in
losses to the program at plan termination. In particular, I will focus on the
experience of the Bethlehem Steel plan because it provides such a vivid
illustration of the immediate and long-term challenges to the program and
the need for additional reforms. To identify the primary risks to the long-
term viability of the program and options to address the challenges facing
the single-employer program, we interviewed pension experts at PBGC, at
the Employee Benefits Security Administration of the Department of
Labor, and in the private sector and reviewed analyses and other
documents provided by them.

Let me first summarize my responses to your questions. The termination,
or expected termination, of several severely underfunded pension plans
was the major reason for PBGC’s single-employer pension insurance
program’s return to an accumulated deficit in 2002. Several underlying
factors contributed to the severity of plans’ underfunded condition at
termination, including a sharp decline in the stock market, which reduced
plan asset values, and a general decline in interest rates, which increased
the cost of terminating defined-benefit pension plans. Falling stock prices
and interest rates can dramatically reduce plan funding as the sponsor
approaches bankruptcy. For example, while annual reports indicated the
Bethlehem Steel Corporation pension plan was almost fully funded in 1999
based on reports to IRS, PBGC estimates that the value of the plan’s assets
was less than 50 percent of the value of its guaranteed liabilities by the


Page 2                                                           GAO-03-873T
time it was terminated in 2002. The current minimum funding rules and
other rules designed to encourage sponsors to fully fund their plans were
not effective at preventing it from being severely underfunded at
termination.

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

While there is not an immediate crisis, there is a serious problem that
needs to be addressed. Some pension professionals have suggested a
“wait and see” approach, betting that brighter economic conditions might
ameliorate PBGC’s financial challenges. However, the recent trends in the
single-employer program’s financial condition illustrate the fragility of
PBGC’s insured plans and suggest that an improvement in plan finances
due to economic recovery may not address certain fundamental
weaknesses and risks facing the single-employer insurance program.
Agency officials and other pension professionals have suggested taking a
more proactive approach and have identified a variety of options to
address the challenges facing PBGC’s single-employer program. In our
view, several types of reforms should be considered. The first would be to
improve the availability of information available to plan participants and
others about plan funding, plan investments, and PBGC guarantees. A
second would be to strengthen funding rules applicable to poorly funded
plans to help ensure plans are better funded should they be terminated in
the future. A third would be to reform PBGC by restructuring its benefit
guarantees and premiums. Guarantees for certain unfunded benefits, such
as so-called “shutdown benefits,” could be modified. With respect to
variable-rate premiums, in addition to the plan’s funding status,
consideration should be given to the economic strength of the plan’s


Page 3                                                          GAO-03-873T
             sponsor, the allocation of the plan’s investment portfolio, the plan’s
             benefit structure, and participant demographics. These options are not
             mutually exclusive, either in combination or individually and several
             variations exist within each. Each option also has advantages and
             disadvantages. In any event, any changes adopted to address the
             challenge facing PBGC should improve the transparency of the plan’s
             financial information, provide plan sponsors with incentives to increase
             plan funding, and provide a means to hold sponsors accountable for
             adequately funding their plans.


             Before enactment of the Employee Retirement and Income Security Act
Background   (ERISA) of 1974, few rules governed the funding of defined-benefit
             pension plans, and there were no guarantees that participants of defined-
             benefit plans would receive the benefits they were promised. When
             Studebaker’s pension plan failed in the 1960s, for example, many plan
             participants lost their pensions.5 Such experiences prompted 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.6 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.7

             Under ERISA, the termination of a single-employer defined-benefit plan
             results in an insurance claim with the single-employer program if the plan
             does not have sufficient assets to pay all benefits accrued under the plan




             5
               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.
             6
              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.
             7
                 See section 4002(a) of P.L. 93-406, Sep. 2, 1974.




             Page 4                                                                     GAO-03-873T
up to the date of plan termination.8 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 65.9
Additionally, benefit increases in the 5 years immediately preceding plan
termination are not fully guaranteed, though PBGC will pay a portion of
these increases.10 The guarantee is limited to certain benefits, including so-
called “shut-down benefits,” -- significant subsidized early retirement
benefits that are triggered by layoffs or plant closings that occur before
plan termination. The guarantee does not generally include supplemental
benefits, such as the temporary benefits that some plans pay to
participants from the time they retire until they are eligible for Social
Security benefits.

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

Concerns about PBGC finances also resulted in efforts to strengthen the
minimum funding rules incorporated by ERISA in the Internal Revenue
Code (IRC). In 1987, for example, the IRC was amended to require that




8
 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. The
termination of 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).
9
    The amount guaranteed by PBGC is reduced for participants under age 65.
10
 The guaranteed amount of the benefit increase is calculated by multiplying the number of
years the benefit increase has been in effect, not to exceed 5 years, by the greater of (1) 20
percent of the monthly benefit calculated in accordance with PBGC regulations or (2) $20
per month. See 29 C.F.R. 4022.25(b).




Page 5                                                                         GAO-03-873T
plan sponsors calculate each plan’s current liability,11 and make additional
contributions to the plan if it is underfunded to the extent defined in the
law.12 As discussed in a report13 we issued earlier this year, concerns that
the 30-year Treasury bond rate no longer resulted in reasonable current
liability calculations has led both the Congress and the administration to
propose alternative rates for these calculations.14

Despite the 1987 amendments to ERISA, concerns about PBGC’s financial
condition persisted. In 1990, as part of our effort to call attention to high-
risk areas in the federal government, we noted that weaknesses in the
single-employer insurance program’s financial condition threatened



11
  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 top of the permissible
range was increased to 20 percent above the weighted average rate for 2002 and 2003. The
weighted average rate is calculated as the average yield over 48 months with rates for the
most recent 12 months weighted by 4, the second most recent 12 months weighted by 3, the
third most recent 12 months weighted by 2, and the fourth weighted by 1.
12
  Under the additional funding 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).
13
 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).
14
  The Pension Preservation and Savings Expansion Act of 2003, H.R. 1776, introduced
April 11, 2003, would make a number of changes to the IRC to address retirement savings
and private pension issues, including replacing the interest rate used for current liability
calculations (currently, the rate on 30-year Treasury bonds) with a rate based on an index
or indices of conservatively invested, long-term corporate bonds. In July of 2003, the
Department of the Treasury unveiled The Administration Proposal to Improve the
Accuracy and Transparency of Pension Information. Its stated purpose is to improve the
accuracy of the pension liability discount rate, increase the transparency of pension plan
information, and strengthen safeguards against pension underfunding.




