oversight

Pension Benefit Guaranty Corporation: Redesigned Premium Structure Could Better Align Rates with Risk from Plan Sponsors

Published by the Government Accountability Office on 2012-11-07.

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

                United States Government Accountability Office

GAO             Report to the Chairman, Committee on
                Health, Education, Labor, and
                Pensions, U.S. Senate


November 2012
                PENSION BENEFIT
                GUARANTY
                CORPORATION
                Redesigned Premium
                Structure Could Better
                Align Rates with Risk
                from Plan Sponsors




GAO-13-58
                                               November 2012

                                               PENSION BENEFIT GUARANTY CORPORATION
                                               Redesigned Premium Structure Could Better Align
                                               Rates with Risk from Plan Sponsors
Highlights of GAO-13-58, a report to the
Chairman, Committee on Health, Education,
Labor, and Pensions, U.S. Senate




Why GAO Did This Study                         What GAO Found
At the end of fiscal year 2011, PBGC           Various options are available to make the Pension Benefit Guaranty
insured the pension benefits of 44             Corporation’s (PBGC) premium structure more risk-based and better reflect the
million U.S. workers, retirees, and            risk of future claims. Historically, PBGC’s premiums have not fully reflected the
beneficiaries in about 27,000 private          risks PBGC insures against—chiefly that a plan sponsor with an underfunded
defined benefit plans. PBGC’s 2011             plan will become bankrupt, forcing the termination of the plan and imposing a
net accumulated deficit of $26 billion,        claim on PBGC. PBGC’s current structure relies largely on a flat-rate premium
coupled with future risks posed by plan        that is based on the number of plan participants and that assesses rates equally
sponsors and their plans, threatens            per plan participant across all sponsors. PBGC also charges a variable-rate
PBGC’s solvency. To help contain               premium that is based on just one risk factor, plan underfunding. One available
PBGC’s deficit, Congress recently              option is to further increase rates within this current structure; however, plan
passed legislation increasing PBGC             underfunding alone is a poor proxy for the risk of new claims. An alternative
premiums. Beyond simply increasing             option is to redesign premiums to incorporate additional risk factors, such as a
rates, the administration has proposed         sponsor’s financial strength (as currently being explored by PBGC) or a plan’s
granting PBGC authority to redesign its
                                               investment strategy (as is currently done in the United Kingdom).
premium structure to more fully reflect
the risk of new claims. To better              Moving to a more risk-based system would shift premium costs among sponsors.
understand the issues involved, GAO            To analyze the potential effects of different premium structures, PBGC developed
was asked to examine (1) the options           a model using data from a sample of about 2,700 plans. Under one possible
available to adjust premiums to                option explored by PBGC that incorporated an additional risk factor for a
improve PBGC’s financial condition; (2)        sponsor’s financial health, financially healthier sponsors would tend to pay less
the potential implications of adjusting        and financially riskier sponsors more—as much as $257 more per participant,
premiums; and (3) the potential                depending on their assigned risk level. Some pension experts and plan sponsors
implementation challenges in moving            we spoke with raised concerns about this potential redistribution of costs. For
to a more risk-based premium
                                               example, some believe that plan terminations would increase. However, prior
structure.
                                               work from GAO and others indicates that other factors—including sponsor size,
To conduct this work, GAO reviewed             collective bargaining agreements, and overall plan cost—are more important in
relevant legislation, analyzed PBGC            sponsors’ decisions to freeze their plans. Some pension experts and plan
premium data, and interviewed officials        sponsors also noted that a more risk-based system could lead to premium
implementing other risk-based                  increases during poor economic conditions when sponsors are least able to pay,
premium structures in this country and         and that it is inequitable for current sponsors to pay higher rates to address costs
the United Kingdom, as well as                 resulting from prior plan terminations. However, experts also made suggestions
numerous experts and plan sponsors             about how to address such concerns within a redesigned premium structure,
reflecting a broad spectrum of                 such as by capping premium levels and averaging sponsors’ funding levels over
perspectives on the topic.
                                               multiple years to reduce volatility.
What GAO Recommends                            The process of redesigning and implementing a more risk-based premium
                                               structure poses potential data and administrative challenges. To help address
GAO suggests that Congress consider
                                               these challenges, PBGC’s model could be further developed to evaluate the
revising PBGC’s premium structure to
better reflect the agency’s risk from          implications of incorporating additional risk factors, such as company financial
individual plans and sponsors, and             health and plan investment mix. Such efforts could include identifying any
recommends that PBGC further                   additional data needs, as well as exploring the effects on sponsors, including any
develop its analyses of possible               potentially disproportional hardships on smaller companies resulting from
redesign options. PBGC agreed with             redistributing higher rates to riskier sponsors based on a redesigned structure.
our recommendation.                            Although PBGC is uniquely situated to take on additional rate-setting
                                               responsibilities, if Congress were to relinquish some authority in this area, certain
                                               safeguards still may be required to help mitigate concerns about PBGC’s
View GAO-13-58. For more information,          governance, oversight, and transparency. These safeguards could include
contact Charles Jeszeck at (202) 512-7215 or
jeszeckc@gao.gov.
                                               additional congressional oversight, soliciting public feedback, and establishing an
                                               appeals process for sponsors who wish to challenge their assessment.
                                                                                        United States Government Accountability Office
Contents


Letter                                                                                1
               Background                                                             4
               Various Options Are Available for More Risk-Based Premiums            13
               Moving to a More Risk-Based Structure Shifts Premium Costs to
                 Riskier Sponsors                                                    26
               Moving to a Risk-Based Premium Structure Poses Various
                 Challenges                                                          38
               Conclusions                                                           47
               Matters for Congressional Consideration                               49
               Recommendation for Executive Action                                   50
               Agency Comments and Our Evaluation                                    50

Appendix I     Recent Legislation Related to the Pension Benefit Guaranty
               Corporation                                                           53



Appendix II    President’s Fiscal Year 2013 Budget Proposal for PBGC                 57



Appendix III   Further GAO Analyses of a Risk-Based Premium Option                   61



Appendix IV    The United Kingdom’s Pension Protection Fund’s Premium
               Structure                                                             64



Appendix V     Overview of Pension Benefit Guaranty Corporation’s Process for
               Calculating Its Deficit                                               68



Appendix VI    Overview of Pension Benefit Guaranty Corporation’s Pension
               Insurance Modeling System                                             75



Appendix VII   Plan Sponsors and Pension Experts Interviewed                         82




               Page i                                            GAO-13-58 PBGC Premiums
Appendix VIII   History of Pension Benefit Guaranty Corporation Premiums for the
                Single-Employer Program, Fiscal Years 1974 to 2012                    84



Appendix IX     Comments from Pension Benefit Guaranty Corporation                    85



Appendix X      GAO Contact and Staff Acknowledgments                                 88



Tables
                Table 1: Premium Rates under MAP-21                                   10
                Table 2: PBGC’s Risk Exposure                                         11
                Table 3: Various Estimates of PBGC’s Total Risk Exposure              12
                Table 4: Rates under MAP-21 Compared to a Hypothetical Option
                         to Adjust PBGC Premiums under the Current Structure          14
                Table 5: Different Options to Incorporate Additional Risk Factors
                         into Premiums                                                17
                Table 6: Total Premium Rates per Participant (Flat + Variable)
                         under a Hypothetical Risk-Based Option                       20
                Table 7: Hypothetical Risk-Based Option Premium Rates Compared
                         to Rates in Plan Year 2010 and in Plan Year 2015 under
                         MAP-21                                                       27
                Table 8: Options Suggested by Experts to Address PBGC’s Past
                         Deficit Costs                                                37
                Table 9: Preliminary Joint Committee on Taxation Score of
                         Revenue Changes Caused by Surface Transportation
                         Conference Report Related to Pension Funding
                         Stabilization and PBGC Premium Provisions, Fiscal Years
                         2012-2022                                                    56
                Table 10: Proposed Budget Savings Listed under PBGC                   58
                Table 11: Increase in Premium Rates for the Single-Employer
                         Program Estimated by PBGC for the President’s Fiscal
                         Year 2013 Budget, Fiscal Years 2013-2022                     59
                Table 12: Distribution of Plans by Financial Health and Funded
                         Status under a Hypothetical Risk-Based Option                61
                Table 13: Number and Percentage of Participants with Premium
                         Rate Changes under One Hypothetical Risk-Based Option        62
                Table 14: Number and Percentage of Plans with Premium Rate
                         Changes under One Hypothetical Risk-Based Option             63


                Page ii                                           GAO-13-58 PBGC Premiums
          Table 15: Components of the United Kingdom’s Pension Protection
                  Fund’s Premium Formula, Plan Year 2012/13                      65
          Table 16: Main Components of Assets and Liabilities Included in
                  PBGC’s Statements of Financial Condition                       69
          Table 17: PBGC Statements of Financial Condition for its Single-
                  Employer and Multiemployer Programs, Fiscal Year 2011          73


Figures
          Figure 1: PBGC’s Annual Premium Revenue Compared to New
                   Claims for the Single-Employer Program, Fiscal Years
                   2000-2011                                                      7
          Figure 2: Percentage of Sample Sponsors with Premium Rate
                   Changes under PBGC’s Hypothetical Risk-Based Option
                   Compared with Estimated Rates in Plan Year 2015 under
                   MAP-21                                                        29
          Figure 3: PBGC’s Surplus/Deficit for the Single-Employer Program,
                   Fiscal Years 1980-2011                                        74
          Figure 4: PBGC Actual and Projected Net Financial Position for the
                   Single-Employer Program, Fiscal Years 2001-2020               80




          Page iii                                           GAO-13-58 PBGC Premiums
Abbreviations

CAMELS            capital, asset quality, management, earnings, liquidity, and
                  sensitivity to market risk
CBO               Congressional Budget Office
DB                defined benefit
ERISA             Employee Retirement Income Security Act of 1974
FDIC              Federal Deposit Insurance Corporation
MAP-21            Moving Ahead for Progress in the 21st Century Act
PBGC              Pension Benefit Guaranty Corporation
PIMS              Pension Insurance Modeling System
PPA               Pension Protection Act of 2006
PPF               Pension Protection Fund
UK                United Kingdom




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Page iv                                                        GAO-13-58 PBGC Premiums
United States Government Accountability Office
Washington, DC 20548




                                   November 7, 2012

                                   The Honorable Tom Harkin
                                   Chairman
                                   Committee on Health, Education, Labor, and Pensions
                                   United States Senate

                                   Dear Mr. Chairman:

                                   The Pension Benefit Guaranty Corporation (PBGC) is a government
                                   corporation established under the Employee Retirement Income Security
                                   Act of 1974 (ERISA) 1 to protect the pension benefits of American
                                   workers. As of the end of fiscal year 2011, PBGC was responsible for
                                   insuring the benefits of nearly 44 million workers, retirees, and
                                   beneficiaries participating in about 27,000 private sector defined benefit
                                   (DB) plans, but faced an accumulated deficit of $26 billion. The bulk of
                                   this deficit ($23 billion) is attributable to PBGC’s single-employer
                                   program, 2 reflecting the disparity between the value of future benefits
                                   owed to participants of terminated plans insured under this program and
                                   the funds available to pay for these benefits. PBGC’s deficit has
                                   increased over the last decade—mostly due to the termination of a few
                                   large, underfunded single-employer DB plans, as well as investment
                                   losses and declines in interest rates following the economic downturn. At
                                   the same time, PBGC’s financial condition has been adversely affected
                                   by long-standing structural challenges—including a steady decline in the
                                   number of private employers sponsoring DB plans and a statutory
                                   premium structure that does not adequately reflect the risk of future
                                   claims from plan terminations. 3



                                   1
                                    Pub. L. No. 93-406, § 4002(a), 88 Stat. 829, 1004 (codified as amended at 29 U.S.C. §
                                   1302(a)).
                                   2
                                    PBGC administers two separate insurance programs: a single-employer program and a
                                   multiemployer program. The single-employer program, comprised of about 25,000 DB
                                   plans, insures each plan established and maintained by one employer. The much smaller
                                   multiemployer program, comprised of about 1,500 plans, insures plans that are arranged
                                   through collective bargaining between one or more labor unions and a group of employers
                                   in a particular trade or industry. This report focuses on the challenges facing PBGC’s
                                   single-employer program.
                                   3
                                    Generally speaking, a claim occurs when a plan sponsor with an underfunded plan goes
                                   bankrupt.




                                   Page 1                                                       GAO-13-58 PBGC Premiums
Congress has periodically increased premium rates for plan sponsors
within the current premium structure to help put the agency on a firmer
financial footing, most recently in the Pension Protection Act of 2006
(PPA) 4 and the Moving Ahead for Progress in the 21st Century Act (MAP-
21), enacted July 6, 2012. 5 Nevertheless, PBGC still faces a substantial
deficit from past claims and exposure to risk of losses from future claims
that could potentially lead to the agency’s insolvency.

One proposal to help address the agency’s deficit—specified in the
President’s fiscal year 2013 budget—would give PBGC the authority to
move to a more risk-based premium structure for plan sponsors
participating in the single-employer program. To gain a better
understanding of the advantages and disadvantages of such a proposal,
you asked us to examine (1) the options that are available to adjust
premiums to improve PBGC’s long-term financial condition, (2) the
potential implications of these options for plan sponsors and participants,
and (3) the potential implementation challenges in moving to a risk-based
premium structure.

To determine what options are available to adjust PBGC’s premium
structure to improve its future financial condition, we first reviewed
relevant federal laws pertaining to PBGC’s current premiums, including
increases to premiums made under MAP-21 (see app. I), and PBGC
policies for collecting premiums for the single-employer program. We then
reviewed the President’s proposal for more risk-based premiums (see
app. II), as well as various academic and policy papers that suggest other
approaches that might be considered in redesigning PBGC’s premium
structure. We also obtained data from a model PBGC developed to
illustrate different premium options. We assessed the validity of the
model’s formulas and assessed the reliability of the model’s data set of
2,699 plans. We used the model’s data set, which represented 81 percent
of the DB population in plan year 2010, to conduct further analyses of



4
    Pub. L. No. 109-280, 120 Stat. 780.
5
 Pub. L. No. 112-141, § 40221, 126 Stat. 404, 850-52 (2012). Although primarily about
funding highways, MAP-21 also included several pension-related provisions, requiring
changes to the funding rules for DB plan sponsors, strengthening PBGC governance
practices, as well as increasing premium rates for DB plans covered by PBGC’s single-
employer and multiemployer insurance programs. Pub. L. No. 112-141, § 40221, 126 Stat.
404, 846-59 (2012). (See app. I for more information on the pension-related provisions
included in MAP-21.)




Page 2                                                     GAO-13-58 PBGC Premiums
various options (see app. III). In addition, we interviewed PBGC officials
and other federal officials from the Department of Commerce, Federal
Deposit Insurance Corporation (FDIC), the Department of Labor (Labor),
and the Department of the Treasury about these options, as well as
pension officials from the United Kingdom’s (UK) Pension Protection
Fund (PPF)—an agency that provides benefit insurance to participants in
DB plans and charges risk-based premiums to plans sponsors in the UK
(see app. IV). 6 To better understand how PBGC determines its risk
exposure for future claims and losses, we obtained information about how
PBGC calculates its deficit (see app. V) and how PBGC uses the Pension
Insurance Modeling System (PIMS), one of the modeling tools the agency
uses to make estimates of its future financial condition and evaluate
premium options (see app. VI). While PBGC’s Inspector General found
problems with some detailed data generated by PIMS, 7 we reviewed the
PIMS data provided to us and conducted a meeting with PBGC officials to
discuss the reliability of these data. We determined that the PIMS data
provided to us and used by PBGC in its 2010 exposure report 8 were
sufficiently reliable to provide information on the approximate magnitude
of PBGC’s future financial condition and to generally understand the
mechanics of premium options.

To obtain information about the potential implications of different premium
options for plan sponsors and participants and the potential
implementation challenges of moving to a risk-based premium structure,
we interviewed a small judgmental sample of nine plan sponsors,
selected to reflect an array of characteristics including plan size, sponsor
financial condition, and union involvement. We also conducted interviews
with a broad range of pension experts including academics, actuaries,
business organizations, and labor officials. (See app. VII for a list of plan
sponsors and organizations we contacted.)


6
 We did not conduct independent legal analysis to verify the information about PPF’s
premium framework, but rather relied on a review of publicly available PPF documents
and discussions with PPF officials. See appendix IV for a description of the risk factors
PPF has incorporated into its premium structure in the UK.
7
 In May 2012, PBGC’s Inspector General released a report finding that PIMS lacks key
internal controls to ensure the integrity of the model’s reported results. See PBGC Office
of Inspector General, Ensuring the Integrity of Policy Research and Analysis Department’s
Actuarial Calculations, PA-12-87 (Washington, D.C.: May 2012).
8
 Pension Benefit Guaranty Corporation, 2010 PBGC Annual Exposure Report.
(Washington, D.C.: November 2011).




Page 3                                                          GAO-13-58 PBGC Premiums
             We conducted this performance audit between July 2011 and November
             2012 in accordance with generally accepted government auditing
             standards. Those standards require that we plan and perform the audit to
             obtain sufficient, appropriate evidence to provide a reasonable basis for
             our findings and conclusions based on our audit objectives. We believe
             the evidence obtained provides a reasonable basis for our findings and
             conclusions based on our audit objectives.


             PBGC was established under ERISA, in part, to insure the pension
Background   benefits of participants in qualified DB plans and pay participants up to
             certain statutory limits should their plans be terminated with insufficient
             funds. 9 DB plans provide a benefit that is determined by a formula based
             on various factors specified in the plan, such as an employee’s salary,
             years of service, and age at retirement.

             PBGC has a three-member board of directors, consisting of the
             Secretaries of the Departments of Commerce, Labor, and the Treasury,
             that is charged with providing policy direction and oversight of PBGC’s
             finances and operations. PBGC’s Director is appointed by the President
             and subject to Senate confirmation. 10 Consistent with our previous




             9
              29 U.S.C. §§ 1302(a)(2) and 1361. The guaranteed benefit limits for participants in
             single-employer plans cannot exceed the statutory maximum, adjusted annually, at the
             time the plan terminates. For 2012, the maximum is $54,000 per year for a person retiring
             at age 65 with no survivor benefit (that is, a single-life annuity). The maximum is lower for
             those retiring under age 65 or with a survivor benefit. 29 U.S.C. § 1322(b)(3); 29 C.F.R. §
             4022.23 (2012). Other guaranteed benefit limits for participants in single-employer plans
             include the phase-in limit and accrued-at-normal limit. Under the phase-in limit, for any
             benefit increase implemented through a plan amendment that has been in effect for less
             than 5 years, only a pro-rata portion can be guaranteed. 29 U.S.C. § 1322(b)(1) and (7);
             29 C.F.R. § 4022.25 (2012). Under the accrued-at-normal limit, the monthly guaranteed
             benefit cannot be greater than the monthly benefit available at the plan’s normal
             retirement age provided as a straight-life annuity (that is, a periodic payment for the life of
             the retiree), with no additional payments to survivors. 29 C.F.R. § 4022.21 (2012).
             10
               29 U.S.C. § 1302(d). Prior to the enactment of the PPA, ERISA charged the Secretary of
             Labor, as the chair of PBGC’s board, with administering PBGC. The Secretary has, in
             turn, historically delegated the responsibility for administering PBGC to an executive
             director. Since the enactment of PPA, the director has replaced the chair of the board as
             PBGC administrator. § 411(a), 120 Stat. 935.




             Page 4                                                            GAO-13-58 PBGC Premiums
recommendations concerning challenges to PBGC’s governance, 11 the
recently enacted MAP-21 included numerous provisions to strengthen
PBGC’s board and governance structure overall (see app. I). 12

PBGC administers two separate insurance programs: a single-employer
program and a multiemployer program 13 and is charged with encouraging
continuation of private pension plans, providing for timely and
uninterrupted payment of participants’ pension benefits (up to the insured
limits) should plans be terminated with insufficient funds, and maintaining
premiums established under the statute at the lowest level consistent with
its obligations under ERISA. 14 PBGC-insured DB plans have been in
decline since the 1980s. As of 2011, PBGC insured about 25,500 single-
employer DB plans covering about 34 million participants, down from
nearly 92,000 plans in 1990. During this period, many sponsors have
voluntarily terminated their plans as “standard” terminations. Standard
terminations occur when sponsors 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




11
  We have previously reported concerns regarding PBGC’s board, including limitations in
its ability to provide policy direction and oversight to PBGC, and the need for the
implementation of certain types of reporting requirements—such as congressional
notifications and reporting protocols for advisory committees—to ensure effective
communication between PBGC and Congress. See GAO, Pension Benefit Guaranty
Corporation: Governance Structure Needs Improvements to Ensure Policy Direction and
Oversight, GAO-07-808 (Washington, D.C.: July 6, 2007) and Pension Benefit Guaranty
Corporation: Improvements Needed to Strengthen Governance Structure and Strategic
Management, GAO-11-182T (Washington, D.C.: Dec. 1, 2010).
12
     § 40231, 126 Stat.853-56.
13
  29 U.S.C. §§ 1322 and 1322a. The single-employer program insures plans established
and maintained by one employer. Single-employer plans can be established unilaterally by
the sponsor or through a collective bargaining agreement with a labor union. The
multiemployer program insures plans that are arranged through collective bargaining
between a labor union and a group of employers in a particular trade or industry.
Management and labor representatives must jointly govern multiemployer plans. 29
U.S.C. § 1002(37).
14
     29 U.S.C. § 1302(a).




Page 5                                                       GAO-13-58 PBGC Premiums
                           paying lump-sum benefits to participants if permissible. 15 An event
                           preceding at least some of these terminations was a so-called plan
                           “freeze”—an amendment to the plan to limit some or all future pension
                           accruals for some or all plan participants. 16


PBGC Funding and Deficit   To finance its operations, PBGC has three key sources of funds: (1)
                           pension assets obtained from underfunded, terminated single-employer
                           plans which it takes over; 17 (2) premiums paid by both single-employer
                           and multiemployer plan sponsors; and (3) investment income and net
                           gains and losses generated from the investment of these funds. 18 Figure
                           1 shows that the annual amount of PBGC’s new claims in the single-
                           employer program has fluctuated dramatically during the last 12 years—
                           sometimes exceeding the amount of premiums and thereby contributing




                           15
                              29 U.S.C. § 1341(b). If the sponsor of a single-employer plan meets the statutory
                           requirements for financial distress and the plan does not have sufficient assets to pay
                           promised (“vested accrued”) benefits, the plan cannot be terminated as a standard
                           termination. Instead, the plan will be terminated as distress or involuntary termination, and
                           PBGC will likely become the plan’s trustee, assuming responsibility for paying benefits to
                           participants as they become due, up to the guaranteed benefit limits. 29 U.S.C. § 1341(c).
                           PBGC may initiate an “involuntary” termination if a plan has not met minimum funding
                           standards, a plan will be unable to pay benefits when due, a reportable event has
                           occurred, or the possible long-run loss to PBGC with respect to a plan may reasonably be
                           expected to increase if the plan is not terminated. 29 U.S.C. § 1342(a).
                           16
                              For example, a pension plan may close to new participants, or a plan may opt to prohibit
                           existing participants from earning pension benefits in the future.
                           17
                             The PPA included provisions to modify funding rules and increase premiums for
                           sponsors of single-employer plans. §§ 101, 102, 111, and 112, and 401 and 405, 120
                           Stat. 784-809, 820-846, and 922 and 928-29. However, Congress has provided sponsors
                           with funding relief in the last few years and revised some provisions to help mitigate the
                           effects of the recent economic downturn. Worker, Retiree, and Employer Recovery Act of
                           2008, Pub. L. No. 110-458, §§ 101, 102, 121 and 122, 122 Stat. 5092, 5093-5103, 5113-
                           14, Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act of
                           2010, Pub. L. No. 111-192, tit. II, 124 Stat.1280, 1283-1306, and MAP-21, § 40221, 126
                           Stat. 850-52.
                           18
                             29 U.S.C. § 1305(b). Throughout this report we refer to all funds generated through the
                           investment of assets as investment income. For further discussion of PBGC’s investment
                           strategy; see GAO, Pension Benefit Guaranty Corporation: Asset Management Needs
                           Better Stewardship, GAO-11-271 (Washington, D.C.: June 30, 2011).




