oversight

Pension Benefit Guaranty Corporation: Long-Term Financing Risks to Single-Employer Insurance Program Highlight Need for Comprehensive Reform

Published by the Government Accountability Office on 2003-10-14.

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

                            United States General Accounting Office

GAO                         Testimony
                            Before the Special Committee on Aging,
                            United States Senate


For Release on Delivery
Expected at 10:00 a.m.
Tuesday, October 14, 2003   PENSION BENEFIT
                            GUARANTY
                            CORPORATION
                            Long-Term Financing Risks
                            to Single-Employer
                            Insurance Program
                            Highlight Need for
                            Comprehensive Reform
                            Statement of Barbara D. Bovbjerg, Director
                            Education, Workforce, and Income Security




GAO-04-150T 

                                                October 14, 2003


                                                PENSION BENEFIT GUARANTY
                                                CORPORATION

Highlights of GAO-04-150T, a testimony          Long-Term Financing Risks to Single-
before the Special Committee on Aging,
U.S. Senate.                                    Employer Insurance Program Highlight
                                                Need for Comprehensive Reform


More than 34 million workers and                The single-employer pension insurance program returned to an accumulated
retirees in 30,000 single-employer              deficit in 2002 largely due to the termination, or expected termination, of
defined benefit pension plans rely              several severely underfunded pension plans. Factors that contributed to the
on a 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
the program's long-term financial               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 losses experienced 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 experienced to date or those
losses to the program in 2002,
additional severe losses may be on              that occur in the future. Revenue from premiums might fall, for example, if
the horizon. PBGC estimates that                the number of program participants decreases. Because of these risks, we
financially weak companies                      recently placed the single-employer insurance program on our high-risk
sponsor plans with $35 billion in               list of agencies with 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
the program.                                    threatening the retirement security of millions of American workers and
This testimony provides GAO's
                                                retirees. Several reforms might reduce the risks to the program’s long-
observations on the factors that                term financial viability. Such changes include: strengthening funding
contributed to recent changes in                rules applicable to poorly funded plans, modifying program guarantees,
the single-employer pension                     restructuring premiums, and improving the availability of information
insurance program's financial                   about plan investments, termination funding, and program guarantees.
condition, risks to the program's               Any changes adopted to address the challenge facing PBGC should
long-term financial viability, and              provide a means to hold plan sponsors accountable for adequately
changes to the program that might
                                                funding their plans, provide plan sponsors with incentives to increase
be considered to reduce those
risks.                                          plan funding, and improve the transparency of plan information.
                                                Program Assets, Liabilities, and Net Position, Fiscal Years 1976-2002
                                                2002 dollars (in billions)
                                                 30
                                                 25
                                                 20
                                                 15
                                                 10
                                                  5
                                                  0
                                                 -5
                                                -10
www.gao.gov/cgi-bin/getrpt?GAO-04-150T.             1976 1978 1980              1982    1984   1986     1988       1990   1992   1994     1996   1998   2000   2002

To view the full product, including the scope                                  Assets                 Liabilites                 Net position
and methodology, click on the link above.
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 (PBGCs) 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 estimated that as of September 30, 2002, it faced exposure to
approximately $35 billion in additional unfunded liabilities from ongoing
plans that were 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 $5.7 billion at the end of July 2003
based on its latest unaudited financial report.
4
 PBGC estimates that by the end of fiscal year 2003, the amount of underfunding in
financially troubled companies could exceed $80 billion. 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, 2003).



Page 1                                                                         GAO-04-150T
This risk 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) changes to the program that might be
considered to reduce those risks.

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 over $4 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. To obtain additional information as to the
risks facing PBGC from certain industries, we discussed with PBGC, and
reviewed annual and actuarial reports for the 2003 distress termination of
the U.S. Airways pension plan for pilots. To determine what changes might
be considered to reduce those risks, we reviewed proposals for reforming
the single-employer program made by the Department of the Treasury,
PBGC, and pension professionals.