Page 6                                                                           GAO-03-873T
PBGC’s long-term viability. 15 We stated that minimum funding rules still
did not ensure that plan sponsors would contribute enough for terminating
plans to have sufficient assets to cover all promised benefits. In 1992, we
also reported that PBGC had weaknesses in its internal controls and
financial systems that placed the entire agency, and not just the single-
employer program, at risk. 16 Three years later, we reported that
legislation enacted in 1994 had strengthened PBGC’s program weaknesses
and that we believed improvements had been significant enough for us to
remove the agency’s high-risk designation. 17 Since that time, we have
continued to monitor PBGC’s financial condition and internal controls.
For example, in 1998, we reported that adverse economic conditions could
threaten PBGC’s financial condition despite recent improvements;18 in
2000, we reported that contracting weaknesses at PBGC, if uncorrected,
could result in PBGC paying too much for required services;19 and this
year, we reported that weaknesses in the PBGC budgeting process limited
its control over administrative expenses.20

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




15
 Letter to the Chairman, Senate Committee on Governmental Affairs and House Committee
on Government Operations, GAO/OCG-90-1, Jan. 23, 1990. GAO’s high risk program has
increasingly focused on those major programs and operations that need urgent attention
and transformation to ensure that our national government functions in the most
economical, efficient, and effective manner. Agencies or programs receiving a “high risk”
designation receive greater attention from GAO and are assessed in regular reports, which
generally coincide with the start of each new Congress.
16
 U.S. General Accounting Office, High Risk Series: Pension Benefit Guaranty
Corporation, GAO/HR-93-5 (Washington, D.C.: Dec. 1992).
17
 U.S. General Accounting Office, High-Risk Series: An Overview, GAO/HR-95-1
(Washington, D.C.: Feb. 1995).
18
 U.S. General Accounting Office, Pension Benefit Guaranty Corporation: Financial
Condition Improving but Long-Term Risks Remain, GAO/HEHS-99-5 (Washington, D.C.:
Oct. 16, 1998).
19
 U.S. General Accounting Office, Pension Benefit Guaranty Corporation: Contracting
Management Needs Improvement, GAO/HEHS-00-130 (Washington, D.C.: Sep. 18, 2000).
20
 U.S. General Accounting Office, Pension Benefit Guaranty Corporation: Statutory
Limitation on Administrative Expenses Does Not Provide Meaningful Control,
GAO-03-301 (Washington, D.C.: Feb. 28, 2003).




Page 7                                                                     GAO-03-873T
during bankruptcy proceedings.21 PBGC finances the unfunded liabilities of
terminated plans with (1) premiums paid by plan sponsors and (2) income
earned from the investment of program assets.

Initially, plan sponsors paid only a flat-rate premium of $1 per participant
per year; however, the flat rate has been increased over the years and is
currently $19 per participant per year. To provide an incentive for
sponsors to better fund their plans, a variable-rate premium was added in
1987. The variable-rate premium, which started at $6 for each $1,000 of
unfunded vested benefits, was initially capped at $34 per participant. The
variable rate was increased to $9 for each $1,000 of unfunded vested
benefits starting in 1991, and the cap on variable-rate premiums was
removed starting in 1996. After increasing sharply in the 1980s, flat-rate
premium income declined from $753 million in 1993 to $654 million in
2002, in constant 2002 dollars.22 (See fig. 1.) Income from the variable-rate
premium fluctuated widely over that period.




21
 According 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).
22
 In 2002 dollars, flat-rate premium income rose from $605 million in 1993 to $654 million in
2002.




Page 8                                                                        GAO-03-873T
Figure 1: Flat- and Variable- Rate Premium Income for the Single-Employer Pension
Insurance Program, Fiscal Years 1975-2002

Income (2002 dollars in millions)
1,400


1,200


1,000


 800


 600


 400


 200


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

                 Variable-rate premiums

                 Flat-rate premiums

Source: PBGC.

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


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




Page 9                                                                           GAO-03-873T
Figure 2: Participants and Plans Covered by the Single-Employer Insurance Program, 1980-2002

Number of participants (millions)                                                                                                               Number of plans (thousands)
40                                                                                                                                                                        120

                                                                                                                                                                          110
35
                                                                                                                                                                          100

30                                                                                                                                                                        90

                                                                                                                                                                          80
25
                                                                                                                                                                          70

20                                                                                                                                                                        60

                                                                                                                                                                          50
15
                                                                                                                                                                          40

10                                                                                                                                                                        30

                                                                                                                                                                          20
 5
                                                                                                                                                                          10

 0                                                                                                                                                                         0
     1980   1981   1982   1983   1984   1985   1986   1987     1988    1989   1990   1991    1992   1993   1994   1995   1996   1997   1998   1999   2000   2001   2002
     Fiscal year

                                                                      Insured participants

                                                                      Plans
Source: PBGC.



                                                        The decline in variable-rate premiums in 2002 may be due to a number of
                                                        factors. For example, all else equal, an increase in the rate used to
                                                        determine the present value of benefits reduces the degree to which
                                                        reports indicate plans are underfunded, which reduces variable-rate
                                                        premium payments. The Job Creation and Worker Assistance Act of 2002
                                                        increased the statutory interest rate for variable-rate premium calculations
                                                        from 85 percent to 100 percent of the interest rate on 30-year U.S. Treasury
                                                        securities for plan years beginning after December 31, 2001, and before
                                                        January 1, 2004.23

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




                                                        23
                                                             See section 405, P.L. 107-147, Mar. 9, 2002.




                                                        Page 10                                                                                             GAO-03-873T
assets.24 For example, PBGC may invest funds recovered from terminated
plans and plan sponsors in equities, real estate, or other securities and
funds from variable-rate premiums in government or private fixed-income
securities. According to PBGC, however, by policy, it invests all premium
income in Treasury securities. As a result of the law and investment
policies, the majority of the single-employer program’s assets are invested
in Treasury securities. (See fig. 3.)




24
  PBGC accounts for single-employer program assets in separate trust and revolving funds.
PBGC accounts for the assets of terminated plans and plan sponsors in a trust fund, which,
according to PBGC, may be invested in equities, real estate, or other securities. PBGC
accounts for single-employer program premiums in two revolving funds. One revolving
fund is used for all variable-rate premiums, and that portion of the flat-rate premium
attributable to the flat-rate in excess of $8.50. The law states that PBGC may invest this
revolving fund in such obligations as it considers appropriate. See 29 U.S.C. 1305(f). The
second revolving fund is used for the remaining flat-rate premiums, and the law restricts
the investment of this revolving fund to obligations issued or guaranteed by the United
States. See 29 U.S.C. 1305(b)(3).




Page 11                                                                     GAO-03-873T
Figure 3: Market Value of Single-Employer Program Assets in Revolving and Trust Funds at Year End, Fiscal Years 1990-2002

Market value (2002 dollars in billions)
25




20




15




10




 5




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

                                                                   Other

                                                                   Equities

                                                                   Government securities

Source: PBGC annual reports.

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


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




                                                        Page 12                                                                          GAO-03-873T
Figure 4: Total Return on the Investment of Single-Employer Program Assets, Fiscal Years 1990-2002

Total return (percent)
30
                                      27.7

                      24.4                           24.1
25
                                                                       21.9

20

                                                                               14.4
15                                                                                               13.2
                               11.2
10                                                            8.5


  5                                                                                     3.6
                                                                                                                   2.1

  0


 -5       -3.9                                                                                            -3.3
                                             -6.4
-10
         1990        1991      1992   1993   1994    1995     1996    1997     1998     1999     2000    2001     2002
       Fiscal year
Source: PBGC annual reports.