                           Page 6                                                           GAO-13-58 PBGC Premiums
to persistent deficits. 19 In contrast, as illustrated in figure 1, the amount of
premium revenue PBGC has collected from plans in the single-employer
program has been much less volatile, growing fairly steadily over the last
10 years from $967 million in fiscal year 2002 (adjusted for inflation) to
nearly $2.1 billion in fiscal year 2011.

Figure 1: PBGC’s Annual Premium Revenue Compared to New Claims for the
Single-Employer Program, Fiscal Years 2000-2011




Note: Data adjusted for inflation.
a
New claims for fiscal year 2000 were $110 million.




19
   PBGC officials noted that where present values are meaningful, such as in calculating
PBGC’s deficit, it is important to consider PBGC’s current financial position in determining
the adequacy of future premiums. In addition, they also noted that the adequacy of any
premium structure is highly dependent on investment income that (a) can improve
PBGC’s financial position over long periods if PBGC’s assets are expected to earn more
than the discount rate on its liabilities, as has been the case; (b) can and has created
significant gains and losses in PBGC’s financial position due to market fluctuations and
the impact on PBGC’s and insured plan’s asset returns; and (c) cannot reduce the growth
of the existing deficit to the extent that liabilities exceed assets.




Page 7                                                          GAO-13-58 PBGC Premiums
As of the end of fiscal year 2011, PBGC’s single-employer program had
an accumulated deficit of just over $23 billion, which is the result of
comparing the value of its assets with the value of its liabilities for claims
incurred to date. 20 Although there are differing views about the
appropriateness of the assumptions PBGC uses in calculating its deficit, 21
there is general agreement that failure to address various structural
challenges could have consequences for both PBGC’s long-term financial
condition and the health of the DB system. Market performance and low
interest rates affect PBGC’s financial position, but so, too, have various
structural challenges, including historically inadequate plan funding
requirements and premium levels for private DB plan sponsors. To help
address these structural challenges, PPA attempted to strengthen plan
funding requirements, but these changes were modified or postponed due
to the economic downturn, resulting in reduced funding for plans. In
addition, MAP-21 included provisions to increase premium rates effective
beginning in 2013, but left the current premium structure intact.

PBGC has reported a net accumulated deficit since 2002. As a result of
these deficits and structural issues impeding PBGC’s ability to adequately
fund its insurance programs, including the likelihood of large, unfunded
pension plan terminations, we have designated PBGC’s single-employer
program as high risk since 2003. 22 PBGC receives no funds from general
tax revenue. However, if at some point in the future the agency were to
exhaust all of its assets and become insolvent, its commitments would not



20
   The value of liabilities is equal to the actuarial present value of projected future benefit
payments, which is determined by use of certain assumptions about interest rates, among
other things, to adjust the amount of future benefit payments to reflect the time value of
money (by discounting) and the probability of payment (by means of decrements, such as
for death or retirement). PBGC also includes the estimated liabilities in excess of assets
for new claims that it deems probable.
21
     See appendix V for a more detailed description of how PBGC calculates its deficit.
22
  GAO, Pension Benefit Guaranty Corporation: Long-Term Vulnerabilities Warrant “High
Risk”, GAO-03-1050SP (Washington, D.C.: July 23, 2003); High-Risk Series: An Update,
GAO-09-271 (Washington, D.C.: January 2009); and High-Risk Series: An Update,
GAO-11-278 (Washington, D.C.: February 2011), 150-153. Although we designated
PBGC’s single-employer program as a “high-risk” program in 2003, we first designated
PBGC as a high-risk area in 1990, citing taxpayers’ exposure to potential losses from the
termination of large, underfunded plans. In 1995, we removed PBGC from our list of high-
risk areas due to congressional and agency actions that we believed would reduce
PBGC’s exposure to losses. In 2009, we also designated the multiemployer program as
high risk.




Page 8                                                            GAO-13-58 PBGC Premiums
                         be backed by the full faith and credit of the federal government, 23 and the
                         agency would only have premium revenue to rely on to pay its benefit
                         obligations. As a consequence, PBGC could be forced to dramatically cut
                         benefit payments to participants, seek federal assistance, or raise
                         premiums significantly to meet its benefit commitments. In previous
                         reports on PBGC, we have recommended that PBGC’s premium structure
                         be re-examined to explore whether premiums could better reflect the risk
                         posed by various plans to the pension system. 24


PBGC’s Current Premium   Under the current premium structure for its single-employer program,
Structure                PBGC collects from sponsors a per participant flat-rate premium and a
                         variable-rate premium that is based on a plan’s level of underfunding. 25
                         PBGC also collects a termination premium from sponsors of single-
                         employer plans that terminate their plans under certain criteria. 26 While
                         conceptually, PBGC uses the flat-rate premium as a proxy for exposure
                         based on the number of participants, to the extent that the premium
                         structure relies on flat-rate premiums, sponsors with greater numbers of
                         participants pay more toward the cost of covering risk than sponsors with
                         smaller numbers of participants, regardless of the ages of the
                         participants, the average level of plan benefits, or other risk-related
                         differences. To the extent that the premium structure relies on variable-
                         rate premiums, sponsors with more underfunded plans pay more toward
                         the cost of covering risk than sponsors with better funded plans,


                         23
                            Historically under ERISA, PBGC was granted a $100 million line of credit from the
                         federal government. ERISA, § 4005(c), 88 Stat. 1010. Under MAP-21, enacted in July
                         2012, this line of credit was discontinued. § 40234, 126 Stat. 858.
                         24
                            GAO, Pension Benefit Guaranty Corporation: Single-Employer Pension Insurance
                         Program Faces Significant Long-Term Risks, GAO-04-90 (Washington, D.C.: October 29,
                         2003).
                         25
                            The nearly $2.1 billion in premium revenue in fiscal year 2011 consisted of $1.1 billion in
                         flat-rate premiums and $929 million in variable-rate premiums.
                         26
                            29 U.S.C. § 1306(a)(3)(A)(1), (E) and (F). A termination premium of $1,250 per
                         participant per year for 3 years generally applies when a single-employer plan terminates
                         in a distress termination under 29 U.S.C. § 1341(c)(2)(B)(ii) or (iii) or in an involuntary
                         termination under 29 U.S.C. § 1342. 29 U.S.C. § 1306(a)(7)(A). However, this premium
                         does not apply in the case of a plan terminated under 29 U.S.C. §§ 1341(c)(2)(B)(ii) or
                         1342 during the pendency of a bankruptcy reorganization (29 U.S.C. § 1306(7)(b)), or to
                         any plan termination during the pendency of any bankruptcy reorganization filed before
                         October 18, 2005 (Deficit Reduction Act of 2005, Pub. L. No. 109-171, § 8101(b) and (d),
                         120 Stat. 181-22 and 183 (2006)).




                         Page 9                                                           GAO-13-58 PBGC Premiums
                                           regardless of the riskiness of the plan assets or the financial health of the
                                           plan sponsor. As a result, there is concern that the current statutory
                                           premium structure does not allocate premiums to match the variation in
                                           risk posed by different plan sponsors. In fact, the heavy focus on the flat-
                                           rate premium tends to create a cross-subsidy paid by financially healthy
                                           sponsors to cover the risks posed by sponsors that are less financially
                                           strong.

                                           For plan years beginning in 2006, the base flat rate was $30 per
                                           participant, increasing with inflation adjustments to $35 for 2012, while the
                                           base variable rate remained at $9 for every $1,000 of plan underfunding.
                                           Under provisions enacted in MAP-21, rates were increased within this
                                           same premium structure. The flat-rate premium begins to rise in 2013,
                                           and then the variable-rate premium begins to rise in 2014. Beginning in
                                           2013, the variable-rate premium is also subject to a $400 per participant
                                           limit (see table 1). 27

Table 1: Premium Rates under MAP-21

                                                                                                  Rates by plan year
Rate type                                              2011              2012             2013                     2014               2015
                                                            a                 a
Flat rate (per participant)                            $35               $35              $42                      $49                $49 or more based
                                                                                                                                                  b
                                                                                                                                      on indexing
Variable rate (per $1,000 of unfunded vested           $9                $9               $9 or more               $13 or more        $18 or more based
         c                                                                                                                                        c
benefits)                                                                                 based on                 based on           on indexing
                                                                                                  c                        c
                                                                                          indexing                 indexing
                                           Sources: MAP-21, Pub. L. No. 112-141, § 40221, 126 Stat. 405, 850-52.

                                           a
                                               This reflects the base rate of $30 adjusted for inflation.
                                           b
                                            After 2014, rates will be indexed based on increases in the national average wage index, as
                                           determined by the Social Security Administration, and then rounded to the nearest whole dollar.
                                           c
                                            Though calculated based on the amount of underfunding, the variable rate is subject to a per
                                           participant limit of $400 for 2013, with indexing based on increases in the national average wage
                                           index, as determined by the Social Security Administration. In addition, MAP-21 provided for an
                                           additional $4 increase in plan year 2014, plus an additional $5 increase in plan year 2015.




                                           27
                                                § 40221(b)(3), 126 Stat. 852 (codified at 29 U.S.C. § 1306(a)(3)(E)(i)(II)).




                                           Page 10                                                                               GAO-13-58 PBGC Premiums
Historical Premium Rates                  Historically, PBGC’s premiums have not fully reflected the risks PBGC
Have Been Inadequate to                   insures against—chiefly that a plan sponsor with an underfunded plan will
Cover Claims                              become bankrupt, forcing the termination of the plan and imposing a
                                          claim on PBGC. 28 Risks related to potential new claims depend largely on
                                          plan sponsor behavior, while PBGC’s risks post-termination depend
                                          largely on the agency’s own investment strategy, among other things (see
                                          table 2).

Table 2: PBGC’s Risk Exposure

Type of risk                    Description
New claims risk                 PBGC exposure is based on several factors:
                                •  plan sponsor behavior with regard to maintaining plans, funding plans, and investment strategy
                                   (allocation of plan assets)
                                •  size of new claims
                                •  economic conditions, including the level of bankruptcies, market returns, and interest rates
                                •  adequacy of premium levels, either set by Congress or by PBGC if granted such authority
                                •  impact of plan freezes
                                •  deterioration in performance of particular industries
                                •  participant longevity improvements greater than expected
PBGC financial risk             PBGC exposure is based on several factors:
                                •  PBGC’s investment strategy
                                •  market returns and interest rate movements
                                •  participant longevity improvements greater than expected
                                          Source: GAO analysis of PBGC’s 2010 exposure report.



                                          PBGC has estimated that if premium rates were kept at fiscal year 2011
                                          levels, 29 total premium revenue from single-employer plans over the next
                                          10 years would be less than the amount of expected new claims. In
                                          addition, many pension experts and the administration believe that PBGC
                                          premiums have been much lower than what a private financial institution
                                          would charge for insuring the same risk and are insufficient for PBGC to
                                          meet its long-term obligations. Indeed, one study estimated that the
                                          overall premiums collected by PBGC are equal to about 50 percent of



                                          28
                                               See appendix VIII for a summary of historical PBGC premium rates, 1974 to 2012.
                                          29
                                           For the purpose of this projection, PBGC assumed that the flat rate would increase each
                                          year over the current rate by approximately $1 to account for an annual increase in the
                                          wage growth index and that the variable rate would remain the same as current law for the
                                          period.




                                          Page 11                                                        GAO-13-58 PBGC Premiums
                                         what a private insurer would charge because its premiums do not
                                         adequately account for risks. 30 To set premiums at a level sufficient to
                                         cover PBGC’s total risk exposure would require an analysis of total risk.
                                         Several methods have been used to estimate PBGC’s total risk exposure
                                         with widely varying results, as described in table 3.

Table 3: Various Estimates of PBGC’s Total Risk Exposure

Estimation method                 Description
Credit ratings of sponsors with   Estimate risk exposure from underfunding by plan sponsors whose credit ratings are below
underfunded plans                 investment grade or that meet one or more financial distress criteria. PBGC already performs
                                  this analysis by classifying these sponsors’ underfunded plans as reasonably possible
                                  terminations.
Market value of insurance         Estimate risk exposure from the price a private insurer would charge. In a 2005 report, the
                                  Congressional Budget Office (CBO) estimated PBGC’s risk exposure using this method based
                                  on the price that a private insurer would charge to accept the insurance obligations of PBGC for
                                  all plans that terminate over a given time period.
Total unfunded liabilities        Estimate PBGC’s risk exposure by calculating the agency’s total potential liabilities from
                                  underfunding in all PBGC-insured plans, whether these unfunded liabilities are vested or not,
                                  and estimate the risk associated with those liabilities.
                                         Source: GAO analysis of reports and data related to PBGC’s total risk exposure.




                                         Each method provides quantifiable insight into the extent of PBGC’s risk
                                         exposure. For example, in fiscal year 2011, PBGC estimated that its risk
                                         exposure to reasonably possible terminations in its single-employer
                                         program totaled approximately $227 billion, an increase from $170 billion
                                         the previous year. Further, PBGC estimated that the total unfunded
                                         liabilities in all PBGC-insured plans were $415 billion in fiscal year 2010. 31
                                         CBO estimated that in 2005, the present value of PBGC’s net costs for
                                         DB pension insurance for single-employer plans over 10 years was about
                                         $87 billion. Total costs for the insurance for 15- and 20-year time horizons
                                         were $119 billion and $142 billion, respectively. 32




                                         30
                                          See Steven Boyce and Richard A. Ippolito, “The Cost of Pension Insurance,” The
                                         Journal of Risk and Insurance, vol. 69, no. 2 (2002): 121-170.
                                         31
                                          PBBC’s estimated total unfunded liabilities are based on all plan liabilities, whether
                                         vested or not.
                                         32
                                          See U.S. Congressional Budget Office, The Risk Exposure of the Pension Benefit
                                         Guaranty Corporation (Washington, D.C.: September 2005).




                                         Page 12                                                                           GAO-13-58 PBGC Premiums
                            In addition, the CBO has proffered several methods for establishing the
                            target level of premium revenue to be generated. One possibility is to
                            adopt what CBO describes as an “actuarially fair premium structure”—
                            that is, one that would equate the present value of expected premium
                            revenues with the present value of expected costs to PBGC. Notably,
                            based on CBO’s 2005 analysis, a uniform risk premium—one that
                            increases both the flat- and variable-rate portions of current-law
                            premiums by a fixed proportion 33—would yield premium charges that
                            were 6.5 times larger than rates in effect in 2005, with a flat rate of
                            $123.50 per participant per year and a variable rate of $58.50 per $1,000
                            of underfunding. This increase would have made rates comparable to
                            premiums charged in a private insurance market to cover PBGC’s
                            insurance obligations at that time.


                            Various options are available to make PBGC’s statutory premium
Various Options Are         structure more risk-based to better reflect the risk of future claims and
Available for More          improve PBGC’s financial condition. The variable-rate component of the
                            premium reflects plan and sponsor risk to some extent, but has been
Risk-Based Premiums         based solely on just one risk factor, plan underfunding. There are
                            numerous options available for incorporating additional risk factors into
                            the variable rate to account for greater levels of risk posed to PBGC by
                            certain plans and sponsors, as is done by other insurance agencies in the
                            United States and abroad. For example, the FDIC, which provides
                            deposits insurance, has used a risk-based premium system since 1993.
                            In addition, the UK’s pension insurer determines its premiums based on a
                            risk factor for a plan’s asset investment mix, as well as the sponsor’s
                            financial strength.


Adjusting Premiums within   Even within the current structure, rates could be adjusted to become
the Current Structure       more risk-based and help PBGC to increase its revenues. Historically, the
                            bulk of premium revenue has been generated from the flat-rate
                            component of the premium (tied to the number of plan participants) that
                            assesses rates equally per capita across all sponsors regardless of risk,
                            rather than the variable-rate component that reflects risk based on level of
                            plan underfunding. By increasing the proportion of revenues generated
                            from the variable rate and increasing rates overall—such as provided



                            33
                                 The uniform premium also does not vary according to sponsor or plan characteristics.




                            Page 13                                                          GAO-13-58 PBGC Premiums
                                             under MAP-21 34—higher premium costs are shifted more to sponsors
                                             with plans that are more underfunded (see table 4). Such changes, even
                                             under the current structure, make premiums more risk-based than in the
                                             past, and could help reduce the growth of PBGC’s deficit while providing
                                             greater incentive to sponsors to fully fund their plans.

Table 4: Rates under MAP-21 Compared to a Hypothetical Option to Adjust PBGC Premiums under the Current Structure

                      Flat rate per          Variable rate per $1000
Premium option        participant            of plan underfunding                   Description
New premium           $49 by plan year       $18 by plan year 2015                  •     Phase-in of rate increase
structure provided    2014 indexed           indexed thereafter                     •     Revenue estimated over 10 years
for in the Moving     thereafter
                                                                                    •     The variable rate is limited to $400 per participant for
Ahead for Progress
                                                                                          plan year 2013 with indexing thereafter
in the 21st Century                                                                                                                             b
Act
    a                                                                               •     $9 billion in additional premium revenue generated
                                                                                    •     58% of additional premium revenue attributable to
                                                                                          increase in flat rate
                                                                                    •     42% of additional premium revenue attributable to
                                                                                          increase in variable rate
Option to increase    Flat rate increased    Variable rate increased so             •     No phase-in of rate increase
rates under the       so that the increase   that the increase to total             •     Revenue estimated on annual basis over 8 years
                 c
current structure     to total premium       premium revenue is
                                                                                    •     $16 billion in additional premium revenue generated ($2
                      revenue is evenly      evenly distributed between                                    d
                                                                                          billion annually)
                      distributed between    the flat rate and variable
                      the flat rate and      rate                                   •     50% of additional premium revenue attributable to the
                      variable rate                                                       flat rate
                                                                                    •     50% of additional premium revenue attributable to the
                                                                                          variable rate
                                             Source: GAO analysis of documents related to PBGC premiums.

                                             a
                                                 MAP-21, § 40221, 126 Stat. 405, 850-852 (2012).
                                             b
                                                 Revenue increase compared to plan year 2012 rates.
                                             c
                                              For this option, rates were generated by PBGC using a hypothetical model created to explore the
                                             effects of different premium options on rates and premium revenue. PBGC’s hypothetical model used
                                             plan year 2010 data from PBGC’s premium database and did not incorporate any projections about
                                             future levels of plan funding or participant counts. This hypothetical option increases rates within the
                                             current premium structure without incorporating additional risk factors.
                                             d
                                                 Revenue increase compared with estimates under plan year 2010 rates.




                                             34
                                               On July 6, 2012, the President signed into law MAP-21, which included provisions calling
                                             for rate increases within PBGC’s current premium structure for all single-employer plan
                                             sponsors insured by PBGC. § 40221, 126 Stat. 446-448 (2012). The act also provided for
                                             rate increases for all multiemployer plan sponsors insured by PBGC. Pub. L. No. 112-141,
                                             § 40222, 126 Stat. 852-53.




                                             Page 14                                                                   GAO-13-58 PBGC Premiums
To explore this option, PBGC developed a model to illustrate the various
ways premiums could be adjusted to meet different revenue targets over
varying lengths of time by increasing either the flat rate or the variable
rate, or both, by certain percentages. 35 The model used standard
quantitative techniques to show how different premium options would
affect rates and generate premium revenue over time without a rate
phase-in. PBGC officials stressed that the model did not use PIMS for its
calculations, and that the model is purely hypothetical and not intended
as a policy proposal. However, by way of illustration, PBGC used the
model to generate one scenario whereby the additional revenue would be
obtained in equal amounts from increases in both the flat and variable
rates over 8 years to meet the administration’s proposed $16 billion
premium revenue target. Under this scenario, PBGC estimated that to
reach the annual $2 billion revenue target in the first year without a rate
phase-in, premium revenue from both the flat rate and variable rate would
have to increase by 77 and 76 percent, respectively. We estimated that
under this option, the flat rate would increase to $62 per participant and
the variable rate to nearly $16 per $1,000 of plan underfunding. 36 Under
this option, 50 percent of the premium revenue increase is attributable to
the variable rate compared to 42 percent under MAP-21 rates. However,
the only risk factor incorporated into the variable rate under both MAP-21
and PBGC’s model scenario described above is plan underfunding, and
as discussed further below, PBGC has concluded from its analyses that
plan underfunding is a poor proxy for the risk of a new claim.




35
   In constructing its model, PBGC selected a sample of plans from its 2010 premium
database that had readily available data regarding either the sponsor’s credit rating or Dun
& Bradstreet score. The resulting sample included 1,114 sponsors of 2,699 DB plans
covering 27.5 million participants. The model covered 81 percent of all PBGC-insured
participants (33.8 million) in 2010. We validated the model by reviewing the formulas
PBGC used to analyze the 2010 premium data and assessed the reliability of the data
used in the model. Where we found problems with formulas or other points of information
used in the model’s analysis, we discussed these issues with PBGC officials and made
corrections to their analysis.
36
  For the purpose of its analysis in the premium model, PBGC estimated a combined flat
and variable rate on a per participant basis for the hypothetical option to increase rates
under the current structure in order to make comparisons to per participant rates under
other options. Under the hypothetical option to increase rates under the current structure,
PBGC estimated that the combined per participant rate (i.e., the flat rate, plus the amount
collected from the variable rate divided by the number of plan participants) ranged from
$60 to $4,367. By way of comparison, PBGC calculated that combined premium rates
under the structure in place for fiscal year 2010 ranged from $35 per participant to $2,481.




Page 15                                                         GAO-13-58 PBGC Premiums
Alternative Options to   Other premium options could more fully take into account the agency’s
Incorporate Additional   exposure to the risk of new claims by incorporating other risk factors.
Risk Factors into        Specifically, PBGC’s risk could be better mitigated through alternative
                         premium options that incorporate other risk factors into the variable rate
Premiums                 to more fully take into account the agency’s exposure to the risk of future
                         losses. Because the variable-rate premium is currently based solely on
                         plan underfunding, it does not capture the agency’s overall risk as well as
                         it could if additional risk factors were also taken into consideration, such
                         as a plan’s investment strategies, benefit structure and benefit level,
                         demographic profile, or the plan sponsor’s financial strength. 37 With
                         congressional action, these additional risk factors could be incorporated
                         into PBGC’s rates, providing proportionally greater amounts of revenue
                         from plan sponsors posing greater risk to the agency, and better
                         alignment with the continuum of risk facing the agency.

                         PBGC has conducted analyses showing that measures of underfunding
                         are poor predictors of plan termination. In these analyses, PBGC
                         reviewed funding levels for plans that had terminated from fiscal years
                         2009 to 2011, 38 and found the average termination funding level was
                         about 54 percent on the date of termination. For the year previous to
                         termination, the average funding level measurement on which the
                         variable-rate premium was calculated for these plans was about 84
                         percent. Because of the differences found in a plan’s funding-level
                         measurements, PBGC officials believe that measures of a sponsor’s
                         financial strength—determined using credit scores or Dun & Bradstreet
                         scores—are better predictors of whether plans terminate than are
                         measures of underfunding.

                         Much like premiums set by insurance companies, 39 PBGC premium rates
                         could be set based on individual risk profiles for sponsors and their plans.
                         Such incorporation of additional risk factors into premiums could help
                         PBGC to better manage risk by raising proportionally greater amounts of



                         37
                              29 U.S.C. § 1306(a)(3)(E).
                         38
                              Data for fiscal year 2011 were through April 2011.
                         39
                            Two pension experts we spoke with believe that PBGC is not a true insurance program,
                         since it is statutorily required to insure all DB plans. These experts instead believe that this
                         makes PBGC more of a social protection program, providing participants a social safety
                         net by obligating the payment of pension benefits up to certain limits for underfunded
                         plans that terminate.




                         Page 16                                                           GAO-13-58 PBGC Premiums
                                           revenue from financially riskier sponsors whose plans are underfunded,
                                           and provide an incentive to sponsors to fully fund their plans and reduce
                                           other risk factors under their control, such as through less risky plan asset
                                           allocation. In addition, as with any premium structure, risk-based
                                           premiums could be designed to address only the risk of new costs that
                                           PBGC will incur from future claims, or they could be designed to help
                                           address PBGC’s risk of future insolvency, which also reflects deficit costs
                                           from past terminations. Possible approaches for incorporating additional
                                           risk factors into PBGC’s premium structure are described further below,
                                           along with information on the approach used by the FDIC for banking
                                           institutions and by PPF for pension plans in the UK (see table 5).