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 the 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

Page 2                                                           GAO-04-150T
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
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 reforms might be considered to reduce the risks to the
single-employer program’s long-term financial viability. These include
strengthening funding rules applicable to poorly funded plans, modifying
program guarantees, restructuring premiums, and improving the

Page 3                                                          GAO-04-150T
               availability of information about plan investments, termination funding,
               and program guarantees. Under each reform, several possible actions
               could be taken. For example, one way to modify program guarantees is to
               phase-in certain unfunded benefits, such as “shutdown benefits.” In
               addition, one way premiums could be restructured would be to base them,
               not only on the degree of plan underfunding, but also on the economic
               strength of the plan sponsor, the degree of risk to 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 provide a means to hold
               sponsors accountable for adequately funding their plans, provide plan
               sponsors with incentives to increase plan funding, and improve the
               transparency of the plan’s financial information.

               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 participants in these plans had no guarantees they
               would receive the benefits promised. When Studebaker’s pension plan
               failed in the 1960s, for example, many plan participants lost their
               pensions.5 Such experiences prompted the passage of ERISA to better
               protect the retirement savings of Americans covered by private pension
               plans. Along with other changes, ERISA established PBGC to pay the
               pension benefits of participants, subject to certain limits, in the event that
               an employer could not.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




               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-04-150T
Under ERISA, the termination of a single-employer defined-benefit plan
results in an insurance claim with the single-employer program if the plan
has insufficient assets to pay all benefits accrued under the plan up to the
date of plan termination.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.




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. Terminating
an underfunded plan is termed a distress termination if the plan sponsor requests the
termination or an involuntary termination if PBGC initiates the termination. PBGC may
institute proceedings to terminate a plan if, among other things, the plan will be unable to
pay benefits when due or the possible long-run loss to PBGC with respect to the plan may
reasonably be expected to increase unreasonably if the plan is not terminated. See 29
U.S.C. 1342(a).
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-04-150T
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
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 report,13 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-


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 their 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-04-150T
risk areas in the federal government, we noted that weaknesses in the
single-employer insurance program’s financial condition threatened
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.: Sept. 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-04-150T
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-04-150T
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: PBGC follows accrual basis accounting, and as a result, included in the fiscal year 2002
statement an estimate of variable rate premium income for the period covering January 1 through
September 30, 2002, for plans whose filings were not received by September 30, 2002. 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-04-150T
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-04-150T
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 U.S. government 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-04-150T
Figure 3: Market Value of Single-Employer Program Assets in Revolving and Trust Funds at Year End, Fiscal Years 1990-2002




                                        Note: Other includes fixed-maturity securities, other than U.S. government securities, such as
                                        corporate bonds. In 2002, fixed-maturity securities, other than U.S. government securities, totaled
                                        $946 million. 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-04-150T
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.




                                                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-04-150T
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
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. PBGC
estimates that this deficit grew to $5.7 billion by July 31, 2003. Despite this
large deficit, according to a PBGC analysis, the single-employer program
was estimated to have enough assets to pay benefits through 2019, given
the program’s conditions and PBGC assumptions as of the end of fiscal
year 2002.27 Losses since that time may have shortened the period over
which the program will be able to cover promised benefits.




27
 The estimate assumes: (1) a rate of return on all PBGC assets of 5.8 percent and a
discount rate on future benefits of 5.67 percent; (2) no premium income and no future
claims beyond all plans with terminations that were deemed “probable” as of September
30, 2002; (3) administrative expenses of $225 million in fiscal year 2003, $229 million per
year for fiscal year 2004-14, and $0 thereafter; (4) mid-year termination for “probables”; and
(5) that PBGC does not assume control of “probable” assets and future benefits until the
date of plan termination.



Page 14                                                                        GAO-04-150T
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.



                                                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
Decline of Single-                              have been promised to plan participants if plants or companies ceased
                                                operations.28 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



                                                28
                                                 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-04-150T
                             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 $705 million 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 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
                             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



                             Page 16                                                          GAO-04-150T
percent as assets decreased and liabilities increased, and sponsor
contributions were not sufficient to offset the changes.

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




Page 17                                                                                GAO-04-150T
                                                indicated that defined-benefit plans in general had about 62.8 percent of
                                                their assets invested in U.S. and international stocks in 1999.29

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,30 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.31 Over that same general period, stocks in the S&P 500 had a
                                                negative return of 38 percent.