                                                For the most part, liabilities of the single-employer pension insurance
                                                program are comprised of the present value of insured participant
                                                benefits. PBGC calculates present values using interest rate factors that,
                                                along with a specified mortality table, reflect annuity prices, net of
                                                administrative expenses, obtained from surveys of insurance companies
                                                conducted by the American Council of Life Insurers.25 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.26 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.

                                                The single-employer program has had an accumulated deficit—that is,
                                                program assets have been less than the present value of benefits and other
                                                liabilities—for much of its existence. (See fig. 5.) In fiscal year 1996, the


                                                25
                                                 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.
                                                26
                                                 Under Statement of Financial Accounting Standard Number 5, loss contingencies are
                                                classified as probable if the future event or events are likely to occur.




                                                Page 13                                                                     GAO-03-873T
                                                program had its first accumulated surplus, and by fiscal year 2000, the
                                                accumulated surplus had increased to almost $10 billion, in 2002 dollars.
                                                However, the program’s finances reversed direction in 2001, and at the end
                                                of fiscal year 2002, its accumulated deficit was about $3.6 billion.

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

2002 dollars in billions
30


25


20


15


10


  5


  0


 -5


-10
       1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

                                                          Assets

                                                          Liabilities

                                                          Net position
Source: PBGC annual reports.

                                                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.




                                                Page 14                                                                         GAO-03-873T
                             The financial condition of the single-employer pension insurance program
Termination of               returned to an accumulated deficit in 2002 largely due to the termination,
Severely Underfunded         or expected termination, of several severely underfunded pension plans. In
                             1992, we reported that many factors contributed to the degree plans were
Plans Was Primary            underfunded at termination, including the payment at termination of
Factor in Financial          additional benefits, such as subsidized early retirement benefits, which
                             have been promised to plan participants if plants or companies ceased
Decline of Single-           operations.27 These factors likely contributed to the degree that plans
Employer Program             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 rates. The current minimum
                             funding rules and variable-rate premiums were not effective at preventing
                             those plans from being severely underfunded at termination.


PBGC Assumed                 Total estimated losses in the single-employer program due to the actual or
Responsibility for Several   probable termination of underfunded plans increased from $1.5 billion in
Severely Underfunded         fiscal year 2001 to $9.3 billion in fiscal year 2002, in 2002 dollars. In
                             addition to $3.0 billion in losses from the unfunded liabilities of terminated
Plans in 2002                plans, the $9.3 billion included $6.3 billion in losses from the unfunded
                             liabilities of plans that were expected to terminate in the near future.
                             Some of the terminations considered probable at the end of fiscal year
                             2002 have already occurred; for example, in December 2002, PBGC
                             involuntarily terminated an underfunded Bethlehem Steel Corporation
                             pension plan, which resulted in the single-employer program assuming
                             responsibility for about $7.2 billion in PBGC-guaranteed liabilities, about
                             $3.7 billion of which was not funded at termination.

                             Much of the program’s losses resulted from the termination of
                             underfunded plans sponsored by failing steel companies. PBGC estimates
                             that in 2002, underfunded steel company pension plans accounted for
                             80 percent of the $9.3 billion in program losses for the year. The three
                             largest losses in the single-employer program’s history resulted from to the
                             termination of underfunded plans sponsored by failing steel companies:
                             Bethlehem Steel, LTV Steel, and National Steel. All three plans were either
                             completed terminations or listed as probable terminations for 2002. Giant
                             vertically integrated steel companies, such as Bethlehem Steel, have faced



                             27
                              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).




                             Page 15                                                                 GAO-03-873T
                            extreme economic difficulty for decades, and efforts to salvage their
                            defined-benefit plans have largely proved unsuccessful. According to
                            PBGC’s executive director, underfunded steel company pension plans
                            have accounted for 58 percent of PBGC single-employer losses since 1975.


Plan Unfunded Liabilities   The termination of underfunded plans in 2002 occurred after a sharp
Were Increased by Stock     decline in the stock market had reduced plan asset values and a general
Market and Interest Rate    decline in interest rates had increased plan liability values, and the
                            sponsors did not make the contributions necessary to adequately fund the
Declines                    plans before they were terminated. The combined effect of these factors
                            was a sharp increase in the unfunded liabilities of the terminating plans.
                            According to annual reports (Annual Return/Report of Employee Benefit
                            Plan, Form 5500) submitted by Bethlehem Steel Corporation, for example,
                            in the 7 years from 1992 to 1999, the Bethlehem Steel pension plan went
                            from 86 percent funded to 97 percent funded. (See fig. 6.) From 1999 to
                            plan termination in December 2002, however, plan funding fell to 45
                            percent as assets decreased and liabilities increased, and sponsor
                            contributions were not sufficient to offset the changes.




                            Page 16                                                        GAO-03-873T
Figure 6: Assets, Liabilities, and Funded Status of the Bethlehem Steel Corporation
Pension Plan, 1992-2002

Dollars in billions                                                                             Percent
8.0                                                                                                 120


7.0
                                                                                                    100

6.0

                                                                                                     80
5.0


4.0                                                                                                  60


3.0
                                                                                                     40

2.0

                                                                                                     20
1.0


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

            Assets

            Current liabilities

            Funded percentage
Source: Annual form 5500 reports and PBGC.

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


A decline in the stock market, which began in 2000, was a major cause of
the decline in plan asset values, and the associated increase in the degree
that plans were underfunded at termination. For example, while total
returns for stocks in the Standard and Poor’s 500 index (S&P 500)
exceeded 20 percent for each year from 1995 through 1999, they were
negative starting in 2000, with negative returns reaching 22.1 percent in
2002. (See fig. 7.) Surveys of plan investments by Greenwich Associates
indicated that defined-benefit plans in general had about 62.8 percent of
their assets invested in U.S. and international stocks in 1999.28




28
     2002 U.S. Investment Management Study, Greenwich Associates, Greenwich, CT.




Page 17                                                                                GAO-03-873T
Figure 7: Total Return on Stocks in the S&P 500 Index, 1992-2002



Total return (percent)
40                                    37.6
35                                                       33.4

30                                                                28.6

25                                           23.0
                                                                           21.0
20
15
                      10.1
10         7.6
  5                            1.3
  0
 -5
-10                                                                                 -9.1
-15                                                                                         -11.9

-20
-25                                                                                                  -22.1

-30
          1992        1993     1994   1995   1996        1997     1998    1999     2000     2001     2002
Source: Standard and Poor's.
                                                A stock market decline as severe as the one experienced from 2000
                                                through 2002 can have a devastating effect on the funding of plans that had
                                                invested heavily in stocks. For example, according to a survey,29 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.30 Over that same general period, stocks in the S&P 500 had a
                                                negative return of 38 percent.

