oversight

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

Published by the Government Accountability Office on 2003-10-29.

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

               United States General Accounting Office

GAO            Report to Congressional Requesters




October 2003
               PENSION BENEFIT
               GUARANTY
               CORPORATION
               Single-Employer
               Pension Insurance
               Program Faces
               Significant Long-Term
               Risks




GAO-04-90 

                                                October 2003


                                                PENSION BENEFIT GUARANTY
                                                CORPORATION

Highlights of GAO-04-90, a report to            Single-Employer Pension Insurance
congressional requesters
                                                Program Faces Significant Long-Term
                                                Risks


More than 34 million participants in            The single-employer pension insurance program returned to an accumulated
30,000 single-employer defined                  deficit in 2002 largely due to the termination, or expected termination, of
benefit pension plans rely on a                 several severely underfunded pension plans. Factors that contributed to the
federal insurance program                       severity of the 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 the Internal Revenue Service
decade, the program swung from a                (IRS), at $3.7 billion when it was terminated in 2002. The plan's assets had
$3.6 billion accumulated deficit                decreased by over $2.5 billion, while its liabilities had increased by about
(liabilities exceeded assets), to a             $1.4 billion since 1999.
$10.1 billion accumulated surplus,
and back to a $3.6 billion                      The single-employer program faces two primary risks to its long-term
accumulated deficit, in 2002                    financial viability. First, the large losses in 2002 could continue or
dollars. Furthermore, despite a                 accelerate if, for example, structural problems in particular industries result
record $9 billion in estimated
                                                in additional bankruptcies. Second, revenue from premiums and investments
losses to the program in 2002,
additional severe losses may be on              might be inadequate to offset program losses. Participant-based premium
the horizon. PBGC estimates that                revenue might fall, for example, if the number of program participants
financially weak companies                      decreases. Because of these risks, GAO has recently placed the single-
sponsor plans with $35 billion in               employer insurance program on its high-risk list of agencies with
unfunded benefits, which                        significant vulnerabilities to the federal government.
ultimately might become losses to
the program.                                    While the recent decline in the single-employer program’s financial condition
                                                is not an immediate crisis, the threats to the program’s long-term viability
                                                should be addressed. Several reforms might be considered to reduce the
GAO is not recommending                         risks to the program’s long-term financial viability. These include
executive action. However, given                strengthening funding rules applicable to poorly funded plans, modifying
the long-term nature of the                     program guarantees, restructuring premiums, and improving the availability
financial risks to PBGC’s single-               of information about plan investments, termination funding, and program
employer insurance program, the                 guarantees. Under each reform, several possible actions could be taken. For
Congress should consider a                      example, one way to modify program guarantees is to phase-in certain
comprehensive response that                     unfunded benefits, such as “shutdown benefits,” which may provide
includes changes to strengthen
                                                significant early retirement benefit subsidies to participants affected by a
plan funding and improve the
transparency of plan information as             plant closing or a permanent layoff.
well as consider proposals to                   Participants and Plans Covered by the Single-Employer Insurance Program, 1980-2002
modify program guarantees. In                   2002 dollars (in billions)
addition, PBGC’s premium                         30
                                                 25
structure should be re-examined to
                                                 20
see whether premiums can better
                                                 15
reflect the risk posed by various                10
plans to the pension system.                      5
                                                  0
www.gao.gov/cgi-bin/getrpt?GAO-04-90.            -5
                                                -10
To view the full product, including the scope       1976 1978 1980              1982    1984   1986     1988       1990   1992   1994     1996   1998   2000   2002
and methodology, click on the link above.
For more information, contact Barbara                                          Assets                 Liabilites                 Net position
Bovbjerg at (202) 512-7215 or
bovbjergb@gao.gov.                              Source: PBGC annual reports.
Contents 



Letter                                                                                      1
                Results in Brief 
                                                          3
                Background
                                                                 4
                Termination of Severely Underfunded Plans Was Primary Factor in 

                  Financial Decline of Single-Employer Program                            16
                PBGC Faces Long-Term Financial Risks from a Potential
                  Imbalance of Assets and Liabilities                                     24
                Several Reforms Might Reduce the Risks to the Program’s
                  Financial Viability                                                     32
                Conclusion                                                                39
                Matters for Congressional Consideration                                   41
                Agency Comments                                                           41

Appendix I      Scope and Methodology                                                     43



Appendix II 	   Key Legislative Changes That Affected the Single-
                Employer Program                                                          45



Appendix III    The Administration Proposal for Pension Reform                            46



Appendix IV 	   Differences in Interest Rate Calculations Contribute
                to Differences between Termination and Current
                Liabilities                                                               49



Appendix V 	    Comments from the Pension Benefit Guaranty
                Corporation                                                               53



Appendix VI     GAO Contacts and Staff Acknowledgments                                    54
                Contacts                                                                  54
                Staff Acknowledgments                                                     54




                Page i                         GAO-04-90 Pension Benefit Guaranty Corporation
Table
          Table 1: Key Legislative Changes to the Single-Employer Insurance
                   Program Since ERISA Was Enacted                                   45


Figures
          Figure 1: Flat- and Variable-Rate Premium Income for the Single-
                   Employer Pension Insurance Program, Fiscal Years 1975-
                   2002                                                              10
          Figure 2: Participants and Plans Covered by the Single-Employer
                   Insurance Program, 1980-2002                                      11
          Figure 3: Market Value of Single-Employer Program Assets in
                   Revolving and Trust Funds at Year End, Fiscal Years 1990-
                   2002                                                              13
          Figure 4: Total Return on the Investment of Single-Employer
                   Program Assets, Fiscal Years 1990-2002                            14
          Figure 5: Assets, Liabilities, and Net Position of the Single-
                   Employer Pension Insurance Program, Fiscal Years 1976-
                   2002                                                              16
          Figure 6: Assets, Liabilities, and Funded Status of the Bethlehem
                   Steel Corporation Pension Plan, 1992-2002                         18
          Figure 7: Total Return on Stocks in the S&P 500 Index, Calendar
                   Years 1992-2002                                                   19
          Figure 8: Interest Rates on Long-Term High-Quality Corporate
                   Bonds, 1990-2002                                                  21
          Figure 9: PBGC Premium and Investment Income, 1976-2002                    28
          Figure 10: Distribution of PBGC-Insured Participants by Industry,
                   2001                                                              30
          Figure 11: Average Termination and Current Liability Funding
                   Ratios for Plans Submitting Termination Liability Data to
                   PBGC under Section 4010 of ERISA, Plan Years 1996 –
                   2001                                                              50
          Figure 12: PBGC Termination, and Highest and Lowest Current
                   Liability, Interest Rates, 1996-2002                              52