Table 5: Different Options to Incorporate Additional Risk Factors into Premiums

                                           Variable rate with additional
Premium option            Flat rate        risk factors                         Description
Option to incorporate      $44 per         Variable rate incorporates           •   No phase-in of rate increase
additional risk factor for participant     additional risk factor for sponsor   •   Variable rate calculated on a per participant basis
sponsor financial                          financial health
       a                                                                        •   Rates capped at four times plan year 2010 rates
health
                                                                                    on a per participant basis
                                                                                •   Revenue estimated on annual basis over 8 years
                                                                                •   $16 billion in additional premium revenue
                                                                                                                    b
                                                                                    generated ($2 billion annually)
                                                                                •   16% of additional premium revenue attributable to
                                                                                                 c
                                                                                    the flat rate
                                                                                •   84% of additional premium revenue attributable to
                                                                                                     d
                                                                                    the variable rate
Option to use different   Not applicable   Risk premium incorporates risk       •   Different methods used to calculate premiums
methods to calculate                       factors for size and financial           based on the size of the institution
premiums based on                          strength                             •   Premiums are generally set based on a bank’s
size of institution                                                                 aggregate assets (funding level) and supervisory
(FDIC)                                                                              rating (financial strength)
                                                                                •   Premiums based on bank placement into one of
                                                                                    four risk categories
                                                                                •   Premiums range set to meet annual revenue
                                                                                    target needed to insure against identified risk
                                                                                •   Premium rates can change quarterly through
                                                                                    monitoring of bank capitalization and supervisory
                                                                                    data




                                           Page 17                                                           GAO-13-58 PBGC Premiums
                                                Variable rate with additional
Premium option               Flat rate          risk factors                                 Description
Option to incorporate        Plan-based         Risk-based premium                           •     Both a plan-based (flat) and risk-based premium
additional risk factor for   premium            (comparable to PBGC variable-                      charged to sponsors
plan investment              (comparable to     rate premium) incorporates risk              •     Premium rates set for 3 years
strategy (UK’s PPF)          PBGC flat- rate    factors for plan underfunding,
                                                                                             •     Scaling factor used to adjust risk-based premiums
                             premium)           sponsor insolvency, and plan
                                                                                                   to meet 3-year revenue target
                             targeted to meet   asset investment risk
                             revenue estimate                                                •     10% of premium revenue attributable to plan-
                                                                                                   based premium and 90% attributable to risk-based
                                                                                                   premium
                                                                                             •     Smoothing techniques used to adjust premium
                                                                                                   rates to account for adverse economic conditions
                                                Source: GAO analysis of documents related to PBGC, FDIC, and PPF premiums.
                                                a
                                                 For this option, rates were generated by PBGC using a hypothetical model created to explore the
                                                effects of different premium options on rates and premium revenue. PBGC’s hypothetical model used
                                                plan year 2010 data from PBGC’s premium database and did not incorporate any projections about
                                                future levels of plan funding or participant counts.
                                                b
                                                    Revenue increase compared with estimates under plan year 2010 rates.
                                                c
                                                 These percentages are for revenue increases attributable to the flat and variable rate before applying
                                                the President’s proposed cap of four times the per participant rate for plan year 2010.

                                                d
                                                 PPF refers to plans as schemes and premiums as levies. For the purpose of this report, we continue
                                                to use plans and premiums when discussing PPF’s premium framework.




Modeling More Risk-Based                        The President’s 2013 budget proposes to reform how PBGC premiums
Options under the                               are determined by giving the PBGC board the authority to take into
President’s Proposal                            account the risks that different sponsors pose to their retirees and to
                                                PBGC. The President’s budget proposes raising $16 billion in additional
                                                premium revenue over a 10-year period, from 2013 to 2022, and would
                                                require a year of study and public comment before any implementation
                                                and the gradual phasing in of any increases due to changes in the
                                                premium structure. To reach this target over this period, the
                                                administration proposed limiting the premium increase to $4 billion in
                                                additional flat-rate premiums and $12 billion in additional variable-rate
                                                premiums. By way of comparison, the increases under MAP-21 are
                                                estimated to generate $5.1 billion from the flat rate and $3.8 billion from
                                                the variable rate over the same period. By relying more heavily on
                                                variable-rate premiums than under MAP-21, the President’s proposal
                                                would result in sponsors posing greater risk to PBGC paying higher
                                                premiums, and sponsors posing less risk to PBGC paying lower
                                                premiums.

                                                PBGC used its model to explore one possible approach to incorporating
                                                an additional risk factor into the variable-rate premium and illustrate how


                                                Page 18                                                                      GAO-13-58 PBGC Premiums
the mechanics of a more risk-based option might work. Under this option,
the financial health of a plan sponsor would be taken into account in
tandem with the funded level of a plan to enhance the extent to which risk
is accounted for in the premium structure. To accomplish this, PBGC
calculated the variable-rate premium for each plan based on a
combination of both plan underfunding and sponsor financial health, to
meet the President’s $16 billion premium revenue target. For the financial
health factor, PBGC assigned a measure on a scale of 1 to 5 based on
the lower of the sponsor’s Standard & Poor’s or Moody’s credit ratings, or,
if credit ratings were unavailable, a sponsor’s Dun & Bradstreet credit risk
ranking. PBGC then combined these scores with scores based on the
plan’s level of funding to assign a corresponding variable rate used for
calculating the premium.

In developing this hypothetical risk-based option, PBGC set rates to reach
the $16 billion target over 8 years by raising an additional $2 billion in
premium revenue over plan year 2010 premiums without a phase-in
period. To accomplish this, PBGC constructed a scenario whereby the flat
rate would increase from $35 to $44 per participant, and the variable rate
would increase on a per participant basis rather than on the dollar amount
of plan underfunding. Specifically, PBGC weighted the variable rate on a
sliding scale that increased as plan funding weakened and decreased
with stronger financial health of the sponsor (see table 6). The flat and
variable rates were combined into a single rate and then capped on a per
participant basis, as under the President’s proposal, so that the result
would not be more than four times the premium rates in plan year 2010. 40
(See appendix III for additional GAO analyses of this premium option.)




40
  The President had also proposed in his September 2011 deficit reduction plan that total
PBGC premiums for any plan would not exceed four times the amount payable with
respect to the plan for the 2010 plan year, on a per participant basis. Under PBGC’s risk-
based option, PBGC estimates that 84 percent of the total increase in premium revenue
over 2010 levels would be attributable to the increase in the variable rate for sponsors.
See Office of Management and Budget, “Living Within Our Means and Investing in the
Future, The President’s Plan for Economic Growth and Deficit Reduction,” (September
2011).




Page 19                                                        GAO-13-58 PBGC Premiums
Table 6: Total Premium Rates per Participant (Flat + Variable) under a Hypothetical Risk-Based Option

                                                                        Funded status
                                       (1)                        (2)                             (3)                      (4)
Financial health                    ≥120% funded         ≥90 to under 120% funded     75% to under 90% funded         <75% funded
Extremely healthy (1)                           $44                            $44                             $69                $94
Very healthy (2)                                $44                            $44                             $94               $144
Healthy (3)                                     $74                           $104                            $119               $194
Risky (4)                                     $124                            $204                            $244               $444
Very risky (5)                                $134                            $224                            $269               $494
                                         Source: PBGC.



                                         However, PBGC’s estimates under the risk-based option could be
                                         adjusted in various ways. For example, the premium rates shown in table
                                         6 that are used in the model could be changed based on the same
                                         underfunding and financial strength risk factors, but using different
                                         weights. Any combination of weighting could be applied to test different
                                         policy options—for example, greater weight could be placed on the rate
                                         for financial weakness. The model’s rates could be set to track with the
                                         actual risk of new claims based on an analysis of historical funding and
                                         financial health data correlated with actual claim patterns. In each case,
                                         rates would vary for certain sponsors who pose greater risk to PBGC
                                         based on financial health.

                                         The risk-based option could also be adjusted to take into account other
                                         risk factors associated with different plans’ asset investment mixes, the
                                         size of a plan relative to the size of its sponsor, and the level of plan
                                         benefits and demographic profile of plan participants, 41 as well as to take
                                         into account changes in assumptions over time. As with the hypothetical
                                         option to increase rates under the current structure, the rates generated
                                         by the model under the risk-based option are based on plan year 2010
                                         plan funding and participant counts, and do not include any phase-in of



                                         41
                                           This particular premium design assesses the variable rate portion of the premium—
                                         which reflects both plan underfunding and sponsor financial health—on a per participant
                                         basis. An alternative would be to assess the variable rate portion as a percentage of the
                                         plan’s liability—which would reflect the fact that two plans with the same number of
                                         participants could have different levels of plan liability, and therefore risk exposure, per
                                         participant, because of differences in the level of benefits provided by the plan and in the
                                         ages of plan participants.




                                         Page 20                                                          GAO-13-58 PBGC Premiums
                             rates or changes to assumptions to reflect changes that may occur over
                             time. Thus, to further fine tune the distribution of the combined
                             underfunding and financial health scores and the associated premium
                             rates, PBGC could incorporate these other risk factors into the model,
                             and change funding and participant count assumptions to allow a rate
                             phase-in. While acknowledging these possibilities, PBGC officials
                             emphasized that the purpose of generating this option was purely to
                             illustrate one hypothetical scenario of how rates could be redesigned to
                             incorporate the additional risk factor of a sponsor’s financial health to
                             raise additional premium revenue and to distribute premiums more in line
                             with the risk posed by different plan sponsors—it is not a policy proposal,
                             and the agency has no plans at this time to conduct further analyses to
                             incorporate additional risk factors.

FDIC’s Risk-Based Premiums   FDIC, a federal corporation that insures the deposits of all federally
                             insured depository institutions, has long used risk-based premiums to
                             help insure depositors against the risk of loss. In 1993, FDIC adopted a
                             risk-related premium system, which was designed to reduce the cross-
                             subsidy that stronger banks implicitly provided to weaker banks under its
                             previous flat-rate premium system. The new system was intended to
                             provide proper incentives for risk taking, whereby banks who pose a
                             higher risk have a higher premium rate. Under FDIC’s risk-based
                             premium system, banks are first categorized on two factors: aggregate
                             assets and a composite supervisory rating reflecting capital, asset quality,
                             management, earnings, liquidity, and sensitivity to market risk (referred to
                             as “CAMELS”). 42 FDIC sets assessment (premium) rates to achieve a
                             target “designated reserve ratio” based on the ratio of the deposit
                             insurance fund to insured deposits. 43 Most banks—specifically, those
                             under $10 billion in assets—are placed in four risk categories on the basis
                             of their capital (which is roughly equivalent to a bank’s funding level) and
                             CAMELS rating (which is roughly equivalent to a bank’s financial health).
                             Following the economic crisis of 2008, FDIC began to reconsider risk-



                             42
                              For more information on FDIC’s efforts to tie premiums to the estimated risk a bank
                             poses to the agency, see GAO, Deposit Insurance: Assessment of Regulators’ Use of
                             Prompt Corrective Action Provisions and FDIC’s New Deposit Insurance System
                             GAO-07-242 (Washington, D.C.: Feb. 15, 2007).
                             43
                               The designated reserve ratio is currently set at 2 percent. According to FDIC officials,
                             regulations implemented in 2010 allow the FDIC to set assessment rates at moderate
                             levels when the designated reserve ratio exceeds 1.15 percent and progressively lower
                             assessment rates when the reserve ratio exceeds 2 percent and 2.5 percent.




                             Page 21                                                         GAO-13-58 PBGC Premiums
                      based pricing methods for large banks, taking into account the risks that
                      caused severe problems for large banks. Effective in the second quarter
                      of 2011, FDIC began using different methodologies to set assessment
                      rates for small and large banks. Both systems attempt to have riskier
                      banks pay higher premiums at the time they assume the risk rather than
                      waiting until conditions deteriorate. However, the FDIC charges a higher
                      premium rate for large banks with high asset concentrations and less
                      stable balance sheet liquidity.

The UK’s DB Premium   At least one country has already moved to a more risk-based system for
Framework             determining premium rates. The UK’s Pension Protection Fund (PPF)—
                      the government corporation responsible for insuring benefits to
                      participants of DB plans—incorporates additional risk factors into its
                      premium structure. 44 PPF’s premium structure has two components: a
                      risk-based premium and a plan-based premium. 45 The risk-based
                      premium is based on the likelihood of a plan making a claim on PPF
                      (which PPF terms “insolvency risk”) and the potential size of that claim
                      (which PPF terms “underfunding risk”). PPF uses the Dun & Bradstreet
                      failure score—a measure of the likelihood of sponsor bankruptcy—as the
                      risk factor for determining a sponsor’s insolvency risk. 46 PPF uses
                      information about the value of plan assets and liabilities, supplied to the
                      agency by sponsors through an exchange, to calculate a sponsor’s
                      underfunding risk. 47 Beginning with plan year 2012/13, PPF will also
                      consider a plan’s investment strategy to adjust underfunding risk when
                      calculating a plan’s premium. (See appendix IV for a description of the


                      44
                        We did not conduct independent legal analysis to verify the information on UK’s DB
                      premium framework, but rather relied on a review of publicly available PPF documents
                      and discussions with PPF officials.
                      45
                         PPF refers to plans as schemes and premiums as levies. For the purpose of this report,
                      we continue to use plans and premiums when discussing PPF’s premium framework.
                      46
                         In the UK, the Dun & Bradstreet failure score predicts the likelihood that a company will
                      obtain legal relief from its creditors or cease operations over the next 12-month period. It
                      is presented as a ranking score ranging from 1-100: 1 indicates the highest risk of failure
                      and 100 the lowest level of risk. Businesses with the same failure score have the same
                      risk of failure.
                      47
                        According to PPF officials, the funding position of plans is reported through an exchange
                      system on a consistent basis, as specified in PPF guidance, and transformed to a
                      consistent date by rolling forward the assets and liabilities notified to a consistent date.
                      The exchange is maintained by the UK’s Pensions Regulator, the agency responsible for
                      regulating pension plans in the UK. The exchange allows sponsors to upload information
                      about their plans and make premium payments electronically.




                      Page 22                                                          GAO-13-58 PBGC Premiums
components of PPF’s premium formula.) PPF then uses a premium
scaling factor to calculate a plan’s premium to meet a certain revenue
target. 48

The changes adopted for plan year 2012/2013 affect how PPF will
calculate both the risk-based premium and the plan-based premium. For
example, before these changes, for plan year 2011/12, all sponsors with
plans funded up to 155 percent paid a risk-based premium based on an
underfunding risk factor that decreased as a plan’s funding level
increased. Sponsors whose plans were funded at or above 155 percent
did not pay a risk-based premium. For the 2012/13 plan year, plan
underfunding will be calculated using 5-year financial market indexes—
referred to as smoothing 49—for plan assets and liabilities, and will for the
first time take a plan’s investment strategy into account, adjusting a plan’s
underfunding risk based on the plan’s level of investment risk. The risk-
based premium is also capped to protect the most vulnerable plans. 50 In
addition, prior to the 2012/13 plan year, the plan-based premium was
based on a plan’s estimated liabilities to its participants. Starting with the
2012/13 plan year, the plan-based premium will be based on a plan’s
smoothed liabilities to its participants and on a premium multiplier to cover
the costs to the agency of capping the highest risk-based premiums. As a
result, the plan-based premium will account for a smaller percentage of




48
  PPF’s annual revenue target is based on estimates of the funds required to meet certain
future financial goals. Beginning in August 2010, PPF has published its funding strategy,
which sets out how the agency intends to have the financial resources needed to pay
existing levels of compensation to current and future PPF participants and become
financially self-sufficient by 2030. For plan year 2012/13, the premium scaling factor is set
to scale down risk-based premiums so that together with the plan-based premiums, PPF
will collect revenue sufficient to meet its target ($864 million) for the year.
49
  To reduce the impact of short-term volatility in the financial markets, and to ensure that
all plans are treated on a consistent basis, for plan year 2012/13, PPF will smooth the
value of the assets and liabilities that a plan reports using 5-year financial market
averages up to March 30, 2012.
50
   The cap for 2012/13 is 75 basis points (0.75 percent) of smoothed liabilities. Where the
risk-based premium calculated using the above formula exceeds 0.75 percent of a plan’s
liabilities, the cap is applied and the premium is decreased accordingly.




Page 23                                                          GAO-13-58 PBGC Premiums
    the total premium, decreasing its portion of the total premium from 20
    percent to an estimated 10 percent. 51

    Beyond these basics, PPF’s premium framework differs from PBGC’s
    current premium structure and from other proposals to redesign PBGC
    premiums in a number of more subtle ways as well. Key features include
    the following:

•   Equitable basis of PPF’s plan-based levy. The plan-based premium used
    prior to the 2012/13 plan year can be considered, essentially, PPF’s
    version of PBGC’s flat-rate premium. The difference is that PBGC’s flat-
    rate premium is calculated on a per participant basis, whereas PPF’s
    plan-based premium is a percentage of the liability owed to participants.
    The percentage of liability approach is a more equitable distribution in the
    sense that it is based on the total liability owed by a plan to its
    participants, rather than on a plan’s participant count (a plan could have
    many participants but a relatively small liability, or few participants but a
    very large liability, so that the number of participants per se has
    limitations as a measure of exposure). For example, consider two plans
    with the same number of participants, but one has a liability twice as
    large as the other (either because of more generous benefits or costlier
    demographics). Although, all other things being equal, the plan with
    greater liability is riskier, under its current premium structure, PBGC
    would charge both plans the same fixed premium, whereas PPF would
    have charged a larger plan-based premium to the plan with greater
    liabilities.

•   Proportionality in PPF’s underfunding factor. In the risk-based premium
    option modeled by PBGC, a plan’s funded status is represented by its
    funded ratio (the ratio of plan assets to plan liabilities). The variable rate
    applied to that plan is, in part, determined using that ratio to assign the
    sponsor to one of the designated risk premium categories and the rate is
    then applied on a per participant basis. In contrast, PPF represents


    51
       While the premium cap applies only to some plans’ risk-based premiums, the multiplier
    is spread across all plans’ plan-based premiums to help meet PPF’s revenue target. PPF
    contends that this approach also makes the necessary cross-subsidy in the plan-based
    premium more transparent as it ends the practice of scaling up risk-based premiums to
    cover the cost of capping. In essence, PPF is minimizing the amount of cross-
    subsidization in the plan-based premium by limiting it to only cover premiums lost via the
    capping on risk-based premiums. In contrast, in the previous plan year (2011/12), a
    multiplier was applied to every plan so that plan-based premiums accounted for an
    estimated 20 percent of the total pension protection premium estimate for the year.




    Page 24                                                        GAO-13-58 PBGC Premiums
    funded status by the actual financial value of the unfunded liability of
    each plan and does not assign a plan to a funded category, but instead
    applies a premium directly to the unfunded amount (similar to the current
    PBGC variable-rate premium), so that the premium charged is more
    proportional to the individual unfunded exposure of the plan. By being
    directly linked to the level of underfunding in each individual plan, PPF’s
    premium may more accurately reflect the level of risk posed by plans
    than the hypothetical approach modeled by PBGC.

•   Linkage of PPF premiums to long-term funding strategy. PPF publishes a
    long-term funding strategy, which sets out how the agency intends to
    have the financial resources needed to pay existing levels of
    compensation to current and future PPF participants and become
    financially self-sufficient by 2030. 52 Integral to its funding strategy, PPF
    monitors how its premiums might need to change under different
    economic circumstances in order to meet its funding target. 53 Although
    PBGC publishes an annual exposure report—which estimates future
    claims and premium revenues—it does not currently have the statutory
    authority to change rates based on these estimates to meet specific
    revenue targets.

•   Proportionality and effectiveness of including plan asset allocation as a
    risk factor. Although new for PPF and therefore untested, incorporating
    this significant risk factor into rates could better align premiums with risk
    and could also provide an incentive for sponsors to use less risky asset
    allocations.



    52
      PPF defines self-sufficiency as a level of assets 10 percent in excess of its liabilities. In
    addition to being fully funded, PPF’s goal is to eliminate its exposure to interest rate
    fluctuation, inflation, and other market risks. PPF also wants to build a reserve to further
    protect itself against future claims and the impact of members living longer than it
    estimates. Most recently, PPF’s latest assessments show that the probability of achieving
    self-sufficiency measured on its base case has improved from 83 percent in March 2010
    to 87 percent in March 2011.
    53
       To help reduce volatility for plan sponsors, PPF’s risk-based premium is now fixed for 3
    years. Beginning with the 2012/13 plan year, PPF revised its funding strategy to reflect a
    “bottom up” approach in which risk factor parameters will be fixed for 3 years and, ideally,
    remain stable between each 3-year review. Under this approach, PPF intends to keep the
    risk-based premium scaling factor and the plan-based multiplier fixed for 3 years—a
    sponsor’s risk-based premium will only change if its risk level changes. Previous to plan
    year 2012/13, PPF’s model reflected a “top down” approach in which PPF would decide
    upon the premium that it deemed appropriate in a given year, and then set the premium
    parameters accordingly on an annual basis.




    Page 25                                                           GAO-13-58 PBGC Premiums
                       In addition, there are differences related to risk premium caps between
                       PPF’s framework and PBGC’s proposed risk-based premium that could
                       potentially have distributional effects on rates and premium levels. The
                       cap on PPF’s risk-based premium is 75 basis points (0.75 percent) of the
                       plan’s liability to its participants. This compares to the administration’s
                       proposal for a different type of cap for PBGC whereby premiums would
                       be limited to four times a sponsor’s plan year 2010 premiums on a per
                       participant basis and the new $400 per participant variable-rate limit set
                       by MAP-21. How premium caps are calculated could change the
                       distributional pattern of the amount of premiums sponsors would pay
                       under different premium options, and could adjust the total amount of
                       revenue collected by PBGC under these options.


                       Compared to the distribution of costs under the current structure,
Moving to a More       premium costs would be redistributed to those sponsors posing greater
Risk-Based Structure   risk to PBGC under a more risk-based structure. For example, if the
                       financial health of the plan sponsor were included as a risk factor,
Shifts Premium Costs   financially risky sponsors would pay more, while financially healthy
to Riskier Sponsors    sponsors would pay less. A more risk-based structure such as this would
                       decrease the cross-subsidization present in the current premium structure
                       that relies largely on the flat rate charged to all sponsors based on
                       number of participants no matter the level of risk they pose. Pension
                       experts and plan sponsors we spoke with raised various concerns about
                       this redistribution of costs. For example, some voiced concerns that the
                       higher premiums for some plan sponsors might increase the frequency of
                       plan freezes and terminations; 54 however, our previous work indicates
                       that, generally, this would be unlikely. Some noted that depending on the
                       way risk is incorporated, premiums could rise during recessions when
                       financially weak companies are least able to bear the costs, especially
                       smaller companies. Some also expressed concern about the equity of
                       various premium redesign options, especially those that require current
                       sponsors to pay higher premiums to address PBGC’s deficit for prior plan
                       terminations. Experts and officials suggested various ways to address
                       such concerns.



                       54
                        A plan freeze is an amendment to the plan to limit some or all future pension accruals for
                       some or all of the plan participants. For example, a pension plan may close to new
                       participants, or a plan may opt to prohibit existing participants from earning pension
                       benefits in the future.




                       Page 26                                                        GAO-13-58 PBGC Premiums
Financially Risky Sponsors                      Under a more risk-based structure that included sponsor financial health
Would Be Charged Higher                         as a risk factor, premium costs would be redistributed to better reflect the
Premiums                                        risk posed by each plan sponsor. To better understand the implications of
                                                moving to one such more risk-based structure, we analyzed the data
                                                provided in PBGC’s sample of 2,699 plans to determine the range of per
                                                participant rates sponsors would pay under PBGC’s hypothetical risk-
                                                based option compared with rates in plan year 2010 and the increases
                                                scheduled to be in place in 2015 as a result of MAP-21. As summarized
                                                in table 7, compared with rates in 2010, minimum rates are higher across
                                                the board under both the act and the more risk-based option, while the
                                                maximum rates are lower due to the adoption of a variable-rate limit (four
                                                times the per participant rate paid in plan year 2010 for the hypothetical
                                                risk-based option and no more than $400 per participant under MAP-21).
                                                In a comparison of rates under the risk-based option with estimated rates
                                                under MAP-21 in plan year 2015, those with plans that are well funded
                                                (that is, funded at 120 percent or more) could see their rates decrease
                                                slightly ($44 vs. $49) if they are financially healthy, while their rates could
                                                more than double ($134 vs. $49) if they are categorized as very risky.
                                                Among those with plans that are poorly funded (that is, funded at less
                                                than 75 percent), sponsors could see higher rates under the more risk-
                                                based structure depending on whether they are financially healthy or not
                                                ($94 to $494 vs. $57 to $449). For example, a poorly funded plan that is
                                                categorized as very risky could see its rates increase as much as $257
                                                per participant. PBGC officials noted, however, that while technically
                                                correct, few plans are likely to have variable-rate premiums near these
                                                upper-end caps.