                                                In addition to the possible effect of the stock market’s decline, a drop in
                                                interest rates likely had a negative effect on plan funding levels by
                                                increasing plan termination costs. Lower interest rates increase plan



                                                29
                                                     Pensions & Investments, Vol. 29, Issue 2 (Chicago; Jan. 22, 2001).
                                                30
                                                  According to the survey, the Bethlehem Steel Corporation pension plan made benefit
                                                payments of $587 million between Sept. 30, 2000, and Sept. 30, 2001. Pensions and
                                                Investments, www.pionline.com/pension/pension.cfm (downloaded on June 13, 2003).




                                                Page 18                                                                    GAO-03-873T
termination liabilities by increasing the present value of future benefit
payments, which in turn increases the purchase price of group annuity
contracts used to terminate defined-benefit pension plans.31 For example, a
PBGC analysis indicates that a drop in interest rates of 1 percentage point,
from 6 percent to 5 percent, increased the termination liabilities of the
Bethlehem Steel pension plan by about 9 percent, which indicates the cost
of terminating the plan through the purchase of a group annuity contract
would also have increased.32

Relevant interest rates may have declined 3 percentage points or more
since 1990.33 For example, interest rates on long-term high-quality
corporate bonds approached 10 percent at the start of the 1990s, but were
below 7 percent at the end of 2002. (See fig. 8.)




31
  Present value calculations reflect the time value of money: a dollar in the future is worth
less than a dollar today because the dollar today can be invested and earn interest. The
calculation requires an assumption about the interest rate, which reflects how much could
be earned from investing today’s dollars. Assuming a lower interest rate increases the
present value of future payments.
32
 The magnitude of an increase or decrease in plan liabilities associated with a given
change in discount rates would depend on the demographic and other characteristics of
each plan.
33
   To terminate a defined-benefit pension plan without submitting a claim to PBGC, the plan
sponsor determines the benefits that have been earned by each participant up to the time
of plan termination and purchases a single-premium group annuity contract from an
insurance company, under which the insurance company guarantees to pay the accrued
benefits when they are due. Interest rates on long-term, high-quality fixed-income securities
are an important factor in pricing group annuity contracts because insurance companies
tend to invest premiums in such securities to finance annuity payments. Other factors that
would have affected group annuity prices include changes in insurance company
assumptions about mortality rates and administrative costs.




Page 19                                                                        GAO-03-873T
Figure 8: Interest Rates on Long-Term High-Quality Corporate Bonds, 1990-2002

Interest rate (percent)
10



  9



  8



  7



  6



  5




  0
   1990          1991           1992   1993   1994        1995    1996       1997       1998       1999       2000       2001       2002
      Month of January
Source: Moody's Investor Services.




Minimum Funding Rules                           IRC minimum funding rules and ERISA variable rate premiums, which are
and Variable-Rate                               designed to ensure plan sponsors adequately fund their plans, did not have
Premiums Did Not                                the desired effect for the terminated plans that were added to the single-
                                                employer program in 2002. The amount of contributions required under
Prevent Plans from Being                        IRC minimum funding rules is generally the amount needed to fund
Severely Underfunded                            benefits earned during that year plus that year’s portion of other liabilities
                                                that are amortized over a period of years.34 Also, the rules require the
                                                sponsor to make an additional contribution if the plan is underfunded to
                                                the extent defined in the law. However, plan funding is measured using
                                                current liabilities, which a PBGC analysis indicates have been typically
                                                less than termination liabilities. 35 Additionally, plans can earn funding
                                                credits, which can be used to offset minimum funding contributions in


                                                34
                                                  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.
                                                35
                                                  For the analysis, PBGC used termination liabilities reported to it under 29 C.F.R. sec
                                                4010.




                                                Page 20                                                                          GAO-03-873T
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.36

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

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 the IRC funding rules from making a tax-deductible




36
     See 26 U.S.C. 412(b).




Page 21                                                           GAO-03-873T
                       contribution to the plan.37 In July 2002, PBGC terminated the Polaroid
                       pension plan, and the single-employer program assumed responsibility for
                       $321.8 million in unfunded PBGC-guaranteed liabilities for the plan. The
                       plan was about 67 percent funded, with assets of about $657 million to pay
                       estimated PBGC-guaranteed liabilities of about $979 million.

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


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




                       37
                         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.




                       Page 22                                                                          GAO-03-873T
Several Factors Affect the   Plan terminations affect the single-employer program’s financial condition
Degree to Which Plans Are    because PBGC takes responsibility for paying benefits to participants of
Underfunded and the          underfunded terminated plans. Several factors would increase the
                             likelihood that sponsoring firms will go bankrupt, and therefore will need
Likelihood That Plan         to terminate their pension plans, and the likelihood that those plans will be
Sponsors Will Go Bankrupt    underfunded at termination. Among these are poor investment returns,
                             low interest rates, and continued weakness in the national economy and
                             or specific sectors. Particularly troubling may be structural weaknesses in
                             certain industries with large underfunded defined-benefit plans.

                             Poor investment returns from a decline in the stock market can affect the
                             funding of pension plans. To the extent that pension plans invest in stocks,
                             the decline in the stock market will increase the chance that plans will be
                             underfunded should they terminate. A Greenwich Associates survey of
                             defined-benefit plan investments indicates that 59.4 percent of plan assets
                             were invested in stocks in 2002.38 Clearly, the future direction of the stock
                             market is very difficult to forecast. From the end of 1999 through the end
                             of 2002, the stock market, as measured by the S&P 500, declined by about
                             40 percent, but has since partially recovered those losses, increasing by
                             over 13 percent (of a smaller base) during 2003, as of August. From
                             January 1975, the beginning of the first year following the passage of
                             ERISA, through July 2003, the S&P 500 grew at an average compounded
                             nominal annual rate of 9.8 percent.

                             A decline in asset values can be particularly problematic for plans if
                             interest rates remain low or fall, which raises plan liabilities, all else equal.
                             The interest rate on 30-year U.S. Treasury securities, from which discount
                             rates to value plan current liabilities are derived, has remained below 5
                             percent since September 2002, its lowest level in over 25 years.39 Falling
                             interest rates raise the price of group annuities that a terminating plan
                             must purchase to cover its promised benefits and increase the likelihood
                             that a terminating plan will not have sufficient assets to make such a




                             38
                                  2002 U.S. Investment Management Study, Greenwich Associates, Greenwich, CT.
                             39
                               The U.S. Treasury stopped publishing a 30-year Treasury bond rate in February 2002, but
                             the Internal Revenue Service publishes rates for pension calculations based on rates for the
                             last-issued bonds in February 2001. Interest rates to calculate plan liabilities must be within
                             a “permissible range” around a 4-year weighted average of 30-year Treasury bond rates; the
                             permissible range for plan years beginning in 2002 and 2003 was 90 to 120 percent of this 4-
                             year weighted average.




                             Page 23                                                                         GAO-03-873T
purchase.40 An increase in liabilities due to falling interest rates also means
that companies may be required under the minimum funding rules to
increase contributions to their plans. This can create financial strain and
increase the chances of the firm going bankrupt, thus increasing the risk
that PBGC will have to take over an underfunded plan.