          Page ii                         GAO-04-90 Pension Benefit Guaranty Corporation
Abbreviations

EBSA              Employee Benefits Security Administration 

ERISA             Employee Retirement and Income Security Act 

IRC               Internal Revenue Code 

IRS               Internal Revenue Service 

OMB               Office of Management and Budget 

PIMS              Pension Insurance Modeling System

PBGC              Pension Benefit Guaranty Corporation 

SAR               Summary Annual Report 

SARS              Severe Acute Respiratory Syndrome 

S&P 500           Standard and Poor’s 500 





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Page iii                               GAO-04-90 Pension Benefit Guaranty Corporation
United States General Accounting Office
Washington, DC 20548




                                   October 29, 2003 


                                   The Honorable John Boehner 

                                   Chairman 

                                   Committee on Education and the Workforce 

                                   House of Representatives 


                                   The Honorable Sam Johnson 

                                   Chairman 

                                   Subcommittee on Employer-Employee Relations

                                   Committee on Education and the Workforce 

                                   House of Representatives 


                                   The Pension Benefit Guaranty Corporation’s (PBGC) single-employer 

                                   insurance program is a federal program to insure 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 program’s finances 

                                   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.2 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 





                                   1
                                    A defined-benefit plan promises a benefit that is generally based on an employee’s salary
                                   and years of service. The employer is responsible for funding the benefit, investing and
                                   managing plan assets, and bearing the investment risk. In contrast, under a defined
                                   contribution plan, benefits are based on the contributions to and investment returns on
                                   individual accounts, and the employee bears the investment risk. There are two federal
                                   insurance programs for defined-benefit plans: one for single-employer plans and another
                                   for multiemployer plans. Our work was limited to the PBGC program to insure the benefits
                                   promised by single-employer defined-benefit pension plans. Single-employer plans provide
                                   benefits to employees of one firm or, if plan terms are not collectively bargained,
                                   employees of several unrelated firms.
                                   2
                                    PBGC estimates that its deficit had grown to about $8.8 billion at the end of August 2003
                                   based on its latest unaudited financial report.



                                   Page 1                                  GAO-04-90 Pension Benefit Guaranty Corporation
liabilities from ongoing plans that were sponsored by financially weak
companies and may terminate.3

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. This report highlights 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, we addressed the following
issues: (1) what factors contributed to recent changes in the single-
employer pension insurance program’s financial condition, (2) what are
the risks to the program’s long-term financial viability, and (3) what
changes to the program 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. 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,



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




Page 2                                   GAO-04-90 Pension Benefit Guaranty Corporation
                   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. We performed our work from
                   April through September 2003 in accordance with generally accepted
                   government auditing standards. Our scope and methodology are explained
                   more fully in appendix I.


                   The termination, or expected termination, of several severely underfunded
Results in Brief   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 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.


                   Page 3                           GAO-04-90 Pension Benefit Guaranty Corporation
               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
               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 of the plan’s investment
               portfolio, the plan’s benefit structure, and participant demographics.

               Because the magnitude and uncertainty of the long-term financial risks
               pose particular challenges for the PBGC’s single-employer insurance
               program and the protection of the retirement security of millions of
               American workers and retirees, this report considers a matter for
               congressional consideration regarding several reforms that might be
               considered to reduce the risks to the single-employer program’s long-term
               financial viability.


               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 had no guarantees that they would receive
               the benefits promised. When Studebaker’s pension plan failed in the
               1960s, for example, many plan participants lost their pensions.4 Such
               experiences prompted the passage of ERISA to better protect the
               retirement savings of Americans covered by private pension plans. Along
               with other changes, ERISA established PBGC to pay the pension benefits
               of participants, subject to certain limits, in the event that an employer
               could not.5 ERISA also required PBGC to encourage the continuation and


               4
                The company and the union agreed to terminate the plan along the lines set out in the
               collective bargaining agreement: retirees and retirement-eligible employees over age
               60 received full pensions and vested employees under age 60 received a lump-sum payment
               worth about 15 percent of the value of their pensions. Employees whose benefit accruals
               had not vested, including all employees under age 40, received nothing. James A. Wooten,
               “The Most Glorious Story of Failure in Business: The Studebaker–Packard Corporation and
               the Origins of ERISA.” Buffalo Law Review, vol. 49 (Buffalo, NY: 2001): 731.
               5
                Some defined-benefit plans are not covered by PBGC insurance; for example, plans
               sponsored by professional service employers, such as physicians and lawyers, with 25 or
               fewer employees.




               Page 4                                 GAO-04-90 Pension Benefit Guaranty Corporation
maintenance of voluntary private pension plans and to maintain premiums
set by the corporation at the lowest level consistent with carrying out its
obligations.6

Under ERISA, the termination of a single-employer defined-benefit plan
results in an insurance claim with the single-employer program if the plan
has insufficient assets to pay all benefits accrued under the plan up to the
date of plan termination.7 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 65.8 Additionally,
benefit increases in the 5 years immediately preceding plan termination
are not fully guaranteed, though PBGC will pay a portion of these
increases.9 The guarantee is limited to certain benefits, including so-called
shutdown 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. For example, sponsors could voluntarily


6
    See section 4002(a) of P.L. 93-406, Sept. 2, 1974.
7
 The termination of a fully funded defined-benefit pension plan is termed a standard
termination. Plan sponsors may terminate fully funded plans by purchasing a group annuity
contract from an insurance company under which the insurance company agrees to pay all
accrued benefits or by paying lump-sum benefits to participants if permissible. Terminating
an underfunded plan is termed a distress termination if the plan sponsor requests the
termination or an involuntary termination if PBGC initiates the termination. PBGC may
institute proceedings to terminate a plan if, among other things, the plan will be unable to
pay benefits when due or the possible long-run loss to PBGC with respect to the plan may
reasonably be expected to increase unreasonably if the plan is not terminated. See
29 U.S.C. 1342(a).
8
    The amount guaranteed by PBGC is reduced for participants under age 65.
9
 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 increase calculated in accordance with PBGC
regulations or (2) $20 per month. See 29 C.F.R. 4022.25(b).




Page 5                                       GAO-04-90 Pension Benefit Guaranty Corporation
terminate their underfunded plans only if they were bankrupt or generally
unable to pay their debts without the termination. Key amendments to
ERISA affecting the single-employer program are listed in appendix II.