Table 7: Hypothetical Risk-Based Option Premium Rates Compared to Rates in Plan Year 2010 and in Plan Year 2015 under
MAP-21

Dollars per participant
                                                                                                                                                                       a
                                                                      Range of per participant premium rates among plans in sample
                                                                                >120% >90% to under 120%                            75% to under                        <75%
                                                                               funded             funded                             90% funded                       funded
                      b
Plan year 2010 rates                                                                $35                      $35-$315                     $38-$708           $39-$2,481
                                                     c
Plan year 2015 rates under MAP-21 (estimated)                                         49                         49-449                       54-449                  57-449
PBGC’s hypothetical risk-based option
(incorporates additional risk factor for financial
       d
health)                                                                        44-134                            44-224                       69-269                  94-494
                                                Source: GAO analysis of PBGC data from a sample of defined benefit plans used in PBGC’s hypothetical premium model.

                                                a
                                                 For the most part, PBGC’s model used plan year 2010 data from a sample of 2,699 DB plans
                                                covering 27.5 million participants. The model covered 81 percent of all PBGC-insured participants
                                                (33.8 million) in 2010. However, in some instances, PBGC used 2009 data to calculate per participant




                                                Page 27                                                                                 GAO-13-58 PBGC Premiums
rates for sponsors. In those instances, the lower bound of the per participant rate was $34, since the
flat rate was $34 per participant in 2009. Thus, we chose to limit our analysis of PBGC’s model to
data from 2010.
b
 To calculate the per participant rates for plan year 2010, PBGC divided the total premiums each plan
paid in plan year 2010 by the participant count for that plan. To calculate the range of premium rates
by funding level, we grouped PBGC’s per participant rates data for each plan into the four funding
categories PBGC used in its hypothetical premiums model.
c
 Pub. L. No. 112-141, 126 Stat. 405 (2012). Rates under MAP-21 for 2015 are estimated using data
from PBGC’s premium model, including participant and underfunding levels from 2010. We estimated
rates by placing a limit of $400 on the variable rate on a per participant basis as required under the
act and by grouping per participant rates data for each plan into the four funding categories PBGC
used in its hypothetical premiums model.
d
 Rates under this option are affected by both the aggregate funding level for a sponsor’s plan and the
sponsor’s financial health rating. To calculate the per participant rates for the risk-based option,
PBGC used plans’ funding levels and participant counts from its plan year 2010 premium database
and incorporated financial health data for each sponsor. Based on a plan’s funding level and the
financial health of the plan’s sponsor, PBGC assigned each plan to a risk category that carried a
specific per participant rate. To calculate the range of premium rates by funding level, we grouped
PBGC’s per participant rates data for each plan into the four funding categories PBGC used for this
option in its hypothetical premiums model.


To determine how these rate changes would be redistributed at the
company level, rather than at the plan level, we aggregated the data in
PBGC’s sample by sponsor. We found that the 2,699 plans in the sample
were sponsored by 1,114 different companies. As summarized in figure 2,
our analysis suggests that for the two-thirds of companies that were
ranked more financially healthy (that is, sponsors whose financial health
is considered extremely healthy, very healthy, or healthy), premiums
would decrease for a majority (71 percent of sample companies). These
decreases were largely due to the lower flat rate under the risk-based
option compared to the MAP-21 rate. In contrast, for the companies that
were ranked less financially healthy (that is, sponsors whose financial
health is considered either risky or very risky), premiums could increase
for most (92 percent of these sample companies). The increases were
mainly due to how the financial health risk factor affects per participant
rates under the risk-based option for these companies, regardless of level
of plan underfunding.




Page 28                                                                 GAO-13-58 PBGC Premiums
Figure 2: Percentage of Sample Sponsors with Premium Rate Changes under
PBGC’s Hypothetical Risk-Based Option Compared with Estimated Rates in Plan
Year 2015 under MAP-21




Because rates under the risk-based option are calculated on a per
participant basis, the magnitude of these changes will vary by company
depending on the number of participants in the plan or plans that they
sponsor. For example, among the 143 least financially healthy companies
with increases in premiums under PBGC’s risk-based option, the number
of plans and participants for companies varied widely. On the small end of
the spectrum, one company sponsored a plan with 825 participants. This
company’s estimated total premium cost would be $407,550 under
PBGC’s risk-based premium, compared with $370,425 under MAP-21 in
plan year 2015, a 10 percent increase. On the large end, another
company sponsored a plan with 327,463 participants. This company’s
estimated total premium cost would be $100.9 million under PBGC’s risk-
based premium, compared with $43.2 million under MAP-21 in plan year
2015, a 133 percent increase, even with the cap.



Page 29                                               GAO-13-58 PBGC Premiums
Premium Changes Have      Although plan sponsors and experts expressed varying opinions about
Not Been Key Factors in   how moving to a more risk-based premium structure might influence plan
Decisions to Freeze or    sponsors, our previous work on the subject found that increases in
                          premium costs were not a significant reason for sponsors to freeze or
Terminate Plans           terminate their DB plans. Among the many reasons sponsors cited in our
                          2008 report for freezing their largest plans, the most often cited were the
                          impact of annual contributions on their firm’s cash flows and the
                          unpredictability of plan funding. The factors that were most likely to
                          influence implementing a hard freeze—that is, a freeze that ceases all
                          future benefit accruals—were sponsor size and the extent to which a
                          sponsor’s plans are subject to collective bargaining agreements. 55 A more
                          recent survey of DB plan sponsors by Towers Watson reported similar
                          findings. 56 Sponsors cited reducing cost and minimizing cost volatility as
                          the primary reasons for freezing plans or converting plans to some other
                          type of retirement savings instrument. PBGC premium increases were not
                          mentioned by sponsors as a factor for freezing or converting their plans. 57




                          55
                             As of 2008, larger sponsors, those with 10,000 or more total participants, were
                          significantly less likely than smaller sponsors to have implemented a hard freeze.
                          Similarly, firms with some or all plans subject to collective bargaining are significantly less
                          likely to implement hard freezes than sponsors with no plans subject to collective
                          bargaining. See GAO, Defined Benefit Pensions: Plan Freezes Affect Millions of
                          Participants and May Pose Retirement Income Challenges, GAO-08-817 (Washington,
                          D.C.: July 21, 2008).
                          56
                            Towers Watson conducted the survey from October 2011 to December 2011 and
                          included responses from 424 DB plan sponsors at midsize and large organizations.
                          Respondents were asked about changes to their retirement plans over the past 10 years,
                          their motivations behind those changes and their future retirement offerings. See Towers
                          Watson, Pensions in Transition: Retirement Plan Changes and Employer Motivations
                          (New York, N.Y.: May 2012).
                          57
                            While higher premiums were not cited as a reason to freeze or terminate a plan, lower
                          premiums were cited as a potential reason to reopen a plan after it had been frozen. Ibid.




                          Page 30                                                           GAO-13-58 PBGC Premiums
Moreover, according to PBGC officials, premiums generally account for a
small percentage of compensation costs. 58

Nevertheless, several experts and others we spoke with pointed out that
increased premium costs could have negative implications for DB plan
sponsors. For example, some commented that increased premiums might
divert funds that sponsors would have otherwise used to fund their
pension plans or other company priorities such as job creation and
business investment. A few told us they viewed a potential increase in
PBGC premiums simply as a tax increase on companies that sponsor DB
pension plans. One sponsor we spoke with commented that DB pension
plans are already in duress because of historically low interest rates for
plan funding obligations, and that increased premium costs would add
another challenge to sponsors. Another noted that it is increasingly more
difficult to justify the costs of DB pension plans to management, and
increased premiums may be the final factor in a sponsors’ decision to
freeze or terminate their plan. However, another sponsor said that given
all the other challenges facing pension plans, increasing premiums is
unlikely to have a significant effect.

Pension experts we spoke with also differed in their opinion on whether
implementing a new premium structure would lead to plan freezes or
terminations. Several—including, five business professionals, three
academics, one labor representative, one actuary, and one federal
official—noted that increased premium costs may cause an increase in
plan freezes or terminations, which could result in negative implications




58
  According to PBGC’s analysis of Bureau of Labor Statistics data, premiums account for
about 1 cent per hour of total average compensation costs. This analysis was based on
data that indicated that, on average, private industry employers spend approximately 3.6
percent of total compensation costs on retirement and savings expenses, and of this,
PBGC premiums generally account for approximately 3.4 percent of total pension costs.
However, PBGC’s analysis does not take into account that only about 10 percent of
private companies offer access to DB plans. A more accurate calculation would need to
reflect the cost of premiums compared to compensation costs among just those firms
offering DB plans, but the Bureau of Labor Statistics does not provide a breakdown of
data to allow such an analysis.




Page 31                                                       GAO-13-58 PBGC Premiums
for the retirement security of plan participants. 59 As one academic noted,
under a risk-based premium structure, premium costs for financially
healthy plans and sponsors may decrease, while financially unhealthy
plans and sponsors will likely have increased premium costs, further
worsening their financial position and potentially causing these plan
sponsors to exit the DB system. However, others stated that they
believed that increased premiums will not increase plan freezes and
terminations. For example, an agency official said that premiums
historically have been set low, and premium increases are unlikely to
cause plan freezes or terminations. Additionally, another agency official
noted that since there are many factors influencing plan sponsors’
decisions to terminate a plan, premium increases will likely have little
impact.

Nevertheless, pension plan freezes and terminations have become more
common in recent years, weakening the DB system. Plan freezes
increased nearly 50 percent from 2003 to 2008. Specifically, PBGC
reported that as of the end of 2009, approximately 27 percent of all
PBGC-insured plans were hard frozen. 60 Voluntary standard terminations
have also increased in recent years, with an approximately 29 percent




59
   Our previous work on the topic noted that plan freezes and terminations may impact
participants’ retirement security by reducing future benefits, though this may be somewhat
or entirely offset by increases in other benefits or a replacement retirement-savings plan.
Additionally, under a plan termination, it takes PBGC about 3 years, on average, to
complete the benefit determination process and provide participants their finalized benefit
amounts. Long delays and uncertainty over final benefit amounts in a plan termination
make it difficult for workers to plan for retirement, and for retirees who have come to
depend on a certain level of monthly income. See GAO-08-817 and GAO, Pension Benefit
Guaranty Corporation: Workers and Retirees Experience Delays and Uncertainty when
Underfunded Plans Are Terminated, GAO10-181T (Washington, D.C.: Oct. 29, 2009).
60
   A hard freeze—the most common type of freeze—occurs when all future benefit
accruals cease. PBGC officials noted that freezes have occurred disproportionately in
smaller plans and that a more accurate metric may be the number of workers affected by
a freeze. According to PBGC, just over 75 percent of all active employees participating in
PBGC-insured single-employer DB plans are still accruing benefits and are in plans that
still cover new employees, indicating that less than 25 percent are in plans that have been
affected by a freeze.




Page 32                                                        GAO-13-58 PBGC Premiums
                             increase from fiscal year 2003 to 2010. 61 Data provided by PBGC indicate
                             that, from 2000 to 2010, about 1.2 million participants were in plans that
                             ceased to exist because of standard plan terminations. 62 The Towers
                             Watson survey found that approximately two-thirds of sponsors that once
                             offered a DB plan to new hires no longer offer these benefits; however,
                             the survey also found that many active DB sponsors remain committed to
                             offering a DB plan in the future. 63


Other Potential Behavioral   Rather than inducing plan sponsors to freeze or terminate their plans,
Effects Cited, but Impact    several pension experts—as well as PBGC officials—expressed the hope
Uncertain                    that moving to a more risk-based premium system would encourage less
                             risky behavior among plan sponsors. For example, when faced with
                             increased premiums for increased risk, sponsors might adopt safer asset
                             allocation practices or contribute more to their plans to keep funding
                             levels higher. In an attempt to quantify this incentive, one pension actuary
                             has noted that the current variable-rate premium can have an economic
                             effect equivalent to an additional return on investment. For example,
                             when, in 2015, the variable rate reaches $18 per year per $1,000 of
                             underfunding, an additional $100 contributed to an underfunded plan will
                             reduce annual premiums by $1.80, or 1.80 percent, and so can be viewed
                             as boosting investment return by almost 2 percent— which is a potentially
                             stronger incentive to fund the plan than what exists currently. Similarly,
                             the new premium assessment in the UK based on the riskiness of plan
                             asset allocation could possibly induce plan sponsors to shift to somewhat


                             61
                                However, voluntary standard plan terminations can be costly, as plan sponsors must
                             fully fund all benefits, either by distributing lump-sum payments (to the extent allowed
                             under the plan and elected by participants) or by purchasing annuities to secure
                             participants’ benefits into the future. 29 U.S.C. § 1341(b). An underfunded plan cannot be
                             terminated unless the sponsor demonstrates it cannot fund the plan, usually through a
                             bankruptcy proceeding. Thus, when a healthy sponsor terminates an underfunded plan, it
                             first must fully fund the plan prior to termination. When PBGC initiates the termination of a
                             plan, it is because it determines the sponsor will be unable to fund the plan, and it
                             intervenes to protect participants’ benefits.
                             62
                              At the same time, PBGC officials noted that in 2010, standard terminations were just
                             about 5 percent lower than the average of 1369 standard terminations for the previous 10
                             years. PBGC officials also indicated that on average, these plans covered about 80
                             participants, and of those 1.2 million participants, about half were workers.
                             63
                               The Towers Watson study also found that larger DB plan sponsors are less likely to
                             move away from a DB design than their smaller counterparts and that certain industries
                             (e.g., utilities, health care) are more likely to depend on DB benefits as a vital component
                             of reward packages to attract and retain skilled workers.




                             Page 33                                                          GAO-13-58 PBGC Premiums
                        less risky asset allocations. Either effect—increased funding or less risky
                        asset allocations—would, in turn, reduce the risk to the pension
                        insurer. Little is yet known about the likelihood or magnitude of these
                        potential effects, however, and PBGC does not include any behavioral
                        impacts in its modeling.


Concerns Raised That    Some pension experts we spoke with raised concerns about the potential
Risk-Based Premiums     for premiums to rise when companies are least able to bear the costs, as
Could Increase during   could be the case during recessions. Depending on how risk factors are
                        incorporated into rates, premiums could have a pro-cyclical effect—that
Recessions              is, they would increase during economic downturns. As economic
                        conditions worsen, more companies would fall into the less financially
                        healthy categories, and more plans would become less well-funded,
                        resulting in higher premiums. This could lead to financially weaker firms
                        being required to pay higher premiums at precisely the time that they can
                        least afford to do so.

                        However, increases in premiums under the current premium structure are
                        already pro-cyclical. For example, the increases in the variable rate under
                        MAP-21, enacted in July 2012, would cause rates to increase to the
                        extent that plan underfunding increased during a recession when firms
                        are least capable of paying higher premiums. Recognizing that such
                        increased premium costs could prove a hardship for some sponsors,
                        Congress included a cap on premium increases under MAP-21, and the
                        President’s proposal also included a cap. 64 Additional steps could be
                        taken to address such concerns with cyclicality under a more risk-based
                        premium structure. For example, PBGC officials said that, in addition to
                        caps, they would consider supporting the use of an average of a




                        64
                          As noted earlier, under MAP-21, per participant premium rates are capped at no more
                        than $400 beginning in 2013. Similarly, under the President’s deficit reduction proposal,
                        per participant rates for premiums are capped at no more than four times the rates paid in
                        plan year 2010.




                        Page 34                                                        GAO-13-58 PBGC Premiums
sponsor’s 5-year funding levels to help smooth the impact that economic
cycles would have on risk-based premium rates. 65

FDIC faced similar concerns when designing its new premium system for
financial institutions in 2006. To address these concerns, the FDIC
capped premiums for its riskiest category of institutions at 60 percent
below what the premium amount would be under a purely risk-based
system. 66 In adopting this cap, FDIC sought to address long-standing
concerns of the industry, regulators, and others that premiums should not
be set so high as to prevent an institution that is troubled and seeking to
rebuild its health from doing so. As a result of the cap, however, some
degree of cross-subsidy still exists in the premium system between
financially healthier institutions and troubled institutions.

The impact of having to pay higher rates under a new premium structure
also may pose more of a challenge for some smaller companies than
some larger ones, as they may have fewer resources to draw from for
these added costs. The data in PBGC’s premium model do not include
information on company size, such as a sponsor’s assets, revenue,
operating costs, or payroll expenditures. Without such data, it is unclear
the extent to which smaller companies may experience a greater hardship
under the risk-based option compared with larger companies. However,
consideration of company size could be incorporated into a redesigned
premium structure. For example, in designing its premium system, the
FDIC created a structure that differentiates between large and small
institutions. Large institutions are priced using one of two “scorecards”—
one for the majority of large institutions, and a separate scorecard for very
large institutions that are structurally and operationally complex or that



65
   During the recent economic downturn and current economic situation, Congress took
similar steps to mitigate the effects of the PPA provisions requiring increased contributions
to underfunded plans, allowing sponsors to amortize increases to their contributions over
a longer period, postponing implementation of the increased funding requirements for
some firms, and averaging market interest rates over a 25-year period to provide relief
against the current low interest rate environment. Preservation of Access to Care for
Medicare Beneficiaries and Pension Relief Act of 2010, Pub. L. No. 111-192, 124 Stat.
1280,1283-1306, §§ 201-211; and Worker, Retiree, and Employer Recovery Act of 2008,
Pub. L. No. 110-458, §§ 101, 102, 121 and 122, 122 Stat. 5092, 5093-5103, 5113-14, and
MAP-21, § 40221, 126 Stat. 850-52.
66
   In 2006, FDIC officials noted that the number of institutions in this highest category is
small and thus the trade-off between lower premiums for troubled institutions and
potentially larger losses for FDIC later would not be significant. See GAO-07-242.




Page 35                                                           GAO-13-58 PBGC Premiums
                           pose unique challenges and risks in case of failure. Each scorecard
                           combines a performance score and a loss severity score. The scorecard
                           for large and complex institutions incorporates various measures of
                           market risk. Smaller institutions have their premiums based on financial
                           ratios, such as an institution’s capital, past-due loans, and income, and its
                           CAMELS ratings. For smaller institutions, FDIC data show that the higher
                           on the CAMELS scale institutions are rated, the higher the rate of failure.


General Concerns about     Plan sponsors and others we spoke with also raised some concerns
Equity Implications of     about the equity of increasing premiums under a more risk-based
Increasing Premiums Also   structure. In particular, several raised concerns about having current
                           sponsors pay higher premiums to pay for PBGC’s liabilities from plans
Raised                     terminated in the past. Further, the amount of revenue currently being
                           proposed to be raised through increased premiums is unlikely to cover
                           the full amount of future claims, let alone help to address liabilities due to
                           past claims.

                           These concerns are not unique to a more risk-based premium structure.
                           Increasing rates under the current premium structure also gives rise to
                           concerns about equity implications, and is the reason for adopting
                           premium caps. 67 However, such provisions do not alleviate the equity
                           concerns of how to deal with “legacy costs” from plans terminated in the
                           past. To further address such equity concerns, several pension experts
                           noted the need to separate PBGC’s existing liabilities from the projected
                           cost of future claims, and they suggested various alternative surcharges
                           for accomplishing this goal (see table 8). 68 These surcharges attempt to
                           raise revenue to pay existing liabilities more equitably by targeting
                           companies that have re-emerged from bankruptcy, that are in industries
                           with the largest previous claims, and that are past as well as current
                           sponsors. However, as noted in the table, each has drawbacks that limit
                           its effectiveness as a potential revenue-raising tool for this purpose.


                           67
                             As noted earlier, to help address such concerns, Congress included provisions in MAP-
                           21 to limit the extent of increases in the variable-rate premium. The administration has
                           also proposed limiting the extent of increases by setting a maximum per participant limit to
                           the total amount of a sponsor’s increase under a more risk-based premium structure.
                           68
                             See also, American Academy of Actuaries, Examining the PBGC Premium Structure,
                           (Washington, D.C.: April 2012). This issue brief describes how PBGC costs could be
                           divided into two distinct categories: (1) going-forward costs, which are associated with the
                           risks of ongoing coverage by PBGC; and (2) past costs, which are associated with existing
                           or imminent claims on PBGC for terminated plans.




                           Page 36                                                         GAO-13-58 PBGC Premiums
Table 8: Options Suggested by Experts to Address PBGC’s Past Deficit Costs

Bankruptcy Re-Emergence       A surcharge could be levied against sponsors whose plans terminate in bankruptcy, but re-emerge
Surcharge                     after turning over their liabilities to PBGC. The surcharge would be separate from, and in addition to,
                              the termination premium, which is levied on plan sponsors that terminate an underfunded pension
                                    a
                              plan. Such a surcharge could promote greater accountability among plan sponsors responsible for
                              PBGC’s deficit, but may place a serious financial burden on these formerly bankrupt companies.
Industry-Specific Surcharge   A surcharge could be levied on those industries that have accounted for a disproportionate amount
                              of PBGC’s deficit. For example, the government could impose a fee on airline tickets that would
                              cover the underfunded airline plans that have been taken over by PBGC. This surcharge may
                              incentivize plan sponsors within certain industries to manage their plans more responsibly. However,
                              it may also place a financial burden on these companies or their customers through increased prices,
                              and these companies would not be the same companies that contributed to PBGC’s deficit by
                              terminating their plans in the past.
Retirement Sponsor            A surcharge could be levied on an ongoing basis across all DB plan participants, and/or a one-time
Surcharge                     surcharge could be levied on any past or present sponsor that provides a DB retirement plan. This
                              approach recognizes that all DB plan sponsors have a stake in the health of the DB retirement
                              system, and PBGC’s insurance program that helps protect its participants. However, this surcharge
                              would place an additional cost on healthy plan sponsors who are less likely to be responsible for
                              contributing to PBGC’s deficit by terminating their plans in the future.
                                        Source: GAO interviews with pension experts.

                                        a
                                         29 U.S.C. 1306(a)(7). Specifically, a termination premium of $1,250 per participant per year for 3
                                        years generally applies when a single-employer plan terminates in a distress termination under 29
                                        U.S.C. § 1341(c)(2)(B)(ii) or (iii) or in an involuntary termination under 29 U.S.C. § 1342. However,
                                        this premium does not apply in the case of a plan terminated under 29 U.S.C. §§ 1341(c)(2)(B)(ii) or
                                        1342 during the pendency of a bankruptcy reorganization (29 U.S.C. § 1306(7)(b)), or to any plan
                                        termination during the pendency of any bankruptcy reorganization filed before October 18, 2005
                                        (Deficit Reduction Act of 2005, Pub. L. No. 109-171, § 8101(b) and (d), 120 Stat. 181-22 and 183
                                        (2006)).


                                        In addition, some plan sponsors and others we spoke with voiced
                                        concerns about whether potential risk-based factors could equitably
                                        represent the future risk of particular sponsors and their plans to PBGC or
                                        could have other adverse consequences for sponsors. For example,
                                        some sponsors expressed concern about including a risk factor
                                        measuring plan asset investment mix, in particular, because, as noted by
                                        one sponsor, it is important for plan sponsors to invest assets according
                                        to their individual needs and priorities. Some experts also expressed
                                        equity concerns about the potential inclusion of a creditworthiness factor.
                                        One expert stated that if information about the financial status of DB plan
                                        sponsors were made public, it could put these companies at a competitive




                                        Page 37                                                                GAO-13-58 PBGC Premiums
                           disadvantage compared to companies that do not sponsor DB plans. 69 A
                           few plan sponsors said that risk-based premiums are conceptually
                           appealing, but that fairly measuring risk may not be feasible. For
                           example, one sponsor said that it would be difficult to fairly measure and
                           assess the risk factors used in setting risk-based premium rates and to
                           make the results of these measurements transparent.

                           Finally, some sponsor advocates we spoke with questioned the need to
                           increase premiums at all. These advocates believe if more appropriate
                           interest rates were used, the deficit would disappear, and no increase in
                           premiums would be warranted. 70


                           The process of redesigning and implementing a more risk-based premium
Moving to a Risk-          structure poses a number of operational challenges. Additional data and
Based Premium              analysis would be needed on the selected risk factors, with regular
                           monitoring to ensure that the data are accurate and up-to-date. PBGC is
Structure Poses            uniquely situated to take on this complex task, but if granted the statutory
Various Challenges         authority to do so, the agency could then face a number of additional
                           administrative challenges concerning governance, transparency, and
                           sponsor recourse.