Economic weakness can also lead to greater underfunding of plans and to
a greater risk that underfunded plans will terminate. For many firms, slow
or declining economic growth causes revenues to decline, which makes
contributions to pension plans more difficult. Economic sluggishness also
raises the likelihood that firms sponsoring pension plans will go bankrupt.
Three of the last five annual increases in bankruptcies coincided with
recessions, and the record economic expansion of the 1990s is associated
with a substantial decline in bankruptcies. Annual plan terminations
resulting in losses to the single-employer program rose from 83 in 1989 to
175 in 1991, and, after declining to 65 in 2000, the number reached 93 in
2001.41

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




40
   A potentially offsetting effect of falling interest rates is the possible increased return on
fixed-income assets that plans, or PBGC, hold. When interest rates fall, the value of existing
fixed-income securities with time left to maturity rises.
41
 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.)




Page 24                                                                          GAO-03-873T
                             Because the financial condition of both firms and their pension plans can
                             eventually affect PBGC’s financial condition, PBGC tries to determine how
                             many firms are at risk of terminating their pension plans and the total
                             amount of unfunded vested benefits. According to PBGC’s fiscal year 2002
                             estimates, the agency is at potential risk of taking over $35 billion in
                             unfunded vested benefits from plans that are sponsored by financially
                             weak companies and could terminate.42 Almost one-third of these
                             unfunded benefits, about $11.4 billion, are in the airline industry.
                             Additionally, PBGC estimates that it could become responsible for over
                             $15 billion in shutdown benefits in PBGC-insured plans.

                             PBGC uses a model called the Pension Insurance Modeling System (PIMS)
                             to simulate the flow of claims to the single-employer program and to
                             project its potential financial condition over a 10-year period. This model
                             produces a very wide range of possible outcomes for PBGC’s future net
                             financial position.43


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

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


                             42
                               This estimate comprises “reasonably possible” terminations, which include plans
                             sponsored by companies with credit quality below investment grade that may terminate,
                             though likely not by year-end. Plan participants have a nonforfeitable right to vested
                             benefits, as opposed to nonvested benefits, for which participants have not yet completed
                             qualification requirements.
                             43
                              PBGC began using PIMS to project its future financial condition in 1998. Prior to this,
                             PBGC provided low-, medium-, and high-loss forecasts, which were extrapolations from the
                             agency’s claims experience and the economic conditions of the previous 2 decades.




                             Page 25                                                                     GAO-03-873T
                                                zero. (See fig. 9.) In 2001, total premium and investment was negative and
                                                in 2002 equaled approximately $1 billion.

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

Income (2002 dollars in millions)
 3.5

 3.0

 2.5

 2.0

 1.5

 1.0

 0.5

   0

-0.5

-1.0
        1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002


                                                          Premium income

                                                          Investment income

Source: PBGC annual financial reports.

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


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

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




                                                Page 26                                                                          GAO-03-873T
to around 30,000 in 2002.44 While the number of total participants in PBGC-
insured single-employer plans has grown approximately 25 percent since
1980, the percentage of participants who are active workers has declined
from 78 percent in 1980 to 53 percent in 2000. Manufacturing, a sector with
virtually no job growth in the last half-century, accounted for almost half
of PBGC’s single-employer program participants in 2001, suggesting that
the program needs to rely on other sectors for any growth in premium
income. (See fig 10.) In addition, a growing percentage of plans have
recently become hybrid plans, such as cash-balance plans, that
incorporate characteristics of both defined-contribution and defined-
benefit plans. Hybrid plans are more likely than traditional defined-benefit
plans to offer participants the option of taking benefits as a lump-sum
distribution. If the proliferation of hybrid plans increases the number of
participants taking lump sums instead of retirement annuities, over time
this would reduce the number of plan participants, thus potentially
reducing PBGC’s flat-rate premium revenue.45 Unless something reverses
these trends, PBGC may have a shrinking plan and participant base to
support the program in the future and that base may be concentrated in
certain, potentially more vulnerable industries.




44
  In contrast, defined-contribution plans have grown significantly over a similar period—
from 462,000 plans in 1985 to 674,000 plans in 1998.
45
  If a plan sponsor purchases an annuity for a retiree from an insurance company to pay
benefits, this would also remove the retiree from the participant pool, which would have
the same effect on flat-rate premiums.




Page 27                                                                      GAO-03-873T
Figure 10: Distribution of PBGC-Insured Participants by Industry, 2001




                                                  Information


                        7%                        Transportation and public utilities
                               8%


                                  12%             Finance, insurance, and real estate
        47%

                                 12%              Other


                       15%
                                                  Services

                                                  Manufacturing
Source: PBGC.

Note: Percentages do not sum to 100 due to rounding.


Even more problematic than the possibility of falling premium income
may be that PBGC’s premium structure does not reflect many of the risks
that affect the probability that a plan will terminate and impose a loss on
PBGC. While PBGC charges plan sponsors a variable-rate premium based
on the plan’s level of underfunding, premiums do not consider other
relevant risk factors, such as the economic strength of the sponsor, plan
asset investment strategies, the plan’s benefit structure, or the plans
demographic profile. Because these affect the risk of PBGC having to take
over an underfunded pension plan, it is possible that PBGC’s premiums
will not adequately and equitably protect the agency against future losses.
The recent terminations of some plans that showed credit balances shortly
before terminating with large underfunded balances lend some evidence to
this possibility. Sponsors also pay flat-rate premiums in addition to
variable-rate premiums, but these reflect only the number of plan
participants and not other risk factors that affect PBGC’s potential
exposure to losses. Full-funding limitations may exacerbate the risk of
underfunded terminations by preventing firms from contributing to their
plans during strong economic times when asset values are high and firms
are in the best financial position to make contributions.



Page 28                                                                          GAO-03-873T
Also, it may be difficult for PBGC to diversify its pool of insured plans
among strong and weak sponsors and plans. In addition to facing firm-
specific risk that an individual underfunded plan may terminate, PBGC
faces market risk that a poor economy may lead to widespread
underfunded terminations during the same period, which potentially could
cause very large losses for PBGC. Similarly, PBGC may face risk from
insuring plans concentrated in vulnerable industries that may suffer
bankruptcies over a short time period, as has happened recently in the
steel and airline industries. One study estimates that the overall premiums
collected by PBGC amount to about 50 percent of what a private insurer
would charge because its premiums do not account for this market risk.46

The net financial position of the single-employer program also depends
heavily on the long-term rate of return that PBGC achieves from the
investment of the program’s assets. All else equal, PBGC’s net financial
condition would improve if its total net return on invested assets exceeded
the discount rate it used to value its liabilities. For example, between 1993
and 2000 the financial position of the single-employer program benefited
from higher rates of return on its invested assets and its financial
condition improved. However, if the rate of return on assets falls below
the discount rate, PBGC’s finances would worsen, all else equal. As of
September 30, 2002, PBGC had approximately 65 percent of its single-
employer program investments in U.S. government securities and
approximately 30 percent in equities. The high percentage of assets
invested in Treasury securities, which typically earn low yields because
they are considered to be relatively “risk-free” assets, may limit the total
return on PBGC’s portfolio.47 Additionally, PBGC bases its discount rate on
surveys of insurance company group annuity prices, and because PBGC
invests differently than do insurance companies, we might expect some
divergence between the discount rate and PBGC’s rate of return on assets.
PBGC’s return on total invested funds was 2.1 percent for the year ending
September 30, 2002, and 5.8 percent for the 5-year period ending on that
date. For fiscal year 2002, PBGC used an annual discount rate of 5.70
percent to determine the present value of future benefit payments through
2027 and a rate of 4.75 percent for payments made in the remaining years.