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,10 and make additional
contributions to the plan if it is underfunded to the extent defined in the
law.11 As discussed in a report we issued earlier this year,12 concerns that
the 30-year Treasury bond rate no longer resulted in reasonable current




10
  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.
11
  Under the additional funding requirement rule, a single-employer plan sponsored by an
employer with more than 100 employees in defined-benefit plans is subject to a deficit
reduction contribution for a plan year if the value of plan assets is less than 90 percent of
its current liability. However, a plan is not subject to the deficit reduction contribution if
the value of plan assets (1) is at least 80 percent of current liability and (2) was at least
90 percent of current liability for each of the 2 immediately preceding years or each of the
second and third immediately preceding years. To determine whether the additional
funding rule applies to a plan, the IRC requires sponsors to calculate current liability using
the highest interest rate allowable for the plan year. See 26 U.S.C. 412(l)(9)(C).
12
 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).




Page 6                                    GAO-04-90 Pension Benefit Guaranty Corporation
liability calculations has led both the Congress and the administration to
propose alternative rates for these calculations.13

Despite the 1987 amendments to ERISA, concerns about PBGC’s financial
condition persisted. In 1990, as part of our effort to call attention to high-
risk areas in the federal government, we noted that weaknesses in the
single-employer insurance program’s financial condition threatened
PBGC’s long-term viability.14 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.15 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.16 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;17 in 2000, we
reported that contracting weaknesses at PBGC, if uncorrected, could


13
  In October 2003, the House passed the Pension Funding Equity Act of Act of 2003
(H.R. 3108), which for plan years beginning in 2004 and 2005 would temporarily change the
permissible range and interest rate for current liability calculations to not above and not
more than 10 percent below, the weighted average of a rate based on one or more 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. See appendix III.
14
  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.
15
 U.S. General Accounting Office, High-Risk Series: Pension Benefit Guaranty
Corporation, GAO/HR-93-5 (Washington, D.C.: Dec. 1992).
16
   U.S. General Accounting Office, High-Risk Series: An Overview, GAO/HR-95-1
(Washington, D.C.: Feb. 1995).
17
 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).




Page 7                                  GAO-04-90 Pension Benefit Guaranty Corporation
result in PBGC paying too much for required services;18 and this year, we
reported that weaknesses in the PBGC budgeting process limited its
control over administrative expenses.19

In 1997, we reported that the cash-based federal budget, which focuses on
annual cash flows, does not adequately reflect the cost or the economic
impact of federal insurance programs, including the single-employer
pension insurance program.20 This is true because, generally, cost is only
recognized in the budget when claims are paid rather than when the
commitment is made. The cost of pension insurance is further obscured in
the budget because while its annual net cash flows reduce the budget
deficit, PBGC’s growing long-term commitment to pay pension benefits
has no effect on the deficit. For example, the liabilities from terminated
underfunded pension plans taken over by PBGC are not recognized in the
budget. We concluded that the use of accrual concepts in the budget for
PBGC and other insurance programs has the potential to better inform
budget choices. We also stated, however, that agencies, such as PBGC,
might need to develop and test methodologies that would enable them to
generate reasonable and unbiased cost estimates of the risk assumed by
the government, which are critical to the successful implementation of
accrual-based budgeting for insurance programs.21 As such, as a first step
toward developing an accrual-based budget, we recommended that the
Office of Managemetn and Budget (OMB) encourage agencies to develop
methodologies and provide cost information on a risk-assumed basis in
the budget document along side the cash-based budget information it
currently provides. OMB agreed with our conclusions and noted that they
would like to pursue such improvements but was not doing so because it
did not have the expertise that would be required.




18
   U.S. General Accounting Office, Pension Benefit Guaranty Corporation: Contracting
Management Needs Improvement, GAO/HEHS-00-130 (Washington, D.C.: Sept. 18, 2000).
19
   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).
20
 U.S. General Accounting Office, Budget Issues: Budgeting for Federal Insurance
Programs, GAO/AIMD-97-16 (Washington D.C.: Sept. 30, 1997).
21
  In most cases, the risk-assumed approach would be analogous to a premium rate-setting
process in that it looks at the long-term expected cost of an insurance commitment at the
time the insurance commitment is extended. The risk assumed by the government is
essentially that portion of a full risk-based premium not charged to the insured.




Page 8                                  GAO-04-90 Pension Benefit Guaranty Corporation
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
during bankruptcy proceedings.22 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. Figure 1 shows that, 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.23 Income from the variable-
rate premium fluctuated widely over that period.




22
 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).
23
 In 2002 dollars, flat-rate premium income rose from $605 million in 1993 to $654 million in
2002.




Page 9                                  GAO-04-90 Pension Benefit Guaranty Corporation
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 10                                      GAO-04-90 Pension Benefit Guaranty Corporation
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, 2004.24

                                                        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




                                                        24
                                                             See section 405, P.L. 107-147, Mar. 9, 2002.




                                                        Page 11                                              GAO-04-90 Pension Benefit Guaranty Corporation
assets.25 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.)




25
  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 12                                 GAO-04-90 Pension Benefit Guaranty Corporation
Figure 3: Market Value of Single-Employer Program Assets in Revolving and Trust Funds at Year End, Fiscal Years 1990-2002

Market value (2002 dollars in billions)
25




20




15




10




 5




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

                                                                    Other

                                                                    Equities

                                                                    U.S. Government securities

Source: PBGC annual reports.

                                                        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 13                                         GAO-04-90 Pension Benefit Guaranty Corporation
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.26 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.27 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.




                                                26
                                                 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.
                                                27
                                                 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 14                                 GAO-04-90 Pension Benefit Guaranty Corporation
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
estimated that this deficit had grown to $8.8 billion by August 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 2002.28 Losses since that time may have shortened the
period over which the program will be able to cover promised benefits.




28
  The estimate assumes: (1) a rate of return on all PBGC assets of 5.8 percent and a
discount rate on future benefits of 5.67 percent; (2) no premium income and no future
claims beyond all plans with terminations that were deemed probable as of September 30,
2002; (3) administrative expenses of $225 million in fiscal year 2003, $229 million per year
for fiscal years 2004-14, 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 15                                 GAO-04-90 Pension Benefit Guaranty Corporation
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
                                                have been promised to plan participants if plants or companies ceased
Decline of Single-                              operations.29 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



                                                29
                                                 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 16                                   GAO-04-90 Pension Benefit Guaranty Corporation
                             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 reported in PBGC
Responsibility for Several   annual reports increased from $705 million in fiscal year 2001 to
Severely Underfunded         $9.3 billion in fiscal year 2002. In addition to $3.0 billion in losses from the
                             unfunded liabilities of terminated plans, the $9.3 billion included
Plans in 2002                $6.3 billion in losses from the unfunded liabilities of plans that were
                             expected to terminate in the near future. Nearly all 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


                             Page 17                            GAO-04-90 Pension Benefit Guaranty Corporation
plan termination in December 2002, however, plan funding fell to
45 percent as assets decreased and liabilities increased, and sponsor
contributions were not sufficient to offset the changes.