Additional Data and        The rate-setting entity responsible for implementation of a risk-based
Analysis Would Be Needed   premium structure likely would require access to financial and other firm-
                           specific information to provide a sound technical basis for the underlying
                           parameters of a risk-based premium regime. The specific types of
                           information needed would depend on the specific factors selected, but the



                           69
                              PBGC officials noted, however, that commercial measures, such as a company’s credit
                           ratings, have been used to estimate the risk of default for individual companies for over a
                           century. Information on creditworthiness on public companies is readily available, and
                           credit scores on private companies are available for purchase from entities such as Dun &
                           Bradstreet.
                           70
                             They believe that the artificially low interest rates following the economic downturn of
                           2008 have, in turn, artificially inflated PBGC’s deficit. Instead of using annuity prices to set
                           interest rates for valuing its future liabilities, these advocates believe it would be more
                           accurate to use a “dollar cost averaging” approach that would set interest rates looking
                           forward over 30 years based on historical interest rates over the last 30 years—much like
                           the approach Congress took in changing funding requirements governing interest rates for
                           DB plans recently in MAP-21, § 40211, 126 Stat. 846-50. For further details on how PBGC
                           calculates its deficit, see appendix V.




                           Page 38                                                           GAO-13-58 PBGC Premiums
information currently being collected may not be sufficient in some cases.
For example, PBGC currently obtains information about plans from data
reported by plan sponsors on the Form 5500 and under section 4010 of
ERISA. Plan sponsors are required to submit the Form 5500 annually to
Labor, Internal Revenue Service, and PBGC. 71 This form includes
information about the level of plan underfunding (which is currently
captured in the variable-rate premium) and the investment mix of plan
assets (which is a potential risk factor that could be incorporated). The
other main source of information, data reported under section 4010 of
ERISA, is submitted to PBGC by plan sponsors only if certain criteria are
met. 72 The PPA revised those criteria, and according to PBGC officials,
some plans are no longer required to provide information under section
4010 of ERISA even though they still pose an increased risk to PBGC. 73

PBGC also obtains information about the financial health of plan sponsors
through its Early Warning Program, which is responsible for monitoring
companies that are deemed to pose a greater risk to PBGC because they
are financially troubled or have a significantly underfunded pension
plan. 74 This program uses information from a variety of sources in
conducting its work, including credit ratings, financial information services,
news databases, and information from Labor, the Internal Revenue
Service, and the Securities and Exchange Commission. While information
gathered through the Early Warning Program would be relevant to the
potential risk factor of a company’s financial health, the program does not
systematically gather data for all plan sponsors, and PBGC may be



71
     29 U.S.C. §§ 1021(b)(1) and 1023.
72
  29 U.S.C. § 1310. Specifically, plan sponsors and members of its controlled group are
required to report financial and actuarial information to PBGC for plans if the (1) the
funding target at the end of the preceding plan year is less than 80 percent, (2) certain
conditions for imposition of a lien have been met, or (3) minimum funding waivers in
excess of $1 million have been granted with respect to any plan maintained by a sponsor
or member of its controlled group, and any portion is still outstanding.
73
     Pub. L. No. 109-280, § 505(a), 120 Stat. 946.
74
   According to PBGC’s fact sheet on the program, the Early Warning Program identifies
potential business transactions that could jeopardize the pension insurance program, and
PBGC works with plans sponsors to negotiate additional contributions or security (which
may include letters of credit or financial guarantees) for underfunded pensions within the
context of the transaction. PBGC states that it will work with the company to tailor a
settlement that is appropriate to the business transaction and financially feasible for the
company.




Page 39                                                         GAO-13-58 PBGC Premiums
limited in its ability to use some credit rating data to assess risk within a
redesigned premium structure. 75

Other government agencies with risk-based premiums have established
reliable sources of needed information to support their premium
structures. For example, the FDIC relies entirely on pre-existing sources
of information and technical resources to assess risk for its risk-based
premiums. FDIC obtains information on institutions’ aggregate assets
from the quarterly reports submitted by each bank. FDIC’s CAMELS
ratings are developed during on-site examinations of each institution,
during which regulators more closely assess institutions’ exposure to risk.
These quarterly reports and on-site examinations existed prior to FDIC’s
shift to risk-based premiums, so FDIC did not need to gather additional
information or develop new expertise when it implemented its risk-based
premium structure.

Alternatively, in the UK, PPF (the UK’s pension insurance agency) relies
on information obtained annually through an online exchange for the
information needed to implement the risk-based premium structure. 76 PPF
calculates its risk-based premiums based on three risk factors: level of
underfunding, risk posed by the plan’s investment strategy, and risk of
sponsor insolvency (or bankruptcy). The exchange provides the agency
with information on a plan’s level of underfunding and how plan assets
are allocated across investments with different levels of risk. According to
a PPF May 2011 policy statement, beginning with plan year 2012/13, very
large plan sponsors—those with plan liabilities of £1.5 billion or greater
(about $2.35 billion in U.S. dollars)—are required to submit additional
information about their investments, while submission is optional for
smaller plans. To assess sponsors’ risk of insolvency, PPF currently
relies on Dun & Bradstreet’s failure scores—a measure of the likelihood


75
   Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, federal
agencies are to review their regulations and remove any reference to or requirement of
reliance on credit ratings and substitute other appropriate standards of creditworthiness.
Pub. L. No. 111-203, § 939A, 124 Stat. 1376, 1887 (2010). Thus, PBGC would be
required to establish its own standard of creditworthiness rather than use credit ratings to
assess the risk of plan sponsors in its premium structure.
76
   The exchange is maintained by The Pensions Regulator, the agency responsible for
regulating pension plans in the UK. The exchange enables sponsors to upload information
about their plans and make premium payments electronically. The Pensions Regulator
works closely with PPF to monitor high-risk plans, minimize claims, and ensure that
employers do not take advantage of the insurance provided by PPF.




Page 40                                                          GAO-13-58 PBGC Premiums
of sponsor bankruptcy—and applies its own schedule of premium rates
for differing Dun & Bradstreet scores. These rates build in a risk margin
equivalent to the charge an insurer would make for costs of capital held
for unexpected claims. 77

However, PBGC’s lack of similar regulatory authority compared with FDIC
and UK’s PPF could limit wholesale applicability of these other entities’
premium frameworks for PBGC. For example, according to PBGC
officials, the agency has virtually no regulatory authority and no
examination authority, and thus cannot routinely obtain the information
that the FDIC has at its disposal as a regulator. Similarly, PPF functions
as part of a larger pension regulatory structure, which includes The
Pensions Regulator—the agency responsible for regulating pension plans
in the UK. One of The Pensions Regulator’s stated objectives is to reduce
the risk that PPF will need to take on unfunded liabilities. On its website,
The Pensions Regulator lists examples of the regulatory actions it can
take against plan sponsors to protect the security of participants’ benefits.
In contrast, the oversight of pensions in the United States is more diffused
with different authorities residing within the Employee Benefits Security
Administration, the Internal Revenue Service, and PBGC. PBGC officials
noted that the President’s proposal for a more risk-based premium
structure called for an analysis and public comment process, in part, to
help address PBGC’s limited authority regarding the additional data and
analysis needed to implement such a structure.

Other differences between PBGC and the UK’s PPF may also limit the
applicability of PPF’s premium framework for PBGC. For example, the
governance structure of U.S. single-employer pensions and UK pensions
differ significantly. According to The Pensions Regulator’s website, UK
pension law requires that at least one-third of individuals responsible for
administering the plan, or plan trustees, must be selected by plan
participants. In contrast, there is no requirement for stakeholder
representation among fiduciaries of U.S. single-employer plans. 78



77
   The Dun & Bradstreet failure score is designed to predict the likelihood that a company
will cease operations without paying all creditors over the next 12 months. This includes
the onset of failure such as a meeting of creditors, administrator appointments,
bankruptcy, receiver appointments, petitions for winding-up and other legal events.
78
   Fiona Stewart and Juan Yermo, “Pension Fund Governance: Challenges and Potential
Solutions,” OECD Working Papers on Insurance and Private Pensions, no. 18. (OECD
publishing, Paris, France: June 2008.)




Page 41                                                        GAO-13-58 PBGC Premiums
Stronger Governance and   Implementing a more risk-based premium structure creates governance
Oversight Would Be        challenges whether authority for premium setting rests with Congress,
Needed                    PBGC, or another entity. Premiums for PBGC’s single-employer
                          program—both the flat-rate premium and the variable-rate premium— are
                          currently set by statute and PBGC lacks the statutory authority to modify
                          premium rates and structures on its own. 79 Although legislation has been
                          enacted to periodically adjust the level of premiums, this process has
                          resulted in rates that do not adequately reflect the risk to PBGC’s financial
                          condition.

                          In moving to more risk-based premium structure, Congress could decide
                          to enact new premium rates directly. For example, Congress could
                          establish a formula under which both financial risk and underfunding
                          would jointly determine a plan’s premium (as shown earlier on table 6).
                          The legislation could include fixed dollar caps (as in MAP-21) or limits on
                          the annual percentage change in premiums.

                          But even if Congress were to decide to delegate authority over setting
                          premium rates under a new structure, it could still maintain an important
                          role in the process. For example, some experts we spoke with suggested
                          that Congress could establish the broad framework for incorporating
                          additional risk factors into PBGC’s premium structure, while leaving the
                          detailed mechanics of how to construct such a structure to others with
                          greater technical expertise. In addition, a number of pension experts we
                          spoke with said that congressional oversight would be useful during the
                          premium redesign process. Many supported regular reporting by PBGC to
                          Congress on progress in developing and implementing a risk-based
                          premium structure, with some going further to suggest that PBGC report




                          79
                               29 U.S.C. § 1306(a)(3)(A)(i), (E) and (F).




                          Page 42                                              GAO-13-58 PBGC Premiums
its proposed changes to the Congress with changes taking effect only if
enacted into law. 80

While Congress has the authority to set and change premiums, PBGC
has considerable expertise in reviewing relevant data to assist with
designing a more risk-based premium structure. In many ways, as the
implementing agency of the current premium structure, PBGC is uniquely
situated to obtain and analyze the complex data needed to design and
implement a more risk-based premium structure. However, if PBGC were
granted statutory authority to redesign its premium structure, stronger
governance and oversight of the agency may be required. MAP-21,
enacted in July 2012, included certain changes to strengthen PBGC’s
governance structure. For example, the act requires the Board of
Directors to meet at least four times a year and convene one joint
meeting per year with the PBGC Advisory Committee. It also requires the
addition of a PBGC risk management officer, 81 a participant and plan
sponsor advocate, 82 and a study of the governing structure of PBGC. 83
MAP-21 also requires the Board of Directors to establish a policy to
identify and mitigate potential conflicts of interest. 84

However, even with the recent legislative changes, concerns with PBGC’s
governance structure with respect to implementing a risk-based premium
structure would persist. Our prior work has found that the current size of
PBGC’s board is not sufficient to include the diverse set of interests or


80
  The President’s deficit reduction proposal to incorporate additional risk factors into the
PBGC premium structure included a provision that would expressly provide for any
regulation incorporating risk factors to be subject to congressional review under section
251 of the Contract with America Act of 1996, commonly referred to as the Congressional
Review Act (Review Act). Pub. L. No. 104-121, § 251, 110 Stat. 847, 868-74 (codified at 5
U.S.C. §§ 801-805). Under the Review Act, federal agencies promulgating a major rule
must submit a copy to GAO and both houses of Congress before it can take effect and
Congress may enact a joint resolution of disapproval that is sent to the President,
becoming law if he signs it. We report to the Congress on each major rule, summarizing
and assessing the procedural steps taken by the federal agencies in promulgating them.
Moreover, Congress always has the option of seeking to overrule any regulation through
the usual legislative process.
81
     § 40231(a)(2) and (c), 126 Stat. 854-56 (codified at 29 U.S.C. § 1302(e) and (k)).
82
     § 40232, 126 Stat. 857.
83
     § 40231(f), 126 Stat. 855-56.
84
     § 40231(b), 126 Stat. 854-55 (codified at 29 U.S.C. § 1302j).




Page 43                                                              GAO-13-58 PBGC Premiums
expertise needed to provide policy direction for PBGC. 85 Some of the
pension experts we spoke with maintained that PBGC’s current board
structure is adequate to provide sufficient oversight, while others echoed
our concerns, commenting that the Board of Directors needs to be more
active and reflect a wider range of technical expertise and stakeholder
interests should it be granted additional statutory authority with respect to
implementing a more risk-based premium structure.

At the same time, some experts we spoke with also noted that certain
safeguards could be put in place to help mitigate such concerns. For
example, special temporary commissions—such as an independent
advisory committee comprised of a range of stakeholders and experts—
are a tool that can be used to formulate recommendations for specific
policy areas. 86 Along these lines, some pension experts we spoke with
suggested establishing an independent advisory committee—comprised
of knowledgeable representatives from a range of fields including
academics, actuarial and labor experts—to play a formal role in the
premium redesign process. Such an advisory committee could help
ensure that the premium redesign process reflects stakeholder concerns
and needed expertise. 87 A number of redesign suggestions from various
stakeholder groups have already emerged, such as setting caps on
premium increases, offering a transition period for new rates, using an
independent third-party measure of creditworthiness, and reducing
adverse effects on sponsors produced by economic downturns and
higher premiums by smoothing (averaging) premium rates over several
years to reduce volatility.



85
  In GAO-07-808, we recommended that PBGC’s board should (1) establish formal
guidelines that articulate the authorities of the board members, their respective
departments, and PBGC’s Director and (2) PBGC’s board should establish policies,
procedures, and mechanisms for providing oversight of PBGC that are consistent with
corporate governance guidelines. These recommendations have been implemented. For
example, PBGC promulgated a final rule revising the board’s bylaws to specifically
delineate roles and responsibilities of involved parties. 73 Fed. Reg. 29,985 (May 23,
2008). However, some of our more recent work shows that while the board has been
meeting more often during the last few years compared to prior years, its members still
have little time to devote to PBGC. See GAO-11-182T.
86
 GAO, 21st Century Challenges: Reexamining the Base of the Federal Government,
GAO-05-325SP (Washington, D.C.: February 2005).
87
  Similarly, the President’s recent proposal on deficit reduction called for the PBGC board
to consult with individuals or organizations representing the interest of employees, plan
sponsors, and the general public in designing a more risk-based premium structure.




Page 44                                                         GAO-13-58 PBGC Premiums
Greater Transparency and   A more risk-based premium structure would likely spur demand for
Provisions for Recourse    procedures to increase the transparency of PBGC’s policies and technical
Would Be Necessary         work to bolster confidence in the agency’s ability to effectively implement
                           such a system, including procedures for recourse in the event of the
                           assessment of excessive or inaccurate premiums. Various concerns have
                           been raised about the agency’s lack of transparency, especially related to
                           the technical tools used to inform policy changes. Such a perceived lack
                           of transparency could hamper public confidence in the agency’s efforts to
                           implement a redesigned premium structure.

                           More specifically, some pension experts and plan sponsors we spoke
                           with expressed concerns that PBGC’s operations are not clear or easily
                           understandable, making it difficult to assess the accuracy and
                           reasonableness of its estimates. Some pointed to the PIMS model, which
                           is used to project the possible impact of policy changes on the agency’s
                           finances. Although PIMS has undergone several external reviews by
                           academics and the Society of Actuaries, among others, 88 concerns about
                           the model persist. In May 2012, such concerns were exacerbated by
                           release of a PBGC Inspector General report critical of PIMS’ internal
                           controls. 89 The issues surrounding PIMS have contributed to a lack of
                           confidence in the agency and its public estimates among some in the plan
                           sponsor and business communities. 90



                           88
                             Among the academic peer reviews of PIMS, most notable is the PIMS Technical Review
                           Panel in November 1996 (sponsored by the Pension Research Council at the Wharton
                           School, University of Pennsylvania). More recently, the Society of Actuaries, used PIMS to
                           prepare a report on pension contributions, published in 2011. PBGC officials also noted
                           that in 2003, PIMS was reviewed by a major investment bank, which was tasked by PBGC
                           with quantifying the value of the PBGC put. Initially, the bank’s analytic team planned to
                           use its own models to perform this analysis. However, after reviewing PIMS and
                           determining that PIMS produced results consistent with their models, the lead consultant
                           decided to use PIMS for the project rather than their own models.
                           89
                              Specifically, the Inspector General found that PBGC had published erroneous and
                           inconsistent results in its 2010 exposure report and that PBGC’s Policy Research and
                           Analysis Department failed to conduct documented reviews of the underlying support used
                           for the report and lacked quality control policies to ensure the integrity of reported
                           estimates. See PBGC Office of Inspector General, Ensuring the Integrity of Policy
                           Research and Analysis Department’s Actuarial Calculations, PA-12-87 (Washington, D.C.:
                           May 2012). For further details, see appendix VI.
                           90
                             Our prior work has noted that the ultimate success of a major policy change—such as
                           the redesign of PBGC’s statutory premium structure—depends, in part, on having reliable
                           data and credible analysis to provide a compelling rationale for the proposed change. See
                           GAO-05-325SP.




                           Page 45                                                       GAO-13-58 PBGC Premiums
    To increase the transparency of any processes that PBGC may be
    authorized to use to calculate risk factors, experts we spoke with
    generally supported adopting various other safeguards, 91 including the
    following:

•   Disclosing the methodology for creating risk profiles. Require publication
    of the methodology used to create sponsors’ risk profiles, while
    continuing to safeguard any non-publicly available information used in
    actually calculating risk-based premiums. 92

•   Publishing a risk-based premium schedule. Require publication of a
    schedule that includes information such as premium rates and key dates
    for plan sponsors.

•   Soliciting public feedback. In redesigning the premium structure, include
    a mechanism for soliciting public feedback—either through a public
    comment period or by holding public hearings—to improve the
    transparency of the process. 93

•   Increasing congressional reporting and oversight. Require PBGC to
    regularly report to Congress—either through testimony or written report—
    on progress made on implementing a risk-based premium structure.
    Such reports could contain specific information related to risk-based
    premiums, such as risk measures, cross indicators, and premiums by
    industry.

    Finally, it is also important to bolster confidence in a redesigned premium
    structure by including provisions for recourse if a sponsor wishes to
    appeal its risk assessment. For example, PPF officials told us that in the
    UK, they were required to implement an appeals process allowing plan



    91
      The President’s deficit reduction proposal included safeguards similar to the suggestions
    outlined here. See Office of Management and Budget, “Living Within Our Means and
    Investing in the Future, The President’s Plan for Economic Growth and Deficit Reduction,”
    (September 2011).
    92
      The President’s 2013 budget proposal to incorporate additional risk into the PBGC
    premium structure would prohibit publicly disclosing information used to determine
    premiums for plan sponsors, and PBGC already protects confidential information.
    93
       In previous work, we found that for policy reconsideration efforts of this scale, success
    depends, in part, on including a clear and transparent process for engaging the broader
    public in the debate over recommended changes. See GAO-05-325SP.




    Page 46                                                          GAO-13-58 PBGC Premiums
              sponsors to request a review of their case if they believed there was a
              mistake in the calculation of the plan-based premium or the underfunding
              component of the risk-based premium. 94 They also noted that in the initial
              year during which risk-based premiums were levied (2006/07), sponsors
              filed approximately 200 appeals (or approximately 3 percent of an
              estimated 7,800 plans). 95 However, 5 years later, in the most recent
              premium year (2011/12), the number of appeals had dropped to 70 (or
              approximately 1 percent of an estimated 6,550 plans), 96 suggesting that
              sponsor confidence in PPF has grown.


              PBGC faces a number of challenges in its role as insurer and protector of
Conclusions   pension benefits under DB systems that millions of Americans depend on
              for their retirement security. To remain financially solvent, PBGC relies on
              returns on its investments as well as premiums. However, the number of
              DB plans has been falling and premium rates have not adequately
              reflected the level of risk posed to PBGC for losses resulting from new
              claims. If PBGC’s current financial challenges are not addressed, the
              agency could ultimately face insolvency, potentially resulting in a need for
              legislative changes either to make painful reductions to participant
              benefits or significant additional increases in premiums, or to provide for
              taxpayers to cover these costs. A key objective of redesigning PBGC’s
              premium structure would be to ensure that premium revenue keeps pace
              with future claims and that the new structure is designed to decrease
              cross-subsidization between financially healthy and unhealthy sponsors.
              By adopting a structure that allows rates to better align with the risk posed
              by individual plans and sponsors, Congress has an opportunity to help
              PBGC contain its deficit and strengthen PBGC’s ability to remain solvent
              into the future.




              94
                According to PPF’s website, plan sponsors have 28 days to appeal their premium
              invoice. If a plan sponsor believes its failure score is inaccurate, they are instructed to
              contact Dun & Bradstreet directly.
              95
                 This includes the number of appeals directed to PPF. Total number of appeals, including
              those relating to the Dun & Bradstreet failure score, was 1,500 in 2006/7 and 560 in
              2011/12.
              96
                This figure reflects the number of PPF-insured plans as of March 31, 2011, the most
              recently available data.




              Page 47                                                           GAO-13-58 PBGC Premiums
Determining whether—and if so, how—to redesign and implement a more
risk-based premium structure will require new tools, new data, and new
processes. PBGC’s hypothetical model created to illustrate different
premium options and its analyses of the effects of incorporating an
additional risk factor are extremely useful tools for informing the debate
on how PBGC’s premium structure might be redesigned. However, these
efforts are only a first step. As illustrated by other risk-based premium
structures implemented in this country by the FDIC and abroad by the
UK’s pension insurance fund, options exist to establish risk-based
premiums using a broad array of financial data. Much like these agencies’
premium structures, PBGC premiums could be designed to identify each
individual sponsor’s unique risk profile and charge each sponsor a
specific risk premium sufficient to cover that sponsor’s risk. To ensure
that any changes to PBGC’s premium structure are designed and
implemented in a reliable and fair way, decisions will need to be informed
by a wide range of perspectives. The continuing involvement of
stakeholders in the form of an advisory committee to assist with
implementing these changes could be helpful in improving the
transparency and legitimacy of the new system, whether Congress
retains its premium-setting authority or determines that the authority for
premium setting should rest with PBGC or another entity.

Moreover, should a more risk-based premium structure be adopted, it will
be important for the responsible rate-setting entity to have access to the
right information and expertise to adequately assess risk to incorporate
any new risk factors into the process on an ongoing basis. Revising
sponsors’ financial reporting requirements—such as the reporting
required under section 4010 of ERISA—could improve PBGC’s ability to
collect key information that may be necessary to help the agency
estimate its risk exposure to future claims and strengthen implementation
of any changes to the premium structure. It will also be important to
ensure that the rate-setting entity has adequate expertise to conduct
rational evaluations of the future risk posed by plan sponsors in order to
provide a sound basis for setting premiums accordingly in alignment with
that risk. To this end, Congress has taken an important step with MAP-21
by establishing quality control requirements for PBGC, including an
annual peer review of PIMS. Ensuring that this annual peer review
includes review of the inputs and assumptions used in PIMS projections
and resulting outputs, specifically as they relate to projecting PBGC’s
future financial condition, would further enhance the transparency and
credibility of any calculations used to support a more risk-based premium
structure.



Page 48                                            GAO-13-58 PBGC Premiums
                Also, should a more risk-based premium structure be adopted, it will be
                important to identify the financial impact that risk-based premiums would
                have on plan sponsors and on the future of the DB system. A more fully
                risk-based premium structure would presumably redistribute costs onto
                plan sponsors posing the greatest risk to PBGC—sponsors who may be
                financially weak. Congress and PBGC will need to consider the impact of
                this added burden on these plan sponsors, particularly during weak
                economic periods.


                To help strengthen the PBGC insurance program, Congress should
Matters for     consider the following action:
Congressional
                1. Authorize redesign of PBGC’s premium structure to more fully reflect
Consideration      the risk posed by plans and sponsors to the agency, such as by
                   providing for the incorporation of additional risk factors.

                In addition, to improve PBGC’s ability to collect key information that may
                be necessary to help the agency estimate its risk exposure to future
                claims and strengthen implementation of any changes to the premium
                structure, Congress should consider the following action:

                2. Provide PBGC with access to additional information needed to assess
                   risk and assist in setting premiums, such as by expanding the criteria
                   requiring plan sponsors to report under section 4010 of ERISA.