                                                29
                                                     2002 U.S. Investment Management Study, Greenwich Associates, Greenwich, Conn.
                                                30
                                                     Pensions & Investments, vol. 29, Issue 2 (Chicago: Jan. 22, 2001).
                                                31
                                                  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-04-150T
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
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.32 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.33

Relevant interest rates may have declined 3 percentage points or more
since 1990.34 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.)




32
  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.
33
 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.
34
   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-04-150T
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 Prevent                        the desired effect for the terminated plans that were added to the single-
                                                employer program in 2002. The amount of contributions required under
Plans from Being Severely                       IRC minimum funding rules is generally the amount needed to fund
Underfunded                                     benefits earned during that year plus that year’s portion of other liabilities
                                                that are amortized over a period of years.35 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.36 Additionally, plans can earn funding
                                                credits, which can be used to offset minimum funding contributions in
                                                later years, by contributing more than required according to minimum



                                                35
                                                  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.
                                                36
                                                     For the analysis, PBGC used termination liabilities reported to it under 29 C.F.R. sec 4010.



                                                Page 20                                                                           GAO-04-150T
     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.37

     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. With respect to two of the terminated underfunded pension
     plans that we examine, for example, a PBGC analysis indicates:

•	   The retirement age assumption for the Anchor Glass pension plan on an
     ongoing plan basis was 65 for separated-vested participants. However, the
     retirement age assumption appropriate for those participants on a
     termination basis was 58—a decrease of 7 years. According to PBGC,
     changing retirement age assumptions for all participants, including
     separated-vested participants, resulted in a net increase in plan liabilities
     of about 4.6 percent.

•	   The retirement age assumption for the Bethlehem Steel pension plan on an
     ongoing plan basis was 62 for those active participants eligible for
     unreduced benefits after 30 years of service. On the other hand, the
     retirement age assumption for them on a plan termination basis was 55 –
     the earliest retirement age. According to PBGC, decreasing the assumed
     retirement age from 62 to 55 approximately doubled the liability for those
     participants.

     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



     37
          See 26 U.S.C. 412(b).



     Page 21                                                          GAO-04-150T
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
contribution to the plan.38 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 plan sponsors 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 applying any contributions and credit
balances in the funding standard account. Each of these four plans met
this criterion.




38
  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-04-150T
                             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.


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 2002.39 Clearly, the future direction of the stock
                             market is very difficult to forecast. From the end of 1999 through the end
                             of 2002, total cumulative returns in the stock market, as measured by the
                             S&P 500, were negative 37.6 percent. In 2003, the S&P 500 has partially
                             recovered those losses, with total returns (from a lower starting point) of
                             14.7 percent through the end of September. From January 1975, the
                             beginning of the first year following the passage of ERISA, through


                             39
                                  2002 U.S. Investment Management Study, Greenwich Associates, Greenwich, Conn.



                             Page 23                                                                    GAO-04-150T
September 2003, the average annual compounded nominal return on the
S&P 500 equaled 13.5 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 highest allowable discount rate for calculating current plan liabilities,
based on the 30-year U.S. Treasury bond rate, has been no higher than 7.1
percent since April, 1998, lower than any previous point during the 1990s.40
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 purchase.41 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
2001.42




40
  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.
41
   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.
42
 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-04-150T
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; 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.

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.43 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.44



43
  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.
44
 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-04-150T
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
                             zero. (See fig. 9.) In 2001, total premium and investment was negative and
                             in 2002 equaled approximately $1 billion.




                             Page 26                                                        GAO-04-150T
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
                                                to around 30,000 in 2002.45 While the number of total participants in



                                                45
                                                  In contrast, defined-contribution plans have grown significantly over a similar period—
                                                from 462,000 plans in 1985 to 674,000 plans in 1998.



                                                Page 27                                                                          GAO-04-150T
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.46 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.




46
  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 28                                                                     GAO-04-150T
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 Bethlehem Steel, Anchor Glass, and Polaroid,
plans that paid no variable-rate premiums 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 29                                                                          GAO-04-150T
It may also 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.47

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.48 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.