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

          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 18                                             GAO-04-90 Pension Benefit Guaranty Corporation
                                                indicated that defined-benefit plans in general had about 62.8 percent of
                                                their assets invested in U.S. and international stocks in 1999.30

Figure 7: Total Return on Stocks in the S&P 500 Index, Calendar Years 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,31
                                                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.32 Over that same general period, stocks in the S&P 500 had a
                                                negative return of 38 percent.



                                                30
                                                     2002 U.S. Investment Management Study, Greenwich Associates, Greenwich, Conn.
                                                31
                                                     Pensions & Investments, vol. 29, Issue 2 (Chicago: Jan. 22, 2001).
                                                32
                                                  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 19                                     GAO-04-90 Pension Benefit Guaranty Corporation
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.33 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.34

Relevant interest rates may have declined 3 percentage points or more
since 1990.35 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.)




33
  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.
34
 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.
35
   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 20                                  GAO-04-90 Pension Benefit Guaranty Corporation
Figure 8: Interest Rates on Long-Term High-Quality Corporate Bonds, 1990-2002

Interest rate (percent)
10



 9



 8



 7



 6



 5




 0
Jan.-90        Jan.-91        Jan. -92   Jan. -93   Jan. -94      Jan. -95   Jan. -96   Jan. -97   Jan. -98   Jan. -99   Jan. -00   Jan. -01   Jan. -02
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.36 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.37 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
                                                         funding rules. Therefore, sponsors of underfunded plans may avoid or



                                                         36
                                                           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.
                                                         37
                                                              For the analysis, PBGC used termination liabilities reported to it under 29 C.F.R. sec 4010.




                                                         Page 21                                       GAO-04-90 Pension Benefit Guaranty Corporation
     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.38

     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.

     As shown in appendix IV, changes in the interest rates used to calculate
     termination and current liabilities also play a role in determining to what
     extent termination liabilities differ from current liabilities.

     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


     38
          See 26 U.S.C. 412(b).




     Page 22                           GAO-04-90 Pension Benefit Guaranty Corporation
of plan year 1996. Starting in 1997, Bethlehem Steel reduced its
contributions to the plan and, according to annual reports, contributed
only about $71.3 million for plan years 1997 through 2001. The plan’s
2001 actuarial report indicates that Bethlehem Steel’s minimum required
contribution for the plan year ending December 31, 2001, would have been
$270 million in the absence of a credit balance; however, the opening
credit balance in the plan’s funding standard account as of January 1, 2001,
was $711 million. Therefore, Bethlehem Steel was not required to make
any cash 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.39 In July 2002, PBGC terminated the Polaroid
pension plan, and the single-employer program assumed responsibility for
$321.8 million in unfunded PBGC-guaranteed liabilities for the plan. The
plan was about 67 percent funded, with assets of about $657 million to pay
estimated PBGC-guaranteed liabilities of about $979 million.

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




39
  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 23                                   GAO-04-90 Pension Benefit Guaranty Corporation
                             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 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 2002.40 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


                             40
                                  2002 U.S. Investment Management Study, Greenwich Associates, Greenwich, CT.




                             Page 24                                  GAO-04-90 Pension Benefit Guaranty Corporation
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.41 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.42 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
2001.43




41
  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.
42
   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.
43
 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 25                                   GAO-04-90 Pension Benefit Guaranty Corporation
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.44 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.45




44
  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.
45
 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 26                                 GAO-04-90 Pension Benefit Guaranty Corporation
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.)




                             Page 27                         GAO-04-90 Pension Benefit Guaranty Corporation
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 2002.46 While the number of total participants in


                                                46
                                                  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 28                                   GAO-04-90 Pension Benefit Guaranty Corporation
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 leaving the program by 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.47
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.




47
  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 29                                 GAO-04-90 Pension Benefit Guaranty Corporation
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 30                                    GAO-04-90 Pension Benefit Guaranty Corporation
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.48

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 could improve if its total net return on invested assets exceeded
the discount rate it used to value its liabilities.49 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.50 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


48
 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.
49
 PBGC’s investment income needs to cover the increase in the present value of future
benefits from existing claims. Investment income above this level would improve PBGC’s
net financial condition, all else equal. Conversely, investment income below the present
value of future claims will increase PBGC’s deficit, all else equal.
50
 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 31                                  GAO-04-90 Pension Benefit Guaranty Corporation
                           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.

                           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.


                           Several types of reforms might be considered to reduce the risks to the
Several Reforms            single-employer program’s long-term financial viability. These reforms
Might Reduce the           could be made to
Risks to the          •    strengthen funding rules applicable to poorly funded plans;
Program’s Financial
                      •    modify program guarantees;
Viability
                      •    restructure premiums; and

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

                           Several variations exist within these options.




                           Page 32                           GAO-04-90 Pension Benefit Guaranty Corporation
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
Reduce Program Risks        plans.51 This approach would improve plan funding over time, while
                            limiting the losses PBGC would incur when a plan is terminated. However,
                            even if funding rules were to be strengthened immediately, it could take
                            years for the change to have a meaningful effect on PBGC’s financial
                            condition. In addition, such a change would require some sponsors to
                            allocate additional resources to their pension plans, which may cause the
                            plan sponsor of an underfunded plan to provide less generous 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 regarding deficit reduction contributions 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



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




                            Page 33                                   GAO-04-90 Pension Benefit Guaranty Corporation
     liabilities. As we reported, selecting an appropriate interest rate for
     termination liability calculations is difficult because little information
     exists on which to base the selection.52

•	   Change requirement for making additional funding contributions. 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 cash
     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.53 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




     52
          GAO-03-313.
     53
      The administration’s proposal would require companies with below investment grade
     credit ratings whose plans are less than 50 percent funded on a termination basis to
     immediately fully fund or secure any new benefit improvements, benefit accruals or lump-
     sum distributions.




     Page 34                                GAO-04-90 Pension Benefit Guaranty Corporation
                            more to their plan than is necessary to cover accrued future benefits.54
                            Raising these limitations might result in pension plans being better funded,
                            decreasing the likelihood that they will be underfunded should they
                            terminate. 55

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.56
                            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



                            54
                             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.
                            55
                               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.
                            56
                              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.