                Moreover, to better understand the mechanics of how best to incorporate
                additional risk factors, improve transparency, and help inform the
                evaluation of the various redesign options, Congress should consider the
                following action:

                3. Establish an independent premiums advisory committee reflecting a
                   range of perspectives—including, for example, representatives from
                   federal agencies, sponsors, actuaries, private insurers, and labor
                   groups—to assist with such activities as developing the mechanics for
                   incorporating additional risk factors and implementing new rates, as
                   well as delineating a variety of alternative methods to address
                   PBGC’s deficit.




                Page 49                                             GAO-13-58 PBGC Premiums
                     To enhance understanding and better inform debate on the possible
Recommendation for   effects of moving to a more risk-based premium structure, during
Executive Action     consideration of various redesign options and after a redesign may be
                     authorized, we recommend that the Director of PBGC take the following
                     action:

                     1. Continue to develop PBGC’s hypothetical model, analyzing various
                        premium redesign options and their impacts on sponsors, and report
                        the results to Congress. As part of these analyses, PBGC should
                        evaluate the potential effects on sponsors of incorporating additional
                        risk factors, such as company financial health and plan investment
                        mix, and include an assessment to identify any potentially
                        disproportional hardships on smaller companies that may result from
                        the redistribution of higher rates to riskier sponsors.

                     We obtained written comments on a draft of this report from PBGC (see
Agency Comments      appendix IX). PBGC generally agreed with our findings and conclusions.
and Our Evaluation   PBGC believes that basing premiums on the actual risk of plan
                     terminations would encourage and reward companies to keep DB plans,
                     and that under a more risk-based approach, many financially sound
                     companies would see their premiums decrease. PBGC also agrees with
                     our finding that moving to more risk-based premiums is not likely to drive
                     sponsors to abandon their DB plans, but characterized our analysis as
                     showing that such claims have no evidence to support them. We would
                     like to clarify that, in our previous work, we found that sponsors
                     mentioned factors other than excessive premiums as the primary reasons
                     for freezing or terminating their DB plans. We did not intend to imply that
                     such concerns about the potential effects of risk-based premiums were
                     unfounded or without any supporting evidence.

                     PBGC agrees with our finding that there are important implementation
                     concerns in moving to a more risk-based premium structure and
                     characterized our suggested ways to address these concerns as
                     constructive, warranting further discussion. For example, some of these
                     concerns could be addressed by Congress simply establishing a more
                     comprehensive risk-based approach statutorily rather than delegating
                     premium-setting authority to another entity such as PBGC.

                     PBGC supports our recommendation for agency action—specifically, that
                     PBGC should conduct further analyses of premium options. PBGC notes
                     that it is committed to continued development of the databases, models,
                     and analyses of various premium redesign options and their impacts on



                     Page 50                                             GAO-13-58 PBGC Premiums
sponsors, and to report the results of these analyses to Congress. We
welcome this commitment, as we believe that such efforts can contribute
to adoption of a more effective and equitable rate-setting system,
especially if these efforts include an evaluation of the potential for any
disproportional hardships on smaller companies that may result from a
more comprehensive risk-based structure.

PBGC supported our matters for congressional consideration in its letter
and technical comments, with respect to authorizing a more risk-based
premium structure, providing PBGC with improved access to key
information concerning plan sponsors’ financial health, and establishing
an independent premiums advisory committee reflecting a range of
perspectives to improve transparency in the premium redesign process.

The Department of the Treasury also provided technical comments, which
are incorporated into the report where appropriate. In addition, we
received technical comments on certain segments of the draft report from
PPF and FDIC, and have incorporated their comments where
appropriate, as well.


As arranged with your offices, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days from the
date of this letter. At that time, we will send copies to the Secretaries of
Commerce, Labor, and the Treasury, and other interested parties. In
addition, the report will be available at no charge on the GAO website at
www.gao.gov.




Page 51                                                GAO-13-58 PBGC Premiums
If you or your staff have any questions about this report, please contact
me at (202) 512-7215 or jeszeckc@gao.gov. Contact points for our
Offices of Congressional Relations and Public Affairs may be found on
the last page of this report. GAO staff that made key contributions to this
report are listed in appendix X.

Sincerely yours,




Charles A. Jeszeck
Director, Education, Workforce, and Income Security Issues




Page 52                                              GAO-13-58 PBGC Premiums
Appendix I: Recent Legislation Related to the
               Appendix I: Recent Legislation Related to the
               Pension Benefit Guaranty Corporation



Pension Benefit Guaranty Corporation

               On July 6, 2012, the President signed into law the Moving Ahead for
               Progress in the 21st Century Act (MAP-21). 1 Although pensions were not
               the primary purpose of the act, it included several provisions that pertain
               to the Pension Benefit Guaranty Corporation (PBGC). For example, the
               act changed the process for determining defined benefit (DB) plan
               funding requirements, increased premium rates for sponsors of single-
               employer and multiemployer DB plans insured by PBGC, and included
               several provisions to improve the governance of PBGC. Sections of the
               act related to PBGC are briefly summarized below, along with a table
               detailing the preliminary revenue scoring by the Joint Committee on
               Taxation for these changes.

               PART I—PENSION FUNDING STABILIZATION

               Sec. 40211. Pension funding stabilization.

               The act changed how the minimum funding required for a single-employer
               plan may be determined. Specifically, it provided for adjustment of
               interest rates to be used in determining a plan’s funding target. Plans that
               take advantage of this provision in determining their required minimum
               funding must provide information on the impact of electing to do so in
               their annual funding notices.

               PART II—PBGC PREMIUMS

               Sec. 40221. Single-employer plan annual premium rates.
               Sec. 40222. Multiemployer annual premium rates.

               The act increases PBGC premium rates for both single-employer and
               multiemployer DB plans.

               Effective beginning in 2013, the act changes the flat and variable
               premium rates and puts a cap on the variable-rate premium. Each flat or
               variable rate is subject to a different inflation adjustment, and the variable-
               rate premium cap has its own inflation adjustment.




               1
                Pub. L. No. 112-141, 125 Stat. 405 (2012). The legislation was enacted primarily to
               authorize funds for highways, highway safety programs, transit programs and for other
               purposes.




               Page 53                                                      GAO-13-58 PBGC Premiums
Appendix I: Recent Legislation Related to the
Pension Benefit Guaranty Corporation




PART III—IMPROVEMENTS OF PBGC
Sec. 40231. Pension Benefit Guaranty Corporation Governance
Improvement.

The act amended the Employee Retirement Income Security Act of 1974
(ERISA) provisions relating to the PBGC Board of Directors, Advisory
Committee, Director and other PBGC officials in various ways. Among
other things, with respect to the Board of Directors, it established that a
majority of its members constitutes a quorum and the vote of a majority of
board members present shall be an act of the board. Under the provision,
the board is to meet no less than four times a year with not fewer than
two members present. At least one of those meetings must be with the
PBGC Advisory Committee. It also provided that the PBGC Inspector
General is to report to the board and at least twice a year attend a board
meeting to report on PBGC operations. Furthermore, the provision
clarifies the role of the General Counsel, and expressly provides that the
Inspector General and the Inspector General legal counsel are
independent of PBGC management and its General Counsel. The act
includes specific requirements to PBGC’s Board of Directors and Director
to avoid conflicts of interest and provides for PBGC to have a risk
management officer. It expressly provided that the PBGC Board of
Directors is ultimately responsible for overseeing PBGC and that the
Director is directly accountable to the Board of Directors and can be
removed by the Board of Directors or the President. It also set the
Director’s term at 5 years unless removed before the expiration of the
term by the President or the Board of Directors.

The act also stated the sense of Congress that (1) the Board of Directors
should form committees, including an Audit Committee and an Investment
Committee composed of at least two members, to enhance the overall
effectiveness of the board, and (2) the Advisory Committee should
provide the board with policy recommendations regarding changes to law
that would be beneficial to PBGC or the voluntary private pension system.

The act also directs PBGC, not later than 90 days after enactment, to
contract with the National Academy of Public Administration to conduct a
study to include (1) a review of governance structures of organizations
analogous to PBGC and (2) recommendations with respect to various
topics relating to the Board of Directors, such as composition,
procedures, and policies to enhance congressional oversight. The results
of the study are to be reported within a year of initiation of the study to the
to the Committee on Health, Education, Labor, and Pensions and the



Page 54                                                GAO-13-58 PBGC Premiums
Appendix I: Recent Legislation Related to the
Pension Benefit Guaranty Corporation




Committee on Finance in the Senate; and the Committee on Education
and the Workforce and the Committee on Ways and Means in the House
of Representatives.

Sec. 40232. Participant and plan sponsor advocate.

The act requires the Board of Directors to choose a Participant and Plan
Sponsor Advocate from the candidates nominated by the PBGC Advisory
Committee. Among other things, this advocate is to act as a liaison
between PBGC and participants in terminated pension plans, ensure that
participants receive everything they are entitled to under law, and provide
plan sponsors with assistance in resolving disputes with PBGC. Each
year, the advocate will provide a report on these activities to the
Committee on Health, Education, Labor, and Pensions and the
Committee on Finance in the Senate; and the Committee on Education
and the Workforce and the Committee on Ways and Means in the House
of Representatives. The report is to summarize the issues raised by
participants and plan sponsors, making recommendations for changes to
improve the system.

Sec. 40233. Quality control procedures for the Pension Benefit Guaranty
Corporation.

The act requires PBGC to contract with a capable agency or organization
independent from PBGC, such as the Social Security Administration, to
conduct an annual peer review of PBGC’s Single-Employer and
Multiemployer Pension Insurance Modeling Systems (PIMS). The first
reviews must be initiated no later than 3 months after enactment of the
act.

The act also requires PBGC to develop written quality review policies and
procedures for all modeling and actuarial work performed by PBGC’s
Policy, Research, and Analysis Department, and conduct a record
management and record keeping review. Finally, it requires PBGC to
provide a timetable for addressing outstanding recommendations made
by the Inspector General relating to the Policy, Research, and Analysis
Department and the Benefits Administration and Payment Department.




Page 55                                             GAO-13-58 PBGC Premiums
                                       Appendix I: Recent Legislation Related to the
                                       Pension Benefit Guaranty Corporation




                                       Sec. 40234. Line of credit repeal.

                                       The act repeals section 4005(c) of ERISA, 2 which permitted PBGC to
                                       issue notes or other obligations in an amount up to $100,000,000.

Table 9: Preliminary Joint Committee on Taxation Score of Revenue Changes Caused by Surface Transportation Conference
Report Related to Pension Funding Stabilization and PBGC Premium Provisions, Fiscal Years 2012-2022

                                                                                                                     2012-   2012-
Category          2012   2013   2014       2015      2016         2017        2018   2019   2020    2021     2022     2017    2022
Pension
funding
stabilization      595   2391   4576       5144      3765         1671         274   -807   -2328   -3121    -2766   18142    9394
Cap single-
employer
variable rate       0      0    -140       -260       -280        -130         -60    -20     -10     -10      -10    -810    -920
Increased flat-
rate premiums       0    200     400        400        500          530       570    600     630     630      670     2030    5130
Variable-rate
premiums            0      0       0        760      1190           810        570    370    290     330      330     2760    4710
Multiemployer
programs            0      20     15         15         25           25         25     30     30      30       40      100     255
Interaction         0      0       0         50        227          231        256    208    209     159      110      508    1450
Extension for
Transfers/420
for life
insurance           0      0      20         41         42           43         44     45     47      18       24      145     354
Net total
revenue
increases          595   2611   4871       6150      5469         3180        1679    426   -1132   -1964    -1602   22875   20373
                                       Source: Joint Committee on Taxation.




                                       2
                                           29 U.S.C. § 1305.




                                       Page 56                                                              GAO-13-58 PBGC Premiums
Appendix II: President’s Fiscal Year 2013
                         Appendix II: President’s Fiscal Year 2013
                         Budget Proposal for PBGC



Budget Proposal for PBGC

                         The Budget of the United States Government, Fiscal Year 2013, includes
                         information on the President’s budget priorities organized by agency.
                         Administratively, PBGC is an entity within of the Department of Labor. In
                         the President’s budget, one of the funding highlights for the Department
                         of Labor includes the following: “Safeguards workers’ pensions by
                         encouraging companies to fully fund their employees’ promised pension
                         benefits and assuring the long-term solvency of the Federal pension
                         insurance system.” The President proposes accomplishing this by (1)
                         raising $16 billion in additional premium revenue over 10 years through
                         phased-in increases to PBGC’s flat- and variable-rate premiums, and (2)
                         giving the PBGC’s Board of Directors the authority to adjust premiums. 1


Excerpts from the        (1) The administration proposed raising $16 billion in additional premium
President’s Budget       revenue over 10 years by raising $4 billion in additional flat-rate premiums
Proposal                 and $12 billion in additional variable-rate premiums (see table 10).
                         Relevant excerpts from the budget proposal are provided below.

                     •   Strengthen the Safety Net for Workers’ Retirement Benefits. All
                         Americans deserve a secure retirement. . . . The Pension Benefit
                         Guaranty Corporation (PBGC), which protects the retirement security of
                         44 million workers in defined benefit pension plans, is also critical to the
                         success of a robust pension system. When underfunded plans terminate,
                         PBGC assumes responsibility for paying the insured benefits. PBGC is
                         responsible for paying current and future retirement benefits to more than
                         1.5 million workers and retirees. PBGC receives no taxpayer financing
                         and relies primarily on premiums paid by insured plans. PBGC premiums
                         are currently much lower than what a private financial institution would
                         charge for insuring the same risk and are insufficient for PBGC to meet
                         its long-term obligations. As of the end of September 2011, PBGC faced
                         a $26 billion deficit. The Administration proposes to encourage
                         companies to fully fund their pension benefits and ensure PBGC’s
                         continued financial soundness by giving the PBGC Board the authority to


                         1
                          The President also suggested various more specific ideas for changing PBGC’s premium
                         structure in his deficit reduction plan. See Office of Management and Budget, “Living
                         Within Our Means and Investing in the Future, The President’s Plan for Economic Growth
                         and Deficit Reduction,” (September 2011). For example, in this plan, the President called
                         for the PBGC board to consult with individuals or organizations representing the interest of
                         employees, plan sponsors, and the general public in designing a more risk-based
                         premium structure, and specified that total PBGC premiums for any plan would not exceed
                         four times the amount payable with respect to the plan for the 2010 plan year, on a per
                         participant basis.




                         Page 57                                                        GAO-13-58 PBGC Premiums
                                                 Appendix II: President’s Fiscal Year 2013
                                                 Budget Proposal for PBGC




                                                 adjust premiums to better account for the risk the agency is insuring. This
                                                 proposal consists of two parts: a gradual increase in the single-employer
                                                 flat-rate premium that will raise approximately $4 billion by 2022; and
                                                 PBGC Board discretion to increase the single-employer variable-rate
                                                 premium to raise $12 billion by 2022. This proposal would save $16
                                                 billion over the next decade. (p. 146)


Table 10: Proposed Budget Savings Listed under PBGC

Deficit increases (+) or decreases (–) in millions of dollars
                                                                                                                                                           Totals
                                                                                                                                                      2013-         2013-
                        2013    2014     2015         2016         2017          2018             2019        2020         2021         2022           2017          2022
Improve PBGC               —      -81   -1,828      -2,275       -2,316        -2,067           -1,713      -1,616       -1,874       -2,210          -6,500    -15,980
solvency
                                                 Source: Budget proposal, p. 231, Table S–9. Mandatory and Receipt Proposals (excerpt under Labor).



                                                 (2) The President’s fiscal year 2013 budget proposes giving the PBGC
                                                 Board of Directors the authority to adjust premiums. Relevant excerpts
                                                 from the budget proposal are provided below.

                                          •      Shores Up the Pension Benefit Guaranty Corporation to Protect
                                                 Worker Pensions. The Pension Benefit Guaranty Corporation (PBGC)
                                                 acts as a backstop to protect pension payments for workers whose
                                                 companies have failed. Currently, the PBGC’s pension insurance system
                                                 is itself underfunded, and the PBGC’s liabilities exceed its assets. The
                                                 PBGC receives no taxpayer funds and its premiums are currently much
                                                 lower than what a private financial institution would charge for insuring
                                                 the same risk. The Budget proposes to give the PBGC Board the
                                                 authority to adjust premiums and directs PBGC to take into account the
                                                 risks that different sponsors pose to their retirees and to PBGC. This will
                                                 both encourage companies to fully fund their pension benefits and ensure
                                                 the continued financial soundness of PBGC. In order to ensure that these
                                                 reforms are undertaken responsibly during challenging economic times,
                                                 the Budget would require a year of study and public comment before any
                                                 implementation and the gradual phasing-in of any premium increases.
                                                 This proposal is estimated to save $16 billion over the next decade. (p.
                                                 147)

Rate Increases under the                         PBGC estimated the increases in the flat and variable rates that would be
President’s Proposal                             needed to reach the administration’s revenue targets over the 10-year
                                                 period. PBGC estimated that the flat rate would need to double from the



                                                 Page 58                                                                                   GAO-13-58 PBGC Premiums
                                        Appendix II: President’s Fiscal Year 2013
                                        Budget Proposal for PBGC




                                        current rate of $35 per participant to $71 in 2022, and the variable rate
                                        would increase almost eight-fold from its current rate of $9 per $1,000 of
                                        underfunding to $71 in 2022 (see table 11).

Table 11: Increase in Premium Rates for the Single-Employer Program Estimated by PBGC for the President’s Fiscal Year
2013 Budget, Fiscal Years 2013-2022

Premium rates                          2013         2014          2015       2016      2017       2018      2019      2020      2021      2022
Flat rate (dollars charged per
            a
participant)                         $36.00        40.00         44.00       48.00     52.00     56.00     60.00     63.00     67.00     71.00
Variable rate (dollars charged per
                         b
$1,000 of underfunding)               $9.00        15.88         22.76       29.64     36.53     43.41     50.29     57.17     64.05     70.93
                                        Source: GAO analysis of PBGC data.

                                        a
                                         The flat-rate premium is calculated on a per participant basis. Under current law, the flat rate for
                                        fiscal year 2012 is $35 per participant, and is indexed to increases in the national average wage
                                        index, as determined by the Social Security Administration. 29 U.S.C. § 1306(a)(3)(A) and (F).
                                        b
                                         The variable-rate premium is calculated based a plan’s level of underfunding whereby every $1,000
                                        of underfunding is multiplied by the rate. Under current law, the variable rate is $9 per every $1,000 of
                                        plan underfunding. 29 U.S.C. § 1306(a)(3)(F).

                                        This estimate is based on PBGC’s projections that assume plan
                                        participant levels would remain unchanged 2 and unfunded vested benefit
                                        levels would decline significantly over the next decade, 3 and that do not
                                        incorporate any additional risk factors into the variable rate. PBGC
                                        projected this decrease in underfunding (increase in funding) due to




                                        2
                                         To estimate the flat-rate premium for the single-employer program for fiscal years 2013 to
                                        2022, PBGC projected that the total participant count in its insured DB plans in this
                                        program would remain unchanged. However, PBGC’s projection on the level of plan
                                        participants over the period stands in contrast to a decline in participants that PBGC has
                                        reported beginning in fiscal year 2005. We estimate that on average, participant levels
                                        have declined by about a quarter percentage point each year since 2005. Using a higher
                                        projected participant count would tend to overstate revenues for the period based on a per
                                        participant premium.
                                        3
                                         PBGC estimates that unfunded vested benefit levels would decrease from nearly $283
                                        billion in fiscal year 2013 to just over $24 billion by fiscal year 2019, remaining close to
                                        that level for the remainder of the period. Based on this assumption, PBGC projects that
                                        even with rate increases proposed under the President’s budget, annual revenues from
                                        the variable rate will decrease from $2.2 billion in fiscal year 2013 to $1.7 billion in fiscal
                                        year 2022. The actual level of unfunded vested benefits in future years would depend on,
                                        among other factors, capital market factors such as stock market returns. Changes in
                                        PBGC’s assumptions about unfunded vested benefit levels could significantly affect the
                                        amount of revenue estimated to be collected through the variable rate.




                                        Page 59                                                                   GAO-13-58 PBGC Premiums
Appendix II: President’s Fiscal Year 2013
Budget Proposal for PBGC




several factors, 4 including PPA funding requirements that will tend to
bolster plan funding over this period. 5

However, PBGC used PIMS to make assumptions about future unfunded
vested benefit levels for estimating premium rates for the President’s
proposal, and PBGC officials recognize that uncertainty exists in the
many economic factors and underlying assumptions used for this
projection. In addition, the agency’s Inspector General recently identified
internal control deficiencies related to actuarial estimates used in the
agency’s PIMS model. 6 We reviewed the PIMS data provided to us and
conducted a meeting with PBGC officials to discuss the reliability of these
data and some of the data used in its 2010 exposure report. We
determined that the PIMS data provided to us and used by PBGC in its
report were sufficiently reliable to provide information on the approximate
magnitude of PBGC’s future financial condition and the mechanics of
premium options.

Using the same assumptions PBGC used to estimate rates for the
President’s fiscal year 2013 budget, we estimated the increases in rates
that would be needed to reach a revenue target of $23 billion, the current
level of PBGC’s deficit in the single-employer program. This scenario
illustrates the increases in rates that would be required if no other sources
of revenue were available to help address PBGC’s deficit, such as returns
on investment. We found that under this scenario, the flat-rate premium
would need to increase to $75 and the variable-rate premium to $106 by
fiscal year 2022.



4
 PBGC uses PIMS to estimate future underfunding under current and future funding rules
as a function of a variety of economic parameters. PIMS models the effect of the PPA
funding requirements and establishes a baseline for equity returns and interest rates over
this period for the underfunding projection. See appendix VI for a description of PIMS.
5
  Pub. L. No. 109-280, §§ 101, 102, 111, and 112, 120 Stat. 784-809 and 820-846. PPA
introduced new funding requirements for single-employer DB plans beginning in 2008. It
requires plan funding to be equal to 100 percent of the plan’s liabilities (these PPA funding
target liabilities are not calculated using the same assumptions and methods as the
liabilities to determine unfunded vested benefits for purposes of determining variable-rate
premiums). The 100 percent funding target is phased in at 92 percent in 2008, 94 percent
in 2009, 96 percent in 2010, and 100 percent in 2011 and later years. Any unfunded
liability will have to be amortized—paid with interest—over 7 years.
6
 See Pension Benefit Guaranty Corporation Office of Inspector General, Ensuring the
Integrity of Policy Research and Analysis Department’s Actuarial Calculations
(Washington, D.C.: May 2012).




Page 60                                                         GAO-13-58 PBGC Premiums
Appendix III: Further GAO Analyses of a
                                         Appendix III: Further GAO Analyses of a Risk-
                                         Based Premium Option



Risk-Based Premium Option

                                         To better understand the impact on rates under one hypothetical risk-
                                         based option, we conducted additional analyses using data provided to us
                                         by PBGC from a premium option model PBGC designed to illustrate
                                         different premium scenarios. PBGC’s model used 2010 data from a
                                         sample of 2,699 DB plans covering 27.5 million participants. The model
                                         covered 81 percent of all PBGC insured participants (33.8 million) in
                                         2010.

                                         First, we analyzed the sample data to determine how the plans would be
                                         distributed based on their financial health and funded status. Results are
                                         summarized in table 12.

Table 12: Distribution of Plans by Financial Health and Funded Status under a Hypothetical Risk-Based Option

                                                                      Funded status
 Financial health                        ≥120%         ≥90% to under 120%                    75% to under 90%                     <75%              Total plans
 Extremely healthy (1)                          21                              110                                  59                 6                       196
 Very healthy (2)                               58                              349                                155                24                        586
 Healthy (3)                                    55                              527                                367                68                      1017
 Risky (4)                                      20                              215                                203                85                        523
 Very risky (5)                                 15                              118                                178                66                        377
 Total                                        169                              1319                                962               249                      2699
                                         Source: GAO analysis of PBGC data from a sample of 2,699 defined benefit plans used in PBGC’s hypothetical premium model.



                                         Next, we analyzed the effect of the rate changes under this option on the
                                         sample based on the number of participants in the sample of plans used
                                         in PBGC’s model, as shown in table 13. In total, we estimate that rates
                                         would decrease under the risk-based option over 2015 rates for plans
                                         covering a majority of participants in the sample when considering the per
                                         participant costs for sponsors, regardless of the funding status of a
                                         participant’s plan or the financial health of the participant’s sponsor.