46
 Boyce, Steven and Richard A. Ippolito, “The Cost of Pension Insurance,” The Journal of
Risk and Insurance, (2002) Vol. 69, No.2, p. 121-170.
47
 The return on fixed-income assets sold before maturity may also be affected by capital
gains (or losses). The price of a bond moves in the opposite direction as interest rates, and
so if interest rates fall, bondholders may reap capital gains.



Page 29                                                                        GAO-03-873T
                       The magnitude and uncertainty of these long-term financial risks pose
                       particular challenges for the PBGC’s single-employer insurance program
                       and potentially for the federal budget. In 1990, we began a special effort to
                       review and report on the federal program areas we considered high risk
                       because they were especially vulnerable to waste, fraud, abuse, and
                       mismanagement. In the past, we considered PBGC to be on our high-risk
                       list because of concern about the program’s viability and about
                       management deficiencies that hindered that agency’s ability to effectively
                       assess and monitor its financial condition. The current challenges to
                       PBGC’s single-employer insurance program concern immediate as well as
                       long-term financial difficulties, which are more structural weaknesses
                       rather than operational or internal control deficiencies. Nevertheless,
                       because of serious risks to the program’s viability, we have placed the
                       PBGC single-employer insurance program on our high-risk list.


                       Although some pension professionals have suggested a “wait and see”
Options That Address   approach, betting that brighter economic conditions improving PBGC’s
Challenges to PBGC     future financial condition are imminent, agency officials and other pension
                       professionals have suggested taking a more prudent, proactive approach,
Have Advantages and    identifying a variety of options that could address the challenges facing
Disadvantages          PBGC’s single-employer program. In our view, several types of reforms
                       should be considered. The first would be to improve the availability of
                       information about plan funding, plan investments, and PBGC guarantees
                       available to plan participants and others. A second would be to strengthen
                       funding rules applicable to poorly funded plans to help ensure plans are
                       better funded should they be terminated in the future. A third would be to
                       reform PBGC by restructuring its benefit guarantees and premiums.
                       Guarantees for certain unfunded benefits, such as so-called shutdown
                       benefits, could be modified. With respect to variable-rate premiums, in
                       addition to the plan’s funding status, consideration should be given to the
                       economic strength of the plan’s sponsor, the allocation of the plan’s
                       investment portfolio, the plan’s benefit structure, and participant
                       demographics. Several variations exist within these options and each
                       option has advantages and disadvantages. In any event, the changes
                       adopted to address the challenges facing PBGC should improve the
                       transparency of the plan’s financial information, provide plan sponsors
                       with incentives to increase plan funding, and provide a means to hold
                       sponsors accountable for adequately funding their plans.

                       To address challenges to PBGC’s financial condition include, we could:




                       Page 30                                                         GAO-03-873T
Increase transparency of plan information. Improving the availability
of information to plan participants and others about plan funding, plan
investments, and PBGC guarantees may give plan sponsors additional
incentives to increase plan funding and make participants better able to
plan for their retirement.

ERISA could be amended to require:

•    Disclosing termination liability. Under a recent administration
     proposal,48 sponsors would be required to report plan termination
     liability annually. Under current law, sponsors are required to report a
     plan’s current liability for funding purposes, which often can be less
     than termination liability. In addition, only participants in plans below
     a certain funding threshold – based on current liability rather than
     termination liability – receive annual notices of the funding status of
     their plans. In either case, plan participants may be unaware of the
     degree to which their plan is underfunded until it terminates. However,
     representatives of plan sponsors have stated that financially strong
     companies that are able to make good on their pension promises
     should not be burdened with additional complex and costly disclosure
     requirements that could be confusing or irrelevant to plan participants.

•    Disclosing plan investments. Disclosing plan asset allocation
     information may give plan sponsors an incentive to increase funding of
     underfunded plans or limit the level of equity investments in their
     plans. Currently, only participants in plans below a certain funding
     threshold receive annual notices of the funding status of their plans,
     and the information plans currently must provide does not reflect how
     the plan’s assets are invested. For example, notices to participants
     could include how much is invested in the sponsor’s securities.

•    Disclosing plan funding status and benefit guarantee limitations
     to additional participants. Expanding the circumstances under
     which sponsors must notify participants of plan underfunding and
     PBGC guarantee limitations might give sponsors an additional
     incentive to increase plan funding and would enable more participants
     to better plan their retirement. 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



48
 The Administration Proposal to Improve the Accuracy and Transparency of Pension
Information. (July 8, 2003).




Page 31                                                               GAO-03-873T
       when plans are required to pay variable-rate premiums and meet
       certain other requirements.49 As a result, many plan participants,
       including participants of the Bethlehem Steel pension plan, have not
       received such notifications in the years immediately preceding plan
       termination. Termination of a severely underfunded plan can
       significantly reduce the benefits participants receive. For example, 59-
       year old pilots were expecting annual benefits of $110,000 per year on
       average when the US Airways plan was terminated in 2003, while the
       maximum PBGC-guaranteed benefit at age 60 is $28,600 per year.50

Strengthen funding rules. Funding rules could be strengthened to
increase minimum contributions to underfunded plans and to allow




49
     See 29 U.S.C. 1311 and 29 C.F.R. 4011.3.
50
  However, the actual benefit paid by PBGC depends on a number of factors and may
exceed the maximum guaranteed benefit. For example, PBGC expects that the average
annual benefit paid to U.S. Airways pilots who are 59 years of age with 29 years of service
will be about $85,000, including nonguaranteed amounts. PBGC said that many US Airways
pilots will receive more that the $28,600 maximum limit because, according to priorities
established under ERISA, pension plan participants may receive benefits in excess of the
guaranteed amounts if there are enough assets or recoveries from the plan sponsors. For
example, a participant who could have retired three years prior to plan termination (but did
not) may be eligible to receive both guaranteed and nonguaranteed amounts. PBGC letter
in response to follow-up questions from the Committee on Finance, United States Senate
(Washington, D.C.: Apr.1, 2003).