                            Page 35                                  GAO-04-90 Pension Benefit Guaranty Corporation
                          plans that are less than 60 percent funded.57 Increasing this threshold, or
                          restricting benefit increases or accruals when plans reach the threshold,
                          could decrease the losses incurred by PBGC from underfunded plans. Plan
                          sponsors have said that the disadvantage of such changes is that they
                          would limit an employer’s flexibility with regard to setting compensation,
                          making it more difficult to respond to labor market developments. For
                          example, a plan sponsor might prefer to offer participants increased
                          pension payments or shutdown benefits instead of offering increased
                          wages because pension benefits can be deferred—providing time for the
                          plan sponsor to improve its financial condition—while wage increases
                          have an immediate effect on the plan sponsor’s financial condition.


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 prompt financially healthy companies to exit
                          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,58 shutdown benefit, and floor-offset provisions.59 One
                               advantage of a rate increase or restructuring is that it might improve



                          57
                           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).
                          58
                           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.
                          59
                           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 36                                  GAO-04-90 Pension Benefit Guaranty Corporation
                                  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.

                             •	   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. Information on the
                                  allocation of plan investments among asset classes—such as equity or
                                  fixed income—is available from Form 5500s prepared by plan
                                  sponsors, but that information is not affirmatively furnished to
                                  participants and beneficiaries. Additionally, some plan investments
                                  may be made through common and collective trusts, master trusts, and
                                  registered investment companies, and asset allocation information for
                                  these investments might need to be obtained from Form 5500s
                                  prepared by those entities or from their prospectuses. Improving the
                                  accessibility of plan asset allocation information may give plan
                                  sponsors an incentive to increase funding of underfunded plans or limit
                                  riskier investments. Moreover, only participants in plans below a
                                  certain funding threshold receive annual notices regarding the funding
                                  status of their plans, and the information plans must currently provide
                                  does not reflect how the plan’s assets are invested. One way to enhance
                                  notices provided to participants could be to include information on
                                  how much of plan assets are invested in the sponsor’s own securities.
                                  This would be of concern because should the sponsor becomes
                                  bankrupt, the value of the securities could be expected to drop



                             Page 37                            GAO-04-90 Pension Benefit Guaranty Corporation
     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 funding status of their plans.60 As a result, many plan
     participants, including participants of the Bethlehem Steel pension
     plan, did not receive such notifications in the years immediately
     preceding the termination of their plans. Expanding the circumstances
     under which sponsors must notify participants of plan underfunding
     might give sponsors an additional incentive to increase plan funding
     and would enable more participants to better plan their retirement.
     Under the administration’s proposal, all sponsors would be required to
     disclose the value of pension plan assets on a termination basis in their
     annual reporting. The administration proposes that all companies
     disclose the value of their defined benefit pension plan assets and
     liabilities on both a current liability and termination liability basis in
     their Summary Annual Report.61

•	   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 U.S. Airways plan was terminated in



60
   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.
61
   Participants and individuals receiving benefits from their plan must receive a Summary
Annual Report (SAR) from their plan’s administrator each year. The SAR summarizes the
plan’s financial status based on information that the plan administrator provides to the
Department of Labor on its annual Form 5500. This document must generally be provided
no later than 9 months after the close of the plan year.




Page 38                                 GAO-04-90 Pension Benefit Guaranty Corporation
                      2003, while the maximum PBGC-guaranteed benefit at age 60 is $28,600
                      per year.62 Expanding the circumstances under which plan sponsors
                      must notify participants of PBGC guarantees may enable more
                      participants to better plan for their retirement.

               Additionally, in 1997, we reported that the current cash-based budget for
               federal insurance programs, such as the single-employer pension
               insurance program generally provides incomplete and misleading
               information on the cost and fiscal impact of those programs.63 We stated
               that accrual-based reporting would recognize the cost of the insurance
               commitment when the decision is made to provide the insurance,
               regardless of when the cash flows occur. This earlier recognition of the
               cost of the government’s commitment would, among other things, provide
               an opportunity to control costs and build budget reserves for future
               claims. However, we also reported that agencies, such as PBGC, might
               need to develop and test methodologies to generate the risk-assumed cost
               estimates critical to the successful implementation of accrual-based
               budgeting for insurance programs. In its comments on our report, OMB
               stated that, while it agreed with our conclusions and would like to pursue
               such improvements, it was not doing so because it did not have the
               expertise that would be required. Given the record losses that the single-
               employer pension insurance program sustained in 2002 and the
               deteriorating financial condition of PBGC it is more important than ever to
               acquire the necessary expertise and invest in the development of loss
               estimation methodologies and tools.


               While the recent decline in the single-employer program’s financial
Conclusion 	   condition is not an immediate crisis, threats to the program’s long-term
               viability should be addressed. The insolvency of PBGC potentially


               62
                 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.: Apr. 1, 2003).
               63
                    GAO/AIMD-97-16, 143.




               Page 39                                 GAO-04-90 Pension Benefit Guaranty Corporation
threatens the retirement security of millions of Americans because
termination of severely underfunded plans can significantly reduce the
benefits participants receive. It also poses risks to the general taxpaying
public who ultimately would be made responsible for paying benefits that
PBGC is unable to afford. These risks require that meaningful, if perhaps
difficult, steps be taken that improve the long-term funding status of plans
and accountability of plan sponsors, especially those that represent a clear
risk to PBGC and plan participants and their beneficiaries. In contrast,
reforms intended to provide immediate relief to struggling plan sponsors—
such as exempting plans from the additional funding requirement or
increasing the discount rate—might actually increase the risk that plan
sponsors terminate with severely underfunded plans in the not so distant
future if the economic fortunes of those sponsors do not improve.

The factors contributing to the deterioration of PBGC’s financial condition
go beyond the effects of the recent economic downturn. For example,
current funding rules do not provide adequate protection to PBGC or
workers and retirees against losses from financially weak sponsors with
significantly unfunded benefits, leaving PBGC to pay benefits at least to
guaranteed levels. In addition, PBGC guarantees other types of benefits,
such as shutdown benefits, that employers have promised their employees
but are not required to fund until shutdown occurs. Furthermore, the
premiums paid by pension sponsors to participate in the single-employer
program do not account for all the risks posed by plans and, therefore,
some sponsors may not be paying enough to compensate PBGC for the
risks it undertakes. Although these issues can affect employee retirement
funds, employers who are going bankrupt may not be required to notify
pension participants of the funding status of their pensions, leaving
participants unable to plan for a future that may include less income than
they were anticipating.