                                         Page 61                                                                                 GAO-13-58 PBGC Premiums
Appendix III: Further GAO Analyses of a Risk-
Based Premium Option




Table 13: Number and Percentage of Participants with Premium Rate Changes
under One Hypothetical Risk-Based Option

                                         Premium rate change over 2015 per participant rate
                                           Number of participants in Number of participants in
                                          plans with increased rates plans with decreased rates
 Plan funded status                                        (percent)                  (percent)
 ≥120%                                                                904,921                                  1,238,648
                                                                        (42%)                                      (58%)
 ≥90% to under                                                     7,158,249                                   9,948,743
 120%                                                                    (42)                                        (58)
 75% to under 90%                                                  2,355,025                                   4,033,812
                                                                         (37)                                        (63)
 <75%                                                              1,375,433                                     491,817
                                                                         (74)                                        (26)
 Plan financial health
 Extremely healthy                                                    5,160                                    2,684,969
 (1)                                                         (less than 1%)                                       (100%)
 Very healthy (2)                                                       67,446                                 9,340,587
                                                                            (1)                                      (99)
 Healthy (3)                                                       4,858,897                                   3,083,163
                                                                         (61)                                        (39)
 Risky (4)                                                         3,603,325                                     390,053
                                                                         (90)                                        (10)
 Very risky (5)                                                    3,258,800                                     214,248
                                                                         (94)                                         (6)
 More financially                                                  4,931,503                                 15,108,719
 healthy (1-3)                                                           (25)                                       (75)
 Less financially                                                  6,862,125                                     604,301
 healthy (4-5)                                                           (92)                                         (8)
Source: GAO analysis of PBGC data from a sample of 2,699 defined benefit plans used in PBGC’s hypothetical premium model.



We further analyzed the effect of the rate changes under this option on
plans in PBGC’s sample. As table 14 shows, the distributional effect of
premium changes for plans using this option varies based on a sponsor’s
financial health and plan funding levels. We estimate that premiums for a
majority of plans categorized as more financially healthy would decrease,
due in part to the proposed increase in the flat rate to $49 per participant
under the act compared to $44 per participant under this option. In the
model, PBGC assumed that plans with 90 percent or greater funding
levels and rated as either extremely healthy or very healthy for financial
health would be considered as low risk for plan termination and would
therefore not have a variable rate included in their premium calculation.
We estimated that two-thirds of plans considered financially healthy would



Page 62                                                                                 GAO-13-58 PBGC Premiums
Appendix III: Further GAO Analyses of a Risk-
Based Premium Option




have their rates decreased and that nearly all plans considered less
financially healthy would experience a rate increase under this option.

Table 14: Number and Percentage of Plans with Premium Rate Changes under One
Hypothetical Risk-Based Option

                                            Premium rate change over 2015 per participant rate
 Plan funded status                                 Number of plans with                   Number of plans with
                                                        increased rates                        decreased rates
                                                               (percent)                              (percent)
 >120%                                                                         90                                     79
                                                                            (53%)                                  (47%)
 >90% to under 120%                                                            770                                    549
                                                                               (58)                                   (42)
 75% to under 90%                                                              408                                    554
                                                                               (42)                                   (58)
 <75%                                                                          169                                      80
                                                                               (68)                                   (32)
 Plan financial health
 Extremely healthy (1)                                                           2                                   194
                                                                              (1%)                                 (99%)
 Very healthy (2)                                                                16                                   570
                                                                                 (3)                                  (97)
 Healthy (3)                                                                   598                                    419
                                                                               (59)                                   (41)
 Risky (4)                                                                     478                                     45
                                                                               (91)                                    (9)
 Very risky (5)                                                                343                                     34
                                                                               (91)                                    (9)
 More financially healthy                                                      616                                  1183
 (1-3)                                                                         (34)                                  (66)
 Less financially healthy                                                      821                                     79
 (4-5)                                                                         (91)                                    (9)
Source: GAO analysis of PBGC data from a sample of 2,699 defined benefit plans used in PBGC’s hypothetical premium model.




Page 63                                                                                 GAO-13-58 PBGC Premiums
Appendix IV: The United Kingdom’s Pension
                            Appendix IV: The United Kingdom’s Pension
                            Protection Fund’s Premium Structure



Protection Fund’s Premium Structure

                            The United Kingdom’s (UK) Pension Protection Fund (PPF) employs a
                            premium structure—which it refers to as a levy 1— that includes a risk-
                            based premium to help mitigate risk presented by sponsors of defined
                            benefit (DB) plans. 2 Beginning with its second plan year in 2006/07, risk
                            factors have been incorporated into premium rates. PPF has experienced
                            a surplus in its net financial position when comparing its assets and its
                            liabilities. As of March 31, 2011, PPF had a $1.08 billion surplus, an
                            increase of $480 million over the previous year.


Features of PPF’s Premium   PPF sets a premium revenue target based on a long-term funding
Structure                   strategy of accumulating assets that are 10 percent larger than its
                            liabilities. To meet its revenue target, PPF collects two types of premiums
                            from plan sponsors: a risk-based premium and a plan-based premium.
                            The risk-based premium is based on three risk factors-—a plan’s asset
                            investment mix, a plan’s funding level, and risk of sponsor bankruptcy,
                            which PPF refers to as insolvency risk. The plan-based premium is based
                            on the size of a plan and its liabilities. For plan year 2012/13, PPF is
                            using the following formula to calculate the plan-based and risk-based
                            premiums:

                                      Risk-based premium
                                      underfunding risk modified by investment risk stress (U*Inv) x insolvency risk (P) x levy
                                      scaling factor (C)
                                      Plan-based premium
                                      .000085 (h) x smoothed liabilities (L)


                            Table 15 describes the different components of PPF’s premium formula
                            for plan year 2012/13.




                            1
                             PPF refers to plans as schemes and premiums as levies. For the purpose of this report,
                            we continue to use plans and premiums when discussing PPF’s premium framework.
                            2
                             We did not conduct independent legal analysis to verify the information in this section of
                            the report but rather relied on a review of publicly available PPF documents and
                            discussions with PPF officials.




                            Page 64                                                                 GAO-13-58 PBGC Premiums
                                           Appendix IV: The United Kingdom’s Pension
                                           Protection Fund’s Premium Structure




Table 15: Components of the United Kingdom’s Pension Protection Fund’s Premium Formula, Plan Year 2012/13

Risk-based premium           Description
components
Underfunding risk (U)        Represents the potential size of a plan’s claim on PPF. U is the underfunding amount of the plan
                             determined by using the plan’s assets and liabilities, taking account of any valid contingent asset
                             arrangements and deficit-reduction contributions. Contingent assets are assets that a sponsor puts
                                                                     a
                             forth to reduce potential losses to PPF. Asset and liability values used in calculating underfunding risk
                             are adjusted based on an investment risk methodology (see below.)
Investment risk (INV)        An adjustment made to underfunding risk that takes into account risk posed by a sponsor’s investment
                             strategy for its plans’ assets. Different asset classes used for investing—such as bonds, equities,
                             commodities, and hedge funds—are stressed according to risk and the value of assets in each asset
                             class is increased or decreased as appropriate by the corresponding asset stress percentage INV.
Insolvency risk (P)          Represents the likelihood of a plan’s sponsor becoming insolvent and the plan potentially becoming a
                             claim on PPF. P is a measure of risk of insolvency of the sponsor, taking into account the plan
                             structure. Measures of risk insolvency are provided to PPF by Dun & Bradstreet. P may be modified
                             where there is a Type A contingent asset, which is a parent or group company guarantee to cover
                             PPF losses should the plan terminate. PPF uses Dun & Bradstreet failure scores to estimate a
                             sponsor’s insolvency risk. Based on this score, a sponsor is placed in one of 10 premium bands, with
                             each band assigned an associated premium rate. The premium rate for each band combines a
                             component based on the Dun & Bradstreet probabilities of insolvency for the failure scores in that
                             band plus a risk margin based on unexpected risk for that band.
Premium scaling factor (C)   Scales down risk-based premium so that together with the plan-based levies, PPF will ensure that the
                             total premium collected matches the premium estimate, which is based on long-term risk exposure. In
                             the premium formula, this is represented as C and is .89 for 2012/13.
Plan-based premium
components
                                                                                                                                   b
Multiplier (H)               H is a plan-based premium multiplier applied to every plan to cover the costs of capping the highest
                             risk-based premiums—about 10% of the premium.
Liabilities (L)              L is the plan’s estimated liabilities as of a certain date.
                                           Source: GAO analysis of PPF data.

                                           a
                                            PPF describes contingent assets as those assets that occur when another company under the same
                                           corporate umbrella as a plan sponsor guarantees a portion of the plan’s liabilities, thereby reducing
                                           the plan sponsor’s risk of entering bankruptcy. Continent assets can also occur when a plan sponsor
                                           (or a company under the same corporate umbrella) pledges assets—a bank account, land, or
                                           securities—that will go to the pension plans if a sponsor enters bankruptcy or when a party outside
                                           the sponsor’s corporate umbrella guarantees a portion of the plan’s liabilities, either through a letter of
                                           credit or a bank guarantee.
                                           b
                                            The risk-based premium is also capped to protect the most vulnerable plans. The cap for 2012/13 is
                                           75 basis points (0.75 percent) of smoothed liabilities. Where the risk-based premium calculated using
                                           the above formula exceeds 0.75 percent of a plan’s liabilities, the cap is applied and the premium is
                                           decreased accordingly.

                                           PPF allows plan sponsors to lower their premium by pledging contingent
                                           assets, which can be used to cover potential losses from underfunded
                                           plans that terminate and reduce the risk posed to PPF, and thus reduce
                                           their risk-based premium. PPF defines contingent assets in a number of
                                           ways. Type A contingent assets occur when another company under the
                                           same corporate umbrella as a plan sponsor guarantees a portion of the


                                           Page 65                                                                   GAO-13-58 PBGC Premiums
                             Appendix IV: The United Kingdom’s Pension
                             Protection Fund’s Premium Structure




                             plan’s liabilities, thereby reducing the plan sponsor’s risk of entering
                             bankruptcy. Type B continent assets occur when a plan sponsor (or a
                             company under the same corporate umbrella) pledges assets—a bank
                             account, land, or securities—that will go to the pension plans if a sponsor
                             enters bankruptcy. Type C contingent assets occur when a party outside
                             the sponsor’s corporate umbrella guarantees a portion of the plan’s
                             liabilities, either through a letter of credit or a bank guarantee. Both Type
                             B and C contingent assets lower the liabilities that PPF would take over in
                             the event that the sponsor was to enter bankruptcy and transfer its plan(s)
                             to the agency.


PPF’s Funding Strategy       PPF’s funding strategy is formulated to meet the agency’s stated long-
                             term goal of accumulating assets that are 10 percent larger than the
                             agency’s liabilities by 2030, which represents a state of self-sufficiency. 3
                             Initially, the premium estimate (the amount PPF aims to collect) reflected
                             a “top down” approach in which PPF would decide upon the total level of
                             premiums that it deemed appropriate in a given year, and adjusted the
                             premium parameters accordingly on an annual basis. Beginning with the
                             2012/13 plan year, the funding strategy is revised to reflect a “bottom up”
                             approach in which the parameters will be fixed for 3 years and, ideally,
                             remain stable for 3 years between reviews, with the amount collected,
                             floating with changes in risk.


Potential Applicability of   Specific components of PPF’s premium structure—such as use of
PPF’s Premium Structure      additional risk factors for sponsor financial health and plan investment
for PBGC                     strategy, setting rates based on long-term budget estimates, and
                             smoothing techniques—might have applicability for PBGC. 4 However,
                             there are substantial regulatory and fiduciary differences between PPF
                             and PBGC. For example, PPF functions as part of a larger pension
                             regulatory structure, which includes The Pension Regulator. One of The
                             Pensions Regulator’s stated objectives is to reduce the risk that PPF will
                             need to take on unfunded liabilities, and the agency has statutory



                             3
                              The 10 percent margin is to cover the risk of longevity improvements greater than what
                             PPF describes as its best estimate, and also the residual risk of future claims. The year
                             2030 is chosen as being the time at which the level of risk from future insolvencies is
                             projected to be relatively low compared with the size of PPF.
                             4
                                 This was discussed in more detail on pages 22-26 and 40-41 of this report.




                             Page 66                                                          GAO-13-58 PBGC Premiums
Appendix IV: The United Kingdom’s Pension
Protection Fund’s Premium Structure




authority to work with plan sponsors to mitigate these risks through
increasing plan funding levels and other measures. In addition, UK
pension law requires that at least one-third of individuals responsible for
administering the plan, or plan trustees, must be selected by plan
participants, while there is no requirement for stakeholder representation
among fiduciaries of U.S. plans.




Page 67                                              GAO-13-58 PBGC Premiums
Appendix V: Overview of Pension Benefit
              Appendix V: Overview of Pension Benefit
              Guaranty Corporation’s Process for
              Calculating Its Deficit


Guaranty Corporation’s Process for
Calculating Its Deficit
              As required under ERISA, 1 each year, PBGC calculates the corporation’s
              net financial position by determining the values of its assets, offset by the
              value of its liabilities, for the single-employer and multiemployer programs
              combined. According to PBGC, a primary objective of its financial
              statements, and specifically its net financial position, is to provide
              information that is useful in assessing the agency’s present and future
              ability to ensure that its plan beneficiaries receive benefits when due.
              Although long-term projections inherently contain a significant degree of
              uncertainty, a surplus net financial position signifies that, based on the
              assumptions used, PBGC estimates that it has sufficient assets to pay all
              current and future guaranteed benefit obligations; a deficit net financial
              position signifies that its assets are not sufficient to pay all future
              obligations. The deficit is calculated in conformance with generally
              accepted accounting principles, which, among other things, require
              making estimates and assumptions that affect the reported amounts of
              liabilities as of the date of the statement and that may change over time.
              In particular, liabilities included in the single-employer deficit calculation
              include those from claims already incurred and claims deemed probable
              in the near term, but not future claims beyond that. 2 The main
              components of PBGC’s assets and liabilities and descriptions of how
              PBGC determines the values for each of those components are
              summarized in table 16. The amounts of assets and liabilities in these
              various categories, for fiscal year-end 2011, can be found in table 17 later
              in this section.




              1
                  29 U.S.C. § 1308.
              2
               Plans of companies with credit ratings below investment grade and multiemployer plans
              that may require future financial assistance are classified as “reasonably possible”
              terminations, rather than “probable” terminations. Although PBGC uses the estimates for
              reasonably possible plan terminations to assist with understanding the agency’s future
              financial condition, these estimates are not included in PBGC’s calculation of its deficit.




              Page 68                                                         GAO-13-58 PBGC Premiums
                                             Appendix V: Overview of Pension Benefit
                                             Guaranty Corporation’s Process for
                                             Calculating Its Deficit




Table 16: Main Components of Assets and Liabilities Included in PBGC’s Statements of Financial Condition

Asset components                  Description of valuation
Investments, at market            Investment assets are valued based on market prices, specifically, on the last sale of a listed
                                  security, on the mean of the “bid-and-ask” for nonlisted securities, or on a valuation model in the
                                                                                               a
                                  case of fixed income securities that are not actively traded. These valuations are determined as of
                                  the end of each fiscal year. Purchases and sales of securities are recorded on the trade date. PBGC
                                  marks a plan’s assets to market and any increase or decrease in the market value of a plan’s assets
                                  occurring after the date on which the plan is terminated must, by law, be credited to or suffered by
                                  PBGC.
Receivables, net (including       Premiums receivable represent the estimated earned but unpaid portion of premiums and past due
premiums and investment           premiums deemed collectible, including penalties and interest. Investment income is accrued as
       b
income)                           earned.
Cash and cash equivalents         Cash includes cash on hand and demand deposits. Cash equivalents are investments with original
                                  maturities of 1 business day and highly liquid investments that are readily convertible into cash
                                  within 1 business day.
Securities lending collateral     PBGC’s custodian bank requires collateral that equals 102% to 105% of the securities lent. The
                                  custodian bank either receives cash or noncash as collateral or returns collateral to cover mark-to-
                                  market changes.
Capitalized assets, net           Capitalized assets include furniture and fixtures, electronic processing equipment and internal-use
                                  software. These costs are shown net of accumulated depreciation and amortization.
Liability components
Total present value of future     Net liabilities for future pension benefits that PBGC is or will be obligated to pay the participants of
benefits, net                     single-employer plans terminated and trusteed, in accordance with the limits specified in ERISA,
                                  and plans that have $50 million or more of underfunding that PBGC believes will probably terminate
                                                       c
                                  in the near future.
Total present value of            The estimated value of nonrecoverable future financial assistance to multiemployer plans that are
                                                                             d
nonrecoverable future financial   not able to meet their benefit obligations. including probable insolvent plans.
assistance
Payables, net (including          The liability for unearned premiums represents an estimate of payments received during the fiscal
unearned premiums, amounts        year that cover the portion of a plan’s year after PBGC’s fiscal year-end. Securities sold under
due for purchases of securities   repurchase agreements are valued at the amounts at which the securities well be subsequently
                         b
and derivative contracts)         reacquired.
Net position (loss)               Total assets minus total liabilities.
                                             Source: PBGC’s 2011 Annual Report.
                                             a
                                              An investment valuation model is a widely accepted method used in finance to compute the current
                                             value of an asset based on statistical inputs for cash flow expectations.
                                             b
                                              In addition, derivative financial instruments are recorded at fair value and are included on the
                                             Statements of Financial Condition as investments and derivative contracts. Swaps are netted rather
                                             than recorded at gross levels for the individual contracts as “Receivables, net – Derivative contracts”
                                             and “Derivative contracts” (liabilities). PBGC invests in and discloses its derivative investments in
                                             accordance with the guidance contained in the FASB Accounting Standards Codification Section 815,
                                             Derivatives and Hedging.
                                             c
                                              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.
                                             d
                                              In accordance with Title IV of ERISA, PBGC provides financial assistance to multiemployer plans, in
                                             the form of loans, to enable the plans to pay guaranteed benefits to participants and reasonable
                                             administrative expenses. 29 U.S.C. § 1431. These loans, issued in exchange for interest-bearing
                                             promissory notes, constitute an obligation of each plan.




                                             Page 69                                                                GAO-13-58 PBGC Premiums
                         Appendix V: Overview of Pension Benefit
                         Guaranty Corporation’s Process for
                         Calculating Its Deficit




PBGC’s Assumptions in    Changes to the underlying assumptions used to value liabilities can have
Valuing Future Benefit   a material effect on PBGC’s net financial position and on any conclusions
Payments                 drawn about PBGC’s ability to pay all current and future guaranteed
                         benefit obligations (from claims already incurred and those deemed
                         probable in the near term) from assets on hand. According to PBGC,
                         liabilities under the single-employer program are valued by estimating the
                         present value of future benefits expected to be paid—that is, PBGC uses
                         certain assumptions to adjust the value of future benefit payments to
                         reflect the time value of money (by discounting) and the probability of
                         payment (by means of decrements, such as for death or retirement).
                         According to agency officials, the method the agency uses to account for
                         liabilities is similar to the “mark to market” practices being required of
                         private sector sponsors of single-employer DB plans, in accordance with
                         FASB. 3 The calculation requires an assumption about interest rates,
                         which reflects how much could be earned in the future from investing
                         today’s dollars. Assuming a lower interest rate increases the present
                         value of future payments or benefits. 4

                         PBGC develops its assumptions on discount rates based on group
                         annuity prices, 5 identified through a group annuity survey conducted by
                         the American Council of Life Insurers. PBGC maintains that the annuity
                         prices found on the survey reflect rates at which its liabilities (net of
                         administrative expenses) could be settled in the market at September 30




                         3
                             Mark to market is the practice of basing values on current market prices.
                         4
                          In addition to the present value of future benefits calculated for the single-employer
                         program, PBGC values the liabilities for the multiemployer program by calculating the
                         present value of estimated nonrecoverable future financial assistance—that is, estimated
                         nonrecoverable payments to be provided in the future to multiemployer plans that are not
                         able to meet their benefit obligations.
                         5
                           A single-premium nonparticipating group annuity is a contract between an insured entity,
                         such as a plan sponsor, and an insurance company that transfers pension obligations
                         from the plan sponsor or other insured entity to the insurance company, in return for a
                         one-time payment to the insurance company. The insurance company thereby takes on
                         the investment risk, longevity risk, and other risks inherent in pension obligations.




                         Page 70                                                           GAO-13-58 PBGC Premiums
Appendix V: Overview of Pension Benefit
Guaranty Corporation’s Process for
Calculating Its Deficit




for the respective year via single-premium nonparticipating group
annuities issued by private insurers. 6

PBGC notes that many factors, including Federal Reserve policy,
changing expectations about longevity risk, and competitive market
conditions may affect these survey rates. Using data from the annuity
survey, PBGC establishes two interest rate factors to compute estimates
of the present value of its liabilities—the “select” and “ultimate” rates. 7 A
decline in PBGC’s asset values can be particularly problematic if these
interest rates remain low or fall, which raises PBGC’s liabilities, all else
equal.

PBGC also notes that, over time, actuarial adjustments may occur as the
result of new data (e.g., mortality experience, revised participant data), as
well as from changes in valuation methodology, such as estimating
liabilities on a group basis (“nonseriatum”) versus calculating a separate
liability for each person (“seriatum”). Liabilities also will grow with the
passage of time (as future benefit payments draw closer to payment), will
decrease as benefits are paid out (discharging part of the liability), and
will change with changes in interest rates and changes in other actuarial
assumptions. These adjustments represent the change in the present




6
 GAO has reported that 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 other, more direct
market-determined alternatives, such as published, high-quality bond interest rates. Such
long term bond rates may track changes in group annuity rates over time, but their
proximity to group annuity rates is also uncertain. For example, a high-quality long-term
bond interest rate may need to be adjusted downward to better reflect the level of group
annuity purchase rates. GAO, Pension Benefit Guaranty Corporation: Single-Employer
Pension Insurance Program Faces Significant Long-Term Risks, GAO-03-873T
(Washington, D.C.: Sept. 4, 2003). PBGC officials noted that they recently had analyzed
the relationship between group annuity rates and long term corporate bond rates and
found that there was only a low correlation (0.377 with an r-square of 0.142) between the
two over an 8-year observation period from December 2000 to September 2008.
7
 These rates—also known as discount rates—effectively form a two-segment yield curve
where cash flows that occur during the initial period are discounted by the “select” interest
rate and those occurring after the initial period are discounted by the “ultimate” interest
rate. For more on these rates see http://www.pbgc.gov/prac/interest.html.




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                          Appendix V: Overview of Pension Benefit
                          Guaranty Corporation’s Process for
                          Calculating Its Deficit




                          value of future benefits that results from applying actuarial assumptions in
                          the calculation of liabilities. 8


PBGC’s Fiscal Year 2011   For fiscal year-end 2011, PBGC reported net accumulated deficit of
Financial Statement       approximately $26.04 billion. To estimate the present value of future
                          benefits, PBGC used a 20-year select interest factor of 4.31 percent
                          followed by an ultimate factor of 4.26 percent for the remaining years.
                          PBGC strengthened its mortality assumptions in 2011 (that is, it assumed
                          longer life expectancy), which resulted in higher interest factors than
                          would have been estimated under the previous mortality assumption. 9 In
                          addition, PBGC has estimated that as of September 30, 2011, 135
                          multiemployer plans 10 will exhaust plan assets and need financial
                          assistance from PBGC to pay guaranteed benefits and plan
                          administrative expenses. 11 A summary of PBGC’s deficit calculation for
                          fiscal year-end 2011 is found in table 17.