Page 32                                                                      GAO-03-873T
additional contributions to fully funded plans. 51 This approach would
improve plan funding over time, while limiting the losses PBGC would
incur when a plan is terminated. However, even if funding rules were to be
strengthened immediately, it could take years for the change to have a
meaningful effect on PBGC’s financial condition. In addition, such a
change would require some sponsors to allocate additional resources to
their pension plans, which may cause the plan sponsor of an underfunded
plan to provide less generous wage or other benefits than would otherwise
be provided.

The IRC could be amended to strengthen the funding rules by:

•    Basing minimum contributions on termination liabilities. One
     way to strengthen funding rules is to require plans to base minimum
     funding contributions and full-funding limits on plan termination
     liabilities, rather than current liabilities. Since plan termination
     liabilities are typically higher than current liabilities, such a change
     would likely reduce potential claims against PBGC. One problem with



51
  If the Congress chooses to replace the 30-year Treasury rate used to calculate pension
plan liabilities, the level of the interest rate selected can also affect plan funding. For
example, if a rate that is higher than the current rate is selected, plan liabilities would
appear better funded, thereby decreasing minimum and maximum employer contributions.
In addition, some plans would reach full-funding limitations and avoid having to pay
variable-rate premiums. Therefore, PBGC would receive less revenue. Conversely, a lower
rate would likely improve PBGC’s financial condition. In 1987, when the 30-year Treasury
rate was adopted for use in certain pension calculations, the Congress intended that the
interest rate used for current liability calculations would, within certain parameters, reflect
the price an insurance company would charge to take responsibility for the plans pension
payments. However, in the late 1990s, when fewer 30-year Treasury bonds were issued and
economic conditions increased demand for the bonds, the 30-year Treasury rate diverged
from other long-term interest rates, an indication that it also may have diverged from group
annuity purchase rates. In 2001, Treasury stopped issuing these bonds altogether, and in
March 2002, the Congress enacted temporary measures to alleviate employer concerns that
low interest rates on the remaining 30-year Treasury bonds were affecting the
reasonableness of the interest rate for employer pension calculations. Selecting a
replacement rate is difficult because little information exists on which to base the
selection. Other than the survey conducted for PBGC, no mechanism exists to collect
information on actual group annuity purchase rates. Compared to other alternatives, the
PBGC interest rate factors may have the most direct connection to the group annuity
market, but PBGC factors are less transparent than market-determined alternatives. Long-
term market rates may track changes in group annuity rates over time, but their proximity
to group annuity rates is also uncertain. For example, an interest rate based on a long-term
market rate, such as corporate bond indexes, may need to be adjusted downward to better
reflect the level of group annuity purchase rates. However, as we stated in our report
earlier this year, establishing a process for regulatory adjustments to any rate selected may
make it more suitable for pension plan liability calculations. See GAO-03-313.




Page 33                                                                         GAO-03-873T
       this approach is the difficulty plan sponsors would have determining
       the appropriate interest rate to use in valuing termination liabilities. As
       we reported, selecting an appropriate interest rate is difficult because
       little information exists on which to base the selection.52 In addition,
       requiring financially strong sponsors to fund a plan's termination
       liabilities may encourage them to curtail or terminate those plans.

•       Strengthening minimum funding rules. Altering the threshold for
       the additional funding rule or the accumulation and use of credit
       balances would likely increase contribution requirements for some
       underfunded plans. 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, which results
       in the lowest possible value for current liability. Basing the threshold
       on a termination liability rate rather than the highest possible current
       liability rate, might help prevent the sponsor of an underfunded plan to
       avoid making an additional contribution. In addition, if a sponsor
       makes a contribution in any given year that exceeds the minimum
       required contribution, the excess plus interest would be 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
       contributions. Such limitations might also be applied on the basis of
       the plan sponsor’s poor cash flow position or credit rating. However,
       significantly reducing the existing funding flexibility of financially
       strong sponsors might encourage them to curtail or terminate their
       plans.

•      Raising full-funding limitations. Raising full-funding limitations may
       help decrease the level of underfunding in pension plans. The IRC and
       ERISA impose full-funding limitations that restrict certain tax-
       deductible contributions to prevent plan sponsors from contributing
       more to their plan than is necessary to cover accrued future benefits.53
       The advantage to raising these limitations is that such additional
       contributions might result in pension plans being better funded,
       decreasing the likelihood that they will be underfunded should they
       terminate. In addition, increasing full-funding limitations may be



52
     GAO-03-313.
53
 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 limit.




Page 34                                                                    GAO-03-873T
     advantageous to plan sponsors because contributions made during
     times of prosperity may carry over, allowing them to avoid minimum
     funding contributions during less prosperous times. For example, the
     current limitation on tax-deductible contributions for plans with assets
     at 100 percent of current liability could be increased.54 The
     disadvantage of raising the full-funding limitations is that the federal
     government would receive less tax revenue because of increases in tax-
     deductible contributions.

Reform PBGC’s benefit guarantee and premium structure.

Reduce benefit guarantees. Reducing certain guaranteed benefits that
plan sponsors are not currently required to fund could decrease losses
incurred by PBGC from underfunded plans. This approach could preserve
plan assets by preventing additional losses that PBGC would incur when a
plan is terminated. However, participants would lose benefits provided by
some plan sponsors. In addition, PBGC’s premium rates could be
increased or restructured to improve PBGC’s financial condition.
Changing premiums could increase PBGC’s revenue or provide an
incentive for plan sponsors to better fund their plans. However, premium
changes that are not based on the degree of risk posed by different plans
may force financially healthy companies out of the defined-benefit system
and discourage other plan sponsors from entering the system. Various
actions could be taken to reduce guaranteed benefits. These include:

•    Phasing-in the guarantee of shutdown benefits. PBGC is
     concerned about its exposure to the level of shutdown benefits that it
     guarantees. Shutdown benefits provide additional benefits, such as
     significant early retirement benefit subsidies to participants affected by
     a plant closing or a permanent layoff. Such benefits are primarily found
     in the pension plans of large unionized companies in the auto, steel,
     and tire industries. In general, shutdown benefits cannot be adequately
     funded before a shutdown occurs. Phasing in guarantees from the date
     of the applicable shutdown could decrease the losses incurred by




54
  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, Committee on
Education and the Workforce, U.S. House of Representatives, Hearing on Strengthening
Pension Security: Examining the Health and Future of Defined Benefit Pension Plans.
(Washington, D.C.: June 4, 2003), 9.




Page 35                                                                     GAO-03-873T
     PBGC from underfunded plans.55 However, modifying these benefits
     would reduce the early retirement benefits for participants who are in
     plans with such provisions and are affected by a plant closing or a
     permanent layoff. Dislocated workers, particularly in manufacturing,
     may suffer additional losses from lengthy periods of unemployment or
     from finding reemployment only at much lower wages.

•    Eliminating or reducing unfunded benefit increases. Currently,
     plan sponsors must meet certain conditions before increasing the
     benefits of plans that are less than 60 percent funded.56 Eliminating
     benefit increases or increasing this percentage could decrease the
     losses incurred by PBGC from underfunded plans. Plan sponsors have
     said that the disadvantage of such changes is that they would limit an
     employer’s flexibility with regard to setting compensation, making it
     more difficult to respond to labor market developments. For example,
     a plan sponsor might prefer to offer participants increased pension
     payments or shutdown benefits instead of offering increased wages
     because pension benefits can be deferred—providing time for the plan
     sponsor to improve its financial condition—while wage increases have
     an immediate effect on the plan sponsor’s financial condition.