In addition to the reforms in the administration’s proposal, the Treasury
Department, Labor Department, and PBGC are considering several areas—
funding rules, actuarial assumption, and other areas such as PBGC
premiums—for reform. However, the challenges facing PBGC suggest that
a broader, more comprehensive response is needed. For example, as we
stated in an earlier report,64 the interest rate used for current liability
calculation should reflect the group annuity purchase rate. However, any
changes to the interest rate should consider related provisions such as


64
     GAO-03-313.




Page 40                          GAO-04-90 Pension Benefit Guaranty Corporation
                  averaging, minimum and maximum rates, and changes to the mortality
                  table. Furthermore, irrespective of the discount rate chosen, differences in
                  plan cash flows should be given consideration in making any changes to
                  the current funding standards. Without a comprehensive approach, efforts
                  to improve the long-term financial condition of PBGC may not be
                  effective.


                  Given the multidimensional and serious nature of the financial risks to
Matters for       PBGC’s single-employer insurance program, to millions of pension plan
Congressional     participants and potentially to the federal budget, the Congress should
                  consider pension reform that is comprehensive in scope and balanced in
Consideration     effect. Such a comprehensive response should include changes to
                  strengthen plan funding, especially for underfunded plans, and improve
                  the transparency of plan information as well as consider proposals to
                  restructure program guarantees, for example those concerning shutdown
                  benefits. In addition, PBGC’s premium structure should be re-examined to
                  see whether premiums can better reflect the risk posed by various plans to
                  the pension system. In any case, reforms in these areas should be based on
                  a thorough analysis of their effects on the potentially competing interests
                  of protecting retirees’ pensions and minimizing the burden on sponsors.

                  Essential elements of this reform would include proposals to require plans
                  to calculate liabilities on a termination basis and disclose this information
                  to all participants annually. Particularly with regard to disclosure, the
                  Congress should consider requiring that all participants receive
                  information about plan investments and the minimum benefit amount that
                  PBGC guarantees should their plan be terminated.

                  To improve the transparency of the potential cost to the government and
                  taxpayers of the PBGC’s pension guarantees, the Congress may also wish
                  to encourage the development and reporting of accrual based risk-
                  assumed cost estimates in the federal budget in conjunction with the
                  current cash-based estimates. Such forward looking estimates could more
                  clearly reflect the financial condition of the program and provide
                  information and incentives necessary to assess the future implications of
                  programmatic decisions.


                  We provided a draft of this report to Labor, Treasury, and PBGC. PBGC
Agency Comments   also provided written comments, which appear in appendix V, that
                  incorporate comments from the Treasury and Labor Departments and
                  represent the views of the Commerce Department. Labor, Treasury, and


                  Page 41                           GAO-04-90 Pension Benefit Guaranty Corporation
PBGC also provided technical comments, which we incorporated as
appropriate.


We are sending copies of this report to the Secretary of Labor, the
Secretary of the Treasury, and the Executive Director of the PBGC,
appropriate congressional committees, and other interested parties. We
will also make copies available to others on request. In addition, the report
will be available at no charge on GAO’s Web site at http://www.gao.gov.

If you have any questions concerning this report, please contact me at
(202) 512-7215 or Charles A. Jeszeck at (202) 512-7036. Other contacts and
acknowledgments are listed in appendix VI.




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




Page 42                           GAO-04-90 Pension Benefit Guaranty Corporation
Appendix I: Scope and Methodology 



              To identify the changes in the financial condition of the single-employer
              program, we reviewed and analyzed Pension Benefit Guaranty
              Corporation (PBGC) financial statements for 1991 through 2002, and
              obtained additional financial information on the program from PBGC for
              1974 through 1990. 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. We also reviewed analyses of the program’s financial
              condition and plan funding issues prepared by actuaries and other pension
              professionals. To examine the difference between termination and current
              liability, and identify the factors that cause that difference, we obtained
              summary level termination liability data, and limited data for specific
              plans, submitted by plans to PBGC under section 4010 of the Employee
              Retirement and Income Security Act (ERISA) of 1974, as amended.

              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 (EBSA) of the Department of Labor, and in the private
              sector and reviewed analyses and other documents provided by them.
              These include data on PBGC’s income, cash flows, premium structure and
              base, investments, and assets and liabilities. 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 to the single-employer program might be
              considered to reduce the risks that it faces, we reviewed and analyzed
              proposals from the administration, the American Academy of Actuaries,
              and various pension plan organizations and legislative proposals
              introduced during the 108th Congress. We also spoke with officials from
              PBGC, EBSA, and the Department of the Treasury; research actuaries; and
              individuals from organizations that represent plan sponsors.




              Page 43                           GAO-04-90 Pension Benefit Guaranty Corporation
Appendix I: Scope and Methodology




We performed our work at PBGC and EBSA from April through September
2003 in accordance with generally accepted government auditing
standards.




Page 44                             GAO-04-90 Pension Benefit Guaranty Corporation
Appendix II: Key Legislative Changes That
Affected the Single-Employer Program

                                               As part of the ERISA, the Congress established 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 P.L. 99-272          Raised the flat-rate premium and established financial distress
            Act of 1986 enacted as Title XI of the                       criteria that sponsoring employers must meet to terminate an
            Consolidated Omnibus Budget                                  underfunded plan.
            Reconciliation Act of 1985
 1987       Pension Protection Act enacted as part of    P.L. 100-203    Increased the flat-rate premium and added a variable-rate
            the Omnibus Budget Reconciliation Act of                     premium for underfunding calculated on the basis of 80 percent
            1987                                                         of the 30-year Treasury rate. In addition, established a
                                                                         permissible range of 90-110 percent around the weighted
                                                                         average the 30-year Treasury rate as the basis for current
                                                                         liability calculations, increased the minimum funding standards,
                                                                         and established a full-funding limitation based on 150 percent of
                                                                         current liability.
 1994       Retirement Protection Act enacted as part of P.L. 103-465    Raised the basis for variable-rate premium calculation from 80
            the Uruguay Rounds Agreements Act, also                      percent to 85 percent of the 30-year Treasury rate (effective July
            referred to as the General Agreement on                      1997). Phased out the cap on the variable-rate premium.
            Tariffs and Trade                                            Strengthened funding requirements by narrowing the permissible
                                                                         range of the allowable interest rates to 90-105 percent of the
                                                                         weighted average the 30-year Treasury rate and standardizing
                                                                         mortality assumptions for the current liability calculation. Also,
                                                                         established 90 percent of current liability as the minimum full-
                                                                         funding limitation.
 1997       Taxpayer Relief Act of 1997                  P.L. 105-34     Phased in increases in the current liability funding limit to155
                                                                         percent for plan years beginning in 1999 with incremental
                                                                         increases to 170 percent for plan years beginning in 2005.
 2001       The Economic Growth and Tax Relief           P.L. 107-16     Accelerated the phasing out of the 160 percent full-funding
            Reconciliation Act of 2001                                   limitation and repealed it for plan years beginning in 2004 and
                                                                         thereafter.
 2002       The Job Creation and Worker Assistance       P.L. 107-147    Temporarily expanded the permissible range of the statutory
            Act of 2002                                                  interest rates to 90-120 percent of the weighted average 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.