                          8
                            PBGC recently changed the actuarial assumptions on participant mortality it uses to
                          estimate present value of future benefits. For September 30, 2010, PBGC reported using
                          the 1994 Group Annuity Mortality 94 Static Table set forward 1 year, projected 26 years to
                          2020 using scale AA. Based on a 2011 study of PBGC’s participant mortality, PBGC
                          reported adopting new healthy lives mortality tables for the June 30, 2011, and
                          subsequent valuations. For June 30, 2011, PBGC used the Retirement Plan-2000
                          Combined Healthy (RP-2000 CH) Male and Female Tables, each set back 1 year and
                          projected 21 years to 2021 using Scale AA. The number of years that PBGC projects the
                          mortality table reflects the number of years from the 2000 base year of the table to the end
                          of the fiscal year (11 years in fiscal year 2011) plus PBGC’s calculated duration of its
                          liabilities (10 years in fiscal year 2011). PBGC reported that the study also recommended
                          changes in the mortality assumptions for disabled lives which will also be implemented in
                          the June 30, 2011, and subsequent valuations.
                          9
                           Annuity prices are based on both underlying interest rate and mortality assumptions.
                          When greater longevity is assumed, a higher interest assumption is then needed to
                          produce annuity rates that match those in the American Council of Life Insurers survey.
                          10
                            The 135 plans fall into three categories—plans currently receiving financial assistance;
                          plans that have terminated but have not yet started receiving financial assistance from
                          PBGC; and ongoing plans (not terminated) that the corporation expects will require
                          financial assistance in the future.
                          11
                             PBGC does not provide assistance for the full amount of these multiemployer plans’
                          liabilities, and not all of PBGC’s financial assistance to multiemployer plans is
                          nonrecoverable. But, as we have reported previously, only 1 of the 62 plans that received
                          PBGC financial assistance between 1981 and 2009 had repaid its loan as of 2010. See
                          GAO, Private Pensions: Changes Needed to Better Protect Multiemployer Pension
                          Benefits, GAO-11-79 (Washington, D.C.: Oct. 18, 2010).




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                        Guaranty Corporation’s Process for
                        Calculating Its Deficit




                        Table 17: PBGC Statements of Financial Condition for its Single-Employer and
                        Multiemployer Programs, Fiscal Year 2011

                        Dollars in millions
                                                                                                   Single-
                                                                    Single-                 employer and
                                                                  employer Multiemployer    multiemployer
                                                                   program       program        combined
                        Assets:
                               Investments, at market              $66,271        $1,720          $67,991
                               Receivables, net (including           3,049            13            3,062
                               premiums)
                               Cash and cash equivalents             5,021             5            5,026
                               Securities lending collateral         4,587             0            4,587
                               Capitalized assets, net                  32             1               33
                               Total assets                         78,960         1,739           80,699
                        Liabilities:
                               Total present value of future        92,953             1           92,954
                               benefits, net
                               Total present value of                    0         4,475            4,475
                               nonrecoverable future financial
                               assistance
                               Total payables                        9,273            33            9,306
                               Total liabilities                   102,226         4,509          106,735
                        Net position (loss)                        (23,266)       (2,770)         (26,036)
                        Source: PBGC’s 2011 Annual Report.




PBGC’s Historical Net   Over the last 20 years, PBGC has experienced marked swings in its
Financial Position      annual net financial position for its single-employer program (see fig. 3).
                        For example, by fiscal year-end 1990, PBGC experienced a $3.0 billion
                        (in 2011 dollars) accumulated deficit, but by fiscal year-end 2000, PBGC’s
                        deficit had shifted to a nearly $12.5 billion surplus (in 2011 dollars), in part
                        due to fewer new claims, higher interest rates used to value liabilities, and
                        investment gains. In recent years, PBGC has again reported growing
                        deficits. Between fiscal year-ends 2008 and 2011, the single-employer
                        program’s deficit grew from just over $11 billion (in 2011 dollars) to just
                        over $23 billion. Much of this recent increase in its accumulated deficit
                        was the result of investment losses and declines in interest rates in the
                        wake of the economic downturn and the termination of a relatively small
                        number of very large underfunded plans.




                        Page 73                                                  GAO-13-58 PBGC Premiums
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                                        Guaranty Corporation’s Process for
                                        Calculating Its Deficit




Figure 3: PBGC’s Surplus/Deficit for the Single-Employer Program, Fiscal Years 1980-2011




                                        Note: Data adjusted for inflation.




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Appendix VI: Overview of Pension Benefit
                        Appendix VI: Overview of Pension Benefit
                        Guaranty Corporation’s Pension Insurance
                        Modeling System


Guaranty Corporation’s Pension Insurance
Modeling System
                        In 1998, PBGC began to use its Pension Insurance Modeling System
                        (PIMS) to help the agency better understand and quantify its long-term
                        risk and exposure to loss under different economic conditions and policy
                        alternatives. Much like insurers of catastrophic risk (natural disasters),
                        PBGC is vulnerable to large losses that occur with relatively low
                        probabilities. With these types of insurance, the historic pattern of claims
                        is not an adequate predictor of future experience. Instead, it is more
                        informative to examine the underlying processes that give rise to claims
                        and assess their likelihood of occurring. PIMS is a stochastic (randomly
                        determined) simulation model designed to quantify the amount of risk
                        facing PBGC’s two insurance programs. The model does not predict
                        future claims. Rather, by fully exploiting the historic relationships of key
                        economic variables, the model assigns probabilities to various levels of
                        potential claims. PBGC uses this information to estimate its potential
                        future financial positions. PIMS is also used to assess various policy
                        alternatives—such as changes in plan funding requirements or PBGC’s
                        premium structure—and their impact on PBGC’s financial condition. PIMS
                        is not used to calculate the current deficit. (See appendix V for
                        information on how PBGC calculates its deficit.)

                        PIMS randomly simulates elements in PBGC’s financial statement. The
                        random effects in the simulation are based on measures of the historical
                        volatility in key factors that underlie the pension insurance, including
                        interest rates, stock market returns, and corporate bankruptcy rates. For
                        each year in a simulation, the model randomly selects values for each
                        element and, combining these factors, determines PBGC’s financial
                        condition under that scenario. The model generates thousands of
                        multiyear projections of PBGC’s future financial condition. The results
                        from the different scenarios are compiled to show how frequently different
                        types of outcomes are simulated. The frequency with which an outcome
                        is simulated (for example, that PBGC attains a surplus in the next 10
                        years) estimates the likelihood of that outcome’s actual occurrence.


Step 1: Modeling the    To project a range of PBGC’s possible future financial positions, PIMS
Underlying Mechanics    must begin by modeling some of the underlying mechanics and
                        relationships that feed into the simulated outcomes. These portions of the
                        model include macroeconomic factors, corporate sponsor behavior, and
                        pension plan behavior.

Macroeconomic Factors   According to PBGC, the most important variables in PIMS are two
                        macroeconomic factors: stock returns and interest rates. Stock returns
                        are modeled to fluctuate in the short-term but revert to a long-term


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                            Guaranty Corporation’s Pension Insurance
                            Modeling System




                            average, so each year’s S&P 500 return is equal to 10.4 percent plus a
                            random disturbance. The disturbance is randomly selected to represent
                            the historic distribution of stock returns. Interest rates, unlike stock
                            returns, are correlated over time. To model interest rates, PIMS uses a
                            simple random walk process whereby this year’s interest rate equals last
                            year’s interest rate plus a random disturbance. Because stock returns are
                            more likely to be high when factors related to the interest rate are falling,
                            PIMS uses historical estimates to correlate the random disturbances that
                            affect stock returns and interest rates.

Plan Sponsor Behavior       For plan sponsors, PIMS models measures of financial health and, from
                            that, the probability of bankruptcy. The measures of financial health
                            include financial ratios (i.e., equity-to-debt and cash flow-to-asset ratios),
                            employment levels, and equity values. Financial ratios are modeled as a
                            regression to long-term averages of these measures, with random
                            disturbances. Employment and equity levels are modeled using a random
                            walk process, and values for both measures are correlated based on their
                            historical relationship. To model plan sponsor bankruptcy, PIMS
                            measures the historical relationship between the probability of bankruptcy
                            and firms’ employment levels and financial ratios. These factors, taken
                            together, determine the probability that a sponsor will enter bankruptcy
                            during a given period.

Pension Plan Behavior       To model pension plan behavior, PIMS uses a database with detailed
                            information about a non-representative sample of 450 of the 28,000 plans
                            covered by PBGC. These 450 plans represented about half of PBGC’s
                            insurance exposure in the single-employer DB system. 1 The plans in the
                            sample are weighted based on funding ratios to represent all plans
                            insured by PBGC. Plan information in the PIMS database includes asset
                            returns, sponsor contributions, participant composition, and benefit and
                            salary levels.

                        •   Asset returns. PIMS uses historical information of individual plans’
                            returns based on correlations with stock returns and interest rates. Each
                            plan’s asset returns also has a random element that is not correlated to
                            the simulated economic scenario.




                            1
                                As measured by Form 5500 filings.




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                             Appendix VI: Overview of Pension Benefit
                             Guaranty Corporation’s Pension Insurance
                             Modeling System




                         •   Sponsor contributions. PIMS models sponsor contributions in two
                             different ways: (1) for projecting future claims, sponsors are assumed to
                             make the minimum contribution required by Internal Revenue Code; and
                             (2) for projecting variable-rate premium collections, a higher level of
                             contributions reflects historical data on PBGC premium collections.

                         •   Participant composition. PIMS models participant composition by
                             simulating participants’ retirement, separation from employment, and
                             death based on actuarial assumptions. In addition, the number of active
                             participants in each plan fluctuates according to the sponsor’s total
                             employment level.

                         •   Benefit and salary levels. PIMS models benefit level growth as equal to
                             the rate of inflation plus a fixed parameter to represent productivity
                             growth. To model salaries paid, PIMS assumes that salaries grow with
                             age and service to reflect merit and promotion, and average salary levels
                             for a given age and service level grow at the rate of inflation plus
                             productivity growth.

Step 2: Combining            In a simulation, PIMS uses these components of its model to project
Components into              possible outcomes. PIMS first draws a series of stock returns and interest
Simulated Scenarios          rates—called an economic scenario—one for each simulated year. Next,
                             plan sponsors and pension plans are all subjected to the economic
                             scenario to determine how they react and, ultimately, how it affects
                             PBGC. To create a distribution of possible future outcomes, PIMS draws
                             500 unique economic scenarios and runs plan sponsors through each
                             economic scenario 10 times for a total of 5,000 different simulations.

Plan Sponsors’ Risk of       Each plan sponsor is brought through the series of economic scenarios.
Bankruptcy                   The model draws new financial ratios and employment levels for each
                             sponsor in each simulated year and, based on that, assigns each sponsor
                             a probability of bankruptcy. PIMS uses this probability to determine
                             whether a sponsor enters bankruptcy during each scenario. To illustrate,
                             PIMS models a sponsor’s chances of bankruptcy as a lottery urn filled
                             with balls. If a sponsor has a 1 percent probability of bankruptcy during an
                             economic scenario, its urn contains one ball to represent bankruptcy and
                             99 balls to represent survival to the next period. PIMS draws a ball from
                             the urn for each of the times a firm is cycled through the model’s




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                                Guaranty Corporation’s Pension Insurance
                                Modeling System




                                simulated economic scenarios. 2 A sponsor enters bankruptcy during any
                                simulation where PIMS draws the ball that represents bankruptcy. Plans
                                sponsored by bankrupt sponsors are assumed to present a claim to
                                PBGC if they are less than 80 percent funded. Otherwise a standard
                                termination is assumed.

Pension Plans’ Risk of          PIMS brings each pension plan through the economic scenario, with
Underfunding                    equity returns, interest rates, and its sponsor’s simulated employment
                                level and plan demographics all affecting the plan’s assets and liabilities.
                                By including minimum funding rules to simulations, PIMS calculates
                                possible paths in underfunding within the constraints of existing funding
                                rules. In addition, plan sponsors will be assessed PBGC premiums and
                                make contributions to the plan. For purposes of modeling future claims in
                                PIMS, it is assumed that employers will contribute the minimum required
                                amount each year and that any credit balance remaining when any new
                                funding rules take effect will be used to the maximum extent permitted
                                until the balance is completely depleted.

PBGC’s Financial Position and   Finally, PBGC is brought through the economic scenario. This includes
Risk of Loss                    effects on PBGC’s existing assets and liabilities from previously
                                terminated plans, both from investment returns and from revaluations of
                                liabilities due to changes in interest rates. The agency also makes benefit
                                payments to trusteed participants and collects premiums from sponsors.
                                To determine premium revenue, PIMS estimates revenue associated with
                                flat-rate premiums (based on each plan’s projected participant level) and
                                variable-rate premiums (based on each plan’s projected funding level).
                                PBGC may also experience a new claim associated with sponsor
                                bankruptcy. When a plan sponsor enters bankruptcy, PIMS estimates the
                                level of underfunding for benefits that PBGC guarantees; any plan funded
                                at 80 percent or less becomes a claim on PBGC.

                                To project PBGC’s future financial condition, PIMS uses a detailed
                                database of about 450 actual plans, sponsored by about 330 firms, which
                                represent about half of PBGC’s insurance exposure in the single-
                                employer DB system measured from the Form 5500 filings. The database
                                includes the plan demographics, plan benefit structure, asset values,
                                liabilities, and actuarial assumptions. It also includes key financial



                                2
                                 A typical simulation consists of 5,000 different scenarios (500 unique economic
                                scenarios, which PBGC and each plan and sponsor experience 10 times).




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                          Guaranty Corporation’s Pension Insurance
                          Modeling System




                          information about the employer sponsoring the plan. The PIMS database
                          contains pension plan information from Schedule B of the Form 5500
                          (Annual Return/Report of Employee Benefit Plan). In addition, more
                          recent data available from filings under section 4010 of ERISA 3 is utilized
                          for certain large underfunded plans.


Step 3: Summarizing the   In its 2010 exposure report, 4 PBGC estimates that of out of 5,000
Results                   simulations, none project that PBGC’s single-employer program will run
                          out of money within the next 10 years (fiscal year 2020). In the PIMS
                          projection for the PBGC 2010 Annual Report, 2.5 percent of the
                          simulations project that the program will run out of money by fiscal year
                          2030. A slight majority of the simulations result in improved or unchanged
                          positions.

                          However, because some simulations result in very large deficits for the
                          program, the average (mean) outcome is a decline in the program’s
                          position from a deficit of $21.3 in fiscal year 2011 to a deficit of $24.2
                          billion (present value as of 2010) by fiscal year 2020 (see fig. 4). PIMS
                          offers a range of probable outcomes, with high and low values calculated
                          for each year. Although PBGC projects a zero percent probability that its
                          single-employer program will be insolvent by the end of fiscal year 2020,
                          as the figure shows, the high and low value estimates—which represent
                          the 85th and 15th percentiles for the projections—ranges from a surplus
                          of $4 billion to a deficit of nearly $53 billion for that fiscal year. 5




                          3
                              29 U.S.C. § 1310.
                          4
                            Pension Benefit Guaranty Corporation, 2010 PBGC Annual Exposure Report.
                          (Washington, D.C.: November 2011).
                          5
                           The mean projection for the single-employer program is based on a range of possible
                          outcomes. For example, while the set of all single-employer results for this period includes
                          “tail” financial positions from a surplus of $55 billion to a deficit of $157 billion, the
                          difference between the projection’s high and low values ranges from a $4.0 billion surplus
                          to a $52.5 billion deficit, significantly less than the full range.




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                      Appendix VI: Overview of Pension Benefit
                      Guaranty Corporation’s Pension Insurance
                      Modeling System




                      Figure 4: PBGC Actual and Projected Net Financial Position for the Single-Employer
                      Program, Fiscal Years 2001-2020




                      Note: The projected net financial positions for future fiscal years after 2010 are calculated as present
                      values as of 2010.



Limitations of PIMS   PIMS is not a predictive model and it does not attempt to anticipate
                      behavioral responses by a company to changed circumstances, such as
                      changes to the premium structure. For example, the model has not been
                      used to anticipate a sponsor’s behavioral reaction—such as voluntarily
                      terminating or freezing their plans, or increasing plan funding above the
                      minimum required, or changing plan asset allocation—to an increase in
                      premiums or to the introduction of risk factors to premium rates. Various
                      paths of underfunding can occur in the future, and PIMS does not allow
                      PBGC to know which particular path of underfunding might occur or which
                      particular firms might enter bankruptcy. However, PBGC assumes that
                      the process that generates historical volatility in key variables is
                      reasonably representative of the process that governs future volatility,
                      and that PIMS provides for a reasonable evaluation of the likelihood that
                      various economic scenarios can develop. By modeling real pension plans
                      and incorporating minimum funding rules, PBGC uses PIMS to quantify
                      the likelihood that various levels of exposure can develop under these
                      conditions.




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Appendix VI: Overview of Pension Benefit
Guaranty Corporation’s Pension Insurance
Modeling System




In May 2012, PBGC’s Inspector General identified internal control
deficiencies related to the agency’s PIMS model. 6 PBGC’s Inspector
General reported that the agency published its 2010 exposure report with
erroneous and inconsistent results from its PIMS model. Furthermore, the
Inspector General reported that PBGC’s Policy Research and Analysis
Department did not conduct any documented review of the underlying
support used for the report and lacks quality control policies to ensure the
integrity of reported estimates. The report made several
recommendations to ensure the quality of this department’s actuarial work
products, including establishing policies and procedures to review
contractor work performed with PIMS; establishing policies and
procedures to retain supporting documentation of work done by
department actuaries and actuarial contractors; and developing and
documenting a strategic review of the process of creating actuarial
reports to identify critical control points to increase quality control.
PBGC’s response to the Inspector General’s findings includes a
commitment to strengthening and documenting the quality assurance
process, to posting a corrected report on PBGC’s website, and to noting
the errors in the forthcoming fiscal year 2011 exposure report. Relevant to
these deficiencies, Congress also made improvements to PBGC in MAP-
21. 7 Under those amendments, PBGC is to contract with an outside
agency or organization to conduct an annual review of PIMS, and PBGC
officials noted that at their request, the Social Security Administration has
agreed to conduct the review. The first reviews will be initiated no later
than 3 months after the enactment of the act. Further, PBGC is also
required to establish written quality control procedures for modeling and
actuarial work done in the Policy Research and Analysis Department,
including a record management review to determine records that must be
retained. Within two months, PBGC is required to submit a report to
Congress detailing a timetable for addressing recommendations from the
Inspector General’s recent report on the department, which was provided
on September 6, 2012.




6
 Pension Benefit Guaranty Corporation Office of Inspector General, Ensuring the Integrity
of Policy Research and Analysis Department’s Actuarial Calculations (Washington, D.C.:
May 2012).
7
    Pub. L. No. 112-141, § 40233, 126 Stat. 857-58, and S. Rep. No. 112-557, at 664 (2012).




Page 81                                                         GAO-13-58 PBGC Premiums
Appendix VII: Plan Sponsors and Pension
                    Appendix VII: Plan Sponsors and Pension
                    Experts Interviewed



Experts Interviewed

Plan Sponsors       We conducted interviews with a small judgmental sample of nine plan
                    sponsors, selected to reflect a range of attributes, including company
                    financial health, plan funded status, size of plan (based on the market
                    value of the plan’s assets), number of participants, status of plan (active
                    or frozen), and union involvement. 1

                •   Comerica Incorporated, Dallas, Texas (financial services)

                •   Exelon Corporation, Chicago, Illinois (energy provider)

                •   General Electric Company, Fairfield, Connecticut (multiple industries)

                •   Lockheed Martin Corporation, Bethesda, Maryland
                    (aeronautics/electronics)

                •   R.R. Donnelley & Sons Company, Chicago, Illinois (communications)

                •   The McClatchy Company, Sacramento, California (publishing)

                •   Tomkins PLC, London, United Kingdom (engineering/manufacturing)

                •   TOTAL S.A., Courbevoie, France (energy provider)

                •   Whirlpool Corporation, Benton Harbor, Michigan (home appliances)




                    1
                      To assist in identifying our sample of plan sponsors to be interviewed, we requested a
                    random list of 180 plans from PBGC with certain descriptive information about each of the
                    plans. According to PBGC, the spreadsheet of 180 plans they provided was randomly
                    selected from a listing of all plans in PBGC’s 2010 premium database that had readily
                    available data regarding either the sponsor’s credit rating for publicly traded companies or
                    Dun & Bradstreet’s score for private companies. PBGC officials said they sorted the list of
                                                                                          th
                    plans in alphabetical order by company and then selected every 15 row to create the
                    random sample of plans. PBGC provided information on company financial health and
                    each plan’s funded status, number of participants, market value of assets, and whether
                    the plan was frozen or partially frozen. We added information on union involvement based
                    on what we could discern from the plan names. We then selected an initial list of 18 plans,
                    and another back-up list of 18 plans, that represented an array of characteristics for
                    potential interviews. We were ultimately able to complete interviews with nine sponsors,
                    listed here.




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                      Appendix VII: Plan Sponsors and Pension
                      Experts Interviewed




Pension Experts       We also conducted interviews with pension experts reflecting a range of
                      academic, actuarial, business, and labor perspectives from the institutions
                      and organizations listed below. 2

                  •   American Benefits Council
                  •   AFL-CIO
                  •   American Academy of Actuaries
                  •   American Enterprise Institute
                  •   American Society of Pension Professionals and Actuaries
                  •   Boston University
                  •   Brookings Institution
                  •   Covington & Burling
                  •   Davis and Harman Drexel University
                  •   Employee Benefit Research Institute
                  •   ERISA Industry Committee
                  •   Massachusetts Institute of Technology
                  •   National Institute on Retirement Security
                  •   The New School
                  •   Pennsylvania State University
                  •   Pension Rights Center
                  •   Society of Actuaries
                  •   Towers Watson
                  •   United Auto Workers
                  •   U.S. Chamber of Commerce




                      2
                       To identify experts to contact, we began with the list of participants from a GAO forum
                      held in 2005, and updated the list with suggestions from agency officials. See GAO,
                      Highlights of a GAO Forum: The Future of the Defined Benefit System and the Pension
                      Benefit Guaranty Corporation, GAO-05-578SP (Washington, D.C.: June 2005).




                      Page 83                                                        GAO-13-58 PBGC Premiums
Appendix VIII: History of Pension Benefit
              Appendix VIII: History of Pension Benefit
              Guaranty Corporation Premiums for the
              Single-Employer Program, Fiscal Years 1974 to

Guaranty Corporation Premiums for the
              2012



Single-Employer Program, Fiscal Years 1974
to 2012
                                                  Flat-rate    Variable-rate premium Termination premium
                  For plan years             premium (per     (per $1000 of unfunded   (per participant per
                                                                                    b                     b
                  beginning                    participant)         vested benefits)     year for 3 years)
                  1974-1977                          $1.00                             -                              -
                  1978-1985                           2.60                             -                              -
                  1986-1987                           8.50                             -                              -
                  1988-1990                          16.00                           $6                               -
                  1994-2005                          19.00                            9                               -
                                                          a
                  2006                              30.00                             9                     $1,250
                  2007                               31.00                            9                      1,250
                  2008                               33.00                            9                      1,250
                  2009                               34.00                            9                      1,250
                  2010-2012                          35.00                            9                      1,250
              Source: GAO analysis of PBGC data.

              a
               For each plan year beginning after 2006, this amount is adjusted annually based on changes in the
              national average wage index, as defined in section 209(k)(1) of the Social Security Act, (42 U.S.C. §
              409(k)(1)). 29 U.S.C. § 1306(a)(3)(F). The premium rate will not decline even if the national average
              wage index declines. The adjusted premium rate is rounded to the nearest multiple of $1.
              b
              Where dashes are shown, the variable-rate premium and termination premium did not yet exist.




              Page 84                                                                GAO-13-58 PBGC Premiums
Appendix IX: Comments from Pension
             Appendix IX: Comments from Pension Benefit
             Guaranty Corporation



Benefit Guaranty Corporation




             Page 85                                      GAO-13-58 PBGC Premiums
                    Appendix IX: Comments from Pension Benefit
                    Guaranty Corporation




Now on p. 30.



Now on pp. 43-48.




                    Page 86                                      GAO-13-58 PBGC Premiums
Appendix IX: Comments from Pension Benefit
Guaranty Corporation




Page 87                                      GAO-13-58 PBGC Premiums
Appendix X: GAO Contact and Staff
                  Appendix X: GAO Contact and Staff
                  Acknowledgments



Acknowledgments

                  Charles A. Jeszeck, (202) 512-7215 or jeszeckc@gao.gov
GAO Contact
                  In addition to the contact named above, Margie K. Shields (Assistant
Staff             Director), Ted A. Burik (Analyst-in-Charge), Margaret H. Childs, and
Acknowledgments   Isabella Johnson were key contributors to this report. Also contributing to
                  this report were David M. Chrisinger, Holly A. Dye, Edda Emmanuelli-
                  Perez, Kimberly M. Granger, Gene G. Kuehneman Jr., Kathy D. Leslie,
                  Thomas J. McCool, Sheila R. McCoy, Mimi Nguyen, Steven J. Sebastian,
                  Salvatore F. Sorbello Jr., Cynthia S. Taylor, Frank Todisco, Walter K.
                  Vance, John C (Jack) Warner, Orice M. Williams, and Craig H. Winslow.




(131098)
                  Page 88                                             GAO-13-58 PBGC Premiums
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