Two actions that could be taken to change premiums are

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

•    Increasing or restructuring variable-rate premium. The current
     variable-rate premium of $9 per $1,000 of unfunded liability could be



55
  Currently, some measures exist to limit the losses incurred by PBGC from newly
terminated plans. PBGC is responsible for only a portion of all benefit increases that the
sponsor adds in the 5 years leading up to termination.
56
 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. 401(a)(29).




Page 36                                                                       GAO-03-873T
                  increased. The rate could also be adjusted so that plans with less
                  adequate funding pay a higher rate. Premium rates could also be
                  restructured based on the degree of risk posed by different plans,
                  which could be assessed by considering the financial strength and
                  prospects of the plan’s sponsor, the risk of the plan’s investment
                  portfolio, participant demographics, and the plan’s benefit structure –
                  including plans that have lump-sum,57 shutdown benefit, and floor-
                  offset provisions.58 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.


             The current financial challenges facing PBGC and the array of policy
Conclusion   options to address those challenges are more appropriately viewed within
             the context of the agency’s overall mission. In 1974, ERISA placed three
             important charges on PBGC: first, protect the pension benefits so essential
             to the retirement security of hard working Americans; second, minimize
             the pension insurance premiums and other costs of carrying out the
             agency’s obligations; and finally, foster the health of the private defined-
             benefit pension plan system. While addressing one or even two of these
             goals would be a challenge, it is a far more formidable endeavor to fulfill
             all three. In any event, any changes adopted to address the challenges
             facing PBGC should provide plan sponsors with incentives to increase
             plan funding, improve the transparency of the plan’s financial information,
             and provide a means to hold sponsors accountable for funding their plans
             adequately. Ultimately, however, for any insurance program, including the
             single-employer pension insurance program, to be self-financing, there
             must be a balance between premiums and the program's exposure to
             losses.



             57
              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.
             58
               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.




             Page 37                                                                     GAO-03-873T
A variety of options are available to the Congress and PBGC to address the
short-term vulnerabilities of the single-employer insurance program.
Congress will have to weigh carefully the strengths and weaknesses of
each option as it crafts the appropriate policy response. However, to
understand the program’s structural problems, it helps to understand how
much the world has changed since the enactment of ERISA. In 1974, the
long-term decline that our nation’s private defined-benefit pension system
has experienced since that time might have been difficult for some to
envision. Although there has been some absolute growth in the system
since 1980, active workers have comprised a declining percentage of
program participants, and defined-benefit plan coverage has declined as a
percentage of the national private labor force. The causes of this long-term
decline are many and complex and have turned out to be more systemic,
more structural in nature, and far more powerful than the resources and
bully pulpit that PBGC can bring to bear.

This trend has had important implications for the nature and the
magnitude of the risk that PBGC must insure. Since 1987, as employers,
both large and small, have exited the system, newer firms have generally
chosen other vehicles to help their employees provide for their retirement
security. This has left PBGC with a risk pool of employers that is
concentrated in sectors of the economy, such as air transportation and
automobiles, which have become increasingly vulnerable. As of 2002,
almost half of all defined-benefit plan participants were covered by plans
offered by firms in manufacturing industries. The secular decline and
competitive turmoil already experienced in industries like steel and air
transportion could well extend to the other remaining strongholds of
defined-benefit plans in the future, weakening the system even further.

Thus, the long-term financial health of PBGC and its ability to protect
workers’ pensions is inextricably bound to this underlying change in the
nature of the risk that it insures, and implicitly to the prospective health of
the defined-benefit system. Options that serve to revitalize the defined-
benefit system could stabilize PBGC’s financial situation, although such
options may be effective only over the long term. Our greater challenge is
to a more fundamental consideration of the manner in which the federal
government protects the defined-benefit pensions of workers in this
increasingly risky environment. We look forward to working with the
Congress on this crucial subject.




Page 38                                                            GAO-03-873T
Appendix I: Key Legislative Changes That
Affect the Single-Employer Insurance
Program
                                               As part of the Employee Retirement and Income Security Act (ERISA) of
                                               1974, the Congress established the Pension Benefit Guaranty Corporation
                                               (PBGC) to administer the federal insurance program. Since 1974, the
                                               Congress has amended ERISA to improve the financial condition of the
                                               insurance program and the funding of single-employer plans (see table 1).

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

 Year       Law                                                  Number         Key provisions
 1974       ERISA                                                P.L. 93-406    Created a federal pension insurance program and
                                                                                established a flat-rate premium and minimum and
                                                                                maximum funding rules.
 1986       Single-Employer Pension Plan Amendments Act of       P.L. 99-272    Raised the flat-rate premium and established financial
            1986 enacted as Title XI of the Consolidated Omnibus                distress criteria that sponsoring employers must meet
            Budget Reconciliation Act of 1985                                   to terminate an underfunded plan.
 1987       Pension Protection Act enacted as part of the        P.L. 100-203   Increased the flat-rate premium and added a variable-
            Omnibus Budget Reconciliation Act of 1987                           rate premium based on 80 percent of the 30-year
                                                                                Treasury rate. In addition, established a permissible
                                                                                range around the 30-year Treasury rate as the basis
                                                                                for current liability calculations, increased the
                                                                                minimum funding standards, and established a full-
                                                                                funding limitation based on 150 percent of current
                                                                                liability.
 1994       Retirement Protection Act enacted as part of the     P.L. 103-465   Raised the basis for variable-rate premium calculation
            Uruguay Rounds Agreements Act, also referred to as                  from 80 percent to 85 percent of the 30-year Treasury
            the General Agreement on Tariffs and Trade                          rate (effective July 1997). Phased out the cap on the
                                                                                variable-rate premium. Strengthened funding
                                                                                requirements by narrowing the permissible range of
                                                                                the allowable interest rates and standardizing mortality
                                                                                assumptions for the current liability calculation. Also,
                                                                                established 90 percent as the minimum full-funding
                                                                                limitation.
 2001       The Economic Growth and Tax Relief Reconciliation    P.L. 107-16    Accelerated the phasing out of the 160 percent full-
            Act of 2001                                                         funding limitation and repealed it for plan years
                                                                                beginning in 2004 and thereafter.
 2002       The Job Creation and Worker Assistance Act of 2002   P.L. 107-147   Temporarily expanded the permissible range of the
                                                                                statutory interest rates for current liability calculations
                                                                                and temporarily increased the PBGC variable-rate
                                                                                premium calculations to 100 percent of the 30-year
                                                                                Treasury rate for plan years beginning after December
                                                                                31, 2001, and before January 1, 2004.
Source: Public Law.




(130284)
                                               Page 39                                                                     GAO-03-873T
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