                                               Page 45                                  GAO-04-90 Pension Benefit Guaranty Corporation
Appendix III: The Administration Proposal
for Pension Reform

              On July 8, 2003, the U.S. Treasury Department announced “The
              Administration Proposal to Improve the Accuracy and Transparency of
              Pension Information.” The proposal presented four areas of change in
              order to improve pension security for Americans: (1) the accuracy of the
              pension liability discount rate, (2) the transparency of pension plan
              information, (3) safeguards against pension underfunding, and
              (4) comprehensive funding reforms. Subsequent congressional testimony
              by the Treasury Department and the U.S. Labor Department highlighted
              other areas of the pension system that the administration is considering
              reforming.

              1. Improving the Accuracy of the Pension Liability Discount Rate

              Sponsors must use a discount rate to calculate the current value of their
              plans’ pension obligations and of lump-sum withdrawals.1 Currently, this
              rate is based on the rate of 30-year Treasury bonds, securities that have
              not been newly issued since 2001. There is concern that too high a
              discount rate would lead to pension underfunding, while too low a rate
              would cause businesses to have to put more money into their pension
              funds to pay promised benefits. The administration recommended
              replacing the 30-year Treasury bond rate with a yield curve based on high-
              quality, long-term corporate bond rates. It claims that pension discount
              rates should reflect the risk embodied in assets held by insurance
              companies to make group annuity payments, and that these assets consists
              largely of highly rated corporate-issued bonds.

              Similarly, the administration proposed using the same yield curve to
              discount lump-sum distributions from plans. Currently, lump sums are
              calculated using the 30-year Treasury rate, a rate that may differ from the
              one used to calculate current plan liabilities. The administration proposal
              would have plans discounting lump sums and plan liabilities at the same
              rate. For both lump sums and liabilities, the administration proposes
              phasing in the yield curve beginning in the third year, with the phase-in
              complete by the fifth year.

              Sponsors would compute liabilities by choosing rates along the yield curve
              based on when the plan is due to make benefit payments. Thus, sponsors
              would discount benefits due farther in the future at a longer-term rate than
              those paid in the near future. Since long-term rates tend to exceed short-


              1
                  GAO-03-313.




              Page 46                          GAO-04-90 Pension Benefit Guaranty Corporation
Appendix III: The Administration Proposal
for Pension Reform




term rates, this would imply that plans with a higher proportion of older
workers and retirees would use lower rates to discount their liabilities
than those with younger workers. Similarly, the proposal would also have
plans use a discount rate along the yield curve for lump sums that reflects
the life expectancy of retirees, with lump sums for older workers
discounted at a shorter-term rate than those for younger workers.

To further increase pension discount rate accuracy, the administration
further proposed reducing the use of smoothing in calculating plan
liabilities. Sponsors currently use a discount rate on plan liabilities based
on a 4-year moving average of interest rates. The administration claimed
that such smoothing reduces the accuracy of liability measures because
the discount rate is not necessarily based on current market conditions,
which may mask changes in plan solvency. The proposal would reduce the
smoothing period, over a 3-year phase-in beginning in the third year, to a
90-day moving average.

2. Increasing the Transparency of Pension Plan Information

To increase transparency, the administration proposal calls for plans to
disclose liabilities on a termination basis, as well as on a current liability
basis, in their annual reporting. Currently, a sponsor must disclose its
plan’s current liability, which is intended to reflect the value of liabilities in
an ongoing plan, using a discount rate based on the 30-year Treasury bond
rate. Termination liability reflects the cost to a company of paying an
insurer to meet its pension obligations should the plan terminate. This is
calculated by using a PBGC interest factor, which is based on a survey of
insurance companies and may reflect group annuity purchase rates, rather
than by using the 30-year Treasury bond rate. Termination liability is often
higher than current liability.

The proposal would also have pension plans with more than $50 million of
underfunding make public their plan assets, liabilities, and funding ratios,
information that PBGC already collects. Currently, section 4011 of the
ERISA, as amended, requires that sponsors of plans that are less than
90 percent funded send notices to workers and retirees describing the
plan’s funding status and the limits of PBGC guarantees.2



2
 In addition, section 4010 of ERISA requires that plan sponsors with more than $50 million
in plan underfunding file annual financial and actuarial information with PBGC, though this
information is not made public.




Page 47                                 GAO-04-90 Pension Benefit Guaranty Corporation
Appendix III: The Administration Proposal
for Pension Reform




The proposal would also have plans disclose liabilities calculated by using
a duration-matched yield curve, even before the yield curve is fully phased
in for funding purposes. That is, sponsors would disclose the value of their
liabilities by using a discount rate on the yield curve that reflects the
duration of its plan liabilities, with a plan with more benefits owed far in
the future using a longer-term discount rate than one with more benefits
owed in the near future.

3. Strengthening Safeguards against Pension Underfunding

Currently, a plan generally may not provide unfunded or unsecured benefit
increases greater than $10 million if the plan’s funding ratio falls below
60 percent of current liability. To strengthen pension funding, the
administration proposed prohibiting benefit increases by the plan
sponsored by firms with a credit rating below investment grade and with
a funding ratio below 50 percent of termination, as opposed to current
liability. In addition, the plan would also be frozen—with no accruals
resulting from additional service, age or salary growth—and lump-sum
payments would also be prohibited unless the employer contributed cash
or provided security to fully fund any added benefits. For firms already in
bankruptcy, the administration would fix the benefit guarantee as of the
date the plan sponsor filed for bankruptcy.

4. Supporting Comprehensive Funding Reforms

In addition to the reforms above, the proposal states that the
administration is exploring additional reforms to improve the funding
status of defined benefit plans. These include:

•	  Changing rules regarding minimum contributions of underfunded
    plans.
• Raising limits on tax-deductible contributions.
• Limiting the use of credit balances.
• Reducing new benefit amortization periods.
• Updating mortality tables.
• Making retirement assumptions accurate.
• Making lump-sum estimates accurate.
• Limit or eliminate certain unfunded benefit guarantees.
• Restructuring PBGC premiums to reflect risk.
• 	 Applying the same principles of accuracy and transparency to the
    multiemployer pension program.