47
 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.
48
 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 30                                                                        GAO-04-150T
                      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 concerns 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”
Several Reforms       approach, betting that brighter economic conditions improving PBGC’s
Might Reduce The      future financial condition are imminent, agency officials and other pension
                      professionals have suggested taking a more prudent, proactive approach,
Risks To The          identifying a variety of options that could address the challenges facing
Program’s Financial   PBGC’s single-employer program. In our view, several types of reforms
Viability             might be considered to reduce the risks to the single-employer program’s
                      long-term financial viability. These reforms could be made to

                      •    strengthen funding rules applicable to poorly funded plans;

                      •    modify program guarantees;

                      •    restructure premiums; and

                      •	   improve the availability of information about plan investments,
                           termination funding, and program guarantees.

                      Several variations exist within these options and each has advantages and
                      disadvantages. In any event, any changes adopted to address the challenge
                      facing PBGC should provide a means to hold sponsors accountable for
                      adequately funding their plans, provide plan sponsors with incentives to
                      increase plan funding, and improve the transparency of the plan’s financial
                      information.




                      Page 31                                                            GAO-04-150T
Strengthening Plan          Funding rules could be strengthened to increase minimum contributions
Funding Rules Might         to underfunded plans and to allow additional contributions to fully funded
                            plans.49 This approach would improve plan funding over time, while
Reduce Program Risks
                            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 wages or
                            benefits than would otherwise be provided. The IRC could be amended to:

                       •	   Base additional funding requirement and maximum tax-deductible
                            contributions on plan termination liabilities, rather than current
                            liabilities. Since plan termination liabilities typically exceed current
                            liabilities, such a change would likely improve plan funding and therefore
                            reduce potential claims against PBGC. One problem with this approach is
                            the difficulty plan sponsors would have determining the appropriate
                            interest rate to use in valuing termination liabilities. As we reported,



                            49
                              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 32                                                                         GAO-04-150T
     selecting an appropriate interest rate for termination liability calculations
     is difficult because little information exists on which to base the
     selection.50

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

•	   Limit the use of credit balances. For sponsors who make contributions
     in any given year that exceed the minimum required contribution, the
     excess plus interest is credited against future required contributions.
     Limiting the use of credit balances to offset contribution requirements
     might also prevent sponsors of significantly underfunded plans from
     avoiding contributions. Such limitations might also be applied based on
     the plan sponsor’s financial condition. For example, sponsors with poor
     cash flow or low credit ratings could be restricted from using their credit
     balances to reduce their contributions.

•	   Limit lump-sum distributions. Defined benefit pension plans may offer
     participants the option of receiving their benefit in a lump-sum payment.
     Allowing participants to take lump-sum distributions from severely
     underfunded plans, especially those sponsored by financially weak
     companies, allows the first participants who request a distribution to drain
     plan assets, which might result in the remaining participants receiving
     reduced payments from PBGC if the plan terminates. However, the
     payment of lump sums by underfunded plans may not directly increase
     losses to the single employer program because lump sums reduce plan
     liabilities as well as plan assets.

•	   Raise the level of tax-deductible contributions. The IRC and ERISA
     restrict tax-deductible contributions to prevent plan sponsors from
     contributing more to their plan than is necessary to cover accrued future
     benefits.51 Raising these limitations might result in pension plans being



     50
          GAO-03-313.
     51
      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 33                                                                    GAO-04-150T
                            better funded, decreasing the likelihood that they will be underfunded
                            should they terminate. 52

Modifying Program           Modifying certain guaranteed benefits could decrease losses incurred by
Guarantee Would Decrease    PBGC from underfunded plans. This approach could preserve plan assets
Plan Underfunding           by preventing additional losses that PBGC would incur when a plan is
                            terminated. However, participants would lose benefits provided by some
                            plan sponsors. ERISA could be amended to:

                       •	   Phase-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 PBGC from underfunded
                            plans.53 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.

                       •	   Expand restrictions on unfunded benefit increases. Currently, plan
                            sponsors must meet certain conditions before increasing the benefits of
                            plans that are less than 60 percent funded.54 Increasing this threshold, or
                            restricting benefit increases when plans reach the threshold, could
                            decrease the losses incurred by PBGC from underfunded plans. Plan


                            52
                              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.
                            53
                              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.
                            54
                             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 34                                                                       GAO-04-150T
                               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.