Page 48                                GAO-04-90 Pension Benefit Guaranty Corporation
                  Appendix IV: Differences in I   rest Rate

Appendix IV: Differences in Interest Rate
Calculations Contribute to Differences
between Termination and Current Liabilities
                  A plan’s termination liability measures the value of accrued benefits using
                  assumptions appropriate for a terminating plan, while its current liability
                  measures the value of accrued benefits using assumptions specified in
                  applicable laws and regulations. Interest rates are a key assumption in
                  calculating the present value of future pension benefits, and the degree
                  that the interest rates used to calculate termination and current liabilities
                  differ would contribute to the degree that the two liability measures differ.
                  Generally:

             •	   Liabilities determined on a termination basis should be calculated using an
                  interest rate that reflects the factors that insurance companies consider in
                  pricing the group annuities they sell to pension plan sponsors who
                  terminate their defined benefit plans. However, information needed to
                  determine actual group annuity purchase rates is not available since
                  annuity purchases are private transactions between insurance companies
                  and purchasers. Instead, under PBGC regulations, sponsors who are
                  required by ERISA, as amended, to report plan termination liability
                  information to PBGC, calculate that liability using a rate published by
                  PBGC.1 PBGC determines that rate based on surveys of insurance
                  companies performed by the American Council of Life Insurers.

             •	   Current liabilities are to be calculated using an interest rate from within a
                  range of permissible rates based on 30-year Treasury rates, as specified in
                  the Internal Revenue Code.2

                  Figure 11 shows that funding ratios using termination liabilities were
                  typically lower than funding ratios using current liabilities, for plans
                  reporting termination liabilities to PBGC under section 4010 of ERISA, as
                  amended. In 1996, for example, the average funding ratio based on
                  termination liability was 69 percent, but the average funding ratio based




                  1
                   Sponsors are required to provide PBGC with termination liability information if, among
                  other things, the aggregate unfunded vested benefits at the time of the preceding plan year
                  of plans maintained by the contributing sponsor and the members of its controlled group
                  exceed $50 million, disregarding plans with no unfunded benefits. See 29 U.S.C. 1310(b).
                  Among the information to be provided to PBGC is the value of benefit liabilities determined
                  using the assumptions applicable to the valuation of benefits to be paid as annuities in
                  trusteed plans terminating at the end of the plan year. See 29 C.F.R. 4010(8)(d)(2).
                  2
                      See footnote 10.




                  Page 49                                 GAO-04-90 Pension Benefit Guaranty Corporation
Appendix IV: Differences in Interest Rate
Calculations Contribute to Differences
between Termination and Current Liabilities




on current liability was 99 percent.3 Termination liability funding ratios are
typically lower than current liability funding ratios because termination
liabilities are typically greater than current liabilities.

Figure 11: Average Termination and Current Liability Funding Ratios for Plans
Submitting Termination Liability Data to PBGC under Section 4010 of ERISA, Plan
Years 1996 –2001

Funding ratio
              99
100                                    97
                          95                       95
                                                                92
    90                                                                    86
                                                                     82
    80                                        75          74
                     71           72
         69
    70

    60

    50

    40

    30

    20

    10

    0
          1996        1997        1998         1999           2000   2001
         Plan year


                   4010 termination liability funding ratio

                   5500 current liability funding ratio

Source: PBGC.

Note: Current liability is reported as of the beginning of the plan year, and termination liability is
reported as of the end of the plan year. Therefore, in figure 11, current liability funding ratios are as of
the beginning of the plan year, and termination liabilities are as of the end of the preceding plan year.
As a result, any changes in plan benefits that went into effect at the beginning of a plan year would be
reflected in that year’s current liability funding ratio but not its termination liability funding ratio.
Funding ratios are calculated by dividing assets by liabilities.


Figure 12 shows that the PBGC rate used to calculate termination
liabilities, and the maximum and minimum rates used to calculate current


3
 We have reported averages for the plans submitting termination liability information to
PBGC, instead of ratios for specific plans, because ERISA generally precludes the
disclosure of the information submitted by plans to PBGC as part of the 4010 process. See
13 U.S.C. 1310(c).




Page 50                                                   GAO-04-90 Pension Benefit Guaranty Corporation
Appendix IV: Differences in Interest Rate
Calculations Contribute to Differences
between Termination and Current Liabilities




liabilities, varied considerably 1996 through 2001. In the first 3 years,
PBGC termination liability rates were typically less than current liability
rates, but in the following 2 years, termination liability rates were typically
higher than current liability rates. Lower interest rates result in higher
liability values, and higher rates result in lower liability values.4 As a result,
when the PBGC termination rate was high, relative to the current liability
rate, termination liabilities would be reduced relative to current liabilities,
causing the gap between the two funding ratios to narrow, as it did in
2001.




4
 When interest rates are lower, for example, more money is needed today to finance future
benefits because it will earn less income when invested. To illustrate the effect of a change
in interest rates on the present value of a stream of future payments: at a 6 percent interest
rate, a promise to pay $1.00 per year for the next 30 years has a present value of about
$14. If the interest rate is reduced to 1.0 percent, however, the present value of $1.00 per
year for 30 years increases to about $26.




Page 51                                  GAO-04-90 Pension Benefit Guaranty Corporation
Appendix IV: Differences in Interest Rate
Calculations Contribute to Differences
between Termination and Current Liabilities




Figure 12: PBGC Termination, and Highest and Lowest Current Liability, Interest
Rates, 1996-2002

Interest rate

8





7





6





5





0

1/1996           1/1997          1/1998        1/1999     1/2000        1/2001        1/2002

     Month

             PBGC termination liability rate
             Maximum current liability rate
             Minimum current liability rate
Source: PBGC and the IRS.

Note: PBGC published two rates, one for the first 20 to 25 years of a valuation period and another for
the remaining years. The figure shows the PBGC rate for the first part of the valuation period.




Page 52                                         GAO-04-90 Pension Benefit Guaranty Corporation
Appendix V: Comments from the Pension
Benefit Guaranty Corporation




         Page 53     GAO-04-90 Pension Benefit Guaranty Corporation
Appendix VI: GAO Contacts and Staff
Acknowledgments

                  Charles A. Jeszeck, Assistant Director (202) 512-7036
Contacts          Daniel F. Alspaugh, Analyst-in-Charge (425) 904-2177


                  In addition to those named above, Joseph Applebaum, Mark M. Glickman,
Staff             Corinna Nicolaou, David Noguera, John M. Schaefer, George A. Scott, and
Acknowledgments   Roger J. Thomas made important contributions to this report.




(130248)
                  Page 54                          GAO-04-90 Pension Benefit Guaranty Corporation
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