Restructuring The              PBGC’s premium rates could be increased or restructured to improve
Program’s Premium              PBGC’s financial condition. Changing premiums could increase PBGC’s
Structure Might Improve        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
Its Financial Viability        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. ERISA could be amended to:

                          •	   Increase or restructure variable-rate premium. The current variable-
                               rate premium of $9 per $1,000 of unfunded liability could be 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,55 shutdown
                               benefit, and floor-offset provisions.56 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.




                               55
                                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.
                               56
                                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 35                                                                     GAO-04-150T
                         •	   Increase 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 Transparency of    Improving the availability of information to plan participants and others
Plan Information Might        about plan investments, termination funding status, and PBGC guarantees
Encourage Sponsors to         may give plan sponsors additional incentives to better fund their plans,
                              making participants better able to plan for their retirement. ERISA could
Better Fund Plans,            be amended to:
Reducing Program Risks
                         •	   Disclose information on plan investments. While some asset
                              allocation information is reported by plans in form 5500 filings with the
                              IRS, some plan investments may be made through common and collective
                              trusts, master trusts, and registered investment companies, which make it
                              difficult or impossible for participants and others to determine the asset
                              classes–such as equity or fixed-income investments–for many plan
                              investments. Improving the availability of plan asset allocation information
                              may give plan sponsors an incentive to increase funding of underfunded
                              plans or limit risky investments. Information provided to participants
                              could also disclose how much of plan assets are invested in the sponsor’s
                              own securities. This would be of concern because should the sponsor
                              becomes bankrupt; the value of the securities could be expected to drop
                              significantly, reducing plan funding. Although this information is currently
                              provided in the plan’s form 5500, it is not readily accessible to participants.
                              Additionally, if the defined-benefit plan has a floor-offset arrangement and
                              its benefits are contingent on the investment performance of a defined-
                              contribution plan, then information provided to participants could also
                              disclose how much of that defined-contribution plan’s assets are invested
                              in the sponsor’s own securities.

                         •	   Disclose plan termination funding status. Under current law, sponsors
                              are required to report a plan’s current liability for funding purposes, which
                              often can be lower than termination liability. In addition, only participants
                              in plans below a certain funding threshold receive annual notices of the




                              Page 36                                                           GAO-04-150T
                 funding status of their plans. 57 As a result, many plan participants,
                 including participants of the Bethlehem Steel pension plan, did not receive
                 such notifications in the years immediately preceding the termination of
                 their plans. Expanding the circumstances under which sponsors must
                 notify participants of plan underfunding might give sponsors an additional
                 incentive to increase plan funding and would enable more participants to
                 better plan their retirement.

             •   Disclose benefit guarantees to additional participants. As with the
                 disclosure of plan funding status, only participants of plans below the
                 funding threshold receive notices on the level of program guarantees
                 should their plan terminate. 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. 58
                 Expanding the circumstances under which plan sponsors must notify
                 participants of PBGC guarantees may enable more participants to better
                 plan for their retirement.


                 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-



                 57
                    The ERISA requirement that plan sponsors notify participants and beneficiaries of the
                 plan’s funding status and limits on the PBGC guarantee currently goes into effect when
                 plans are required to pay variable-rate premiums and meet certain other requirements. See
                 29 U.S.C. 1311 and 29 C.F.R. 4011.3.
                 58
                   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 than 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 3 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, U. S. Senate
                 (Washington, D.C.: April 1, 2003).



                 Page 37                                                                      GAO-04-150T
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.

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
transportation 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

Page 38                                                            GAO-04-150T
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. The more immediate
challenge, however, is the 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.


Mr. Chairman, members of the committee, that concludes my statement.
I’d be happy to answer any questions you may have.




Page 39                                                        GAO-04-150T
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 of 90-110 percent around the weighted average
                                                                                 30-year of the 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 to 90-105 percent of the
                                                                                 weighted average 30-year Treasury rate 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 to 90 to 120 percent of the
                                                                                weighted average of the 30-year Treasury rate 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.




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                                               Page 40                                                                      GAO-04-150T
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